diff --git a/raw/filings/0000893538/2014/0000893538-15-000011/filing.txt b/raw/filings/0000893538/2014/0000893538-15-000011/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..06efbfbf69f65314e573ea4aff91332a4ddebab2 --- /dev/null +++ b/raw/filings/0000893538/2014/0000893538-15-000011/filing.txt @@ -0,0 +1,7622 @@ +10-K +1 +sm-20141231x10k.htm +10-K +SM-2014.12.31-10K +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +For the fiscal year ended December 31, 2014 +or +o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +Commission file number 001-31539 +SM ENERGY COMPANY +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction +of incorporation or organization) +41-0518430 +(I.R.S. Employer Identification No.) +1775 Sherman Street, Suite 1200, Denver, Colorado +(Address of principal executive offices) +80203 +(Zip Code) +(303) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common stock, $.01 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer þ +Accelerated filer o +Non-accelerated filer o (Do not check if a smaller reporting company) +Smaller reporting company o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ +The aggregate market value of the 66,163,202 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant's common stock on June 30, 2014 , the last business day of the registrant’s most recently completed second fiscal quarter, of $84.10 per share, as reported on the New York Stock Exchange; was $5,564,325,288 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 18, 2015 , the registrant had 67,463,060 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III is incorporated by reference from portions of the registrant’s definitive proxy statement relating to its 2015 annual meeting of stockholders to be filed within 120 days after December 31, 2014 . +1 +TABLE OF CONTENTS +ITEM +PAGE +PART I +ITEMS 1. and 2. +BUSINESS and PROPERTIES +4 +General +4 +Strategy +4 +Significant Developments in 2014 +4 +Outlook for 2015 +5 +Core Operational Areas +6 +Reserves +8 +Production +12 +Productive Wells +13 +Drilling and Completion Activity +13 +Acreage +14 +Delivery Commitments +14 +Major Customers +15 +Employees and Office Space +15 +Title to Properties +15 +Seasonality +16 +Competition +16 +Government Regulations +16 +Cautionary Information about Forward-Looking Statements +21 +Available Information +23 +Glossary of Oil and Gas Terms +24 +ITEM 1A. +RISK FACTORS +29 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +51 +ITEM 3. +LEGAL PROCEEDINGS +51 +ITEM 4. +MINE SAFETY DISCLOSURES +51 +PART II +52 +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +52 +ITEM 6. +SELECTED FINANCIAL DATA +55 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF +FINANCIAL CONDITION AND RESULTS OF OPERATIONS +58 +Overview of the Company +58 +Financial Results of Operations and Additional Comparative Data +66 +Comparison of Financial Results and Trends between 2014 and 2013 +69 +Comparison of Financial Results and Trends between 2013 and 2012 +72 +Overview of Liquidity and Capital Resources +74 +Critical Accounting Policies and Estimates +80 +Accounting Matters +83 +Environmental +83 +Non-GAAP Financial Measures +84 +2 +TABLE OF CONTENTS +(Continued) +ITEM +PAGE +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT +MARKET RISK (included within the content of ITEM 7) +85 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +87 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS +ON ACCOUNTING AND FINANCIAL DISCLOSURE +142 +ITEM 9A. +CONTROLS AND PROCEDURES +142 +ITEM 9B. +OTHER INFORMATION +146 +PART III +146 +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE +GOVERNANCE +146 +ITEM 11. +EXECUTIVE COMPENSATION +146 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL +OWNERS AND MANAGEMENT AND RELATED +STOCKHOLDER MATTERS +146 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, +AND DIRECTOR INDEPENDENCE +148 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +148 +PART IV +149 +ITEM 15. +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +149 +3 +PART I +When we use the terms “SM Energy,” “the Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business under Glossary of Oil and Gas Terms. Throughout this document we make statements that may be classified as “forward-looking.” Please refer to the Cautionary Information about Forward-Looking Statements section of this document for an explanation of these types of statements. +ITEMS 1. and 2. BUSINESS and PROPERTIES +General +We are an independent energy company engaged in the acquisition, exploration, development, and production of crude oil and condensate, natural gas, and natural gas liquids (also respectively referred to as “oil,” “gas,” and “NGLs,” respectively, throughout the document) in onshore North America. We were founded in 1908 and incorporated in Delaware in 1915. Our initial public offering of common stock was in December 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal offices are located at 1775 Sherman Street, Suite 1200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +Our strategic objective is to build our ownership and operatorship of North American oil, gas, and NGL producing assets that have high operating margins and significant opportunities for additional economic investment. We pursue opportunities through both acquisitions and exploration, and seek to maximize the value of our assets through industry leading technology application and outstanding operational execution. We are returns focused and maintain a simple, strong balance sheet through a conservative approach to leverage. +Significant Developments in 2014 +• +Resource Play Delineation and Development Results in Record Production and Record Year-End Proved Reserve Estimates. Our estimated proved reserves increased 28 percent to 547.7 MMBOE at December 31, 2014 , from 428.7 MMBOE at December 31, 2013 . We added 143.9 MMBOE through drilling activities during the year, led by our efforts in our Eagle Ford shale play in south Texas and our Bakken/Three Forks play in North Dakota. Our proved reserve life increased to 9.9 years in 2014 compared to 8.9 years in 2013. We also achieved record levels of production in 2014 . Our average daily production was composed of 45.6 MBbl of oil, 419.0 MMcf of gas, and 35.6 MBbl of NGLs for an average equivalent production rate of 151.1 MBOE per day, which was an increase of 14 percent from an average of 132.4 MBOE per day in 2013 . Costs incurred for drilling and exploration activities, excluding acquisitions, increased 36 percent to $2.1 billion in 2014 when compared to 2013. Please refer to Core Operational Areas below for additional discussion concerning our 2014 estimated proved reserves, production, and capital investment. +• +Acquisition Activity . During 2014 , we acquired a total of 21.9 MMBOE of proved reserves through multiple transactions for consideration of approximately $544.6 million in cash plus approximately 7,000 net acres of non-core assets in our Rocky Mountain region. Through these acquisitions, we added approximately 74,000 net acres in our Gooseneck area in Divide County, North Dakota and approximately 38,000 net acres in our Powder River Basin program in Wyoming. +• +Volatility and Decline in Commodity Prices . Our financial condition and results of operations are significantly affected by the prices we receive for oil, gas, and NGLs, which can fluctuate dramatically. +4 +Oil prices drastically declined in late 2014 . The daily NYMEX spot price ranged from a high of $107.62 per Bbl in July to a low of $53.27 per Bbl in December. Oil prices declined further subsequent to year end 2014, dropping to a low of $44.45 per Bbl in January 2015. The average NYMEX price decreased to $93.03 per Bbl in 2014 compared to $97.99 per Bbl in 2013 . +Natural gas prices have been under downward pressure due to high levels of supply in recent years and were volatile during 2014 . The daily NYMEX spot price improved early in 2014 with a high of $7.92 per MMBtu in March and then dropped significantly to a low of $2.75 per MMBtu in December. Gas prices declined further subsequent to year end 2014, dropping to a low of $2.55 per MMBtu in February 2015. The average NYMEX price increased in 2014 to $4.35 per MMBtu compared to $3.73 per MMBtu in 2013 . +NGL prices decreased in 2014 in line with the steep decline in oil prices. The monthly OPIS NGL price reached a high of $48.43 per Bbl in February and a low of $22.44 per Bbl in December. NGL prices declined further subsequent to year end 2014, dropping to a low of $20.03 per Bbl in January 2015. The average OPIS price decreased in 2014 to $38.93 per Bbl compared to $40.44 per Bbl in 2013 . +• +Impairments. We recorded impairment of proved properties expense of $84.5 million and abandonment and impairment of unproved properties expense of $75.6 million for the year ended December 31, 2014 . Impairments recorded in 2014 were a result of the significant decline in commodity prices in late 2014 and recognition of the outcomes of exploration and delineation wells in certain prospects in our South Texas & Gulf Coast and Permian regions. +Outlook for 2015 +We view 2015 as a year of transition as the broader oil and gas industry adjusts to lower oil prices. Exploration and production companies are reducing drilling and completion activity, which we expect to result in service companies lowering the price of their services. Our plan for 2015 is to scale down activity over the course of the year while preserving the value of our assets and protecting the strength of our balance sheet. Our goal is to be well positioned entering 2016 in what we expect will be a stronger commodity price and lower service cost environment, while having the strength and flexibility to adapt should industry conditions worsen. +Our capital program for 2015 will be approximately $1.2 billion, of which approximately $1.0 billion will be invested in drilling and completion activities. We expect to focus 85 percent of our drilling and completion capital on our core development programs in the Eagle Ford shale and the Bakken/Three Forks formations. The remaining capital is being allocated to the construction of facilities, leasehold acquisitions, exploration overhead, and geological and geophysical costs. Please refer to Outlook for 2015 under Part II, Item 7 of this report for additional discussion concerning our capital plans for 2015 . +5 +Core Operational Areas +Our operations are concentrated in four onshore operating areas in the United States. The following table summarizes estimated proved reserves, PV-10, production, and costs incurred in oil and gas activities for the year ended December 31, 2014 , for our core operating areas: +South Texas & Gulf Coast +Rocky +Mountain +Permian +Mid- +Continent +Total (1) +Proved Reserves +Oil (MMBbl) +64.5 +91.5 +13.5 +0.2 +169.7 +Gas (Bcf) +1,193.3 +89.6 +38.9 +144.8 +1,466.5 +NGLs (MMBbl) +131.2 +2.0 +— +0.4 +133.5 +MMBOE (1) +394.6 +108.4 +20.0 +24.7 +547.7 +Relative percentage +72 +% +20 +% +4 +% +4 +% +100 +% +Proved Developed % +48 +% +56 +% +76 +% +83 +% +52 +% +PV-10 (in millions) (2) +Proved Developed +$ +2,942.8 +$ +1,651.5 +$ +440.8 +$ +217.9 +$ +5,253.0 +Proved Undeveloped +1,593.0 +699.0 +55.5 +16.4 +2,363.9 +Total Proved +$ +4,535.8 +$ +2,350.5 +$ +496.3 +$ +234.3 +$ +7,616.9 +Relative percentage +60 +% +31 +% +6 +% +3 +% +100 +% +Production +Oil (MMBbl) +7.1 +7.4 +2.0 +0.1 +16.7 +Gas (Bcf) +121.6 +7.0 +4.5 +19.8 +152.9 +NGLs (MMBbl) +12.8 +0.1 +— +0.1 +13.0 +MMBOE (1) +40.2 +8.7 +2.8 +3.5 +55.1 +Avg. Daily Equivalents +(MBOE/d) +110.1 +23.9 +7.6 +9.5 +151.1 +Relative percentage +73 +% +16 +% +5 +% +6 +% +100 +% +Costs Incurred (in millions) (3) +$ +1,187.8 +$ +1,241.8 +$ +195.4 +$ +58.9 +$ +2,711.7 +____________________________________________ +(1) +Totals may not sum or recalculate due to rounding. +(2) +The standardized measure PV-10 calculation is presented in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report. A reconciliation between PV-10 and the after tax amount is shown in the Reserves section below. +(3) +Amounts do not sum to total costs incurred due to certain costs relating to our new venture projects being excluded from the regional table above. +South Texas & Gulf Coast Region. Operations in our South Texas & Gulf Coast region are managed from our office in Houston, Texas. Within this region, we have both operated and non-operated Eagle Ford shale programs on approximately 180,000 net acres. Our operated program accounts for approximately 75 percent of our total Eagle Ford acreage and production. Our acreage position covers a significant portion of the western Eagle Ford shale play, including acreage in the oil/condensate, NGL-rich gas, and dry gas windows of the play. +In addition, we continued to evaluate an emerging new venture play in east Texas in 2014 . We have approximately 215,000 net acres that provide opportunities in the Austin Chalk, Woodbine, and Eagle Ford shale intervals. During 2014, we constructed a gathering system to allow for longer-term production tests on our wells. +6 +We deployed a significant amount of capital in our South Texas & Gulf Coast region in 2014 in our operated and outside-operated Eagle Ford shale programs. Costs incurred increased to $1.2 billion in 2014 from $849.4 million in 2013 . Estimated proved reserves at year-end 2014 increased 27 percent from 311.2 MMBOE at year-end 2013 . We added approximately 105.8 MMBOE of estimated proved reserves through drilling activities. During 2012, 2013, and early 2014, we were carried for substantially all of our drilling and completion costs in our outside-operated Eagle Ford program pursuant to our Acquisition and Development Agreement with Mitsui E&P Texas LP (“Mitsui”), an indirect subsidiary of Mitsui & Co., Ltd. (the “Acquisition and Development Agreement”). The remainder of our carry was expended during the first and second quarters of 2014, at which point we began accruing and funding our share of previously carried drilling and completion costs. Please refer to Note 12 - Acquisition and Development Agreement in Part II, Item 8 for additional discussion. Production in 2014 increased 30 percent from the 30.9 MMBOE produced in 2013 . +Rocky Mountain Region. Operations in our Rocky Mountain region are managed from our office in Billings, Montana. Our 2014 activity in this region focused on the development and growth through acquisition of assets targeting the Bakken/Three Forks formations, primarily in Williams, McKenzie, and Divide Counties of North Dakota, and on the expansion and delineation of our Powder River Basin program in Wyoming. In the Williston Basin, we have approximately 245,000 net acres, of which approximately 160,000 net acres are being actively developed in the Bakken and Three Forks formations. In the Powder River Basin, we have approximately 175,000 net acres, a large portion of which are prospective for the Frontier and Shannon intervals. +Costs incurred in our Rocky Mountain region increased from $474.7 million in 2013 to $1.2 billion in 2014 , largely as a result of our Williston Basin and Powder River Basin proved and unproved property acquisitions totaling $561.6 million in 2014. This amount includes the fair value of properties acquired in an asset exchange and the estimated asset retirement obligations associated with the acquired producing properties. Estimated proved reserves for the region at the end of 2014 increased 43 percent from 76.0 MMBOE at year-end 2013 . During the year, we added approximately 25.3 MMBOE of proved reserves in this region through drilling activities and approximately 21.9 MMBOE through acquisitions. Production for 2014 increased 18 percent from 7.4 MMBOE produced in 2013 . +Permian Region. Operations in our Permian region are managed from our office in Midland, Texas. Our Permian region covers western Texas and southeastern New Mexico. Our 2014 activity focused on the testing of shale potential and development of our assets in the Midland Basin. As of December 31, 2014, we had approximately 113,000 net acres in our Permian region. +Costs incurred in our Permian region decreased to $195.4 million in 2014 compared to $275.7 million in 2013 . Estimated proved reserves increased 22 percent from 2013 year-end proved reserves of 16.3 MMBOE. Production increased 16 percent from 2.4 MMBOE produced in 2013 . +Mid-Continent Region. Our Mid-Continent region is managed from our office in Tulsa, Oklahoma, and consists of our Haynesville and Woodford Shale assets. +Costs incurred in our Mid-Continent region decreased to $58.9 million in 2014 compared to $91.9 million incurred in 2013 . Estimated proved reserves decreased two percent from 2013 year-end proved reserves of 25.2 MMBOE. Production decreased 55 percent from 7.7 MMBOE produced in 2013 , primarily as a result of the divestiture of our Anadarko Basin assets in December 2013. +Subsequent to December 31, 2014, we announced plans to close our regional office in Tulsa, Oklahoma and market our remaining assets located in the Arkoma Basin of Oklahoma and Arklatex area of east Texas and northern Louisiana. +7 +Reserves +The table below presents summary information with respect to the estimates of our proved reserves for each of the years in the three-year period ended December 31, 2014 . We engaged Ryder Scott Company, L.P. (“Ryder Scott”) to audit at least 80 percent of our total calculated proved reserve PV-10 for each year presented. The prices used in the calculation of proved reserve estimates reflect the 12 month average of the first-day-of-the-month prices in accordance with Securities and Exchange Commission (“SEC”) rules, and were $94.99 per Bbl for oil, $4.35 per MMBtu for natural gas, and $39.91 per Bbl for NGLs for the year ended December 31, 2014 . We then adjust these prices to reflect appropriate basis, quality, and location differentials over the period in estimating our proved reserves. +Reserve estimates are inherently imprecise and estimates for new discoveries and undeveloped locations are more imprecise than reserve estimates for producing oil and gas properties. Accordingly, these estimates are expected to change as new information becomes available. PV-10 shown in the following table is not intended to represent the current market value of our estimated proved reserves. The actual quantities and present value of our estimated proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The following table should be read along with the section entitled Risk Factors – Risks Related to Our Business below. +Our ability to replace our production is critical to us. Please refer to the reserve replacement terms in the Glossary of Oil and Gas Terms section of this report for information describing how our reserve replacement metrics are calculated. Our reserve replacement percentages are calculated using information from the Oil and Gas Reserve Quantities section of Supplemental Oil and Gas Information located in Part II, Item 8 of this report. We believe the concept of reserve replacement, as well as reserve metrics presented in this report, are widely understood by those who make investment decisions related to the oil and gas exploration and production business. +8 +The following table summarizes estimated proved reserves, PV-10, standardized measure of discounted future cash flows, and reserve replacement as of December 31, 2014, 2013, and 2012: +As of December 31, +2014 +2013 +2012 +Reserve data: +Proved developed +Oil (MMBbl) +89.3 +70.2 +58.8 +Gas (Bcf) +784.6 +569.2 +483.2 +NGLs (MMBbl) +66.7 +43.8 +27.2 +MMBOE (1) +286.8 +208.9 +166.5 +Proved undeveloped +Oil (MMBbl) +80.4 +56.3 +33.5 +Gas (Bcf) +682.0 +620.1 +350.2 +NGLs (MMBbl) +66.8 +60.2 +35.1 +MMBOE (1) +260.9 +219.9 +126.9 +Total Proved (1) +Oil (MMBbl) (1) +169.7 +126.6 +92.2 +Gas (Bcf) (1) +1,466.5 +1,189.3 +833.4 +NGLs (MMBbl) (1) +133.5 +103.9 +62.3 +MMBOE (1) +547.7 +428.7 +293.4 +Proved developed reserves % +52 +% +49 +% +57 +% +Proved undeveloped reserves % +48 +% +51 +% +43 +% +Reserve data (in millions): +Proved developed PV-10 +$ +5,253.0 +$ +3,898.6 +$ +2,982.6 +Proved undeveloped PV-10 +2,363.9 +1,629.9 +866.5 +Total proved PV-10 +$ +7,616.9 +$ +5,528.5 +$ +3,849.1 +Standardized measure of discounted future cash flows +$ +5,698.8 +$ +4,009.4 +$ +3,021.0 +Reserve replacement – drilling, excluding revisions +261 +% +405 +% +411 +% +All in – including sales of reserves +316 +% +380 +% +329 +% +All in – excluding sales of reserves +320 +% +418 +% +337 +% +Reserve life (years) +9.9 +8.9 +8.0 +(1) Totals may not sum or recalculate due to rounding. +9 +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the pre-tax PV-10 (Non-GAAP) of total proved reserves. Please see the definitions of standardized measure of discounted future net cash flows and PV-10 in the Glossary of Oil and Gas Terms section of this report below. +As of December 31, +2014 +2013 +2012 +(in millions) +Standardized measure of discounted future net cash flows +$ +5,698.8 +$ +4,009.4 +$ +3,021.0 +Add: 10 percent annual discount, net of income taxes +3,407.2 +2,500.6 +1,742.1 +Add: future undiscounted income taxes +3,511.4 +2,722.2 +1,609.4 +Undiscounted future net cash flows +12,617.4 +9,232.2 +6,372.5 +Less: 10 percent annual discount without tax effect +(5,000.5 +) +(3,703.7 +) +(2,523.4 +) +PV-10 +$ +7,616.9 +$ +5,528.5 +$ +3,849.1 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of production when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time period. As of December 31, 2014 , we had one undrilled proved undeveloped location on our operated Eagle Ford asset that had been on our books in excess of five years. Drilling has been initiated on that location as of the date of this report. +For locations that are more than one location removed from developed producing locations, we utilized reliable geologic and engineering technology to add approximately 61.9 MMBOE of proved undeveloped reserves in the more developed portions of our Eagle Ford shale position and 5.6 MMBOE of proved undeveloped reserves in the more developed portions of our Bakken/Three Forks shale position. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected), and petrophysical analysis of the log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as significant statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. In all other areas, we restricted proved undeveloped locations to immediate offsets to producing wells. +10 +As of December 31, 2014 , we had 260.9 MMBOE of proved undeveloped reserves, which is an increase of 41.0 MMBOE, or 19 percent , from 219.9 MMBOE at December 31, 2013 . The following table provides a reconciliation of our proved undeveloped reserves for the year ended December 31, 2014 : +Total +(MMBOE) +Total proved undeveloped reserves: +Beginning of year +219.9 +Revisions of previous estimates (1) +6.6 +Additions from discoveries, extensions, and infill (2) +113.0 +Sales of reserves +— +Purchases of minerals in place +13.9 +Removed for five-year rule +(4.3 +) +Conversions to proved developed (3) +(88.2 +) +End of year +260.9 +____________________________________________ +(1) +Revisions of previous estimates primarily relate to a positive performance revision of 6.1 MMBOE on our operated Eagle Ford assets due to improved performance and lower operating expenses. +(2) +We added 85.0 MMBOE of infill proved undeveloped reserves primarily in our assets in the Bakken/Three Forks and Eagle Ford shale plays, as well as an additional 28.0 MMBOE of proved undeveloped reserves through extensions and discoveries, primarily in our Eagle Ford shale play. +(3) +Conversions of proved undeveloped reserves to proved developed reserves were primarily in our Eagle Ford shale and Bakken/Three Forks plays. During 2014 , we incurred a total of $908.6 million on projects associated with reserves booked as proved undeveloped reserves at the end of 2013 . Please refer to Note 12 - Acquisition and Development Agreement in Part II, Item 8 of this report for discussion of the carry of certain drilling and completion costs in our outside-operated Eagle Ford program during the first and second quarters of 2014. +As of December 31, 2014 , estimated future development costs relating to our proved undeveloped reserves are approximately $746 million, $921 million, and $840 million in 2015 , 2016 , and 2017 , respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group, which is managed by our Senior Manager of Reserves, subject to the oversight of our management and the Audit Committee of our Board of Directors, as discussed below. Our Senior Manager of Reserves has over 15 years of experience in the energy industry, and holds a Bachelor of Science degree in Chemical Engineering with a Petroleum Certificate from the University of Alabama. She is also a member of the Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the year by our regional staff. This data, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our regional engineering technical staff do not report directly to our Senior Manager of Reserves; they report to either their respective regional technical managers or directly to the regional manager. This design is intended to promote objective and independent analysis within our regions in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are +11 +required to be within 10 percent of our proved reserve amounts for the total company, as well as for each respective region. Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world for over 70 years. The technical person at Ryder Scott primarily responsible for overseeing our reserves audit is an Advising Senior Vice President who received a Bachelor of Science degree in Chemical Engineering from Purdue University in 1979 and a Master of Science Degree in Chemical Engineering from the University of California, Berkeley, in 1981. He is a licensed Professional Engineer in the State of Texas, a member of the Society of Petroleum Engineers, and the Society of Petroleum Evaluation Engineers. The Ryder Scott 2014 report concerning our reserves is included as Exhibit 99.1. +In addition to a third party audit, our reserves are reviewed by our management with the Audit Committee of our Board of Directors. Management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Executive Vice President - Operations, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives from time to time to discuss processes and findings. +Production +The following table summarizes the volumes and realized prices of oil, gas, and NGLs produced and sold from properties in which we held an interest during the periods indicated. Realized prices presented below exclude the effects of derivative contract settlements. Also presented is a summary of related production costs per BOE. +For the Years Ended December 31, +2014 +2013 +2012 +Net production +Oil (MMBbl) +16.7 +13.9 +10.4 +Gas (Bcf) +152.9 +149.3 +120.0 +NGLs (MMBbl) +13.0 +9.5 +6.1 +MMBOE (2) +55.1 +48.3 +36.5 +Eagle Ford net production (1) +Oil (MMBbl) +6.9 +5.1 +3.1 +Gas (Bcf) +120.6 +97.1 +58.1 +NGLs (MMBbl) +12.7 +9.2 +5.7 +MMBOE (2) +39.7 +30.5 +18.5 +Realized price +Oil (per Bbl) +$ +80.97 +$ +91.19 +$ +85.45 +Gas (per Mcf) +$ +4.58 +$ +3.93 +$ +2.98 +NGLs (per Bbl) +$ +33.34 +$ +35.95 +$ +37.61 +Per BOE +$ +45.01 +$ +45.50 +$ +40.39 +Production costs per BOE +Lease operating expense, excluding ad valorem taxes +$ +4.28 +$ +4.49 +$ +4.54 +Ad valorem taxes +$ +0.46 +$ +0.33 +$ +0.39 +Transportation costs +$ +6.11 +$ +5.34 +$ +3.81 +Production taxes +$ +2.13 +$ +2.19 +$ +2.00 +____________________________________________ +(1) +In each of the years 2014 , 2013 , and 2012 , total estimated proved reserves attributed to our Eagle Ford shale properties exceeded 15 percent of our total proved reserves expressed on an equivalent basis. +(2) +Amounts may not recalculate due to rounding. +12 +Productive Wells +As of December 31, 2014 , we had working interests in 1,500 gross (869 net) productive oil wells and 2,648 gross (931 net) productive gas wells. Productive wells are either wells producing in commercial quantities or wells mechanically capable of commercial production, but are temporarily shut-in. Multiple completions in the same wellbore are counted as one well. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil produced when it first commenced production; such designation may not be indicative of current production. +Drilling and Completion Activity +All of our drilling and completion activities are conducted using independent contractors. We do not own any drilling or completion equipment. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2014 , 2013 , and 2012 , excluding non-consented projects, active injector wells, salt water disposal wells, and any wells in which we own only a royalty interest: +For the Years Ended December 31, +2014 +2013 +2012 +Gross +Net +Gross +Net +Gross +Net +Development wells: +Oil +133 +66.1 +154 +75.4 +127 +47.2 +Gas +476 +165.5 +443 +162.5 +337 +124.5 +Non-productive +8 +5.3 +10 +8.5 +10 +6.3 +617 +236.9 +607 +246.4 +474 +178.0 +Exploratory wells: +Oil +5 +3.0 +6 +5.1 +9 +6.9 +Gas +7 +4.8 +4 +2.4 +8 +6.8 +Non-productive +4 +3.3 +1 +0.3 +8 +6.8 +16 +11.1 +11 +7.8 +25 +20.5 +Total +633 +248.0 +618 +254.2 +499 +198.5 +A productive well is an exploratory, development, or extension well that is producing or capable of commercial production of oil, gas, and/or NGLs. A non-productive well, frequently referred to within the industry as a dry hole, is an exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in commercial quantities. +As defined by the SEC, an exploratory well is a well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. A development well is a well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive. The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. Completion refers to the installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry well, the reporting to the appropriate authority that the well has been plugged and abandoned. +In addition to the wells drilled and completed in 2014 (included in the table above), as of February 18, 2015 , we were participating in the drilling of 22 gross wells. We operate 15 of these wells on a gross basis (14 on a net basis) and other companies operate the remaining 7 gross wells (1 on a net basis). With respect to completion activity, at such date, there were 326 gross wells in which we have an interest that were being completed. We operate 87 of these completion activities on a gross basis (78 on a net basis), and were participating in 239 gross (40 on a net basis) outside-operated completion activities. +13 +Acreage +The following table sets forth the gross and net acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes held by us as of December 31, 2014 . Undeveloped acreage includes leasehold interests containing proved undeveloped reserves. +Developed Acres (1) +Undeveloped Acres (2) +Total +Gross +Net +Gross +Net +Gross +Net +Louisiana +51,079 +19,319 +33,766 +30,858 +84,845 +50,177 +Montana +50,479 +32,654 +268,334 +184,941 +318,813 +217,595 +North Dakota +313,809 +159,199 +159,782 +68,675 +473,591 +227,874 +Oklahoma +46,121 +26,330 +40,411 +19,694 +86,532 +46,024 +Texas +304,710 +166,078 +618,047 +421,244 +922,757 +587,322 +Wyoming +59,366 +36,499 +383,906 +303,346 +443,272 +339,845 +Other (3) +22,637 +17,049 +40,707 +34,981 +63,344 +52,030 +Total (4)(5) +848,201 +457,128 +1,544,953 +1,063,739 +2,393,154 +1,520,867 +____________________________________________ +(1) +Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations, but has been included only as developed acreage in the presentation above. +(2) +Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) +Includes interests in Arkansas, Colorado, Kansas, Mississippi, Nebraska, New Mexico, Pennsylvania, Utah, and insignificant other fee and mineral servitude properties. +(4) +As of the filing date of this report, we had 165,995, 185,174, and 81,249 net acres scheduled to expire by December 31, 2015 , 2016 , and 2017 , respectively, if production is not established or we take no other action to extend the terms of the applicable lease or leases. +(5) +Subsequent to December 31, 2014, we announced plans to exit the Mid-Continent region and sell approximately 113,000 net acres in the Arkoma Basin of Oklahoma and Arklatex area of east Texas and northern Louisiana in 2015. +Delivery Commitments +As of December 31, 2014 , we had gathering, processing, and transportation through-put commitments with various parties that require us to deliver fixed, determinable quantities of production over specified time frames. We have an aggregate minimum commitment to deliver 1,411 Bcf of natural gas and 48 MMBbl of oil. These contracts expire at various dates through 2028 . We are required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments. If a shortfall in the minimum volume commitment for natural gas is projected, we have rights under certain contracts to arrange for third party gas to be delivered, and such volume will count toward our minimum volume commitment. Our current production is insufficient to offset these aggregate contractual liabilities, but we expect to fulfill the delivery commitments with production from the future development of our proved undeveloped reserves and from the future development of resources not yet characterized as proved reserves or through arranging for the delivery of third party gas. Therefore, we do not expect any material shortfalls. +14 +Major Customers +We do not believe the loss of any single purchaser of our crude oil, natural gas, and NGLs would materially impact our operating results, as these are products with well-established markets and numerous purchasers are present in our operating regions. During 2014 , we had one major customer that accounted for approximately 19 percent of our total production revenue, which is discussed in the next paragraph. In 2014, we also sold to four entities that are under common ownership. In aggregate, these four entities accounted for approximately 14 percent of our total production revenue in 2014; however, none of these entities individually accounted for greater than 10 percent of our production revenues. During 2013 , we had three major customers that accounted for approximately 26 percent , 16 percent , and 12 percent , respectively, of our total production revenue. During 2012 , we had two major customers that accounted for approximately 21 percent and 13 percent , respectively, of our total production revenue. +During the third quarter of 2013, we entered into various marketing agreements with a joint venture partner, whereby we are subject to certain gathering, transportation, and processing through-put commitments for up to 10 years pursuant to each contract. While our joint venture partner is the first purchaser under these contracts, accounting for 19 percent of our total production revenue in 2014, we also share with it the risk of non-performance by its counterparty purchasers and have included this joint venture partner as a major customer in the discussion above. Several of the joint venture partner’s counterparty purchasers under these contracts are also direct purchasers of our production. +Employees and Office Space +As of February 18, 2015 , we had 896 full-time employees. None of our employees are subject to a collective bargaining agreement, and we consider our relations with our employees to be good. +The following table summarizes the approximate square footage of office space leased by us, as of December 31, 2014 , including our corporate headquarters and regional offices: +Region +Approximate Square Footage Leased +Corporate +101,000 +South Texas & Gulf Coast +64,000 +Rocky Mountain +50,000 +Permian +54,000 +Mid-Continent +54,000 +Total Leased Office Space +323,000 +In addition to the leased office space in the table above, we own a total of 44,000 square feet of office space across all four of our operating regions. +Subsequent to year end 2014, we announced plans to close our Tulsa, Oklahoma regional office in 2015. +15 +Title to Properties +Substantially all of our interests are held pursuant to oil and gas leases from third parties. A title opinion is usually obtained prior to the commencement of initial drilling operations. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such properties in accordance with standards generally accepted in the oil and gas industry. Most of our producing properties are subject to mortgages securing indebtedness under our credit facility, royalty and overriding royalty interests, liens for current taxes, and other burdens that we believe do not materially interfere with the use of, or affect the value of, such properties. We typically perform only minimal title investigation before acquiring undeveloped leasehold acreage. +Seasonality +Generally, but not always, the demand and price levels for natural gas increase during winter months and decrease during summer months. To lessen the impact of seasonal demand fluctuations, pipelines, utilities, local distribution companies, and industrial users utilize natural gas storage facilities and forward purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can place increased demand on storage volumes. Demand for oil and heating oil is also generally higher in the winter and the summer driving season, although oil prices are impacted more significantly by global supply and demand. Seasonal anomalies, such as mild winters, sometimes lessen these fluctuations. Recently, the impact of seasonality on oil has been somewhat muted by overall supply and demand economics attributable to worldwide production capacity in excess of existing worldwide demand for oil. Certain of our drilling, completion, and other operations are also subject to seasonal limitations. Seasonal weather conditions, government regulations and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. See Risk Factors - Risks Related to Our Business below for additional discussion. +Competition +The oil and gas industry is intensely competitive, particularly with respect to acquiring prospective oil and natural gas properties. We believe our acreage position provides a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from a substantial number of major and independent oil and gas companies, which in some cases have larger technical staffs and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and natural gas reserves, but also have gathering, processing or refining operations, market refined products, own drilling rigs or other equipment, or generate electricity. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting and processing of crude oil, natural gas and NGLs. Consequently, we may face shortages, delays or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including other fossil fuels such as coal and imported liquefied natural gas. Competitive conditions may be affected by future energy, climate-related, financial, and/or other policies, legislation, and regulations. +In addition, we compete for people, including experienced geologists, geophysicists, engineers, and other professionals. Throughout the oil and gas industry, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. We are not insulated from the competition for quality people, and we must compete effectively in order to be successful. +Government Regulations +Our business is extensively controlled by numerous federal, state, and local laws and governmental regulations. These laws and regulations may be changed from time to time in response to economic or political conditions, or other developments, and our regulatory burden may increase in the future. Laws and regulations have the potential of increasing our cost of doing business and consequently could affect our profitability. However, we do not believe that we are affected to a materially greater or lesser extent than others in our industry. +Energy Regulations. Many of the states in which we conduct our operations have adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, impose bonding requirements in order to drill or operate wells, and govern the timing of drilling and location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to various state conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, state conservation laws sometimes establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and +16 +may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Some of our operations are conducted on federal lands pursuant to oil and gas leases administered by the Bureau of Land Management (“BLM”). These leases contain relatively standardized terms and require compliance with detailed regulations and orders that are subject to change. In addition to permits required from other regulatory agencies, lessees must obtain a permit from the BLM before drilling and must comply with regulations governing, among other things, engineering and construction specifications for production facilities, safety procedures, the valuation of production and payment of royalties, the removal of facilities, and the posting of bonds to ensure that lessee obligations are met. Under certain circumstances, the BLM may suspend or terminate our operations on federal leases. +In May 2010, the BLM adopted changes to its oil and gas leasing program requiring, among other things, a more detailed environmental review prior to leasing oil and natural gas resources, increased public engagement in the development of master leasing and development plans prior to leasing areas where intensive new oil and gas development is anticipated, and a comprehensive parcel review process. These changes have increased the amount of time and regulatory costs necessary to obtain oil and gas leases administered by the BLM. +Our sales of natural gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of natural gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of natural gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for natural gas production. +17 +Environmental, Health and Safety Matters +General. Our operations are subject to stringent and complex federal, state, tribal and local laws and regulations governing protection of the environment and worker health and safety as well as the discharge of materials into the environment. These laws and regulations may, among other things: +• +require the acquisition of various permits before drilling commences; +• +restrict the types, quantities and concentration of various substances that can be released into the environment in connection with oil and natural gas drilling and production and saltwater disposal activities; +• +limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +• +require remedial measures to mitigate pollution from former and ongoing operations, such as requirements to close pits and plug abandoned wells. +These laws, rules and regulations may also restrict the rate of oil and natural gas production below the rate that would otherwise be possible. The regulatory burden on the oil and natural gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent permitting, waste handling, disposal and cleanup requirements for the oil and natural gas industry and could have a significant impact on our operating costs. +The following is a summary of some of the existing laws, rules and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Under the auspices of the federal Environmental Protection Agency (the “EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or natural gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and natural gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation and Liability Act. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +18 +We currently own, lease, or operate numerous properties that have been used for oil and natural gas exploration and production for many years. Although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, U.S. Army Corps of Engineers or analogous state agencies. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for containment and removal costs, natural resource damages and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”), and comparable state laws, regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with air permits or other requirements of the federal CAA and associated state laws and regulations. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane and other “greenhouse gases” present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on these findings, the EPA has begun adopting and implementing a comprehensive suite of regulations to restrict emissions of greenhouse gases under existing provisions of the CAA. Legislative and regulatory initiatives related to climate change could have an adverse effect on our operations and the demand for oil and gas. See Risk Factors - Risks Related to Our Business - Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for crude oil, natural gas and NGLs . In addition to the effects of regulation, the meteorological effects of global climate change could pose additional risks to our operations, including physical damage risks associated with more frequent, more intensive storms and flooding, and could adversely affect the demand for our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion and production +19 +activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +National Environmental Policy Act. Oil and natural gas exploration and production activities on federal lands are subject to the National Environmental Policy Act (“NEPA”). NEPA requires federal agencies, including the Department of Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an environmental assessment to determine the potential direct, indirect and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed environmental impact statement that may be made available for public review and comment. All of our current exploration and production activities, as well as proposed exploration and development plans, on federal lands require governmental permits subject to the requirements of NEPA. This process has the potential to delay development of some of our oil and natural gas projects. +OSHA and other laws and regulation. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and natural gas commissions. However, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s (the “SDWA”) Underground Injection Control Program. The federal SDWA protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition to oil and gas activities using hydraulic fracturing techniques, which could potentially cause a decrease in the completion of new oil and gas wells, increased compliance costs, and delays, all of which could adversely affect our financial position, results of operations and cash flows. If new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and natural gas that we are ultimately able to produce from our reserves. +We believe it is reasonably likely that the trend in environmental legislation and regulation will continue toward stricter standards. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health and Safety Initiatives. We are committed to conducting our business in a manner that protects the environment and the health and safety of our employees, contractors and the public. We set annual goals for our environmental, health and safety program focused on reducing the number of safety related incidents that occur and the number and impact of spills of produced fluids. We also periodically conduct regulatory compliance audits of our operations to ensure our compliance with all regulations and provide appropriate training +20 +for our employees. Reducing air emissions as a result of leaks, venting or flaring of natural gas during operations has become a major focus area for regulatory efforts and for our compliance efforts. While flaring is sometimes necessary, releases of natural gas to the environment and flaring is an economic waste and reducing these volumes is a priority for us. To avoid flaring where possible, we restrict testing periods and make every effort to ensure that our production is connected to gas pipeline infrastructure as quickly as possible after well completions. During 2013 and 2014, we also cooperated with other producers in North Dakota in the ongoing development of recommendations to reduce the amount of flaring that is occurring there as a result of area wide infrastructure limitations that are beyond our control. Another focus for our environmental effort has been reduction of water use through recycling of flowback water in south Texas for use as frac fluid. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +Cautionary Information about Forward-Looking Statements +This Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included in this Form 10-K that address activities, events, or developments with respect to our financial condition, results of operations, or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “estimate,” “expect,” “forecast,” “intend,” “plan,” “project,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear in a number of places in this Form 10-K, and include statements about such matters as: +• +the amount and nature of future capital expenditures and the availability of liquidity and capital resources to fund capital expenditures; +• +the drilling of wells and other exploration and development activities and plans, as well as possible future acquisitions; +• +the possible divestiture or farm-down of, or joint venture relating to, certain properties; +• +proved reserve estimates and the estimates of both future net revenues and the present value of future net revenues associated with those proved reserve estimates; +• +future oil, gas, and NGL production estimates; +• +our outlook on future oil, gas, and NGL prices, well costs, and service costs; +• +cash flows, anticipated liquidity, and the future repayment of debt; +• +business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, and our outlook on our future financial condition or results of operations; and +• +other similar matters such as those discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in Item 7 of this Form 10-K. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. These statements are subject to a number of known and unknown risks and uncertainties, which may cause our actual results and performance to be materially different +21 +from any future results or performance expressed or implied by the forward-looking statements. Some of these risks are described in the Risk Factors section of this Form 10-K, and include such factors as: +• +the volatility of oil, gas, and NGL prices, and the effect it may have on our profitability, financial condition, cash flows, access to capital, and ability to grow production volumes and/or proved reserves; +• +weakness in economic conditions and uncertainty in financial markets; +• +our ability to replace reserves in order to sustain production; +• +our ability to raise the substantial amount of capital required to develop and/or replace our reserves; +• +our ability to compete against competitors that have greater financial, technical, and human resources; +• +our ability to attract and retain key personnel; +• +the imprecise estimations of our actual quantities and present value of proved oil, gas, and NGL reserves; +• +the uncertainty in evaluating recoverable reserves and estimating expected benefits or liabilities; +• +the possibility that exploration and development drilling may not result in commercially producible reserves; +• +our limited control over activities on outside operated properties; +• +our reliance on the skill and expertise of third-party service providers on our operated properties; +• +the possibility that title to properties in which we have an interest may be defective; +• +the possibility that our planned drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques is subject to drilling and completion risks and may not meet our expectations for reserves or production; +• +the uncertainties associated with acquisitions, divestitures, joint ventures, farm-downs, farm-outs and similar transactions with respect to certain assets, including whether such transactions will be consummated or completed in the form or timing and for the value that we anticipate; +• +the uncertainties associated with enhanced recovery methods; +• +our commodity derivative contracts may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales; +• +the inability of one or more of our service providers, customers, or contractual counterparties to meet their obligations; +• +our ability to deliver necessary quantities of natural gas or crude oil to contractual counterparties; +• +price declines or unsuccessful exploration efforts resulting in write-downs of our asset carrying values; +• +the impact that lower oil, gas, or NGL prices could have on the amount we are able to borrow under our credit facility; +22 +• +the possibility our amount of debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt; +• +the possibility that covenants in our debt agreements may limit our discretion in the operation of our business, prohibit us from engaging in beneficial transactions or lead to the accelerated payment of our debt; +• +operating and environmental risks and hazards that could result in substantial losses; +• +the impact of seasonal weather conditions and lease stipulations on our ability to conduct drilling activities; +• +our ability to acquire adequate supplies of water and dispose of or recycle water we use at a reasonable cost in accordance with environmental and other applicable rules; +• +complex laws and regulations, including environmental regulations, that result in substantial costs and other risks; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities; +• +our ability to sell and/or receive market prices for our oil, gas, and NGLs; +• +new technologies may cause our current exploration and drilling methods to become obsolete; +• +the possibility of security threats, including terrorist attacks and cybersecurity breaches, against, or otherwise impacting, our facilities and systems; +• +the possibility we may face unforeseen difficulties or expenses related to our implementation of a new enterprise resource planning software system (“ERP”); and +• +litigation, environmental matters, the potential impact of legislation and government regulations, and the use of management estimates regarding such matters. +We caution you that forward-looking statements are not guarantees of future performance and actual results or performance may be materially different from those expressed or implied in the forward-looking statements. The forward-looking statements in this report speak as of the filing date of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by securities laws. +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC. We also make available through our website’s corporate governance section our Corporate Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, and the Charters of the Audit, Compensation, Executive, and Nominating and Corporate Governance Committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +23 +Glossary of Oil and Gas Terms +The oil and gas terms defined in this section are used throughout this report. The definitions of the terms developed reserves, exploratory well, field, proved reserves, and undeveloped reserves have been abbreviated from the respective definitions under SEC Rule 4-10(a) of Regulation S-X, as amended effective for fiscal years ending after December 31, 2009. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the SEC’s website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, or other liquid hydrocarbons. +Bcf . Billion cubic feet, used in reference to natural gas. +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of natural gas to one Bbl of oil or NGLs. +BTU. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. A well found to be incapable of producing either oil, natural gas, and/or NGLs in commercial quantities. +Exploratory well. A well drilled to find and produce oil or natural gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or natural gas in another reservoir, or to extend a known reservoir beyond its known horizon. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and natural gas) rights. +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature or stratigraphic condition. +Finding and development cost. Expressed in dollars per BOE. Finding and development cost metrics provide information as to the cost of adding proved reserves from various activities, and are widely utilized within the exploration and production industry, as well as by investors and analysts. The information used to calculate these metrics is included in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report. It should be noted that finding and development cost metrics have limitations. For example, exploration efforts related to a particular set of proved reserve additions may extend over several years. As a result, the exploration costs incurred in earlier periods are not included in the amount of exploration costs incurred during the period in which that set of proved reserves is added. In addition, consistent with industry practice, future capital costs to develop proved undeveloped reserves are not included in costs incurred. Since the additional development costs that will need to be +24 +incurred in the future before the proved undeveloped reserves are ultimately produced are not included in the amount of costs incurred during the period in which those reserves were added, those development costs in future periods will be reflected in the costs associated with adding a different set of reserves. The calculations of various finding and development cost metrics are explained below. +Finding and development cost – Drilling, excluding revisions. Calculated by dividing the amount of costs incurred for development and exploration activities, by the amount of estimated net proved reserves added through discoveries, extensions, and infill drilling, during the same period. +Finding and development cost – Drilling, including revisions. Calculated by dividing the amount of costs incurred for development and exploration activities, by the amount of estimated net proved reserves added through discoveries, extensions, infill drilling, and revisions of previous estimates, during the same period. +Finding and development cost – Drilling and acquisitions, excluding revisions. Calculated by dividing the amount of costs incurred for development, exploration, and acquisition of proved properties, by the amount of estimated net proved reserves added through discoveries, extensions, infill drilling, and acquisitions, during the same period. +Finding and development cost – Drilling and acquisitions, including revisions. Calculated by dividing the amount of costs incurred for development, exploration, and acquisition of proved properties, by the amount of estimated net proved reserves added through discoveries, extensions, infill drilling, acquisitions, and revisions of previous estimates, during the same period. +Finding and development cost – All in, including sales of reserves. Calculated by dividing the amount of total capital expenditures for oil and natural gas activities, by the amount of estimated net proved reserves added through discoveries, extensions, infill drilling, acquisitions, and revisions of previous estimates less sales of reserves, during the same period. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +Frac spread. Hydraulic fracturing requires custom-designed and purpose-built equipment. A “frac spread” is the equipment necessary to carry out a fracturing job. +Gross acre. An acre in which a working interest is owned. +Gross well. A well in which a working interest is owned. +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses. The expenses incurred in the lifting of crude oil, natural gas, and/or associated liquids from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels of crude oil, NGLs, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to natural gas. +MCFE. One thousand cubic feet of natural gas equivalent. Natural gas equivalents are determined using the ratio of six Mcf of natural gas to one Bbl of oil or NGLs. +MMBbl. One million barrels of oil, NGLs, or other liquid hydrocarbons. +25 +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to natural gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +Net asset value per share. The result of the fair market value of total assets less total liabilities, divided by the total number of outstanding shares of common stock. +NGLs. The combination of ethane, propane, butane, and natural gasolines that when removed from natural gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for crude oil. +NYMEX Henry Hub . New York Mercantile Exchange Henry Hub, a common industry benchmark price for natural gas. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +PV-10 (Non-GAAP). The present value of estimated future revenue to be generated from the production of estimated net proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. This is a non-GAAP measure. +Productive well. A well that is producing crude oil, natural gas, and/or NGLs or that is capable of commercial production of those products. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +Reserve life. Expressed in years, represents the estimated net proved reserves at a specified date divided by actual production for the preceding 12-month period. +26 +Reserve replacement. Reserve replacement metrics are used as indicators of a company’s ability to replenish annual production volumes and grow its reserves, and provide information related to how successful a company is at growing its proved reserve base. These are believed to be useful non-GAAP measures that are widely utilized within the exploration and production industry, as well as by investors and analysts. They are easily calculable metrics, and the information used to calculate these metrics is included in the Supplemental Oil and Gas Information section of Part II, Item 8 of this report. It should be noted that reserve replacement metrics have limitations. They are limited because they typically vary widely based on the extent and timing of new discoveries and property acquisitions. Their predictive and comparative value is also limited for the same reasons. In addition, because the metrics do not embed the cost or timing of future production of new reserves, they cannot be used as a measure of value creation. The calculations of various reserve replacement metrics are explained below. +Reserve replacement – Drilling, excluding revisions. Calculated as a numerator comprised of the sum of reserve extensions and discoveries and infill reserves in an existing proved field divided by production for the same period. This metric is an indicator of the relative success a company is having in replacing its production through drilling activity. +Reserve replacement – Drilling, including revisions. Calculated as a numerator comprised of the sum of reserve extensions, discoveries, infill reserves, and revisions of previous estimates in an existing proved field divided by production for the same period. This metric is an indicator of the relative success a company is having in replacing its production through drilling activity with an adjustment for revisions. +Reserve replacement – Drilling and acquisitions, excluding revisions. Calculated as a numerator comprised of the sum of reserve acquisitions and reserve extensions, discoveries, and infill reserves in an existing proved field divided by production for the same period. This metric is an indicator of the relative success a company is having in replacing its production through drilling and acquisition activities. +Reserve replacement – Drilling and acquisitions, including revisions. Calculated as a numerator comprised of the sum of reserve acquisitions and reserve extensions, discoveries, infill reserves, and revisions of previous estimates in an existing proved field divided by production for the same period. This metric is an indicator of the relative success a company is having in replacing its production through drilling and acquisition activities with an adjustment for revisions. +Reserve replacement – All in, excluding sales of reserves. The sum of reserve extensions and discoveries, infill drilling, reserve acquisitions, and reserve revisions of previous estimates for a specified period of time divided by production for the same period. +Reserve replacement –All in, including sales of reserves. The sum of sales of reserves, infill drilling, reserve extensions and discoveries, reserve acquisitions, and reserve revisions of previous estimates for a specified period of time divided by production for that same period. +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible crude oil, natural gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of crude oil, natural gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from crude oil, natural gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +27 +Royalty interest. An interest in an oil and natural gas property entitling the owner to shares of crude oil, natural gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +Standardized measure of discounted future net cash flows. The discounted future net cash flows relating to proved reserves based on prices used in estimating the reserves, year-end costs, and statutory tax rates, and a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information located in Part II, Item 8 of this report. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, natural gas, and associated liquids regardless of whether such acreage contains estimated net proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +28 +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in us. +Risks Related to Our Business +Crude oil, natural gas, and NGL prices are volatile, and declines in prices adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and natural gas properties depend heavily on the prices we receive for crude oil, natural gas and NGL sales. Crude oil, natural gas, and NGL prices also affect our cash flows available for capital expenditures and other items, our borrowing capacity, and the volume and amount of our crude oil, natural gas, and NGL reserves. For example, the amount of our borrowing base under our credit facility is subject to periodic redeterminations based on crude oil, natural gas, and NGL prices specified by our bank group at the time of redetermination. In addition, we may have crude oil and natural gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. +Historically, the markets for crude oil, natural gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in crude oil, natural gas, and NGL prices may result from relatively minor changes in the supply of and demand for crude oil, natural gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• +global and domestic supplies of crude oil, natural gas, and NGLs, and the productive capacity of the industry as a whole; +• +the level of consumer demand for crude oil, natural gas, and NGLs; +• +overall global and domestic economic conditions; +• +weather conditions; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities in regional or localized areas that may affect the realized price for crude oil, natural gas, or NGLs; +• +liquefied natural gas deliveries to and from the United States; +• +the price and level of imports and exports of crude oil, refined petroleum products, and liquefied natural gas; +• +the price and availability of alternative fuels; +• +technological advances and regulations affecting energy consumption and conservation; +• +the ability of the members of the Organization of Petroleum Exporting Countries and other exporting countries to agree to and maintain crude oil price and production controls; +• +political instability or armed conflict in crude oil or natural gas producing regions; +• +strengthening and weakening of the United States dollar relative to other currencies; and +• +governmental regulations and taxes. +29 +These factors and the volatility of crude oil, natural gas, and NGL markets make it extremely difficult to predict future crude oil, natural gas, and NGL price movements with any certainty. Declines in crude oil, natural gas, and NGL prices would reduce our revenues and could also reduce the amount of crude oil, natural gas, and NGLs that we can produce economically, which could have a materially adverse effect on us. +Weakness in economic conditions or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +In recent years, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, increased levels of unemployment, and an unprecedented level of intervention by the United States federal government and other governments. Although the United States economy appears to have stabilized, the extent and timing of a recovery, and whether it can be sustained, are uncertain. Renewed weakness in the United States or other large economies could materially adversely affect our business and financial condition. For example: +• +crude oil, NGL and natural gas prices have recently been lower than at various times in the last decade because of increased supply resulting from, among other things, increased drilling in unconventional reservoirs, leading to lower revenues, which could affect our financial condition and results of operations; +• +the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• +the liquidity available under our credit facility could be reduced if any lender is unable to fund its commitment; +• +our ability to access the capital markets may be restricted at a time when we would like, or need, to raise capital for our business, including for the exploration and/or development of reserves; +• +our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; and +• +variable interest rate spread levels, including for LIBOR and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our credit facility. +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find, develop, or acquire crude oil, natural gas, and NGL reserves that are economically producible. Our properties produce crude oil, natural gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate and develop or acquire new crude oil, natural gas, and NGL reserves to replace those being depleted by production. Without successful drilling or acquisition activities, our reserves and production will decline over time. In addition, competition for crude oil and natural gas properties is intense, and many of our competitors have financial, technical, human, and other resources necessary to evaluate and integrate acquisitions that are substantially greater than those available to us. +In the event we do complete an acquisition, its successful impact on our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price for the acquisition, future crude oil, natural gas, and NGL prices, the ability to reasonably estimate or assess the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation and development activities on the acquired properties, and future +30 +abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves, actual future production rates, and associated costs and potential liabilities with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. A customary review of subject properties will not necessarily reveal all existing or potential problems. +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of special risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce crude oil, natural gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for crude oil, natural gas, and NGL sales, our success in locating and developing and acquiring new reserves, and the orderly functioning of credit and capital markets. If crude oil, natural gas, and NGL prices decrease or if we encounter operating difficulties that result in our cash flows from operations being less than expected, we may reduce our planned capital expenditures unless we can raise additional funds through debt or equity financing or the divestment of assets. Debt or equity financing may not always be available to us in sufficient amounts or on acceptable terms, and the proceeds offered to us for potential divestitures may not always be of acceptable value to us. +If our revenues decrease due to lower crude oil, natural gas, or NGL prices, decreased production, or other reasons, and if we cannot obtain funding through our credit facility, other acceptable debt or equity financing arrangements, or through the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from major oil and gas companies, independent oil and gas exploration and production companies, and institutional and individual investors who seek oil and gas investments throughout the world, as well as the equipment, expertise, labor, and materials required to operate crude oil and natural gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many crude oil and natural gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. We may not be successful in acquiring and developing profitable properties in the face of this competition. In addition, other companies may have a greater ability to continue drilling activities during periods of low natural gas or oil prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Also, we compete for human resources. Over the last few years, the need for talented people across all disciplines in the industry has grown, while the number of talented people available has not grown at the same pace, and in many cases, is declining due +31 +to the demographics of the industry. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition and results of operations. +The loss of key personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team and other key personnel. The loss of the services of these or other key personnel could adversely affect our business. Our drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen and other professionals. Competition for many of these professionals is intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +The actual quantities and present value of our proved crude oil, natural gas, and NGL reserves may be less than we have estimated. +This report and other of our SEC filings contain estimates of our proved crude oil, natural gas, and NGL reserves and the estimated future net revenues from those reserves. These estimates are based on various assumptions, including assumptions required by the SEC relating to crude oil, natural gas, and NGL prices, drilling and completion costs, gathering and transportation costs, operating expenses, capital expenditures, effects of governmental regulation, taxes, timing of operations, and availability of funds. The process of estimating crude oil, natural gas, and NGL reserves is complex. The process involves significant decisions and assumptions in the evaluation of available geological, geophysical, engineering, and economic data for each reservoir. These estimates are dependent on many variables, and changes often occur as our knowledge of these variables evolve. Therefore, these estimates are inherently imprecise. In addition, the reserve estimates we make for properties that do not have a significant production history may be less reliable than estimates for properties with lengthy production histories. A lack of production history may contribute to inaccuracy in our estimates of proved reserves, future production rates, and the timing and/or amount of development expenditures. +Actual future production, prices for crude oil, natural gas, and NGLs, revenues, production taxes, development expenditures, operating expenses, and quantities of producible crude oil, natural gas, and NGL reserves will most likely vary from those estimated. Any significant variance of any nature could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than we have previously estimated. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration, operations and development activity, prevailing crude oil, natural gas, and NGL prices, costs to develop and operate properties, and other factors, many of which are beyond our control. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2014 , 48 percent , or 260.9 MMBOE, of our estimated proved reserves were proved undeveloped, and three percent , or 17.2 MMBOE, were proved developed non-producing. In order to develop our proved undeveloped reserves, as of December 31, 2014 , we estimate approximately $3.1 billion of capital expenditures would be required. Production revenues from proved developed non-producing reserves will not be realized until sometime in the future and after some investment of capital. In order to develop our proved developed non-producing reserves, as of December 31, 2014 , we estimate capital expenditures of approximately $29 million would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +32 +You should not assume that the PV-10 and standardized measure of discounted future net cash flows included in this report represent the current market value of our estimated proved crude oil, natural gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. For example, the present value of our proved reserves as of December 31, 2014 , was estimated using a calculated 12-month average sales price of $4.35 per MMBtu of natural gas (NYMEX Henry Hub spot price), $94.99 per Bbl of oil (NYMEX WTI spot price), and $39.91 per Bbl of NGL (OPIS spot price). We then adjust these prices to reflect appropriate basis, quality, and location differentials over the period in estimating our proved reserves. During 2014 , our monthly average realized natural gas prices, excluding the effect of derivative settlements, were as high as $5.78 per Mcf and as low as $3.69 per Mcf. For the same period, our monthly average realized crude oil prices before the effect of derivative settlements were as high as $94.36 per Bbl and as low as $50.22 per Bbl, and were as high as $42.83 per Bbl and as low as $19.94 per Bbl for NGLs. Many other factors will affect actual future net cash flows, including: +• +amount and timing of actual production; +• +supply and demand for crude oil, natural gas, and NGLs; +• +curtailments or increases in consumption by oil purchasers and natural gas pipelines; and +• +changes in government regulations or taxes, including severance and excise taxes. +The timing of production from oil and natural gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to be used to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and natural gas industry in general are subject. +Our property acquisitions may not be worth what we paid due to uncertainties in evaluating recoverable reserves and other expected benefits, as well as potential liabilities. +Successful property acquisitions require an assessment of a number of factors, some of which are beyond our control. These factors include exploration potential, future crude oil, natural gas, and NGL prices, operating costs, and potential environmental and other liabilities. These assessments are not precise and their accuracy is inherently uncertain. +In connection with our acquisitions, we typically perform a customary review of the acquired properties that will not necessarily reveal all existing or potential problems. In addition, our review may not allow us to fully assess the potential deficiencies of the properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. Normally, we acquire interests in properties on an “as is” basis with limited remedies for breaches of representations and warranties. +In addition, significant acquisitions can change the nature of our operations and business if the acquired properties have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such acquisitions may be limited. +33 +Integrating acquired properties and businesses involves a number of other special risks, including the risk that management may be distracted from normal business concerns by the need to integrate operations and systems as well as retain and assimilate additional employees. Therefore, we may not be able to realize all of the anticipated benefits of our acquisitions. +We have limited control over the activities on properties we do not operate. +Some of our properties, including a portion of our interests in the Eagle Ford shale in south Texas, are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs and materially and adversely affect our financial condition and results of operations. +We rely on third-party service providers to conduct drilling and completion and other related operations on properties we operate. +Where we are the operator of a property, we rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, natural gas, and NGLs prevailing economic conditions and financial, business and other factors. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title reports in acquiring oil and gas leasehold interests and obtain title opinions only on significant properties that we drill. There is no assurance that we will not suffer a monetary loss from title defects or title failure. Additionally, undeveloped acreage has greater risk of title defects than developed acreage. Title insurance is not available for oil and gas properties. As is customary in our industry, we rely upon the judgment of staff and independent landmen who perform the field work of examining records in the appropriate governmental offices and title abstract facilities before attempting to acquire or place under lease a specific mineral interest and/or undertake drilling activities. We, in some cases, perform curative work to correct deficiencies in the marketability of the title to us. Generally, under the terms of the operating agreements affecting our properties, any monetary loss attributable to a loss of title is to be borne by all parties to any such agreement in proportion to their interests in such property. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our financial condition, results of operations and operating cash flow if such property is of sufficient value. +34 +Exploration and development drilling may not result in commercially producible reserves. +Crude oil and natural gas drilling, completion and production activities are subject to numerous risks, including the risk that no commercially producible crude oil, natural gas, or associated liquids will be found. The cost of drilling and completing wells is often uncertain, and crude oil, natural gas or associated liquids drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors include: +• +unexpected adverse drilling or completion conditions; +• +title problems; +• +disputes with owners or holders of surface interests on or near areas where we operate; +• +pressure or geologic irregularities in formations; +• +engineering and construction delays; +• +equipment failures or accidents; +• +hurricanes, tornadoes, flooding, or other adverse weather conditions; +• +governmental permitting delays; +• +compliance with environmental and other governmental requirements; and +• +shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +The prevailing prices for crude oil, natural gas, and NGLs affect the cost of and the demand for drilling rigs, completion and production equipment, and other related services. However, changes in costs may not occur simultaneously with corresponding changes in commodity prices. The availability of drilling rigs can vary significantly from region to region at any particular time. Although land drilling rigs can be moved from one region to another in response to changes in levels of demand, an undersupply of rigs in any region may result in drilling delays and higher drilling costs for the available rigs in that region. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a materially adverse effect on our ability to explore or develop our properties. +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if crude oil, natural gas, or NGLs are present, or whether they can be produced economically. The cost of drilling, completing, and operating a well is often uncertain, and cost factors can adversely affect the economics of a project. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of crude oil, natural gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +35 +Results in our newer resource plays may be more uncertain than results in resource plays that are more developed and have longer established production histories. For example, industry experience and knowledge in the Eagle Ford shale play, is more limited compared to more established resource plays, such as the Barnett or Woodford shales, and we and the industry generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of these new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +In addition, a significant part of our strategy involves increasing our inventory of drilling locations. Such multi-year drilling inventories can be more susceptible to long-term uncertainties that could materially alter the occurrence or timing of actual drilling. Because of these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled, although we have the present intent to do so for locations booked as proved undeveloped locations, or if we will be able to produce crude oil, natural gas, or NGLs from these potential drilling locations. +Our future drilling activities may not be successful. Our overall drilling success rate or our drilling success rate within a particular area may decline. In addition, we may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire and we would lose our right to develop the related properties. Our total net acreage expiring in the next three years represents approximately 41 percent of our total net undeveloped acreage at December 31, 2014 . Although we have identified numerous potential drilling locations, we may not be able to economically produce crude oil, natural gas, or NGLs from all of them and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +Part of our strategy involves drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques. The results of our planned exploratory and delineation drilling in these plays are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +Ultimately, the success of these drilling and completion techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for crude oil, natural gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +36 +Uncertainties associated with enhanced recovery methods may result in us not realizing an acceptable return on our investments in such projects. +We inject water into formations on some of our properties to increase the production of crude oil, natural gas, and associated liquids. We may in the future expand these efforts to more of our properties or employ other enhanced recovery methods in our operations. The additional production and reserves, if any, attributable to the use of enhanced recovery methods are inherently difficult to predict. If our enhanced recovery methods do not allow for the extraction of crude oil, natural gas, and associated liquids in a manner or to the extent that we anticipate, we may not realize an acceptable return on our investments in such projects. In addition, if proposed legislation and regulatory initiatives relating to hydraulic fracturing become law, the cost of some of these enhanced recovery methods could increase substantially. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids towards the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, could result in increased lease operating expenses and could adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for crude oil, natural gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in crude oil, natural gas, and NGL prices and the associated impact on cash flows, we have entered into various derivative contracts. Our derivative contracts in place include swap and collar arrangements for crude oil, natural gas, and NGLs. As of December 31, 2014 , we were in a net accrued asset position of $592.1 million with respect to our crude oil, natural gas, and NGL derivative activities. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• +our production is less than expected; +• +one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +• +there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +The risk of one or more counterparties defaulting on their obligations is heightened by the recent decline in crude oil, natural gas, and NGL prices. These circumstances may adversely affect the ability of our counterparties to meet their obligations to us pursuant to derivative transactions, which could reduce our revenues and cash flows from derivative settlements. As a result, our financial condition, results of operations, and cash flows could be materially affected in an adverse way if our counterparties default on their contractual obligations under our commodity derivative contracts. +37 +In addition, commodity derivative contracts may limit the prices we receive for our crude oil, natural gas and NGL sales if crude oil, natural gas, or NGL prices rise substantially over the price established by the commodity derivative contract. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from crude oil, natural gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other conditions, including the recent decrease in crude oil prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. The Company does not believe the loss of any single purchaser would materially impact its operating results, as the Company has numerous options for purchasers in each of its operating regions for its crude oil, natural gas, and NGL production. Please refer to Note 1 - Summary of Significant Accounting Policies, under the heading Concentration of Credit Risk and Major Customers in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. +We have entered into firm transportation contracts that require us to pay fixed amounts of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of natural gas to our counterparties, our results of operations and liquidity could be adversely affected. +As of December 31, 2014 , we were contractually committed to deliver 1,411 Bcf of natural gas and 48 MMBbl of crude oil pursuant to contracts expiring at various dates through 2028 . We may enter into additional firm transportation agreements as our development of our resource plays expands. At the current time, we do not have enough proved developed reserves to offset these contractual liabilities, but we intend to develop reserves that will exceed the commitments and therefore do not expect any material shortfalls. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, the requirements to pay for quantities not delivered could have a material impact on our results of operations and liquidity. +Future crude oil, natural gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our crude oil and natural gas properties. All property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending the determination of whether proved reserves have been discovered. If commercial quantities of hydrocarbons are not discovered with an exploratory well, the costs of drilling the well are expensed. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net revenues, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Unproved properties are evaluated at the lower of cost or fair market value. We incurred impairment of proved properties and impairment of unproved properties totaling $84.5 million and $75.6 million , respectively, during 2014 , $172.6 million and $46.1 million , respectively, during 2013 , and $208.9 million and $16.3 million , respectively, during 2012 . Commodity prices significantly declined in 2014. Continued declines in the prices of crude oil, natural gas, or NGLs or unsuccessful exploration efforts could cause additional proved and/or unproved property impairments in the future. +We review the carrying value of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and natural gas properties cannot be reversed at a later date, even if crude oil, natural gas, or NGL prices increase. +38 +Lower crude oil, natural gas, or NGL prices could limit our ability to borrow under our credit facility. +Our credit facility has a current commitment amount of $1.5 billion , subject to a borrowing base that the lenders redetermine semi-annually based on the bank group’s assessment of the value of our crude oil and natural gas properties, which in turn is impacted by crude oil, natural gas, and NGL prices. The current borrowing base under our credit facility is $2.4 billion . The prices of crude oil and NGLs declined significantly beginning in mid-2014 and declined further subsequent to December 31, 2014. These declines in the prices of crude oil and NGLs, or significant declines in natural gas prices in the future could limit our borrowing base and reduce the amount we can borrow under our credit facility. Our amendment to our credit facility in 2014 specified that the borrowing base was not reduced by the issuance of the 6.125% Senior Notes due 2022 (“2022 Notes”) that we issued on November 17, 2014 , and will remain at $2.4 billion until the next scheduled redetermination date of April 1, 2015 . Additionally, divestitures of properties or other bond offerings could result in a reduction of our borrowing base. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2014 , we had $350.0 million of long-term senior unsecured debt outstanding relating to our 6.625% Senior Notes due 2019 (the “2019 Notes”) that we issued on February 7, 2011; $350.0 million of long-term senior unsecured debt outstanding relating to our 6.50% Senior Notes due 2021 (the “2021 Notes”) that we issued on November 8, 2011; $600.0 million of long-term senior unsecured debt outstanding relating to our 2022 Notes that we issued on November 17, 2014 ; $400.0 million of long-term senior unsecured debt outstanding relating to our 6.50% Senior Notes due 2023 (the “2023 Notes”) that we issued on June 29, 2012; and $500.0 million of long-term senior unsecured debt outstanding relating to our 5.0% Senior Notes due 2024 (the “2024 Notes”) that we issued on May 20, 2013 (collectively, the 2019 Notes, the 2021 Notes, the 2022 Notes, the 2023 Notes, and the 2024 Notes are referred to as our “Senior Notes”); and $166.0 million of outstanding borrowings under our secured credit facility. We had three outstanding letters of credit in the aggregate amount of $808,000 (which reduce the amount available for borrowing under the facility on a dollar-for-dollar basis), resulting in $1.3 billion of available debt capacity under our credit facility, assuming the borrowing conditions under this facility will be met. Our long-term debt represented 51 percent of our total book capitalization as of December 31, 2014 . +Our indebtedness could have important consequences for our operations, including: +• +making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• +requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to productive investments; +• +limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• +placing us at a competitive disadvantage compared to our competitors with less debt; and +• +making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +Our ability to make payments on our debt, refinance our debt, and fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control. If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our credit facility or from other sources, we might not be able to service our debt or fund our other liquidity needs. If we are +39 +unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our existing and future credit agreements, may prohibit us from pursuing any of these alternatives. Further, changes in the credit ratings of our debt may negatively affect the cost, terms, conditions, and availability of future financing. +Our debt agreements, including the agreement governing our credit facility and the indentures governing the Senior Notes, permit us to incur additional debt in the future, subject to compliance with restrictive covenants under those agreements. In addition, entities we may acquire in the future could have significant amounts of debt outstanding that we could be required to assume, and in some cases accelerate repayment thereof, in connection with the acquisition, or we may incur our own significant indebtedness to consummate an acquisition. +As discussed above, our credit facility is subject to periodic borrowing base redeterminations. We could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate renewals of our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our ability to borrow under our credit facility is subject to compliance with certain financial covenants, including (i) maintenance of a quarterly ratio of total debt to 12-month trailing consolidated adjusted earnings before interest, taxes, depreciation, amortization, and exploration expense of less than 4.0, and (ii) maintenance of an adjusted current ratio of no less than 1.0, each as defined in our credit facility. Our credit facility also requires us to comply with certain financial covenants, including requirements that we maintain certain levels of stockholders’ equity and limit our annual cash dividends to no more than $50.0 million . These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. +The respective indentures governing the Senior Notes also contain covenants that, among other things, limit our ability and the ability of our subsidiaries to: +• +incur additional debt; +• +make certain dividends or pay dividends or distributions on our capital stock or purchase, redeem, or retire capital stock; +• +sell assets, including capital stock of our subsidiaries; +• +restrict dividends or other payments of our subsidiaries; +• +create liens that secure debt; +• +enter into transactions with affiliates; and +• +merge or consolidate with another company. +40 +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of crude oil, natural gas and associated liquids or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occurs, we could sustain substantial losses. +Furthermore, if we experience any of the problems with well stimulation and completion activities referenced above, our ability to explore for and produce crude oil, natural gas, or NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shutdown, abandon or relocate drilling operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling and disposal of materials, including solid and hazardous wastes and petroleum hydrocarbons. We may incur joint and several, strict liability under applicable United States federal and state environmental laws in connection with releases of petroleum hydrocarbons and other hazardous substances at, on, under or from our leased or owned properties, some of which have been used for natural gas and oil exploration and production activities for a number of years, often by third parties not under our control. For our outside operated properties, we are dependent on the operator for operational and regulatory compliance, and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or away from could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including the CERCLA or the Superfund law, the RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under any implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury or property damage allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial +41 +assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer a material loss. +Our operations are subject to complex laws and regulations, including environmental regulations that result in substantial costs and other risks. +Federal, state, tribal, and local authorities extensively regulate the oil and natural gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing or marketing of crude oil, natural gas and NGL production. Noncompliance with statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +Governmental authorities regulate various aspects of drilling for and the production of crude oil, natural gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in crude oil and natural gas properties, rights-of-way and easements, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, and restoration standards, oil and gas operations, and restoration. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Federal authorities also may require any of our ongoing or planned operations on federal leases to be delayed, suspended, or terminated. Any such delay, suspension, or termination could have a materially adverse effect on our operations. +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, tribal and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate, could result in material costs or claims with respect to properties we own or have owned. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, and tribal environmental laws for noise emissions and for discharges of crude oil, natural gas, and associated liquids or other pollutants into the air, soil, surface water, or groundwater. We could be required to spend substantial amounts on investigations, litigation, and remediation for these emissions and discharges and other compliance issues. Any unpermitted release of petroleum or other pollutants from our operations could result not only in cleanup costs, but also natural resources, real or personal property and other damages and civil and criminal liabilities. The listing of additional wildlife or plant species as federally endangered or threatened could result in limitations on exploration and production activities in certain locations. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a materially adverse effect on us. +Seasonal weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Operations in certain of our regions, such as our Rocky Mountain and Permian regions, are adversely affected by seasonal weather conditions and lease stipulations designed to protect various wildlife or plant species. In certain areas on federal lands, drilling and other oil and natural gas activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs, oil field equipment, services, supplies and qualified personnel, which may lead to periodic +42 +shortages. Wildlife seasonal restrictions may limit access to federal leases or across federal lands. Possible restrictions may include seasonal restrictions in greater sage-grouse habitat during breeding and nesting seasons, within a certain distance of active raptor nests during fledging, and in big game winter or parturition ranges during winter or calving seasons. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Hydraulic fracturing is an essential and common practice in the oil and gas industry used to stimulate production of oil, natural gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and natural gas properties, including our unconventional resource plays in the Eagle Ford shale of south Texas and the Bakken/Three Forks formations in North Dakota. Hydraulic fracturing involves using water, sand and certain chemicals to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and natural gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities as outlined below. +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the SDWA. The EPA has published an interpretive memorandum and permitting guidance related to regulation of fracturing fluids using this regulatory authority. The EPA also plans to update its chloride water quality criteria for the protection of aquatic life under the Clean Water Act. Flowback and produced water from the hydraulic fracturing process contain total dissolved solids, including chlorides, and regulation of these fluids could be affected by the new criteria. The EPA has delayed issuing a draft criteria document until 2015. The EPA has also announced that it will develop pre-treatment standards for disposal of wastewater produced from shale gas operations through publicly owned treatment works. The regulations will be developed under the EPA’s Effluent Guidelines Program under the authority of the Clean Water Act. The EPA anticipates issuing the proposed rules in 2015. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states in which we operate, including Texas and Wyoming, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. For example, Texas adopted a law in June 2011 requiring disclosure to the Railroad Commission of Texas and the public of certain information regarding the components and volume of water used in the hydraulic fracturing process. In addition to state laws, local land use restrictions, such as city ordinances, may restrict or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, several municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Several agencies of the federal governmental are actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. The White House Council on Environmental Quality is coordinating a review of hydraulic fracturing practices, and a committee of the United States House of Representatives has conducted an investigation of hydraulic fracturing practices and government studies related thereto. Furthermore, a number of federal agencies are analyzing, or have been requested to review, a variety of environmental issues associated with hydraulic fracturing. The EPA has commenced a study of the potential +43 +environmental effects of hydraulic fracturing on drinking water and groundwater. The EPA issued a progress report in 2012, and plans to issue a draft report of results in 2015 for public comment, following release of peer reviewed papers in late 2014 and early 2015. The United States Department of Energy is actively involved in research on hydraulic fracturing practices, including groundwater protection. Also, the United States Department of the Interior proposed a rule to regulate hydraulic fracturing on public lands in May of 2013. The proposed rule contains disclosure requirements and other mandates for well integrity and management of water produced by the process, and is under review by the Office of Management and Budget. +Legislation has been introduced before Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. If hydraulic fracturing is regulated at the federal level, our fracturing activities could become subject to additional permit or disclosure requirements, associated permitting delays, operational restrictions, litigation risk and potential cost increases. Additionally, certain members of Congress have called upon the United States Government Accountability Office to investigate how hydraulic fracturing might adversely affect water resources, the SEC to investigate the natural gas industry and any possible misleading of investors or the public regarding the economic feasibility of pursuing natural gas deposits in shales by means of hydraulic fracturing, and the United States Energy Information Administration to provide a better understanding of that agency’s estimates regarding natural gas reserves, including reserves from shale formations, as well as uncertainties associated with those estimates. The United States Geological Survey Offices of Energy Resources Program, Water Resources and Natural Hazards and Environmental Health Offices also have ongoing research projects on hydraulic fracturing. These ongoing studies, depending on their course and outcomes, could spur initiatives to further regulate hydraulic fracturing under the SDWA or other regulatory processes. +Further, on August 16, 2012, the EPA issued final rules subjecting all new and modified oil and gas operations (production, processing, transmission, storage, and distribution) to regulation under the New Source Performance Standards (“NSPS”) and all existing and new operations to the National Emission Standards for Hazardous Air Pollutants (“NESHAP”) programs. The EPA rules also include NSPS standards for completions of hydraulically fractured gas wells. These standards require the use of reduced emission completion (“REC”) techniques developed in the EPA's Natural Gas STAR program along with the pit flaring of gas not sent to the gathering line beginning in January 2015. The standards are applicable to newly drilled and fractured wells as well as existing wells that are refractured. Further, the regulations under NESHAP include maximum achievable control technology (“MACT”) standards for those glycol dehydrators and certain storage vessels at major sources of hazardous air pollutants not currently subject to MACT standards. These rules will require additional control equipment, changes to procedure, and extensive monitoring and reporting. The EPA stated in January 2013, however, that it intends to reconsider portions of the final rule. On September 23, 2013, the EPA published new standards for storage tanks subject to the NSPS. In December 2014, the EPA finalized additional updates to the 2012 NSPS. The amendments clarified stages for flowback and the point at which green completion equipment is required and updated requirements for storage tanks and leak detection requirements for processing plants. The EPA has stated that it continues to review other issues raised in petitions for reconsideration. We are currently evaluating the effect of these rules on our business. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. Over the past year, several court cases have addressed aspects of hydraulic fracturing. In a case that could delay operations on public lands, a court in California held that the BLM did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. Courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to +44 +increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for and production of oil, natural gas, and associated liquids, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional federal, state, or local laws, or the implementation of new regulations, regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +Our ability to produce crude oil, natural gas, and associated liquids economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the water we use at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of crude oil, natural gas, and NGLs requires the use and disposal of significant quantities of water. +Our inability to secure sufficient amounts of water, or to dispose of or recycle the water used in our operations, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of crude oil, natural gas, and NGLs. +Compliance with environmental regulations and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +Certain United States federal income tax deductions currently available with respect to oil and natural gas exploration and production may be eliminated as a result of future legislation . +Recent federal budget proposals, if enacted into law, would eliminate certain key United States federal income tax incentives currently available to oil and natural gas exploration and production companies. These potential changes include: +• +the elimination of current deductions for intangible drilling and development costs; +• +the repeal of the percentage depletion allowance for oil and natural gas properties; +• +the elimination of the deduction for certain domestic production activities; and +• +an extension of the amortization period for certain geological and geophysical expenditures. +It is unclear when or if these or similar changes will be enacted. The passage of legislation enacting these or similar changes in federal income tax laws could eliminate or postpone certain tax deductions that are currently available with respect to oil and natural gas exploration and development. Any such changes could have an adverse effect on our financial position, results of operations and cash flows. +Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for crude oil, natural gas, and NGLs. +In December 2009, the EPA made a finding that emissions of carbon dioxide, methane, and other “greenhouse gases” endanger public health and the environment because emissions of such gases contribute to +45 +warming of the earth’s atmosphere and other climatic changes. Based on this finding, the EPA has over the past four years adopted and implemented a comprehensive suite of regulations to restrict and otherwise regulate emissions of greenhouse gases under existing provisions of the CAA. In particular, the EPA has adopted two sets of rules regulating greenhouse gas emissions under the CAA. One rule requires a reduction in greenhouse gas emissions from motor vehicles, and the other regulates permitting and greenhouse gas emissions from certain large stationary sources. These EPA regulatory actions have been challenged by various industry groups, initially in the D.C. Circuit, which in 2012 ruled in favor of the EPA in all respects. However, in June 2014, the United States Supreme Court reversed the D.C. Circuit and struck down the EPA’s greenhouse gas permitting rules to the extent they impose a requirement to obtain a permit based solely on emissions of greenhouse gases. However, large sources of air pollutants other than greenhouse gases would still be required to implement the best available capture technology for greenhouse gases. The EPA has also adopted reporting rules for greenhouse gas emissions from specified greenhouse gas emission sources in the United States, including petroleum refineries as well as certain onshore oil and natural gas extraction and production facilities. +Several other kinds of cases on greenhouse gases have been heard by the courts in recent years. While courts have generally declined to assign direct liability for climate change to large sources of greenhouse gas emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant greenhouse gas emissions, and new claims for damages and increased government scrutiny will likely continue. Such cases often seek to challenge air emissions permits that greenhouse gas emitters apply for, seek to force emitters to reduce their emissions, or seek damages for alleged climate change impacts to the environment, people, and property. Any court rulings, laws or regulations that restrict or require reduced emissions of greenhouse gases could lead to increased operating and compliance costs, and could have an adverse effect on demand for the oil and natural gas that we produce. +The United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases, and almost one-half of the states have already taken measures to reduce emissions of greenhouse gases, primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas “cap and trade” programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. Recently, the Congressional Budget Office provided Congress with a study on the potential effects on the United States economy of a tax on greenhouse gas emissions. While “carbon tax” legislation has been introduced in the Senate, the prospects for passage of such legislation are highly uncertain at this time. +On June 25, 2013, President Obama outlined plans to address climate change through a variety of executive actions, including reduction of methane emissions from oil and gas production and processing operations as well as pipelines and coal mines (the “Climate Plan”). The President’s Climate Plan, along with recent regulatory initiatives and ongoing litigation filed by states and environmental groups, signal a new focus on methane emissions, which could pose substantial regulatory risk to our operations. In March 2014, President Obama released a strategy to reduce methane emissions, which directed the EPA to consider additional regulations to reduce methane emissions from the oil and gas sector. On January 14, 2015, the Obama Administration announced additional steps to reduce methane emissions from the oil and gas sector by 40 to 45 percent by 2025. These actions include a commitment from the EPA to issue new source performance standards for methane emissions from the oil and gas sector. The EPA plans to propose the rule in 2015 and finalize the standards in 2016. The focus on legislating methane also could eventually result in: +• requirements for methane emission reductions from existing oil and gas equipment; +• increased scrutiny for sources emitting high levels of methane, including during permitting processes; +46 +• analysis, regulation and reduction of methane emissions as a requirement for project approval; and +• actions taken by one agency for a specific industry establishing precedents for other agencies and +industry sectors. +In relation to the Climate Plan, both assumed Global Warming Potential (“GWP”) and assumed social costs associated with methane and other greenhouse gas emissions have been finalized, including a 20% increase in the GWP of methane. Changes to these measurement tools could adversely impact permitting requirements, application of agencies’ existing regulations for source categories with high methane emissions, and determinations of whether a source qualifies for regulation under the CAA. +Finally, it should be noted that some scientists have predicted that increasing concentrations of greenhouse gases in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. Some scientists refute these predictions. However, President Obama’s Climate Plan emphasizes preparation for such events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements. +Current or proposed financial legislation and rulemaking could have an adverse effect on our ability to use derivative instruments to reduce the effect of commodity price, interest rate and other risks associated with our business. +The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was signed into law on July 21, 2010, establishes, among other provisions, federal oversight and regulation of the over-the-counter derivatives market and entities that participate in that market. The Dodd-Frank Act also establishes margin requirements and certain transaction clearing and trade execution requirements. On October 18, 2011, the Commodities Futures Trading Commission (the “CFTC”) approved regulations to set position limits for certain futures and option contracts in the major energy markets, which were successfully challenged in federal district court by the Securities Industry Financial Markets Association and the International Swaps and Derivatives Association and largely vacated by the court. On November 5, 2013, the CFTC proposed new rules that would place limits on positions in certain core futures and equivalent swaps contracts for or linked to certain physical commodities, subject to exceptions for certain bona fide hedging transactions. The comment period on these new rules has been reopened multiple times since comments were first due in early January 2014, and as these new position limit rules are not yet final, the impact of those provisions on us is uncertain at this time. +Under CFTC final rules promulgated under the Dodd-Frank Act, we believe our derivatives activity will qualify for the non-financial, commercial end-user exception, which exempts derivatives intended to hedge or mitigate commercial risk from the mandatory swap clearing requirement. The Dodd-Frank Act may also require us to comply with margin requirements in our derivative activities, although the application of those provisions to us is uncertain at this time. The financial reform legislation may also require the counterparties to our derivative instruments to spin off some of their derivatives activities to separate entities, which may not be as creditworthy as the current counterparties. Therefore, the Dodd-Frank Act and the rules promulgated thereunder could significantly increase the cost of derivative contracts (including through requirements to post collateral), materially alter the terms of derivative contracts, reduce the availability of derivatives to protect against risks we encounter, reduce our ability to monetize or restructure our existing derivative contracts, and increase our exposure to less creditworthy counterparties. +47 +If we reduce our use of derivatives as a result of the Dodd-Frank Act and related regulations, our results of operations may become more volatile and our cash flows may be less predictable, which could adversely affect our ability to plan for and fund capital expenditures. Finally, the Dodd-Frank Act was intended, in part, to reduce the volatility of oil and gas prices, which some legislators attributed to speculative trading in derivatives and commodity instruments related to oil and gas. Our revenues could therefore be adversely affected if a consequence of the Dodd-Frank Act and related regulations is to lower commodity prices. Any of these consequences could have a material adverse effect on our consolidated financial position, results of operations and cash flows. +Our ability to sell crude oil, natural gas and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines and other transportation systems owned or operated by others or by other interruptions. +The marketability of our crude oil, natural gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay or discontinuance of development plans for our properties, or lower price realizations. Although we have some contractual control over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of crude oil, natural gas, and NGL production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, and transport crude oil, natural gas, and NGLs. +In particular, if drilling in the Eagle Ford shale and Bakken/Three Forks resource plays continue to be successful, the amount of crude oil, natural gas, and NGLs being produced by us and others could exceed the capacity of, and result in strains on, the various gathering and transportation systems, pipelines, processing facilities, and other infrastructure available in these areas. It will be necessary for additional infrastructure, pipelines, gathering and transportation systems and processing facilities to be expanded, built or developed to accommodate anticipated production from these areas. Because of the current commodity price environment, certain processing, pipeline, and other gathering or transportation projects that might be, or are being, considered for these areas may not be developed timely or at all due to lack of financing or other constraints. Capital and other constraints could also limit our ability to build or access intrastate gathering and transportation systems necessary to transport our production to interstate pipelines or other points of sale or delivery. In such event, we might have to delay or discontinue development activities or shut in our wells to wait for sufficient infrastructure development or capacity expansion and/or sell production at significantly lower prices, which would adversely affect our results of operations and cash flows. In addition, the operations of the third parties on whom we rely for gathering and transportation services are subject to complex and stringent laws and regulations, which require obtaining and maintaining numerous permits, approvals and certifications from various federal, state, and local government authorities. These third parties may incur substantial costs in order to comply with existing laws and regulations. If existing laws and regulations governing such third-party services are revised or reinterpreted, or if new laws and regulations become applicable to their operations, these changes may affect the costs we pay for such services. Similarly, a failure to comply with such laws and regulations by the third parties on whom we rely could have a material adverse effect on our business, financial condition and results of operations. +A portion of our production in any region may be interrupted, or shut in, from time to time for numerous reasons, including as a result of weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market conditions. If a substantial amount of our production is interrupted at the same time, it could temporarily and adversely affect our cash flows and results of operations. +48 +New technologies may cause our current exploration and drilling methods to become obsolete. +The oil and gas industry is subject to rapid and significant advancements in technology, including the introduction of new products and services using new technologies. As competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, competitors may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. One or more of the technologies we currently use or implement in the future may become obsolete. We cannot be certain we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. If we are unable to maintain technological advancements consistent with industry standards, our operations and financial condition may be adversely affected. +We implemented a new ERP system beginning January 1, 2015. We may experience unforeseen difficulties or delays related to implementation of the new system. +We implemented a new ERP system beginning January 1, 2015. We rigorously planned and tested the implementation of this system prior to its implementation; however, if we encounter unforeseen difficulties in the use of this system, we may experience delays in financial reporting, weaknesses in internal controls, or unanticipated expenses. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As a crude oil, natural gas, and NGLs producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +Cybersecurity attacks in particular are evolving and include but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information and corruption of data. These events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. +The threat of terrorism and the impact of military and other action have caused instability in world financial markets and could lead to increased volatility in prices for crude oil, natural gas, and NGLs, all of which could adversely affect the markets for our operations. Energy assets might be specific targets of terrorist attacks. These developments have subjected our operations to increased risk and, depending on their occurrence and ultimate magnitude, could have a material adverse effect on our business. +49 +Risks Related to Our Common Stock +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2014 , to February 18, 2015 , the low and high intraday sales price per share of our common stock as reported by the New York Stock Exchange ranged from a low of $29.41 per share in December 2014 to a high of $90.38 per share in September 2014. We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include: +• +changes in crude oil, natural gas, or NGL prices; +• +variations in drilling, recompletion, and operating activity; +• +changes in financial estimates by securities analysts; +• +changes in market valuations of comparable companies; +• +additions or departures of key personnel; +• +future sales of our common stock; and +• +changes in the national and global economic outlook. +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +Shares eligible for future sale may cause the market price of our common stock to drop significantly, even if our business is doing well. +The potential for sales of substantial amounts of our common stock in the public market may have a materially adverse effect on our stock price. As of February 18, 2015 , 67,407,214 shares of our common stock were freely tradable without substantial restriction or the requirement of future registration under the Securities Act. In addition, restricted stock units (“RSUs”) providing for the issuance of up to a total of 512,987 shares of our common stock and 744,253 performance share units (“PSUs”) were outstanding. The PSUs represent the right to receive, upon settlement of the PSUs after the completion of a three-year performance period, a number of shares of our common stock that may be from zero to two times the number of PSUs granted, depending on the extent to which the underlying performance criteria have been achieved and the extent to which the PSUs have vested. As of February 18, 2015 , there were 67,463,060 shares of our common stock outstanding. +50 +We may not always pay dividends on our common stock. +Payment of future dividends remains at the discretion of our Board of Directors, and will continue to depend on our earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to a covenant in our credit facility limiting our annual cash dividends to no more than $50.0 million , and to covenants in the indentures for our Senior Notes that limit our ability to pay dividends beyond a certain amount. Our Board of Directors may determine in the future to reduce the current semi-annual dividend rate of $0.05 per share, or discontinue the payment of dividends altogether. +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Securities Exchange Act of 1934. +ITEM 3. LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the filing date of this report, no legal proceedings are pending against us that we believe individually or collectively could have a materially adverse effect upon our financial condition, results of operations or cash flows. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +51 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” The following table presents the range of high and low intraday sales prices per share for the indicated quarterly periods in 2014 and 2013 , as reported by the New York Stock Exchange: +Quarter Ended +High +Low +December 31, 2014 +$ +79.89 +$ +29.41 +September 30, 2014 +$ +90.38 +$ +74.57 +June 30, 2014 +$ +85.39 +$ +71.00 +March 31, 2014 +$ +90.22 +$ +69.03 +December 31, 2013 +$ +94.00 +$ +76.72 +September 30, 2013 +$ +77.70 +$ +60.22 +June 30, 2013 +$ +65.55 +$ +55.30 +March 31, 2013 +$ +62.26 +$ +52.67 +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2009 , and ending on December 31, 2014 , with the cumulative total returns of the Dow Jones U.S. Exploration and Production Index, and the Standard & Poor’s 500 Stock Index. +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +Holders. As of February 18, 2015 , the number of record holders of our common stock was 78. Based upon inquiry, management believes that the number of beneficial owners of our common stock is approximately 25,100. +52 +Dividends. We have paid cash dividends to our stockholders every year since 1940. Annual dividends of $0.05 per share were paid in each of the years 1998 through 2004. Annual dividends of $0.10 per share were paid in 2005 through 2014 . We expect our practice of paying dividends on our common stock to continue, although the payment of future dividends will continue to depend on our earnings, cash flow, capital requirements, financial condition, and other factors, including the discretion of our Board of Directors. In addition, the payment of dividends is subject to covenants in our credit facility that limit our annual dividend payment to no more than $50.0 million per year. We are also subject to certain covenants under our Senior Notes that restrict certain payments, including dividends; provided, however, the first $6.5 million of dividends paid each year are not restricted by this covenant. Based on our current performance, we do not anticipate that these covenants will restrict future annual dividend payments of $0.10 per share of common stock. Dividends are currently paid on a semi-annual basis. Dividends paid totaled $6.7 million for each year ended December 31, 2014 , and December 31, 2013 . +Restricted Shares. We have no restricted shares outstanding as of December 31, 2014 , aside from Rule 144 restrictions on shares held by insiders and shares issued to members of the Board of Directors under our Equity Incentive Compensation Plan (“Equity Plan”). +Purchases of Equity Securities by the Issuer and Affiliated Purchasers. The following table provides information about purchases by the Company and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and year ended December 31, 2014 , of shares of the Company’s common stock, which is the sole class of equity securities registered by the Company pursuant to Section 12 of the Exchange Act. +ISSUER PURCHASES OF EQUITY SECURITIES +Total Number of Shares Purchased (1) +Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program +Maximum Number of Shares that May Yet be Purchased Under the Program (2) +January 1, 2014 - +March 31, 2014 +— +$ +— +— +3,072,184 +April 1, 2014 - +June 30, 2014 +866 +$ +73.59 +— +3,072,184 +July 1, 2014 - +September 30, 2014 +124,942 +$ +84.14 +— +3,072,184 +October 1, 2014 - +October 31, 2014 +668 +$ +71.78 +— +3,072,184 +November 1, 2014 - +November 30, 2014 +— +$ +— +— +3,072,184 +December 1, 2014 - +December 31, 2014 +— +$ +— +— +3,072,184 +Total October 1, 2014 - +December 31, 2014 +668 +$ +71.78 +— +3,072,184 +Total +126,476 +$ +84.00 +— +3,072,184 +____________________________________________ +(1) +All shares purchased in 2014 were purchased by us to offset tax withholding obligations that occur upon the delivery of outstanding shares underlying RSUs and PSUs delivered under the terms of grants under the Equity Plan. +(2) +In July 2006, our Board of Directors approved an increase in the number of shares that may be repurchased under the original August 1998 authorization to 6,000,000 as of the effective date of the resolution. Accordingly, as of the date of this filing, subject to the approval of our Board of Directors, we may repurchase up to 3,072,184 shares of common stock on a prospective basis. The shares may be repurchased from time to time in open market transactions or privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our credit facility, the indentures governing our Senior Notes and compliance with securities laws. Stock repurchases may be funded with +53 +existing cash balances, internal cash flow, or borrowings under our credit facility. The stock repurchase program may be suspended or discontinued at any time. Please refer to Dividends above for a description of our dividend limitations. +54 +ITEM 6. SELECTED FINANCIAL DATA +The following table sets forth selected supplemental financial and operating data as of the dates and periods indicated. The financial data for each of the five years presented were derived from our consolidated financial statements. The following data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report, which includes a discussion of factors materially affecting the comparability of the information presented, and in conjunction with our consolidated financial statements included in this report. +Years Ended December 31, +2014 +2013 +2012 +2011 +2010 +(in millions, except per share data) +Total operating revenues +$ +2,522.3 +$ +2,293.4 +$ +1,505.1 +$ +1,603.3 +$ +1,092.8 +Net income (loss) +$ +666.1 +$ +170.9 +$ +(54.2 +) +$ +215.4 +$ +196.8 +Net income (loss) per share: +Basic +$ +9.91 +$ +2.57 +$ +(0.83 +) +$ +3.38 +$ +3.13 +Diluted +$ +9.79 +$ +2.51 +$ +(0.83 +) +$ +3.19 +$ +3.04 +Total assets at year-end +$ +6,516.7 +$ +4,705.2 +$ +4,199.5 +$ +3,799.0 +$ +2,744.3 +Long-term debt: +Revolving credit facility +$ +166.0 +$ +— +$ +340.0 +$ +— +$ +48.0 +3.50% Senior Convertible Notes, net of debt discount +$ +— +$ +— +$ +— +$ +285.1 +$ +275.7 +Senior Notes +$ +2,200.0 +$ +1,600.0 +$ +1,100.0 +$ +700.0 +$ +— +Cash dividends declared and paid per common share +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +55 +Supplemental Selected Financial and Operations Data +For the Years Ended December 31, +2014 +2013 +2012 +2011 +2010 +Balance Sheet Data (in millions) +Total working capital (deficit) +$ +(39.6 +) +$ +8.4 +$ +(201.0 +) +$ +(42.6 +) +$ +(227.4 +) +Total stockholders’ equity +$ +2,286.7 +$ +1,606.8 +$ +1,414.5 +$ +1,462.9 +$ +1,218.5 +Weighted-average common shares outstanding (in thousands) +Basic +67,230 +66,615 +65,138 +63,755 +62,969 +Diluted +68,044 +67,998 +65,138 +67,564 +64,689 +Reserves +Oil (MMBbl) +169.7 +126.6 +92.2 +71.7 +57.4 +Gas (Bcf) +1,466.5 +1,189.3 +833.4 +664.0 +640.0 +NGLs (MMBbl) +133.5 +103.9 +62.3 +27.5 +— +MMBOE +547.7 +428.7 +293.4 +209.9 +164.1 +Production and Operations (in millions) +Oil, gas, and NGL production revenue +$ +2,481.5 +$ +2,199.6 +$ +1,473.9 +$ +1,332.4 +$ +836.3 +Oil, gas, and NGL production expense +$ +715.9 +$ +597.0 +$ +391.9 +$ +290.1 +$ +195.1 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +767.5 +$ +822.9 +$ +727.9 +$ +511.1 +$ +336.1 +General and administrative +$ +167.1 +$ +149.6 +$ +119.8 +$ +118.5 +$ +106.7 +Production Volumes +Oil (MMBbl) +16.7 +13.9 +10.4 +8.1 +6.4 +Gas (Bcf) +152.9 +149.3 +120.0 +100.3 +71.9 +NGLs (MMBbl) +13.0 +9.5 +6.1 +3.5 +— +MMBOE +55.1 +48.3 +36.5 +28.3 +18.3 +Realized price +Oil (per Bbl) +$ +80.97 +$ +91.19 +$ +85.45 +$ +88.23 +$ +72.65 +Gas (per Mcf) +$ +4.58 +$ +3.93 +$ +2.98 +$ +4.32 +$ +5.21 +NGLs (per Bbl) +$ +33.34 +$ +35.95 +$ +37.61 +$ +53.32 +$ +— +Adjusted price (net of derivative settlements) +Oil (per Bbl) +$ +82.68 +$ +89.92 +$ +83.52 +$ +78.89 +$ +66.85 +Gas (per Mcf) +$ +4.40 +$ +4.14 +$ +3.48 +$ +4.80 +$ +6.05 +NGLs (per Bbl) +$ +34.18 +$ +36.66 +$ +38.90 +$ +47.90 +$ +— +Expense per BOE +Lease operating expenses +$ +4.74 +$ +4.82 +$ +4.93 +$ +5.30 +$ +6.63 +Transportation costs +$ +6.11 +$ +5.34 +$ +3.81 +$ +3.05 +$ +1.15 +Production taxes +$ +2.13 +$ +2.19 +$ +2.00 +$ +1.90 +$ +2.86 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +13.92 +$ +17.02 +$ +19.95 +$ +18.07 +$ +18.33 +General and administrative +$ +3.03 +$ +3.09 +$ +3.28 +$ +4.19 +$ +5.82 +Statement of Cash Flow Data (in millions) +Provided by operating activities +$ +1,456.6 +$ +1,338.5 +$ +922.0 +$ +760.5 +$ +497.1 +Used in investing activities +$ +(2,478.7 +) +$ +(1,192.9 +) +$ +(1,457.3 +) +$ +(1,264.9 +) +$ +(361.6 +) +Provided by (used in) financing activities +$ +740.0 +$ +130.7 +$ +422.1 +$ +618.5 +$ +(141.1 +) +56 +Note: Beginning in 2011, we changed our reporting for natural gas volumes to show natural gas and NGL production volumes consistent with title transfer for each product. Rapid production growth from our NGL-rich assets associated with plant product sales contracts necessitated a change in our reporting of production volumes. Our 2010 NGL production volumes, revenues, and prices have not been reclassified to conform to the current presentation given the immateriality of the amounts. +57 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +This discussion includes forward-looking statements. Please refer to Cautionary Information about Forward-Looking Statements in Part I, Items 1 and 2 of this report for important information about these types of statements. +Overview of the Company +General Overview +We are an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in onshore North America. We have leading positions in the Eagle Ford shale and Bakken/Three Forks resource plays that are the focus of our development programs. We also have smaller delineation and exploration programs in the Powder River Basin, the Permian Basin, and in east Texas. We have built a portfolio of onshore properties primarily through early entry into existing and emerging resource plays. This portfolio is comprised of properties with established production and reserves, prospective drilling opportunities, and unconventional resource prospects. We believe our strategy provides for stable and predictable production and reserves growth. +Our strategic objective is to build our ownership and operatorship of North American oil, gas, and NGL producing assets that have high operating margins and significant opportunities for additional economic investment. We pursue opportunities through both acquisitions and exploration, and seek to maximize the value of our assets through industry leading technology application and outstanding operational execution. We are returns focused and maintain a simple, strong balance sheet through a conservative approach to leverage. +In 2014 , we had the following financial and operational results: +• +At year-end 2014 , we had estimated proved reserves of 547.7 MMBOE, of which 55 percent were liquids (oil and NGLs) and 52 percent were characterized as proved developed. We added 143.9 MMBOE through our drilling program, the majority of which related to our activity in the Eagle Ford shale in south Texas and the Bakken/Three Forks program in North Dakota, and acquired 21.9 MMBOE near our existing Gooseneck area in Divide County, North Dakota and in the Powder River Basin in Wyoming. We had upward engineering revisions of 10.4 MMBOE primarily related to improved performance and lower operating expenses in our operated Eagle Ford assets. We divested of 2.1 MMBOE of proved reserves in the Montana portion of the Williston Basin. Our proved reserve life increased to 9.9 years in 2014 compared to 8.9 years in 2013. Please refer to Reserves included in Part I, Items 1 and 2 of this report for additional discussion. +• +The PV-10 of our estimated proved reserves was $7.6 billion as of December 31, 2014 , compared with $5.5 billion as of December 31, 2013 . The after tax amount, represented by the standardized measure calculation, was $5.7 billion as of December 31, 2014 , compared with $4.0 billion as of December 31, 2013 . The standardized measure calculation is presented in the Supplemental Oil and Gas Information section located in Part II, Item 8 of this report. A reconciliation between PV-10 and the standardized measure of discounted future net cash flows is shown under Reserves in Part I, Items 1 and 2 of this report. +• +We had record annual production in 2014 . Our average daily production in 2014 was 45.6 MBbls of oil, 419.0 MMcf of gas, and 35.6 MBbls of NGLs, for an average daily equivalent production rate of 151.1 MBOE, compared with 132.4 MBOE in 2013 , an increase of 14 percent year-over-year. Please refer to the caption Production Results below for additional discussion. +58 +• +We recorded net income of $666.1 million , or $9.79 per diluted share, for the year ended December 31, 2014 . This compares with net income of $170.9 million , or $2.51 per diluted share, for the year ended December 31, 2013 . This increase in net income in 2014 is driven largely by higher production, an increase in the fair value of commodity derivative contracts, and an increase in oil, gas, and NGL production revenue. Please refer to the caption Comparison of Financial Results and Trends Between 2014 and 2013 below for additional discussion regarding the components of net income. +• +We had record cash flow provided by operating activities of $1.5 billion for the year ended December 31, 2014 , compared with $1.3 billion for the year ended December 31, 2013 , which was an increase of nine percent year-over-year. Please refer to Analysis of cash flow changes between 2014 and 2013 below for additional discussion. +• +Costs incurred for oil and gas property acquisitions and exploration and development activities for the year ended December 31, 2014 , totaled $2.7 billion . The majority of our drilling and completion costs incurred during this period were in our Eagle Ford shale and Bakken/Three Forks programs. We acquired approximately $561.6 million of proved and unproved properties in our Gooseneck area and in the Powder River Basin during 2014. Total costs incurred for the same period in 2013 totaled $1.7 billion . Please refer to the caption Costs Incurred in Oil and Gas Producing Activities below for additional discussion. +• +Adjusted EBITDAX, a non-GAAP financial measure, for the year ended December 31, 2014 , was $1.6 billion , compared with $1.5 billion for the same period in 2013 . Please refer to the caption Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and reconciliations of our GAAP net income (loss) and net cash provided by operating activities to adjusted EBITDAX. +Reserve Replacement, Finding and Development Costs, and Growth +An exploration and production company depletes part of its asset base with each unit of oil, gas, or NGL it produces. Our future growth will depend on our ability to economically add reserves in excess of production. The information used to calculate reserve replacement and finding and development cost metrics is included in the Supplemental Oil and Gas Information section located in Part II, Item 8 of this report with the terms defined in the Glossary of Oil and Gas Terms in Part I, Items 1 and 2 of this report. +The following table provides various reserve replacement and finding and development cost metrics for the year ended December 31, 2014 : +Reserve Replacement Percentage +Finding and Development Cost per BOE (1) +Excluding Divestitures +Including Divestitures +Excluding Divestitures +Including Divestitures +Drilling, excluding revisions +261 +% +257 +% +$ +14.39 +$ +14.60 +Drilling, including revisions +280 +% +276 +% +$ +13.41 +$ +13.60 +Drilling and acquisitions, excluding revisions +301 +% +297 +% +$ +14.14 +$ +14.32 +Drilling and acquisitions, including revisions +320 +% +316 +% +$ +13.30 +$ +13.46 +Reserve acquisitions +40 +% +36 +% +$ +12.49 +$ +13.83 +All-in +320 +% +316 +% +$ +15.39 +$ +15.58 +____________________________________________ +(1) Please refer to Note 12 - Acquisition and Development Agreement in Part II, Item 8 for a discussion of the arrangement under which we were carried on 90 percent of certain drilling and completion costs for a portion of 2014. The remaining carry was utilized during the second quarter of 2014. +59 +The following table provides average reserve replacement and finding and development cost metrics for the three-year period ended December 31, 2014 : +Reserve Replacement Percentage +Finding and Development Cost per BOE (1) +Excluding Divestitures +Including Divestitures +Excluding Divestitures +Including Divestitures +Drilling, excluding revisions +350 +% +333 +% +$ +10.53 +$ +11.06 +Drilling, including revisions +341 +% +325 +% +$ +10.80 +$ +11.35 +Drilling and acquisitions, excluding revisions +366 +% +350 +% +$ +10.65 +$ +11.16 +Drilling and acquisitions, including revisions +358 +% +341 +% +$ +10.91 +$ +11.44 +Reserve acquisitions +17 +% +N/M +$ +13.16 +N/M +All-in +358 +% +341 +% +$ +12.22 +$ +12.81 +____________________________________________ +N/M - Percentage or amount, as applicable, is not meaningful. +(1) Please refer to Note 12 - Acquisition and Development Agreement in Part II, Item 8 for a discussion of the arrangement under which we were carried on 90 percent of certain drilling and completion costs in 2012, 2013, and for a portion of 2014. +Growing net asset value per share is an important factor in growing our stock price over the long term. We believe annual reserve replacement percentages and finding and development costs are important analytical measures and are widely used by investors and industry peers in evaluating and comparing the performance of oil and gas companies. While single-year measurements are meaningful, we believe aberrations, causing both positive and negative results, will occur over the short term. +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. We sell the majority of our gas under contracts using first-of-the-month index pricing, which means gas produced in a given month is sold at the first-of-the-month price regardless of the spot price on the day the gas is produced. For assets where high BTU gas is sold at the wellhead, we also receive additional value for the higher energy content contained in the gas stream. Our NGL production is generally sold using contracts paying us a monthly average of the posted OPIS daily settlement prices, adjusted for processing, transportation, and location differentials. Our oil is sold using contracts paying us various industry posted prices, adjusted for basis differentials. We are paid the average of the daily settlement price for the respective posted prices for the period in which the product is sold, adjusted for quality, transportation, American Petroleum Institute (“API”) gravity, and location differentials. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effects of derivative settlements, unless otherwise indicated. +60 +The following table summarizes commodity price data, as well as the effects of derivative settlements as further discussed under the caption Derivative Activity below, for the years ended December 31, 2014 , 2013 , and 2012 : +For the Years Ended December 31, +2014 +2013 +2012 +Crude Oil (per Bbl): +Average NYMEX price +$ +93.03 +$ +97.99 +$ +94.10 +Realized price, before the effects of derivative settlements +$ +80.97 +$ +91.19 +$ +85.45 +Effects of derivative settlements +$ +1.71 +$ +(1.27 +) +$ +(1.93 +) +Natural Gas: +Average NYMEX price (per MMBtu) +$ +4.35 +$ +3.73 +$ +2.75 +Realized price, before the effects of derivative settlements (per Mcf) +$ +4.58 +$ +3.93 +$ +2.98 +Effects of derivative settlements (per Mcf) +$ +(0.18 +) +$ +0.21 +$ +0.50 +NGLs (per Bbl): +Average OPIS price +$ +38.93 +$ +40.44 +$ +44.91 +Realized price, before the effects of derivative settlements +$ +33.34 +$ +35.95 +$ +37.61 +Effects of derivative settlements +$ +0.84 +$ +0.71 +$ +1.29 +____________________________________________ +Note: Average OPIS prices per barrel of NGL, historical or strip, are based on a product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline for all periods presented. This product mix represents an industry standard composite barrel and does not necessarily represent our actual product mix for NGL production. Actual prices received for NGLs produced reflect our actual product mix. +While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location, and transportation differentials for these products. +We expect future prices for oil, gas, and NGLs to be volatile. In addition to supply and demand fundamentals, as a global commodity, the price of oil will continue to be impacted by real or perceived geopolitical risks in oil producing regions of the world, particularly the Middle East. The relative strength of the U.S. dollar compared to other currencies also could affect the price of oil. Lower forecasted levels of global economic growth combined with excess global supply have weighed on oil prices in recent months. This was exacerbated by the decision of the Organization of Petroleum Exporting Countries (“OPEC”) not to cut production in November of 2014. The supply of NGLs in the United States has continued to grow as a result of the number of industry participants targeting projects that produce these products in recent years, negatively impacting prices as demand is not as strong. The prices of several NGL products generally correlate to the price of oil and accordingly prices for these products have fallen in recent months and are likely to continue following that market. Gas prices have been under downward pressure for the past several years due to high levels of gas in storage. Longer term, we anticipate natural gas prices will trade in a range higher than current price levels. Changes to existing laws and regulations pertaining to the ability to export oil, gas, and NGLs also have the potential to impact the prices for these commodities. +61 +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs (same product mix as discussed under the table above) as of February 18, 2015 , and December 31, 2014 : +As of February 18, 2015 +As of December 31, 2014 +NYMEX WTI oil (per Bbl) +$ +57.14 +$ +56.57 +NYMEX Henry Hub gas (per MMBtu) +$ +3.05 +$ +3.06 +OPIS NGLs (per Bbl) +$ +23.80 +$ +20.95 +Derivative Activity +We use financial derivative instruments as part of our financial risk management program. We have a financial risk management policy governing our use of derivatives. The amount of our production covered by derivatives is driven by the amount of debt on our balance sheet and the level of capital commitments and long-term obligations we have in place. With our current derivative contracts, we believe we have established a base cash flow stream for our future operations and have partially reduced our exposure to volatility in commodity prices in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil and gas prices while also setting a price floor for a portion of our production. Please refer to Note 10 - Derivative Financial Instruments in Part II, Item 8 of this report for additional information regarding our oil, gas, and NGL derivatives. +The Dodd-Frank Act included provisions requiring over-the-counter derivative transactions to be cleared through clearinghouses and traded on exchanges. On July 10, 2012, the Commodity Futures Trading Commission (“CFTC”) and the SEC adopted final joint rules under Title VII of the Dodd-Frank Act, which define certain terms that determine what types of transactions will be subject to regulation under the Dodd-Frank Act swap rules. The issuance of these final rules also triggers compliance dates for a number of other final Dodd-Frank Act rules, including new rules proposed by the CFTC governing margin requirements for uncleared swaps entered into by non-bank swap entities, and new rules proposed by U.S. banking regulators regarding margin requirements for uncleared swaps entered into by bank swap entities. The ultimate effect on our business of these new rules and any additional regulations is currently uncertain. Under CFTC rules we believe our derivative activity will qualify for the non-financial, commercial end-user exception, which exempts derivatives intended to hedge or mitigate commercial risk entered into by entities predominantly engaged in non-financial activity from the mandatory swap clearing requirement. However, we are not certain whether the provisions of the final rules and regulations will exempt us from the requirements to post margin in connection with commodity price risk management activities. Final rules and regulations on major provisions of the legislation, such as new margin requirements, are to be established through regulatory rulemaking. Although we cannot predict the ultimate outcome of these rulemakings, new rules and regulations in this area may result in increased costs and cash collateral requirements for the types of derivative instruments we use to manage our financial risks related to volatility in oil, gas, and NGL commodity prices. +2014 Highlights +Operational Activities. The primary focus of our operated drilling activity this year was oil and NGL-rich gas projects, with the majority of our 2014 capital budget being deployed to the development of our Eagle Ford shale and Bakken/Three Forks programs. +In our operated Eagle Ford shale program in south Texas, we operated between four and five drilling rigs supported by two frac spreads during 2014. In 2014, our development program shifted to utilizing longer laterals and completions with higher sand loadings. Early results from these enhanced completion techniques suggest significantly improved well performance. +62 +In our non-operated Eagle Ford shale program, the operator ran nine to 10 drilling rigs in the first half of 2014 , but dropped to seven rigs in the third quarter. During the second quarter of 2014, the remainder of our carry under our Acquisition and Development Agreement with Mitsui was expended. At that time, we began accruing and funding our full share of drilling and completion costs for this program. +In our Bakken/Three Forks program, we operated three drilling rigs for most of 2014 and added two rigs during the fourth quarter. We focused on infill drilling of our Raven/Bear Den and Gooseneck properties in the North Dakota portion of the Williston Basin. We are monitoring the results of various tests, including drilling and completion optimizations, down-spacing of both our operated and non-operated properties, and we are testing the Bakken interval on our Gooseneck acreage. During 2014, we completed proved and unproved property acquisitions that added approximately 74,000 net acres in our Gooseneck area for a total of $410.1 million . +In our Permian program, we operated two drilling rigs during 2014 focused on horizontal testing and development of the Wolfcamp B interval in our Sweetie Peck property in Upton County, Texas. In our Buffalo prospect in Gaines and Dawson Counties, Texas, we are testing various target intervals, including the Wolfcamp B, Wolfcamp D, and lower Spraberry. +In our Powder River Basin program in Wyoming, we accelerated our delineation activity and expanded our acreage position by approximately 38,000 net acres through multiple acquisitions during 2014. We increased our rig count throughout 2014, exiting the year operating four drilling rigs. +We have an ongoing exploration program to acquire leasehold and test concepts in new plays. In 2014, we continued to evaluate our exploration area in east Texas. We completed the construction of a gathering system in this area at the end of 2014 to allow for longer-term production tests on wells we have drilled and completed. +Production Results. The table below provides a regional breakdown of our production for 2014 : +South Texas & Gulf Coast +Rocky +Mountain +Permian +Mid-Continent +Total (1) +Production: +Oil (MMBbl) +7.1 +7.4 +2.0 +0.1 +16.7 +Gas (Bcf) +121.6 +7.0 +4.5 +19.8 +152.9 +NGLs (MMBbl) +12.8 +0.1 +— +0.1 +13.0 +Equivalent (MMBOE) (1) +40.2 +8.7 +2.8 +3.5 +55.1 +Avg. Daily Equivalents (MBOE/d) +110.1 +23.9 +7.6 +9.5 +151.1 +Relative percentage +73 +% +16 +% +5 +% +6 +% +100 +% +____________________________________________ +(1) Totals may not sum or recalculate due to rounding. +We had record production in 2014 , which was primarily driven by the continued development of our Eagle Ford shale and Bakken/Three Forks programs. Please refer to Comparison of Financial Results and Trends between 2014 and 2013 below for additional discussion on production. +63 +Costs Incurred in Oil and Gas Producing Activities. Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended December 31, 2014 +(in millions) +Development costs +$ +1,782.3 +Exploration costs +288.3 +Acquisitions +Proved properties +272.9 +Unproved properties +368.2 +Total, including asset retirement obligation (1) +$ +2,711.7 +____________________________________________ +(1) Please refer to the section Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information in Part II, Item 8 of this report for additional discussion on the costs included in this table. +The majority of our drilling and completion costs incurred during 2014 were in our Eagle Ford shale and Bakken/Three Forks programs. During 2014 , we incurred $561.6 million to acquire proved and unproved properties in our Gooseneck area in North Dakota and in the Powder River Basin in Wyoming. Please refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +Divestiture Activity . During the second quarter of 2014, we divested certain non-strategic assets in the Williston Basin located in our Rocky Mountain region. Total cash proceeds received at closing (referred throughout this report as “divestiture proceeds”) were $50.1 million and the final gain on this divestiture was $26.9 million . Please refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +Impairment of Proved and Unproved Properties. We recorded impairment of proved properties expense of $84.5 million and abandonment and impairment of unproved properties expense of $75.6 million for the year ended December 31, 2014 . This was a result of the significant decline in commodity prices in late 2014 and recognition of the outcomes of exploration and delineation wells in certain prospects in our South Texas & Gulf Coast and Permian regions. +2022 Notes. During 2014, we issued $600.0 million in aggregate principal amount of 6.125% Senior Notes. The notes were issued at par and mature on November 15, 2022 . We received net proceeds of $590.0 million from this issuance, which we used to repay outstanding borrowings under our credit facility and for general corporate purposes. Please refer to Note 5 - Long-term Debt in Part II, Item 8 of this report for additional discussion. +Revolving Credit Facility. In the fourth quarter of 2014, the borrowing base under our credit facility was increased by our lenders to $2.4 billion from $2.2 billion . Additionally, in December 2014 we entered into a Second Amendment to the Fifth Amended and Restated Credit Agreement with our lenders, which resulted in an extension of the maturity date to December 10, 2019 , and an increase in current aggregate lender commitments to $1.5 billion . Please refer to Overview of Liquidity and Capital Resources below for additional discussion of our credit facility. +Marketing of Properties. Subsequent to December 31, 2014, we announced our plan to exit the Mid-Continent region and began marketing our assets in the Arkoma Basin of Oklahoma and in the Arklatex area of east Texas and northern Louisiana. +64 +Outlook for 2015 +We view 2015 as a year of transition as the broader oil and gas industry adjusts to lower oil prices. Exploration and production companies are reducing drilling and completion activity, which we expect to result in service companies lowering the price for their services. Our plan for 2015 is to scale back activity over the course of the year while preserving the value of our assets and protecting the strength of our balance sheet. Our goal is to be well positioned entering 2016 in what we expect will be a stronger commodity price and lower service cost environment, while having the strength and flexibility to adapt should industry conditions worsen. +Our capital program for 2015 will be approximately $1.2 billion, of which $1.0 billion will be invested in drilling and completion activities. We expect to focus 85 percent of our drilling and completion capital on our core development programs in the Eagle Ford shale and the Bakken/Three Forks formations. +In our operated Eagle Ford shale program, we expect to invest approximately $470 million in drilling and completion activities in 2015. Our plan is to operate four drilling rigs for the majority of the year and to complete wells in a manner that allows us to take advantage of cost reductions currently being realized and expected to continue throughout 2015 and into 2016. We expect we will continue to test the potential of the upper Eagle Ford interval throughout the year. +In our outside-operated Eagle Ford shale program, we expect to invest approximately $135 million for drilling and completion activities in 2015. Our expectation is that the operator will slow the pace of development in 2015. As our carry with Mitsui was fully utilized in 2014, we will be responsible for funding our share of the costs for this program in 2015. +We plan to invest $255 million in our Bakken/Three Forks program in 2015 for drilling and completion activities, approximately 75 percent of which will be on operated properties. We expect to reduce operated drilling activity over the course of the year from a five rig program at the beginning of the year to a two rig program by year-end. We plan to focus more of our activity in our Gooseneck area in Divide County, North Dakota in 2015 to develop and delineate acreage that we added in 2014. +Given current industry conditions, we are scaling back activity in our delineation and exploration programs in 2015. We expect our activity in the Powder River Basin, the Permian Basin, and east Texas will be reduced, and we will focus on preserving those acreage positions. +We currently expect our 2015 capital program to be funded by cash flows from operations and proceeds from planned divestitures, supplemented by borrowings under our credit facility. Please refer to Overview of Liquidity and Capital Resources below for additional discussion. +65 +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the quarter ended December 31, 2014 , and the immediately preceding three quarters. A detailed discussion follows. +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2014 +2014 +2014 +2014 +(in millions, except for production data) +Production (MMBOE) +16.2 +13.1 +13.4 +12.5 +Oil, gas, and NGL production revenue +$ +586.6 +$ +617.2 +$ +654.7 +$ +623.1 +Lease operating expense +$ +75.3 +$ +66.5 +$ +62.8 +$ +57.0 +Transportation costs +$ +93.4 +$ +81.5 +$ +83.0 +$ +79.2 +Production taxes +$ +27.5 +$ +30.4 +$ +31.8 +$ +27.5 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +219.3 +$ +183.3 +$ +187.8 +$ +177.2 +Exploration +$ +49.7 +$ +34.6 +$ +24.3 +$ +21.3 +General and administrative +$ +52.2 +$ +41.7 +$ +38.1 +$ +35.1 +Net income +$ +331.7 +$ +208.9 +$ +59.8 +$ +65.6 +____________________________________________ +Note: Quarterly amounts may not calculate to annual amounts due to rounding. +Selected Performance Metrics: +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2014 +2014 +2014 +2014 +Average net daily production equivalent (MBOE per day) +175.8 +142.5 +147.0 +138.6 +Lease operating expense (per BOE) +$ +4.66 +$ +5.07 +$ +4.69 +$ +4.58 +Transportation costs (per BOE) +$ +5.77 +$ +6.22 +$ +6.20 +$ +6.35 +Production taxes as a percent of oil, gas, and NGL production revenue +4.7 +% +4.9 +% +4.9 +% +4.4 +% +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) +$ +13.56 +$ +13.97 +$ +14.03 +$ +14.21 +General and administrative (per BOE) +$ +3.23 +$ +3.18 +$ +2.85 +$ +2.81 +____________________________________________ +Note: Amounts may not recalculate due to rounding. +66 +A year-to-year overview of selected production and financial information, including trends: +For the Years Ended December 31, +Amount Change Between +Percent Change Between +2014 +2013 +2012 +2014/2013 +2013/2012 +2014/2013 +2013/2012 +Net production volumes (1) +Oil (MMBbl) +16.7 +13.9 +10.4 +2.7 +3.6 +19 +% +34 +% +Gas (Bcf) +152.9 +149.3 +120.0 +3.6 +29.3 +2 +% +24 +% +NGLs (MMBbl) +13.0 +9.5 +6.1 +3.5 +3.4 +37 +% +55 +% +Equivalent (MMBOE) (2) +55.1 +48.3 +36.5 +6.8 +11.8 +14 +% +32 +% +Average net daily production (1) +Oil (MBbl per day) +45.6 +38.2 +28.3 +7.4 +9.9 +19 +% +35 +% +Gas (MMcf per day) +419.0 +409.2 +328.0 +9.8 +81.2 +2 +% +25 +% +NGLs (MBbl per day) +35.6 +26.0 +16.7 +9.6 +9.3 +37 +% +56 +% +Equivalent (MBOE per day) (2) +151.1 +132.4 +99.7 +18.6 +32.7 +14 +% +33 +% +Oil, gas, and NGL production revenue (in millions) +Oil production revenue +$ +1,348.3 +$ +1,271.5 +$ +886.2 +$ +76.8 +$ +385.3 +6 +% +43 +% +Gas production revenue +699.8 +586.3 +357.7 +113.5 +228.6 +19 +% +64 +% +NGL production revenue +433.4 +341.8 +230.0 +91.6 +111.8 +27 +% +49 +% +Total +$ +2,481.5 +$ +2,199.6 +$ +1,473.9 +$ +281.9 +$ +725.7 +13 +% +49 +% +Oil, gas, and NGL production expense (in millions) +Lease operating expense +$ +261.6 +$ +233.0 +$ +180.1 +$ +28.6 +$ +52.9 +12 +% +29 +% +Transportation costs +337.1 +258.2 +138.9 +78.9 +119.3 +31 +% +86 +% +Production taxes +117.2 +105.8 +72.9 +11.4 +32.9 +11 +% +45 +% +Total +$ +715.9 +$ +597.0 +$ +391.9 +$ +118.9 +$ +205.1 +20 +% +52 +% +Realized price +Oil (per Bbl) +$ +80.97 +$ +91.19 +$ +85.45 +$ +(10.22 +) +$ +5.74 +(11 +)% +7 +% +Gas (per Mcf) +$ +4.58 +$ +3.93 +$ +2.98 +$ +0.65 +$ +0.95 +17 +% +32 +% +NGLs (per Bbl) +$ +33.34 +$ +35.95 +$ +37.61 +$ +(2.61 +) +$ +(1.66 +) +(7 +)% +(4 +)% +Per BOE (2) +$ +45.01 +$ +45.50 +$ +40.39 +$ +(0.49 +) +$ +5.11 +(1 +)% +13 +% +Per BOE data (2) +Production costs: +Lease operating expense +$ +4.74 +$ +4.82 +$ +4.93 +$ +(0.08 +) +$ +(0.11 +) +(2 +)% +(2 +)% +Transportation costs +$ +6.11 +$ +5.34 +$ +3.81 +$ +0.77 +$ +1.53 +14 +% +40 +% +Production taxes +$ +2.13 +$ +2.19 +$ +2.00 +$ +(0.06 +) +$ +0.19 +(3 +)% +10 +% +General and administrative +$ +3.03 +$ +3.09 +$ +3.28 +$ +(0.06 +) +$ +(0.19 +) +(2 +)% +(6 +)% +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +13.92 +$ +17.02 +$ +19.95 +$ +(3.10 +) +$ +(2.93 +) +(18 +)% +(15 +)% +Derivative settlement gain (3) +$ +0.22 +$ +0.42 +$ +1.32 +$ +(0.20 +) +$ +(0.90 +) +(48 +)% +(68 +)% +Earnings per share information +Basic net income (loss) per common share +$ +9.91 +$ +2.57 +$ +(0.83 +) +$ +7.34 +$ +3.40 +286 +% +410 +% +Diluted net income (loss) per common share +$ +9.79 +$ +2.51 +$ +(0.83 +) +$ +7.28 +$ +3.34 +290 +% +402 +% +Basic weighted-average common shares outstanding (in thousands) +67,230 +66,615 +65,138 +615 +1,477 +1 +% +2 +% +Diluted weighted-average common shares outstanding (in thousands) +68,044 +67,998 +65,138 +46 +2,860 +— +% +4 +% +67 +____________________________________________ +(1) Amounts and percentage changes may not recalculate due to rounding. +(2) 2012 equivalent volumes and per-unit metrics have been conformed to current year presentation on a BOE basis rather than an MCFE basis. +(3) We discontinued hedge accounting on January 1, 2011. As a result, fair values at December 31, 2010, were frozen in accumulated other comprehensive loss (“AOCL”) and were reclassified into earnings as the original derivative transactions settled, the last of which settled in the third quarter of 2013. For the years ended December 31, 2013, and 2012, derivative settlements are included within the other operating revenues and derivative gain line items in the accompanying statements of operations. All derivative settlements for the year ended December 31, 2014, are included within the derivative gain line item only. +We present per BOE information because we use this information to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis. Average daily production for the year ended December 31, 2014 , increased 14 percent compared to the same period in 2013 , driven by continued development of our Eagle Ford shale assets. Please refer to Comparison of Financial Results and Trends between 2014 and 2013 below for additional discussion on changes in our production mix in 2014 . +Changes in production volumes, revenues, and costs reflect the highly volatile nature of our industry. Our realized price on a per BOE basis for the year ended December 31, 2014 , decreased slightly compared to the same period in 2013 . Our derivative contracts had a favorable impact on our average realized price, after the effects of derivative settlements, in the last half of 2014 in light of the significant decline in commodity prices. +Lease operating expense (“LOE”) on a per BOE basis for the year ended December 31, 2014 , decreased two percent compared to the same period in 2013 . Overall, LOE increased; however, production increased at a faster rate, resulting in reduced LOE on a per BOE basis. We experience volatility in our LOE as a result of seasonality in workover expense and the impact that industry activity has on service provider costs. For 2015, we expect a decrease in service provider costs in response to the weak commodity price environment. We anticipate an increase in production in 2015 based on our forecasted drilling plan. Both of these projected trends are expected to drive our LOE on a per BOE basis down in 2015. +Transportation costs on a per BOE basis for the year ended December 31, 2014 , increased 14 percent compared to the same period in 2013 . Our Eagle Ford shale program has meaningfully higher transportation expense per unit of production compared to our other regions. Ongoing development of the Eagle Ford shale program has resulted in production from these assets becoming a larger portion of our total production, thereby increasing company-wide transportation expense per BOE over time. The run-rate of our per unit transportation cost in the Eagle Ford shale program increased in 2014 due to incremental compression charges and increased variable fuel costs associated with higher natural gas prices. Additionally, our transportation arrangements have shifted over the years to contracts that have more favorable terms for product prices but also include higher transportation fees. We expect this upward trend in transportation costs on a per BOE basis to continue in 2015. +Production taxes on a per BOE basis for the year ended December 31, 2014 , decreased three percent compared to the same period in 2013 . We generally expect absolute production tax expense to trend with oil, gas, and NGL production revenue. Product mix, the location of production, and incentives to encourage oil and gas development can all impact or change the amount of production tax we recognize. +General and administrative expense on a per BOE basis for the year ended December 31, 2014 , decreased two percent compared to the same period in 2013 , as production increased at a faster rate than our general and administrative expense. A portion of our general and administrative expense is linked to our profitability and cash flow, which are driven in large part by the realized commodity prices we receive for our production. A portion of our short-term incentive compensation correlates with net cash flows and therefore is subject to variability. In 2015, we expect general and administrative expense on a per BOE basis will decrease, as we anticipate production will continue to increase at a faster rate than our increase in absolute general and administrative expense. +68 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion ( “DD&A”) expense, for the year ended December 31, 2014 , decreased 18 percent , on a per BOE basis, compared to the same period in 2013 . Our DD&A rate can fluctuate as a result of impairments, planned and closed divestitures, and changes in the mix of our production and the underlying proved reserve volumes. Our DD&A rate has decreased as assets with lower finding and development costs have become a larger portion of our total production mix. Our finding and development costs have benefited from a general decrease in well costs and an increase in recoveries per well, as well as from our outside-operated Eagle Ford shale program, where, for the last several years and throughout the first half of 2014, we added reserves with minimal associated costs due to our carry with Mitsui under our Acquisition and Development Agreement. This carry was exhausted during the second quarter of 2014. We expect our DD&A rate to increase in future periods as we begin to record our full share of costs in our outside-operated Eagle Ford shale program, which will increase our depletable asset base. Please refer to Note 12 - Acquisition and Development Agreement in Part II, Item 8 of this report for additional discussion on the Mitsui transaction. +Please refer to Comparison of Financial Results and Trends between 2014 and 2013 for additional discussion on oil, gas, and NGL production expense, DD&A expense, and general and administrative expense. +Please refer to the section Earnings per Share in Note 1 - Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion on the types of shares included in our basic and diluted net income (loss) per common share calculations. We recorded a net loss for the year ended December 31, 2012 . Consequently, our in-the-money stock options, unvested RSUs, and contingent PSUs were anti-dilutive for the year ended December 31, 2012, resulting in an increase in the diluted weighted-average common shares outstanding for the year ended December 31, 2013, when compared to 2012. +Comparison of Financial Results and Trends between 2014 and 2013 +Oil, gas, and NGL production. The following table presents the regional changes in our production and oil, gas, and NGL production revenues and production costs between the years ended December 31, 2014 , and 2013 : +Average Net Daily Production Added (Lost) +Oil, Gas & NGL Revenue Added (Lost) +Production Costs Increase (Decrease) +(MBOE/d) +(in millions) +(in millions) +South Texas & Gulf Coast +25.5 +$ +359.1 +$ +104.3 +Rocky Mountain +3.6 +40.6 +31.0 +Permian +1.0 +7.2 +(0.5 +) +Mid-Continent +(11.5 +) +(125.0 +) +(15.9 +) +Total +18.6 +$ +281.9 +$ +118.9 +The significant production growth in our Eagle Ford shale program far exceeded the production decrease in our Mid-Continent region, which resulted from the divestiture of our assets in the Anadarko Basin in December 2013. +A 14 percent increase in production on an equivalent basis combined with a one percent decrease in realized price per BOE resulted in a 13 percent increase in revenue between the two periods. Based on our planned drilling and completion activity, we expect production volumes to increase in 2015 . We expect our realized price, before the effects of derivative settlements, to trend with commodity prices. +69 +Gain (loss) on divestiture activity. We recorded a net gain on divestiture activity of $646,000 for the year ended December 31, 2014 , compared with a net gain of $28.0 million in 2013 . The net gain on divestiture activity for the year ended December 31, 2014, is due to a gain realized on the sale of non-strategic properties in the Williston Basin in our Rocky Mountain region during the second quarter of 2014 of $26.9 million , which was mostly offset by write downs recorded on assets classified as held for sale in the second and third quarters of 2014. The net gain on divestiture activity for the year ended December 31, 2013, is largely due to gains recorded on the divestiture of certain assets in our Mid-Continent and Rocky Mountain regions slightly offset by a loss recorded on the divestiture of non-strategic assets in our Permian region. We will continue to evaluate our portfolio to determine whether there are non-strategic properties we could divest. Please refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +Marketed gas system revenue and expense. Marketed gas system revenue decreased to $24.9 million for the year ended December 31, 2014 , compared with $60.0 million for the comparable period of 2013 . Concurrent with the decrease in marketed gas system revenue, marketed gas system expense decreased to $24.5 million for the year ended December 31, 2014 , from $57.6 million for the comparable period of 2013 . The decrease occurred primarily as a result of the divestiture of our assets in the Anadarko Basin in December 2013, which reduced marketed gas volumes and the overall significance of marketed gas system revenues and expenses. We expect marketed gas revenue and expense to correlate with changes in production and our realized gas price throughout 2015. Subsequent to December 31, 2014, we announced our plan to exit the Mid-Continent region and sell our Arkoma Basin and Arklatex assets. If we successfully divest these assets, our marketed gas volumes will be eliminated. +Other operating revenues. Other operating revenues increased to $15.2 million for the year ended December 31, 2014 , compared with $5.8 million for the comparable period of 2013 . We recorded a $10.7 million gain in the second quarter of 2014 related to our settlement with Endeavour Operating Corporation (“Endeavour”), in which we, our working interest partners, and Endeavour agreed to mutually release all claims and dismiss certain litigation in exchange for certain cash payments and other consideration. +Oil, gas, and NGL production expense. Total production costs increased $118.9 million , or 20 percent , to $715.9 million for the year ended December 31, 2014 , compared with $597.0 million in 2013 , primarily due to a 14 percent increase in production volumes on a per BOE basis, as well as an overall increase in transportation costs in our South Texas & Gulf Coast region. Please refer to the caption A year-to-year overview of selected production and financial information, including trends above for discussion of production costs on a per BOE basis. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion. DD&A expense decreased seven percent to $767.5 million in 2014 compared with $822.9 million in 2013 . Please refer to our caption A year-to-year overview of selected production and financial information, including trends above for discussion of DD&A expense on a per BOE basis. +Exploration. The components of exploration expense are summarized as follows: +For the Years Ended December 31, +2014 +2013 +Summary of Exploration Expense +(in millions) +Geological and geophysical expenses +$ +11.4 +$ +4.3 +Exploratory dry hole +44.4 +5.8 +Overhead and other expenses +74.1 +64.0 +Total +$ +129.9 +$ +74.1 +70 +Exploration expense for 2014 increased 75 percent compared with the same period in 2013 mainly due to expensing three exploratory dry holes in certain prospects in our South Texas & Gulf Coast region in 2014. An exploratory project resulting in non-commercial quantities of oil, gas, or NGLs is deemed an exploratory dry hole and impacts the amount of exploration expense we record. We have an active exploration program, which can result in periodic dry hole expense. During the first quarter of 2014, we performed a seismic study in our Powder River Basin program, which resulted in increased geological and geophysical (“G&G”) expenses year over year. We have also experienced an overall increase in exploration overhead. +Impairment of proved properties. We recorded impairment of proved properties expense of $84.5 million for the year ended December 31, 2014 . The impairments recorded in 2014 were a result of the significant decline in commodity prices in late 2014 and recognition of the outcomes of exploration and delineation wells in certain prospects in our South Texas & Gulf Coast and Permian regions. We recorded impairment of proved properties expense of $172.6 million for the comparable period in 2013 as a result of negative engineering revisions on our Mississippian limestone assets in our Permian region at the end of the year, the commencement of a plugging and abandonment program of dry gas assets in the Olmos interval in our South Texas & Gulf Coast region, and our decision to no longer pursue the development of certain under-performing assets during the year. Future crude oil, natural gas, and NGL price declines, downward engineering revisions, or unsuccessful exploration efforts may result in additional proved property impairments. +Abandonment and impairment of unproved properties. We recorded abandonment and impairment of unproved properties expense of $75.6 million for the year ended December 31, 2014 , related to acreage we no longer intended to develop as a result of exploration and delineation activities and changes to our drilling plans in light of the recent decline in commodity prices. We recorded $46.1 million of abandonment and impairment of unproved properties expense for the comparable period in 2013 , the majority of which related to acreage we no longer intended to develop in our Permian region. We expect our abandonment and impairment of unproved properties expense to fluctuate with the timing of lease expirations, unsuccessful exploration activities, and changes in drilling plans if commodity prices remain low. +General and administrative. General and administrative expense increased to $167.1 million for the year ended December 31, 2014 , compared with $149.6 million for the same period in 2013 . The increase is due to an increase in employee headcount during 2014 , which resulted in increased base compensation, benefits, and general corporate office expenses. Please refer to our caption A year-to-year overview of selected production and financial information, including trends above for discussion of general and administrative costs on a per BOE basis. +Change in Net Profits Plan liability. This non-cash expense (benefit) generally relates to the change in the estimated value of the associated liability between the reporting periods. For 2014 , we recorded a non-cash benefit of $29.8 million compared to a non-cash benefit of $21.8 million in 2013 . The increase in the benefit between these two periods is mostly due to the decrease in commodity strip pricing as of December 31, 2014, as compared to December 31, 2013. The change in our liability is subject to estimation and may change from period to period based on assumptions used for production rates, reserve quantities, commodity pricing, discount rates, and production costs. We generally expect the change in our Net Profits Plan liability to correlate with fluctuations in commodity prices. +Derivative gain. We recognized a derivative gain of $583.3 million for the year ended December 31, 2014 , consisting of a $12.6 million gain on settlements and a $570.7 million increase in the fair value of commodity derivative contracts driven by the significant decline in oil and gas commodity strip pricing in the fourth quarter of 2014. This compares to a net derivative gain of $3.1 million for the same period in 2013 , which consists of a $22.1 million gain on settlements and a $19.0 million decrease in the fair value of commodity derivative contracts during the period. Please refer to Note 10 - Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +71 +Other operating expenses. Other operating expenses were $4.7 million in 2014 compared with $30.1 million in 2013 . In 2013, other operating expenses included $23.1 million of expenses related to an agreed clarification concerning royalty payment provisions of various leases on certain South Texas & Gulf Coast acreage. +Income tax (expense) benefit. We recorded income tax expense of $398.6 million for 2014 compared to income tax expense of $107.7 million for 2013 , resulting in effective tax rates of 37.4 percent and 38.6 percent , respectively. The increase in tax expense for the year ended December 31, 2014, generally trends with the increase in net income. The net decrease in tax rate is partially attributable to our 2013 Anadarko Basin divestiture which caused a decrease in the composition of our blended state tax rate for future years offset by an increase in our valuation allowance on state net operating losses in 2014. However, state cash taxes are lower as a result of a decrease in estimated Texas margin tax. Please refer to Note 4 - Income Taxes in Part II, Item 8 of this report for additional discussion. State apportionment factor changes in 2015 and the likelihood we will file amended returns to claim additional research and development (“R&D”) credits are expected to result in a lower effective tax rate in 2015. +Comparison of Financial Results and Trends between 2013 and 2012 +Oil, gas and NGL production. The following table presents the regional changes in our production and oil, gas, and NGL production revenues and production costs between the years ended December 31, 2013 and 2012 : +Average Net Daily Production Added (Lost) +Oil, Gas & NGL Revenue Added +Production Costs Increase (Decrease) +(MBOE/d) +(in millions) +(in millions) +South Texas & Gulf Coast +33.4 +$ +515.5 +$ +159.2 +Rocky Mountain +3.4 +136.6 +28.7 +Permian +1.4 +51.6 +19.4 +Mid-Continent +(5.5 +) +22.0 +(2.2 +) +Total +32.7 +$ +725.7 +$ +205.1 +The largest regional production increase in 2013 occurred in our South Texas & Gulf Coast region as a result of drilling activity in our Eagle Ford shale program. The increase in oil and gas prices caused an increase in oil, gas, and NGL production revenue in our Mid-Continent region between the years ended December 31, 2013, and 2012, despite a decrease in production volumes attributable to base decline. +A 32 percent increase in production on an equivalent basis combined with a 13 percent increase in realized price per BOE resulted in a 49 percent increase in revenue between the two periods. +Gain (loss) on divestiture activity. We recorded a net gain on divestiture activity of $28.0 million for the year ended December 31, 2013 , compared with a net loss of $27.0 million for the comparable period of 2012. The net gain on divestiture activity for the year ended December 31, 2013, was largely due to gains recorded on the divestiture of certain assets in our Mid-Continent and Rocky Mountain regions slightly offset by a loss recorded on the divestiture of non-strategic assets in our Permian region. The net loss for the year ended December 31, 2012, was due to an unsuccessful property sale effort and the corresponding write-down of those assets held for sale to their fair value. This loss was partially offset by a net gain on completed divestitures. Please refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +Marketed gas system revenue and expense. Marketed gas system revenue increased to $60.0 million for the year ended December 31, 2013 , compared with $52.8 million for the comparable period of 2012 , as a result of an increase in gas prices. Concurrent with the increase in marketed gas system revenue, marketed gas system expense increased to $57.6 million for the year ended December 31, 2013 , from $47.6 million for the comparable period of +72 +2012. The decrease in our net margin was due to an increase in gathering fees paid to third parties, which went into effect in the second half of 2012. +Oil, gas, and NGL production expense. Total production costs increased $205.1 million , or 52 percent , to $597.0 million for the year ended December 31, 2013 , compared with $391.9 million in 2012 , primarily due to a 32 percent increase in production volumes on a per BOE basis, as well as an overall increase in transportation costs in our South Texas & Gulf Coast region. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion. DD&A expense increased 13 percent to $822.9 million in 2013 , compared with $727.9 million in 2012 , as a result of the continued development of our Eagle Ford and Bakken/Three Forks assets and the associated growth in our production, partially offset by the sale of our Anadarko Basin properties that were classified as held for sale at the beginning of the third quarter of 2013. +Exploration. The components of exploration expense are summarized as follows: +For the Years Ended December 31, +2013 +2012 +Summary of Exploration Expense +(in millions) +Geological and geophysical expenses +$ +4.3 +$ +13.6 +Exploratory dry hole +5.8 +20.9 +Overhead and other expenses +64.0 +55.7 +Total +$ +74.1 +$ +90.2 +Exploration expense for 2013 decreased 18 percent compared with the same period in 2012 as a result of decreased G&G due to a large seismic study conducted in the first quarter of 2012 and fewer exploratory dry holes expensed in 2013, partially offset by an increase in exploration overhead in 2013 mainly due to an increase in performance-based compensation. +Impairment of proved properties. We recorded impairment of proved properties expense of $172.6 million for the year ended December 31, 2013 . The impairments in 2013 were a result of negative engineering revisions on Mississippian limestone assets in our Permian region at the end of the year, the commencement of a plugging and abandonment program of dry gas assets in the Olmos interval in our South Texas & Gulf Coast region, and our decision to no longer pursue the development of certain under-performing assets during the year. We recorded impairment of proved properties expense of $208.9 million for the comparable period in 2012 related to write-downs of our Wolfberry assets in our Permian region due to downward engineering revisions, as well as write-downs of our Haynesville shale assets due to low natural gas prices. +Abandonment and impairment of unproved properties. We recorded abandonment and impairment of unproved properties expense of $46.1 million for the year ended December 31, 2013 , the majority of which related to acreage we no longer intended to develop in our Permian region. We recorded $16.3 million of abandonment and impairment of unproved properties expense for the comparable period in 2012, the majority of which related to acreage we no longer intended to develop in our Rocky Mountain and Mid-Continent regions. +General and administrative. General and administrative expense increased to $149.6 million for the year ended December 31, 2013 , compared with $119.8 million for the same period in 2012 . The increase was due to an increase in performance-based compensation that reflects exceeding our performance metrics, as well as an increase in employee headcount during 2013, which resulted in increased base compensation, benefits, and general corporate office expenses. These were slightly offset by an increase in COPAS overhead reimbursement as a result of an increase in operated well count. +73 +Change in Net Profits Plan liability. For 2013 , we recorded a non-cash benefit of $21.8 million compared to a non-cash benefit of $28.9 million in 2012 . Please refer to Comparison of Financial Results and Trends between 2014 and 2013 above for additional discussion on the assumptions used in estimating the liability. +Derivative gain. We recognized a derivative gain of $3.1 million for the year ended December 31, 2013 , which was comprised of a $22.1 million gain on settlements and a $19.0 million decrease in the fair value of commodity derivative contracts during the period. This compares to a gain of $55.6 million for the same period in 2012 , which consisted of a $44.3 million gain on settlements and an $11.4 million increase in the fair value of commodity derivative contracts during the period. Please refer to Note 10 - Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Other operating expenses. Other operating expenses were $30.1 million in 2013 compared with $7.0 million in 2012 . In 2013, other operating expenses included $23.1 million of expenses related to an agreed clarification concerning royalty payment provisions of various leases on certain South Texas & Gulf Coast acreage. +Income tax (expense) benefit. We recorded income tax expense of $107.7 million for 2013 compared to income tax benefit of $29.3 million for 2012 , resulting in effective tax rates of 38.6 percent and 35.0 percent , respectively. The 2013 rate increase resulted primarily from the Anadarko Basin divestiture that closed at the end of 2013, which caused a shift in anticipated recognition of future state tax benefits from a state with a higher applicable state rate to states with lower applicable rates. A combination of lower enacted state income tax rates during the year and a shift between states of our anticipated future apportioned income caused a decrease in our overall state rate which partially offset the increase. Other factors impacting our effective tax rate between tax years include decreased impact for valuation allowances, a decreased impact in benefit from the R&D credit, and to a much lesser extent, net decreases resulting from the differing effects of percentage depletion and other permanent differences. +Overview of Liquidity and Capital Resources +We believe we have sufficient liquidity and capital resources to execute our business plan for the foreseeable future. We continue to manage the duration and level of our drilling and completion service commitments in order to provide expected flexibility to reduce activity and capital expenditures in periods of prolonged commodity price decline. +Sources of cash +We currently expect our 2015 capital program to be funded by cash flows from operations and proceeds from planned divestitures, supplemented by borrowings under our credit facility. Although we anticipate that cash flows from these sources will be sufficient to fund our expected 2015 capital program, we may also elect to access the capital markets, depending on prevailing market conditions, as well as divest of additional non-strategic oil and gas properties to provide additional sources of funding. From time to time, we may enter into carrying cost funding and sharing arrangements with third parties for particular exploration and/or development programs. All of our sources of liquidity can be impacted by the general condition of the broader economy and by fluctuations in commodity prices, operating costs, and volumes produced, all of which affect us and our industry. We have no control over the market prices for oil, gas, or NGLs, although we are able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of derivative contracts as part of our commodity price risk management program. Historically, decreases in commodity prices have limited our industry’s access to capital markets. The borrowing base under our credit facility could be reduced as a result of lower commodity prices, divestitures of proved properties, or newly issued debt. See Credit facility below for a discussion of our most recent borrowing base redetermination. +In the fourth quarter of 2014, we issued $600.0 million in aggregate principal amount of 2022 Notes and amended our credit facility agreement, resulting in an extended maturity date and an increased aggregate lender commitment amount. +74 +In late 2011, we consummated our Acquisition and Development Agreement with Mitsui, pursuant to which Mitsui funded, or carried, 90 percent of certain drilling and completion costs attributable to our remaining interest in our non-operated Eagle Ford shale acreage until $680.0 million was expended on our behalf. Our remaining 10 percent was funded over the carry period with the reimbursement of net costs paid attributable to the transferred interest during the period between the effective date and the closing date. The remaining carry was utilized during the second quarter of 2014, at which point we became responsible for funding our share of drilling and completion costs. +Proposals to reform the Internal Revenue Code (“IRC”), which include eliminating or reducing current tax deductions for intangible drilling costs, depreciation of equipment acquisition costs, the domestic production activities deduction, percentage depletion, and other deductions which reduce our taxable income, continue to circulate. We expect that future legislation modifying or eliminating these deductions would reduce net operating cash flows over time, thereby reducing funding available for our exploration and development capital programs, as well as funding available to our peers in the industry for similar programs. If enacted, these funding reductions could have a significant adverse effect on drilling in the United States for a number of years. +Credit facility +During the fourth quarter of 2014, we and our lenders entered into a Second Amendment to our Fifth Amended and Restated Credit Agreement. As amended, the credit facility has a maximum loan amount of $2.5 billion , current aggregate lender commitments of $1.5 billion , and a maturity date of December 10, 2019 . On October 6, 2014 , the lending group redetermined the Company's borrowing base under the credit facility and increased it from $2.2 billion to $2.4 billion . The subsequent amendment to the credit facility specified that the borrowing base would not be reduced by the issuance of the 2022 Notes and will remain at $2.4 billion until the next scheduled redetermination date of April 1, 2015 . The borrowing base redetermination process under the credit facility considers the value of the Company’s proved oil and gas properties, as determined by the lender group. We believe the current commitment amount is sufficient to meet our anticipated liquidity and operating needs. No individual bank participating in our credit facility represents more than 10 percent of the lending commitments under the credit facility. Borrowings under our credit facility are secured by mortgages on at least 75 percent of the value of our proved oil and gas properties. Please refer to Note 5 - Long-term Debt in Part II, Item 8 of this report for additional discussion as well as the presentation of the outstanding balance, total amount of letters of credit, and available borrowing capacity under our credit facility as of February 18, 2015 , December 31, 2014 , and December 31, 2013 . +We are subject to customary covenants under our credit facility, including limitations on dividend payments and requirements to maintain certain financial ratios, which include debt to adjusted EBITDAX, as defined by our credit agreement as the ratio of debt to 12-month trailing adjusted EBITDAX, of less than 4.0 and an adjusted current ratio, as defined by our credit agreement, of no less than 1.0. Please refer to the caption Non-GAAP Financial Measures below. As of the filing date of this report, we are in compliance with all financial and non-financial covenants under our credit facility. +Operating cash flow and cash received from the divestiture of properties were sufficient in meeting our capital expenditure needs through the first half of 2014. During the third quarter of 2014, we began to draw upon our credit facility, primarily to fund acquisitions of oil and gas properties. Our daily weighted-average credit facility debt balance was approximately $86.6 million and $192.4 million for the years ended December 31, 2014 , and 2013 , respectively. Our daily weighted-average credit facility balance was lower throughout 2014 as a result of proceeds received from property divestitures in the fourth quarter of 2013. In addition, we used the proceeds from our 2022 Notes to reduce our credit facility balance in the fourth quarter of 2014. Cash flows provided by our operating activities, proceeds received from divestitures of properties, and the amount of our capital expenditures all impact the amount we have borrowed under our credit facility. +75 +Weighted-average interest rates +Our calculated weighted-average interest rates include paid and accrued interest, fees on the unused portion of the credit facility’s aggregate commitment amount, letter of credit fees, and the non-cash amortization of deferred financing costs. Additionally, our 2012 weighted-average interest rate includes amortization of the debt discount related to our 3.50% Senior Convertible Notes due 2027 (the “3.50% Senior Convertible Notes”). Our calculated weighted-average borrowing rates include paid and accrued interest only . +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2014 , 2013 , and 2012 . +For the Years Ended December 31, +2014 +2013 +2012 +Weighted-average interest rate +6.5 +% +6.3 +% +6.4 +% +Weighted-average borrowing rate +5.9 +% +5.7 +% +5.5 +% +Our weighted-average interest rates and weighted average borrowing rates for the years ended December 31, 2014 , 2013 , and 2012 , have been impacted by the timing of Senior Notes issuances in 2014 and prior years, the average balance on our revolving credit facility, and the fees paid on the unused portion of our aggregate commitment. +Uses of cash +We use cash for the acquisition, exploration, and development of oil and gas properties and for the payment of operating and general and administrative costs, income taxes, dividends, and debt obligations, including interest. Expenditures for the exploration and development of oil and gas properties are the primary use of our capital resources. During 2014 , we spent $2.5 billion for exploration and development capital activities and proved and unproved oil and gas property acquisitions. These amounts differ from the cost incurred amounts, which are accrual-based and include asset retirement obligation, G&G, and exploration overhead amounts. +The amount and allocation of future capital expenditures will depend upon a number of factors, including the number and size of acquisition opportunities, our cash flows from operating, investing, and financing activities, and our ability to assimilate acquisitions and execute our drilling program. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, and the timing and results of our operated and non-operated development and exploratory activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget to assess changes in current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. +We may from time to time repurchase certain amounts of our outstanding debt securities for cash and/or through exchanges for other securities. Such repurchases or exchanges may be made in open market transactions, privately negotiated transactions, or otherwise. Any such repurchases or exchanges will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. +As of the filing date of this report, we could repurchase up to 3,072,184 shares of our common stock under our stock repurchase program, subject to the approval of our Board of Directors. Shares may be repurchased from time to time in the open market, or in privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our credit facility, the indentures governing our Senior Notes, compliance with securities laws, and the terms and provisions of our stock repurchase program. Our Board of Directors reviews this program as part of the allocation of our capital. During 2014 , we did not repurchase any shares of our common stock, and we currently do not plan to repurchase any outstanding shares. +76 +During 2014 , we paid $6.7 million in dividends to our stockholders, which constitutes a dividend of $0.10 per share. Our intention is to continue to make dividend payments for the foreseeable future, subject to our future earnings, our financial condition, credit facility and other covenants, and other factors which could arise. Payment of future dividends remains at the discretion of our Board of Directors. +The following table presents changes in cash flows between the years ended December 31, 2014 , 2013 , and 2012 , for our operating, investing, and financing activities. The analysis following the table should be read in conjunction with our consolidated statements of cash flows in Part II, Item 8 of this report. +For the Years Ended +December 31, +Amount of Changes Between +Percent of Change Between +2014 +2013 +2012 +2014/2013 +2013/2012 +2014/2013 +2013/2012 +(in millions) +Net cash provided by operating activities +$ +1,456.6 +$ +1,338.5 +$ +922.0 +$ +118.1 +$ +416.5 +9 +% +45 +% +Net cash used in investing activities +$ +(2,478.7 +) +$ +(1,192.9 +) +$ +(1,457.3 +) +$ +(1,285.8 +) +$ +264.4 +108 +% +(18 +)% +Net cash provided by financing activities +$ +740.0 +$ +130.7 +$ +422.1 +$ +609.3 +$ +(291.4 +) +466 +% +(69 +)% +Analysis of cash flow changes between 2014 and 2013 +Operating activities. Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, increased $256.0 million , or 14 percent , to $2.0 billion for the year ended December 31, 2014 , compared with the same period in 2013 . Cash paid for lease operating expenses in 2014 increased $20.6 million from 2013 . These increases were driven by a 14 percent increase in production volumes. Cash paid for interest, net of capitalized interest, increased $18.4 million during 2014 compared with the same period in 2013 due to the first interest payment on our 2024 Notes issued in 2013 being made in the first quarter of 2014. Additionally, cash bonuses paid in 2014 for the 2013 performance year were $41.8 million compared to $16.3 million paid in 2013 for the 2012 performance year. These changes are offset by a decrease in other operating working capital in 2014. +Investing activities. Capital expenditures in 2014 increased $421.3 million , or 27 percent , compared with the same period in 2013 due to increased spending in our Eagle Ford shale and Bakken/Three Forks programs. Acquisitions of proved and unproved properties increased $483.0 million as a result of property acquisitions in our Gooseneck area and the Powder River Basin in 2014. Net proceeds from the sale of oil and gas properties in 2014 decreased $381.0 million compared to the same period in 2013 due largely to the sale of our Anadarko Basin assets in the fourth quarter of 2013. +Financing activities. We received $590.0 million of net proceeds from the issuance of our 2022 Notes in 2014, compared with $490.2 million of net proceeds from the issuance of our 2024 Notes in 2013. These proceeds were used to repay outstanding borrowings under our credit facility and for general corporate purposes. We had net borrowings under our credit facility of $166.0 million during the year ended December 31, 2014 , compared with net payments of $340.0 million during the same period in 2013 . +77 +Analysis of cash flow changes between 2013 and 2012 +Operating activities. Cash received from oil, gas, and NGL production revenues, including derivative cash settlements, increased $652.6 million , or 43 percent , to $2.2 billion for the year ended December 31, 2013 , compared with the same period in 2012 . Cash paid for lease operating expenses in 2013 increased $54.5 million from 2012 . These increases were driven by a 32 percent increase in production volumes. Cash paid for interest, net of capitalized interest, during 2013 increased $19.4 million compared with the same period in 2012 due to interest paid on our 2023 Notes issued in 2012 in the first and third quarters of 2013 , offset partially by interest no longer paid on the 3.50% Senior Convertible Notes that we settled in April 2012. +Investing activities. Net proceeds from the sale of oil and gas properties in 2013 increased $369.5 million compared to the same period in 2012 due largely to the sale of our Anadarko Basin assets in the fourth quarter of 2013 . Capital expenditures in 2013, including costs to acquire proved and unproved oil and gas properties, increased $101.5 million , or seven percent , compared with the same period in 2012 . This increase is primarily the result of our completed acquisition of proved and unproved properties in our Rocky Mountain region in the second quarter of 2013 . +Financing activities. We received $490.2 million of net proceeds from the issuance of our 2024 Notes in 2013 , compared with $392.1 million of net proceeds from the issuance of our 2023 Notes in 2012 . These proceeds were used to repay outstanding borrowings under our credit facility and for general corporate purposes. We had net payments under our credit facility of $340.0 million during the year ended December 31, 2013 , compared with net borrowings of $340.0 million during the same period in 2012 . During the second quarter of 2012 , we paid $287.5 million to settle our 3.50% Senior Convertible Notes. +Interest Rate Risk +We are exposed to market risk due to the floating interest rate on our revolving credit facility. Our credit agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the credit facility’s fair market value, but will not impact results of operations or cash flows. Conversely, for the portion of the credit facility that has a floating interest rate, interest rate changes will not affect the fair market value, but will impact future results of operations and cash flows. Changes in interest rates do not impact the amount of interest we pay on our fixed-rate Senior Notes, but can impact their fair market values. As of December 31, 2014 , our fixed-rate debt and floating-rate debt outstanding totaled $2.2 billion and $166.0 million , respectively. The carrying amount of our floating-rate debt at December 31, 2014, approximates its fair value. Assuming a constant floating-rate debt level of $166.0 million , the before-tax cash flow impact resulting from a 100 basis point change in our interest rate would be $1.7 million over a 12-month period. +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly impact our revenue, overall profitability, access to capital, and future rate of growth. Oil, gas, and NGL prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. The markets for oil, gas, and NGLs have been volatile, especially in recent months, and these markets will likely continue to be volatile in the future. The prices we receive for our production depend on numerous factors beyond our control. Based on our 2014 production, a 10 percent decrease in our average realized price, before the effects of derivative settlements, would have reduced our oil, gas, and NGL production revenues by $134.8 million , $70.0 million , and $43.3 million , respectively. +78 +We enter into commodity derivative contracts in order to reduce the impact of fluctuations in commodity prices. Please refer to Note 10 – Derivative Financial Instruments of Part II, Item 8 of this report for additional information about our oil, gas, and NGL derivative contracts . +The fair values of our commodity derivative contracts are largely determined by estimates of the forward curves of the relevant price indices. At December 31, 2014 , a 10 percent increase or decrease in the forward curves associated with our oil, gas, and NGL commodity derivative instruments would have changed our net asset positions by approximately $85 million , $78 million , and $2 million , respectively. +Schedule of Contractual Obligations +The following table summarizes our contractual obligations at December 31, 2014 , for the periods specified (in millions): +Contractual Obligations +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Long-term debt (1) +$ +2,366.0 +$ +— +$ +— +$ +516.0 +$ +1,850.0 +Interest payments (2) +1,051.1 +140.7 +281.5 +269.5 +359.4 +Delivery commitments (3) +939.4 +113.5 +227.0 +245.4 +353.5 +Operating leases and contracts (3) +197.1 +111.4 +39.2 +16.4 +30.1 +Net Profits Plan (4) +28.1 +5.9 +10.1 +8.4 +3.7 +Asset retirement obligations (5) +152.3 +28.4 +4.0 +7.6 +112.3 +Other (6) +31.9 +6.0 +10.5 +12.1 +3.3 +Total +$ +4,765.9 +$ +405.9 +$ +572.3 +$ +1,075.4 +$ +2,712.3 +____________________________________________ +(1) Long-term debt consists of our Senior Notes and the outstanding balance under our long-term revolving credit facility, and assumes no principal repayment until the due dates of the instruments. The actual payments under our revolving credit facility may vary significantly. +(2) Interest payments on our Senior Notes are estimated assuming no principal repayment until the due dates of the instruments. Interest payments on our credit facility have been estimated using the rate applicable to the balance on our credit facility as of December 31, 2014, and assume no future borrowing or repayment until the December 10, 2019 due date. The actual interest payments on our Senior Notes and credit facility may vary significantly. +(3) Please refer to Note 6 – Commitments and Contingencies in Part II, Item 8 of this report for additional discussion regarding our operating leases, contracts, and gathering, processing, and transportation through-put commitments. +(4) Amounts shown represent undiscounted forecasted payments for the Net Profits Plan for the next six years. Payments are expected to gradually decrease for the years beyond what are shown in this table and are not included due to these payments being highly variable, as outlined below. The amount recorded on the accompanying consolidated balance sheets reflects all future Net Profits Plan payments and the impact of discounting, and therefore differs from the amounts disclosed in this table. The variability in the amount of payments will be a direct reflection of commodity prices, production rates, capital expenditures, and operating costs in future periods. Predicting the timing and amounts of payments associated with this liability is contingent upon estimates of appropriate discount factors, adjusting for risk and time value, and upon a number of factors we cannot control. Please refer to Note 7 – Compensation Plans and Note 11 - Fair Value Measurements in Part II, Item 8 of this report for additional discussion regarding our Net Profits Plan liability. +(5) +Amounts shown represent estimated future undiscounted plugging and abandonment costs. The discounted obligations are recorded as liabilities on our accompanying consolidated balance sheets as of December 31, 2014 . The timing and amount of the ultimate settlement of these obligations is unknown and can be impacted by economic factors, a change in development plans, and federal and state regulations. Inactive wells as of December 31, 2014, are shown as an obligation in 2015 due to the substantial uncertainty on the timing of plugging or re-entering these shut-in or temporarily abandoned wells. Please refer to Note 9 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion regarding our asset retirement obligations. +(6) The majority of the amount shown relates to the unfunded portion of our estimated pension liability of $29.9 million , for which we have estimated the timing of future payments based on historical annual contribution amounts. We expect to make contributions to our pension plan in 2015 of $5.8 million . Other amounts include the liability portion of the marked-to-market value of our commodity derivatives based on estimates of the forward curves of the relevant price indices at December 31, 2014 , and excludes estimated oil, gas, and NGL commodity derivative receipts. +79 +Off-balance Sheet Arrangements +As part of our ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +We evaluate our transactions to determine if any variable interest entities exist. If it is determined that we are the primary beneficiary of a variable interest entity, that entity is consolidated into our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions in 2014 or 2013. +Critical Accounting Policies and Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate due to changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Oil and gas reserve quantities. Our estimated proved reserve quantities and future net cash flows are critical to the understanding of the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our financial statements, including the calculations of depletion and impairment of proved oil and gas properties and the estimate of our Net Profits Plan liability. Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure calculations require a 10 percent discount rate to be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir-evaluation consulting firm, to audit at least 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year-end. For purposes of depletion and impairment, reserve quantities are adjusted in accordance with GAAP for the impact of additions and dispositions. Changes in depletion or impairment calculations caused by changes in reserve quantities or net cash flows are recorded in the period the reserve estimates change. Please refer to Supplemental Oil and Gas Information in Part II, Item 8 of this report. +80 +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2014 +2013 +2012 +MMBOE +MMBOE +MMBOE +Change +Change +Change +Revisions resulting from price changes +3.4 +0.6 +(12.1 +) +Revisions resulting from performance (1) +7.0 +4.4 +(15.3 +) +Total +10.4 +5.0 +(27.4 +) +____________________________________________ +(1) Performance revisions include the removal of proved undeveloped reserves that are no longer in our development plan within five years. +As previously noted, commodity prices are volatile, and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. Please refer to additional reserves discussion above under Overview of the Company. +The following table reflects the estimated MMBOE change and percentage change to our total reported reserve volumes from the described hypothetical changes: +For the Years Ended December 31, +2014 +2013 +2012 +MMBOE +Percentage +MMBOE +Percentage +MMBOE +Percentage +Change +Change +Change +Change +Change +Change +10% decrease in SEC pricing +(9.6 +) +(2 +)% +(9.8 +) +(2 +)% +(11.2 +) +(4 +)% +10% decrease in proved undeveloped reserves +(26.1 +) +(5 +)% +(22.0 +) +(5 +)% +(12.7 +) +(4 +)% +The table above solely reflects the impact of a 10 percent decrease in SEC pricing or decrease in proved undeveloped reserves and does not include additional impacts to our proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. Additional reserve information can be found in the reserve table and discussion included in Items 1 and 2 of Part I of this report, and in Supplemental Oil and Gas Information of Part II, Item 8 of this report. +Successful efforts method of accounting. GAAP provides for two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method. Both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 - Summary of Significant Accounting Policies of Part II, Item 8 of this report. +81 +Revenue recognition. Our revenue recognition policy is significant because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. We derive our revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized when our production is delivered to the purchaser, but payment is generally received between 30 and 90 days after the date of production. No revenue is recognized unless it is determined that title to the product has transferred to a purchaser. At the end of each month, we make estimates of the amount of production delivered to the purchaser and the price we will receive. We use our knowledge of our properties, their historical performance, NYMEX, local spot market, and OPIS prices, and other factors as the basis for these estimates. Variances between our estimates and the actual amounts received are recorded in the month payment is received. A 10 percent change in our year end revenue accrual would have impacted total operating revenues by approximately $18 million in 2014 . +Asset retirement obligations. We are required to recognize an estimated liability for future costs associated with the abandonment of our oil and gas properties. We base our estimate of the liability on our historical experience in abandoning oil and gas wells and our current understanding of federal and state regulatory requirements. Our present value calculations require us to estimate the economic lives of our properties, estimate future inflation rates, and determine what credit-adjusted risk-free discount rate to use. The impact to the accompanying consolidated statements of operations from these estimates is reflected in our depreciation, depletion, and amortization calculations and occurs over the remaining life of our respective oil and gas properties. Please refer to Note 9 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +Impairment of oil and gas properties. Our proved oil and gas properties are recorded at cost. We evaluate our proved properties for impairment when events or changes in circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected future cash flows of our oil and gas properties and compare these undiscounted cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the oil and gas properties to fair value. The factors used to determine fair value include, but are not limited to, estimates of reserves, future commodity prices, future production estimates, estimated future operating and capital expenditures, and discount rates. +Unproved oil and gas properties are assessed periodically for impairment on a prospect-by-prospect basis based on the remaining lease terms, drilling results, commodity price outlook, and future capital allocations. Unproved oil and gas properties are impaired when we determine that the property will not be developed or the carrying value will not be realized. +Please refer to Impairment of Proved and Unproved Properties in Note 1 - Summary of Significant Accounting Policies in Part II, Item 8 of this report for impairment results. +Derivatives and Hedging. We periodically enter into commodity derivative contracts to manage our exposure to oil, gas and NGL price volatility. The accounting treatment for the change in fair value of a derivative instrument is dependent upon whether or not a derivative instrument is designated as a cash flow hedge. Prior to January 1, 2011, we designated our commodity derivative contracts as cash flow hedges, for which unrealized changes in fair value were recorded to AOCL, to the extent the hedges were effective. As of January 1, 2011, we elected to de-designate all of our commodity derivative contracts that had been previously designated as cash flow hedges at December 31, 2010. As a result, subsequent to December 31, 2010, we recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in AOCL. The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. +82 +Income taxes. We provide for deferred income taxes on the difference between the tax basis of an asset or liability and its carrying amount in our financial statements. This difference will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax expense by approximately $10.6 million for the year ended December 31, 2014 . +Accounting Matters +Please refer to the section entitled Recently Issued Accounting Standards under Note 1 – Summary of Significant Accounting Policies for additional information on the recent adoption of new authoritative accounting guidance in Part II, Item 8 of this report. +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, see Risk Factors – Risks Related to Our Business – Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Climate Change. In December 2009, the EPA determined that emissions of carbon dioxide, methane, and other ‘‘greenhouse gases’’ present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on these findings, the EPA has begun adopting and implementing regulations to restrict emissions of greenhouse gases under existing provisions of the CAA. The EPA recently adopted two sets of rules regulating greenhouse gas emissions under the CAA, one of which requires a reduction in emissions of greenhouse gases from motor vehicles and the other of which regulates emissions of greenhouse gases from certain large stationary sources, effective January 2, 2011. The EPA has also adopted rules requiring the reporting of greenhouse gas emissions from specified large greenhouse gas emission sources in the United States, including petroleum refineries, on an annual basis, beginning in 2011 for emissions occurring after January 1, 2010, as well as certain onshore oil and natural gas production facilities, on an annual basis, beginning in 2012 for emissions occurring in 2011. +In June 2013, President Obama announced a Climate Action Plan designed to further reduce greenhouse gas emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Plan targets methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. On January 14, 2015, the Obama Administration announced additional steps to reduce methane emissions from the oil and gas sector by 40 to 45 percent by 2025. These actions include a commitment from the EPA to issue new source performance standards for methane emissions from the oil and gas sector. The EPA plans to propose the rule in 2015 and finalize the standards in 2016. The EPA has not committed to proposing existing source standards for the oil and gas sector. In addition, President Obama directed the EPA to issue stringent carbon standards for new fossil fuel-fired power plants. The EPA proposed new source performance standards in September 2013, which would require carbon capture and sequestration for coal-fired boilers and combined cycle technology for natural gas-fired +83 +boilers. The EPA plans to finalize the new source performance standards in the summer of 2015. In June 2014, the EPA proposed existing source performance standards as stringent state emission “goals.” The proposed standards focus on re-dispatching electricity from coal-fired units to natural gas combined cycle plants and renewables. The EPA plans to finalize the rule in the summer of 2015, with state plans to implement and enforce the standards in 2016. +In addition, the United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases and almost one-half of the states have already taken legal measures to reduce emissions of greenhouse gases primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. +The adoption of legislation or regulatory programs to reduce emissions of greenhouse gases could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and natural gas we produce. Consequently, legislation and regulatory programs to reduce emissions of greenhouse gases could have an adverse effect on our business, financial condition, and results of operations. Finally, it should be noted that some scientists have concluded that increasing concentrations of greenhouse gases in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. If any such effects were to occur, they could have an adverse effect on our financial condition and results of operations. +In terms of opportunities, the regulation of greenhouse gas emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and natural gas that we produce, the relative demand for natural gas may increase because the burning of natural gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources, such as wind or solar power become more prevalent, natural gas-fired electric plants may provide an alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, natural gas may become a more attractive transportation fuel. Approximately 46 and 51 percent of our production on an BOE basis in 2014 and 2013 , respectively, was natural gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and natural gas reservoirs, could also benefit us through the potential to obtain greenhouse gas emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +Non-GAAP Financial Measures +Adjusted EBITDAX represents income (loss) before interest expense, other non-operating income or expense, income taxes, depreciation, depletion, amortization, and accretion, exploration expense, property impairments, non-cash stock compensation expense, derivative gains and losses net of settlements, change in the Net Profits Plan liability, and gains and losses on divestitures. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally one-time in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that is presented because we believe it provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for exploration, development, acquisitions, and to service debt. We are also subject to a financial covenant under our credit facility based on our debt to adjusted EBITDAX ratio. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or profitability or liquidity measures +84 +prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. +The following table provides reconciliations of our net income (loss) and net cash provided by operating activities to adjusted EBITDAX for the periods presented: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Net income (loss) (GAAP) +$ +666,051 +$ +170,935 +$ +(54,249 +) +Interest expense +98,554 +89,711 +63,720 +Other non-operating (income) expense, net +2,561 +(67 +) +(220 +) +Income tax expense (benefit) +398,648 +107,676 +(29,268 +) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +767,532 +822,872 +727,877 +Exploration (1) +122,577 +65,888 +81,809 +Impairment of proved properties +84,480 +172,641 +208,923 +Abandonment and impairment of unproved properties +75,638 +46,105 +16,342 +Stock-based compensation expense +32,694 +32,347 +30,185 +Derivative gain +(583,264 +) +(3,080 +) +(55,630 +) +Derivative settlement gain (2) +12,615 +22,062 +44,264 +Change in Net Profits Plan liability +(29,849 +) +(21,842 +) +(28,904 +) +(Gain) loss on divestiture activity +(646 +) +(27,974 +) +27,018 +Adjusted EBITDAX (Non-GAAP) +1,647,591 +1,477,274 +1,031,867 +Interest expense +(98,554 +) +(89,711 +) +(63,720 +) +Other non-operating income (expense), net +(2,561 +) +67 +220 +Income tax (expense) benefit +(398,648 +) +(107,676 +) +29,268 +Exploration (1) +(122,577 +) +(65,888 +) +(81,809 +) +Exploratory dry hole expense +44,427 +5,846 +20,861 +Amortization of debt discount and deferred financing costs +6,146 +5,390 +6,769 +Deferred income taxes +397,780 +105,555 +(29,638 +) +Plugging and abandonment +(8,796 +) +(9,946 +) +(2,856 +) +Other, net +1,069 +2,775 +527 +Changes in current assets and liabilities +(9,302 +) +14,828 +10,480 +Net cash provided by operating activities (GAAP) +$ +1,456,575 +$ +1,338,514 +$ +921,969 +____________________________________________ +(1) Stock-based compensation expense is a component of exploration expense and general and administrative expense on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration. +(2) +Derivative settlement gain is reported in the derivative cash settlements line item on the accompanying statements of cash flows within net cash provided by operating activities with the change in accrued settlements between years being reported in change in accounts receivable and change in accounts payable and accrued expenses line items. +85 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this item is provided under the captions Commodity Price Risk and Interest Rate Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place under Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +86 +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +The Board of Directors and Stockholders of SM Energy Company and subsidiaries +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries as of December 31, 2014 , and 2013, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SM Energy Company and subsidiaries at December 31, 2014 , and 2013, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), SM Energy Company’s internal control over financial reporting as of December 31, 2014 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 25, 2015 , expressed an unqualified opinion thereon. +/s/ Ernst & Young LLP +Denver, Colorado +February 25, 2015 +87 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of SM Energy Company and Subsidiaries +Denver, Colorado +We have audited the accompanying consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows of SM Energy Company and subsidiaries (the “Company”) for the year ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. +In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of SM Energy Company and subsidiaries for the year ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 21, 2013 +88 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share amounts) +December 31, +2014 +2013 +ASSETS +Current assets: +Cash and cash equivalents +$ +120 +$ +282,248 +Accounts receivable (note 2) +322,630 +318,371 +Derivative asset +402,668 +21,559 +Deferred income taxes +— +10,749 +Prepaid expenses and other +19,625 +14,574 +Total current assets +745,043 +647,501 +Property and equipment (successful efforts method): +Proved oil and gas properties +7,348,436 +5,637,462 +Less - accumulated depletion, depreciation, and amortization +(3,233,012 +) +(2,583,698 +) +Unproved oil and gas properties +532,498 +271,100 +Wells in progress +503,734 +279,654 +Oil and gas properties held for sale, net of accumulated depletion, depreciation and amortization of $22,482 and $7,390, respectively +17,891 +19,072 +Other property and equipment, net of accumulated depreciation of $37,079 and $28,775, respectively +334,356 +236,202 +Total property and equipment, net +5,503,903 +3,859,792 +Noncurrent assets: +Derivative asset +189,540 +30,951 +Restricted cash +— +96,713 +Other noncurrent assets +78,214 +70,208 +Total other noncurrent assets +267,754 +197,872 +Total Assets +$ +6,516,700 +$ +4,705,165 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable and accrued expenses (note 2) +$ +640,684 +$ +606,751 +Derivative liability +— +26,380 +Deferred tax liability +142,976 +— +Other current liabilities +1,000 +6,000 +Total current liabilities +784,660 +639,131 +Noncurrent liabilities: +Revolving credit facility +166,000 +— +Senior Notes (note 5) +2,200,000 +1,600,000 +Asset retirement obligation +120,867 +118,692 +Net Profits Plan liability +27,136 +56,985 +Deferred income taxes +891,681 +650,125 +Derivative liability +70 +4,640 +Other noncurrent liabilities +39,631 +28,771 +Total noncurrent liabilities +3,445,385 +2,459,213 +Commitments and contingencies (note 6) +Stockholders' equity: +Common stock, $0.01 par value - authorized: 200,000,000 shares; issued: 67,463,060 and 67,078,853 shares outstanding, respectively; net of treasury shares: 67,463,060 and 67,056,441, respectively +675 +671 +Additional paid-in capital +283,295 +257,720 +Treasury stock, at cost: zero and 22,412 shares, respectively +— +(823 +) +Retained earnings +2,013,997 +1,354,669 +Accumulated other comprehensive loss +(11,312 +) +(5,416 +) +Total stockholders' equity +2,286,655 +1,606,821 +Total Liabilities and Stockholders' Equity +$ +6,516,700 +$ +4,705,165 +The accompanying notes are an integral part of these consolidated financial statements. +89 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share amounts) +For the Years Ended +December 31, +2014 +2013 +2012 +Operating revenues: +Oil, gas, and NGL production revenue +$ +2,481,544 +$ +2,199,550 +$ +1,473,868 +Gain (loss) on divestiture activity +646 +27,974 +(27,018 +) +Marketed gas system revenue +24,897 +60,039 +52,808 +Other operating revenues +15,220 +5,811 +5,444 +Total operating revenues and other income +2,522,307 +2,293,374 +1,505,102 +Operating expenses: +Oil, gas, and NGL production expense +715,878 +597,045 +391,872 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +767,532 +822,872 +727,877 +Exploration +129,857 +74,104 +90,248 +Impairment of proved properties +84,480 +172,641 +208,923 +Abandonment and impairment of unproved properties +75,638 +46,105 +16,342 +General and administrative +167,103 +149,551 +119,815 +Change in Net Profits Plan liability +(29,849 +) +(21,842 +) +(28,904 +) +Derivative gain +(583,264 +) +(3,080 +) +(55,630 +) +Marketed gas system expense +24,460 +57,647 +47,583 +Other operating expenses +4,658 +30,076 +6,993 +Total operating expenses +1,356,493 +1,925,119 +1,525,119 +Income (loss) from operations +1,165,814 +368,255 +(20,017 +) +Non-operating income (expense): +Other, net +(2,561 +) +67 +220 +Interest expense +(98,554 +) +(89,711 +) +(63,720 +) +Income (loss) before income taxes +1,064,699 +278,611 +(83,517 +) +Income tax (expense) benefit +(398,648 +) +(107,676 +) +29,268 +Net income (loss) +$ +666,051 +$ +170,935 +$ +(54,249 +) +Basic weighted-average common shares outstanding +67,230 +66,615 +65,138 +Diluted weighted-average common shares outstanding +68,044 +67,998 +65,138 +Basic net income (loss) per common share +$ +9.91 +$ +2.57 +$ +(0.83 +) +Diluted net income (loss) per common share +$ +9.79 +$ +2.51 +$ +(0.83 +) +The accompanying notes are an integral part of these consolidated financial statements. +90 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +For the Years Ended +December 31, +2014 +2013 +2012 +Net income (loss) +$ +666,051 +$ +170,935 +$ +(54,249 +) +Other comprehensive income (loss), net of tax: +Reclassification to earnings (1) +— +1,115 +(2,264 +) +Pension liability adjustment (2) +(5,896 +) +2,483 +(2,470 +) +Total other comprehensive income (loss), net of tax +(5,896 +) +3,598 +(4,734 +) +Total comprehensive income (loss) +$ +660,155 +$ +174,533 +$ +(58,983 +) +(1) +Reclassification from accumulated other comprehensive loss related to de-designated hedges. Refer to Note 10 - Derivative Financial Instruments for further information. +(2) +Refer to Note 1 - Summary of Significant Accounting Policies for detail of the pension amount reclassified to general and administrative expense on the Company ’s consolidated statements of operations. +The accompanying notes are an integral part of these consolidated financial statements. +91 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share amounts) +Additional Paid-in Capital +Accumulated Other Comprehensive Loss +Total Stockholders’ Equity +Common Stock +Treasury Stock +Retained Earnings +Shares +Amount +Shares +Amount +Balances, January 1, 2012 +64,145,482 +$ +641 +$ +216,966 +(81,067 +) +$ +(1,544 +) +$ +1,251,157 +$ +(4,280 +) +$ +1,462,940 +Net loss +— +— +— +— +— +(54,249 +) +— +(54,249 +) +Other comprehensive loss +— +— +— +— +— +— +(4,734 +) +(4,734 +) +Cash dividends, $ 0.10 per share +— +— +— +— +— +(6,511 +) +— +(6,511 +) +Issuance of common stock under Employee Stock Purchase Plan +66,485 +1 +2,775 +— +— +— +— +2,776 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +929,375 +9 +(21,631 +) +— +— +— +— +(21,622 +) +Issuance of common stock upon stock option exercises +240,368 +2 +3,038 +— +— +— +— +3,040 +Conversion of 3.50% Senior Convertible Notes to common stock, including income tax benefit of conversion +864,106 +9 +2,632 +— +— +— +— +2,641 +Stock-based compensation expense +— +— +29,862 +30,486 +323 +— +— +30,185 +Balances, December 31, 2012 +66,245,816 +$ +662 +$ +233,642 +(50,581 +) +$ +(1,221 +) +$ +1,190,397 +$ +(9,014 +) +$ +1,414,466 +Net income +— +— +— +— +— +170,935 +— +170,935 +Other comprehensive income +— +— +— +— +— +— +3,598 +3,598 +Cash dividends, $ 0.10 per share +— +— +— +— +— +(6,663 +) +— +(6,663 +) +Issuance of common stock under Employee Stock Purchase Plan +77,427 +1 +3,671 +— +— +— +— +3,672 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +526,852 +5 +(16,225 +) +— +— +— +— +(16,220 +) +Issuance of common stock upon stock option exercises +228,758 +3 +3,183 +— +— +— +— +3,186 +Stock-based compensation expense +— +— +31,949 +28,169 +398 +— +— +32,347 +Other income tax benefit +— +— +1,500 +— +— +— +— +1,500 +Balances, December 31, 2013 +67,078,853 +$ +671 +$ +257,720 +(22,412 +) +$ +(823 +) +$ +1,354,669 +$ +(5,416 +) +$ +1,606,821 +Net income +— +— +— +— +— +666,051 +— +666,051 +Other comprehensive income +— +— +— +— +— +— +(5,896 +) +(5,896 +) +Cash dividends, $ 0.10 per share +— +— +— +— +— +(6,723 +) +— +(6,723 +) +Issuance of common stock under Employee Stock Purchase Plan +83,136 +1 +4,060 +— +— +— +— +4,061 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +256,718 +3 +(10,627 +) +— +— +— +— +(10,624 +) +Issuance of common stock upon stock option exercises +39,088 +— +816 +— +— +— +— +816 +Stock-based compensation expense +5,265 +— +31,871 +22,412 +823 +— +— +32,694 +Other income tax expense +— +— +(545 +) +— +— +— +— +(545 +) +Balances, December 31, 2014 +67,463,060 +$ +675 +$ +283,295 +— +$ +— +$ +2,013,997 +$ +(11,312 +) +$ +2,286,655 +The accompanying notes are an integral part of these consolidated financial statements. +92 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2014 +2013 +2012 +Cash flows from operating activities: +Net income (loss) +$ +666,051 +$ +170,935 +$ +(54,249 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +(Gain) loss on divestiture activity +(646 +) +(27,974 +) +27,018 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +767,532 +822,872 +727,877 +Exploratory dry hole expense +44,427 +5,846 +20,861 +Impairment of proved properties +84,480 +172,641 +208,923 +Abandonment and impairment of unproved properties +75,638 +46,105 +16,342 +Stock-based compensation expense +32,694 +32,347 +30,185 +Change in Net Profits Plan liability +(29,849 +) +(21,842 +) +(28,904 +) +Derivative gain +(583,264 +) +(3,080 +) +(55,630 +) +Derivative cash settlements +(28,419 +) +22,062 +44,264 +Amortization of debt discount and deferred financing costs +6,146 +5,390 +6,769 +Deferred income taxes +397,780 +105,555 +(29,638 +) +Plugging and abandonment +(8,796 +) +(9,946 +) +(2,856 +) +Other, net +1,069 +2,775 +527 +Changes in current assets and liabilities: +Accounts receivable +24,088 +(78,494 +) +(21,389 +) +Prepaid expenses and other +(1,822 +) +98 +733 +Accounts payable and accrued expenses +9,466 +93,224 +31,136 +Net cash provided by operating activities +1,456,575 +1,338,514 +921,969 +Cash flows from investing activities: +Net proceeds from sale of oil and gas properties +43,858 +424,849 +55,375 +Capital expenditures +(1,974,798 +) +(1,553,536 +) +(1,507,828 +) +Acquisition of proved and unproved oil and gas properties +(544,553 +) +(61,603 +) +(5,773 +) +Other, net +(3,256 +) +(2,613 +) +893 +Net cash used in investing activities +(2,478,749 +) +(1,192,903 +) +(1,457,333 +) +Cash flows from financing activities: +Proceeds from credit facility +1,285,500 +1,203,000 +1,609,000 +Repayment of credit facility +(1,119,500 +) +(1,543,000 +) +(1,269,000 +) +Debt issuance costs related to credit facility +(3,388 +) +(3,444 +) +— +Net proceeds from Senior Notes +589,991 +490,185 +392,138 +Repayment of 3.50% Senior Convertible Notes +— +— +(287,500 +) +Proceeds from sale of common stock +4,877 +6,858 +5,816 +Dividends paid +(6,723 +) +(6,663 +) +(6,511 +) +Net share settlement from issuance of stock awards +(10,624 +) +(16,220 +) +(21,622 +) +Other, net +(87 +) +(5 +) +(225 +) +Net cash provided by financing activities +740,046 +130,711 +422,096 +Net change in cash and cash equivalents +(282,128 +) +276,322 +(113,268 +) +Cash and cash equivalents at beginning of period +282,248 +5,926 +119,194 +Cash and cash equivalents at end of period +$ +120 +$ +282,248 +$ +5,926 +The accompanying notes are an integral part of these consolidated financial statements. +93 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) +Supplemental schedule of additional cash flow information and non-cash activities: +For the Years Ended +December 31, +2014 +2013 +2012 +(in thousands) +Cash paid for interest, net of capitalized interest +$ +89,145 +$ +70,702 +$ +51,328 +Net cash paid (refunded) for income taxes +$ +1,936 +$ +(204 +) +$ +(1,389 +) +As of December 31, 2014 , 2013 , and 2012 , $357.2 million , $217.8 million , and $262.8 million , respectively, of accrued capital expenditures were included in accounts payable and accrued expenses in the Company's consolidated balance sheets. These oil and gas property additions are reflected in cash used in investing activities in the periods during which the payables are settled. +During the second quarter of 2014, the Company exchanged properties in its Rocky Mountain region with a fair value of $6.2 million . During the third quarter of 2013, the Company exchanged properties in its Rocky Mountain region with a fair value of $25.0 million . The cash consideration exchanged at the respective closings for agreed upon adjustments is reflected in the acquisition of proved and unproved oil and gas properties line item in the consolidated statements of cash flows. +94 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company is an independent energy company engaged in the acquisition, exploration, development, and production of crude oil and condensate, natural gas, and NGLs in onshore North America. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Subsidiaries that the Company does not control are accounted for using the equity or cost methods as appropriate. Equity method investments are included in other noncurrent assets in the accompanying consolidated balance sheets (“accompanying balance sheets”). Intercompany accounts and transactions have been eliminated. In connection with the preparation of the consolidated financial statements, the Company evaluated subsequent events after the balance sheet date of December 31, 2014 , through the filing date of this report. +Certain prior period amounts have been reclassified to conform to the current period presentation on the accompanying financial statements. The Company’s refundable income taxes are combined and presented in the prepaid expenses and other financial statement line item within the accompanying balance sheets. The Company’s land and materials inventory are combined and presented in the other property and equipment, net of accumulated depreciation financial statement line item within the accompanying balance sheets. Lastly, the asset retirement obligation associated with oil and gas properties held for sale is no longer separately presented and is presented in the asset retirement obligation financial statement line item within the accompanying balance sheets. Within the accompanying consolidated statements of operations (“accompanying statements of operations”), the Company’s realized hedge gain (loss) is combined and presented in the other operating revenues financial statement line item. In the accompanying consolidated statements of cash flows (“accompanying statements of cash flows”) in cash flows from operating activities, refundable income taxes is now combined and presented with prepaid expenses and other. Additionally, receipts from restricted cash related to any like-kind exchanges under Section 1031 of the Internal Revenue Code are now combined and presented in the other, net financial statement line item within net cash used in investing activities on the accompanying statements of cash flows. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of depletion, depreciation, and amortization expense, impairment of proved properties, asset retirement obligations, and the Net Profits Plan liability, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents +The Company considers all liquid investments purchased with an initial maturity of three months or less to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. +95 +Restricted Cash +The Company has no restricted cash at December 31, 2014 . The restricted cash balance at December 31, 2013 , mainly consisted of cash payments that were contractually restricted to be used solely for development of long-term capital assets pursuant to the Company’s Acquisition and Development Agreement with Mitsui and accordingly classified as non-current assets. Please refer to Note 12 - Acquisition and Development Agreement for additional information. +Accounts Receivable +The Company’s accounts receivable consist mainly of receivables from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables from joint interest owners, the Company typically has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil and gas receivables are collected within two months, and the Company has had minimal bad debts. +Although diversified among many companies, collectability is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. As of December 31, 2014 and 2013 , the Company had no allowance for doubtful accounts recorded. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to regular review. The Company does not believe the loss of any single purchaser would materially impact its operating results, as crude oil, natural gas, and NGLs are products with well-established markets and numerous purchasers in the Company’s operating regions. During 2014 , the Company had one major customer, which accounted for approximately 19 percent of total production revenue, which is discussed in the next paragraph. In 2014, the Company also sold to four entities that are under common ownership. In aggregate, these four entities accounted for approximately 14 percent of total production revenues in 2014, however, none of these entities individually accounted for greater than 10 percent of total production revenue. During 2013 , the Company had three major customers, which accounted for approximately 26 percent , 16 percent , and 12 percent , respectively, of total production revenue. During 2012 , the Company had two major customers, which accounted for approximately 21 percent and 13 percent , respectively, of total production revenue. +During the third quarter of 2013, the Company entered into various marketing agreements with a joint venture partner, whereby the Company is subject to certain gathering, transportation, and processing through-put commitments for up to 10 years pursuant to each contract. While the Company’s joint venture partner is the first purchaser under these contracts, accounting for 19 percent of total production revenue in 2014, the Company also shares with them the risk of non-performance by their counterparty purchasers. Several of the Company’s joint venture partner’s counterparty purchasers under these contracts are also direct purchasers of products produced by the Company. +The Company’s policy is to use the commodity affiliates of the lenders under its credit facility as its derivative counterparties. Additionally, the Company’s policy is that the counterparty must have investment grade senior unsecured debt ratings. Each of the Company’s nine counterparties currently meet both of these requirements. +The Company has accounts in the following locations with a national bank: Denver, Colorado ; Houston, Texas ; Midland, Texas ; and Billings, Montana . The Company’s policy is to invest in highly-rated instruments and to limit the amount of credit exposure at each individual institution. +96 +Oil and Gas Producing Activities +The Company accounts for its oil and gas exploration and development costs using the successful efforts method. G&G costs are expensed as incurred. Exploratory well costs are capitalized pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that economic proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in cash flows from investing activities as part of capital expenditures within the accompanying statements of cash flows. The costs of development wells are capitalized whether those wells are successful or unsuccessful. +DD&A of capitalized costs related to proved oil and gas properties is calculated on a pool-by-pool basis using the units-of-production method based upon proved reserves. The computation of DD&A takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. As of December 31, 2014 , and 2013 , the estimated salvage value of the Company’s equipment was $50.8 million and $57.5 million , respectively. +Assets Held for Sale +Any properties held for sale as of the balance sheet date have been classified as assets held for sale and are separately presented on the accompanying balance sheets at the lower of net book value or fair value less the cost to sell. For additional discussion on assets held for sale, please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale . +Other Property and Equipment +Other property and equipment such as facilities, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from three to 30 years , or the unit of output method where appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the accounts. +Internal-Use Software Development Costs +The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing and installation activities. Training and maintenance costs are expensed as incurred, while upgrades and enhancements are capitalized if it is probable that such expenditures will result in additional functionality. Capitalized software costs are depreciated over the estimated useful life of the underlying project on a straight-line basis upon completion of the project. As of December 31, 2014 , and 2013 , the Company has capitalized approximately $35.0 million and $11.2 million , respectively, related to the ongoing development and implementation of accounting and operational software. +Derivative Financial Instruments +The Company seeks to manage or reduce commodity price risk on production by entering into derivative contracts. The Company seeks to minimize its basis risk and indexes its oil derivative contracts to NYMEX prices, its NGL derivative contracts to OPIS prices, and its gas derivative contracts to various regional index prices associated with pipelines into which the Company’s gas production is sold. For additional discussion on derivatives, please see Note 10 – Derivative Financial Instruments . +97 +Net Profits Plan +The Company records the estimated fair value of expected future payments to be made under the Net Profits Plan as a noncurrent liability in the accompanying balance sheets. The underlying assumptions used in the calculation of the estimated liability include estimates of production, proved reserves, recurring and workover lease operating expense, transportation, production and ad valorem tax rates, present value discount factors, pricing assumptions, and overall market conditions. The estimates used in calculating the long-term liability are adjusted from period-to-period based on the most current information attributable to the underlying assumptions. Changes in the estimated liability of future payments associated with the Net Profits Plan are recorded as increases or decreases to expense in the current period as a separate line item in the accompanying statements of operations, as these changes are considered changes in estimates. +The distribution amounts due to participants and payable in each period under the Net Profits Plan as cash compensation related to periodic operations are recognized as compensation expense and are included within general and administrative expense and exploration expense in the accompanying statements of operations. The corresponding current liability is included in accounts payable and accrued expenses in the accompanying balance sheets. This treatment provides for a consistent matching of cash expense with net cash flows from the oil and gas properties in each respective pool of the Net Profits Plan. For additional discussion, please refer to the heading Net Profits Plan in Note 7 – Compensation Plans and Note 11 – Fair Value Measurements . +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is completed or acquired. The increase in carrying value is included in proved oil and gas properties in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and gas properties. For additional discussion, please refer to Note 9 – Asset Retirement Obligations . +Revenue Recognition +The Company derives revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized when the Company’s production is delivered to the purchaser, but payment is generally received between 30 and 90 days after the date of production. No revenue is recognized unless it is determined that title to the product has transferred to the purchaser. At the end of each month, the Company estimates the amount of production delivered to the purchaser and the price the Company will receive. The Company uses knowledge of its properties and historical performance, NYMEX, OPIS, and local spot market prices, quality and transportation differentials, and other factors as the basis for these estimates. The Company uses the sales method of accounting for gas revenue whereby sales revenue is recognized on all gas sold to purchasers, regardless of whether the sales are proportionate to the Company’s ownership in the property. +Impairment of Proved and Unproved Properties +Proved oil and gas property costs are evaluated for impairment and reduced to fair value, which is based on expected future discounted cash flows, when there is an indication that the carrying costs may not be recoverable. Expected future cash flows are calculated on all proved developed reserves and risk adjusted proved undeveloped, probable, and possible reserves using a discount rate and price forecasts that management believes are representative of current market conditions. The prices for oil and gas are forecasted based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecasted using OPIS pricing, adjusted for basis differentials, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also +98 +adjusted as deemed appropriate for these estimates. An impairment is recorded on unproved property when the Company determines that either the property will not be developed or the carrying value is not realizable. +The Company recorded $84.5 million , $172.6 million , and $208.9 million , of proved property impairment expense for the years ended December 31, 2014 , 2013 , and 2012 , respectively. The impairments of proved properties in 2014 were a result of the significant decline in commodity prices in late 2014 and recognition of the outcomes of exploration and delineation wells in certain prospects in the Company’s South Texas & Gulf Coast and Permian regions. The impairments in 2013 resulted from the write-down of certain Mississippian limestone assets in the Company’s Permian region due to negative engineering revisions, write-downs related to Olmos interval, dry gas assets in the South Texas & Gulf Coast region as a result of a plugging and abandonment program, and write-downs of certain underperforming assets due to the Company’s decision to no longer pursue the development of those assets. The impairments in 2012 were a result of the Company’s write-down of Wolfberry assets in its Permian region due to negative engineering revisions and the Company’s Haynesville shale assets as a result of low natural gas prices. +For the years ended December 31, 2014 , 2013 , and 2012 , the Company recorded expense related to the abandonment and impairment of unproved properties of $75.6 million , $46.1 million , and $16.3 million , respectively. The Company’s abandonment and impairment of unproved properties expense in 2014 was due to acreage the Company no longer intended to develop as a result of exploration and delineation activities and the recent decline in commodity prices. The Company’s abandonment and impairment of unproved properties expense in 2013 was mostly related to acreage the Company no longer intended to develop in its Permian region. The Company’s abandonment and impairment of unproved properties expense in 2012 related to acreage that the Company no longer intended to develop in its Rocky Mountain region. +Sales of Proved and Unproved Properties +The partial sale of proved property within an existing field is accounted for as normal retirement and no gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of proved properties. +The partial sale of unproved property is accounted for as a recovery of cost when substantial uncertainty exists as to the ultimate recovery of the cost applicable to the interest retained. A gain on divestiture activity is recognized to the extent that the sales price exceeds the carrying amount of the unproved property. A gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of unproved property. For additional discussion, please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale . +Stock-Based Compensation +At December 31, 2014 , the Company had stock-based employee compensation plans that included RSUs, PSUs, and restricted stock awards issued to employees and non-employee directors, as more fully described in Note 7 - Compensation Plans. The Company records expense associated with the fair value of stock-based compensation in accordance with authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant. +99 +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. +Earnings per Share +Basic net income (loss) per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average common shares outstanding for the respective period. The earnings per share calculations reflect the impact of any repurchases of shares of common stock made by the Company. +Diluted net income (loss) per common share is calculated by dividing adjusted net income or loss by the diluted weighted-average common shares outstanding, which includes the effect of potentially dilutive securities. Potentially dilutive securities for this calculation consist of in-the-money outstanding stock options, unvested RSUs, contingent PSUs, and shares into which the 3.50% Senior Convertible Notes were convertible. When there is a loss from continuing operations, as was the case for the year ended December 31, 2012, all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of diluted earnings per share. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three-year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 7 – Compensation Plans under the heading Performance Share Units Under the Equity Incentive Compensation Plan . +The Company called for redemption of its 3.50% Senior Convertible Notes on April 2, 2012, after which the majority of the holders of the outstanding 3.50% Senior Convertible Notes elected to convert their notes. The Company issued 864,106 common shares upon conversion, and these shares were included in the calculation of basic weighted-average common shares outstanding for the year ended December 31, 2012, and all subsequent years the shares remain outstanding. Please refer to Note 5 - Long-term Debt for additional discussion. Prior to calling the 3.50% Senior Convertible Notes for redemption, the Company’s notes had a net-share settlement right giving the Company the option to irrevocably elect, by notice to the trustee under the indenture for the notes, to settle the Company’s obligation, in the event that holders of the notes elected to convert all or a portion of their notes, by delivering cash in an amount equal to each $1,000 principal amount of notes surrendered for conversion and, if applicable, at the Company’s option, shares of common stock or cash, or any combination of common stock and cash, for the amount of conversion value in excess of the principal amount. Prior to the settlement of the Company’s 3.50% Senior Convertible Notes, potentially dilutive shares associated with the conversion feature were accounted for using the treasury stock method when shares of the Company’s common stock traded at an average closing price that exceeded the $54.42 conversion price. Shares of the Company’s common stock traded at an average closing price exceeding the conversion price and were included on an adjusted weighted basis for the portion of the year ended December 31, 2012, for which they were outstanding. The Company recorded a loss from continuing operations for the year ended December 31, 2012, and therefore, the shares into which the 3.50% Senior Convertible Notes were convertible were anti-dilutive and excluded from the calculation of diluted earnings per share, as shown in the table below. +The treasury stock method is used to measure the dilutive impact of in-the-money stock options, unvested RSUs, contingent PSUs, and the 3.50% Senior Convertible Notes. +100 +The following table details the weighted-average dilutive and anti-dilutive securities related to stock options, RSUs, PSUs, and the 3.50% Senior Convertible Notes for the years presented: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Dilutive +814 +1,383 +— +Anti-dilutive +— +— +2,102 +The following table sets forth the calculations of basic and diluted earnings per share: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands, except per share amounts) +Net income (loss) +$ +666,051 +$ +170,935 +$ +(54,249 +) +Basic weighted-average common shares outstanding +67,230 +66,615 +65,138 +Add: dilutive effect of stock options, unvested RSUs, and contingent PSUs +814 +1,383 +— +Add: dilutive effect of 3.50% Senior Convertible Notes (1) +— +— +— +Diluted weighted-average common shares outstanding +68,044 +67,998 +65,138 +Basic net income (loss) per common share +$ +9.91 +$ +2.57 +$ +(0.83 +) +Diluted net income (loss) per common share +$ +9.79 +$ +2.51 +$ +(0.83 +) +____________________________________________ +(1) For the year ended December 31, 2012, the shares into which the 3.50% Senior Convertible Notes were convertible were anti-dilutive and excluded from the calculation of diluted earnings per share. +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income (loss). +101 +The changes in the balances of components comprising other comprehensive income (loss) are presented in the following table: +Derivative Adjustments +Pension Liability Adjustments +(in thousands) +For the year ended December 31, 2012 +Net actuarial loss +$ +(4,680 +) +Reclassification to earnings +$ +(3,865 +) +771 +Tax benefit +1,601 +1,439 +Loss, net of tax +$ +(2,264 +) +$ +(2,470 +) +For the year ended December 31, 2013 +Net actuarial gain +$ +2,766 +Reclassification to earnings +$ +1,777 +1,239 +Tax expense +(662 +) +(1,522 +) +Income, net of tax +$ +1,115 +$ +2,483 +For the year ended December 31, 2014 +Net actuarial loss +$ +(10,062 +) +Reclassification to earnings +$ +— +706 +Tax benefit +— +3,460 +Loss, net of tax +$ +— +$ +(5,896 +) +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The recorded value of the Company’s credit facility approximates its fair value as it bears interest at a floating rate that approximates a current market rate. The Company had $166.0 million of outstanding loans under its credit facility as of December 31, 2014 . The Company had no borrowings outstanding under its credit facility as of December 31, 2013 . The Company’s Senior Notes are recorded at cost and the respective fair values are disclosed in Note 11 - Fair Value Measurements. The Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry and all of the Company’s operations are conducted entirely within the United States. The Company reports as a single industry segment. The Company’s gas marketing function provides mostly internal services and acts as the first purchaser of natural gas and natural gas liquids produced by the Company in certain cases. The Company considers its marketing function as ancillary to its oil and gas producing activities. The amount of income these operations generate from marketing gas produced by third parties is not material to the Company’s results of operations, and segmentation of such activity would not provide a better understanding of the Company’s performance. However, gross revenue and expense related to marketing activities for gas produced by third parties are presented in the marketed gas system revenue and marketed gas system expense line items in the accompanying statements of operations. +102 +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPE”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that SM Energy is the primary beneficiary of a variable interest entity, that entity is consolidated into SM Energy. The Company has not been involved in any unconsolidated SPE transactions in 2014 or 2013. +Recently Issued Accounting Standards +Effective October 1, 2014, the Company early adopted, on a prospective basis, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” This ASU changed the criteria for reporting discontinued operations while enhancing disclosures in this area. There was no impact to the Company’s financial statements or disclosures from the early adoption of this standard. +In May 2014, the FASB issued new authoritative accounting guidance related to the recognition of revenue from contracts with customers. This guidance is to be applied using a retrospective method or a modified retrospective method, as outlined in the guidance, and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. Early application is not permitted. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures. +In August 2014, the FASB issued new authoritative guidance that requires management to evaluate whether there are conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the entity’s financial statements are issued, or within one year after the date the entity’s financial statements are available to be issued, and to provide disclosures when certain criteria are met. This guidance is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures but does not believe it will impact the Company's financial statements or disclosures. +In January 2015, the FASB issued new authoritative accounting guidance that simplifies income statement presentation by eliminating extraordinary items from GAAP. This guidance is to be applied either prospectively or retrospectively and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early application is permitted provided the guidance is applied from the beginning of the annual year of adoption. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures. +In February 2015, the FASB issued new authoritative accounting guidance meant to clarify the consolidation reporting guidance in GAAP. This guidance is to be applied using a retrospective method or a modified retrospective method, as outlined in the guidance, and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early application is permitted. The Company is currently evaluating the provisions of this guidance and assessing its impact on the Company’s financial statements and disclosures. +There are no other accounting standards applicable to the Company that have been issued but not yet adopted by the Company as of December 31, 2014 , and through the filing date of this report. +103 +Note 2 – Accounts Receivable and Accounts Payable and Accrued Expenses +Accounts receivable are comprised of the following: +As of December 31, +2014 +2013 +(in thousands) +Accrued oil, gas, and NGL production revenue +$ +180,250 +$ +228,169 +Amounts due from joint interest owners +58,347 +37,517 +Accrued derivative settlements +39,811 +770 +State severance tax refunds +24,394 +29,213 +Other +19,828 +22,702 +Total accounts receivable +$ +322,630 +$ +318,371 +Accounts payable and accrued expenses are comprised of the following: +As of December 31, +2014 +2013 +(in thousands) +Accrued capital expenditures +$ +357,156 +$ +217,820 +Revenue and severance tax payable +63,779 +87,852 +Accrued lease operating expense +34,822 +29,296 +Accrued property taxes +15,059 +10,401 +Joint owner advances +152 +96,636 +Accrued compensation +56,279 +71,466 +Accrued interest +40,786 +40,027 +Other +72,651 +53,253 +Total accounts payable and accrued expenses +$ +640,684 +$ +606,751 +Note 3 – Acquisitions, Divestitures, and Assets Held for Sale +2014 Acquisition Activity +• +Gooseneck Property Acquisitions. On September 24, 2014 , the Company acquired approximately 61,000 net acres of proved and unproved oil and gas properties in its Gooseneck area in North Dakota, along with related equipment, contracts, records, and other assets. Total cash consideration paid by the Company was $325.2 million and the effective date for the acquisition was July 1, 2014 . +On October 15, 2014 , the Company acquired additional interests in proved and unproved oil and gas properties in its Gooseneck area. Total cash consideration paid by the Company was $84.8 million and the effective date for the acquisition was August 1, 2014 . +It was determined that both of these acquisitions met the criteria of a business combination under Accounting Standards Codification (“ASC”) Topic 805, Business Combinations . The Company allocated the preliminary adjusted purchase price to the acquired assets and liabilities based on fair value as of the respective acquisition dates, as summarized in the table below. These acquisitions are subject to normal post-closing adjustments, which are expected to be completed in the first half of 2015. Refer to Note 11 – Fair Value Measurements for additional discussion on the valuation techniques used in determining the fair value of acquired properties. +104 +As of September 24, 2014 +As of October 15, 2014 +Purchase Price +(in thousands) +Cash consideration +$ +325,230 +$ +84,836 +Fair value of assets acquired: +Proved oil and gas properties +$ +203,493 +$ +54,360 +Unproved oil and gas properties +126,622 +29,469 +Total fair value of oil and gas properties acquired +330,115 +83,829 +Working capital +(2,772 +) +2,625 +Asset retirement obligation +(2,113 +) +(1,618 +) +Total fair value of net assets acquired +$ +325,230 +$ +84,836 +• +Rocky Mountain Acquisitions. In addition to the Gooseneck property acquisitions discussed above, the Company acquired other proved and unproved properties in its Rocky Mountain region during 2014 in multiple transactions for approximately $134.5 million in total cash consideration, plus approximately 7,000 net acres of non-core assets in the Company’s Rocky Mountain region. These acquisitions are subject to normal post-closing adjustments, which are expected to be completed in early 2015. +2014 Divestiture Activity +• +Rocky Mountain Divestiture. During the second quarter of 2014, the Company divested certain non-core assets in the Montana portion of the Williston Basin. Total divestiture proceeds were $50.1 million and the final gain on this divestiture was $26.9 million . +The Company recorded $27.6 million of write-downs to fair value less estimated costs to sell for assets that were held for sale during the year ended December 31, 2014, which are reflected as a loss on divestiture activity in the accompanying statements of operations, and mostly offset the gain on the Rocky Mountain divestiture discussed above. Please refer to Assets Held for Sale below for further discussion. +2013 Divestiture Activity +• +Mid-Continent Divestitures. In December 2013, the Company divested of certain non-strategic assets located in its Mid-Continent region, with the largest transaction being the sale of the Company’s Anadarko Basin assets. Total divestiture proceeds were $368.5 million and the net gain on these divestitures was $25.3 million . A portion of one transaction was structured to qualify as a like-kind exchange under Section 1031 of the IRC. +• +Rocky Mountain Divestitures . During 2013, the Company divested of certain non-strategic assets located in its Rocky Mountain region. Final divestiture proceeds for these divestitures were $57.1 million and the final net gain was $13.2 million . +• +Permian Divestiture . In December 2013, the Company divested of certain non-strategic assets located in its Permian region. Final proceeds for this divestiture were $14.0 million and the final net loss was $7.0 million . +The Company recorded an immaterial write-down to fair value less estimated costs to sell for assets that were held for sale as of December 31, 2013. +105 +2012 Divestiture Activity +In 2012, the Company divested of various non-strategic properties located in its Rocky Mountain and +Mid-Continent regions. Final divestiture proceeds were $57.9 million and the final net gain on these divestitures was $7.4 million . +During 2012, the Company reclassified a portion of the assets previously held for sale to assets held and used, as the assets were no longer being actively marketed. The assets were measured at the lower of the carrying value of the assets before being classified as held for sale, adjusted for any DD&A that would have been recognized had the assets been continuously held and used, or the fair value of the assets at the date they no longer met the criteria as held for sale. As a result of this measurement, the Company recognized $1.7 million of DD&A expense and a $33.9 million loss on unsuccessful sale of properties, which is included in gain (loss) on divestiture activity in the accompanying statements of operations. +Assets Held for Sale +Assets are classified as held for sale when the Company commits to a plan to sell the assets and there is reasonable certainty the sale will take place within one year. Upon classification as held for sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to identify and expense any excess of carrying value over fair value less costs to sell. Subsequent changes to the estimated fair value less the costs to sell will impact the measurement of assets held for sale for which fair value less costs to sell is determined to be less than the carrying value of the assets. +A s of December 31, 2014 , the accompanying balance sheets present $17.9 million of assets held for sale, net of accumulated DD&A expense. There is a corresponding asset retirement obligation liability of $438,000 for assets held for sale included in the asset retirement obligation financial statement line item. Assets held for sale are recorded at the lesser of their respective carrying value or fair value less estimated costs to sell. Certain assets classified as held for sale during 2014 were written down to fair value less estimated costs to sell, which was recorded in the gain (loss) on divestiture activity line item in the accompanying statements of operations. +Subsequent to December 31, 2014, the Company began marketing its assets in the Arkoma Basin of Oklahoma and in the Arklatex area of east Texas and northern Louisiana and expects the assets to be sold during 2015 . These assets did not meet the requirements to be classified as held for sale as of December 31, 2014. +The Company determined that neither these planned nor executed asset sales qualify for discontinued operations accounting under financial statement presentation authoritative guidance. +106 +Note 4 – Income Taxes +The provision for income taxes consists of the following: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Current portion of income tax expense +Federal +$ +— +$ +— +$ +— +State +868 +2,121 +370 +Deferred portion of income tax expense (benefit) +397,780 +105,555 +(29,638 +) +Total income tax expense (benefit) +$ +398,648 +$ +107,676 +$ +(29,268 +) +Effective tax rate +37.4 +% +38.6 +% +35.0 +% +The Company reduces its income tax payable to reflect employee stock option exercises. There was no excess income tax benefit associated with stock awards in 2014 , 2013 , or 2012 . +The components of the net deferred income tax liabilities are as follows: +As of December 31, +2014 +2013 +(in thousands) +Deferred tax liabilities: +Oil and gas properties +$ +1,029,424 +$ +768,463 +Derivative asset +220,437 +9,529 +Other +4,475 +1,245 +Total deferred tax liabilities +1,254,336 +779,237 +Deferred tax assets: +Federal and state tax net operating loss carryovers +184,447 +91,788 +Stock compensation +16,763 +18,820 +Other long-term liabilities +16,301 +13,341 +Net Profits Plan liability +9,414 +20,913 +Total deferred tax assets +226,925 +144,862 +Valuation allowance +(7,246 +) +(5,001 +) +Net deferred tax assets +219,679 +139,861 +Total net deferred tax liabilities +1,034,657 +639,376 +Less: current deferred income tax liabilities +(152,082 +) +(172 +) +Add: current deferred income tax assets +9,106 +10,921 +Non-current net deferred tax liabilities +$ +891,681 +$ +650,125 +Current federal income tax refundable +$ +4,734 +$ +4,630 +Current state income tax refundable +$ +— +$ +— +Current state income tax payable +$ +25 +$ +1,460 +At December 31, 2014 , the Company estimated its federal net operating loss carryforward at $626.2 million , which includes unrecognized excess income tax benefits associated with stock awards of $126.7 million . The federal net operating loss carryforward begins to expire in 2031 . The Company has estimated state net operating loss carryforwards of $284.8 million that expire between 2015 and 2035 and it has federal R&D credit carryforwards of $3.5 million that expire between 2028 and 2032. The Company’s valuation allowance relates to charitable contribution carryforwards, state net operating loss carryforwards, and state tax credits, which the +107 +Company anticipates will expire before they can be utilized. The change in the valuation allowance from 2013 to 2014 primarily reflects a change in the Company’s position regarding anticipated utilization of cumulative state net operating losses. +Federal income tax expense differs from the amount that would be provided by applying the statutory United States federal income tax rate to income before income taxes primarily due to the effect of state income taxes, changes in valuation allowances, percentage depletion, R&D credits, and other permanent differences, as follows: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Federal statutory tax expense (benefit) +$ +372,644 +$ +97,514 +$ +(29,231 +) +Increase (decrease) in tax resulting from: +State tax expense (benefit) (net of federal benefit) +21,350 +9,400 +(992 +) +Research and development credit +— +— +(970 +) +Change in valuation allowance +2,245 +(314 +) +1,524 +Other +2,409 +1,076 +401 +Income tax expense (benefit) +$ +398,648 +$ +107,676 +$ +(29,268 +) +Acquisitions, divestitures, drilling activity, and basis differentials impacting the prices received for oil, gas, and NGLs affect apportionment of taxable income to the states where the Company owns oil and gas properties. As its apportionment factors change, the Company’s blended state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax expense (benefit) reported in the current year. Items affecting state apportionment factors are evaluated at the beginning of each year, after completion of the prior year income tax return, and when significant acquisition, divestiture or changes in drilling activity or estimated state revenue occurs during the year. +The Company and its subsidiaries file federal income tax returns and various state income tax returns. With certain exceptions, the Company is no longer subject to United States federal or state income tax examinations by these tax authorities for years before 2007. The Internal Revenue Service (“IRS”) initiated an audit in the first quarter of 2012 related to an R&D tax credit claimed by the Company for the 2007 through 2010 tax years. On April 23, 2013, the IRS issued a Notice of Proposed Adjustment disallowing $4.6 million of an R&D tax credit claimed for open tax years during the audit period. During the third quarter ended September 30, 2014, the Company successfully reached an agreement with the IRS Appeals Office (“Appeals”) related to the claimed R&D credit and recorded an immaterial adjustment. In the fourth quarter of 2014, Appeals returned the case to the Examination Team for final review. At December 31, 2014, the Company was waiting on final review and evaluating the basis for claiming the R&D credit for the 2012 and 2013 tax years. Subsequent to year-end, the Company concluded its evaluation, and preliminary estimates indicate it may be entitled to claim approximately $2.4 million of additional net R&D credit. The Company anticipates finalizing the amounts and filing amended returns in the first quarter of 2015. The tables above do not include the impact of the estimated amount. +On September 13, 2013, the United States Department of the Treasury and IRS issued final and re-proposed tangible property regulations effective for tax years beginning January 1, 2014. The Company has determined it is materially compliant with the requirements of these regulations as of December 31, 2014 . +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. Interest expense in the accompanying statements of operations includes a negligible amount associated with income taxes. At December 31, 2014 , the Company estimates the range of reasonably possible change in 2015 to the table below could be from zero to $1.2 million . +108 +The total amount recorded for unrecognized tax benefits is presented below: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Beginning balance +$ +2,358 +$ +2,278 +$ +1,961 +Additions for tax positions of prior years +140 +80 +317 +Settlements +(916 +) +— +— +Ending balance +$ +1,582 +$ +2,358 +$ +2,278 +Note 5 – Long-term Debt +Revolving Credit Facility +The Company and its lenders entered into a Second Amendment to the Fifth Amended and Restated Credit Agreement on December 10, 2014 . The Company incurred approximately $3.4 million in deferred financing costs associated with the amendment and extension of this credit facility. As amended, the Company’s credit facility has a maximum loan amount of $2.5 billion , current aggregate lender commitments of $1.5 billion , and a maturity date of December 10, 2019 . The borrowing base is subject to regular semi-annual redeterminations. On October 6, 2014 , the lending group redetermined the Company's borrowing base under the credit facility and increased it from $2.2 billion to $2.4 billion . The December 10, 2014 amendment to the credit facility specified that the borrowing base was not reduced by the issuance of the 2022 Notes and will remain at $2.4 billion until the next redetermination date, scheduled for April 1, 2015 . The borrowing base redetermination process under the credit facility considers the value of the Company’s proved oil and gas properties, as determined by the lender group. Borrowings under the facility are secured by at least 75 percent of the value of the Company’s proved oil and gas properties. +The Company must comply with certain financial and non-financial covenants under the terms of its credit facility agreement, including limitations on dividend payments and requirements to maintain certain financial ratios, which include debt to adjusted EBITDAX, as defined by the Company’s credit agreement as the ratio of debt to 12-month trailing adjusted EBITDAX, of less than 4.0 and an adjusted current ratio, as defined by the Company’s credit agreement, of no less than 1.0. The Company was in compliance with all financial and non-financial covenants under the credit facility as of December 31, 2014 , and through the filing date of this report. +Interest and commitment fees are accrued based on the borrowing base utilization grid below. Eurodollar loans accrue interest at the London Interbank Offered Rate plus the applicable margin from the utilization table below, and Alternate Base Rate (“ABR”) and swingline loans accrue interest at Prime plus the applicable margin from the utilization table below. Commitment fees are accrued on the unused portion of the aggregate commitment amount and are included in interest expense in the accompanying statements of operations. +Borrowing Base Utilization Grid +Borrowing Base Utilization Percentage +<25% +≥25% <50% +≥50% <75% +≥75% <90% +≥90% +Eurodollar Loans +1.250 +% +1.500 +% +1.750 +% +2.000 +% +2.250 +% +ABR Loans or Swingline Loans +0.250 +% +0.500 +% +0.750 +% +1.000 +% +1.250 +% +Commitment Fee Rate +0.300 +% +0.300 +% +0.350 +% +0.375 +% +0.375 +% +109 +The following table presents the outstanding balance, total amount of letters of credit, and available borrowing capacity under the Company's credit facility as of February 18, 2015 , December 31, 2014 , and December 31, 2013 : +As of February 18, 2015 +As of December 31, 2014 +As of December 31, 2013 +(in thousands) +Credit facility balance +$ +341,000 +$ +166,000 +$ +— +Letters of credit (1) +$ +808 +$ +808 +$ +808 +Available borrowing capacity +$ +1,158,192 +$ +1,333,192 +$ +1,299,192 +____________________________________________ +(1) Letters of credit reduce the amount available under the credit facility on a dollar-for-dollar basis. +Senior Notes +The Senior Notes line on the accompanying balance sheets, as of December 31, 2014 , and 2013 , consisted of the following: +As of December 31, +2014 +2013 +(in thousands) +2019 Notes +$ +350,000 +$ +350,000 +2021 Notes +350,000 +350,000 +2022 Notes +600,000 +— +2023 Notes +400,000 +400,000 +2024 Notes +500,000 +500,000 +Total Senior Notes +$ +2,200,000 +$ +1,600,000 +The Senior Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt, and are senior in right of payment to any future subordinated debt. There are no subsidiary guarantors of the Senior Notes. The Company is subject to certain covenants under the indenture governing the Senior Notes that limit the Company’s ability to incur additional indebtedness, issue preferred stock, and make restricted payments, including dividends; provided, however, that the first $6.5 million of dividends paid each year are not restricted by the restricted payment covenant. The Company was in compliance with all covenants under its Senior Notes as of December 31, 2014 , and through the filing date of this report. +2022 Notes +On November 17, 2014 , the Company issued $600.0 million in aggregate principal amount of 6.125% Senior Notes due 2022 . The 2022 Notes were issued at par and mature on November 15, 2022 . The Company received net proceeds of $590.0 million after deducting fees of $10.0 million , which are being amortized as deferred financing costs over the life of the 2022 Notes. The net proceeds were used to repay outstanding borrowings under the Company’s credit facility and for general corporate purposes. +Prior to November 15, 2017 , the Company may redeem, on one or more occasions, up to 35 percent of the aggregate principal amount of the 2022 Notes with the net cash proceeds of certain equity offerings at a redemption price of 106.125% of the principal amount thereof, plus accrued and unpaid interest. The Company may also redeem the 2022 Notes, in whole or in part, at any time prior to November 15, 2018 , at a redemption price equal to 100 percent of the principal amount of the 2022 Notes to be redeemed, plus a specified make-whole premium and accrued and unpaid interest to the applicable redemption date. +110 +On or after November 15, 2018 , the Company may also redeem all or, from time to time, a portion of the 2022 Notes at the redemption prices set forth below, during the twelve-month period beginning on November 15 of each applicable year, expressed as a percentage of the principal amount redeemed, plus accrued and unpaid interest: +2018 +103.063 +% +2019 +101.531 +% +2020 and thereafter +100.000 +% +Additionally, on November 17, 2014 , the Company entered into a registration rights agreement that provides holders of the 2022 Notes certain registration rights under the Securities Act. Pursuant to the registration rights agreement, the Company is required to file an exchange offer registration statement with the SEC with respect to its offer to exchange the 2022 Notes for substantially identical notes that are registered under the Securities Act. Under certain circumstances, the Company has agreed to file a shelf registration statement relating to the resale of the 2022 Notes in lieu of a registered exchange offer. If the registration statement related to the exchange offer is not declared effective on or before November 17, 2015 , or if the shelf registration statement, if required, is not declared effective within the time periods specified in the registration rights agreement, the Company has agreed to pay additional interest with respect to the 2022 Notes in an amount not to exceed one percent of the principal amount of the 2022 Notes until the exchange offer is completed or the shelf registration statement is declared effective. +2024 Notes +On May 20, 2013 , the Company issued $500.0 million in aggregate principal amount of 5.0% Senior Notes due 2024 . The 2024 Notes were issued at par and mature on January 15, 2024 . The Company received net proceeds of $490.2 million after deducting fees of $9.8 million , which are being amortized as deferred financing costs over the life of the 2024 Notes. The net proceeds were used to reduce the Company’s outstanding credit facility balance. +Prior to July 15, 2016 , the Company may redeem, on one or more occasions, up to 35 percent of the aggregate principal amount of the 2024 Notes with the net cash proceeds of certain equity offerings at a redemption price of 105% of the principal amount thereof, plus accrued and unpaid interest. The Company may also redeem the 2024 Notes, in whole or in part, at any time prior to July 15, 2018 , at a redemption price equal to 100 percent of the principal amount of the 2024 Notes to be redeemed, plus a specified make-whole premium and accrued and unpaid interest to the applicable redemption date. +On or after July 15, 2018 , the Company may also redeem all or, from time to time, a portion of the 2024 Notes at the redemption prices set forth below, during the twelve-month period beginning on July 15 of each applicable year, expressed as a percentage of the principal amount redeemed, plus accrued and unpaid interest: +2018 +102.500 +% +2019 +101.677 +% +2020 +100.833 +% +2021 and thereafter +100.000 +% +Additionally, on May 20, 2013 , the Company entered into a registration rights agreement that provides holders of the 2024 Notes certain registration rights under the Securities Act. The Company closed its offer to exchange its 2024 Notes for notes registered under the Securities Act on June 25, 2014. +111 +2023 Notes +On June 29, 2012 , the Company issued $400.0 million in aggregate principal amount of 6.50% Senior Notes due 2023 . The 2023 Notes were issued at par and mature on January 1, 2023 . The Company received net proceeds of $392.1 million after deducting fees of $7.9 million , which are being amortized as deferred financing costs over the life of the 2023 Notes. The net proceeds were used to reduce the Company’s outstanding credit facility balance. +Prior to July 1, 2015 , the Company may redeem, on one or more occasions, up to 35 percent of the aggregate principal amount of the 2023 Notes with the net cash proceeds of certain equity offerings at a redemption price of 106.5% of the principal amount thereof, plus accrued and unpaid interest. The Company may also redeem the 2023 Notes, in whole or in part, at any time prior to July 1, 2017 , at a redemption price equal to 100 percent of the principal amount of the 2023 Notes to be redeemed, plus a specified make-whole premium and accrued and unpaid interest to the applicable redemption date. +On or after July 1, 2017 , the Company may also redeem all or, from time to time, a portion of the 2023 Notes at the redemption prices set forth below, during the twelve-month period beginning on July 1 of each applicable year, expressed as a percentage of the principal amount redeemed, plus accrued and unpaid interest: +2017 +103.250 +% +2018 +102.167 +% +2019 +101.083 +% +2020 and thereafter +100.000 +% +Additionally, on June 29, 2012 , the Company entered into a registration rights agreement that provides holders of the 2023 Notes certain registration rights under the Securities Act. The Company satisfied its obligations to exchange its outstanding $400.0 million of its 2023 Notes for notes registered under the Securities Act on October 30, 2012 . +2021 Notes +On November 8, 2011 , the Company issued $350.0 million in aggregate principal amount of 6.50% Senior Notes due 2021 . The 2021 Notes were issued at par and mature on November 15, 2021 . The Company received net proceeds of $343.1 million after deducting fees of $6.9 million , which are being amortized as deferred financing costs over the life of the 2021 Notes. The net proceeds were used for general corporate purposes and to reduce the Company’s outstanding credit facility balance. +The Company may redeem the 2021 Notes, in whole or in part, at any time prior to November 15, 2016 , at a redemption price equal to 100 percent of the principal amount, plus a specified make-whole premium and accrued and unpaid interest . +The Company may also redeem all or, from time to time, a portion of the 2021 Notes on or after November 15, 2016 , at the prices set forth below, during the twelve-month period beginning on November 15 of the applicable year, expressed as a percentage of the principal amount redeemed, plus accrued and unpaid interest: +2016 +103.250 +% +2017 +102.167 +% +2018 +101.083 +% +2019 and thereafter +100.000 +% +112 +Additionally, on November 8, 2011 , the Company entered into a registration rights agreement that provides holders of the 2021 Notes certain registration rights for the 2021 Notes under the Securities Act. The Company satisfied its obligations to exchange its outstanding $350.0 million of its 2021 Notes for notes registered under the Securities Act on March 7, 2012 . +2019 Notes +On February 7, 2011 , the Company issued $350.0 million in aggregate principal amount of 6.625% Senior Notes due 2019 . The 2019 Notes were issued at par and mature on February 15, 2019 . The Company received net proceeds of $341.1 million after deducting fees of $8.9 million , which are being amortized as deferred financing costs over the life of the 2019 Notes. The net proceeds were used to repay borrowings under the Company’s credit facility, to fund the Company’s ongoing capital expenditure program, and for general corporate purposes. +The Company may redeem all or, from time to time, a portion of the 2019 Notes on or after February 15, 2015 , at the prices set forth in the table below, during the twelve-month period beginning on February 15 of the applicable year, expressed as a percentage of the principal amount redeemed, plus accrued and unpaid interest: +2015 +103.313 +% +2016 +101.656 +% +2017 and thereafter +100.000 +% +Additionally, on February 7, 2011 , the Company entered into a registration rights agreement that provides holders of the 2019 Notes certain registration rights for the 2019 Notes under the Securities Act. The Company satisfied its obligations to exchange its outstanding $350.0 million of its 2019 Notes for notes registered under the Securities Act on January 11, 2012 . +3.50% Senior Convertible Notes +On April 2, 2012 , the Company called for redemption all of its outstanding 3.50% Senior Convertible Notes. The call for redemption resulted in holders of $281.3 million aggregate principal amount electing to convert their notes. The Company settled the principal amount of all converted 3.50% Senior Convertible Notes in cash and settled the excess conversion value by issuing 864,106 shares of its common stock. The Company redeemed the remaining $6.2 million of aggregate principal amount of notes that were not converted on the redemption date at par plus accrued interest in cash. The Company used funds borrowed under its credit facility to pay the cash portion of the settlement. +Capitalized Interest +Capitalized interest costs for the Company for the years ended December 31, 2014 , 2013 , and 2012 , were $16.2 million , $11.0 million , and $12.1 million , respectively. +113 +Note 6 – Commitments and Contingencies +Commitments +The Company has entered into various agreements, which include drilling rig contracts of $116.1 million , gathering, processing, and transportation through-put commitments of $939.4 million , office leases, including maintenance, of $69.3 million , and other miscellaneous contracts and leases of $11.7 million . The annual minimum payments for the next five years and total minimum payments thereafter are presented below: +Years Ending December 31, +(in thousands) +2015 +$ +224,897 +2016 +147,896 +2017 +118,320 +2018 +128,866 +2019 +132,920 +Thereafter +383,619 +Total +$ +1,136,518 +Drilling rig contracts +The Company has multiple long-term drilling rig contracts . Early termination of these rig contracts as of December 31, 2014, would result in termination penalties of $75.8 million , which would be in lieu of paying the remaining drilling commitments of $116.1 million included in the table above. +Transportation commitments +The Company has gathering, processing, and transportation through-put commitments with various third parties that require delivery of a minimum amount of 1,411 Bcf of natural gas and 48 MMBbl of crude oil. These contracts expire at various dates through 2028 and the total amount of the commitment is approximately $939.4 million . The Company will be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments. If a shortfall in the minimum volume commitment for natural gas is projected, the Company has rights under certain contracts to arrange for third party gas to be delivered, and such volumes would count toward its minimum volume commitment. As of the filing date of this report, the Company does not expect to incur any material shortfalls. +Office leases +The Company leases office space under various operating leases with terms extending as far as 2026 . Rent expense for years ended December 31, 2014 , 2013 , and 2012 , was $6.5 million , $5.7 million , and $5.4 million , respectively. The Company also leases office equipment under various operating leases. +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the results of such pending litigation and claims will not have a material effect on the results of operations, the financial position, or the cash flows of the Company. +114 +Note 7 – Compensation Plans +Cash Bonus Plan +The Company has a cash bonus plan based on a performance measurement framework whereby selected eligible employee participants may be awarded an annual cash bonus. As the plan is currently administered, any awards under the plan are based on Company and regional performance and are then further refined by individual performance. The Company accrues cash bonus expense based upon the Company’s current year performance. Included in general and administrative expense, lease operating expense, and exploration expense in the accompanying statements of operations are $37.8 million , $41.8 million , and $16.3 million of cash bonus expense related to the specific performance years ended December 31, 2014 , 2013 , and 2012 , respectively. +Equity Plan +There are several components to the Company’s Equity Plan that are described in this section. Various types of equity awards have been granted by the Company in different periods. +As of December 31, 2014 , 3.6 million shares of common stock remained available for grant under the Equity Plan. The issuance of a direct share benefit such as a share of common stock, a stock option, a restricted share, a RSU, or a PSU counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. Stock options were issued out of the St. Mary Land & Exploration Company Stock Option Plan and the St. Mary Land & Exploration Company Incentive Stock Option Plan, both predecessors to the Equity Plan. +Performance Share Units Under the Equity Incentive Compensation Plan +The Company grants PSUs to eligible employees as a part of its equity compensation program. The PSU factor is based on the Company’s performance after completion of a three-year performance period. The performance criteria for the PSUs are based on a combination of the Company’s annualized Total Shareholder Return (“TSR”) for the performance period and the relative performance of the Company’s TSR compared with the annualized TSR of certain peer companies for the performance period. PSUs are recognized as general and administrative and exploration expense over the vesting periods of the award. +The fair value of PSUs was measured at the grant date with a stochastic process method using the Geometric Brownian Motion Model (“GBM Model”). A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for those iterations. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will take over the three-year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the most likely path the stock price will take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +Total expense recorded for PSUs was $16.0 million , $16.8 million , and $18.2 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively. As of December 31, 2014 , there was $19.8 million of total unrecognized expense related to PSUs, which is being amortized through 2017 . +115 +A summary of the status and activity of non-vested PSUs is presented in the following table: +For the Years Ended December 31, +2014 +2013 +2012 +PSUs +Weighted-Average Grant-Date Fair Value +PSUs +Weighted-Average Grant-Date Fair Value +PSUs +Weighted-Average Grant-Date Fair Value +Non-vested at beginning of year (1) +572,469 +$ +66.07 +669,308 +$ +63.91 +885,894 +$ +57.52 +Granted (1) +202,404 +$ +94.66 +274,831 +$ +64.13 +314,853 +$ +51.98 +Vested (1) +(206,830 +) +$ +64.79 +(345,005 +) +$ +60.06 +(493,679 +) +$ +44.72 +Forfeited (1) +(134,383 +) +$ +86.72 +(26,665 +) +$ +69.74 +(37,760 +) +$ +65.35 +Non-vested at end of year (1) +433,660 +$ +73.63 +572,469 +$ +66.07 +669,308 +$ +63.91 +____________________________________________ +(1) +The number of awards assumes a one multiplier. The final number of shares of common stock issued may vary depending on the ending three -year performance multiplier, which ranges from zero to two . +The fair value of the PSUs granted in 2014 , 2013 , and 2012 was $19.2 million , $17.6 million , and $16.4 million for the 2014 , 2013 , and 2012 grants, respectively. The PSUs granted in 2013 and 2014 will remain unvested until the third anniversary date of their issuance, at which time they will fully vest. The PSUs granted in 2012 vest 1/3 on each of the first three anniversary dates of their issuance. +The total fair value of PSUs that vested during the years ended December 31, 2014 , 2013 , and 2012 was $13.4 million , $20.7 million , and $22.1 million , respectively. +During the year ended December 31, 2014 , the Company settled PSUs that were granted in 2011 , which earned a 0.55 -times multiplier, by issuing a net 85,121 shares of the Company’s common stock in accordance with the terms of the PSU awards. The Company and the majority of grant participants mutually agreed to net share settle the awards to cover income and payroll tax withholdings as provided for in the plan document and award agreements. As a result, 45,042 shares were withheld to satisfy income and payroll tax withholding obligations that occurred upon delivery of the shares underlying those PSUs for 2014 . +During the year ended December 31, 2013 , the Company settled PSUs that were granted in 2010 , which earned a 1.725 -times multiplier, by issuing a net 387,461 shares of the Company’s common stock in accordance with the terms of the PSU awards. The Company and the majority of grant participants mutually agreed to net share settle the awards to cover income and payroll tax withholdings as provided for in the plan document and award agreements. As a result, 200,050 shares were withheld to satisfy income and payroll tax withholding obligations that occurred upon delivery of the shares underlying those PSUs for 2013 . +During the year ended December 31, 2012 , the Company settled PSUs that were granted in 2009 , which earned a 2.0 -times multiplier, by issuing a net 812,562 shares of the Company’s common stock in accordance with the terms of the PSU awards. The Company and the majority of grant participants mutually agreed to net share settle the awards to cover income and payroll tax withholdings as provided for in the plan document and award agreements. As a result, 406,866 shares were withheld to satisfy income and payroll tax withholding obligations that occurred upon delivery of the shares underlying those PSUs for 2012 . +116 +Restricted Stock Units Under the Equity Incentive Compensation Plan +The Company grants RSUs to eligible employees as a part of its equity incentive compensation program. Restrictions and vesting periods for the awards are determined by the Compensation Committee of the Board of Directors and are set forth in the award agreements. Each RSU represents a right for one share of the Company’s common stock to be delivered upon settlement of the award at the end of a specified period. RSUs are recognized as general and administrative and exploration expense over the vesting periods of the award. +The total expense associated with RSUs for the years ended December 31, 2014 , 2013 , and 2012 , was $13.9 million , $13.1 million , and $9.8 million , respectively. As of December 31, 2014 , there was $22.5 million of total unrecognized expense related to unvested RSU awards, which is being amortized through 2017 . The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the date of grant. The fair value of an RSU is equal to the closing price of the Company’s common stock on the day before grant. +A summary of the status and activity of non-vested RSUs is presented below: +For the Years Ended December 31, +2014 +2013 +2012 +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +Non-vested at beginning of year +580,431 +$ +57.05 +496,244 +$ +51.81 +308,877 +$ +44.33 +Granted +234,560 +$ +83.98 +329,939 +$ +60.01 +379,332 +$ +49.47 +Vested +(253,031 +) +$ +58.19 +(207,376 +) +$ +49.73 +(166,672 +) +$ +32.72 +Forfeited +(46,236 +) +$ +62.06 +(38,376 +) +$ +54.37 +(25,293 +) +$ +51.06 +Non-vested at end of year +515,724 +$ +68.29 +580,431 +$ +57.05 +496,244 +$ +51.81 +The fair value of RSUs granted in 2014 , 2013 , and 2012 was $19.7 million , $19.8 million , and $18.8 million , respectively. The RSUs granted in 2014, 2013, and 2012 vest 1/3 on each of the first three anniversary dates of the awards. +The total fair value of RSUs that vested during the years ended December 31, 2014 , 2013 , and 2012 , was $14.7 million , $10.3 million , and $5.4 million , respectively. +During the years ended December 31, 2014 , 2013 , and 2012 , the Company settled 253,031 , 207,378 , and 166,670 RSUs, respectively. The Company and the majority of grant participants mutually agreed to net share settle the awards to cover income and payroll tax withholdings as provided for in the plan document and award agreements. As a result, the Company issued net shares of common stock of 171,597 , 139,391 , and 116,813 for 2014 , 2013 , and 2012 , respectively. The remaining 81,434 , 67,987 , and 49,857 shares were withheld to satisfy income and payroll tax withholding obligations that occurred upon the delivery of the shares underlying those RSUs for 2014 , 2013 , and 2012 , respectively. +117 +Stock Option Grants Under the Equity Incentive Compensation Plan +The Company previously granted stock options under the St. Mary Land & Exploration Company Stock Option Plan and the St. Mary Land & Exploration Company Incentive Stock Option Plan. The last issuance of stock options occurred on December 31, 2004. Stock options to purchase shares of the Company’s common stock had been granted to eligible employees and members of the Board of Directors. All options granted under the option plans were granted at exercise prices equal to the respective closing market price of the Company’s underlying common stock on the grant dates. All stock options granted under the option plans were exercisable for a period of up to 10 years from the date of grant. The remaining options from the 2004 grant were exercised during the year ended December 31, 2014. As of December 31, 2014 , there was no unrecognized compensation expense related to stock option awards. +A summary of activity associated with the Company’s Stock Option Plans during the last three years is presented in the following table: +Weighted - +Average +Aggregate +Exercise +Intrinsic +Shares +Price +Value +For the year ended December 31, 2012 +Outstanding, start of year +508,214 +$ +13.86 +Exercised +(240,368 +) +$ +12.65 +$ +11,842,575 +Forfeited +— +$ +— +Outstanding, end of year +267,846 +$ +14.95 +$ +9,983,177 +Vested and exercisable at end of year +267,846 +$ +14.95 +$ +9,983,177 +For the year ended December 31, 2013 +Outstanding, start of year +267,846 +$ +14.95 +Exercised +(228,758 +) +$ +13.92 +$ +12,326,994 +Forfeited +— +$ +— +Outstanding, end of year +39,088 +$ +20.87 +$ +2,432,837 +Vested and exercisable at end of year +39,088 +$ +20.87 +$ +2,432,837 +For the year ended December 31, 2014 +Outstanding, start of year +39,088 +$ +20.87 +Exercised +(39,088 +) +$ +20.87 +$ +1,993,726 +Forfeited +— +$ +— +Outstanding, end of year +— +$ +— +$ +— +Vested and exercisable at end of year +— +$ +— +$ +— +The fair value of options was measured at the date of grant using the Black-Scholes-Merton option-pricing model. +Cash flows resulting from excess tax benefits are classified as part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for vested RSUs, settled PSUs, and exercised options in excess of the deferred tax asset attributable to stock compensation costs for such equity awards. The Company recorded no excess tax benefits for the years ended December 31, 2014 , 2013 , and 2012 . Cash received from exercises under all share-based payment arrangements for the years ended December 31, 2014 , 2013 , and 2012 , was $4.0 million , $3.2 million , and $3.0 million , respectively. +118 +Director Shares +In 2014 , 2013 , and 2012 , the Company issued 27,677 , 28,169 , and 30,486 shares, respectively, of the Company’s common stock to its non-employee directors pursuant to the Company’s Equity Plan. The Company recorded compensation expense related to these issuances of $1.6 million , $1.4 million , and $1.3 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively. +All shares of common stock issued to the Company’s non-employee directors are earned over the one -year service period following the date of grant, unless five years of service has been provided by the director, in which case that director’s shares vest immediately. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation, without accruing in excess of $25,000 in fair market value from purchases for each calendar year. The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on the first or last day of the purchase period. All shares issued under the ESPP on or after December 31, 2011, have no minimum restriction period. The ESPP is intended to qualify under Section 423 of the IRC. The Company has 1.1 million shares available under the ESPP for issuance as of December 31, 2014 . Shares issued under the ESPP totaled 83,136 in 2014 , 77,427 in 2013 , and 66,485 in 2012 . Total proceeds to the Company for the issuance of these shares were $4.1 million , $3.7 million , and $2.8 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively. +The fair value of ESPP shares was measured at the date of grant using the Black-Scholes-Merton option-pricing model. Expected volatility was calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six month vesting period. +The fair value of ESPP shares issued during the periods reported were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2014 +2013 +2012 +Risk free interest rate +0.1 +% +0.1 +% +0.1 +% +Dividend yield +0.1 +% +0.2 +% +0.2 +% +Volatility factor of the expected market +price of the Company’s common stock +33.0 +% +41.1 +% +47.8 +% +Expected life (in years) +0.5 +0.5 +0.5 +The Company expensed $1.1 million , $1.1 million , and $948,000 for the years ended December 31, 2014 , 2013 , and 2012 , respectively, based on the estimated fair value of grants. +119 +401(k) Plan +The Company has a defined contribution pension plan (the “401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. The Company matches each employee’s contribution up to six percent of the employee’s base salary and may make additional contributions at its discretion. Beginning in 2014, the Company also matches employee contributions up to six percent of the employee’s bonus paid pursuant to the Company’s cash bonus plan. The Company’s matching contributions to the 401(k) Plan were $6.4 million , $4.2 million , and $3.5 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively. No discretionary contributions were made by the Company to the 401(k) Plan for any of these years. +Non-qualified Deferred Compensation Plan +In January 2014, the Company established a non-qualified deferred compensation (“NQDC”) plan intended to provide plan participants with the ability to plan for income tax events and the opportunity to receive a benefit for matching contributions in excess of IRC limits applicable to the Company’s 401(k) plan. The NQDC plan is designed to allow employee participants to defer a portion of base salary and cash bonuses paid pursuant to the Company’s cash bonus plan and director participants to defer a portion of the cash retainer paid to directors. Each year, participating employees may elect to defer (i) between 0% and 50% of their base salary and (ii) between 0% and 100% of the cash bonus paid pursuant to the cash bonus plan, and participating directors may elect to defer between 0% and 100% of their cash retainer. The NQDC plan requires the Company to make contributions for each eligible employee equal to 100% of the deferred amount for such employee, limited to 6% of such employee’s base salary and cash bonus. Each eligible employee’s interest in contributions made by the Company will vest 40% after the second year of such employee’s service to the Company, and 20% per year thereafter. A participant’s account will be distributed based upon the participant’s payment election made at the time of deferral. A participant may elect to have distributions made in lump sum or in annual installments ranging for a period from 1 to 10 years. Participants in the NQDC plan are currently limited to the Company’s officers and directors. +Net Profits Plan +Under the Company’s Net Profits Plan, all oil and gas wells that were completed or acquired during each year were designated within a specific pool. Key employees recommended by senior management and designated as participants by the Compensation Committee of the Company’s Board of Directors and employed by the Company on the last day of that year became entitled to payments under the Net Profits Plan after the Company has received net cash flows returning 100 percent of all costs associated with that pool. Thereafter, 10 percent of future net cash flows generated by the pool are allocated among the participants and distributed at least annually. The portion of net cash flows from the pool to be allocated among the participants increases to 20 percent after the Company has recovered 200 percent of the total costs for the pool, including payments made under the Net Profits Plan at the 10 percent level. In December 2007, the Board of Directors discontinued the creation of new pools under the Net Profits Plan. As a result, the 2007 pool was the last Net Profits Plan pool established by the Company. +120 +Cash payments made or accrued under the Net Profits Plan that have been recorded as either general and administrative expense or exploration expense are detailed in the table below: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +General and administrative expense +$ +8,326 +$ +13,734 +$ +15,565 +Exploration expense +690 +1,310 +1,751 +Total +$ +9,016 +$ +15,044 +$ +17,316 +Additionally, the Company made or accrued cash payments under the Net Profits Plan of $8.3 million , $10.3 million , and $2.3 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively, as a result of divestiture proceeds. The cash payments are accounted for as a reduction in the gain (loss) on divestiture activity line item in the accompanying statements of operations. +The Company records changes in the present value of estimated future payments under the Net Profits Plan as a separate line item in the accompanying statements of operations. The change in the estimated liability is recorded as a non-cash expense or benefit in the current period. The amount recorded as an expense or benefit associated with the change in the estimated liability is not allocated to general and administrative expense or exploration expense because it is associated with the future net cash flows from oil and gas properties in the respective pools rather than results being realized through current period production. If the Company allocated the change in liability to these specific functional line items, based on the current allocation of actual distributions made by the Company, such expenses or benefits would predominately be allocated to general and administrative expense. The amount that would be allocated to exploration expense is minimal in comparison. Over time, less of the amount distributed relates to prospective exploration efforts as more of the amount distributed is paid to employees that have terminated employment and do not provide ongoing exploration support to the Company. +Note 8 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering substantially all employees who meet age and service requirements (the “Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (the “Nonqualified Pension Plan” and together with the Qualified Pension Plan, the “Pension Plans”). +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status, (i.e. the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment to accumulated other comprehensive income, net of tax. The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation but excludes the effects of assumed future salary increases. The Company’s measurement date for plan assets and obligations is December 31. +121 +For the Years Ended December 31, +2014 +2013 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year +$ +43,285 +$ +40,237 +Service cost +6,335 +6,291 +Interest cost +2,191 +1,627 +Plan amendments +— +— +Actuarial (gain) loss +8,821 +(1,577 +) +Benefits paid +(2,765 +) +(3,293 +) +Projected benefit obligation at end of year +57,867 +43,285 +Change in plan assets: +Fair value of plan assets at beginning of year +24,658 +20,254 +Actual return on plan assets +737 +2,726 +Employer contribution +5,310 +4,971 +Benefits paid +(2,765 +) +(3,293 +) +Fair value of plan assets at end of year +27,940 +24,658 +Funded status at end of year +$ +(29,927 +) +$ +(18,627 +) +The Company’s underfunded status for the Pension Plans for the years ended December 31, 2014 and 2013 , is $29.9 million and $18.6 million , respectively, and is recognized in the accompanying balance sheets as a portion of other noncurrent liabilities. No plan assets of the Qualified Pension Plan were returned to the Company during the fiscal year ended December 31, 2014 . There are no plan assets in the Nonqualified Pension Plan. +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2014 +2013 +(in thousands) +Projected benefit obligation +$ +57,867 +$ +43,285 +Accumulated benefit obligation +$ +43,205 +$ +32,396 +Less: Fair value of plan assets +(27,940 +) +(24,658 +) +Underfunded accumulated benefit obligation +$ +15,265 +$ +7,738 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for a year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +122 +Pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in accumulated other comprehensive loss as of December 31, 2014 and 2013 , consist of: +As of December 31, +2014 +2013 +(in thousands) +Unrecognized actuarial losses +$ +17,812 +$ +8,439 +Unrecognized prior service costs +118 +136 +Unrecognized transition obligation +— +— +Accumulated other comprehensive loss +$ +17,930 +$ +8,575 +The estimated net loss that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year is $1.2 million . +Pre-tax changes recognized in other comprehensive income (loss) during 2014 , 2013 , and 2012 , were as follows: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Net actuarial gain (loss) +$ +(10,062 +) +$ +2,766 +$ +(4,680 +) +Prior service cost +— +— +— +Less: Amortization of: +Prior service cost +(17 +) +(17 +) +(17 +) +Actuarial loss +(689 +) +(1,222 +) +(754 +) +Total other comprehensive income (loss) +$ +(9,356 +) +$ +4,005 +$ +(3,909 +) +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Components of net periodic benefit cost: +Service cost +$ +6,335 +$ +6,291 +$ +4,934 +Interest cost +2,191 +1,627 +1,374 +Expected return on plan assets that reduces periodic pension cost +(1,978 +) +(1,538 +) +(1,165 +) +Amortization of prior service cost +17 +17 +17 +Amortization of net actuarial loss +689 +1,222 +754 +Net periodic benefit cost +$ +7,254 +$ +7,619 +$ +5,914 +Gains and losses in excess of 10 percent of the greater of the benefit obligation and the market-related value of assets are amortized over the average remaining service period of active participants. +123 +Pension Plan Assumptions +Weighted-average assumptions to measure the Company’s projected benefit obligation and net periodic benefit cost are as follows: +As of December 31, +2014 +2013 +2012 +Projected benefit obligation +Discount rate +4.3% +5.0% +3.9% +Rate of compensation increase +6.2% +6.2% +6.2% +Net periodic benefit cost +Discount rate +5.0% +3.9% +4.7% +Expected return on plan assets (1) +7.5% +7.5% +7.5% +Rate of compensation increase +6.2% +6.2% +6.2% +____________________________________________ +(1) +There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy does not permit the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting the optimal expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. The weighted-average asset allocation of the Qualified Pension Plan is as follows: +Target +As of December 31, +Asset Category +2015 +2014 +2013 +Equity securities +42.0 +% +39.6 +% +43.6 +% +Fixed income securities +35.0 +% +33.9 +% +32.2 +% +Other securities +23.0 +% +26.5 +% +24.2 +% +Total +100.0 +% +100.0 +% +100.0 +% +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in that plan. An expected return on plan assets of 7.5 percent was used to calculate the Company’s obligation under the Qualified Pension Plan for 2014 and 2013 . Factors considered in determining the expected rate of return include the long-term historical rate of return provided by the equity and debt securities markets and input from the investment consultants and trustees managing the plan assets. The difference in investment income using the projected rate of return compared to the actual rates of return for the past two years was not material and is not expected to have a material effect on the accompanying statements of operations or cash flows from operating activities in future years. +124 +Fair Value Assumptions +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2014 and 2013 , utilizing the fair value hierarchy discussed in Note 11 – Fair Value Measurements is as follows: +Fair Value Measurements Using: +Actual Asset Allocation +Total +Level 1 Inputs +Level 2 Inputs +Level 3 Inputs +(in thousands) +December 31, 2014 +Cash +— +% +$ +— +$ +— +$ +— +$ +— +Equity Securities +Domestic (1) +27.1 +% +7,569 +5,550 +2,019 +— +International (2) +12.5 +% +3,498 +3,498 +— +— +Total Equity Securities +39.6 +% +11,067 +9,048 +2,019 +— +Fixed Income Securities +High-Yield Bonds (3) +2.9 +% +797 +797 +— +— +Core Fixed Income (4) +22.4 +% +6,247 +6,247 +— +— +Floating Rate Corp Loans (5) +8.6 +% +2,413 +2,413 +— +— +Total Fixed Income Securities +33.9 +% +9,457 +9,457 +— +— +Other Securities: +Commodities (6) +2.9 +% +810 +810 +— +— +Real Estate (7) +4.7 +% +1,327 +— +— +1,327 +Hedge Fund (8) +14.8 +% +4,130 +593 +— +3,537 +Collective Investment Trusts (9) +4.1 +% +1,149 +— +1,149 +— +Total Other Securities +26.5 +% +7,416 +1,403 +1,149 +4,864 +Total Investments +100.0 +% +$ +27,940 +$ +19,908 +$ +3,168 +$ +4,864 +December 31, 2013 +Cash and Money Market Funds +— +% +$ +— +$ +— +$ +— +$ +— +Equity Securities +Domestic (1) +29.9 +% +7,371 +4,888 +2,483 +— +International (2) +13.7 +% +3,373 +3,373 +— +— +Total Equity Securities +43.6 +% +10,744 +8,261 +2,483 +— +Fixed Income Securities +High-Yield Bonds (3) +5.9 +% +1,448 +1,448 +— +— +Core Fixed Income (4) +20.3 +% +5,006 +5,006 +— +— +Floating Rate Corp Loans (5) +6.0 +% +1,483 +1,483 +— +— +Total Fixed Income Securities +32.2 +% +7,937 +7,937 +— +— +Other Securities: +Commodities (6) +3.8 +% +945 +945 +— +— +Real Estate (7) +3.5 +% +859 +— +— +859 +Hedge Fund (8) +14.3 +% +3,517 +955 +— +2,562 +Collective Investment Trusts (9) +2.6 +% +656 +— +656 +— +Total Other Securities +24.2 +% +5,977 +1,900 +656 +3,421 +Total Investments +100.0 +% +$ +24,658 +$ +18,098 +$ +3,139 +$ +3,421 +____________________________________________ +125 +(1) +Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold upon demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of this fund is to approximate the S&P 500 by investing in one or more collective investment funds. +(2) +International equity securities consists of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets and believed to have strong sustainable financial productivity at attractive valuations. +(3) +High-yield bonds consist of non-investment grade fixed income securities. The investment objective is to obtain high current income. Due to the increased level of default risk, security selection focuses on credit-risk analysis. +(4) +The objective is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay's Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +(5) +Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +(6) +Investments with exposure to commodity price movements, primarily through the use of futures, swaps and other commodity-linked securities. +(7) +The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(8) +The hedge fund portfolio includes an investment in an actively traded global mutual fund that focuses on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +(9) +Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +Included below is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2013 +$ +2,384 +Purchases +742 +Realized gain on assets +161 +Unrealized gain on assets +134 +Balance at December 31, 2013 +$ +3,421 +Purchases +1,232 +Realized gain on assets +144 +Unrealized gain on assets +67 +Balance at December 31, 2014 +$ +4,864 +Contributions +The Company contributed $5.3 million , $5.0 million , and $5.4 million , to the Pension Plans in the years ended December 31, 2014 , 2013 , and 2012 , respectively. The Company is expected to make a $5.8 million contribution to the Pension Plans in 2015 . +126 +Benefit Payments +The Pension Plans made actual benefit payments of $2.8 million , $3.3 million , and $1.0 million in the years ended December 31, 2014 , 2013 , and 2012 , respectively. Expected benefit payments over the next 10 years are as follows: +Years Ending December 31, +(in thousands) +2015 +$ +3,006 +2016 +$ +3,046 +2017 +$ +3,921 +2018 +$ +4,558 +2019 +$ +5,204 +2020 through 2024 +$ +38,427 +Note 9 – Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the plugging and abandonment of its oil and gas properties. A liability for the fair value of an asset retirement obligation (“ARO”) and a corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is completed or acquired. The increase in carrying value is included in proved oil and gas properties in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and gas properties. Cash paid to settle asset retirement obligations is included in the operating section of the Company’s accompanying statements of cash flows. +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent . In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or changes in inflation factors and changes to the Company’s credit-adjusted risk-free rate as market conditions warrant. +A reconciliation of the Company’s total asset retirement obligation liability is as follows: +As of December 31, +2014 +2013 +(in thousands) +Beginning asset retirement obligation +$ +121,186 +$ +120,518 +Liabilities incurred +13,506 +18,682 +Liabilities settled +(11,372 +) +(33,129 +) +Accretion expense +6,090 +5,997 +Revision to estimated cash flows +(7,286 +) +9,118 +Ending asset retirement obligation +$ +122,124 +$ +121,186 +As of December 31, 2014 and 2013 , accounts payable and accrued expenses contain $1.3 million and $2.5 million , respectively, related to the Company’s current asset retirement obligation liability for estimated plugging and abandonment costs associated with a platform structure that is being retired, which is also included in the table above. +127 +Note 10 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company has entered into various commodity derivative contracts to mitigate a portion of the exposure to potentially adverse market changes in commodity prices and the associated impact on cash flows. All contracts are entered into for other-than-trading purposes. The Company’s derivative contracts in place include swap and collar arrangements for oil, gas, and NGLs. +As of December 31, 2014 , the Company had commodity derivative contracts outstanding through the fourth quarter of 2019 for a total of 14.7 million Bbls of oil production, 230.8 million MMBtu of gas production, and 781,000 Bbls of NGL production. +In a typical commodity swap agreement, if the agreed upon published third-party index price is lower than the swap fixed price, the Company receives the difference between the index price and the agreed upon swap fixed price. If the index price is higher than the swap fixed price, the Company pays the difference. For collar agreements, the Company receives the difference between an agreed upon index and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +The following tables summarize the approximate volumes and average contract prices of contracts the Company had in place as of December 31, 2014 : +Oil Contracts +Oil Swaps +Contract Period +NYMEX WTI Volumes +Weighted- +Average +Contract +Price +(Bbls) +(per Bbl) +First quarter 2015 +1,711,000 +$ +91.96 +Second quarter 2015 +1,639,000 +$ +91.26 +Third quarter 2015 +1,254,000 +$ +90.78 +Fourth quarter 2015 +1,137,000 +$ +90.15 +2016 +5,570,000 +$ +88.01 +All oil swaps +11,311,000 +Oil Collars +Contract Period +NYMEX WTI +Volumes +Weighted- +Average +Floor +Price +Weighted- +Average +Ceiling +Price +(Bbls) +(per Bbl) +(per Bbl) +First quarter 2015 +882,000 +$ +85.00 +$ +99.53 +Second quarter 2015 +709,000 +$ +85.00 +$ +94.06 +Third quarter 2015 +906,000 +$ +85.00 +$ +91.25 +Fourth quarter 2015 +869,000 +$ +85.00 +$ +92.19 +All oil collars +3,366,000 +128 +Natural Gas Contracts +Gas Swaps +Contract Period +Volumes +Weighted- +Average +Contract +Price +(MMBtu) +(per MMBtu) +First quarter 2015 +23,548,000 +$ +4.22 +Second quarter 2015 +15,985,000 +$ +3.90 +Third quarter 2015 +14,950,000 +$ +4.03 +Fourth quarter 2015 +13,570,000 +$ +4.02 +2016 +48,896,000 +$ +4.12 +2017 +37,414,000 +$ +4.16 +2018 +35,241,000 +$ +4.21 +2019 +28,159,000 +$ +4.28 +All gas swaps* +217,763,000 +____________________________________________ +*Natural gas swaps are comprised of IF El Paso Permian ( 3% ), IF HSC ( 82% ), IF NGPL TXOK ( 1% ), IF NNG Ventura ( 3% ), and IF Enable East ( 11% ). +Gas Collars +Contract Period +Volumes +Weighted- +Average +Floor +Price +Weighted- +Average +Ceiling +Price +(MMBtu) +(per MMBtu) +(per MMBtu) +First quarter 2015 +2,524,000 +$ +4.00 +$ +4.30 +Second quarter 2015 +2,297,000 +$ +4.00 +$ +4.30 +Third quarter 2015 +2,005,000 +$ +4.00 +$ +4.30 +Fourth quarter 2015 +6,176,000 +$ +3.97 +$ +4.30 +All gas collars* +13,002,000 +____________________________________________ +*Natural gas collars are comprised of IF El Paso Permian ( 4% ), IF HSC ( 80% ), IF NNG Ventura ( 8% ), and IF Enable East ( 8% ). +NGL Contracts +NGL Swaps +Contract Period +Volumes +Weighted- +Average +Contract +Price +(Bbls) +(per Bbl) +First quarter 2015 +781,000 +$ +55.42 +All NGL swaps* +781,000 +____________________________________________ +*NGL swaps are comprised of OPIS Natural Gasoline Mt Belv Non TET ( 28% ) and OPIS Propane Mt Belv TET ( 72% ). +129 +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities. The fair value of the commodity derivative contracts was a net asset of $592.1 million and $21.5 million at December 31, 2014 and 2013 , respectively. +The following tables detail the fair value of derivatives recorded in the accompanying balance sheets, by category: +As of December 31, 2014 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity Contracts +Current assets +$ +402,668 +Current liabilities +$ +— +Commodity Contracts +Noncurrent assets +189,540 +Noncurrent liabilities +70 +Derivatives not designated as hedging instruments +$ +592,208 +$ +70 +As of December 31, 2013 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity Contracts +Current assets +$ +21,559 +Current liabilities +$ +26,380 +Commodity Contracts +Noncurrent assets +30,951 +Noncurrent liabilities +4,640 +Derivatives not designated as hedging instruments +$ +52,510 +$ +31,020 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2014 and 2013 , all derivative instruments held by the Company were subject to enforceable master netting arrangements held by various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that occur on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s derivative contracts: +Derivative Assets +Derivative Liabilities +As of December 31, +As of December 31, +Offsetting of Derivative Assets and Liabilities +2014 +2013 +2014 +2013 +(in thousands) +Gross amounts presented in the accompanying balance sheets +$ +592,208 +$ +52,510 +$ +(70 +) +$ +(31,020 +) +Amounts not offset in the accompanying balance sheets +(70 +) +(30,652 +) +70 +30,652 +Net amounts +$ +592,138 +$ +21,858 +$ +— +$ +(368 +) +130 +Discontinuance of Cash Flow Hedge Accounting +As of January 1, 2011, the Company elected to de-designate all of its commodity derivative contracts that had been previously designated as cash flow hedges at December 31, 2010. Fair values at December 31, 2010, were frozen in AOCL as of the de-designation date and were reclassified into earnings as the original derivative transactions settled. As of September 30, 2013 , all commodity derivative contracts that had been previously designated as cash flow hedges had settled and had been reclassified into earnings from AOCL. +Subsequent to December 31, 2010, the Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in AOCL. The Company had no derivatives designated as cash flow hedges for the years ended December 31, 2014 , 2013 , and 2012 , and no new gains or losses were deferred to AOCL during these respective years. Please refer to Note 11 - Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +The following table summarizes the components of derivative gain presented in the accompanying statements of operations: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Derivative settlement (gain) loss: +Oil contracts +$ +(28,410 +) +$ +15,161 +$ +11,893 +Gas contracts +26,706 +(30,338 +) +(47,270 +) +NGL contracts +(10,911 +) +(6,885 +) +(8,887 +) +Total derivative settlement gain (1) +$ +(12,615 +) +$ +(22,062 +) +$ +(44,264 +) +Total derivative (gain) loss: +Oil contracts +$ +(457,082 +) +$ +14,665 +$ +(20,088 +) +Gas contracts +(93,267 +) +(14,053 +) +(15,493 +) +NGL contracts +(32,915 +) +(3,692 +) +(20,049 +) +Total derivative gain (2) +$ +(583,264 +) +$ +(3,080 +) +$ +(55,630 +) +____________________________________________ +(1) +Total derivative settlement gain is reported in the derivative cash settlements line item on the accompanying statements of cash flows within net cash provided by operating activities with the change in accrued settlements between years being reported in change in accounts receivable and change in accounts payable and accrued expenses line items. Total derivative settlement gains are adjusted by a $41.0 million decrease attributable to the change in current assets and liabilities at December 31, 2014. +(2) +Total derivative gain is reported in the derivative gain line item on the accompanying statements of cash flows within net cash provided by operating activities. +The following table details the effect of derivative instruments on AOCL and the accompanying statements of operations (net of income tax): +Location on +Accompanying +Statements of +Operations +For the Years Ended December 31, +Derivatives +2014 +2013 +2012 +(in thousands) +Amount reclassified from AOCL +Commodity Contracts +Other operating revenues +$ +— +$ +1,115 +$ +(2,264 +) +131 +The realized net hedge loss for the year ended December 31, 2013, and net hedge gain for the year ended December 31, 2012, shown net of income tax in the table above, are comprised of realized settlements on commodity derivative contracts that were previously designated as cash flow hedges. Realized hedge gains or losses from the settlement of commodity derivatives previously designated as cash flow hedges are reported in the other operating revenues line item on the accompanying statements of operations. The Company realized a pre-tax net loss of $1.8 million and a pre-tax net gain of $3.9 million from its commodity derivative contracts that were previously designated as cash flow hedges for the years ended December 31, 2013 , and 2012 , respectively. +Credit Related Contingent Features +As of December 31, 2014 , and through the filing date of this report, all of the Company’s derivative counterparties were members of the Company’s credit facility lender group. The Company’s obligations under its credit facility and derivative contracts are secured by liens on at least 75 percent of the Company’s proved oil and gas properties. +Convertible Note Derivative Instrument +The contingent interest provision of the 3.50% Senior Convertible Notes was an embedded derivative instrument. The 3.50% Senior Convertible Notes were settled during the second quarter of 2012. Please refer to Note 5 - Long-term Debt for additional discussion. +Note 11 – Fair Value Measurements +The Company follows fair value measurement authoritative accounting guidance for all assets and liabilities measured at fair value. Authoritative accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• +Level 1 – quoted prices in active markets for identical assets or liabilities +• +Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +• +Level 3 – significant inputs to the valuation model are unobservable +The following table is a listing of the Company’s assets and liabilities that are measured at fair value and where they were classified within the fair value hierarchy as of December 31, 2014 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +592,208 +$ +— +Proved oil and gas properties (2) +$ +— +$ +— +$ +33,423 +Oil and gas properties held for sale (2) +$ +— +$ +— +$ +17,891 +Liabilities: +Derivatives (1) +$ +— +$ +70 +$ +— +Net Profits Plan (1) +$ +— +$ +— +$ +27,136 +____________________________________________ +(1) This represents a financial asset or liability that is measured at fair value on a recurring basis. +(2) This represents a non-financial asset that is measured at fair value on a nonrecurring basis. +132 +The following table is a listing of the Company’s assets and liabilities that are measured at fair value and where they were classified within the hierarchy as of December 31, 2013 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +52,510 +$ +— +Proved oil and gas properties (2) +$ +— +$ +— +$ +62,178 +Unproved oil and gas properties (2) +$ +— +$ +— +$ +3,280 +Oil and gas properties held for sale (2) +$ +— +$ +— +$ +650 +Liabilities: +Derivatives (1) +$ +— +$ +31,020 +$ +— +Net Profits Plan (1) +$ +— +$ +— +$ +56,985 +____________________________________________ +(1) This represents a financial asset or liability that is measured at fair value on a recurring basis. +(2) This represents a non-financial asset that is measured at fair value on a nonrecurring basis. +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivatives. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit-price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk and takes into account the Company’s credit rating, current credit facility margins, and any change in such margins since the last measurement date. All of the Company’s derivative counterparties are members of the Company’s credit facility lender group. +133 +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with accounting authoritative guidance and with other marketplace participants, the Company recognizes that third parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Refer to Note 10 - Derivative Financial Instruments for more information regarding the Company’s derivative instruments. +Net Profits Plan +The Net Profits Plan is a standalone liability for which there is no available market price, principal market, or market participants. The inputs available for this instrument are unobservable and are therefore classified as Level 3 inputs. The Company employs the income valuation technique, which converts expected future cash flow amounts to a single present value amount. This technique uses the estimate of future cash payments, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk to calculate the fair value. There is a direct correlation between realized oil, gas, and NGL commodity prices driving net cash flows and the Net Profits Plan liability. Generally, higher commodity prices result in a larger Net Profits Plan liability and lower commodity prices result in a smaller Net Profits Plan liability. +The Company records the estimated fair value of the long-term liability for estimated future payments under the Net Profits Plan based on the discounted value of estimated future payments associated with each individual pool. The calculation of this liability is a significant management estimate. A discount rate of 12 percent is used to calculate this liability, which is intended to represent the Company’s best estimate of the present value of expected future payments under the Net Profits Plan. +The Company’s estimate of its liability is highly dependent on commodity prices, cost assumptions, discount rates, and overall market conditions. The Company regularly assesses the current market environment. The Net Profits Plan liability is determined using price assumptions of five one -year strip prices with the fifth year’s pricing then carried out indefinitely. The average price is adjusted for realized price differentials and to include the effects of the forecasted production covered by derivative contracts in the relevant periods. The non-cash expense associated with this significant management estimate is highly volatile from period to period due to fluctuations that occur in the oil, gas, and NGL commodity markets. +If the commodity prices used in the calculation changed by five percent , the liability recorded at December 31, 2014 , would differ by approximately $2.6 million . A one percent increase or decrease in the discount rate would result in a change of approximately $1.1 million . Actual cash payments to be made to participants in future periods are dependent on realized actual production, realized commodity prices, and actual costs associated with the properties in each individual pool of the Net Profits Plan. Consequently, actual cash payments are inherently different from the amounts estimated. +No published market quotes exist on which to base the Company’s estimate of fair value of its Net Profits Plan liability. As such, the recorded fair value is based entirely on management estimates that are described within this footnote. While some inputs to the Company’s calculation of fair value of the Net Profits Plan’s future payments are from published sources, others, such as the discount rate and the expected future cash flows, are derived from the Company’s own calculations and estimates. +134 +The following table reflects the activity for the Company’s Net Profits Plan liability measured at fair value using Level 3 inputs: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Beginning balance +$ +56,985 +$ +78,827 +$ +107,731 +Net increase (decrease) in liability (1) +(12,492 +) +3,527 +(9,251 +) +Net settlements (1) (2) +(17,357 +) +(25,369 +) +(19,653 +) +Transfers in (out) of Level 3 +— +— +— +Ending balance +$ +27,136 +$ +56,985 +$ +78,827 +____________________________________________ +(1) +Net changes in the Net Profits Plan liability are shown in the Change in Net Profits Plan liability line item of the accompanying statements of operations. +(2) +Settlements represent cash payments made or accrued under the Net Profits Plan. The amounts in the table include cash payments made or accrued under the Net Profits Plan of $8.3 million , $10.3 million , and $2.3 million relating to divestiture proceeds for the years ended December 31, 2014 , 2013 , and 2012 , respectively. +Long-term Debt +The following table reflects the fair value of the Senior Notes measured using Level 1 inputs based on quoted secondary market trading prices. The Senior Notes were not presented at fair value on the accompanying balance sheets as of December 31, 2014 or 2013 , as they are recorded at historical value. +As of December 31, +2014 +2013 +(in thousands) +2019 Notes +$ +350,018 +$ +374,290 +2021 Notes +$ +343,000 +$ +373,625 +2022 Notes (1) +$ +556,500 +$ +— +2023 Notes +$ +379,000 +$ +422,000 +2024 Notes +$ +435,000 +$ +475,315 +____________________________________________ +(1) The 2022 Notes were issued on November 17, 2014 . +The carrying value of the Company’s credit facility approximates its fair value, as the applicable interest rates are floating, based on prevailing market rates. +Proved and Unproved Oil and Gas Properties +Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique, which converts future amounts to a single present value amount, to measure the fair value of proved properties through an application of discount rates and price forecasts selected by the Company’s management. The calculation of the discount rate is based on the best information available and was estimated to be 12 percent as of December 31, 2014 , and 2013 . The Company believes that the discount rate is representative of current market conditions and takes into account estimates of future cash payments, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk. The prices for oil and gas are forecasted based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecasted using OPIS +135 +pricing, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. Proved properties classified as held for sale are valued using a market approach, based on an estimated selling price, as evidenced by the most current bid prices received from third parties. If an estimated selling price is not available, the Company utilizes the income valuation technique discussed above. +As a result of asset write-downs, proved oil and gas properties measured at fair value within the accompanying balance sheets totaled $33.4 million and $62.2 million as of December 31, 2014 , and 2013 , respectively. +Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: future development plans, risk weighted potential resource recovery, and estimated reserve values. Unproved properties classified as held for sale are valued using a market approach, based on an estimated selling price, as evidenced by the most current bid prices received from third parties. If an estimated selling price is not available, the Company estimates acreage value based on the price received for similar acreage in recent transactions by the Company or other market participants in the principal market. +Impaired unproved oil and gas properties measured at fair value were written down to zero and $3.3 million in the accompanying balance sheets as of December 31, 2014 , and 2013 , respectively. +The fair value measurements of assets acquired and liabilities assumed are measured on a nonrecurring basis on the acquisition date using an income valuation technique based on inputs that are not observable in the market and therefore represent Level 3 inputs. Significant inputs to the valuation of acquired oil and gas properties include estimates of: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgments and estimates by the Company’s management at the time of the valuation. Refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale for additional information on the fair value of assets acquired during 2014 . +Asset Retirement Obligations +The Company utilizes the income valuation technique to determine the fair value of the asset retirement obligation liability at the point of inception by applying a credit-adjusted risk-free rate, which takes into account the Company’s credit risk, the time value of money, and the current economic state, to the undiscounted expected abandonment cash flows. Given the unobservable nature of the inputs, the initial measurement of the asset retirement obligation liability is deemed to use Level 3 inputs. +Note 12 - Acquisition and Development Agreement +In June 2011, the Company entered into an Acquisition and Development Agreement with Mitsui. Pursuant to the Acquisition and Development Agreement, the Company agreed to transfer to Mitsui a 12.5 percent working interest in certain non-operated oil and gas assets representing approximately 39,000 net acres in Dimmit, LaSalle, Maverick, and Webb Counties, Texas. As consideration for the oil and gas interests transferred, Mitsui agreed to pay, or carry, 90 percent of certain drilling and completion costs attributable to the Company’s remaining interest in these assets until Mitsui expended an aggregate $680.0 million on behalf of the Company. The Acquisition and Development Agreement also provided for reimbursement of capital expenditures and other costs, net of revenues, paid by the Company that were attributable to the transferred interest during the period between the effective date and the closing date, which the parties agreed would be applied over the carry period to cover the Company’s remaining 10 percent of drilling and completion costs for the affected acreage. +136 +During the second quarter of 2014, the remainder of the carry under the Acquisition and Development Agreement was expended. Accordingly, the Company accrued and funded its full share of drilling and completion costs in its non-operated Eagle Ford shale program for the remainder of 2014. +Note 13 - Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2014 , 2013 , and 2012 . The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Beginning balance on January 1, +$ +34,527 +$ +9,100 +$ +18,600 +Additions to capitalized exploratory well costs pending the determination of proved reserves +43,589 +34,527 +9,100 +Reclassifications to wells, facilities, and equipment based on the determination of proved reserves +(33,340 +) +(9,100 +) +(5,865 +) +Capitalized exploratory well costs charged to expense +(1,187 +) +— +(12,735 +) +Ending balance at December 31, +$ +43,589 +$ +34,527 +$ +9,100 +As of December 31, 2014, there were no exploratory well costs that were capitalized for more than one year. +137 +Supplemental Oil and Gas Information (unaudited) +Costs Incurred in Oil and Gas Producing Activities +Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Development costs (1) +$ +1,782,324 +$ +1,350,116 +$ +1,346,216 +Exploration costs +288,270 +168,612 +220,921 +Acquisitions +Proved properties +272,902 +29,859 +5,773 +Unproved properties (2) +368,208 +172,546 +114,971 +Total, including asset retirement obligation (3)(4) +$ +2,711,704 +$ +1,721,133 +$ +1,687,881 +____________________________________________ +(1) +Includes facility costs of $75.1 million , $49.5 million , and $62.2 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively. +(2) +Includes $288.7 million , $58.5 million , and $3.4 million of unproved properties acquired as part of proved property acquisitions for the years ended December 31, 2014 , 2013 , and 2012 , respectively. The remaining balance relates to leasing activity. +(3) +Includes capitalized interest of $16.0 million , $11.0 million , and $12.1 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively. +(4) +Includes amounts relating to estimated asset retirement obligations of $11.4 million , $26.8 million , and $30.6 million for the years ended December 31, 2014 , 2013 , and 2012 , respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting reserve estimation and disclosure. +Proved reserves are the estimated quantities of oil, gas, and NGLs, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated proved reserves are located in the United States. +138 +The table below presents a summary of changes in the Company’s estimated proved reserves for each of the years in the three-year period ended December 31, 2014 . The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company‘s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +For the Years Ended December 31, +2014 (1) +2013 (2) +2012 (3) +Oil +Gas +NGLs +Oil +Gas +NGLs +Oil +Gas +NGLs +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +Total proved reserves: +Beginning of year +126.6 +1,189.3 +103.9 +92.2 +833.4 +62.3 +71.7 +664.0 +27.5 +Revisions of previous estimate +(5.1 +) +46.0 +7.8 +(5.2 +) +68.8 +(1.3 +) +(4.5 +) +(123.3 +) +(2.4 +) +Discoveries and extensions +15.0 +103.5 +10.5 +34.6 +399.2 +39.8 +17.1 +297.4 +30.6 +Infill reserves in an existing proved field +32.0 +270.8 +24.1 +21.6 +118.7 +13.2 +19.2 +125.1 +12.7 +Sales of +reserves (4) +(1.9 +) +(1.1 +) +— +(3.4 +) +(85.1 +) +(0.6 +) +(1.0 +) +(11.0 +) +— +Purchases of minerals in place +19.8 +10.9 +0.2 +0.7 +3.6 +— +0.1 +1.2 +— +Production +(16.7 +) +(152.9 +) +(13.0 +) +(13.9 +) +(149.3 +) +(9.5 +) +(10.4 +) +(120.0 +) +(6.1 +) +End of year (5) +169.7 +1,466.5 +133.5 +126.6 +1,189.3 +103.9 +92.2 +833.4 +62.3 +Proved developed reserves: +Beginning of year +70.2 +569.2 +43.8 +58.8 +483.2 +27.2 +50.3 +451.2 +15.2 +End of year +89.3 +784.6 +66.7 +70.2 +569.2 +43.8 +58.8 +483.2 +27.2 +Proved undeveloped reserves: +Beginning of year +56.3 +620.1 +60.2 +33.5 +350.2 +35.1 +21.4 +212.8 +12.3 +End of year +80.4 +682.0 +66.8 +56.3 +620.1 +60.2 +33.5 +350.2 +35.1 +____________________________________________ +Note: Amounts may not recalculate due to rounding. +(1) +For the year ended December 31, 2014, the Company added 143.9 MMBOE from its drilling program, the majority of which related to activity in the Eagle Ford shale in south Texas and Bakken/Three Forks plays in North Dakota. These additions are included in discoveries and extensions and infill reserves. The Company had upward engineering revisions of 10.4 MMBOE primarily related to improved performance and lower operating expenses in its operated Eagle Ford assets. +(2) +For the year ended December 31, 2013, of the 5.0 MMBOE upward revision of a previous estimate, 0.6 MMBOE and 4.4 MMBOE relate to price and performance revisions, respectively. The prices used in the calculation of proved reserve estimates as of December 31, 2013, were $96.94 per Bbl, $3.67 per MMBtu, and $40.29 per Bbl for oil, natural gas, and NGLs respectively. These prices were two percent higher, 33 percent higher, and 12 percent lower, respectively, than the prices used in 2012. The Company added 195.5 MMBOE from its drilling program, the majority of which related to activity in the Eagle Ford shale in south Texas and Bakken/Three Forks plays in North Dakota. These additions are included in discoveries and extensions and infill reserves. +(3) +For the year ended December 31, 2012, of the 27.4 MMBOE downward revision of a previous estimate, 12.1 MMBOE and 15.3 MMBOE relate to price and performance revisions, respectively. The prices used in the calculation of proved reserve estimates as of December 31, 2012, were $94.71 per Bbl, $2.76 per MMBtu, and $45.65 per Bbl, for oil, natural gas, and NGLs respectively. These prices were two percent lower, 33 percent lower, and 23 percent lower, +139 +respectively, than the prices used in 2011. The Company added 150.0 MMBOE from its drilling program, the majority of which related to activity in the Eagle Ford shale in south Texas. These additions are included in discoveries and extensions and infill reserves. +(4) +The Company divested of certain non-core assets during 2014 , 2013 , and 2012 . Please refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale for additional information. +(5) +For the years ended December 31, 2014 , 2013 , and 2012 , amounts included insignificant net gas imbalance positions. +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of future net cash flows and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year-end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the proved reserves in place at the end of the period using year-end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities. +The assumptions used to compute the standardized measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations since these reserve quantity estimates are the basis for the valuation process. The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the standardized measure: +For the Years Ended December 31, +2014 +2013 +2012 +Oil (per Bbl) +$ +84.65 +$ +90.19 +$ +86.80 +Gas (per Mcf) +$ +4.63 +$ +3.99 +$ +3.08 +NGLs (per Bbl) +$ +35.48 +$ +35.92 +$ +41.00 +140 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the standardized measure. +As of December 31, +2014 +2013 +2012 +(in thousands) +Future cash inflows +$ +25,897,730 +$ +19,895,360 +$ +13,129,243 +Future production costs +(9,986,239 +) +(7,771,747 +) +(5,013,720 +) +Future development costs +(3,294,164 +) +(2,891,325 +) +(1,742,978 +) +Future income taxes +(3,511,352 +) +(2,722,230 +) +(1,609,397 +) +Future net cash flows +9,105,975 +6,510,058 +4,763,148 +10 percent annual discount +(3,407,192 +) +(2,500,619 +) +(1,742,134 +) +Standardized measure of discounted future net cash flows +$ +5,698,783 +$ +4,009,439 +$ +3,021,014 +The principle sources of changes in the standardized measure of discounted future net cash flows are: +For the Years Ended December 31, +2014 +2013 +2012 +(in thousands) +Standardized measure, beginning of year +$ +4,009,439 +$ +3,021,014 +$ +2,580,040 +Sales of oil, gas, and NGLs produced, net of production costs +(1,765,666 +) +(1,602,505 +) +(1,081,997 +) +Net changes in prices and production costs +(75,966 +) +142,199 +(550,293 +) +Extensions, discoveries and other including infill reserves in an existing proved field, net of related costs +1,819,657 +2,309,075 +1,872,810 +Sales of reserves in place +(49,736 +) +(259,031 +) +(41,020 +) +Purchase of reserves in place +413,175 +30,771 +3,785 +Previously estimated development costs incurred during the period +1,015,694 +581,107 +163,937 +Changes in estimated future development costs +138,247 +68,613 +47,980 +Revisions of previous quantity estimates +167,500 +82,226 +(452,454 +) +Accretion of discount +552,852 +384,914 +346,118 +Net change in income taxes +(399,587 +) +(690,953 +) +53,005 +Changes in timing and other +(126,826 +) +(57,991 +) +79,103 +Standardized measure, end of year +$ +5,698,783 +$ +4,009,439 +$ +3,021,014 +141 +Quarterly Financial Information (unaudited) +The Company’s quarterly financial information for fiscal years 2014 and 2013 is as follows (in thousands, except per share amounts): +First +Second +Third (2) +Fourth (2) (3) +Quarter +Quarter +Quarter +Quarter +Year Ended December 31, 2014 +Total operating revenues +$ +632,720 +$ +674,980 +$ +618,786 +$ +595,821 +Total operating expenses +504,086 +553,264 +261,807 +37,336 +Income from operations +$ +128,634 +$ +121,716 +$ +356,979 +$ +558,485 +Income before income taxes +$ +104,470 +$ +95,829 +$ +333,686 +$ +530,714 +Net income +$ +65,607 +$ +59,780 +$ +208,938 +$ +331,726 +Basic net income per common share (1) +$ +0.98 +$ +0.89 +$ +3.10 +$ +4.92 +Diluted net income per common share (1) +$ +0.96 +$ +0.88 +$ +3.05 +$ +4.91 +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +Year Ended December 31, 2013 +Total operating revenues +$ +484,180 +$ +559,360 +$ +613,107 +$ +636,727 +Total operating expenses +437,982 +415,076 +475,623 +596,438 +Income from operations +$ +46,198 +$ +144,284 +$ +137,484 +$ +40,289 +Income before income taxes +$ +27,109 +$ +122,727 +$ +113,024 +$ +15,751 +Net income +$ +16,727 +$ +76,522 +$ +70,690 +$ +6,996 +Basic net income per common share (1) +$ +0.25 +$ +1.15 +$ +1.06 +$ +0.10 +Diluted net income per common share (1) +$ +0.25 +$ +1.13 +$ +1.04 +$ +0.10 +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +____________________________________________ +(1) +Amounts may not sum due to rounding. +(2) +The third and fourth quarters of 2014 included net derivative gains of $190.7 million and $616.7 million , respectively. Please refer to the caption Derivative gain included in Comparison of Financial Results and Trends between 2014 and 2013 included in Part II, Item 7 of this report for additional discussion. +(3) +The fourth quarter of 2014 and 2013 included impairment of proved properties of $84.5 million and $110.9 million , respectively, and abandonment and impairment of unproved properties of $57.2 million and $37.6 million , respectively. Please refer to the caption Impairment of Proved and Unproved Properties included in Note 1 - Summary of Significant Accounting Policies for additional discussion. +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +142 +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +The Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) released the updated Internal Control–Integrated Framework (“2013 Framework”) in May 2013 which superseded the original 1992 Framework. During 2014 , we transitioned to the criteria set forth by COSO in the 2013 Framework from the original 1992 Framework. This transition did not materially affect, and is not reasonably likely to materially affect, our internal control over financial reporting. +Effective January 1, 2015 , we implemented a new enterprise resource planning system (“ERP”) that is expected to materially affect our internal control over financial reporting. In connection with this ERP implementation, we are updating our internal control over financial reporting, as necessary, to accommodate modifications to our business processes and accounting procedures. We do not believe that this ERP implementation will have an adverse effect on our internal control over financial reporting. +143 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2014 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal controls over financial reporting. That report immediately follows this report. +144 +Report of Independent Registered Public Accounting Firm +The Board of Directors and Stockholders of SM Energy Company and subsidiaries +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2014 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). SM Energy Company and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, SM Energy Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of SM Energy Company and subsidiaries as of December 31, 2014 , and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the year then ended and our report dated February 25, 2015 expressed an unqualified opinion thereon . +/s/ Ernst & Young LLP +Denver, Colorado +February 25, 2015 +145 +ITEM 9B. OTHER INFORMATION +None. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning SM Energy’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about Executive Officers,” and “Corporate Governance” in SM Energy’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed within 120 days from December 31, 2014 . +The information required by this Item concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the information provided under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in SM Energy’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed within 120 days from December 31, 2014 . +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation” and “Director Compensation” in SM Energy’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed within 120 days from December 31, 2014 . +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in SM Energy’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed within 120 days from December 31, 2014 . +146 +Securities Authorized for Issuance Under Equity Compensation Plans. SM Energy has the Equity Plan under which options and shares of SM Energy common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. Our stockholders have approved this plan. See Note 7 – Compensation Plans included in Part II, Item 8 of this report for further information about the material terms of our equity compensation plans. The following table is a summary of the shares of common stock authorized for issuance under the equity compensation plans as of December 31, 2014 : +(a) +(b) +(c) +Plan category +Number of securities to be issued upon exercise of outstanding options, warrants, and rights +Weighted-average exercise price of outstanding options, warrants, and rights +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan +Stock options and incentive stock options (1) +— +$ +— +Restricted stock (1)(3) +515,724 +N/A +Performance share units (1)(3)(4) +745,264 +N/A +Total for Equity Incentive Compensation Plan +1,260,988 +$ +— +3,602,270 +Employee Stock Purchase Plan (2) +— +— +1,146,921 +Equity compensation plans not approved by security holders +— +— +— +Total for all plans +1,260,988 +$ +— +4,749,191 +____________________________________________ +(1) +In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of SM Energy or any affiliate of SM Energy. The Equity Plan serves as the successor to the St. Mary Land & Exploration Company Stock Option Plan, the St. Mary Land & Exploration Company Incentive Stock Option Plan, the SM Energy Company Restricted Stock Plan, and the SM Energy Company Non-Employee Director Stock Compensation Plan (collectively referred to as the “Predecessor Plans”). All grants of equity are now made under the Equity Plan, and no further grants will be made under the Predecessor Plans. Each outstanding award under a Predecessor Plan immediately prior to the effective date of the Equity Plan continues to be governed solely by the terms and conditions of the instruments evidencing such grants or issuances. Our Board of Directors approved amendments to the Equity Plan in 2009, 2010, and 2013 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The awards granted in 2014 , 2013 , and 2012 under the Equity Plan were 464,641 , 632,939 , and 724,671 , respectively. +(2) +Under the SM Energy Company ESPP, eligible employees may purchase shares of our common stock through payroll deductions of up to 15 percent of their eligible compensation. The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on the first or last day of the six-month offering period, and shares issued under the ESPP on or after December 31, 2011, have no minimum restriction period. The ESPP is intended to qualify under Section 423 of the Internal Revenue Code. Shares issued under the ESPP totaled 83,136 , 77,427 , and 66,485 in 2014 , 2013 , and 2012 , respectively. +(3) +RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per share fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per share fair value for the outstanding RSUs and PSUs was $68.29 and $67.48, respectively. Please refer to Note 7 - Compensation Plans in Part II, Item 8 of this report for additional discussion. +(4) +The number of awards vested assumes a one multiplier. The final number of shares issued upon settlement may vary depending on the three -year multiplier determined at the end of the performance period under the Equity Plan, which ranges from zero to two . +147 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “Certain Relationships and Related Transactions” and “Corporate Governance” in SM Energy’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed within 120 days from December 31, 2014 . +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “Independent Registered Public Accounting Firm” and “Audit Committee Preapproval Policy and Procedures” in SM Energy’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed within 120 days from December 31, 2014 . +148 +PART IV +ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Financial Statements and Financial Statement Schedules: +Reports of Independent Registered Public Accounting Firms +87 +Consolidated Balance Sheets +89 +Consolidated Statements of Operations +90 +Consolidated Statements of Comprehensive Income (Loss) +91 +Consolidated Statements of Stockholders’ Equity +92 +Consolidated Statements of Cash Flows +93 +Notes to Consolidated Financial Statements +95 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +2.1 +Purchase and Sale Agreement dated June 9, 2011, among SM Energy Company, Statoil Texas Onshore Properties LLC, and Talisman Energy USA Inc. (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 and incorporated herein by reference) +2.2 +Acquisition and Development Agreement dated June 29, 2011 between SM Energy Company and Mitsui E&P Texas LP (filed as Exhibit 2.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 and incorporated herein by reference) +2.3 +First Amendment to Acquisition and Development Agreement dated October 13, 2011 between SM Energy Company and Mitsui E&P Texas LP (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 and incorporated herein by reference) +2.4 *** +Purchase and Sale Agreement dated November 4, 2013, among SM Energy Company, EnerVest Energy Institutional Fund XIII-A, L.P., EnerVest Energy Institutional Fund XIII-WIB, L.P., and EnerVest Energy Institutional Fund XIII-WIC, L.P. (filed as Exhibit 2.4 to the registrant’s Amendment to the Annual Report on Form 10-K/A filed on May 9, 2014 for the year ended December 31, 2013, and incorporated herein by reference) +2.5 *** +Purchase and Sale Agreement dated July 29, 2014 between SM Energy Company and Baytex Energy USA LLC (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 and incorporated herein by reference) +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 and incorporated herein by reference) +3.2 +Amended and Restated By-Laws of SM Energy Company amended effective as of December 16, 2014 (filed as Exhibit 3.1 to the registrant’s Current Report on Form 8-K filed on December 19, 2014, and incorporated herein by reference) +149 +4.1 +Indenture related to the 3.50% Senior Convertible Notes due 2027, dated as of April 4, 2007, between St. Mary Land & Exploration Company and Wells Fargo Bank, National Association, as trustee (including the form of 3.50% Senior Convertible Notes due 2027) (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on April 4, 2007 and incorporated herein by reference) +4.2 +Indenture related to the 6.625% Senior Notes due 2019, dated as of February 7, 2011, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on February 10, 2011, and incorporated herein by reference) +4.3 +Indenture related to the 6.50% Senior Notes due 2021, dated as of November 8, 2011, by and among SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 10, 2011, and incorporated herein by reference) +4.4 +Indenture related to the 6.50% Senior Notes due 2023, dated June 29, 2012, between SM Energy Company, as Issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on July 3, 2012, and incorporated herein by reference) +4.5 +Indenture related to the 5.0% Senior Notes due 2024, dated May 20, 2013, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant's Current Report on Form 8-K filed on May 20, 2013, and incorporated herein by reference) +4.6 +Indenture related to the 6.125% Senior Notes due 2022, dated November 17, 2014, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant's Current Report on Form 8-K filed on November 18, 2014, and incorporated herein by reference) +4.7 +Registration Rights Agreement, dated November 17, 2014, by and among SM Energy Company and Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities LLC and Wells Fargo Securities, LLC, as representatives of several purchasers (filed as Exhibit 4.2 to the registrant's Current Report on Form 8-K filed on November 18, 2014, and incorporated herein by reference) +10.1† +Stock Option Plan, as Amended on May 22, 2003 (filed as Exhibit 99.1 to the registrant’s Registration Statement on Form S-8 (Registration No. 333-106438) and incorporated herein by reference) +10.2† +Incentive Stock Option Plan, as Amended on May 22, 2003 (filed as Exhibit 99.2 to the registrant’s Registration Statement on Form S-8 (Registration No. 333-106438) and incorporated herein by reference) +10.3† +Form of Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference) +10.4† +Form of Amendment to Form of Change of Control Executive Severance Agreement (filed as Exhibit 10.9 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005 and incorporated herein by reference) +10.5† +Employment Agreement of A.J. Best dated May 1, 2006 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 4, 2006 and incorporated herein by reference) +10.6 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.7 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.8† +Equity Incentive Compensation Plan as Amended and Restated as of March 26, 2009 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 27, 2009, and incorporated herein by reference) +150 +10.9† +Equity Incentive Compensation Plan As Amended and Restated as of April 1, 2010 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on June 2, 2010, and incorporated herein by reference) +10.10 s +SM Energy Company Equity Incentive Compensation Plan, As Amended as of July 30, 2010 (filed as Exhibit 10.7 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.11† +Third Amendment to Employee Stock Purchase Plan dated September 23, 2009 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009, and incorporated herein by reference) +10.12† +Fourth Amendment to Employee Stock Purchase Plan dated December 29, 2009 (filed as Exhibit 10.46 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2009, and incorporated herein by reference) +10.13 s +Employee Stock Purchase Plan, As Amended and Restated as of July 30, 2010 (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.14† +Form of Performance Share and Restricted Stock Unit Award Agreement as of July 1, 2010 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 and incorporated herein by reference) +10.15† +Form of Performance Share and Restricted Stock Unit Award Notice as of July 1, 2010 (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 and incorporated herein by reference) +10.16† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 and incorporated herein by reference) +10.17*** +Gas Services Agreement effective as of July 1, 2010 between SM Energy Company and Eagle Ford Gathering LLC (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.18 s +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.19 s +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan, As Amended as of July 30, 2010 (filed as Exhibit 10.8 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.20† +Form of Amendment to Form of Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on December 29, 2010, and incorporated herein by reference) +10.21† +Amendment to A.J. Best Employment Agreement dated December 31, 2010 (filed as Exhibit 10.28 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.22 † +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.23+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of November 9, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.24 +Fourth Amended and Restated Credit Agreement dated May 27, 2011 among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.25 +Gas Gathering Agreement dated May 31, 2011 between Regency Field Services LLC and SM Energy Company (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +151 +10.26 +Gathering and Natural Gas Services Agreement effective as of April 1, 2011 between SM Energy Company and ETC Texas Pipeline, Ltd. (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.27 +Gas Processing Agreement effective as of April 1, 2011 between ETC Texas Pipeline, Ltd. and SM Energy Company (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.28† +Employee Stock Purchase Plan, As Amended and Restated as of June 10, 2011 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.29† +Form of Performance Stock Unit Award Agreement as of July 1, 2011 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.30† +Form of Restricted Stock Unit Award Agreement as of July 1, 2011 (filed as Exhibit 10.7 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.31† +Form of Performance Stock Unit Award Agreement as of September 6, 2011 (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, and incorporated herein by reference) +10.32† +Form of Restricted Stock Unit Award Agreement as of September 6, 2011 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, and incorporated herein by reference) +10.33 † +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.34 † +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.35† +Equity Incentive Compensation Plan, As Amended as of May 22, 2013 (filed as Annex A to the registrant’s Schedule 14A filed on April 11, 2013, and incorporated herein by reference) +10.36 +Fifth Amended and Restated Credit Agreement dated April 12, 2013, among SM Energy Company, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report of Form 8-K filed on April 15, 2013, and incorporated herein by reference) +10.37† +Form of Performance Stock Unit Award Agreement as of July 31, 2013 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, and incorporated herein by reference) +10.38† +Form of Restricted Stock Unit Award Agreement as of July 31, 2013 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, and incorporated herein by reference) +10.39† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.40† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.41*† +Summary of Compensation Arrangements for Non-Employee Directors +10.42† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant's Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.43 +Second Amendment to the Fifth Amended and Restated Credit Agreement dated December 10, 2014, among SM Energy Company, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report of Form 8-K filed on December 16, 2014, and incorporated herein by reference) +152 +12.1* +Computation of Ratio of Earnings to Fixed Charges +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Deloitte & Touche LLP +23.3* +Consent of Ryder Scott Company L.P. +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +99.1* +Ryder Scott Audit Letter +101.INS* +XBRL Instance Document +101.SCH* +XBRL Schema Document +101.CAL* +XBRL Calculation Linkbase Document +101.LAB* +XBRL Label Linkbase Document +101.PRE* +XBRL Presentation Linkbase Document +101.DEF* +XBRL Taxonomy Extension Definition Linkbase Document +* Filed with this Form 10-K. +** Furnished with this Form 10-K. +*** +Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. +† +Exhibit constitutes a management contract or compensatory plan or agreement. +s +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. See Item 15(a) above. +153 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: +February 25, 2015 +By: +/s/ JAVAN D. OTTOSON +Javan D. Ottoson +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Javan D. Ottoson and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2014 , and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ JAVAN D. OTTOSON +President, Chief Executive Officer, and Director +February 25, 2015 +Javan D. Ottoson +(Principal Executive Officer) +/s/ A. WADE PURSELL +Executive Vice President and Chief Financial Officer +February 25, 2015 +A. Wade Pursell +(Principal Financial Officer) +/s/ MARK T. SOLOMON +Vice President - Controller and Assistant Secretary +February 25, 2015 +Mark T. Solomon +(Principal Accounting Officer) +154 +Signature +Title +Date +/s/ WILLIAM D. SULLIVAN +Chairman of the Board of Directors +February 25, 2015 +William D. Sullivan +/s/ ANTHONY J. BEST +Director +February 25, 2015 +Anthony J. Best +/s/ LARRY W. BICKLE +Director +February 25, 2015 +Larry W. Bickle +/s/ STEPHEN R. BRAND +Director +February 25, 2015 +Stephen R. Brand +/s/ WILLIAM J. GARDINER +Director +February 25, 2015 +William J. Gardiner +/s/ LOREN M. LEIKER +Director +February 25, 2015 +Loren M. Leiker +/s/ RAMIRO G. PERU +Director +February 25, 2015 +Ramiro G. Peru +/s/ JULIO M. QUINTANA +Director +February 25, 2015 +Julio M. Quintana +/s/ ROSE M. ROBESON +Director +February 25, 2015 +Rose M. Robeson +/s/ JOHN M. SEIDL +Director +February 25, 2015 +John M. Seidl +155 \ No newline at end of file diff --git a/raw/filings/0000893538/2014/0000893538-15-000011/filing_metadata.csv b/raw/filings/0000893538/2014/0000893538-15-000011/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..ef48cbc47fba0cf72f06fbeba27c3527634b87d2 --- /dev/null +++ b/raw/filings/0000893538/2014/0000893538-15-000011/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2015-02-25,2014-12-31,2015-02-25T14:16:31.000Z,0000893538-15-000011,sm-20141231x10k.htm,10-K,20581570,1,0,https://www.sec.gov/Archives/edgar/data/893538/000089353815000011/sm-20141231x10k.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353815000011/,2014,2014,1 diff --git a/raw/filings/0000893538/2014/0000893538-15-000011/item1.txt b/raw/filings/0000893538/2014/0000893538-15-000011/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2014/0000893538-15-000011/item13.txt b/raw/filings/0000893538/2014/0000893538-15-000011/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..aadd951104a05f38c848178c59136347bc3aabfd --- /dev/null +++ b/raw/filings/0000893538/2014/0000893538-15-000011/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “Certain Relationships and Related Transactions” and “Corporate Governance” in SM Energy’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed within 120 days from December 31, 2014 . \ No newline at end of file diff --git a/raw/filings/0000893538/2014/0000893538-15-000011/item9a.txt b/raw/filings/0000893538/2014/0000893538-15-000011/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..477f01a2fa1052949bc11c1e3eaede59d997096c --- /dev/null +++ b/raw/filings/0000893538/2014/0000893538-15-000011/item9a.txt @@ -0,0 +1,36 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +142 +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +The Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) released the updated Internal Control–Integrated Framework (“2013 Framework”) in May 2013 which superseded the original 1992 Framework. During 2014 , we transitioned to the criteria set forth by COSO in the 2013 Framework from the original 1992 Framework. This transition did not materially affect, and is not reasonably likely to materially affect, our internal control over financial reporting. +Effective January 1, 2015 , we implemented a new enterprise resource planning system (“ERP”) that is expected to materially affect our internal control over financial reporting. In connection with this ERP implementation, we are updating our internal control over financial reporting, as necessary, to accommodate modifications to our business processes and accounting procedures. We do not believe that this ERP implementation will have an adverse effect on our internal control over financial reporting. +143 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2014 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal controls over financial reporting. That report immediately follows this report. +144 +Report of Independent Registered Public Accounting Firm +The Board of Directors and Stockholders of SM Energy Company and subsidiaries +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2014 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). SM Energy Company and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, SM Energy Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of SM Energy Company and subsidiaries as of December 31, 2014 , and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the year then ended and our report dated February 25, 2015 expressed an unqualified opinion thereon . +/s/ Ernst & Young LLP +Denver, Colorado +February 25, 2015 +145 \ No newline at end of file diff --git a/raw/filings/0000893538/2014/0000893538-15-000011/rp_note.txt b/raw/filings/0000893538/2014/0000893538-15-000011/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2014/0000893538-15-000011/rpt_disclosure.txt b/raw/filings/0000893538/2014/0000893538-15-000011/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4375a00cf3c1436a1b1dc3c83da28e348e38b2de --- /dev/null +++ b/raw/filings/0000893538/2014/0000893538-15-000011/rpt_disclosure.txt @@ -0,0 +1,40 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee's review of any transaction, +arrangement, or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, +(b) the aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of +our Related Person Transactions Policy, a "related person" means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more +than 5% of our outstanding shares of common stock, and (iii) any immediate family member of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it +determines in good faith are in, or are not inconsistent with, our best interests and the best interests of our stockholders. +In +determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among +others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director's independence in the event the related person is a director, and the extent +of the related person's interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in +compliance with the policy and remain appropriate. +In +addition, our By-Laws provide that a director, officer, or employee of our company may not pursue for his or her own account a business or investment opportunity that he or she +learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than 1% of the publicly traded stock of another company. +Related Person Transactions +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are +consistent with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when the Board, acting through the Audit Committee or as +otherwise described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, +but are not limited to, situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we +obtain products or services from, or provide products or services to, related persons on an arm's length basis on terms comparable to those obtained from or provided to unrelated third parties or on +terms comparable to those obtained from or provided to employees generally. The only transaction between our company and a related person since January 1, 2014, involves our relationship with +Tesco Corporation ("Tesco"). Mr. Quintana was the President, Chief Executive Officer, and a director of Tesco before his retirement in January 2015. Tesco designs, manufactures, and delivers +technology based solutions for the upstream energy industry, including oilfield drilling and completion technology, services, and equipment. In 2006, we entered into an agreement with Tesco to provide +equipment and services to us in connection with our drilling and completion operations based on Tesco's industry-recognized ability to supply specific high-quality equipment and services for drilling +and casing needs, which are particularly well suited for certain of our operations. Under our agreement, +12 +Table of Contents +Tesco +from time to time upon our request, provides equipment or services to us. This agreement continues until canceled by either us or Tesco on 30 days advance written notice. Pursuant to this +agreement, we are obligated to pay Tesco only for services actually performed or equipment provided. This agreement does not require us to make any other payments to Tesco, nor does it obligate us to +use Tesco for any services or equipment. Mr. Quintana did not have any direct or indirect interest in the transaction, other than as a result of having served as an executive officer and +director of Tesco. Mr. Quintana had no input in our selection of Tesco for equipment and services or the terms of our agreement with Tesco. Decisions to use Tesco are made by technical +professionals supervising the relevant regional activity, based on their assessment of Tesco's equipment and services and related costs in comparison to other providers. In 2014, we paid Tesco +$1,115,956. The amount we paid Tesco during 2014 for equipment and services represented approximately 8% of the total amount paid by us to all service providers (including Tesco) for similar equipment +and services during 2014. In accordance with our Related Person Transactions Policy, the Audit Committee reviewed the relationship between us and Tesco and determined that the relationship is in our +best interests and the best interests of our stockholders. +13 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000893538/2016/0000893538-17-000013/filing.txt b/raw/filings/0000893538/2016/0000893538-17-000013/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..6c802326bd9d38fb0c622a913d496567d29d7cca --- /dev/null +++ b/raw/filings/0000893538/2016/0000893538-17-000013/filing.txt @@ -0,0 +1,8483 @@ +10-K +1 +sm-20161231x10k.htm +10-K +Document +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +For the fiscal year ended December 31, 2016 +or +o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +Commission file number 001-31539 +SM ENERGY COMPANY +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction +of incorporation or organization) +41-0518430 +(I.R.S. Employer Identification No.) +1775 Sherman Street, Suite 1200, Denver, Colorado +(Address of principal executive offices) +80203 +(Zip Code) +(303) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common stock, $.01 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer þ +Accelerated filer o +Non-accelerated filer o (Do not check if a smaller reporting company) +Smaller reporting company o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ +The aggregate market value of the 67,398,312 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock on June 30, 2016 , the last business day of the registrant’s most recently completed second fiscal quarter, of $27.00 per share, as reported on the New York Stock Exchange, was $1,819,754,424 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 15, 2017 , the registrant had 111,257,703 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III is incorporated by reference from portions of the registrant’s Definitive Proxy Statement on Schedule 14A relating to its 2017 annual meeting of stockholders to be filed within 120 days after December 31, 2016 . +1 +TABLE OF CONTENTS +ITEM +PAGE +PART I +ITEMS 1. and 2. +BUSINESS and PROPERTIES +4 +General +4 +Strategy +4 +Significant Developments in 2016 +4 +Outlook for 2017 +5 +Core Operational Areas +6 +Reserves +8 +Production +13 +Productive Wells +13 +Drilling and Completion Activity +14 +Acreage +15 +Delivery Commitments +16 +Major Customers +16 +Employees and Office Space +17 +Title to Properties +17 +Seasonality +17 +Competition +18 +Government Regulations +18 +Cautionary Information about Forward-Looking Statements +21 +Available Information +24 +Glossary of Oil and Gas Terms +24 +ITEM 1A. +RISK FACTORS +28 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +48 +ITEM 3. +LEGAL PROCEEDINGS +48 +ITEM 4. +MINE SAFETY DISCLOSURES +48 +PART II +49 +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +49 +ITEM 6. +SELECTED FINANCIAL DATA +51 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF +FINANCIAL CONDITION AND RESULTS OF OPERATIONS +53 +Overview of the Company +53 +Financial Results of Operations and Additional Comparative Data +60 +Comparison of Financial Results and Trends Between 2016 and 2015 and Between 2015 and 2014 +63 +Overview of Liquidity and Capital Resources +70 +Critical Accounting Policies and Estimates +76 +Accounting Matters +79 +Environmental +79 +Non-GAAP Financial Measures +81 +2 +TABLE OF CONTENTS +(Continued) +ITEM +PAGE +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT +MARKET RISK (included within the content of ITEM 7) +83 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +84 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS +ON ACCOUNTING AND FINANCIAL DISCLOSURE +140 +ITEM 9A. +CONTROLS AND PROCEDURES +140 +ITEM 9B. +OTHER INFORMATION +144 +PART III +144 +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE +GOVERNANCE +144 +ITEM 11. +EXECUTIVE COMPENSATION +144 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL +OWNERS AND MANAGEMENT AND RELATED +STOCKHOLDER MATTERS +144 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, +AND DIRECTOR INDEPENDENCE +146 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +146 +PART IV +147 +ITEM 15. +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +147 +3 +PART I +When we use the terms “SM Energy,” “the Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business under Glossary of Oil and Gas Terms. Throughout this document we make statements that may be classified as “forward-looking.” Please refer to the Cautionary Information about Forward-Looking Statements section of this document for an explanation of these types of statements. +ITEMS 1. and 2. BUSINESS and PROPERTIES +General +We are an independent energy company engaged in the acquisition, exploration, development, and production of crude oil and condensate, natural gas, and natural gas liquids (also respectively referred to as “oil,” “gas,” and “NGLs” throughout the document) in onshore North America. We were founded in 1908 and incorporated in Delaware in 1915. Our initial public offering of common stock was in December 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal offices are located at 1775 Sherman Street, Suite 1200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +Our strategic objective is to profitably build our ownership and operatorship of North American oil, gas, and NGL producing assets that have high operating margins and significant opportunities for additional economic investment. We pursue growth opportunities through both acquisitions and exploration, and seek to maximize the value of our assets through industry-leading technology application and outstanding operational execution. We focus on achieving high full-cycle economic returns on our investments and maintaining a simple, strong balance sheet. +Significant Developments in 2016 +• +Acquisition Activity. During 2016, we acquired approximately 62,000 net acres in the Midland Basin in Howard and Martin Counties, Texas with producing and prospective intervals in the Lower and Middle Spraberry and Wolfcamp A and B shale formations and 15.0 MMBOE of existing proved reserves. We acquired these properties for total consideration of approximately $2.6 billion , which included $2.2 billion in cash and the issuance of 13.4 million shares of our common stock. +• +Divestiture Activity . During 2016 , we divested a total of 47.7 MMBOE of proved reserves in multiple transactions for total net cash proceeds of approximately $946.1 million . Our most significant divestiture was the sale of our Williston Basin assets outside of Divide County, North Dakota (referred to as “Raven/Bear Den” throughout this report) in the fourth quarter of 2016. +• +Reserves and Capital Investment. Our estimated proved reserves decreased 16 percent to 395.8 MMBOE at December 31, 2016 , from 471.3 MMBOE at December 31, 2015 , of which 47.7 MMBOE related to the divestiture of proved reserves, as discussed above. We had strong reserve additions of 108.2 MMBOE as a result of our success in reducing costs, optimizing and enhancing completions, and generating better well results. These successes were offset by negative reserve revisions due to lower commodity prices and the removal of certain longer term proved undeveloped reserves that reflects our shift to develop our predominately unproven Midland Basin properties. Costs incurred for development and exploration activities, excluding acquisitions, decreased 48 percent to $713.6 million in 2016 when compared with 2015 . Our proved reserve life index decreased slightly to 7.2 years in 2016 . Please refer to Reserves and Core Operational Areas below for additional discussion. +• +Liquidity . During 2016, we issued $500.0 million in aggregate principal amount of 6.75% Senior Notes due September 15, 2026 , at par, for net proceeds of $491.6 million . Additionally, we issued $172.5 million in aggregate principal amount of 1.50% Senior Convertible Notes due July 1, 2021 , for net proceeds of $166.6 million . During 2016, we also repurchased a total of $46.3 million in aggregate principal amount of a portion of our Senior Notes in open market transactions and paid down the entire $202.0 million outstanding balance on our +4 +credit facility as of December 31, 2015. Further, our borrowing base and lender commitments were reduced to $1.17 billion as of December 31, 2016. Please refer to Overview of Liquidity and Capital Resources in Part II, Item 7 of this report for additional discussion on our current and future liquidity. +• +Equity Market Activities. During 2016, we issued approximately 29.3 million shares of our common stock in two public equity offerings and received $934.1 million in net proceeds. These issuances were in addition to the approximate 13.4 million shares of our common stock issued as partial consideration for certain acquired properties as discussed above. +• +Production. Our average daily production in 2016 consisted of 45.4 MBbl of oil, 401.5 MMcf of gas, and 38.8 MBbl of NGLs, for an average equivalent production rate of 151.0 MBOE per day, which represents a 14 percent decrease on an equivalent basis compared with 2015 . This decrease in production was driven by our reduced drilling and completion activity and divestiture of assets. Please refer to Core Operational Areas below for additional discussion. +• +Impairments. We recorded impairments of proved and unproved properties totaling $435.0 million for the year ended December 31, 2016 . These impairments were largely due to the continued decline in commodity prices in early 2016 impacting our outside-operated Eagle Ford shale assets and negative performance revisions on our Powder River Basin assets at year-end 2016. +Outlook for 2017 +Our priorities for 2017 are to: +• +demonstrate the value of our 2016 acquisitions in the Midland Basin; +• +generate high margin production growth from our operated acreage positions in the Midland Basin and Eagle Ford shale; +• +successfully execute the sale of our outside-operated Eagle Ford shale and Divide County assets; and +• +reduce our outstanding debt. +Our capital program for 2017 , excluding acquisitions, is expected to be approximately $875 million with the focus on our core operated acreage positions in the Midland Basin and Eagle Ford shale. We plan to continue our focus on conducting safe operations even as we ramp up activity. Please refer to Outlook for 2017 under Part II, Item 7 of this report for additional discussion concerning our capital plans for 2017 . +5 +Core Operational Areas +Our 2016 operations were concentrated in three onshore operating areas in the United States. The following table summarizes estimated proved reserves, production, and costs incurred in oil and gas activities for the year ended December 31, 2016 , for our core operating areas: +South Texas & Gulf Coast +Permian +Rocky +Mountain +Total (1) +Proved Reserves +Oil (MMBbl) +35.4 +37.9 +31.6 +104.9 +Gas (Bcf) +989.3 +94.6 +27.2 +1,111.1 +NGLs (MMBbl) +105.2 +0.1 +0.5 +105.7 +MMBOE (1)(2) +305.4 +53.8 +36.5 +395.8 +Relative percentage +77 +% +14 +% +9 +% +100 +% +Proved Developed % +55 +% +40 +% +53 +% +53 +% +Production +Oil (MMBbl) +5.5 +2.7 +8.3 +16.6 +Gas (Bcf) +130.9 +6.0 +10.0 +146.9 +NGLs (MMBbl) +13.9 +— +0.3 +14.2 +MMBOE (1)(2) +41.2 +3.8 +10.3 +55.3 +Avg. Daily Equivalents (MBOE/d) (1) +112.6 +10.2 +28.2 +151.0 +Relative percentage +74 +% +7 +% +19 +% +100 +% +Costs Incurred (in millions) (3) +$ +254.6 +$ +2,874.1 +$ +226.0 +$ +3,373.9 +____________________________________________ +(1) +Totals may not sum or calculate due to rounding. +(2) +As of December 31, 2016, our outside-operated Eagle Ford shale assets were held for sale. Subsequent to year-end, we entered into a definitive agreement with an expected closing date in the first quarter of 2017. These assets represented approximately 74.0 MMBOE of our proved reserves as of December 31, 2016, and approximately 9.7 MMBOE of 2016 production on an equivalent basis. Additionally, subsequent to December 31, 2016, we announced our plans to sell our Divide County, North Dakota assets. +(3) +Amounts do not sum to total costs incurred due primarily to corporate overhead charges incurred on exploration activity that is excluded from the regional table above. Please refer to the caption Costs Incurred in Oil and Gas Producing Activities in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report. +Outside of acquisition activity in our Permian region, we reduced our capital spending activity in 2016 in light of the low commodity price environment. We had strong proved reserve additions as a result of our success in reducing costs, optimizing and enhancing completions, and generating better well results in our core development programs. However, total estimated proved reserves decreased from year-end 2015 due to divestitures, a negative price revision, and removal of proved undeveloped reserves as a result of changes in our development plan. +South Texas & Gulf Coast Region. Operations in our South Texas & Gulf Coast region are managed from our office in Houston, Texas. Within this region, we have both an operated and outside-operated Eagle Ford shale program. Our operated Eagle Ford shale position includes approximately 161,000 net acres and accounted for approximately 75 percent of our total Eagle Ford shale production in 2016. Our outside-operated Eagle Ford shale program includes approximately 36,000 net acres. Our acreage position covers a significant portion of the western Eagle Ford shale play, including acreage in the oil/condensate, NGL-rich gas, and dry gas windows of the play. Our outside-operated Eagle Ford shale assets, including the associated midstream assets, were held for sale as of December 31, 2016, with the sale expected to close in the first quarter of 2017. +6 +In 2016, we focused our capital on completing wells that were drilled but not completed at year-end 2015 and drilling wells required to satisfy lease obligations. We incurred $253.6 million of costs to add approximately 66.7 MMBOE of estimated proved reserves through our drilling activities. Overall, estimated proved reserves decreased 11 percent to 305.4 MMBOE at December 31, 2016, from 342.4 MMBOE at year-end 2015 . Production decreased 15 percent year-over-year to 41.2 MMBOE for 2016 due to reduced drilling activity during the year. As of December 31, 2016 , we had 47 gross and net wells that had been drilled but not completed in our operated Eagle Ford shale program. +Permian Region. Operations in our Permian region are managed from our office in Midland, Texas. In 2016, we closed multiple transactions in the Midland Basin in west Texas acquiring approximately 62,000 net acres and 15.0 MMBOE of existing proved reserves in Howard and Martin Counties (referred to as our “RockStar” program throughout this report). +The table above reflects costs incurred on acquisitions totaling $2.6 billion , including $2.2 billion in cash consideration and the issuance of approximately 13.4 million shares of our common stock valued at $437.2 million . Additionally, for the year ended December 31, 2016, we incurred $216.7 million of costs to add approximately 24.0 MMBOE of estimated proved reserves through our drilling activities. The majority of this capital was deployed on our Sweetie Peck assets in Upton County, Texas, where we ran two drilling rigs throughout 2016. We added two drilling rigs on our acquired RockStar acreage in the fourth quarter of 2016, and expect to add two additional rigs on this acreage in early 2017 with the focus on delineating and developing the acreage. Estimated proved reserves increased 159 percent to 53.8 MMBOE at year-end 2016 from 20.8 MMBOE at year-end 2015 . Production increased 40 percent year-over-year to 3.8 MMBOE for 2016. As of December 31, 2016 , we had 17 gross and net wells that had been drilled but not completed in our operated Midland Basin program. +Rocky Mountain Region. Operations in our Rocky Mountain region were managed from our office in Billings, Montana until November 2016, at which time we closed that office and began managing our Rocky Mountain regional operations from our corporate office in Denver, Colorado. As of December 31, 2016, we had approximately 124,000 net acres in Divide County, North Dakota, and approximately 156,000 net acres in the Powder River Basin. +In 2016, we incurred $223.9 million of costs to add approximately 17.4 MMBOE of estimated proved reserves in our Rocky Mountain region through our drilling activities. Estimated proved reserves decreased to 36.5 MMBOE at year-end 2016 from 108.1 MMBOE at year-end 2015 , primarily due to the divestiture of our Raven/Bear Den assets and other non-core Rocky Mountain region assets. Production decreased nine percent year-over-year to 10.3 MMBOE for 2016. Current activities in our Powder River Basin program are under an acquisition and development funding agreement with a third party in which our costs to drill and complete a specified number of initial wells are being carried by such party. As of December 31, 2016 , we had 20 gross ( 17 net) drilled but not completed wells in our operated Bakken/Three Forks program. Subsequent to December 31, 2016, we announced our plans to sell our remaining Williston Basin assets in Divide County, North Dakota by mid-2017. +7 +Reserves +The table below presents summary information with respect to the estimates of our proved reserves for each of the years in the three-year period ended December 31, 2016 . We engaged Ryder Scott Company, L.P. (“Ryder Scott”) to audit at least 80 percent of our total calculated proved reserve PV-10 for each year presented. The prices used in the calculation of proved reserve estimates reflect the 12-month average of the first-day-of-the-month prices in accordance with Securities and Exchange Commission (“SEC”) rules, and were $42.75 per Bbl for oil, $2.47 per MMBtu for natural gas, and $19.50 per Bbl for NGLs for the year ended December 31, 2016 . We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. +Reserve estimates are inherently imprecise and estimates for new discoveries and undeveloped locations are more imprecise than reserve estimates for producing oil and gas properties. Accordingly, we expect these estimates to change as new information becomes available. PV-10 shown in the following table is a non-GAAP financial measure, and generally differs from the standardized measure of discounted future net cash flows, the most directly comparable GAAP financial measure, because it does not include the effects of income taxes on future net revenues. Neither PV-10 nor the standardized measure of discounted future net cash flows represents the fair market value of our oil and gas properties. We and others in the oil and gas industry use PV-10 as a measure to compare the relative size and value of proved reserves held without regard to the specific tax characteristics of such entities. Please refer to the Glossary of Oil and Gas Terms section of this report for additional information regarding these measures. The actual quantities and present value of our estimated proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The following table should be read along with the section entitled Risk Factors – Risks Related to Our Business below. +Our ability to replace our production is critical to us. Please refer to the reserve replacement term in the Glossary of Oil and Gas Terms section of this report for information describing how this metric is calculated. +8 +The following table summarizes estimated proved reserves, the standardized measure of discounted future net cash flows, and PV-10 as of December 31, 2016 , 2015 , and 2014 : +As of December 31, +2016 +2015 +2014 +Reserve data: +Proved developed +Oil (MMBbl) +48.5 +75.6 +89.3 +Gas (Bcf) +609.1 +644.4 +784.6 +NGLs (MMBbl) +58.6 +61.5 +66.7 +MMBOE (1) +208.7 +244.5 +286.8 +Proved undeveloped +Oil (MMBbl) +56.4 +69.6 +80.4 +Gas (Bcf) +502.0 +619.7 +682.0 +NGLs (MMBbl) +47.1 +53.9 +66.8 +MMBOE (1) +187.1 +226.8 +260.9 +Total proved (1) +Oil (MMBbl) +104.9 +145.3 +169.7 +Gas (Bcf) (2) +1,111.1 +1,264.0 +1,466.5 +NGLs (MMBbl) +105.7 +115.4 +133.5 +MMBOE (1)(3) +395.8 +471.3 +547.7 +Proved developed reserves % +53 +% +52 +% +52 +% +Proved undeveloped reserves % +47 +% +48 +% +48 +% +Reserve data (in millions): +Standardized measure of discounted future net cash flows (GAAP) +$ +1,152.1 +$ +1,790.5 +$ +5,698.8 +PV-10 (non-GAAP): +Proved developed PV-10 +$ +1,051.1 +$ +1,593.0 +$ +5,253.0 +Proved undeveloped PV-10 +101.0 +197.5 +2,363.9 +Total proved PV-10 +$ +1,152.1 +$ +1,790.5 +$ +7,616.9 +Reserve life index (years) +7.2 +7.3 +9.9 +____________________________________________ +(1) +Totals may not sum or calculate due to rounding. +(2) +For the years ended December 31, 2016, and 2015, proved gas reserves contained 43.7 Bcf and 48.1 Bcf of gas, respectively, that we expect to produce and use as field fuel (primarily for compressors). +(3) +As of December 31, 2016, our outside-operated Eagle Ford shale assets were held for sale. Subsequent to year-end, we entered into a definitive agreement with an expected closing date in the first quarter of 2017. These assets represented approximately 74.0 MMBOE of our estimated proved reserves as of December 31, 2016. Additionally, subsequent to December 31, 2016, we announced our plans to sell our Divide County, North Dakota assets. +9 +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the pre-tax PV-10 (Non-GAAP) of total proved reserves. Please see the definitions of standardized measure of discounted future net cash flows and PV-10 in the Glossary of Oil and Gas Terms section of this report. +As of December 31, +2016 +2015 +2014 +(in millions) +Standardized measure of discounted future net cash flows (GAAP) +$ +1,152.1 +$ +1,790.5 +$ +5,698.8 +Add: 10 percent annual discount, net of income taxes +937.1 +1,307.1 +3,407.2 +Add: future undiscounted income taxes +— +— +3,511.4 +Undiscounted future net cash flows +2,089.2 +3,097.6 +12,617.4 +Less: 10 percent annual discount without tax effect +(937.1 +) +(1,307.1 +) +(5,000.5 +) +PV-10 (non-GAAP) +$ +1,152.1 +$ +1,790.5 +$ +7,616.9 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of production when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time period. As of December 31, 2016 , we did not have any proved undeveloped reserves that had been on our books in excess of five years. +For locations that are more than one location removed from developed producing locations, we utilized reliable geologic and engineering technology to add approximately 44.4 MMBOE of proved undeveloped reserves in the more developed portions of our Eagle Ford shale position, 8.3 MMBOE of proved undeveloped reserves in the more developed portion of our Wolfcamp and Lower Spraberry shale positions in the Midland Basin, and 0.9 MMBOE of proved undeveloped reserves in the more developed portions of our Bakken/Three Forks shale position. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected) and petrophysical analysis of that log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as significant statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. In all other areas, we restricted proved undeveloped locations to immediate offsets to producing wells. +10 +As of December 31, 2016 , we had 187.1 MMBOE of proved undeveloped reserves, which is a decrease of 39.7 MMBOE, or 18 percent , from 226.8 MMBOE at December 31, 2015 . The following table provides a reconciliation of our proved undeveloped reserves for the year ended December 31, 2016 : +Total +(MMBOE) +Total proved undeveloped reserves: +Beginning of year +226.8 +Revisions of previous estimates (1) +(34.3 +) +Additions from discoveries, extensions, and infill (2) +89.4 +Sales of reserves +(17.1 +) +Purchases of minerals in place (3) +8.1 +Removed for five-year rule (4) +(43.0 +) +Conversions to proved developed (5) +(42.8 +) +End of year (6) +187.1 +____________________________________________ +(1) +Revisions of previous estimates relate to a negative price revision of 25.5 MMBOE due to the decline in commodity prices during 2016 and a negative performance revision of 8.8 MMBOE. +(2) +We added 78.4 MMBOE of infill proved undeveloped reserves and an additional 11.0 MMBOE of proved undeveloped reserves through extensions and discoveries primarily in our Eagle Ford shale program. +(3) +We acquired 8.1 MMBOE of proved undeveloped reserves primarily in the Midland Basin. As of December 31, 2016, a relatively small portion of our future development capital was allocated to proved reserve locations. The remainder of capital allocated was to delineate our extensive acquired Midland Basin acreage position, still classified as unproven. We expect reserve growth over time as additional acreage is classified as proven and capital is allocated to offset locations. +(4) +Proved undeveloped reserves were reduced by 43.0 MMBOE due to changes in our development plan, which caused these locations to be reclassified primarily to the probable reserves category due to the five-year rule. These locations were replaced by higher quality proved undeveloped reserves, which are classified as extensions or infills in the table above, and resulted from our testing and delineation programs. +(5) +Conversions of proved undeveloped reserves to proved developed reserves were primarily in our Eagle Ford shale and Bakken/Three Forks programs. Our 2016 track record was slightly below 20 percent due to fewer conversions of proved undeveloped reserves in our Raven/Bear Den program, which we sold during the fourth quarter of 2016, and in our outside-operated Eagle Ford shale program due to the operator curtailing activity in 2016. Our 2016 development pace and our multi-year historical track record were both in excess of 20 percent. During 2016 , we incurred approximately $268 million on projects associated with reserves booked as proved undeveloped reserves at the end of 2015 , of which approximately $226 million was spent on proved undeveloped reserves converted to proved developed reserves by December 31, 2016. At December 31, 2016, drilled but not completed wells represented 28.0 MMBOE of total proved undeveloped reserves. We expect to incur approximately $145 million of capital expenditures in completing these wells, and we expect all of these wells to be completed within five years from their initial booking as proved undeveloped reserves. +(6) +As of December 31, 2016, none of our proved undeveloped reserves were on acreage expected to expire before their targeted completion date. +As of December 31, 2016 , estimated future development costs relating to our proved undeveloped reserves were approximately $181 million , $378 million , and $402 million in 2017 , 2018 , and 2019 , respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group and is coordinated by our Corporate Business Development Director, subject to the oversight of our management and the Audit Committee of our Board of Directors, as discussed below. Our Corporate Business Development Director has over 25 years of experience in the energy industry, and holds a Bachelor of Science Degree in Petroleum Engineering from Montana Tech of The University of Montana. He is also a member of the +11 +Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the year by our regional staff. This data, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our regional engineering technical staff do not report directly to our Corporate Business Development Director; they report to either their respective regional technical managers or directly to the regional manager. This design is intended to promote objective and independent analysis within our regions in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are required to be within 10 percent of our proved reserve amounts for the total company, as well as for each respective region. Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world for over 70 years. The technical person at Ryder Scott primarily responsible for overseeing our reserves audit is an Advising Senior Vice President who received a Bachelor of Science Degree in Chemical Engineering from Purdue University in 1979 and a Master of Science Degree in Chemical Engineering from the University of California, Berkeley in 1981. He is a licensed Professional Engineer in the State of Texas, a member of the Society of Petroleum Engineers, and the Society of Petroleum Evaluation Engineers. The Ryder Scott 2016 report concerning our reserves is included as Exhibit 99.1. +In addition to a third-party audit, our reserves are reviewed by our management with the Audit Committee of our Board of Directors. Management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Executive Vice President - Operations, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives from time to time to discuss processes and findings. +12 +Production +The following table summarizes the volumes and realized prices of oil, gas, and NGLs produced and sold from properties in which we held an interest during the periods indicated. Realized prices presented below exclude the effects of derivative contract settlements. Also presented is a summary of related production costs on a per BOE basis. +For the Years Ended December 31, +2016 +2015 +2014 +Net production (2) +Oil (MMBbl) +16.6 +19.2 +16.7 +Gas (Bcf) +146.9 +173.6 +152.9 +NGLs (MMBbl) +14.2 +16.1 +13.0 +MMBOE (3) +55.3 +64.2 +55.1 +Eagle Ford net production (1)(2) +Oil (MMBbl) +5.4 +7.6 +6.9 +Gas (Bcf) +129.9 +147.2 +120.6 +NGLs (MMBbl) +13.8 +15.6 +12.7 +MMBOE (3) +40.9 +47.7 +39.7 +Realized price, before the effect of derivative settlements +Oil (per Bbl) +$ +36.85 +$ +41.49 +$ +80.97 +Gas (per Mcf) +$ +2.30 +$ +2.57 +$ +4.58 +NGLs (per Bbl) +$ +16.16 +$ +15.92 +$ +33.34 +Per BOE +$ +21.32 +$ +23.36 +$ +45.01 +Production costs per BOE +Lease operating expense +$ +3.51 +$ +3.73 +$ +4.28 +Transportation costs +$ +6.16 +$ +6.02 +$ +6.11 +Production taxes +$ +0.94 +$ +1.13 +$ +2.13 +Ad valorem tax expense +$ +0.21 +$ +0.39 +$ +0.46 +____________________________________________ +(1) +In each of the years 2016 , 2015 , and 2014 , total estimated proved reserves attributed to our Eagle Ford shale properties exceeded 15 percent of our total proved reserves expressed on an equivalent basis. +(2) +As of December 31, 2016, our outside-operated Eagle Ford shale assets were held for sale. Subsequent to year-end, we entered into a definitive agreement with an expected closing date in the first quarter of 2017. These assets represented approximately 9.7 MMBOE of production on an equivalent basis for the year ended December 31, 2016. +(3) +Amounts may not calculate due to rounding. +Productive Wells +As of December 31, 2016 , we had working interests in 1,027 gross (841 net) productive oil wells and 1,882 gross (704 net) productive gas wells. Productive wells are either wells producing in commercial quantities or wells mechanically capable of commercial production, but are temporarily shut-in. Multiple completions in the same wellbore are counted as one well. As of December 31, 2016 , three of these wells had multiple completions. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil when it first commenced production, but such designation may not be indicative of current production. +13 +Drilling and Completion Activity +All of our drilling and completion activities are conducted by independent contractors. We do not own any drilling or completion equipment. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2016 , 2015 , and 2014 , excluding non-consented projects, active injector wells, salt water disposal wells, and any wells in which we own only a royalty interest: +For the Years Ended December 31, +2016 +2015 +2014 +Gross +Net +Gross +Net +Gross +Net +Development wells: +Oil +100 +73.0 +87 +56.5 +133 +66.1 +Gas +114 +56.1 +272 +100.8 +476 +165.5 +Non-productive +2 +1.1 +— +— +8 +5.3 +216 +130.2 +359 +157.3 +617 +236.9 +Exploratory wells: +Oil +7 +6.8 +5 +3.5 +5 +3.0 +Gas +— +— +1 +1.0 +7 +4.8 +Non-productive +— +— +5 +4.1 +4 +3.3 +7 +6.8 +11 +8.6 +16 +11.1 +Total +223 +137.0 +370 +165.9 +633 +248.0 +A productive well is an exploratory, development, or extension well that is producing or capable of commercial production of oil, gas, and/or NGLs. A non-productive well, frequently referred to within the industry as a dry hole, is an exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in commercial quantities to justify completion, or upon completion, the economic operation of a well. +As defined by the SEC, an exploratory well is a well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. A development well is a well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive. The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. Completion refers to the installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry well, the reporting to the appropriate authority that the well has been plugged and abandoned. +In addition to the wells drilled and completed in 2016 (included in the table above), see the table below for additional drilling and completion activity in progress as of the date noted below: +As of January 31, 2017 +Gross +Net +Drilling: (2) +Operated +9 +8.9 +Outside-operated +24 +5.0 +Total +33 +13.9 +Drilled but not completed: (1) (2) +Operated +81 +77.7 +Outside-operated +133 +24.8 +Total +214 +102.5 +____________________________________________ +(1) +Represents wells that were being completed or waiting on completion as of January 31, 2017. +14 +(2) +Subsequent to December 31, 2016, we executed a definitive sales agreement for our outside-operated Eagle Ford shale assets and announced our plans to sell our remaining Williston Basin assets in Divide County, North Dakota in 2017. As of January 31, 2017, we were participating in the drilling of 22 gross (4 net) outside-operated wells related to these assets. The drilled but not completed wells presented above include 20 gross (17 net) operated wells and 132 gross (24 net) outside-operated wells related to these assets. +Acreage +The following table sets forth the gross and net acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes that we held as of December 31, 2016 . Undeveloped acreage includes leasehold interests containing proved undeveloped reserves. +Developed Acres (1) +Undeveloped Acres (2)(3) +Total +Gross +Net +Gross +Net +Gross +Net +South Texas & Gulf Coast: +Operated Eagle Ford +69,777 +67,960 +97,175 +93,525 +166,952 +161,485 +Outside-operated Eagle Ford (5) +139,383 +24,893 +89,900 +10,929 +229,283 +35,822 +Other +5,780 +869 +7,783 +5,771 +13,563 +6,640 +Permian: +RockStar (4) +32,641 +26,632 +48,419 +35,338 +81,060 +61,970 +Sweetie Peck +15,020 +14,409 +361 +192 +15,381 +14,601 +Halff East +9,080 +5,468 +1,490 +516 +10,570 +5,984 +Rocky Mountain: +North Rockies: +Divide (6) +165,510 +110,625 +24,283 +12,943 +189,793 +123,568 +Other (7) +— +— +244,371 +172,148 +244,371 +172,148 +South Rockies: +PRB Cretaceous +50,429 +38,625 +141,116 +117,637 +191,545 +156,262 +Other (7) +1,316 +987 +103,921 +85,126 +105,237 +86,113 +Other (8) +10,499 +10,499 +18,891 +16,232 +29,390 +26,731 +Total +499,435 +300,967 +777,710 +550,357 +1,277,145 +851,324 +____________________________________________ +(1) +Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations, but has been included only as developed acreage in the presentation above. +(2) +Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) +As of the filing date of this report, approximately 35,900 , 20,200 , and 7,900 net acres of undeveloped acreage are scheduled to expire by December 31, 2017 , 2018 , and 2019 , respectively, if production is not established or we take no other action to extend the terms of the applicable lease or leases. +(4) +Refers to our recently acquired Midland Basin acreage in Howard and Martin Counties, Texas. +(5) +Our outside-operated Eagle Ford shale assets were held for sale as of December 31, 2016. Subsequent to year-end 2016, we entered into a definitive agreement with an expected closing date in the first quarter of 2017. +(6) +Subsequent to December 31, 2016, we announced our plans to sell our Divide County, North Dakota assets. +(7) +Includes other non-core acreage located in North Dakota, Montana, Wyoming, and Utah. +(8) +Includes Louisiana fee and other non-core acreage. +15 +Delivery Commitments +As of December 31, 2016 , we had gathering, processing, and transportation throughput commitments with various third parties that have aggregate minimum commitments to deliver 1,461 Bcf of natural gas, 70 MMBbl of crude oil, 13 MMBbl of NGLs, and 25 MMBbl of water through 2034 . We are required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments. If a shortfall in the minimum volume commitment for natural gas is projected, we have rights under certain contracts to arrange for third party gas to be delivered, and such volume will count toward our minimum volume commitment. Our current production is insufficient to offset these aggregate contractual liabilities, but we expect to fulfill the delivery commitments with production from the future development of our proved undeveloped reserves and from the future development of resources not yet characterized as proved reserves or through arranging for the delivery of third party gas. In the event that no product is delivered in accordance with these agreements, the aggregate undiscounted deficiency payments would have been approximately $970.9 million as of December 31, 2016 . Please refer to Note 6 - Commitments and Contingencies in Part II, Item 8 for additional discussion. +Subsequent to December 31, 2016, we entered into a definitive agreement for the sale of our outside-operated Eagle Ford shale assets held for sale at December 31, 2016, and expect to close the transaction in the first quarter of 2017. Upon closing the sale, we would no longer be subject to transportation throughput commitments totaling 514 Bcf of natural gas, 52 MMBbl of oil, and 13 MMBbl of NGLs, or $501.9 million of potential undiscounted deficiency payments. Please refer to the caption Major Customers below, as our operator in our outside-operated Eagle Ford shale program is identified as a major customer under the various marketing agreements we were party to as of December 31, 2016. +As of the filing date of this report, we do not expect any material shortfalls. +Major Customers +We do not believe the loss of any single purchaser of our crude oil, natural gas, and NGLs would materially impact our operating results, as these are products with well-established markets and numerous purchasers are present in our operating regions. +We had the following major customer and sales to entities under common ownership, which accounted for 10 percent or more of our total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2016 +2015 +2014 +Major customer (1) +18 +% +21 +% +19 +% +Group #1 of entities under common ownership (2) +15 +% +10 +% +14 +% +Group #2 of entities under common ownership (2) +8 +% +11 +% +9 +% +____________________________________________ +(1) +This major customer is our operator in our outside-operated Eagle Ford shale program, which we entered into various marketing agreements with during 2013, whereby we are subject to certain gathering, transportation, and processing throughput commitments for up to 10 years pursuant to each contract. Because we share with our operator the risk of non-performance by its counterparty purchasers, we have included our operator as a major customer in the table above. Several of the operator’s counterparty purchasers under these contracts are also direct purchasers of our production from other areas. As of December 31, 2016, our outside-operated Eagle Ford shale assets were classified as held for sale. +(2) +In the aggregate, these groups of entities under common ownership represent more than 10 percent of total production revenue for the period(s) shown; however, none of the entities comprising either group individually represented more than 10 percent of our production revenue. +16 +Employees and Office Space +As of February 15, 2017 , we had 607 full-time employees. This is a 23 percent decrease from the 786 reported full-time employees as of February 17, 2016 . None of our employees are subject to a collective bargaining agreement, and we consider our relations with our employees to be good. +The following table summarizes the approximate square footage of office space leased by us, as of December 31, 2016 , including our corporate headquarters and regional offices: +Region +Approximate Square Footage Leased +Corporate +108,000 +Permian +54,000 +South Texas & Gulf Coast +64,000 +Rocky Mountain (1) +— +Mid-Continent (2) +50,000 +Total +276,000 +____________________________________________ +(1) +During the fourth quarter of 2016, we closed our office in Billings, Montana, and we executed an agreement to terminate the lease effective November 11, 2016 . Please refer to Note 14 - Exit and Disposal Costs in Part II, Item 8 for additional discussion. +(2) +During the third quarter of 2015, we closed our office in Tulsa, Oklahoma. We have subleased this space through 2019 and our lease expires in 2022. Please refer to Note 14 - Exit and Disposal Costs in Part II, Item 8 for additional discussion. +In addition to the leased office space summarized in the table above, we own a total of 58,500 square feet of office space in our South Texas & Gulf Coast and Rocky Mountain regions. +Title to Properties +Substantially all of our interests are held pursuant to oil and gas leases from third parties. We usually obtain title opinions prior to commencing our initial drilling operations on our properties. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such properties in accordance with standards generally accepted in the oil and gas industry. Most of our producing properties are subject to mortgages securing indebtedness under our Credit Agreement, royalty and overriding royalty interests, liens for current taxes, and other burdens that we believe do not materially interfere with the use of, or affect the value of, such properties. We typically perform only minimal title investigation before acquiring undeveloped leasehold acreage. +Seasonality +Generally, but not always, the demand and price levels for natural gas increase during winter months and decrease during summer months. To lessen the impact of seasonal demand fluctuations, pipelines, utilities, local distribution companies, and industrial users utilize natural gas storage facilities and forward purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can divert gas that traditionally is placed into storage. This could reduce the typical seasonal price differential. Demand for oil and heating oil is also generally higher in the winter and the summer driving season, although oil prices are impacted more significantly by global supply and demand. Seasonal anomalies, such as mild winters, sometimes lessen these fluctuations. Recently, the impact of seasonality on oil has been somewhat muted by overall supply and demand economics attributable to worldwide production in excess of existing worldwide demand. Certain of our drilling, completion, and other operations are also subject to seasonal limitations. Seasonal weather conditions, government regulations, and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. See Risk Factors - Risks Related to Our Business below for additional discussion. +17 +Competition +The oil and gas industry is intensely competitive, particularly with respect to acquiring prospective oil and natural gas properties. We believe our acreage positions provide a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from a substantial number of major and independent oil and gas companies, which in some cases have larger technical staffs and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and natural gas reserves, but also have gathering, processing or refining operations, market refined products, own drilling rigs or other equipment, or generate electricity. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting, and processing of crude oil, natural gas, and NGLs. Consequently, we may face shortages, delays, or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including other fossil fuels such as coal and imported liquefied natural gas. Competitive conditions may be affected by future energy, climate-related, financial, or other policies, legislation, and regulations. +In addition, we compete for people, including experienced geologists, geophysicists, engineers, and other professionals. Throughout the oil and gas industry, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. We are not insulated from the competition for quality people, and we must compete effectively in order to be successful. +Government Regulations +Our business is extensively controlled by numerous federal, state, and local laws and governmental regulations. These laws and regulations may be changed from time to time in response to economic or political conditions, or other developments, and our regulatory burden may increase in the future. Laws and regulations have the potential to increase our cost of doing business and consequently could affect our profitability. However, we do not believe that we are affected to a materially greater or lesser extent than others in our industry. +Energy Regulations. Many of the states in which we conduct our operations have adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, imposing bond requirements in order to drill or operate wells, and governing the timing of drilling and location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to various state conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, state conservation laws sometimes establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Some of our operations are conducted on federal lands pursuant to oil and gas leases administered by the Bureau of Land Management (“BLM”). These leases contain relatively standardized terms and require compliance with detailed regulations and orders that are subject to change. In addition to permits required from other regulatory agencies, lessees must obtain a permit from the BLM before drilling and must comply with regulations governing, among other things, engineering and construction specifications for production facilities, safety procedures, the valuation of production and payment of royalties, the removal of facilities, and the posting of bonds to ensure that lessee obligations are met. Under certain circumstances, the BLM may suspend or terminate our operations on federal leases. +18 +Our sales of natural gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of natural gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of natural gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for natural gas production. +Environmental, Health and Safety Matters +General. Our operations are subject to stringent and complex federal, state, tribal, and local laws and regulations governing protection of the environment and worker health and safety as well as the discharge of materials into the environment. These laws and regulations may, among other things: +• +require the acquisition of various permits before drilling commences; +• +restrict the types, quantities and concentration of various substances that can be released into the environment in connection with oil and natural gas drilling and production and saltwater disposal activities; +• +limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +• +require remedial measures to mitigate pollution from former and ongoing operations, such as closing pits and plugging abandoned wells. +These laws, rules and regulations may also restrict the rate of oil and natural gas production below the rate that would otherwise be possible. The regulatory burden on the oil and natural gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent permitting, waste handling, disposal, and cleanup requirements for the oil and natural gas industry and could have a significant impact on our operating costs. +The following is a summary of some of the existing laws, rules and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or natural gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and natural gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation and Liability Act. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +19 +We currently own, lease, or operate numerous properties that have been used for oil and natural gas exploration and production for many years. Although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, U.S. Army Corps of Engineers or analogous state agencies. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for containment and removal costs, natural resource damages and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane and other “greenhouse gases” present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on these findings, the EPA has begun adopting and implementing a comprehensive suite of regulations to restrict emissions of greenhouse gases under existing provisions of the CAA. Legislative and regulatory initiatives related to climate change could have an adverse effect on our operations and the demand for oil and gas. See Risk Factors - Risks Related to Our Business - Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for crude oil, natural gas, and NGLs . In addition to the effects of regulation, the meteorological effects of global climate change could pose additional risks to our operations, including physical damage risks associated with more frequent, more intensive storms and flooding, and could adversely affect the demand for our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +National Environmental Policy Act. Oil and natural gas exploration and production activities on federal lands are subject to the National Environmental Policy Act (“NEPA”). NEPA requires federal agencies, including the Department of Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an environmental assessment to determine the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed environmental impact statement that may be made available for public review and comment. All of our current exploration and production activities, as well as proposed +20 +exploration and development plans, on federal lands require governmental permits subject to the requirements of NEPA. This process has the potential to delay development of some of our oil and natural gas projects. +OSHA and other laws and regulations. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and natural gas commissions. However, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition to oil and gas activities using hydraulic fracturing techniques, which could potentially cause a decrease in the completion of new oil and gas wells, increased compliance costs, and delays, all of which could adversely affect our financial position, results of operations and cash flows. As new laws or regulations that significantly restrict hydraulic fracturing are adopted, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and natural gas that we are ultimately able to produce from our reserves. +We believe it is reasonably likely that the trend in local and state environmental legislation and regulation will continue toward stricter standards, while the trend in federal environmental legislation and regulation faces an uncertain future under the Trump administration. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health and Safety Initiatives. We are committed to conducting our business in a manner that protects the environment and the health and safety of our employees, contractors and the public. We set annual goals for our environmental, health and safety program focused on reducing the number of safety related incidents that occur and the number and impact of spills of produced fluids. We also periodically conduct regulatory compliance audits of our operations to ensure our compliance with all regulations and provide appropriate training for our employees. Reducing air emissions as a result of leaks, venting, or flaring of natural gas during operations has become a major focus area for regulatory efforts and for our compliance efforts. While flaring is sometimes necessary, releases of natural gas to the environment and flaring is an economic waste and reducing these volumes is a priority for us. To avoid flaring where possible, we restrict testing periods and make every effort to ensure that our production is connected to gas pipeline infrastructure as quickly as possible after well completions. We have cooperated with other producers in North Dakota in the ongoing development of recommendations to reduce the amount of flaring that is occurring there as a result of area wide infrastructure limitations that are beyond our control. Another focus for our environmental effort has been reduction of water use through recycling of flowback water in south Texas for use as frac fluid. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +Cautionary Information about Forward-Looking Statements +This Annual Report on Form 10-K (“Form 10-K”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of +21 +1934, as amended (the “Exchange Act”). All statements, other than statements of historical facts, included in this Form 10-K that address activities, events, or developments with respect to our financial condition, results of operations, or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “estimate,” “expect,” “forecast,” “intend,” “plan,” “project,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this Form 10-K, and include statements about such matters as: +• +the amount and nature of future capital expenditures and the availability of liquidity and capital resources to fund capital expenditures; +• +our outlook on future oil, gas, and NGL prices, well costs, and service costs; +• +the drilling of wells and other exploration and development activities and plans, as well as possible or expected acquisitions or divestitures; +• +the possible divestiture or farm-down of, or joint venture relating to, certain properties; +• +proved reserve estimates and the estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates; +• +future oil, gas, and NGL production estimates; +• +cash flows, anticipated liquidity, and the future repayment of debt; +• +business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, and our outlook on our future financial condition or results of operations; and +• +other similar matters such as those discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in Part II, Item 7 of this Form 10-K. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. These statements are subject to a number of known and unknown risks and uncertainties, which may cause our actual results and performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Some of these risks are described in the Risk Factors section of this Form 10-K, and include such factors as: +• +the volatility of oil, gas, and NGL prices, and the effect it may have on our profitability, financial condition, cash flows, access to capital, and ability to grow production volumes and/or proved reserves; +• +weakness in economic conditions and uncertainty in financial markets; +• +our ability to replace reserves in order to sustain production; +• +our ability to raise the substantial amount of capital required to develop and/or replace our reserves; +• +our ability to compete against competitors that have greater financial, technical, and human resources; +• +our ability to attract and retain key personnel; +• +the imprecise estimations of our actual quantities and present value of proved oil, gas, and NGL reserves; +• +the uncertainty in evaluating recoverable reserves and estimating expected benefits or liabilities; +• +the possibility that exploration and development drilling may not result in commercially producible reserves; +22 +• +our limited control over activities on outside-operated properties; +• +our reliance on the skill and expertise of third-party service providers on our operated properties; +• +the possibility that title to properties in which we claim an interest may be defective; +• +our planned drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques is subject to drilling and completion risks and may not meet our expectations for reserves or production; +• +the uncertainties associated with acquisitions, divestitures, joint ventures, farm-downs, farm-outs and similar transactions with respect to certain assets, including whether such transactions will be consummated or completed in the form or timing and for the value that we anticipate; +• +the uncertainties associated with enhanced recovery methods; +• +our commodity derivative contracts may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales; +• +the inability of one or more of our service providers, customers, or contractual counterparties to meet their obligations; +• +our ability to deliver required quantities of crude oil, natural gas, natural gas liquids, or water to contractual counterparties; +• +price declines or unsuccessful exploration efforts resulting in write-downs of our asset carrying values; +• +the impact that depressed oil, gas, or NGL prices could have on our borrowing capacity under our Credit Agreement; +• +the possibility our amount of debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt; +• +the possibility that covenants in our Credit Agreement or the indentures governing the Senior Notes and Senior Convertible Notes may limit our discretion in the operation of our business, prohibit us from engaging in beneficial transactions or lead to the accelerated payment of our debt; +• +operating and environmental risks and hazards that could result in substantial losses; +• +the impact of seasonal weather conditions and lease stipulations on our ability to conduct drilling activities; +• +our ability to acquire adequate supplies of water and dispose of or recycle water we use at a reasonable cost in accordance with environmental and other applicable rules; +• +complex laws and regulations, including environmental regulations, that result in substantial costs and other risks; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities; +• +our ability to sell and/or receive market prices for our oil, gas, and NGLs; +• +new technologies may cause our current exploration and drilling methods to become obsolete; +• +the possibility of security threats, including terrorist attacks and cybersecurity breaches, against, or otherwise impacting, our facilities and systems; and +• +litigation, environmental matters, the potential impact of legislation and government regulations, and the use of management estimates regarding such matters. +23 +We caution you that forward-looking statements are not guarantees of future performance and actual results or performance may be materially different from those expressed or implied in the forward-looking statements. The forward-looking statements in this report speak as of the filing date of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by securities laws. +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC. We also make available through our website our Corporate Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, and the Charters of the Audit, Compensation, Executive, and Nominating and Corporate Governance Committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +Glossary of Oil and Gas Terms +The oil and gas terms defined in this section are used throughout this report. The definitions of the terms developed reserves, exploratory well, field, proved reserves, and undeveloped reserves have been abbreviated from the respective definitions under Rule 4-10(a) of Regulation S-X. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the SEC’s website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +Bcf . Billion cubic feet, used in reference to natural gas. +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of natural gas to one Bbl of oil or NGLs. +BTU. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. A well found to be incapable of producing either oil, natural gas, and/or NGLs in commercial quantities. +Exploratory well. A well drilled to find and produce oil or natural gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or natural gas in another reservoir, or to extend a known reservoir beyond its known horizon. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and natural gas) rights. +24 +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. +Finding and development cost. Expressed in dollars per BOE. Finding and development cost metrics provide information as to the cost of adding proved reserves from various activities, and are widely utilized within the exploration and production industry, as well as by investors and analysts. The information used to calculate these metrics is included in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report. It should be noted that finding and development cost metrics have limitations. For example, exploration efforts related to a particular set of proved reserve additions may extend over several years. As a result, the exploration costs incurred in earlier periods are not included in the amount of exploration costs incurred during the period in which that set of proved reserves is added. In addition, consistent with industry practice, future capital costs to develop proved undeveloped reserves are not included in costs incurred. Since the additional development costs that will need to be incurred in the future before the proved undeveloped reserves are ultimately produced are not included in the amount of costs incurred during the period in which those reserves were added, those development costs in future periods will be reflected in the costs associated with adding a different set of reserves. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +Frac spread. Hydraulic fracturing requires custom-designed and purpose-built equipment. A “frac spread” is the equipment necessary to carry out a fracturing job. +Gross acre. An acre in which a working interest is owned. +Gross well. A well in which a working interest is owned. +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses. The expenses incurred in the lifting of crude oil, natural gas, and/or associated liquids from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels of crude oil, NGLs, water, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to natural gas. +MMBbl. One million barrels of oil, NGLs, water, or other liquid hydrocarbons. +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to natural gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +NGLs. The combination of ethane, propane, butane, and natural gasolines that when removed from natural gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for crude oil. +NYMEX Henry Hub . New York Mercantile Exchange Henry Hub, a common industry benchmark price for natural gas. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +25 +PV-10 (Non-GAAP). PV-10 is a non-GAAP measure. The present value of estimated future revenue to be generated from the production of estimated net proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. +Productive well. A well that is producing crude oil, natural gas, and/or NGLs or that is capable of commercial production of those products. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +Reserve life index. Expressed in years, represents the estimated net proved reserves at a specified date divided by actual production for the preceding 12-month period. +Reserve replacement. Reserve replacement metrics are used as indicators of a company’s ability to replenish annual production volumes and grow its reserves, and provide information related to how successful a company is at growing its proved reserve base. These are believed to be useful non-GAAP measures that are widely utilized within the exploration and production industry, as well as by investors and analysts. They are easily calculable metrics, and the information used to calculate these metrics is included in the Supplemental Oil and Gas Information section of Part II, Item 8 of this report. It should be noted that reserve replacement metrics have limitations. They are limited because they typically vary widely based on the extent and timing of new discoveries and property acquisitions. Their predictive and comparative value is also limited for the same reasons. In addition, because the metrics do not embed the cost or timing of future production of new reserves, they cannot be used as a measure of value creation. +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible crude oil, natural gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of crude oil, natural gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from crude oil, natural gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +Royalty interest. An interest in an oil and natural gas property entitling the owner to shares of crude oil, natural gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +26 +Standardized measure of discounted future net cash flows. The discounted future net cash flows relating to proved reserves based on prices used in estimating the reserves, year-end costs, and statutory tax rates, and a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information located in Part II, Item 8 of this report. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, natural gas, and associated liquids regardless of whether such acreage contains estimated net proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +27 +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in us. +Risks Related to Our Business +Crude oil, natural gas, and NGL prices are volatile, and declines in prices adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and natural gas properties depend heavily on the prices we receive for crude oil, natural gas, and NGL sales. Crude oil, natural gas, and NGL prices also affect our cash flows available for capital expenditures and other items, our borrowing capacity, and the volume and amount of our crude oil, natural gas, and NGL reserves. For example, the amount of our borrowing base under our Credit Agreement is subject to periodic redeterminations based on crude oil, natural gas, and NGL prices specified by our bank group at the time of redetermination. In addition, we may have crude oil and natural gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. The decline in commodity prices during 2016 resulted in reductions to our proved reserve volumes and PV-10; reductions in revenues received from the sale of oil, gas, and NGLs, and thus cash flow from operating activities; and impairments of proved and unproved properties. Please refer to the captions Significant Developments in 2016 and Reserves within Part I, Items 1 and 2, Comparison of Financial Results and Trends between 2016 and 2015 and between 2015 and 2014 within Part II, Item 7, and Note 1 – Summary of Significant Accounting Policies , Note 11 – Fair Value Measurements , and Supplemental Oil and Gas Information in Part II, Item 8 for specific discussion. +Historically, the markets for crude oil, natural gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in crude oil, natural gas, and NGL prices may result from relatively minor changes in the supply of and demand for crude oil, natural gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• +global and domestic supplies of crude oil, natural gas, and NGLs, and the productive capacity of the industry as a whole; +• +the level of consumer demand for crude oil, natural gas, and NGLs; +• +overall global and domestic economic conditions; +• +weather conditions; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities in regional or localized areas that may affect the realized prices for crude oil, natural gas, or NGLs; +• +liquefied natural gas deliveries to and from the United States; +• +the price and level of imports and exports of crude oil, refined petroleum products, and liquefied natural gas; +• +the price and availability of alternative fuels; +• +technological advances and regulations affecting energy consumption and conservation; +• +the ability of the members of the Organization of Petroleum Exporting Countries and other exporting countries to agree to and maintain crude oil price and production controls; +• +political instability or armed conflict in crude oil or natural gas producing regions; +• +strengthening and weakening of the United States dollar relative to other currencies; and +• +governmental regulations and taxes. +28 +These factors and the volatility of crude oil, natural gas, and NGL markets make it extremely difficult to predict future crude oil, natural gas, and NGL price movements with any certainty. Declines in crude oil, natural gas, and NGL prices would reduce our revenues and could also reduce the amount of crude oil, natural gas, and NGLs that we can produce economically, which could have a materially adverse effect on us. +Weakness in economic conditions or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +In recent years, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, increased levels of unemployment, and an unprecedented level of intervention by the United States federal government and other governments. Although the United States economy appears to have stabilized, the extent and timing of a recovery, and whether it can be sustained, are uncertain. Renewed weakness in the United States or other large economies could materially adversely affect our business and financial condition. For example: +• +crude oil, natural gas, and NGL prices have recently been lower than at various times in the last decade because of increased supply resulting from, among other things, increased drilling in unconventional reservoirs, leading to lower revenues, which could affect our financial condition and results of operations; +• +the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• +the liquidity available under our Credit Agreement could be reduced if any lender is unable to fund its commitment; +• +our ability to access the capital markets may be restricted at a time when we would like, or need, to raise capital for our business, including for the exploration and/or development of reserves; +• +our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; and +• +variable interest rate spread levels, including for LIBOR and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our Credit Agreement. +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find, develop, or acquire crude oil, natural gas, and NGL reserves that are economically producible. Our properties produce crude oil, natural gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate and develop or acquire new crude oil, natural gas, and NGL reserves to replace those being depleted by production. Without successful drilling or acquisition activities, our reserves and production will decline over time. In addition, competition for crude oil and natural gas properties is intense, and many of our competitors have financial, technical, human, and other resources necessary to evaluate and integrate acquisitions that are substantially greater than those available to us. +For our recent acquisitions or any future acquisitions we may complete, a successful impact on our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price for the acquisition, future crude oil, natural gas, and NGL prices, the ability to reasonably estimate or assess the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves, actual future production rates, and associated costs and potential liabilities with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. A customary review of subject properties will not necessarily reveal all existing or potential problems. +29 +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of special risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce crude oil, natural gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for crude oil, natural gas, and NGL sales, our success in locating and developing and acquiring new reserves, and the orderly functioning of credit and capital markets. If crude oil, natural gas, and NGL prices further decrease or if we encounter operating difficulties that result in our cash flows from operations being less than expected, we may further reduce our planned capital expenditures unless we can raise additional funds through debt or equity financing or the divestment of assets. Debt or equity financing may not always be available to us in sufficient amounts or on acceptable terms, and the proceeds offered to us for potential divestitures may not always be of acceptable value to us. Any downgrades to our credit ratings may make it more difficult or expensive for us to borrow additional funds. +During 2016, our revenues decreased from 2015 due to continued declines in commodity prices and lower production; however, we were able to fund our capital program through cash flows from operations, proceeds from divestitures, and financing activities. If our revenues continue to decrease in the future due to lower crude oil, natural gas, or NGL prices, decreased production, or other reasons, and if we cannot obtain funding through our Credit Agreement, other acceptable debt or equity financing arrangements, or through the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Downgrades in our credit ratings by various credit rating agencies could impact our access to capital and materially adversely affect our business and financial condition. +In February 2016, Moody’s Investors Service and Standard & Poor’s downgraded our credit ratings (“Debt Rating”). Our Debt Rating levels could have materially adverse consequences on our business and future prospects and could: +• +limit our ability to access debt markets, including for the purpose of refinancing our existing debt; +• +cause us to refinance or issue debt with less favorable terms and conditions, which debt may restrict, among other things, our ability to make any dividend distributions or repurchase shares; +• +negatively impact current and prospective customers’ willingness to transact business with us; +• +impose additional insurance, guarantee and collateral requirements; +• +limit our access to bank and third-party guarantees, surety bonds and letters of credit; and +• +cause our suppliers and financial institutions to lower or eliminate the level of credit provided through payment terms or intraday funding when dealing with us, thereby increasing the need for higher levels of cash on hand, which would decrease our ability to repay outstanding indebtedness. +We cannot provide assurance that any of our current Debt Ratings will remain in effect for any given period of time or that a Debt Rating will not be further lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances warrant. +30 +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from major oil and gas companies, independent oil and gas exploration and production companies, and institutional and individual investors who seek oil and gas investments throughout the world, as well as the equipment, expertise, labor, and materials required to operate crude oil and natural gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many crude oil and natural gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. We may not be successful in acquiring and developing profitable properties in the face of this competition. In addition, other companies may have a greater ability to continue drilling activities during periods of low natural gas or oil prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Also, we compete for human resources. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition and results of operations. +The loss of key personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team and other key personnel. The loss of their services could adversely affect our business. Our drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen and other professionals. Competition for many of these professionals can be intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +The actual quantities and present value of our proved crude oil, natural gas, and NGL reserves may be less than we have estimated. +This report and certain of our other SEC filings contain estimates of our proved crude oil, natural gas, and NGL reserves and the estimated future net revenues from those reserves. These estimates are based on various assumptions, including assumptions required by the SEC relating to crude oil, natural gas, and NGL prices, drilling and completion costs, gathering and transportation costs, operating expenses, capital expenditures, effects of governmental regulation, taxes, timing of operations, and availability of funds. The process of estimating crude oil, natural gas, and NGL reserves is complex. The process involves significant decisions and assumptions in the evaluation of available geological, geophysical, engineering, and economic data for each reservoir. These estimates depend on many variables, and changes often occur as our knowledge of these variables evolve. Therefore, these estimates are inherently imprecise. In addition, our reserve estimates for properties that do not have a significant production history may be less reliable than estimates for properties with lengthy production histories. A lack of production history may contribute to inaccuracy in our estimates of proved reserves, future production rates, and the timing and/or amount of development expenditures. +Actual future production; prices for crude oil, natural gas, and NGLs; revenues; production taxes; development expenditures; operating expenses; and quantities of producible crude oil, natural gas, and NGL reserves will most likely vary from those estimated. Any significant variance of any nature could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than we have previously estimated. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration, operations and development activity, prevailing crude oil, natural gas, and NGL prices, costs to develop and operate properties, and other factors, many of which are beyond our control. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2016 , 47 percent , or 187.1 MMBOE, of our estimated proved reserves were proved undeveloped. In order to develop our proved undeveloped reserves, as of December 31, 2016 , we estimate approximately $1.5 billion of capital expenditures would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +31 +You should not assume that the PV-10 and standardized measure of discounted future net cash flows included in this report represent the current market value of our estimated proved crude oil, natural gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. For example, the present value of our proved reserves as of December 31, 2016 , was estimated using calculated 12-month average sales prices of $42.75 per Bbl of oil (NYMEX WTI spot price), $2.47 per MMBtu of natural gas (NYMEX Henry Hub spot price), and $19.50 per Bbl of NGL (OPIS spot price). We then adjust these prices to reflect appropriate basis, quality, and location differentials over the period in estimating our proved reserves. During 2016 , our monthly average realized crude oil prices before the effect of derivative settlements were as high as $45.94 per Bbl and as low as $21.72 per Bbl, and were as high as $21.81 per Bbl and as low as $11.07 per Bbl for NGLs. For the same period, our monthly average realized natural gas prices, excluding the effect of derivative settlements, were as high as $3.12 per Mcf and as low as $1.51 per Mcf. Many other factors will affect actual future net cash flows, including: +• +amount and timing of actual production; +• +supply and demand for crude oil, natural gas, and NGLs; +• +curtailments or increases in consumption by oil purchasers and natural gas pipelines; +• +changes in government regulations or taxes, including severance and excise taxes; and +• +escalations or reductions in service provider and equipment costs resulting from changes in supply and demand. +The timing of production from oil and natural gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to be used to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and natural gas industry in general are subject. +Our property acquisitions may not be worth what we paid due to uncertainties in evaluating recoverable reserves and other expected benefits, as well as potential liabilities. +Successful property acquisitions require an assessment of a number of factors, some of which are beyond our control. These factors include exploration potential, future crude oil, natural gas, and NGL prices, operating costs, title to acquired properties, and potential environmental and other liabilities. These assessments are not precise and their accuracy is inherently uncertain. +In connection with our acquisitions, we typically perform a customary review of the acquired properties that will not necessarily reveal all existing or potential problems. In addition, our review may not allow us to fully assess the potential deficiencies of the properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, title, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. We often acquire interests in properties on an “as is” basis with limited remedies for breaches of representations and warranties. +Our disposition activities may be subject to factors beyond our control, and in certain cases we may retain unforeseen liabilities for certain matters . +We regularly sell non-core assets in order to increase capital resources available for core assets and to create organizational and operational efficiencies. We also occasionally sell interests in core assets for the purpose of accelerating the development and increasing efficiencies in other core assets. Various factors could materially affect our ability to dispose of such assets, including the approvals of governmental agencies or third parties and the availability of purchasers willing to acquire the assets or terms we deem acceptable. We at times may be required to retain certain liabilities or agree to indemnify buyers for certain matters related to the sold assets. The magnitude of any such retained liabilities or of the indemnification obligations may be difficult to quantify at the time of the transaction and ultimately could be material. +32 +We have limited control over the activities on properties we do not operate. +Some of our properties, including a portion of our interests in the Eagle Ford shale in south Texas, are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs and materially and adversely affect our financial condition and results of operations. +We rely on third-party service providers to conduct drilling and completion and other related operations on properties we operate. +Where we are the operator of a property, we rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, natural gas, and NGLs, prevailing economic conditions and financial, business, and other factors. In addition, continued low commodity prices may cause third-party service providers to consolidate or declare bankruptcy, which could limit our options for engaging such providers. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title reports in acquiring oil and gas leasehold interests and obtain title opinions only on significant properties that we drill. There is no assurance that we will not suffer a monetary loss from title defects or title failure. Additionally, undeveloped acreage has greater risk of title defects than developed acreage. Title insurance is not generally available for oil and gas properties. As is customary in our industry, we rely upon the judgment of staff and independent landmen who perform the field work of examining records in the appropriate governmental offices and title abstract facilities before acquiring a specific mineral interest and/or undertaking drilling activities. We, in some cases, perform curative work to correct deficiencies in the marketability of the title to us. Generally, under the terms of the operating agreements affecting our properties, any monetary loss attributable to a loss of title is to be borne by all parties to any such agreement in proportion to their interests in such property. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our financial condition, results of operations, and operating cash flow if such property is of sufficient value. +Exploration and development drilling may not result in commercially producible reserves. +Crude oil and natural gas drilling, completion, and production activities are subject to numerous risks, including the risk that no commercially producible crude oil, natural gas, or associated liquids will be found. The cost of drilling and completing wells is often uncertain, and crude oil, natural gas, or associated liquids drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors include: +• +unexpected adverse drilling or completion conditions; +• +title problems; +• +disputes with owners or holders of surface interests on or near areas where we operate; +• +pressure or geologic irregularities in formations; +• +engineering and construction delays; +• +equipment failures or accidents; +33 +• +hurricanes, tornadoes, flooding, or other adverse weather conditions; +• +governmental permitting delays; +• +compliance with environmental and other governmental requirements; and +• +shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +The prevailing prices for crude oil, natural gas, and NGLs affect the cost of and the demand for drilling rigs, completion and production equipment, and other related services. However, changes in costs may not occur simultaneously with corresponding changes in commodity prices. The availability of drilling rigs can vary significantly from region to region at any particular time. Although land drilling rigs can be moved from one region to another in response to changes in levels of demand, an undersupply of rigs in any region may result in drilling delays and higher drilling costs for the available rigs in that region. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a materially adverse effect on our ability to explore or develop our properties. +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if crude oil, natural gas, or NGLs are present, or whether they can be produced economically. The cost of drilling, completing, and operating a well is often uncertain, and cost factors can adversely affect the economics of a project. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of crude oil, natural gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +Results in our newer resource plays, including those plays where we have recently acquired acreage, may be more uncertain than results in resource plays that are more developed and have longer established production histories. We and the industry generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +In addition, a significant part of our strategy involves increasing our inventory of drilling locations. Such multi-year drilling inventories can be more susceptible to long-term uncertainties that could materially alter the occurrence or timing of actual drilling. Because of these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled, although we have the present intent to do so for locations booked as proved undeveloped locations, or if we will be able to produce crude oil, natural gas, or NGLs from these potential drilling locations. +Our future drilling activities may not be successful. Our overall drilling success rate or our drilling success rate within a particular area may decline. In addition, we may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire and we will lose our right to develop the related properties. Our total net acreage expiring in the next three years represents approximately 12 percent of our total net undeveloped acreage at December 31, 2016 . Although we have identified numerous potential drilling locations, we may not be able to economically drill for and produce crude oil, natural gas, or NGLs from all of them, and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +34 +Part of our strategy involves drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques. The results of our planned exploratory and delineation drilling in these plays are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +Ultimately, the success of these drilling and completion techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for crude oil, natural gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids toward the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, could result in increased lease operating expenses and could adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for crude oil, natural gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in crude oil, natural gas, and NGL prices and the associated impact on cash flows, we have entered into various derivative contracts. Our derivative contracts in place include swap arrangements for natural gas and NGLs, and both swap and collar arrangements for crude oil. As of December 31, 2016 , we were in a net accrued liability position of $91.7 million with respect to our crude oil, natural gas, and NGL derivative activities. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• +our production is less than expected; +• +one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +• +there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +The risk of one or more counterparties defaulting on their obligations is heightened by depressed crude oil, natural gas, and NGL prices. These circumstances may adversely affect the ability of our counterparties to meet their obligations to us pursuant to derivative transactions, which could reduce our revenues and cash flows from derivative settlements. As a result, our financial condition, results of operations, and cash flows could be materially affected in an adverse way if our counterparties default on their contractual obligations under our commodity derivative contracts. +35 +In addition, commodity derivative contracts may limit the prices we receive for our crude oil, natural gas and NGL sales if crude oil, natural gas, or NGL prices rise substantially over the price established by the commodity derivative contract. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from crude oil, natural gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other conditions, including declines in crude oil, natural gas, and NGL prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. We do not believe the loss of any single purchaser would materially impact our operating results, as we have numerous options for purchasers in each of our operating regions for our crude oil, natural gas, and NGL production. Please refer to Note 1 - Summary of Significant Accounting Policies, under the heading Concentration of Credit Risk and Major Customers in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. Additionally, the inability of our co-owners to pay joint interest billings could negatively impact our cash flow and financial ability to drill and complete current and future wells. +We have entered into firm transportation contracts that require us to pay fixed sums of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of natural gas, crude oil, natural gas liquids, or water to our counterparties, our results of operations, financial position, and liquidity could be adversely affected. +As of December 31, 2016 , we were contractually committed to deliver 1,461 Bcf of natural gas, 70 MMBbl of crude oil, 13 MMBbl of natural gas liquids, and 25 MMBbl of water. These contracts expire at various dates through 2034 . We may enter into additional firm transportation agreements as the development of our resource plays expands. At the current time, we do not have enough proved developed reserves to offset these contractual liabilities, but we expect to develop reserves that will meet or exceed the commitments and therefore do not expect any material shortfalls. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, or if we further limit our capital expenditures due to further commodity price declines, the requirements to pay for quantities not delivered could have a material impact on our results of operations, financial position, and liquidity. +Future crude oil, natural gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our crude oil and natural gas properties. All property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending the determination of whether proved reserves have been discovered. If commercial quantities of hydrocarbons are not discovered with an exploratory well, the costs of drilling the well are expensed. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net cash flows, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Unproved properties are evaluated at the lower of cost or fair market value. We incurred impairment of proved properties expense and impairment of unproved properties expense totaling $354.6 million and $80.4 million , respectively, during 2016 , $468.7 million and $78.6 million , respectively, during 2015 , and $84.5 million and $75.6 million , respectively, during 2014 . We also incurred impairment of other property, plant, and equipment expense totaling $49.4 million during 2015. Commodity prices have declined in recent years starting in late 2014. If the prices of crude oil, natural gas, or NGLs continue to remain depressed or decline further, or we have unsuccessful exploration efforts, it could cause additional proved and/or unproved property impairments in the future. +We review the carrying values of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and natural gas properties held for use cannot be reversed at a later date, even if crude oil, natural gas, or NGL prices increase. +36 +Lower crude oil, natural gas, or NGL prices could limit our ability to borrow under our Credit Agreement. +Our Credit Agreement has a current commitment amount of $1.17 billion , subject to a borrowing base that the lenders redetermine semi-annually based on the bank group’s assessment of the value of our proved reserves, which in turn is impacted by crude oil, natural gas, and NGL prices. The borrowing base under our Credit Agreement is $1.17 billion , down from $2.0 billion at December 31, 2015. This reduction was primarily a result of the sale of our Raven/Bear Den assets in the fourth quarter of 2016, non-core asset sales in the third quarter of 2016, as well as adjustments consistent with lower commodity prices. We expect a further reduction to our borrowing base during the next semi-annual redetermination scheduled for April 1, 2017 , as a result of the anticipated sale of our outside-operated Eagle Ford shale assets, as well as the decrease in our proved reserves at December 31, 2016. Divestitures of additional properties, incurrence of additional debt, or a further decline in commodity prices could limit our borrowing base and reduce the amount we can borrow under our Credit Agreement. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2016 , we had $172.5 million in aggregate principal amount of long-term senior unsecured convertible debt outstanding relating to our 1.50% Senior Convertible Notes due July 1, 2021 (“Senior Convertible Notes”) that we issued on August 12, 2016 . As of December 31, 2016 , we had $347.0 million of long-term senior unsecured debt outstanding relating to our 6.50% Senior Notes due 2021 (“2021 Notes”) that we issued on November 8, 2011; $561.8 million of long-term senior unsecured debt outstanding relating to our 6.125% Senior Notes due 2022 (“2022 Notes”) that we issued on November 17, 2014 ; $395.0 million of long-term senior unsecured debt outstanding relating to our 6.50% Senior Notes due 2023 (“2023 Notes”) that we issued on June 29, 2012; $500.0 million of long-term senior unsecured debt outstanding relating to our 5.0% Senior Notes due 2024 (“2024 Notes”) that we issued on May 20, 2013; $500.0 million of long-term senior unsecured debt outstanding relating to our 5.625% Senior Notes due 2025 (“2025 Notes”) that we issued on May 21, 2015 ; and $500.0 million of long-term senior unsecured debt outstanding relating to our 6.75% Senior Notes due 2026 (“2026 Notes”) that we issued on September 12, 2016 (collectively, the 2021 Notes, 2022 Notes, 2023 Notes, 2024 Notes, 2025 Notes, and 2026 Notes are referred to as our “Senior Notes”); and no outstanding borrowings under our secured credit facility. We had one outstanding letter of credit in the aggregate amount of $200,000 (which reduces the amount available for borrowing under the facility on a dollar-for-dollar basis), resulting in $1.2 billion of available borrowing capacity under our Credit Agreement, assuming the borrowing conditions will be met. Our long-term debt represented 54 percent of our total book capitalization as of December 31, 2016 . +Our indebtedness could have important consequences for our operations, including: +• +making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• +requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to productive investments; +• +limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• +placing us at a competitive disadvantage compared to our competitors with less debt; and +• +making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +Our ability to make payments on our debt, refinance our debt, and fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control. If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our Credit Agreement or from other sources, we might not be able to service our debt or fund our other liquidity needs. If we are unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our Credit Agreement and any future credit agreements, may prohibit us from pursuing any of these +37 +alternatives. Further, changes in the credit ratings of our debt may negatively affect the cost, terms, conditions, and availability of future financing. +Our debt agreements, including the Credit Agreement and the indentures governing our Senior Convertible Notes and our Senior Notes, permit us to incur additional debt in the future, subject to compliance with restrictive covenants under those agreements. In addition, entities we may acquire in the future could have significant amounts of debt outstanding that we could be required to assume, and in some cases accelerate repayment thereof, in connection with the acquisition, or we may incur our own significant indebtedness to consummate an acquisition. +As discussed above, our Credit Agreement is subject to periodic borrowing base redeterminations. We could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate renewals of our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our ability to borrow under our Credit Agreement is subject to compliance with certain financial covenants. Financial covenants under the Credit Agreement require, as of the last day of each of the Company’s fiscal quarters, our (a) ratio of senior secured debt to 12-month trailing adjusted EBITDAX to be not more than 2.75 to 1.0; (b) adjusted current ratio to be not less than 1.0 to 1.0; and (c) ratio of 12-month trailing adjusted EBITDAX to interest expense to be not less than 2.0 to 1.0. Our Credit Agreement also requires us to comply with certain financial covenants, including requirements that we maintain certain levels of stockholders’ equity and limit our annual cash dividends to no more than $50.0 million . These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. +The respective indentures governing the Senior Notes and Senior Convertible Notes also contain covenants that, among other things, limit our ability and the ability of our subsidiaries to: +• +incur additional debt; +• +make certain dividends or pay dividends or distributions on our capital stock or purchase, redeem, or retire capital stock; +• +sell assets, including capital stock of our subsidiaries; +• +restrict dividends or other payments of our subsidiaries; +• +create liens that secure debt; +• +enter into transactions with affiliates; and +• +merge or consolidate with another company. +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +38 +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of crude oil, natural gas and associated liquids, or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occurs, we could sustain substantial losses. +Furthermore, if we experience any of the problems with well stimulation and completion activities referenced above, our ability to explore for and produce crude oil, natural gas, or NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shutdown, abandon, or relocate drilling operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling and disposal of materials, including solid and hazardous wastes and petroleum hydrocarbons. We may incur joint and several, strict liability under applicable United States federal and state environmental laws in connection with releases of petroleum hydrocarbons and other hazardous substances at, on, under or from our leased or owned properties, some of which have been used for natural gas and oil exploration and production activities for a number of years, often by third parties not under our control. For our outside-operated properties, we are dependent on the operator for operational and regulatory compliance, and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or therefrom could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including the CERCLA or the Superfund law, the RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under any implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury or property damage, including induced seismicity damage, allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer a material loss. +Our operations are subject to complex laws and regulations, including environmental regulations that result in substantial costs and other risks. +Federal, state, tribal, and local authorities extensively regulate the oil and natural gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing or marketing of crude oil, natural gas, and NGL production. Noncompliance with statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +39 +Governmental authorities regulate various aspects of drilling for and the production of crude oil, natural gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in crude oil and natural gas properties, rights-of-way and easements, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, and restoration standards, and oil and gas operations. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Federal authorities also may require any of our ongoing or planned operations on federal leases to be delayed, suspended, or terminated. Any such delay, suspension, or termination could have a materially adverse effect on our operations. +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, tribal and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate in, could result in material costs or claims with respect to properties we own or have owned. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, and tribal environmental laws for noise emissions and for discharges of crude oil, natural gas, and associated liquids or other pollutants into the air, soil, surface water, or groundwater. We could be required to spend substantial amounts on investigations, litigation, and remediation for these emissions and discharges and other compliance issues. Any unpermitted release of petroleum or other pollutants from our operations could result not only in cleanup costs, but also natural resources, real or personal property and other damages and civil and criminal liabilities. The listing of additional wildlife or plant species as federally endangered or threatened could result in limitations on exploration and production activities in certain locations. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a materially adverse effect on us. +Seasonal weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Operations in certain of our regions, such as our Rocky Mountain and Permian regions, are adversely affected by seasonal weather conditions and lease stipulations designed to protect various wildlife or plant species. In certain areas on federal lands, drilling and other oil and natural gas activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs, oil field equipment, services, supplies and qualified personnel, which may lead to periodic shortages. Wildlife seasonal restrictions may limit access to federal leases or across federal lands. Possible restrictions may include seasonal restrictions in greater sage-grouse habitat during breeding and nesting seasons, within a certain distance of active raptor nests during fledging, and in big game winter or parturition ranges during winter or calving seasons. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Hydraulic fracturing is a common practice in the oil and gas industry used to stimulate the production of oil, natural gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and natural gas properties, including our unconventional resource plays in the Wolfcamp and Spraberry shale intervals in the Midland Basin, the Eagle Ford shale of south Texas, and the Bakken/Three Forks formations in North Dakota. Hydraulic fracturing involves injecting water, sand and certain chemicals under pressure to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and natural gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities, as outlined below. +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the SDWA. The EPA has published an interpretive memorandum and permitting guidance related to regulation of fracturing fluids using this regulatory authority. In June 2016, the EPA issued regulations under the Federal Clean Water Act establishing federal pre-treatment standards for wastewater generated during the hydraulic fracturing process in the Federal Register. If adopted, the new pre-treatment rules will require shale gas operations to pre-treat wastewater before transferring it to publicly-owned +40 +treatment facilities. Under a recent settlement, the EPA will decide by March 2019 whether to initiate rulemaking governing the disposal of wastewater from oil and gas development. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states in which we operate, including Texas and Wyoming, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, several municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Several federal governmental agencies are actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. A number of federal agencies are analyzing, or have been requested to review, a variety of environmental issues associated with hydraulic fracturing. In December 2016, the EPA issued a final assessment of potential impacts to drinking water resources from hydraulic fracturing. The EPA’s inspector general released a report on July 16, 2015 recommending increased EPA oversight of permit issuances as well as the chemicals used in hydraulic fracturing. The United States Department of Energy is also actively involved in research on hydraulic fracturing practices, including groundwater protection. +On March 26, 2015, the Bureau of Land Management (“BLM”) published a final rule governing hydraulic fracturing on federal and Indian lands, including private surface lands with underlying federal minerals. The rule was scheduled to become effective on June 24, 2015, but was temporarily stayed by a federal court. The rule requires public disclosure of chemicals used in hydraulic fracturing on federal and Indian lands, confirmation that wells used in hydraulic fracturing operations meet certain construction standards, development of appropriate plans for managing flowback water that returns to the surface, heightened standards for interim storage of recovered waste fluids, and submission of detailed information to the BLM regarding the geology, depth and location of pre-existing wells. Although several states, tribes, and industry groups filed several pending lawsuits challenging the rule and the BLM’s authority to regulate hydraulic fracturing, the outcome of this litigation is uncertain. If the rule becomes effective, we expect to incur additional costs to comply with such requirements that may be significant in nature, and we could experience delays or even curtailment in the pursuit of hydraulic fracturing activities in certain wells on federal and Indian lands. The rule could also affect drilling units that include both private and federal mineral resources. +Legislation has been introduced before Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the hydraulic fracturing process. If hydraulic fracturing becomes regulated at the federal level, our fracturing activities could become subject to additional permit or disclosure requirements, associated permitting delays, operational restrictions, litigation risk, and potential cost increases. Additionally, certain members of Congress have called upon the United States Government Accountability Office to investigate how hydraulic fracturing might adversely affect water resources, the SEC to investigate the natural gas industry and any possible misleading of investors or the public regarding the economic feasibility of pursuing natural gas deposits in shales by means of hydraulic fracturing, and the United States Energy Information Administration to provide a better understanding of that agency’s estimates regarding natural gas reserves, including reserves from shale formations, as well as uncertainties associated with those estimates. The United States Geological Survey Offices of Energy Resources Program, Water Resources and Natural Hazards and Environmental Health Offices also have ongoing research projects on hydraulic fracturing. These ongoing studies, depending on their course and outcomes, could spur initiatives to further regulate hydraulic fracturing under the SDWA or other regulatory processes. +Further, on August 16, 2012, the EPA issued final rules subjecting all new and modified oil and gas operations (production, processing, transmission, storage, and distribution) to regulation under the New Source Performance Standards (“NSPS”) and all existing and new operations to the National Emission Standards for Hazardous Air Pollutants (“NESHAP”) programs. The EPA rules also include NSPS standards for completions of hydraulically fractured gas wells. These standards require the use of reduced emission completion (“REC”) techniques developed in the EPA’s Natural Gas STAR program along +41 +with the pit flaring of gas not sent to the gathering line beginning in January 2015. The standards are applicable to newly drilled and fractured wells as well as existing wells that are refractured. Further, the regulations under NESHAP include maximum achievable control technology (“MACT”) standards for those glycol dehydrators and certain storage vessels at major sources of hazardous air pollutants not currently subject to MACT standards. These rules will require additional control equipment, changes to procedure, and extensive monitoring and reporting. The EPA stated in January 2013, however, that it intends to reconsider portions of the final rule. On September 23, 2013, the EPA published new standards for storage tanks subject to the NSPS. In December 2014, the EPA finalized additional updates to the 2012 NSPS. The amendments clarified stages for flowback and the point at which green completion equipment is required and updated requirements for storage tanks and leak detection requirements for processing plants. In October 2016, the EPA denied the remaining petitions for reconsideration with respect to the issues not otherwise addressed in the previous reconsideration actions. As part of the EPA’s strategy to reduce methane and ozone-forming VOC emissions from the oil and gas industry, on May 12, 2016, the EPA issued final regulations that amend and expand the 2012 regulations by setting emission limits for greenhouse gases, or GHGs, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of greenhouse gases in the form of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The final regulation requires, among other things, GHG and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and natural gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. Both the 2012 and 2016 rules are the subjects of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia. In a related action, in November of 2016, the EPA issued oil and gas companies a final information request as part of an effort to develop standards under the Clean Air Act NSPS provisions for methane and other emissions from existing sources in the oil and natural gas industry. The request requires companies to provide the EPA with a wide range of information related to operations, equipment, and emissions controls within 180 days of receipt. It is unclear whether the Trump Administration will proceed with developing an existing source rule based on the information collected through this request. +In October 2015, the EPA revised and lowered the ambient air quality standard for ozone in the U.S. under the Clean Air Act, from 75 parts per billion to 70 parts per billion, which is likely to result in more, and expanded, ozone non-attainment areas, which in turn will require states to adopt implementation plans to reduce emissions of ozone-forming pollutants, like VOCs and nitrogen oxides, that are emitted from, among others, the oil and gas industry. In October 2016, the EPA finalized Control Techniques Guidelines for VOC emissions from existing oil and natural gas equipment and processes in moderate ozone non-attainment areas. These Control Techniques Guidelines provide recommendations for states and local air agencies to consider when determining what emissions requirements apply to sources in the non-attainment areas. On May 12, 2016, the EPA also issued a final rule named the “Source Determination Rule” that was issued to clarify when multiple pieces of oil and gas equipment and activities must be aggregated as a single source for determining whether major source permitting programs apply. This action can expand the permitting and related control requirements to sources that were not previously subject to permitting requirements. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. Over the past year, several court cases have addressed aspects of hydraulic fracturing. In a case that could delay operations on public lands, a court in California held that the BLM did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. Courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing, including damages from induced seismicity, could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for, and production of, oil, natural gas, and associated liquids, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional federal, state, or local laws, or the implementation of new regulations, regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +42 +Requirements to reduce gas flaring could have an adverse effect on our operations. +Wells in the Bakken and Three Forks formations in North Dakota, where we have significant operations, produce natural gas as well as crude oil. Constraints in the current gas gathering and processing network in certain areas have resulted in some of that natural gas being flared instead of gathered, processed and sold. In June 2014, the North Dakota Industrial Commission, North Dakota’s chief energy regulator, adopted a policy to reduce the volume of natural gas flared from oil wells in the Bakken and Three Forks formations. The Commission is requiring operators to develop gas capture plans that describe how much natural gas is expected to be produced, how it will be delivered to a processor and where it will be processed. Production caps or penalties will be imposed on certain wells that cannot meet the capture goals. In November 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands. The regulations prohibit venting gas except in limited situations and limit the flaring of gas. These capture requirements, and any similar future obligations in North Dakota or our other locations, may increase our operational costs or restrict our production, which could materially and adversely affect our financial condition, results of operations and cash flows. +Our ability to produce crude oil, natural gas, and associated liquids economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the water we use at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of crude oil, natural gas, and NGLs requires the use and disposal of significant quantities of water. +Our inability to secure sufficient amounts of water, or to dispose of or recycle the water used in our operations, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of crude oil, natural gas, and NGLs. +Compliance with environmental regulations and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +Certain United States federal income tax deductions currently available with respect to oil and natural gas exploration and production could be eliminated or modified as a result of future legislation . +Budget proposals in recent years, if enacted into law, would have eliminated certain key United States federal income tax incentives available to oil and natural gas exploration and production companies. The proposals included: +• +the elimination of current deductions for intangible drilling and development costs; +• +the repeal of the percentage depletion allowance for oil and natural gas properties; +• +the elimination of the deduction for certain domestic production activities; and +• +an extension of the amortization period for certain geological and geophysical expenditures. +Congress is currently considering tax reform proposals which could have a significant impact on business taxes and it could be that none of these or similar changes will be enacted. The passage of legislation eliminating or postponing certain tax deductions currently available with respect to oil and natural gas exploration and development could have an adverse effect on our financial position, results of operations and cash flows. +43 +Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for crude oil, natural gas, and NGLs. +In December 2009, the EPA made a finding that emissions of carbon dioxide, methane, and other “greenhouse gases” endanger public health and the environment because emissions of such gases contribute to warming of the earth’s atmosphere and other climatic changes. Based on this finding, the EPA adopted and implemented a comprehensive suite of regulations to restrict and otherwise regulate emissions of greenhouse gases under existing provisions of the CAA. In particular, the EPA has adopted two sets of rules regulating greenhouse gas emissions under the CAA. One rule requires a reduction in greenhouse gas emissions from motor vehicles, and the other regulates permitting and greenhouse gas emissions from certain large stationary sources. These EPA regulatory actions have been challenged by various industry groups, initially in the D.C. Circuit, which in 2012 ruled in favor of the EPA in all respects. However, in June 2014, the United States Supreme Court reversed the D.C. Circuit and struck down the EPA’s greenhouse gas permitting rules to the extent they impose a requirement to obtain a permit based solely on emissions of greenhouse gases. The EPA proposed a rule in 2016 to comply with the U.S. Supreme Court’s ruling by limiting the requirement to obtain permits addressing emissions of greenhouse gases to large sources of other air pollutants, such as volatile organic compounds or nitrogen oxides, which also emit 100,000 tons per year or more of CO 2 (or modifications of these sources that result in an emissions increase of 75,000 tons per year or more of CO 2 e). If finalized, large sources of air pollutants other than greenhouse gases will be required to implement the best available capture technology for greenhouse gases. The EPA has also adopted reporting rules for greenhouse gas emissions from specified greenhouse gas emission sources in the United States, including petroleum refineries as well as certain onshore oil and natural gas extraction and production facilities. +Several other kinds of cases on greenhouse gases have been heard by the courts in recent years. While courts have generally declined to assign direct liability for climate change to large sources of greenhouse gas emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant greenhouse gas emissions, and new claims for damages and increased government scrutiny will likely continue. Such cases often seek to challenge air emissions permits that greenhouse gas emitters apply for, seek to force emitters to reduce their emissions, or seek damages for alleged climate change impacts to the environment, people, and property. Any court rulings, laws or regulations that restrict or require reduced emissions of greenhouse gases could lead to increased operating and compliance costs, and could have an adverse effect on demand for the oil and natural gas that we produce. +The United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases, and almost one-half of the states have already taken measures to reduce emissions of greenhouse gases, primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas “cap and trade” programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. Recently, the Congressional Budget Office provided Congress with a study on the potential effects on the United States economy of a tax on greenhouse gas emissions. While “carbon tax” legislation has been introduced in the Senate, the prospects for passage of such legislation are highly uncertain at this time. +On June 25, 2013, President Obama outlined plans to address climate change through a variety of executive actions, including reduction of methane emissions from oil and gas production and processing operations as well as pipelines and coal mines (the “Climate Plan”). The President’s Climate Plan, along with recent regulatory initiatives and ongoing litigation filed by states and environmental groups, signal a new focus on methane emissions, which could pose substantial regulatory risk to our operations. In March 2014, President Obama released a strategy to reduce methane emissions, which directed the EPA to consider additional regulations to reduce methane emissions from the oil and gas sector. On January 14, 2015, the Obama Administration announced additional steps to reduce methane emissions from the oil and gas sector by 40 to 45 percent by 2025. These actions include a commitment from the EPA to issue new source performance standards for methane emissions from the oil and gas sector. Pursuant to this commitment, in October 2016, the EPA finalized emission standards for methane and VOC for sources in the oil and gas sector constructed or modified after September 1, 2015. See Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays for more information on this rule and steps the EPA has taken to address existing sources. On November 16, 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands, as part of the Climate Plan. The regulations, named the Methane and Waste Prevention Rule, are intended to reduce the waste of natural gas from flaring, venting, and leaks by oil and gas production. The rule includes requirements that prohibit venting gas except in limited circumstances and limit flaring of gas and includes requirements for leak detection and +44 +repair. The rule also increases royalty payments for “waste” gas that is released in contravention of the rule requirements. The rule, which was immediately challenged in federal district court, faces an uncertain future in the Trump Administration and is a potential target of rescission through the Congressional Review Act. The focus on legislating methane also could eventually result in: +• requirements for methane emission reductions from existing oil and gas equipment; +• increased scrutiny for sources emitting high levels of methane, including during permitting processes; +• analysis, regulation and reduction of methane emissions as a requirement for project approval; and +• actions taken by one agency for a specific industry establishing precedents for other agencies and +industry sectors. +In relation to the Climate Plan, both assumed Global Warming Potential (“GWP”) and assumed social costs associated with methane and other greenhouse gas emissions have been finalized, including a 20% increase in the GWP of methane. Changes to these measurement tools could adversely impact permitting requirements, application of agencies’ existing regulations for source categories with high methane emissions, and determinations of whether a source qualifies for regulation under the CAA. The continued use of the social cost of carbon under the Trump Administration is uncertain. +Finally, it should be noted that some scientists have predicted that increasing concentrations of greenhouse gases in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. Some scientists refute these predictions. However, President Obama’s Climate Plan emphasizes preparation for such events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements. +Our ability to sell crude oil, natural gas, and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines and other transportation systems owned or operated by others or by other interruptions. +The marketability of our crude oil, natural gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay or discontinuance of development plans for our properties, or lower price realizations. Although we have some contractual control over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of crude oil, natural gas, and NGL production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, and transport crude oil, natural gas, and NGLs. +In particular, if drilling in the Midland Basin continues to be successful, the amount of crude oil, natural gas, and NGLs being produced by us and others could exceed the capacity of, and result in strains on, the various gathering and transportation systems, pipelines, processing facilities, and other infrastructure available in that area. It will be necessary for additional infrastructure, pipelines, gathering and transportation systems and processing facilities to be expanded, built or developed to accommodate anticipated production from these areas. Because of the current commodity price environment, certain processing, pipeline, and other gathering or transportation projects that might be, or are being, considered for these areas may not be developed timely or at all due to lack of financing or other constraints, including permitting constraints. Capital and other constraints could also limit our ability to build or access intrastate gathering and transportation systems necessary to transport our production to interstate pipelines or other points of sale or delivery. In such event, we might have to delay or discontinue development activities or shut in our wells to wait for sufficient infrastructure development or capacity +45 +expansion and/or sell production at significantly lower prices, which would adversely affect our results of operations and cash flows. In addition, the operations of the third parties on whom we rely for gathering and transportation services are subject to complex and stringent laws and regulations, which require obtaining and maintaining numerous permits, approvals, and certifications from various federal, state, tribal and local government authorities. These third parties may incur substantial costs in order to comply with existing laws and regulations. If existing laws and regulations governing such third-party services are revised or reinterpreted, or if new laws and regulations become applicable to their operations, these changes may affect the amounts we pay for such services. Similarly, a failure to comply with such laws and regulations by the third parties on whom we rely could have a material adverse effect on our business, financial condition and results of operations. +A portion of our production in any region may be interrupted, or shut in, from time to time for numerous reasons, including as a result of weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market conditions. If a substantial amount of our production is interrupted at the same time, it could temporarily and adversely affect our cash flows and results of operations. +New technologies may cause our current exploration and drilling methods to become obsolete. +The oil and gas industry is subject to rapid and significant advancements in technology, including the introduction of new products and services that use new technologies. As competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, competitors may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. One or more of the technologies we currently use or implement in the future may become obsolete. We cannot be certain we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. If we are unable to maintain technological advancements consistent with industry standards, our operations and financial condition may be adversely affected. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As a crude oil, natural gas, and NGLs producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +Cybersecurity attacks in particular are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data. These events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. +The threat of terrorism and the impact of military and other action have caused instability in world financial markets and could lead to increased volatility in prices for crude oil, natural gas, and NGLs, all of which could adversely affect the markets for our operations. Energy assets might be specific targets of terrorist attacks. These developments have subjected our operations to increased risk and, depending on their occurrence and ultimate magnitude, could have a material adverse effect on our business. +46 +Risks Related to Our Common Stock +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2016 , to February 15, 2017 , the low and high intraday trading prices per share of our common stock as reported by the New York Stock Exchange ranged from a low of $6.99 per share in February 2016 to a high of $43.09 per share in October 2016 . We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include: +• +changes in crude oil, natural gas, or NGL prices; +• +variations in drilling, recompletion, and operating activity; +• +changes in financial estimates by securities analysts; +• +changes in market valuations of comparable companies; +• +additions or departures of key personnel; +• +future sales of our common stock; and +• +changes in the national and global economic outlook. +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +Shares eligible for future sale may cause the market price of our common stock to drop significantly, even if our business is doing well. +The potential for sales of substantial amounts of our common stock in the public market may have a materially adverse effect on our stock price. As of February 15, 2017 , 97,871,754 shares of our common stock were freely tradable without substantial restriction or the requirement of future registration under the Securities Act. In addition, (a) approximately 13.4 million shares issued pursuant to the QStar Acquisition were subject to a Lock-Up and Registration Rights Agreement that prohibits sale of such stock until no earlier than the 90th day after issuance; (b) restricted stock units (“RSUs”) providing for the issuance of up to a total of 591,380 shares of our common stock were outstanding; and (c) 865,598 performance share units (“PSUs”) were outstanding. The PSUs represent the right to receive, upon settlement of the PSUs after the completion of a three-year performance period, a number of shares of our common stock that may be from zero to two times the number of PSUs granted, depending on the extent to which the underlying performance criteria have been achieved and the extent to which the PSUs have vested. As of February 15, 2017 , there were 111,257,703 shares of our common stock outstanding. +47 +We may not always pay dividends on our common stock. +Payment of future dividends remains at the discretion of our Board of Directors, and will continue to depend on our earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to a covenant in our Credit Agreement limiting our annual cash dividends to no more than $50.0 million , and to covenants in the indentures for our Senior Notes and Senior Convertible Notes that limit our ability to pay dividends beyond a certain amount. Our Board of Directors may determine in the future to reduce the current semi-annual dividend rate of $0.05 per share, or discontinue the payment of dividends altogether. +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Exchange Act. +ITEM 3. LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our business and operations in the normal course of business. As of the filing date of this report, no legal proceedings are pending against us that we believe individually or collectively could have a materially adverse effect upon our financial condition, results of operations or cash flows. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +48 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” The following table presents the range of high and low intraday sales prices per share for the indicated quarterly periods in 2016 and 2015 , as reported by the New York Stock Exchange: +Quarter Ended +High +Low +December 31, 2016 +$ +43.09 +$ +30.25 +September 30, 2016 +$ +40.39 +$ +23.58 +June 30, 2016 +$ +35.60 +$ +17.04 +March 31, 2016 +$ +20.65 +$ +6.99 +December 31, 2015 +$ +42.23 +$ +18.06 +September 30, 2015 +$ +45.98 +$ +18.21 +June 30, 2015 +$ +60.28 +$ +43.70 +March 31, 2015 +$ +53.31 +$ +31.01 +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2011 , and ending on December 31, 2016 , with the cumulative total returns of the Dow Jones U.S. Exploration and Production Index, and the Standard & Poor’s 500 Stock Index. +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +Holders. As of February 15, 2017 , the number of record holders of our common stock was 85. Based upon inquiry, management believes that the number of beneficial owners of our common stock is approximately 25,700. +49 +Dividends. We have paid cash dividends to our stockholders every year since 1940. Annual dividends of $0.05 per share were paid in each of the years 1998 through 2004. Annual dividends of $0.10 per share were paid in each of the years 2005 through 2016 . We expect our practice of paying dividends on our common stock to continue, although the payment and amount of future dividends will continue to depend on our earnings, cash flow, capital requirements, financial condition, and other factors, including the discretion of our Board of Directors. In addition, the payment of dividends is subject to covenants in our Credit Agreement that limit our annual dividend payment to no more than $50.0 million per year. We are also subject to certain covenants under the indentures governing our Senior Notes and Senior Convertible Notes that restrict certain payments, including dividends; however, the first $6.5 million of dividends paid each year are not restricted by this covenant. Based on our current performance, we do not anticipate that these covenants will restrict future annual dividend payments in amounts not to exceed $0.10 per share of common stock. Dividends are currently paid on a semi-annual basis. Dividends paid totaled $7.8 million , $6.8 million , and $6.7 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers. The following table provides information about purchases made by us and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and year ended December 31, 2016 , of shares of our common stock, which is the sole class of equity securities registered by us pursuant to Section 12 of the Exchange Act. +ISSUER PURCHASES OF EQUITY SECURITIES +Total Number of Shares Purchased (1) +Weighted Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program +Maximum Number of Shares that May Yet be Purchased Under the Program (2) +January 1, 2016 - +March 31, 2016 +176 +$ +14.87 +— +3,072,184 +April 1, 2016 - +June 30, 2016 +1,053 +$ +28.99 +— +3,072,184 +July 1, 2016 - +September 30, 2016 +85,418 +$ +27.02 +— +3,072,184 +October 1, 2016 - +October 31, 2016 +343 +$ +39.37 +— +3,072,184 +November 1, 2016 - +November 30, 2016 +— +$ +— +— +3,072,184 +December 1, 2016 - +December 31, 2016 +— +$ +— +— +3,072,184 +Total October 1, 2016 - +December 31, 2016 +343 +$ +39.37 +— +3,072,184 +Total +86,990 +$ +27.07 +— +3,072,184 +____________________________________________ +(1) +All shares purchased by us in 2016 offset tax withholding obligations that occurred upon the delivery of outstanding shares underlying RSUs and PSUs delivered under the terms of grants under the Equity Incentive Compensation Plan (“Equity Plan”). +(2) +In July 2006, our Board of Directors approved an increase in the number of shares that may be repurchased under the original August 1998 authorization to 6,000,000 as of the effective date of the resolution. Accordingly, as of the date of this filing, subject to the approval of our Board of Directors, we may repurchase up to 3,072,184 shares of common stock on a prospective basis. The shares may be repurchased from time to time in open market transactions or privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes and Senior Convertible Notes, and compliance with securities laws. Stock repurchases may be funded with existing cash balances, internal cash flow, or borrowings under our Credit Agreement. The stock repurchase program may be suspended or discontinued at any time. Please refer to Dividends above for a description of our dividend limitations. +50 +ITEM 6. SELECTED FINANCIAL DATA +The following table sets forth selected supplemental financial and operating data as of the dates and periods indicated. The financial data for each of the five years presented were derived from our consolidated financial statements. The following data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report, which includes a discussion of factors materially affecting the comparability of the information presented, and in conjunction with our consolidated financial statements included in this report. +Years Ended December 31, +2016 +2015 +2014 +2013 +2012 +(in millions, except per share data) +Statement of Operations Data: +Total operating revenues and other income +$ +1,217.5 +$ +1,557.0 +$ +2,522.3 +$ +2,293.4 +$ +1,505.1 +Net income (loss) +$ +(757.7 +) +$ +(447.7 +) +$ +666.1 +$ +170.9 +$ +(54.2 +) +Net income (loss) per share: +Basic +$ +(9.90 +) +$ +(6.61 +) +$ +9.91 +$ +2.57 +$ +(0.83 +) +Diluted +$ +(9.90 +) +$ +(6.61 +) +$ +9.79 +$ +2.51 +$ +(0.83 +) +Balance Sheet Data (at end of period): +Total assets +$ +6,393.5 +$ +5,621.6 +$ +6,483.1 +$ +4,678.1 +$ +4,179.0 +Long-term debt: +Revolving credit facility +$ +— +$ +202.0 +$ +166.0 +$ +— +$ +340.0 +Senior Notes, net of unamortized deferred financing costs +$ +2,766.7 +$ +2,316.0 +$ +2,166.4 +$ +1,572.9 +$ +1,079.5 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +$ +130.9 +$ +— +$ +— +$ +— +$ +— +Cash dividends declared and paid per common share +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +51 +Supplemental Selected Financial and Operations Data +For the Years Ended December 31, +2016 +2015 +2014 +2013 +2012 +Balance Sheet Data (in millions): +Total working capital (deficit) +$ +(190.5 +) +$ +216.5 +$ +(39.6 +) +$ +8.4 +$ +(201.0 +) +Total stockholders’ equity +$ +2,497.1 +$ +1,852.4 +$ +2,286.7 +$ +1,606.8 +$ +1,414.5 +Weighted-average common shares outstanding (in thousands): +Basic +76,568 +67,723 +67,230 +66,615 +65,138 +Diluted +76,568 +67,723 +68,044 +67,998 +65,138 +Reserves: +Oil (MMBbl) +104.9 +145.3 +169.7 +126.6 +92.2 +Gas (Bcf) +1,111.1 +1,264.0 +1,466.5 +1,189.3 +833.4 +NGLs (MMBbl) +105.7 +115.4 +133.5 +103.9 +62.3 +MMBOE +395.8 +471.3 +547.7 +428.7 +293.4 +Production and Operations (in millions): +Oil, gas, and NGL production revenue +$ +1,178.4 +$ +1,499.9 +$ +2,481.5 +$ +2,199.6 +$ +1,473.9 +Oil, gas, and NGL production expense +$ +597.6 +$ +723.6 +$ +715.9 +$ +597.0 +$ +391.9 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +790.7 +$ +921.0 +$ +767.5 +$ +822.9 +$ +727.9 +General and administrative +$ +126.4 +$ +157.7 +$ +167.1 +$ +149.6 +$ +119.8 +Production Volumes: +Oil (MMBbl) +16.6 +19.2 +16.7 +13.9 +10.4 +Gas (Bcf) +146.9 +173.6 +152.9 +149.3 +120.0 +NGLs (MMBbl) +14.2 +16.1 +13.0 +9.5 +6.1 +MMBOE +55.3 +64.2 +55.1 +48.3 +36.5 +Realized price, before the effect of derivative settlements: +Oil (per Bbl) +$ +36.85 +$ +41.49 +$ +80.97 +$ +91.19 +$ +85.45 +Gas (per Mcf) +$ +2.30 +$ +2.57 +$ +4.58 +$ +3.93 +$ +2.98 +NGLs (per Bbl) +$ +16.16 +$ +15.92 +$ +33.34 +$ +35.95 +$ +37.61 +Expense per BOE: +Lease operating expense +$ +3.51 +$ +3.73 +$ +4.28 +$ +4.49 +$ +4.54 +Transportation costs +$ +6.16 +$ +6.02 +$ +6.11 +$ +5.34 +$ +3.81 +Production taxes +$ +0.94 +$ +1.13 +$ +2.13 +$ +2.19 +$ +2.00 +Ad valorem tax expense +$ +0.21 +$ +0.39 +$ +0.46 +$ +0.33 +$ +0.39 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +14.30 +$ +14.34 +$ +13.92 +$ +17.02 +$ +19.95 +General and administrative +$ +2.29 +$ +2.46 +$ +3.03 +$ +3.09 +$ +3.28 +Statement of Cash Flow Data (in millions): +Provided by operating activities +$ +552.8 +$ +978.4 +$ +1,456.6 +$ +1,338.5 +$ +922.0 +Used in investing activities +$ +(1,870.6 +) +$ +(1,144.6 +) +$ +(2,478.7 +) +$ +(1,192.9 +) +$ +(1,457.3 +) +Provided by financing activities +$ +1,327.2 +$ +166.2 +$ +740.0 +$ +130.7 +$ +422.1 +52 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +This discussion includes forward-looking statements. Please refer to Cautionary Information about Forward-Looking Statements in Part I, Items 1 and 2 of this report for important information about these types of statements. +Overview of the Company +General Overview +We are an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in onshore North America. We currently have development positions in the Midland Basin, Eagle Ford shale, and Bakken/Three Forks resource plays. Our strategic objective is to become a premier operator of top tier assets. During 2016, we cored up our portfolio through several acquisitions in the Midland Basin where we expanded our footprint to approximately 82,550 net acres. We were able to accomplish this through the divestiture of non-core assets and through successful financing transactions. Our Midland Basin assets, as well as our operated Eagle Ford shale assets, have high operating margins and significant opportunities for additional economic investment. We seek to maximize the value of our assets through industry leading technology application and outstanding operational execution. Our portfolio is comprised of properties with prospective drilling opportunities and unconventional resource prospects, which we believe provide for long-term production and reserves growth. We focus on achieving high full-cycle economic returns on our investments and maintaining a simple, strong balance sheet. +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. We sell the majority of our gas under contracts using first-of-the-month index pricing, which means gas produced in a given month is sold at the first-of-the-month price regardless of the spot price on the day the gas is produced. For assets where high BTU gas is sold at the wellhead, we also receive additional value for the higher energy content contained in the gas stream. Our NGL production is generally sold using contracts paying us a monthly average of the posted OPIS daily settlement prices, adjusted for processing, transportation, and location differentials. Our oil is sold using the calendar month average of the NYMEX WTI daily contract settlement prices, excluding weekends, during the month of production, adjusted for quality, transportation, American Petroleum Institute (“API”) gravity, and location differentials. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effects of derivative settlements, unless otherwise indicated. +53 +The following table summarizes commodity price data, as well as the effects of derivative settlements as further discussed under the caption Derivative Activity below, for the years ended December 31, 2016 , 2015 , and 2014 : +For the Years Ended December 31, +2016 +2015 +2014 +Crude Oil (per Bbl): +Average NYMEX contract monthly price +$ +43.32 +$ +48.68 +$ +93.03 +Realized price, before the effect of derivative settlements +$ +36.85 +$ +41.49 +$ +80.97 +Effect of oil derivative settlements +$ +14.63 +$ +18.85 +$ +1.71 +Natural Gas: +Average NYMEX monthly settle price (per MMBtu) +$ +2.46 +$ +2.61 +$ +4.35 +Realized price, before the effect of derivative settlements (per Mcf) +$ +2.30 +$ +2.57 +$ +4.58 +Effect of natural gas derivative settlements (per Mcf) (1) +$ +0.64 +$ +0.71 +$ +(0.18 +) +NGLs (per Bbl): +Average OPIS price (2) +$ +19.98 +$ +19.76 +$ +38.93 +Realized price, before the effect of derivative settlements +$ +16.16 +$ +15.92 +$ +33.34 +Effect of NGL derivative settlements +$ +(0.60 +) +$ +1.69 +$ +0.84 +____________________________________________ +(1) +Natural gas derivative settlements for the years ended December 31, 2015, and 2014, include $15.3 million and $5.6 million , respectively, of early settlements of futures contracts as a result of divesting assets in our Mid-Continent region. These early settlements increased the effect of derivative settlements by $0.09 per Mcf and $0.04 per Mcf for the years ended December 31, 2015, and 2014, respectively. +(2) +Average OPIS prices per barrel of NGL, historical or strip, are based on a product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline for all periods presented. This product mix represents the industry standard composite barrel and does not necessarily represent our product mix for NGL production. Realized prices reflect our actual product mix. +While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location, and transportation differentials for these products. +We expect future prices for oil, gas, and NGLs to continue to be volatile. In addition to supply and demand fundamentals, as a global commodity, the price of oil is affected by real or perceived geopolitical risks in all regions of the world as well as the relative strength of the U.S. dollar compared to other currencies. Oil markets continue to be unstable as a result of over-supply with global demand remaining the biggest source of uncertainty for future prices. The recent increase in oil prices is primarily attributable to the Organization of Petroleum Exporting Countries (OPEC) and non-OPEC exporting countries agreeing to cut production in 2017, although there is still uncertainty as to whether these cuts will actually occur or be sustained. Drilling activity in the U.S. has increased in recent months putting continued downward pressure on oil prices in the near term. +Natural gas pricing increased during 2016, partially as a result of demand growth from gas fired power generation and both LNG exports and exports to Mexico exceeding prior expectations. We expect prices to remain near current levels in the near term as drilling rigs in operation have increased in recent months leading to increased supply, which we expect will be offset by continued demand growth from LNG exports and exports to Mexico. We also expect prices to fluctuate with changes in demand resulting from the weather. +NGL prices have recovered in recent months due to oil and natural gas price recovery. We expect NGL prices to remain near current levels through 2017, as increased demand from export and petrochemical markets is offset by increased drilling activity. +54 +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs (same product mix as discussed under the table above) as of February 15, 2017 , and December 31, 2016 : +As of February 15, 2017 +As of December 31, 2016 +NYMEX WTI oil (per Bbl) +$ +54.53 +$ +56.01 +NYMEX Henry Hub gas (per MMBtu) +$ +3.25 +$ +3.63 +OPIS NGLs (per Bbl) +$ +27.39 +$ +27.14 +We use financial derivative instruments as part of our financial risk management program. We have a financial risk +management policy governing our use of derivatives. The amount of our production covered by derivatives is driven by the amount of debt on our balance sheet, the level of capital commitments and long-term obligations we have in place, and our ability to enter into favorable derivative commodity contracts. With our current derivative contracts, we believe we have partially reduced our exposure to volatility in commodity prices in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil prices while also setting a price floor for a portion of our production. Please refer to Note 10 - Derivative Financial Instruments in Part II, Item 8 of this report and the caption titled Commodity Price Risk in Overview of Liquidity and Capital Resources below for additional information regarding our oil, gas, and NGL derivatives. +Due to the depressed commodity price environment in recent years, and our belief that commodity prices will remain near current levels, we cored up our portfolio in 2016 through various acquisitions and divestitures. As noted below, we expect additional divestitures in 2017, proceeds from which will partially fund the development of our recently acquired Midland Basin assets, as well as pay down debt should market conditions be favorable. +Costs Incurred in Oil and Gas Producing Activities. Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended +December 31, 2016 +(in millions) +Development costs +$ +595.3 +Exploration costs +118.2 +Acquisitions +Proved properties +201.7 +Unproved properties +2,458.7 +Total, including asset retirement obligation (1) +$ +3,373.9 +____________________________________________ +(1) +Please refer to the section Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information in Part II, Item 8 of this report. +Outside of acquisition activity in the Permian region, our costs relating to exploration and development activities were incurred evenly across our core development programs in the Eagle Ford shale, Midland Basin, and Bakken/Three Forks for the year ended December 31, 2016. +Acquisition Activity: +• +On October 4, 2016 , we closed our Rock Oil Acquisition in Howard County, Texas, for an adjusted purchase price of approximately $991.0 million , subject to customary post-closing adjustments. +• +On December 21, 2016 , we closed our QStar Acquisition in Howard and Martin Counties, Texas, for an adjusted purchase price of approximately $1.6 billion , subject to customary post-closing adjustments. +These acquisitions significantly increased our footprint in the Midland Basin, with the acquired acreage having producing and prospective intervals in the Lower and Middle Spraberry and Wolfcamp A and B shale formations. +55 +In order to fund our 2016 acquisition activity and a portion of the future development of acquired assets, we divested of assets in 2016, have additional divestitures in process, and executed certain financing transactions, as discussed below. +Divestiture Activity: +• +On December 1, 2016, we completed our Raven/Bear Den asset divestiture for net divestiture proceeds of $756.2 million , subject to customary post-closing adjustments, as discussed in Note 3 – Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report. +• +During the third quarter of 2016, we closed the divestitures of certain non-core properties in southeast New Mexico and in the Williston and Powder River Basins for total net divestiture proceeds of $165.2 million , subject to customary post-closing adjustments. +• +We began marketing our outside-operated Eagle Ford shale assets during the third quarter of 2016. Subsequent to December 31, 2016, we executed a definitive sales agreement for a gross purchase price of $800 million, subject to customary purchase price adjustments, with the sale expected to close in the first quarter of 2017. +• +Subsequent to December 31, 2016, we announced our plans to sell our remaining Williston Basin assets in Divide County, North Dakota. +Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +Equity Offerings: +• +On August 12, 2016 , we issued approximately 18.4 million shares of common stock in a public offering for net proceeds of $530.9 million . +• +On December 7, 2016 , we issued an additional approximately 10.9 million shares of common stock in a public offering for net proceeds of $403.2 million . +• +On December 21, 2016 , to partially fund the QStar Acquisition, we issued to the sellers approximately 13.4 million shares of common stock valued at $437.2 million . +Please refer to Note 15 - Equity in Part II, Item 8 of this report for additional discussion. +Long-Term Debt: +• +Senior Convertible Notes . On August 12, 2016 , we issued $172.5 million in aggregate principal amount of 1.50% Senior Convertible Notes due 2021 for net proceeds of $166.6 million . In conjunction with this issuance, we paid $24.2 million for capped call transactions, which are generally expected to reduce the potential dilution and/or partially offset any cash payments required upon conversion. +• +2026 Notes . On September 12, 2016 , we issued $500.0 million in aggregate principal amount of 6.75% Senior Notes due 2026 and received net proceeds of $491.6 million . +• +Repurchased Notes . During the first quarter of 2016, we repurchased a total of $46.3 million in aggregate principal amount of certain of our Senior Notes in open market transactions for a settlement amount of $29.9 million , excluding interest, which resulted in a net gain on extinguishment of debt of approximately $15.7 million . +• +Credit Agreement . Our borrowing base and aggregate lender commitments changed throughout 2016 due to the normal redetermination process, amendments to the Credit Agreement, and significant transactions that occurred. As of December 31, 2016, our borrowing base and aggregate lender commitments under the Credit Agreement were $1.17 billion . +Please refer to Overview of Liquidity and Capital Resources below and Note 5 - Long-Term Debt in Part II, Item 8 of this report for additional discussion. +56 +2016 Operational Activity and Financial Results +Operational Activities. During 2016, we focused on coring up our portfolio to high-grade assets and build long-term inventory. Please refer to the table below summarizing our operated drilling and completion activities for the year ended December 31, 2016. We incurred capital expenditures, excluding asset acquisitions, below adjusted EBITDAX in 2016. +In our Midland Basin program, we began operating one drilling rig in early 2016 and added a second drilling rig in the second quarter of 2016, both focused on developing the Wolfcamp and Spraberry shale intervals on our Sweetie Peck property in Upton County, Texas. We closed our Rock Oil and QStar acquisitions during the fourth quarter of 2016 and added two operated rigs on the acquired acreage. During the third quarter of 2016, we sold our non-core assets in southeast New Mexico. +In our operated Eagle Ford shale program, we began 2016 operating three drilling rigs and released all three rigs during the year. In addition, we utilized one frac crew through the third quarter of 2016. In 2016, our capital was primarily spent on wells that were drilled but not completed at year-end 2015 and to meet lease obligations. +In our outside-operated Eagle Ford shale program, the operator began 2016 running one drilling rig, which was released in the first quarter of 2016 with no further drilling activity for the remainder of the year. The operator completed 69 gross (11 net) wells during 2016, all of which were completed prior to mid-year. Our outside-operated Eagle Ford shale assets, including the associated midstream assets, were held for sale as of December 31, 2016, with the sale expected to close in the first quarter of 2017. Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional information. +In our Bakken/Three Forks program, we started the year operating two drilling rigs. We released one drilling rig during the second quarter of 2016 and ran the second rig through November 2016. During the third quarter of 2016, we sold non-core Williston Basin assets, and on December 1, 2016 , we completed the divestiture of our Raven/Bear Den assets. Subsequent to December 31, 2016, we announced our plans to sell our remaining Williston Basin assets in Divide County, North Dakota with closing expected by mid-year 2017. +In our Powder River Basin program, we began 2016 operating one drilling rig and released the rig during the first quarter. We added a drilling rig during the third quarter of 2016 for activities under an acquisition and development funding agreement with a third party, under which our costs to drill and complete a specified number of initial wells are being carried by the third party. +The table below provides a summary of changes in our drilled but not completed well count and current year drilling and completion activity in our operated programs during the year ended December 31, 2016 . +Eagle Ford Shale +Midland Basin +Bakken/Three Forks +Total +Gross +Net +Gross +Net +Gross +Net +Gross +Net +Wells drilled but not completed at December 31, 2015 +76 +76 +9 +9 +47 +39 +132 +124 +Wells drilled +16 +16 +27 +25 +24 +23 +67 +64 +Wells acquired (1) +— +— +11 +11 +— +— +11 +11 +Wells completed (2) +(45 +) +(45 +) +(30 +) +(28 +) +(51 +) +(45 +) +(126 +) +(118 +) +Wells drilled but not completed at December 31, 2016 (3) +47 +47 +17 +17 +20 +17 +84 +81 +_________________________________________ +(1) +Represents in-progress wells acquired in the Rock Oil and QStar acquisitions . In all cases, the sellers initiated the drilling of the well. Of these acquired in-progress wells, we completed six gross and net wells after the closing dates and before year-end 2016. +(2) +Of the wells we completed in 2016, 11 gross (eight net) wells were divested in the fourth quarter of 2016. +(3) +Subsequent to December 31, 2016, we announced plans to sell our remaining Bakken/Three Forks assets in Divide County, North Dakota. +57 +Production Results. The table below provides a regional breakdown of our production for 2016 : +South Texas & Gulf Coast +Permian +Rocky +Mountain +Total (1) +Production: +Oil (MMBbl) +5.5 +2.7 +8.3 +16.6 +Gas (Bcf) +130.9 +6.0 +10.0 +146.9 +NGLs (MMBbl) +13.9 +— +0.3 +14.2 +Equivalent (MMBOE) (1) +41.2 +3.8 +10.3 +55.3 +Avg. Daily Equivalents (MBOE/d) +112.6 +10.2 +28.2 +151.0 +Relative percentage +74 +% +7 +% +19 +% +100 +% +____________________________________________ +(1) +Amounts may not calculate due to rounding. +Production decreased for the year ended December 31, 2016 , compared with the same period in 2015, driven by the reduction in our drilling and completion activity and the divestitures of properties in our Rocky Mountain and Permian regions in the last half of 2016, as well as the impact of the sale of our Mid-Continent properties in the second quarter of 2015. Please refer to the table above for a summary of wells drilled, acquired, and completed in our operated programs during the year ended December 31, 2016 . +Please refer to Comparison of Financial Results and Trends Between 2016 and 2015 and Between 2015 and 2014 and A Year-to-Year Overview of Selected Production and Financial Information, Including Trends below for additional discussion on production. +Financial Results for 2016 +• +We recorded a net loss of $757.7 million , or $9.90 per diluted share, for the year ended December 31, 2016 . This compares with a net loss of $447.7 million , or $6.61 per diluted share, for the year ended December 31, 2015 . The net loss in 2016 was driven largely by decreased production revenue due to sustained low commodity prices, discussed in detail above and a decrease in the fair value of commodity derivative contracts. Additionally, we recorded proved and unproved property impairments of $354.6 million and $80.4 million , respectively, for the year ended December 31, 2016 . These impairments were largely due to the continued decline in commodity prices in early 2016 impacting our outside-operated Eagle Ford shale assets and negative reserve performance revisions on our Powder River Basin assets at year-end 2016. Please refer to the caption Comparison of Financial Results and Trends Between 2016 and 2015 and Between 2015 and 2014 below for additional discussion regarding the components of net income (loss). +• +At year-end 2016 , we had estimated proved reserves of 395.8 MMBOE, of which 53 percent were liquids (oil and NGLs) and 53 percent were characterized as proved developed. During 2016, we added 108.2 MMBOE through our drilling program and acquired 15.5 MMBOE, as discussed above. We divested of 47.7 MMBOE of proved reserves and had negative revisions totaling 96.2 MMBOE, consisting of a negative 18.1 MMBOE performance revision, a negative 35.1 MMBOE price revision due to the decline in commodity prices in 2016, and 43.0 MMBOE of proved undeveloped reserves removed due to the five-year rule. Our proved reserve life index decreased slightly to 7.2 years in 2016 . Please refer to Reserves included in Part I, Items 1 and 2 of this report for additional discussion. +• +The standardized measure of discounted future net cash flows was $1.2 billion as of December 31, 2016 , compared with $1.8 billion as of December 31, 2015 . Please refer to the Supplemental Oil and Gas Information section located in Part II, Item 8 of this report. +• +We had net cash provided by operating activities of $552.8 million for the year ended December 31, 2016 , compared with $978.4 million for the year ended December 31, 2015 , which was a decrease of 43 percent year-over-year. Please refer to Analysis of Cash Flow Changes Between 2016 and 2015 and Between 2015 and 2014 below for additional discussion. +58 +• +Adjusted EBITDAX, a non-GAAP financial measure, for the year ended December 31, 2016 , was $790.8 million , compared with $1.1 billion for the same period in 2015 . Please refer to Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and a reconciliation of our net income (loss) and net cash provided by operating activities to adjusted EBITDAX. +Outlook for 2017 +Our priorities for 2017 are to: +• +demonstrate the value of our 2016 acquisitions in the Midland Basin; +• +generate high margin production growth from our operated acreage positions in the Midland Basin and Eagle Ford shale; +• +successfully execute the sale of our outside-operated Eagle Ford shale and Divide County assets; and +• +reduce our outstanding debt. +Our capital program for 2017 , excluding acquisitions, is expected to be approximately $875 million. By concentrating our capital on the highest return programs and operating at strong performance levels, we believe we will generate higher company-wide margins, cash flow growth, and value creation for our stockholders going forward. +In our Midland Basin program, we entered 2017 operating four drilling rigs and plan to increase to six drilling rigs in early 2017 and continue with six drilling rigs in operation through the year. In 2017, our focus will be on developing the Wolfcamp and Spraberry shale intervals on our Sweetie Peck property in Upton County, Texas, as well as delineating and developing the Lower and Middle Spraberry and Wolfcamp A and B shale intervals on our recently acquired acreage in Howard and Martin Counties, Texas. Subsequent to December 31, 2016, we acquired approximately 2,900 additional net acres in Howard County, Texas for approximately $60.0 million. +In our operated Eagle Ford shale program, we began operating a drilling rig in February 2017, and plan to run a one to two rig program throughout 2017. We will remain focused on reducing our drilled but not completed well count and meeting lease obligations. +We expect the sale of our outside-operated Eagle Ford shale assets, including our ownership interest in related midstream assets, to close in the first quarter of 2017 under the executed definitive agreement for a gross purchase price of $800 million, subject to customary closing adjustments. +Subsequent to December 31, 2016, we announced our plans to sell our remaining Bakken/Three Forks assets in Divide County, North Dakota. We expect this sale to be completed by mid-2017. +In our Powder River Basin program, we intend to continue running one drilling rig in 2017 under an acquisition and development funding agreement with a third party, in which the third party is carrying our drilling and completion costs, as discussed above. +Please refer to Overview of Liquidity and Capital Resources below for additional discussion on how we expect to fund our 2017 capital program. +59 +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the quarter ended December 31, 2016 , and the immediately preceding three quarters. A detailed discussion follows. +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2016 +2016 +2016 +2016 +(in millions, except for production data) +Production (MMBOE) +13.4 +14.2 +14.3 +13.4 +Oil, gas, and NGL production revenue +$ +346.3 +$ +329.2 +$ +291.1 +$ +211.8 +Oil, gas, and NGL production expense +$ +151.9 +$ +152.5 +$ +148.6 +$ +144.5 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +171.6 +$ +194.0 +$ +211.0 +$ +214.2 +Exploration +$ +23.7 +$ +13.5 +$ +13.2 +$ +15.3 +General and administrative +$ +33.3 +$ +32.7 +$ +28.2 +$ +32.2 +Net income (loss) +$ +(200.9 +) +$ +(40.9 +) +$ +(168.7 +) +$ +(347.2 +) +____________________________________________ +Note: Amounts may not calculate due to rounding. +Selected Performance Metrics: +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2016 +2016 +2016 +2016 +Average net daily production equivalent (MBOE per day) +145.6 +153.9 +157.2 +147.5 +Lease operating expense (per BOE) +$ +3.67 +$ +3.29 +$ +3.31 +$ +3.79 +Transportation costs (per BOE) +$ +6.39 +$ +6.24 +$ +5.95 +$ +6.06 +Production taxes as a percent of oil, gas, and NGL production revenue +4.3 +% +4.5 +% +4.6 +% +4.2 +% +Ad valorem tax expense (per BOE) +$ +0.17 +$ +0.21 +$ +0.19 +$ +0.27 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) +$ +12.81 +$ +13.70 +$ +14.75 +$ +15.96 +General and administrative (per BOE) +$ +2.49 +$ +2.31 +$ +1.97 +$ +2.40 +____________________________________________ +Note: Amounts may not calculate due to rounding. +60 +A Year-to-Year Overview of Selected Production and Financial Information, Including Trends: +For the Years Ended December 31, +Amount Change Between +Percent Change Between +2016 +2015 +2014 +2016/2015 +2015/2014 +2016/2015 +2015/2014 +Net production volumes (1) +Oil (MMBbl) +16.6 +19.2 +16.7 +(2.6 +) +2.6 +(14 +)% +15 +% +Gas (Bcf) +146.9 +173.6 +152.9 +(26.7 +) +20.7 +(15 +)% +14 +% +NGLs (MMBbl) +14.2 +16.1 +13.0 +(1.9 +) +3.1 +(12 +)% +24 +% +Equivalent (MMBOE) +55.3 +64.2 +55.1 +(8.9 +) +9.1 +(14 +)% +16 +% +Average net daily production (1) +Oil (MBbl per day) +45.4 +52.7 +45.6 +(7.3 +) +7.0 +(14 +)% +15 +% +Gas (MMcf per day) +401.5 +475.7 +419.0 +(74.2 +) +56.7 +(16 +)% +14 +% +NGLs (MBbl per day) +38.8 +44.0 +35.6 +(5.2 +) +8.4 +(12 +)% +24 +% +Equivalent (MBOE per day) +151.0 +175.9 +151.1 +(24.9 +) +24.9 +(14 +)% +16 +% +Oil, gas, and NGL production revenue (in millions) +Oil production revenue +$ +611.8 +$ +797.3 +$ +1,348.3 +$ +(185.5 +) +$ +(551.0 +) +(23 +)% +(41 +)% +Gas production revenue +337.3 +447.0 +699.8 +(109.7 +) +(252.8 +) +(25 +)% +(36 +)% +NGL production revenue +229.3 +255.6 +433.4 +(26.3 +) +(177.8 +) +(10 +)% +(41 +)% +Total +$ +1,178.4 +$ +1,499.9 +$ +2,481.5 +$ +(321.5 +) +$ +(981.6 +) +(21 +)% +(40 +)% +Oil, gas, and NGL production expense (in millions) +Lease operating expense +$ +194.0 +$ +239.6 +$ +235.8 +$ +(45.6 +) +$ +3.8 +(19 +)% +2 +% +Transportation costs +340.3 +386.6 +337.1 +(46.3 +) +49.5 +(12 +)% +15 +% +Production taxes +51.9 +72.4 +117.2 +(20.5 +) +(44.8 +) +(28 +)% +(38 +)% +Ad valorem tax expense +11.4 +25.0 +25.8 +(13.6 +) +(0.8 +) +(54 +)% +(3 +)% +Total +$ +597.6 +$ +723.6 +$ +715.9 +$ +(126.0 +) +$ +7.7 +(17 +)% +1 +% +Realized price, before the effect of derivative settlements +Oil (per Bbl) +$ +36.85 +$ +41.49 +$ +80.97 +$ +(4.64 +) +$ +(39.48 +) +(11 +)% +(49 +)% +Gas (per Mcf) +$ +2.30 +$ +2.57 +$ +4.58 +$ +(0.27 +) +$ +(2.01 +) +(11 +)% +(44 +)% +NGLs (per Bbl) +$ +16.16 +$ +15.92 +$ +33.34 +$ +0.24 +$ +(17.42 +) +2 +% +(52 +)% +Per BOE +$ +21.32 +$ +23.36 +$ +45.01 +$ +(2.04 +) +$ +(21.65 +) +(9 +)% +(48 +)% +Per BOE data (1) +Production costs: +Lease operating expense +$ +3.51 +$ +3.73 +$ +4.28 +$ +(0.22 +) +$ +(0.55 +) +(6 +)% +(13 +)% +Transportation costs +$ +6.16 +$ +6.02 +$ +6.11 +$ +0.14 +$ +(0.09 +) +2 +% +(1 +)% +Production taxes +$ +0.94 +$ +1.13 +$ +2.13 +$ +(0.19 +) +$ +(1.00 +) +(17 +)% +(47 +)% +Ad valorem tax expense +$ +0.21 +$ +0.39 +$ +0.46 +$ +(0.18 +) +$ +(0.07 +) +(46 +)% +(15 +)% +General and administrative +$ +2.29 +$ +2.46 +$ +3.03 +$ +(0.17 +) +$ +(0.57 +) +(7 +)% +(19 +)% +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +14.30 +$ +14.34 +$ +13.92 +$ +(0.04 +) +$ +0.42 +— +% +3 +% +Derivative settlement gain (2) +$ +5.96 +$ +7.98 +$ +0.22 +$ +(2.02 +) +$ +7.76 +(25 +)% +3,527 +% +Earnings per share information +Basic net income (loss) per common share +$ +(9.90 +) +$ +(6.61 +) +$ +9.91 +$ +(3.29 +) +$ +(16.52 +) +50 +% +(167 +)% +Diluted net income (loss) per common share +$ +(9.90 +) +$ +(6.61 +) +$ +9.79 +$ +(3.29 +) +$ +(16.40 +) +50 +% +(168 +)% +Basic weighted-average common shares outstanding (in thousands) +76,568 +67,723 +67,230 +8,845 +493 +13 +% +1 +% +Diluted weighted-average common shares outstanding (in thousands) +76,568 +67,723 +68,044 +8,845 +(321 +) +13 +% +— +% +61 +____________________________________________ +(1) +Amounts and percentage changes may not calculate due to rounding. +(2) +Natural gas derivative settlements for the years ended December 31, 2015, and 2014, include $15.3 million and $5.6 million , respectively, of early settlements of futures contracts as a result of divesting assets in our Mid-Continent region. These early settlements increased the effect of derivative settlements by $0.24 and $0.10 per BOE for the years ended December 31, 2015, and 2014, respectively. +We present per BOE information because we use this information to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis. Average net daily production for the year ended December 31, 2016 , decreased 14 percent compared with the same period in 2015 , driven by our reduced drilling and completion activity and the divestiture of assets. Overall, we expect 2017 total net production to decrease compared with 2016 due to the impact of closed and anticipated divestitures, which will be partially offset by the increase in development activity in our Midland Basin program. Our average net daily production for assets sold and assets expected to be sold by mid-2017, specifically our outside-operated Eagle Ford shale and Divide County assets, was approximately 52.6 MBOE per day during 2016. Please refer to Comparison of Financial Results and Trends Between 2016 and 2015 and Between 2015 and 2014 below for additional discussion. +Changes in production volumes, revenues, and costs reflect the highly volatile nature of our industry. Our realized price on a per BOE basis for the year ended December 31, 2016 , decreased nine percent compared with 2015 as a result of declines in commodity prices in the first half of 2016. Our derivative contracts resulted in a $5.96 settlement gain on a per BOE basis for the year ended December 31, 2016 , which decreased 25 percent compared with 2015 settlements. +Lease operating expense (“LOE”) on a per BOE basis for the year ended December 31, 2016 , decreased six percent compared with the same period in 2015 due to lower service provider costs and reduced workover activity. We experience volatility in our LOE as a result of the impact industry activity has on service provider costs and seasonality in workover expense. Throughout 2015 and into 2016, industry activity decreased in light of the low commodity price environment resulting in service providers lowering costs. For 2017, we expect LOE on a per BOE basis to be relatively flat compared with 2016. We expect that any increase in service provider costs resulting from increased development activity in the Midland Basin will be offset by the executed and planned divestitures of our higher cost Williston Basin properties. +Transportation costs on a per BOE basis for the year ended December 31, 2016 , remained relatively flat compared with the same period in 2015 . We expect transportation costs on a per BOE basis to decrease in 2017 upon selling our outside-operated Eagle Ford shale assets in the early part of the year and our Midland Basin assets becoming a larger portion of our production mix. The majority of our Midland Basin production is sold at the wellhead under current contracts, and therefore, there is minimal transportation expense separately recorded on the accompanying statements of operations. +Production taxes on a per BOE basis for the year ended December 31, 2016 , decreased 17 percent compared with the same period in 2015 driven by the decrease in production revenues, as well as a decrease in our company-wide production tax rate. Our production tax rate for the years ended December 31, 2016 , and 2015, was 4.4 percent and 4.8 percent , respectively. We generally expect production tax expense to trend with oil, gas, and NGL production revenue on an absolute and per BOE basis. Product mix, the location of production, and incentives to encourage oil and gas development can all impact the amount of production tax we recognize. For 2017, we generally expect our production tax rate to decrease year-over-year as a result of our closed and anticipated divestitures; however, we expect an increase in production taxes on a per BOE basis in line with improved commodity prices. +Ad valorem tax expense on a per BOE basis for the year ended December 31, 2016 , decreased 46 percent compared with the same period in 2015 due to the lower valuation of properties subject to ad valorem taxes in 2016 as a result of declining commodity prices. We expect ad valorem tax expense on a per BOE basis to increase in 2017 as a result of changes in our asset and production base year-over-year. The majority of our ad valorem tax expense is related to our Texas properties. Since we have acquired producing properties in Texas and divested properties in our Rocky Mountain region, we expect ad valorem tax expense on an absolute and per BOE basis to increase in 2017. Additionally, we expect an increase in commodity price assumptions used in 2017 property tax valuations. +General and administrative (“G&A”) expense decreased seven percent on a per BOE basis for the year ended December 31, 2016 , compared with the same period in 2015 as our absolute G&A expense decreased at a faster rate than the decrease in production volumes. The 20 percent decrease in absolute G&A expense is due largely to lower +62 +headcount in 2016. We closed our Tulsa, Oklahoma regional office upon selling our Mid-Continent assets in the second quarter of 2015, conducted a company-wide workforce reduction in the third quarter of 2016, and closed our Billings, Montana regional office in the fourth quarter of 2016. These events resulted in a reduction in headcount; however, we incurred $5.1 million and $9.3 million in related exit and disposal costs for the years ended December 31, 2016, and 2015, respectively. We expect G&A expense on an absolute basis to remain relatively flat in 2017 compared with 2016 due to reduced headcount in 2016 being offset by headcount changes resulting from recent and anticipated acquisition and divestiture activity and an expected increase in base and short-term incentive compensation. However, we expect an overall increase in G&A expense on a per BOE basis in 2017 due to a decrease in production volumes. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (“DD&A”) expense remained flat on a per BOE basis for the year ended December 31, 2016 , compared with the same period in 2015 . Our DD&A rate fluctuates as a result of impairments, planned and closed divestitures, and changes in the mix of our production and the underlying proved reserve volumes. In the beginning of 2016, our DD&A rate was higher as a result of the decrease in our proved reserve volumes at December 31, 2015. This increase was offset by the impact of assets held for sale throughout the year, as these assets were not depleted while classified as held for sale. In general, we expect DD&A expense on a per BOE basis to decrease in 2017 due to selling our higher cost Raven/Bear Den assets in late 2016 and our Divide County assets being classified as held for sale in the first quarter of 2017 with no recorded DD&A expense until the sale is finalized (assuming a definitive agreement is executed and all customary closing conditions are met). Please refer to Comparison of Financial Results and Trends Between 2016 and 2015 and Between 2015 and 2014 for additional discussion. +Please refer to the section Earnings per Share in Note 1 - Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion on the types of shares included in our basic and diluted net income (loss) per common share calculations. Our basic and diluted weighted-average share count has increased in 2016 compared with 2015 due to the public and private equity offerings of our common stock made in the last half of 2016. We recorded a net loss for the years ended December 31, 2016, and 2015. Consequently, our unvested RSUs and contingent PSUs were anti-dilutive for the years ended December 31, 2016, and 2015. +Comparison of Financial Results and Trends Between 2016 and 2015 and Between 2015 and 2014 +Oil, Gas, and NGL production +The following table presents the regional changes in our oil, gas, and NGL production, production revenues, and production costs between the years ended December 31, 2016 , and 2015 : +Average Net Daily Production Increase (Decrease) +Production Revenue Increase (Decrease) +Production Costs Decrease +(MBOE/d) +(in millions) +(in millions) +South Texas & Gulf Coast +(20.3 +) +$ +(240.8 +) +$ +(93.6 +) +Rocky Mountain +(2.9 +) +(90.7 +) +(19.6 +) +Permian +2.9 +35.9 +(0.6 +) +Mid-Continent (1) +(4.6 +) +(25.9 +) +(12.2 +) +Total +(24.9 +) +$ +(321.5 +) +$ +(126.0 +) +___________________________________________ +(1) +We divested our Mid-Continent assets in the second quarter of 2015. +We experienced a 14 percent decrease in equivalent production volumes in 2016 from 2015 due to a reduction in our drilling and completion activity and assets divested in both years. Additionally, our realized price on a per BOE basis decreased nine percent in 2016 from 2015. Both of these factors resulted in a 21 percent decrease in oil, gas, and NGL production revenue between the two periods. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of the expected downward trend in production in 2017 due to assets sold in 2016 and expected to be sold in 2017. Please refer to the caption Oil, gas, and NGL production expense below for discussion of the reasons for the decrease in total production costs in 2016 compared with 2015 . +63 +The following table presents the regional changes in our oil, gas, and NGL production, production revenues, and production costs between the years ended December 31, 2015 , and 2014 : +Average Net Daily Production Increase (Decrease) +Production Revenue Decrease +Production Costs Increase (Decrease) +(MBOE/d) +(in millions) +(in millions) +South Texas & Gulf Coast +22.8 +$ +(587.8 +) +$ +54.0 +Rocky Mountain +7.2 +(230.5 +) +(8.2 +) +Permian +(0.2 +) +(98.8 +) +(16.6 +) +Mid-Continent (1) +(4.9 +) +(64.5 +) +(21.5 +) +Total +24.9 +$ +(981.6 +) +$ +7.7 +___________________________________________ +(1) +We divested our Mid-Continent assets in the second quarter of 2015. +We experienced a 16 percent increase in equivalent production volumes in 2015 from 2014 despite selling our Mid-Continent assets in the second quarter of 2015. This increase was primarily driven by continued development in our Eagle Ford shale and Bakken/Three Forks programs. However, oil, gas, and NGL production revenue between the two periods decreased 40 percent due to a 48 percent decrease in realized price on a per BOE basis. Please refer to the caption Oil, gas, and NGL production expense below for discussion on the reasons for the change in production costs in 2015 from 2014 . +Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for realized prices received before the effects of derivative settlements for the years ended December 31, 2016 , 2015 , and 2014 , and discussion of trends on a per BOE basis. +Net gain on divestiture activity +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Net gain on divestiture activity +$ +37.1 +$ +43.0 +$ +0.6 +The net gain on divestiture activity recorded for the year ended December 31, 2016 , is primarily a result of the approximate $29.5 million net gain recorded on our Raven/Bear Den assets sold in the fourth quarter of 2016, as well as a $6.3 million total net gain recorded on the non-core Williston Basin, Powder River Basin, and southeast New Mexico asset divestitures in the third quarter of 2016. Certain of these sold assets were written down in the first quarter of 2016 and subsequently written up in the second quarter of 2016 based on changes in the estimated fair value less costs to sell. Subsequent to December 31, 2016, we announced our plan to sell our remaining Williston Basin assets in Divide County, North Dakota. Please refer to Critical Accounting Policies and Estimates below for additional discussion regarding the expected write-down to be recorded in the first quarter of 2017 upon these assets being classified as held for sale. +The net gain on divestiture activity recorded for the year ended December 31, 2015 , is due to the $108.4 million net gain recorded on the sale of our Mid-Continent assets in the second quarter, partially offset by losses on certain other non-core assets sold during 2015. +The minimal net gain on divestiture activity recorded for the year ended December 31, 2014 , is due to the $26.9 million gain recorded on the sale of non-core Williston Basin properties during the second quarter of 2014, which was mostly offset by write-downs to fair value recorded on other unrelated assets held for sale. +Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +64 +Marketed gas system revenue and expense +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Marketed gas system revenue +$ +— +$ +9.5 +$ +24.9 +Marketed gas system expense +$ +— +$ +13.9 +$ +24.5 +There was no marketed gas system revenue or expense in 2016, and there was a decrease in marketed gas system revenue and expense in 2015 from 2014, due to the sale of our Mid-Continent gas assets in the second quarter of 2015, which eliminated all marketing activities for gas produced by third parties. +Other operating revenues +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Other operating revenues +$ +2.0 +$ +4.5 +$ +15.2 +There were no material other operating revenues recorded for the years ended December 31, 2016 , or 2015 . +Other operating revenues for the year ended December 31, 2014, included a $10.7 million gain related to our settlement with Endeavour Operating Corporation (“Endeavour”), in which we, our working interest partners, and Endeavour agreed to mutually release all claims and dismiss certain litigation in exchange for certain cash payments and other consideration from Endeavour. +Oil, gas, and NGL production expense +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Oil, gas, and NGL production expense +$ +597.6 +$ +723.6 +$ +715.9 +Total production costs for the year ended December 31, 2016 , decreased $126.0 million , or 17 percent , from the same period in 2015 , primarily due to a 14 percent decrease in net equivalent production volumes, continued declines in service provider costs, and a decrease in production taxes due to lower commodity prices. Please refer to the caption A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of production costs on a per BOE basis. +Total production costs for the year ended December 31, 2015 , slightly increased compared with the same period in 2014 due to a 16 percent increase in net equivalent production volumes and a 15 percent increase in transportation expense resulting from the continued development of our Eagle Ford shale program, largely offset by lower service provider costs and a decrease in production taxes due to lower commodity prices. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +790.7 +$ +921.0 +$ +767.5 +65 +DD&A expense for the year ended December 31, 2016 , decreased 14 percent compared with the same period in 2015 due to a 14 percent decrease in production volumes, and the impact of assets sold or classified as held for sale throughout 2016 since no DD&A expense is recorded after the point the assets were classified as held for sale. The impact from assets divested and held for sale was mostly offset by a higher DD&A rate in the beginning year due to a reduction in our proved reserves at December 31, 2015. Please refer to the caption A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of DD&A expense on a per BOE basis. +DD&A expense for the year ended December 31, 2015 , increased 20 percent compared with the same period in 2014 due to an increase in production volumes and a higher DD&A rate in 2015, partially offset by our Mid-Continent assets held for sale in the beginning of 2015 and sold in the second quarter of 2015. +Exploration +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Geological and geophysical expenses +$ +11.0 +$ +7.5 +$ +11.4 +Exploratory dry hole +— +36.6 +44.4 +Overhead and other expenses +54.6 +76.5 +74.1 +Total +$ +65.6 +$ +120.6 +$ +129.9 +Exploration expense for the year ended December 31, 2016 , decreased 46 percent compared with 2015 primarily due to exploratory dry holes being expensed in 2015 (described in the next paragraph) with none recorded in 2016, as well as reduced overhead costs as a result of reduced exploration activity in 2016. These decreases were partially offset by expenses incurred for a seismic study performed on our recently acquired Midland Basin acreage in the fourth quarter of 2016. An exploratory project resulting in non-commercial quantities of oil, gas, or NGLs is deemed an exploratory dry hole and impacts the amount of exploration expense we record. In 2017, we expect to focus on testing and delineating our acquired Midland Basin acreage, and as a result, expect increased exploration activity and related expenses compared with 2016. +Exploration expense for the year ended December 31, 2015, decreased seven percent compared with 2014 mainly due to decreases in exploratory dry hole expense and geological and geophysical costs (“G&G”) expenses in 2015. During 2015, we expensed one exploratory dry hole in our Rocky Mountain region and three lower cost non-Eagle Ford exploratory dry holes in our South Texas & Gulf Coast region, compared to three higher cost exploratory non-Eagle Ford dry holes expensed in our South Texas & Gulf Coast region in 2014. During the first quarter of 2014, we performed a seismic study in our Powder River Basin program, which resulted in higher G&G expenses in 2014 compared with 2015. +Impairment of proved properties and Abandonment and impairment of unproved properties +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Impairment of proved properties +$ +354.6 +$ +468.7 +$ +84.5 +Abandonment and impairment of unproved properties +$ +80.4 +$ +78.6 +$ +75.6 +The majority of our proved property impairment expense for the year ended December 31, 2016, was recorded in the first quarter of 2016 in our outside-operated Eagle Ford shale program as a result of continued commodity price declines. In the fourth quarter of 2016, we recorded proved and unproved property impairment expense on our Powder River Basin assets as a result of negative performance reserve revisions at year-end 2016 and lower market prices on recent third-party acreage transactions. Additionally, we allowed certain leases to expire throughout the year ended December 31, 2016. We expect proved property impairments to be more likely to occur in periods of declining or depressed commodity prices, and unproved property impairments to fluctuate with the timing of lease expirations, unsuccessful exploration activities, and changing economics associated with volatile commodity prices. Additionally, changes in drilling plans, downward engineering revisions, or unsuccessful exploration efforts may result in proved and unproved property impairments. Any amount of future impairment is difficult to predict, but based on updated commodity price assumptions as of February 15, 2017 , we do not expect any +66 +material impairments on assets held for use in the first quarter of 2017 due to commodity price impacts. Please refer to Critical Accounting Policies and Estimates below for additional discussion. +Proved and unproved property impairments recorded in 2015 were due to continued commodity price declines, largely impacting our Powder River Basin program and certain legacy and non-core assets, as well as our decision to reduce capital invested in the development of our east Texas exploration program in light of the sustained, low commodity price environment. +Proved and unproved property impairments recorded in 2014 were due to the significant decline in commodity prices in late 2014 resulting in changes in our drilling plans and the abandonment of certain acreage, as well as recognition of the outcomes of exploration and delineation wells in certain prospects in our South Texas & Gulf Coast and Permian regions. +Impairment of other property and equipment +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Impairment of other property and equipment +$ +— +$ +49.4 +$ +— +We impaired our gas gathering system assets in our east Texas program during the year ended December 31, 2015 , in conjunction with the impairment of the associated proved and unproved properties resulting from our decision not to allocate additional capital to the program in light of sustained low commodity prices. We did not record impairments of other property and equipment for the years ended December 31, 2016 , and 2014 . +General and administrative +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +General and administrative +$ +126.4 +$ +157.7 +$ +167.1 +Exit and disposal costs (1) +$ +5.1 +$ +9.3 +$ +— +___________________________________________ +(1) +Exit and disposal costs are recorded in general and administrative expense in the accompanying statements of operations. +G&A expense for the year ended December 31, 2016 , decreased $31.3 million, or 20 percent , from 2015 primarily due to lower headcount and overhead costs in 2016 resulting from the closure of our Tulsa, Oklahoma regional office in the beginning of the third quarter of 2015, the company-wide workforce reduction that occurred in the third quarter of 2016, and the closure of our Billings, Montana regional office in the fourth quarter of 2016. For the years ended December 31, 2016 , and 2015 , $5.1 million and $9.3 million , respectively, of exit and disposal costs related to these events was included in G&A expense. Please refer to Note 14 - Exit and Disposal Costs in Part II, Item 8 of this report for additional discussion. Additionally, refer to the caption A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of G&A costs on a per BOE basis. +G&A expense decreased $9.4 million , or six percent , in 2015 from 2014 due to lower short-term incentive compensation and reduced headcount and overhead costs resulting from the closing of our Tulsa office in the beginning of the third quarter of 2015. +Change in Net Profits Plan liability +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Change in Net Profits Plan liability +$ +(7.2 +) +$ +(19.5 +) +$ +(29.8 +) +67 +This non-cash expense (benefit) generally relates to the change in the estimated value of the associated liability between the reporting periods resulting from settlements made or accrued during the period and changes in assumptions used in valuing the remaining liability. The non-cash benefit for 2016 was primarily due to the divestiture of assets subject to the Net Profits Plan in 2016. Please refer to Note 11 - Fair Value Measurements in Part II, Item 8 of this report for tabular presentation of the change in the Net Profits Plan liability. +The non-cash benefit for 2015 and 2014 was a result of a 72 percent and 52 percent respective decrease in the corresponding liability, resulting from the continued decline in commodity prices and cash payments made or accrued under the plan. +Net derivative (gain) loss +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Net derivative (gain) loss +$ +250.6 +$ +(408.8 +) +$ +(583.3 +) +We recognized a net derivative loss of $250.6 million for the year ended December 31, 2016 . For contracts settled during 2016 , the fair value was a net asset of $367.7 million at December 31, 2015 , and net cash settlements totaled $329.5 million, resulting in a $38.2 million loss. Additionally, we recorded a $212.4 million mark-to-market loss on remaining contracts as of December 31, 2016, resulting from the increase in commodity strip prices. +We recognized a net derivative gain of $408.8 million for the year ended December 31, 2015 . For contracts settled during 2015 , the fair value was a net asset of $402.7 million at December 31, 2014 , and net cash settlements totaled $512.6 million, resulting in a $109.9 million gain. Additionally, we recorded a $298.9 million mark-to-market gain on remaining contracts as of December 31, 2015, resulting from the decrease in commodity strip prices. +We recognized a net derivative gain of $583.3 million for the year ended December 31, 2014 . For contracts settled during 2014 , the fair value was a net liability of $4.8 million at December 31, 2013, and net cash settlements totaled $12.6 million, resulting in a $17.4 million gain. Additionally, we recorded a $565.9 million mark-to-market gain on remaining contracts as of December 31, 2014 , resulting from the decrease in commodity strip prices. +Please refer to Note 10 - Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Other operating expenses +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Other operating expenses +$ +18.0 +$ +30.6 +$ +4.7 +Other operating expenses for the year ended December 31, 2016, consisted primarily of drilling rig termination and standby fees of $8.7 million , $2.4 million of materials inventory write-downs, and $3.2 million paid to the lessor to terminate our office lease in Billings, Montana. Other operating expenses for the year ended December 31, 2015, consisted primarily of drilling rig termination and standby fees of $13.7 million , $5.3 million of expense related to estimated claims for payment of royalties on certain Federal and Indian leases, and $4.1 million of materials inventory write-downs. There were no individually material other operating expenses in 2014. +Gain (loss) on extinguishment of debt +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Gain (loss) on extinguishment of debt +$ +15.7 +$ +(16.6 +) +$ +— +68 +For the year ended December 31, 2016, we recorded a $15.7 million net gain on the early extinguishment of a portion of our Senior Notes (as defined and discussed in Note 5 - Long-Term Debt in Part II, Item 8 of this report), which includes approximately $16.4 million associated with the discount realized upon repurchase, slightly offset by approximately $700,000 related to the acceleration of unamortized deferred financing costs. +For the year ended December 31, 2015 , we recorded a $16.6 million loss on the early extinguishment of our 6.625% Senior Notes due 2019, which included approximately $12.5 million associated with the premium paid for the tender offer and redemption of the notes and approximately $4.1 million for the acceleration of unamortized deferred financing costs. +Interest expense +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Interest expense +$ +(158.7 +) +$ +(128.1 +) +$ +(98.6 +) +The $30.6 million, or 24 percent, increase in interest expense for the year ended December 31, 2016, compared with the same period in 2015, was due to the additional debt issued in 2016, as presented in Note 5 - Long-Term Debt in Part II, Item 8 of this report, as well as $10.0 million paid to terminate a second lien facility that was not necessary to fund the Rock Oil Acquisition. +The $29.5 million, or 30 percent, increase in interest expense for the year ended December 31, 2015, compared with the same period in 2014, was primarily due to a larger outstanding debt balance in 2015, partially offset by a slight reduction in our weighted-average interest rate. +Please refer to Overview of Liquidity and Capital Resources below for additional discussion of weighted-average interest and borrowing rates for the years presented. +Income tax (expense) benefit +For the Years Ended December 31, +2016 +2015 +2014 +(in millions, except tax rate) +Income tax (expense) benefit +$ +444.2 +$ +275.2 +$ +(398.6 +) +Effective tax rate +37.0 +% +38.1 +% +37.4 +% +The decrease in the effective tax rate in 2016 compared with 2015 reflects the tax benefit of Oklahoma permanent tax benefits and claimed research and development credits recognized in 2015. The effective tax benefit rate realized in 2016 primarily includes a positive effect from the divestiture of properties in high marginal rate states and acquisition of properties in a lower marginal rate state, as well as a positive effect from the release of certain valuation allowances on utilized tax assets. The tax gain recognized on the Raven/Bear Den divestiture, which closed in the fourth quarter of 2016, is much larger than the estimated and recorded book gain. The same is true for announced property sales scheduled to occur in 2017. As a result, we were able to consider tax planning strategies which would allow for the utilization of net operating loss carryovers in certain states which we previously determined would expire before they could be used, as well as utilization of certain carryover federal tax deductions, limited based upon taxable income, which were also expected to expire. As of this date, we intend to implement these planning strategies to utilize deferred tax assets, but cannot ensure that future events will not change these plans and cause the valuation allowances to be reestablished. In general, our historical effective tax rate has not varied significantly year-over-year, but like all companies, our effective tax rate will be impacted by the effect of those permanent items consistently reported compared to reported income or loss. As a result of our divestitures and acquisitions, our base rate has been decreasing over the last three years and has now settled at a rate we expect to be consistent in future periods. Please refer to Critical Accounting Policies and Estimates below and Note 4 - Income Taxes in Part II, Item 8 of this report for further discussion. +The increase in the effective tax rate in 2015 compared with 2014 resulted from a tax benefit effect of Oklahoma permanent tax benefits, enacted state rate changes in Texas and North Dakota, and claimed research and development credits added to the benefit created by a pre-tax loss recorded for the year ended December 31, 2015. +69 +Overview of Liquidity and Capital Resources +Based on the current commodity price environment, we believe we have sufficient liquidity and capital resources to execute our business plan for the foreseeable future. We continue to manage the duration and level of our drilling and completion service commitments to maintain the flexibility to adjust our activity and capital expenditures in periods of prolonged weak commodity prices or to respond should commodity prices recover further. +Sources of Cash +We currently expect our 2017 capital program to be funded by cash flows from operations and proceeds from the divestiture of properties. +Although we anticipate cash flows from these sources will be sufficient to fund our expected 2017 capital program, we may also elect to borrow under our Credit Agreement and/or raise funds through debt or equity financings or from other sources or enter into carrying cost funding and sharing arrangements with third parties for particular exploration and/or development programs. Decreases in commodity prices have limited our industry’s access to capital markets in recent periods. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be diluted, and these newly-issued securities may have rights, preferences, or privileges senior to those of existing stockholders. During the first quarter of 2016, our credit ratings were downgraded by two major rating agencies. These downgrades and any future downgrades may make it more difficult or expensive for us to borrow additional funds. All of our sources of liquidity can be impacted by the general condition of the broader economy and by fluctuations in commodity prices, operating costs, and volumes produced, all of which affect us and our industry. Our Credit Agreement borrowing base could be further reduced as a result of lower commodity prices, divestitures of proved properties, or newly issued debt. See Credit Agreement below for a discussion of recent changes to our borrowing base and the expected reduction as part of the upcoming redetermination process. +We have no control over the market prices for oil, gas, or NGLs, although we may be able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of derivative contracts as part of our commodity price risk management program. During 2016, cash received from the settlement of commodity derivative contracts provided a significant positive source of cash, which is reflected in net cash provided by operating activities on our consolidated statements of cash flows. The fair value of our commodity derivative contracts was a net liability of $91.7 million at December 31, 2016 . Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional information about our oil, gas, and NGL derivative contracts currently in place and the timing of settlement of those contracts . +Please refer to the section Uses of Cash below for discussion of financing activities in 2016, including the issuances of our Senior Convertible Notes and 2026 Notes, and public equity offerings, and the use of these proceeds in funding acquisition activities. +Proposals to reform the Internal Revenue Code of 1986 (“IRC”), as amended, which include eliminating or reducing current tax deductions for intangible drilling costs, depreciation of equipment acquisition costs, the domestic production activities deduction, percentage depletion, and other deductions which reduce our taxable income, have been discussed in past years. Although we believe this possibility has decreased with the recent congressional discussions on tax reform, we expect that future legislation eliminating these deductions would reduce net operating cash flows over time, thereby reducing funding available for our exploration and development capital programs, as well as funding available to our peers in the industry for similar programs. If enacted, reductions in available deductions could have a significant adverse effect on drilling in the United States for a number of years. +70 +Credit Agreement +Our Credit Agreement provides a maximum loan amount of $2.5 billion and has a maturity date of December 10, 2019 . As of December 31, 2016 , our borrowing base and the current aggregate lender commitments were $1.17 billion . Our borrowing base is subject to regular semi-annual redeterminations, as well as periodic adjustments as a result of significant transactions made by the Company. Please refer to Note 5 - Long-Term Debt in Part II, Item 8 of this report for additional discussion of changes in our borrowing capacity throughout 2016 resulting from our debt and equity issuances and our acquisitions and divestitures. The borrowing base redetermination process considers the value of both our (a) proved oil and gas properties reflected in our most recent reserve report and (b) commodity derivative contracts, each as determined by our lender group. The Sixth Amendment to the Credit Agreement revised certain of our covenants under the Credit Agreement and modified the borrowing base utilization grid. On December 1, 2016, the borrowing base was reduced as a result of closing the Raven/Bear Den asset divestiture. We expect a further reduction to our borrowing base during the next semi-annual redetermination scheduled for April 1, 2017 , as a result of the anticipated sale of our outside-operated Eagle Ford shale assets, as well as the decrease in our proved reserves at December 31, 2016. We do not expect to be negatively impacted by this anticipated borrowing base reduction, as we expect to have ample cash on hand upon the closings of planned divestitures and believe the revised borrowing base amount will be sufficient to meet any other anticipated liquidity and operating needs. We had a zero outstanding balance under our Credit Agreement as of December 31, 2016. No individual bank participating in our Credit Agreement represents more than 10 percent of the lender commitments under the Credit Agreement. Please refer to Note 5 - Long-Term Debt in Part II, Item 8 of this report for additional discussion as well as the presentation of the outstanding balance, total amount of letters of credit, and available borrowing capacity under our Credit Agreement as of February 15, 2017 , December 31, 2016 , and December 31, 2015 . +We must comply with certain financial and non-financial covenants under the Credit Agreement, including covenants limiting dividend payments and requiring the Company to maintain certain financial ratios, as defined by the Credit Agreement. Financial covenants under the Credit Agreement require, as of the last day of each of the Company’s fiscal quarters, our (a) ratio of senior secured debt to 12-month trailing adjusted EBITDAX to be not more than 2.75 to 1.0; (b) adjusted current ratio to be not less than 1.0 to 1.0; and (c) ratio of 12-month trailing adjusted EBITDAX to interest expense to be not less than 2.0 to 1.0. We were in compliance with all financial and non-financial covenants under the Credit Agreement as of December 31, 2016 , and through the filing date of this report. Please refer to the caption Non-GAAP Financial Measures below for the calculation of adjusted EBITDAX, and a reconciliation of adjusted EBITDAX to net income (loss) and to net cash provided by operating activities. +Our daily weighted-average credit facility debt balance was approximately $183.8 million , $253.7 million , and $86.6 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively. Cash flows provided by our operating activities, proceeds received from divestitures of properties, capital markets activities, and the amount of our capital expenditures, including acquisitions, all impact the amount we have borrowed under our Credit Agreement. +Weighted-Average Interest Rates +Our weighted-average interest rates include paid and accrued interest, fees on the unused portion of the credit facility’s aggregate commitment amount, letter of credit fees, the non-cash amortization of deferred financing costs and the non-cash amortization of the discount related to the Senior Convertible Notes. Our weighted-average borrowing rates include paid and accrued interest only. +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2016 , 2015 , and 2014 . +For the Years Ended December 31, +2016 +2015 +2014 +Weighted-average interest rate +6.2 +% +6.0 +% +6.5 +% +Weighted-average borrowing rate +5.7 +% +5.5 +% +5.9 +% +Our weighted-average interest rates and weighted average borrowing rates for the years ended December 31, 2016 , 2015 , and 2014 , have been impacted by the timing of Senior Notes and Senior Convertible Notes issuances and redemptions, the average balance on our revolving credit facility, and the fees paid on the unused portion of our aggregate commitment. The rates disclosed in the above table for the year ended December 31, 2016 , do not reflect the approximate $16.4 million discount +71 +realized upon repurchase of certain of our Senior Notes during 2016, the approximate $700,000 acceleration of unamortized deferred financing costs expensed upon repurchase, or the $10.0 million fee paid to terminate an unused second lien facility. The rates disclosed for the year ended December 31, 2015, do not reflect the approximate $12.5 million premium paid for the tender offer and redemption of the 2019 Notes or the approximate $4.1 million of unamortized deferred financing costs expensed upon extinguishment of these notes during 2015. Please refer to Note 5 - Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Uses of Cash +We use cash for the acquisition, exploration, and development of oil and gas properties and for the payment of operating and general and administrative costs, income taxes, dividends, and debt obligations, including interest. Expenditures for the acquisition, exploration, and development of oil and gas properties are the primary use of our capital resources. During 2016 , we spent $2.8 billion in capital expenditures and in acquiring proved and unproved oil and gas properties. These amounts differ from the costs incurred amounts, which are accrual-based and include asset retirement obligations, geological and geophysical expenses, exploration overhead amounts, and the fair value of the equity consideration given to the sellers of the QStar Acquisition. +The amount and allocation of future capital expenditures will depend upon a number of factors, including the number and size of acquisition opportunities, our cash flows from operating, investing, and financing activities, and our ability to assimilate acquisitions and execute our drilling program. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, and the timing and results of our operated and outside-operated exploration and development activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget to assess changes in current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. +We may from time to time repurchase certain amounts of our outstanding debt securities for cash and/or through exchanges for other securities. Such repurchases or exchanges may be made in open market transactions, privately negotiated transactions, or otherwise. Any such repurchases or exchanges will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. Repurchases or exchanges are reviewed as part of the allocation of our capital. During 2016, we repurchased a portion of our Senior Notes in open market transactions at a discount, resulting in a $15.7 million net gain on extinguishment of debt. Please refer to Note 5 - Long-Term Debt in Part II, Item 8 of this report for additional discussion. As part of our strategy for 2017, we plan to reduce debt by repurchasing a portion of our Senior Notes. +As of the filing date of this report, we could repurchase up to 3,072,184 shares of our common stock under our stock repurchase program, subject to the approval of our Board of Directors. Shares may be repurchased from time to time in the open market, or in privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes, the indenture governing our Senior Convertible Notes, compliance with securities laws, and the terms and provisions of our stock repurchase program. Our Board of Directors periodically reviews this program as part of the allocation of our capital. During 2016 , we did not repurchase any shares of our common stock, and we currently do not plan to repurchase any outstanding shares. +During 2016 , we paid $7.8 million in dividends to our stockholders, reflecting a dividend of $0.10 per share. Our current intention is to continue to make dividend payments for the foreseeable future, subject to our future earnings, our financial condition, Credit Agreement, indentures governing our Senior Convertible Notes and Senior Notes, other covenants, and other factors which could arise. The payment and amount of future dividends remains at the discretion of our Board of Directors. +Analysis of Cash Flow Changes Between 2016 and 2015 and Between 2015 and 2014 +The following tables present changes in cash flows between the years ended December 31, 2016 , 2015 , and 2014 , for our operating, investing, and financing activities. The analysis following each table should be read in conjunction with our consolidated statements of cash flows in Part II, Item 8 of this report. +72 +Operating Activities +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2016 +2015 +2014 +2016/2015 +2015/2014 +2016/2015 +2015/2014 +(in millions) +Net cash provided by operating activities +$ +552.8 +$ +978.4 +$ +1,456.6 +$ +(425.6 +) +$ +(478.2 +) +(43 +)% +(33 +)% +Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, decreased $588.0 million , or 35 percent , to $1.1 billion for the year ended December 31, 2016 , compared with the same period in 2015 . This decrease was a result of the decline in production volumes, realized commodity prices, and derivative cash settlements. Cash paid for LOE in 2016 decreased $52.6 million , or 21 percent , to $199.9 million compared with the same period in 2015 due primarily to a 14 percent decrease in production volumes and a reduction in service provider costs. During 2016, we paid $10.0 million to terminate a second lien facility that was not needed to fund the Rock Oil Acquisition. During 2015, we paid approximately $12.5 million associated with the premium for the tender offer and redemption of the 2019 Notes. The remaining change was related to decreases in cash G&A expense, exploration overhead, and ad valorem taxes, as well as changes in working capital balances. +Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, decreased $366.1 million , or 18 percent , to $1.7 billion for the year ended December 31, 2015 , compared with the same period in 2014 . Cash paid for LOE in 2015 increased $22.2 million , or 10 percent , to $252.5 million compared with the same period in 2014 , due primarily to a 16 percent increase in production volumes, partially offset by a reduction in service provider costs. Cash paid for interest, net of capitalized interest, increased $37.8 million during 2015 compared with 2014 due to making, in 2015, the first interest payment on our 2022 Notes issued at the end of 2014. Additionally, we paid approximately $12.5 million associated with the premium for the tender offer and redemption of the 2019 Notes. +Investing Activities +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2016 +2015 +2014 +2016/2015 +2015/2014 +2016/2015 +2015/2014 +(in millions) +Net cash used in investing activities +$ +(1,870.6 +) +$ +(1,144.6 +) +$ +(2,478.7 +) +$ +(726.0 +) +$ +1,334.1 +63 +% +(54 +)% +Net cash used in investing activities increased for the year ended December 31, 2016 , compared with the same period in 2015 . During 2016 , cash paid to acquire proved and unproved properties in the Midland Basin totaled $2.2 billion , whereas we had no significant acquisition activity in 2015. Net proceeds from the sale of oil and gas properties increased $588.1 million for the year ended December 31, 2016 , compared with the same period in 2015 , due to proceeds from the divestitures of our Raven/Bear Den assets and other non-core assets in 2016 exceeding proceeds from the sale of our Mid-Continent assets in 2015. Capital expenditures in 2016 decreased $863.7 million , or 58 percent , compared with 2015 as a result of reduced drilling and completion activities and lower service provider costs, as well as a significant amount of accrued 2014 drilling and completion payables paid in early 2015. +Capital expenditures in 2015 decreased $481.2 million , or 24 percent , compared with 2014 . Drilling capital incurred decreased approximately 38 percent in 2015 compared with 2014 as a result of reduced operated and non-operated rig count and lower service provider costs. Partially offsetting this decrease in capital activity was our payment, in 2015, of a significant amount of accrued drilling and completion payables at year-end 2014. Additionally, we did not have significant acquisition activity during 2015, whereas we acquired $544.6 million of proved and unproved properties in our Gooseneck prospect area and in the Powder River Basin during 2014. Net proceeds from the sale of oil and gas properties increased $314.1 million in 2015 compared with 2014 due primarily to the divestiture of our remaining Mid-Continent assets during the second quarter of 2015. +73 +Financing Activities +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2016 +2015 +2014 +2016/2015 +2015/2014 +2016/2015 +2015/2014 +(in millions) +Net cash provided by financing activities +$ +1,327.2 +$ +166.2 +$ +740.0 +$ +1,161.0 +$ +(573.8 +) +699 +% +(78 +)% +During 2016, we received $934.1 million of net proceeds from two public equity offerings, $491.6 million of net proceeds from our 2026 Notes issuance, and $166.6 million of net proceeds from our Senior Convertible Notes issuance. These proceeds were used to partially fund the Rock Oil and QStar acquisitions, as well as to pay down our credit facility balance. As a result, we had net repayments under our credit facility of $202.0 million during the year ended December 31, 2016 , compared with net borrowings of $36.0 million during 2015 . During 2015, we received $491.0 million of net proceeds from the issuance of our 2025 Notes, which were used for the tender and redemption of the $350.0 million principal amount of our 2019 Notes. Additionally, in 2016, we paid $24.2 million for capped call transactions related to our Senior Convertible Notes and paid $29.9 million for the repurchase of $46.3 million in aggregate principal amount of a portion of our Senior Notes. Please refer to Note 5 - Long-Term Debt in Part II, Item 8 of this report for additional discussion. +We received $491.0 million of net proceeds from the issuance of our 2025 Notes in 2015 , compared with $590.0 million of net proceeds from the issuance of our 2022 Notes during 2014. The 2015 proceeds were primarily used for the tender and redemption of our 2019 Notes. We had net borrowings under our credit facility of $36.0 million during the year ended December 31, 2015 , compared with net borrowings of $166.0 million in 2014. +Interest Rate Risk +We are exposed to market risk due to the floating interest rate on our revolving credit facility. Our Credit Agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the credit facility’s fair market value, but will not impact results of operations or cash flows. Conversely, for the portion of the credit facility that has a floating interest rate, interest rate changes will not affect the fair market value, but will impact future results of operations and cash flows. Changes in interest rates do not impact the amount of interest we pay on our fixed-rate Senior Notes or fixed-rate Senior Convertible Notes, but can impact their fair market values. As of December 31, 2016 , our fixed-rate debt outstanding totaled $3.0 billion , however, we had no floating-rate debt outstanding, thus we had no exposure to market risk related to floating interest rates at that date. Please refer to Note 11 - Fair Value Measurements in Part II, Item 8 of this report for additional discussion on the fair value of our Senior Notes and Senior Convertible Notes. +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly impact our revenue, overall profitability, access to capital, and future rate of growth. Oil, gas, and NGL prices are subject to wide fluctuations in response to changes in supply and demand and other factors. The markets for oil, gas, and NGLs have been volatile, especially over the last several years, and these markets will likely continue to be volatile in the future. The prices we receive for our production depend on numerous factors beyond our control. Based on our 2016 production, a 10 percent decrease in our average realized oil, gas, and NGL prices, before the effects of derivative settlements, would have reduced our oil, gas, and NGL production revenues by approximately $61.2 million , $33.7 million , and $22.9 million , respectively. If our 2016 realized prices, before the effects of derivative settlements, had been 10 percent lower, our derivative settlements would have been higher, partially offsetting the decrease in production revenues quantified above. +74 +We enter into commodity derivative contracts in order to reduce the impact of fluctuations in commodity prices. The fair values of our commodity derivative contracts are largely determined by estimates of the forward curves of the relevant price indices. At December 31, 2016 , a 10 percent increase or decrease in the forward curves associated with our oil, gas, and NGL commodity derivative instruments would have changed our net liability positions by approximately $56 million , $47 million , and $27 million , respectively. +Schedule of Contractual Obligations +The following table summarizes our contractual obligations at December 31, 2016 , for the periods specified (in millions): +Contractual Obligations +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Long-term debt (1) +$ +2,976.2 +$ +— +$ +— +$ +519.4 +$ +2,456.8 +Interest payments (2) +1,275.8 +174.3 +351.2 +347.6 +402.7 +Delivery commitments (3) +970.9 +105.7 +274.9 +269.0 +321.3 +Operating leases and contracts (3) +87.2 +39.4 +17.7 +13.7 +16.4 +Asset retirement obligations (4) +161.2 +6.8 +34.8 +2.2 +117.4 +Derivative liability (5) +214.4 +115.6 +97.4 +1.4 +— +Other (6) +38.4 +7.9 +15.6 +14.9 +— +Total +$ +5,724.1 +$ +449.7 +$ +791.6 +$ +1,168.2 +$ +3,314.6 +____________________________________________ +(1) +Long-term debt consists of our Senior Notes and Senior Convertible Notes, and assumes no principal repayment until the due dates of the instruments. The actual payments may vary significantly. As of December 31, 2016, we had a zero balance on our revolving credit facility. +(2) +Interest payments on our Senior Notes and Senior Convertible Notes are estimated assuming no principal repayment until the due dates of the instruments. As our credit facility balance was zero at December 31, 2016, the above table reflects only the fee that would be paid on the unused credit facility’s aggregate lender commitment amount through the maturity date of the Credit Agreement. The actual interest payments on our Senior Notes, Senior Convertible Notes, and credit facility may vary significantly. +(3) +Please refer to Note 6 – Commitments and Contingencies in Part II, Item 8 of this report for additional discussion. The amount relating to our gathering, processing, and transportation throughput commitments in the table above reflects the aggregate undiscounted deficiency payments assuming we delivered no product. Subsequent to December 31, 2016 , we entered into a definitive agreement for the sale of our outside-operated Eagle Ford shale assets held for sale at December 31, 2016 , and expect to close the transaction in the first quarter of 2017, at which point we would no longer be subject to throughput commitments totaling $501.9 million of the deficiency payments presented in the table above. +(4) +Amounts shown represent estimated future undiscounted plugging and abandonment costs. The discounted obligations are recorded as liabilities on our accompanying consolidated balance sheets as of December 31, 2016 . The timing and amount of the ultimate settlement of these obligations is unknown and can be impacted by economic factors, a change in development plans, and federal and state regulations. Obligations related to inactive wells or wells that are not economic at current commodity price levels as of December 31, 2016 , are shown as an obligation in 1-3 years due to the substantial uncertainty on the timing of plugging or re-entering these wells. Please refer to Note 9 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +(5) +Amounts shown represent only the liability portion of the marked-to-market value of our commodity derivatives based on future market prices as of December 31, 2016 , and exclude estimated oil, gas, and NGL commodity derivative receipts. This amount varies from the liability amounts presented on the accompanying balance sheets, as those amounts are presented at fair value, which considers time value, volatility, and the risk of non-performance for us and for our counterparties. The ultimate settlement amounts under our derivative contracts are unknown, as they are subject to continuing market risk and commodity price volatility. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +(6) +The majority of this amount is related to the unfunded portion of our estimated pension liability of $37.9 million , for which we have estimated the timing of future payments based on historical annual contribution amounts. +75 +Off-Balance Sheet Arrangements +As part of our ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +We evaluate our transactions to determine if any variable interest entities exist. If it is determined that we are the primary beneficiary of a variable interest entity, that entity is consolidated into our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions in 2016 or 2015 . +Critical Accounting Policies and Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate due to changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Successful Efforts Method of Accounting. GAAP provides for two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method. Both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 - Summary of Significant Accounting Policies of Part II, Item 8 of this report. +Oil and Gas Reserve Quantities. Our estimated proved reserve quantities and future net cash flows are critical to understanding the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our financial statements, including the calculations of depletion and impairment of proved oil and gas properties. Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure of discounted future net cash flows calculation requires a 10 percent discount rate to be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir-evaluation consulting firm, to audit at least 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year-end. It should not be assumed that the standardized measure of discounted future net cash flows (GAAP) or PV-10 (non-GAAP) as of December 31, 2016, is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based these measures on a 12-month average of the first-day-of-the-month prices for the year ended December 31, 2016. Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimates. Please refer to Risk Factors in Part I, Item 1A of this report. +Our estimates of proved reserves materially impact depletion expense and impairment of proved and unproved properties. If the estimates of proved reserves decline, the rate at which we record depletion expense will increase, reducing future earnings. Such a decline may result from lower commodity prices, which may make it uneconomical to drill for or produce higher cost fields. In addition, a decline in proved reserve estimates may impact the outcome of our assessment of proved properties for impairment. Changes in depletion or impairment calculations caused by changes in reserve quantities or net cash flows are recorded in the period the reserve estimates change. +76 +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2016 +2015 +2014 +MMBOE +MMBOE +MMBOE +Change +Change +Change +Revisions resulting from performance +(18.1 +) +47.3 +11.3 +Removal of proved undeveloped reserves no longer in our five-year development plan +(43.0 +) +(79.4 +) +(4.3 +) +Revisions resulting from price changes +(35.1 +) +(116.5 +) +3.4 +Total +(96.2 +) +(148.6 +) +10.4 +As previously noted, commodity prices are volatile and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. +The Company cannot reasonably predict future commodity prices, although we believe that together, the below analyses provide reasonable information regarding the impact of changes in pricing and trends on total proved reserves. The following table reflects the estimated MMBOE change and percentage change to our total reported proved reserve volumes from the described hypothetical changes: +For the Year Ended +December 31, 2016 +MMBOE +Percentage +Change +Change +10 percent decrease in SEC pricing (1) +(81 +) +(21 +)% +Average NYMEX strip pricing as of fiscal year end (2) +163 +41 +% +10 percent decrease in proved undeveloped reserves (3) +(19 +) +(5 +)% +___________________________________________ +(1) +The change solely reflects the impact of a 10 percent decrease in SEC pricing to the total reported proved reserve volumes as of December 31, 2016, and does not include additional impacts to our proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. +(2) +The change reflects the impact of replacing SEC pricing with the calculated average of the five year NYMEX strip pricing for each product as of December 31, 2016. The five year average NYMEX strip prices used in the analysis were $56.19 per Bbl for oil, $3.09 per MMBtu for gas, and $27.44 per Bbl for NGL. Other impacts modeled in the analysis resulting from the hypothetical improved pricing include: 1) management’s estimate of escalation in future service and equipment costs at the commodity price level noted above 2) extension of economic lives and increase in economically recoverable volumes; 3) additional proved undeveloped reserve locations that pass the PV-0 hurdle; and 4) additional proved undeveloped reserve locations that could be reasonably drilled within five years given additional capital that would be available for development at the commodity price level noted above. We did not add any proved undeveloped reserve locations in our outside-operated Eagle Ford shale or Bakken/Three Forks program in Divide County, North Dakota given our intent to sell these properties in 2017. +(3) +The change solely reflects a 10 percent decrease in proved undeveloped reserves as of December 31, 2016, and does not include any additional impacts to our proved reserves. +Additional reserve information can be found in the Reserves section in Part I, Items 1 and 2 of this report, and in Supplemental Oil and Gas Information in Part II, Item 8 of this report. +77 +Impairment of Oil and Gas Properties. Proved properties are evaluated periodically for impairment on a pool-by-pool basis and when events or changes in circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected future cash flows of our oil and gas properties and compare these undiscounted cash flows to the carrying amount to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the oil and gas properties to fair value (or discounted future cash flows). Management estimates future cash flows from all proved reserves and risk adjusted probable and possible reserves using various factors, which are subject to our judgment and expertise, and include, but are not limited to, commodity price forecasts, estimated future operating and capital costs, development plans, and discount rates to incorporate the risk and current market conditions associated with realizing the expected cash flows projects. +Unproved oil and gas properties are evaluated periodically for impairment on a prospect-by-prospect basis and when there is an indication that the carrying costs may not be recoverable. We estimate the fair value of unproved properties, using a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by us or other market participants. Unproved oil and gas properties are impaired when we determine that the property will not be developed or the carrying value will not be realized. +Proved and unproved oil and gas properties are classified as held for sale when we commit to a plan to sell the assets and there is reasonable certainty the sale will take place within one year. Upon classification as held for sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to identify and expense any excess of carrying value over fair value less costs to sell. +We cannot predict when or if future impairment charges will be recorded because of the uncertainty in the factors discussed above. Despite any amount of future impairment being difficult to predict, based on updated commodity price assumptions as of February 15, 2017, we do not expect any material impairments on assets held for use in the first quarter of 2017 due to commodity price impacts. We do, however, anticipate recognizing an impairment in the first quarter of 2017 upon the reclassification of our remaining Williston Basin assets in Divide County, North Dakota as assets held for sale. We announced the plan to sell these assets subsequent to December 31, 2016. At year-end 2016, the estimated undiscounted cash flows for the Divide County assets exceeded the carrying amount. Based on preliminary estimates of fair value less costs to sell, we expect an impairment in the range of $200 million to $400 million to be recorded in the first quarter of 2017. +Please refer to Note 1 - Summary of Significant Accounting Policies and Note 11 - Fair Value Measurements in Part II, Item 8 of this report for impairments of oil and gas properties and other property and equipment recorded for the years ended December 31, 2016, 2015, and 2014. +Purchase Price Allocation . Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets and liabilities acquired based on their estimated fair value as of the acquisition date. Various assumptions are made when estimating fair values assigned to proved and unproved oil and gas properties including: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgment by management at the time of the valuation. +Asset Retirement Obligations. We are required to recognize an estimated liability for future costs associated with the abandonment of our oil and gas properties. We base our estimate of the liability on our historical experience in abandoning oil and gas wells and our current understanding of federal and state regulatory requirements. Our present value calculations require us to estimate the cost, estimate the economic lives and timing of abandonment of our properties, estimate future inflation rates, and determine what credit-adjusted risk-free discount rate to use. The impact to the accompanying consolidated statements of operations from these estimates is reflected in our depletion, depreciation, and amortization calculations and occurs over the remaining life of our respective oil and gas properties. Please refer to Note 9 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +Revenue Recognition. Our revenue recognition policy is a critical accounting policy because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. We derive our revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized when our production is delivered to the purchaser, but payment is generally received between 30 and 90 days after the date of production. No revenue is recognized unless it is determined that title to the product has transferred to a purchaser. At the end of each month, we make estimates of the amount of production delivered to the purchaser and the price we will receive. We use our knowledge of our properties, contractual arrangements, their historical performance, NYMEX, local spot market, and OPIS prices, and other factors as the basis for these estimates. Variances between our estimates and the actual amounts received are +78 +recorded in the month payment is received. A 10 percent change in our year-end revenue accrual would have impacted total operating revenues by approximately $10 million in 2016 . +Derivative Financial Instruments. We periodically enter into commodity derivative contracts to manage our exposure to oil, gas and NGL price volatility. We recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive loss. The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. +Income Taxes. We provide for deferred income taxes on the difference between the tax basis of an asset or liability and its carrying amount in our financial statements. This difference will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period, as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax benefit by approximately $12 million for the year ended December 31, 2016 . +Accounting Matters +Please refer to the section entitled Recently Issued Accounting Standards under Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional information on the recent adoption of new authoritative accounting guidance. +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +Hydraulic Fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, see Risk Factors – Risks Related to Our Business – Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Climate Change. In June 2013, President Obama announced a Climate Action Plan designed to further reduce greenhouse gas emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Plan targets methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. On January 14, 2015, the Obama Administration announced additional steps to reduce methane emissions from the oil and gas sector by 40 to 45 percent by 2025. Pursuant to this commitment, on May 12, 2016, the EPA issued final regulations that amend and expand the 2012 regulations by setting emission limits for greenhouse gases, or GHGs, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of greenhouse gases in the form of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The final regulation requires, among other things, greenhouse gas and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and natural gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of greenhouse gases and VOCs from well completions. Both the 2012 and 2016 rules are the subjects of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia. The rule does not extend to existing sources and the EPA has not indicated when it will propose existing source standards. Additionally, on November 16, 2016, the Bureau of Land Management finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands, as part of President Obama’s Climate Action Plan. The regulations, named the Methane and Waste Prevention Rule, is intended to +79 +reduce the waste of natural gas from flaring, venting, and leaks by oil and gas production. The rule includes requirements that prohibits venting gas except in limited circumstances and limits flaring of gas and includes requirements for leak detection and repair. The rule also increases royalty payments for “waste” gas that is released in contravention of the rule requirements. The rule, which was immediately challenged in federal district court, faces an uncertain future in the Trump Administration and is a target of rescission through the Congressional Review Act. +In August of 2015, the EPA finalized existing source performance standards as stringent state emission “goals” for utilities to reduce greenhouse gas emissions. The proposed standards focus on re-dispatching electricity from coal-fired units to natural gas combined cycle plants and renewables. In February 2016, however, the Supreme Court stayed these rules pending judicial review and the rule is expected to be significantly weakened or rescinded by the Trump Administration. +In addition, the United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases and almost one-half of the states have already taken legal measures to reduce emissions of greenhouse gases primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. +The adoption of legislation or regulatory programs to reduce emissions of greenhouse gases could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and natural gas we produce. Consequently, legislation and regulatory programs to reduce emissions of greenhouse gases could have an adverse effect on our business, financial condition, and results of operations. Finally, it should be noted that some scientists have concluded that increasing concentrations of greenhouse gases in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. If any such effects were to occur, they could have an adverse effect on our financial condition and results of operations. +In terms of opportunities, the regulation of greenhouse gas emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and natural gas that we produce, the relative demand for natural gas may increase because the burning of natural gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources, such as wind or solar power become more prevalent, natural gas-fired electric plants may provide an alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, natural gas may become a more attractive transportation fuel. Approximately 44 and 45 percent of our production on a BOE basis in 2016 and 2015 , respectively, was natural gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and natural gas reservoirs, could also benefit us through the potential to obtain greenhouse gas emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +80 +Non-GAAP Financial Measures +Adjusted EBITDAX represents net income (loss) before interest expense, other non-operating income or expense, income taxes, depletion, depreciation, amortization and asset retirement obligation liability accretion expense, exploration expense, property impairments, non-cash stock-based compensation expense, derivative gains and losses net of settlements, change in the Net Profits Plan liability, gains and losses on divestitures, gains or losses on extinguishment of debt, and materials inventory impairments. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally one-time in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that we present because we believe it provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for exploration, development, acquisitions, and to service debt. We are also subject to financial covenants under our Credit Agreement based on adjusted EBITDAX ratios as further described in Note 5 - Long-Term Debt in Part II, Item 8 of this report. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or profitability or liquidity measures prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. Our credit facility provides a material source of liquidity for us. Under the terms of our Credit Agreement, if we fail to comply with the covenants that establish a maximum permitted ratio of senior secured debt to adjusted EBITDAX and a minimum permitted ratio of adjusted EBITDAX to interest, we will be in default, an event that would prevent us from borrowing under our credit facility and would therefore materially limit our sources of liquidity. In addition, if we default under our credit facility and are unable to obtain a waiver of that default from our lenders, lenders under that facility and under indentures governing our outstanding Senior Notes and Senior Convertible Notes would be entitled to exercise all of their remedies for default. +81 +The following table provides reconciliations of our net income (loss) and net cash provided by operating activities to adjusted EBITDAX for the periods presented: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Net income (loss) (GAAP) +$ +(757,744 +) +$ +(447,710 +) +$ +666,051 +Interest expense +158,685 +128,149 +98,554 +Other non-operating (income) expense, net +(362 +) +(649 +) +2,561 +Income tax expense (benefit) +(444,172 +) +(275,151 +) +398,648 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +790,745 +921,009 +767,532 +Exploration (1) +59,194 +113,158 +122,577 +Impairment of proved properties +354,614 +468,679 +84,480 +Abandonment and impairment of unproved properties +80,367 +78,643 +75,638 +Impairment of other property and equipment +— +49,369 +— +Stock-based compensation expense +26,897 +27,467 +32,694 +Net derivative (gain) loss +250,633 +(408,831 +) +(583,264 +) +Derivative settlement gain (2) +329,478 +512,566 +12,615 +Change in Net Profits Plan liability +(7,200 +) +(19,525 +) +(29,849 +) +Net gain on divestiture activity +(37,074 +) +(43,031 +) +(646 +) +(Gain) loss on extinguishment of debt +(15,722 +) +16,578 +— +Materials inventory impairment +2,436 +4,054 +— +Adjusted EBITDAX (Non-GAAP) +790,775 +1,124,775 +1,647,591 +Interest expense +(158,685 +) +(128,149 +) +(98,554 +) +Other non-operating income (expense), net +362 +649 +(2,561 +) +Income tax (expense) benefit +444,172 +275,151 +(398,648 +) +Exploration (1) +(59,194 +) +(113,158 +) +(122,577 +) +Exploratory dry hole expense +(16 +) +36,612 +44,427 +Amortization of discount and deferred financing costs +9,938 +7,710 +6,146 +Deferred income taxes +(448,643 +) +(276,722 +) +397,780 +Plugging and abandonment +(6,214 +) +(7,496 +) +(8,796 +) +Loss on extinguishment of debt +— +(12,455 +) +— +Other, net +1,063 +9,707 +1,069 +Changes in current assets and liabilities +(20,754 +) +61,728 +(9,302 +) +Net cash provided by operating activities (GAAP) +$ +552,804 +$ +978,352 +$ +1,456,575 +____________________________________________ +(1) +Stock-based compensation expense is a component of exploration expense and general and administrative expense on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration expense. +(2) +Derivative settlement gain for the years ended December 31, 2015, and 2014, includes $15.3 million and $5.6 million , respectively, of gains on the early settlement of futures contracts as a result of divesting our Mid-Continent assets. +82 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this item is provided under the captions Commodity Price Risk and Interest Rate Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place under Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +83 +ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +The Board of Directors and Stockholders of SM Energy Company and subsidiaries +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries as of December 31, 2016 and 2015 , and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 . These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SM Energy Company and subsidiaries at December 31, 2016 and 2015 , and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 , in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2016 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 23, 2017 expressed an unqualified opinion thereon. +/s/ Ernst & Young LLP +Denver, Colorado +February 23, 2017 +84 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share amounts) +December 31, +2016 +2015 +ASSETS +Current assets: +Cash and cash equivalents +$ +9,372 +$ +18 +Accounts receivable +151,950 +134,124 +Derivative asset +54,521 +367,710 +Prepaid expenses and other +8,799 +17,137 +Total current assets +224,642 +518,989 +Property and equipment (successful efforts method): +Proved oil and gas properties +5,700,418 +7,606,405 +Less - accumulated depletion, depreciation, and amortization +(2,836,532 +) +(3,481,836 +) +Unproved oil and gas properties +2,471,947 +284,538 +Wells in progress +235,147 +387,432 +Oil and gas properties held for sale, net +372,621 +641 +Other property and equipment, net of accumulated depreciation of $42,882 and $32,956, respectively +137,753 +153,100 +Total property and equipment, net +6,081,354 +4,950,280 +Noncurrent assets: +Derivative asset +67,575 +120,701 +Other noncurrent assets +19,940 +31,673 +Total other noncurrent assets +87,515 +152,374 +Total Assets +$ +6,393,511 +$ +5,621,643 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable and accrued expenses +$ +299,708 +$ +302,517 +Derivative liability +115,464 +8 +Total current liabilities +415,172 +302,525 +Noncurrent liabilities: +Revolving credit facility +— +202,000 +Senior Notes, net of unamortized deferred financing costs +2,766,719 +2,315,970 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +130,856 +— +Asset retirement obligation +96,134 +137,284 +Asset retirement obligation associated with oil and gas properties held for sale +26,241 +241 +Deferred income taxes +315,672 +758,279 +Derivative liability +98,340 +— +Other noncurrent liabilities +47,244 +52,943 +Total noncurrent liabilities +3,481,206 +3,466,717 +Commitments and contingencies (note 6) +Stockholders ’ equity: +Common stock, $0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 111,257,500 and 68,075,700 shares, respectively +1,113 +681 +Additional paid-in capital +1,716,556 +305,607 +Retained earnings +794,020 +1,559,515 +Accumulated other comprehensive loss +(14,556 +) +(13,402 +) +Total stockholders ’ equity +2,497,133 +1,852,401 +Total Liabilities and Stockholders ’ Equity +$ +6,393,511 +$ +5,621,643 +The accompanying notes are an integral part of these consolidated financial statements. +85 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share amounts) +For the Years Ended +December 31, +2016 +2015 +2014 +Operating revenues and other income: +Oil, gas, and NGL production revenue +$ +1,178,426 +$ +1,499,905 +$ +2,481,544 +Net gain on divestiture activity +37,074 +43,031 +646 +Marketed gas system revenue +— +9,485 +24,897 +Other operating revenues +1,950 +4,544 +15,220 +Total operating revenues and other income +1,217,450 +1,556,965 +2,522,307 +Operating expenses: +Oil, gas, and NGL production expense +597,565 +723,633 +715,878 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +790,745 +921,009 +767,532 +Exploration +65,641 +120,569 +129,857 +Impairment of proved properties +354,614 +468,679 +84,480 +Abandonment and impairment of unproved properties +80,367 +78,643 +75,638 +Impairment of other property and equipment +— +49,369 +— +General and administrative +126,428 +157,668 +167,103 +Change in Net Profits Plan liability +(7,200 +) +(19,525 +) +(29,849 +) +Net derivative (gain) loss +250,633 +(408,831 +) +(583,264 +) +Marketed gas system expense +— +13,922 +24,460 +Other operating expenses +17,972 +30,612 +4,658 +Total operating expenses +2,276,765 +2,135,748 +1,356,493 +Income (loss) from operations +(1,059,315 +) +(578,783 +) +1,165,814 +Non-operating income (expense): +Interest expense +(158,685 +) +(128,149 +) +(98,554 +) +Gain (loss) on extinguishment of debt +15,722 +(16,578 +) +— +Other, net +362 +649 +(2,561 +) +Income (loss) before income taxes +(1,201,916 +) +(722,861 +) +1,064,699 +Income tax (expense) benefit +444,172 +275,151 +(398,648 +) +Net income (loss) +$ +(757,744 +) +$ +(447,710 +) +$ +666,051 +Basic weighted-average common shares outstanding +76,568 +67,723 +67,230 +Diluted weighted-average common shares outstanding +76,568 +67,723 +68,044 +Basic net income (loss) per common share +$ +(9.90 +) +$ +(6.61 +) +$ +9.91 +Diluted net income (loss) per common share +$ +(9.90 +) +$ +(6.61 +) +$ +9.79 +The accompanying notes are an integral part of these consolidated financial statements. +86 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +For the Years Ended +December 31, +2016 +2015 +2014 +Net income (loss) +$ +(757,744 +) +$ +(447,710 +) +$ +666,051 +Other comprehensive loss, net of tax: +Pension liability adjustment (1) +(1,154 +) +(2,090 +) +(5,896 +) +Total other comprehensive loss, net of tax +(1,154 +) +(2,090 +) +(5,896 +) +Total comprehensive income (loss) +$ +(758,898 +) +$ +(449,800 +) +$ +660,155 +____________________________________________ +(1) +Refer to Note 1 - Summary of Significant Accounting Policies for detail of the pension amount reclassified to general and administrative expense on the Company ’s consolidated statements of operations. +The accompanying notes are an integral part of these consolidated financial statements. +87 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share amounts) +Additional Paid-in Capital +Accumulated Other Comprehensive Loss +Total Stockholders’ Equity +Common Stock +Treasury Stock +Retained Earnings +Shares +Amount +Shares +Amount +Balances, January 1, 2014 +67,078,853 +$ +671 +$ +257,720 +(22,412 +) +$ +(823 +) +$ +1,354,669 +$ +(5,416 +) +$ +1,606,821 +Net income +— +— +— +— +— +666,051 +— +666,051 +Other comprehensive loss +— +— +— +— +— +— +(5,896 +) +(5,896 +) +Cash dividends, $ 0.10 per share +— +— +— +— +— +(6,723 +) +— +(6,723 +) +Issuance of common stock under Employee Stock Purchase Plan +83,136 +1 +4,060 +— +— +— +— +4,061 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +256,718 +3 +(10,627 +) +— +— +— +— +(10,624 +) +Issuance of common stock upon stock option exercises +39,088 +— +816 +— +— +— +— +816 +Stock-based compensation expense +5,265 +— +31,871 +22,412 +823 +— +— +32,694 +Other income tax expense +— +— +(545 +) +— +— +— +— +(545 +) +Balances, December 31, 2014 +67,463,060 +$ +675 +$ +283,295 +— +$ +— +$ +2,013,997 +$ +(11,312 +) +$ +2,286,655 +Net loss +— +— +— +— +— +(447,710 +) +— +(447,710 +) +Other comprehensive loss +— +— +— +— +— +— +(2,090 +) +(2,090 +) +Cash dividends, $ 0.10 per share +— +— +— +— +— +(6,772 +) +— +(6,772 +) +Issuance of common stock under Employee Stock Purchase Plan +197,214 +2 +4,842 +— +— +— +— +4,844 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +375,523 +4 +(8,682 +) +— +— +— +— +(8,678 +) +Stock-based compensation expense +39,903 +— +27,467 +— +— +— +— +27,467 +Other income tax expense +— +— +(1,315 +) +— +— +— +— +(1,315 +) +Balances, December 31, 2015 +68,075,700 +$ +681 +$ +305,607 +— +$ +— +$ +1,559,515 +$ +(13,402 +) +$ +1,852,401 +Net loss +— +— +— +— +— +(757,744 +) +— +(757,744 +) +Other comprehensive loss +— +— +— +— +— +— +(1,154 +) +(1,154 +) +Cash dividends, $ 0.10 per share +— +— +— +— +— +(7,751 +) +— +(7,751 +) +Issuance of common stock under Employee Stock Purchase Plan +218,135 +2 +4,196 +— +— +— +— +4,198 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +199,243 +2 +(2,356 +) +— +— +— +— +(2,354 +) +Stock-based compensation expense +53,473 +1 +26,896 +— +— +— +— +26,897 +Issuance of common stock from stock offerings, net of tax +42,710,949 +427 +1,382,666 +— +— +— +— +1,383,093 +Equity component of 1.50% Senior Convertible Notes due 2021 issuance, net of tax +— +— +33,575 +— +— +— +— +33,575 +Purchase of capped call transactions +— +— +(24,195 +) +— +— +— +— +(24,195 +) +Other income tax expense +— +— +(9,833 +) +— +— +— +— +(9,833 +) +Balances, December 31, 2016 +111,257,500 +$ +1,113 +$ +1,716,556 +— +$ +— +$ +794,020 +$ +(14,556 +) +$ +2,497,133 +The accompanying notes are an integral part of these consolidated financial statements. +88 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2016 +2015 +2014 +Cash flows from operating activities: +Net income (loss) +$ +(757,744 +) +$ +(447,710 +) +$ +666,051 +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Net gain on divestiture activity +(37,074 +) +(43,031 +) +(646 +) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +790,745 +921,009 +767,532 +Exploratory dry hole expense +(16 +) +36,612 +44,427 +Impairment of proved properties +354,614 +468,679 +84,480 +Abandonment and impairment of unproved properties +80,367 +78,643 +75,638 +Impairment of other property and equipment +— +49,369 +— +Stock-based compensation expense +26,897 +27,467 +32,694 +Change in Net Profits Plan liability +(7,200 +) +(19,525 +) +(29,849 +) +Net derivative (gain) loss +250,633 +(408,831 +) +(583,264 +) +Derivative settlement gain +329,478 +512,566 +12,615 +Amortization of discount and deferred financing costs +9,938 +7,710 +6,146 +Non-cash (gain) loss on extinguishment of debt +(15,722 +) +4,123 +— +Deferred income taxes +(448,643 +) +(276,722 +) +397,780 +Plugging and abandonment +(6,214 +) +(7,496 +) +(8,796 +) +Other, net +3,499 +13,761 +1,069 +Changes in current assets and liabilities: +Accounts receivable +(10,562 +) +140,200 +24,088 +Prepaid expenses and other +8,478 +2,563 +(1,822 +) +Accounts payable and accrued expenses +(53,210 +) +(86,267 +) +9,466 +Accrued derivative settlements +34,540 +5,232 +(41,034 +) +Net cash provided by operating activities +552,804 +978,352 +1,456,575 +Cash flows from investing activities: +Net proceeds from the sale of oil and gas properties +946,062 +357,938 +43,858 +Capital expenditures +(629,911 +) +(1,493,608 +) +(1,974,798 +) +Acquisition of proved and unproved oil and gas properties +(2,183,790 +) +(7,984 +) +(544,553 +) +Other, net +(3,000 +) +(985 +) +(3,256 +) +Net cash used in investing activities +(1,870,639 +) +(1,144,639 +) +(2,478,749 +) +Cash flows from financing activities: +Proceeds from credit facility +947,000 +1,872,500 +1,285,500 +Repayment of credit facility +(1,149,000 +) +(1,836,500 +) +(1,119,500 +) +Debt issuance costs related to credit facility +(3,132 +) +— +(3,388 +) +Net proceeds from Senior Notes +491,640 +490,951 +589,991 +Cash paid to repurchase Senior Notes +(29,904 +) +(350,000 +) +— +Net proceeds from Senior Convertible Notes +166,617 +— +— +Cash paid for capped call transactions +(24,195 +) +— +— +Net proceeds from sale of common stock +938,268 +4,844 +4,877 +Dividends paid +(7,751 +) +(6,772 +) +(6,723 +) +Net share settlement from issuance of stock awards +(2,354 +) +(8,678 +) +(10,624 +) +Other, net +— +(160 +) +(87 +) +Net cash provided by financing activities +1,327,189 +166,185 +740,046 +Net change in cash and cash equivalents +9,354 +(102 +) +(282,128 +) +Cash and cash equivalents at beginning of period +18 +120 +282,248 +Cash and cash equivalents at end of period +$ +9,372 +$ +18 +$ +120 +The accompanying notes are an integral part of these consolidated financial statements. +89 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) +Supplemental schedule of additional cash flow information and non-cash activities: +For the Years Ended +December 31, +2016 +2015 +2014 +(in thousands) +Supplemental Cash Flow Information: +Operating activities: +Cash paid for interest, net of capitalized interest +$ +129,761 +$ +126,988 +$ +89,145 +Net cash (refunded) paid for income taxes +$ +(4,690 +) +$ +1,630 +$ +1,936 +Investing activities: +Changes in capital expenditure accruals and other +$ +8,044 +$ +(210,819 +) +$ +130,143 +Supplemental Non-Cash Investing Activities: +Fair value of properties exchanged +$ +733 +$ +— +$ +6,164 +Supplemental Non-Cash Financing Activities: +Issuance of common stock for an asset acquisition (1) +$ +437,194 +$ +— +$ +— +____________________________________________ +(1) +Refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale and Note 15 - Equity for additional discussion. +90 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company is an independent energy company engaged in the acquisition, exploration, development, and production of crude oil and condensate, natural gas, and NGLs in onshore North America. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Intercompany accounts and transactions have been eliminated. In connection with the preparation of the consolidated financial statements, the Company evaluated subsequent events after the balance sheet date of December 31, 2016 , through the filing date of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the consolidated financial statements. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of depletion, depreciation, and amortization expense, impairment of proved properties, and asset retirement obligations, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents +The Company considers all liquid investments purchased with an initial maturity of three months or less to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. +Accounts Receivable +The Company’s accounts receivable consist mainly of receivables from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables from joint interest owners, the Company typically has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil and gas receivables are collected within two months and the Company has had minimal bad debts. +Although diversified among many companies, collectability is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. The Company’s allowance for doubtful accounts as of December 31, 2016 , and 2015 , totaled $1.7 million and $1.1 million , respectively, primarily for receivables from joint interest owners. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to regular review. +91 +The Company does not believe the loss of any single purchaser of its production would materially impact its operating results, as crude oil, natural gas, and NGLs are products with well-established markets and numerous purchasers in the Company’s operating regions. The Company had the following major customer and sales to entities under common ownership, which accounted for 10 percent or more of its total oil, natural gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2016 +2015 +2014 +Major customer (1) +18 +% +21 +% +19 +% +Group #1 of entities under common ownership (2) +15 +% +10 +% +14 +% +Group #2 of entities under common ownership (2) +8 +% +11 +% +9 +% +____________________________________________ +(1) +This major customer is the operator of the Company’s outside-operated Eagle Ford shale program, in which the Company entered into various marketing agreements with during 2013, whereby the Company is subject to certain gathering, transportation, and processing throughput commitments for up to 10 years pursuant to each contract. Because the Company shares with its operator the risk of non-performance by its counterparty purchasers, the Company has included its operator as a major customer in the table above. Several of the operator’s counterparty purchasers under these contracts are also direct purchasers of the Company’s production from other areas. As of December 31, 2016, the Company’s outside-operated Eagle Ford shale assets were classified as held for sale. +(2) +In the aggregate these groups of entities under common ownership represent more than 10 percent of total production revenue for the period(s) shown, however, none of the entities comprising either group individually represented more than 10 percent of the Company’s production revenue. +The Company’s policy is to use the commodity affiliates of the lenders under its Credit Agreement as its derivative counterparties, and each counterparty must have investment grade senior unsecured debt ratings. Each of the Company’s 10 derivative counterparties meet both of these requirements as of the filing date of this report. +The Company has accounts in the following locations with a national bank: Denver, Colorado ; Houston, Texas ; Midland, Texas ; and Billings, Montana . The Company’s policy is to invest in highly-rated instruments and to limit the amount of credit exposure at each individual institution. +Oil and Gas Producing Activities +Proved properties . The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, the costs of development wells are capitalized whether those wells are successful or unsuccessful. Capitalized drilling costs, including lease and well equipment and intangible development costs, are depleted as a group of assets (properties aggregated with a common geological structure) using the units-of-production method based on estimated proved developed oil and gas reserves. Similarly, producing leasehold costs are depleted on the same group asset basis; however, the units-of-production method is based on estimated total proved oil and gas reserves. The computation of DD&A takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. +Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Expected future discounted cash flows are calculated on all proved reserves and risk adjusted probable and possible reserves using discount rates and price forecasts that management believes are representative of current market conditions. The prices for oil and gas are forecasted based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecasted using OPIS pricing, adjusted for basis differentials, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. Please refer to Note 11 – Fair Value Measurements for additional discussion. +The partial sale of a proved property within an existing field is accounted for as a normal retirement and no net gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A net gain or loss on divestiture activity is recognized in the accompanying consolidated statements of operations (“accompanying statements of operations”) for all other sales of proved properties. +92 +Unproved properties . Unproved properties consist of costs to acquire undeveloped leases as well as acquisitions of unproved reserves. When successful wells are drilled on undeveloped leaseholds, unproved property costs are reclassified to proved properties and depleted on a units-of-production basis. An impairment is recorded on unproved property when the Company determines that either the property will not be developed or the carrying value is not realizable. Please refer to Note 11 – Fair Value Measurements for additional discussion. +The partial sale of unproved property is accounted for as a recovery of cost when substantial uncertainty exists as to the ultimate recovery of the cost applicable to the interest retained. A net gain on divestiture activity is recognized to the extent that the sales price exceeds the carrying amount of the unproved property. A net gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of unproved property. +Exploratory . G&G, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Under the successful efforts method, exploratory well costs are capitalized pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that economic proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in cash flows from investing activities as part of capital expenditures within the accompanying consolidated statements of cash flows. +Other Property and Equipment +Other property and equipment such as facilities, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing and installation activities. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from three to 30 years, or the unit of output method where appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the accounts. +A long-lived asset is evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. The Company uses an income valuation technique if there is not a market-observable price for the asset. Please refer to Note 11 - Fair Value Measurements for additional discussion. +Assets Held for Sale +Any properties held for sale as of the balance sheet date have been classified as assets held for sale and are separately presented on the accompanying consolidated balance sheets (“accompanying balance sheets”) at the lower of carrying value or fair value less the cost to sell. Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale and Note 11 - Fair Value Measurements for additional discussion. +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties, including facilities requiring decommissioning. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired and a facility is constructed. The increase in carrying value is included in proved oil and gas properties in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and gas properties. Cash paid to settle asset retirement obligations is included in the operating section of the Company’s accompanying consolidated statements of cash flows. +93 +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent . In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or changes in inflation factors or the Company’s credit-adjusted risk-free rate as market conditions warrant. Please refer to Note 9 – Asset Retirement Obligations for a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2016, and 2015. +Derivative Financial Instruments +The Company seeks to manage or reduce commodity price risk on its production by entering into derivative contracts. The Company seeks to minimize its basis risk and indexes its oil derivative contracts to NYMEX prices, its NGL derivative contracts to OPIS prices, and its gas derivative contracts to various regional index prices associated with pipelines into which the Company’s gas production is sold. The Company does not designate its derivative instruments to qualify for hedge accounting. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its accompanying statements of operations as they occur. For additional discussion on derivatives, please see Note 10 – Derivative Financial Instruments . +Revenue Recognition +The Company derives revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized when the Company’s production is delivered to the purchaser, but payment is generally received between 30 and 90 days after the date of production. No revenue is recognized unless it is determined that title to the product has transferred to the purchaser. At the end of each month, the Company estimates the amount of production delivered to the purchaser and the price the Company will receive. The Company uses knowledge of its properties and historical performance, contractual agreements, NYMEX, OPIS, and local spot market prices, quality and transportation differentials, and other factors as the basis for these estimates. The Company follows the sales method of accounting for natural gas production imbalances. If the Company’s sales volumes for a well exceed the Company’s proportionate share of production from the well, a liability is recognized to the extent that the Company’s share of estimated remaining recoverable reserves from the well is insufficient to satisfy this imbalance. +Stock-Based Compensation +At December 31, 2016 , the Company had stock-based employee compensation plans that included RSUs and PSUs issued to employees and restricted stock issued to non-employee directors, as well as an employee stock purchase plan available to eligible employees. These are more fully described in Note 7 - Compensation Plans. The Company records expense associated with the fair value of stock-based compensation in accordance with authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant, and included within general and administrative expense and exploration expense in the accompanying statements of operations. +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. +94 +Earnings per Share +Basic net income (loss) per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average common shares outstanding for the respective period. The earnings per share calculations reflect the impact of any repurchases of shares of common stock made by the Company. +Diluted net income (loss) per common share is calculated by dividing adjusted net income or loss by the diluted weighted-average common shares outstanding, which includes the effect of potentially dilutive securities. Potentially dilutive securities for this calculation consist of unvested RSUs, contingent PSUs, shares issuable upon the conversion of the Senior Convertible Notes, and in-the-money outstanding stock options, which are measured using the treasury stock method. All outstanding stock options were exercised during the year ended December 31, 2014. When the Company recognizes a loss from continuing operations, as was the case for the years ended December 31, 2016 , and 2015 , all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of diluted earnings per share. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three -year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 7 – Compensation Plans under the heading Performance Share Units . +On August 12, 2016, the Company issued $172.5 million in aggregate principal amount of Senior Convertible Notes due 2021. Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. The Company has initially elected a net-settlement method to satisfy its conversion obligation, which allows the Company to settle the principal amount of the Senior Convertible Notes in cash and to settle the excess conversion value in shares, as well as cash in lieu of fractional shares. However, the Company reserves the right to settle the Senior Convertible Notes in any manner allowed under the indenture as business conditions warrant. Shares of the Company’s common stock traded at an average closing price below the $40.50 conversion price for the portion of the year ended December 31, 2016, during which the Senior Convertible Notes were outstanding. In connection with the Senior Convertible Notes offering, the Company entered into capped call transactions with affiliates of the underwriters that effectively prevent dilution upon settlement up to the $60.00 cap price. The capped call transactions are not reflected in diluted net income per share, nor will they ever be, as they are anti-dilutive. Please refer to Note 5 - Long-Term Debt for additional discussion. +The following table details the weighted-average dilutive and anti-dilutive securities for the years presented: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Dilutive +— +— +814 +Anti-dilutive +280 +256 +— +95 +The following table sets forth the calculations of basic and diluted earnings per share: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands, except per share amounts) +Net income (loss) +$ +(757,744 +) +$ +(447,710 +) +$ +666,051 +Basic weighted-average common shares outstanding +76,568 +67,723 +67,230 +Add: dilutive effect of unvested RSUs, contingent PSUs, and stock options (1) +— +— +814 +Add: dilutive effect of 1.50% Senior Convertible Notes (2) +— +— +— +Diluted weighted-average common shares outstanding +76,568 +67,723 +68,044 +Basic net income (loss) per common share +$ +(9.90 +) +$ +(6.61 +) +$ +9.91 +Diluted net income (loss) per common share +$ +(9.90 +) +$ +(6.61 +) +$ +9.79 +____________________________________________ +(1) +For the years ended December 31, 2016 , and 2015 , the shares were anti-dilutive and excluded from the calculation of diluted earnings per share. +(2) +For the year ended December 31, 2016 , shares of the Company’s common stock traded at an average closing price below the $40.50 conversion price, and therefore, had no dilutive impact and were excluded from the calculation of diluted earnings per share. +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income (loss). +The changes in the balances of components comprising other comprehensive income (loss) are presented in the following table: +Pension Liability Adjustments +(in thousands) +For the year ended December 31, 2014 +Net actuarial loss +$ +(10,062 +) +Reclassification to earnings +706 +Tax benefit +3,460 +Loss, net of tax +$ +(5,896 +) +For the year ended December 31, 2015 +Net actuarial loss +$ +(4,990 +) +Reclassification to earnings +1,853 +Tax benefit +1,047 +Loss, net of tax +$ +(2,090 +) +For the year ended December 31, 2016 +Net actuarial loss +$ +(3,322 +) +Reclassification to earnings +1,598 +Tax benefit +570 +Loss, net of tax +$ +(1,154 +) +96 +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The recorded value of the Company’s credit facility approximates its fair value as it bears interest at a floating rate that approximates a current market rate. The Company had a zero balance under its credit facility as of December 31, 2016 , compared with $202.0 million of outstanding loans as of December 31, 2015 . The Company’s Senior Notes and Senior Convertible Notes are recorded at cost, net of any unamortized discount and deferred financing costs, and the respective fair values are disclosed in Note 11 - Fair Value Measurements. The Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry within the United States. The Company reports as a single industry segment. Prior to the sale of the Company’s Mid-Continent assets in 2015, the Company acted as the first purchaser of natural gas and natural gas liquids produced by third parties in certain cases. The Company considered this function as ancillary to its oil and gas producing activities. The amount of income these operations generated from marketing gas produced by third parties was not material to the Company’s results of operations, and segmentation of such activity would not have provided a better understanding of the Company’s performance. However, gross revenue and expense related to marketing activities for gas produced by third parties is presented in the marketed gas system revenue and marketed gas system expense line items in the accompanying statements of operations. There was no marketed gas system revenue or expense recorded for the year ended December 31, 2016. +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPE”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that the Company is the primary beneficiary of a variable interest entity, that entity is consolidated. The Company has not been involved in any unconsolidated SPE transactions in 2016 or 2015 . +Recently Issued Accounting Standards +Effective January 1, 2016, the Company adopted, on a retrospective basis, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis . This ASU clarifies the consolidation reporting guidance in GAAP. There was no impact to the Company’s financial statements or disclosures from the adoption of this standard. +Effective December 31, 2016, the Company adopted FASB ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern . This ASU requires management to evaluate whether there are conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the entity’s financial statements are issued, or within one year after the date the entity’s financial statements are available to be issued, and to provide disclosures when certain criteria are met. There was no impact to the Company’s financial statements or disclosures from the adoption of this standard. +In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”) for the recognition of revenue from contracts with customers. Subsequent to the issuance of this ASU, the FASB issued additional related ASUs as follows: +• +In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date . This ASU deferred the effective date of ASU 2014-09 by one year. +• +In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) . This ASU amends the principal versus agent guidance in ASU No. 2014-09. +97 +• +In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing . This ASU amends the identification of performance obligations and accounting for licenses in ASU 2014-09. +• +In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. This ASU amends certain issues in ASU 2014-09 on transition, collectibility, noncash consideration, and the presentation of sales taxes and other similar taxes. +• +In December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers . This ASU is meant to improve and clarify or to correct unintended application of narrow aspects of the guidance in ASU 2014-09. +ASU 2014-09 and each update have the same effective date and transition requirements. That is, the guidance under these standards is to be applied using a full retrospective method or a modified retrospective method, as outlined in ASU 2014-09, and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted only for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company has established a cross-functional implementation team that is currently evaluating the provisions of each of these standards, analyzing their impact on the Company’s contract portfolio, reviewing current accounting policies and practices to identify potential differences that would result from applying the requirements of these standards to the Company’s revenue contracts, and assessing their potential impact on the Company’s financial statements and disclosures. The Company currently plans to apply the modified retrospective method upon adoption and plans to adopt the guidance on the effective date of January 1, 2018. +In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which changes the accounting for leases. This guidance is to be applied using a modified retrospective method and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the provisions of this guidance and assessing its potential impact on the Company’s financial statements and disclosures. +In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . This ASU makes targeted amendments to the accounting for employee share-based payments. This guidance is to be applied using various transition methods, such as full retrospective, modified retrospective, and prospective, based on the criteria for the specific amendments as outlined in the guidance. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. Early adoption is permitted, as long as all of the amendments are adopted in the same period; however, the Company plans on adopting in the first quarter of 2017. The Company is currently evaluating the provisions of this guidance and assessing its potential impact on the Company’s financial statements and disclosures. +In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. This guidance is to be applied using a retrospective method. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, as long as all of the amendments are adopted in the same period. The Company is currently evaluating the provisions of this guidance and assessing its potential impact on the Company’s financial statements and disclosures. +In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. This ASU clarifies how entities should present restricted cash and restricted cash equivalents in the statement of cash flows. This guidance is to be applied using a retrospective method and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. The Company is currently evaluating the provisions of this guidance and assessing its potential impact on the Company’s financial statements and disclosures. +In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). This ASU clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance is to be applied using a prospective method and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted as outlined in ASU 2017-01. The Company is currently evaluating the provisions of this guidance and assessing its potential impact on the Company’s financial statements and disclosures. +98 +In February 2017, the FASB issued ASU No. 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets . This ASU is meant to clarify the scope of ASC Subtopic 610-20, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets and to add guidance for partial sales of nonfinancial assets. This guidance is to be applied using a full retrospective method or a modified retrospective method as outlined in the guidance and is effective at the same time as ASU 2014-09. Further, the Company is required to adopt this guidance at the same time that it adopts the guidance in ASU 2014-09. The Company is currently evaluating the provisions of this guidance and assessing its potential impact on the Company’s financial statements and disclosures. +There are no other accounting standards applicable to the Company that would have a material effect on the Company’s financial statements and disclosures that have been issued but not yet adopted by the Company as of December 31, 2016 , and through the filing date of this report. +Note 2 – Accounts Receivable and Accounts Payable and Accrued Expenses +Accounts receivable are comprised of the following: +As of December 31, +2016 +2015 +(in thousands) +Accrued oil, gas, and NGL production revenue +$ +96,101 +$ +58,256 +Amounts due from joint interest owners +29,669 +22,269 +State severance tax refunds +15,320 +12,072 +Accrued derivative settlements +6,512 +34,579 +Other +4,348 +6,948 +Total accounts receivable +$ +151,950 +$ +134,124 +Accounts payable and accrued expenses are comprised of the following: +As of December 31, +2016 +2015 +(in thousands) +Accrued capital expenditures +$ +107,009 +$ +97,355 +Revenue and severance tax payable +39,617 +44,387 +Accrued lease operating expense +15,956 +21,943 +Accrued property taxes +6,606 +14,078 +Accrued compensation +34,761 +41,154 +Accrued derivative settlements +6,473 +— +Accrued interest +45,059 +34,378 +Other +44,227 +49,222 +Total accounts payable and accrued expenses +$ +299,708 +$ +302,517 +99 +Note 3 – Acquisitions, Divestitures, and Assets Held for Sale +2016 Acquisition Activity +• +Rock Oil Acquisition. On October 4, 2016 , the Company acquired all membership interests of JPM EOC Opal, LLC, which owned proved and unproved properties in the Midland Basin, from Rock Oil Holdings, LLC (referred to as the “Rock Oil Acquisition”) for an adjusted purchase price of $991.0 million . The effective date of the acquisition was September 1, 2016. The Company funded the acquisition with proceeds from divestitures in 2016 and the Senior Convertible Notes and equity offerings in August 2016, as discussed in Note 5 - Long-Term Debt and Note 15 - Equity , respectively. +The Company determined that the Rock Oil Acquisition met the criteria of a business combination under ASC Topic 805, Business Combinations . The Company allocated the preliminary adjusted purchase price to the acquired assets and liabilities based on fair value as of the acquisition date, as summarized in the table below. This measurement resulted in no goodwill or bargain purchase gain being recognized. Refer to Note 11 - Fair Value Measurements for additional discussion on the valuation techniques used in determining the fair value of the acquired properties. The acquisition costs were insignificant and were expensed as incurred. +As of October 4, 2016 +(in thousands) +Cash consideration +$ +991,038 +Fair value of assets and liabilities acquired: +Wells in progress +$ +5,672 +Proved oil and gas properties +81,917 +Unproved oil and gas properties +913,594 +Other assets +5,338 +Total fair value of oil and gas properties acquired +1,006,521 +Working capital +(7,888 +) +Asset retirement obligation +(7,595 +) +Total fair value of net assets acquired +$ +991,038 +• +QStar Acquisition. On December 21, 2016 , the Company acquired additional proved and unproved properties in the Midland Basin from QStar LLC and RRP-QStar, LLC (referred to as the “QStar Acquisition”) for $1.6 billion , consisting of $1.2 billion in cash consideration and the issuance of approximately 13.4 million shares of the Company’s common stock. The cash consideration was funded by proceeds from the recent Raven/Bear Den divestiture and the December 2016 equity offering. Please refer to Note 15 - Equity for additional discussion. The effective date of the acquisition was September 1, 2016 . Under authoritative accounting guidance, the transaction was considered an asset acquisition, and therefore, the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and transaction costs were capitalized as a component of the cost of the assets acquired. +100 +The Company allocated the preliminary adjusted purchase price to the acquired assets and liabilities, as summarized in the table below. +As of December 21, 2016 +(in thousands) +Cash consideration, including acquisition costs paid +$ +1,167,373 +Fair value of equity consideration (1) +437,194 +Total consideration at closing +$ +1,604,567 +Assets and liabilities acquired: +Wells in progress +$ +21,812 +Proved oil and gas properties +61,614 +Unproved oil and gas properties +1,537,923 +Total oil and gas properties acquired +1,621,349 +Working capital +(9,141 +) +Asset retirement obligation +(7,641 +) +Total net assets acquired +$ +1,604,567 +____________________________________________ +(1) +The Company issued approximately 13.4 million shares of common stock, par value $0.01 per share, in a private placement to the sellers in the QStar Acquisition on December 21, 2016. The equity consideration was valued on this date using Level 1 and Level 2 inputs with a discount applied due to the lack of marketability in the near term in accordance with the Lock-Up and Registration Rights Agreement that prohibits the sale of such stock until no earlier than the 90th day after issuance. +The Rock Oil Acquisition and QStar Acquisition are each subject to normal post-closing adjustments expected to occur in the first half of 2017. These post-closing adjustments are estimated as of December 31, 2016, and reflected in the tables above. +• +Other Acquisitions. During the fourth quarter of 2016, the Company entered into a definitive purchase agreement to acquire approximately 2,900 net acres of oil and gas assets in the Midland Basin for a gross purchase price of $60 million , subject to customary purchase price adjustments. This acquisition closed subsequent to December 31, 2016. +2015 Acquisition Activity +There was no significant acquisition activity during the year ended December 31, 2015. +2014 Acquisition Activity +• +Gooseneck Property Acquisitions +On September 24, 2014 , the Company acquired approximately 61,000 net acres of proved and unproved oil and gas properties in its Gooseneck area in North Dakota, along with related equipment, contracts, records, and other assets. Total cash consideration paid by the Company after final closing adjustments was $321.8 million and the effective date for the acquisition was July 1, 2014 . +On October 15, 2014 , the Company acquired additional interests in proved and unproved oil and gas properties in its Gooseneck area. Total cash consideration paid by the Company was $84.8 million and the effective date for the acquisition was August 1, 2014 . +Each of these acquisitions qualified as a business combination under ASC Topic 805, Business Combinations . The Company allocated the final adjusted purchase prices to the acquired assets and liabilities based on fair value as of the respective acquisition dates, as summarized in the table below. These measurements resulted in no goodwill or bargain purchase gain being recognized. +101 +Acquisition #1 +Acquisition #2 +As of September 24, 2014 +As of October 15, 2014 +(in thousands) +Cash consideration +$ +321,807 +$ +84,836 +Fair value of assets and liabilities acquired: +Proved oil and gas properties +$ +203,467 +$ +54,612 +Unproved oil and gas properties +126,588 +29,610 +Total fair value of oil and gas properties acquired +330,055 +84,222 +Working capital +(6,135 +) +2,232 +Asset retirement obligation +(2,113 +) +(1,618 +) +Total fair value of net assets acquired +$ +321,807 +$ +84,836 +• +Rocky Mountain Acquisitions. In addition to the Gooseneck property acquisitions discussed above, the Company acquired other proved and unproved properties in its Rocky Mountain region during 2014, primarily in the Powder River Basin, in multiple transactions for approximately $135.5 million in total cash consideration after final closing adjustments, plus approximately 7,000 net acres of non-core assets in the Company’s Rocky Mountain region. +2016 Divestiture Activity +• +Rocky Mountain Divestitures. During the third quarter of 2016, the Company divested certain non-core properties in the Williston Basin and Powder River Basin in two separate packages for total cash received at closing, net of commissions and payments to Net Profits Plan participants (referred throughout this report as “net divestiture proceeds”), of $110.6 million . The Company recorded a net gain of $16.4 million related to these divested assets for the year ended December 31, 2016 . +During the fourth quarter of 2016, the Company divested certain Williston Basin assets located outside of Divide County, North Dakota (referred to as “Raven/Bear Den” throughout this report) for net divestiture proceeds of $756.2 million . The Company recorded a net gain of $29.5 million related to these divested assets for the year ended December 31, 2016 . In conjunction with the divestiture of certain Rocky Mountain assets, the Company closed its Billings, Montana office. Please refer to Note 14 - Exit and Disposal Costs for additional discussion. +The following table presents income (loss) before income taxes of the Raven/Bear Den assets sold on December 1, 2016, for the years ended December 31, 2016, 2015, and 2014. This divestiture is considered a disposal of a significant asset group. +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Income (loss) before income taxes (1) +$ +(6,601 +) +$ +(12,530 +) +$ +197,256 +____________________________________________ +(1) +Income (loss) before income taxes reflects oil, gas, and NGL production revenue, less oil, gas, and NGL production expense and depletion, depreciation, amortization, and asset retirement obligation liability accretion. Additionally, income (loss) before income taxes includes impairment of proved properties expense of approximately $17.8 million for the year ended December 31, 2015. +• +Permian Divestiture. During the third quarter of 2016, the Company divested its non-core properties in southeast New Mexico for net divestiture proceeds of $54.6 million and recorded a net loss of $10.1 million for the year ended December 31, 2016 . +Each of these divestitures are subject to normal post-closing adjustments, and the respective post-closings are expected to occur in the first half of 2017. +102 +2015 Divestiture Activity +• +Mid-Continent Divestiture. During the second quarter of 2015, the Company divested its Mid-Continent assets in multiple transactions for total net divestiture proceeds of $310.3 million and a final net gain of $108.4 million . In conjunction with the divestiture of its Mid-Continent assets, the Company closed its Tulsa, Oklahoma office. Please refer to Note 14 - Exit and Disposal Costs for additional discussion. +• +Permian Divestiture. During the fourth quarter of 2015, the Company divested certain non-core assets in its Permian region. Net divestiture proceeds were $25.1 million and the final net gain on this divestiture was $2.3 million . +Write-downs on certain other assets held for sale and subsequently sold during the year ended December 31, 2015, totaled $68.6 million , which partially offset the net gain on the Mid-Continent and Permian divestitures discussed above. +2014 Divestiture Activity +• +Rocky Mountain Divestiture. During the second quarter of 2014, the Company divested certain non-core assets in the Montana portion of the Williston Basin. Net divestiture proceeds were $42.0 million and the final net gain on this divestiture was $26.9 million . +The Company recorded $27.6 million of write-downs to fair value less estimated costs to sell for assets that were held for sale during the year ended December 31, 2014, which offset the net gain on the Rocky Mountain Divestiture discussed above. +Assets Held for Sale +Assets are classified as held for sale when the Company commits to a plan to sell the assets and there is reasonable certainty the sale will take place within one year. Upon classification as held for sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to identify and expense any excess of carrying value over fair value less costs to sell. Any subsequent changes to the fair value less estimated costs to sell impact the measurement of assets held for sale, with any gain or loss reflected in the net gain on divestiture activity line item in the accompanying statements of operations. +As of December 31, 2016 , the accompanying balance sheets present $372.6 million of assets held for sale, net of accumulated depletion, depreciation, and amortization expense, which consists of the Company’s outside-operated Eagle Ford shale assets. A corresponding aggregate asset retirement obligation liability of $26.2 million is separately presented. There were no material assets held for sale as of December 31, 2015. +Subsequent to December 31, 2016 , the Company entered into a definitive agreement with Venado EF LLC (“Venado”) for the sale of its outside-operated Eagle Ford shale assets, including its ownership interest in related midstream assets (the “Eagle Ford Transaction”) for a gross purchase price of $800 million , subject to customary purchase price adjustments. The Company expects to close the Eagle Ford Transaction in the first quarter of 2017. +Pursuant to the Venado definitive agreement, the Company entered into certain NYMEX swap contracts to be novated to Venado at closing, as summarized below: +• +Oil swap contracts through the fourth quarter of 2021 for a total of 4.3 million Bbls of oil production at contract prices ranging from $54.05 to $57.00 per Bbl. +• +Gas swap contracts through the fourth quarter of 2021 for a total of 4.6 million MMBtu of gas production at contract prices ranging from $2.82 to $2.99 per MMBtu. +• +NGL swap contracts through the fourth quarter of 2019 for a total of 4.5 million Bbls of NGL production at contract prices ranging from $11.81 to $48.51 per Bbl. +The Company is not at risk of a net financial obligation with the derivative counterparties should the value of the contracts become negative, unless the Eagle Ford Transaction is terminated because the Company did not comply in all material respects with its covenants under the definitive agreement or because of a material inaccuracy of the Company’s representations and warranties. +103 +The closing of the Eagle Ford Transaction is subject to the satisfaction of customary closing conditions, and there can be no assurance that it will close on the expected closing date or at all. +The following table presents income (loss) before income taxes for the years ended December 31, 2016, 2015, and 2014, of the Company’s outside-operated Eagle Ford shale assets held for sale as of December 31, 2016, which is considered a significant asset disposal group. +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Income (loss) before income taxes (1) +$ +(218,506 +) +$ +71,556 +$ +294,376 +____________________________________________ +(1) +Income (loss) before income taxes reflects oil, gas, and NGL production revenue less oil, gas, and NGL production expense and depletion, depreciation, amortization, and asset retirement obligation liability accretion expense. Additionally, loss before income taxes for the year ended December 31, 2016 , includes $269.6 million of proved property impairment expense. +Subsequent to December 31, 2016, the Company announced its plans to sell its remaining Williston Basin assets in the Divide County, North Dakota area (referred to as “Divide County” throughout this report) by mid-year 2017. These assets were classified as held and used as of December 31, 2016. Based on preliminary estimates of fair value less selling costs as of the filing date of this report, the Company expects to record a write down in the range of $200 million to $400 million in the first quarter of 2017 upon the Divide County assets being reclassified to held for sale. +The Company determined that neither these planned nor executed asset sales qualify for discontinued operations accounting under financial statement presentation authoritative guidance. +104 +Note 4 – Income Taxes +The provision for income taxes consists of the following: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Current portion of income tax expense +Federal +$ +2,932 +$ +— +$ +— +State +1,539 +1,571 +868 +Deferred portion of income tax expense (benefit) +(448,643 +) +(276,722 +) +397,780 +Total income tax expense (benefit) +$ +(444,172 +) +$ +(275,151 +) +$ +398,648 +Effective tax rate +37.0 +% +38.1 +% +37.4 +% +The components of the net deferred income tax liabilities are as follows: +As of December 31, +2016 +2015 +(in thousands) +Deferred tax liabilities: +Oil and gas properties +$ +518,394 +$ +854,029 +Derivative asset +— +179,543 +Other +7,733 +1,233 +Total deferred tax liabilities +526,127 +1,034,805 +Deferred tax assets: +Federal and state tax net operating loss carryovers +151,343 +244,942 +Derivative liability +31,349 +— +Stock compensation +10,083 +14,529 +Credit carryover +12,448 +6,952 +Other liabilities +10,567 +20,497 +Total deferred tax assets +215,790 +286,920 +Valuation allowance +(5,335 +) +(10,394 +) +Net deferred tax assets +210,455 +276,526 +Total net deferred tax liabilities +$ +315,672 +$ +758,279 +Current federal income tax refundable +$ +644 +$ +5,378 +Current state income tax refundable +$ +— +$ +65 +Current state income tax payable +$ +1,181 +$ +— +At December 31, 2016 , the Company estimated its federal net operating loss (“NOL”) carryforward at $540.2 million , which includes unrecognized excess income tax benefits associated with stock awards of $126.7 million . The Company also has federal R&D credit carryforwards of $7.2 million . The federal NOL carryforward begins to expire in 2031 and the federal R&D credit carryforwards expire between 2028 and 2033. The Company’s alternative minimum tax (“AMT”) credit carryforward of $5.6 million does not expire. State NOL carryforwards were $184.6 million and state tax credits were $528,000 as of December 31, 2016 . State NOLs and credits expire between 2017 and 2037. The Company’s current valuation allowance relates to state NOL carryforwards and state tax credits, which the Company anticipates will expire before they can be utilized. The change in the valuation allowance from 2015 to 2016 primarily relates to anticipated utilization of accumulated charitable contributions and an allocable change to the Company’s mix of state apportioned losses and the anticipated utilization of state cumulative NOLs. +105 +Federal income tax expense differs from the amount that would be provided by applying the statutory United States federal income tax rate to income before income taxes primarily due to the effect of state income taxes, changes in valuation allowances, R&D credits, and accumulated impacts of other smaller permanent differences, reported as follows: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Federal statutory tax expense (benefit) +$ +(420,671 +) +$ +(253,001 +) +$ +372,644 +Increase (decrease) in tax resulting from: +State tax expense (benefit) (net of federal benefit) +(17,549 +) +(21,583 +) +21,350 +Change in valuation allowance +(5,059 +) +3,148 +2,245 +Research and development credit +— +(1,971 +) +— +Other +(893 +) +(1,744 +) +2,409 +Income tax expense (benefit) +$ +(444,172 +) +$ +(275,151 +) +$ +398,648 +Acquisitions, divestitures, drilling activity, and basis differentials impacting the prices received for oil, gas, and NGLs impact the apportionment of taxable income to the states where the Company owns oil and gas properties. As these factors change, the Company’s state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax expense (benefit) reported in the current year. Items affecting state apportionment factors are evaluated upon completion of the prior year income tax return, and after significant acquisitions, divestitures, or changes in drilling activity or estimated state revenue occurs during the year. In 2016, most of this activity occurred in the fourth quarter. +The Company and its subsidiaries file federal income tax returns and various state income tax returns. With an exception for activity related to its 2003 tax year, the Company is no longer subject to United States federal or state income tax examinations by these tax authorities for years before 2013. The Company recorded an additional $2.0 million net R&D credit in 2015 as a result of its R&D credit settlement with the IRS Appeals Office. During 2016, the Company’s 2007 - 2011 IRS examination was finalized, as was the 2013 IRS audit of the SM-Mitsui Tax Partnership with no material adjustments to previously recorded amounts. +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. Interest expense in the accompanying statements of operations includes a negligible amount associated with income taxes. The Company does not expect a significant change to the recorded unrecognized tax benefits in 2017 . +The total amount recorded for unrecognized tax benefits is presented below: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Beginning balance +$ +2,782 +$ +1,582 +$ +2,358 +Additions for tax positions of prior years +9 +1,200 +140 +Settlements +(2,345 +) +— +(916 +) +Ending balance +$ +446 +$ +2,782 +$ +1,582 +106 +Note 5 – Long-Term Debt +Revolving Credit Facility +The Company’s Fifth Amended and Restated Credit Agreement (the “Credit Agreement”) provides for a maximum loan amount of $2.5 billion and has a maturity date of December 10, 2019 . During 2016, the following amendments were made to the Credit Agreement: +• +On April 8, 2016 , as part of the regular, semi-annual borrowing base redetermination process, the Company entered into a Sixth Amendment to the Credit Agreement, which reduced the Company’s borrowing base to $1.25 billion from $2.0 billion at December 31, 2015. This expected reduction was primarily due to a decline in commodity prices, which resulted in a decrease in the Company’s proved reserves as of December 31, 2015. The amendment also reduced the aggregate lender commitments to $1.25 billion , and changed the required percentage of oil and gas properties subject to a mortgage to at least 90 percent of the total PV-9 of the Company’s proved oil and gas properties evaluated in the most recent reserve report. Further, this amendment revised certain of the Company’s covenants under the Credit Agreement and modified the borrowing base utilization grid, as discussed below. The Company incurred approximately $3.1 million in deferred financing costs associated with this amendment to the Credit Agreement. +• +On August 8, 2016 , the Company entered into a Seventh Amendment to the Credit Agreement to allow for capped call transactions. +• +Upon issuing the Senior Convertible Notes and 2026 Notes (as defined and discussed below) during the third quarter of 2016, the Company’s borrowing base and aggregate lender commitments were reduced to $1.1 billion . +• +On September 30, 2016, as part of the regular, semi-annual borrowing base redetermination process, the Company entered into an Eighth Amendment to the Credit Agreement, which increased the Company’s borrowing base to $1.35 billion and the aggregate lender commitments to $1.25 billion due to an increase in commodity prices and the value of the proved reserves associated with the Rock Oil Acquisition. +• +On December 1, 2016 , the Company’s borrowing base and aggregate lender commitments were reduced to $1.17 billion as a result of closing the sale of the Company’s Raven/Bear Den assets. +As a result of the various reductions to the Company’s borrowing base and aggregate lender commitments throughout 2016, the Company recorded approximately $2.5 million of expense related to the acceleration of unamortized deferred financing costs for the year ended December 31, 2016. +The borrowing base redetermination process considers the value of both the Company’s (a) proved oil and gas properties reflected in the Company’s most recent reserve report and (b) commodity derivative contracts, each as determined by the Company’s lender group. The next scheduled redetermination date is April 1, 2017 , and the Company expects a reduction to its borrowing base as a result of the anticipated sale of its outside-operated Eagle Ford shale assets and the decrease in proved reserves at December 31, 2016. +The Company must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring the Company to maintain certain financial ratios, as defined by the Credit Agreement. Financial covenants under the Credit Agreement require, as of the last day of each of the Company’s fiscal quarters, the Company’s (a) ratio of senior secured debt to 12-month trailing adjusted EBITDAX to be not more than 2.75 to 1.0; (b) adjusted current ratio to be not less than 1.0 to 1.0; and (c) ratio of 12-month trailing adjusted EBITDAX to interest expense to be not less than 2.0 to 1.0. The Company was in compliance with all financial and non-financial covenants under the Credit Agreement as of December 31, 2016 , and through the filing date of this report. +107 +Interest and commitment fees are accrued based on a borrowing base utilization grid set forth in the Credit Agreement. Eurodollar loans accrue interest at the London Interbank Offered Rate plus the applicable margin from the utilization table below, and Alternate Base Rate (“ABR”) and swingline loans accrue interest at the prime rate, plus the applicable margin from the utilization table below. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount and are included in interest expense in the accompanying statements of operations. The borrowing base utilization grid under the Credit Agreement is as follows: +Borrowing Base Utilization Percentage +<25% +≥25% <50% +≥50% <75% +≥75% <90% +≥90% +Eurodollar Loans +1.750 +% +2.000 +% +2.250 +% +2.500 +% +2.750 +% +ABR Loans or Swingline Loans +0.750 +% +1.000 +% +1.250 +% +1.500 +% +1.750 +% +Commitment Fee Rate +0.300 +% +0.300 +% +0.350 +% +0.375 +% +0.375 +% +The following table presents the outstanding balance, total amount of letters of credit, and available borrowing capacity under the Credit Agreement as of February 15, 2017 , December 31, 2016 , and December 31, 2015 : +As of February 15, 2017 +As of December 31, 2016 +As of December 31, 2015 +(in thousands) +Credit facility balance (1) +$ +103,500 +$ +— +$ +202,000 +Letters of credit (2) +200 +200 +200 +Available borrowing capacity +1,061,300 +1,164,800 +1,297,800 +Total aggregate lender commitment amount +$ +1,165,000 +$ +1,165,000 +$ +1,500,000 +____________________________________________ +(1) +Unamortized deferred financing costs attributable to the credit facility are presented as a component of other noncurrent assets on the accompanying balance sheets and totaled $5.9 million and $4.9 million as of December 31, 2016 , and 2015 , respectively. +(2) +Letters of credit reduce the amount available under the credit facility on a dollar-for-dollar basis. +Senior Notes +The Company’s Senior Notes consist of 6.50% Senior Notes due 2021, 6.125% Senior Notes due 2022, 6.50% Senior Notes due 2023, 5.0% Senior Notes due 2024, 5.625% Senior Notes due 2025, and 6.75% Senior Notes due 2026 (collectively referred to as “Senior Notes”). The Senior Notes, net of unamortized deferred financing costs line on the accompanying balance sheets as of December 31, 2016 , and 2015 , consisted of the following: +As of December 31, +2016 +2015 +Principal Amount +Unamortized Deferred Financing Costs +Senior Notes, Net of Unamortized Deferred Financing Costs +Principal Amount +Unamortized Deferred Financing Costs +Senior Notes, Net of Unamortized Deferred Financing Costs +(in thousands) +6.50% Senior Notes due 2021 +$ +346,955 +$ +3,372 +$ +343,583 +$ +350,000 +$ +4,106 +$ +345,894 +6.125% Senior Notes due 2022 +561,796 +6,979 +554,817 +600,000 +8,714 +591,286 +6.50% Senior Notes due 2023 +394,985 +4,436 +390,549 +400,000 +5,231 +394,769 +5.0% Senior Notes due 2024 +500,000 +6,533 +493,467 +500,000 +7,455 +492,545 +5.625% Senior Notes due 2025 +500,000 +7,619 +492,381 +500,000 +8,524 +491,476 +6.75% Senior Notes due 2026 +500,000 +8,078 +491,922 +— +— +— +Total +$ +2,803,736 +$ +37,017 +$ +2,766,719 +$ +2,350,000 +$ +34,030 +$ +2,315,970 +108 +The Senior Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt, and are senior in right of payment to any future subordinated debt. There are no subsidiary guarantors of the Senior Notes. The Company is subject to certain covenants under the indentures governing the Senior Notes that limit the Company’s ability to incur additional indebtedness, issue preferred stock, and make restricted payments, including dividends; however, the first $6.5 million of dividends paid each year are not restricted by the restricted payment covenant. The Company was in compliance with all covenants under its Senior Notes as of December 31, 2016 , and through the filing date of this report. All Senior Notes are registered under the Securities Act as of December 31, 2016 . The Company may redeem some or all of its Senior Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest, as described in the indentures governing the Senior Notes. +During the first quarter of 2016, the Company repurchased in open market transactions a total of $46.3 million in aggregate principal amount of certain of its 6.50% Senior Notes due 2021, 6.125% Senior Notes due 2022, and 6.50% Senior Notes due 2023 for a settlement amount of $29.9 million , excluding interest, which resulted in a net gain on extinguishment of debt of approximately $15.7 million . This amount includes a gain of $16.4 million associated with the discount realized upon repurchase, which was partially offset by approximately $700,000 related to the acceleration of unamortized deferred financing costs. The Company canceled all repurchased Senior Notes upon cash settlement. +2019 Notes . On May 7, 2015 , the Company commenced a cash tender offer for any and all of its outstanding 6.625% Senior Notes due 2019 (“2019 Notes”) at a price of $1,036.88 per $1,000 of principal amount for all 2019 Notes tendered by May 20, 2015 (“Consent Payment Deadline”), and at a price of $1,006.88 per $1,000 of principal amount for all 2019 Notes properly tendered thereafter. On the Consent Payment Deadline, the Company received tenders and consents from the holders of approximately $242.9 million in aggregate principal amount, or approximately 69% , of its outstanding 2019 Notes in connection with the cash tender offer. Following its entry into the supplemental indenture dated as of May 21, 2015, to the indenture dated as of February 7, 2011, between the Company and U.S. Bank National Association, as trustee, the Company accepted the 2019 Notes tendered as of the Consent Payment Deadline in exchange for payment of total consideration, including accrued interest, of approximately $256.2 million under the Tender Offer and Consent Solicitation. On June 5, 2015 , the Company accepted $1.5 million of 2019 Notes tendered after the Consent Payment Deadline in exchange for payment of total consideration, including accrued interest, of approximately $1.6 million . On June 22, 2015 , the Company redeemed the remaining outstanding 2019 Notes at a redemption price of 103.313% of the principal amount for payment of total consideration, including accrued interest, of approximately $111.5 million . +The Company recorded a loss on extinguishment of debt related to the tender offer and redemption of its 2019 Notes of approximately $16.6 million for the year ended December 31, 2015. This amount includes approximately $12.5 million associated with the premium paid for the tender offer and redemption of the 2019 Notes and approximately $4.1 million related to the acceleration of unamortized deferred financing costs. +2021 Notes. On November 8, 2011 , the Company issued $350.0 million in aggregate principal amount of 6.50% Senior Notes due 2021 at par, which mature on November 15, 2021 . The Company received net proceeds of $343.1 million after deducting fees of $6.9 million , which are being amortized as deferred financing costs over the life of the 2021 Notes. During the first quarter of 2016, the Company repurchased $3.1 million in aggregate principal amount of its 2021 Notes for a settlement amount of $2.3 million , excluding interest. +2022 Notes. On November 17, 2014 , the Company issued $600.0 million in aggregate principal amount of 6.125% Senior Notes due 2022 at par, which mature on November 15, 2022 . The Company received net proceeds of $590.0 million after deducting fees of $10.0 million , which are being amortized as deferred financing costs over the life of the 2022 Notes. The net proceeds were used to repay outstanding borrowings under the Company’s credit facility and for general corporate purposes. During the first quarter of 2016, the Company repurchased $38.2 million in aggregate principal amount of its 2022 Notes for a settlement amount of $24.3 million , excluding interest. +2023 Notes. On June 29, 2012 , the Company issued $400.0 million in aggregate principal amount of 6.50% Senior Notes due 2023 at par, which mature on January 1, 2023 . The Company received net proceeds of $392.1 million after deducting fees of $7.9 million , which are being amortized as deferred financing costs over the life of the 2023 Notes. During the first quarter of 2016, the Company repurchased $5.0 million in aggregate principal amount of its 2023 Notes for a settlement amount of $3.3 million , excluding interest. +109 +2024 Notes. On May 20, 2013 , the Company issued $500.0 million in aggregate principal amount of 5.0% Senior Notes due 2024 at par, which mature on January 15, 2024 . The Company received net proceeds of $490.2 million after deducting fees of $9.8 million , which are being amortized as deferred financing costs over the life of the 2024 Notes. +2025 Notes. On May 21, 2015 , the Company issued $500.0 million in aggregate principal amount of 5.625% Senior Notes due 2025 at par, which mature on June 1, 2025 . The Company received net proceeds of $491.0 million after deducting fees of $9.0 million , which are being amortized as deferred financing costs over the life of the 2025 Notes. The net proceeds were used to fund the consideration paid to the tendering holders of the 2019 Notes and to redeem the remaining untendered 2019 Notes, as well as repay outstanding borrowings under the Credit Agreement and for general corporate purposes. +2026 Notes. On September 12, 2016 , the Company issued $500.0 million in aggregate principal amount of 6.75% Senior Notes due 2026 , at par (the “2026 Notes”), which mature on September 15, 2026 . The Company received net proceeds of $491.6 million after deducting fees of $8.4 million , which are being amortized as deferred financing costs over the life of the 2026 Notes. The net proceeds were used to partially fund the Rock Oil Acquisition that closed on October 4, 2016 . +Senior Convertible Notes +On August 12, 2016 , the Company issued $172.5 million in aggregate principal amount of 1.50% Senior Convertible Notes due 2021 (“the Senior Convertible Notes”), which mature on July 1, 2021 . The Senior Convertible Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt, and are senior in right of payment to any future subordinated debt. The Company received net proceeds of $166.6 million after deducting fees of $5.9 million , of which a portion is being amortized over the life of the Senior Convertible Notes. The net proceeds were used to partially fund the Rock Oil Acquisition that closed on October 4, 2016 , as well as pay the cost of the capped call transactions discussed below. +The Senior Convertible Notes mature on July 1, 2021 , unless earlier repurchased or converted. Holders may convert their Senior Convertible Notes at their option at any time prior to January 1, 2021, only under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter) commencing after the calendar quarter ending on September 30, 2016, if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price (as defined in the indenture) per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after January 1, 2021, until the maturity date, holders may convert their Senior Convertible Notes at any time, regardless of the foregoing circumstances. The Company may not redeem the Senior Convertible Notes prior to the maturity date. Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. Holders may convert their notes based on a conversion rate of 24.6914 shares of the Company’s common stock per $1,000 principal amount of the Senior Convertible Notes, which is equal to an initial conversion price of approximately $40.50 per share, subject to adjustment. +The Company has initially elected a net-settlement method to satisfy its conversion obligation, which allows the Company to settle the principal amount of the Senior Convertible Notes in cash and to settle the excess conversion value in shares, as well as cash in lieu of fractional shares. The Senior Convertible Notes were not convertible at the option of holders as of December 31, 2016 , or through the filing date of this report. Notwithstanding the inability to convert, the if-converted value of the Senior Convertible Notes as of December 31, 2016 , did not exceed the principal amount. +In accounting for the Senior Convertible Notes at issuance, the Company allocated proceeds from the Senior Convertible Notes into debt and equity components according to the authoritative accounting guidance for convertible debt instruments that may be fully or partially settled in cash upon conversion. The initial carrying amount of the debt component, which approximates its fair value, was estimated using an interest rate for nonconvertible debt with terms similar to the Senior Convertible Notes. The effective interest rate used was 7.25% . The excess of the principal amount of the Senior Convertible Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The Company incurred transaction costs of $5.9 million relating to the issuance of the Senior Convertible Notes, which were allocated between the debt and equity components in proportion to their determined fair value amounts. The debt discount and debt-related issuance costs are amortized to the carrying value of the Senior Convertible Notes as interest +110 +expense through the maturity date of July 1, 2021 . Upon issuance of the Senior Convertible Notes, the Company recorded $132.3 million as long-term debt and $40.2 million as additional paid-in capital in stockholders’ equity in the accompanying balance sheets. Interest expense recognized on the Senior Convertible Notes related to the stated interest rate and amortization of the debt discount totaled $3.7 million for the year ended December 31, 2016 . +The net carrying amount of the liability component of the Senior Convertible Notes, as reflected on the accompanying balance sheets, consisted of the following as of December 31, 2016 : +As of December 31, 2016 +(in thousands) +Principal amount of Senior Convertible Notes +$ +172,500 +Unamortized debt discount +(37,513 +) +Unamortized deferred financing costs +(4,131 +) +Net carrying amount +$ +130,856 +The net carrying amount of the equity component of the Senior Convertible Notes recorded in additional paid-in capital on the accompanying balance sheets consisted of the following as of December 31, 2016 : +As of December 31, 2016 +(in thousands) +Equity component due to allocation of proceeds to equity +$ +40,217 +Less: related issuance costs +(1,375 +) +Less: deferred tax liability +(5,267 +) +Net carrying amount +$ +33,575 +If the Company undergoes a fundamental change, holders of the Senior Convertible Notes may require the Company to repurchase for cash all or any portion of their notes at a fundamental change repurchase price equal to 100% of the principal amount of the Senior Convertible Notes to be repurchased, plus accrued and unpaid interest. The indenture governing the Senior Convertible Notes contains customary events of default with respect to the Senior Convertible Notes, including that upon certain events of default, the trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding Senior Convertible Notes by notice to the Company, may declare 100% of the principal and accrued and unpaid interest, if any, due and payable immediately. In case of certain events of bankruptcy, insolvency or reorganization involving the Company or a significant subsidiary, 100% of the principal and accrued and unpaid interest on the Senior Convertible Notes will automatically become due and payable. +The Company is subject to certain covenants under the indenture governing the Senior Convertible Notes and was in compliance with all covenants as of December 31, 2016 , and through the filing date of this report. +Capped Call Transactions +In connection with the issuance of the Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters of such issuance. The aggregate cost of the capped call transactions was approximately $24.2 million . The capped call transactions are generally expected to reduce the potential dilution upon conversion of the Senior Convertible Notes and/or partially offset any cash payments the Company is required to make in excess of the principal amount of converted Senior Convertible Notes in the event that the market price per share of the Company’s common stock, as measured under the terms of the capped call transactions (“market price per share”), is greater than the strike price of the capped call transactions, which initially corresponds to the approximate $40.50 per share conversion price of the Senior Convertible Notes and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion rate of the Senior Convertible Notes. The cap price of the capped call transactions was initially $60.00 per share, and is subject to certain adjustments under the terms of the capped call transactions. If, however, the market price per share exceeds the cap price of the capped call transactions, there would be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that such market price per share exceeds the cap price of the capped call transactions. +111 +The Company evaluated the capped call transactions under authoritative accounting guidance and determined that they should be accounted for as separate transactions and classified as equity instruments with no recurring fair value measurement recorded. +Capitalized Interest +Capitalized interest costs for the Company for the years ended December 31, 2016 , 2015 , and 2014 , were $17.0 million , $25.1 million , and $16.2 million , respectively. +Note 6 – Commitments and Contingencies +Commitments +The Company has entered into various agreements, which include drilling rig contracts of $31.1 million , gathering, processing, and transportation throughput commitments of $970.9 million , office leases, including maintenance, of $50.1 million , and other miscellaneous contracts and leases of $6.0 million . The annual minimum payments for the next five years and total minimum payments thereafter are presented below: +Years Ending December 31, +Amount (1) +(in thousands) +2017 +$ +145,075 +2018 +148,240 +2019 +144,379 +2020 +141,010 +2021 +141,654 +Thereafter +337,745 +Total +$ +1,058,103 +____________________________________________ +(1) +During the third quarter of 2015, the Company closed its office in Tulsa, Oklahoma. These amounts include lease payments for the Tulsa office, net of sublease income. The Company expects to receive $2.7 million of total sublease income through 2019 . +Drilling Rig Contracts +The Company has several drilling rig contracts in place to facilitate drilling plans. Early termination of these rig contracts as of December 31, 2016 , would have resulted in termination penalties of $14.2 million , which would be in lieu of paying the remaining drilling commitments of $31.1 million included in the table above. For the years ended December 31, 2016 , and 2015 , the Company incurred $8.7 million and $13.7 million , respectively, of expenses related to the early termination of drilling rig contracts or fees incurred for rigs placed on standby, which are recorded in the other operating expenses line item in the accompanying statements of operations. +Pipeline Transportation Commitments +The Company has gathering, processing, and transportation throughput commitments with various third parties that require delivery of a minimum amount of natural gas, crude oil, NGLs, and water. As of December 31, 2016 , the Company has commitments to deliver a minimum of 1,461 Bcf of natural gas, 70 MMBbl of crude oil, 13 MMBbl of NGLs, and 25 MMBbl of water through 2034 . The Company will be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. As of December 31, 2016 , if the Company delivered no further product, the aggregate undiscounted deficiency payments total approximately $970.9 million through 2034. If a shortfall in the minimum volume commitment for natural gas is projected, the Company has rights under certain contracts to arrange for third party gas to be delivered, and such volumes would count toward its minimum volume commitment. +Subsequent to December 31, 2016 , the Company entered into a definitive agreement for the sale of its outside-operated Eagle Ford shale assets held for sale at December 31, 2016 , and expects to close the transaction in the first quarter of 2017. Upon closing of the sale, the Company would no longer be subject to transportation throughput commitments totaling +112 +514 Bcf of natural gas, 52 MMBbl of oil, and 13 MMBbl of NGLs, or $501.9 million of the potential undiscounted deficiency payments presented in the table above. +As of the filing date of this report, the Company does not expect to incur any material shortfalls. +Office Leases +The Company leases office space under various operating leases with terms extending as far as 2026 . Rent expense, net of sublease income, for the years ended December 31, 2016 , 2015 , and 2014 , was $5.2 million , $6.1 million , and $6.5 million , respectively. The Company closed its office in Billings, Montana in November 2016 and paid $3.2 million to the lessor to terminate the lease, which is not reflected in the rent expense amount above. +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the results of such pending litigation and claims will not have a material effect on the results of operations, the financial position, or the cash flows of the Company. +Note 7 – Compensation Plans +Equity Plan +There are several components to the Company’s Equity Plan that are described in this section. Various types of equity awards have been granted by the Company in different periods. +As of December 31, 2016 , approximately 5.5 million shares of common stock remained available for grant under the Equity Plan. The issuance of a direct share benefit, such as a share of common stock, a stock option, a restricted share, an RSU, or a PSU, counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. Stock options were issued out of the St. Mary Land & Exploration Company Stock Option Plan and the St. Mary Land & Exploration Company Incentive Stock Option Plan, both predecessors to the Equity Plan, although the last grant was in 2004, and all remaining stock options were exercised during the year ended December 31, 2014. +Performance Share Units +The Company grants PSUs to eligible employees as part of its long-term equity compensation program. The number of shares of the Company’s common stock issued to settle PSUs ranges from 0% to 200% of the number of PSUs awarded and is determined based on certain performance criteria over a three -year measurement period. The performance criteria for the PSUs are based on a combination of the Company’s annualized Total Shareholder Return (“TSR”) for the performance period and the relative performance of the Company’s TSR compared with the annualized TSR of certain peer companies for the performance period. Compensation expense for PSUs is recognized within general and administrative and exploration expense over the vesting periods of the respective awards. +The fair value of PSUs was measured at the grant date with a stochastic process method using the Geometric Brownian Motion Model (“GBM Model”). A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for those iterations. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will take over the three-year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the path the stock price will take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +113 +The Company records compensation expense associated with the issuance of PSUs based on the fair value of the awards as of the date of grant. Total compensation expense recorded for PSUs was $11.0 million , $10.6 million , and $16.0 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively. As of December 31, 2016 , there was $15.9 million of total unrecognized expense related to PSUs, which is being amortized through 2019 . +A summary of the status and activity of non-vested PSUs is presented in the following table: +For the Years Ended December 31, +2016 +2015 +2014 +PSUs +Weighted-Average Grant-Date Fair Value +PSUs +Weighted-Average Grant-Date Fair Value +PSUs +Weighted-Average Grant-Date Fair Value +Non-vested at beginning of year (1) +626,328 +$ +61.81 +433,660 +$ +73.63 +572,469 +$ +66.07 +Granted (1) +447,971 +$ +26.56 +320,753 +$ +45.34 +202,404 +$ +94.66 +Vested (1) +(130,353 +) +$ +64.17 +(76,438 +) +$ +51.76 +(206,830 +) +$ +64.79 +Forfeited (1) +(115,023 +) +$ +55.59 +(51,647 +) +$ +73.62 +(134,383 +) +$ +86.72 +Non-vested at end of year (1) +828,923 +$ +43.25 +626,328 +$ +61.81 +433,660 +$ +73.63 +____________________________________________ +(1) +The number of awards assumes a multiplier of one . The final number of shares of common stock issued may vary depending on the three -year performance multiplier, which ranges from zero to two . +The fair value of the PSUs granted in 2016 , 2015 , and 2014 was $11.9 million , $14.5 million , and $19.2 million , respectively. The PSUs granted in 2015 and 2014 will remain unvested until the third anniversary date of their issuance, at which time they will fully vest, unless the employee is retirement eligible in which case the PSUs vest immediately upon attainment of retirement age. PSUs granted in 2016 fully vest on the third anniversary of the date of the grant; however, employees who are retirement eligible at the time a PSU award was granted, vest in each portion of that award equally in six-month increments over a three-year period beginning at grant date. Retirement eligible employees must stay with the company through the entire six-month vesting period to receive that increment of vesting and any unvested portions of a PSU award will be forfeited when the employee leaves the company. +A summary of the shares of common stock issued to settle PSUs is presented in the table below: +For the Years Ended December 31, +2016 +2015 +2014 +Shares of common stock issued to settle PSUs (1) +44,870 +288,962 +130,163 +Less: shares of common stock withheld for income and payroll taxes +(14,809 +) +(100,683 +) +(45,042 +) +Net shares of common stock issued +30,061 +188,279 +85,121 +Multiplier earned +0.2 +1.0 +0.55 +____________________________________________ +(1) +During the years ended December 31, 2016 , 2015 , and 2014 , the Company issued shares of common stock for PSUs granted in 2013, 2012, and 2011. The Company and the majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of PSUs that vested during the years ended December 31, 2016, 2015, and 2014 was $8.4 million , $4.0 million , and $13.4 million , respectively. +Restricted Stock Units +The Company grants RSUs to eligible employees as part of its long-term equity incentive compensation program. Each RSU represents a right to receive one share of the Company’s common stock upon settlement of the award at the end of the specified vesting period. Compensation expense for RSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the award. +114 +Total compensation expense recorded for RSUs for the years ended December 31, 2016 , 2015 , and 2014 , was $11.9 million , $13.4 million , and $13.9 million , respectively. As of December 31, 2016 , there was $14.4 million of total unrecognized expense related to unvested RSU awards, which is being amortized through 2019 . The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the date of grant. The fair value of an RSU is equal to the closing price of the Company’s common stock on the day of the grant. +A summary of the status and activity of non-vested RSUs is presented below: +For the Years Ended December 31, +2016 +2015 +2014 +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +Non-vested at beginning of year +543,737 +$ +55.01 +515,724 +$ +68.29 +580,431 +$ +57.05 +Granted +417,065 +$ +28.08 +356,246 +$ +43.72 +234,560 +$ +83.98 +Vested +(241,363 +) +$ +58.06 +(278,289 +) +$ +63.12 +(253,031 +) +$ +58.19 +Forfeited +(115,323 +) +$ +43.52 +(49,944 +) +$ +66.53 +(46,236 +) +$ +62.06 +Non-vested at end of year +604,116 +$ +37.39 +543,737 +$ +55.01 +515,724 +$ +68.29 +The fair value of RSUs granted in 2016 , 2015 , and 2014 was $11.7 million , $15.6 million , and $19.7 million , respectively. The RSUs granted in 2015 and 2014 vest one-third of the total grant on each anniversary of the grant dates, unless the employee is retirement eligible in which case the RSUs vest immediately upon attainment of retirement age. The RSUs granted in 2016 vest one-third of the total grant on each anniversary of the grant dates, unless the employee is retirement eligible in which case the RSUs vest in each portion of that award equally in six-month increments over a three-year period beginning at grant date. Retirement eligible employees must stay with the company through the entire six-month vesting period to receive that increment of vesting and any unvested portions of a RSU award will be forfeited when the employee leaves the company. +A summary of the shares of common stock issued to settle RSUs is presented in the table below: +For the Years Ended December 31, +2016 +2015 +2014 +Shares of common stock issued to settle RSUs (1) +241,363 +278,289 +253,031 +Less: shares of common stock withheld for income and payroll taxes +(72,181 +) +(91,045 +) +(81,434 +) +Net shares of common stock issued +169,182 +187,244 +171,597 +____________________________________________ +(1) +During the years ended December 31, 2016 , 2015 , and 2014 , the Company issued shares of common stock for RSUs granted in previous years. The Company and the majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of RSUs that vested during the years ended December 31, 2016, 2015, and 2014 was $14.0 million , $17.6 million , and $14.7 million , respectively. +Stock Option Grants +The Company previously granted stock options under the St. Mary Land & Exploration Company Stock Option Plan and the St. Mary Land & Exploration Company Incentive Stock Option Plan. The last issuance of stock options occurred on December 31, 2004. Stock options to purchase shares of the Company’s common stock were granted to eligible employees and members of the Board of Directors. All options granted under the option plans were granted at exercise prices equal to the respective closing market price of the Company’s underlying common stock on the grant dates. All stock options granted under the option plans were exercisable for a period of up to 10 years from the date of grant. The remaining options from the 2004 grant were exercised during the year ended December 31, 2014, and thus there is no unrecognized compensation expense related to stock option awards. +115 +A summary of activity associated with the Company’s Stock Option Plans during the year ended December 31, 2014, is presented in the following table: +Shares +Weighted-Average Exercise Price +Aggregate Intrinsic Value +For the year ended December 31, 2014 +Outstanding, start of year +39,088 +$ +20.87 +$ +— +Exercised +(39,088 +) +$ +20.87 +$ +1,993,726 +Forfeited +— +$ +— +$ +— +Outstanding, end of year +— +$ +— +$ +— +Vested and exercisable at end of year +— +$ +— +$ +— +The fair value of options was measured at the date of grant using the Black-Scholes-Merton option-pricing model. Cash received from stock options exercised for the year ended December 31, 2014 , was $4.0 million . +Cash flows resulting from excess tax benefits are classified as part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for vested RSUs, settled PSUs, and exercised options in excess of the deferred tax asset attributable to stock compensation costs for such equity awards. The Company recorded no excess tax benefits for the years ended December 31, 2016 , 2015 , and 2014 . +Director Shares +In 2016 , 2015 , and 2014 , the Company issued 53,473 , 39,903 , and 27,677 shares, respectively, of its common stock to its non-employee directors under the Company’s Equity Plan. The Company recorded $2.0 million of compensation expense for the year ended December 31, 2016 , related to director shares issued, and $1.6 million for each of the years ended December 31, 2015 , and 2014 . +Beginning with the awards granted in 2016, all shares issued to non-employee directors fully vest on December 31 st of the year granted. Prior to 2016, all shares of common stock issued to the Company’s non-employee directors were earned over the one -year service period following the date of grant, unless five years of service had been provided to the Company by the director, in which case that director’s shares vested upon the earlier of the completion of the one year service period or the director retiring from the Board of Directors. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation, without accruing in excess of $25,000 in value from purchases for each calendar year. The purchase price of the stock is the lower of 85% of the closing price of the stock on the first day of the offering period or 85% of the closing price of the stock on the purchase date, and shares issued under the ESPP have no restriction period. The ESPP is intended to qualify under Section 423 of the IRC. The Company had approximately 0.7 million shares available for issuance under the ESPP as of December 31, 2016 . There were 218,135 , 197,214 , and 83,136 shares issued under the ESPP in 2016 , 2015 , and 2014 , respectively. Total proceeds to the Company for the issuance of these shares were $4.2 million , $4.8 million , and $4.1 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively. +The fair value of ESPP grants is measured at the date of grant using the Black-Scholes-Merton option-pricing model. Expected volatility was calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six-month vesting period. +116 +The fair value of ESPP shares issued during the periods reported were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2016 +2015 +2014 +Risk free interest rate +0.4 +% +0.1 +% +0.1 +% +Dividend yield +0.4 +% +0.2 +% +0.1 +% +Volatility factor of the expected market +price of the Company’s common stock +95.0 +% +61.2 +% +33.0 +% +Expected life (in years) +0.5 +0.5 +0.5 +The Company expensed $2.0 million , $1.8 million , and $1.1 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively, based on the estimated fair value of the ESPP grants. +401(k) Plan +The Company has a defined contribution plan (the “401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. For employees hired before December 31, 2014, the Company matches each employee’s contribution up to six percent of the employee’s base salary and performance bonus, and may make additional contributions at its discretion. The Company matches contributions made by employees hired after December 31, 2014, up to nine percent of the employee’s base salary and performance bonus in lieu of pension plan benefits, and may make additional contributions at its discretion. Please refer to Note 8 - Pension Benefits for additional discussion of pension benefits. The Company’s matching contributions to the 401(k) Plan were $5.4 million , $5.6 million , and $6.4 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively. +Net Profits Plan +Under the Company’s Net Profits Plan, all oil and gas wells that were completed or acquired during each year were designated within a specific pool with key employees designated as participants that became entitled to payments under the Net Profits Plan after the Company has received net cash flows returning 100 percent of all costs associated with that pool. Thereafter, 10 percent of future net cash flows generated by the pool are allocated among the participants and distributed at least annually. The portion of net cash flows from the pool to be allocated among the participants increases to 20 percent after the Company has recovered 200 percent of the total costs for the pool, including payments made under the Net Profits Plan at the 10 percent level. In December 2007, the Board of Directors discontinued the creation of new pools under the Net Profits Plan. As a result, the 2007 pool was the last Net Profits Plan pool established by the Company. +The following table presents cash payments made or accrued under the Net Profits Plan related to periodic operations, of which the majority is recorded as general and administrative expense, and cash payments made or accrued as a result of divestitures of properties subject to the Net Profits Plan, which are recorded as a reduction to the net gain on divestiture activity line item in the accompanying statements of operations. +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Cash payments made or accrued related to operations +$ +6,608 +$ +3,498 +$ +9,016 +Cash payments made or accrued related to divestitures +24,349 +3,789 +8,341 +Total net settlements +$ +30,957 +$ +7,287 +$ +17,357 +117 +Note 8 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering substantially all employees who meet age and service requirements (the “Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (the “Nonqualified Pension Plan” and together with the Qualified Pension Plan, the “Pension Plans”). The Company froze the Pension Plans to new participants, effective as of December 31, 2015. Employees participating in the Pension Plans as of December 31, 2015, will continue to earn benefits. +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status (i.e. the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment to accumulated other comprehensive loss, net of tax. The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation, but excludes the effects of assumed future salary increases. The Company’s measurement date for plan assets and obligations is December 31. +For the Years Ended December 31, +2016 +2015 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year +$ +62,547 +$ +57,867 +Service cost +8,200 +7,949 +Interest cost +2,908 +2,496 +Actuarial loss +2,662 +2,397 +Benefits paid +(6,658 +) +(8,162 +) +Projected benefit obligation at end of year +69,659 +62,547 +Change in plan assets: +Fair value of plan assets at beginning of year +25,769 +27,940 +Actual return on plan assets +1,575 +(410 +) +Employer contribution +11,045 +6,401 +Benefits paid +(6,658 +) +(8,162 +) +Fair value of plan assets at end of year +31,731 +25,769 +Funded status at end of year +$ +(37,928 +) +$ +(36,778 +) +The Company’s underfunded status for the Pension Plans as of December 31, 2016 , and 2015 , is $37.9 million and $36.8 million , respectively, and is recognized in the accompanying balance sheets as a portion of other noncurrent liabilities. No plan assets of the Qualified Pension Plan were returned to the Company during the year ended December 31, 2016 . There are no plan assets in the Nonqualified Pension Plan. +118 +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2016 +2015 +(in thousands) +Projected benefit obligation +$ +69,659 +$ +62,547 +Accumulated benefit obligation +$ +54,681 +$ +46,439 +Less: Fair value of plan assets +(31,731 +) +(25,769 +) +Underfunded accumulated benefit obligation +$ +22,950 +$ +20,670 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of the unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for a year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +Pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in accumulated other comprehensive loss during 2016 , 2015 , and 2014 , were as follows: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Unrecognized actuarial losses +$ +22,708 +$ +20,966 +$ +17,812 +Unrecognized prior service costs +83 +101 +118 +Unrecognized transition obligation +— +— +— +Accumulated other comprehensive loss +$ +22,791 +$ +21,067 +$ +17,930 +The estimated net loss that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year is $1.6 million . +Pre-tax changes recognized in other comprehensive loss during 2016 , 2015 , and 2014 , were as follows: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Net actuarial loss +$ +(3,322 +) +$ +(4,990 +) +$ +(10,062 +) +Prior service cost +— +— +— +Less: +Amortization of prior service cost +(16 +) +(17 +) +(17 +) +Amortization of net actuarial loss +(1,582 +) +(1,486 +) +(689 +) +Settlements +— +(350 +) +— +Total other comprehensive loss +$ +(1,724 +) +$ +(3,137 +) +$ +(9,356 +) +119 +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Components of net periodic benefit cost: +Service cost +$ +8,200 +$ +7,949 +$ +6,335 +Interest cost +2,908 +2,496 +2,191 +Expected return on plan assets that reduces periodic pension cost +(2,235 +) +(2,182 +) +(1,978 +) +Amortization of prior service cost +16 +17 +17 +Amortization of net actuarial loss +1,582 +1,486 +689 +Settlements +— +350 +— +Net periodic benefit cost +$ +10,471 +$ +10,116 +$ +7,254 +Pension Plan Assumptions +Weighted-average assumptions used to measure the Company’s projected benefit obligation and net periodic benefit cost are as follows: +As of December 31, +2016 +2015 +2014 +Projected benefit obligation +Discount rate +4.2% +4.7% +4.3% +Rate of compensation increase +6.2% +6.2% +6.2% +Net periodic benefit cost +Discount rate +4.7% +4.3% +5.0% +Expected return on plan assets (1) +7.5% +7.5% +7.5% +Rate of compensation increase +6.2% +6.2% +6.2% +____________________________________________ +(1) +There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy does not permit the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting the optimal expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. The weighted-average asset allocation of the Qualified Pension Plan is as follows: +120 +Target +As of December 31, +Asset Category +2017 +2016 +2015 +Equity securities +35.0 +% +28.8 +% +39.1 +% +Fixed income securities +43.0 +% +35.5 +% +34.0 +% +Other securities +22.0 +% +35.7 +% +26.9 +% +Total +100.0 +% +100.0 +% +100.0 +% +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in that plan. An expected return on plan assets of 7.5 percent was used to calculate the Company’s obligation under the Qualified Pension Plan for 2016 and 2015 . Factors considered in determining the expected rate of return include the long-term historical rate of return provided by the equity and debt securities markets and input from the investment consultants and trustees managing the plan assets. The difference in investment income using the projected rate of return compared to the actual rates of return for the past two years was not material and is not expected to have a material effect on the accompanying statements of operations or cash flows from operating activities in future years. +121 +Pension Plan Assets +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2016 , and 2015 , utilizing the fair value hierarchy discussed in Note 11 – Fair Value Measurements are as follows: +Fair Value Measurements Using: +Actual Asset Allocation +Total +Level 1 Inputs +Level 2 Inputs +Level 3 Inputs +(in thousands) +As of December 31, 2016 +Cash +— +% +$ +— +$ +— +$ +— +$ +— +Equity Securities: +Domestic (1) +18.7 +% +5,945 +4,471 +1,474 +— +International (2) +10.1 +% +3,192 +3,192 +— +— +Total Equity Securities +28.8 +% +9,137 +7,663 +1,474 +— +Fixed Income Securities: +High-Yield Bonds (3) +2.6 +% +822 +822 +— +— +Core Fixed Income (4) +25.0 +% +7,923 +7,923 +— +— +Floating Rate Corp Loans (5) +7.9 +% +2,495 +2,495 +— +— +Total Fixed Income Securities +35.5 +% +11,240 +11,240 +— +— +Other Securities: +Commodities (6) +1.8 +% +578 +578 +— +— +Real Estate (7) +5.1 +% +1,629 +— +— +1,629 +Collective Investment Trusts (8) +17.5 +% +5,562 +— +5,562 +— +Hedge Fund (9) +11.3 +% +3,585 +— +— +3,585 +Total Other Securities +35.7 +% +11,354 +578 +5,562 +5,214 +Total Investments +100.0 +% +$ +31,731 +$ +19,481 +$ +7,036 +$ +5,214 +As of December 31, 2015 +Cash +— +% +$ +— +$ +— +$ +— +$ +— +Equity Securities: +Domestic (1) +26.1 +% +6,729 +4,943 +1,786 +— +International (2) +13.0 +% +3,353 +3,353 +— +— +Total Equity Securities +39.1 +% +10,082 +8,296 +1,786 +— +Fixed Income Securities: +High-Yield Bonds (3) +2.8 +% +722 +722 +— +— +Core Fixed Income (4) +22.5 +% +5,789 +5,789 +— +— +Floating Rate Corp Loans (5) +8.7 +% +2,247 +2,247 +— +— +Total Fixed Income Securities +34.0 +% +8,758 +8,758 +— +— +Other Securities: +Commodities (6) +2.7 +% +700 +700 +— +— +Real Estate (7) +5.8 +% +1,499 +— +— +1,499 +Collective Investment Trusts (8) +4.6 +% +1,184 +— +1,184 +— +Hedge Fund (9) +13.8 +% +3,546 +— +— +3,546 +Total Other Securities +26.9 +% +6,929 +700 +1,184 +5,045 +Total Investments +100.0 +% +$ +25,769 +$ +17,754 +$ +2,970 +$ +5,045 +122 +____________________________________________ +(1) +Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold upon demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of this fund is to approximate the S&P 500 by investing in one or more collective investment funds. +(2) +International equity securities consists of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets and believed to have strong sustainable financial productivity at attractive valuations. +(3) +High-yield bonds consist of non-investment grade fixed income securities. The investment objective is to obtain high current income. Due to the increased level of default risk, security selection focuses on credit-risk analysis. +(4) +The objective of core fixed income funds is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay’s Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +(5) +Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +(6) +Investments with exposure to commodity price movements, primarily through the use of futures, swaps and other commodity-linked securities. +(7) +The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(8) +Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +(9) +The hedge fund portfolio includes an investment in an actively traded global mutual fund that focuses on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +Included below is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2015 +$ +4,864 +Purchases +— +Realized gain on assets +165 +Unrealized gain on assets +16 +Balance at December 31, 2015 +$ +5,045 +Purchases +561 +Realized gain on assets +54 +Unrealized gain on assets +115 +Disposition +(561 +) +Balance at December 31, 2016 +$ +5,214 +Contributions +The Company contributed $11.0 million , $6.4 million , and $5.3 million to the Pension Plans in the years ended December 31, 2016 , 2015 , and 2014 , respectively. The Company expects to make a $7.8 million contribution to the Pension Plans in 2017 . +123 +Benefit Payments +The Pension Plans made actual benefit payments of $6.7 million , $8.2 million , and $2.8 million in the years ended December 31, 2016 , 2015 , and 2014 , respectively. Expected benefit payments over the next 10 years are as follows: +Years Ending December 31, +(in thousands) +2017 +$ +6,532 +2018 +$ +3,256 +2019 +$ +4,480 +2020 +$ +4,778 +2021 +$ +5,772 +2022 through 2026 +$ +38,708 +Note 9 – Asset Retirement Obligations +Please refer to Asset Retirement Obligations in Note 1 – Summary of Significant Accounting Policies for a discussion of the initial and subsequent measurements of asset retirement obligation liabilities and the significant assumptions used in the estimates. +A reconciliation of the Company’s total asset retirement obligation liability is as follows: +As of December 31, +2016 +2015 +(in thousands) +Beginning asset retirement obligation +$ +140,874 +$ +122,124 +Liabilities incurred (1) +21,293 +14,471 +Liabilities settled (2) +(57,100 +) +(24,781 +) +Accretion expense +7,795 +5,091 +Revision to estimated cash flows +10,445 +23,969 +Ending asset retirement obligation (3)(4) +$ +123,307 +$ +140,874 +____________________________________________ +(1) +Reflects liabilities incurred through drilling activities and acquisitions of drilled wells. +(2) +Reflects liabilities settled through plugging and abandonment activities and divestitures of properties. +(3) +Balance as of December 31, 2016, included $26.2 million of asset retirement obligations associated with oil and gas properties held for sale, specifically the Company’s outside-operated Eagle Ford shale assets. There were no material asset retirement obligations related to assets held for sale as of December 31, 2015. +(4) +Balances as of December 31, 2016 , and 2015 , included $932,000 and $3.3 million , respectively, related to the Company’s current asset retirement obligation liability, which is recorded in accounts payable and accrued expenses on the accompanying balance sheets. +124 +Note 10 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company has entered into various commodity derivative contracts to mitigate a portion of its exposure to potentially adverse market changes in commodity prices and the associated impact on cash flows. As of December 31, 2016, all derivative counterparties were members of the Company’s credit facility lender group and all contracts were entered into for other-than-trading purposes. The Company’s derivative contracts consist of swap and collar arrangements for oil, gas, and NGLs. In a typical commodity swap agreement, if the agreed upon published third-party index price (“index price”) is lower than the swap fixed price, the Company receives the difference between the index price and the agreed upon swap fixed price. If the index price is higher than the swap fixed price, the Company pays the difference. For collar arrangements, the Company receives the difference between an agreed upon index and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +As of December 31, 2016 , the Company had commodity derivative contracts outstanding through the second quarter of 2020 for a total of 11.3 million Bbls of oil production, 137.2 million MMBtu of net gas production, and 13.4 million Bbls of NGL production, as summarized in the tables below. +Oil Swaps +Contract Period +NYMEX WTI Volumes +Weighted- +Average +Contract +Price +(MBbls) +(per Bbl) +First quarter 2017 +1,574 +$ +46.41 +Second quarter 2017 +1,444 +$ +46.44 +Third quarter 2017 +1,340 +$ +46.66 +Fourth quarter 2017 +1,254 +$ +46.35 +Total +5,612 +Oil Collars +Contract Period +NYMEX WTI Volumes +Weighted- +Average Floor +Price +Weighted- +Average Ceiling +Price +(MBbls) +(per Bbl) +(per Bbl) +First quarter 2017 +704 +$ +45.00 +$ +54.17 +Second quarter 2017 +636 +$ +45.00 +$ +54.10 +Third quarter 2017 +583 +$ +45.00 +$ +54.05 +Fourth quarter 2017 +540 +$ +45.00 +$ +54.01 +2018 +2,312 +$ +50.00 +$ +59.24 +2019 +943 +$ +50.00 +$ +61.15 +Total +5,718 +125 +Natural Gas Swaps +Contract Period +Sold Volumes +Weighted- +Average +Contract +Price +Purchased Volumes (1) +Weighted- +Average +Contract +Price +Net Volumes +(BBtu) +(per MMBtu) +(BBtu) +(per MMBtu) +(BBtu) +First quarter 2017 +29,420 +$ +3.76 +— +$ +— +29,420 +Second quarter 2017 +26,205 +$ +3.98 +— +$ +— +26,205 +Third quarter 2017 +23,657 +$ +4.01 +— +$ +— +23,657 +Fourth quarter 2017 +22,001 +$ +3.98 +— +$ +— +22,001 +2018 +63,166 +$ +3.68 +(30,606 +) +$ +4.27 +32,560 +2019 +27,743 +$ +4.20 +(24,415 +) +$ +4.34 +3,328 +Total (2) +192,192 +(55,021 +) +137,171 +____________________________________________ +(1) +During 2016, the Company restructured certain of its gas derivative contracts by buying fixed price volumes to offset existing 2018 and 2019 fixed price swap contracts totaling 55.0 million MMBtu. The Company then entered into new 2017 fixed price swap contracts totaling 38.6 million MMBtu with a contract price of $4.43 per MMBtu. No cash or other consideration was included as part of the restructuring. +(2) +Total net volumes of natural gas swaps are comprised of IF El Paso Permian ( 3% ), IF HSC ( 94% ), and IF NNG Ventura ( 3% ). +NGL Swaps +OPIS Purity Ethane Mont Belvieu +OPIS Propane Mont Belvieu Non-TET +OPIS Normal Butane Mont Belvieu Non-TET +OPIS Isobutane Mont Belvieu Non-TET +OPIS Natural Gasoline Mont Belvieu Non-TET +Contract Period +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +(MBbls) +(per Bbl) +(MBbls) +(per Bbl) +(MBbls) +(per Bbl) +(MBbls) +(per Bbl) +(MBbls) +(per Bbl) +First quarter 2017 +847 +$ +8.63 +692 +$ +21.90 +122 +$ +30.69 +94 +$ +31.12 +156 +$ +47.54 +Second quarter 2017 +787 +$ +8.86 +634 +$ +21.90 +112 +$ +30.69 +86 +$ +31.12 +143 +$ +47.56 +Third quarter 2017 +736 +$ +9.14 +588 +$ +21.91 +104 +$ +30.70 +80 +$ +31.12 +133 +$ +47.59 +Fourth quarter 2017 +692 +$ +9.10 +550 +$ +21.91 +98 +$ +30.70 +74 +$ +31.12 +124 +$ +47.61 +2018 +2,434 +$ +10.18 +1,442 +$ +22.86 +— +$ +— +— +$ +— +— +$ +— +2019 +2,176 +$ +11.95 +— +$ +— +— +$ +— +— +$ +— +— +$ +— +2020 +539 +$ +11.13 +— +$ +— +— +$ +— +— +$ +— +— +$ +— +Total +8,211 +3,906 +436 +334 +556 +126 +Commodity Derivative Contracts Entered Into After December 31, 2016 +Subsequent to December 31, 2016, and pursuant to a definitive agreement, the Company entered into certain NYMEX swap contracts on behalf of the buyer of its outside-operated Eagle Ford shale assets, which will be novated to the buyer at closing expected to occur in the first quarter of 2017. Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale . +Additionally, subsequent to December 31, 2016, the Company entered into various derivative contracts, as summarized below: +• +derivative costless collar contracts through the fourth quarter of 2019 for a total of 2.7 million Bbls of oil production with contract floor prices of $50.00 per Bbl and contract ceiling prices ranging from $57.00 per Bbl to $58.40 per Bbl; +• +derivative fixed price Midland-Cushing basis swap contracts through the fourth quarter of 2019 for a total of 3.7 million Bbls of oil production at contract prices ranging from ($1.23) per Bbl to ($1.45) per Bbl; and +• +derivative fixed price swap contracts through the first quarter of 2018 for a total of 1.1 million Bbls of NGL production at contract prices ranging from $35.07 per Bbl to $49.88 per Bbl. +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities. The fair value of the commodity derivative contracts was a net liability of $91.7 million at December 31, 2016 , and net asset of $488.4 million at December 31, 2015 . +The following tables detail the fair value of derivatives recorded in the accompanying balance sheets, by category: +As of December 31, 2016 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity contracts +Current assets +$ +54,521 +Current liabilities +$ +115,464 +Commodity contracts +Noncurrent assets +67,575 +Noncurrent liabilities +98,340 +Derivatives not designated as hedging instruments +$ +122,096 +$ +213,804 +As of December 31, 2015 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity contracts +Current assets +$ +367,710 +Current liabilities +$ +8 +Commodity contracts +Noncurrent assets +120,701 +Noncurrent liabilities +— +Derivatives not designated as hedging instruments +$ +488,411 +$ +8 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2016 , and 2015 , all derivative instruments held by the Company were subject to master netting arrangements by various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that settle on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +127 +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s derivative contracts: +Derivative Assets +Derivative Liabilities +As of December 31, +As of December 31, +Offsetting of Derivative Assets and Liabilities +2016 +2015 +2016 +2015 +(in thousands) +Gross amounts presented in the accompanying balance sheets +$ +122,096 +$ +488,411 +$ +(213,804 +) +$ +(8 +) +Amounts not offset in the accompanying balance sheets +(118,080 +) +(8 +) +118,080 +8 +Net amounts +$ +4,016 +$ +488,403 +$ +(95,724 +) +$ +— +The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive loss. The Company had no derivatives designated as hedging instruments for the years ended December 31, 2016 , 2015 , and 2014 . Please refer to Note 11 - Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +The following table summarizes the components of net derivative (gain) loss presented in the accompanying statements of operations: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Derivative settlement (gain) loss: +Oil contracts +$ +(243,102 +) +$ +(362,219 +) +$ +(28,410 +) +Gas contracts (1) +(94,936 +) +(123,180 +) +26,706 +NGL contracts +8,560 +(27,167 +) +(10,911 +) +Total derivative settlement gain +$ +(329,478 +) +$ +(512,566 +) +$ +(12,615 +) +Total derivative (gain) loss: +Oil contracts +$ +85,370 +$ +(191,165 +) +$ +(457,082 +) +Gas contracts +81,060 +(189,734 +) +(93,267 +) +NGL contracts +84,203 +(27,932 +) +(32,915 +) +Total net derivative (gain) loss +$ +250,633 +$ +(408,831 +) +$ +(583,264 +) +____________________________________________ +(1) +Natural gas derivative settlements for the years ended December 31, 2015, and 2014, include $15.3 million and $5.6 million , respectively, of early settlements of futures contracts as a result of divesting assets in the Company’s Mid-Continent region. +Credit Related Contingent Features +As of December 31, 2016, and through the filing date of this report, all of the Company’s derivative counterparties were members of the Company’s credit facility lender group. The Company’s obligations under its Credit Agreement and derivative contracts are secured by mortgages on assets having a value equal to at least 90 percent of the total PV-9 of the Company’s proved oil and gas properties evaluated in the most recent reserve report. +128 +Note 11 – Fair Value Measurements +The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• +Level 1 – quoted prices in active markets for identical assets or liabilities +• +Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +• +Level 3 – significant inputs to the valuation model are unobservable +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2016 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +122,096 +$ +— +Total property and equipment, net (2) +$ +— +$ +— +$ +88,205 +Liabilities: +Derivatives (1) +$ +— +$ +213,804 +$ +— +Net Profits Plan (1) +$ +— +$ +— +$ +411 +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +(2) +This represents a non-financial asset that is measured at fair value on a nonrecurring basis. +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2015 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +488,411 +$ +— +Total property and equipment, net (2) +$ +— +$ +— +$ +124,813 +Liabilities: +Derivatives (1) +$ +— +$ +8 +$ +— +Net Profits Plan (1) +$ +— +$ +— +$ +7,611 +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +(2) +This represents a non-financial asset that is measured at fair value on a nonrecurring basis. +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. +129 +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivatives. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit-price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. All of the Company’s derivative counterparties are members of the Company’s credit facility lender group. +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current credit facility margins, and any change in such margins since the last measurement date. +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and with other marketplace participants, the Company recognizes that third parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Refer to Note 10 - Derivative Financial Instruments for more information regarding the Company’s derivative instruments. +Proved and Unproved Oil and Gas Properties and Other Property and Equipment +Proved oil and gas properties . Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique, which converts future cash flow amounts to a single present value amount, to measure the fair value of proved properties through an application of discount rates and price forecasts representative of the current operating environment, as selected by the Company’s management. The calculation of the discount rates is based on the best information available and the rates used ranged from 10 percent to 15 percent based on the reservoir specific weightings of future estimated proved and unproved cash flows as of December 31, 2016 , and 2015 . The Company believes the discount rates are representative of current market conditions and consider estimates of future cash payments, reserve categories, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk. The prices for oil and gas are forecast based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecast using OPIS Mont Belvieu pricing, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. +The following table presents impairment of proved properties expense recorded for the periods presented: +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Impairment of proved properties +$ +354.6 +$ +468.7 +$ +84.5 +Impairments of proved properties during the year ended December 31, 2016 , related primarily to the decline in expected reserve cash flows for the Company’s outside-operated Eagle Ford shale assets driven by commodity price declines during the first quarter of 2016, and downward performance reserve revisions in the fourth quarter of 2016 for the Company’s +130 +Powder River Basin assets. Impairments of proved properties during the year ended December 31, 2015 , were due to the decline in expected reserve cash flows driven by commodity price declines and were recorded mainly in the Company’s east Texas and Powder River Basin programs with smaller impacts on other legacy and non-core assets in the Rocky Mountain region. Impairments of proved properties during the year ended December 31, 2014, resulted from the significant decline in commodity prices in late 2014 and recognition of the outcomes of exploration and delineation wells in certain prospects in the Company’s South Texas & Gulf Coast and Permian regions. +Unproved oil and gas properties . Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +The following table presents abandonment and impairment of unproved properties expense recorded for the periods presented: +For the Years Ended December 31, +2016 +2015 +2014 +(in millions) +Abandonment and impairment of unproved properties +$ +80.4 +$ +78.6 +$ +75.6 +Abandonment and impairment of unproved properties during the year ended December 31, 2016, related primarily to a decrease in the fair value of the Company’s unproved Powder River Basin properties due to downward performance reserve revisions and lower market prices based on recent third-party acreage transactions. In all other periods, abandonment and impairment expense resulted from lease expirations and acreage the Company no longer intended to develop in light of changes in drilling plans in response to the decline in commodity prices. +Other property and equipment . Other property and equipment costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. To measure the fair value of other property and equipment, the Company uses an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. The valuation includes consideration of the proved and unproved assets supported by the property and equipment, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. During the year ended December 31, 2015 , the Company recorded impairment of other property and equipment expense of $49.4 million on the Company’s gathering system assets in its east Texas program. These assets were impaired in conjunction with the impairment of the associated proved and unproved properties, which the Company did not intend to develop and subsequently sold. There were no other property and equipment impairments in 2016 or 2014. +Oil and gas properties held for sale . Proved and unproved oil and gas properties classified as held for sale, including the corresponding asset retirement obligation liability, are valued using a market approach, based on an estimated net selling price, as evidenced by the most current bid prices received from third parties, if available. If an estimated selling price is not available, the Company utilizes the various income valuation techniques discussed above. Any initial write-down and subsequent changes to the fair value less estimated cost to sell is included within the net gain on divestiture activity line item in the accompanying statements of operations. There were no assets held for sale recorded at fair value as of December 31, 2016 , or 2015 , as the carrying values were below the estimated fair values less costs to sell. Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale for additional discussion. +Acquisitions of proved and unproved properties . Assets acquired and liabilities assumed under transactions that meet the criteria of a business combination under ASC Topic 805, Business Combinations are recorded at fair value on the acquisition date using an income valuation technique based on inputs that are not observable in the market and therefore represent Level 3 inputs. Significant inputs to the valuation of acquired oil and gas properties include estimates of: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgments and estimates by the Company’s management at the time of the valuation. The Rock Oil Acquisition closed on October 4, 2016, and therefore, was not recorded at fair value as of December 31. 2016. +131 +Assets acquired and liabilities assumed under transactions that do not meet the criteria of a business combination under ASC Topic 805, Business Combinations are accounted for as an asset acquisition and are recorded based on the fair value of the total consideration transferred on the acquisition date using the lowest observable inputs available. In connection with the QStar Acquisition, the Company issued approximately 13.4 million shares of common stock as a component of the total consideration transferred to the sellers on December 21, 2016. Fair value of the equity consideration transferred was based on the closing price of the Company’s common stock on the date of acquisition, as adjusted using an option pricing model to account for the lack of marketability of the shares issued. +Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale for additional discussion. +Net Profits Plan +The Net Profits Plan is a liability for which there is no available market price, principal market, or market participants. The inputs available for this instrument are unobservable and are therefore classified as Level 3 inputs. The Company employs the income valuation technique, which converts expected future cash flow amounts to a single present value amount. The estimate is highly dependent on commodity prices, cost assumptions, discount rates, and overall market conditions. Due to divestitures of assets subject to the Net Profits Plan in recent years, the liability has been significantly reduced and is no longer considered a significant accounting estimate. The Net Profits Plan liability is included in the other noncurrent liabilities line on the accompanying balance sheets. +The following table reflects the activity for the Company’s Net Profits Plan liability measured at fair value using Level 3 inputs: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Beginning balance +$ +7,611 +$ +27,136 +$ +56,985 +Net increase (decrease) in liability (1) +23,757 +(12,238 +) +(12,492 +) +Net settlements (1) (2) +(30,957 +) +(7,287 +) +(17,357 +) +Transfers in (out) of Level 3 +— +— +— +Ending balance +$ +411 +$ +7,611 +$ +27,136 +____________________________________________ +(1) +Net changes in the Company’s Net Profits Plan liability are shown in the change in Net Profits Plan liability line item of the accompanying statements of operations. +(2) +Settlements represent cash payments made or accrued under the Net Profits Plan and are recognized as compensation expense or a reduction to the net gain on divestiture activity line in the accompanying statements of operations, as discussed in Note 7 – Compensation Plans. +132 +Long-Term Debt +The following table reflects the fair value of the Senior Notes and Senior Convertible Notes measured using Level 1 inputs based on quoted secondary market trading prices. These notes were not presented at fair value on the accompanying balance sheets as of December 31, 2016 , or 2015 , as they are recorded at carrying value, net of any unamortized discounts and deferred financing costs. Please refer to Note 5 - Long-Term Debt for additional discussion. +As of December 31, +2016 +2015 +Principal Amount +Fair Value +Principal Amount +Fair Value +(in thousands) +6.50% Senior Notes due 2021 +$ +346,955 +$ +354,546 +$ +350,000 +$ +262,938 +6.125% Senior Notes due 2022 +$ +561,796 +$ +570,925 +$ +600,000 +$ +440,250 +6.50% Senior Notes due 2023 +$ +394,985 +$ +403,134 +$ +400,000 +$ +296,000 +5.0% Senior Notes due 2024 +$ +500,000 +$ +475,975 +$ +500,000 +$ +334,065 +5.625% Senior Notes due 2025 +$ +500,000 +$ +485,000 +$ +500,000 +$ +326,875 +6.75% Senior Notes due 2026 +$ +500,000 +$ +516,565 +$ +— +$ +— +1.50% Senior Convertible Notes due 2021 +$ +172,500 +$ +202,189 +$ +— +$ +— +The carrying value of the Company’s credit facility approximates its fair value, as the applicable interest rates are floating, based on prevailing market rates. +Note 12 - Acquisition and Development Agreement +In June 2011, the Company entered into an Acquisition and Development Agreement with Mitsui E&P Texas LP (“Mitsui” and the “Acquisition and Development Agreement”). Pursuant to the Acquisition and Development Agreement, the Company agreed to transfer to Mitsui a 12.5 percent working interest in certain outside-operated oil and gas assets representing approximately 39,000 net acres in Dimmit, LaSalle, Maverick, and Webb Counties, Texas. As consideration for the oil and gas interests transferred, Mitsui agreed to pay, or carry, 90 percent of certain drilling and completion costs attributable to the Company’s remaining interest in these assets until Mitsui expended an aggregate $680.0 million on behalf of the Company. The Acquisition and Development Agreement also provided for reimbursement of capital expenditures and other costs, net of revenues, paid by the Company that were attributable to the transferred interest during the period between the effective date and the closing date, which the parties agreed would be applied over the carry period to cover the Company’s remaining 10 percent of drilling and completion costs for the affected acreage. During the second quarter of 2014, the remainder of the carry under the Acquisition and Development Agreement was expended. +133 +Note 13 - Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2016 , 2015 , and 2014 . The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Beginning balance on January 1, +$ +11,952 +$ +43,589 +$ +34,527 +Additions to capitalized exploratory well costs pending the determination of proved reserves +19,846 +11,952 +43,589 +Divestitures +— +(809 +) +— +Reclassifications to wells, facilities, and equipment based on the determination of proved reserves +(11,952 +) +(18,485 +) +(33,340 +) +Capitalized exploratory well costs charged to expense +— +(24,295 +) +(1,187 +) +Ending balance at December 31, +$ +19,846 +$ +11,952 +$ +43,589 +As of December 31, 2016 , there were no exploratory well costs that were capitalized for more than one year. +Note 14 - Exit and Disposal Costs +2016 Activity . In the third quarter of 2016, the Company conducted a company-wide reduction in workforce and in the fourth quarter of 2016, the Company closed its Billings, Montana regional office and relocated certain employees to the Company’s corporate office in Denver, Colorado or other Company offices. This decision was made in an effort to reduce future costs and better position the Company for efficient growth in response to prolonged commodity price weakness. The Company expects to incur approximately $7.6 million of total exit and disposal costs related to termination benefits, relocation of certain employees, and other related matters, excluding lease expenses discussed below, all of which are included in general and administrative expense in the accompanying statements of operations. The Company incurred $5.1 million of exit and disposal costs during the year ended December 31, 2016 , and expects to incur the remaining costs in early 2017. Upon closing the office in Billings, Montana, the Company paid $3.2 million to the lessor to terminate the lease. +2015 Activity . In conjunction with its Mid-Continent divestitures in 2015, the Company closed its Tulsa, Oklahoma regional office and incurred $9.3 million of exit and disposal costs, excluding the lease expenses discussed below, all of which were included in general and administrative expense in the accompanying statements of operations for the year ended December 31, 2015. The Company subsequently subleased its space for a portion of the remaining lease term. As of December 31, 2016, the Company is obligated to pay lease costs of approximately $3.8 million , net of expected income from subleased office space, which will be expensed over the remaining duration of the lease, which expires in 2022. +134 +Note 15 - Equity +On August 12, 2016 , the Company completed an underwritten public offering of approximately 18.4 million shares of its common stock at an offering price of $30.00 per share. Net proceeds from the offering totaled $530.9 million , after deducting underwriting discounts and commissions and offering expenses, which the Company used to partially fund the Rock Oil Acquisition that closed on October 4, 2016. +On December 7, 2016 , the Company completed an underwritten public offering of approximately 10.9 million shares of its common stock at an offering price of $38.25 per share. Net proceeds from the offering totaled $403.2 million , after deducting underwriting discounts and commissions and offering expenses, which the Company used to partially fund the QStar Acquisition. +These public equity offerings were made pursuant to an effective shelf registration statement on Form S-3 filed with the SEC. +On December 21, 2016, and as part of the QStar Acquisition, the Company issued approximately 13.4 million shares of its common stock valued at approximately $437.2 million in a private placement to the sellers as partial consideration for the acquired properties. Please refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale for additional discussion. +Supplemental Oil and Gas Information (unaudited) +Costs Incurred in Oil and Gas Producing Activities +Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Development costs (1) +$ +595,331 +$ +1,234,114 +$ +1,782,324 +Exploration costs +118,224 +132,465 +288,270 +Acquisitions (2) +Proved properties +201,672 +10,040 +272,902 +Unproved properties (3) +2,458,667 +18,382 +368,208 +Total, including asset retirement obligation (4)(5) +$ +3,373,894 +$ +1,395,001 +$ +2,711,704 +____________________________________________ +(1) +Includes facility costs of $25.9 million , $75.6 million , and $75.1 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively. +(2) +Includes the $437.2 million value of the equity consideration given to the sellers of the QStar Acquisition. Please refer to Note 3 - Acquisitions, Divestitures, and Assets Held for Sale for additional discussion. +(3) +Includes amounts related to leasing activity outside of acquisitions of proved and unproved properties totaling $7.5 million , $17.5 million , and $79.5 million for the years ended December 31, 2016, 2015 , and 2014 , respectively. +(4) +Includes amounts relating to estimated asset retirement obligations of $32.1 million , $38.5 million , and $11.4 million for the years ended December 31, 2016, 2015 , and 2014 , respectively. For the year ended December 31, 2016, $16.5 million of the estimated asset retirement obligation amount relates to acquired proved properties. +(5) +Includes capitalized interest of $17.0 million , $25.1 million , and $16.2 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting of reserve estimation and disclosure. +Proved reserves are the estimated quantities of oil, gas, and NGLs, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which +135 +contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated proved reserves are located in the United States. +The table below presents a summary of changes in the Company’s estimated proved reserves for each of the years in the three-year period ended December 31, 2016 . The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company’s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +For the Years Ended December 31, +2016 (1) +2015 (2) +2014 (3) +Oil +Gas +NGLs +Oil +Gas +NGLs +Oil +Gas +NGLs +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +Total proved reserves: +Beginning of year +145.3 +1,264.0 +115.4 +169.7 +1,466.5 +133.5 +126.6 +1,189.3 +103.9 +Revisions of previous estimate +(36.0 +) +(249.8 +) +(18.6 +) +(46.2 +) +(369.6 +) +(40.6 +) +(5.1 +) +46.0 +7.8 +Discoveries and extensions +7.8 +42.5 +4.1 +16.9 +122.3 +9.3 +15.0 +103.5 +10.5 +Infill reserves in an existing proved field +32.3 +228.1 +18.9 +24.9 +356.2 +29.7 +32.0 +270.8 +24.1 +Sales of +reserves (4) +(40.0 +) +(46.7 +) +— +(1.9 +) +(138.4 +) +(0.4 +) +(1.9 +) +(1.1 +) +— +Purchases of minerals in place (4) +12.1 +19.9 +0.1 +1.1 +0.6 +— +19.8 +10.9 +0.2 +Production +(16.6 +) +(146.9 +) +(14.2 +) +(19.2 +) +(173.6 +) +(16.1 +) +(16.7 +) +(152.9 +) +(13.0 +) +End of year (5) +104.9 +1,111.1 +105.7 +145.3 +1,264.0 +115.4 +169.7 +1,466.5 +133.5 +Proved developed reserves: +Beginning of year +75.6 +644.4 +61.5 +89.3 +784.6 +66.7 +70.2 +569.2 +43.8 +End of year +48.5 +609.1 +58.6 +75.6 +644.4 +61.5 +89.3 +784.6 +66.7 +Proved undeveloped reserves: +Beginning of year +69.6 +619.7 +53.9 +80.4 +682.0 +66.8 +56.3 +620.1 +60.2 +End of year +56.4 +502.0 +47.1 +69.6 +619.7 +53.9 +80.4 +682.0 +66.8 +____________________________________________ +Note: Amounts may not calculate due to rounding. +136 +(1) +For the year ended December 31, 2016, the Company added 108.2 MMBOE from its drilling program and acquired 15.5 MMBOE. These additions were offset by net negative engineering revisions of 96.2 MMBOE, consisting of 18.1 MMBOE of negative performance revisions, a 35.1 MMBOE negative price revision, and the removal of 43.0 MMBOE of certain longer term proved undeveloped reserves reflecting the Company’s shift to develop its predominately unproven Midland Basin properties. Additionally, the Company sold 47.7 MMBOE during 2016. +(2) +For the year ended December 31, 2015, the Company added 160.6 MMBOE from its drilling program, the majority of which related to activity in the Eagle Ford shale and Bakken/Three Forks resource plays. The Company had net negative engineering revisions of 148.6 MMBOE, consisting of 47.3 MMBOE of positive performance revisions in the Eagle Ford shale and Bakken/Three Forks resource plays resulting from enhanced completions and reductions in operating expenses, offset by a 116.5 MMBOE negative price revision due to the decline in commodity prices in 2015 and the removal of 79.4 MMBOE of proved undeveloped reserves due to the five-year rule. Additionally, the Company sold 25.4 MMBOE in 2015. +(3) +For the year ended December 31, 2014, the Company added 143.9 MMBOE from its drilling program and had upward engineering revisions of 10.4 MMBOE related primarily to improved performance and lower operating expenses in its operated Eagle Ford shale assets. +(4) +Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale for additional information. +(5) +As of December 31, 2016, the Company’s outside-operated Eagle Ford shale assets were held for sale. Subsequent to year-end, the Company entered into a definitive agreement with an expected closing date in the first quarter of 2017. These assets represented approximately 74.0 MMBOE of the Company’s proved reserves as of December 31, 2016. Additionally, subsequent to December 31, 2016, the Company announced plans to sell its Divide County, North Dakota assets. +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of future net cash flows (“Standardized Measure”) and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year-end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the proved reserves in place at the end of the period using year-end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities. +The assumptions used to compute the Standardized Measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the Standardized Measure computations since these reserve quantity estimates are the basis for the valuation process. The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the Standardized Measure: +For the Years Ended December 31, +2016 +2015 +2014 +Oil (per Bbl) +$ +37.22 +$ +42.98 +$ +84.65 +Gas (per Mcf) +$ +2.45 +$ +2.48 +$ +4.63 +NGLs (per Bbl) +$ +16.38 +$ +16.99 +$ +35.48 +137 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the Standardized Measure. +As of December 31, +2016 +2015 +2014 +(in thousands) +Future cash inflows +$ +8,359,938 +$ +11,337,865 +$ +25,897,730 +Future production costs +(4,634,649 +) +(6,234,687 +) +(9,986,239 +) +Future development costs +(1,636,077 +) +(2,005,599 +) +(3,294,164 +) +Future income taxes (1) +— +— +(3,511,352 +) +Future net cash flows +2,089,212 +3,097,579 +9,105,975 +10 percent annual discount +(937,099 +) +(1,307,053 +) +(3,407,192 +) +Standardized measure of discounted future net cash flows +$ +1,152,113 +$ +1,790,526 +$ +5,698,783 +___________________________________________ +(1) +Regarding the calculation as of December 31, 2016, and 2015, after evaluating all factors and giving effect to tax basis, future tax deductions, and available tax credits, the Company determined that at price levels for each respective period, future net cash flows would not be subject to federal or state income tax for the projected life of the reserves under authoritative tax legislation. +The principle sources of changes in the Standardized Measure were: +For the Years Ended December 31, +2016 +2015 +2014 +(in thousands) +Standardized Measure, beginning of year +$ +1,790,526 +$ +5,698,783 +$ +4,009,439 +Sales of oil, gas, and NGLs produced, net of production costs +(580,861 +) +(776,272 +) +(1,765,666 +) +Net changes in prices and production costs +(315,725 +) +(4,709,908 +) +(75,966 +) +Extensions, discoveries and other including infill reserves in an existing proved field, net of related costs +242,556 +386,069 +1,819,657 +Sales of reserves in place +(377,607 +) +(262,210 +) +(49,736 +) +Purchase of reserves in place +115,270 +4,686 +413,175 +Previously estimated development costs incurred during the period +290,837 +449,738 +1,015,694 +Changes in estimated future development costs +27,961 +191,447 +138,247 +Revisions of previous quantity estimates +(124,845 +) +(1,819,639 +) +167,500 +Accretion of discount +179,050 +761,746 +552,852 +Net change in income taxes +— +1,918,670 +(399,587 +) +Changes in timing and other +(95,049 +) +(52,584 +) +(126,826 +) +Standardized Measure, end of year +$ +1,152,113 +$ +1,790,526 +$ +5,698,783 +138 +Quarterly Financial Information (unaudited) +The Company’s quarterly financial information for fiscal years 2016 and 2015 is as follows (in thousands, except per share amounts): +First +Second +Third +Fourth +Quarter +Quarter +Quarter +Quarter +Year Ended December 31, 2016 (2) +Total operating revenues and other income +$ +143,076 +$ +341,814 +$ +352,660 +$ +379,900 +Total operating expenses +669,801 +572,363 +370,314 +664,287 +Loss from operations +$ +(526,725 +) +$ +(230,549 +) +$ +(17,654 +) +$ +(284,387 +) +Loss before income taxes +$ +(542,085 +) +$ +(264,579 +) +$ +(64,639 +) +$ +(330,613 +) +Net loss +$ +(347,210 +) +$ +(168,681 +) +$ +(40,907 +) +$ +(200,946 +) +Basic net loss per common share (1) +$ +(5.10 +) +$ +(2.48 +) +$ +(0.52 +) +$ +(2.20 +) +Diluted net loss per common share (1) +$ +(5.10 +) +$ +(2.48 +) +$ +(0.52 +) +$ +(2.20 +) +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +Year Ended December 31, 2015 (3) +Total operating revenues and other income +$ +365,934 +$ +516,146 +$ +371,151 +$ +303,734 +Total operating expenses +420,369 +567,025 +339,047 +809,307 +Income (loss) from operations +$ +(54,435 +) +$ +(50,879 +) +$ +32,104 +$ +(505,573 +) +Loss before income taxes +$ +(86,511 +) +$ +(98,211 +) +$ +(1,026 +) +$ +(537,113 +) +Net income (loss) +$ +(53,058 +) +$ +(57,508 +) +$ +3,114 +$ +(340,258 +) +Basic net income (loss) per common share (1) +$ +(0.79 +) +$ +(0.85 +) +$ +0.05 +$ +(5.01 +) +Diluted net income (loss) per common share (1) +$ +(0.79 +) +$ +(0.85 +) +$ +0.05 +$ +(5.01 +) +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +____________________________________________ +(1) +Amounts may not sum due to rounding. +(2) +First quarter of 2016 included the following: +• +$272.1 million of proved and unproved property impairments on the Company’s outside-operated Eagle Ford shale assets due to declining commodity prices (see Note 11 - Fair Value Measurements ) +• +$69.0 million net pre-tax loss on divestiture activity related to write-downs on certain non-core assets held for sale (see Note 3 - Acquisitions, Divestitures, and Assets Held for Sale ) +• +$14.2 million net derivative gain (see Note 10 - Derivative Financial Instruments ) +• +$15.7 million net gain on the repurchase of a portion of the Company’s Senior Notes (see Note 5 - Long-Term Debt ) +Second quarter of 2016 included the following: +• +$50.0 million net pre-tax gain on divestiture activity related to an increase in fair value less costs to sell on assets held for sale (see Note 3 - Acquisitions, Divestitures, and Assets Held for Sale ) +• +$163.4 million net derivative loss (see Note 10 - Derivative Financial Instruments ) +Third quarter of 2016 included the following: +• +$11.6 million of proved and unproved property impairments (see Note 11 - Fair Value Measurements ) +• +$22.4 million net pre-tax gain on divestiture activity upon closing divestitures in the Company’s Rocky Mountain and Permian regions (see Note 3 - Acquisitions, Divestitures, and Assets Held for Sale ) +• +$28.0 million net derivative gain (see Note 10 - Derivative Financial Instruments ) +Fourth quarter of 2016 included the following: +• +$151.2 million of proved and unproved property impairments related primarily to negative performance revisions on the Company’s Powder River Basin assets (see Note 11 - Fair Value Measurements ) +• +$33.7 million net pre-tax gain on divestiture activity upon closing the Raven/Bear Den divestiture (see Note 3 - Acquisitions, Divestitures, and Assets Held for Sale ) +• +$129.5 million net derivative loss (see Note 10 - Derivative Financial Instruments ) +139 +(3) +First quarter of 2015 included the following: +• +$67.2 million of proved and unproved property impairments due to commodity price declines and the Company’s decision to reduce capital invested in the development of certain prospects in its South Texas & Gulf Coast and Permian regions and acreage it no longer intended to develop (see Note 11 - Fair Value Measurements ) +• +$16.3 million of expense relating to an exploratory dry hole +• +$35.8 million net pre-tax loss on divestiture activity related to write-downs on certain assets held for sale in the Company’s Mid-Continent region (see Note 3 - Acquisitions, Divestitures, and Assets Held for Sale ) +• +$154.2 million net derivative gain (see Note 10 - Derivative Financial Instruments ) +Second quarter of 2015 included the following: +• +$18.7 million of proved and unproved property impairments (see Note 11 - Fair Value Measurements ) +• +$71.9 million net pre-tax gain on divestiture activity upon closing the sale of the Company’s Mid-Continent assets (see Note 3 - Acquisitions, Divestitures, and Assets Held for Sale ) +• +$80.9 million net derivative loss (see Note 10 - Derivative Financial Instruments ) +• +$16.6 million net loss on the early extinguishment of the Company’s 2019 Notes (see Note 5 - Long-Term Debt ) +Third quarter of 2015 included the following: +• +$62.6 million of proved and unproved property impairments primarily on legacy assets in the Company’s Rocky Mountain region as a result of the continued decline in commodity strip prices (see Note 11 - Fair Value Measurements ) +• +$212.3 million net derivative gain (see Note 10 - Derivative Financial Instruments ) +Fourth quarter of 2015 included the following: +• +$448.2 million of proved, unproved, and other property and equipment impairments due to continued commodity price declines, largely impacting the Company’s Powder River Basin program, as well as the Company’s decision to reduce capital invested in the development of its east Texas exploration program in its South Texas & Gulf Coast region (see Note 11 - Fair Value Measurements ) +• +$13.8 million expense relating to exploratory dry holes +• +$123.3 million net derivative gain (see Note 10 - Derivative Financial Instruments ) +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all +140 +potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +141 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2016 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +142 +Report of Independent Registered Public Accounting Firm +The Board of Directors and Stockholders of SM Energy Company and subsidiaries +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2016 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). SM Energy Company and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, SM Energy Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of SM Energy Company and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 of SM Energy Company and subsidiaries and our report dated February 23, 2017 expressed an unqualified opinion thereon . +/s/ Ernst & Young LLP +Denver, Colorado +February 23, 2017 +143 +ITEM 9B. OTHER INFORMATION +Amendment to By-Laws +Effective February 21, 2017, the Board of Directors amended and restated the Company’s by-laws (the “By-Laws”). The By-Laws include, among other things, the following changes: +• +provide the Board with explicit authority to cancel, postpone or reschedule a shareholder meeting; +• +provide the chairman of the meeting with explicit authority to adjourn or recess a shareholder meeting; +• +clarify the powers of the chairman of the meeting to conduct a shareholder meeting; +• +provide for additional disclosure requirements for notices of director nominations and shareholder proposals; and +• +clarify the procedural parameters governing the right of stockholders to take action by written consent. +The foregoing description of the terms of the By-Laws do not purport to be complete and are subject to, and qualified in their entirety by, reference to the complete text of the By-Laws, a copy of which is filed as Exhibit 3.2 to this Annual Report on Form 10-K and incorporated by reference herein. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning SM Energy’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about Executive Officers,” and “Corporate Governance” in SM Energy’s definitive proxy statement for the 2017 annual meeting of stockholders to be filed within 120 days from December 31, 2016 . +The information required by this Item concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the information provided under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in SM Energy’s definitive proxy statement for the 2017 annual meeting of stockholders to be filed within 120 days from December 31, 2016 . +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation” and “Director Compensation” in SM Energy’s definitive proxy statement for the 2017 annual meeting of stockholders to be filed within 120 days from December 31, 2016 . +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in SM Energy’s definitive proxy statement for the 2017 annual meeting of stockholders to be filed within 120 days from December 31, 2016 . +144 +Securities Authorized for Issuance Under Equity Compensation Plans. SM Energy has the Equity Plan under which options and shares of SM Energy common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. Our stockholders have approved this plan. See Note 7 – Compensation Plans included in Part II, Item 8 of this report for further information about the material terms of our equity compensation plans. The following table is a summary of the shares of common stock authorized for issuance under equity compensation plans as of December 31, 2016 : +(a) +(b) +(c) +Plan category +Number of securities to be issued upon exercise of outstanding options, warrants, and rights +Weighted-average exercise price of outstanding options, warrants, and rights +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan +Stock options and incentive stock options (1) +— +$ +— +Restricted stock (1)(3) +604,116 +N/A +Performance share units (1)(3)(4) +878,844 +N/A +Total for Equity Incentive Compensation Plan +1,482,960 +$ +— +5,531,614 +Employee Stock Purchase Plan (2) +— +— +731,572 +Equity compensation plans not approved by security holders +— +— +— +Total for all plans +1,482,960 +$ +— +6,263,186 +____________________________________________ +(1) +In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of SM Energy or any affiliate of SM Energy. Our Board of Directors approved amendments to the Equity Plan in 2009, 2010, 2013, and 2016 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The number of shares underlying awards granted in 2016 , 2015 , and 2014 under the Equity Plan were 918,509 , 714,949, and 464,641 , respectively. +(2) +Under the SM Energy Company ESPP, eligible employees may purchase shares of our common stock through payroll deductions of up to 15 percent of their eligible compensation. The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on the first or last day of the six-month offering period, and shares issued under the ESPP on or after December 31, 2011, have no minimum restriction period. The ESPP is intended to qualify under Section 423 of the IRC. Shares issued under the ESPP totaled 218,135 , 197,214 , and 83,136 in 2016 , 2015 , and 2014 , respectively. +(3) +RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per share fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per share fair value for the outstanding RSUs and PSUs was $37.39 and $45.53, respectively. Please refer to Note 7 - Compensation Plans in Part II, Item 8 of this report for additional discussion. +(4) +The number of awards vested assumes a one multiplier. The final number of shares issued upon settlement may vary depending on the three -year multiplier determined at the end of the performance period under the Equity Plan, which ranges from zero to two . +145 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “Certain Relationships and Related Transactions” and “Corporate Governance” in SM Energy’s definitive proxy statement for the 2017 annual meeting of stockholders to be filed within 120 days from December 31, 2016 . +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “Independent Registered Public Accounting Firm” and “Audit Committee Preapproval Policy and Procedures” in SM Energy’s definitive proxy statement for the 2017 annual meeting of stockholders to be filed within 120 days from December 31, 2016 . +146 +PART IV +ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Financial Statements and Financial Statement Schedules: +Report of Independent Registered Public Accounting Firm +84 +Consolidated Balance Sheets +85 +Consolidated Statements of Operations +86 +Consolidated Statements of Comprehensive Income (Loss) +87 +Consolidated Statements of Stockholders’ Equity +88 +Consolidated Statements of Cash Flows +89 +Notes to Consolidated Financial Statements +91 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +1.1 +Underwriting Agreement dated May 7, 2015, among SM Energy Company, and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner, & Smith Incorporated and J.P. Morgan Securities LLC, as representatives of the several underwriters (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on May 8, 2015, and incorporated herein by reference)
 +1.2 +Underwriting Agreement dated August 8, 2016 by and among SM Energy Company and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and J.P. Morgan Securities LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +1.3 +Underwriting Agreement dated August 8, 2016 by and among SM Energy Company and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and J.P. Morgan Securities LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +1.4 +Underwriting Agreement dated September 7, 2016 by and among SM Energy Company and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Wells Fargo Securities, LLC, and J.P. Morgan Securities LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +1.5 +Underwriting Agreement, dated December 1, 2016, by and among SM Energy Company and J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wells Fargo Securities, LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on December 7, 2016, and incorporated herein by reference) +2.1 +Acquisition and Development Agreement dated June 29, 2011 between SM Energy Company and Mitsui E&P Texas LP (filed as Exhibit 2.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +2.2 +First Amendment to Acquisition and Development Agreement dated October 13, 2011 between SM Energy Company and Mitsui E&P Texas LP (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, and incorporated herein by reference) +2.3*** +Purchase and Sale Agreement dated November 4, 2013, among SM Energy Company, EnerVest Energy Institutional Fund XIII-A, L.P., EnerVest Energy Institutional Fund XIII-WIB, L.P., and EnerVest Energy Institutional Fund XIII-WIC, L.P. (filed as Exhibit 2.4 to the registrant’s Amendment to the Annual Report on Form 10-K/A filed on May 9, 2014 for the year ended December 31, 2013, and incorporated herein by reference) +147 +2.4*** +Purchase and Sale Agreement dated July 29, 2014 between SM Energy Company and Baytex Energy USA LLC (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, and incorporated herein by reference) +2.5 +Membership Interest Purchase Agreement dated August 8, 2016 between SM Energy Company and Rock Oil Holdings LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on August 8, 2016, and incorporated herein by reference) +2.6 +Purchase and Sale Agreement, dated October 17, 2016, by and between SM Energy Company and QStar LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +2.7 +Letter Agreement dated October 17, 2016, by and among SM Energy Company, QStar LLC, and RRP-QStar, LLC (filed as Exhibit 2.2 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +2.8 +Purchase and Sale Agreement dated October 17, 2016, by and between SM Energy Company and Oasis Petroleum North America LLC (filed as Exhibit 2.3 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +3.2* +Amended and Restated By-Laws of SM Energy Company, effective as of February 21, 2017 +4.1 +Indenture related to the 6.625% Senior Notes due 2019, dated February 7, 2011, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on February 10, 2011, and incorporated herein by reference) +4.2 +Indenture related to the 6.50% Senior Notes due 2021, dated November 8, 2011, by and among SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 10, 2011, and incorporated herein by reference) +4.3 +Indenture related to the 6.50% Senior Notes due 2023, dated June 29, 2012, between SM Energy Company, as Issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on July 3, 2012, and incorporated herein by reference) +4.4 +Indenture related to the 5.0% Senior Notes due 2024, dated May 20, 2013, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on May 20, 2013, and incorporated herein by reference) +4.5 +Indenture related to the 6.125% Senior Notes due 2022, dated November 17, 2014, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 18, 2014, and incorporated herein by reference) +4.6 +Indenture related to senior debt securities of SM Energy Company by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-3 filed on May 7, 2015 (Registration No. 333-203936) and incorporated herein by reference) +4.7 +2025 Notes Supplemental Indenture (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on May 21, 2015, and incorporated herein by reference) +4.8 +2019 Notes Supplemental Indenture (filed as Exhibit 4.3 to the registrant’s Current Report on Form 8-K filed on May 21, 2015 and incorporated herein by reference) +4.9 +Base Indenture, dated as of May 21, 2015, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.10 +Second Supplemental Indenture, dated August 12, 2016, by and between SM Energy Company and U.S. Bank, National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.11 +Third Supplemental Indenture, dated September 12, 2016 by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +4.12† +Equity Incentive Compensation Plan, amended and restated effective May 24, 2016 (filed as Exhibit 4.3 to the registrant’s Form S-8 filed on June 30, 2016, and incorporated herein by reference) +4.13* +Lock-Up and Registration Rights Agreement, dated December 21, 2016, by and among SM Energy Company, QStar LLC and RRP-QStar, LLC +10.1† +Stock Option Plan, as Amended on May 22, 2003 (filed as Exhibit 99.1 to the registrant’s Registration Statement on Form S-8 (Registration No. 333-106438) and incorporated herein by reference) +148 +10.2† +Incentive Stock Option Plan, as Amended on May 22, 2003 (filed as Exhibit 99.2 to the registrant’s Registration Statement on Form S-8 (Registration No. 333-106438) and incorporated herein by reference) +10.3 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.4 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.5† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +10.6*** +Gas Services Agreement effective as of July 1, 2010 between SM Energy Company and Eagle Ford Gathering LLC (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, and incorporated herein by reference) +10.7 s +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.8† +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.9+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of November 9, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.10 +Gas Gathering Agreement dated May 31, 2011 between Regency Field Services LLC and SM Energy Company (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.11 +Gathering and Natural Gas Services Agreement effective as of April 1, 2011 between SM Energy Company and ETC Texas Pipeline, Ltd. (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.12 +Gas Processing Agreement effective as of April 1, 2011 between ETC Texas Pipeline, Ltd. and SM Energy Company (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.13† +Employee Stock Purchase Plan, As Amended and Restated as of June 10, 2011 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.14† +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.15† +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.16† +Equity Incentive Compensation Plan, As Amended as of May 22, 2013 (filed as Annex A to the registrant’s Schedule 14A filed on April 11, 2013, and incorporated herein by reference) +10.17 +Fifth Amended and Restated Credit Agreement dated April 12, 2013, among SM Energy Company, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on April 15, 2013, and incorporated herein by reference) +10.18† +Form of Performance Stock Unit Award Agreement as of July 31, 2013 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, and incorporated herein by reference) +10.19† +Form of Restricted Stock Unit Award Agreement as of July 31, 2013 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, and incorporated herein by reference) +10.20† +Performance Stock Unit Award Agreement as of July 1, 2016 (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.21† +Restricted Stock Unit Award Agreement as of July 1, 2016 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +149 +10.22† +Non-Employee Director Restricted Stock Award Agreement as of May 25, 2016 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.23† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.24† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.25† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.26*† +Summary of Compensation Arrangements for Non-Employee Directors +10.27 +Second Amendment to the Fifth Amended and Restated Credit Agreement dated December 10, 2014, among SM Energy Company, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on December 16, 2014, and incorporated herein by reference) +10.28 +Third Amendment to Fifth Amended and Restated Credit Agreement, dated May 20, 2015, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 27, 2015, and incorporated herein by reference) +10.29 +Fourth Amendment to Fifth Amended and Restated Credit Agreement, dated October 7, 2015, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 8, 2015, and incorporated herein by reference) +10.30 +Fifth Amendment to Fifth Amended and Restated Credit Agreement, dated November 11, 2015, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on November 11, 2015, and incorporated herein by reference) +10.31 +Sixth Amendment to Fifth Amended and Restated Credit Agreement, dated April 8, 2016, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on April 13, 2016, and incorporated herein by reference) +10.32 +Seventh Amendment to Fifth Amended and Restated Credit Agreement, dated August 8, 2016, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on August 9, 2016, and incorporated herein by reference) +10.33 +Eighth Amendment to Fifth Amended and Restated Credit Agreement, dated September 30, 2016, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 6, 2016 and incorporated herein by reference) +10.34† +Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 20, 2015, and incorporated herein by reference) +10.35† +Amendment No. 3 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2016 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2015, and incorporated herein by reference) +10.36*** +Amendment to Amended and Restated Gas Gathering Agreement, effective as of September 1, 2015, by and between SM Energy Company and Regency Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on September 15, 2015, and incorporated herein by reference) +10.37 +Amendment to Amended and Restated Gas Gathering Agreement, effective as of February 1, 2016, by and between SM Energy Company and ETC Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on February 22, 2016, and incorporated herein by reference) +10.38 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.39 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +150 +10.40 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.41 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.42 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.5 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.43 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.6 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +12.1* +Computation of Ratio of Earnings to Fixed Charges +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Ryder Scott Company L.P. +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +99.1* +Ryder Scott Audit Letter +101.INS* +XBRL Instance Document +101.SCH* +XBRL Schema Document +101.CAL* +XBRL Calculation Linkbase Document +101.LAB* +XBRL Label Linkbase Document +101.PRE* +XBRL Presentation Linkbase Document +101.DEF* +XBRL Taxonomy Extension Definition Linkbase Document +* Filed with this Form 10-K. +** Furnished with this Form 10-K. +*** +Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. +† +Exhibit constitutes a management contract or compensatory plan or agreement. +s +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. See Item 15(a) above. +151 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: +February 23, 2017 +By: +/s/ JAVAN D. OTTOSON +Javan D. Ottoson +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Javan D. Ottoson and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2016 , and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ JAVAN D. OTTOSON +President, Chief Executive Officer, and Director +February 23, 2017 +Javan D. Ottoson +(Principal Executive Officer) +/s/ A. WADE PURSELL +Executive Vice President and Chief Financial Officer +February 23, 2017 +A. Wade Pursell +(Principal Financial Officer) +/s/ MARK T. SOLOMON +Vice President - Controller and Assistant Secretary +February 23, 2017 +Mark T. Solomon +(Principal Accounting Officer) +152 +Signature +Title +Date +/s/ WILLIAM D. SULLIVAN +Chairman of the Board of Directors +February 23, 2017 +William D. Sullivan +/s/ LARRY W. BICKLE +Director +February 23, 2017 +Larry W. Bickle +/s/ STEPHEN R. BRAND +Director +February 23, 2017 +Stephen R. Brand +/s/ LOREN M. LEIKER +Director +February 23, 2017 +Loren M. Leiker +/s/ RAMIRO G. PERU +Director +February 23, 2017 +Ramiro G. Peru +/s/ JULIO M. QUINTANA +Director +February 23, 2017 +Julio M. Quintana +/s/ ROSE M. ROBESON +Director +February 23, 2017 +Rose M. Robeson +153 \ No newline at end of file diff --git a/raw/filings/0000893538/2016/0000893538-17-000013/filing_metadata.csv b/raw/filings/0000893538/2016/0000893538-17-000013/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..4a2eac62dea6abe511ae12810591dfd7a77d17df --- /dev/null +++ b/raw/filings/0000893538/2016/0000893538-17-000013/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2017-02-23,2016-12-31,2017-02-23T14:16:21.000Z,0000893538-17-000013,sm-20161231x10k.htm,10-K,17461188,1,0,https://www.sec.gov/Archives/edgar/data/893538/000089353817000013/sm-20161231x10k.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353817000013/,2016,2016,1 diff --git a/raw/filings/0000893538/2016/0000893538-17-000013/item1.txt b/raw/filings/0000893538/2016/0000893538-17-000013/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2016/0000893538-17-000013/item13.txt b/raw/filings/0000893538/2016/0000893538-17-000013/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..c770827b7cfa15208acc84facf3d39cf21eff813 --- /dev/null +++ b/raw/filings/0000893538/2016/0000893538-17-000013/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “Certain Relationships and Related Transactions” and “Corporate Governance” in SM Energy’s definitive proxy statement for the 2017 annual meeting of stockholders to be filed within 120 days from December 31, 2016 . \ No newline at end of file diff --git a/raw/filings/0000893538/2016/0000893538-17-000013/item9a.txt b/raw/filings/0000893538/2016/0000893538-17-000013/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..b07294df7a30219a73ef6d5341a2f6fc002661ce --- /dev/null +++ b/raw/filings/0000893538/2016/0000893538-17-000013/item9a.txt @@ -0,0 +1,35 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all +140 +potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +141 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2016 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +142 +Report of Independent Registered Public Accounting Firm +The Board of Directors and Stockholders of SM Energy Company and subsidiaries +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2016 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). SM Energy Company and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, SM Energy Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of SM Energy Company and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 of SM Energy Company and subsidiaries and our report dated February 23, 2017 expressed an unqualified opinion thereon . +/s/ Ernst & Young LLP +Denver, Colorado +February 23, 2017 +143 \ No newline at end of file diff --git a/raw/filings/0000893538/2016/0000893538-17-000013/rp_note.txt b/raw/filings/0000893538/2016/0000893538-17-000013/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2016/0000893538-17-000013/rpt_disclosure.txt b/raw/filings/0000893538/2016/0000893538-17-000013/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..518b2e1cf78ed08658097dba7b281bdb9cc12aaa --- /dev/null +++ b/raw/filings/0000893538/2016/0000893538-17-000013/rpt_disclosure.txt @@ -0,0 +1,26 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee's review of any transaction, arrangement, +or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, (b) the +aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of our Related +Person Transactions Policy, a "related person" means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more than 5% of +our outstanding shares of common stock, and (iii) any immediate family member +of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it determines in good faith are in, or are not inconsistent with, our best interests and the best +interests of our stockholders. +In +determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among +others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director's independence in the event the related person is a director, and the extent +of the related person's interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in +compliance with the policy and remain appropriate. +In +addition, our By-Laws provide that a director, officer, or employee of our company may not pursue for his or her own account a business or investment opportunity that he or she +learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than 1% of the publicly traded stock of another company. +Related Person Transactions +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are consistent +with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when the Board, acting through the Audit Committee or as otherwise +described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, but are not +limited to, situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we obtain products +or services from, or provide products or services to, related persons on an arm's length basis on terms comparable to those obtained from or provided to unrelated third parties or on terms comparable +to those obtained from or provided to employees generally. We had no transactions that required approval under our Related Person Transactions Policy during 2016. +12 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000893538/2017/0000893538-18-000005/filing.txt b/raw/filings/0000893538/2017/0000893538-18-000005/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..d227310dd8bf5744424d9868cf704165bb85227c --- /dev/null +++ b/raw/filings/0000893538/2017/0000893538-18-000005/filing.txt @@ -0,0 +1,8072 @@ +10-K +1 +sm-20171231x10k.htm +10-K +Document +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +For the fiscal year ended December 31, 2017 +or +o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +Commission file number 001-31539 +SM ENERGY COMPANY +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of incorporation or organization) +41-0518430 +(I.R.S. Employer Identification No.) +1775 Sherman Street, Suite 1200, Denver, Colorado +(Address of principal executive offices) +80203 +(Zip Code) +(303) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common stock, $.01 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer þ +Accelerated filer o +Non-accelerated filer o +(Do not check if a smaller reporting company) +Smaller reporting company o +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ +The aggregate market value of the 110,439,354 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock on June 30, 2017 , the last business day of the registrant’s most recently completed second fiscal quarter, of $16.53 per share, as reported on the New York Stock Exchange, was $1,825,562,522 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 14, 2018 , the registrant had 111,687,016 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III is incorporated by reference from portions of the registrant’s Definitive Proxy Statement on Schedule 14A relating to its 2018 annual meeting of stockholders to be filed within 120 days after December 31, 2017 . +1 +TABLE OF CONTENTS +ITEM +PAGE +PART I +4 +ITEMS 1. and 2. +BUSINESS and PROPERTIES +4 +General +4 +Strategy +4 +Significant Developments in 2017 +4 +Outlook for 2018 +5 +Areas of Operation +6 +Reserves +8 +Production +13 +Productive Wells +13 +Drilling and Completion Activity +14 +Acreage +15 +Delivery Commitments +15 +Major Customers +16 +Employees and Office Space +16 +Title to Properties +16 +Seasonality +17 +Competition +17 +Government Regulations +17 +Cautionary Information about Forward-Looking Statements +21 +Available Information +23 +Glossary of Oil and Gas Terms +23 +ITEM 1A. +RISK FACTORS +26 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +44 +ITEM 3. +LEGAL PROCEEDINGS +44 +ITEM 4. +MINE SAFETY DISCLOSURES +44 +PART II +45 +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +45 +ITEM 6. +SELECTED FINANCIAL DATA +47 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +49 +Overview of the Company +49 +Financial Results of Operations and Additional Comparative Data +55 +Comparison of Financial Results and Trends Between 2017 and 2016 and Between 2016 and 2015 +58 +Overview of Liquidity and Capital Resources +64 +Critical Accounting Policies and Estimates +70 +Accounting Matters +73 +Environmental +73 +Non-GAAP Financial Measures +75 +2 +TABLE OF CONTENTS +(Continued) +ITEM +PAGE +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (included within the content of ITEM 7) +77 +ITEM 8. +CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +78 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +128 +ITEM 9A. +CONTROLS AND PROCEDURES +128 +ITEM 9B. +OTHER INFORMATION +131 +PART III +131 +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +131 +ITEM 11. +EXECUTIVE COMPENSATION +131 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +131 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +133 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +133 +PART IV +134 +ITEM 15. +EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +134 +ITEM 16. +FORM 10-K SUMMARY +138 +3 +PART I +When we use the terms “SM Energy,” the “Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business under Glossary of Oil and Gas Terms . Throughout this document we make statements that may be classified as “forward-looking.” Please refer to the Cautionary Information about Forward-Looking Statements section of this document for an explanation of these types of statements. +ITEMS 1. and 2. BUSINESS and PROPERTIES +General +We are an independent energy company engaged in the acquisition, exploration, development, and production of crude oil and condensate, natural gas, and natural gas liquids (also respectively referred to as “oil,” “gas,” and “NGLs” throughout the document) in onshore North America. We were founded in 1908 and incorporated in Delaware in 1915. Our initial public offering of common stock was in December 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal offices are located at 1775 Sherman Street, Suite 1200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +Our strategic objective is to be a premier operator of top tier assets. We pursue growth opportunities through both acquisitions and exploration, and seek to maximize the value of our assets through industry-leading technology and outstanding operational execution. We focus on achieving high full-cycle economic returns on our investments and maintaining a strong balance sheet. +Significant Developments in 2017 +Reserves and Capital Investment. Our estimated proved reserves increased 18 percent to 468.1 MMBOE at December 31, 2017 , from 395.8 MMBOE at December 31, 2016 . We had net reserve additions of 191.6 MMBOE primarily as a result of our successful development programs and completion optimizations that resulted in improved well performance. These positive results were partially offset by the divestiture of 76.0 MMBOE of estimated proved reserves, primarily associated with the sale of our outside-operated Eagle Ford shale assets as further discussed below. Costs incurred for development and exploration activities, excluding acquisitions, increased 33 percent to $947.0 million in 2017 when compared with 2016 . Our proved reserve life index increased significantly to 10.5 years in 2017 compared to 7.2 years in 2016 . Please refer to Areas of Operation and Reserves below, and to the caption Oil and Gas Reserve Quantities in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report for additional discussion. +Divestiture Activity . On March 10, 2017 , we successfully completed the divestiture of our outside-operated Eagle Ford shale assets, including our ownership interest in related midstream assets, for net divestiture proceeds of $744.1 million and a final net gain of $396.8 million . We also divested certain non-core properties in our Rocky Mountain and Permian regions for net divestiture proceeds of $36.2 million during 2017. As of December 31, 2017, the majority of our Powder River Basin assets were classified as held for sale. Subsequent to December 31, 2017, we entered into a definitive agreement for the sale of these assets for a gross purchase price of $500.0 million , subject to customary closing price adjustments (the “PRB Divestiture”). The PRB Divestiture is expected to close in the first quarter of 2018 and is subject to satisfying customary closing conditions. There can be no assurance that the PRB Divestiture will close on time or at all. +Acquisition Activity. During 2017, we finalized the 2016 acquisitions from Rock Oil Holdings, LLC and from QStar LLC and RRP-QStar, LLC of Midland Basin properties located in Howard and Martin Counties, Texas (collectively referred to as our “RockStar” assets throughout this report). In addition to the acreage we acquired in the RockStar acquisitions, we also continued to core up our position in Howard and Martin Counties, Texas during 2017 by acquiring approximately 3,600 net acres of primarily unproved properties for $76.5 million of cash consideration, as well as completing numerous non-monetary acreage trades. Through these efforts we continue to improve our ability to drill longer lateral wells and generate higher returns. +4 +Production. Our average daily production in 2017 consisted of 37.4 MBbl of oil, 337.0 MMcf of gas, and 28.2 MBbl of NGLs, for an average equivalent production rate of 121.8 MBOE per day, which represents a 19 percent decrease on an equivalent basis compared with 2016 . This decrease in production was driven by the divestiture of our outside-operated Eagle Ford shale assets in the first quarter of 2017, the divestiture of our Williston Basin assets outside of Divide County, North Dakota (referred to as “Raven/Bear Den” throughout this report) in the fourth quarter of 2016, and reduced capital investment in our retained Rocky Mountain and Eagle Ford shale programs in 2017 , when compared with 2016 . These decreases were partially offset by increased production in our Permian region as a result of ramping up development activities on our acquired acreage and stronger than expected well results. When excluding production from all assets sold in 2016 and 2017 , production from retained assets and assets acquired increased approximately eight percent for the year ended December 31, 2017 , compared with 2016 . Please refer to Areas of Operation below for additional discussion. +Outlook for 2018 +Our priorities for 2018 are to: +• +continue generating high margin returns from top tier projects that drive cash flow growth; +• +core up our portfolio (PRB Divestiture) to focus on assets that generate the highest returns; and +• +improve our credit metrics and maintain strong financial flexibility. +Our capital program for 2018 , excluding acquisitions, is expected to be approximately $1.27 billion. We expect our program to concentrate on developing our top tier assets in the Midland Basin and Eagle Ford shale. We expect to allocate the majority of our 2018 capital to our Midland Basin program, which generates the highest margins and returns in our portfolio. Planned drilling and completion activity in the Eagle Ford shale will be partially funded by a third-party as part of our previously announced joint venture agreement. We will continue to prioritize safety in all of our operations. Please refer to Outlook for 2018 and Overview of Liquidity and Capital Resources under Part II, Item 7 of this report for additional discussion of our financing and capital plans for 2018 . +5 +Areas of Operation +Our 2017 operations were concentrated in our three onshore operating regions in the United States. The following table summarizes estimated proved reserves, production, and costs incurred in oil and gas activities for the year ended December 31, 2017 , for these regions: +Permian +South Texas & Gulf Coast +Rocky +Mountain +Total (1) +Proved reserves +Oil (MMBbl) +117.5 +13.3 +27.4 +158.2 +Gas (Bcf) +252.8 +998.1 +29.2 +1,280.1 +NGLs (MMBbl) +0.2 +95.6 +0.7 +96.5 +MMBOE (1)(2) +159.9 +275.2 +33.0 +468.1 +Relative percentage +34 +% +59 +% +7 +% +100 +% +Proved developed % +34 +% +52 +% +53 +% +46 +% +Production +Oil (MMBbl) +8.5 +2.0 +3.2 +13.7 +Gas (Bcf) +14.7 +104.2 +4.1 +123.0 +NGLs (MMBbl) +— +10.1 +0.2 +10.3 +MMBOE (1)(2) +11.0 +29.5 +4.1 +44.5 +Avg. daily equivalents (MBOE/d) (1) +30.0 +80.7 +11.1 +121.8 +Relative percentage +25 +% +66 +% +9 +% +100 +% +Costs incurred (in millions) (3) +$ +831.4 +$ +170.3 +$ +19.5 +$ +1,040.0 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +As of December 31, 2017, a majority of our Powder River Basin assets were held for sale, and subsequent to December 31, 2017, we entered into the PRB Divestiture agreement. These assets represented approximately 4.2 MMBOE of our estimated proved reserves as of December 31, 2017, and approximately 1.0 MMBOE of 2017 production on an equivalent basis. There can be no assurance that the PRB Divestiture will close on time or at all. +(3) +Amounts do not sum to total costs incurred due primarily to corporate overhead charges incurred on exploration activity that are excluded from this regional table. Please refer to the caption Costs Incurred in Oil and Gas Producing Activities in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report. +Excluding acquisition activity, we increased our capital spending in 2017 as we accelerated development activities in our Permian region, particularly on our RockStar properties. We had 191.6 MMBOE of net proved reserve additions during the year primarily as a result of our successful development efforts and improved well results in the Midland Basin and enhanced completion techniques in the Eagle Ford shale. These increases were partially offset by the divestiture of our outside-operated Eagle Ford shale assets and removal of proved undeveloped reserves due to the five-year rule as a result of changes in our development plans. Overall, total estimated proved reserves for year end 2017 increased 18 percent from year end 2016 . +Permian Region. Operations in our Permian region are managed from our office in Midland, Texas. In 2017 , we focused on delineating, developing, and coring up our approximately 85,000 net acre Midland Basin position in western Texas. Our acreage position provides for substantial future development opportunities within multiple oil-rich intervals, including the Spraberry and Wolfcamp formations. +We incurred $739.5 million of costs and added approximately 110.7 MMBOE of estimated proved reserves through our drilling and completion activities in 2017. The majority of our Midland Basin capital was deployed on projects targeting the Lower Spraberry and Wolfcamp A and B intervals on our RockStar assets in Howard and Martin Counties, Texas and Sweetie Peck assets in Upton and Midland Counties, Texas. We began 2017 with four operated drilling rigs and one completion crew and added four operated drilling rigs and three completion crews throughout the year. As of December 31, 2017 , we had seven operated drilling rigs and three completion crews focused on delineating and developing our RockStar assets, and one operated drilling rig and one completion crew focused on developing our Sweetie Peck assets. Estimated +6 +proved reserves increased 197 percent to 159.9 MMBOE at year end 2017 from 53.8 MMBOE at year end 2016 . We completed 72 gross ( 70 net) wells during 2017 and production increased 192 percent year-over-year to 11.0 MMBOE for 2017 . +As of December 31, 2017 , we had 49 gross ( 41 net) wells that had been drilled but not completed in our Midland Basin program. +South Texas & Gulf Coast Region. Operations in our South Texas & Gulf Coast region are managed from our office in Houston, Texas. This region is primarily comprised of our Eagle Ford shale position, which includes approximately 163,000 net acres. Our largely contiguous acreage position covers a significant portion of the western Eagle Ford shale play, including acreage in the gas/condensate, NGL-rich gas, and dry gas windows of the play. We sold our outside-operated Eagle Ford shale assets, including the associated midstream assets, in the first quarter of 2017. +In 2017 , we incurred $169.4 million of costs and added approximately 62.6 MMBOE of estimated proved reserves through our drilling and completion activities. Estimated proved reserves decreased 10 percent to 275.2 MMBOE at year end 2017 from 305.4 MMBOE at year end 2016 . This decrease primarily related to the divestiture of 72.5 MMBOE from our outside-operated Eagle Ford shale assets and production of 29.5 MMBOE during the year. Offsetting the majority of these decreases were proved reserve additions as a result of our development activities and improved well performance on our retained Eagle Ford shale assets. We completed 38 gross ( 35 net) wells during 2017 on our operated acreage. +In September 2017, we entered into a joint venture agreement with a third-party to drill 16 wells and complete 23 wells in a focused portion of our Eagle Ford North area. The third-party in this arrangement will carry substantially all drilling and completion costs and will be entitled to a majority of the associated production revenue until certain payout thresholds are reached. This partnership allows us to leverage third-party capital to prove up the value of our Eagle Ford North area, while also allowing us to test cutting edge technology, capture additional technical data, satisfy certain lease obligations, and potentially expand economic drilling inventory. The joint venture resulted in the completion of seven gross wells and the drilling of four gross wells in 2017. We expect the remaining wells associated with this joint venture to be drilled and completed in 2018. +As of December 31, 2017 , we had 33 gross ( 30 net) wells that had been drilled but not completed in our operated Eagle Ford shale program. +Rocky Mountain Region. Operations in our Rocky Mountain region are managed from our corporate office in Denver, Colorado. As of December 31, 2017 , we had approximately 119,000 net acres in Divide County, North Dakota, and approximately 139,000 net acres in the Powder River Basin in Wyoming, of which approximately 112,000 net acres were classified as held for sale as of December 31, 2017 . Subsequent to December 31, 2017 , we entered into the PRB Divestiture agreement for the sale of these assets for a gross purchase price of $500.0 million , subject to customary closing price adjustments. The PRB Divestiture is expected to close in the first quarter of 2018 and is subject to satisfying customary closing conditions. There can be no assurance that the PRB Divestiture will close on time or at all. +In 2017 , we incurred $19.3 million of costs to add approximately 1.7 MMBOE of estimated proved reserves in our Rocky Mountain region through our drilling and completion activities. Total estimated proved reserves decreased 10 percent to 33.0 MMBOE at year end 2017 from 36.5 MMBOE at year end 2016 . Production decreased 61 percent year-over-year to 4.1 MMBOE for 2017 primarily as a result of the divestiture of our Raven/Bear Den assets in the fourth quarter of 2016 and reduced capital investment on our retained Rocky Mountain assets during 2017. Current activities in our Powder River Basin program are under an acquisition and development funding agreement with a third-party in which our costs to drill and complete a specified number of initial wells are being carried by such party. +As of December 31, 2017 , we had 18 gross ( 15 net) drilled but not completed wells in our operated Bakken/Three Forks program. +7 +Reserves +The table below presents summary information with respect to the estimates of our proved reserves for each of the years in the three-year period ended December 31, 2017 . We engaged Ryder Scott Company, L.P. (“Ryder Scott”) to audit at least 80 percent of our total calculated estimated proved reserve PV-10 for each year presented. The prices used in the calculation of proved reserve estimates reflect the 12-month average of the first-day-of-the-month prices in accordance with Securities and Exchange Commission (“SEC”) rules, and were $51.34 per Bbl for oil, $3.00 per MMBtu for gas, and $27.69 per Bbl for NGLs for the year ended December 31, 2017 . We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. +Reserve estimates are inherently imprecise and estimates for new discoveries and undeveloped locations are more imprecise than reserve estimates for producing oil and gas properties. Accordingly, we expect these estimates to change as new information becomes available. PV-10 shown in the following table is a non-GAAP financial measure, and generally differs from the standardized measure of discounted future net cash flows, the most directly comparable GAAP financial measure, because it does not include the effects of income taxes on future net revenues. Neither PV-10 nor the standardized measure of discounted future net cash flows represents the fair market value of our oil and gas properties. We and others in the oil and gas industry use PV-10 as a measure to compare the relative size and value of proved reserves held without regard to the specific tax characteristics of such entities. Please refer to the Glossary of Oil and Gas Terms section of this report for additional information regarding these measures. The actual quantities and present value of our estimated proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The following table should be read along with the section entitled Risk Factors – Risks Related to Our Business below. +Our ability to replace our production is critical to us. Please refer to the reserve life index term in the Glossary of Oil and Gas Terms section of this report for information describing how this metric is calculated. +8 +The following table summarizes estimated proved reserves, the standardized measure of discounted future net cash flows, PV-10, and reserve life index as of December 31, 2017 , 2016 , and 2015 : +As of December 31, +2017 +2016 +2015 +Reserve data: +Proved developed +Oil (MMBbl) +58.6 +48.5 +75.6 +Gas (Bcf) +642.9 +609.1 +644.4 +NGLs (MMBbl) +49.0 +58.6 +61.5 +MMBOE (1) +214.7 +208.7 +244.5 +Proved undeveloped +Oil (MMBbl) +99.6 +56.4 +69.6 +Gas (Bcf) +637.2 +502.0 +619.7 +NGLs (MMBbl) +47.6 +47.1 +53.9 +MMBOE (1) +253.4 +187.1 +226.8 +Total proved (1) +Oil (MMBbl) +158.2 +104.9 +145.3 +Gas (Bcf) (2) +1,280.1 +1,111.1 +1,264.0 +NGLs (MMBbl) +96.5 +105.7 +115.4 +MMBOE (3) +468.1 +395.8 +471.3 +Proved developed reserves % +46 +% +53 +% +52 +% +Proved undeveloped reserves % +54 +% +47 +% +48 +% +Reserve data (in millions): +Standardized measure of discounted future net cash flows (GAAP) +$ +3,024.1 +$ +1,152.1 +$ +1,790.5 +PV-10 (non-GAAP): +Proved developed PV-10 +$ +1,984.2 +$ +1,051.1 +$ +1,593.0 +Proved undeveloped PV-10 +1,072.3 +101.0 +197.5 +Total proved PV-10 +$ +3,056.5 +$ +1,152.1 +$ +1,790.5 +Reserve life index (years) +10.5 +7.2 +7.3 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +For the years ended December 31, 2017 , 2016 , and 2015 , proved gas reserves contained 48.1 Bcf, 43.7 Bcf, and 48.1 Bcf of gas, respectively, that we expect to produce and use as field fuel (primarily for compressors). +(3) +As of December 31, 2017, a majority of our Powder River Basin assets were held for sale, and subsequent to year end 2017, we entered into the PRB Divestiture agreement. These assets represented approximately 4.2 MMBOE of our total estimated proved reserves as of December 31, 2017. There can be no assurance that the PRB Divestiture will close on time or at all. +9 +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the pre-tax PV-10 (Non-GAAP) of total estimated proved reserves. Please see the definitions of standardized measure of discounted future net cash flows and PV-10 in the Glossary of Oil and Gas Terms section of this report. +As of December 31, +2017 +2016 +2015 +(in millions) +Standardized measure of discounted future net cash flows (GAAP) +$ +3,024.1 +$ +1,152.1 +$ +1,790.5 +Add: 10 percent annual discount, net of income taxes +2,573.2 +937.1 +1,307.1 +Add: future undiscounted income taxes +205.7 +— +— +Undiscounted future net cash flows +5,803.0 +2,089.2 +3,097.6 +Less: 10 percent annual discount without tax effect +(2,746.5 +) +(937.1 +) +(1,307.1 +) +PV-10 (non-GAAP) +$ +3,056.5 +$ +1,152.1 +$ +1,790.5 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of production when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time. As of December 31, 2017 , we did not have any proved undeveloped reserves that had been on our books in excess of five years. +For proved undeveloped locations that are more than one development spacing area from developed producing locations, we utilized reliable geologic and engineering technology when booking estimated proved undeveloped reserves. Of the 253.4 MMBOE of total proved undeveloped reserves as of December 31, 2017, approximately 66.8 MMBOE of proved undeveloped reserves in our Eagle Ford shale position, 49.3 MMBOE of proved undeveloped reserves in our Wolfcamp and Lower Spraberry shale positions in the Midland Basin, and 0.7 MMBOE of proved undeveloped reserves in our Bakken/Three Forks shale position were offset by more than one development spacing area from the nearest developed producing location. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected) and petrophysical analysis of that log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as significant statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. In all other areas, we restricted proved undeveloped locations to development spacing areas that are immediately adjacent to developed spacing areas. +10 +As of December 31, 2017 , we had 253.4 MMBOE of estimated proved undeveloped reserves, which was an increase of 66.3 MMBOE, or 35 percent , from 187.1 MMBOE at December 31, 2016 . The following table provides a reconciliation of our proved undeveloped reserves for the year ended December 31, 2017 : +Total +(MMBOE) +Total proved undeveloped reserves: +Beginning of year +187.1 +Revisions of previous estimates +2.9 +Additions from discoveries, extensions, and infill (1) +132.8 +Sales of reserves (2) +(35.1 +) +Purchases of minerals in place +0.3 +Removed for five-year rule (3) +(13.9 +) +Conversions to proved developed (4) +(20.7 +) +End of year (5) +253.4 +____________________________________________ +(1) +We added 132.4 MMBOE of infill proved undeveloped reserves, primarily from our Midland Basin and Eagle Ford shale programs, and an additional 0.4 MMBOE of proved undeveloped reserves through various extensions and discoveries. We added 76.7 MMBOE and 54.8 MMBOE of proved undeveloped reserves in our Midland Basin and Eagle Ford shale programs, respectively, in 2017 . +(2) +Sale of proved undeveloped reserves resulting from the divestiture of our outside-operated Eagle Ford shale assets during the first quarter of 2017. +(3) +Proved undeveloped reserves were reduced by 13.9 MMBOE due to changes in our development plan, which caused these locations to be reclassified primarily to the probable reserves category due to the five-year rule. These locations, which were predominately located in our Eagle Ford shale program, were replaced by higher quality proved undeveloped reserves, which are classified as extensions or infills in the table above, and resulted from our testing and delineation programs. +(4) +Conversions of proved undeveloped reserves to proved developed reserves were primarily in our Midland Basin and Eagle Ford shale programs. Our 2017 conversion track record was approximately 11 percent due to fewer conversions of proved undeveloped reserves in our Eagle Ford shale and Rocky Mountain programs as we focused on developing our Midland Basin assets, which had minimal proved undeveloped reserves booked at year end 2016 . We expect our conversion track record to increase in 2018 as a result of increased capital expenditures related to converting proved undeveloped reserves added during 2017 in our Midland Basin program. During 2017 , we incurred approximately $187 million on projects associated with reserves booked as proved undeveloped at the end of 2016 , of which approximately $165 million was spent on proved undeveloped reserves converted to proved developed reserves by December 31, 2017 . At December 31, 2017 , drilled but not completed wells represented 31.0 MMBOE of total proved undeveloped reserves. We expect to incur approximately $193 million of capital expenditures in completing these drilled but not completed wells, and we expect all proved undeveloped reserves to be converted to proved developed reserves within five years from their initial booking as proved undeveloped reserves. +(5) +As of December 31, 2017 , none of our proved undeveloped reserves were on acreage expected to expire or on acreage that was not expected to be held through renewal before their targeted completion date. +As of December 31, 2017 , estimated future development costs relating to our proved undeveloped reserves were approximately $554 million , $524 million , and $601 million in 2018 , 2019 , and 2020 , respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group and is coordinated by our Corporate Business Development Director, subject to the oversight of our management and the Audit Committee of our Board of Directors, as discussed below. Our Corporate Business Development Director has over 25 years of experience in the energy industry, and holds a Bachelor of Science Degree in Petroleum Engineering from Montana Tech of the University of Montana. He is also a member of the Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the +11 +year by our regional staff. This data, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our regional engineering technical staff do not report directly to our Corporate Business Development Director; they report to either their respective regional technical managers or directly to the regional manager. This design is intended to promote objective and independent analysis within our regions in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are required to be within 10 percent of our proved reserve amounts for the total company, as well as for each respective region. Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world for over 70 years. The technical person at Ryder Scott primarily responsible for overseeing our reserves audit is an Advising Senior Vice President who received a Bachelor of Science Degree in Chemical Engineering from Purdue University in 1979 and a Master of Science Degree in Chemical Engineering from the University of California, Berkeley in 1981. He is a licensed Professional Engineer in the State of Texas, a member of the Society of Petroleum Engineers, and the Society of Petroleum Evaluation Engineers. The Ryder Scott 2017 report concerning our reserves is included as Exhibit 99.1. +In addition to a third-party audit, our reserves are reviewed by our management with the Audit Committee of our Board of Directors. Our management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Executive Vice President - Operations, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives from time to time to discuss processes and findings. +12 +Production +The following table summarizes the volumes and realized prices of oil, gas, and NGLs produced and sold from properties in which we held an interest during the periods indicated. Realized prices presented below exclude the effects of derivative contract settlements. Also presented is a summary of related production expense on a per BOE basis. +For the Years Ended December 31, +2017 +2016 +2015 +Net production volumes +Oil (MMBbl) +13.7 +16.6 +19.2 +Gas (Bcf) +123.0 +146.9 +173.6 +NGLs (MMBbl) +10.3 +14.2 +16.1 +Equivalent (MMBOE) (1) +44.5 +55.3 +64.2 +Midland Basin net production volumes (2) +Oil (MMBbl) +8.5 +2.6 +1.4 +Gas (Bcf) +14.7 +5.6 +4.3 +NGLs (MMBbl) +— +— +— +Equivalent (MMBOE) (1) +11.0 +3.5 +2.1 +Eagle Ford net production volumes (2)(3) +Oil (MMBbl) +1.9 +5.4 +7.6 +Gas (Bcf) +104.0 +129.9 +147.2 +NGLs (MMBbl) +10.1 +13.8 +15.6 +Equivalent (MMBOE) (1) +29.3 +40.9 +47.7 +Realized price, before the effect of derivative settlements +Oil (per Bbl) +$ +47.88 +$ +36.85 +$ +41.49 +Gas (per Mcf) +$ +3.00 +$ +2.30 +$ +2.57 +NGLs (per Bbl) +$ +22.35 +$ +16.16 +$ +15.92 +Per BOE +$ +28.20 +$ +21.32 +$ +23.36 +Production expense per BOE +Lease operating expense +$ +4.43 +$ +3.51 +$ +3.73 +Transportation costs +$ +5.48 +$ +6.16 +$ +6.02 +Production taxes +$ +1.18 +$ +0.94 +$ +1.13 +Ad valorem tax expense +$ +0.34 +$ +0.21 +$ +0.39 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +As of December 31, 2017 , total estimated proved reserves attributed to our Midland Basin properties exceeded 15 percent of our total estimated proved reserves expressed on an equivalent basis. For each of the annual periods presented, total estimated proved reserves attributed to our Eagle Ford shale properties also exceeded 15 percent of our total estimated proved reserves expressed on an equivalent basis. During each of the annual periods presented, no other field exceeded 15 percent of our total estimated proved reserves on an equivalent basis. +(3) +During the first quarter of 2017, we completed a divestiture of our outside-operated Eagle Ford shale assets. These assets represented approximately 1.5 MMBOE, 9.7 MMBOE, and 12.0 MMBOE of net production on an equivalent basis for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +Productive Wells +As of December 31, 2017 , we had working interests in 1,099 gross (919 net) productive oil wells and 497 gross (489 net) productive gas wells. Productive wells are either wells producing in commercial quantities or wells mechanically capable of commercial production, but are temporarily shut-in. Multiple completions in the same wellbore are counted as one well. As of December 31, 2017 , four of these wells had multiple completions. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil when it first commenced production, but such designation may not be indicative of current production. +13 +Drilling and Completion Activity +All of our drilling and completion activities are conducted by independent contractors. We do not own any drilling or completion equipment. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2017 , 2016 , and 2015 , excluding non-consented projects, active injector wells, salt water disposal wells, and any wells in which we own only a royalty interest: +For the Years Ended December 31, +2017 +2016 +2015 +Gross +Net +Gross +Net +Gross +Net +Development wells +Oil +56 +46.5 +100 +73.0 +87 +56.5 +Gas +38 +34.6 +114 +56.1 +272 +100.8 +Non-productive +4 +3.2 +2 +1.1 +— +— +98 +84.3 +216 +130.2 +359 +157.3 +Exploratory wells +Oil +32 +28.7 +7 +6.8 +5 +3.5 +Gas +— +— +— +— +1 +1.0 +Non-productive +1 +0.1 +— +— +5 +4.1 +33 +28.8 +7 +6.8 +11 +8.6 +Total +131 +113.1 +223 +137.0 +370 +165.9 +A productive well is an exploratory, development, or extension well that is producing or is capable of commercial production of oil, gas, and/or NGLs. A non-productive well, frequently referred to within the industry as a dry hole, is an exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in commercial quantities to justify completion, or upon completion, the economic operation of a well. +As defined by the SEC, an exploratory well is a well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. A development well is a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. Completion refers to the installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry hole, the reporting to the appropriate authority that the well has been plugged and abandoned. +In addition to the wells drilled and completed in 2017 (included in the table above), we were actively participating in the drilling of 32 gross (30.7 net) wells and had 103 gross (82.9 net) drilled but not completed wells as of January 31, 2018. These drilled but not completed wells represent wells that were being completed or were waiting on completion as of January 31, 2018. +14 +Acreage +The following table sets forth the gross and net acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes that we held as of December 31, 2017 . Undeveloped acreage includes leasehold interests containing proved undeveloped reserves. +Developed Acres (1) +Undeveloped Acres (2)(3) +Total +Gross +Net +Gross +Net +Gross +Net +Midland Basin: +RockStar +40,708 +34,767 +38,929 +30,382 +79,637 +65,149 +Sweetie Peck +14,888 +14,042 +894 +771 +15,782 +14,813 +Halff East +8,951 +5,174 +1,276 +246 +10,227 +5,420 +Midland Basin Total +64,547 +53,983 +41,099 +31,399 +105,646 +85,382 +Eagle Ford +70,708 +70,126 +96,332 +92,727 +167,040 +162,853 +Rocky Mountain: +Divide +162,584 +108,801 +21,922 +10,615 +184,506 +119,416 +Powder River Basin (4) +52,773 +41,840 +120,547 +96,704 +173,320 +138,544 +Rocky Mountain Other (5) +— +— +254,744 +186,845 +254,744 +186,845 +Other (6) +16,279 +11,368 +16,991 +15,298 +33,270 +26,666 +Total +366,891 +286,118 +551,635 +433,588 +918,526 +719,706 +____________________________________________ +(1) +Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations, but has been included only as developed acreage in the presentation above. +(2) +Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) +As of February 14, 2018 , approximately 17,900 , 10,200 , and 5,300 net acres of undeveloped acreage are scheduled to expire by December 31, 2018 , 2019 , and 2020 , respectively, if production is not established or we take no other action to extend the terms of the applicable lease or leases. +(4) +Approximately 112,000 net acres of our Powder River Basin acreage was held for sale as of December 31, 2017 , and subsequent to December 31, 2017, we entered into the PRB Divestiture agreement. There can be no assurance that the PRB Divestiture will close on time or at all. +(5) +Includes other non-core acreage located in North Dakota, Montana, Wyoming, and Utah. +(6) +Includes other non-core acreage. +Delivery Commitments +As of December 31, 2017 , we had gathering, processing, transportation throughput, and delivery commitments with various third-parties that have aggregate minimum delivery commitments of 19 MMBbl of oil, 789 Bcf of gas, and 24 MMBbl of produced water through 2028 . We are required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments. If a shortfall in the minimum volume commitment for gas is projected, we have rights under certain contracts to arrange for third-party gas to be delivered, and such volumes will count toward our minimum volume commitment. Our current production is insufficient to offset these aggregate contractual liabilities, but we expect to fulfill the delivery commitments with production from the future development of our proved undeveloped reserves and from the future development of resources not yet characterized as proved reserves, or through arranging for the delivery of third-party gas. In the event that no more product is delivered in accordance with these agreements, the aggregate undiscounted future deficiency payments as of December 31, 2017 , would total $463.4 million . Please refer to Note 6 – Commitments and Contingencies in Part II, Item 8 for additional discussion. +As of the filing of this report, we do not expect any material shortfalls in our delivery commitments. +15 +Major Customers +We do not believe the loss of any single purchaser of our oil, gas, or NGLs would materially impact our operating results, as these are products with well established markets and numerous purchasers are present in our operating regions. +We had the following major customers and sales to entities under common ownership, which accounted for 10 percent or more of our total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2017 +2016 +2015 +Major customer #1 (1) +10 +% +5 +% +4 +% +Major customer #2 (2) +7 +% +18 +% +21 +% +Group #1 of entities under common ownership (3) +17 +% +15 +% +10 +% +Group #2 of entities under common ownership (3) +8 +% +8 +% +11 +% +____________________________________________ +(1) +This major customer is a purchaser of a portion of our production from our Permian region. +(2) +This major customer was the operator in our outside-operated Eagle Ford shale program, which we divested during the first quarter of 2017. Prior to the divestiture, we were party to various marketing agreements whereby we were subject to certain gathering, transportation, and processing throughput commitments. Because we shared with the operator the risk of non-performance by its counterparty purchasers, we included the operator as a major customer in the table above. Several of the operator’s counterparty purchasers under these contracts were also direct purchasers of our production from other areas. +(3) +In the aggregate, these groups of entities under common ownership represent more than 10 percent of total oil, gas, and NGL production revenue for at least one of the periods shown; however, none of the individual entities comprising either group represented more than 10 percent of our total oil, gas, and NGL production revenue. +Employees and Office Space +As of February 14, 2018 , we had 635 full-time employees. This is a five percent increase from the 607 reported full-time employees as of February 15, 2017 . None of our employees are subject to a collective bargaining agreement, and we consider our relations with our employees to be good. +The following table summarizes the approximate square footage of office space leased by us, as of December 31, 2017 , including our corporate headquarters and regional offices: +Approximate Square Footage Leased +Corporate +107,000 +Permian +54,000 +South Texas & Gulf Coast +70,000 +Mid-Continent (1) +50,000 +Total +281,000 +____________________________________________ +(1) +During the third quarter of 2015, we closed our office in Tulsa, Oklahoma. We have subleased this space through 2019 , and our lease expires in 2022. +In addition to the leased office space summarized in the table above, we own a total of 79,000 square feet of office space in our South Texas & Gulf Coast and Rocky Mountain regions. +Title to Properties +Substantially all of our interests are held pursuant to oil and gas leases from third-parties. We usually obtain title opinions prior to commencing our initial drilling operations on our properties. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such +16 +properties. Most of our producing properties are subject to mortgages securing indebtedness under our Fifth Amended and Restated Credit Agreement, as amended (the “Credit Agreement”), royalty and overriding royalty interests, liens for current taxes, and other burdens that we believe do not materially interfere with the use of such properties. We typically perform title investigation in accordance with standards generally accepted in the oil and gas industry before acquiring undeveloped leasehold acreage. +Seasonality +Generally, but not always, the demand and price levels for gas increase during winter months and decrease during summer months. To lessen the impact of seasonal demand fluctuations, pipelines, utilities, local distribution companies, and industrial users utilize gas storage facilities and forward purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can divert gas that traditionally is placed into storage. This could reduce the typical seasonal price differential. Demand for energy is also generally higher in the winter and the summer driving season, although oil prices are impacted more significantly by global supply and demand. Seasonal anomalies, such as mild winters, sometimes lessen these fluctuations. Certain of our drilling, completion, and other operations are also subject to seasonal limitations. Seasonal weather conditions, government regulations, and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. See Risk Factors - Risks Related to Our Business below for additional discussion. +Competition +The oil and gas industry is intensely competitive, particularly with respect to acquiring prospective oil and gas properties. We believe our acreage positions provide a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from a substantial number of major and independent oil and gas companies, which in some cases have larger technical staffs and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and gas reserves, but also have gathering, processing or refining operations, market refined products, own drilling rigs or other equipment, or generate electricity. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting, and processing of oil, gas, and NGLs. Consequently, we may face shortages, delays, or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including other fossil fuels such as coal and imported liquefied natural gas. Competitive conditions may be affected by future energy, climate-related, financial, or other policies, legislation, and regulations. +In addition, we compete for people, including experienced geologists, geophysicists, engineers, and other professionals. Throughout the oil and gas industry, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. We are not insulated from the competition for quality people, and we must compete effectively in order to be successful. +Government Regulations +Our business is extensively controlled by numerous federal, state, and local laws and governmental regulations. These laws and regulations may be changed from time to time in response to economic or political conditions, or other developments, and our regulatory burden may increase in the future. Laws and regulations have the potential to increase our cost of doing business and consequently could affect our profitability. However, we do not believe that we are affected to a materially greater or lesser extent than others in our industry. +Energy Regulations +Many of the states in which we conduct our operations have adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, imposing bond requirements in order to drill or operate wells, governing the timing of drilling and location of wells, the method of +17 +drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to various state conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, state conservation laws sometimes establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Some of our operations are conducted on federal lands pursuant to oil and gas leases administered by the Bureau of Land Management (“BLM”). These leases contain relatively standardized terms and require compliance with detailed regulations and orders that are subject to change. In addition to permits required from other regulatory agencies, lessees must obtain a permit from the BLM before drilling and must comply with regulations governing, among other things, engineering and construction specifications for production facilities, safety procedures, the valuation of production and payment of royalties, the removal of facilities, and the posting of bonds to ensure that lessee obligations are met. Under certain circumstances, the BLM may suspend or terminate our operations on federal leases. +Our sales of gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for gas production. +Environmental, Health and Safety Matters +General. Our operations are subject to stringent and complex federal, state, tribal, and local laws and regulations governing protection of the environment and worker health and safety as well as the discharge of materials into the environment. These laws and regulations may, among other things: +• +require the acquisition of various permits before drilling commences; +• +restrict the types, quantities and concentration of various substances that can be released into the environment in connection with oil and gas drilling and production and saltwater disposal activities; +• +limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +• +require remedial measures to mitigate pollution from former and ongoing operations, such as closing pits and plugging abandoned wells. +These laws, rules, and regulations may also restrict the rate of oil and gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent, or different permitting, waste handling, disposal, and cleanup requirements for the oil and gas industry and could have a significant impact on our operating costs. +The following is a summary of some of the existing laws, rules, and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation, and Liability Act. The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a +18 +hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +We currently own, lease, or operate numerous properties that have been used for oil and gas exploration and production for many years. Although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third-parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, United States Army Corps of Engineers, or analogous state agencies. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for containment and removal costs, natural resource damages and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane, and other “greenhouse gases” present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on these findings, the EPA began adopting and implementing a comprehensive suite of regulations to restrict emissions of greenhouse gases under existing provisions of the CAA. The Trump Administration has taken steps to rescind or review many of these regulations. Legislative and regulatory initiatives related to climate change could have an adverse effect on our operations and the demand for oil and gas. See Risk Factors - Risks Related to Our Business - Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs . In addition to the effects of regulation, the meteorological effects of global climate change could pose additional risks to our operations, including physical damage risks associated with more frequent, more intensive storms and flooding, and could adversely affect the demand for our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +19 +National Environmental Policy Act. Oil and gas exploration and production activities on federal lands are subject to the National Environmental Policy Act (“NEPA”). NEPA requires federal agencies, including the Department of Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an environmental assessment to determine the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed environmental impact statement that may be made available for public review and comment. All of our current exploration and production activities, as well as proposed exploration and development plans, on federal lands require governmental permits subject to the requirements of NEPA. This process has the potential to delay development of some of our oil and gas projects. +OSHA and other laws and regulations. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand, and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions. However, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition to oil and gas activities using hydraulic fracturing techniques, which could potentially cause a decrease in the completion of new oil and gas wells, increased compliance costs, and delays, all of which could adversely affect our financial position, results of operations and cash flows. As new laws or regulations that significantly restrict hydraulic fracturing are adopted at the state and local level, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and gas that we are ultimately able to produce from our reserves. +We believe it is reasonably likely that the trend in local and state environmental legislation and regulation will continue toward stricter standards, while the trend in federal environmental legislation and regulation faces an uncertain future under the Trump administration. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health and Safety Initiatives. We are committed to conducting our business in a manner that protects the environment and the health and safety of our employees, contractors and the public. We set annual goals for our environmental, health and safety program focused on reducing the number of safety related incidents that occur and the number and impact of spills of produced fluids. We also periodically conduct regulatory compliance audits of our operations to ensure our compliance with all regulations and provide appropriate training for our employees. Reducing air emissions as a result of leaks, venting, or flaring of gas during operations has become a major focus area for regulatory efforts and for our compliance efforts. While flaring is sometimes necessary, releases of gas to the environment and flaring is an economic waste and reducing these volumes is a priority for us. To avoid flaring where possible, we restrict testing periods and make every effort to ensure that our production is connected to gas pipeline infrastructure as quickly as possible after well completions. We have cooperated with other producers in North Dakota in the ongoing development of recommendations to reduce the amount of flaring that is occurring there as a result of area wide infrastructure limitations that are beyond our control. Another focus for our environmental effort has been reduction of water use through recycling of flowback water in south Texas for use as frac fluid. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +20 +Cautionary Information about Forward-Looking Statements +This Annual Report on Form 10-K (“Form 10-K”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements, other than statements of historical facts, included in this report that address activities, events, or developments with respect to our financial condition, results of operations, or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “estimate,” “expect,” “forecast,” “intend,” “pending,” “plan,” “project,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this report, and include statements about such matters as: +• +the amount and nature of future capital expenditures and the availability of liquidity and capital resources to fund capital expenditures; +• +our outlook on future oil, gas, and NGL prices, well costs, and service costs; +• +the drilling of wells and other exploration and development activities and plans, as well as possible or expected acquisitions or divestitures; +• +the possible divestiture or farm-down of, or joint venture relating to, certain properties; +• +proved reserve estimates and the estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates; +• +future oil, gas, and NGL production estimates; +• +cash flows, anticipated liquidity, and the future repayment of debt; +• +business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, and our outlook on our future financial condition or results of operations; and +• +other similar matters such as those discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in Part II, Item 7 of this report. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. These statements are subject to a number of known and unknown risks and uncertainties, which may cause our actual results and performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Some of these risks are described in the Risk Factors section of this report, and include such factors as: +• +the volatility of oil, gas, and NGL prices, and the effect it may have on our profitability, financial condition, cash flows, access to capital, and ability to grow production volumes and/or proved reserves; +• +weakness in economic conditions and uncertainty in financial markets; +• +our ability to replace reserves in order to sustain production; +• +our ability to raise the substantial amount of capital required to develop and/or replace our reserves; +• +our ability to compete against competitors that have greater financial, technical, and human resources; +• +our ability to attract and retain key personnel; +• +the imprecise estimations of our actual quantities and present value of proved oil, gas, and NGL reserves; +• +the uncertainty in evaluating recoverable reserves and estimating expected benefits or liabilities; +• +the possibility that exploration and development drilling may not result in commercially producible reserves; +• +our limited control over activities on outside-operated properties; +• +our reliance on the skill and expertise of third-party service providers on our operated properties; +• +the possibility that title to properties in which we claim an interest may be defective; +21 +• +our planned drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques is subject to drilling and completion risks and may not meet our expectations for reserves or production; +• +the uncertainties associated with acquisitions, divestitures, joint ventures, farm-downs, farm-outs and similar transactions with respect to certain assets, including whether such transactions will be consummated or completed in the form or timing and for the value that we anticipate (including any delay in our planned PRB Divestiture as a result of litigation); +• +the uncertainties associated with enhanced recovery methods; +• +our commodity derivative contracts may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales; +• +the inability of one or more of our service providers, customers, or contractual counterparties to meet their obligations; +• +our ability to deliver required quantities of oil, gas, NGL, or water to contractual counterparties; +• +price declines or unsuccessful exploration efforts resulting in write-downs of our asset carrying values; +• +the impact that depressed oil, gas, or NGL prices could have on our borrowing capacity under our Credit Agreement; +• +the possibility our amount of debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt; +• +the possibility that covenants in our Credit Agreement or the indentures governing the Senior Notes and Senior Convertible Notes may limit our discretion in the operation of our business, prohibit us from engaging in beneficial transactions or lead to the accelerated payment of our debt; +• +operating and environmental risks and hazards that could result in substantial losses; +• +the impact of seasonal weather conditions and lease stipulations on our ability to conduct drilling activities; +• +our ability to acquire adequate supplies of water and dispose of or recycle water we use at a reasonable cost in accordance with environmental and other applicable rules; +• +complex laws and regulations, including environmental regulations, that result in substantial costs and other risks; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities; +• +our ability to sell and/or receive market prices for our oil, gas, and NGLs; +• +new technologies may cause our current exploration and drilling methods to become obsolete; +• +the possibility of security threats, including terrorist attacks and cybersecurity breaches, against, or otherwise impacting, our facilities and systems; and +• +litigation, environmental matters, the potential impact of legislation and government regulations, and the use of management estimates regarding such matters. +We caution you that forward-looking statements are not guarantees of future performance and actual results or performance may be materially different from those expressed or implied in the forward-looking statements. The forward-looking statements in this report speak as of the filing of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by securities laws. +22 +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC. We also make available through our website our Corporate Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, and the Charters of the Audit, Compensation, Executive, and Nominating and Corporate Governance Committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +Glossary of Oil and Gas Terms +The oil and gas terms defined in this section are used throughout this report. The definitions of the terms developed reserves, exploratory well, field, proved reserves, and undeveloped reserves have been abbreviated from the respective definitions under Rule 4-10(a) of Regulation S-X. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the SEC’s website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +BBtu. One billion British thermal units. +Bcf . Billion cubic feet, used in reference to gas. +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of gas to one Bbl of oil or NGLs. +Btu. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. A well found to be incapable of producing either oil, gas, and/or NGLs in commercial quantities. +Exploratory well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and gas) rights. +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +Gross acre. An acre in which a working interest is owned. +23 +Gross well. A well in which a working interest is owned. +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses. The expenses incurred in the lifting of oil, gas, and/or NGLs from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels of oil, NGLs, water, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to gas. +MMBbl. One million barrels of oil, NGLs, water, or other liquid hydrocarbons. +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +NGLs. The combination of ethane, propane, butane, and natural gasolines that when removed from gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for oil. +NYMEX Henry Hub . New York Mercantile Exchange Henry Hub, a common industry benchmark price for gas. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +PV-10 (Non-GAAP). PV-10 is a non-GAAP measure. The present value of estimated future revenue to be generated from the production of estimated net proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. +Productive well. A well that is producing oil, gas, and/or NGLs or that is capable of commercial production of those products. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +24 +Reserve life index. Expressed in years, represents the estimated net proved reserves at a specified date divided by actual production for the preceding 12-month period. +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil, gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of oil, gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from oil, gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +Royalty interest. An interest in an oil and gas property entitling the owner to shares of oil, gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +Standardized measure of discounted future net cash flows. The discounted future net cash flows related to estimated proved reserves based on prices used in estimating the reserves, year end costs, and statutory tax rates, at a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information located in Part II, Item 8 of this report. +Track record. Current year conversions of proved undeveloped reserves to proved developed reserves, divided by beginning of the year proved undeveloped reserves. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and NGLs regardless of whether such acreage contains estimated net proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +25 +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in us. +Risks Related to Our Business +Oil, gas, and NGL prices are volatile, and declines in prices adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and gas properties depend heavily on the prices we receive for oil, gas, and NGL sales. Oil, gas, and NGL prices also affect our cash flows available for capital expenditures and other items, our borrowing capacity, and the volume and amount of our oil, gas, and NGL reserves. For example, the amount of our borrowing base under our Credit Agreement is subject to periodic redeterminations based on oil, gas, and NGL prices specified by our bank group at the time of redetermination. In addition, we may have oil and gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. Please refer to Significant Developments in 2017 and Reserves within Part I, Items 1 and 2, Comparison of Financial Results and Trends Between 2017 and 2016 and Between 2016 and 2015 within Part II, Item 7, and Note 1 – Summary of Significant Accounting Policies , Note 11 – Fair Value Measurements , and Supplemental Oil and Gas Information in Part II, Item 8 for specific discussion. +Historically, the markets for oil, gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in oil, gas, and NGL prices may result from relatively minor changes in the supply of and demand for oil, gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• +global and domestic supplies of oil, gas, and NGLs, and the productive capacity of the industry as a whole; +• +the level of consumer demand for oil, gas, and NGLs; +• +overall global and domestic economic conditions; +• +weather conditions; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities in regional or localized areas; +• +liquefied natural gas deliveries to and from the United States; +• +the price and availability of alternative fuels; +• +technological advances and regulations affecting energy consumption and conservation; +• +the ability of the members of the Organization of Petroleum Exporting Countries and other exporting countries to maintain effective oil price and production controls; +• +political instability or armed conflict in oil or gas producing regions; +• +strengthening and weakening of the United States dollar relative to other currencies; and +• +governmental regulations and taxes. +Declines in oil, gas, and NGL prices would reduce our revenues and could also reduce the amount of oil, gas, and NGLs that we can produce economically, which could have a materially adverse effect on us. +Weakness in economic conditions or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +In the last decade, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, increased levels of unemployment, and an unprecedented level of intervention by the United States federal government and other governments. Although the United States economy appears to have stabilized, future uncertainty is possible. Renewed +26 +weakness in the United States or other large economies could materially adversely affect our business and financial condition. For example: +• +the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• +the liquidity available under our Credit Agreement could be reduced if any lender is unable to fund its commitment; +• +our ability to access the capital markets may be restricted at a time when we would like, or need, to raise capital for our business, including for the exploration and/or development of reserves; +• +our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; and +• +variable interest rate spread levels, including for LIBOR and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our Credit Agreement. +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find, develop, or acquire oil, gas, and NGL reserves that are economically producible. Our properties produce oil, gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate and develop or acquire new oil, gas, and NGL reserves to replace those being depleted by production. Competition for oil and gas properties is intense, and many of our competitors have financial, technical, human, and other resources necessary to evaluate and integrate acquisitions that are substantially greater than those available to us. +For our recent acquisitions or any future acquisitions we may complete, a successful impact on our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price for the acquisition, future oil, gas, and NGL prices, the ability to reasonably estimate or assess the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves, actual future production rates, and associated costs and potential liabilities with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. Our customary review in connection with property acquisitions will not necessarily reveal, or allow us to fully assess, all existing or potential problems and deficiencies with the properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. We often acquire interests in properties on an “as-is” basis with limited remedies for breaches of representations and warranties. +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of special risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce oil, gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for oil, gas, and NGL sales, our success in locating and developing and acquiring new reserves, and the orderly functioning of credit and capital markets. If our cash flows from operations are less than expected, we may reduce our planned capital expenditures unless we can raise additional funds through debt or equity financing or the divestment +27 +of assets. Debt or equity financing may not always be available to us in sufficient amounts or on acceptable terms, and the proceeds offered to us for potential divestitures may not always be acceptable to us. Any downgrades to our credit ratings may make it more difficult or expensive for us to borrow additional funds. +If our revenues decrease in the future due to lower oil, gas, or NGL prices, decreased production, or other reasons, and if we cannot obtain funding through our Credit Agreement, other acceptable debt or equity financing arrangements, or through the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Downgrades in our credit ratings by various credit rating agencies could impact our access to capital and materially adversely affect our business and financial condition. +In February 2016, Moody’s Investors Service and Standard & Poor’s downgraded our credit ratings (“Debt Rating”). Our Debt Rating levels could have materially adverse consequences on our business and future prospects and could: +• +limit our ability to access debt markets, including for the purpose of refinancing our existing debt; +• +cause us to refinance or issue debt with less favorable terms and conditions, which debt may restrict, among other things, our ability to make any dividend distributions or repurchase shares; +• +negatively impact current and prospective customers’ willingness to transact business with us; +• +impose additional insurance, guarantee and collateral requirements; +• +limit our access to bank and third-party guarantees, surety bonds and letters of credit; and +• +cause our suppliers and financial institutions to lower or eliminate the level of credit provided through payment terms or intraday funding when dealing with us, thereby increasing the need for higher levels of cash on hand, which would decrease our ability to repay outstanding indebtedness. +We cannot provide assurance that any of our current Debt Ratings will remain in effect for any given period of time or that a Debt Rating will not be further lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances warrant. +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from major oil and gas companies, independent oil and gas exploration and production companies, and institutional and individual investors who seek oil and gas investments throughout the world, as well as the equipment, expertise, labor, and materials required to operate oil and gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many oil and gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. We may not be successful in acquiring and developing profitable properties in the face of this competition. In addition, other companies may have a greater ability to continue drilling activities during periods of low oil or gas prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition, and results of operations. +The loss of key personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team and other key personnel. The loss of their services could adversely affect our business. Our drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen, and other professionals. Competition for many of these professionals can be intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +28 +The actual quantities and present value of our proved oil, gas, and NGL reserves may be less than we have estimated. +This report and certain of our other SEC filings contain estimates of our proved oil, gas, and NGL reserves and the estimated future net revenues from those reserves. These estimates are based on various assumptions, including assumptions required by the SEC relating to oil, gas, and NGL prices, drilling and completion costs, gathering and transportation costs, operating expenses, capital expenditures, effects of governmental regulation, taxes, timing of operations, and availability of funds. The process of estimating oil, gas, and NGL reserves is complex and involves significant decisions and assumptions in the evaluation of available geological, geophysical, engineering, and economic data for each reservoir. These estimates depend on many variables, and changes often occur as our knowledge of these variables evolves. Therefore, these estimates are inherently imprecise. In addition, our reserve estimates for properties that do not have a significant production history may be less reliable than estimates for properties with lengthy production histories. A lack of production history may contribute to inaccuracy in our estimates of proved reserves, future production rates, and the timing and/or amount of development expenditures. +Actual future production; prices for oil, gas, and NGLs; revenues; production taxes; development expenditures; operating expenses; and quantities of producible oil, gas, and NGL reserves will most likely vary from those estimated. Any significant variance of any nature could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than we have previously estimated. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration, operations and development activity, prevailing oil, gas, and NGL prices, costs to develop and operate properties, and other factors, many of which are beyond our control. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2017 , 54% , or 253.4 MMBOE, of our estimated proved reserves were proved undeveloped. In order to develop our proved undeveloped reserves, as of December 31, 2017 , we estimate approximately $2.5 billion of capital expenditures would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +You should not assume that the PV-10 and standardized measure of discounted future net cash flows included in this report represent the current market value of our estimated proved oil, gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. For example, the present value of our proved reserves as of December 31, 2017 , was estimated using calculated 12-month average sales prices of $51.34 per Bbl of oil (NYMEX WTI spot price), $3.00 per MMBtu of gas (NYMEX Henry Hub spot price), and $27.69 per Bbl of NGL (OPIS spot price). We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. During 2017 , our monthly average realized oil prices before the effect of derivative settlements were as high as $56.35 per Bbl and as low as $41.34 per Bbl, and were as high as $27.98 per Bbl and as low as $18.88 per Bbl for NGLs. For the same period, our monthly average realized gas prices, excluding the effect of derivative settlements, were as high as $3.42 per Mcf and as low as $2.54 per Mcf. Many other factors will affect actual future net cash flows, including: +• +amount and timing of actual production; +• +supply and demand for oil, gas, and NGLs; +• +curtailments or increases in consumption by oil purchasers and gas pipelines; +• +changes in government regulations or taxes, including severance and excise taxes; and +• +escalations or reductions in service provider and equipment costs resulting from changes in supply and demand. +The timing of production from oil and gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to be used to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and gas industry in general are subject. +29 +Our disposition activities may be subject to factors beyond our control, and in certain cases we may retain unforeseen liabilities for certain matters . +We regularly sell non-core assets in order to increase capital resources available for core assets and other purposes and to create organizational and operational efficiencies. We also occasionally sell interests in core assets for the purpose of accelerating the development and increasing efficiencies in other core assets. Various factors could materially affect our ability to dispose of such assets, including the approvals of governmental agencies or third-parties, the availability of purchasers willing to acquire the assets on terms we deem acceptable, or other matters or uncertainties that could impact such dispositions, including whether transactions could be consummated or completed in the form or timing and for the value that we anticipate (including any delay in our planned PRB Divestiture as a result of litigation). We at times may be required to retain certain liabilities or agree to indemnify buyers for certain matters related to the sold assets. The magnitude of any such retained liabilities or of the indemnification obligations may be difficult to quantify at the time of the transaction and ultimately could be material. +We have limited control over the activities on properties we do not operate. +Some of our properties are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs and materially and adversely affect our financial condition and results of operations. +We rely on third-party service providers to conduct drilling and completion and other related operations on properties we operate. +Where we are the operator of a property, we rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, gas, and NGLs, prevailing economic conditions and financial, business, and other factors. In addition, sustained low commodity prices could cause third-party service providers to consolidate or declare bankruptcy, which could limit our options for engaging such providers. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title reports in acquiring oil and gas leasehold interests and obtain title opinions only on significant properties that we drill. Undeveloped acreage has greater risk of title defects than developed acreage and title insurance is not generally available for oil and gas properties. As is customary in our industry, we rely upon the judgment of staff and independent landmen who perform the field work of examining records in the appropriate governmental offices and title abstract facilities before acquiring a specific mineral interest and/or undertaking drilling activities. We, in some cases, perform curative work to correct deficiencies in the marketability of the title. Generally, under the terms of the operating agreements affecting our properties, any monetary loss attributable to a loss of title is to be borne by all parties to any such agreement in proportion to their interests in such property. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our financial condition, results of operations, and operating cash flow if such property is of sufficient value. +30 +Exploration and development drilling may not result in commercially producible reserves. +Oil and gas drilling, completion, and production activities are subject to numerous risks, including the risk that no commercially producible oil, gas, or NGLs will be found. The cost of drilling and completing wells is often uncertain, and oil, gas, or NGLs drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors include: +• +unexpected adverse drilling or completion conditions; +• +title problems; +• +disputes with owners or holders of surface interests on or near areas where we operate; +• +pressure or geologic irregularities in formations; +• +engineering and construction delays; +• +equipment failures or accidents; +• +hurricanes, tornadoes, flooding, or other adverse weather conditions; +• +governmental permitting delays; +• +compliance with environmental and other governmental requirements; and +• +shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +The prevailing prices for oil, gas, and NGLs affect the cost of and the demand for drilling rigs, completion and production equipment, and other related services. However, changes in costs may not occur simultaneously with corresponding changes in commodity prices. The availability of drilling rigs can vary significantly from region to region at any particular time. Although land drilling rigs can be moved from one region to another in response to changes in levels of demand, an undersupply of rigs in any region may result in drilling delays and higher drilling costs for the available rigs in that region. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a materially adverse effect on our ability to explore or develop our properties. +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if oil, gas, or NGLs are present, or whether they can be produced economically. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of oil, gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +Results in our newer resource plays, including those plays where we have recently acquired acreage, may be more uncertain than results in resource plays that are more developed and have longer established production histories. We and the industry generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +In addition, a significant part of our strategy involves increasing our inventory of drilling locations. Such multi-year drilling inventories can be more susceptible to long-term uncertainties that could materially alter the occurrence or timing of actual drilling. Because of these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled, although we have the present intent to do so for locations booked as proved undeveloped locations, or if we will be able to produce oil, gas, or NGLs from these potential drilling locations. +31 +We may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire and we will lose our right to develop the related properties. Our total net acreage as of February 14, 2018 , that is scheduled to expire over the next three years, represents approximately eight percent of our total net undeveloped acreage as of December 31, 2017 . Although we have identified numerous potential drilling locations, we may not be able to economically drill for and produce oil, gas, or NGLs from all of them, and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +Part of our strategy involves drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques. The results of our planned exploratory and delineation drilling in these plays are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +Ultimately, the success of these drilling and completion techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for oil, gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing, or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids toward the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, could result in increased lease operating expenses and could adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in oil, gas, and NGL prices and the associated impact on cash flows, we have entered into various derivative contracts. Our derivative contracts in place include swap and collar arrangements for oil, and swap arrangements for gas and NGLs. As of December 31, 2017 , we were in a net accrued liability position of $139.4 million with respect to our oil, gas, and NGL derivative activities. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• +our production is less than expected; +• +one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +32 +• +there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +In addition, commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from oil, gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other conditions, including declines in oil, gas, and NGL prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. We do not believe the loss of any single purchaser would materially impact our operating results, as we have numerous options for purchasers in each of our operating regions for our oil, gas, and NGL production. Please refer to Note 1 – Summary of Significant Accounting Policies , under the heading Concentration of Credit Risk and Major Customers in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. Additionally, the inability of our co-owners to pay joint interest billings could negatively impact our cash flows and financial ability to drill and complete current and future wells. +We have entered into firm transportation contracts that require us to pay fixed sums of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of oil, gas, NGL, or produced water to our counterparties, our results of operations, financial position, and liquidity could be adversely affected. +As of December 31, 2017 , we were contractually committed to deliver 19 MMBbl of oil, 789 Bcf of gas, and 24 MMBbl of produced water. These contracts expire at various dates through 2028 . We may enter into additional firm transportation agreements as we expand the development of our resource plays. At the current time, we do not have enough proved developed reserves to offset these contractual liabilities, but we expect to develop reserves that will meet or exceed the commitments and therefore do not expect any material shortfalls. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, or if we further limit our capital expenditures due to future commodity price declines, the requirements to pay for quantities not delivered could have a material impact on our results of operations, financial position, and liquidity. +Future oil, gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our oil and gas properties. All property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending the determination of whether proved reserves have been discovered. If commercial quantities of hydrocarbons are not discovered with an exploratory well, the costs of drilling the well are expensed. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net cash flows, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Unproved properties are evaluated at the lower of cost or fair market value. We incurred impairment of proved properties expense and impairment of unproved properties expense totaling $3.8 million and $12.3 million , respectively, during 2017 , $354.6 million and $80.4 million , respectively, during 2016 , and $468.7 million and $78.6 million , respectively, during 2015 . We also incurred impairment of other property, plant, and equipment expense totaling $49.4 million during 2015. If the prices of oil, gas, or NGLs decline, or we have unsuccessful exploration efforts, it could cause additional proved and/or unproved property impairments in the future. +We review the carrying values of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and gas properties held for use cannot be reversed at a later date, even if oil, gas, or NGL prices increase. +33 +Lower oil, gas, or NGL prices could limit our ability to borrow under our Credit Agreement. +Our Credit Agreement has a current commitment amount of $925 million , subject to a borrowing base that the lenders redetermine semi-annually based on the bank group’s assessment of the value of our proved reserves, which in turn is impacted by oil, gas, and NGL prices. The borrowing base under our Credit Agreement is $925 million , down from $1.2 billion at December 31, 2016 . This reduction was primarily a result of the sale of our outside-operated Eagle Ford shale assets during the first quarter of 2017, as well as adjustments consistent with lower commodity prices. The next semi-annual redetermination date is scheduled for April 1, 2018 . We expect this redetermination to result in an increase to our borrowing base as a result of the increase in our proved reserves at December 31, 2017 . Divestitures of additional properties, incurrence of additional debt, or declines in commodity prices could limit our borrowing base and reduce the amount we can borrow under our Credit Agreement. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2017 , we had $172.5 million in aggregate principal amount of long-term senior unsecured convertible debt outstanding relating to our 1.50% Senior Convertible Notes due July 1, 2021 (“Senior Convertible Notes”) that we issued on August 12, 2016 . As of December 31, 2017 , we had $344.6 million of long-term senior unsecured debt outstanding relating to our 6.50% Senior Notes due 2021 (“2021 Notes”) that we issued on November 8, 2011; $561.8 million of long-term senior unsecured debt outstanding relating to our 6.125% Senior Notes due 2022 (“2022 Notes”) that we issued on November 17, 2014 ; $395.0 million of long-term senior unsecured debt outstanding relating to our 6.50% Senior Notes due 2023 (“2023 Notes”) that we issued on June 29, 2012; $500.0 million of long-term senior unsecured debt outstanding relating to our 5.0% Senior Notes due 2024 (“2024 Notes”) that we issued on May 20, 2013; $500.0 million of long-term senior unsecured debt outstanding relating to our 5.625% Senior Notes due 2025 (“2025 Notes”) that we issued on May 21, 2015 ; and $500.0 million of long-term senior unsecured debt outstanding relating to our 6.75% Senior Notes due 2026 (“2026 Notes”) that we issued on September 12, 2016 (collectively, the 2021 Notes, 2022 Notes, 2023 Notes, 2024 Notes, 2025 Notes, and 2026 Notes are referred to as our “Senior Notes”); and no outstanding borrowings under our secured credit facility. We had one outstanding letter of credit in the aggregate amount of $200,000 (which reduces the amount available for borrowing under the facility on a dollar-for-dollar basis), resulting in $924.8 million of available borrowing capacity under our secured credit facility, assuming the borrowing conditions will be met. Our long-term debt represented 55 percent of our total book capitalization as of December 31, 2017 . +Our indebtedness could have important consequences for our operations, including: +• +making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• +requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to productive investments; +• +limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• +placing us at a competitive disadvantage compared to our competitors with less debt; and +• +making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our Credit Agreement or from other sources, we might not be able to service our debt or fund our planned capital expenditures and other liquidity needs. If we are unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our Credit Agreement and any future credit agreements, may prohibit us from pursuing any of these alternatives. Further, changes in the credit ratings of our debt may negatively affect the cost, terms, conditions, and availability of future financing. +Our debt agreements, including the Credit Agreement and the indentures governing our Senior Convertible Notes and our Senior Notes, permit us to incur additional debt in the future, subject to compliance with restrictive covenants under those agreements. In addition, entities we may acquire in the future could have significant amounts of debt outstanding that we could +34 +be required to assume, and in some cases accelerate repayment thereof, in connection with the acquisition, or we may incur our own significant indebtedness to consummate an acquisition. +As discussed above, our Credit Agreement is subject to periodic borrowing base redeterminations. We could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate renewals of our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements, including the Credit Agreement and the indentures governing our Senior Convertible Notes and our Senior Notes, contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our ability to borrow under our Credit Agreement is subject to compliance with certain financial covenants. Financial covenants under the Credit Agreement require, as of the last day of each of the Company’s fiscal quarters, our (a) ratio of senior secured debt to 12-month trailing adjusted EBITDAX to be not more than 2.75 to 1.0; (b) adjusted current ratio to be not less than 1.0 to 1.0; and (c) ratio of 12-month trailing adjusted EBITDAX to interest expense to be not less than 2.0 to 1.0. Our Credit Agreement also requires us to comply with certain additional financial covenants, including requirements that we maintain certain levels of stockholders’ equity and limit our annual cash dividends to no more than $50 million . These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. +The respective indentures governing the Senior Notes and Senior Convertible Notes also contain covenants that, among other things, limit our ability and the ability of our subsidiaries to: +• +incur additional debt; +• +make certain dividends or pay dividends or distributions on our capital stock or purchase, redeem, or retire common stock; +• +sell assets, including common stock of our subsidiaries; +• +restrict dividends or other payments of our subsidiaries; +• +create liens that secure debt; +• +enter into transactions with affiliates; and +• +merge or consolidate with another company. +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of oil, gas and NGLs, or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, seismic events, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occurs, we could sustain substantial losses. +Furthermore, if we experience any of the problems with well stimulation and completion activities referenced above, our ability to explore for and produce oil, gas, or NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shutdown, abandon, or relocate drilling +35 +operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling, and disposal of materials, including produced water, solid and hazardous wastes, and petroleum hydrocarbons. We may incur joint and several, strict liability under applicable United States federal and state environmental laws in connection with releases of petroleum hydrocarbons and other hazardous substances at, on, under or from our leased or owned properties, some of which have been used for oil and gas exploration and production activities for a number of years, often by third-parties not under our control. For our outside-operated properties, we are dependent on the operator for operational and regulatory compliance, and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or therefrom could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including the CERCLA or the Superfund law, the RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under any implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury or property damage, including induced seismicity damage, allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third-parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer a material loss. +Our operations are subject to complex laws and regulations, including environmental regulations that result in substantial costs and other risks. +Federal, state, tribal, and local authorities extensively regulate the oil and gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing, or marketing of oil, gas, and NGL production. Non-compliance with statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +Governmental authorities regulate various aspects of drilling for and the production of oil, gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in oil and gas properties, rights-of-way and easements, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, restoration standards, and oil and gas operations. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Federal authorities also may require any of our ongoing or planned operations on federal leases to be delayed, suspended, or terminated. Any such delay, suspension, or termination could have a materially adverse effect on our operations. +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, tribal, and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate in, could result in material costs or claims with respect +36 +to properties we own or have owned. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, tribal, and local environmental laws for noise emissions and for discharges of oil, gas, and NGLs or other pollutants into the air, soil, surface water, or groundwater. We could be required to spend substantial amounts on investigations, litigation, and remediation for these emissions and discharges and other compliance issues. Any unpermitted release of petroleum or other pollutants from our operations could result not only in cleanup costs, but also natural resources, real or personal property and other damages and civil and criminal liabilities. The listing of additional wildlife or plant species as federally endangered or threatened could result in limitations on exploration and production activities in certain locations. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a materially adverse effect on us. +Seasonal weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Operations in certain of our regions, such as our Permian, South Texas, and Rocky Mountain regions, are adversely affected by seasonal weather conditions and lease stipulations designed to protect various wildlife or plant species. In certain areas on federal lands, drilling and other oil and gas activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs, oil field equipment, services, supplies and qualified personnel, which may lead to periodic shortages. Wildlife seasonal restrictions, including in greater sage-grouse habitats during breeding and nesting seasons, within a certain distance of active raptor nests during fledging, and in big game winter or parturition ranges during winter or calving seasons, may limit access to federal leases or across federal lands. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays . +Hydraulic fracturing is a common practice in the oil and gas industry used to stimulate the production of oil, gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and gas properties, including our unconventional resource plays in the Wolfcamp and Spraberry shale intervals in the Midland Basin, the Eagle Ford shale of south Texas, and the Bakken/Three Forks formations in North Dakota. Hydraulic fracturing involves injecting water, sand, and certain chemicals under pressure to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities, as outlined below. +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the Safe Drinking Water Act. The EPA has published an interpretive memorandum and permitting guidance related to regulation of fracturing fluids using this regulatory authority. In June 2016, the EPA issued regulations under the Federal Clean Water Act establishing federal pre-treatment standards for wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process. Under a recent settlement, the EPA will decide by March 2019 whether to initiate rulemaking governing the disposal of wastewater from oil and gas development. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays, or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states in which we operate, including Texas and Wyoming, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict, or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, +37 +experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +In the recent past, several federal governmental agencies were actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. For example, in December 2016, the EPA issued a final assessment of potential impacts to drinking water resources from hydraulic fracturing. On March 28, 2017, President Trump issued Executive Order 13783 entitled “Promoting Energy Independence and Economic Growth” (“Executive Order 13783”). Executive Order 13783 directed executive departments and agencies to review regulations that potentially burden the development or use of domestically produced energy resources and, as appropriate, suspend, revise, or rescind those that unduly burden domestic energy resources development. +On March 26, 2015, the BLM published a final rule requiring, among other things, disclosure of chemicals used in hydraulic fracturing on federal and tribal lands, including private surface lands with underlying federal minerals. The rule was never implemented due to court challenges. On December 29, 2017, the BLM rescinded the rule. We will continue to be subject to uncertainty associated with new regulatory suspensions, revisions or rescissions and inconsistent state and federal regulatory mandates that could adversely affect our production. +Further, as to air quality and greenhouse gas (“GHG”) regulation of oil and gas sources, the overall trend has been toward increased regulation and requirements for reduced emissions. The Trump Administration has taken steps toward rescinding or reviewing many of those regulations, but any deregulation will likely face immediate judicial challenges. The Obama Administration took several actions to regulate air quality and GHGs, many of which continue to be in effect. For example, on August 16, 2012, the EPA issued final rules subjecting all new and modified oil and gas operations (production, processing, transmission, storage, and distribution) to regulation under the New Source Performance Standards (“NSPS”) and all existing and new operations to the National Emission Standards for Hazardous Air Pollutants (“NESHAP”) programs. The EPA rules also include NSPS standards for completions of hydraulically fractured gas wells. These standards require the use of reduced emission completion (“REC”) techniques developed in the EPA’s Natural Gas STAR program along with the pit flaring of gas not sent to the gathering line beginning in January 2015. The standards are applicable to newly drilled and fractured wells as well as existing wells that are refractured. Further, the regulations under NESHAP include maximum achievable control technology (“MACT”) standards for those glycol dehydrators and certain storage vessels at major sources of hazardous air pollutants not currently subject to MACT standards. These rules require additional control equipment, changes to procedure, and extensive monitoring and reporting. In September 2013 and December 2014, the EPA published technical fixes to the 2012 NSPS, including standards for storage tanks subject to the NSPS. The amendments clarified stages for flowback and the point at which green completion equipment is required and updated requirements for storage tanks and leak detection requirements for processing plants. As part of the EPA’s strategy during the Obama Administration to reduce methane and ozone-forming volatile organic compound (“VOC”) emissions from the oil and gas industry, on May 12, 2016, the EPA issued final regulations that amend and expand the 2012 regulations. The 2016 NSPS requires reduction of greenhouse gases in the form of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The final regulation requires, among other things, GHG and VOC standards for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and natural gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. Both the 2012 and 2016 rules are the subjects of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia, though the litigation of both rules has been stayed. In June 2017, the EPA proposed a 2-year stay of the compliance requirements in the 2016 NSPS. In a related action in March 2017, the EPA withdrew the final information request it had issued in 2016 as part of an effort to develop standards under the CAA NSPS provisions for methane and other emissions from existing sources in the oil and natural gas industry. +In October 2015, the EPA revised and lowered the ambient air quality standard for ozone in the U.S. under the CAA, from 75 parts per billion to 70 parts per billion, which is likely to result in more, and expanded, ozone non-attainment areas, which in turn will require states to adopt implementation plans to reduce emissions of ozone-forming pollutants, like VOCs and nitrogen oxides, that are emitted from, among others, the oil and gas industry. The judicial challenge to the ozone standard has been stayed while the EPA reviews the standard. In October 2016, the EPA finalized Control Techniques Guidelines for VOC emissions from existing oil and natural gas equipment and processes in moderate ozone non-attainment areas. These Control Techniques Guidelines provide recommendations for states and local air agencies to consider when determining what emissions requirements apply to sources in the non-attainment areas. The EPA indicated in late 2017 that it will take comments on completely withdrawing the guidelines. On May 12, 2016, the EPA also issued a final rule named the “Source Determination Rule” that was issued to clarify when multiple pieces of oil and gas equipment and activities must be aggregated as a single +38 +source for determining whether major source permitting programs apply. This action can expand the permitting and related control requirements to sources that were not previously subject to permitting requirements. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third-parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. Over the past year, several court cases have addressed aspects of hydraulic fracturing. In a case that could delay operations on public lands, a court in California held that the BLM did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. Courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing, including damages from induced seismicity, could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for, and production of, oil, gas, and NGLs, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional state or local laws, or the implementation of new regulations, regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +Requirements to reduce gas flaring could have an adverse effect on our operations. +Wells in the Bakken and Three Forks formations in North Dakota, where we have significant operations, produce gas as well as oil. Constraints in the current gas gathering and processing network in certain areas have resulted in some of that gas being flared instead of gathered, processed, and sold. In June 2014, the North Dakota Industrial Commission, North Dakota’s chief energy regulator, adopted a policy to reduce the volume of gas flared from oil wells in the Bakken and Three Forks formations. The Commission is requiring operators to develop gas capture plans that describe how much gas is expected to be produced, how it will be delivered to a processor, and where it will be processed. Production caps or penalties will be imposed on certain wells that cannot meet the capture goals. In November 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands. The regulations prohibit venting gas except in limited situations and limit the flaring of gas. A preliminary injunction sought by industry groups was denied in U.S. District Court and the regulation went into effect on January 17, 2017; however, on December 8, 2017, the BLM finalized a rule suspending or delaying many of the provisions of the regulation while it reviews the regulation. This suspension of the rule is being challenged in the courts. These capture requirements, and any similar future obligations in North Dakota or our other locations, may increase our operational costs, or restrict our production, which could materially and adversely affect our financial condition, results of operations and cash flows. +Our ability to produce oil, gas, and NGLs economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the water we use at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of oil, gas, and NGLs requires the use and disposal of significant quantities of water. +Our inability to secure sufficient amounts of water, or to dispose of or recycle the water produced from our wells, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of oil, gas, and NGLs. +Compliance with environmental regulations and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +39 +Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs. +In December 2009, the EPA made a finding that emissions of carbon dioxide, methane, and other “greenhouse gases” endanger public health and the environment because emissions of such gases contribute to warming of the earth’s atmosphere and other climatic changes. Based on this finding, the EPA adopted and implemented a comprehensive suite of regulations to restrict and otherwise regulate emissions of greenhouse gases under existing provisions of the CAA. In particular, the EPA has adopted two sets of rules regulating greenhouse gas emissions under the CAA. One rule requires a reduction in greenhouse gas emissions from motor vehicles, and the other regulates permitting and greenhouse gas emissions from certain large stationary sources. These EPA regulatory actions have been challenged by various industry groups, initially in the D.C. Circuit, which in 2012 ruled in favor of the EPA in all respects. However, in June 2014, the United States Supreme Court reversed the D.C. Circuit and struck down the EPA’s greenhouse gas permitting rules to the extent they impose a requirement to obtain a permit based solely on emissions of greenhouse gases. The EPA proposed a rule in 2016 to comply with the U.S. Supreme Court’s ruling by limiting the requirement to obtain permits addressing emissions of greenhouse gases to large sources of other air pollutants, such as volatile organic compounds or nitrogen oxides, which also emit 100,000 tons per year or more of CO 2 (or modifications of these sources that result in an emissions increase of 75,000 tons per year or more of CO 2 e). If finalized, large sources of air pollutants other than greenhouse gases will be required to implement the best available capture technology for greenhouse gases. However, the EPA has not taken action on the proposed rule and is unlikely to do so under the Trump Administration. The EPA has also adopted reporting rules for greenhouse gas emissions from specified greenhouse gas emission sources in the United States, including petroleum refineries as well as certain onshore oil and gas extraction and production facilities. +Several other kinds of cases on greenhouse gases have been heard by the courts in recent years. While courts have generally declined to assign direct liability for climate change to large sources of greenhouse gas emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant greenhouse gas emissions, and new claims for damages and increased government scrutiny, especially from state and local governments, will likely continue. Such cases often seek to challenge air emissions permits that greenhouse gas emitters apply for, seek to force emitters to reduce their emissions, or seek damages for alleged climate change impacts to the environment, people, and property. Any court rulings, laws, or regulations that restrict or require reduced emissions of greenhouse gases could lead to increased operating and compliance costs, and could have an adverse effect on demand for the oil and gas that we produce. +The United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases, and almost one-half of the states have already taken measures to reduce emissions of greenhouse gases, primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas “cap and trade” programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. Recently, the Congressional Budget Office provided Congress with a study on the potential effects on the United States economy of a tax on greenhouse gas emissions. While “carbon tax” legislation has been introduced in the Senate, the prospects for passage of such legislation are highly uncertain at this time. +On June 25, 2013, President Obama issued a Climate Action Plan to address climate change through a variety of executive actions, including reduction of methane emissions from oil and gas production and processing operations as well as pipelines and coal mines (the “Climate Action Plan”). Please refer to Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays for more information on EPA actions to implement the Climate Action Plan. The focus on legislating and/or regulating methane could eventually result in: +• +requirements for methane emission reductions from existing oil and gas equipment; +• +increased scrutiny for sources emitting high levels of methane, including during permitting processes; +• +analysis, regulation and reduction of methane emissions as a requirement for project approval; and +• +actions taken by one agency for a specific industry establishing precedents for other agencies and industry sectors. +In relation to the Climate Action Plan, both assumed Global Warming Potential (“GWP”) and assumed social costs associated with methane and other greenhouse gas emissions have been finalized, including a 20% increase in the GWP of +40 +methane. Changes to these measurement tools could adversely impact permitting requirements, application of agencies’ existing regulations for source categories with high methane emissions, and determinations of whether a source qualifies for regulation under the CAA. However, in Executive Order 13783, President Trump ordered a review of the use of social cost of carbon for regulatory impact analysis. Therefore, the continued use of the social cost of carbon under the Trump Administration is uncertain. +Finally, it should be noted that scientists have predicted that increasing concentrations of greenhouse gases in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies, or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses, or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements. +Our ability to sell oil, gas, and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines and other transportation systems owned or operated by others or by other interruptions. +The marketability of our oil, gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third-parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay, or discontinuance of development plans for our properties, or lower price realizations. Although we have some contractual control over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of oil, gas, and NGL production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, and transport oil, gas, and NGLs. +In particular, if drilling in the Midland Basin continues to be successful, the amount of oil, gas, and NGLs being produced by us and others could exceed the capacity of, and result in strains on, the various gathering and transportation systems, pipelines, processing facilities, and other infrastructure available in that area. It will be necessary for additional infrastructure, pipelines, gathering and transportation systems and processing facilities to be expanded, built, or developed to accommodate anticipated production from these areas. Certain processing, pipeline, and other gathering or transportation projects that might be, or are being, considered for these areas may not be developed timely or at all due to lack of financing or other constraints, including permitting constraints. Capital and other constraints could also limit our ability to build or access intrastate gathering and transportation systems necessary to transport our production to interstate pipelines or other points of sale or delivery. In such event, we might have to delay or discontinue development activities or shut in our wells to wait for sufficient infrastructure development or capacity expansion and/or sell production at significantly lower prices, which would adversely affect our results of operations and cash flows. In addition, the operations of the third-parties on whom we rely for gathering and transportation services are subject to complex and stringent laws and regulations, which require obtaining and maintaining numerous permits, approvals, and certifications from various federal, state, tribal, and local government authorities. These third-parties may incur substantial costs in order to comply with existing laws and regulations. If existing laws and regulations governing such third-party services are revised or reinterpreted, or if new laws and regulations become applicable to their operations, these changes may affect the amounts we pay for such services. Similarly, a failure to comply with such laws and regulations by the third-parties on whom we rely could have a material adverse effect on our business, financial condition, and results of operations. +A portion of our production in any region may be interrupted, or shut in, from time to time for numerous reasons, including as a result of weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market conditions. If a substantial amount of our production is interrupted at the same time, it could temporarily and adversely affect our cash flows and results of operations. +41 +New technologies may cause our current exploration and drilling methods to become obsolete. +The oil and gas industry is subject to rapid and significant advancements in technology, including the introduction of new products and services that use new technologies. As competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, competitors may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. One or more of the technologies we currently use or implement in the future may become obsolete. We cannot be certain we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. If we are unable to maintain technological advancements consistent with industry standards, our operations, and financial condition may be adversely affected. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As an oil, gas, and NGLs producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third-party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel, or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +Cybersecurity attacks in particular are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data. These events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. +The threat of terrorism and the impact of military and other action have caused instability in world financial markets and could lead to increased volatility in prices for oil, gas, and NGLs, all of which could adversely affect the markets for our operations. Energy assets might be specific targets of terrorist attacks. These developments have subjected our operations to increased risk and, depending on their occurrence and ultimate magnitude, could have a material adverse effect on our business. +Risks Related to Our Common Stock +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2017 , to February 14, 2018 , the intraday trading prices per share of our common stock as reported by the New York Stock Exchange ranged from a low of $12.29 per share in August 2017 to a high of $36.77 per share in January 2017 . We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include: +• +changes in oil, gas, or NGL prices; +• +variations in drilling, recompletion, and operating activity; +• +changes in financial estimates by securities analysts; +• +changes in market valuations of comparable companies; +• +additions or departures of key personnel; +• +increased volatility due to the impacts of algorithmic trading practices; +• +future sales of our common stock; and +• +changes in the national and global economic outlook. +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +42 +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third-party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +We may not always pay dividends on our common stock. +Payment of future dividends remains at the discretion of our Board of Directors, and will continue to depend on our earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to a covenant in our Credit Agreement limiting our annual cash dividends to no more than $50.0 million , and to covenants in the indentures for our Senior Notes and Senior Convertible Notes that limit our ability to pay dividends beyond a certain amount. Our Board of Directors may determine in the future to reduce the current semi-annual dividend rate of $0.05 per share, or discontinue the payment of dividends altogether. +43 +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Exchange Act. +ITEM 3. LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our business and operations in the normal course of business. As of the filing of this report, no legal proceedings are pending against us that we believe individually or collectively are likely to have a materially adverse effect upon our financial condition, results of operations or cash flows. +On February 1, 2018, SPM NAM LLC, an affiliate of Schlumberger Limited, filed a lawsuit in the District Court of Harris County, Texas against us, asserting that we had breached certain transfer provisions of the Acquisition and Development Funding Agreement, dated as of August 2, 2016 (the “ADFA”), by and among us, SPM NAM LLC, and certain other Schlumberger affiliates (Schlumberger Technology Corporation, Smith International, Inc., M-I LLC, and Cameron International Corporation (collectively such affiliates, the “Schlumberger Affiliates”)), and seeking, among other declaratory and equitable relief, to rescind SPM NAM LLC’s previously granted consent, which would allow us to consummate our planned sale of the majority of our Powder River Basin assets. We filed a motion seeking the dismissal of SPM NAM LLC’s rescission claim on February 8, 2018, and filed our answer and counterclaims against SPM NAM LLC on February 16, 2018. In addition, we filed a motion seeking to join the Schlumberger Affiliates to the lawsuit on February 16, 2018. +We believe that we have complied with the provisions of the ADFA, strongly dispute SPM NAM LLC’s allegations, and plan to vigorously defend ourselves. As further explained in our motion to dismiss, we do not believe that the laws of the State of Texas permit SPM NAM LLC to rescind the previously granted consent and believe that pursuant to the terms of the ADFA, SPM NAM LLC waived any right it may have had to a rescission remedy. We do not expect that these claims will impact our ability to divest our Powder River Basin assets. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +44 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” The following table presents the range of high and low intraday sales prices per share for the indicated quarterly periods in 2017 and 2016 , as reported by the New York Stock Exchange: +Quarter Ended +High +Low +December 31, 2017 +$ +23.09 +$ +16.72 +September 30, 2017 +$ +19.32 +$ +12.29 +June 30, 2017 +$ +25.22 +$ +13.76 +March 31, 2017 +$ +36.77 +$ +20.01 +December 31, 2016 +$ +43.09 +$ +30.25 +September 30, 2016 +$ +40.39 +$ +23.58 +June 30, 2016 +$ +35.60 +$ +17.04 +March 31, 2016 +$ +20.65 +$ +6.99 +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2012 , and ending on December 31, 2017 , with the cumulative total returns of the Dow Jones U.S. Exploration and Production Index, and the Standard & Poor’s 500 Stock Index. +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +45 +Holders. As of February 14, 2018 , the number of record holders of our common stock was 65. Based upon inquiry, management believes that the number of beneficial owners of our common stock is approximately 23,400. +Dividends . We have paid cash dividends to our stockholders every year since 1940. Annual dividends of $0.05 per share were paid in each of the years 1998 through 2004. Annual dividends of $0.10 per share were paid in each of the years 2005 through 2017 . We expect our practice of paying dividends on our common stock to continue, although the payment and amount of future dividends will continue to depend on our earnings, cash flows, capital requirements, financial condition, and other factors, including the discretion of our Board of Directors. In addition, the payment of dividends is subject to covenants in our Credit Agreement that limit our annual dividend payment to no more than $50.0 million per year. We are also subject to certain covenants under the indentures governing our Senior Notes and Senior Convertible Notes that restrict certain payments, including dividends; however, the first $6.5 million of dividends paid each year are not restricted by these covenants. Based on our current performance, we do not anticipate that these covenants will restrict future annual dividend payments in amounts not to exceed $0.10 per share of common stock. Dividends are currently paid on a semi-annual basis. Dividends paid totaled $11.1 million , $7.8 million , and $6.8 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +Purchases of Equity Securities by the Issuer and Affiliated Purchasers. The following table provides information about purchases made by us and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and year ended December 31, 2017 , of shares of our common stock, which is the sole class of equity securities registered by us pursuant to Section 12 of the Exchange Act. +PURCHASES OF EQUITY SECURITIES BY ISSUER AND AFFILIATED PURCHASERS +Period +Total Number of Shares Purchased (1) +Weighted Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program +Maximum Number of Shares that May Yet be Purchased Under the Program (2) +01/01/2017 - +03/31/2017 +379 +$ +27.69 +— +3,072,184 +04/01/2017 - +06/30/2017 +— +$ +— +— +3,072,184 +07/01/2017 - +09/30/2017 +74,368 +$ +16.52 +— +3,072,184 +10/01/2017 - +12/31/2017 +— +$ +— +— +3,072,184 +Total +74,747 +$ +16.57 +— +3,072,184 +____________________________________________ +(1) +All shares purchased by us in 2017 were to offset tax withholding obligations that occurred upon the delivery of outstanding shares underlying RSUs delivered under the terms of grants under the Equity Incentive Compensation Plan (“Equity Plan”). +(2) +In July 2006, our Board of Directors approved an increase in the number of shares that may be repurchased under the original August 1998 authorization to 6,000,000 as of the effective date of the resolution. Accordingly, as of the filing of this report, subject to the approval of our Board of Directors, we may repurchase up to 3,072,184 shares of common stock on a prospective basis. The shares may be repurchased from time to time in open market transactions or privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes and Senior Convertible Notes, and compliance with securities laws. Stock repurchases may be funded with existing cash balances, internal cash flows, or borrowings under our Credit Agreement. The stock repurchase program may be suspended or discontinued at any time. Please refer to Dividends above for a description of our dividend limitations. +46 +ITEM 6. SELECTED FINANCIAL DATA +The following table sets forth selected supplemental financial and operating data as of the dates or for the years indicated. The financial data for each of the five years presented were derived from our consolidated financial statements. The following data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report, which includes a discussion of factors materially affecting the comparability of the information presented, and in conjunction with our consolidated financial statements included in this report. +As of or for the Years Ended December 31, +2017 +2016 +2015 +2014 +2013 +(in millions, except per share data) +Statement of operations data: +Total operating revenues and other income +$ +1,129.4 +$ +1,217.5 +$ +1,557.0 +$ +2,522.3 +$ +2,293.4 +Net income (loss) +$ +(160.8 +) +$ +(757.7 +) +$ +(447.7 +) +$ +666.1 +$ +170.9 +Net income (loss) per share: +Basic +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +$ +9.91 +$ +2.57 +Diluted +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +$ +9.79 +$ +2.51 +Cash dividends declared and paid per common share +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +Balance sheet data: +Total assets +$ +6,176.8 +$ +6,393.5 +$ +5,621.6 +$ +6,483.1 +$ +4,678.1 +Long-term debt: +Revolving credit facility +$ +— +$ +— +$ +202.0 +$ +166.0 +$ +— +Senior Notes, net of unamortized deferred financing costs +$ +2,769.7 +$ +2,766.7 +$ +2,316.0 +$ +2,166.4 +$ +1,572.9 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +$ +139.1 +$ +130.9 +$ +— +$ +— +$ +— +47 +Supplemental Selected Financial and Operations Data +As of or for the Years Ended December 31, +2017 +2016 +2015 +2014 +2013 +Balance sheet data (in millions): +Total working capital (deficit) +$ +(10.1 +) +$ +(190.5 +) +$ +216.5 +$ +(39.6 +) +$ +8.4 +Total stockholders ’ equity +$ +2,394.6 +$ +2,497.1 +$ +1,852.4 +$ +2,286.7 +$ +1,606.8 +Weighted-average common shares outstanding (in thousands): +Basic +111,428 +76,568 +67,723 +67,230 +66,615 +Diluted +111,428 +76,568 +67,723 +68,044 +67,998 +Reserves: +Oil (MMBbl) +158.2 +104.9 +145.3 +169.7 +126.6 +Gas (Bcf) +1,280.1 +1,111.1 +1,264.0 +1,466.5 +1,189.3 +NGLs (MMBbl) +96.5 +105.7 +115.4 +133.5 +103.9 +MMBOE (1) +468.1 +395.8 +471.3 +547.7 +428.7 +Production and operations (in millions): +Oil, gas, and NGL production revenue +$ +1,253.8 +$ +1,178.4 +$ +1,499.9 +$ +2,481.5 +$ +2,199.6 +Oil, gas, and NGL production expense +$ +507.9 +$ +597.6 +$ +723.6 +$ +715.9 +$ +597.0 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +557.0 +$ +790.7 +$ +921.0 +$ +767.5 +$ +822.9 +General and administrative +$ +120.6 +$ +126.4 +$ +157.7 +$ +167.1 +$ +149.6 +Production volumes: +Oil (MMBbl) +13.7 +16.6 +19.2 +16.7 +13.9 +Gas (Bcf) +123.0 +146.9 +173.6 +152.9 +149.3 +NGLs (MMBbl) +10.3 +14.2 +16.1 +13.0 +9.5 +MMBOE (1) +44.5 +55.3 +64.2 +55.1 +48.3 +Realized price, before the effect of derivative settlements: +Oil (per Bbl) +$ +47.88 +$ +36.85 +$ +41.49 +$ +80.97 +$ +91.19 +Gas (per Mcf) +$ +3.00 +$ +2.30 +$ +2.57 +$ +4.58 +$ +3.93 +NGLs (per Bbl) +$ +22.35 +$ +16.16 +$ +15.92 +$ +33.34 +$ +35.95 +Expense per BOE: +Lease operating expense +$ +4.43 +$ +3.51 +$ +3.73 +$ +4.28 +$ +4.49 +Transportation costs +$ +5.48 +$ +6.16 +$ +6.02 +$ +6.11 +$ +5.34 +Production taxes +$ +1.18 +$ +0.94 +$ +1.13 +$ +2.13 +$ +2.19 +Ad valorem tax expense +$ +0.34 +$ +0.21 +$ +0.39 +$ +0.46 +$ +0.33 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +12.53 +$ +14.30 +$ +14.34 +$ +13.92 +$ +17.02 +General and administrative +$ +2.71 +$ +2.29 +$ +2.46 +$ +3.03 +$ +3.09 +Statement of cash flows data (in millions): +Provided by operating activities (2) +$ +515.4 +$ +552.8 +$ +990.8 +$ +1,456.6 +$ +1,338.5 +Used in investing activities (2) +$ +(201.5 +) +$ +(1,867.6 +) +$ +(1,144.6 +) +$ +(2,575.5 +) +$ +(1,183.0 +) +Provided by (used in) financing activities (2) +$ +(12.3 +) +$ +1,327.2 +$ +153.7 +$ +740.0 +$ +130.7 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +Certain prior period amounts have been reclassified to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 for additional discussion of the change in presentation on the accompanying statements of cash flows as a result of adopting new accounting standards. +48 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +This discussion includes forward-looking statements. Please refer to Cautionary Information about Forward-Looking Statements in Part I, Items 1 and 2 of this report for important information about these types of statements. +Overview of the Company +General Overview +We are an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in onshore North America. Our strategic objective is to be a premier operator of top tier assets. We seek to maximize the value of our assets by applying industry leading technology and outstanding operational execution. Our portfolio is comprised of unconventional resource prospects with prospective drilling opportunities, which we believe provide for long-term production and reserves growth. We focus on achieving high full-cycle economic returns on our investments and maintaining a strong balance sheet. +We currently have material core producing assets and acreage positions in the Midland Basin and Eagle Ford shale in Texas, as well as producing assets and material acreage positions in the Bakken/Three Forks play in North Dakota, and the Powder River Basin in Wyoming. The majority of our Powder River Basin assets were classified as held for sale as of December 31, 2017 and are expected to be sold in the first quarter of 2018. There can be no assurance that the PRB Divestiture will close on time or at all. During 2016, and continuing through 2017, we made several proved and unproved property acquisitions and acreage trades in the Midland Basin, while divesting non-core assets in other areas. By actively managing our asset portfolio in this way, we are seeking to concentrate our investments in areas with the highest economic returns and provide value through accelerated development activity. +2017 Financial and Operational Highlights +• +We recorded a net loss of $160.8 million , or $1.44 per diluted share, for the year ended December 31, 2017 . This compares with a net loss of $757.7 million , or $9.90 per diluted share, for the year ended December 31, 2016 . Please refer to Comparison of Financial Results and Trends Between 2017 and 2016 and Between 2016 and 2015 below for additional discussion regarding the components of net loss for each period presented. +• +At year end 2017 , our estimated proved reserves totaled 468.1 MMBOE, of which 54 percent were liquids (oil and NGLs) and 46 percent were characterized as proved developed. During 2017 , we added 175.0 MMBOE through our drilling program and acquired 1.3 MMBOE. We had positive revisions totaling 16.6 MMBOE, consisting of 23.1 MMBOE of price revisions due to increased commodity prices in 2017 and 7.4 MMBOE of positive performance revisions, offset by 13.9 MMBOE of proved undeveloped reserves removed due to the five year rule. Further, we divested of 76.0 MMBOE of proved reserves in 2017 , which primarily related to our outside-operated Eagle Ford shale assets. Our proved reserve life index increased significantly to 10.5 years in 2017 compared to 7.2 years in 2016 . Please refer to Reserves in Part I, Items 1 and 2 of this report for additional discussion. +• +The standardized measure of discounted future net cash flows was $3.0 billion as of December 31, 2017 , compared with $1.2 billion as of December 31, 2016 , which was an increase of 162 percent year-over-year. Please refer to Supplemental Oil and Gas Information in Part II, Item 8 of this report for additional discussion. +• +We had net cash provided by operating activities of $515.4 million for the year ended December 31, 2017 , compared with $552.8 million for the year ended December 31, 2016 , which was a decrease of seven percent year-over-year. Please refer to Analysis of Cash Flow Changes Between 2017 and 2016 and Between 2016 and 2015 below for additional discussion. +• +Adjusted EBITDAX, a non-GAAP financial measure, for the year ended December 31, 2017 , was $664.7 million , compared with $790.8 million for the same period in 2016 . Please refer to Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and a reconciliation of our net loss and net cash provided by operating activities to adjusted EBITDAX. +49 +Operational Activities +During 2017 , we focused on demonstrating the significant value potential of our Midland Basin position and cored-up this position to maximize long-term growth. Please refer to the table below that summarizes our operated drilling and completion activities for the year ended December 31, 2017 . +In our Midland Basin program, we began 2017 operating four drilling rigs and one completion crew and added four drilling rigs and three completion crews throughout the year. Our operations during 2017 were focused on delineating and developing our RockStar acreage in Howard and Martin Counties, Texas, and developing our Sweetie Peck acreage position in Upton and Midland Counties, Texas. In both areas, we were targeting the Lower Spraberry and Wolfcamp A and B intervals. We completed 72 gross ( 70 net) operated wells during 2017 and increased production year-over-year by 192 percent to 11.0 MMBOE. Approximately 80 percent of our total 2017 capital was dedicated to coring up and developing our Midland Basin position. +In our operated Eagle Ford shale program, we added one operated drilling rig and one completion crew early in the first quarter of 2017 . We added a second operated drilling rig in the third quarter. We completed 38 gross ( 35 net) wells on our operated acreage during 2017. Total operated and outside-operated Eagle Ford shale production was 29.3 MMBOE for 2017, a 28 percent decrease from 2016. The decrease in production from our Eagle Ford program was primarily driven by the sale of our outside-operated assets in the first quarter of 2017 and reduced capital investment on our operated acreage. Our focus in 2017 was on drilling and completion optimization and satisfying certain lease obligations. Approximately 16 percent of our 2017 capital program was dedicated to our Eagle Ford shale program. +During the third quarter of 2017, we entered into a joint venture agreement with a third-party to drill 16 wells and complete 23 wells in a focused portion of our Eagle Ford North area. This joint venture allows us to leverage third-party capital to prove up the value of our Eagle Ford North area, while also allowing us to test cutting edge technology, capture additional technical data, satisfy certain lease obligations, and potentially expand our economic drilling inventory and acreage value. In 2017, this joint venture resulted in the completion of seven gross wells, in which our working interest was reduced in accordance with the terms of the joint venture agreement, and the drilling of four gross wells. We expect the remaining wells associated with the joint venture to be drilled and completed in 2018. +In our Powder River Basin program, we operated one drilling rig and one completion crew during 2017 . All development activity in 2017 was performed under an acquisition and development funding agreement with a third-party, pursuant to which the third-party carried all of our drilling and completion costs for the year. Strong well results and successful delineation efforts were key to our recent announcement of the agreement to sell these assets for a gross purchase price of $500.0 million , subject to customary closing price adjustments. We expect the sale of these assets to close in the first quarter of 2018, but there can be no assurance it will close on time or at all. +2017 activity in our Bakken/Three Forks program in Divide County, North Dakota, was limited to the completion of two wells that had been previously drilled. We expected to divest of these properties at the beginning of 2017 but offers submitted in the sales process did not reach our expectations. As a result, we elected in the second quarter of 2017 to retain these assets and leverage the cash flows they generate to fund other projects in our Midland Basin and Eagle Ford shale programs. +The table below provides a summary of changes in our drilled but not completed well count and current year drilling and completion activity in our operated programs during the year ended December 31, 2017 . +Midland Basin +Eagle Ford Shale +Bakken/Three Forks +Total +Gross +Net +Gross +Net +Gross +Net +Gross +Net +Wells drilled but not completed at December 31, 2016 +17 +17 +47 +47 +20 +17 +84 +81 +Wells drilled +104 +94 +27 +24 +— +— +131 +118 +Wells completed +(72 +) +(70 +) +(38 +) +(35 +) +(2 +) +(2 +) +(112 +) +(107 +) +Other (1) +— +— +(3 +) +(6 +) +— +— +(3 +) +(6 +) +Wells drilled but not completed at December 31, 2017 +49 +41 +33 +30 +18 +15 +100 +86 +_________________________________________ +(1) +Reflects net working interest changes resulting from the Eagle Ford North joint venture agreement discussed above, as well as three previously drilled wells that we no longer intend to complete. +50 +Production Results +The table below provides a regional breakdown of our production for the year ended December 31, 2017 : +Permian +South Texas & Gulf Coast +Rocky +Mountain +Total (1) +Production: +Oil (MMBbl) +8.5 +2.0 +3.2 +13.7 +Gas (Bcf) +14.7 +104.2 +4.1 +123.0 +NGLs (MMBbl) +— +10.1 +0.2 +10.3 +Equivalent (MMBOE) (1) +11.0 +29.5 +4.1 +44.5 +Avg. Daily Equivalents (MBOE/d) +30.0 +80.7 +11.1 +121.8 +Relative percentage +25 +% +66 +% +9 +% +100 +% +____________________________________________ +(1) +Amounts may not calculate due to rounding. +Production on an equivalent basis decreased by 20 percent for the year ended December 31, 2017 , compared with the same period in 2016 . Production declines were primarily a result of property divestitures, which occurred in the last half of 2016 and the first quarter of 2017, specifically our Raven/Bear Den and outside-operated Eagle Ford shale asset divestitures. These declines were partially offset by increased production in our Permian region. When excluding production from all assets sold in 2016 and 2017, production from retained and acquired assets increased approximately eight percent for the year ended December 31, 2017 , compared with the same period in 2016 , driven primarily by the ramp up in our Midland Basin development program. Please refer to Comparison of Financial Results and Trends Between 2017 and 2016 and Between 2016 and 2015 and A Year-to-Year Overview of Selected Production and Financial Information, Including Trends below for additional discussion on production. +Costs Incurred in Oil and Gas Producing Activities +Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended +December 31, 2017 +(in millions) +Development costs +$ +675.5 +Exploration costs +271.5 +Acquisitions +Proved properties +1.6 +Unproved properties +91.4 +Total, including asset retirement obligations (1) +$ +1,040.0 +____________________________________________ +(1) +Please refer to Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information in Part II, Item 8 of this report. +The majority of our development costs were incurred in our Midland Basin and operated Eagle Ford shale programs for the year ended December 31, 2017 . Exploration costs were primarily incurred in our Midland Basin program as we focused on delineating and optimizing the development of our undeveloped acreage in Howard and Martin Counties, Texas. Please refer to Operational Activities above for additional information on our regional activities. +Acquisition Activity +• +We acquired approximately 3,600 net acres of primarily unproved properties in Howard and Martin Counties, Texas, in multiple transactions for a total of $76.5 million of cash consideration. We also completed several non-monetary acreage trades in Howard and Martin Counties, Texas, that are excluded from the costs incurred table presented above. +51 +• +During 2017, we finalized the 2016 acquisitions of Midland Basin properties from Rock Oil Holdings, LLC and from QStar LLC and RRP-QStar, LLC by paying additional cash consideration of $7.7 million and $7.3 million , respectively. +Divestiture Activity +• +On March 10, 2017 , we divested our outside-operated Eagle Ford shale assets, including our ownership interest in related midstream assets, for net divestiture proceeds of $744.1 million and a final net gain of $396.8 million . +• +During 2017, we divested certain non-core properties in our Rocky Mountain and Permian regions for net divestiture proceeds of $36.2 million . +• +During the second quarter of 2017, we made the decision to retain our Divide County, North Dakota assets previously held for sale, as offers submitted in the sales process did not reach our expectations. During the year ended December 31, 2017 , we recorded a $526.5 million write-down on these assets. +• +As of December 31, 2017, the majority of our Powder River Basin assets were classified as held for sale. Subsequent to year end, we executed a definitive sales agreement related to these assets for a gross purchase price of $500.0 million , subject to customary closing price adjustments. We expect the sale of these assets to close in the first quarter of 2018, but there can be no assurance it will close on time or at all. +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. We sell the majority of our gas under contracts using first-of-the-month index pricing, which means gas produced in a given month is sold at the first-of-the-month price regardless of the spot price on the day the gas is produced. For assets where high Btu gas is sold at the wellhead, we also receive additional value for the higher energy content contained in the gas stream. Our NGL production is generally sold using contracts paying us a monthly average of the posted OPIS daily settlement prices, adjusted for processing, transportation, and location differentials. Our oil is sold using the calendar month average of the NYMEX WTI daily contract settlement prices during the month of production, adjusted for quality, transportation, American Petroleum Institute (“API”) gravity, and location differentials. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effects of derivative settlements, unless otherwise indicated. While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location, and transportation differentials for these products. +52 +The following table summarizes commodity price data, as well as the effects of derivative settlements, for the years ended December 31, 2017 , 2016 , and 2015 : +For the Years Ended December 31, +2017 +2016 +2015 +Oil (per Bbl): +Average NYMEX contract monthly price +$ +50.95 +$ +43.32 +$ +48.68 +Realized price, before the effect of derivative settlements +$ +47.88 +$ +36.85 +$ +41.49 +Effect of oil derivative settlements +$ +(2.28 +) +$ +14.63 +$ +18.85 +Gas: +Average NYMEX monthly settle price (per MMBtu) +$ +3.11 +$ +2.46 +$ +2.61 +Realized price, before the effect of derivative settlements (per Mcf) +$ +3.00 +$ +2.30 +$ +2.57 +Effect of gas derivative settlements (per Mcf) (1) +$ +0.72 +$ +0.64 +$ +0.71 +NGLs (per Bbl): +Average OPIS price (2) +$ +27.63 +$ +19.98 +$ +19.76 +Realized price, before the effect of derivative settlements +$ +22.35 +$ +16.16 +$ +15.92 +Effect of NGL derivative settlements +$ +(3.44 +) +$ +(0.60 +) +$ +1.69 +____________________________________________ +(1) +Gas derivative settlements for the year ended December 31, 2015 , included $15.3 million of early settlements of futures contracts as a result of divesting assets in our Mid-Continent region. These early settlements increased the effect of derivative settlements by $0.09 per Mcf for the year ended December 31, 2015 . +(2) +Average OPIS prices per barrel of NGL, historical or strip, are based on a product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline for all periods presented. This product mix represents the industry standard composite barrel and does not necessarily represent our product mix for NGL production. Realized prices reflect our actual product mix. +We expect future prices for oil, gas, and NGLs to continue to be volatile. In addition to supply and demand fundamentals, as a global commodity, the price of oil is affected by real or perceived geopolitical risks in various regions of the world as well as the relative strength of the United States dollar compared to other currencies. Oil markets have strengthened due to recent inventory drawdowns, but we expect oil prices to remain volatile due to uncertainty in global demand and easy access to new supply such as increases in oil production from United States shale. Oil prices began to increase at the end of 2017 as a result of the Organization of Petroleum Exporting Countries (“OPEC”) and several non-OPEC exporting countries agreeing to maintain previously agreed upon production cuts through 2018. +Gas pricing has improved over the last year, largely as a result of demand growth from gas fired power generation, gas exports to Mexico, and liquefied natural gas (“LNG”) exports. We expect prices to remain near current levels in the near term as drilling rigs in operation increased during 2017 and into 2018 leading to increased supply. We also expect prices to fluctuate with changes in demand resulting from the weather. +NGL prices have also improved over the last year due to oil and gas price recovery, increased exports of ethane and propane, and new processing plants. We expect NGL prices to continue to benefit from increased demand from export and petrochemical markets while being offset by increased drilling activity. +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs (same product mix as discussed under the table above) as of February 14, 2018 , and December 31, 2017 : +As of February 14, 2018 +As of December 31, 2017 +NYMEX WTI oil (per Bbl) +$ +58.72 +$ +59.62 +NYMEX Henry Hub gas (per MMBtu) +$ +2.77 +$ +2.83 +OPIS NGLs (per Bbl) +$ +27.30 +$ +30.82 +53 +We use financial derivative instruments as part of our financial risk management program. We have a financial risk management policy governing our use of derivatives. The amount of our production covered by derivatives is driven by the amount of debt on our balance sheet, the level of capital commitments and long-term obligations we have in place, and our ability to enter into favorable derivative commodity contracts. With our current derivative contracts, we believe we have partially reduced our exposure to volatility in commodity prices in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil prices while also setting a price floor for a portion of our oil production. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and to Commodity Price Risk in Overview of Liquidity and Capital Resources below for additional information regarding our oil, gas, and NGL derivatives. +Outlook for 2018 +Our priorities for 2018 , are to: +• +continue generating high margin returns from top tier projects that drive cash flow growth; +• +core up our portfolio (PRB Divestiture) to focus on assets that generate the highest returns; and +• +improve our credit metrics and maintain strong financial flexibility. +Our capital program for 2018 , excluding acquisitions, is expected to be approximately $1.27 billion. We expect our capital program to concentrate on developing our top tier assets in the Midland Basin and Eagle Ford shale. We expect to allocate the majority of our 2018 capital to our Midland Basin program, which generates the highest margins and returns in our portfolio. Planned drilling and completion activity in the Eagle Ford shale will be partially funded by a third-party as part of our previously announced joint venture agreement. By concentrating our capital on the highest return programs and operating at strong performance levels, we believe we will generate higher company-wide margins, cash flow growth, and value creation for our stockholders. +In our Midland Basin program, we entered 2018 operating eight drilling rigs and four completion crews and anticipate maintaining this level of activity on average throughout the remainder of the year. We plan to drill approximately 150 gross (130 net) wells and plan to complete approximately 125 gross (100 net) wells in 2018, the majority of which we will operate. In 2018, our focus will continue to be on delineating and developing the Lower Spraberry and Wolfcamp A and B shale intervals on our RockStar acreage in Howard and Martin Counties, Texas, and our Sweetie Peck acreage in Upton and Midland Counties, Texas. +In our operated Eagle Ford shale program, we entered 2018 operating two drilling rigs and one completion crew. We plan to run one to two operated drilling rigs and one to two completion crews throughout the remainder of 2018. We plan to drill approximately 33 gross (17 net) wells and plan to complete approximately 39 gross (25 net) wells in 2018. We expect our previously announced joint venture in a portion of our Eagle Ford North area will allow for an increase in our capital efficiency. This joint venture allows us to test new technologies and completion designs at varied well spacing on a portion of our acreage that does not currently generate substantial cash flows, potentially enhancing the asset’s value while reducing our required capital outlay for acreage holding. +We intend to run one operated drilling rig in our Powder River Basin program until we complete our PRB Divestiture. Our activity in the Powder River Basin through the closing of the divestiture is expected to be funded under an acquisition and development funding agreement with a third-party, in which the third-party is carrying our drilling and completion costs. After the completion of this divestiture, we do not intend to run a drilling rig or completion crew on our remaining Powder River Basin acreage. There can be no assurance that the PRB Divestiture will close on time or at all. +Please refer to Overview of Liquidity and Capital Resources below for additional discussion on how we expect to fund our 2018 capital program. +We expect our net income (loss) in our 2018 consolidated statement of operations to be significantly affected as a result of tax reform enacted during the fourth quarter of 2017. Please refer to Comparison of Financial Results and Trends Between December 31, 2017 and 2016 and Between 2016 and 2015 , Overview of Liquidity and Capital Resources , and Critical Accounting Policies and Estimates below, as well as Note 4 – Income Taxes in Part II, Item 8 of this report for further discussion. +54 +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the quarter ended December 31, 2017 , and the immediately preceding three quarters. A detailed discussion follows. +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2017 +2017 +2017 +2017 +(in millions) +Production (MMBOE) +10.4 +10.7 +11.3 +12.1 +Oil, gas, and NGL production revenue +$ +341.2 +$ +294.5 +$ +284.9 +$ +333.2 +Oil, gas, and NGL production expense +$ +122.8 +$ +122.7 +$ +124.4 +$ +138.0 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +131.4 +$ +134.6 +$ +153.2 +$ +137.8 +Exploration +$ +16.9 +$ +14.2 +$ +13.1 +$ +12.0 +General and administrative +$ +35.0 +$ +27.9 +$ +28.5 +$ +29.2 +Net income (loss) +$ +(26.3 +) +$ +(89.1 +) +$ +(119.9 +) +$ +74.4 +____________________________________________ +Note: Amounts may not calculate due to rounding. +Selected Performance Metrics +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2017 +2017 +2017 +2017 +Average net daily production equivalent (MBOE per day) +112.6 +116.0 +124.6 +134.4 +Lease operating expense (per BOE) +$ +5.10 +$ +4.81 +$ +4.11 +$ +3.82 +Transportation costs (per BOE) +$ +5.01 +$ +5.24 +$ +5.71 +$ +5.88 +Production taxes as a percent of oil, gas, and NGL production revenue +4.3 +% +4.2 +% +4.0 +% +4.2 +% +Ad valorem tax expense (per BOE) +$ +0.33 +$ +0.29 +$ +0.16 +$ +0.55 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) +$ +12.69 +$ +12.61 +$ +13.52 +$ +11.39 +General and administrative (per BOE) +$ +3.38 +$ +2.61 +$ +2.51 +$ +2.42 +____________________________________________ +Note: Amounts may not calculate due to rounding. +55 +A Year-to-Year Overview of Selected Production and Financial Information, Including Trends +For the Years Ended December 31, +Amount Change Between +Percent Change Between +2017 +2016 +2015 +2017/2016 +2016/2015 +2017/2016 +2016/2015 +Net production volumes (1) +Oil (MMBbl) +13.7 +16.6 +19.2 +(2.9 +) +(2.6 +) +(18 +)% +(14 +)% +Gas (Bcf) +123.0 +146.9 +173.6 +(23.9 +) +(26.7 +) +(16 +)% +(15 +)% +NGLs (MMBbl) +10.3 +14.2 +16.1 +(3.9 +) +(1.9 +) +(27 +)% +(12 +)% +Equivalent (MMBOE) +44.5 +55.3 +64.2 +(10.8 +) +(8.9 +) +(20 +)% +(14 +)% +Average net daily production (1) +Oil (MBbl per day) +37.4 +45.4 +52.7 +(7.9 +) +(7.3 +) +(17 +)% +(14 +)% +Gas (MMcf per day) +337.0 +401.5 +475.7 +(64.5 +) +(74.2 +) +(16 +)% +(16 +)% +NGLs (MBbl per day) +28.2 +38.8 +44.0 +(10.6 +) +(5.2 +) +(27 +)% +(12 +)% +Equivalent (MBOE per day) +121.8 +151.0 +175.9 +(29.2 +) +(24.9 +) +(19 +)% +(14 +)% +Oil, gas, and NGL production revenue (in millions) +Oil production revenue +$ +654.3 +$ +611.8 +$ +797.3 +$ +42.5 +$ +(185.5 +) +7 +% +(23 +)% +Gas production revenue +369.4 +337.3 +447.0 +32.1 +(109.7 +) +10 +% +(25 +)% +NGL production revenue +230.1 +229.3 +255.6 +0.8 +(26.3 +) +— +% +(10 +)% +Total +$ +1,253.8 +$ +1,178.4 +$ +1,499.9 +$ +75.4 +$ +(321.5 +) +6 +% +(21 +)% +Oil, gas, and NGL production expense (in millions) +Lease operating expense +$ +196.9 +$ +194.0 +$ +239.6 +$ +2.9 +$ +(45.6 +) +1 +% +(19 +)% +Transportation costs +243.6 +340.3 +386.6 +(96.7 +) +(46.3 +) +(28 +)% +(12 +)% +Production taxes +52.4 +51.9 +72.4 +0.5 +(20.5 +) +1 +% +(28 +)% +Ad valorem tax expense +15.0 +11.4 +25.0 +3.6 +(13.6 +) +32 +% +(54 +)% +Total +$ +507.9 +$ +597.6 +$ +723.6 +$ +(89.7 +) +$ +(126.0 +) +(15 +)% +(17 +)% +Realized price, before the effect of derivative settlements +Oil (per Bbl) +$ +47.88 +$ +36.85 +$ +41.49 +$ +11.03 +$ +(4.64 +) +30 +% +(11 +)% +Gas (per Mcf) +$ +3.00 +$ +2.30 +$ +2.57 +$ +0.70 +$ +(0.27 +) +30 +% +(11 +)% +NGLs (per Bbl) +$ +22.35 +$ +16.16 +$ +15.92 +$ +6.19 +$ +0.24 +38 +% +2 +% +Per BOE +$ +28.20 +$ +21.32 +$ +23.36 +$ +6.88 +$ +(2.04 +) +32 +% +(9 +)% +Per BOE data +Production expense: +Lease operating expense +$ +4.43 +$ +3.51 +$ +3.73 +$ +0.92 +$ +(0.22 +) +26 +% +(6 +)% +Transportation costs +$ +5.48 +$ +6.16 +$ +6.02 +$ +(0.68 +) +$ +0.14 +(11 +)% +2 +% +Production taxes +$ +1.18 +$ +0.94 +$ +1.13 +$ +0.24 +$ +(0.19 +) +26 +% +(17 +)% +Ad valorem tax expense +$ +0.34 +$ +0.21 +$ +0.39 +$ +0.13 +$ +(0.18 +) +62 +% +(46 +)% +General and administrative +$ +2.71 +$ +2.29 +$ +2.46 +$ +0.42 +$ +(0.17 +) +18 +% +(7 +)% +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +12.53 +$ +14.30 +$ +14.34 +$ +(1.77 +) +$ +(0.04 +) +(12 +)% +— +% +Derivative settlement gain (2) +$ +0.48 +$ +5.96 +$ +7.98 +$ +(5.48 +) +$ +(2.02 +) +(92 +)% +(25 +)% +Earnings per share information +Basic net loss per common share +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +$ +8.46 +$ +(3.29 +) +85 +% +(50 +)% +Diluted net loss per common share +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +$ +8.46 +$ +(3.29 +) +85 +% +(50 +)% +Basic weighted-average common shares outstanding (in thousands) +111,428 +76,568 +67,723 +34,860 +8,845 +46 +% +13 +% +Diluted weighted-average common shares outstanding (in thousands) +111,428 +76,568 +67,723 +34,860 +8,845 +46 +% +13 +% +56 +____________________________________________ +(1) +Amounts and percentage changes may not calculate due to rounding. +(2) +Gas derivative settlements for the year ended December 31, 2015 included $15.3 million of early settlements of futures contracts as a result of divesting assets in our Mid-Continent region. These early settlements increased the effect of derivative settlements by $0.24 per BOE for the year ended December 31, 2015. +We present per BOE information because we use this information to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis. Average net daily production for the year ended December 31, 2017 , decreased 19 percent compared with the same period in 2016 . This decrease is primarily due to property divestitures across our regions in the last half of 2016 and the first quarter of 2017, specifically the sale of our Raven/Bear Den and outside-operated Eagle Ford shale assets. When excluding production from all assets sold in 2016 and 2017, daily production from retained assets and assets acquired increased approximately eight percent , which is driven primarily by our ramp up in the Midland Basin. Overall, we anticipate 2018 total production to remain flat compared with 2017 , as we expect production increases in our Midland Basin program to be offset by the loss of production from our outside-operated Eagle Ford shale assets that we divested of in the first quarter of 2017 and lower activity levels in our operated Eagle Ford shale program. On a retained asset basis, we expect production to increase and the percentage of oil relative to our total product mix to also increase in 2018 compared with 2017. Please refer to Comparison of Financial Results and Trends Between 2017 and 2016 and Between 2016 and 2015 below for additional discussion. +Changes in production volumes, revenues, and costs are directly influenced by the volatility of commodity prices for the products we produce, fluctuations in costs necessary to develop and operate our properties, our ability to increase efficiencies in operations, and changes in our overall asset portfolio. Our realized price before the effects of derivative settlements on a per BOE basis for the year ended December 31, 2017 , increased 32 percent compared with the same period in 2016 . Commodity prices were at multi-year lows in early 2016, began to recover in the second half of 2016, and fluctuated throughout 2017. Overall, commodity prices for all products were higher in 2017 compared with the prior year. Our derivative contracts resulted in a $0.48 settlement gain on a per BOE basis for the year ended December 31, 2017 , which was a 92 percent decrease compared with 2016 settlements. Overall, there was a slight increase in our realized price after the effect of derivative settlements for the year ended December 31, 2017 , when compared with the same period in 2016 . +Lease operating expense (“LOE”) on a per BOE basis for the year ended December 31, 2017 , increased 26 percent compared with the same period in 2016 , primarily due to the sale of our outside-operated Eagle Ford shale assets in the first quarter of 2017, which had lower average lifting costs. We also experienced higher unanticipated LOE costs in our operated Eagle Ford shale program during the second half of 2017. For 2018 , we expect LOE on a per BOE basis to be higher compared with 2017 , as our product mix continues to shift toward more oil production, which typically has higher LOE per BOE. We expect to experience volatility in our LOE as a result of changes in industry activity and the effects this has on service provider costs, changes in total production, changes in our overall production mix, and timing of workover projects. +Transportation costs on a per BOE basis for the year ended December 31, 2017 , decreased 11 percent compared with the same period in 2016 . This decrease was primarily driven by the sale of our outside-operated Eagle Ford shale assets in the first quarter of 2017, which had higher average transportation costs. Going forward, we expect total transportation expense to fluctuate in line with changes in production from our operated Eagle Ford shale program as these assets incur the majority of our transportation costs. On a per BOE basis, we expect transportation costs to decrease in 2018 as production from our Midland Basin assets becomes a larger portion of our total production. The majority of our Midland Basin production is currently sold at the wellhead, and therefore, we incur minimal transportation expense on these assets. +Production taxes on a per BOE basis for the year ended December 31, 2017 , increased 26 percent compared with the same period in 2016 , due to a 32 percent increase in our realized price per BOE before the effect of derivative settlements, partially offset by a decrease in our production tax rate. Our production tax rate for the years ended December 31, 2017 , and 2016 was 4.2 percent and 4.4 percent , respectively. The decrease in our production tax rate is primarily a result of divesting our Raven/Bear Den and other Rocky Mountain assets, which were taxed at higher rates than our Texas assets. We generally expect production tax expense to trend with oil, gas, and NGL production revenue on an absolute and per BOE basis. If prices in 2018 remain consistent with strip pricing as of February 14, 2018 , as presented above within Oil, Gas, and NGL Prices , we would expect higher production tax expense in 2018 as compared with 2017 due to the expected increase in the percentage of oil in our overall production mix and higher realized prices. Product mix, the location of production, and incentives to encourage oil and gas development can all impact the amount of production tax we recognize. +Ad valorem tax expense on a per BOE basis for the year ended December 31, 2017 , increased 62 percent compared with the same period in 2016 , due to increased property tax valuations as a result of the increase in the overall value attributed +57 +to our reserve volumes during 2017. The majority of ad valorem tax expense is related to our Texas properties, which are the focus of our 2018 development plan. As a result, we expect an increase in ad valorem tax expense in 2018 as compared with 2017 on both an absolute and per BOE basis. +General and administrative (“G&A”) expense increased 18 percent on a per BOE basis for the year ended December 31, 2017 , compared with the same period in 2016 , due primarily to the decrease in production volumes as a result of recent divestitures. We expect G&A expense on an absolute basis to increase in 2018 compared with 2017 due to an anticipated increase in headcount. We expect G&A expense on a per BOE basis in 2018 to slightly increase compared with 2017 , as a result of increased G&A expense on an absolute basis. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (“DD&A”) expense on a per BOE basis decreased 12 percent for the year ended December 31, 2017 compared with the same period in 2016 , as a result of divested assets, specifically our higher cost Raven/Bear Den assets sold at the end of 2016, our outside-operated Eagle Ford shale assets that were held for sale prior to being sold in the first quarter of 2017, and our Divide County, North Dakota assets that were classified as held for sale during the first quarter and a portion of the second quarter in 2017. These assets were not depleted while classified as held for sale. Our DD&A rate fluctuates as a result of impairments, divestiture activity, changes in our production mix, and changes in our total proved reserve volumes. In general, we expect DD&A expense on a per BOE basis in 2018 to increase slightly compared with 2017 as a result of a higher percentage of our production coming from our Midland Basin assets, which has a higher depletion rate than our Eagle Ford shale and Divide County assets. Please refer to Comparison of Financial Results and Trends Between 2017 and 2016 and Between 2016 and 2015 for additional discussion. +Please refer to Earnings per Share in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion on the types of shares included in our basic and diluted net loss per common share calculations. Our basic and diluted weighted-average share count increased in 2017 compared with 2016 primarily due to the public and private equity offerings of our common stock made in the last half of 2016. We recorded a net loss for the years ended December 31, 2017 , 2016 , and 2015 . Consequently, all potentially dilutive shares were anti-dilutive and were excluded from the calculation of diluted net loss per common share. +Comparison of Financial Results and Trends Between 2017 and 2016 and Between 2016 and 2015 +Oil, gas, and NGL production, production revenue, and production expense +The following table presents the regional changes in our oil, gas, and NGL production, production revenue, and production expense between the years ended December 31, 2017 , and 2016 : +Average Net Daily Production Increase (Decrease) +Production Revenue Increase (Decrease) +Production Expense Increase (Decrease) +(MBOE/d) +(in millions) +(in millions) +Permian +19.8 +$ +347.3 +$ +76.5 +South Texas & Gulf Coast +(31.9 +) +(113.5 +) +(92.5 +) +Rocky Mountain +(17.1 +) +(158.4 +) +(73.7 +) +Total +(29.2 +) +$ +75.4 +$ +(89.7 +) +We experienced a 19 percent decrease in average net equivalent daily production in 2017 compared with 2016 primarily as a result of divestiture activity. The decrease in production was offset by a 32 percent increase in realized prices on a per BOE basis, resulting in an overall six percent increase in oil, gas, and NGL production revenue in 2017 compared with 2016 . Production expense decreased 15 percent in 2017 compared with 2016 , primarily due to the decrease in net equivalent production volumes, as discussed above. On a per BOE basis, production expense increased slightly in 2017 compared with 2016 primarily due to the sale of our non-operated Eagle Ford assets in the first quarter of 2017, which had lower average lifting costs per BOE than our retained assets. +58 +The following table presents the regional changes in our oil, gas, and NGL production, production revenues, and production expense between the years ended December 31, 2016 , and 2015 : +Average Net Daily Production Increase (Decrease) +Production Revenue Increase (Decrease) +Production Expense Decrease +(MBOE/d) +(in millions) +(in millions) +Permian +2.9 +$ +35.9 +$ +(0.6 +) +South Texas & Gulf Coast +(20.3 +) +(240.8 +) +(93.6 +) +Rocky Mountain +(2.9 +) +(90.7 +) +(19.6 +) +Mid-Continent (1) +(4.6 +) +(25.9 +) +(12.2 +) +Total +(24.9 +) +$ +(321.5 +) +$ +(126.0 +) +___________________________________________ +(1) +We divested our Mid-Continent assets in the second quarter of 2015. +We experienced a 14 percent decrease in average net equivalent daily production volumes in 2016 from 2015 primarily due to a reduction in our drilling and completion activity and assets divested in both years. Additionally, our realized price on a per BOE basis decreased nine percent in 2016 from 2015 . Both of these factors resulted in a 21 percent decrease in oil, gas, and NGL production revenue between the two periods. Total production expense for the year ended December 31, 2016 , decreased $126.0 million , or 17 percent , from the same period in 2015 due to a 14 percent decrease in net equivalent production volumes, continued declines in service provider costs, and a decrease in production taxes due to lower commodity prices. While our aggregate production decreased in 2016 as compared with 2015 , this decrease was partially offset by an increase in production in our Permian region due to increased development activity and acquisition activity within that region. On a per BOE basis, production expense decreased slightly in 2016 compared with 2015 primarily due to the decreases in service provider costs and production taxes as a result of low commodity prices and decreases in our production revenues. +Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for additional discussion of trends on a per BOE basis for the years ended December 31, 2017 , 2016 , and 2015 . +Net gain (loss) on divestiture activity +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Net gain (loss) on divestiture activity +$ +(131.0 +) +$ +37.1 +$ +43.0 +The net loss on divestiture activity recorded for the year ended December 31, 2017 was primarily the result of $526.5 million of total impairments taken on our previously held for sale assets in Divide County, North Dakota. These assets were subsequently reclassified back into held for use in the second quarter of 2017 upon our decision to retain the assets due to offers submitted in the sales process not reaching our expectations. These impairments were partially offset by a $396.8 million net gain on the sale of our outside-operated Eagle Ford shale assets during the first quarter of 2017. +The net gain on divestiture activity recorded for the year ended December 31, 2016 , was primarily a result of the approximate $29.5 million net gain recorded on our Raven/Bear Den assets sold in the fourth quarter of 2016, as well as a $6.3 million total net gain recorded on the non-core Williston Basin, Powder River Basin, and southeast New Mexico asset divestitures in the third quarter of 2016. +The net gain on divestiture activity recorded for the year ended December 31, 2015 , was due to the $108.4 million net gain recorded on the sale of our Mid-Continent assets in the second quarter, partially offset by losses on certain other non-core assets sold during 2015 . +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +59 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +557.0 +$ +790.7 +$ +921.0 +DD&A expense for the year ended December 31, 2017 , decreased 30 percent compared with the same period in 2016 due to a 20 percent decrease in production volumes and the impact of assets sold or classified as held for sale throughout 2017. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of DD&A expense on a per BOE basis. +DD&A expense for the year ended December 31, 2016 , decreased 14 percent compared with the same period in 2015 due to a decrease in production volumes and the impact of assets sold or classified as held for sale throughout 2016 . +Exploration +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Geological and geophysical expenses +$ +4.0 +$ +11.0 +$ +7.5 +Exploratory dry hole +2.4 +— +36.6 +Overhead and other expenses +49.8 +54.6 +76.5 +Total +$ +56.2 +$ +65.6 +$ +120.6 +Exploration expense for the year ended December 31, 2017 , decreased 14 percent compared with 2016 driven primarily by geological and geophysical expenses incurred for a seismic study performed on our Midland Basin acreage in the fourth quarter of 2016, which were not incurred in 2017. In 2018 , we expect to continue our focus on testing and delineating our Midland Basin acreage, and as a result, expect increased exploration activity and related expenses compared with 2017 . However, exploration expense may vary depending upon allocated overhead and exploratory dry hole expense. +Exploration expense for the year ended December 31, 2016 , decreased 46 percent compared with 2015 primarily due to $36.6 million of exploratory dry holes being expensed in 2015 compared to none being recorded in 2016 , as well as reduced overhead costs as a result of reduced exploration activity in 2016 . These decreases were partially offset by expenses incurred for a seismic study performed on our Midland Basin acreage in the fourth quarter of 2016. +Impairment of proved properties and Abandonment and impairment of unproved properties +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Impairment of proved properties +$ +3.8 +$ +354.6 +$ +468.7 +Abandonment and impairment of unproved properties +$ +12.3 +$ +80.4 +$ +78.6 +There was no material impairment of proved properties recognized for the year ended December 31, 2017 . Abandonment and impairment of unproved properties expense recorded during the year ended December 31, 2017 , related primarily to lease expirations. We expect proved property impairments to more likely occur in periods of declining or depressed commodity prices, and unproved property impairments to fluctuate with the timing of lease expirations, unsuccessful exploration activities, and changing economics associated with volatile commodity prices. Additionally, changes in drilling plans, downward engineering revisions, or unsuccessful exploration efforts may result in proved and unproved property impairments. Any amount of future impairment is difficult to predict, but based on updated commodity price assumptions as of +60 +February 14, 2018 , we do not expect any material impairments in the first quarter of 2018 due to commodity price impacts. Please refer to Critical Accounting Policies and Estimates below for additional discussion. +The majority of our proved property impairments during 2016 were recorded in the first quarter of 2016 in our outside-operated Eagle Ford shale program as a result of commodity price declines. In the fourth quarter of 2016, we recorded proved and unproved property impairment expense on our Powder River Basin assets as a result of negative performance reserve revisions at year end 2016 and lower market prices on third-party acreage transactions. Additionally, we allowed certain leases to expire throughout the year ended December 31, 2016 . +Proved and unproved property impairments recorded in 2015 were due to continued commodity price declines, largely impacting our Powder River Basin program and certain legacy and non-core assets, as well as our decision to reduce capital invested in the development of our east Texas exploration program in light of the sustained, low commodity price environment. +Impairment of other property and equipment +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Impairment of other property and equipment +$ +— +$ +— +$ +49.4 +We impaired our gas gathering system assets in our east Texas program during the year ended 2015, in conjunction with the impairment of the associated proved and unproved properties resulting from our decision not to allocate additional capital to the program in light of sustained low commodity prices. We did not record impairments of other property and equipment for the years ended December 31, 2017 , or 2016 . +General and administrative +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +General and administrative +$ +120.6 +$ +126.4 +$ +157.7 +G&A expense for the year ended December 31, 2017 , decreased five percent from 2016 primarily due to decreased compensation expense resulting from lower average headcount for the full year in 2017. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of G&A costs on a per BOE basis. +G&A expense decreased 20 percent in 2016 from 2015 primarily due to lower headcount and overhead costs during 2016 resulting from the closure of our Tulsa, Oklahoma regional office in the third quarter of 2015, a company-wide workforce reduction that occurred in the third quarter of 2016, and the closure of our Billings, Montana regional office in the fourth quarter of 2016. For the years ended December 31, 2016 and 2015 , $5.1 million and $9.3 million , respectively, of exit and disposal costs related to these events was included in G&A expense. +Net derivative (gain) loss +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Net derivative (gain) loss +$ +26.4 +$ +250.6 +$ +(408.8 +) +We recognized a net derivative loss of $26.4 million for the year ended December 31, 2017 . For contracts that settled during 2017 , the fair value was a net liability of $60.9 million at December 31, 2016 , and net cash settlements received totaled +61 +$21.2 million, resulting in an $82.1 million gain. Offsetting this gain was a $108.5 million mark-to-market loss on remaining contracts as of December 31, 2017 , resulting from an increase in commodity strip prices. +We recognized a net derivative loss of $250.6 million for the year ended December 31, 2016 . For contracts that settled during 2016 , the fair value was a net asset of $367.7 million at December 31, 2015 , and net cash settlements totaled $329.5 million, resulting in a $38.2 million loss. Additionally, we recorded a $212.4 million mark-to-market loss on remaining contracts as of December 31, 2016 , resulting from an increase in commodity strip prices. +We recognized a net derivative gain of $408.8 million for the year ended December 31, 2015 . For contracts that settled during 2015 , the fair value was a net asset of $402.7 million at December 31, 2014 , and net cash settlements totaled $512.6 million, resulting in a $109.9 million gain. Additionally, we recorded a $298.9 million mark-to-market gain on remaining contracts as of December 31, 2015 , resulting from a decrease in commodity strip prices. +Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Interest expense +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Interest expense +$ +(179.3 +) +$ +(158.7 +) +$ +(128.1 +) +The $20.6 million , or 13 percent , increase in interest expense for the year ended December 31, 2017 , compared with the same period in 2016 , was primarily driven by an increase in total debt outstanding for the full year 2017 due to additional debt issuances in the second half of 2016, as presented in Note 5 – Long-Term Debt in Part II, Item 8 of this report. +The $30.6 million , or 24 percent , increase in interest expense for the year ended December 31, 2016 , compared with the same period in 2015 , was due to the additional debt issuances in 2016, as presented in Note 5 – Long-Term Debt in Part II, Item 8 of this report, as well as $10.0 million paid to terminate a second lien credit facility that was not necessary to fund a portion of one of our Midland Basin acquisitions. +Please refer to Overview of Liquidity and Capital Resources below for additional discussion of weighted-average interest and borrowing rates for the years presented. +Gain (loss) on extinguishment of debt +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Gain (loss) on extinguishment of debt +$ +— +$ +15.7 +$ +(16.6 +) +For the year ended December 31, 2016 , we recorded a $15.7 million net gain on the early extinguishment of a portion of our Senior Notes (as defined and discussed in Note 5 – Long-Term Debt in Part II, Item 8 of this report), which includes approximately $16.4 million associated with the discount realized upon repurchase, slightly offset by approximately $700,000 related to the acceleration of unamortized deferred financing costs. +For the year ended December 31, 2015 , we recorded a $16.6 million loss on the early extinguishment of our 6.625% Senior Notes due 2019 (“2019 Notes”), which included approximately $12.5 million associated with the premium paid for the tender offer and redemption of the notes and approximately $4.1 million for the acceleration of unamortized deferred financing costs. +62 +Income tax benefit +For the Years Ended December 31, +2017 +2016 +2015 +(in millions, except tax rate) +Income tax benefit +$ +183.0 +$ +444.2 +$ +275.2 +Effective tax rate +53.2 +% +37.0 +% +38.1 +% +The increase in the effective tax rate in 2017 compared with 2016 is primarily due to enactment into law on December 22, 2017 of H.R.1, formally the Tax Cuts and Jobs Act (the “2017 Tax Act”). This law decreased the highest marginal corporate tax rate from 35 percent to 21 percent and resulted in an 18.5 percentage point nonrecurring adjustment affecting our effective tax rate, recorded in the fourth quarter of 2017 . This increase was partially offset by a discrete expense recorded in the third quarter of 2017 relating to an excess tax deficiency from the settlement of employee share-based payment awards. The tax benefit also reflects state apportionment changes due to the sale of our outside-operated Eagle Ford shale assets and a net decrease in valuation allowances due to projected utilization of various state net operating losses. We are still planning to implement strategies to utilize deferred tax assets. In accordance with the 2017 Tax Act, our effective tax rate is expected to decrease significantly in 2018 and future years. +The decrease in the effective tax rate in 2016 compared with 2015 reflected the tax benefit of Oklahoma permanent tax benefits and claimed research and development credits recognized in 2015 . The effective tax benefit rate realized in 2016 primarily includes a positive effect from the divestiture of properties in high marginal rate states and acquisition of properties in a lower marginal rate state, as well as a positive effect from the release of certain valuation allowances on utilized tax assets. The tax gain recognized on the Raven/Bear Den divestiture, which closed in the fourth quarter of 2016 , is much larger than the estimated and recorded book gain. As a result, we were able to consider tax planning strategies which would allow for the utilization of net operating loss carryovers in certain states which we previously determined would expire before they could be used, as well as utilization of certain carryover federal tax deductions, limited based upon taxable income, which were also expected to expire. +Please refer to Overview of Liquidity and Capital Resources and Critical Accounting Policies and Estimates below as well as Note 4 – Income Taxes in in Part II, Item 8 of this report for further discussion. +63 +Overview of Liquidity and Capital Resources +Based on the current commodity price environment, we believe we have sufficient liquidity and capital resources to execute our business plan for the foreseeable future. We continue to manage the duration and level of our drilling and completion service commitments to maintain the flexibility to adjust our activity and capital expenditures in periods of prolonged weak commodity prices or to respond should commodity prices recover further. +Sources of Cash +We currently expect our 2018 capital program to be funded by cash flows from operations and proceeds from the divestiture of properties. As of December 31, 2017 , our cash balance totaled $313.9 million , which combined with our $924.8 million of available borrowing capacity under our Credit Agreement, resulted in $1.2 billion in liquidity. In addition, as a result of our previously announced PRB Divestiture, which is expected to close in the first quarter of 2018, we expect to have additional cash from the sale of these assets of $500.0 million , subject to customary closing price adjustments. There can be no assurance that the PRB Divestiture will close on time or at all. +Although we anticipate cash flows from operations and divestiture proceeds will be sufficient to fund our expected 2018 capital program, we may also elect to borrow under our Credit Agreement, raise funds through debt or equity financings, or raise funds from other sources. Further, we may enter into additional carrying cost funding and sharing arrangements with third-parties for particular exploration and/or development programs. See Credit Agreement below for discussion of the reduction in our borrowing base in early 2017. Our borrowing base could be further reduced as a result of lower commodity prices, divestitures of proved properties, or newly issued debt. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders could be diluted, and these newly-issued securities may have rights, preferences, or privileges senior to those of existing stockholders. Any future downgrades in our credit ratings could make it more difficult or expensive for us to borrow additional funds. All of our sources of liquidity can be affected by the general condition of the broader economy and by fluctuations in commodity prices, operating costs, and volumes produced, all of which affect us and our industry. +We have no control over the market prices for oil, gas, or NGLs, although we may be able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of derivative contracts as part of our commodity price risk management program. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional information about our oil, gas, and NGL derivative contracts currently in place and the timing of settlement of those contracts . +The enactment of the 2017 Tax Act reduced our highest marginal federal tax rate for 2018 and future years from 35 percent to 21 percent. It also eliminated the domestic production activities deduction for all taxpayers, the alternative minimum tax (“AMT”) for corporate taxpayers, and may impact our ability to deduct interest expense in future years. However, it did not impact current tax deductions for intangible drilling costs, percentage depletion, or amortization of geological and geophysical expenses, and it will allow us the option to expense 100 percent of our equipment acquisition costs in future years. In general, we believe the enactment of the 2017 Tax Act will have a positive impact on our future operating cash flows. +Credit Agreement +Our Credit Agreement provides for a maximum loan amount of $2.5 billion and has a maturity date of December 10, 2019 . On March 31, 2017, we entered into a Ninth Amendment to the Credit Agreement (the “Ninth Amendment”). Pursuant to the Ninth Amendment, and as part of the regular, semi-annual borrowing base redetermination process, the borrowing base and aggregate lender commitments under our Credit Agreement were reduced to $925 million . This expected decrease was primarily due to the sale of our outside-operated Eagle Ford shale assets in the first quarter of 2017 and the decrease in the value of our estimated proved reserves as of December 31, 2016. Additionally, as part of the Ninth Amendment, we are now able to enter into derivative contracts for an increased percentage of projected production volumes. The borrowing base redetermination process considers the value of both our (a) proved oil and gas properties reflected in our most recent reserve report, and (b) commodity derivative contracts, each as determined by our lender group. We expect an increase to our borrowing base and aggregate lender commitments during the next semi-annual redetermination scheduled for April 1, 2018 , as a result of the increase in our estimated proved reserves at December 31, 2017 . We had no outstanding balance under our Credit Agreement as of December 31, 2017 , or 2016 . No individual bank participating in our Credit Agreement represents more than 10 percent of the lender commitments under the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion as well as the presentation of the outstanding balance, total amount of letters of +64 +credit, and available borrowing capacity under our Credit Agreement as of February 14, 2018 , December 31, 2017 , and December 31, 2016 . +We must comply with certain financial and non-financial covenants under the Credit Agreement, including covenants limiting dividend payments and requiring us to maintain certain financial ratios, as defined by the Credit Agreement. Certain financial covenants under the Credit Agreement require, as of the last day of each fiscal quarter, our (a) ratio of senior secured debt to 12-month trailing adjusted EBITDAX to be not more than 2.75 to 1.0; (b) adjusted current ratio to be not less than 1.0 to 1.0; and (c) ratio of 12-month trailing adjusted EBITDAX to interest expense to be not less than 2.0 to 1.0. We were in compliance with all financial and non-financial covenants under the Credit Agreement as of December 31, 2017 , and through the filing of this report. Please refer to the caption Non-GAAP Financial Measures below for the calculation of adjusted EBITDAX and reconciliations of net loss and net cash provided by operating activities to adjusted EBITDAX. +We had minimal credit facility activity during 2017, due to our significant cash balance resulting from the divestiture of our Raven/Bear Den assets in December 2016 and proceeds received from the sale of our outside-operated Eagle Ford shale assets during the first quarter of 2017. Our daily weighted-average credit facility debt balance was approximately $13.1 million , $183.8 million , and $253.7 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. Cash flows provided by our operating activities, divestiture proceeds, capital markets activity, and the amount of our capital expenditures, including acquisitions, all impact the amount we borrow under our credit facility. +Weighted-Average Interest Rates +Our weighted-average interest rate includes paid and accrued interest, fees on the unused portion of the aggregate commitment amount under the Credit Agreement, letter of credit fees, the non-cash amortization of deferred financing costs, and the non-cash amortization of the discount related to the Senior Convertible Notes. Our weighted-average borrowing rate includes paid and accrued interest only. +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2017 , 2016 , and 2015 . +For the Years Ended December 31, +2017 +2016 +2015 +Weighted-average interest rate +6.4 +% +6.2 +% +6.0 +% +Weighted-average borrowing rate +5.8 +% +5.7 +% +5.5 +% +Our weighted-average interest rates and weighted average borrowing rates for the years ended December 31, 2017 , 2016 , and 2015 , have been impacted by the timing of Senior Notes and Senior Convertible Notes issuances and redemptions, the average balance on our revolving credit facility under the Credit Agreement, and the fees paid on the unused portion of our aggregate commitment. The increase in our weighted-average interest rate and weighted-average borrowing rate for the year ended December 31, 2017 , as compared with 2016 and 2015 , is largely due to the issuance of the Senior Convertible Notes and the 2026 Notes in the third quarter of 2016. Further impacting these rates is the timing and amount of Senior Notes redemptions, changes in our aggregate lender commitment amount under our Credit Agreement, and the average balance on our credit facility under the Credit Agreement. The rates disclosed in the above table do not reflect amounts associated with the repurchase of Senior Notes, such as the discount realized or premium paid upon repurchase, or the acceleration of unamortized deferred financing costs expensed upon repurchase. The rates also do not reflect the $10.0 million fee paid to terminate an unused second lien facility in the third quarter of 2016 and the premium paid in 2015 for the tender offer and redemption of the 2019 Notes. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Uses of Cash +We use cash for the acquisition, exploration, and development of oil and gas properties and for the payment of operating and general and administrative costs, income taxes, dividends, and debt obligations, including interest. Expenditures for the acquisition, exploration, and development of oil and gas properties are the primary use of our capital resources. During 2017 , we spent $978.2 million on capital expenditures and on acquiring proved and unproved oil and gas properties. This amount differs from the costs incurred amount, which is accrual-based and includes asset retirement obligations, geological and geophysical expenses, and exploration overhead amounts. +65 +The amount and allocation of our future capital expenditures will depend upon a number of factors, including the number and size of acquisition opportunities, our cash flows from operating, investing, and financing activities, and our ability to assimilate acquisitions and execute our drilling program. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, and the timing and results of our exploration and development activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget to assess changes in current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. +We may from time to time repurchase certain amounts of our outstanding debt securities for cash and/or through exchanges for other securities. Such repurchases or exchanges may be made in open market transactions, privately negotiated transactions, or otherwise. Any such repurchases or exchanges will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. Repurchases or exchanges are reviewed as part of the allocation of our capital. During 2017 , we repurchased a portion of our Senior Notes in open market transactions at a slight premium, as discussed in more detail in Note 5 – Long-Term Debt in Part II, Item 8 of this report. As part of our strategy for 2018, we will focus on improving our debt metrics and potentially reducing outstanding debt. +As of the filing of this report, we could repurchase up to 3,072,184 shares of our common stock under our stock repurchase program, subject to the approval of our Board of Directors. Shares may be repurchased from time to time in the open market, or in privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes, the indenture governing our Senior Convertible Notes, compliance with securities laws, and the terms and provisions of our stock repurchase program. Our Board of Directors periodically reviews this program as part of the allocation of our capital. During 2017 , we did not repurchase any shares of our common stock, and we currently do not plan to repurchase any outstanding shares of our common stock during 2018 . +During 2017 , we paid $11.1 million in dividends to our stockholders, reflecting a dividend of $0.10 per share. Our current intention is to continue to make dividend payments for the foreseeable future, subject to our future earnings, our financial condition, Credit Agreement, indentures governing our Senior Convertible Notes and Senior Notes, other covenants, and other factors which could arise. The payment and amount of future dividends remains at the discretion of our Board of Directors. +Analysis of Cash Flow Changes Between 2017 and 2016 and Between 2016 and 2015 +The following tables present changes in cash flows between the years ended December 31, 2017 , 2016 , and 2015 , for our operating, investing, and financing activities. Certain prior period amounts have been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 for additional discussion of the change in presentation on the accompanying consolidated statements of cash flows (“accompanying statements of cash flows”) as a result of adopting new accounting standards. The analysis following each table should be read in conjunction with our accompanying statements of cash flows in Part II, Item 8 of this report. +Operating Activities +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2017 +2016 +2015 +2017/2016 +2016/2015 +2017/2016 +2016/2015 +(as adjusted) +Net cash provided by operating activities (in millions) +$ +515.4 +$ +552.8 +$ +990.8 +$ +(37.4 +) +$ +(438.0 +) +(7 +)% +(44 +)% +Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, decreased $91.6 million , or eight percent , to $1.0 billion for the year ended December 31, 2017 , compared with the same period in 2016 , as a result of a 20 percent decline in production volumes partially offset by an increase in our realized price after the effect of derivative settlements. Interest paid increased $34.3 million for the year ended December 31, 2017 , compared with the same period in 2016 , due to the issuance of our 2026 Notes and Senior Convertible Notes in the third quarter of 2016. Cash paid for LOE and ad valorem taxes in 2017 decreased $19.7 million , or nine percent , +66 +to $199.1 million compared with the same period in 2016 , as a result of a 20 percent decline in production volumes partially offset by an increase in production costs on a per BOE basis, specifically LOE, production taxes, and ad valorem taxes. Cash paid for G&A expense decreased $13.8 million , or 12 percent , to $98.6 million in 2017 compared with the same period in 2016, primarily as a result of the decrease in average headcount for 2017. Further, net cash provided by operating activities is affected by working capital changes and the timing of cash receipts and disbursements. During 2016, we paid $10.0 million to terminate a second lien facility that was not needed to fund the Rock Oil Acquisition. +Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, decreased $588.0 million , or 35 percent , to $1.1 billion for the year ended December 31, 2016 , compared with the same period in 2015 . This decrease was primarily a result of the decline in production volumes, realized commodity prices, and derivative cash settlements. Cash paid for LOE in 2016 decreased $52.6 million , or 21 percent , to $199.9 million compared with the same period in 2015 , due primarily to a 14 percent decrease in production volumes and a reduction in service provider costs. During 2016, we paid $10.0 million to terminate a second lien facility that was not needed to fund the Rock Oil Acquisition. The remaining change was related to decreases in cash G&A expense, exploration overhead, and ad valorem taxes, as well as changes in working capital balances. +In 2017, we adjusted certain prior period amounts to conform to the current period presentation on the consolidated financial statements. As a result, we reclassified $12.5 million associated with the premium for the tender offer and redemption of the 2019 Notes from operating activities to financing activities, resulting in an increase in net cash provided by operating activities in 2015. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 for additional discussion of the change in presentation on the accompanying statements of cash flows as a result of adopting new accounting standards. +Investing Activities +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2017 +2016 +2015 +2017/2016 +2016/2015 +2017/2016 +2016/2015 +(as adjusted) +Net cash used in investing activities (in millions) +$ +(201.5 +) +$ +(1,867.6 +) +$ +(1,144.6 +) +$ +1,666.1 +$ +(723.0 +) +(89 +)% +63 +% +Net cash used in investing activities decreased for the year ended December 31, 2017 , compared with the same period in 2016 . During 2017, cash paid to acquire proved and unproved properties in the Midland Basin totaled $89.9 million compared with $2.2 billion paid in 2016 . Net proceeds from the sale of oil and gas properties decreased $169.3 million for the year ended December 31, 2017 , compared with the same period in 2016 . During 2017 , net proceeds were primarily from the sale of our outside-operated Eagle Ford shale assets, and during 2016, net proceeds were primarily related to the divestitures of our Raven/Bear Den assets and certain other non-core Permian and Rocky Mountain assets. Capital expenditures in 2017 increased $258.4 million , or 41 percent , compared with 2016 as a result of increased drilling and completion activities and slightly higher service provider costs. +Net cash used in investing activities increased for the year ended December 31, 2016 , compared with the same period in 2015 . During 2016 , cash paid to acquire proved and unproved properties in the Midland Basin totaled $2.2 billion , whereas we had no significant acquisition activity in 2015. Net proceeds from the sale of oil and gas properties increased $588.1 million for the year ended December 31, 2016 , compared with the same period in 2015 , due to proceeds from the divestitures of our Raven/Bear Den and other none-core Permian and Rocky Mountain assets in 2016 exceeding proceeds from the sale of our Mid-Continent assets in 2015. Capital expenditures in 2016 decreased $863.7 million , or 58 percent , compared with 2015 as a result of reduced drilling and completion activities and lower service provider costs, as well as a significant amount of accrued 2014 drilling and completion payables paid in early 2015. +In 2017, we adjusted certain prior period amounts to conform to the current period presentation on the consolidated financial statements. As a result, we reclassified $3.0 million of restricted cash out of investing activities and combined it with cash and cash equivalents when reconciling the beginning and end of period balances on the accompanying statements of cash flows, resulting in a decrease in net cash used in investing activities in 2016. Please refer to Recently Issued Accounting +67 +Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 for additional discussion of the change in presentation on the accompanying statements of cash flows as a result of adopting new accounting standards. +Financing Activities +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2017 +2016 +2015 +2017/2016 +2016/2015 +2017/2016 +2016/2015 +(as adjusted) +Net cash provided by (used in) financing activities (in millions) +$ +(12.3 +) +$ +1,327.2 +$ +153.7 +$ +(1,339.5 +) +$ +1,173.5 +(101 +)% +764 +% +We had a zero balance on our credit facility as of December 31, 2017 and 2016 , due to our cash balance resulting from the proceeds received from the sale of our Raven/Bear Den assets in December 2016 and proceeds received from the sale of our outside-operated Eagle Ford shale assets during 2017. Consequently, net credit facility repayments were zero in 2017. This compares to net repayments of $202.0 million during the year ended December 31, 2016 . During 2016 , we received $934.1 million of net proceeds from two public equity offerings, $491.6 million of net proceeds from our 2026 Notes issuance, and $166.6 million of net proceeds from our Senior Convertible Notes issuance. These proceeds were used to partially fund the Rock Oil Acquisition and QStar Acquisition, as well as pay down our credit facility balance. Additionally, in 2016, we paid $24.2 million for capped call transactions related to our Senior Convertible Notes and paid $29.9 million for the repurchase of $46.3 million in aggregate principal amount of a portion of our Senior Notes. During 2015, we received $491.0 million of net proceeds from the issuance of our 2025 Notes, which were used for the tender and redemption of the $350.0 million principal amount of our 2019 Notes. Please refer to Note 5 – Long-Term Debt and Note 13 – Equity in Part II, Item 8 of this report for additional discussion. +In 2017, we adjusted certain prior period amounts to conform to the current period presentation on the consolidated financial statements. As a result, we reclassified $12.5 million associated with the premium for the tender offer and redemption of the 2019 Notes from operating activities to financing activities, resulting in a decrease in net cash provided by financing activities in 2015. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 for additional discussion of the change in presentation on the accompanying statements of cash flows as a result of adopting new accounting standards. +Interest Rate Risk +We are exposed to market risk due to the floating interest rate associated with any outstanding balance on our revolving credit facility. As of December 31, 2017 , and through the filing of this report, we had a zero balance on our credit facility. Our Credit Agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the credit facility’s fair market value, but will not impact results of operations or cash flows. Conversely, for the portion of the credit facility that has a floating interest rate, interest rate changes will not affect the fair market value, but will impact future results of operations and cash flows. Changes in interest rates do not impact the amount of interest we pay on our fixed-rate Senior Notes or fixed-rate Senior Convertible Notes, but can impact their fair market values. As of December 31, 2017 , our outstanding fixed-rate debt totaled $3.0 billion . Please refer to Note 11 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion on the fair values of our Senior Notes and Senior Convertible Notes. +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly impact our revenue, overall profitability, access to capital, and future rate of growth. Oil, gas, and NGL prices are subject to wide fluctuations in response to changes in supply and demand and other factors. The markets for oil, gas, and NGLs have been volatile, especially over the last several years, and these markets will likely continue to be volatile in the future. The prices we receive for our production depend on numerous factors beyond our control. Based on our 2017 production, a 10 percent decrease in our average realized oil, gas, and NGL prices before the effects of derivative settlements would have reduced our oil, gas, and NGL production revenues by approximately $65.4 million , $36.9 million , and $23.0 million , respectively. If commodity prices had been 10 percent lower, our derivative settlements would have been higher, partially offsetting the decrease in production revenues quantified above. +68 +We enter into commodity derivative contracts in order to reduce the impact of fluctuations in commodity prices. The fair value of our commodity derivative contracts are largely determined by estimates of the forward curves of the relevant price indices. At December 31, 2017 , a 10 percent increase or decrease in the forward curves associated with our oil, gas, and NGL commodity derivative instruments would have changed our net liability positions by approximately $99.2 million , $24.6 million , and $31.7 million , respectively. +Schedule of Contractual Obligations +The following table summarizes our contractual obligations at December 31, 2017 , for the periods specified (in millions): +Contractual Obligations +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Long-term debt (1) +$ +2,973.9 +$ +— +$ +— +$ +1,078.9 +$ +1,895.0 +Interest payments (2) +1,050.8 +174.7 +346.5 +310.5 +219.1 +Delivery commitments (3) +463.4 +59.6 +197.4 +155.5 +50.9 +Operating leases and contracts (3) +111.3 +54.2 +26.6 +19.2 +11.3 +Asset retirement obligations (4) +139.1 +6.3 +28.4 +5.9 +98.5 +Derivative liabilities (5) +245.6 +173.3 +72.3 +— +— +Other (6) +41.4 +4.0 +16.3 +21.1 +— +Total +$ +5,025.5 +$ +472.1 +$ +687.5 +$ +1,591.1 +$ +2,274.8 +____________________________________________ +(1) +Long-term debt consists of our Senior Notes and Senior Convertible Notes, and assumes no principal repayment until the due dates of the instruments. The actual payments may vary significantly. As of December 31, 2017 , we had a zero balance on our revolving credit facility. +(2) +Interest payments on our Senior Notes and Senior Convertible Notes are estimated assuming no principal repayment until the due dates of the instruments. As our credit facility balance was zero at December 31, 2017 , the above table reflects only the fee that would be paid on the unused credit facility’s aggregate lender commitment amount through the maturity date of the Credit Agreement. +(3) +Please refer to Note 6 – Commitments and Contingencies in Part II, Item 8 of this report for additional discussion regarding our operating leases, contracts and gathering, processing, transportation throughput, and delivery commitments. The amount relating to our gathering, processing, transportation throughput, and delivery commitments reflects the aggregate undiscounted deficiency payments assuming we delivered no product. +(4) +Amounts shown represent estimated future undiscounted plugging and abandonment costs. The discounted obligations are recorded as liabilities on our accompanying consolidated balance sheets (“accompanying balance sheets”) as of December 31, 2017 . The timing and amount of the ultimate settlement of these obligations is unknown and can be impacted by economic factors, a change in development plans, and federal and state regulations. Obligations related to inactive wells or wells that are not economic at current commodity price levels as of December 31, 2017 , are shown as an obligation in 1-3 years due to the substantial uncertainty on the timing of plugging or re-entering these wells. Please refer to Note 9 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +(5) +Amounts shown represent only the liability portion of the marked-to-market value of our commodity derivatives based on future market prices as of December 31, 2017 , and exclude estimated oil, gas, and NGL commodity derivative receipts. This amount varies from the liability amounts presented on the accompanying balance sheets, as those amounts are presented at fair value, which considers time value, volatility, and the risk of non-performance for us and for our counterparties. The ultimate settlement amounts under our derivative contracts are unknown, as they are subject to continuing market risk and commodity price volatility. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +(6) +The majority of this amount is related to the unfunded portion of our estimated pension liability of $41.0 million , for which we have estimated the timing of future payments based on historical annual contribution amounts. +69 +Off-Balance Sheet Arrangements +As part of our ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +We evaluate our transactions to determine if any variable interest entities exist. If it is determined that we are the primary beneficiary of a variable interest entity, that entity is consolidated into our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions in 2017 or 2016 . +Critical Accounting Policies and Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our consolidated financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate due to changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Successful Efforts Method of Accounting . GAAP provides for two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method. Both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report. +Oil and Gas Reserve Quantities . Our estimated proved reserve quantities and future net cash flows are critical to understanding the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our consolidated financial statements, including the calculations of depletion and impairment of proved and unproved oil and gas properties. Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure of discounted future net cash flows calculation requires that a 10 percent discount rate be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir-evaluation consulting firm, to audit at least 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year end. It should not be assumed that the standardized measure of discounted future net cash flows (GAAP) or PV-10 (non-GAAP) as of December 31, 2017 , is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based these measures on a 12-month average of the first-day-of-the-month prices for the year ended December 31, 2017 . Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimates. Please refer to Risk Factors in Part I, Item 1A of this report. +If the estimates of proved reserves decline, the rate at which we record depletion expense will increase, reducing future earnings. Such a decline may result from lower commodity prices, which may make it uneconomical to drill for or produce higher cost fields. In addition, a decline in proved reserve estimates may impact the outcome of our assessment of proved and unproved properties for impairment. Changes in depletion or impairment calculations caused by changes in reserve quantities or net cash flows are recorded in the period the reserve estimates change. +70 +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2017 +2016 +2015 +MMBOE +MMBOE +MMBOE +Change +Change +Change +Revisions resulting from performance +7.4 +(18.1 +) +47.3 +Removal of proved undeveloped reserves no longer in our five-year development plan +(13.9 +) +(43.0 +) +(79.4 +) +Revisions resulting from price changes +23.1 +(35.1 +) +(116.5 +) +Total +16.6 +(96.2 +) +(148.6 +) +As previously noted, commodity prices are volatile and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. +We cannot reasonably predict future commodity prices, although we believe that together, the below analyses provide reasonable information regarding the impact of changes in pricing and trends on total estimated proved reserves. The following table reflects the estimated MMBOE change and percentage change to our total reported estimated proved reserve volumes from the described hypothetical changes: +For the year ended December 31, 2017 +MMBOE +Percentage +Change +Change +10 percent decrease in SEC pricing (1) +(17.3 +) +(4 +)% +Average NYMEX strip pricing as of fiscal year end (2) +NM +NM +10 percent decrease in proved undeveloped reserves (3) +(25.3 +) +(5 +)% +___________________________________________ +(1) +The change solely reflects the impact of a 10 percent decrease in SEC pricing to the total reported estimated proved reserve volumes as of December 31, 2017 , and does not include additional impacts to our estimated proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. +(2) +The impact of replacing SEC pricing with average NYMEX strip pricing as of December 31, 2017 , did not result in a meaningful change to our total reported proved reserve volumes as SEC pricing of $51.34 per Bbl for oil, $3.00 per MMBtu for gas, and $27.69 per Bbl for NGLs as of December 31, 2017 , was not materially different than five year average NYMEX strip pricing of $54.71 per Bbl for oil, $2.84 per MMBtu for gas, and $29.22 per Bbl for NGLs as of December 31, 2017 . +(3) +The change solely reflects a 10 percent decrease in proved undeveloped reserves as of December 31, 2017 , and does not include any additional impacts to our estimated proved reserves. +Additional reserve information can be found in the Reserves section in Part I, Items 1 and 2 of this report, and in Supplemental Oil and Gas Information in Part II, Item 8 of this report. +Impairment of Oil and Gas Properties . Proved properties are evaluated periodically for impairment on a pool-by-pool basis and when events or changes in circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected future cash flows of our oil and gas properties and compare these undiscounted cash flows to the carrying amount to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the oil and gas properties to fair value (or discounted future cash flows). Management estimates future cash flows from all proved reserves and risk adjusted probable and possible reserves using various factors, which are subject to our judgment and expertise, and include, but are not limited to, commodity price forecasts, estimated future operating and capital costs, development plans, and discount rates to incorporate the risk and current market conditions associated with realizing the expected cash flows. +71 +Unproved oil and gas properties are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by prospect and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and our intent to renew leases. We estimate the fair value of unproved properties, using a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by us or other market participants. +Proved and unproved oil and gas properties are classified as held for sale when we commit to a plan to sell the assets and there is reasonable certainty the sale will take place within one year. Upon classification as held for sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to identify and expense any excess of carrying value over fair value less costs to sell. +We cannot predict when or if future impairment charges will be recorded because of the uncertainty in the factors discussed above. Despite any amount of future impairment being difficult to predict, based on updated commodity price assumptions as of February 14, 2018 , we do not expect any material impairments in the first quarter of 2018 due to commodity price impacts. +Please refer to Note 1 – Summary of Significant Accounting Policies and Note 11 – Fair Value Measurements in Part II, Item 8 of this report for impairments of oil and gas properties and other property and equipment recorded for the years ended December 31, 2017 , 2016 , and 2015 . +Purchase Price Allocation . Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets and liabilities acquired based on their estimated fair value as of the acquisition date. Various assumptions are made when estimating fair values assigned to proved and unproved oil and gas properties including: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgment by management at the time of the valuation. +Asset Retirement Obligations . We are required to recognize an estimated liability for future costs associated with the abandonment of our oil and gas properties. We base our estimate of the liability on our historical experience in abandoning oil and gas wells and our current understanding of federal and state regulatory requirements. Our present value calculations require us to estimate the cost, the economic lives and timing of abandonment of our properties, future inflation rates, and the appropriate credit-adjusted risk-free discount rate to use. The impact to the accompanying consolidated statements of operations (“accompanying statements of operations”) from these estimates is reflected in our depletion, depreciation, and amortization calculations and occurs over the remaining life of our respective oil and gas properties. Please refer to Note 9 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +Revenue Recognition . Our revenue recognition policy is a critical accounting policy because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. We derive our revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized when our production is delivered to the purchaser, but payment is generally received between 30 and 90 days after the date of production. No revenue is recognized unless it is determined that title to the product has transferred to a purchaser. At the end of each month, we make estimates of the amount of production delivered to the purchaser and the price we will receive. We use our knowledge of our properties, contractual arrangements, their historical performance, NYMEX, local spot market, OPIS prices, and other factors as the basis for these estimates. Variances between our estimates and the actual amounts received are recorded in the month payment is received. A 10 percent change in our year end revenue accrual would have impacted total operating revenues by approximately $9.7 million in 2017 . +Effective January 1, 2018, our revenue recognition policy changed due to the adoption of new accounting guidance. Please refer to Note 1 – Summary of Significant Accounting Policies under the heading Recently Issued Accounting Standards in Part II, Item 8 of this report for additional discussion. +Derivative Financial Instruments . We periodically enter into commodity derivative contracts to manage our exposure to oil, gas, and NGL price volatility. We recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income (loss). The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our +72 +consolidated financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. +Income Taxes . We provide for deferred income taxes on the difference between the tax basis of an asset or liability and its carrying amount in our consolidated financial statements. This difference will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period, as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax benefit by approximately $3.4 million for the year ended December 31, 2017 . +Accounting Matters +Please refer to Recently Issued Accounting Standards under Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for information on new authoritative accounting guidance. +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes, and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +Hydraulic Fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, please refer to Risk Factors – Risks Related to Our Business – Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays . +Climate Change. In June 2013, President Obama announced a Climate Action Plan designed to further reduce greenhouse gas emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Climate Action Plan targeted methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. As part of the Climate Action Plan, on May 12, 2016, the EPA issued final regulations that amend and expand 2012 regulations for the oil and gas sector by setting emission limits for VOCs and methane, a greenhouse gas, or GHG, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of greenhouse gases in the form of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The final regulation requires, among other things, greenhouse gas and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of greenhouse gases and VOCs from well completions. Both the 2012 and 2016 rules are the subject of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia, although the litigation of both rules has been stayed. In June 2017, the EPA proposed a 2-year stay of the compliance requirements in the 2016 NSPS. The rule does not extend to existing sources and the Trump EPA has rescinded the Information Collection Request that was intended to gather information to develop existing source standards. On November 16, 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands, as part of President Obama’s Climate Action Plan. The regulations are intended to reduce the waste of gas from flaring, venting, and leaks by oil and gas production. The rule includes requirements that prohibits venting gas except in limited circumstances and limits flaring of gas and includes requirements for leak detection and repair. The rule also increases royalty payments for “waste” gas that is released in contravention of the rule requirements. A preliminary injunction sought by industry groups was denied in U.S. District Court and the regulation went into effect on January 17, 2017; however, on December 8, 2017, the BLM finalized a rule suspending or delaying many of the provisions of the regulation while it reviews the regulation. This suspension of the rule is being challenged in the courts. +73 +In August of 2015, the EPA finalized existing source performance standards as stringent state emission “goals” for utilities to reduce greenhouse gas emissions. The proposed standards focus on re-dispatching electricity from coal-fired units to gas combined cycle plants and renewables. In February 2016, however, the Supreme Court stayed these rules pending judicial review. The EPA has proposed a repeal of the rule and issued an advanced notice of proposed rulemaking asking for comments on a replacement rule. +The United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases and almost one-half of the states have already taken legal measures to reduce emissions of greenhouse gases primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. In addition, there have been international conventions and efforts to establish standards for the reduction of greenhouse gases globally, including the Paris accords in December 2015. The conditions for entry into force of the Paris accords were met on October 5, 2016 and the Agreement went into force 30 days later on November 4, 2016. However, in August 2017, the U.S. notified the United Nations Secretary-General that it intends to withdraw from the agreement as soon as it is able to do so, or November 2019. +The adoption of legislation or regulatory programs to reduce emissions of greenhouse gases could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and gas we produce. Consequently, legislation and regulatory programs to reduce emissions of greenhouse gases could have an adverse effect on our business, financial condition, and results of operations. Finally, scientists have concluded that increasing concentrations of greenhouse gases in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. If any such effects were to occur, they could have an adverse effect on our financial condition and results of operations. +In terms of opportunities, the regulation of greenhouse gas emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and gas that we produce, the relative demand for gas may increase because the burning of gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources, such as wind or solar power become more prevalent, gas-fired electric plants may provide an alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, gas may become a more attractive transportation fuel. Approximately 46 and 44 percent of our production on a BOE basis in 2017 and 2016 , respectively, was gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and gas reservoirs, could also benefit us through the potential to obtain greenhouse gas emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +74 +Non-GAAP Financial Measures +Adjusted EBITDAX represents net income (loss) before interest expense, interest income, income taxes, depletion, depreciation, amortization and asset retirement obligation liability accretion expense, exploration expense, property abandonment and impairment expense, non-cash stock-based compensation expense, derivative gains and losses net of settlements, gains and losses on divestitures, gains and losses on extinguishment of debt, and certain other items. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally one-time in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that we present because we believe it provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for exploration, development, acquisitions, and to service debt. We are also subject to financial covenants under our Credit Agreement based on adjusted EBITDAX ratios as further described in Credit Agreement in Overview of Liquidity and Capital Resources above. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or other profitability or liquidity measures prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. Our credit facility provides a material source of liquidity for us. Under the terms of our Credit Agreement, if we failed to comply with the covenants that establish a maximum permitted ratio of senior secured debt to adjusted EBITDAX and a minimum permitted ratio of adjusted EBITDAX to interest, we would be in default, an event that would prevent us from borrowing under our credit facility and would therefore materially limit our sources of liquidity. In addition, if we are in default under our credit facility and are unable to obtain a waiver of that default from our lenders, lenders under that facility and under the indentures governing our outstanding Senior Notes and Senior Convertible Notes would be entitled to exercise all of their remedies for default. +75 +The following table provides reconciliations of our net loss and net cash provided by operating activities to adjusted EBITDAX for the periods presented: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Net loss (GAAP) +$ +(160,843 +) +$ +(757,744 +) +$ +(447,710 +) +Interest expense +179,257 +158,685 +128,149 +Interest income (1) +(3,968 +) +(362 +) +(649 +) +Income tax benefit +(182,970 +) +(444,172 +) +(275,151 +) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +557,036 +790,745 +921,009 +Exploration (2) +49,879 +59,194 +113,158 +Impairment of proved properties +3,806 +354,614 +468,679 +Abandonment and impairment of unproved properties +12,272 +80,367 +78,643 +Impairment of other property and equipment +— +— +49,369 +Stock-based compensation expense +22,700 +26,897 +27,467 +Net derivative (gain) loss +26,414 +250,633 +(408,831 +) +Derivative settlement gain (3) +21,234 +329,478 +512,566 +Net (gain) loss on divestiture activity +131,028 +(37,074 +) +(43,031 +) +(Gain) loss on extinguishment of debt +35 +(15,722 +) +16,578 +Other, net +8,820 +(4,764 +) +(15,471 +) +Adjusted EBITDAX (Non-GAAP) +664,700 +790,775 +1,124,775 +Interest expense +(179,257 +) +(158,685 +) +(128,149 +) +Interest income (1) +3,968 +362 +649 +Income tax benefit +182,970 +444,172 +275,151 +Exploration (2) +(49,879 +) +(59,194 +) +(113,158 +) +Exploratory dry hole expense +2,381 +(16 +) +36,612 +Amortization of debt discount and deferred financing costs +16,276 +9,938 +7,710 +Deferred income taxes +(192,066 +) +(448,643 +) +(276,722 +) +Plugging and abandonment +(2,735 +) +(6,214 +) +(7,496 +) +Other, net +(581 +) +1,063 +9,707 +Changes in current assets and liabilities +69,613 +(20,754 +) +61,728 +Net cash provided by operating activities (GAAP) (4) +$ +515,390 +$ +552,804 +$ +990,807 +____________________________________________ +(1) +Interest income is included in “Other, net” on the accompanying statements of operations in Part II, Item 8 of this report. +(2) +Stock-based compensation expense is a component of exploration expense and general and administrative expense on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration expense. +(3) +Derivative settlement gain for the year ended December 31, 2015, includes $15.3 million of gains on the early settlement of futures contracts as a result of divesting our Mid-Continent assets. +(4) +Net cash provided by operating activities (GAAP) for the year ended December 31, 2015 has been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report for additional discussion of the change in presentation on the accompanying statements of cash flows as a result of a new accounting standard. +76 +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this item is provided under the captions Commodity Price Risk and Interest Rate Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place under Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +77 +ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries (the Company) as of December 31, 2017 and 2016 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 , in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 21, 2018 expressed an unqualified opinion thereon. +Adoption of ASU No. 2016-09 +As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for share-based arrangements in the December 31, 2017 consolidated financial statements due to the adoption of ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ Ernst & Young LLP +We have served as the Company’s auditor since 2012. +Denver, Colorado +February 21, 2018 +78 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2017 +2016 +ASSETS +Current assets: +Cash and cash equivalents +$ +313,943 +$ +9,372 +Accounts receivable +160,154 +151,950 +Derivative assets +64,266 +54,521 +Prepaid expenses and other +10,752 +8,799 +Total current assets +549,115 +224,642 +Property and equipment (successful efforts method): +Proved oil and gas properties +6,139,379 +5,700,418 +Less - accumulated depletion, depreciation, and amortization +(3,171,575 +) +(2,836,532 +) +Unproved oil and gas properties +2,047,203 +2,471,947 +Wells in progress +321,347 +235,147 +Oil and gas properties held for sale, net +111,700 +372,621 +Other property and equipment, net of accumulated depreciation of $49,985 and $42,882, respectively +106,738 +137,753 +Total property and equipment, net +5,554,792 +6,081,354 +Noncurrent assets: +Derivative assets +40,362 +67,575 +Other noncurrent assets +32,507 +19,940 +Total other noncurrent assets +72,869 +87,515 +Total assets +$ +6,176,776 +$ +6,393,511 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable and accrued expenses +$ +386,630 +$ +299,708 +Derivative liabilities +172,582 +115,464 +Total current liabilities +559,212 +415,172 +Noncurrent liabilities: +Revolving credit facility +— +— +Senior Notes, net of unamortized deferred financing costs +2,769,663 +2,766,719 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +139,107 +130,856 +Asset retirement obligations +103,026 +96,134 +Asset retirement obligations associated with oil and gas properties held for sale +11,369 +26,241 +Deferred income taxes +79,989 +315,672 +Derivative liabilities +71,402 +98,340 +Other noncurrent liabilities +48,400 +47,244 +Total noncurrent liabilities +3,222,956 +3,481,206 +Commitments and contingencies (note 6) +Stockholders ’ equity: +Common stock, $0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 111,687,016 and 111,257,500 shares, respectively +1,117 +1,113 +Additional paid-in capital +1,741,623 +1,716,556 +Retained earnings +665,657 +794,020 +Accumulated other comprehensive loss +(13,789 +) +(14,556 +) +Total stockholders ’ equity +2,394,608 +2,497,133 +Total liabilities and stockholders ’ equity +$ +6,176,776 +$ +6,393,511 +The accompanying notes are an integral part of these consolidated financial statements. +79 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +For the Years Ended +December 31, +2017 +2016 +2015 +Operating revenues and other income: +Oil, gas, and NGL production revenue +$ +1,253,783 +$ +1,178,426 +$ +1,499,905 +Net gain (loss) on divestiture activity +(131,028 +) +37,074 +43,031 +Other operating revenues +6,621 +1,950 +14,029 +Total operating revenues and other income +1,129,376 +1,217,450 +1,556,965 +Operating expenses: +Oil, gas, and NGL production expense +507,906 +597,565 +723,633 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +557,036 +790,745 +921,009 +Exploration +56,179 +65,641 +120,569 +Impairment of proved properties +3,806 +354,614 +468,679 +Abandonment and impairment of unproved properties +12,272 +80,367 +78,643 +Impairment of other property and equipment +— +— +49,369 +General and administrative +120,585 +126,428 +157,668 +Net derivative (gain) loss +26,414 +250,633 +(408,831 +) +Other operating expenses +13,667 +10,772 +25,009 +Total operating expenses +1,297,865 +2,276,765 +2,135,748 +Loss from operations +(168,489 +) +(1,059,315 +) +(578,783 +) +Non-operating income (expense): +Interest expense +(179,257 +) +(158,685 +) +(128,149 +) +Gain (loss) on extinguishment of debt +(35 +) +15,722 +(16,578 +) +Other, net +3,968 +362 +649 +Loss before income taxes +(343,813 +) +(1,201,916 +) +(722,861 +) +Income tax benefit +182,970 +444,172 +275,151 +Net loss +$ +(160,843 +) +$ +(757,744 +) +$ +(447,710 +) +Basic weighted-average common shares outstanding +111,428 +76,568 +67,723 +Diluted weighted-average common shares outstanding +111,428 +76,568 +67,723 +Basic net loss per common share +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +Diluted net loss per common share +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +The accompanying notes are an integral part of these consolidated financial statements. +80 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +For the Years Ended +December 31, +2017 +2016 +2015 +Net loss +$ +(160,843 +) +$ +(757,744 +) +$ +(447,710 +) +Other comprehensive income (loss), net of tax: +Pension liability adjustment (1) +767 +(1,154 +) +(2,090 +) +Total other comprehensive income (loss), net of tax +767 +(1,154 +) +(2,090 +) +Total comprehensive loss +$ +(160,076 +) +$ +(758,898 +) +$ +(449,800 +) +____________________________________________ +(1) +Please refer to Note 8 – Pension Benefits for additional discussion on the pension liability adjustment. +The accompanying notes are an integral part of these consolidated financial statements. +81 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share data and dividends per share) +Additional Paid-in Capital +Accumulated Other Comprehensive Loss +Total Stockholders’ Equity +Common Stock +Retained Earnings +Shares +Amount +Balances, January 1, 2015 +67,463,060 +$ +675 +$ +283,295 +$ +2,013,997 +$ +(11,312 +) +$ +2,286,655 +Net loss +— +— +— +(447,710 +) +— +(447,710 +) +Other comprehensive loss +— +— +— +— +(2,090 +) +(2,090 +) +Cash dividends, $ 0.10 per share +— +— +— +(6,772 +) +— +(6,772 +) +Issuance of common stock under Employee Stock Purchase Plan +197,214 +2 +4,842 +— +— +4,844 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +375,523 +4 +(8,682 +) +— +— +(8,678 +) +Stock-based compensation expense +39,903 +— +27,467 +— +— +27,467 +Other +— +— +(1,315 +) +— +— +(1,315 +) +Balances, December 31, 2015 +68,075,700 +$ +681 +$ +305,607 +$ +1,559,515 +$ +(13,402 +) +$ +1,852,401 +Net loss +— +— +— +(757,744 +) +— +(757,744 +) +Other comprehensive loss +— +— +— +— +(1,154 +) +(1,154 +) +Cash dividends, $ 0.10 per share +— +— +— +(7,751 +) +— +(7,751 +) +Issuance of common stock under Employee Stock Purchase Plan +218,135 +2 +4,196 +— +— +4,198 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +199,243 +2 +(2,356 +) +— +— +(2,354 +) +Stock-based compensation expense +53,473 +1 +26,896 +— +— +26,897 +Issuance of common stock from stock offerings, net of tax +42,710,949 +427 +1,382,666 +— +— +1,383,093 +Equity component of 1.50% Senior Convertible Notes due 2021 issuance, net of tax +— +— +33,575 +— +— +33,575 +Purchase of capped call transactions +— +— +(24,195 +) +— +— +(24,195 +) +Other +— +— +(9,833 +) +— +— +(9,833 +) +Balances, December 31, 2016 +111,257,500 +$ +1,113 +$ +1,716,556 +$ +794,020 +$ +(14,556 +) +$ +2,497,133 +Net loss +— +— +— +(160,843 +) +— +(160,843 +) +Other comprehensive income +— +— +— +— +767 +767 +Cash dividends, $0.10 per share +— +— +— +(11,144 +) +— +(11,144 +) +Issuance of common stock under Employee Stock Purchase Plan +186,665 +2 +2,621 +— +— +2,623 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings +171,278 +1 +(1,241 +) +— +— +(1,240 +) +Stock-based compensation expense +71,573 +1 +22,699 +— +— +22,700 +Cumulative effect of accounting change (1) +— +— +1,108 +43,624 +— +44,732 +Other +— +— +(120 +) +— +— +(120 +) +Balances, December 31, 2017 +111,687,016 +$ +1,117 +$ +1,741,623 +$ +665,657 +$ +(13,789 +) +$ +2,394,608 +____________________________________________ +(1) +Refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies for additional information. +The accompanying notes are an integral part of these consolidated financial statements. +82 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2017 +2016 +2015 +(as adjusted) +(as adjusted) +Cash flows from operating activities: +Net loss +$ +(160,843 +) +$ +(757,744 +) +$ +(447,710 +) +Adjustments to reconcile net loss to net cash provided by operating activities: +Net (gain) loss on divestiture activity +131,028 +(37,074 +) +(43,031 +) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +557,036 +790,745 +921,009 +Exploratory dry hole expense +2,381 +(16 +) +36,612 +Impairment of proved properties +3,806 +354,614 +468,679 +Abandonment and impairment of unproved properties +12,272 +80,367 +78,643 +Impairment of other property and equipment +— +— +49,369 +Stock-based compensation expense +22,700 +26,897 +27,467 +Net derivative (gain) loss +26,414 +250,633 +(408,831 +) +Derivative settlement gain +21,234 +329,478 +512,566 +Amortization of debt discount and deferred financing costs +16,276 +9,938 +7,710 +(Gain) loss on extinguishment of debt +35 +(15,722 +) +16,578 +Deferred income taxes +(192,066 +) +(448,643 +) +(276,722 +) +Plugging and abandonment +(2,735 +) +(6,214 +) +(7,496 +) +Other, net +8,239 +(3,701 +) +(5,764 +) +Changes in current assets and liabilities: +Accounts receivable +13,997 +(10,562 +) +140,200 +Prepaid expenses and other +(1,953 +) +8,478 +2,563 +Accounts payable and accrued expenses +44,985 +(53,210 +) +(86,267 +) +Accrued derivative settlements +12,584 +34,540 +5,232 +Net cash provided by operating activities +515,390 +552,804 +990,807 +Cash flows from investing activities: +Net proceeds from the sale of oil and gas properties +776,719 +946,062 +357,938 +Capital expenditures +(888,353 +) +(629,911 +) +(1,493,608 +) +Acquisition of proved and unproved oil and gas properties +(89,896 +) +(2,183,790 +) +(7,984 +) +Other, net +— +— +(985 +) +Net cash used in investing activities +(201,530 +) +(1,867,639 +) +(1,144,639 +) +Cash flows from financing activities: +Proceeds from credit facility +406,000 +947,000 +1,872,500 +Repayment of credit facility +(406,000 +) +(1,149,000 +) +(1,836,500 +) +Debt issuance costs related to credit facility +— +(3,132 +) +— +Net proceeds from Senior Notes +— +491,640 +490,951 +Cash paid to repurchase Senior Notes +(2,344 +) +(29,904 +) +(350,000 +) +Cash paid for extinguishment of debt +(13 +) +— +(12,455 +) +Net proceeds from Senior Convertible Notes +— +166,617 +— +Cash paid for capped call transactions +— +(24,195 +) +— +Net proceeds from sale of common stock +2,623 +938,268 +4,844 +Dividends paid +(11,144 +) +(7,751 +) +(6,772 +) +Net share settlement from issuance of stock awards +(1,240 +) +(2,354 +) +(8,678 +) +Other, net +(171 +) +— +(160 +) +Net cash provided by (used in) financing activities +(12,289 +) +1,327,189 +153,730 +Net change in cash, cash equivalents, and restricted cash (1) +301,571 +12,354 +(102 +) +Cash, cash equivalents, and restricted cash at beginning of period (1) +12,372 +18 +120 +Cash, cash equivalents, and restricted cash at end of period (1) +$ +313,943 +$ +12,372 +$ +18 +The accompanying notes are an integral part of these consolidated financial statements. +83 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) +(in thousands) +Supplemental schedule of additional cash flow information and non-cash activities: +For the Years Ended +December 31, +2017 +2016 +2015 +(as adjusted) +(as adjusted) +Supplemental cash flows information: +Operating activities: +Cash paid for interest, net of capitalized interest +$ +(164,097 +) +$ +(129,761 +) +$ +(126,988 +) +Net cash (refunded) paid for income taxes +$ +5,986 +$ +(4,690 +) +$ +1,630 +Investing activities: +Changes in capital expenditure accruals and other +$ +7,309 +$ +8,044 +$ +(210,819 +) +Supplemental non-cash investing activities: +Carrying value of properties exchanged +$ +293,963 +$ +733 +$ +— +Supplemental non-cash financing activities: +Issuance of common stock for an asset acquisition (2) +$ +— +$ +437,194 +$ +— +Non-cash (gain) loss on extinguishment of debt, net +$ +22 +$ +(15,722 +) +$ +4,123 +____________________________________________ +(1) +Refer to Note 1 – Summary of Significant Accounting Policies for a reconciliation of cash, cash equivalents, and restricted cash reported to the amounts reported within the accompanying balance sheets. +(2) +Refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions and Note 13 – Equity for additional discussion. +84 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company is an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in onshore North America. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Intercompany accounts and transactions have been eliminated. In connection with the preparation of the consolidated financial statements, the Company evaluated subsequent events after the balance sheet date of December 31, 2017 , through the filing of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the consolidated financial statements. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of depletion, depreciation, and amortization expense, impairment of proved properties, and asset retirement obligations, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents and Restricted Cash +The Company considers all liquid investments purchased with an initial maturity of three months or less to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. Restricted cash includes cash that is contractually restricted for its use through an agreement with a non-related party. The Company includes restricted cash in other noncurrent assets on the accompanying balance sheets. +Accounts Receivable +The Company’s accounts receivable consist mainly of receivables from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables from joint interest owners, the Company typically has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil, gas, and NGL receivables are collected within two months and the Company has had minimal bad debts. +Although diversified among many companies, collectability is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. Please refer to Note 2 – Accounts Receivable and Accounts Payable and Accrued Expenses for additional disclosure. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to regular review. +85 +The Company does not believe the loss of any single purchaser of its production would materially impact its operating results, as oil, gas, and NGLs are products with well established markets and numerous purchasers in the Company’s operating regions. The Company had the following major customers and sales to entities under common ownership, which accounted for 10 percent or more of its total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2017 +2016 +2015 +Major customer #1 (1) +10 +% +5 +% +4 +% +Major customer #2 (2) +7 +% +18 +% +21 +% +Group #1 of entities under common ownership (3) +17 +% +15 +% +10 +% +Group #2 of entities under common ownership (3) +8 +% +8 +% +11 +% +____________________________________________ +(1) +This major customer is a purchaser of the Company’s production from its Permian region. +(2) +This major customer was the operator of the Company’s outside-operated Eagle Ford shale program, which was divested of during the first quarter of 2017. Prior to the divestiture, the Company was party to various marketing agreements, which included certain gathering, transportation, and processing throughput commitments. Because the Company shared with the operator the risk of non-performance by its counterparty purchasers, the Company included the operator as a major customer in the table above. Several of the operator’s counterparty purchasers under these contracts were also direct purchasers of the Company’s production from other areas. +(3) +In the aggregate these groups of entities under common ownership represent more than 10 percent of total oil, gas, and NGL production revenue for the period(s) shown, however, none of the individual entities comprising either group represented more than 10 percent of the Company’s total oil, gas, and NGL production revenue. +The Company’s policy is to use the commodity affiliates of the lenders under its Credit Agreement as its derivative counterparties, and each counterparty must have investment grade senior unsecured debt ratings. Each of the Company’s 10 derivative counterparties meet both of these requirements as of the filing of this report. +The Company maintains its primary bank accounts with a large, multinational bank that has branch locations in the Company’s areas of operations. The Company’s policy is to diversify its concentration of cash and cash equivalent investments among multiple institutions and investment products to limit the amount of credit exposure to any single institution or investment. The Company maintains investments in highly rated, highly liquid investment products with numerous banks that are party to its revolving credit facility. +Oil and Gas Producing Activities +Proved properties . The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, the costs of development wells are capitalized whether those wells are successful or unsuccessful. Capitalized drilling costs, including lease and well equipment and intangible development costs, are depleted as a group of assets (properties aggregated with a common geological structure) using the units-of-production method based on estimated proved developed oil and gas reserves. Similarly, proved leasehold costs are depleted on the same group asset basis; however, the units-of-production method is based on estimated total proved oil and gas reserves. The computation of DD&A takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. +Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Expected future discounted cash flows are calculated on all estimated proved reserves and risk-adjusted probable and possible reserves using discount rates and price forecasts that management believes are representative of current market conditions. The prices for oil and gas are forecasted based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecasted using OPIS pricing, adjusted for basis differentials, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. Please refer to Note 11 – Fair Value Measurements for additional discussion. +The partial sale of a proved property within an existing field is accounted for as a normal retirement and no net gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A net gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of proved properties. +86 +Unproved properties . The unproved oil and gas properties line item on the accompanying balance sheets consists of costs incurred to acquire unproved leases. When successful wells are drilled on unproved leases, unproved property costs allocated to those leases are reclassified to proved properties and depleted on a units-of-production basis. An impairment is recorded on unproved property when the Company determines that either the property will not be developed or the carrying value is not realizable. Please refer to Note 11 – Fair Value Measurements for additional discussion. +For the sale of unproved properties where the original cost has been partially or fully amortized by providing a valuation allowance on a group basis, neither a gain nor loss is recognized unless the sales price exceeds the original cost of the property, in which case a gain shall be recognized in the accompanying statements of operations in the amount of such excess. +Exploratory . Exploratory G&G, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Under the successful efforts method, exploratory well costs are capitalized pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that economic proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in cash flows from investing activities as part of capital expenditures within the accompanying statements of cash flows. +Other Property and Equipment +Other property and equipment such as facilities, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing, and installation activities. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from 3 to 30 years, or the unit of output method where appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the accounts. +A long-lived asset is evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. The Company uses an income valuation technique if there is not a market-observable price for the asset. Please refer to Note 11 – Fair Value Measurements for additional discussion. +Assets Held for Sale +Any properties held for sale as of the balance sheet date have been classified as assets held for sale and are separately presented on the accompanying balance sheets at the lower of carrying value or fair value less the estimated cost to sell. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions and Note 11 – Fair Value Measurements for additional discussion. +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties, including facilities requiring decommissioning. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired and a facility is constructed. The increase in carrying value is included in proved oil and gas properties in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and gas properties. Cash paid to settle asset retirement obligations is included in the operating section of the Company’s accompanying statements of cash flows. +87 +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent . In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or changes in inflation factors or the Company’s credit-adjusted risk-free rate as market conditions warrant. Please refer to Note 9 – Asset Retirement Obligations for a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2017 , and 2016 . +Derivative Financial Instruments +The Company seeks to manage or reduce commodity price risk on its production by entering into derivative contracts. The Company seeks to minimize its basis risk and indexes its oil derivative contracts to NYMEX prices, its NGL derivative contracts to OPIS prices, and its gas derivative contracts to various regional index prices associated with pipelines into which the Company’s gas production is sold. The Company does not designate its derivative instruments to qualify for hedge accounting. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its accompanying statements of operations as they occur. For additional discussion on derivatives, please see Note 10 – Derivative Financial Instruments . +Revenue Recognition +The Company derives revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized when the Company’s production is delivered to the purchaser, but payment is generally received between 30 and 90 days after the date of production. No revenue is recognized unless it is determined that title to the product has transferred to the purchaser. At the end of each month, the Company estimates the amount of production delivered to the purchaser and the price the Company will receive. The Company uses knowledge of its properties and historical performance, contractual agreements, NYMEX, OPIS, and local spot market prices, quality and transportation differentials, and other factors as the basis for these estimates. The Company follows the sales method of accounting for gas production imbalances. If the Company’s sales volumes for a well exceed the Company’s proportionate share of production from the well, a liability is recognized to the extent that the Company’s share of estimated remaining recoverable reserves from the well is insufficient to satisfy this imbalance. Effective January 1, 2018, the Company’s revenue recognition policy changed due to the adoption of new accounting guidance. Please refer to Recently Issued Accounting Standards below for additional discussion. +Stock-Based Compensation +At December 31, 2017 , the Company had stock-based employee compensation plans that included RSUs and PSUs issued to employees and RSUs and restricted stock issued to non-employee directors, as well as an employee stock purchase plan available to eligible employees. These are more fully described in Note 7 – Compensation Plans . The Company records expense associated with the fair value of stock-based compensation in accordance with authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant, and included within general and administrative expense and exploration expense in the accompanying statements of operations. Further, the Company accounts for forfeitures of stock-based compensation awards as they occur. +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the consolidated financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. Please refer to Note 4 – Income Taxes for additional disclosure. +88 +Earnings per Share +Basic net income (loss) per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average number of common shares outstanding for the respective period. +Diluted net income (loss) per common share is calculated by dividing adjusted net income or loss by the diluted weighted-average number of common shares outstanding, which includes the effect of potentially dilutive securities. Potentially dilutive securities for this calculation consist primarily of non-vested RSUs, contingent PSUs, and shares into which the Senior Convertible Notes are convertible, which are measured using the treasury stock method. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three -year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 7 – Compensation Plans under the heading Performance Share Units . +On August 12, 2016 , the Company issued $172.5 million in aggregate principal amount of Senior Convertible Notes due 2021 . Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. The Company has initially elected a net-settlement method to satisfy its conversion obligation, which would result in the Company settling the principal amount of the Senior Convertible Notes in cash and the excess conversion value in shares. However, the Company has not made an irrevocable election and thereby reserves the right to settle the Senior Convertible Notes in any manner allowed under the indenture as business circumstances warrant. Shares of the Company’s common stock traded at an average closing price below the $40.50 conversion price for the year ended December 31, 2017 and for the portion of the year ended December 31, 2016 , during which the Senior Convertible Notes were outstanding. Therefore, the Senior Convertible Notes had no dilutive impact. In connection with the offering of the Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters that would effectively prevent dilution upon settlement up to the $60.00 cap price. The capped call transactions will always be anti-dilutive and therefore will never be reflected in diluted net income (loss) per share. Please refer to Note 5 – Long-Term Debt for additional discussion. +When the Company recognizes a net loss from continuing operations, as was the case for the years ended December 31, 2017 , 2016 , and 2015 , all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of diluted net loss per common share. +The following table details the weighted-average anti-dilutive securities for the years presented: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Anti-dilutive +264 +280 +256 +The following table sets forth the calculations of basic and diluted net loss per common share: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands, except per share data) +Net loss +$ +(160,843 +) +$ +(757,744 +) +$ +(447,710 +) +Basic weighted-average common shares outstanding +111,428 +76,568 +67,723 +Add: dilutive effect of non-vested RSUs and contingent PSUs +— +— +— +Add: dilutive effect of Senior Convertible Notes +— +— +— +Diluted weighted-average common shares outstanding +111,428 +76,568 +67,723 +Basic net loss per common share +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +Diluted net loss per common share +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +89 +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income (loss). Please refer to Note 8 – Pension Benefits for detail on the changes in the balances of components comprising other comprehensive income (loss). +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The recorded value of the Company’s credit facility approximates its fair value as it bears interest at a floating rate that approximates a current market rate. The Company had a zero balance under its credit facility as of December 31, 2017 , and 2016 . The Company’s Senior Notes and Senior Convertible Notes are recorded at cost, net of any unamortized discount and deferred financing costs, and the respective fair values are disclosed in Note 11 – Fair Value Measurements . The Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry in onshore United States. The Company reports as a single industry segment. +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or SPEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that the Company is the primary beneficiary of a variable interest entity, that entity is consolidated. The Company has not been involved in any unconsolidated SPE transactions in 2017 or 2016 . +Recently Issued Accounting Standards +Effective January 1, 2017, the Company adopted, using various transition methods, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 is meant to simplify certain aspects of accounting for share-based arrangements, including income tax effects, accounting for forfeitures, and net share settlements. The Company adopted the various applicable amendments, which are summarized as follows: +• +On January 1, 2017, a $44.3 million cumulative-effect adjustment was made to retained earnings and a corresponding deferred tax asset was recorded for previously unrecognized excess tax benefits using a modified retrospective transition method. Going forward, excess tax benefits will be presented in operating activities on the accompanying statements of cash flows. +• +Also on January 1, 2017, the Company elected to change its policy to account for forfeitures of share-based payment awards as they occur, rather than applying an estimated forfeiture rate. This change was made using a modified retrospective transition method and resulted in an increase in additional paid-in capital of $1.1 million , a decrease in deferred tax assets of $0.4 million , and a net $0.7 million cumulative effect adjustment decrease to retained earnings. +• +Under this new guidance, excess tax benefits and deficiencies from share-based payments impact the Company’s effective tax rate between periods. Please refer to Note 4 – Income Taxes for additional discussion . +Effective December 31, 2017, the Company early adopted, on a retrospective basis, FASB ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”) and FASB +90 +ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The Company determined that of the eight issues addressed in ASU 2016-15, only the issue related to debt extinguishment costs impacted the Company’s consolidated financial statements and disclosures. In accordance with ASU 2016-15, the Company reclassified certain debt extinguishment costs from operating activities to financing activities. ASU 2016-18 is intended to clarify guidance on the classification and presentation of restricted cash and restricted cash equivalents in the statement of cash flows. In accordance with ASU 2016-18, the Company has reclassified restricted cash out of investing activities and combined it with cash and cash equivalents when reconciling the beginning and end of period balances on the statements of cash flows. The December 31, 2016, and 2015 accompanying statements of cash flows line items that were adjusted as a result of the adoption of ASU 2016-15 and ASU 2016-18 are summarized as follows: +For the Years Ended December 31, +2016 +2015 +As Reported +As Adjusted +As Reported +As Adjusted +(in thousands) +Non-cash (gain) loss on extinguishment of debt +$ +(15,722 +) +N/A +$ +4,123 +N/A +(Gain) loss on extinguishment of debt +N/A +$ +(15,722 +) +N/A +$ +16,578 +Net cash provided by operating activities +$ +552,804 +$ +552,804 +$ +978,352 +$ +990,807 +Other, net +$ +(3,000 +) +$ +— +$ +(985 +) +$ +(985 +) +Net cash used in investing activities +$ +(1,870,639 +) +$ +(1,867,639 +) +$ +(1,144,639 +) +$ +(1,144,639 +) +Cash paid for extinguishment of debt +N/A +$ +— +N/A +$ +(12,455 +) +Net cash provided by financing activities +$ +1,327,189 +$ +1,327,189 +$ +166,185 +$ +153,730 +Net change in cash and cash equivalents +$ +9,354 +N/A +$ +(102 +) +N/A +Net change in cash, cash equivalents, and restricted cash +N/A +$ +12,354 +N/A +$ +(102 +) +Cash and cash equivalents at beginning of period +$ +18 +N/A +$ +120 +N/A +Cash, cash equivalents, and restricted cash at beginning of period +N/A +$ +18 +N/A +$ +120 +Cash and cash equivalents at end of period +$ +9,372 +N/A +$ +18 +N/A +Cash, cash equivalents, and restricted cash at end of period +N/A +$ +12,372 +N/A +$ +18 +The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the accompanying balance sheets to the amounts shown in the accompanying statements of cash flows: +December 31, +2017 +2016 +2015 +(in thousands) +Cash and cash equivalents +$ +313,943 +$ +9,372 +$ +18 +Restricted cash (1) +— +3,000 +— +Total cash, cash equivalents, and restricted cash shown in the accompanying statements of cash flows +$ +313,943 +$ +12,372 +$ +18 +____________________________________________ +(1) +Restricted cash is included in other noncurrent assets on the accompanying balance sheets. +In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”) . Under the new standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. The standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB issued several additional ASUs related to ASU 2014-09 that provide clarified implementation guidance +91 +and deferred the effective date of ASU 2014-09. The Company adopted ASU 2014-09 and all related ASUs using a modified retrospective transition method on the effective date of January 1, 2018 and will apply the new guidance to contracts for which all, or substantially all, of the revenue has not been recognized as of December 31, 2017 under legacy revenue guidance. This adoption will not result in a material change to current or prior period results, business processes, systems, or controls. However, upon adoption the Company will expand its current disclosures to comply with the disclosure requirements of the new guidance. +In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”) , which requires lessees to recognize a right-of-use asset and a lease liability for virtually all leases currently classified as operating leases. The Company is currently analyzing the impact this standard will have on the Company’s contract portfolio, including non-cancelable leases, drilling rigs, pipeline gathering, transportation, gas processing, and other existing arrangements. Further, the Company is evaluating current accounting policies, applicable systems, controls, and processes to support the potential recognition and disclosure changes resulting from ASU 2016-02. Based upon the Company’s initial assessment, ASU 2016-02 is expected to result in an increase in assets and liabilities recorded. The Company will adopt ASU 2016-02 using a modified retrospective method on the effective date of January 1, 2019. In January 2018, the FASB issued ASU No. 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842 (“ASU 2018-01”). ASU 2018-01 provides an optional transitional practical expedient which allows entities to exclude from evaluation land easements that exist or expired before adoption of ASU 2016-02. The Company is currently evaluating this practical expedient and will adopt ASU 2018-01 at the same time as ASU 2016-02. +In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The Company has determined that the adoption of ASU 2017-01 on the effective date of January 1, 2018, using a prospective method, does not impact the Company’s current consolidated financial statements or disclosures. However, the clarified definition of a business will be applied by the Company to future transactions. +In February 2017, the FASB issued ASU No. 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets (“ASU 2017-05”). ASU 2017-05 is meant to clarify the scope of Accounting Standards Codification (“ASC”) Subtopic 610-20, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets and to add guidance for partial sales of nonfinancial assets. The Company has determined that the adoption of ASU 2017-05 on the effective date of January 1, 2018, using a modified retrospective method, does not impact the Company’s current consolidated financial statements or disclosures. +In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”). ASU 2017-07 requires presentation of service cost in the same line item(s) as other compensation costs arising from services rendered by employees during the period and presentation of the remaining components of net benefit cost in a separate line item, outside operating items. In addition, only the service cost component of net benefit cost is eligible for capitalization. The Company adopted ASU 2017-07 on the effective date of January 1, 2018, with retrospective application of the service cost component and the other components of net benefit cost in the consolidated statements of operations and prospective application for the capitalization of the service cost component of net benefit costs in assets. While the adoption of ASU 2017-07 resulted in the Company reclassifying certain amounts from operating expenses to non-operating expenses, ASU 2017-07 did not result in a material impact to the Company’s consolidated financial statements or disclosures. +In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”). ASU 2018-02 permits entities to reclassify tax effects stranded in accumulated other comprehensive income (loss) to retained earnings as a result of the 2017 Tax Act. ASU 2018-02, is to be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the United States federal corporate income tax rate in the 2017 Tax Act is recognized. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted as outlined in ASU 2018-02. The Company is currently evaluating the provisions of this guidance and assessing the potential impact on the Company’s consolidated financial statements and disclosures. +92 +There are no other ASUs applicable to the Company that would have a material effect on the Company’s consolidated financial statements and related disclosures that have been issued but not yet adopted by the Company as of December 31, 2017 , and through the filing of this report. +Note 2 – Accounts Receivable and Accounts Payable and Accrued Expenses +Accounts receivable are comprised of the following accruals: +As of December 31, +2017 +2016 +(in thousands) +Oil, gas, and NGL production revenue +$ +96,610 +$ +96,101 +Amounts due from joint interest owners +56,929 +29,669 +State severance tax refunds +2,276 +15,320 +Derivative settlements +99 +6,512 +Other +4,240 +4,348 +Total accounts receivable +$ +160,154 +$ +151,950 +Accounts payable and accrued expenses are comprised of the following accruals: +As of December 31, +2017 +2016 +(in thousands) +Capital expenditures +$ +164,620 +$ +107,009 +Revenue and severance tax payable +60,328 +39,617 +Lease operating expense +22,078 +15,956 +Property taxes +13,222 +6,606 +Compensation +39,471 +34,761 +Derivative settlements +12,644 +6,473 +Interest +45,057 +45,059 +Other +29,210 +44,227 +Total accounts payable and accrued expenses +$ +386,630 +$ +299,708 +Note 3 – Divestitures, Assets Held for Sale, and Acquisitions +2017 Divestiture Activity +Eagle Ford Divestiture. During the first quarter of 2017, the Company divested its outside-operated Eagle Ford shale assets, including its ownership interest in related midstream assets, for total cash received, net of costs (referred to throughout this report as “net divestiture proceeds”), of $744.1 million . The Company recorded a final net gain of $396.8 million related to these divested assets for the year ended December 31, 2017 . These assets were classified as held for sale as of December 31, 2016 . +93 +The following table presents income (loss) before income taxes from the outside-operated Eagle Ford shale assets sold for the years ended December 31, 2017 , 2016 , and 2015 . This divestiture was considered a disposal of a significant asset group. +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Income (loss) before income taxes (1) +$ +24,324 +$ +(218,506 +) +$ +71,556 +____________________________________________ +(1) +Income (loss) before income taxes reflects oil, gas, and NGL production revenue, less oil, gas, and NGL production expense, and depletion, depreciation, amortization, and asset retirement obligation liability accretion. Additionally, income (loss) before income taxes includes approximately $269.6 million of impairment of proved properties expense for the year ended December 31, 2016 . +Rocky Mountain and Permian Divestitures. During 2017, the Company divested certain non-core properties in its Rocky Mountain and Permian regions for net divestiture proceeds of $36.2 million and a small net gain. Please refer to the Assets Held for Sale section below for an explanation of divestiture losses the Company recorded during 2017 for its Divide County, North Dakota assets, which were held for sale in the first quarter and a portion of the second quarter of 2017. +2016 Divestiture Activity +Rocky Mountain Divestitures. During the third quarter of 2016, the Company divested certain non-core properties in the Williston Basin and Powder River Basin in two separate packages for net divestiture proceeds of $110.3 million and a final net gain of $16.4 million . +During the fourth quarter of 2016, the Company divested certain Williston Basin assets located outside of Divide County, North Dakota (referred to as “Raven/Bear Den” throughout this report) for net divestiture proceeds of $755.7 million and a final net gain of $29.5 million . In conjunction with this divestiture, the Company closed its Billings, Montana office. +Permian Divestiture. During the third quarter of 2016, the Company divested its non-core properties in southeast New Mexico for net divestiture proceeds of $54.7 million and recorded a final net loss of $10.0 million . +The Company finalized these divestitures in 2017. +2015 Divestiture Activity +Mid-Continent Divestiture. During the second quarter of 2015, the Company divested its Mid-Continent assets in multiple transactions for total net divestiture proceeds of $310.3 million and a final net gain of $108.4 million . In conjunction with the divestiture of its Mid-Continent assets, the Company closed its Tulsa, Oklahoma office. +Permian Divestiture. During the fourth quarter of 2015, the Company divested certain non-core assets in its Permian region. Net divestiture proceeds were $25.1 million and the final net gain on this divestiture was $2.3 million . +Write-downs on certain other assets held for sale and subsequently sold during the year ended December 31, 2015, totaled $68.6 million , which partially offset the net gain on the Mid-Continent and Permian divestitures discussed above. +Assets Held for Sale +Assets are classified as held for sale when the Company commits to a plan to sell the assets and it is probable the sale will take place within one year. Upon classification as held for sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to identify and expense any excess of carrying value over fair value less estimated costs to sell. When assets no longer meet the criteria of assets held for sale, they are measured at the lower of the carrying value of the assets before being classified as held for sale, adjusted for any depletion, depreciation, and amortization expense that would have been recognized, or the fair value at the date they are reclassified to assets held for use. Any gain or loss recognized on assets held for sale or on assets held for sale that are subsequently reclassified to assets held for use is reflected in the net gain (loss) on divestiture activity line item in the accompanying statements of operations. +94 +During the year ended December 31, 2017 , the Company recorded a $526.5 million write-down on its retained Divide County, North Dakota assets held for sale in early 2017, of which $359.6 million was recorded in the first quarter of 2017 based on estimated fair value less selling costs. An additional $166.9 million write-down was recorded in the second quarter of 2017 based on market conditions that existed on the date the Company decided to retain the assets. +As of December 31, 2017 , the accompanying balance sheets present $111.7 million of assets held for sale, net of accumulated depletion, depreciation, and amortization expense, which consists primarily of approximately 112,000 net acres in the Powder River Basin. A corresponding aggregate asset retirement obligation liability of $11.4 million is separately presented. Subsequent to December 31, 2017 , the Company entered into a definitive agreement for the sale of these assets for a gross purchase price of $500.0 million , subject to customary closing price adjustments. The Company expects to close this divestiture in the first quarter of 2018. The closing of this divestiture is subject to the satisfaction of customary closing conditions and there can be no assurance that the transaction will close on time or at all. +The Company determined that neither planned nor executed asset sales qualify for discontinued operations accounting under financial statement presentation authoritative guidance. +2017 Acquisition Activity +During the year ended December 31, 2017 , the Company acquired approximately 3,600 net acres of primarily unproved properties in Howard and Martin Counties, Texas, in multiple transactions for a total of $76.5 million of cash consideration. Under authoritative accounting guidance, these transactions were considered asset acquisitions and the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and transaction costs were capitalized as a component of the cost of the assets acquired. +Also, during the year ended December 31, 2017 , the Company completed several non-monetary acreage trades of primarily unproved properties in Howard and Martin Counties, Texas, resulting in the Company acquiring approximately 8,125 net acres in exchange for approximately 7,580 net acres with $294.0 million of carrying value attributed to the properties surrendered by the Company in such trades. These trades were recorded at carryover basis with no gain or loss recognized. +2016 Acquisition Activity +Rock Oil Acquisition. During the fourth quarter of 2016, the Company acquired all membership interests of JPM EOC Opal, LLC, which owned proved and unproved properties in the Midland Basin, from Rock Oil Holdings, LLC (referred to as the “Rock Oil Acquisition”). The Company finalized the Rock Oil Acquisition during 2017 by paying $7.7 million of cash consideration in addition to the initial adjusted purchase price of $991.0 million , resulting in total consideration of $998.7 million paid after final closing adjustments. The Company funded the acquisition with proceeds from divestitures in 2016 and the Senior Convertible Notes and equity offerings in August 2016, as discussed in Note 5 – Long-Term Debt and Note 13 – Equity , respectively. +The Company determined that the Rock Oil Acquisition met the criteria of a business combination under ASC Topic 805, Business Combinations . The Company allocated the final adjusted purchase price to the acquired assets and liabilities based on fair value as of the acquisition date, as summarized in the table below. This measurement resulted in no goodwill or bargain purchase gain being recognized. Refer to Note 11 – Fair Value Measurements for additional discussion on the valuation techniques used in determining the fair value of the acquired properties. The acquisition costs were insignificant and were expensed as incurred. +95 +As of October 4, 2016 +(in thousands) +Cash consideration +$ +998,691 +Fair value of assets and liabilities acquired: +Wells in progress +$ +5,672 +Proved oil and gas properties +82,584 +Unproved oil and gas properties +913,819 +Other assets +5,338 +Total fair value of oil and gas properties acquired +1,007,413 +Working capital +(1,127 +) +Asset retirement obligations +(7,595 +) +Total fair value of net assets acquired +$ +998,691 +QStar Acquisition. During the fourth quarter of 2016, the Company acquired additional proved and unproved properties in the Midland Basin from QStar LLC and RRP-QStar, LLC (referred to as the “QStar Acquisition”). The Company finalized the QStar Acquisition during the third quarter of 2017 by paying $7.3 million of cash consideration in addition to the initial consideration of $1.2 billion in cash consideration and the issuance of approximately 13.4 million shares of the Company’s common stock, resulting in total consideration of approximately $1.6 billion paid after final closing adjustments. The Company funded the acquisition with proceeds from the 2016 divestitures and the December 2016 equity offering. Please refer to Note 13 – Equity for additional discussion. +Under authoritative accounting guidance, the transaction was considered an asset acquisition, and therefore, the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and transaction costs were capitalized as a component of the cost of the assets acquired. The Company allocated the final adjusted purchase price to the acquired assets and liabilities, as summarized in the table below. +As of December 21, 2016 +(in thousands) +Cash consideration, including acquisition costs paid +$ +1,174,628 +Fair value of equity consideration (1) +437,194 +Total consideration +$ +1,611,822 +Assets and liabilities acquired: +Wells in progress +$ +21,812 +Proved oil and gas properties +61,239 +Unproved oil and gas properties +1,538,264 +Total oil and gas properties acquired +1,621,315 +Working capital +(1,852 +) +Asset retirement obligations +(7,641 +) +Total net assets acquired +$ +1,611,822 +____________________________________________ +(1) +The Company issued approximately 13.4 million shares of common stock, par value $0.01 per share, in a private placement to the sellers in the QStar Acquisition on December 21, 2016. The equity consideration was valued on this date using Level 1 and Level 2 inputs with a discount applied due to the lack of marketability in the near term in accordance with the Lock-Up and Registration Rights Agreement that prohibited the sale of such stock until no earlier than the 90th day after issuance. +2015 Acquisition Activity +There was no significant acquisition activity during the year ended December 31, 2015 . +96 +Note 4 – Income Taxes +The provision for income taxes consists of the following: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Current portion of income tax expense +Federal +$ +5,698 +$ +2,932 +$ +— +State +3,398 +1,539 +1,571 +Deferred portion of income tax benefit +(192,066 +) +(448,643 +) +(276,722 +) +Total income tax benefit +$ +(182,970 +) +$ +(444,172 +) +$ +(275,151 +) +Effective tax rate +53.2 +% +37.0 +% +38.1 +% +The components of the net deferred tax liabilities are as follows: +As of December 31, +2017 +2016 +(in thousands) +Deferred tax liabilities +Oil and gas properties +$ +142,467 +$ +518,394 +Other +3,412 +7,733 +Total deferred tax liabilities +145,879 +526,127 +Deferred tax assets +Derivative liabilities +29,463 +31,349 +Credit carryover +22,537 +12,448 +Pension +7,986 +10,366 +Federal and state tax net operating loss carryovers +3,867 +151,343 +Stock compensation +3,545 +10,083 +Other liabilities +1,470 +201 +Total deferred tax assets +68,868 +215,790 +Valuation allowance +(2,978 +) +(5,335 +) +Net deferred tax assets +65,890 +210,455 +Total net deferred tax liabilities +$ +79,989 +$ +315,672 +Current federal income tax refundable +$ +37 +$ +644 +Current state income tax payable +$ +3,009 +$ +1,181 +The enactment of the 2017 Tax Act on December 22, 2017 reduced the Company’s federal tax rate for 2018 and future years from 35 percent to 21 percent . This rate change was required to be applied to the Company’s total temporary differences as of December 31, 2017, resulting in a decrease in net deferred tax liabilities and a realized tax benefit of $63.7 million in the fourth quarter of 2017. This realized tax benefit amount represents 18.5 percentage points of the effective tax rate for 2017 reported above. Please refer to the table below for additional detail. Although the Company believes it has properly analyzed the tax accounting impacts of the 2017 Tax Act and appropriately re-measured its net deferred tax liability as of December 31, 2017, it will continue to monitor provisions with discrete rate impacts, such as the limitation on executive compensation, for subsequent events and guidance within one year of the enacted date. +As of December 31, 2017 , the Company estimated its federal net operating loss (“NOL”) carryforward at $1.3 million , which reflects the planning strategies to utilize NOLs for the 2017 and 2016 tax years. After the adoption of ASU 2016-09 in 2017, the Company no longer records a deferred tax amount for unrecognized excess income tax benefits associated with employee share-based payment awards. A cumulative effect adjustment was recorded to the beginning deferred income tax +97 +balance and retained earnings as of January 1, 2017. Please refer to Note 1 – Summary of Significant Accounting Policies above for additional information regarding the adoption of ASU 2016-09. +The Company has federal R&D credit carryforwards of $7.2 million . The federal R&D credit carryforwards expire between 2028 and 2033. The Company’s AMT credit carryforward of $15.7 million does not expire and is expected to be fully refunded by 2022 subject to possible limitations placed on these types of refunds under the sequestration rules enacted by Congress. State NOL carryforwards were $71.8 million and state tax credits were $283,000 as of December 31, 2017 . Federal and state NOLs and state credits expire between 2018 and 2038. The Company’s current valuation allowance relates to state NOL carryforwards and state tax credits, which could not be utilized in the respective states for the tax years 2017 and 2016, and are expected to expire before they can be utilized. The change in the valuation allowance from 2016 to 2017 primarily relates to an allocable change to the Company’s mix of state apportioned losses, anticipated utilization of state cumulative NOLs and to a lesser extent the cumulative state effect of adopting ASU 2016-09. +Federal income tax benefit differs from the amount that would be provided by applying the U.S. federal statutory rate to income before income taxes primarily due to the effect of state income taxes, changes in valuation allowances, R&D credits, and accumulated impacts of other smaller permanent differences, reported as follows: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Federal statutory tax benefit +$ +(120,335 +) +$ +(420,671 +) +$ +(253,001 +) +Increase (decrease) in tax resulting from: +Federal tax reform changes - 2017 Tax Act +(63,675 +) +— +— +State tax benefit (net of federal benefit) +(3,286 +) +(17,549 +) +(21,583 +) +Change in valuation allowance +(2,727 +) +(5,059 +) +3,148 +Employee share-based compensation +8,190 +— +— +Other +(1,137 +) +(893 +) +(3,715 +) +Income tax benefit +$ +(182,970 +) +$ +(444,172 +) +$ +(275,151 +) +Acquisitions, divestitures, drilling activity, and basis differentials, which impact the prices received for oil, gas, and NGLs, impact the apportionment of taxable income to the states where the Company owns oil and gas properties. As these factors change, the Company’s state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax expense (benefit) reported in the current year. Items affecting state apportionment factors are evaluated upon completion of the prior year income tax return, after significant acquisitions and divestitures, if there are significant changes in drilling activity, or if estimated state revenue changes occur during the year. +The Company and its subsidiaries file federal income tax returns and various state income tax returns. With an exception for activity related to its 2003 - 2005 tax years, the Company is generally no longer subject to United States federal or state income tax examinations by tax authorities for years before 2013. The exception tax years have been reopened for net operating loss carryback claims and are currently under examination by the Internal Revenue Service (the “IRS”). During the third quarter of 2017, the Company received a $5.5 million refund in advance of the IRS completing its examination of the Company’s claims. During 2016, the Company’s 2007 - 2011 IRS examination was finalized, as was the 2013 IRS audit of the SM-Mitsui Tax Partnership with no material adjustments to previously recorded amounts. The Company recorded an additional $2.0 million net R&D credit in 2015 as a result of its R&D credit settlement with the IRS Appeals Office. +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. Interest expense in the accompanying statements of operations includes a negligible amount associated with income taxes. The Company does not expect a significant change to the recorded unrecognized tax benefits in 2018 . +98 +The total amount recorded for unrecognized tax benefits is presented below: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Beginning balance +$ +446 +$ +2,782 +$ +1,582 +Additions for tax positions of prior years +— +9 +1,200 +Settlements +— +(2,345 +) +— +Ending balance +$ +446 +$ +446 +$ +2,782 +Note 5 – Long-Term Debt +Credit Agreement +The Company’s Credit Agreement provides for a maximum loan amount of $2.5 billion and has a maturity date of December 10, 2019 . On March 31, 2017 , the Company entered into the Ninth Amendment with its lenders. Pursuant to the Ninth Amendment, and as part of the regular, semi-annual borrowing base redetermination process, the borrowing base and aggregate lender commitments were reduced to $925 million primarily due to the sale of the Company’s outside-operated Eagle Ford shale assets and the decrease in the value of the Company’s estimated proved reserves as of December 31, 2016. +The borrowing base redetermination process considers the value of both the Company’s (a) proved oil and gas properties reflected in the Company’s most recent reserve report and (b) commodity derivative contracts, each as determined by the Company’s lender group. The next semi-annual redetermination date is scheduled for April 1, 2018 . +The Company must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring the Company to maintain certain financial ratios, as defined by the Credit Agreement. Financial covenants under the Credit Agreement require, as of the last day of each of the Company’s fiscal quarters, the Company’s (a) ratio of senior secured debt to 12-month trailing adjusted EBITDAX to be not more than 2.75 to 1.0; (b) adjusted current ratio to be not less than 1.0 to 1.0; and (c) ratio of 12-month trailing adjusted EBITDAX to interest expense to be not less than 2.0 to 1.0. The Company was in compliance with all financial and non-financial covenants under the Credit Agreement as of December 31, 2017 , and through the filing of this report. +Interest and commitment fees are accrued based on a borrowing base utilization grid set forth in the Credit Agreement. Eurodollar loans accrue interest at the London Interbank Offered Rate plus the applicable margin from the utilization table below, and Alternate Base Rate (“ABR”) and swingline loans accrue interest at the prime rate, plus the applicable margin from the utilization table below. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount and are included in interest expense in the accompanying statements of operations. The borrowing base utilization grid under the Credit Agreement is as follows: +Borrowing Base Utilization Percentage +<25% +≥25% <50% +≥50% <75% +≥75% <90% +≥90% +Eurodollar Loans +1.750 +% +2.000 +% +2.250 +% +2.500 +% +2.750 +% +ABR Loans or Swingline Loans +0.750 +% +1.000 +% +1.250 +% +1.500 +% +1.750 +% +Commitment Fee Rate +0.300 +% +0.300 +% +0.350 +% +0.375 +% +0.375 +% +99 +The following table presents the outstanding balance, total amount of letters of credit outstanding, and available borrowing capacity under the Credit Agreement as of February 14, 2018 , December 31, 2017 , and December 31, 2016 : +As of February 14, 2018 +As of December 31, 2017 +As of December 31, 2016 +(in thousands) +Credit facility balance (1) +$ +— +$ +— +$ +— +Letters of credit (2) +200 +200 +200 +Available borrowing capacity +924,800 +924,800 +1,164,800 +Total aggregate lender commitment amount +$ +925,000 +$ +925,000 +$ +1,165,000 +____________________________________________ +(1) +Unamortized deferred financing costs attributable to the credit facility are presented as a component of other noncurrent assets on the accompanying balance sheets and totaled $3.1 million and $5.9 million as of December 31, 2017 , and 2016 , respectively. +(2) +Letters of credit outstanding reduce the amount available under the credit facility on a dollar-for-dollar basis. +Senior Notes +The Company’s Senior Notes consist of 6.50% Senior Notes due 2021, 6.125% Senior Notes due 2022, 6.50% Senior Notes due 2023, 5.0% Senior Notes due 2024, 5.625% Senior Notes due 2025, and 6.75% Senior Notes due 2026 (collectively referred to as “Senior Notes”). The Senior Notes, net of unamortized deferred financing costs line on the accompanying balance sheets as of December 31, 2017 , and 2016 , consisted of the following: +As of December 31, +2017 +2016 +Principal Amount +Unamortized Deferred Financing Costs +Senior Notes, Net of Unamortized Deferred Financing Costs +Principal Amount +Unamortized Deferred Financing Costs +Senior Notes, Net of Unamortized Deferred Financing Costs +(in thousands) +6.50% Senior Notes due 2021 +$ +344,611 +$ +2,656 +$ +341,955 +$ +346,955 +$ +3,372 +$ +343,583 +6.125% Senior Notes due 2022 +561,796 +5,800 +555,996 +561,796 +6,979 +554,817 +6.50% Senior Notes due 2023 +394,985 +3,707 +391,278 +394,985 +4,436 +390,549 +5.0% Senior Notes due 2024 +500,000 +5,610 +494,390 +500,000 +6,533 +493,467 +5.625% Senior Notes due 2025 +500,000 +6,714 +493,286 +500,000 +7,619 +492,381 +6.75% Senior Notes due 2026 +500,000 +7,242 +492,758 +500,000 +8,078 +491,922 +Total +$ +2,801,392 +$ +31,729 +$ +2,769,663 +$ +2,803,736 +$ +37,017 +$ +2,766,719 +The Senior Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. There are no subsidiary guarantors of the Senior Notes. The Company is subject to certain covenants under the indentures governing the Senior Notes that limit the Company’s ability to incur additional indebtedness, issue preferred stock, and make restricted payments, including dividends; however, the first $6.5 million of dividends paid each year are not restricted by the restricted payment covenant. The Company was in compliance with all covenants under its Senior Notes as of December 31, 2017 , and through the filing of this report. All Senior Notes are registered under the Securities Act. The Company may redeem some or all of its Senior Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest, as described in the indentures governing the Senior Notes. +During the first quarter of 2016, the Company repurchased in open market transactions a total of $46.3 million in aggregate principal amount of certain of its 6.50% Senior Notes due 2021, 6.125% Senior Notes due 2022, and 6.50% Senior Notes due 2023 for a settlement amount of $29.9 million , excluding interest, which resulted in a net gain on extinguishment of debt of approximately $15.7 million . This amount includes a gain of $16.4 million associated with the discount realized upon +100 +repurchase, which was partially offset by approximately $700,000 related to the acceleration of unamortized deferred financing costs. +2019 Notes . During 2015, the Company conducted a tender offer and subsequent redemption of its 2019 Notes. As a result, the Company recorded a loss on the extinguishment of debt of approximately $16.6 million for the year ended December 31, 2015. This amount includes approximately $12.5 million associated with the premium paid for the tender offer and redemption of the 2019 Notes and approximately $4.1 million related to the acceleration of unamortized deferred financing costs. +2021 Notes. On November 8, 2011 , the Company issued $350.0 million in aggregate principal amount of 6.50% Senior Notes due 2021 at par, which mature on November 15, 2021 . The Company received net proceeds of $343.1 million after deducting fees of $6.9 million , which are being amortized as deferred financing costs over the life of the 2021 Notes. During the first quarter of 2016, the Company repurchased $3.1 million in aggregate principal amount of its 2021 Notes for a settlement amount of $2.3 million , excluding interest. During the first quarter of 2017, the Company repurchased in open market transactions a total of $2.3 million in aggregate principal amount of its 2021 Notes at a slight premium. +2022 Notes. On November 17, 2014 , the Company issued $600.0 million in aggregate principal amount of 6.125% Senior Notes due 2022 at par, which mature on November 15, 2022 . The Company received net proceeds of $590.0 million after deducting fees of $10.0 million , which are being amortized as deferred financing costs over the life of the 2022 Notes. During the first quarter of 2016, the Company repurchased $38.2 million in aggregate principal amount of its 2022 Notes for a settlement amount of $24.3 million , excluding interest. +2023 Notes. On June 29, 2012 , the Company issued $400.0 million in aggregate principal amount of 6.50% Senior Notes due 2023 at par, which mature on January 1, 2023 . The Company received net proceeds of $392.1 million after deducting fees of $7.9 million , which are being amortized as deferred financing costs over the life of the 2023 Notes. During the first quarter of 2016, the Company repurchased $5.0 million in aggregate principal amount of its 2023 Notes for a settlement amount of $3.3 million , excluding interest. +2024 Notes. On May 20, 2013 , the Company issued $500.0 million in aggregate principal amount of 5.0% Senior Notes due 2024 at par, which mature on January 15, 2024 . The Company received net proceeds of $490.2 million after deducting fees of $9.8 million , which are being amortized as deferred financing costs over the life of the 2024 Notes. +2025 Notes. On May 21, 2015 , the Company issued $500.0 million in aggregate principal amount of 5.625% Senior Notes due 2025 at par, which mature on June 1, 2025 . The Company received net proceeds of $491.0 million after deducting fees of $9.0 million , which are being amortized as deferred financing costs over the life of the 2025 Notes. The net proceeds were used to fund the consideration paid to the tendering holders of the 2019 Notes and to redeem the remaining untendered 2019 Notes, as well as repay outstanding borrowings under the Credit Agreement and for general corporate purposes. +2026 Notes. On September 12, 2016 , the Company issued $500.0 million in aggregate principal amount of 6.75% Senior Notes due 2026 , at par (the “2026 Notes”), which mature on September 15, 2026 . The Company received net proceeds of $491.6 million after deducting fees of $8.4 million , which are being amortized as deferred financing costs over the life of the 2026 Notes. The net proceeds were used to partially fund the Rock Oil Acquisition that closed during the fourth quarter of 2016. +Senior Convertible Notes +On August 12, 2016 , the Company issued $172.5 million in aggregate principal amount of 1.50% Senior Convertible Notes due July 1, 2021 (the “Senior Convertible Notes”). The Senior Convertible Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. The Company received net proceeds of $166.6 million after deducting fees of $5.9 million , of which a portion is being amortized over the life of the Senior Convertible Notes. +The Senior Convertible Notes mature on July 1, 2021 , unless earlier converted. Holders may convert their Senior Convertible Notes at their option at any time prior to January 1, 2021, only under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter) commencing after the calendar quarter ending on September 30, 2016, if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater +101 +than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price (as defined in the indenture) per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after January 1, 2021, until the maturity date, holders may convert their Senior Convertible Notes at any time. The Company may not redeem the Senior Convertible Notes prior to the maturity date. Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. Holders may convert their notes based on a conversion rate of 24.6914 shares of the Company’s common stock per $1,000 principal amount of the Senior Convertible Notes, which is equal to an initial conversion price of approximately $40.50 per share, subject to adjustment. +The Company has initially elected a net-settlement method to satisfy its conversion obligation, which would result in the Company settling the principal amount in cash with any excess conversion in shares of the Company’s common stock. The Senior Convertible Notes were not convertible at the option of holders as of December 31, 2017 , or through the filing of this report. Notwithstanding the inability to convert, the if-converted value of the Senior Convertible Notes as of December 31, 2017 , did not exceed the principal amount. +Upon the issuance of the Senior Convertible Notes, the Company recorded $132.3 million as the initial carrying amount of the debt component, which approximated its fair value at issuance, and, was estimated by using an interest rate for nonconvertible debt with terms similar to the Senior Convertible Notes. The effective interest rate used was 7.25% . The $40.2 million excess of the principal amount of the Senior Convertible Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The Company incurred transaction costs of $5.9 million relating to the issuance of the Senior Convertible Notes, which were allocated between the debt and equity components in proportion to their determined fair value amounts. The debt discount and debt-related issuance costs are amortized to the principal value of the Senior Convertible Notes as interest expense through the maturity date of July 1, 2021 . Interest expense recognized on the Senior Convertible Notes related to the stated interest rate and amortization of the debt discount totaled $9.9 million and $3.7 million for the years ended December 31, 2017 and 2016 , respectively. +The net carrying amount of the liability component of the Senior Convertible Notes, as reflected on the accompanying balance sheets, consisted of the following as of December 31, 2017 and 2016: +As of December 31, +2017 +2016 +(in thousands) +Principal amount of Senior Convertible Notes +$ +172,500 +$ +172,500 +Unamortized debt discount +(30,183 +) +(37,513 +) +Unamortized deferred financing costs +(3,210 +) +(4,131 +) +Net carrying amount +$ +139,107 +$ +130,856 +The net carrying amount of the equity component of the Senior Convertible Notes recorded in additional paid-in capital on the accompanying balance sheets consisted of the following as of December 31, 2017 and 2016: +As of December 31, +2017 +2016 +(in thousands) +Equity component due to allocation of proceeds to equity +$ +40,217 +$ +40,217 +Related issuance costs +(1,375 +) +(1,375 +) +Deferred tax liability +(5,267 +) +(5,267 +) +Net carrying amount +$ +33,575 +$ +33,575 +If the Company undergoes a fundamental change, holders of the Senior Convertible Notes may require the Company to repurchase for cash all or any portion of their notes at a fundamental change repurchase price equal to 100% of the principal amount of the Senior Convertible Notes to be repurchased, plus accrued and unpaid interest. The indenture governing the +102 +Senior Convertible Notes contains customary events of default with respect to the Senior Convertible Notes, including that upon certain events of default, the trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding Senior Convertible Notes by notice to the Company, may declare 100% of the principal and accrued and unpaid interest, if any, due and payable immediately. In case of certain events of bankruptcy, insolvency or reorganization involving the Company or a significant subsidiary, 100% of the principal and accrued and unpaid interest on the Senior Convertible Notes will automatically become due and payable. +The Company is subject to certain covenants under the indenture governing the Senior Convertible Notes and was in compliance with all covenants as of December 31, 2017 , and through the filing of this report. +Capped Call Transactions +In connection with the issuance of the Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters of such issuance. The aggregate cost of the capped call transactions was approximately $24.2 million . The capped call transactions are generally expected to reduce the potential dilution upon conversion of the Senior Convertible Notes and/or partially offset any cash payments the Company is required to make in excess of the principal amount of converted Senior Convertible Notes in the event that the market price per share of the Company’s common stock is greater than the strike price of the capped call transactions, which initially corresponds to the approximate $40.50 per share conversion price of the Senior Convertible Notes. The cap price of the capped call transactions is initially $60.00 per share. If the market price per share exceeds the cap price of the capped call transactions, there could be dilution or there would not be an offset of such potential cash payments. +The Company evaluated the capped call transactions under authoritative accounting guidance and determined that they should be accounted for as separate transactions and classified as equity instruments with no recurring fair value measurement recorded. +Capitalized Interest +Capitalized interest costs for the Company for the years ended December 31, 2017 , 2016 , and 2015 , were $12.6 million , $17.0 million , and $25.1 million , respectively. +Note 6 – Commitments and Contingencies +Commitments +The Company has entered into various agreements, which include drilling rig contracts of $37.8 million , gathering, processing, transportation throughput, and delivery commitments of $463.4 million , office leases, including maintenance, of $43.3 million , and other miscellaneous contracts and leases of $30.2 million . The annual minimum payments for the next five years and total minimum payments thereafter are presented below: +Years Ending December 31, +Amount +(in thousands) +2018 +$ +113,774 +2019 +112,860 +2020 +111,107 +2021 +102,606 +2022 +72,073 +Thereafter +62,245 +Total +$ +574,665 +Subsequent to December 31, 2017 , the Company entered into a fixed price contract to purchase electricity through 2027 for a total of $27.9 million . As of the filing of this report, the Company expects to meet this purchase commitment. +103 +Drilling Contracts +The Company has several drilling rig contracts in place to facilitate drilling plans. Early termination of these rig contracts as of December 31, 2017 , would have resulted in termination penalties of $27.7 million , which would be in lieu of paying the remaining drilling commitments of $37.8 million included in the table above. For the years ended December 31, 2016 , and 2015 , the Company incurred $8.7 million and $13.7 million , respectively, of expenses related to the early termination of drilling rig contracts or fees incurred for rigs placed on standby, which are recorded in the other operating expenses line item in the accompanying statements of operations. No such expenses were recorded by the Company for the year ended December 31, 2017 . +Pipeline Transportation Commitments +The Company has gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum amount of oil, gas, and produced water. As of December 31, 2017 , the Company has commitments to deliver a minimum of 19 MMBbl of oil, 789 Bcf of gas, and 24 MMBbl of produced water through 2028 . The Company will be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. As of December 31, 2017 , if the Company fails to deliver any product, as applicable, the aggregate undiscounted deficiency payments total approximately $463.4 million . If a shortfall in the minimum volume commitment for gas is projected, the Company has rights under certain contracts to arrange for third-party gas to be delivered, and such volumes would count toward its minimum volume commitment. +During the first quarter of 2017, the Company completed the divestiture of its outside-operated Eagle Ford shale assets. Upon closing of the sale, the Company is no longer subject to transportation throughput commitments totaling 52 MMBbl of oil, 514 Bcf of gas, and 13 MMBbl of NGLs, or $501.9 million of the potential undiscounted deficiency payments as of December 31, 2016 . +As of the filing of this report, the Company does not expect to incur any material shortfalls. +Office Leases +The Company leases office space under various operating leases with terms extending as far as 2026 . Rent expense, net of sublease income, for the years ended December 31, 2017 , 2016 , and 2015 , was $4.8 million , $5.2 million , and $6.1 million , respectively. The Company closed its office in Billings, Montana in November 2016 and paid $3.2 million to the lessor to terminate the lease, which is not reflected in the rent expense amount above. +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the results of such pending litigation and claims is not likely to have a material effect on the results of operations, the financial position, or the cash flows of the Company. +Note 7 – Compensation Plans +Equity Plan +There are several components to the Company’s Equity Plan that are described in this section. Various types of equity awards have been granted by the Company in different periods. +As of December 31, 2017 , approximately 3.3 million shares of common stock remained available for grant under the Equity Plan. The issuance of a direct share benefit, such as a share of common stock, a stock option, a restricted share, an RSU, or a PSU, counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. +104 +Performance Share Units +The Company grants PSUs to eligible employees as part of its long-term equity compensation program. The number of shares of the Company’s common stock issued to settle PSUs ranges from zero to two times the number of PSUs awarded and is determined based on certain performance criteria over a three -year measurement period. The performance criteria for PSUs are based on a combination of the Company’s annualized Total Shareholder Return (“TSR”) for the performance period and the relative performance of the Company’s TSR compared with the annualized TSR of certain peer companies for the performance period. Compensation expense for PSUs is recognized within general and administrative and exploration expense over the vesting periods of the respective awards. +The fair value of PSUs is measured at the grant date with a stochastic process method using the Geometric Brownian Motion Model (“GBM Model”). A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for those iterations. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will take over the three-year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the path the stock price may take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +The Company records compensation expense associated with the issuance of PSUs based on the fair value of the awards as of the date of grant. Total compensation expense recorded for PSUs was $9.7 million , $11.0 million , and $10.6 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. As of December 31, 2017 , there was $18.8 million of total unrecognized expense related to PSUs, which is being amortized through 2020 . +A summary of the status and activity of non-vested PSUs is presented in the following table: +For the Years Ended December 31, +2017 +2016 +2015 +PSUs +Weighted-Average Grant-Date Fair Value +PSUs +Weighted-Average Grant-Date Fair Value +PSUs +Weighted-Average Grant-Date Fair Value +Non-vested at beginning of year (1) +828,923 +$ +43.25 +626,328 +$ +61.81 +433,660 +$ +73.63 +Granted (1) +977,731 +$ +15.86 +447,971 +$ +26.56 +320,753 +$ +45.34 +Vested (1) +(94,338 +) +$ +85.85 +(130,353 +) +$ +64.17 +(76,438 +) +$ +51.76 +Forfeited (1) +(178,825 +) +$ +44.99 +(115,023 +) +$ +55.59 +(51,647 +) +$ +73.62 +Non-vested at end of year (1) +1,533,491 +$ +22.97 +828,923 +$ +43.25 +626,328 +$ +61.81 +____________________________________________ +(1) +The number of awards assumes a multiplier of one . The final number of shares of common stock issued may vary depending on the three -year performance multiplier, which ranges from zero to two . +The fair value of the PSUs granted in 2017 , 2016 , and 2015 was $15.5 million , $11.9 million , and $14.5 million , respectively. The PSUs granted in 2015 will remain non-vested until the third anniversary date of their issuance, at which time they will fully vest, unless the employee is retirement eligible in which case the PSUs vest immediately upon attainment of retirement age. PSUs granted in 2017 and 2016 fully vest on the third anniversary of the date of the grant; however, employees who are retirement eligible at the time a PSU award was granted, vest in each portion of that award equally in six-month increments over a three-year period beginning at grant date. Retirement eligible employees must stay with the company through the entire six-month vesting period to receive that increment of vesting and any non-vested portions of a PSU award will be forfeited when the employee leaves the company. +105 +During the year ended December 31, 2017 , there were no shares of common stock issued to settle PSUs granted in 2014 as the multiplier earned was zero. A summary of the shares of common stock issued to settle PSUs for the years ended December 31, 2016 , and 2015 , is presented in the table below: +For the Years Ended December 31, +2016 +2015 +Shares of common stock issued to settle PSUs (1) +44,870 +288,962 +Less: shares of common stock withheld for income and payroll taxes +(14,809 +) +(100,683 +) +Net shares of common stock issued +30,061 +188,279 +Multiplier earned +0.2 +1.0 +____________________________________________ +(1) +During the years ended December 31, 2016 , and 2015 , the Company issued shares of common stock for PSUs granted in 2013, and 2012. The Company and a majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of PSUs that vested during the years ended December 31, 2017 , 2016 , and 2015 was $8.1 million , $8.4 million , and $4.0 million , respectively. +Employee Restricted Stock Units +The Company grants RSUs to eligible employees as part of its long-term equity incentive compensation program. Each RSU represents a right to receive one share of the Company’s common stock upon settlement of the award at the end of the specified vesting period. Compensation expense for RSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the award. +Total compensation expense recorded for employee RSUs for the years ended December 31, 2017 , 2016 , and 2015 , was $10.3 million , $11.9 million , and $13.4 million , respectively. As of December 31, 2017 , there was $19.3 million of total unrecognized expense related to non-vested RSU awards, which is being amortized through 2020 . The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the date of grant. The fair value of an RSU is equal to the closing price of the Company’s common stock on the day of the grant. +A summary of the status and activity of non-vested RSUs for eligible employees is presented in the following table: +For the Years Ended December 31, +2017 +2016 +2015 +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +Non-vested at beginning of year +604,116 +$ +37.39 +543,737 +$ +55.01 +515,724 +$ +68.29 +Granted +1,020,780 +$ +16.64 +417,065 +$ +28.08 +356,246 +$ +43.72 +Vested +(246,025 +) +$ +43.99 +(241,363 +) +$ +58.06 +(278,289 +) +$ +63.12 +Forfeited +(134,609 +) +$ +26.38 +(115,323 +) +$ +43.52 +(49,944 +) +$ +66.53 +Non-vested at end of year +1,244,262 +$ +20.25 +604,116 +$ +37.39 +543,737 +$ +55.01 +The fair value of RSUs granted to eligible employees in 2017 , 2016 , and 2015 was $17.0 million , $11.7 million , and $15.6 million , respectively. The RSUs granted in 2015 vest one-third of the total grant on each anniversary of the grant dates, unless the employee is retirement eligible in which case the RSUs vest immediately upon attainment of retirement age. The RSUs granted in 2017 and 2016 generally vest one-third of the total grant on each anniversary of the grant dates, unless the employee is retirement eligible in which case the RSUs generally vest in each portion of that award equally in six-month increments over a three-year period beginning at grant date. Retirement eligible employees must stay with the company through the entire six-month vesting period to receive that increment of vesting and any non-vested portions of a RSU award will be forfeited when the employee leaves the company. +106 +A summary of the shares of common stock issued to settle employee RSUs is presented in the table below: +For the Years Ended December 31, +2017 +2016 +2015 +Shares of common stock issued to settle RSUs (1) +246,025 +241,363 +278,289 +Less: shares of common stock withheld for income and payroll taxes +(74,747 +) +(72,181 +) +(91,045 +) +Net shares of common stock issued +171,278 +169,182 +187,244 +____________________________________________ +(1) +During the years ended December 31, 2017 , 2016 , and 2015 , the Company issued shares of common stock for RSUs granted in previous years. The Company and a majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of employee RSUs that vested during the years ended December 31, 2017 , 2016 , and 2015 was $10.8 million , $14.0 million , and $17.6 million , respectively. +Director Shares and Restricted Stock Units +In 2017 , 2016 , and 2015 , the Company issued 71,573 , 53,473 , and 39,903 shares, respectively, of its common stock to its non-employee directors under the Company’s Equity Plan. Also in 2017 , the Company issued 8,794 RSUs to a non-employee director. For the years ended December 31, 2017 , 2016 , and 2015 , the Company recorded $1.6 million , $2.0 million , and $1.6 million , respectively, of compensation expense related to director shares and RSUs issued. +Beginning with the awards granted in 2016, all shares issued to non-employee directors fully vest on December 31 st of the year granted. Prior to 2016, all shares of common stock issued to the Company’s non-employee directors were earned over the one -year service period following the date of grant, unless five years of service had been provided to the Company by the director, in which case that director’s shares vested upon the earlier of the completion of the one year service period or the director retiring from the Board of Directors. The RSUs issued to a non-employee director in 2017 fully vested on December 31, 2017 , and will settle upon the earlier to occur of May 25, 2027, or the director resigning from the board of directors. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation, without accruing in excess of $25,000 in value from purchases for each calendar year. The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on either the first or last day of the purchase period. The ESPP is intended to qualify under Section 423 of the IRC. The Company had approximately 1.8 million shares of its common stock available for issuance under the ESPP as of December 31, 2017 . There were 186,665 , 218,135 , and 197,214 shares issued under the ESPP in 2017 , 2016 , and 2015 , respectively. Total proceeds to the Company for the issuance of these shares were $2.6 million , $4.2 million , and $4.8 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +The fair value of ESPP grants is measured at the date of grant using the Black-Scholes-Merton option-pricing model. Expected volatility is calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six-month vesting period. +The fair value of ESPP shares issued during the periods reported were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2017 +2016 +2015 +Risk free interest rate +0.9 +% +0.4 +% +0.1 +% +Dividend yield +0.5 +% +0.4 +% +0.2 +% +Volatility factor of the expected market +price of the Company’s common stock +62.5 +% +95.0 +% +61.2 +% +Expected life (in years) +0.5 +0.5 +0.5 +107 +The Company expensed $1.0 million , $2.0 million , and $1.8 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively, based on the estimated fair value of the ESPP grants. +401(k) Plan +The Company has a defined contribution plan (the “401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. For employees hired before December 31, 2014, the Company matches each employee’s contribution up to six percent of the employee’s base salary and performance bonus, and may make additional contributions at its discretion. The Company matches contributions made by employees hired after December 31, 2014, up to nine percent of the employee’s base salary and performance bonus in lieu of pension plan benefits, and may make additional contributions at its discretion. Please refer to Note 8 – Pension Benefits for additional discussion of pension benefits. The Company’s matching contributions to the 401(k) Plan were $4.5 million , $5.4 million , and $5.6 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +Net Profits Plan +Under the Company’s Net Profits Plan, all oil and gas wells that were completed or acquired during each year were designated within a specific pool with key employees designated as participants that became entitled to payments under the Net Profits Plan after the Company has received net cash flows returning 100 percent of all costs associated with that pool. Thereafter, 10 percent of future net cash flows generated by the pool are allocated among the participants and distributed at least annually. The portion of net cash flows from the pool to be allocated among the participants increases to 20 percent after the Company has recovered 200 percent of the total costs for the pool, including payments made under the Net Profits Plan at the 10 percent level. In December 2007, the Board of Directors discontinued the creation of new pools under the Net Profits Plan. As a result, the 2007 pool was the last Net Profits Plan pool established by the Company. +The following table presents cash payments made or accrued under the Net Profits Plan related to periodic operations, of which the majority is recorded as general and administrative expense, and cash payments made or accrued as a result of divestitures of properties subject to the Net Profits Plan, which are recorded as a reduction to the net gain on divestiture activity line item in the accompanying statements of operations. +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Cash payments made or accrued related to operations +$ +(54 +) +$ +6,608 +$ +3,498 +Cash payments made or accrued related to divestitures +2,753 +24,349 +3,789 +Total net settlements +$ +2,699 +$ +30,957 +$ +7,287 +Note 8 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering substantially all employees who meet age and service requirements and who began employment with the Company prior to January 1, 2016 (the “Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (the “Nonqualified Pension Plan” and together with the Qualified Pension Plan, the “Pension Plans”). The Company froze the Pension Plans to new participants, effective as of January 1, 2016. Employees participating in the Pension Plans as of December 31, 2014, will continue to earn benefits. +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status (i.e. the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment to accumulated other comprehensive income (loss), net of tax. The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation, but excludes the effects of assumed future salary increases. The Company’s measurement date for plan assets and obligations is December 31. +108 +For the Years Ended December 31, +2017 +2016 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year +$ +69,659 +$ +62,547 +Service cost +6,638 +8,200 +Interest cost +2,689 +2,908 +Actuarial loss +3,708 +2,662 +Benefits paid +(10,757 +) +(6,658 +) +Projected benefit obligation at end of year +71,937 +69,659 +Change in plan assets: +Fair value of plan assets at beginning of year +31,731 +25,769 +Actual return on plan assets +2,956 +1,575 +Employer contribution +7,048 +11,045 +Benefits paid +(10,757 +) +(6,658 +) +Fair value of plan assets at end of year +30,978 +31,731 +Funded status at end of year +$ +(40,959 +) +$ +(37,928 +) +The Company’s underfunded status for the Pension Plans as of December 31, 2017 , and 2016 , was $41.0 million and $37.9 million , respectively, and is recognized in the accompanying balance sheets as a portion of other noncurrent liabilities. No plan assets of the Qualified Pension Plan were returned to the Company during the year ended December 31, 2017 . There are no plan assets in the Nonqualified Pension Plan. +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2017 +2016 +(in thousands) +Projected benefit obligation +$ +71,937 +$ +69,659 +Accumulated benefit obligation +$ +56,045 +$ +54,681 +Less: Fair value of plan assets +(30,978 +) +(31,731 +) +Underfunded accumulated benefit obligation +$ +25,067 +$ +22,950 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of the unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for a year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +109 +The pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in accumulated other comprehensive loss as of December 31, 2017 , and 2016 , were as follows: +As of December 31, +2017 +2016 +(in thousands) +Unrecognized actuarial losses +$ +21,397 +$ +22,708 +Unrecognized prior service costs +66 +83 +Accumulated other comprehensive loss +$ +21,463 +$ +22,791 +The estimated net loss that will be amortized from accumulated other comprehensive loss into net periodic benefit cost for the year ended December 31, 2018, is $1.3 million . +The pension liability adjustments recognized in other comprehensive income (loss) during 2017 , 2016 , and 2015 , were as follows: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Net actuarial loss +$ +(2,995 +) +$ +(3,322 +) +$ +(4,990 +) +Amortization of prior service cost +17 +16 +17 +Amortization of net actuarial loss +1,297 +1,582 +1,486 +Settlements +3,009 +— +350 +Total pension liability adjustment, pre-tax +1,328 +(1,724 +) +(3,137 +) +Tax (expense) benefit +(561 +) +570 +1,047 +Total pension liability adjustment, net of tax +$ +767 +$ +(1,154 +) +$ +(2,090 +) +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Components of net periodic benefit cost: +Service cost +$ +6,638 +$ +8,200 +$ +7,949 +Interest cost +2,689 +2,908 +2,496 +Expected return on plan assets that reduces periodic pension benefit cost +(2,244 +) +(2,235 +) +(2,182 +) +Amortization of prior service cost +17 +16 +17 +Amortization of net actuarial loss +1,297 +1,582 +1,486 +Settlements +3,009 +— +350 +Net periodic benefit cost +$ +11,406 +$ +10,471 +$ +10,116 +110 +Pension Plan Assumptions +The weighted-average assumptions used to measure the Company’s projected benefit obligation are as follows: +As of December 31, +2017 +2016 +Projected benefit obligation: +Discount rate +3.8% +4.2% +Rate of compensation increase +6.2% +6.2% +The weighted-average assumptions used to measure the Company’s net periodic benefit cost are as follows: +For the Years Ended December 31, +2017 +2016 +2015 +Net periodic benefit cost: +Discount rate +4.2% +4.7% +4.3% +Expected return on plan assets (1) +6.5% +7.5% +7.5% +Rate of compensation increase +6.2% +6.2% +6.2% +____________________________________________ +(1) +There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy prohibits the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting the optimal expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. +The weighted-average asset allocation of the Qualified Pension Plan is as follows: +Target +As of December 31, +Asset Category +2018 +2017 +2016 +Equity securities +35.0 +% +38.4 +% +28.8 +% +Fixed income securities +43.0 +% +39.8 +% +35.5 +% +Other securities +22.0 +% +21.8 +% +35.7 +% +Total +100.0 +% +100.0 +% +100.0 +% +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in that plan. An expected return on plan assets of 6.5 percent and 7.5 percent was used to calculate the Company’s obligation under the Qualified Pension Plan as of December 31, 2017 , and 2016 , respectively. The expected long-term rate of return assumption of the Qualified Pension Plan is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the expected rate of return on plan assets assumption on an annual basis. +111 +Pension Plan Assets +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2017 , and 2016 , utilizing the fair value hierarchy discussed in Note 11 – Fair Value Measurements are as follows: +Fair Value Measurements Using: +Actual Asset Allocation (1) +Total +Level 1 Inputs +Level 2 Inputs +Level 3 Inputs +(in thousands) +As of December 31, 2017 +Cash +— +% +$ +— +$ +— +$ +— +$ +— +Equity securities: +Domestic (2) +22.2 +% +6,865 +4,805 +2,060 +— +International (3) +16.2 +% +5,032 +3,806 +1,226 +— +Total equity securities +38.4 +% +11,897 +8,611 +3,286 +— +Fixed income securities: +High-yield bonds (4) +2.8 +% +876 +876 +— +— +Core fixed income (5) +28.6 +% +8,842 +8,842 +— +— +Floating rate corp loans (6) +8.4 +% +2,607 +2,607 +— +— +Total fixed income securities +39.8 +% +12,325 +12,325 +— +— +Other securities: +Commodities (7) +1.9 +% +588 +588 +— +— +Real estate (8) +5.6 +% +1,735 +— +— +1,735 +Collective investment trusts (9) +3.1 +% +959 +— +959 +— +Hedge fund (10) +11.2 +% +3,474 +— +— +3,474 +Total other securities +21.8 +% +6,756 +588 +959 +5,209 +Total investments +100.0 +% +$ +30,978 +$ +21,524 +$ +4,245 +$ +5,209 +As of December 31, 2016 +Cash +— +% +$ +— +$ +— +$ +— +$ +— +Equity securities: +Domestic (2) +18.7 +% +5,945 +4,471 +1,474 +— +International (3) +10.1 +% +3,192 +3,192 +— +— +Total equity securities +28.8 +% +9,137 +7,663 +1,474 +— +Fixed income securities: +High-yield bonds (4) +2.6 +% +822 +822 +— +— +Core fixed income (5) +25.0 +% +7,923 +7,923 +— +— +Floating rate corp loans (6) +7.9 +% +2,495 +2,495 +— +— +Total fixed income securities +35.5 +% +11,240 +11,240 +— +— +Other securities: +Commodities (7) +1.8 +% +578 +578 +— +— +Real estate (8) +5.1 +% +1,629 +— +— +1,629 +Collective investment trusts (9) +17.5 +% +5,562 +— +5,562 +— +Hedge fund (10) +11.3 +% +3,585 +— +— +3,585 +Total other securities +35.7 +% +11,354 +578 +5,562 +5,214 +Total investments +100.0 +% +$ +31,731 +$ +19,481 +$ +7,036 +$ +5,214 +112 +____________________________________________ +(1) +Percentages may not calculate due to rounding. +(2) +Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold upon demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of this fund is to approximate the S&P 500 by investing in one or more collective investment funds. +(3) +International equity securities consists of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets and believed to have strong sustainable financial productivity at attractive valuations. +(4) +High-yield bonds consist of non-investment grade fixed income securities. The investment objective is to obtain high current income. Due to the increased level of default risk, security selection focuses on credit-risk analysis. +(5) +The objective of core fixed income funds is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay’s Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +(6) +Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +(7) +Investments with exposure to commodity price movements, primarily through the use of futures, swaps and other commodity-linked securities. +(8) +The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(9) +Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +(10) +The hedge fund portfolio includes an investment in an actively traded global mutual fund that focuses on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +Included below is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2016 +$ +5,045 +Purchases +561 +Realized gain on assets +54 +Unrealized gain on assets +115 +Disposition +(561 +) +Balance at December 31, 2016 +$ +5,214 +Purchases +300 +Realized gain on assets +130 +Unrealized gain on assets +120 +Disposition +(555 +) +Balance at December 31, 2017 +$ +5,209 +Contributions +The Company contributed $7.0 million , $11.0 million , and $6.4 million to the Pension Plans in the years ended December 31, 2017 , 2016 , and 2015 , respectively. The Company expects to make a $4.0 million contribution to the Pension Plans in 2018 . +113 +Benefit Payments +The Pension Plans made actual benefit payments of $10.8 million , $6.7 million , and $8.2 million in the years ended December 31, 2017 , 2016 , and 2015 , respectively. Expected benefit payments over the next 10 years are as follows: +Years Ending December 31, +(in thousands) +2018 +$ +4,217 +2019 +$ +3,818 +2020 +$ +4,363 +2021 +$ +5,561 +2022 +$ +6,117 +2023 through 2027 +$ +36,279 +Note 9 – Asset Retirement Obligations +Please refer to Asset Retirement Obligations in Note 1 – Summary of Significant Accounting Policies for a discussion of the initial and subsequent measurements of asset retirement obligation liabilities and the significant assumptions used in the estimates. +A reconciliation of the Company’s total asset retirement obligation liability is as follows: +As of December 31, +2017 +2016 +(in thousands) +Beginning asset retirement obligations +$ +123,307 +$ +140,874 +Liabilities incurred (1) +7,588 +21,293 +Liabilities settled (2) +(30,432 +) +(57,100 +) +Accretion expense +5,988 +7,795 +Revision to estimated cash flows +8,019 +10,445 +Ending asset retirement obligations (3)(4) +$ +114,470 +$ +123,307 +____________________________________________ +(1) +Reflects liabilities incurred through drilling activities and acquisitions of drilled wells. +(2) +Reflects liabilities settled through plugging and abandonment activities and divestitures of properties. +(3) +Balances as of December 31, 2017 , and 2016 , included $11.4 million and $26.2 million , respectively, of asset retirement obligations associated with oil and gas properties held for sale. +(4) +Balances as of December 31, 2017 , and 2016 , included $75,000 and $932,000 , respectively, related to the Company’s current asset retirement obligation liability, which is recorded in accounts payable and accrued expenses on the accompanying balance sheets. +114 +Note 10 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company has entered into various commodity derivative contracts to mitigate a portion of its exposure to potentially adverse market changes in commodity prices and the associated impact on cash flows. As of December 31, 2017 , all derivative counterparties were members of the Company’s credit facility lender group and all contracts were entered into for other-than-trading purposes. The Company’s commodity derivative contracts consist of swap and collar arrangements for oil, and swap arrangements for gas and NGLs. In a typical commodity swap agreement, if the agreed upon published third-party index price (“index price”) is lower than the swap fixed price, the Company receives the difference between the index price and the agreed upon swap fixed price. If the index price is higher than the swap fixed price, the Company pays the difference. For collar arrangements, the Company receives the difference between an agreed upon index and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +As of December 31, 2017 , the Company had commodity derivative contracts outstanding through the second quarter of 2020 , as summarized in the tables below. +Oil Swaps +Contract Period +NYMEX WTI Volumes +Weighted-Average +Contract Price +(MBbl) +(per Bbl) +First quarter 2018 +1,075 +$ +50.16 +Second quarter 2018 +1,534 +$ +49.57 +Third quarter 2018 +1,769 +$ +49.77 +Fourth quarter 2018 +1,894 +$ +49.87 +2019 +1,940 +$ +50.70 +Total +8,212 +Oil Collars +Contract Period +NYMEX WTI Volumes +Weighted-Average +Floor Price +Weighted-Average +Ceiling Price +(MBbl) +(per Bbl) +(per Bbl) +First quarter 2018 +1,445 +$ +50.00 +$ +59.07 +Second quarter 2018 +1,459 +$ +50.00 +$ +59.03 +Third quarter 2018 +1,948 +$ +50.00 +$ +58.61 +Fourth quarter 2018 +2,222 +$ +50.00 +$ +58.44 +2019 +5,908 +$ +47.65 +$ +59.19 +Total +12,982 +115 +Oil Basis Swaps +Contract Period +Midland-Cushing Volumes +Weighted-Average +Contract Price (1) +(MBbl) +(per Bbl) +First quarter 2018 +2,113 +$ +(1.15 +) +Second quarter 2018 +2,392 +$ +(1.03 +) +Third quarter 2018 +3,018 +$ +(1.06 +) +Fourth quarter 2018 +3,327 +$ +(1.08 +) +2019 +5,788 +$ +(1.09 +) +Total +16,638 +____________________________________________ +(1) +Represents the price differential between WTI prices at Midland, Texas and WTI prices at Cushing, Oklahoma. +Gas Swaps +Contract Period +Sold Volumes +Weighted-Average +Contract Price +Purchased Volumes +Weighted-Average +Contract Price +Net Volumes +(BBtu) +(per MMBtu) +(BBtu) +(per MMBtu) +(BBtu) +First quarter 2018 +28,910 +$ +3.55 +(8,121 +) +$ +4.34 +20,789 +Second quarter 2018 +23,507 +$ +3.31 +(7,795 +) +$ +4.24 +15,712 +Third quarter 2018 +24,627 +$ +3.29 +(7,480 +) +$ +4.23 +17,147 +Fourth quarter 2018 +25,856 +$ +3.29 +(7,210 +) +$ +4.27 +18,646 +2019 +41,394 +$ +3.76 +(24,415 +) +$ +4.34 +16,979 +Total (1) +144,294 +(55,021 +) +89,273 +____________________________________________ +(1) +Total net volumes of gas swaps are comprised of IF HSC ( 99% ) and IF El Paso Permian ( 1% ). +NGL Swaps +OPIS Purity Ethane Mont Belvieu +OPIS Propane Mont Belvieu Non-TET +OPIS Normal Butane Mont Belvieu Non-TET +OPIS Isobutane Mont Belvieu +Non-TET +OPIS Natural Gasoline Mont Belvieu Non-TET +Contract Period +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +First quarter 2018 +923 +$ +10.90 +629 +$ +25.39 +206 +$ +35.83 +167 +$ +35.76 +188 +$ +49.40 +Second quarter 2018 +915 +$ +10.87 +554 +$ +24.94 +84 +$ +35.69 +66 +$ +35.07 +109 +$ +49.57 +Third quarter 2018 +1,033 +$ +10.99 +610 +$ +24.27 +93 +$ +35.70 +70 +$ +35.07 +118 +$ +49.56 +Fourth quarter 2018 +1,146 +$ +11.18 +671 +$ +24.39 +102 +$ +35.70 +76 +$ +35.07 +129 +$ +49.57 +2019 +3,533 +$ +12.31 +1,503 +$ +27.83 +154 +$ +35.64 +117 +$ +35.70 +197 +$ +50.93 +2020 +539 +$ +11.13 +— +$ +— +— +$ +— +— +$ +— +— +$ +— +Total +8,089 +3,967 +639 +496 +741 +116 +Commodity Derivative Contracts Entered Into After December 31, 2017 +Subsequent to December 31, 2017 , the Company entered into NGL Swap contracts for 2018 for approximately 228 MBbl of OPIS Natural Gasoline Mont Belvieu Non-TET NGL production at a contract price of $53.34 per Bbl. +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities. The Company does not designate its derivative commodity contracts as hedging instruments. The fair value of the derivative commodity contracts was a net liability of $139.4 million at December 31, 2017 , and net liability of $91.7 million at December 31, 2016 . +The following tables detail the fair value of derivatives recorded in the accompanying balance sheets, by category: +As of December 31, 2017 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity contracts +Current assets +$ +64,266 +Current liabilities +$ +172,582 +Commodity contracts +Noncurrent assets +40,362 +Noncurrent liabilities +71,402 +Total commodity contracts +$ +104,628 +$ +243,984 +As of December 31, 2016 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity contracts +Current assets +$ +54,521 +Current liabilities +$ +115,464 +Commodity contracts +Noncurrent assets +67,575 +Noncurrent liabilities +98,340 +Total commodity contracts +$ +122,096 +$ +213,804 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2017 , and 2016 , all derivative instruments held by the Company were subject to master netting arrangements with various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that settle on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s derivative contracts: +Derivative Assets +Derivative Liabilities +As of December 31, +As of December 31, +Offsetting of Derivative Assets and Liabilities +2017 +2016 +2017 +2016 +(in thousands) +Gross amounts presented in the accompanying balance sheets +$ +104,628 +$ +122,096 +$ +(243,984 +) +$ +(213,804 +) +Amounts not offset in the accompanying balance sheets +(100,035 +) +(118,080 +) +100,035 +118,080 +Net amounts +$ +4,593 +$ +4,016 +$ +(143,949 +) +$ +(95,724 +) +117 +The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income (loss). The Company had no derivatives designated as hedging instruments for the years ended December 31, 2017 , 2016 , and 2015 . Please refer to Note 11 – Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +The following table summarizes the components of net derivative (gain) loss presented in the accompanying statements of operations: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Derivative settlement (gain) loss: +Oil contracts +$ +31,176 +$ +(243,102 +) +$ +(362,219 +) +Gas contracts (1) +(87,857 +) +(94,936 +) +(123,180 +) +NGL contracts +35,447 +8,560 +(27,167 +) +Total derivative settlement gain +$ +(21,234 +) +$ +(329,478 +) +$ +(512,566 +) +Net derivative (gain) loss: +Oil contracts +$ +71,502 +$ +85,370 +$ +(191,165 +) +Gas contracts +(76,315 +) +81,060 +(189,734 +) +NGL contracts +31,227 +84,203 +(27,932 +) +Total net derivative (gain) loss +$ +26,414 +$ +250,633 +$ +(408,831 +) +____________________________________________ +(1) +Gas derivative settlements for the year ended December 31, 2015, include $15.3 million of early settlements of futures contracts as a result of divesting assets in the Company’s Mid-Continent region. +Credit Related Contingent Features +As of December 31, 2017, and through the filing of this report, all of the Company’s derivative counterparties were members of the Company’s credit facility lender group. The Company’s obligations under its Credit Agreement and derivative contracts are secured by mortgages on assets having a value equal to at least 90 percent of the total PV-9 of the Company’s proved oil and gas properties evaluated in the most recent reserve report. +Note 11 – Fair Value Measurements +The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• +Level 1 – quoted prices in active markets for identical assets or liabilities +• +Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +• +Level 3 – significant inputs to the valuation model are unobservable +118 +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2017 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +104,628 +$ +— +Liabilities: +Derivatives (1) +$ +— +$ +243,984 +$ +— +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2016 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +122,096 +$ +— +Total property and equipment, net (2) +$ +— +$ +— +$ +88,205 +Liabilities: +Derivatives (1) +$ +— +$ +213,804 +$ +— +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +(2) +This represents a non-financial asset that is measured at fair value on a nonrecurring basis. +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivatives. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit-price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The commodity derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. All of the Company’s commodity derivative counterparties are members of the Company’s credit facility lender group. +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any commodity derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current credit facility margins, and any change in such margins since the last measurement date. +119 +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and with other marketplace participants, the Company recognizes that third-parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Refer to Note 10 – Derivative Financial Instruments for more information regarding the Company’s commodity derivative instruments. +Proved and Unproved Oil and Gas Properties and Other Property and Equipment +Proved oil and gas properties . Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique, which converts future cash flow amounts to a single present value amount, to measure the fair value of proved properties through an application of discount rates and price forecasts representative of the current operating environment, as selected by the Company’s management. The calculation of the discount rates is based on the best information available and the rates used ranged from 10 percent to 15 percent based on the reservoir specific weightings of future estimated proved and unproved cash flows as of December 31, 2017 , and 2016 . The Company believes the discount rates are representative of current market conditions and consider estimates of future cash payments, reserve categories, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk. The prices for oil and gas are forecast based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecast using OPIS pricing, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. +The Company did not recognize any material impairment of proved properties expense for the year ended December 31, 2017 . The Company recorded impairment of proved properties expense of $354.6 million for the year ended December 31, 2016 , related primarily to the decline in expected reserve cash flows for the Company’s outside-operated Eagle Ford shale assets driven by commodity price declines during the first quarter of 2016, and downward performance reserve revisions in the fourth quarter of 2016 for the Company’s Powder River Basin assets. The Company recorded impairment of proved properties expense of $468.7 million for the year ended December 31, 2015 , related primarily to the decline in expected reserve cash flows driven by commodity price declines recorded mainly in the Company’s East Texas and Powder River Basin programs with smaller impacts on other legacy and non-core assets in the Rocky Mountain region. +Unproved oil and gas properties . Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by prospect and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and the Company’s intent to renew leases. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +The following table presents abandonment and impairment of unproved properties expense recorded for the periods presented: +For the Years Ended December 31, +2017 +2016 +2015 +(in millions) +Abandonment and impairment of unproved properties +$ +12.3 +$ +80.4 +$ +78.6 +Abandonment and impairment of unproved properties expense recorded during the year ended December 31, 2017 , related primarily to lease expirations. During the year ended December 31, 2016 , abandonment and impairment expense related primarily to a decrease in the fair value of the Company’s unproved Powder River Basin properties due to downward performance reserve revisions and lower market prices based on third-party acreage transactions. During the year ended +120 +December 31, 2015 , abandonment and impairment expense resulted from lease expirations and acreage the Company no longer intended to develop in light of changes in drilling plans in response to the decline in commodity prices. +Other property and equipment . Other property and equipment costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. To measure the fair value of other property and equipment, the Company uses an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. The valuation includes consideration of the proved and unproved assets supported by the property and equipment, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. During the year ended December 31, 2015 , the Company recorded impairment of other property and equipment expense of $49.4 million on the Company’s gathering system assets in its east Texas program. These assets were impaired in conjunction with the impairment of the associated proved and unproved properties, which the Company did not intend to develop and subsequently sold. There were no other property and equipment impairments in 2017 or 2016. +Oil and gas properties held for sale . Proved and unproved oil and gas properties classified as held for sale, including the corresponding asset retirement obligation liability, are valued using a market approach, based on an estimated net selling price, as evidenced by the most current bid prices received from third-parties, if available. If an estimated selling price is not available, the Company utilizes the various income valuation techniques discussed above. Any initial write-down and subsequent changes to the fair value less estimated cost to sell is included within the net gain (loss) on divestiture activity line item in the accompanying statements of operations. +There were no assets held for sale recorded at fair value as of December 31, 2017 , or 2016 , as the carrying values were below the estimated fair values less costs to sell. However, for the year ended December 31, 2017, the Company recorded a $526.5 million write-down on its Divide County, North Dakota assets which were held for sale in early 2017. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional discussion. +Acquisitions of proved and unproved properties . Assets acquired and liabilities assumed under transactions that meet the criteria of a business combination under ASC Topic 805, Business Combinations are recorded at fair value on the acquisition date using an income valuation technique based on inputs that are not observable in the market and therefore represent Level 3 inputs. Significant inputs to the valuation of acquired oil and gas properties include estimates of: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgments and estimates by the Company’s management at the time of the valuation. +Assets acquired and liabilities assumed under transactions that do not meet the criteria of a business combination under ASC Topic 805, Business Combinations are accounted for as an asset acquisition and are recorded based on the fair value of the total consideration transferred on the acquisition date using the lowest observable inputs available. In connection with the QStar Acquisition, the Company issued approximately 13.4 million shares of common stock as a component of the total consideration transferred to the sellers on December 21, 2016. Fair value of the equity consideration transferred was based on the closing price of the Company’s common stock on the date of acquisition, as adjusted using an option pricing model to account for the lack of marketability of the shares issued. +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional discussion. +121 +Long-Term Debt +The following table reflects the fair value of the Senior Notes and Senior Convertible Notes measured using Level 1 inputs based on quoted secondary market trading prices. These notes were not presented at fair value on the accompanying balance sheets as of December 31, 2017 , or 2016 , as they are recorded at carrying value, net of any unamortized discounts and deferred financing costs. Please refer to Note 5 – Long-Term Debt for additional discussion. +As of December 31, +2017 +2016 +Principal Amount +Fair Value +Principal Amount +Fair Value +(in thousands) +6.50% Senior Notes due 2021 +$ +344,611 +$ +351,682 +$ +346,955 +$ +354,546 +6.125% Senior Notes due 2022 +$ +561,796 +$ +571,627 +$ +561,796 +$ +570,925 +6.50% Senior Notes due 2023 +$ +394,985 +$ +403,434 +$ +394,985 +$ +403,134 +5.0% Senior Notes due 2024 +$ +500,000 +$ +483,440 +$ +500,000 +$ +475,975 +5.625% Senior Notes due 2025 +$ +500,000 +$ +494,355 +$ +500,000 +$ +485,000 +6.75% Senior Notes due 2026 +$ +500,000 +$ +516,350 +$ +500,000 +$ +516,565 +1.50% Senior Convertible Notes due 2021 +$ +172,500 +$ +168,291 +$ +172,500 +$ +202,189 +The carrying value of the Company’s credit facility approximates its fair value, as the applicable interest rates are floating, based on prevailing market rates. +Note 12 – Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2017 , 2016 , and 2015 . The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Beginning balance +$ +19,846 +$ +11,952 +$ +43,589 +Additions to capitalized exploratory well costs pending the determination of proved reserves +49,446 +19,846 +11,952 +Divestitures +— +— +(809 +) +Reclassifications to wells, facilities, and equipment based on the determination of proved reserves +(19,846 +) +(11,952 +) +(18,485 +) +Capitalized exploratory well costs charged to expense +— +— +(24,295 +) +Ending balance +$ +49,446 +$ +19,846 +$ +11,952 +As of December 31, 2017 , there were no exploratory well costs that were capitalized for more than one year. +122 +Note 13 – Equity +On August 12, 2016 , the Company completed an underwritten public offering of approximately 18.4 million shares of its common stock at an offering price of $30.00 per share. Net proceeds from the offering totaled $530.9 million , after deducting underwriting discounts and commissions and offering expenses, which the Company used to partially fund the Rock Oil Acquisition that closed during the fourth quarter of 2016. +On December 7, 2016 , the Company completed an underwritten public offering of approximately 10.9 million shares of its common stock at an offering price of $38.25 per share. Net proceeds from the offering totaled $403.2 million , after deducting underwriting discounts and commissions and offering expenses, which the Company used to partially fund the QStar Acquisition that also closed during the fourth quarter of 2016. +The Company’s 2016 public equity offerings were made pursuant to an effective shelf registration statement on Form S-3 filed with the SEC. +On December 21, 2016, and as part of the QStar Acquisition, the Company issued approximately 13.4 million shares of its common stock valued at approximately $437.2 million in a private placement to the sellers as partial consideration for the acquired properties. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional discussion. +The Company did not conduct any equity offerings during 2017. +Supplemental Oil and Gas Information (unaudited) +Costs Incurred in Oil and Gas Producing Activities +Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Development costs (1) +$ +675,523 +$ +595,331 +$ +1,234,114 +Exploration costs +271,502 +118,224 +132,465 +Acquisitions (2) +Proved properties +1,602 +201,672 +10,040 +Unproved properties (3) +91,420 +2,458,667 +18,382 +Total, including asset retirement obligations (4)(5) +$ +1,040,047 +$ +3,373,894 +$ +1,395,001 +____________________________________________ +(1) +Includes facility costs of $43.8 million , $25.9 million , and $75.6 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +(2) +Balances at December 31, 2016 , include $437.2 million of value attributed to the equity consideration given to the sellers of the assets acquired in the QStar Acquisition. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional discussion. +(3) +Includes amounts related to leasing activity outside of acquisitions of proved and unproved properties totaling $12.8 million , $7.5 million , and $17.5 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +(4) +Includes amounts relating to estimated asset retirement obligations of $13.6 million , $32.1 million , and $38.5 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +(5) +Includes capitalized interest of $12.6 million , $17.0 million , and $25.1 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting of reserve estimation and disclosure. +123 +Proved reserves are the estimated quantities of oil, gas, and NGLs, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated proved reserves are located in the United States. +The table below presents a summary of changes in the Company’s estimated proved reserves for each of the years in the three-year period ended December 31, 2017 . The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company’s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +For the Years Ended December 31, +2017 (1) +2016 (2) +2015 (3) +Oil +Gas +NGLs +Oil +Gas +NGLs +Oil +Gas +NGLs +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +Total proved reserves: +Beginning of year +104.9 +1,111.1 +105.7 +145.3 +1,264.0 +115.4 +169.7 +1,466.5 +133.5 +Revisions of previous estimate +1.0 +63.8 +4.9 +(36.0 +) +(249.8 +) +(18.6 +) +(46.2 +) +(369.6 +) +(40.6 +) +Discoveries and extensions +11.5 +21.9 +— +7.8 +42.5 +4.1 +16.9 +122.3 +9.3 +Infill reserves in an existing proved field +79.0 +347.4 +22.9 +32.3 +228.1 +18.9 +24.9 +356.2 +29.7 +Sales of +reserves (4) +(25.3 +) +(143.8 +) +(26.7 +) +(40.0 +) +(46.7 +) +— +(1.9 +) +(138.4 +) +(0.4 +) +Purchases of minerals in place (4) +0.8 +2.7 +— +12.1 +19.9 +0.1 +1.1 +0.6 +— +Production +(13.7 +) +(123.0 +) +(10.3 +) +(16.6 +) +(146.9 +) +(14.2 +) +(19.2 +) +(173.6 +) +(16.1 +) +End of year +158.2 +1,280.1 +96.5 +104.9 +1,111.1 +105.7 +145.3 +1,264.0 +115.4 +Proved developed reserves: +Beginning of year +48.5 +609.1 +58.6 +75.6 +644.4 +61.5 +89.3 +784.6 +66.7 +End of year +58.6 +642.9 +49.0 +48.5 +609.1 +58.6 +75.6 +644.4 +61.5 +Proved undeveloped reserves: +Beginning of year +56.4 +502.0 +47.1 +69.6 +619.7 +53.9 +80.4 +682.0 +66.8 +End of year +99.6 +637.2 +47.6 +56.4 +502.0 +47.1 +69.6 +619.7 +53.9 +____________________________________________ +Note: Amounts may not calculate due to rounding. +124 +(1) +For the year ended December 31, 2017 , the Company added 175.0 MMBOE from its drilling program. The Company sold 76.0 MMBOE during 2017 including 72.5 MMBOE related to its outside-operated Eagle Ford shale assets which were sold in the first quarter of 2017. +(2) +For the year ended December 31, 2016 , the Company added 108.2 MMBOE from its drilling program and acquired 15.5 MMBOE. These additions were offset by net negative engineering revisions of 96.2 MMBOE, consisting of 18.1 MMBOE of negative performance revisions, a 35.1 MMBOE negative price revision, and the removal of 43.0 MMBOE of certain longer term proved undeveloped reserves reflecting the Company’s shift to develop its predominately unproven Midland Basin properties. Additionally, the Company sold 47.7 MMBOE during 2016. +(3) +For the year ended December 31, 2015 , the Company added 160.6 MMBOE from its drilling program, the majority of which related to activity in the Eagle Ford shale and Bakken/Three Forks resource plays. The Company had net negative engineering revisions of 148.6 MMBOE, consisting of 47.3 MMBOE of positive performance revisions in the Eagle Ford shale and Bakken/Three Forks resource plays resulting from enhanced completions and reductions in operating expenses, offset by a 116.5 MMBOE negative price revision due to the decline in commodity prices in 2015 and the removal of 79.4 MMBOE of proved undeveloped reserves due to the five-year rule. Additionally, the Company sold 25.4 MMBOE in 2015. +(4) +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional information. +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of future net cash flows (“Standardized Measure”) and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes, which include the effects of the 2017 Tax Act, are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the estimated proved reserves in place at the end of the period using year end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities. +The assumptions used to compute the Standardized Measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the Standardized Measure computations since these reserve quantity estimates are the basis for the valuation process. The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the Standardized Measure: +For the Years Ended December 31, +2017 +2016 +2015 +Oil (per Bbl) +$ +48.57 +$ +37.22 +$ +42.98 +Gas (per Mcf) +$ +3.20 +$ +2.45 +$ +2.48 +NGLs (per Bbl) +$ +23.33 +$ +16.38 +$ +16.99 +125 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the Standardized Measure. +As of December 31, +2017 +2016 +2015 +(in thousands) +Future cash inflows +$ +14,035,704 +$ +8,359,938 +$ +11,337,865 +Future production costs +(5,594,226 +) +(4,634,649 +) +(6,234,687 +) +Future development costs +(2,638,459 +) +(1,636,077 +) +(2,005,599 +) +Future income taxes (1) +(205,694 +) +— +— +Future net cash flows +5,597,325 +2,089,212 +3,097,579 +10 percent annual discount +(2,573,183 +) +(937,099 +) +(1,307,053 +) +Standardized measure of discounted future net cash flows +$ +3,024,142 +$ +1,152,113 +$ +1,790,526 +___________________________________________ +(1) +Regarding the calculations as of December 31, 2016, and 2015, after evaluating all factors and giving effect to tax basis, future tax deductions, and available tax credits, the Company determined that at price levels for each respective period, future net cash flows would not be subject to federal or state income tax for the projected life of the reserves under authoritative tax legislation. +The principle sources of changes in the Standardized Measure were: +For the Years Ended December 31, +2017 +2016 +2015 +(in thousands) +Standardized Measure, beginning of year +$ +1,152,113 +$ +1,790,526 +$ +5,698,783 +Sales of oil, gas, and NGLs produced, net of production costs +(745,877 +) +(580,861 +) +(776,272 +) +Net changes in prices and production costs +1,181,447 +(315,725 +) +(4,709,908 +) +Extensions, discoveries and other including infill reserves in an existing proved field, net of related costs +1,638,734 +242,556 +386,069 +Sales of reserves in place +(226,528 +) +(377,607 +) +(262,210 +) +Purchase of reserves in place +12,032 +115,270 +4,686 +Previously estimated development costs incurred during the period +121,879 +290,837 +449,738 +Changes in estimated future development costs +(116,609 +) +27,961 +191,447 +Revisions of previous quantity estimates +103,916 +(124,845 +) +(1,819,639 +) +Accretion of discount +115,211 +179,050 +761,746 +Net change in income taxes +(32,426 +) +— +1,918,670 +Changes in timing and other +(179,750 +) +(95,049 +) +(52,584 +) +Standardized Measure, end of year +$ +3,024,142 +$ +1,152,113 +$ +1,790,526 +126 +Quarterly Financial Information (unaudited) +The Company’s quarterly financial information for fiscal years 2017 and 2016 is as follows (in thousands, except per share data): +First +Second +Third +Fourth +Quarter +Quarter +Quarter +Quarter +Year Ended December 31, 2017 (2) +Total operating revenues and other income +$ +372,738 +$ +120,721 +$ +295,379 +$ +340,538 +Total operating expenses +207,145 +268,359 +380,971 +441,390 +Income (loss) from operations +$ +165,593 +$ +(147,638 +) +$ +(85,592 +) +$ +(100,852 +) +Income (loss) before income taxes +$ +118,940 +$ +(190,968 +) +$ +(128,382 +) +$ +(143,403 +) +Net income (loss) +$ +74,434 +$ +(119,907 +) +$ +(89,112 +) +$ +(26,258 +) +Basic net income (loss) per common share (1) +$ +0.67 +$ +(1.08 +) +$ +(0.80 +) +$ +(0.24 +) +Diluted net income (loss) per common share (1) +$ +0.67 +$ +(1.08 +) +$ +(0.80 +) +$ +(0.24 +) +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +Year Ended December 31, 2016 (3) +Total operating revenues and other income +$ +143,076 +$ +341,814 +$ +352,660 +$ +379,900 +Total operating expenses +669,801 +572,363 +370,314 +664,287 +Loss from operations +$ +(526,725 +) +$ +(230,549 +) +$ +(17,654 +) +$ +(284,387 +) +Loss before income taxes +$ +(542,085 +) +$ +(264,579 +) +$ +(64,639 +) +$ +(330,613 +) +Net loss +$ +(347,210 +) +$ +(168,681 +) +$ +(40,907 +) +$ +(200,946 +) +Basic net loss per common share (1) +$ +(5.10 +) +$ +(2.48 +) +$ +(0.52 +) +$ +(2.20 +) +Diluted net loss per common share (1) +$ +(5.10 +) +$ +(2.48 +) +$ +(0.52 +) +$ +(2.20 +) +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +During the first quarter of 2017, the Company recorded a $37.5 million net pre-tax gain on divestiture activity related to the sale of the Company’s outside-operated Eagle Ford shale assets partially offset by a write-down of the Company’s Divide County, North Dakota assets, which were previously classified as held for sale. During the second quarter of 2017, the Company recorded a $167.1 million net pre-tax loss on divestiture activity related primarily to an additional write-down of the Company’s retained Divide County, North Dakota assets upon reclassification as assets held for use (see Note 3 – Divestitures, Assets Held for Sale, and Acquisitions ). For the first, second, third, and fourth quarters of 2017, the Company recorded a $114.8 million net derivative gain, a $55.2 million net derivative gain, an $80.6 million net derivative loss, and a $115.8 million net derivative loss, respectively (see Note 10 – Derivative Financial Instruments ). +(3) +First quarter of 2016 included the following: +• +$272.1 million of proved and unproved property impairments on the Company’s outside-operated Eagle Ford shale assets due to declining commodity prices (see Note 11 – Fair Value Measurements ) +• +$69.0 million net pre-tax loss on divestiture activity related to write-downs on certain non-core assets held for sale (see Note 3 – Divestitures, Assets Held for Sale, and Acquisitions ) +• +$14.2 million net derivative gain (see Note 10 – Derivative Financial Instruments ) +• +$15.7 million net gain on the repurchase of a portion of the Company’s Senior Notes (see Note 5 – Long-Term Debt ) +Second quarter of 2016 included the following: +• +$50.0 million net pre-tax gain on divestiture activity related to an increase in fair value less costs to sell on assets held for sale (see Note 3 – Divestitures, Assets Held for Sale, and Acquisitions ) +• +$163.4 million net derivative loss (see Note 10 – Derivative Financial Instruments ) +Third quarter of 2016 included the following: +• +$11.6 million of proved and unproved property impairments (see Note 11 – Fair Value Measurements ) +• +$22.4 million net pre-tax gain on divestiture activity upon closing divestitures in the Company’s Rocky Mountain and Permian regions (see Note 3 – Divestitures, Assets Held for Sale, and Acquisitions ) +• +$28.0 million net derivative gain (see Note 10 – Derivative Financial Instruments ) +127 +Fourth quarter of 2016 included the following: +• +$151.2 million of proved and unproved property impairments related primarily to negative performance revisions on the Company’s Powder River Basin assets (see Note 11 – Fair Value Measurements ) +• +$33.7 million net pre-tax gain on divestiture activity upon closing the Raven/Bear Den divestiture (see Note 3 – Divestitures, Assets Held for Sale, and Acquisitions ) +• +$129.5 million net derivative loss (see Note 10 – Derivative Financial Instruments +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +128 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2017 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +129 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes and our report dated February 21, 2018 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 21, 2018 +130 +ITEM 9B. OTHER INFORMATION +None. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning the Company’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about Executive Officers,” and “Corporate Governance” in the Company’s definitive proxy statement for the 2018 annual meeting of stockholders to be filed within 120 days from December 31, 2017 . +The information required by this Item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the information provided under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement for the 2018 annual meeting of stockholders to be filed within 120 days from December 31, 2017 . +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation” and “Director Compensation” in the Company’s definitive proxy statement for the 2018 annual meeting of stockholders to be filed within 120 days from December 31, 2017 . +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s definitive proxy statement for the 2018 annual meeting of stockholders to be filed within 120 days from December 31, 2017 . +131 +Securities Authorized for Issuance Under Equity Compensation Plans. The Company has the Equity Plan under which options and shares of the Company’s common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. The Company’s stockholders have approved this plan. See Note 7 – Compensation Plans included in Part II, Item 8 of this report for further information about the material terms of the Company’s equity compensation plans. The following table is a summary of the shares of common stock authorized for issuance under equity compensation plans as of December 31, 2017 : +(a) +(b) +(c) +Plan category +Number of securities to be issued upon exercise of outstanding options, warrants, and rights +Weighted-average exercise price of outstanding options, warrants, and rights +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan +Stock options and incentive stock options (1) +— +$ +— +Restricted stock units (1)(2) +1,253,056 +N/A +Performance share units (1)(2)(3) +1,560,202 +N/A +Total for Equity Incentive Compensation Plan +2,813,258 +$ +— +3,277,107 +Employee Stock Purchase Plan (4) +— +— +1,813,335 +Equity compensation plans not approved by security holders +— +— +— +Total for all plans +2,813,258 +$ +— +5,090,442 +____________________________________________ +(1) +In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of the Company or any affiliate of the Company. The Company’s Board of Directors approved amendments to the Equity Plan in 2009, 2010, 2013, and 2016 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The number of shares of the Company’s common stock underlying awards granted in 2017 , 2016 , and 2015 under the Equity Plan were 2,078,878 , 918,509 , and 716,902 , respectively. +(2) +RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per unit fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per unit fair value for the outstanding RSUs and PSUs was $20.24 and $23.29, respectively. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for additional discussion. +(3) +The number of awards vested assumes a one multiplier. The final number of shares of the Company’s common stock issued upon settlement may vary depending on the three -year multiplier determined at the end of the performance period under the Equity Plan, which ranges from zero to two . +(4) +Under the ESPP, eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their eligible compensation. The purchase price of the common stock is 85 percent of the lower of the fair market value of the common stock on the first or last day of the six-month offering period, and shares issued under the ESPP on or after December 31, 2011, have no minimum restriction period. The ESPP is intended to qualify under Section 423 of the IRC. The number of shares of the Company’s common stock issued in 2017 , 2016 , and 2015 under the ESPP were 186,665 , 218,135 , and 197,214 , respectively. +132 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “Certain Relationships and Related Transactions” and “Corporate Governance” in the Company’s definitive proxy statement for the 2018 annual meeting of stockholders to be filed within 120 days from December 31, 2017 . +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “Independent Registered Public Accounting Firm” and “Audit Committee Preapproval Policy and Procedures” in the Company’s definitive proxy statement for the 2018 annual meeting of stockholders to be filed within 120 days from December 31, 2017 . +133 +PART IV +ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Consolidated Financial Statements and Financial Statement Schedules: +Report of Independent Registered Public Accounting Firm +78 +Consolidated Balance Sheets +79 +Consolidated Statements of Operations +80 +Consolidated Statements of Comprehensive Income (Loss) +81 +Consolidated Statements of Stockholders’ Equity +82 +Consolidated Statements of Cash Flows +83 +Notes to Consolidated Financial Statements +85 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +1.1 +Underwriting Agreement dated May 7, 2015, among SM Energy Company, and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner, & Smith Incorporated and J.P. Morgan Securities LLC, as representatives of the several underwriters (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on May 8, 2015, and incorporated herein by reference) +1.2 +Underwriting Agreement dated August 8, 2016 by and among SM Energy Company and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and J.P. Morgan Securities LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +1.3 +Underwriting Agreement dated August 8, 2016 by and among SM Energy Company and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and J.P. Morgan Securities LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +1.4 +Underwriting Agreement dated September 7, 2016 by and among SM Energy Company and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Wells Fargo Securities, LLC, and J.P. Morgan Securities LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +1.5 +Underwriting Agreement, dated December 1, 2016, by and among SM Energy Company and J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wells Fargo Securities, LLC, as representatives of the several underwriters named therein (filed as Exhibit 1.1 to the registrant’s Current Report on Form 8-K filed on December 7, 2016, and incorporated herein by reference) +2.1 +Membership Interest Purchase Agreement dated August 8, 2016 between SM Energy Company and Rock Oil Holdings LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on August 8, 2016, and incorporated herein by reference) +2.2 +Purchase and Sale Agreement, dated October 17, 2016, by and between SM Energy Company and QStar LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +2.3 +Letter Agreement dated October 17, 2016, by and among SM Energy Company, QStar LLC, and RRP-QStar, LLC (filed as Exhibit 2.2 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +2.4 +Purchase and Sale Agreement dated October 17, 2016, by and between SM Energy Company and Oasis Petroleum North America LLC (filed as Exhibit 2.3 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +134 +2.5 +Membership Interest Purchase Agreement dated January 1, 2017 between SM Energy Company and Venado EF LLC (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, and incorporated herein by reference) +2.6 +Second Amendment to Membership Interest Purchase Agreement dated March 4, 2017 between SM Energy and Venado EF L.P. (filed as Exhibit 2.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, and incorporated herein by reference) +2.7 +Purchase and Sale Agreement dated January 8, 2018 by and between SM Energy Company and Converse Energy Acquisitions, LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on January 11, 2018 and incorporated herein by reference) +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +3.2 +Amended and Restated By-Laws of SM Energy Company, effective as of February 21, 2017 (filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +4.1 +Indenture related to the 6.50% Senior Notes due 2021, dated November 8, 2011, by and among SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 10, 2011, and incorporated herein by reference) +4.2 +Indenture related to the 6.50% Senior Notes due 2023, dated June 29, 2012, between SM Energy Company, as Issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on July 3, 2012, and incorporated herein by reference) +4.3 +Indenture related to the 5.0% Senior Notes due 2024, dated May 20, 2013, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on May 20, 2013, and incorporated herein by reference) +4.4 +Indenture related to the 6.125% Senior Notes due 2022, dated November 17, 2014, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 18, 2014, and incorporated herein by reference) +4.5 +Indenture related to senior debt securities of SM Energy Company by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-3 filed on May 7, 2015 (Registration No. 333-203936) and incorporated herein by reference) +4.6 +2025 Notes Supplemental Indenture (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on May 21, 2015, and incorporated herein by reference) +4.7 +Base Indenture, dated as of May 21, 2015, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.8 +Second Supplemental Indenture, dated August 12, 2016, by and between SM Energy Company and U.S. Bank, National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.9 +Third Supplemental Indenture, dated September 12, 2016 by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +4.10† +Equity Incentive Compensation Plan, amended and restated effective May 24, 2016 (filed as Exhibit 4.3 to the registrant’s Form S-8 filed on June 30, 2016, and incorporated herein by reference) +4.11 +Lock-Up and Registration Rights Agreement, dated December 21, 2016, by and among SM Energy Company, QStar LLC and RRP-QStar, LLC (filed as Exhibit 4.13 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +10.1 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.2 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.3† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +135 +10.4*** +Gas Services Agreement effective as of July 1, 2010 between SM Energy Company and Eagle Ford Gathering LLC (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, and incorporated herein by reference) +10.5†† +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.6† +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.7+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of November 9, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.8 +Gas Gathering Agreement dated May 31, 2011 between Regency Field Services LLC and SM Energy Company (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.9 +Gathering and Natural Gas Services Agreement effective as of April 1, 2011 between SM Energy Company and ETC Texas Pipeline, Ltd. (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.10 +Gas Processing Agreement effective as of April 1, 2011 between ETC Texas Pipeline, Ltd. and SM Energy Company (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.11† +Employee Stock Purchase Plan, As Amended and Restated as of June 10, 2011 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.12† +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.13† +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.14† +Equity Incentive Compensation Plan, As Amended as of May 22, 2013 (filed as Annex A to the registrant’s Schedule 14A filed on April 11, 2013, and incorporated herein by reference) +10.15 +Fifth Amended and Restated Credit Agreement dated April 12, 2013, among SM Energy Company, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on April 15, 2013, and incorporated herein by reference) +10.16† +Form of Performance Stock Unit Award Agreement as of July 31, 2013 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, and incorporated herein by reference) +10.17† +Form of Restricted Stock Unit Award Agreement as of July 31, 2013 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, and incorporated herein by reference) +10.18† +Performance Stock Unit Award Agreement as of July 1, 2016 (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.19† +Restricted Stock Unit Award Agreement as of July 1, 2016 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.20† +Non-Employee Director Restricted Stock Award Agreement as of May 25, 2016 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.21† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.22† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.23† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.24*† +Summary of Compensation Arrangements for Non-Employee Directors +136 +10.25 +Second Amendment to the Fifth Amended and Restated Credit Agreement dated December 10, 2014, among SM Energy Company, as Borrower, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on December 16, 2014, and incorporated herein by reference) +10.26 +Third Amendment to Fifth Amended and Restated Credit Agreement, dated May 20, 2015, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 27, 2015, and incorporated herein by reference) +10.27 +Fourth Amendment to Fifth Amended and Restated Credit Agreement, dated October 7, 2015, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 8, 2015, and incorporated herein by reference) +10.28 +Fifth Amendment to Fifth Amended and Restated Credit Agreement, dated November 11, 2015, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on November 11, 2015, and incorporated herein by reference) +10.29 +Sixth Amendment to Fifth Amended and Restated Credit Agreement, dated April 8, 2016, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on April 13, 2016, and incorporated herein by reference) +10.30 +Seventh Amendment to Fifth Amended and Restated Credit Agreement, dated August 8, 2016, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on August 9, 2016, and incorporated herein by reference) +10.31 +Eighth Amendment to Fifth Amended and Restated Credit Agreement, dated September 30, 2016, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 6, 2016 and incorporated herein by reference) +10.32 +Ninth Amendment to Fifth Amended and Restated Credit Agreement, dated March 31, 2017, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on April 3, 2017 and incorporated herein by reference) +10.33† +Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 20, 2015, and incorporated herein by reference) +10.34† +Amendment No. 3 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2016 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2015, and incorporated herein by reference) +10.35*** +Amendment to Amended and Restated Gas Gathering Agreement, effective as of September 1, 2015, by and between SM Energy Company and Regency Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on September 15, 2015, and incorporated herein by reference) +10.36 +Amendment to Amended and Restated Gas Gathering Agreement, effective as of February 1, 2016, by and between SM Energy Company and ETC Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on February 22, 2016, and incorporated herein by reference) +10.37 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.38 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.39 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.40 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.41 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.5 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +137 +10.42 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.6 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.43† +SM Energy Company Employee Stock Purchase Plan, amended and restated effective as of April 6, 2017 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 13, 2017, and incorporated herein by reference) +12.1* +Computation of Ratio of Earnings to Fixed Charges +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Ryder Scott Company L.P. +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +99.1* +Ryder Scott Audit Letter +101.INS* +XBRL Instance Document +101.SCH* +XBRL Schema Document +101.CAL* +XBRL Calculation Linkbase Document +101.LAB* +XBRL Label Linkbase Document +101.PRE* +XBRL Presentation Linkbase Document +101.DEF* +XBRL Taxonomy Extension Definition Linkbase Document +* Filed with this report. +** Furnished with this report. +*** +Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Exchange Act. +† +Exhibit constitutes a management contract or compensatory plan or agreement. +†† +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. See Item 15(a) above. +ITEM 16. FORM 10-K SUMMARY +None. +138 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: +February 21, 2018 +By: +/s/ JAVAN D. OTTOSON +Javan D. Ottoson +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Javan D. Ottoson and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2017 , and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ JAVAN D. OTTOSON +President, Chief Executive Officer, and Director +February 21, 2018 +Javan D. Ottoson +(Principal Executive Officer) +/s/ A. WADE PURSELL +Executive Vice President and Chief Financial Officer +February 21, 2018 +A. Wade Pursell +(Principal Financial Officer) +/s/ MARK T. SOLOMON +Vice President - Controller and Assistant Secretary +February 21, 2018 +Mark T. Solomon +(Principal Accounting Officer) +139 +Signature +Title +Date +/s/ WILLIAM D. SULLIVAN +Chairman of the Board of Directors +February 21, 2018 +William D. Sullivan +/s/ LARRY W. BICKLE +Director +February 21, 2018 +Larry W. Bickle +/s/ STEPHEN R. BRAND +Director +February 21, 2018 +Stephen R. Brand +/s/ LOREN M. LEIKER +Director +February 21, 2018 +Loren M. Leiker +/s/ RAMIRO G. PERU +Director +February 21, 2018 +Ramiro G. Peru +/s/ JULIO M. QUINTANA +Director +February 21, 2018 +Julio M. Quintana +/s/ ROSE M. ROBESON +Director +February 21, 2018 +Rose M. Robeson +140 \ No newline at end of file diff --git a/raw/filings/0000893538/2017/0000893538-18-000005/filing_metadata.csv b/raw/filings/0000893538/2017/0000893538-18-000005/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..e33a632bad8a3ee9a7adfc85d312e94995d373c6 --- /dev/null +++ b/raw/filings/0000893538/2017/0000893538-18-000005/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2018-02-21,2017-12-31,2018-02-21T22:05:41.000Z,0000893538-18-000005,sm-20171231x10k.htm,10-K,16730687,1,0,https://www.sec.gov/Archives/edgar/data/893538/000089353818000005/sm-20171231x10k.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353818000005/,2017,2017,1 diff --git a/raw/filings/0000893538/2017/0000893538-18-000005/item1.txt b/raw/filings/0000893538/2017/0000893538-18-000005/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2017/0000893538-18-000005/item13.txt b/raw/filings/0000893538/2017/0000893538-18-000005/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..6fddd649b76e924dae59a1c871f1c3595b6851c5 --- /dev/null +++ b/raw/filings/0000893538/2017/0000893538-18-000005/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “Certain Relationships and Related Transactions” and “Corporate Governance” in the Company’s definitive proxy statement for the 2018 annual meeting of stockholders to be filed within 120 days from December 31, 2017 . \ No newline at end of file diff --git a/raw/filings/0000893538/2017/0000893538-18-000005/item9a.txt b/raw/filings/0000893538/2017/0000893538-18-000005/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..dd09063016626547a93e290d6dbc27c39b94ace8 --- /dev/null +++ b/raw/filings/0000893538/2017/0000893538-18-000005/item9a.txt @@ -0,0 +1,37 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +128 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2017 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +129 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes and our report dated February 21, 2018 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 21, 2018 +130 \ No newline at end of file diff --git a/raw/filings/0000893538/2017/0000893538-18-000005/rp_note.txt b/raw/filings/0000893538/2017/0000893538-18-000005/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2017/0000893538-18-000005/rpt_disclosure.txt b/raw/filings/0000893538/2017/0000893538-18-000005/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..f9cb1a608706e9334b2fe90573d516f43070f535 --- /dev/null +++ b/raw/filings/0000893538/2017/0000893538-18-000005/rpt_disclosure.txt @@ -0,0 +1,32 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee's review of any transaction, arrangement, +or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, (b) the +aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of our Related +Person Transactions Policy, a "related person" means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more than 5% of +our outstanding shares of common stock, and (iii) any immediate family member of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it determines in +good faith are in, or are not inconsistent with, our best interests and the best interests of our stockholders. +In +determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among +others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director's independence in the event the related person is a director, and the extent +of the related person's interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in +compliance with the policy and remain appropriate. +In +addition, our By-Laws provide that a director, officer, or employee of our Company may not pursue for his or her own account a business or investment opportunity that he or she +learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than 1% of the publicly traded stock of another company. +Transactions with Related Persons +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are consistent +with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when the Board, acting through the Audit Committee or as otherwise +described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, but are not +limited to, situations where we may obtain products +or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we obtain products or services from, or provide products or services to, +related persons on an arm's length basis on terms comparable to those obtained from or provided to unrelated third parties or on terms comparable to those obtained from or provided to employees +generally. With the exception of the transaction described in the following paragraph, which was approved by our Audit Committee, we had no transactions that required approval under our Related Person +Transactions Policy. +Dean +Lutey, the spouse of Ms. Lutey, our Senior Vice President and Regional Manager, joined the Company in 2008 and has been the Vice President—Information Technology +of the Company since May 2013. During the fiscal year ended December 31, 2018, he earned total compensation of $674,022, which included his base salary, annual bonus, LTIP awards, benefits +under our qualified and non-qualified benefit plans, and matching contributions by the Company under its 401(k) Profit Sharing Plan and Non-Qualified Deferred Compensation Plan. Mr. Lutey also +participated in the Company's benefit programs for its employees. +63 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000893538/2018/0000893538-19-000012/filing.txt b/raw/filings/0000893538/2018/0000893538-19-000012/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..0b6db2c3e395e2130dd772ac1cbb50c10655c56a --- /dev/null +++ b/raw/filings/0000893538/2018/0000893538-19-000012/filing.txt @@ -0,0 +1,7965 @@ +10-K +1 +sm-20181231x10k.htm +10-K +Document +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +For the fiscal year ended December 31, 2018 +or +o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +Commission file number 001-31539 +SM ENERGY COMPANY +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of incorporation or organization) +41-0518430 +(I.R.S. Employer Identification No.) +1775 Sherman Street, Suite 1200, Denver, Colorado +(Address of principal executive offices) +80203 +(Zip Code) +(303) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +Common stock, $.01 par value +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer þ +Accelerated filer o +Non-accelerated filer o +Smaller reporting company o +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ +The aggregate market value of the 110,740,087 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock on June 29, 2018 , the last business day of the registrant’s most recently completed second fiscal quarter, of $25.69 per share, as reported on the New York Stock Exchange, was $2,844,912,835 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 7, 2019 , the registrant had 112,243,245 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III is incorporated by reference from portions of the registrant’s Definitive Proxy Statement on Schedule 14A relating to its 2019 annual meeting of stockholders to be filed within 120 days after December 31, 2018 . +1 +TABLE OF CONTENTS +ITEM +PAGE +PART I +4 +ITEMS 1. AND 2. +BUSINESS AND PROPERTIES +4 +General +4 +Strategy +4 +Significant Developments in 2018 +4 +Outlook for 2019 +5 +Areas of Operation +6 +Reserves +7 +Production +11 +Productive Wells +11 +Drilling and Completion Activity +12 +Acreage +13 +Delivery Commitments +13 +Major Customers +13 +Employees and Office Space +14 +Title to Properties +14 +Seasonality +14 +Competition +15 +Government Regulations +15 +Cautionary Information about Forward-Looking Statements +18 +Available Information +20 +Glossary of Oil and Gas Terms +20 +ITEM 1A. +RISK FACTORS +23 +ITEM 1B. +UNRESOLVED STAFF COMMENTS +39 +ITEM 3. +LEGAL PROCEEDINGS +39 +ITEM 4. +MINE SAFETY DISCLOSURES +39 +PART II +40 +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +40 +ITEM 6. +SELECTED FINANCIAL DATA +42 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +44 +Overview of the Company +44 +Financial Results of Operations and Additional Comparative Data +50 +Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 +53 +Overview of Liquidity and Capital Resources +58 +Critical Accounting Policies and Estimates +63 +Accounting Matters +65 +Environmental +66 +Non-GAAP Financial Measures +67 +2 +TABLE OF CONTENTS +(Continued) +ITEM +PAGE +ITEM 7A. +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (included within the content of ITEM 7) +69 +ITEM 8. +CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +70 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +117 +ITEM 9A. +CONTROLS AND PROCEDURES +118 +ITEM 9B. +OTHER INFORMATION +121 +PART III +121 +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +121 +ITEM 11. +EXECUTIVE COMPENSATION +121 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +122 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +123 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +123 +PART IV +124 +ITEM 15. +EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +124 +ITEM 16. +FORM 10-K SUMMARY +127 +3 +PART I +When we use the terms “SM Energy,” the “Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business under Glossary of Oil and Gas Terms . Throughout this document we make statements that may be classified as “forward-looking.” Please refer to the Cautionary Information about Forward-Looking Statements section of this document for an explanation of these types of statements. +ITEMS 1. AND 2. BUSINESS AND PROPERTIES +General +We are an independent energy company engaged in the development, production, exploration, and acquisition of crude oil and condensate, natural gas, and natural gas liquids (also respectively referred to as “oil,” “gas,” and “NGLs” throughout the document) in onshore North America. We were founded in 1908 and incorporated in Delaware in 1915. Our initial public offering of common stock was in December 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal office is located at 1775 Sherman Street, Suite 1200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +Our strategic objective is to be a premier operator of top tier assets. We pursue growth opportunities through both acquisitions and exploration, and we seek to maximize the value of our assets through industry leading technology and outstanding operational execution. We are focused on generating strong full-cycle economic returns on our investments and maintaining a strong balance sheet. +Significant Developments in 2018 +Reserves and Capital Investment. Our estimated proved reserves increased eight percent to 503.4 MMBOE at December 31, 2018 , from 468.1 MMBOE at December 31, 2017 . Reserve additions from discoveries, extensions, and infills were 188.0 MMBOE and were a result of our successful development programs, completion optimizations that resulted in improved well performance, and development plan improvements that we believe will enhance inventory value. These positive results for 2018 were partially offset by the divestiture of 40.3 MMBOE of estimated proved reserves, and net downward revisions of 68.8 MMBOE, which resulted primarily from changes in our development plans in our Eagle Ford shale program. On a retained asset basis, estimated proved reserves increased 18 percent year-over-year. Our proved reserve life index increased to 11.5 years as of December 31, 2018 , compared with 10.5 years as of December 31, 2017 . Costs incurred for development and exploration activities, excluding acquisitions, increased 41 percent from the prior year to $1.3 billion in 2018 . Please refer to Areas of Operation and Reserves below, and to the caption Oil and Gas Reserve Quantities in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report for additional discussion. +Production. Our average daily production in 2018 consisted of 51.4 MBbl of oil, 282.7 MMcf of gas, and 21.8 MBbl of NGLs, for an average net daily equivalent production rate of 120.3 MBOE, which represents a one percent decrease compared with 2017 . Our Permian region realized a 91 percent increase in production volumes during 2018, compared with 2017, as a result of ramping up development activities and realizing stronger than expected well results. Increased production volumes from our Permian region were offset by the divestiture of our remaining producing assets in the Rocky Mountain region in the first half of 2018 and decreased production volumes from our Eagle Ford shale assets as a result of reduced capital investment in this area. On a retained asset basis, our production volumes increased 11 percent in 2018. Please refer to Areas of Operation below for additional discussion. +Net Cash Provided by Operating Activities. Net cash provided by operating activities was $720.6 million for the year ended December 31, 2018 , compared with $515.4 million for the year ended December 31, 2017 , which was an increase of 40 percent year-over-year. The increase in net cash provided by operating activities for 2018 , compared with 2017 , was primarily the result of 37 percent growth in higher margin oil production, which, combined with increased benchmark pricing for oil and NGLs, drove a 32 percent increase in our realized price per BOE before the effects of derivative settlements, and led to a 31 percent increase in oil, gas, and NGL production revenue. Partially offsetting the increase from oil, gas, and NGL production revenue was a cash settlement loss on derivatives of $135.8 million for the year ended December 31, 2018 , compared to a cash settlement gain on derivatives of $21.2 million for 2017 . Please refer to Analysis of Cash Flow Changes Between 2018 and 2017 and Between 2017 and 2016 in Part II, Item 7 and Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Divestiture Activity . During the first quarter of 2018, we successfully completed the divestiture of our Powder River Basin assets (the “PRB Divestiture”) for total cash consideration, net of costs (referred to throughout this report as “net divestiture proceeds”) of $492.2 million and recorded a final net gain of $410.6 million . During the second quarter of 2018, we completed divestitures of our remaining assets in the Williston Basin located in Divide County, North Dakota (the “Divide County Divestiture”) and our non-operated Halff East assets in the Midland Basin (the “Halff East Divestiture”), for combined net divestiture proceeds of $252.2 million , and a final +4 +net gain of $15.4 million . Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +Long-Term Debt Reduction. During 2018 we completed multiple transactions that resulted in overall long-term debt reduction and extension of the average maturity date for our remaining long-term debt. Total principal outstanding for long-term debt decreased from $3.0 billion at year end 2017, to $2.6 billion at year end 2018, and was accomplished through the redemption of our 6.50% Senior Notes due 2021 (“2021 Senior Notes”) using cash proceeds from divestitures. We also successfully extended the average maturity of our remaining long-term debt obligations by issuing 6.625% Senior Notes due 2027 (“2027 Senior Notes”) and using the net proceeds from this issuance to repurchase our 6.50% Senior Notes due 2023 (“2023 Senior Notes”) and a portion of our 6.125% Senior Notes due 2022 (“2022 Senior Notes”). Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Outlook +We remain focused on maximizing the returns and increasing the value of our top tier capital project inventory in the Midland Basin and Eagle Ford shale. We expect to do this through exploration, acquisitions, and further development optimization. These assets will allow for production growth while maximizing internally generated cash flows, which will also support our priorities for improving our credit metrics and maintaining strong financial flexibility. +Our capital program for 2019 , excluding acquisitions, is expected to range from $1.00 billion to $1.07 billion. We expect our program to concentrate on developing our top tier assets in the Midland Basin and Eagle Ford shale, with the majority of our 2019 capital being allocated to our Midland Basin program. Planned drilling and completion activity in the Eagle Ford shale will continue to be partially funded by a third-party as part of our joint venture agreement, which was extended into 2019 to include 12 additional wells that we expect to be completed in 2019. Please refer to the caption Outlook in the Overview of the Company section and Overview of Liquidity and Capital Resources , under Part II, Item 7 of this report for additional discussion of our financing and capital plans for 2019 . +5 +Areas of Operation +Our 2018 operations were concentrated in our onshore Permian and South Texas & Gulf Coast regions in the United States. We divested all remaining producing assets in the Rocky Mountain region in the first half of 2018. The following table summarizes estimated proved reserves, production, and costs incurred in oil and gas activities for the year ended December 31, 2018 , for these regions: +Permian +South Texas & Gulf Coast +Rocky +Mountain +Total (1) +Proved reserves +Oil (MMBbl) +159.4 +16.3 +— +175.7 +Gas (Bcf) +328.4 +993.4 +— +1,321.8 +NGLs (MMBbl) +0.2 +107.2 +— +107.4 +MMBOE (1) +214.3 +289.1 +— +503.4 +Relative percentage +43 +% +57 +% +— +% +100 +% +Proved developed % +40 +% +55 +% +N/A +49 +% +Production +Oil (MMBbl) +16.6 +1.3 +0.9 +18.8 +Gas (Bcf) +25.8 +76.2 +1.2 +103.2 +NGLs (MMBbl) +— +7.9 +— +7.9 +MMBOE (1) +20.9 +21.8 +1.1 +43.9 +Avg. daily equivalents (MBOE/d) (1) +57.4 +59.9 +3.1 +120.3 +Relative percentage +48 +% +50 +% +2 +% +100 +% +Costs incurred (in millions) (2) (3) +$ +1,180.9 +$ +185.3 +$ +2.7 +$ +1,389.5 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +Regional costs incurred do not sum to total costs incurred due primarily to corporate overhead charges incurred on exploration activities that are excluded from this regional table. Please refer to the caption Costs Incurred in Oil and Gas Producing Activities in the Supplemental Oil and Gas Information section in Part II, Item 8 of this report. +(3) +Costs incurred for 2018 included $57.0 million relating to acquisitions of primarily unproved oil and gas properties in our Permian region. Please refer to Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information in Part II, Item 8 of this report. +Excluding acquisition activity, costs incurred increased in 2018 by 41 percent compared with the prior year as we continued to accelerate development activities in our Permian region. Total estimated proved reserves at year end 2018 increased eight percent from the prior year and increased 18 percent on a retained asset basis. Production decreased one percent on an equivalent basis for the year ended December 31, 2018 , compared with 2017 , but increased 11 percent on a retained asset basis. +Permian Region. Operations in our Permian region are managed from our regional office in Midland, Texas. In 2018 , we focused on continuing to delineate, develop, and expand our Midland Basin position in western Texas. Our approximately 79,800 net acre position as of December 31, 2018, excludes approximately 1,885 net acres associated with drill-to-earn opportunities we plan to pursue, and is lower than our year end 2017 net acreage position as a result of the Halff East Divestiture, which reduced our Midland Basin position by approximately 5,400 net acres year-over-year. Our current Midland Basin position provides for substantial future development opportunities within multiple oil-rich intervals, including the Spraberry and Wolfcamp formations. +We incurred approximately $1.2 billion of costs and added approximately 78.3 MMBOE of estimated proved reserves, net of price and performance revisions, through our drilling and completion activities in 2018 . The majority of our Midland Basin capital was deployed on projects targeting the Lower Spraberry and Wolfcamp A and B intervals on our RockStar assets in Howard and Martin Counties, Texas and Sweetie Peck assets in Upton and Midland Counties, Texas. Capital was also invested in our water transportation and handling facilities, which began operations in mid-2018 and now serve a significant portion of our disposal needs on our RockStar acreage. During 2018 , we operated an average of seven drilling rigs and four completion crews. As of December 31, 2018 , we had six drilling rigs and three completion crews running in the Midland Basin, primarily focused on developing our RockStar acreage. Estimated proved reserves increased 34 percent to 214.3 MMBOE at year end 2018 , from 159.9 MMBOE at year end 2017 . We completed 114 gross ( 104 net) wells during 2018 , and full-year production increased 91 percent year-over-year to 20.9 MMBOE for 2018 . +As of December 31, 2018 , there were 61 gross ( 55 net) wells that had been drilled but not completed in our Midland Basin program. +6 +South Texas & Gulf Coast Region. Operations in our South Texas & Gulf Coast region are managed from our regional office in Houston, Texas. This region is primarily comprised of our Eagle Ford shale position, which includes approximately 163,000 contiguous net acres. Our acreage position in the Eagle Ford shale covers a significant portion of the western Eagle Ford shale play and includes acreage across the gas-condensate and dry gas windows of the play with gas composition amenable to processing for NGL extraction. +In 2018 , we incurred $185.3 million of costs and added approximately 40.8 MMBOE of estimated proved reserves, net of revisions, primarily as a result of a net increase in proved undeveloped reserves resulting from changes to our future development plans, and positive price revisions. During 2018, we averaged one drilling rig and one completion crew on our Eagle Ford shale acreage. Estimated proved reserves increased five percent to 289.1 MMBOE at year end 2018 , from 275.2 MMBOE at year end 2017 . We completed 40 gross ( 26 net) wells during 2018 on our operated acreage, and full-year regional production decreased 26 percent year-over-year to 21.8 MMBOE for 2018 . The decrease in production from our Eagle Ford shale program was primarily driven by the sale of our outside-operated assets in the first quarter of 2017, reduced capital investment on our retained operated acreage, and reduced working and revenue interests associated with certain Eagle Ford shale wells as a result of the joint venture agreement discussed below. +In September 2017, we entered into a joint venture agreement with a third-party to drill 16 wells and complete 23 wells in a focused portion of our Eagle Ford North area (“Phase 1 JV”). In December 2018, we extended this agreement and added an additional 12 wells to be drilled and completed (“Phase 2 JV”). The agreement provides that the third-party carries substantially all drilling and completion costs and receives a majority of the working and revenue interest in these wells until certain payout thresholds are reached. This arrangement allows us to leverage third-party capital to prove up the value of our Eagle Ford North area, while also allowing us to test cutting edge technology, capture additional technical data, satisfy certain lease obligations, and potentially expand economic drilling inventory in the future. All Phase 1 JV wells were drilled and completed as of December 31, 2018. Six of the 12 Phase 2 JV wells were drilled during 2018, and we expect the remaining six wells to be drilled and all 12 wells to be completed during 2019. +As of December 31, 2018 , there were 29 gross ( 23 net) wells that had been drilled but not completed in our South Texas & Gulf Coast region. +Rocky Mountain Region. We divested all remaining producing assets in the Rocky Mountain region in the first half of 2018. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +Reserves +The table below presents summary information with respect to the estimates of our proved reserves for each of the years in the three-year period ended December 31, 2018 . We engaged Ryder Scott Company, L.P. (“Ryder Scott”) to audit at least 80 percent of our total calculated estimated proved reserve PV-10 for each year presented. The prices used in the calculation of proved reserve estimates reflect the 12-month average of the first-day-of-the-month prices in accordance with Securities and Exchange Commission (“SEC”) rules, and were $65.56 per Bbl for oil, $3.10 per MMBtu for gas, and $33.45 per Bbl for NGLs for the year ended December 31, 2018 . We then adjusted these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. +Reserve estimates are inherently imprecise and estimates for new discoveries and undeveloped locations are more imprecise than reserve estimates for producing oil and gas properties. Accordingly, we expect these estimates to change as new information becomes available. PV-10 shown in the following table is a non-GAAP financial measure, and generally differs from the standardized measure of discounted future net cash flows, the most directly comparable GAAP financial measure, because it does not include the effects of income taxes on future net revenues. Neither PV-10 nor the standardized measure of discounted future net cash flows represents the fair market value of our oil and gas properties. We and others in the oil and gas industry use PV-10 as a measure to compare the relative size and value of proved reserves held without regard to the specific tax characteristics of such entities. Please refer to the Glossary of Oil and Gas Terms section of this report for additional information regarding these measures, and refer to the reconciliation of the standardized measure of discounted future net cash flows to PV-10 set forth below. The actual quantities and present value of our estimated proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The following table should be read along with the section entitled Risk Factors – Risks Related to Our Business below. +Our ability to replace our production is critical to us. Please refer to the reserve life index term in the Glossary of Oil and Gas Terms section of this report for information describing how this metric is calculated. +7 +The following table summarizes estimated proved reserves, the standardized measure of discounted future net cash flows, PV-10, and reserve life index as of December 31, 2018 , 2017 , and 2016 : +As of December 31, +2018 +2017 +2016 +Reserve data: +Proved developed +Oil (MMBbl) +68.2 +58.6 +48.5 +Gas (Bcf) +699.1 +642.9 +609.1 +NGLs (MMBbl) +60.1 +49.0 +58.6 +MMBOE (1) +244.8 +214.7 +208.7 +Proved undeveloped +Oil (MMBbl) +107.6 +99.6 +56.4 +Gas (Bcf) +622.7 +637.2 +502.0 +NGLs (MMBbl) +47.2 +47.6 +47.1 +MMBOE (1) +258.6 +253.4 +187.1 +Total proved (1) +Oil (MMBbl) +175.7 +158.2 +104.9 +Gas (Bcf) (2) +1,321.8 +1,280.1 +1,111.1 +NGLs (MMBbl) +107.4 +96.5 +105.7 +MMBOE +503.4 +468.1 +395.8 +Proved developed reserves % +49 +% +46 +% +53 +% +Proved undeveloped reserves % +51 +% +54 +% +47 +% +Reserve data (in millions): +Standardized measure of discounted future net cash flows (GAAP) +$ +4,654.4 +$ +3,024.1 +$ +1,152.1 +PV-10 (non-GAAP): +Proved developed PV-10 +$ +3,084.2 +$ +1,984.2 +$ +1,051.1 +Proved undeveloped PV-10 +2,020.1 +1,072.3 +101.0 +Total proved PV-10 (non-GAAP) +$ +5,104.3 +$ +3,056.5 +$ +1,152.1 +Reserve life index (years) +11.5 +10.5 +7.2 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +For the years ended December 31, 2018 , 2017 , and 2016 , proved gas reserves contained 59.1 Bcf, 48.1 Bcf, and 43.7 Bcf of gas, respectively, that we expect to produce and use as a field equipment fuel source (primarily to power compressors). +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the pre-tax PV-10 (non-GAAP) of total estimated proved reserves. Please see the definitions of standardized measure of discounted future net cash flows and PV-10 in the Glossary of Oil and Gas Terms section of this report. +As of December 31, +2018 +2017 +2016 +(in millions) +Standardized measure of discounted future net cash flows (GAAP) +$ +4,654.4 +$ +3,024.1 +$ +1,152.1 +Add: 10 percent annual discount, net of income taxes +3,847.1 +2,573.2 +937.1 +Add: future undiscounted income taxes +1,012.2 +205.7 +— +Undiscounted future net cash flows +9,513.7 +5,803.0 +2,089.2 +Less: 10 percent annual discount without tax effect +(4,409.4 +) +(2,746.5 +) +(937.1 +) +PV-10 (non-GAAP) +$ +5,104.3 +$ +3,056.5 +$ +1,152.1 +8 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from future wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of production when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time. As of December 31, 2018 , we did not have any proved undeveloped reserves that had been on our books in excess of five years, and none of our proved undeveloped reserves were on acreage expected to expire or on acreage that was not expected to be held through renewal before before the targeted completion date. +For proved undeveloped locations that are more than one development spacing area from developed producing locations, we utilized reliable geologic and engineering technology when booking estimated proved undeveloped reserves. Of the 258.6 MMBOE of total proved undeveloped reserves as of December 31, 2018 , approximately 81.4 MMBOE of proved undeveloped reserves in our Wolfcamp and Lower Spraberry shale positions in the Midland Basin and 71.4 MMBOE of proved undeveloped reserves in our Eagle Ford shale position were offset by more than one development spacing area from the nearest developed producing location. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected) and petrophysical analysis of that log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. In all other areas, we restricted proved undeveloped locations to development spacing areas that are immediately adjacent to developed spacing areas. +As of December 31, 2018 , estimated proved undeveloped reserves totaled 258.6 MMBOE, which was an increase of 5.2 MMBOE, or two percent , from 253.4 MMBOE at December 31, 2017 . The following table provides a reconciliation of our proved undeveloped reserves for the year ended December 31, 2018 : +Total +(MMBOE) +Total proved undeveloped reserves: +Beginning of year +253.4 +Revisions of previous estimates +(54.4 +) +Additions from discoveries, extensions, and infill +151.7 +Sales of reserves +(22.0 +) +Purchases of minerals in place +0.1 +Removed for five-year rule +(22.6 +) +Conversions to proved developed +(47.6 +) +End of year +258.6 +Revisions of previous estimates. Revisions of previous estimates includes a downward performance revision of 37.8 MMBOE from our Eagle Ford shale program as a result of optimizing our development plan. Offsetting these downward reserve revisions are proved undeveloped reserves in our Eagle Ford shale program that are engineered with wider spacing and longer lateral completions, which are reflected as additions from discoveries, extensions, and infill. In addition, we had downward performance revisions of 17.2 MMBOE in our Midland Basin program as we updated certain of our previous assumptions based on actual well results observed during the year. +Additions from discoveries, extensions, and infill. We added 67.6 MMBOE and 78.8 MMBOE of infill estimated proved undeveloped reserves in our Midland Basin and Eagle Ford shale programs, respectively, in 2018 . We added an additional 5.3 MMBOE of estimated proved undeveloped reserves in the Midland Basin through various extensions and discoveries. The majority of additions in our Midland Basin program were the result of future development projects identified by our on-going development activities, while the majority of additions in our Eagle Ford shale program were from newly identified locations based on an optimized development plan that includes wider well spacing and longer lateral completions. +Sales of reserves. Proved undeveloped reserves sold during the year primarily related to our PRB Divestiture, Divide County Divestiture, and Halff East Divestiture. There was also a reduction in proved undeveloped reserves as a result of the joint venture we executed in December 2018 for the development of certain Eagle Ford shale wells in which our working interest was reduced. +9 +Removed for five-year rule. As a result of our testing and delineation efforts in 2018, we removed 22.6 MMBOE of estimated proved undeveloped reserves due to changes in our future development activities. Our development plans continue to be focused on maximizing returns and the value of our assets, and changes to these plans in 2018 caused these locations to be reclassified to unproved reserve categories and were replaced by higher quality proved undeveloped reserves, which are reflected as additions from discoveries, extensions, and infill. +Conversions to proved developed. Conversions of proved undeveloped reserves to proved developed reserves were in our Midland Basin and Eagle Ford shale programs. Our 2018 conversion track record was 19 percent . We expect our conversion track record to increase in 2019 as a result of increased capital expenditures related to converting proved undeveloped reserves. During 2018 , we incurred $490.4 million on projects with reserves booked as proved undeveloped at the end of 2017 , of which $442.4 million was spent on proved undeveloped reserves that converted to proved developed reserves by December 31, 2018 . At December 31, 2018 , drilled but not completed wells represented 40.1 MMBOE of total estimated proved undeveloped reserves. We expect to incur $254.3 million of capital expenditures in completing these drilled but not completed wells, and we expect all estimated proved undeveloped reserves to be converted to proved developed reserves within five years from their initial booking as proved undeveloped reserves. +As of December 31, 2018 , estimated future development costs relating to our proved undeveloped reserves were $661.7 million , $457.7 million , and $599.1 million in 2019 , 2020 , and 2021 , respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group and is coordinated by our Corporate Engineering Manager, subject to the oversight of our management and the Audit Committee of our Board of Directors, as discussed below. Our Corporate Engineering Manager has approximately 10 years of experience in the energy industry and has been employed by the Company for nine years. He holds a Bachelor of Science Degree in Petroleum Engineering from Montana Tech of the University of Montana and is a Registered Professional Petroleum Engineer in the states of Texas, Wyoming and Montana. He is also a member of the Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the year by our regional staff. This data, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our regional engineering technical staff do not report directly to our Corporate Engineering Manager; they report to either their respective regional technical managers or directly to the regional manager. This design is intended to promote objective and independent analysis within our regions in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are required to be within 10 percent of our proved reserve amounts for the total company, as well as for each respective region. Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world for over 70 years. The technical person at Ryder Scott primarily responsible for overseeing our reserves audit is a Managing Senior Vice President who received a Bachelor of Science degree in Chemical Engineering from Brigham Young University in 2003. He is a licensed Professional Engineer in the State of Texas and a member of the Society of Petroleum Engineers. The Ryder Scott 2018 report concerning our reserves is included as Exhibit 99.1. +In addition to a third-party audit, our reserves are reviewed by our management with the Audit Committee of our Board of Directors. Our management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Executive Vice President - Operations, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives, apart from our management, from time to time to discuss processes and findings. +10 +Production +The following table summarizes the volumes and realized prices of oil, gas, and NGLs produced and sold from properties in which we held an interest during the periods presented. Realized prices presented below exclude the effects of derivative contract settlements. Also presented is a summary of related production expense on a per BOE basis. +For the Years Ended December 31, +2018 +2017 +2016 +Net production volumes +Oil (MMBbl) +18.8 +13.7 +16.6 +Gas (Bcf) +103.2 +123.0 +146.9 +NGLs (MMBbl) +7.9 +10.3 +14.2 +Equivalent (MMBOE) (1) +43.9 +44.5 +55.3 +Midland Basin net production volumes (2) +Oil (MMBbl) +16.6 +8.5 +2.6 +Gas (Bcf) +25.8 +14.7 +5.6 +NGLs (MMBbl) +— +— +— +Equivalent (MMBOE) (1) +20.9 +11.0 +3.5 +Eagle Ford shale net production volumes (2)(3) +Oil (MMBbl) +1.2 +1.9 +5.4 +Gas (Bcf) +76.1 +104.0 +129.9 +NGLs (MMBbl) +7.9 +10.1 +13.8 +Equivalent (MMBOE) (1) +21.8 +29.3 +40.9 +Realized price, before the effect of derivative settlements +Oil (per Bbl) +$ +56.80 +$ +47.88 +$ +36.85 +Gas (per Mcf) +$ +3.43 +$ +3.00 +$ +2.30 +NGLs (per Bbl) +$ +27.22 +$ +22.35 +$ +16.16 +Per BOE +$ +37.27 +$ +28.20 +$ +21.32 +Production expense per BOE +Lease operating expense +$ +4.74 +$ +4.43 +$ +3.51 +Transportation costs +$ +4.36 +$ +5.48 +$ +6.16 +Production taxes +$ +1.52 +$ +1.18 +$ +0.94 +Ad valorem tax expense +$ +0.48 +$ +0.34 +$ +0.21 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +For each of the years ended December 31, 2018 , and 2017 , total estimated proved reserves attributed to our Midland Basin properties exceeded 15 percent of our total estimated proved reserves expressed on an equivalent basis. For each of the annual periods presented, total estimated proved reserves attributed to our Eagle Ford shale properties exceeded 15 percent of our total estimated proved reserves expressed on an equivalent basis. +(3) +During the first quarter of 2017, we completed a divestiture of our outside-operated Eagle Ford shale assets. These assets represented approximately 1.5 MMBOE and 9.7 MMBOE of net production on an equivalent basis for the years ended December 31, 2017 , and 2016 , respectively. +Productive Wells +As of December 31, 2018 , we had working interests in 715 gross (671 net) productive oil wells and 504 gross (485 net) productive gas wells. Productive wells are either wells producing in commercial quantities or wells mechanically capable of commercial production, but are temporarily shut-in. Multiple completions in the same wellbore are counted as one well. As of December 31, 2018 , two of these wells had multiple completions. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil when it first commenced production, but such designation may not be indicative of current production composition. +11 +Drilling and Completion Activity +All of our drilling and completion activities are conducted by independent contractors. We do not own any drilling or completion equipment. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2018 , 2017 , and 2016 , excluding non-consented projects, active injector wells, salt water disposal wells, or wells in which we own only a royalty interest: +For the Years Ended December 31, +2018 +2017 +2016 +Gross +Net +Gross +Net +Gross +Net +Development wells +Oil +103 +92 +56 +46 +100 +73 +Gas +39 +24 +38 +35 +114 +56 +Non-productive +— +— +4 +3 +2 +1 +142 +116 +98 +84 +216 +130 +Exploratory wells +Oil +18 +14 +32 +29 +7 +7 +Gas +1 +1 +— +— +— +— +Non-productive +— +— +1 +— +— +— +19 +15 +33 +29 +7 +7 +Total +161 +131 +131 +113 +223 +137 +A productive well is an exploratory, development, or extension well that is producing or is capable of commercial production of oil, gas, and/or NGLs. A non-productive well, frequently referred to within the industry as a dry hole, is an exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in commercial quantities to justify completion, or upon completion, the economic operation of a well. +As defined by the SEC, an exploratory well is a well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. A development well is a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. Completion refers to the installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry hole, the reporting to the appropriate authority that the well has been plugged and abandoned. +In addition to the wells drilled and completed in 2018 (included in the table above), we were actively participating in the drilling of 21 gross (19 net) wells and had 104 gross (91 net) drilled but not completed wells as of January 31, 2019. These drilled but not completed wells represent wells that were being completed or were waiting on completion as of January 31, 2019. +12 +Acreage +The following table sets forth the gross and net acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes that we held as of December 31, 2018 . Undeveloped acreage includes leasehold interests containing proved undeveloped reserves. +Developed Acres (1) +Undeveloped Acres (2)(3) +Total +Gross +Net +Gross +Net +Gross +Net +Midland Basin: +RockStar +55,632 +49,552 +20,451 +15,321 +76,083 +64,873 +Sweetie Peck +15,176 +14,189 +3,736 +772 +18,912 +14,961 +Midland Basin Total (4) +70,808 +63,741 +24,187 +16,093 +94,995 +79,834 +Eagle Ford +73,926 +73,549 +92,379 +89,443 +166,305 +162,992 +Other (5) +16,278 +11,368 +262,059 +188,994 +278,337 +200,362 +Total +161,012 +148,658 +378,625 +294,530 +539,637 +443,188 +____________________________________________ +(1) +Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations but has been included only as developed acreage in the table above. +(2) +Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) +As of February 7, 2019 , approximately 1,406 , 2,016 , and 244 net acres of undeveloped acreage are scheduled to expire by December 31, 2019 , 2020 , and 2021 , respectively, if production is not established or we take no other action to extend the terms of the applicable lease or leases. +(4) +As of December 31, 2018 , total Midland Basin acreage excludes approximately 1,885 net acres associated with drill-to-earn opportunities we intend to pursue. +(5) +Includes other non-core acreage located in Louisiana, Montana, North Dakota, Texas, Utah, and Wyoming. +Delivery Commitments +As of December 31, 2018 , we had gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum quantity of 29 MMBbl of oil, 595 Bcf of gas, and 21 MMBbl of produced water through 2027 . We are required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. We expect to fulfill our delivery commitments from a combination of production from: a) our existing productive wells, b) future development of our proved undeveloped reserves, and c) future development of resources not yet characterized as proved reserves. Under certain of our commitments, if we are unable to deliver the minimum quantity from our production, we may deliver production acquired from third-parties to satisfy our minimum volume commitments. +In the event that no more product is delivered in accordance with these agreements, the aggregate undiscounted future deficiency payments as of December 31, 2018 , would total $287.8 million . This amount does not include deficiency payment estimates associated with approximately 18.6 MMBbl of future oil delivery commitments where we cannot predict with accuracy the amount and timing of these payments, as such payments are dependent upon the price of oil in effect at the time of settlement. +As of the filing of this report, we do not expect to incur any material shortfalls with regard to these commitments. +Major Customers +We do not believe the loss of any single purchaser of our oil, gas, or NGLs would materially impact our operating results, as these are products with well-established markets and other viable purchaser options are available in our operating regions. +13 +We had the following major customers and sales to entities under common ownership, which accounted for 10 percent or more of our total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2018 +2017 +2016 +Major customer #1 (1) +18 +% +6 +% +— +% +Major customer #2 (1) +10 +% +10 +% +5 +% +Group #1 of entities under common ownership (2) +18 +% +17 +% +15 +% +Group #2 of entities under common ownership (2) +12 +% +8 +% +8 +% +____________________________________________ +(1) +These major customers are purchasers of a portion of our production from our Permian region. +(2) +In the aggregate, these groups of entities under common ownership represented more than 10 percent of total oil, gas, and NGL production revenue for at least one of the periods presented; however, no individual entity comprising either group represented more than 10 percent of our total oil, gas, and NGL production revenue. +Employees and Office Space +As of February 7, 2019 , we had 611 full-time employees. This is a four percent decrease from the 635 reported full-time employees as of February 14, 2018 . None of our employees are subject to a collective bargaining agreement. +The following table summarizes the approximate square footage of office space leased by us, as of December 31, 2018 , including our corporate headquarters and regional offices: +Approximate Square Footage Leased +Corporate +107,000 +Permian +59,000 +South Texas & Gulf Coast +62,000 +Mid-Continent (1) +50,000 +Total +278,000 +____________________________________________ +(1) +During the third quarter of 2015, we closed our office in Tulsa, Oklahoma. We have subleased this space through the expiration of the lease, which will occur in September 2019 . +In addition to the leased office space summarized in the table above, as of December 31, 2018 , we owned a total of 79,000 square feet of office space in our South Texas & Gulf Coast and Rocky Mountain regions. +Title to Properties +Substantially all of our interests are held pursuant to oil and gas leases from third parties. We usually obtain title opinions prior to commencing our initial drilling operations on our properties. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such properties. Most of our producing properties are subject to mortgages securing indebtedness under our Sixth Amended and Restated Credit Agreement (the “Credit Agreement”), royalty and overriding royalty interests, liens for current taxes, and other burdens that we believe do not materially interfere with the use of such properties. We typically perform title investigation in accordance with standards generally accepted in the oil and gas industry before acquiring undeveloped leasehold acreage. +Seasonality +Generally, but not always, the demand and price levels for gas increase during winter months and decrease during summer months. To lessen the impact of seasonal demand fluctuations, pipelines, utilities, local distribution companies, and industrial users utilize gas storage facilities and forward purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can divert gas that traditionally is placed into storage. This could reduce the typical seasonal price differential. Demand for energy is also generally higher in the winter and the summer driving season, although oil prices are impacted more significantly by global supply and demand. Seasonal anomalies, such as mild winters, sometimes lessen these fluctuations. Certain of our drilling, completion, and other operations are also subject to seasonal limitations. Seasonal weather conditions, government regulations, and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. See Risk Factors - Risks Related to Our Business below for additional discussion. +14 +Competition +The oil and gas industry is intensely competitive, particularly with respect to acquiring prospective oil and gas properties. We believe our acreage positions provide a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from a substantial number of major and independent oil and gas companies, which in some cases have larger technical teams and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and gas reserves, but also have gathering, processing or refining operations, market refined products, own drilling rigs or other equipment, or generate electricity. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting, and processing of oil, gas, and NGLs. Consequently, we may face shortages, delays, or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including other fossil fuels such as coal and imported liquefied natural gas. Competitive conditions may be affected by future energy, climate-related, financial, or other policies, legislation, and regulations. +In addition, we compete for people, including experienced geologists, geophysicists, engineers, and other professionals. Throughout the oil and gas industry, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. We are not insulated from the competition for quality people, and we must compete effectively in order to be successful. +Government Regulations +Our business is extensively controlled by numerous federal, state, and local laws and governmental regulations. These laws and regulations may be changed from time to time in response to economic or political conditions, or other developments, and our regulatory burden may increase in the future. Laws and regulations have the potential to increase our cost of doing business and consequently could affect our profitability. However, we do not believe that we are affected to a materially greater or lesser extent than others in our industry. +Energy Regulations +Many of the states in which we conduct our operations or own assets have adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, imposing bond requirements in order to drill or operate wells, governing the timing of drilling and location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to various state conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, state conservation laws sometimes establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Some of our operations are conducted on federal lands pursuant to oil and gas leases administered by the Bureau of Land Management (“BLM”). These leases contain relatively standardized terms and require compliance with detailed regulations and orders that are subject to change. In addition to permits required from other regulatory agencies, lessees must obtain a permit from the BLM before drilling and must comply with regulations governing, among other things, engineering and construction specifications for production facilities, safety procedures, the valuation of production and payment of royalties, the removal of facilities, and the posting of bonds to ensure that lessee obligations are met. Under certain circumstances, the BLM may suspend or terminate our operations on federal leases. +Our sales of gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for gas production. +15 +Environmental, Health and Safety Matters +General. Our operations are subject to stringent and complex federal, state, tribal, and local laws and regulations governing protection of the environment and worker health and safety as well as the discharge of materials into the environment. These laws and regulations may, among other things: +• +require the acquisition of various permits before drilling commences; +• +restrict the types, quantities and concentration of various substances that can be released into the environment in connection with oil and gas drilling and production and saltwater disposal activities; +• +limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +• +require remedial measures to mitigate pollution from former and ongoing operations, such as closing pits and plugging abandoned wells. +These laws, rules, and regulations may also restrict the rate of oil and gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent, or different permitting, waste handling, disposal, and cleanup requirements for the oil and gas industry and could have a significant impact on our operating costs. +The following is a summary of some of the existing laws, rules, and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation, and Liability Act. The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release or threatened release of a hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +We currently own, lease, or operate numerous properties that have been used for oil and gas exploration and production for many years. Although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third-parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, or analogous state agencies. The Clean Water Act also prohibits discharge of dredged or fill material into waters of the United States, including wetlands, except in accordance with the terms of a permit issued by the United States Army Corps of Engineers, or a state if the state has assumed authority to issue such permits. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for +16 +containment and removal costs, natural resource damages and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane, and other “greenhouse gases” present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on these findings, the EPA began adopting and implementing a comprehensive suite of regulations to restrict emissions of greenhouse gases under existing provisions of the CAA. The Trump administration has taken steps to rescind or review many of these regulations. Legislative and regulatory initiatives related to climate change could have an adverse effect on our operations and the demand for oil and gas. See Risk Factors - Risks Related to Our Business - Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs . In addition to the effects of regulation, the meteorological effects of global climate change could pose additional risks to our operations, including physical damage risks associated with more frequent, more intensive storms and flooding, and could adversely affect the demand for our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +National Environmental Policy Act. Oil and gas exploration and production activities on federal lands are subject to the National Environmental Policy Act (“NEPA”). NEPA requires federal agencies, including the Department of Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an environmental assessment to determine the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed environmental impact statement that may be made available for public review and comment. All of our current exploration and production activities, as well as proposed exploration and development plans, on federal lands require governmental permits subject to the requirements of NEPA. This process has the potential to delay development of some of our oil and gas projects. +OSHA and other laws and regulations. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand, and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions. However, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition to oil and gas activities using hydraulic fracturing techniques, which could potentially cause a decrease in the completion of new oil and gas wells, an increase in compliance costs, and delays, all of which could adversely affect our financial position, results of operations and cash flows. As new laws or regulations that significantly restrict hydraulic fracturing are adopted at the state and local levels, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and gas that we are ultimately able to produce from our reserves. +17 +We believe it is reasonably likely that the trend in local and state environmental legislation and regulation will continue toward stricter standards, while the trend in federal environmental legislation and regulation faces an uncertain future under the Trump administration. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health and Safety Initiatives. We are committed to conducting our business in a manner that protects the environment and the health and safety of our employees, contractors and the public. We set annual goals for our environmental, health and safety program focused on reducing the number of safety related incidents that occur and the number and impact of spills of produced fluids. We also periodically conduct regulatory compliance audits of our operations to ensure compliance with all regulations and provide appropriate training for our employees. Reducing air emissions as a result of leaks, venting, or flaring of gas during operations has become a major focus area for regulatory efforts and for our compliance efforts. While flaring is sometimes necessary, releases of gas into the environment and flaring is an economic waste and reducing these volumes is a priority for us. To avoid flaring where possible, we restrict testing periods and make every effort to ensure that our production is connected to gas pipeline infrastructure as quickly as possible after well completions. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +Cautionary Information about Forward-Looking Statements +This Annual Report on Form 10-K (“Form 10-K”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements, other than statements of historical facts, included in this report that address activities, events, or developments with respect to our financial condition, results of operations, or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “estimate,” “expect,” “forecast,” “intend,” “pending,” “plan,” “project,” “target,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this report, and include statements about such matters as: +• +the amount and nature of future capital expenditures and the availability of liquidity and capital resources to fund capital expenditures; +• +any changes to the borrowing base or aggregate lender commitments under our Credit Agreement; +• +our outlook on future oil, gas, and NGL prices, well costs, service costs, and general and administrative costs; +• +the drilling of wells and other exploration and development activities and plans by us, our joint venture partners, and/or other third-party operators, as well as possible or expected acquisitions or divestitures; +• +the possible divestiture or farm-down of, or joint venture relating to, certain properties; +• +proved reserve estimates and the estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates; +• +future oil, gas, and NGL production estimates; +• +cash flows, anticipated liquidity, interest and related debt service expenses, and the future repayment of debt; +• +business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, plans with respect to future dividend payments, and our outlook on our future financial condition or results of operations; +• +the possible divestiture or farm-down of, or joint venture relating to, certain properties; and +• +other similar matters, such as those discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in Part II, Item 7 of this report. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. These statements are subject to a number of known and unknown risks and uncertainties, which may cause our actual results and performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Some of these risks are described in the Risk Factors section of this report, and include without limitation such factors as: +• +domestic and foreign supply of oil, natural gas, and NGLs; +• +the volatility of oil, gas, and NGL prices, and the effect it may have on our profitability, financial condition, cash flows, access to capital, and ability to grow production volumes and/or proved reserves; +• +weakness in economic conditions, consumer demand, and uncertainty in financial markets; +18 +• +our ability to replace reserves in order to sustain production; +• +our ability to raise the substantial amount of capital required to develop and/or replace our reserves; +• +our ability to compete against competitors that have greater financial, technical, and human resources; +• +our ability to attract and retain key personnel; +• +the imprecise estimations of our actual quantities and present value of proved oil, gas, and NGL reserves, and that development of our proved undeveloped reserves may take longer and may require greater capital expenditures than we anticipate; +• +the uncertainty in evaluating recoverable reserves and estimating expected benefits or liabilities; +• +the possibility that exploration and development drilling may not result in commercially producible reserves; +• +our limited control over activities on outside-operated properties; +• +our reliance on the skill, expertise and availability of third-party service providers and equipment for our operated activities; +• +the possibility that title to properties in which we claim an interest may be defective; +• +our planned drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques is subject to drilling and completion risks and may not meet our expectations for reserves or production; +• +the uncertainties associated with acquisitions, divestitures, joint ventures, farm-downs, farm-outs and similar transactions with respect to certain assets, including our success in integrating new assets, and whether such transactions will be consummated or completed in the form or timing and for the value that we anticipate; +• +the uncertainties associated with enhanced recovery methods; +• +our commodity derivative contracts expose us to counterparty credit risk and may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales; +• +the inability of one or more of our service providers, customers, or contractual counterparties to meet their obligations; +• +our ability to deliver required quantities of oil, gas, NGL, or water to contractual counterparties; +• +price declines or unsuccessful exploration efforts resulting in write-downs of our asset carrying values; +• +the impact that depressed oil, gas, or NGL prices could have on our borrowing capacity under our Credit Agreement; +• +the possibility our amount of debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt; +• +the possibility that covenants in our Credit Agreement or the indentures governing the Senior Notes and 1.50% Senior Convertible Notes due July 1, 2021 (the “Senior Convertible Notes”) may limit our discretion in the operation of our business, prohibit us from engaging in beneficial transactions or lead to the accelerated payment of our debt; +• +operating and environmental risks and hazards that could result in substantial losses; +• +the impact of extreme weather conditions, laws and regulations, and lease stipulations on our ability to conduct drilling activities; +• +our ability to acquire adequate supplies of water and dispose of or recycle water we use at a reasonable cost in accordance with environmental and other applicable rules; +• +complex laws and regulations, including environmental regulations, that result in substantial costs, delays, and other risks; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities; +• +our ability to sell and/or receive market prices for our oil, gas, and NGLs; +• +new technologies may cause our current exploration and drilling methods to become obsolete; +• +the possibility of security threats, including terrorist attacks and cybersecurity attacks and breaches, against, or otherwise impacting, our facilities and systems; and +• +litigation, environmental matters, the potential impact of legislation and government regulations, and the use of management estimates regarding such matters. +We caution you that forward-looking statements are not guarantees of future performance and actual results or performance may be materially different from those expressed or implied in the forward-looking statements. The forward-looking statements in this report speak as of the filing of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by securities laws. +19 +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC, and can be located at www.sec.gov. We also make available through our website our Corporate Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, and the Charters of the Audit, Compensation, Executive, and Nominating and Corporate Governance Committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +Glossary of Oil and Gas Terms +The oil and gas terms defined in this section are used throughout this report. The definitions of the terms developed reserves, exploratory well, field, proved reserves, and undeveloped reserves have been abbreviated from the respective definitions under Rule 4-10(a) of Regulation S-X. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the SEC’s website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +BBtu. One billion British thermal units. +Bcf . Billion cubic feet, used in reference to gas. +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of gas to one Bbl of oil or NGLs. +Btu. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. A well found to be incapable of producing either oil, gas, and/or NGLs in commercial quantities. +Exploratory well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and gas) rights. +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +Gross acre. An acre in which a working interest is owned. +Gross well. A well in which a working interest is owned. +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses. The expenses incurred in the lifting of oil, gas, and/or NGLs from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, +20 +maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels of oil, NGLs, water, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to gas. +MMBbl. One million barrels of oil, NGLs, water, or other liquid hydrocarbons. +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +NGLs. The combination of ethane, propane, isobutane, normal butane, and natural gasoline that when removed from gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for oil. +NYMEX Henry Hub . New York Mercantile Exchange Henry Hub, a common industry benchmark price for gas. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +PV-10 (Non-GAAP). PV-10 is a non-GAAP measure. The present value of estimated future revenue to be generated from the production of estimated net proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. +Productive well. A well that is producing oil, gas, and/or NGLs or that is capable of commercial production of those products. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +Reserve life index. Expressed in years, represents the estimated net proved reserves at a specified date divided by actual production for the preceding 12-month period. +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil, gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of oil, gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from oil, gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +21 +Royalty interest. An interest in an oil and gas property entitling the owner to shares of oil, gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +Standardized measure of discounted future net cash flows. The discounted future net cash flows related to estimated proved reserves based on prices used in estimating the reserves, year end costs, and statutory tax rates, at a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information located in Part II, Item 8 of this report. +Track record. Current year conversions of proved undeveloped reserves to proved developed reserves, divided by beginning of the year proved undeveloped reserves. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and NGLs regardless of whether such acreage contains estimated net proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +22 +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in us. +Risks Related to Our Business +Oil, gas, and NGL prices are volatile, and declines in prices adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and gas properties depend heavily on the prices we receive for oil, gas, and NGL sales. Oil, gas, and NGL prices also affect our cash flows available for capital expenditures and other items, our borrowing capacity, and the volume and value of our oil, gas, and NGL reserves. For example, the amount of our borrowing base under our Credit Agreement is subject to periodic redetermination based on oil, gas, and NGL prices specified by our bank group at the time of redetermination. In addition, we may have oil and gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. Please refer to Significant Developments in 2018 and Reserves within Part I, Items 1 and 2, Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 within Part II, Item 7, and Note 1 – Summary of Significant Accounting Policies , Note 11 – Fair Value Measurements , and Supplemental Oil and Gas Information in Part II, Item 8 for specific discussion. +Historically, the markets for oil, gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in oil, gas, and NGL prices may result from relatively minor changes in the supply of and demand for oil, gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• +global and domestic supplies of oil, gas, and NGLs, and the productive capacity of the industry as a whole; +• +the level of consumer demand for oil, gas, and NGLs; +• +overall global and domestic economic conditions; +• +weather conditions; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities in regional or localized areas; +• +liquefied natural gas deliveries to and from the United States; +• +the price and availability of alternative fuels; +• +technological advances and regulations affecting energy consumption and conservation; +• +the ability of the members of the Organization of Petroleum Exporting Countries and other exporting countries to maintain effective oil price and production controls; +• +political instability or armed conflict in oil or gas producing regions; +• +strengthening and weakening of the United States dollar relative to other currencies; and +• +governmental regulations and taxes. +Declines in oil, gas, and NGL prices would reduce our revenues and could also reduce the amount of oil, gas, and NGLs that we can produce economically, which could have a materially adverse effect on us. +Weakness in economic conditions or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +In the last decade, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, increased levels of unemployment, and an unprecedented level of intervention by the United States federal government and other governments. Although the United States economy appears to have stabilized, future uncertainty is possible. Renewed weakness in the United States or other large economies could materially adversely affect our business and financial condition. For example: +• +the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• +the liquidity available under our Credit Agreement could be reduced if any lender is unable to fund its commitment; +• +our ability to access the capital markets may be restricted at a time when we would like, or need, to raise capital for our business, including for the exploration and/or development of reserves; +23 +• +our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; and +• +variable interest rate spread levels, including for LIBOR and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our Credit Agreement. +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find, develop, or acquire oil, gas, and NGL reserves that are economically producible. Our properties produce oil, gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate and develop or acquire new oil, gas, and NGL reserves to replace those being depleted by production. Competition for oil and gas properties is intense, and many of our competitors have financial, technical, human, and other resources necessary to evaluate and integrate acquisitions that are substantially greater than those available to us. +For our recent acquisitions, or any future acquisitions we may complete, a successful impact on our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price and transaction costs for the acquisition, future oil, gas, and NGL prices, the ability to reasonably estimate the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves, actual future production rates, and associated costs and potential liabilities with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. Our customary review in connection with property acquisitions will not necessarily reveal, or allow us to fully assess, all existing or potential problems and deficiencies with the properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. We often acquire interests in properties on an “as-is” basis with limited remedies for breaches of representations and warranties. +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of special risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce oil, gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for oil, gas, and NGL sales, our success in locating, developing and acquiring new reserves, and the orderly functioning of credit and capital markets. If our cash flows from operations are less than expected, we may reduce our planned capital expenditures unless we can raise additional funds through debt or equity financing or the divestment of assets. Debt or equity financing may not always be available to us in sufficient amounts or on acceptable terms, and the proceeds offered to us for potential divestitures may not always be acceptable to us. Any downgrades to our credit ratings may make it more difficult or expensive for us to borrow additional funds. +If our revenues decrease in the future due to lower oil, gas, or NGL prices, decreased production, or other reasons, and if we cannot obtain funding through our Credit Agreement, other acceptable debt or equity financing arrangements, or through the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Our ability to sell oil, gas, and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third-parties or by other interruptions beyond our control, which could obstruct, limit, or eliminate our access to oil, gas, and NGL markets. +The marketability of our oil, gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems, which are generally owned or operated by third-parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay, or discontinuance of development plans for our properties, or lower price realizations. Although we have some influence over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of oil, gas, and NGL production and transportation, tax +24 +and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines or processing facilities, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, transport, or market oil, gas, and NGLs. +In particular, if production from the Midland Basin continues to grow, the amount of oil, gas, and NGLs being produced by us and others could exceed the capacity of, and result in constraints on, available gathering and transportation systems, pipelines, processing facilities, and other infrastructure. In such circumstances, it will be necessary for pipelines, gathering and transportation systems, processing facilities, and additional infrastructure to be expanded, built, or developed to accommodate anticipated production. Certain processing, pipeline, and other gathering, transportation, and infrastructure projects that might be, or are being, considered for these areas may not be developed timely or at all due to lack of financing or other constraints, including regulatory constraints. Capital and other constraints could also limit our ability to build or access intrastate gathering and transportation systems necessary to transport our production to interstate pipelines or other points of sale or delivery. In such event, we might have to delay or discontinue development activities or shut in our wells to wait for sufficient infrastructure development or capacity expansion and/or sell production at significantly lower prices, which would adversely affect our results of operations and cash flows. In addition, the operations of the third-parties on whom we rely for gathering, processing, and transportation services are subject to complex and stringent laws and regulations, which require obtaining and maintaining numerous permits, approvals, and certifications from various federal, state, and local government authorities. These third-parties may incur substantial costs in order to comply with existing and future laws and regulations. If existing laws and regulations governing such third-party services are revised or reinterpreted, or if new laws and regulations become applicable to their operations, these changes may affect the availability and costs of such services. Similarly, a failure to comply with such laws and regulations by the third-parties on whom we rely could have a material adverse effect on our business, financial condition, and results of operations. +A portion of our production in any region may be interrupted, or shut in, from time to time for numerous reasons, including as a result of weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market or other conditions. If a substantial amount of our production is interrupted at the same time, it could adversely affect our cash flows and results of operations. +Downgrades in our credit ratings by various credit rating agencies could impact our access to capital and materially adversely affect our business and financial condition. +In February 2016, Moody’s Investors Service and Standard & Poor’s downgraded our credit ratings (“Debt Rating”). Our Debt Rating levels could have materially adverse consequences on our business and future prospects and could: +• +limit our ability to access debt markets, including for the purpose of refinancing our existing debt; +• +cause us to refinance or issue debt with less favorable terms and conditions, which debt may restrict, among other things, our ability to make any dividend distributions or repurchase shares; +• +negatively impact current and prospective customers’ willingness to transact business with us; +• +impose additional insurance, guarantee and collateral requirements; +• +limit our access to bank and third-party guarantees, surety bonds and letters of credit; and +• +cause our suppliers and financial institutions to lower or eliminate the level of credit provided through payment terms or intraday funding when dealing with us, thereby increasing the need for higher levels of cash on hand, which would decrease our ability to repay outstanding indebtedness. +We cannot provide assurance that any of our current Debt Ratings will remain in effect for any given period of time or that a Debt Rating will not be further lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances warrant. +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from major oil and gas companies, independent oil and gas exploration and production companies, and institutional and individual investors who seek oil and gas investments throughout the world, as well as the equipment, expertise, labor, and materials required to operate oil and gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many oil and gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. We may not be successful in acquiring and developing profitable properties in the face of this competition. In addition, other companies may have a greater ability to continue drilling activities during periods of low oil or gas prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition, and results of operations. +25 +The loss of key personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team and other key personnel. The loss of their services could adversely affect our business. Our drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen, and other professionals. Competition for many of these professionals can be intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +The actual quantities and present value of our proved oil, gas, and NGL reserves may be less than we have estimated. +This report and certain of our other SEC filings contain estimates of our proved oil, gas, and NGL reserves and the estimated future net revenues from those reserves. These estimates are based on various assumptions, including assumptions required by the SEC relating to oil, gas, and NGL prices, drilling and completion costs, gathering and transportation costs, operating expenses, capital expenditures, effects of governmental regulation, taxes, timing of operations, and availability of funds. The process of estimating oil, gas, and NGL reserves is complex and involves significant decisions and assumptions in the evaluation of available geological, geophysical, engineering, and economic data for each reservoir. These estimates depend on many variables, and changes often occur as our knowledge of these variables evolves. Therefore, these estimates are inherently imprecise. In addition, our reserve estimates for properties that do not have a significant production history may be less reliable than estimates for properties with lengthy production histories. A lack of production history may contribute to inaccuracy in our estimates of proved reserves, future production rates, and the timing and/or amount of development expenditures. +Actual future production; prices for oil, gas, and NGLs; revenues; production taxes; development expenditures; operating expenses; and quantities of producible oil, gas, and NGL reserves will most likely vary from those estimated. Any significant variance of any nature could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than what we have previously estimated. In addition, we may adjust estimates of proved reserves to reflect production history, results of operations, results of exploration and development activity, prevailing oil, gas, and NGL prices, costs to develop and operate properties, and other factors, many of which are beyond our control. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2018 , 51% , or 258.6 MMBOE, of our estimated proved reserves were proved undeveloped. In order to develop our proved undeveloped reserves, as of December 31, 2018 , we estimate approximately $2.6 billion of capital expenditures would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +You should not assume that the PV-10 or the standardized measure of discounted future net cash flows included in this report represent the current market value of our estimated proved oil, gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. For example, the present value of our proved reserves as of December 31, 2018 , was estimated using 12-month average sales prices of $65.56 per Bbl of oil (NYMEX WTI spot price), $3.10 per MMBtu of gas (NYMEX Henry Hub spot price), and $33.45 per Bbl of NGL (OPIS spot price). We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. During 2018 , our monthly average realized oil prices before the effect of derivative settlements were as high as $64.02 per Bbl and as low as $41.87 per Bbl, were as high as $34.56 per Bbl and as low as $19.59 per Bbl for NGLs, and were as high as $4.04 per Mcf and as low as $2.70 per Mcf for gas. Many other factors will affect actual future net cash flows, including: +• +amount and timing of actual production; +• +supply and demand for oil, gas, and NGLs; +• +curtailments or increases in consumption by oil purchasers and gas pipelines; +• +changes in government regulations or taxes, including severance and excise taxes; and +• +escalations or reductions in service provider and equipment costs resulting from changes in supply and demand. +The timing of production from oil and gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to be used to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and gas industry in general are subject. +26 +Our disposition activities may be subject to factors beyond our control, and in certain cases we may retain unforeseen liabilities for certain matters . +We regularly sell non-core assets in order to increase capital resources available for core assets and other purposes and to create organizational and operational efficiencies. We also occasionally sell interests in core assets for the purpose of accelerating the development and increasing efficiencies in other core assets. Various factors could materially affect our ability to dispose of such assets, including the approvals of governmental agencies or third-parties, the availability of purchasers willing to acquire the assets on terms we deem acceptable, or other matters or uncertainties that could impact such dispositions, including whether transactions could be consummated or completed in the form or timing and for the value that we anticipate. We at times may be required to retain certain liabilities or agree to indemnify buyers for certain matters related to the sold assets. The magnitude of any such retained liabilities or of the indemnification obligations may be difficult to quantify at the time of the transaction and ultimately could be material. +We have limited control over the activities on properties we do not operate. +Some of our properties are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs and materially and adversely affect our financial condition and results of operations. +We rely on third-party service providers to conduct drilling and completion and other related operations on properties we operate. +Where we are the operator of a property, we rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, gas, and NGLs, prevailing economic conditions and financial, business, and other factors. In addition, sustained low commodity prices could cause third-party service providers to consolidate or declare bankruptcy, which could limit our options for engaging such providers. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title reports in acquiring oil and gas leasehold interests and obtain title opinions only on significant properties that we drill. Undeveloped acreage has greater risk of title defects than developed acreage and title insurance is not generally available for oil and gas properties. As is customary in our industry, we rely upon the judgment of staff and independent landmen who perform the field work of examining records in the appropriate governmental offices and title abstract facilities before acquiring a specific mineral interest and/or undertaking drilling activities. We, in some cases, perform curative work to correct deficiencies in the marketability of the title. Generally, under the terms of the operating agreements affecting our properties, any monetary loss attributable to a loss of title is to be borne by all parties to any such agreement in proportion to their interests in such property. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our financial condition, results of operations, and operating cash flow if such property is of sufficient value. +Exploration and development drilling may not result in commercially producible reserves. +Oil and gas drilling, completion, and production activities are subject to numerous risks, including the risk that no commercially producible oil, gas, or NGLs will be found. The cost of drilling and completing wells is often uncertain, and oil, gas, or NGLs drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors may include, but are not limited to: +• +unexpected adverse drilling or completion conditions; +• +title problems; +• +disputes with owners or holders of surface interests on or near areas where we operate; +• +pressure or geologic irregularities in formations; +• +engineering and construction delays; +• +equipment failures or accidents; +• +hurricanes, tornadoes, flooding, or other adverse weather conditions; +27 +• +governmental permitting delays; +• +compliance with environmental and other governmental requirements; and +• +shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +The prevailing prices for oil, gas, and NGLs affect the cost of and the demand for drilling rigs, completion and production equipment, and other related services. However, changes in costs may not occur simultaneously with corresponding changes in commodity prices. The availability of drilling rigs can vary significantly from region to region at any particular time. Although land drilling rigs can be moved from one region to another in response to changes in levels of demand, an undersupply of rigs in any region may result in drilling delays and higher drilling costs for the available rigs in that region. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a materially adverse effect on our ability to explore or develop our properties. +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if oil, gas, or NGLs are present, or whether they can be produced economically. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of oil, gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +Results in our newer resource plays, including those plays where we have recently acquired acreage, may be more uncertain than results in resource plays that are more developed and have longer established production histories. We and the industry generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +In addition, a significant part of our strategy involves increasing our inventory of drilling locations. Such multi-year drilling inventories can be more susceptible to long-term uncertainties that could materially alter the occurrence or timing of actual drilling. Because of these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled, although we have the present intent to do so for locations booked as proved undeveloped locations, or if we will be able to produce oil, gas, or NGLs from these potential drilling locations. +We may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire and we will lose our right to develop the related properties. Our total net acreage as of February 7, 2019 , that is scheduled to expire over the ensuing three years, represents approximately one percent of our total net undeveloped acreage as of December 31, 2018 . Although we have identified numerous potential drilling locations, we may not be able to economically drill for and produce oil, gas, or NGLs from all of them, and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +Part of our strategy involves drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques. The results of our planned exploratory and delineation drilling in these plays are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us, other operators and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +Ultimately, the success of these drilling and completion techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and +28 +takeaway capacity, and/or prices for oil, gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing, or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids toward the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, result in increased lease operating expenses and adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in oil, gas, and NGL prices and the associated impact on cash flows, we have entered into various derivative contracts. Our derivative contracts in place include swap and collar arrangements for oil and gas, and swap arrangements for NGLs. We have also entered into basis swap arrangements for a portion of our expected Midland Basin oil production to reduce volatility associated with location differentials between where these volumes are sold and NYMEX WTI. As of December 31, 2018 , we were in a net accrued asset position of $158.3 million with respect to our oil, gas, and NGL derivative activities. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• +our production is less than expected; +• +one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +• +there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +In addition, commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from oil, gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other market conditions, including declines in oil, gas, and NGL prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. We do not believe the loss of any single purchaser would materially impact our operating results, as we have numerous options for purchasers in each of our operating regions for our oil, gas, and NGL production. Please refer to Note 1 – Summary of Significant Accounting Policies , under the heading Concentration of Credit Risk and Major Customers in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. Additionally, the inability of our co-owners to pay joint interest billings could negatively impact our cash flows and financial ability to drill and complete current and future wells. +We have entered into firm transportation contracts that require us to pay fixed sums of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of oil, gas, NGL, or produced water to our counterparties, our results of operations, financial position, and liquidity could be adversely affected. +As of December 31, 2018 , we were contractually committed to deliver 29 MMBbl of oil, 595 Bcf of gas, and 21 MMBbl of produced water. These contracts expire at various dates through 2027 . We may enter into additional firm transportation agreements as we expand the development of our resource plays. At the current time, we do not have enough proved developed reserves to offset these contractual liabilities, but we expect to develop reserves that will meet or exceed the commitments and therefore do not expect any material shortfalls. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, or if we further limit our capital expenditures due to future commodity price declines or for other reasons, the requirements to pay for quantities not delivered could have a material impact on our results of operations, financial position, and liquidity. +29 +Future oil, gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our oil and gas properties. All property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending the determination of whether proved reserves have been discovered. If commercial quantities of hydrocarbons are not discovered with an exploratory well, the costs of drilling the well are expensed. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net cash flows, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Write downs for unproved properties are also evaluated for carrying costs in excess of fair value. This evaluation considers the potential for abandonment due to lease expirations, and other inherent acreage risks. For the year ended December 31, 2018 , we incurred abandonment and impairment of unproved properties expense totaling $49.9 million . We incurred impairment of proved properties expense and abandonment and impairment of unproved properties expense totaling $3.8 million and $12.3 million , respectively, during 2017 , and $354.6 million and $80.4 million , respectively, during 2016 . If the prices of oil, gas, or NGLs decline, or we have unsuccessful exploration efforts, it could cause additional proved and/or unproved property impairments in the future. +We review the carrying values of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and gas properties held for use cannot be reversed at a later date, even if oil, gas, or NGL prices increase. +Lower oil, gas, or NGL prices could limit our ability to borrow under our Credit Agreement. +Our Credit Agreement has a current commitment amount of $1.0 billion , subject to a borrowing base that the lenders redetermine semi-annually based on the bank group’s assessment of the value of our proved reserves, which in turn is impacted by oil, gas, and NGL prices. The borrowing base under our Credit Agreement is $1.5 billion , up from $925.0 million at December 31, 2017 . The next semi-annual redetermination date is scheduled for April 1, 2019 . We do not expect a material change to the borrowing base or the aggregate lender commitments as a result of this redetermination. Divestitures of additional properties, incurrence of additional debt, or declines in commodity prices could limit our borrowing base and reduce the amount we can borrow under our Credit Agreement. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2018 , we had the following outstanding long-term debt: +• +$172.5 million in aggregate principal amount of long-term senior unsecured convertible debt outstanding relating to our 1.50% Senior Convertible Notes due July 1, 2021 that we issued on August 12, 2016 ; +• +$476.8 million of long-term senior unsecured debt outstanding relating to our 6.125% Senior Notes due 2022 that we issued on November 17, 2014 ; +• +$500.0 million of long-term senior unsecured debt outstanding relating to our 5.0% Senior Notes due 2024 that we issued on May 20, 2013; +• +$500.0 million of long-term senior unsecured debt outstanding relating to our 5.625% Senior Notes due 2025 that we issued on May 21, 2015 ; +• +$500.0 million of long-term senior unsecured debt outstanding relating to our 6.75% Senior Notes due 2026 that we issued on September 12, 2016 ; and, +• +$500.0 million of long-term senior unsecured debt outstanding relating to our 6.625% Senior Notes due 2027 that we issued on August 20, 2018 . +Additionally, we had no outstanding borrowings under our Credit Agreement as of December 31, 2018 . We had one outstanding letter of credit in the aggregate amount of $200,000 (which reduces the amount available for borrowing under the facility on a dollar-for-dollar basis), resulting in $999.8 million of available borrowing capacity under our secured credit facility. Our long-term debt represented 47 percent of our total book capitalization as of December 31, 2018 . +Our indebtedness could have important consequences for our operations, including: +• +making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• +requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to productive investments; +30 +• +limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• +placing us at a competitive disadvantage compared to our competitors with less debt; and +• +making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our Credit Agreement or from other sources, we might not be able to service our debt, issue additional debt, or fund our planned capital expenditures and other liquidity needs. If we are unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our Credit Agreement and any future credit agreements, may prohibit us from pursuing any of these alternatives. Further, changes in the credit ratings of our debt may negatively affect the cost, terms, conditions, and availability of future financing. +Our debt agreements, including the Credit Agreement and the indentures governing our Senior Convertible Notes and our Senior Notes, permit us to incur additional debt in the future, subject to compliance with restrictive covenants under those agreements. In addition, entities we may acquire in the future could have significant amounts of debt outstanding that we could be required to assume, and in some cases accelerate repayment thereof, in connection with the acquisition, or we may incur our own significant indebtedness to consummate an acquisition. +As discussed above, our Credit Agreement is subject to periodic borrowing base redeterminations. We could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate renewals of our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt arrangements contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements, including the Credit Agreement and the indentures governing our Senior Convertible Notes and our Senior Notes, contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our ability to borrow under our Credit Agreement is subject to compliance with certain financial covenants. Financial covenants under the Credit Agreement require, that the Company’s (a) total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX ratio for the most recently ended four consecutive fiscal quarters (excluding the first three quarters which will use annualized adjusted EBITDAX), cannot be greater than 4.25 to 1.00 beginning with the quarter ending December 31, 2018, through and including the fiscal quarter ending December 31, 2019, and for each quarter ending thereafter, the ratio cannot be greater than 4.00 to 1.00; and (b) adjusted current ratio cannot be less than 1.0 to 1.0 as of the last day of any fiscal quarter. Our Credit Agreement also requires us to comply with certain additional financial covenants, including a requirement that we limit our annual cash dividends to no more than $50.0 million . These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. The Company was in compliance with all financial and non-financial covenants as of December 31, 2018 , and through the filing of this report. +The respective indentures governing the Senior Notes and Senior Convertible Notes also contain covenants that, among other things, limit our ability and the ability of our subsidiaries to: +• +incur additional debt; +• +make certain dividends or pay dividends or distributions on our capital stock or purchase, redeem, or retire common stock; +• +sell assets, including common stock of our subsidiaries; +• +restrict dividends or other payments of our subsidiaries; +• +create liens that secure debt; +• +enter into transactions with affiliates; and +• +merge or consolidate with another company. +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +31 +Our increasing dependence on digital technologies puts us at risk for a cyber incident that could result in information theft, data corruption, operational disruptions or financial loss. +We are subject to cybersecurity risks. The oil and gas industry is increasingly dependent on digital technology in all aspects of our business. We use digital technology to conduct certain of our drilling development, production and gathering activities, manage drilling rigs, gather and interpret seismic data, conduct reservoir modeling, record financial and operating data, and maintain employee and other databases. Our service providers, including those who gather, process and market our oil, gas and NGLs, are also increasingly reliant on digital technology. Our and their reliance on this technology increasingly puts us at risk for technology system failures, data or network disruptions, cyberattacks and other breaches in cybersecurity. Power failures, telecommunication or other system failures due to hardware or software malfunctions, computer viruses, vandalism, terrorism, natural disasters, fire, flood, human error or other means could significantly impair our ability to conduct our business. +Cybersecurity attacks in particular are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data. Deliberate attacks on, or security breaches in our systems, infrastructure, the systems and infrastructure of third-parties, or cloud-based applications could lead to disclosure of confidential information, a corruption or loss of our proprietary data, delays in production or exploration activities, difficulty in completing or settling transactions, challenges in maintaining our books and records, environmental damage, communication or other operational disruptions, and liability to third parties. Our insurance may not provide adequate protection from these risks. Any such events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. As these cyber risks continue to evolve and our dependence on digital technologies grows, we may be required to expend significant additional resources to continue to modify or enhance our protective measures and remediate cyber vulnerabilities. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As an oil, gas, and NGL producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third-party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel, or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +The threat of terrorism and the impact of military and other actions have caused instability in world financial markets and could lead to increased volatility in prices for oil, gas, and NGLs, all of which could adversely affect the markets for our production. Energy assets might be specific targets of terrorist attacks. While we currently maintain some insurance that provides coverage against terrorist attacks, such insurance has become increasingly expensive and difficult to obtain. As a result, insurance providers may not continue to offer this coverage to us on terms we consider reasonable, or at all. In addition, this insurance may not cover all of our losses for a terrorist attack. These developments have subjected our operations to increased risk and, depending on their occurrence and ultimate magnitude, could have a material adverse effect on our business, financial condition, or results of operations. +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of oil, gas and NGLs, or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, seismic events, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occurs, we could sustain substantial losses. +Furthermore, if we experience any of the problems with well stimulation and completion activities referenced above, our ability to explore for and produce oil, gas, or NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shut down, abandon, or relocate drilling operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling, and disposal of materials, including produced water, solid and hazardous wastes, and petroleum hydrocarbons. We may incur joint and several, and/or strict liability under applicable United States federal and state environmental laws in connection with releases of petroleum hydrocarbons and other hazardous substances at, on, under or from our leased or owned properties, some +32 +of which have been used for oil and gas exploration and production activities for a number of years, often by third-parties not under our control. For our outside-operated properties, we are dependent on the operator for operational and regulatory compliance and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or therefrom could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including the CERCLA or the Superfund law, the RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under various implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury or property damage, including induced seismicity damage, allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third-parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer a material loss. +Our operations are subject to complex laws and regulations, including environmental regulations that result in substantial costs and other risks. +Federal, state, and local authorities extensively regulate the oil and gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing, or marketing of oil, gas, and NGL production. Non-compliance with statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +Governmental authorities regulate various aspects of drilling for and the production of oil, gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in oil and gas properties, rights-of-way and easements, disposal of produced water, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, restoration standards, and oil and gas operations. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Federal authorities also may require any of our ongoing or planned operations on federal leases to be delayed, suspended, or terminated. Any such delay, suspension, or termination could have a materially adverse effect on our operations. +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate in, could result in material costs or claims with respect to properties we own or have owned. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, and local environmental laws for emissions and for discharges of oil, gas, and NGLs or other pollutants into the air, soil, surface water, or groundwater. We could be required to spend substantial amounts on investigations, litigation, and remediation for these emissions and discharges and other compliance issues. Any unpermitted release of petroleum or other pollutants from our operations could result not only in cleanup costs, but also natural resources, real or personal property and other damages and civil and criminal liabilities. The listing of additional wildlife or plant species as federally endangered or threatened could result in limitations on exploration and production activities in certain locations. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a materially adverse effect on us. +The impact of extreme weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Our operations in our Permian and South Texas & Gulf Coast regions are adversely affected by the impact of extreme weather conditions and lease stipulations designed to protect various wildlife or plant species. In certain areas, drilling and other oil and gas +33 +activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs, oil field equipment, services, supplies and qualified personnel, which may lead to periodic shortages. Wildlife seasonal restrictions may limit access to federal leases or across federal lands. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing, air quality, and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays . +Hydraulic fracturing is a common practice in the oil and gas industry used to stimulate the production of oil, gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and gas properties, including our unconventional resource plays within our Permian and South Texas & Gulf Coast regions. Hydraulic fracturing involves injecting water, sand, and certain chemicals under pressure to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities, as outlined below. +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the Safe Drinking Water Act. The EPA has published an interpretive memorandum and permitting guidance related to regulation of fracturing fluids using this regulatory authority. In June 2016, the EPA issued regulations under the Federal Clean Water Act establishing federal pre-treatment standards for wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process. Under a recent settlement, the EPA will decide by March 2019 whether to initiate rulemaking governing the disposal of wastewater from oil and gas development. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states, including Texas, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict, or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event that state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +In the recent past, several federal governmental agencies were actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. For example, in December 2016, the EPA issued a final assessment of potential impacts to drinking water resources from hydraulic fracturing. On March 28, 2017, President Trump issued Executive Order 13783 entitled “Promoting Energy Independence and Economic Growth” (“Executive Order 13783”). Executive Order 13783 directed executive departments and agencies to review regulations that potentially burden the development or use of domestically produced energy resources and, as appropriate, suspend, revise, or rescind those that unduly burden domestic energy resources development. +On March 26, 2015, the BLM published a final rule requiring, among other things, disclosure of chemicals used in hydraulic fracturing on federal and tribal lands, including private surface lands with underlying federal minerals. The rule was never implemented due to court challenges. On December 29, 2017, the BLM rescinded the rule. We will continue to be subject to uncertainty associated with new regulatory suspensions, revisions or rescissions and inconsistent state and federal regulatory mandates that could adversely affect our production. +Further, as to air quality and greenhouse gas (“GHG”) regulation of oil and gas sources, the overall trend has been toward increased regulation and requirements for reduced emissions. The Trump administration has taken steps toward rescinding or reviewing many of those regulations, but any deregulation will likely face immediate judicial challenges. The Obama administration took several actions to regulate air quality and GHGs, many of which remain in effect. For example, on August 16, 2012, the EPA issued final rules subjecting all new and modified oil and gas operations (production, processing, transmission, storage, and distribution) to regulation under the New Source Performance Standards (“NSPS”) and all existing and new operations to the National Emission Standards for Hazardous Air Pollutants (“NESHAP”) programs. The EPA rules also include NSPS standards for completions of hydraulically fractured gas wells. These standards require the use of reduced emission completion (“REC”) techniques developed in the EPA’s Natural Gas STAR program along with the pit flaring of gas not sent to the gathering line beginning in January 2015. The standards are applicable to newly drilled and fractured wells as well as existing wells that are refractured. Further, the regulations under NESHAP include maximum achievable control technology (“MACT”) standards for those glycol dehydrators and certain storage vessels at major sources of hazardous air pollutants not previously subject to MACT standards. These rules require additional control equipment, changes to procedure, and extensive monitoring and reporting. In September 2013 and December 2014, the EPA published technical fixes to the 2012 NSPS, including standards for storage tanks subject to the NSPS. The amendments clarified stages for flowback and the point at which green completion equipment is required and updated requirements for storage tanks and +34 +leak detection requirements for processing plants. As part of the EPA’s strategy during the Obama administration to reduce methane and ozone-forming volatile organic compound (“VOC”) emissions from the oil and gas industry, on May 12, 2016, the EPA issued final regulations that amend and expand the 2012 regulations. The 2016 NSPS requires reduction of greenhouse gases in the form of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The final regulation requires, among other things, GHG and VOC standards for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and natural gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. Both the 2012 and 2016 rules are the subjects of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia, though the litigation of both rules has been stayed. In June 2017, the EPA proposed a 2-year stay of the compliance requirements in the 2016 NSPS. In a related action in March 2017, the EPA withdrew the final information request it had issued in 2016 as part of an effort to develop standards under the CAA NSPS provisions for methane and other emissions from existing sources in the oil and natural gas industry. In September 2018, the EPA proposed changes to the 2016 NSPS amending specific provisions related to, among other things, fugitive emissions requirements. +In October 2015, the EPA revised and lowered the ambient air quality standard for ozone in the U.S. under the CAA, from 75 parts per billion to 70 parts per billion, which is likely to result in more, and expanded, ozone non-attainment areas, which in turn will require states to adopt implementation plans to reduce emissions of ozone-forming pollutants, like VOCs and nitrogen oxides, that are emitted from, among others, the oil and gas industry. A decision in the judicial challenge to the ozone standard is expected in 2019. In October 2016, the EPA finalized Control Techniques Guidelines for VOC emissions from existing oil and natural gas equipment and processes in moderate ozone non-attainment areas. These Control Techniques Guidelines provide recommendations for states and local air agencies to consider when determining what emissions requirements apply to sources in the non-attainment areas. The EPA has proposed to completely withdraw the rules. On May 12, 2016, the EPA also issued a final rule named the “Source Determination Rule” that was issued to clarify when multiple pieces of oil and gas equipment and activities must be aggregated as a single source for determining whether major source permitting programs apply. This action can expand the permitting and related control requirements to sources that were not previously subject to permitting requirements. However, more recently, the EPA has issued several guidance documents and memorandums related to aggregation of facilities that may narrow the effect of the Source Determination Rule. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third-parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. In 2013, a court in California held that the BLM did not comply with NEPA because it did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. Courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing, including damages from induced seismicity, could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for, and production of, oil, gas, and NGLs, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional state or local laws, or the implementation of new regulations regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +Requirements to reduce gas flaring could have an adverse effect on our operations. +Wells in the Midland Basin in Texas, where we have significant operations, produce natural gas, as well as oil and NGLs. Constraints in the gas gathering and processing network in certain areas of the Midland Basin have resulted in some of that gas being flared instead of gathered, processed, and sold. Further, we are subject to laws established by state and other regulatory agencies that restrict the duration and amount of natural gas that can be legally flared. These laws and regulations, including potential future regulations that may impose further restrictions on flaring, could limit the amount of oil and gas the Company can produce from the Company’s wells or may limit the number of wells or the locations that the Company can drill. +In November 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands. The regulations prohibit venting gas except in limited situations and limit the flaring of gas. After continuous court challenges, the BLM issued a final rule in September 2018 that rescinded most of the 2016 rule, including most of the methane control requirements. Any future regulations requiring similar capture standards may increase our operational costs, or restrict our production, which could materially and adversely affect our financial condition, results of operations and cash flows. +35 +Our ability to produce oil, gas, and NGLs economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the water we use at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of oil, gas, and NGLs requires the use and disposal of significant quantities of water. +Our inability to secure sufficient amounts of water, or to dispose of or recycle the water produced from our wells, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of oil, gas, and NGLs. +Compliance with environmental regulations and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs. +In December 2009, the EPA made a finding that emissions of carbon dioxide, methane, and other “greenhouse gases” endanger public health and the environment because emissions of such gases contribute to warming of the earth’s atmosphere and other climatic changes. Based on this finding, the EPA adopted and implemented a comprehensive suite of regulations to restrict and otherwise regulate emissions of greenhouse gases under existing provisions of the CAA. In particular, the EPA adopted two sets of rules regulating greenhouse gas emissions under the CAA. One rule requires a reduction in greenhouse gas emissions from motor vehicles, and the other regulates permitting and greenhouse gas emissions from certain large stationary sources. These EPA regulatory actions have been challenged by various industry groups, initially in the D.C. Circuit, which in 2012 ruled in favor of the EPA in all respects. However, in June 2014, the United States Supreme Court reversed the D.C. Circuit and struck down the EPA’s greenhouse gas permitting rules to the extent they impose a requirement to obtain a permit based solely on emissions of greenhouse gases. The EPA proposed a rule in 2016 to comply with the U.S. Supreme Court’s ruling by limiting the requirement to obtain permits addressing emissions of greenhouse gases to large sources of other air pollutants, such as volatile organic compounds or nitrogen oxides, which also emit 100,000 tons per year or more of CO 2 (or modifications of these sources that result in an emissions increase of 75,000 tons per year or more of CO 2 e). If finalized, large sources of air pollutants other than greenhouse gases will be required to implement the best available capture technology for greenhouse gases. However, the EPA has not taken action on the proposed rule and is unlikely to do so under the Trump administration. The EPA has also adopted reporting rules for greenhouse gas emissions from specified greenhouse gas emission sources in the United States, including petroleum refineries as well as certain onshore oil and gas extraction and production facilities. +Several other cases regarding greenhouse gases have been heard by the courts in recent years. While courts have generally declined to assign direct liability for climate change to large sources of greenhouse gas emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant greenhouse gas emissions, and new claims for damages and increased government scrutiny, especially from state and local governments, will likely continue. Such cases often seek to challenge air emissions permits that greenhouse gas emitters apply for, seek to force emitters to reduce their emissions, or seek damages for alleged climate change impacts to the environment, people, and property. Any court rulings, laws, or regulations that restrict or require reduced emissions of greenhouse gases could lead to increased operating and compliance costs and could have an adverse effect on demand for the oil and gas that we produce. +The United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases, and almost one-half of the states have already taken measures to reduce emissions of greenhouse gases, primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas “cap and trade” programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. In 2013, the Congressional Budget Office provided Congress with a study on the potential effects on the United States economy of a tax on greenhouse gas emissions and recently summarized the impact of imposition of a tax on greenhouse gas emissions for reducing the deficit. While “carbon tax” legislation has been introduced in Congress, the prospects for passage of such legislation are uncertain at this time. +On June 25, 2013, President Obama issued a Climate Action Plan to address climate change through a variety of executive actions, including reduction of methane emissions from oil and gas production and processing operations as well as pipelines and coal mines (the “Climate Action Plan”). Please refer to Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays for more information on EPA actions to implement the Climate Action Plan. The focus on legislating and/or regulating methane could eventually result in: +36 +• +requirements for methane emission reductions from existing oil and gas equipment; +• +increased scrutiny for sources emitting high levels of methane, including during permitting processes; +• +analysis, regulation and reduction of methane emissions as a requirement for project approval; and +• +actions taken by one agency for a specific industry establishing precedents for other agencies and industry sectors. +In relation to the Climate Action Plan, both assumed global warming potential (“GWP”) and assumed social costs associated with methane and other greenhouse gas emissions have been finalized, including a 20% increase in the GWP of methane. Changes to these measurement tools could adversely impact permitting requirements, application of agencies’ existing regulations for source categories with high methane emissions, and determinations of whether a source qualifies for regulation under the CAA. However, in Executive Order 13783, President Trump ordered a review of the use of social cost of carbon for regulatory impact analysis. Therefore, the continued use of the social cost of carbon under the Trump administration is uncertain. +Finally, it should be noted that scientists have predicted that increasing concentrations of greenhouse gases in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies, or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses, or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements. +New technologies may cause our current exploration and drilling methods to become obsolete. +The oil and gas industry is subject to rapid and significant advancements in technology, including the introduction of new products and services that use new technologies. As competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, competitors may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. One or more of the technologies we currently use or implement in the future may become obsolete. We cannot be certain we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. If we are unable to maintain technological advancements consistent with industry standards, our operations, and financial condition may be adversely affected. +Risks Related to Our Common Stock +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2018 , to February 7, 2019 , the intraday trading prices per share of our common stock as reported by the New York Stock Exchange ranged from a low of $13.15 per share in December 2018 to a high of $33.76 per share in October 2018 . We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include, in addition to the other Risk Factors set forth herein, the following: +• +changes in oil, gas, or NGL prices; +• +changes in the outlook for regional, national, or global commodity supply and demand; +• +variations in drilling, recompletion, and operating activity; +• +changes in financial estimates by securities analysts; +• +changes in market valuations of comparable companies; +• +additions or departures of key personnel; +• +increased volatility due to the impacts of algorithmic trading practices; +• +future sales of our common stock; and +• +changes in the national and global economic outlook, including potential impacts from trade agreements. +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +37 +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third-party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +We may not always pay dividends on our common stock. +Payment of future dividends remains at the discretion of our Board of Directors, and will continue to depend on our earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to a covenant in our Credit Agreement limiting our annual cash dividends to no more than $50.0 million , and to covenants in the indentures for our Senior Notes and Senior Convertible Notes that limit our ability to pay dividends beyond a certain amount. Our Board of Directors may determine in the future to reduce the current semi-annual dividend rate of $0.05 per share or discontinue the payment of dividends altogether. +38 +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Exchange Act. +ITEM 3. LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our business and operations in the normal course of business. As of the filing of this report, no legal proceedings are pending against us that we believe individually or collectively are likely to have a materially adverse effect upon our financial condition, results of operations or cash flows. +Chieftain Royalty Company v. SM Energy Company, Case No. CIV-11-D, In the United States District Court, Western District of Oklahoma. On January 27, 2011, Chieftain Royalty Company (“Plaintiff”) commenced a putative class action lawsuit against the Company by filing a Petition in the District Court of Beaver County, Oklahoma, in the matter originally styled Chieftain Royalty Company v. SM Energy Company (including predecessors, successors and affiliates), Case No. CJ-201104, alleging that the Company had improperly deducted post-production costs from royalty payments due on production from wells located throughout Oklahoma, and asserting claims against the Company for breach of contract, tortious breach of contract, breach of fiduciary or quasi-fiduciary duty, fraud (actual and constructive), deceit, conversion and conspiracy. +The Company removed the case to the United States District Court for the Western District of Oklahoma. Thereafter, the Court stayed this matter pending the outcome of two appeals involving XTO Energy, Inc (“XTO”), before the Tenth Circuit Court of Appeals. After resolution of the XTO appeals, the stay was lifted in 2013. +The Company was originally the only named defendant, but, as a result of the Company’s 2013 disposition of approximately 75% of its Oklahoma properties to various entities, with those entities agreeing to assume any liability for any past or present royalty claims, Plaintiff filed a Second Amended Complaint in 2014 joining such entities as defendants. Those defendants subsequently settled all claims with Plaintiff; however, that settlement was effectively stayed during extended appellate proceedings concerning disputed attorneys’ fees in the matter. The Chieftain matter concerning the remaining Oklahoma properties was stayed during the fee dispute proceedings. +On August 2, 2018, the Court in this matter required that Plaintiff file any motion to certify a class by February 8, 2019. Plaintiff filed such motion but only with respect to royalty owners in wells attached to the Coal County, Oklahoma pipeline system, which was owned by the Company’s affiliate, Four Winds Marketing, LLC, until 2015, when the subject wells and pipeline system were sold to a third party. +This case involves complex legal and factual issues and uncertainties as to Oklahoma law and federal law concerning class certification under the circumstances of this case, and has resulted in a significant amount of discovery. The Company believes that it has properly paid royalties under Oklahoma law and that the class as proposed by Plaintiff should not be certified. The Company has and will continue to vigorously defend this case. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +39 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2013 , and ending on December 31, 2018 , with the cumulative total returns of the Dow Jones U.S. Exploration and Production Index, and the Standard & Poor’s 500 Stock Index. +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +Holders. As of February 7, 2019 , the number of record holders of our common stock was 65. Based upon inquiry, management believes that the number of beneficial owners of our common stock is approximately 21,337. +Purchases of Equity Securities by Issuer and Affiliated Purchasers. The following table provides information about purchases made by us and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and year ended December 31, 2018 , of shares of our common stock, which is the sole class of equity securities registered by us pursuant to Section 12 of the Exchange Act. +40 +PURCHASES OF EQUITY SECURITIES BY ISSUER AND AFFILIATED PURCHASERS +Period +Total Number of Shares Purchased (1) +Weighted Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program +Maximum Number of Shares that May Yet be Purchased Under the Program (2) +01/01/2018 - +03/31/2018 +— +$ +— +— +3,072,184 +04/01/2018 - +06/30/2018 +355 +$ +26.64 +— +3,072,184 +07/01/2018 - +09/30/2018 +115,429 +$ +25.69 +— +3,072,184 +10/01/2018 - +12/31/2018 +— +$ +— +— +3,072,184 +Total +115,784 +$ +25.69 +— +3,072,184 +____________________________________________ +(1) +All shares purchased by us in 2018 were to offset tax withholding obligations that occurred upon the delivery of outstanding shares underlying Restricted Stock Units (“RSUs”) issued under the terms of award agreements granted under the SM Energy Equity Incentive Compensation Plan, as amended and restated effective as of May 22, 2018 (the “Equity Plan”). +(2) +In July 2006, our Board of Directors approved an increase in the number of shares that may be repurchased under the original August 1998 authorization to 6,000,000 as of the effective date of the resolution. Accordingly, as of the filing of this report, subject to the approval of our Board of Directors, we may repurchase up to 3,072,184 shares of common stock on a prospective basis. The shares may be repurchased from time to time in open market transactions or privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes and Senior Convertible Notes, and compliance with securities laws. Stock repurchases may be funded with existing cash balances, internal cash flows, or borrowings under our Credit Agreement. The stock repurchase program may be suspended or discontinued at any time. +41 +ITEM 6. SELECTED FINANCIAL DATA +The following table sets forth selected supplemental financial and operating data as of the dates or for the years indicated. The financial data for each of the five years presented was derived from our consolidated financial statements. The following data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report, which includes a discussion of factors materially affecting the comparability of the information presented, and in conjunction with our consolidated financial statements included in this report. +As of or for the Years Ended December 31, +2018 +2017 +2016 +2015 +2014 +(in millions, except per share data) +Statement of operations data: +Total operating revenues and other income +$ +2,067.1 +$ +1,129.4 +$ +1,217.5 +$ +1,557.0 +$ +2,522.3 +Net income (loss) +$ +508.4 +$ +(160.8 +) +$ +(757.7 +) +$ +(447.7 +) +$ +666.1 +Net income (loss) per share: +Basic +$ +4.54 +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +$ +9.91 +Diluted +$ +4.48 +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +$ +9.79 +Cash dividends declared and paid per common share +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +Balance sheet data: +Total assets +$ +6,352.9 +$ +6,176.8 +$ +6,393.5 +$ +5,621.6 +$ +6,483.1 +Long-term debt: +Revolving credit facility +$ +— +$ +— +$ +— +$ +202.0 +$ +166.0 +Senior Notes, net of unamortized deferred financing costs +$ +2,448.4 +$ +2,769.7 +$ +2,766.7 +$ +2,316.0 +$ +2,166.4 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +$ +147.9 +$ +139.1 +$ +130.9 +$ +— +$ +— +42 +Supplemental Selected Financial and Operations Data +As of or for the Years Ended December 31, +2018 +2017 +2016 +2015 +2014 +Balance sheet data (in millions): +Total working capital (deficit) +$ +(36.8 +) +$ +(10.1 +) +$ +(190.5 +) +$ +216.5 +$ +(39.6 +) +Total stockholders’ equity +$ +2,920.3 +$ +2,394.6 +$ +2,497.1 +$ +1,852.4 +$ +2,286.7 +Weighted-average common shares outstanding (in thousands): +Basic +111,912 +111,428 +76,568 +67,723 +67,230 +Diluted +113,502 +111,428 +76,568 +67,723 +68,044 +Reserves: +Oil (MMBbl) +175.7 +158.2 +104.9 +145.3 +169.7 +Gas (Bcf) +1,321.8 +1,280.1 +1,111.1 +1,264.0 +1,466.5 +NGLs (MMBbl) +107.4 +96.5 +105.7 +115.4 +133.5 +MMBOE (1) +503.4 +468.1 +395.8 +471.3 +547.7 +Production and operations (in millions): +Oil, gas, and NGL production revenue +$ +1,636.4 +$ +1,253.8 +$ +1,178.4 +$ +1,499.9 +$ +2,481.5 +Oil, gas, and NGL production expense +$ +487.4 +$ +507.9 +$ +597.6 +$ +723.6 +$ +715.9 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +665.3 +$ +557.0 +$ +790.7 +$ +921.0 +$ +767.5 +General and administrative (2) +$ +116.5 +$ +117.3 +$ +124.8 +$ +156.1 +$ +166.5 +Production volumes: +Oil (MMBbl) +18.8 +13.7 +16.6 +19.2 +16.7 +Gas (Bcf) +103.2 +123.0 +146.9 +173.6 +152.9 +NGLs (MMBbl) +7.9 +10.3 +14.2 +16.1 +13.0 +MMBOE (1) +43.9 +44.5 +55.3 +64.2 +55.1 +Realized price, before the effect of derivative settlements: +Oil (per Bbl) +$ +56.80 +$ +47.88 +$ +36.85 +$ +41.49 +$ +80.97 +Gas (per Mcf) +$ +3.43 +$ +3.00 +$ +2.30 +$ +2.57 +$ +4.58 +NGLs (per Bbl) +$ +27.22 +$ +22.35 +$ +16.16 +$ +15.92 +$ +33.34 +Per BOE +$ +37.27 +$ +28.20 +$ +21.32 +$ +23.36 +$ +45.01 +Expense per BOE: +Lease operating expense +$ +4.74 +$ +4.43 +$ +3.51 +$ +3.73 +$ +4.28 +Transportation costs +$ +4.36 +$ +5.48 +$ +6.16 +$ +6.02 +$ +6.11 +Production taxes +$ +1.52 +$ +1.18 +$ +0.94 +$ +1.13 +$ +2.13 +Ad valorem tax expense +$ +0.48 +$ +0.34 +$ +0.21 +$ +0.39 +$ +0.46 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +15.15 +$ +12.53 +$ +14.30 +$ +14.34 +$ +13.92 +General and administrative (2) +$ +2.65 +$ +2.64 +$ +2.26 +$ +2.43 +$ +3.02 +Statement of cash flows data (in millions): +Provided by operating activities (2) +$ +720.6 +$ +515.4 +$ +552.8 +$ +990.8 +$ +1,456.6 +Used in investing activities (2) +$ +(587.9 +) +$ +(201.5 +) +$ +(1,867.6 +) +$ +(1,144.6 +) +$ +(2,575.5 +) +Provided by (used in) financing activities (2) +$ +(368.7 +) +$ +(12.3 +) +$ +1,327.2 +$ +153.7 +$ +740.0 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +Certain prior period amounts have been reclassified to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 for additional discussion of the change in presentation as a result of adopting new accounting standards. +43 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +This discussion includes forward-looking statements. Please refer to Cautionary Information about Forward-Looking Statements in Part I, Items 1 and 2 of this report for important information about these types of statements. +Overview of the Company +General Overview +We are an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in onshore North America. We currently have producing assets and significant acreage positions in the Midland Basin and Eagle Ford shale in Texas. Our strategic objective is to be a premier operator of top tier assets. We seek to maximize the value of our assets by applying industry leading technology and outstanding operational execution. Our portfolio is comprised of unconventional resource prospects with expanding prospective drilling opportunities, which we believe provides for long-term production and reserves growth. We are focused on generating strong full-cycle economic returns on our investments and maintaining a strong balance sheet. +2018 Financial and Operational Highlights +Our objective to be a premier operator of top tier assets led to our multi-year portfolio transformation, which now allows us to focus solely on maximizing the value of our core acreage positions located in the Midland Basin and Eagle Ford shale. As part of our transformation strategy, we completed divestitures of substantially all remaining non-core assets in the first half of 2018. We used proceeds from these divestitures, along with operating cash flows, to fully fund our 2018 capital program and to meaningfully reduce our long-term debt. Additionally, we completed financial transactions during the year that extended the average maturity on our remaining long-term debt, and we had no outstanding borrowings against our credit facility as of December 31, 2018 . Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions and Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Financial and Operational Results. During the year ended December 31, 2018 , we achieved the following financial and operational results: +• +Total estimated proved reserves increased eight percent from the prior year to 503.4 MMBOE as of December 31, 2018 , of which 56 percent were liquids (oil and NGLs) and 49 percent were characterized as proved developed. During 2018 , we added 188.0 MMBOE through our Midland Basin and Eagle Ford shale drilling programs as well as from changes to our future development strategy in the Eagle Ford shale, which includes wider spacing and longer lateral completions. These positive results for 2018 were partially offset by the divestiture of 40.3 MMBOE of estimated proved reserves, and net downward revisions of 68.8 MMBOE, which resulted primarily from changes in our development plans in our Eagle Ford shale program. On a retained asset basis, estimated proved reserves increased 18 percent year-over-year. Further, our estimated proved reserve life index increased to 11.5 years at December 31, 2018 , compared to 10.5 years at December 31, 2017 . Please refer to Reserves in Part I, Items 1 and 2 of this report for additional discussion. +• +The standardized measure of discounted future net cash flows was $4.7 billion as of December 31, 2018 , compared with $3.0 billion as of December 31, 2017 , which was an increase of 54 percent year-over-year. Please refer to Supplemental Oil and Gas Information in Part II, Item 8 of this report for additional discussion. +• +Average net daily production for the year ended December 31, 2018 , was 120.3 MBOE, compared with 121.8 MBOE for the same period in 2017 . This decrease was driven largely by producing property divestitures in 2017 and in the first half of 2018. On a retained asset basis, production increased 11 percent year-over-year, which was due to a 91 percent increase in production volumes in our Permian region for the year ended December 31, 2018 , compared with 2017 . Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends below for additional discussion on production. +• +We recorded net income of $508.4 million , or $4.48 per diluted share, for the year ended December 31, 2018 . This compares with a net loss of $160.8 million , or $1.44 per diluted share, for the year ended December 31, 2017 . Please refer to Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 below for additional discussion regarding the components of net income (loss) for each period presented. +• +Net cash provided by operating activities was $720.6 million for the year ended December 31, 2018 , compared with $515.4 million for the year ended December 31, 2017 , which was an increase of 40 percent year-over-year. The increase in net cash provided by operating activities for 2018 , compared with 2017 , was primarily the result of 37 percent growth in higher margin oil production, which, combined with increased benchmark pricing for oil and NGLs, drove a 32 percent increase in our realized price per BOE before the effects of derivative settlements, and led to a 31 percent increase in oil, gas, and NGL production revenue. Partially offsetting the increase from oil, gas, and NGL production revenue was a cash settlement loss on derivatives of $135.8 million for the year ended December 31, 2018 , compared to a cash settlement +44 +gain on derivatives of $21.2 million during 2017 . Please refer to Analysis of Cash Flow Changes Between 2018 and 2017 and Between 2017 and 2016 below for additional discussion. +• +Adjusted EBITDAX, a non-GAAP financial measure, for the year ended December 31, 2018 , was $900.4 million , compared with $663.2 million for the same period in 2017 . The increase in adjusted EBITDAX for 2018 was largely driven by the growth in higher margin oil production and improved benchmark pricing for oil and NGLs. This increase was partially offset by increased losses on derivative settlements. Please refer to Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and reconciliations to our net income (loss) and net cash provided by operating activities. +Long-Term Debt. During the year ended December 31, 2018 , we executed certain long-term debt transactions and agreements, which are summarized below: +• +2021 Senior Notes Redemption. On July 16, 2018, we redeemed the $344.6 million principal outstanding of our 2021 Senior Notes using cash on hand resulting from property divestitures. Redemption of the 2021 Senior Notes resulted in a loss on extinguishment of debt of $9.8 million for the year ended December 31, 2018 . This loss included $7.5 million associated with the premium paid and $2.3 million due to the acceleration of previously unamortized deferred financing costs. +• +2027 Senior Notes Issuance. On August 20, 2018 , we issued $500.0 million in aggregate principal amount of 6.625% Senior Notes due 2027 and received net proceeds of $492.1 million . This offering was made in order to fund the tender offer and notes redemption discussed below. +• +Tender Offer and Redemption of our 2023 Senior Notes and a Portion of our 2022 Senior Notes. Concurrently with our 2027 Senior Notes offering, we announced a cash tender offer (the “Tender Offer”), which included plans to redeem our 2023 Senior Notes and a portion of our 2022 Senior Notes. Upon completion of these transactions, we retired the $395.0 million principal outstanding of our 2023 Senior Notes and $85.0 million principal outstanding of our 2022 Senior Notes. We paid total consideration, including accrued interest, of $497.8 million to complete these transactions, which resulted in a loss on extinguishment of debt of $16.9 million for the year ended December 31, 2018 . This amount included $12.9 million associated with premiums paid and $4.0 million due to the acceleration of previously unamortized deferred financing costs. +• +Credit Agreement. On September 28, 2018 , we entered into the Credit Agreement with our lenders which provides for a senior secured revolving credit facility with a maximum loan amount of $2.5 billion , an initial borrowing base of $1.5 billion , and initial aggregate lender commitments totaling $1.0 billion . The Credit Agreement is scheduled to mature on September 28, 2023 . The maturity date could, however, occur earlier on August 16, 2022, to the extent we have not completed certain repurchase, redemption, or refinancing activities associated with our 2022 Senior Notes as outlined in the Credit Agreement. +Please refer to Overview of Liquidity and Capital Resources below and Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Operational Activities . The value of the RockStar area of our Midland Basin position continues to exceed our pre-acquisition expectations and was key to driving significant growth in our operating margin and cash flows from operations in 2018 due to the high percentage of oil these wells produce. Our operational execution and development strategy in this region has resulted in stronger well performance due to enhanced completion design and our ability to drill longer laterals given the increasingly contiguous nature of our acreage position as a result of successful infill leasing and acreage trades. Efficiency in completions and operations also increased in 2018, as a large portion of our water transportation and disposal needs are being satisfied by the water facilities we constructed in a core area of our RockStar acreage. We also continued to increase our use of locally sourced sand in our well completions, which has resulted in further cost savings and improved returns for our program. +In our Midland Basin program, we averaged seven drilling rigs and four completion crews during 2018 , focusing on the development of the Lower Spraberry and Wolfcamp A and B shale intervals on our RockStar acreage in Howard and Martin Counties, Texas, as well as our Sweetie Peck acreage in Upton and Midland Counties, Texas. We completed 114 gross ( 104 net) operated wells during 2018 and increased production volumes year-over-year by 91 percent to 20.9 MMBOE, 79 percent of which was oil. 84 percent of our total 2018 drilling and completion capital was allocated to our Midland Basin program. +During 2018 in our operated Eagle Ford shale program, we were focused on increasing overall inventory value through optimizing our completion designs and by evaluating our development strategy and electing to revise our development plans to include wider spaced locations and longer lateral well completions that we believe will yield greater returns. We have also been active in assessing new intervals outside of the core Eagle Ford shale formation to further expand our future drilling inventory. +In September 2017, we entered into a joint venture agreement with a third-party to drill 16 wells and complete 23 wells in a focused portion of our Eagle Ford North area (“Phase 1 JV”). In December 2018, we extended this agreement and added an additional 12 wells to be drilled and completed (“Phase 2 JV”). The agreement provides that the third-party carries substantially all drilling and completion costs and receives a majority of the working and revenue interest in these wells until certain payout thresholds are reached. +45 +This arrangement allows us to leverage third-party capital to prove up the value of our Eagle Ford North area, while also allowing us to test cutting edge technology, capture additional technical data, satisfy certain lease obligations, and potentially expand economic drilling inventory in the future. All Phase 1 JV wells were drilled and completed as of December 31, 2018. Six of the 12 Phase 2 JV wells were drilled during 2018, and we expect the remaining six wells to be drilled and all 12 wells to be completed during 2019. +Our Eagle Ford shale program averaged one drilling rig and one completion crew during 2018 . We completed 40 gross ( 26 net) wells during 2018 . Total production for 2018 was 21.8 MMBOE, a 26 percent decrease from 2017. The decrease in production from our Eagle Ford shale program was primarily driven by the sale of our outside-operated assets in the first quarter of 2017 and reduced capital investment on our retained operated acreage. 14 percent of our total 2018 drilling and completion capital was allocated to our Eagle Ford shale program. +The table below provides a summary of changes in our drilled but not completed well count and current year drilling and completion activity in our operated programs for the year ended December 31, 2018 . +Permian +South Texas & Gulf Coast +Bakken/Three Forks (1) +Total +Gross +Net +Gross +Net +Gross +Net +Gross +Net +Wells drilled but not completed at December 31, 2017 +49 +41 +33 +30 +18 +15 +100 +86 +Wells drilled +126 +117 +36 +20 +— +— +162 +137 +Wells completed +(114 +) +(104 +) +(40 +) +(26 +) +— +— +(154 +) +(130 +) +Wells sold (1) +— +— +— +— +(18 +) +(15 +) +(18 +) +(15 +) +Other (2) +— +1 +— +(1 +) +— +— +— +— +Wells drilled but not completed at December 31, 2018 +61 +55 +29 +23 +— +— +90 +78 +_____________________________________ +(1) +Drilled but not completed wells in this table relating to the Bakken/Three Forks operated program were included as part of the Divide County Divestiture, which was completed in the second quarter of 2018. +(2) +Reflects net working interest changes resulting from normal business operations. +Costs Incurred in Oil and Gas Producing Activities. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended +December 31, 2018 +(in millions) +Development costs +$ +1,147.6 +Exploration costs +184.9 +Acquisitions +Proved properties +1.3 +Unproved properties +55.7 +Total, including asset retirement obligations (1) +$ +1,389.5 +____________________________________________ +(1) +Please refer to Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information in Part II, Item 8 of this report. +All of our development and exploration costs were incurred in our Midland Basin and Eagle Ford shale programs for the year ended December 31, 2018 , with 84 percent of these costs being directed towards activities on our Midland Basin assets. Costs incurred for acquisitions during the year related to transactions in the Midland Basin, as well as payments made to extend certain lease terms, to acquire new leases, and to acquire certain surface rights associated with our Midland Basin water handling and transportation facilities. Please refer to Operational Activities above and Acquisition Activity below for additional information on our regional activities. +46 +Production Results. The table below presents the disaggregation of our production by product type for each of our operating regions for the year ended December 31, 2018 : +Permian +South Texas & Gulf Coast +Rocky +Mountain (1) +Total +Production: +Oil (MMBbl) +16.6 +1.3 +0.9 +18.8 +Gas (Bcf) +25.8 +76.2 +1.2 +103.2 +NGLs (MMBbl) +— +7.9 +— +7.9 +Equivalent (MMBOE) +20.9 +21.8 +1.1 +43.9 +Avg. Daily Equivalents (MBOE/d) +57.4 +59.9 +3.1 +120.3 +Relative percentage +48 +% +50 +% +2 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) +We divested all remaining producing assets in the Rocky Mountain region in the first half of 2018. As a result, there have been no production volumes from this region after the second quarter of 2018. +We experienced a one percent decrease in production on an equivalent basis for the year ended December 31, 2018 , compared with 2017 . The decrease in overall production volumes was primarily a result of the divestiture of our outside-operated Eagle Ford shale assets in the first quarter of 2017, decreased production from our operated Eagle Ford shale assets as a result of reduced capital investment, and the divestiture of our remaining producing assets in the Rocky Mountain region in the first half of 2018. Production decreases from the Eagle Ford shale and Rocky Mountain region were mostly offset by the Permian region, which had an increase in production volumes of 91 percent for the year ended December 31, 2018 , compared with 2017 . Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends and Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 below for additional discussion on production. +Divestiture Activity. On March 26, 2018 , we divested approximately 112,000 net acres of our Powder River Basin assets for net divestiture proceeds of $492.2 million and recorded a final net gain of $410.6 million for the year ended December 31, 2018 . During the second quarter of 2018, we divested our remaining assets in the Williston Basin, and our non-operated Halff East assets in the Midland Basin for combined net divestiture proceeds of $252.2 million . We recorded a combined final net gain of $15.4 million for the year ended December 31, 2018 . +Acquisition Activity. During 2018, we acquired approximately 1,030 net acres of unproved properties in Howard and Martin Counties, Texas, in two separate transactions totaling $33.3 million . We also completed two non-monetary acreage trades of primarily unproved properties located in Howard and Martin Counties, Texas, resulting in the exchange of approximately 2,650 net acres, with $95.1 million of carrying value attributed to the properties we surrendered. These trades were recorded at carryover basis with no gain or loss recognized. +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effects of derivative settlements, unless otherwise indicated. While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location, and transportation differentials for these products. +47 +The following table summarizes commodity price data, as well as the effects of derivative settlements, for the years ended December 31, 2018 , 2017 , and 2016 : +For the Years Ended December 31, +2018 +2017 +2016 +Oil (per Bbl): +Average NYMEX contract monthly price +$ +64.77 +$ +50.95 +$ +43.32 +Realized price, before the effect of derivative settlements +$ +56.80 +$ +47.88 +$ +36.85 +Effect of oil derivative settlements +$ +(3.67 +) +$ +(2.28 +) +$ +14.63 +Gas: +Average NYMEX monthly settle price (per MMBtu) +$ +3.09 +$ +3.11 +$ +2.46 +Realized price, before the effect of derivative settlements (per Mcf) +$ +3.43 +$ +3.00 +$ +2.30 +Effect of gas derivative settlements (per Mcf) +$ +(0.12 +) +$ +0.72 +$ +0.64 +NGLs (per Bbl): +Average OPIS price (1) +$ +32.96 +$ +27.63 +$ +19.98 +Realized price, before the effect of derivative settlements +$ +27.22 +$ +22.35 +$ +16.16 +Effect of NGL derivative settlements +$ +(6.78 +) +$ +(3.44 +) +$ +(0.60 +) +____________________________________________ +(1) +Average OPIS prices per barrel of NGL, historical or strip, are based on a product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline for all periods presented. This product mix represents the industry standard composite barrel and does not necessarily represent our product mix for NGL production. Realized prices reflect our actual product mix. +We expect future prices for oil and NGLs to continue to be volatile. In addition to supply and demand fundamentals, as a global commodity, the price of oil is affected by real or perceived geopolitical risks in various regions of the world as well as the relative strength of the United States dollar compared to other currencies. We expect oil prices to remain volatile due to uncertainty in global supply and demand. +We expect gas prices to remain near current levels in the near term due to the abundance of supply relative to demand. Demand from increased liquefied natural gas (“LNG”) exports and gas exports to Mexico are expected to help balance supply. +We expect NGL prices to continue to benefit from increased demand from export and petrochemical markets while being offset by increased drilling activity. +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs (same product mix as discussed under the table above) as of February 7, 2019 , and December 31, 2018 : +As of February 7, 2019 +As of December 31, 2018 +NYMEX WTI oil (per Bbl) +$ +54.48 +$ +46.96 +NYMEX Henry Hub gas (per MMBtu) +$ +2.75 +$ +2.85 +OPIS NGLs (per Bbl) +$ +25.11 +$ +24.04 +We use financial derivative instruments as part of our financial risk management program. We have a financial risk management policy governing our use of derivatives. The amount of our production covered by derivatives is driven by the amount of debt on our balance sheet, the level of capital commitments and long-term obligations we have in place, and our ability to enter into favorable derivative commodity contracts. With our current derivative contracts, we believe we have partially reduced our exposure to volatility in commodity prices and location differentials in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil and gas prices while also setting a price floor for a portion of our oil and gas production. +Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and to Commodity Price Risk in Overview of Liquidity and Capital Resources below for additional information regarding our oil, gas, and NGL derivatives. +Outlook +We remain focused on maximizing the returns and increasing the value of our top tier capital project inventory in the Midland Basin and Eagle Ford shale. We expect to do this through exploration, acquisitions, and further development optimization. These +48 +assets will allow for production growth while maximizing internally generated cash flows, which will also support our priorities for improving our credit metrics and maintaining strong financial flexibility. +Our capital program for 2019 , excluding acquisitions, is expected to range from $1.00 billion to $1.07 billion. We expect our capital program to concentrate on developing our top tier assets in the Midland Basin and Eagle Ford shale. We expect to allocate approximately 80% of our 2019 capital to our Midland Basin program, which generates the highest margins in our portfolio. Planned drilling and completion activity in the Eagle Ford shale will be partially funded by a third-party as part of our joint venture agreement. By concentrating our capital on high return investments and operating at strong performance levels, we believe we will generate higher company-wide margins, cash flow growth, and value creation for our stockholders. +In our Permian region, we entered 2019 with six drilling rigs and three completion crews and anticipate maintaining this level of activity on average throughout the remainder of the year. On our operated acreage, we plan to drill and complete approximately 100 net wells in 2019. Our focus will continue to be on delineating and developing the Lower Spraberry and Wolfcamp A and B shale intervals on our RockStar acreage in Howard and Martin Counties, Texas, and our Sweetie Peck acreage in Upton and Midland Counties, Texas. +In our South Texas & Gulf Coast region, we entered 2019 with one drilling rig and added one completion crew in January. We anticipate averaging one to two drilling rigs and one completion crew throughout 2019. We plan to drill approximately 28 net wells and plan to complete approximately 18 net wells in 2019. We expect our joint venture in a portion of our Eagle Ford North area will allow for an increase in our capital efficiency. This joint venture will continue to test new technologies and completion designs at varied well spacing, potentially enhancing the asset’s value while reducing the required capital outlay that is necessary to meet certain lease obligations. +Please refer to Overview of Liquidity and Capital Resources below for additional discussion on how we expect to fund our 2019 capital program. +49 +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the three months ended December 31, 2018 , and the immediately preceding three quarters. +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2018 +2018 +2018 +2018 +(in millions) +Production (MMBOE) +11.3 +12.0 +10.5 +10.1 +Oil, gas, and NGL production revenue +$ +392.5 +$ +458.4 +$ +402.6 +$ +382.9 +Oil, gas, and NGL production expense +$ +121.5 +$ +127.6 +$ +117.4 +$ +120.9 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +182.0 +$ +201.1 +$ +151.8 +$ +130.5 +Exploration +$ +14.3 +$ +13.1 +$ +14.1 +$ +13.7 +General and administrative +$ +30.4 +$ +29.5 +$ +28.9 +$ +27.7 +Net income (loss) +$ +309.7 +$ +(135.9 +) +$ +17.2 +$ +317.4 +____________________________________________ +Note: Amounts may not calculate due to rounding. +Selected Performance Metrics +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2018 +2018 +2018 +2018 +Average net daily production equivalent (MBOE per day) +122.8 +130.2 +115.2 +112.7 +Lease operating expense (per BOE) +$ +4.98 +$ +4.41 +$ +4.66 +$ +4.95 +Transportation costs (per BOE) +$ +4.19 +$ +4.20 +$ +4.47 +$ +4.63 +Production taxes as a percent of oil, gas, and NGL production revenue +3.4 +% +4.1 +% +4.3 +% +4.4 +% +Ad valorem tax expense (per BOE) +$ +0.39 +$ +0.45 +$ +0.41 +$ +0.67 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) +$ +16.10 +$ +16.78 +$ +14.48 +$ +12.87 +General and administrative (per BOE) +$ +2.69 +$ +2.46 +$ +2.76 +$ +2.73 +____________________________________________ +Note: Amounts may not calculate due to rounding. +50 +A Year-to-Year Overview of Selected Production and Financial Information, Including Trends +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2018 +2017 +2016 +2018/2017 +2017/2016 +2018/2017 +2017/2016 +Net production volumes: (1) +Oil (MMBbl) +18.8 +13.7 +16.6 +5.1 +(2.9 +) +37 +% +(18 +)% +Gas (Bcf) +103.2 +123.0 +146.9 +(19.8 +) +(23.9 +) +(16 +)% +(16 +)% +NGLs (MMBbl) +7.9 +10.3 +14.2 +(2.4 +) +(3.9 +) +(23 +)% +(27 +)% +Equivalent (MMBOE) +43.9 +44.5 +55.3 +(0.6 +) +(10.8 +) +(1 +)% +(20 +)% +Average net daily production: (1) +Oil (MBbl per day) +51.4 +37.4 +45.4 +14.0 +(7.9 +) +37 +% +(17 +)% +Gas (MMcf per day) +282.7 +337.0 +401.5 +(54.3 +) +(64.5 +) +(16 +)% +(16 +)% +NGLs (MBbl per day) +21.8 +28.2 +38.8 +(6.4 +) +(10.6 +) +(23 +)% +(27 +)% +Equivalent (MBOE per day) +120.3 +121.8 +151.0 +(1.5 +) +(29.2 +) +(1 +)% +(19 +)% +Oil, gas, and NGL production revenue (in millions): (1) +Oil production revenue +$ +1,065.7 +$ +654.3 +$ +611.8 +$ +411.4 +$ +42.5 +63 +% +7 +% +Gas production revenue +354.5 +369.4 +337.3 +(15.0 +) +32.1 +(4 +)% +10 +% +NGL production revenue +216.2 +230.1 +229.3 +(13.9 +) +0.8 +(6 +)% +— +% +Total oil, gas, and NGL production revenue +$ +1,636.4 +$ +1,253.8 +$ +1,178.4 +$ +382.6 +$ +75.4 +31 +% +6 +% +Oil, gas, and NGL production expense (in millions): (1) +Lease operating expense +$ +208.1 +$ +196.9 +$ +194.0 +$ +11.2 +$ +2.9 +6 +% +1 +% +Transportation costs +191.5 +243.6 +340.3 +(52.1 +) +(96.7 +) +(21 +)% +(28 +)% +Production taxes +66.9 +52.4 +51.9 +14.5 +0.5 +28 +% +1 +% +Ad valorem tax expense +20.9 +15.0 +11.4 +5.9 +3.6 +39 +% +32 +% +Total oil, gas, and NGL production expense +$ +487.4 +$ +507.9 +$ +597.6 +$ +(20.5 +) +$ +(89.7 +) +(4 +)% +(15 +)% +Realized price, before the effect of derivative settlements: +Oil (per Bbl) +$ +56.80 +$ +47.88 +$ +36.85 +$ +8.92 +$ +11.03 +19 +% +30 +% +Gas (per Mcf) +$ +3.43 +$ +3.00 +$ +2.30 +$ +0.43 +$ +0.70 +14 +% +30 +% +NGLs (per Bbl) +$ +27.22 +$ +22.35 +$ +16.16 +$ +4.87 +$ +6.19 +22 +% +38 +% +Per BOE +$ +37.27 +$ +28.20 +$ +21.32 +$ +9.07 +$ +6.88 +32 +% +32 +% +Per BOE data: +Production costs: +Lease operating expense +$ +4.74 +$ +4.43 +$ +3.51 +$ +0.31 +$ +0.92 +7 +% +26 +% +Transportation costs +$ +4.36 +$ +5.48 +$ +6.16 +$ +(1.12 +) +$ +(0.68 +) +(20 +)% +(11 +)% +Production taxes +$ +1.52 +$ +1.18 +$ +0.94 +$ +0.34 +$ +0.24 +29 +% +26 +% +Ad valorem tax expense +$ +0.48 +$ +0.34 +$ +0.21 +$ +0.14 +$ +0.13 +41 +% +62 +% +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +15.15 +$ +12.53 +$ +14.30 +$ +2.62 +$ +(1.77 +) +21 +% +(12 +)% +General and administrative (2) +$ +2.65 +$ +2.64 +$ +2.26 +$ +0.01 +$ +0.38 +— +% +17 +% +Derivative settlement gain (loss) (3) +$ +(3.09 +) +$ +0.48 +$ +5.96 +$ +(3.57 +) +$ +(5.48 +) +(744 +)% +(92 +)% +Earnings per share information: +Basic weighted-average common shares outstanding (in thousands) +111,912 +111,428 +76,568 +484 +34,860 +— +% +46 +% +Diluted weighted-average common shares outstanding (in thousands) +113,502 +111,428 +76,568 +2,074 +34,860 +2 +% +46 +% +Basic net income (loss) per common share +$ +4.54 +$ +(1.44 +) +$ +(9.90 +) +$ +5.98 +$ +8.46 +415 +% +85 +% +Diluted net income (loss) per common share +$ +4.48 +$ +(1.44 +) +$ +(9.90 +) +$ +5.92 +$ +8.46 +411 +% +85 +% +51 +____________________________________________ +(1) +Amounts and percentage changes may not calculate due to rounding. +(2) +Prior periods have been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion. +(3) +Derivative settlements for the years ended December 31, 2018 , 2017 , and 2016 , are included within the net derivative (gain) loss line item in the accompanying statements of operations. +Average net equivalent daily production for the year ended December 31, 2018 , decreased one percent compared with 2017 . This decrease is primarily due to the divestiture of our outside-operated Eagle Ford shale assets in the first quarter of 2017, the divestiture of our remaining producing assets in the Rocky Mountain region in the first half of 2018, and decreasing production due to reduced capital investment in our operated Eagle Ford shale assets. Production decreases in the Eagle Ford shale and Rocky Mountain region were substantially offset by our Permian region, which had a 91 percent increase in production volumes for the year ended December 31, 2018 , compared with 2017 . We anticipate 2019 total production to be higher than 2018 total production, driven by continued development of our Permian assets in the Midland Basin. Please refer to Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 below for additional discussion. +We present certain information on a per BOE basis in order to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis and discussion. +Changes in production volumes, revenues, and costs are directly influenced by the volatility of commodity prices for the products we produce, fluctuations in costs necessary to develop and operate our properties, our ability to increase efficiencies in operations, and changes in our overall asset portfolio. Our realized price before the effect of derivative settlements on a per BOE basis for the year ended December 31, 2018 , increased 32 percent compared with 2017 , which was driven primarily by a 37 percent growth in higher margin oil production and improved benchmark pricing for oil and NGLs. For the year ended December 31, 2018 , we realized a loss of $3.09 per BOE on the settlement of our derivative contracts, which was primarily driven by improving oil and NGL prices in 2018, compared to a gain of $0.48 per BOE in 2017 . Settlement losses due to strengthening commodity prices in 2018 were partially offset by cash settlement gains on our Midland Basin oil basis swaps that settled during 2018. Overall, there was a 19 percent increase in our realized price after the effect of derivative settlements for the year ended December 31, 2018 , compared with 2017 . +Lease operating expense (“LOE”) increased seven percent on a per BOE basis for the year ended December 31, 2018 , compared with 2017 . This increase was primarily driven by the increased percentage of oil in our total product mix, which has higher lifting costs per BOE. We expect LOE on a per BOE basis to be flat or slightly higher in 2019 compared with 2018 as our product mix continues to shift towards more oil production. We anticipate volatility in LOE on a per BOE basis as a result of changes in total production, changes in our overall production mix, timing of workover projects, and changes in industry activity and the effects this has on service provider costs. +Transportation costs decreased 20 percent on a per BOE basis for the year ended December 31, 2018 , compared with 2017 . The decrease in transportation costs per BOE continues to be driven by production decreases from our Eagle Ford shale assets, which have higher average transportation costs. Our Permian region production is primarily sold at the wellhead and therefore is subject to minimal transportation costs. We expect total transportation costs to fluctuate in line with changes in production from our operated Eagle Ford shale program as these assets incur the majority of our transportation costs. On a per BOE basis, we expect transportation costs to decrease in 2019, as compared with 2018, as production from our Midland Basin assets continues to become a larger portion of our total production. +Production taxes on a per BOE basis for the year ended December 31, 2018 , increased 29 percent compared with 2017 , primarily due to a 32 percent increase in our realized price on a per BOE basis before the effect of derivative settlements for the year ended December 31, 2018 , compared with 2017 . Our overall production tax rate for the years ended December 31, 2018 , and 2017 was 4.1 percent and 4.2 percent , respectively. The slight decrease in our production tax rate was primarily a result of divesting our remaining producing assets in the Rocky Mountain region, which were taxed at higher rates than our Texas properties. We generally expect production tax expense to trend with oil, gas, and NGL production revenue on an absolute and per BOE basis. We expect our overall production tax expense to remain consistent in 2019 compared to 2018, as the impacts of expected higher production volumes are expected to be offset by lower commodity prices, assuming such prices are consistent with the 12-month strip pricing as of February 7, 2019 , as presented above within the Oil, Gas, and NGL Prices section. We expect our overall production tax rate to remain consistent in 2019 compared to 2018. Product mix, the location of production, and incentives to encourage oil and gas development can also impact the amount of production tax we recognize. +Ad valorem tax expense on a per BOE basis for the year ended December 31, 2018 , increased 41 percent compared with 2017 , due to changes in our asset and production base and increased commodity price assumptions used in 2018 property tax valuations. The majority of ad valorem tax expense is related to our Texas properties. We expect an overall increase in the value attributed to our reserves volumes in 2019, which would increase ad valorem tax on an absolute basis compared with 2018. On a per BOE basis, we expect 2019 ad valorem expense to also increase compared to 2018, but this increase could be partially offset by expected increases in production volumes in 2019 compared with the prior year. +52 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (“DD&A”) expense on a per BOE basis increased 21 percent for the year ended December 31, 2018 , compared with 2017 . The increase was primarily driven by the increase in production volumes from our Midland Basin assets, which have higher depletion rates than our Eagle Ford shale assets. DD&A was also higher as a result of the capital we invested in 2018 to construct our water transportation facilities in the Midland Basin. Our DD&A rate fluctuates as a result of impairments, divestiture activity, carrying cost funding and sharing arrangements with third parties, changes in our production mix, and changes in our total estimated proved reserve volumes. In general, we expect DD&A expense on a per BOE basis in 2019 to increase compared with 2018 as production from our Midland Basin program continues to increase as a percentage of our total production. +General and administrative (“G&A”) expense remained flat on a per BOE basis for the year ended December 31, 2018 , compared with 2017 . We expect G&A expense on a per BOE basis in 2019 to decrease slightly compared with 2018 , as total production in 2019 is expected to increase from total 2018 production. +Please refer to Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 for additional discussion. +Please refer to Note 9 - Earnings Per Share in Part II, Item 8 of this report for additional discussion on the types of shares included in our basic and diluted net income (loss) per common share calculations. For the year ended December 31, 2018 , we recorded net income and thus considered dilutive shares in the calculation of diluted net income per common share as of December 31, 2018 . We recorded a net loss for the years ended December 31, 2017 , and 2016 . Consequently, all potentially dilutive shares were anti-dilutive and were excluded from the calculation of diluted net loss per common share for the years ended December 31, 2017 , and 2016 . +Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 +Net equivalent production, production revenue, and production expense +The following table presents the regional changes in our net equivalent production, production revenue, and production expense between the years ended December 31, 2018 , and 2017 : +Net Equivalent Production Increase (Decrease) +Production Revenue Increase (Decrease) +Production Expense Increase (Decrease) +(MBOE per day) +(in millions) +(in millions) +Permian +27.4 +$ +582.5 +$ +89.5 +South Texas & Gulf Coast +(20.8 +) +(95.9 +) +(64.5 +) +Rocky Mountain (1) +(8.1 +) +(104.0 +) +(45.5 +) +Total +(1.5 +) +$ +382.6 +$ +(20.5 +) +__________________________________________ +Note: Amounts may not calculate due to rounding. +(1) +We divested all remaining producing assets in the Rocky Mountain region in the first half of 2018. As a result, there have been no production volumes from this region after the second quarter of 2018. +We experienced a one percent decrease in net equivalent production in 2018 compared with 2017 . The decrease in overall production volumes was a result of decreased production from our operated Eagle Ford shale assets as a result of reduced capital investment, the divestiture of our outside-operated Eagle Ford shale assets, which occurred in the first quarter of 2017, and the divestiture of our remaining producing assets in the Rocky Mountain region in the first half of 2018. Production decreases in the Eagle Ford shale and Rocky Mountain region were predominately offset by the 91 percent production volume increase in our Permian region for the year ended December 31, 2018 , compared with 2017 . Increased production in the Permian region also drove oil production as a percentage of our overall product mix to increase from 31 percent in 2017 , to 43 percent in 2018 . The increase in higher margin oil production also increased realized prices, before the effects of derivative settlements, on a per BOE basis by 32 percent in 2018 , resulting in a 31 percent increase in oil, gas, and NGL production revenue for the year ended 2018 compared to the prior year. Production expense in 2018 , compared with 2017 , decreased four percent , and was primarily driven by the divestiture of the remaining assets in our Rocky Mountain region in the first half of 2018, which had the highest average production costs in our portfolio. +53 +The following table presents the regional changes in our net equivalent production, production revenue, and production expense between the years ended December 31, 2017 , and 2016 : +Net Equivalent Production Increase (Decrease) +Production Revenue Increase (Decrease) +Production Expense Increase (Decrease) +(MBOE per day) +(in millions) +(in millions) +Permian +19.8 +$ +347.3 +$ +76.5 +South Texas & Gulf Coast +(31.9 +) +(113.5 +) +(92.5 +) +Rocky Mountain +(17.1 +) +(158.4 +) +(73.7 +) +Total +(29.2 +) +$ +75.4 +$ +(89.7 +) +__________________________________________ +Note: Amounts may not calculate due to rounding. +Oil, gas, and NGL production revenue increased six percent in 2017 compared with 2016 as the 32 percent increase in realized price, before the effects of derivative settlements, on a per BOE basis was mostly offset by the 20 percent decrease in net equivalent production volumes as a result of divestiture activity. 2017 production expense decreased $89.7 million when compared with 2016 due to a 20 percent decrease in net equivalent production volumes. The 15 percent decrease in production expense was less than the 20 percent decrease in net equivalent production volumes, which resulted in increased production expense per BOE. On a per BOE basis, production expense increased slightly in 2017 compared with 2016 primarily due to the sale of our outside-operated Eagle Ford shale assets in the first quarter of 2017, which had lower average lifting costs per BOE than our retained assets. +Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of trends on a per BOE basis for the years ended December 31, 2018 , 2017 , and 2016 . +Net gain (loss) on divestiture activity +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Net gain (loss) on divestiture activity +$ +426.9 +$ +(131.0 +) +$ +37.1 +The $426.9 million net gain on divestiture activity recorded for the year ended December 31, 2018 , was the result of a total net gain of $410.6 million recorded for the PRB Divestiture, which closed in the first quarter of 2018, and a combined total net gain of $15.4 million recorded for the Divide County Divestiture and the Halff East Divestiture, both of which closed in the second quarter of 2018. +The net loss on divestiture activity recorded for the year ended December 31, 2017 , was primarily the result of $526.5 million of write-downs recorded on certain retained North Dakota assets previously held for sale. These assets were divested in the second quarter of 2018, as discussed above. Partially offsetting these write-downs recorded during 2017, was a $396.8 million total net gain recorded on the sale of our outside-operated Eagle Ford shale assets. +The net gain on divestiture activity recorded for the year ended December 31, 2016 , was primarily the result of the $29.5 million net gain recorded on our Raven/Bear Den assets sold in the fourth quarter of 2016, as well as a $6.3 million total net gain recorded on the non-core Williston Basin, Powder River Basin, and southeast New Mexico asset divestitures in the third quarter of 2016. +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +665.3 +$ +557.0 +$ +790.7 +DD&A expense for the year ended December 31, 2018 , increased 19 percent compared with 2017. The increase is directly related to the 91 percent increase in production volumes from our Midland Basin assets in the Permian region, which have higher depletion rates than our Eagle Ford shale assets in the South Texas & Gulf Coast region. +54 +DD&A expense for the year ended December 31, 2017 , decreased 30 percent compared with 2016 due to a 20 percent decrease in production volumes and the impact of assets sold or classified as held for sale throughout 2017. +Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of DD&A expense on a per BOE basis. +Exploration +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Geological and geophysical expenses +$ +5.6 +$ +4.0 +$ +11.0 +Exploratory dry hole +— +2.4 +— +Overhead and other expenses (1) +49.6 +48.3 +54.0 +Total (1) +$ +55.2 +$ +54.7 +$ +65.0 +___________________________________________ +(1) +Prior periods have been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion. +Exploration expense increased one percent for the year ended December 31, 2018 , compared with 2017 . In 2019 , we expect to continue focusing on testing and delineating our Midland Basin acreage, which may result in additional geological and geophysical expenses; however, we do not expect total exploration activity and related expenses to differ significantly compared with 2018 . Our expectations for exploration expense could change significantly depending on actual geological and geophysical studies we perform, the amount of allocated overhead, and the potential for exploratory dry hole expense. +Exploration expense for the year ended December 31, 2017 , decreased 16 percent compared with 2016 driven primarily by geological and geophysical expenses incurred for a seismic study performed on our Midland Basin acreage in the fourth quarter of 2016, which were not incurred in 2017. +Impairment of proved properties and Abandonment and impairment of unproved properties +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Impairment of proved properties +$ +— +$ +3.8 +$ +354.6 +Abandonment and impairment of unproved properties +$ +49.9 +$ +12.3 +$ +80.4 +There was no impairment of proved properties expense recognized for the year ended December 31, 2018 . Unproved property abandonments and impairments recorded for the year ended December 31, 2018 related to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. We expect proved property impairments to more likely occur in periods of declining or depressed commodity prices, and unproved property impairments to fluctuate with the timing of lease expirations or defects, unsuccessful exploration activities, and changing economics associated with decreases in commodity prices. Additionally, changes in drilling plans, downward engineering revisions, or unsuccessful exploration efforts may result in proved and unproved property impairments. Future impairments of proved and unproved properties are difficult to predict; however, based on our updated commodity price assumptions as of February 7, 2019 , we do not expect any material impairments in the first quarter of 2019 resulting from commodity price impacts. Please refer to Critical Accounting Policies and Estimates below for additional discussion. +There was no material impairment of proved properties recognized for the year ended December 31, 2017 . Abandonment and impairment of unproved properties expense recorded during the year ended December 31, 2017 , related primarily to lease expirations. +The majority of our proved property impairments during 2016 were recorded in the first quarter of 2016 in our outside-operated Eagle Ford shale program as a result of commodity price declines. In the fourth quarter of 2016, we recorded proved and unproved property impairment expense on our Powder River Basin assets as a result of negative performance reserve revisions at year end 2016 and lower market prices on third-party acreage transactions. Additionally, we allowed certain leases to expire throughout the year ended December 31, 2016 . +55 +General and administrative +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +General and administrative (1) +$ +116.5 +$ +117.3 +$ +124.8 +___________________________________________ +(1) +Prior periods have been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion. +G&A expense for the year ended December 31, 2018 , was flat compared with 2017 . We expect G&A expense in total to continue to remain relatively flat in 2019 compared with 2018. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of G&A costs on a per BOE basis. +G&A expense for the year ended December 31, 2017 , decreased six percent from 2016 primarily due to decreased compensation expense resulting from lower average headcount for the full year in 2017. +Net derivative (gain) loss +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Net derivative (gain) loss +$ +(161.8 +) +$ +26.4 +$ +250.6 +We recognized a net derivative gain of $161.8 million for the year ended December 31, 2018 . For contracts that settled during 2018 , the fair value was a net liability of $108.3 million at December 31, 2017 , and net cash settlements paid totaled $135.8 million, resulting in a $27.5 million loss. Additionally, we recorded a $189.3 million mark-to-market gain on remaining contracts as of December 31, 2018 , resulting from a decrease in commodity strip prices toward the end of 2018. +We recognized a net derivative loss of $26.4 million for the year ended December 31, 2017 . For contracts that settled during 2017 , the fair value was a net liability of $60.9 million at December 31, 2016 , and net cash settlements received totaled $21.2 million, resulting in an $82.1 million gain. Offsetting this gain was a $108.5 million mark-to-market loss on remaining contracts as of December 31, 2017, resulting from an increase in commodity strip prices. +We recognized a net derivative loss of $250.6 million for the year ended December 31, 2016 . For contracts that settled during 2016 , the fair value was a net asset of $367.7 million at December 31, 2015, and net cash settlements received totaled $329.5 million, resulting in a $38.2 million loss. Additionally, we recorded a $212.4 million mark-to-market loss on remaining contracts as of December 31, 2016, resulting from an increase in commodity strip prices. +Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Interest expense +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Interest expense +$ +(160.9 +) +$ +(179.3 +) +$ +(158.7 +) +The $18.4 million , or 10 percent , decrease in interest expense for the year ended December 31, 2018 , compared with the same period in 2017 , was driven in part by the redemption of our 2021 Senior Notes, which reduced interest expense related to debt in 2018 by $9.4 million compared with 2017. In addition to the overall reduction in debt, interest expense was also reduced as the amount of interest we capitalized increased given our higher level of development activity in 2018 compared with 2017. As a result of our overall reduction in long-term debt, we expect interest expense related to our Senior Notes to be lower in 2019 compared with 2018; however, total interest expense can vary based on the timing and amount of any borrowings against our credit facility. +The $20.6 million , or 13 percent , increase in interest expense for the year ended December 31, 2017 , compared with 2016 , was driven by an increase in total debt outstanding for full year 2017 due to additional debt issuances in the second half of 2016. Offsetting a portion of the increase was additional interest expense of $10.0 million recognized in 2016 as a result of terminating an unused second lien facility that was no longer necessary to fund a portion of our Midland Basin acquisitions. +56 +Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report and Overview of Liquidity and Capital Resources below for additional discussion. +Gain (loss) on extinguishment of debt +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Gain (loss) on extinguishment of debt +$ +(26.7 +) +$ +— +$ +15.7 +For the year ended December 31, 2018 , we recorded a $26.7 million net loss on the early extinguishment of our 2021 Senior Notes, 2023 Senior Notes, and a portion of our 2022 Senior Notes. The net loss on extinguishment of debt included $20.4 million associated with the premiums paid upon redemption and repurchase, and $6.3 million related to the acceleration of unamortized deferred financing costs. +For the year ended December 31, 2016 , we recorded a $15.7 million net gain on the early extinguishment of a portion of our Senior Notes, which included $16.4 million associated with the discount realized upon repurchase, slightly offset by $700,000 related to the acceleration of unamortized deferred financing costs. +Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Income tax (expense) benefit +For the Years Ended December 31, +2018 +2017 +2016 +(in millions, except tax rate) +Income tax (expense) benefit +$ +(143.4 +) +$ +183.0 +$ +444.2 +Effective tax rate +22.0 +% +53.2 +% +37.0 +% +The decrease in the effective tax rate for 2018 compared with 2017 is primarily due to the impacts of the Tax Cuts and Jobs Act (the “2017 Tax Act”). The 18.5 percentage point increase in 2017 from a nonrecurring deferred tax adjustment was caused by the 14 percentage point decrease in the highest marginal corporate rate from 35 percent to 21 percent beginning in 2018. The effect for 2017 was cumulatively added to a tax benefit calculated for that year. The 14 percentage point decrease is reflected in the 2018 income tax expense rate. In addition, the year-over-year tax rate decreased due to effects related to an excess tax deficiency from settlement of employee share-based payment awards, which had the effect of increasing the 2018 tax rate and partially offsetting the year-over-year decrease. Other nominal 2018 tax rate decreases included effects from property sales, net apportionment changes, research credits, and percentage depletion offset by the effects from limits to certain covered individual’s compensation. +The increase in the effective tax rate in 2017 compared with 2016 was primarily due to the enactment of the 2017 Tax Act into law on December 22, 2017, which decreased the highest marginal corporate tax rate and resulted in an 18.5 percentage point nonrecurring benefit adjustment increasing the effective tax rate. This increase was partially offset by an excess tax deficiency from the settlement of employee share-based payment awards, state apportionment changes due to the sale of our outside-operated Eagle Ford shale assets, and a net decrease in valuation allowances due to projected utilization of various state net operating losses. +Please refer to Overview of Liquidity and Capital Resources and Critical Accounting Policies and Estimates below as well as Note 4 – Income Taxes in in Part II, Item 8 of this report for further discussion. +57 +Overview of Liquidity and Capital Resources +Based on the current commodity price environment, we believe we have sufficient liquidity and capital resources to execute our business plan for the foreseeable future. We continue to manage the duration and level of our drilling and completion service commitments to maintain the flexibility to adjust our activity and capital expenditures. +Sources of Cash +We currently expect our 2019 capital program to be funded by cash flows from operations, cash proceeds from prior divestiture activities, and with any remaining cash needs being funded by borrowings under our credit facility. During the year ended December 31, 2018 , we generated $720.6 million of cash flows from operating activities and we received $748.5 million of net proceeds from the sale of oil and gas properties. As of December 31, 2018 , the combination of our cash balance of $78.0 million with our $1.0 billion of available borrowing capacity under our Credit Agreement provided $1.1 billion in liquidity. Although we anticipate cash flows from these sources will be sufficient to fund our expected 2019 capital program, we may also elect to raise funds through debt or equity financings or from other sources. Further, we may enter into additional carrying cost funding and sharing arrangements with third parties for particular exploration and/or development programs. Our borrowing base could be reduced as a result of lower commodity prices, divestitures of proved properties, or the issuance of debt securities. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders could be diluted, and these newly-issued securities may have rights, preferences, or privileges senior to those of existing stockholders. Any future downgrades in our credit ratings could make it more difficult or expensive for us to borrow additional funds. All of our sources of liquidity can be affected by the general condition of the broader economy and by fluctuations in commodity prices, operating costs, and volumes produced, all of which affect us and our industry. +We have no control over the market prices for oil, gas, or NGLs, although we may be able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of derivative contracts as part of our commodity price risk management program. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional information about our oil, gas, and NGL derivative contracts currently in place and the timing of settlement of those contracts . +The enactment of the 2017 Tax Act reduced our highest marginal federal tax rate for 2018 and future years from 35 percent to 21 percent. It also eliminated the domestic production activities deduction for all taxpayers, the alternative minimum tax (“AMT”) for corporate taxpayers, and may impact our ability to deduct interest expense in future years. However, it did not impact current tax deductions for intangible drilling costs, percentage depletion, or amortization of geological and geophysical expenses, and it will allow us the option to expense 100 percent of our equipment acquisition costs in future years. In general, we believe the enactment of the 2017 Tax Act will have a positive impact on our future operating cash flows. +Credit Agreement +On September 28, 2018, we entered into the Sixth Amended and Restated Credit Agreement with our lenders. The Credit Agreement, which replaced our Fifth Amended and Restated Credit Agreement, provides for a senior secured revolving credit facility with a maximum loan amount of $2.5 billion , an initial borrowing base of $1.5 billion , and initial aggregate lender commitments totaling $1.0 billion . The Credit Agreement is scheduled to mature on September 28, 2023 . The maturity date could, however, occur earlier on August 16, 2022, if we have not completed certain repurchase, redemption, or refinancing activities associated with our 2022 Senior Notes, as outlined in the Credit Agreement. We had no outstanding balance under our Credit Agreement as of December 31, 2018 , or 2017 . No individual bank participating in our Credit Agreement represents more than 10 percent of the lender commitments under the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion as well as the presentation of the outstanding balance, total amount of letters of credit, and available borrowing capacity under our Credit Agreement as of February 7, 2019 , December 31, 2018 , and December 31, 2017 . +The borrowing base under the Credit Agreement is subject to regular, semi-annual redetermination, and considers the value of both our (a) proved oil and gas properties reflected in the most recent reserve report provided to our lenders under the Credit Agreement; and (b) commodity derivative contracts, each as determined by our lender group. We do not expect a material change to the borrowing base or the aggregate lender commitments during the next scheduled redetermination on April 1, 2019 . +We must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring that we maintain certain financial ratios, as defined by the Credit Agreement. The financial covenants under the Credit Agreement require that our (a) total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX ratio for the most recently ended four consecutive fiscal quarters (excluding the first three quarters which will use annualized adjusted EBITDAX), cannot be greater than 4.25 to 1.00 beginning with the quarter ending December 31, 2018 through and including the fiscal quarter ending December 31, 2019, and for each quarter ending thereafter, the ratio cannot be greater than 4.00 to 1.00; and (b) adjusted current ratio cannot be less than 1.0 to 1.0 as of the last day of any fiscal quarter. We were in compliance with all financial and non-financial covenants as of December 31, 2018 , and through the filing of this report. Please refer to the caption Non-GAAP Financial Measures below for the calculation of adjusted EBITDAX and reconciliations of net income (loss) and net cash provided by operating activities to adjusted EBITDAX. +58 +We had no credit facility borrowing activity during 2018. This was a result of our cash balance entering 2018 and cash proceeds received during 2018 from the PRB Divestiture, Divide County Divestiture, and Halff East Divestiture. Our daily weighted-average credit facility debt balance was approximately $13.1 million and $183.8 million for the years ended December 31, 2017 , and 2016 , respectively. Cash flows provided by our operating activities, divestiture proceeds, capital markets activities, and the amount of our capital expenditures, including acquisitions, all impact the amount we borrow under our credit facility. +Weighted-Average Interest Rates +Our weighted-average interest rate includes paid and accrued interest, fees on the unused portion of the aggregate commitment amount under the Credit Agreement, letter of credit fees, the non-cash amortization of deferred financing costs, and the non-cash amortization of the discount related to the Senior Convertible Notes. Our weighted-average borrowing rate includes paid and accrued interest only. +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2018 , 2017 , and 2016 . +For the Years Ended December 31, +2018 +2017 +2016 +Weighted-average interest rate +6.4 +% +6.4 +% +6.2 +% +Weighted-average borrowing rate +5.8 +% +5.8 +% +5.7 +% +Our weighted-average interest rates and weighted average borrowing rates for the years ended December 31, 2018 , 2017 , and 2016 , have been impacted by the timing of long-term debt issuances and redemptions, the average balance on our revolving credit facility under the Credit Agreement, and the fees paid on the unused portion of our aggregate commitment. There was no change in our weighted-average interest rate or weighted-average borrowing rate for the years ended December 31, 2018 , and 2017 . The increase in these rates for the year ended 2017, as compared with 2016 , was largely due to the issuance of the Senior Convertible Notes and the 2026 Senior Notes in the third quarter of 2016. The rates disclosed in the above table do not reflect amounts associated with the repurchase of Senior Notes, such as the discount realized or premium paid upon repurchase, or the acceleration of unamortized deferred financing costs expensed upon repurchase. The rates also do not reflect the $10.0 million fee paid to terminate an unused second lien facility in the third quarter of 2016. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Uses of Cash +We use cash for the acquisition, exploration, and development of oil and gas properties and for the payment of operating and general and administrative costs, income taxes, dividends, and debt obligations, including interest. Expenditures for the acquisition, exploration, and development of oil and gas properties are the primary use of our capital resources. During 2018 , we spent approximately $1.3 billion on capital expenditures and on acquisitions, which were comprised primarily of unproved oil and gas properties. This amount differs from the costs incurred amount, which is accrual-based and includes asset retirement obligations, geological and geophysical expenses, and exploration overhead amounts. +The amount and allocation of our future capital expenditures will depend upon a number of factors, including the number and size of acquisitions, our cash flows from operating, investing, and financing activities, and our ability to execute our drilling program. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, and the timing and results of our exploration and development activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget to assess changes in current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. +We may from time to time repurchase certain amounts of our outstanding debt securities for cash and/or through exchanges for other securities. Such repurchases or exchanges may be made in open market transactions, privately negotiated transactions, or otherwise. Any such repurchases or exchanges will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. Repurchases or exchanges are reviewed as part of the allocation of our capital. On July 16, 2018, we completed the 2021 Senior Notes Redemption which resulted in the payment of total cash consideration, including accrued interest, of $355.9 million . On August 20, 2018, we issued $500.0 million in aggregate principal amount of 2027 Senior Notes which resulted in the receipt of net proceeds of $492.1 million after deducting fees of $7.9 million , which are being amortized as deferred financing costs over the life of the 2027 Senior Notes. The proceeds received from the issuance of the 2027 Senior Notes were used to complete the Tender Offer and 2023 Senior Notes Redemption. As a result, we repurchased our 2023 Senior Notes and a portion of our 2022 Senior Notes during the third quarter of 2018, which resulted in the payment of total consideration, including accrued interest, of $497.8 million. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. As part of our strategy for 2019, we will continue to focus on improving our debt metrics and potentially reducing outstanding debt. +59 +As of the filing of this report, we could repurchase up to 3,072,184 shares of our common stock under our stock repurchase program, subject to the approval of our Board of Directors. Shares may be repurchased from time to time in the open market, or in privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes, the indenture governing our Senior Convertible Notes, compliance with securities laws, and the terms and provisions of our stock repurchase program. Our Board of Directors periodically reviews this program as part of the allocation of our capital. During 2018 , we did not repurchase any shares of our common stock, and we currently do not plan to repurchase any outstanding shares of our common stock during 2019 . +During 2018 , we paid $11.2 million in dividends to our stockholders, reflecting a dividend of $0.10 per share. Our current intention is to continue to make dividend payments for the foreseeable future, subject to our future earnings, our financial condition, Credit Agreement, indentures governing our Senior Convertible Notes and Senior Notes, other covenants, and other factors which could arise. The payment and amount of future dividends remains at the discretion of our Board of Directors. +Analysis of Cash Flow Changes Between 2018 and 2017 and Between 2017 and 2016 +The following tables present changes in cash flows between the years ended December 31, 2018 , 2017 , and 2016 , for our operating, investing, and financing activities. The year ended December 31, 2016, has been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion of adjustments made as a result of adopting new accounting standards. The analysis following each table should be read in conjunction with our accompanying consolidated statements of cash flows (“accompanying statements of cash flows”) in Part II, Item 8 of this report. +Operating Activities +For the Years Ended December 31, +Amount Change Between +Percent Change Between +2018 +2017 +2016 +2018/2017 +2017/2016 +2018/2017 +2017/2016 +(in millions) +Net cash provided by operating activities +$ +720.6 +$ +515.4 +$ +552.8 +$ +205.2 +$ +(37.4 +) +40 +% +(7 +)% +Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, increased $196.0 million , or 19 percent , to $1.2 billion for the year ended December 31, 2018 , compared with the same period in 2017 , primarily as a result of an increase in our realized price, after the effect of derivative settlements. Interest paid decreased $13.4 million for the year ended December 31, 2018 , compared with the same period in 2017 , due to the redemption and repurchase of senior notes in the third quarter of 2018. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, decreased $91.6 million , or eight percent , to $1.0 billion for the year ended December 31, 2017 , compared with the same period in 2016 , as a result of a 20 percent decrease in production volumes partially offset by an increase in our realized price after the effect of derivative settlements. Interest paid increased $34.3 million for the year ended December 31, 2017 , compared with the same period in 2016 , due to the issuance of our 2026 Senior Notes and Senior Convertible Notes in the third quarter of 2016. Cash paid for LOE and ad valorem taxes in 2017 decreased $19.7 million , or nine percent , to $199.1 million compared with 2016, as a result of a 20 percent decrease in production volumes partially offset by an increase in production costs on a per BOE basis, specifically LOE, production taxes, and ad valorem taxes. Cash paid for G&A expense decreased $13.8 million , or 12 percent , to $98.6 million in 2017 compared with 2016, primarily as a result of the decrease in average headcount for 2017. During 2016, we paid $10.0 million to terminate a second lien facility that was not needed to fund the Rock Oil Acquisition. Further, net cash provided by operating activities is affected by working capital changes. +Investing Activities +For the Years Ended December 31, +Amount Change Between +Percent Change Between +2018 +2017 +2016 +2018/2017 +2017/2016 +2018/2017 +2017/2016 +(in millions) +Net cash used in investing activities +$ +(587.9 +) +$ +(201.5 +) +$ +(1,867.6 +) +$ +(386.4 +) +$ +1,666.1 +192 +% +(89 +)% +Net cash used in investing activities increased for the year ended December 31, 2018 , compared with the same period in 2017 . Capital expenditures in 2018 increased $414.8 million , or 47 percent , compared with 2017 as a result of increased drilling and +60 +completion activities. During 2018, cash paid to acquire proved and unproved properties decreased $56.6 million , or 63 percent compared with 2017. Further, net proceeds from the sale of oil and gas properties decreased $28.2 million for 2018 , compared with the same period in 2017 . During 2018 , net proceeds were primarily from the PRB Divestiture, Divide County Divestiture, and Halff East Divestiture. During 2017 , net proceeds were primarily from the sale of our outside-operated Eagle Ford shale assets. +Net cash used in investing activities decreased for the year ended December 31, 2017 , compared with the same period in 2016 . During 2017 , cash paid to acquire proved and unproved properties in the Midland Basin totaled $89.9 million compared with $2.2 billion paid in 2016. Net proceeds from the sale of oil and gas properties decreased $169.3 million for the year ended December 31, 2017 , compared with the same period in 2016 . During 2017 , net proceeds were primarily from the sale of our outside-operated Eagle Ford shale assets, and during 2016 , net proceeds were primarily related to the divestitures of our Raven/Bear Den and certain other non-core Permian and Rocky Mountain assets. Capital expenditures in 2017 increased $258.4 million , or 41 percent , compared with 2016 as a result of increased drilling and completion activities and slightly higher service provider costs. +In 2017, we adjusted year ended December 31, 2016, amounts to conform to the current period presentation on the consolidated financial statements. As a result, we reclassified $3.0 million of restricted cash out of investing activities and combined it with cash and cash equivalents when reconciling the beginning and end of period balances on the accompanying statements of cash flows, resulting in a decrease in net cash used in investing activities in 2016. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 for additional discussion of adjustments made as a result of adopting new accounting standards. +Financing Activities +For the Years Ended December 31, +Amount Change Between +Percent Change Between +2018 +2017 +2016 +2018/2017 +2017/2016 +2018/2017 +2017/2016 +(in millions) +Net cash provided by (used in) financing activities +$ +(368.7 +) +$ +(12.3 +) +$ +1,327.2 +$ +(356.4 +) +$ +(1,339.5 +) +2,898 +% +(101 +)% +Net cash used in financing activities increased for the year ended December 31, 2018 , compared with the same period in 2017 primarily as a result of the redemption of $344.6 million principal outstanding of our 2021 Senior Notes. Cash flows related to financing activities during 2018 were also impacted by the repurchase of $395.0 million principal outstanding of our 2023 Senior Notes and $85.0 million principal outstanding of our 2022 Senior Notes. Premiums totaling $20.4 million were also paid in connection with these redemptions and repurchases during 2018. Offsetting these cash outflows, was cash provided by the issuance of our 2027 Senior Notes in 2018 for net proceeds of $492.1 million . Dividend payments during the years ended December 31, 2018 and 2017 , were $11.2 million and $11.1 million , respectively. We had a zero balance on our credit facility as of December 31, 2018 and 2017 , due to our cash balance resulting from the proceeds received from the PRB Divestiture, Divide County Divestiture, and Halff East Divestiture in the first half of 2018, proceeds received from the sale of our outside-operated Eagle Ford shale assets during 2017, and proceeds received from the sale of our Raven/Bear Den assets in December 2016. Consequently, there was no credit facility activity during 2018, and credit facility borrowings and repayments netted to zero in 2017. +During 2016 , we received $934.1 million of net proceeds from two public equity offerings, $491.6 million of net proceeds from our 2026 Senior Notes issuance, and $166.6 million of net proceeds from our Senior Convertible Notes issuance. These proceeds were used to partially fund the Rock Oil Acquisition and QStar Acquisition, as well as repay our credit facility balance of $202.0 million during the year ended December 31, 2016 . Additionally, in 2016, we paid $24.2 million for capped call transactions related to our Senior Convertible Notes and paid $29.9 million for the repurchase of $46.3 million in aggregate principal amount of a portion of our senior notes. Please refer to Note 5 – Long-Term Debt and Note 13 – Equity in Part II, Item 8 of this report for additional discussion. +Interest Rate Risk +We are exposed to market risk due to the floating interest rate associated with any outstanding balance on our revolving credit facility. As of December 31, 2018 , we had a zero balance on our credit facility. Our Credit Agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the credit facility’s fair market value, but will not impact results of operations or cash flows. Conversely, for the portion of the credit facility that has a floating interest rate, interest rate changes will not affect the fair market value, but will impact future results of operations and cash flows. Changes in interest rates do not impact the amount of interest we pay on our fixed-rate Senior Notes or fixed-rate Senior Convertible Notes, but can impact their fair market values. As of December 31, 2018 , our outstanding principal amount of fixed-rate debt totaled $2.6 billion . Please refer to Note 11 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion on the fair values of our Senior Notes and Senior Convertible Notes. +61 +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly impact our revenue, overall profitability, access to capital, and future rate of growth. Oil, gas, and NGL prices are subject to wide fluctuations in response to changes in supply and demand and other factors. The markets for oil, gas, and NGLs have been volatile, especially over the last several years, and these markets will likely continue to be volatile in the future. The prices we receive for our production depend on numerous factors beyond our control. Based on our 2018 production, a 10 percent decrease in our average realized oil, gas, and NGL prices before the effects of derivative settlements would have reduced our oil, gas, and NGL production revenues by approximately $106.6 million , $35.4 million , and $21.6 million , respectively. If commodity prices had been 10 percent lower, our net derivative settlements for the year ended December 31, 2018 would have offset the declines in oil, gas, and NGL production revenue by approximately $117.8 million. +We enter into commodity derivative contracts in order to reduce the risk of fluctuations in commodity prices. The fair value of our commodity derivative contracts is largely determined by estimates of the forward curves of the relevant price indices. As of December 31, 2018 , a 10 percent increase or decrease in the forward curves associated with our oil, gas, and NGL commodity derivative instruments would have changed our net liability positions by approximately $71.8 million , $23.9 million , and $12.9 million , respectively. +Schedule of Contractual Obligations +The following table summarizes our contractual obligations at December 31, 2018 , for the periods specified (in millions): +Contractual Obligations +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Long-term debt (1) +$ +2,649.3 +$ +— +$ +172.5 +$ +476.8 +$ +2,000.0 +Interest payments (2) +970.4 +155.5 +309.8 +272.1 +233.0 +Delivery commitments (3) +287.8 +40.3 +150.8 +88.2 +8.5 +Operating leases and contracts (3) +169.7 +92.2 +41.2 +19.9 +16.4 +Asset retirement obligations (4) +116.9 +2.3 +36.9 +1.0 +76.7 +Derivative liabilities (5) +75.8 +63.1 +12.7 +— +— +Other (6) +36.4 +4.0 +17.5 +14.9 +— +Total +$ +4,306.3 +$ +357.4 +$ +741.4 +$ +872.9 +$ +2,334.6 +____________________________________________ +(1) +Long-term debt consists of our Senior Notes and Senior Convertible Notes and assumes no principal repayment until the due dates of the instruments. The actual payment dates may vary significantly. As of December 31, 2018 , we had a zero balance on our revolving credit facility. +(2) +Interest payments on our Senior Notes and Senior Convertible Notes are estimated assuming no principal repayment until the due dates of the instruments. As our credit facility balance was zero at December 31, 2018 , the above table includes only the fee that would be paid on the unused credit facility’s aggregate lender commitment amount through the maturity date of the Credit Agreement. +(3) +Please refer to Note 6 – Commitments and Contingencies in Part II, Item 8 of this report for additional discussion regarding our operating leases, contracts and gathering, processing, transportation throughput, and delivery commitments. The amount relating to our gathering, processing, transportation throughput, and delivery commitments reflects the aggregate undiscounted deficiency payments assuming we delivered no product. This amount does not include any costs that may be incurred for certain contracts where we cannot predict with accuracy the amount and timing of any payments that may be incurred for not meeting certain minimum commitments, as such payments are dependent upon the price of oil in effect at the time of settlement. +(4) +Amounts shown represent estimated future undiscounted plugging and abandonment costs. The discounted obligations are recorded as liabilities on our accompanying consolidated balance sheets (“accompanying balance sheets”) as of December 31, 2018 . The timing and amount of the ultimate settlement of these obligations is unknown and can be impacted by economic factors, a change in development plans, and federal and state regulations. Obligations related to inactive wells or wells that are not economic at current commodity price levels as of December 31, 2018 , are shown as an obligation in 1-3 years, however, there is substantial uncertainty on the timing of plugging or re-entering these wells. Please refer to Note 14 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +(5) +Amounts shown represent only the liability portion of the marked-to-market value of our commodity derivatives based on future market prices as of December 31, 2018 , and exclude estimated oil, gas, and NGL commodity derivative receipts. This amount varies from the liability amounts presented on the accompanying balance sheets, as those amounts are presented at fair value, which considers time value, volatility, and the risk of non-performance for us and for our counterparties. The ultimate settlement amounts under our derivative contracts are unknown, as they are subject to continuing market risk and commodity price volatility. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +(6) +The majority of this amount is related to the unfunded portion of our estimated pension liability of $36.0 million , for which we have estimated the timing of future payments based on historical annual contribution amounts. +62 +In December 2018, we entered into an agreement that included minimum drilling and completion requirements for certain existing leases. Based on our expectation that we will meet these minimum requirements, this agreement is not reflected in the Schedule of Contractual Obligations table above. Please refer to Note 6 – Commitments and Contingencies in Part II, Item 8 of this report for additional discussion on this agreement. +Off-Balance Sheet Arrangements +As part of our ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +We evaluate our transactions to determine if any variable interest entities exist. If we determine that we are the primary beneficiary of a variable interest entity, that entity is consolidated into our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions during 2018 or 2017 , or through the filing of this report. +Critical Accounting Policies and Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our consolidated financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate due to changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below, those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Successful Efforts Method of Accounting . GAAP provides for two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method. Both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report. +Oil and Gas Reserve Quantities . Our estimated proved reserve quantities and future net cash flows are critical to understanding the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our consolidated financial statements, including the calculations of depletion and impairment of proved and unproved oil and gas properties. Please refer to the Oil and Gas Producing Activities section of Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report for additional discussion on our accounting policies impacted by estimated reserve quantities. +Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure of discounted future net cash flows calculation requires that a 10 percent discount rate be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir evaluation consulting firm, to audit at least 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year end. It should not be assumed that the standardized measure of discounted future net cash flows (GAAP) or PV-10 (non-GAAP) as of December 31, 2018 , is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based these measures on a 12-month average of the first-day-of-the-month prices for the year ended December 31, 2018 . Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimates. Please refer to Risk Factors in Part I, Item 1A of this report. +If the estimates of proved reserves decline, the rate at which we record depletion expense will increase, which would reduce future net income. Changes in depletion rate calculations caused by changes in reserve quantities are made prospectively. In addition, a decline in reserve estimates may impact the outcome of our assessment of proved and unproved properties for impairment. Impairments are recorded in the period in which they are identified. +63 +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2018 +2017 +2016 +MMBOE +MMBOE +MMBOE +Change +Change +Change +Revisions resulting from performance +(59.7 +) +7.4 +(18.1 +) +Removal of proved undeveloped reserves no longer in our five-year development plan +(22.6 +) +(13.9 +) +(43.0 +) +Revisions resulting from price changes +13.5 +23.1 +(35.1 +) +Total +(68.8 +) +16.6 +(96.2 +) +As previously noted, commodity prices are volatile and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. +We cannot reasonably predict future commodity prices, although we believe that together, the below analyses provide reasonable information regarding the impact of changes in pricing and trends on total estimated proved reserves. The following table reflects the estimated MMBOE change and percentage change to our total reported estimated proved reserve volumes from the described hypothetical changes: +For the year ended December 31, 2018 +MMBOE +Percentage +Change +Change +10 percent decrease in SEC pricing (1) +(4.6 +) +(1 +)% +Average NYMEX strip pricing as of fiscal year end (2) +(12.2 +) +(2 +)% +10 percent decrease in proved undeveloped reserves (3) +(25.9 +) +(5 +)% +___________________________________________ +(1) +The change solely reflects the impact of a 10 percent decrease in SEC pricing to the total reported estimated proved reserve volumes as of December 31, 2018 , and does not include additional impacts to our estimated proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. +(2) +The change solely reflects the impact of replacing SEC pricing with the five-year average NYMEX strip pricing as of December 31, 2018 . SEC pricing of $65.56 per Bbl for oil, $3.10 per MMBtu for gas, and $33.45 per Bbl for NGLs as of December 31, 2018 , compared to the five-year average NYMEX strip pricing of $50.02 per Bbl for oil, $2.70 per MMBtu for gas, and $23.67 per Bbl for NGLs as of December 31, 2018 , would result in a two percent decrease to our total reported estimated proved reserve volumes. +(3) +The change solely reflects a 10 percent decrease in proved undeveloped reserves as of December 31, 2018 , and does not include any additional impacts to our estimated proved reserves. +Additional reserve information can be found in the Reserves section in Part I, Items 1 and 2 of this report, and in Supplemental Oil and Gas Information in Part II, Item 8 of this report. +Impairment of Oil and Gas Properties . Proved properties are evaluated periodically for impairment on a pool-by-pool basis and when events or changes in circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected future cash flows of our oil and gas properties and compare these undiscounted cash flows to the carrying amount to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the oil and gas properties to fair value (or discounted future cash flows). Management estimates future cash flows from all proved reserves and risk adjusted probable and possible reserves using various factors, which are subject to our judgment and expertise, and include, but are not limited to, commodity price forecasts, estimated future operating and capital costs, development plans, and discount rates to incorporate the risk and current market conditions associated with realizing the expected cash flows. +Unproved oil and gas properties are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by prospect and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and our intent to renew leases. We estimate the fair value of unproved properties, using a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by us or other market participants. +64 +Proved and unproved oil and gas properties are classified as held for sale when we commit to a plan to sell the assets and there is reasonable certainty the sale will take place within one year. Upon classification as held for sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to identify and expense any excess of carrying value over fair value less costs to sell. +We cannot predict when or if future impairment charges will be recorded because of the uncertainty in the factors discussed above. Despite any amount of future impairment being difficult to predict, based on our commodity price assumptions as of February 7, 2019 , we do not expect any material property impairments in the first quarter of 2019 resulting from commodity price impacts. +Please refer to Note 1 – Summary of Significant Accounting Policies and Note 11 – Fair Value Measurements in Part II, Item 8 of this report for discussion of impairments of oil and gas properties recorded for the years ended December 31, 2018 , 2017 , and 2016 . +Purchase Price Allocation . Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets and liabilities acquired based on their estimated fair value as of the acquisition date. Various assumptions are made when estimating fair values assigned to proved and unproved oil and gas properties including: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgment by management at the time of the valuation. +Asset Retirement Obligations . We are required to recognize an estimated liability for future costs associated with the abandonment of our oil and gas properties. We base our estimate of the liability on our historical experience in abandoning oil and gas wells and our current understanding of federal and state regulatory requirements. Our present value calculations require us to estimate the cost, the economic lives and timing of abandonment of our properties, future inflation rates, and the appropriate credit-adjusted risk-free discount rate to use. The impact to the accompanying consolidated statements of operations (“accompanying statements of operations”) from these estimates is reflected in our depletion, depreciation, and amortization calculations and occurs over the remaining life of our respective oil and gas properties. Please refer to Note 14 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +Revenue Recognition . Effective January 1, 2018, our revenue recognition policy was updated to reflect the adoption of new accounting guidance. Our revenue recognition policy is a critical accounting policy because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. Our primary source of revenue is derived by the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when control of the product, as defined by contractual terms, transfers to the purchaser. Payment for these sales is typically received between 30 and 90 days after the date of production. At the end of each month, we make estimates of the amount of production delivered to the purchaser and the price we will receive. We use our knowledge of our properties, contractual arrangements, historical performance, NYMEX, local spot market, OPIS prices, and other factors as the basis for these estimates. Variances between our estimates and the actual amounts received are recorded in the month payment is received. A 10 percent change in our revenue accrual at year end would have impacted total operating revenues by approximately $10.7 million in 2018 . Please refer to Note 1 – Summary of Significant Accounting Policies under the heading Recently Issued Accounting Standards and Note 2 - Revenue from Contracts with Customers in Part II, Item 8 of this report for additional discussion. +Derivative Financial Instruments . We periodically enter into commodity derivative contracts to manage our exposure to oil, gas, and NGL price volatility and location differentials. We recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income (loss). The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our consolidated financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. +Income Taxes . We provide for deferred income taxes on the difference between the tax basis of an asset or liability and its carrying amount in our consolidated financial statements. This difference will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period, as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax expense by approximately $6.5 million for the year ended December 31, 2018 . +Accounting Matters +Please refer to Recently Issued Accounting Standards under Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for information on new authoritative accounting guidance. +65 +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes, and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +Hydraulic Fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, please refer to Risk Factors – Risks Related to Our Business – Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing, air quality, and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays . +Climate Change. In June 2013, President Obama announced a Climate Action Plan designed to further reduce greenhouse gas emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Climate Action Plan targeted methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. As part of the Climate Action Plan, on May 12, 2016, the EPA issued final regulations that amend and expand 2012 regulations for the oil and gas sector by setting emission limits for VOCs and methane, a greenhouse gas, or GHG, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The regulation requires, among other things, greenhouse gas and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly boosting and garnering compressor stations and gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of greenhouse gases and VOCs from well completions. Both the 2012 and 2016 rules are the subject of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia, although the litigation of both rules has been stayed. In October 2018, the EPA proposed scaling back provisions of the 2016 NSPS directed toward cutting leaks of methane, including proposing allowing only annual inspections for many sites. The rule does not extend to existing sources and the Trump EPA has rescinded the Information Collection Request that was intended to gather information to develop existing source standards. On November 16, 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands, as part of President Obama’s Climate Action Plan. The regulations were intended to reduce the waste of gas from flaring, venting, and leaks by oil and gas production. The rule included requirements that prohibits venting gas except in limited circumstances and limits flaring of gas and includes requirements for leak detection and repair. The rule also increased royalty payments for “waste” gas that is released in contravention of the rule requirements. After continuous court challenges, the BLM issued a final rule in September 2018 that rescinded most of the 2016 rule, including most of the methane control requirements. Any future regulations requiring similar capture standards may increase our operational costs, or restrict our production, which could materially and adversely affect our financial condition, results of operations and cash flows. +In August of 2015, the EPA finalized existing source performance standards as stringent state emission “goals” for utilities to reduce greenhouse gas emissions. The proposed standards focus on re-dispatching electricity from coal-fired units to gas combined cycle plants and renewables. In February 2016, however, the Supreme Court stayed these rules pending judicial review. The EPA has proposed a repeal of the rule based on a new legal interpretation of the EPA’s authority. The EPA proposed a replacement rule, the Affordable Clean Energy Rule, in August 2018. +The United States Congress has from time to time considered adopting legislation to reduce emissions of greenhouse gases and almost one-half of the states have already taken legal measures to reduce emissions of greenhouse gases primarily through the planned development of greenhouse gas emission inventories and/or regional greenhouse gas cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall greenhouse gas emission reduction goal. In addition, there have been international conventions and efforts to establish standards for the reduction of greenhouse gases globally, including the Paris accords in December 2015. The conditions for entry into force of the Paris accords were met on October 5, 2016 and the Agreement went into force 30 days later on November 4, 2016. However, in August 2017, the U.S. notified the United Nations Secretary-General that it intends to withdraw from the agreement as soon as it is able to do so, or November 2019. +The adoption of legislation or regulatory programs to reduce emissions of greenhouse gases could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and gas we produce. Consequently, legislation and regulatory programs to reduce emissions of greenhouse gases could have an adverse effect on our business, financial condition, and results of operations. Finally, scientists have concluded that increasing concentrations of greenhouse gases in the earth’s atmosphere produce climate changes that likely have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. Such effects could have an adverse effect on our financial condition and results of operations. +66 +In terms of opportunities, the regulation of greenhouse gas emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and gas that we produce, the relative demand for gas may increase because the burning of gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources, such as wind or solar power become more prevalent, gas-fired electric plants may provide an alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, gas may become a more attractive transportation fuel. Approximately 39 percent and 46 percent of our production on a BOE basis in 2018 and 2017 , respectively, was gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and gas reservoirs, could also benefit us through the potential to obtain greenhouse gas emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +Non-GAAP Financial Measures +Adjusted EBITDAX represents net income (loss) before interest expense, interest income, income taxes, depletion, depreciation, amortization and asset retirement obligation liability accretion expense, exploration expense, property abandonment and impairment expense, non-cash stock-based compensation expense, derivative gains and losses net of settlements, gains and losses on divestitures, gains and losses on extinguishment of debt, and certain other items. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally non-recurring in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that we present because we believe it provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for exploration, development, acquisitions, and to service debt. We are also subject to financial covenants under our Credit Agreement based on adjusted EBITDAX ratios as further described in the Credit Agreement section in Overview of Liquidity and Capital Resources above. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or other profitability or liquidity measures prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. Our credit facility provides a material source of liquidity for us. Under the terms of our Credit Agreement, if we failed to comply with the covenants that establish a maximum permitted ratio of total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX, we would be in default, an event that would prevent us from borrowing under our credit facility and would therefore materially limit our sources of liquidity. In addition, if we are in default under our credit facility and are unable to obtain a waiver of that default from our lenders, lenders under that facility and under the indentures governing our outstanding Senior Notes and Senior Convertible Notes would be entitled to exercise all of their remedies for default. +67 +The following table provides reconciliations of our net income (loss) (GAAP) and net cash provided by operating activities (GAAP) to adjusted EBITDAX (non-GAAP) for the periods presented: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Net income (loss) (GAAP) +$ +508,407 +$ +(160,843 +) +$ +(757,744 +) +Interest expense +160,906 +179,257 +158,685 +Interest income (1) +(5,191 +) +(3,968 +) +(362 +) +Income tax expense (benefit) +143,370 +(182,970 +) +(444,172 +) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +665,313 +557,036 +790,745 +Exploration (2) (3) +49,627 +48,413 +58,523 +Impairment of proved properties +— +3,806 +354,614 +Abandonment and impairment of unproved properties +49,889 +12,272 +80,367 +Stock-based compensation expense +23,908 +22,700 +26,897 +Net derivative (gain) loss +(161,832 +) +26,414 +250,633 +Derivative settlement gain (loss) +(135,803 +) +21,234 +329,478 +Net (gain) loss on divestiture activity +(426,917 +) +131,028 +(37,074 +) +(Gain) loss on extinguishment of debt +26,740 +35 +(15,722 +) +Other, net +1,977 +8,820 +(4,764 +) +Adjusted EBITDAX (non-GAAP) (3) +900,394 +663,234 +790,104 +Interest expense +(160,906 +) +(179,257 +) +(158,685 +) +Interest income (1) +5,191 +3,968 +362 +Income tax (expense) benefit +(143,370 +) +182,970 +444,172 +Exploration (2) (3) +(49,627 +) +(48,413 +) +(58,523 +) +Amortization of debt discount and deferred financing costs +15,258 +16,276 +9,938 +Deferred income taxes +141,708 +(192,066 +) +(448,643 +) +Other, net (3) +(1,690 +) +(935 +) +(5,167 +) +Changes in current assets and liabilities +13,671 +69,613 +(20,754 +) +Net cash provided by operating activities (GAAP) (3) +$ +720,629 +$ +515,390 +$ +552,804 +____________________________________________ +(1) +Interest income is included within the other non-operating income (expense), net line item on the accompanying statements of operations in Part II, Item 8 of this report. +(2) +Stock-based compensation expense is a component of the exploration expense and general and administrative expense line items on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration expense. +(3) +Certain prior period amounts have been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion. +68 +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this item is provided under the captions Commodity Price Risk and Interest Rate Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place under Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +69 +ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries (the Company) as of December 31, 2018 and 2017 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 21, 2019 expressed an unqualified opinion thereon. +Adoption of ASU No. 2016-09 +As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for share-based arrangements in the December 31, 2017 consolidated financial statements due to the adoption of ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ Ernst & Young LLP +We have served as the Company’s auditor since 2012. +Denver, Colorado +February 21, 2019 +70 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2018 +2017 +ASSETS +Current assets: +Cash and cash equivalents +$ +77,965 +$ +313,943 +Accounts receivable +167,536 +160,154 +Derivative assets +175,130 +64,266 +Prepaid expenses and other +8,632 +10,752 +Total current assets +429,263 +549,115 +Property and equipment (successful efforts method): +Proved oil and gas properties +7,278,362 +6,139,379 +Accumulated depletion, depreciation, and amortization +(3,417,953 +) +(3,171,575 +) +Unproved oil and gas properties +1,581,401 +2,047,203 +Wells in progress +295,529 +321,347 +Properties held for sale, net +5,280 +111,700 +Other property and equipment, net of accumulated depreciation of $57,102 and $49,985, respectively +88,546 +106,738 +Total property and equipment, net +5,831,165 +5,554,792 +Noncurrent assets: +Derivative assets +58,499 +40,362 +Other noncurrent assets +33,935 +32,507 +Total noncurrent assets +92,434 +72,869 +Total assets +$ +6,352,862 +$ +6,176,776 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable and accrued expenses +$ +403,199 +$ +386,630 +Derivative liabilities +62,853 +172,582 +Total current liabilities +466,052 +559,212 +Noncurrent liabilities: +Revolving credit facility +— +— +Senior Notes, net of unamortized deferred financing costs +2,448,439 +2,769,663 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +147,894 +139,107 +Asset retirement obligations +91,859 +103,026 +Asset retirement obligations associated with oil and gas properties held for sale +— +11,369 +Deferred income taxes +223,278 +79,989 +Derivative liabilities +12,496 +71,402 +Other noncurrent liabilities +42,522 +48,400 +Total noncurrent liabilities +2,966,488 +3,222,956 +Commitments and contingencies (note 6) +Stockholders’ equity: +Common stock, $0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 112,241,966 and 111,687,016 shares, respectively +1,122 +1,117 +Additional paid-in capital +1,765,738 +1,741,623 +Retained earnings (1) +1,165,842 +665,657 +Accumulated other comprehensive loss (1) +(12,380 +) +(13,789 +) +Total stockholders’ equity +2,920,322 +2,394,608 +Total liabilities and stockholders’ equity +$ +6,352,862 +$ +6,176,776 +____________________________________________ +(1) +The Company reclassified $3.0 million of tax effects stranded in accumulated other comprehensive loss to retained earnings as of January 1, 2018. Please refer to Note 1 – Summary of Significant Accounting Policies for further detail. +The accompanying notes are an integral part of these consolidated financial statements. +71 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +For the Years Ended +December 31, +2018 +2017 +2016 +(as adjusted) +(as adjusted) +Operating revenues and other income: +Oil, gas, and NGL production revenue +$ +1,636,357 +$ +1,253,783 +$ +1,178,426 +Net gain (loss) on divestiture activity +426,917 +(131,028 +) +37,074 +Other operating revenues +3,798 +6,621 +1,950 +Total operating revenues and other income +2,067,072 +1,129,376 +1,217,450 +Operating expenses: +Oil, gas, and NGL production expense +487,367 +507,906 +597,565 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +665,313 +557,036 +790,745 +Exploration +55,166 +54,713 +64,970 +Impairment of proved properties +— +3,806 +354,614 +Abandonment and impairment of unproved properties +49,889 +12,272 +80,367 +General and administrative +116,504 +117,283 +124,828 +Net derivative (gain) loss +(161,832 +) +26,414 +250,633 +Other operating expenses, net +18,328 +13,667 +10,772 +Total operating expenses +1,230,735 +1,293,097 +2,274,494 +Income (loss) from operations +836,337 +(163,721 +) +(1,057,044 +) +Interest expense +(160,906 +) +(179,257 +) +(158,685 +) +Gain (loss) on extinguishment of debt +(26,740 +) +(35 +) +15,722 +Other non-operating income (expense), net +3,086 +(800 +) +(1,909 +) +Income (loss) before income taxes +651,777 +(343,813 +) +(1,201,916 +) +Income tax (expense) benefit +(143,370 +) +182,970 +444,172 +Net income (loss) +$ +508,407 +$ +(160,843 +) +$ +(757,744 +) +Basic weighted-average common shares outstanding +111,912 +111,428 +76,568 +Diluted weighted-average common shares outstanding +113,502 +111,428 +76,568 +Basic net income (loss) per common share +$ +4.54 +$ +(1.44 +) +$ +(9.90 +) +Diluted net income (loss) per common share +$ +4.48 +$ +(1.44 +) +$ +(9.90 +) +The accompanying notes are an integral part of these consolidated financial statements. +72 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +For the Years Ended +December 31, +2018 +2017 +2016 +Net income (loss) +$ +508,407 +$ +(160,843 +) +$ +(757,744 +) +Other comprehensive income (loss), net of tax: +Pension liability adjustment (1) +4,378 +767 +(1,154 +) +Total other comprehensive income (loss), net of tax +4,378 +767 +(1,154 +) +Total comprehensive income (loss) +$ +512,785 +$ +(160,076 +) +$ +(758,898 +) +____________________________________________ +(1) +Please refer to Note 8 – Pension Benefits for additional discussion on the pension liability adjustment. +The accompanying notes are an integral part of these consolidated financial statements. +73 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share data and dividends per share) +Additional Paid-in Capital +Accumulated Other Comprehensive Loss +Total Stockholders’ Equity +Common Stock +Retained Earnings +Shares +Amount +Balances, January 1, 2016 +68,075,700 +$ +681 +$ +305,607 +$ +1,559,515 +$ +(13,402 +) +$ +1,852,401 +Net loss +— +— +— +(757,744 +) +— +(757,744 +) +Other comprehensive loss +— +— +— +— +(1,154 +) +(1,154 +) +Cash dividends, $ 0.10 per share +— +— +— +(7,751 +) +— +(7,751 +) +Issuance of common stock under Employee Stock Purchase Plan +218,135 +2 +4,196 +— +— +4,198 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings +199,243 +2 +(2,356 +) +— +— +(2,354 +) +Stock-based compensation expense +53,473 +1 +26,896 +— +— +26,897 +Issuance of common stock from stock offerings, net of tax +42,710,949 +427 +1,382,666 +— +— +1,383,093 +Equity component of 1.50% Senior Convertible Notes due 2021 issuance, net of tax +— +— +33,575 +— +— +33,575 +Purchase of capped call transactions +— +— +(24,195 +) +— +— +(24,195 +) +Other +— +— +(9,833 +) +— +— +(9,833 +) +Balances, December 31, 2016 +111,257,500 +$ +1,113 +$ +1,716,556 +$ +794,020 +$ +(14,556 +) +$ +2,497,133 +Net loss +— +— +— +(160,843 +) +— +(160,843 +) +Other comprehensive income +— +— +— +— +767 +767 +Cash dividends, $0.10 per share +— +— +— +(11,144 +) +— +(11,144 +) +Issuance of common stock under Employee Stock Purchase Plan +186,665 +2 +2,621 +— +— +2,623 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings +171,278 +1 +(1,241 +) +— +— +(1,240 +) +Stock-based compensation expense +71,573 +1 +22,699 +— +— +22,700 +Cumulative effect of accounting change (1) +— +— +1,108 +43,624 +— +44,732 +Other +— +— +(120 +) +— +— +(120 +) +Balances, December 31, 2017 +111,687,016 +$ +1,117 +$ +1,741,623 +$ +665,657 +$ +(13,789 +) +$ +2,394,608 +Net income +— +— +— +508,407 +— +508,407 +Other comprehensive income +— +— +— +— +4,378 +4,378 +Cash dividends, $0.10 per share +— +— +— +(11,191 +) +— +(11,191 +) +Issuance of common stock under Employee Stock Purchase Plan +199,464 +2 +3,185 +— +— +3,187 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings +291,745 +3 +(2,978 +) +— +— +(2,975 +) +Stock-based compensation expense +63,741 +— +23,908 +— +— +23,908 +Cumulative effect of accounting change (1) +— +— +— +2,969 +(2,969 +) +— +Balances, December 31, 2018 +112,241,966 +$ +1,122 +$ +1,765,738 +$ +1,165,842 +$ +(12,380 +) +$ +2,920,322 +____________________________________________ +(1) +Refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies for additional information. +The accompanying notes are an integral part of these consolidated financial statements. +74 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2018 +2017 +2016 +Cash flows from operating activities: +Net income (loss) +$ +508,407 +$ +(160,843 +) +$ +(757,744 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Net (gain) loss on divestiture activity +(426,917 +) +131,028 +(37,074 +) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +665,313 +557,036 +790,745 +Impairment of proved properties +— +3,806 +354,614 +Abandonment and impairment of unproved properties +49,889 +12,272 +80,367 +Stock-based compensation expense +23,908 +22,700 +26,897 +Net derivative (gain) loss +(161,832 +) +26,414 +250,633 +Derivative settlement gain (loss) +(135,803 +) +21,234 +329,478 +Amortization of debt discount and deferred financing costs +15,258 +16,276 +9,938 +(Gain) loss on extinguishment of debt +26,740 +35 +(15,722 +) +Deferred income taxes +141,708 +(192,066 +) +(448,643 +) +Other, net +287 +7,885 +(9,931 +) +Changes in current assets and liabilities: +Accounts receivable +(30,152 +) +13,997 +(10,562 +) +Prepaid expenses and other +(729 +) +(1,953 +) +8,478 +Accounts payable and accrued expenses +23,819 +44,985 +(53,210 +) +Accrued derivative settlements +20,733 +12,584 +34,540 +Net cash provided by operating activities +720,629 +515,390 +552,804 +Cash flows from investing activities: +Net proceeds from the sale of oil and gas properties +748,509 +776,719 +946,062 +Capital expenditures +(1,303,188 +) +(888,353 +) +(629,911 +) +Acquisition of proved and unproved oil and gas properties +(33,255 +) +(89,896 +) +(2,183,790 +) +Net cash used in investing activities +(587,934 +) +(201,530 +) +(1,867,639 +) +Cash flows from financing activities: +Proceeds from credit facility +— +406,000 +947,000 +Repayment of credit facility +— +(406,000 +) +(1,149,000 +) +Net proceeds from senior notes +492,079 +— +491,640 +Cash paid to repurchase senior notes, including premium +(845,002 +) +(2,357 +) +(29,904 +) +Net proceeds from Senior Convertible Notes +— +— +166,617 +Cash paid for capped call transactions +— +— +(24,195 +) +Net proceeds from sale of common stock +3,187 +2,623 +938,268 +Dividends paid +(11,191 +) +(11,144 +) +(7,751 +) +Other, net +(7,746 +) +(1,411 +) +(5,486 +) +Net cash provided by (used in) financing activities +(368,673 +) +(12,289 +) +1,327,189 +Net change in cash, cash equivalents, and restricted cash (1) +(235,978 +) +301,571 +12,354 +Cash, cash equivalents, and restricted cash at beginning of period (1) +313,943 +12,372 +18 +Cash, cash equivalents, and restricted cash at end of period (1) +$ +77,965 +$ +313,943 +$ +12,372 +____________________________________________ +(1) +Cash, cash equivalents, and restricted cash for the year ended December 31, 2016, includes $3.0 million of restricted cash which is included in other noncurrent assets on the accompanying balance sheets. +The accompanying notes are an integral part of these consolidated financial statements. +75 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) +(in thousands) +Supplemental schedule of additional cash flow information and non-cash activities: +For the Years Ended +December 31, +2018 +2017 +2016 +Operating activities: +Cash paid for interest, net of capitalized interest +$ +(150,727 +) +$ +(164,097 +) +$ +(129,761 +) +Net cash paid (refunded) for income taxes +$ +2,995 +$ +5,986 +$ +(4,690 +) +Investing activities: +Changes in capital expenditure accruals and other +$ +(2,774 +) +$ +7,309 +$ +8,044 +Supplemental non-cash investing activities: +Carrying value of properties exchanged +$ +95,121 +$ +293,963 +$ +733 +Supplemental non-cash financing activities: +Issuance of common stock for an asset acquisition (1) +$ +— +$ +— +$ +437,194 +Non-cash (gain) loss on extinguishment of debt, net +$ +6,334 +$ +22 +$ +(15,722 +) +____________________________________________ +(1) +Refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions and Note 13 – Equity for additional discussion. +76 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company, together with its consolidated subsidiaries, is an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in onshore North America. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Intercompany accounts and transactions have been eliminated. In connection with the preparation of the consolidated financial statements, the Company evaluated events subsequent to the balance sheet date of December 31, 2018 , through the filing of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the consolidated financial statements. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of depletion, depreciation, and amortization expense, impairment of proved properties, and asset retirement obligations, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents and Restricted Cash +The Company considers all liquid investments purchased with an initial maturity of three months or less to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. Restricted cash includes cash that is contractually restricted for its use through an agreement with a non-related party. The Company includes restricted cash in other noncurrent assets on the accompanying balance sheets. +Accounts Receivable +The Company’s accounts receivable consists mainly of receivables from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables due from joint interest owners, the Company generally has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil, gas, and NGL receivables are collected within 30 to 90 days and the Company has had minimal bad debts. +Although diversified among many companies, collectibility is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. Please refer to Note 15 – Accounts Receivable and Accounts Payable and Accrued Expenses for additional disclosure. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to regular review. +77 +The Company does not believe the loss of any single purchaser of its production would materially impact its operating results, as oil, gas, and NGLs are products with well-established markets and numerous purchasers in the Company’s operating regions. The Company had the following major customers and sales to entities under common ownership, which accounted for 10 percent or more of its total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2018 +2017 +2016 +Major customer #1 (1) +18 +% +6 +% +— +% +Major customer #2 (1) +10 +% +10 +% +5 +% +Group #1 of entities under common ownership (2) +18 +% +17 +% +15 +% +Group #2 of entities under common ownership (2) +12 +% +8 +% +8 +% +____________________________________________ +(1) +These major customers are purchasers of a portion of the Company’s production from its Permian region. +(2) +In the aggregate, these groups of entities under common ownership represented more than 10 percent of total oil, gas, and NGL production revenue for at least one of the periods presented; however, no individual entity comprising either group represented more than 10 percent of the Company’s total oil, gas, and NGL production revenue. +The Company’s policy is to use the commodity affiliates of the lenders under its Credit Agreement as its derivative counterparties, and each counterparty must have investment grade senior unsecured debt ratings. Each of the Company’s 10 derivative counterparties meet both of these requirements as of the filing of this report. +The Company maintains its primary bank accounts with a large, multinational bank that has branch locations in the Company’s areas of operations. The Company’s policy is to diversify its concentration of cash and cash equivalent investments among multiple institutions and investment products to limit the amount of credit exposure to any single institution or investment. The Company maintains investments in highly rated, highly liquid investment products with numerous banks that are party to its revolving credit facility. +Oil and Gas Producing Activities +Proved properties . The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, the costs of development wells are capitalized whether those wells are successful or unsuccessful. Capitalized drilling and completion costs, including lease and well equipment, intangible development costs, and operational support facilities in the field, are depleted on a group basis (properties aggregated with a common geological structure) using the units-of-production method based on estimated proved developed oil and gas reserves. Similarly, proved leasehold costs are depleted on the same group asset basis; however, the units-of-production method is based on estimated total proved oil and gas reserves. The computation of DD&A takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. +Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that associated carrying costs may not be recoverable. The Company uses an income valuation technique, which converts future cash flow to a single present value amount, to measure the fair value of proved properties through an application of discount rates and price forecasts, as selected by the Company’s management. The Company uses discount rates that are representative of current market conditions and considers estimates of future cash payments, reserve categories, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk. The discount rates typically range from 10 percent to 15 percent based on the reservoir specific weightings of future estimated proved and unproved cash flows. The prices for oil and gas are forecasted based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecasted using OPIS pricing, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. +The partial sale of a proved property within an existing field is accounted for as a normal retirement and no net gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A net gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of proved properties. +Unproved properties . The unproved oil and gas properties line item on the accompanying balance sheets consists of costs incurred to acquire unproved leases. Leasehold costs allocated to those leases, or partial leases that have associated proved reserves recorded, are reclassified to proved properties and depleted on a units-of-production basis. Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by prospect and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and the Company’s intent to renew leases. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +78 +For the sale of unproved properties where the original cost has been partially or fully amortized by providing a valuation allowance on a group basis, neither a gain nor loss is recognized unless the sales price exceeds the original cost of the property, in which case a gain shall be recognized in the accompanying statements of operations in the amount of such excess. +Exploratory . Exploratory geological and geophysical, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Under the successful efforts method, exploratory well costs are capitalized pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are found, exploratory wells costs will be capitalized as proved properties and will be accounted for following the successful efforts method of accounting described above. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that economic proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in cash flows from investing activities as part of capital expenditures within the accompanying statements of cash flows. +Other Property and Equipment +Other property and equipment such as facilities, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing, and installation activities. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from 3 to 30 years, or the unit of output method when appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the accounts. +Other property and equipment costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. To measure the fair value of other property and equipment, the Company uses an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. The valuation includes consideration of the proved and unproved assets supported by the property and equipment, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. +Assets Held for Sale +Any properties held for sale as of the balance sheet date have been classified as assets held for sale and are separately presented on the accompanying balance sheets at the lower of carrying value or fair value less the estimated cost to sell. Properties classified as held for sale, including any corresponding asset retirement obligation liability, are valued using a market approach, based on an estimated net selling price, as evidenced by the most current bid prices received from third-parties, if available. If an estimated selling price is not available, the Company utilizes the various valuation techniques discussed above. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions . +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties, including facilities requiring decommissioning. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired, or a facility is constructed. The increase in carrying value is included in proved oil and gas properties in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and gas properties. Cash paid to settle asset retirement obligations is included in the operating section of the Company’s accompanying statements of cash flows. +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent . In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or economic life, or changes in inflation factors or the Company’s credit-adjusted risk-free rate as market conditions warrant. Please refer to Note 14 – Asset Retirement Obligations for a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2018 , and 2017 . +Derivative Financial Instruments +The Company periodically enters into derivative commodity instruments to reduce its exposure to pricing volatility for a portion of its expected future oil, natural gas, and NGL production. These instruments typically include commodity price swaps and costless +79 +collars, as well as, basis differential swaps. Derivative instruments are measured at fair value and are included in the accompanying consolidated balance sheets as assets and/or liabilities. The Company does not designate its derivative instruments to qualify for hedge accounting. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its accompanying statements of operations as they occur. Gains and losses on derivatives are included within cash flows from operations in the accompanying consolidated statement of cash flows. For additional discussion on derivatives, please see Note 10 – Derivative Financial Instruments . +Revenue Recognition +The Company derives revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when control of the product transfers to the customer, which differs depending on the contractual terms of each of the Company’s arrangements. Revenue accruals are recorded monthly and are based on estimated production delivered to a purchaser and the expected price to be received. Variances between estimates and the actual amounts received are recorded in the month payment is received. Please refer to Note 2 - Revenue from Contracts with Customers for additional discussion. +Stock-Based Compensation +At December 31, 2018 , the Company had stock-based employee compensation plans that included restricted stock units (“RSUs”) and performance share units (“PSUs”) issued to employees and RSUs and restricted stock issued to non-employee directors, as well as an employee stock purchase plan available to eligible employees. These are more fully described in Note 7 – Compensation Plans . The Company records expense associated with the fair value of stock-based compensation in accordance with authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant, and is included within general and administrative and exploration expense in the accompanying statements of operations. For stock-based compensation awards containing non-market based performance conditions, the Company evaluates the probability of the number of shares that are expected to vest, and then adjusts the expense to reflect the number of shares expected to vest and the cumulative vesting period met to date. Further, the Company accounts for forfeitures of stock-based compensation awards as they occur. +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the consolidated financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. Please refer to Note 4 – Income Taxes for additional disclosure. +Earnings per Share +The Company uses the treasury stock method to determine the potential dilutive effect of non-vested restricted stock units, contingent Performance Share Units, and Senior Convertible Notes. Please refer to Note 9 - Earnings Per Share for additional discussion. +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income (loss). Please refer to Note 8 – Pension Benefits for detail on the changes in the balances of components comprising other comprehensive income (loss). +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The recorded value of the Company’s credit facility approximates its fair value as it bears interest at a floating rate that approximates a current market rate. The Company had a zero balance under its credit facility as of December 31, 2018 , and 2017 . The Company’s Senior Notes and Senior Convertible Notes are recorded at cost, net of any unamortized discount and deferred financing costs, and the respective fair values are disclosed in Note 11 – Fair Value Measurements . The Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +80 +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry, onshore in the United States. The Company reports as a single industry segment. +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or SPEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that the Company is the primary beneficiary of a variable interest entity, that entity is consolidated. The Company has not been involved in any unconsolidated SPE transactions in 2018 or 2017 . +Recently Issued Accounting Standards +Effective January 1, 2017, the Company adopted, using various transition methods, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 is meant to simplify certain aspects of accounting for share-based arrangements, including income tax effects, accounting for forfeitures, and net share settlements. The Company adopted the various applicable amendments, which are summarized as follows: +• +On January 1, 2017, a $44.3 million cumulative-effect adjustment was made to retained earnings and a corresponding deferred tax asset was recorded for previously unrecognized excess tax benefits using a modified retrospective transition method. Effective January 1, 2017, excess tax benefits are presented in net cash provided by operating activities on the accompanying statements of cash flows. +• +On January 1, 2017, the Company elected to change its policy to account for forfeitures of share-based payment awards as they occur, rather than applying an estimated forfeiture rate. This change was made using a modified retrospective transition method and resulted in an increase in additional paid-in capital of $1.1 million , a decrease in deferred tax assets of $400,000 , and a net $700,000 cumulative effect adjustment decrease to retained earnings. +• +Under this new guidance, excess tax benefits and deficiencies from share-based payments impact the Company’s effective tax rate between periods. Please refer to Note 4 – Income Taxes for additional discussion . +Effective December 31, 2017, the Company early adopted, on a retrospective basis, FASB ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”) and FASB ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The Company determined that of the eight issues addressed in ASU 2016-15, only the issue related to debt extinguishment costs impacted the Company’s consolidated financial statements and disclosures. In accordance with ASU 2016-15, the Company reclassified certain debt extinguishment costs from operating activities to financing activities. ASU 2016-18 is intended to clarify guidance on the classification and presentation of restricted cash and restricted cash equivalents in the statement of cash flows. In accordance with ASU 2016-18, the Company reclassified $3.0 million of restricted cash out of investing activities and combined it with cash and cash equivalents in the accompanying statements of cash flows for the year ended December 31, 2016. +In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”) . Under the new standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. The standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB issued several additional ASUs related to ASU 2014-09 that provide clarified implementation guidance and deferred the effective date of ASU 2014-09. Effective January 1, 2018, the Company adopted ASU 2014-09 and all related ASUs using the modified retrospective transition method, which was applied to all active contracts as of the effective date. The adoption of ASU 2014-09 did not result in a change to current or prior period results nor did it result in a material change to the Company’s business processes, systems, or controls. However, upon adoption, the Company expanded its disclosures to comply with the disclosure requirements of ASU 2014-09. Please refer to Note 2 - Revenue from Contracts with Customers for additional discussion. +In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) , followed by other related ASUs that provided targeted improvements and additional practical expedient options (collectively “ASU 2016-02”). ASU 2016-02 requires lessees to recognize right-of-use assets and lease payment liabilities on the balance sheet for leases representing the Company’s right to use the underlying assets for the lease term. Each lease that is recognized in the balance sheet will be classified as either finance or operating, with such classification affecting the pattern and classification of expense recognition in the consolidated statements of operations and presentation within the statements of cash flows. +81 +The Company leveraged a dedicated project team and external consultants to evaluate the impacts of ASU 2016-02, which included an analysis of contracts for office leases, drilling rig agreements, well completion agreements, midstream agreements, water handling agreements, certain field equipment rentals, land easements, and other arrangements that included potential lease components. The scope of ASU 2016-02 does not apply to leases used in the exploration or use of minerals, oil, natural gas, or other similar non-regenerative resources. The Company has completed the process of reviewing and determining contracts to which the new guidance applies, and has implemented policies, internal controls, and processes that are necessary to support the additional accounting and disclosure requirements going forward. The lease administration system that will support the on-going maintenance and accounting after adoption is operational and is currently being populated with the necessary lease data and relevant assumptions. Policy elections and practical expedients the Company has implemented as part of adopting ASU 2016-02 include (a) excluding from the balance sheet leases with terms that are less than one year, (b) for agreements that contain both lease and non-lease components, combining these components together and accounting for them as a single lease, (c) the package of practical expedients, which allows the Company to avoid reassessing contracts that commenced prior to adoption that were properly evaluated under legacy GAAP, (d) excluding land easements that existed or expired before adoption of ASU 2016-02, and (e) the policy election that eliminates the need for adjusting prior period comparable financial statements prepared under legacy lease accounting guidance. The Company adopted ASU 2016-02 on January 1, 2019, using the modified retrospective approach, and has necessary staff and processes in place to ensure on-going compliance. Adoption of this guidance will result in an increase in right-of-use assets and related liabilities on the Company’s consolidated balance sheets. +In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The Company adopted ASU 2017-01 on the effective date of January 1, 2018, on a prospective basis. +In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”). ASU 2017-07 requires presentation of service cost in the same line item(s) as other compensation costs arising from services rendered by employees during the period, and presentation of the remaining components of net benefit cost in a separate line item, outside operating items. In addition, only the service cost component of net benefit cost is eligible for capitalization. The Company adopted ASU 2017-07 on the effective date of January 1, 2018, with retrospective application of the service cost component and the other components of net benefit cost in the consolidated statements of operations, and prospective application for the capitalization of the service cost component of net benefit costs in assets. While the adoption of ASU 2017-07 resulted in the Company reclassifying certain amounts from operating expenses to non-operating expenses, ASU 2017-07 did not result in a material impact to the Company’s consolidated financial statements or disclosures. +The accompanying statements of operations line items that were adjusted as a result of the adoption of ASU 2017-07 for the years ended December 31, 2017 , and 2016 are summarized as follows: +For the Year Ended +December 31, 2017 +For the Year Ended +December 31, 2016 +As Reported +As Adjusted +As Reported +As Adjusted +(in thousands) +Operating expenses: +Exploration +$ +56,179 +$ +54,713 +$ +65,641 +$ +64,970 +General and administrative +$ +120,585 +$ +117,283 +$ +126,428 +$ +124,828 +Total operating expenses +$ +1,297,865 +$ +1,293,097 +$ +2,276,765 +$ +2,274,494 +Income (loss) from operations +$ +(168,489 +) +$ +(163,721 +) +$ +(1,059,315 +) +$ +(1,057,044 +) +Other non-operating income (expense), net +$ +3,968 +$ +(800 +) +$ +362 +$ +(1,909 +) +In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”). ASU 2018-02 permits entities to reclassify tax effects stranded in accumulated other comprehensive income (loss) to retained earnings as a result of the 2017 Tax Act. The Company early adopted ASU 2018-02 effective January 1, 2018 using a retrospective method. As a result of adopting ASU 2018-02, the Company reclassified $3.0 million of tax effects stranded in accumulated other comprehensive loss to retained earnings as of January 1, 2018. The Company’s policy for releasing income tax effects within accumulated other comprehensive loss is an incremental, unit-of-account approach. +In August 2018, the FASB issued ASU No. 2018-14, Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans (“ASU 2018-14”). ASU +82 +2018-14 provides updated disclosure requirements related to retirement benefits and defined pension plans with the purpose of improving the effectiveness of disclosures with regard to such topics. The guidance is to be applied using a retrospective method and is effective for fiscal years ending after December 15, 2020, with early adoption permitted. The Company early adopted ASU 2018-14 on December 31, 2018, and it did not result in a material impact to the Company’s consolidated financial statements or disclosures. +In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company expects to adopt ASU 2018-15 on January 1, 2020, with prospective application. The Company is evaluating the impact of ASU 2018-15 on its consolidated financial statements. +There are no other ASUs applicable to the Company that would have a material effect on the Company’s consolidated financial statements and related disclosures that have been issued but not yet adopted by the Company as of December 31, 2018 , and through the filing of this report. +Note 2 - Revenue from Contracts with Customers +The Company recognizes its share of revenue from the sale of produced oil, gas, and NGLs in its Permian, South Texas & Gulf Coast, and Rocky Mountain regions. During the first quarter of 2018, the Company entered into two definitive agreements to sell all of its producing properties in its Rocky Mountain region. One transaction closed in the first quarter of 2018, and the second transaction closed in the second quarter of 2018. As a result of these divestitures, there has been no production revenue from the Rocky Mountain region after the second quarter of 2018. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional detail. Oil, gas, and NGL production revenue presented within the accompanying statements of operations is reflective of the revenue generated from contracts with customers. +The tables below present the disaggregation of oil, gas, and NGL production revenue by product type for each of the Company’s operating regions for the years ended December 31, 2018 , 2017 , and 2016 : +For the year ended December 31, 2018 +Permian +South Texas & Gulf Coast +Rocky Mountain +Total +(in thousands) +Oil, gas, and NGL production revenue: +Oil production revenue +$ +938,004 +$ +72,821 +$ +54,851 +$ +1,065,676 +Gas production revenue +125,603 +227,252 +1,595 +354,450 +NGL production revenue +1,000 +214,441 +790 +216,231 +Total +$ +1,064,607 +$ +514,514 +$ +57,236 +$ +1,636,357 +Relative percentage +65 +% +32 +% +3 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +For the year ended December 31, 2017 +Permian +South Texas & Gulf Coast +Rocky Mountain +Total +(in thousands) +Oil, gas, and NGL production revenue: +Oil production revenue +$ +419,732 +$ +82,674 +$ +151,844 +$ +654,250 +Gas production revenue +61,781 +301,780 +5,849 +369,410 +NGL production revenue +547 +226,031 +3,545 +230,123 +Total +$ +482,060 +$ +610,485 +$ +161,238 +$ +1,253,783 +Relative percentage +38 +% +49 +% +13 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +83 +For the year ended December 31, 2016 +Permian +South Texas & Gulf Coast +Rocky Mountain +Total +(in thousands) +Oil, gas, and NGL production revenue: +Oil production revenue +$ +117,399 +$ +189,313 +$ +305,126 +$ +611,838 +Gas production revenue +17,315 +308,829 +11,144 +337,288 +NGL production revenue +92 +225,821 +3,387 +229,300 +Total +$ +134,806 +$ +723,963 +$ +319,657 +$ +1,178,426 +Relative percentage +11 +% +62 +% +27 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +The Company recognizes oil, gas, and NGL production revenue at the point in time when control of the product transfers to the customer, which differs depending on the contractual terms of each of the Company’s arrangements. Transfer of control drives the presentation of transportation, gathering, processing, and other post-production expenses (“fees and other deductions”) within the accompanying statements of operations. Fees and other deductions incurred prior to control transfer are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations, while fees and other deductions incurred subsequent to control transfer are recorded as a reduction of oil, gas, and NGL production revenue. The Company has four categories under which oil, gas, and NGL production revenue is generated. Each of the Company’s operating regions generate production revenue from a combination of some or all of the four different contract types summarized below: +1) +The Company sells oil production at or near the wellhead and receives an agreed-upon index price from the purchaser, net of basis, quality, and transportation differentials. Under this arrangement, control transfers at or near the wellhead. +2) +The Company sells unprocessed gas to a midstream processor at the wellhead or inlet of the midstream processing facility. The midstream processor gathers and processes the raw gas stream and remits proceeds to the Company from the ultimate sale of the processed NGLs and residue gas to third parties. In such arrangements, the midstream processor obtains control of the product at the wellhead or inlet of the facility and is considered the customer. Proceeds received for unprocessed gas under these arrangements are reflected as gas production revenue and are recorded net of transportation and processing fees incurred by the midstream processor after control has transferred. +3) +The Company has certain processing arrangements that include the delivery of unprocessed gas to the inlet of a midstream processor’s facility for processing. Upon completion of processing, the midstream processor purchases the NGLs and redelivers residue gas back to the Company in-kind. For the NGLs extracted during processing, the midstream processor remits payment to the Company based on the proceeds it generates from selling the NGLs to other third parties. For the residue gas taken in-kind, the Company has separate sales contracts where control transfers at points downstream of the processing facility. Given the structure of these arrangements and where control transfers, the Company separately recognizes gathering, transportation, and processing fees incurred prior to control transfer. These fees are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. +4) +The Company has certain midstream processing arrangements where unprocessed gas is delivered to the inlet of the midstream processor’s facility for processing. Upon completion of processing, the midstream processor purchases the processed NGLs and residue gas and remits the proceeds to the Company from the sale of the products to third-party customers. In these arrangements, control transfers at the tailgate of the midstream processing facility for both products. Given the structure of these arrangements and where control transfers, the Company separately recognizes gathering, transportation, and processing fees incurred prior to control transfer. These fees are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. +Significant judgments made in applying the guidance in ASC Topic 606, Revenue from Contracts with Customers relate to the point in time when control transfers to customers in gas processing arrangements with midstream processors. The Company does not believe that significant judgments are required with respect to the determination of the transaction price, including amounts that represent variable consideration, as volume and price carry a low level of estimation uncertainty given the precision of volumetric measurements and the use of index pricing with predictable differentials. Accordingly, the Company does not consider estimates of variable consideration to be constrained. +The Company’s contractual performance obligations arise upon the production of hydrocarbons from wells in which the Company has an ownership interest. The performance obligations are considered satisfied upon control transferring to a customer at the wellhead, inlet, or tailgate of the midstream processor’s processing facility, or other contractually specified delivery point. The time period between production and satisfaction of performance obligations is generally less than one day; thus, there are no material unsatisfied or partially unsatisfied performance obligations at the end of the reporting period. +84 +Revenue is recorded in the month when contractual performance obligations are satisfied. However, settlement statements from the purchasers of hydrocarbons and the related cash consideration are received 30 to 90 days after production has occurred. As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the product. Estimated revenue due to the Company is recorded within accounts receivable on the accompanying balance sheets until payment is received. The accounts receivable balances from contracts with customers within the accompanying balance sheets as of December 31, 2018 and December 31, 2017 , were $107.2 million and $96.6 million , respectively. To estimate accounts receivable from contracts with customers, the Company uses knowledge of its properties, historical performance, contractual arrangements, index pricing, quality and transportation differentials, and other factors as the basis for these estimates. Differences between estimates and actual amounts received for product sales are recorded in the month that payment is received from the purchaser. Revenue recognized for the year ended December 31, 2018 , that related to performance obligations satisfied in prior reporting periods, was immaterial. +Note 3 – Divestitures, Assets Held for Sale, and Acquisitions +2018 Divestiture Activity +PRB Divestiture. On March 26, 2018 , the Company divested approximately 112,000 net acres of its Powder River Basin assets for net divestiture proceeds of $492.2 million , and recorded a final net gain of $410.6 million for the year ended December 31, 2018 . These assets were recorded as properties held for sale as of December 31, 2017. +Divide County Divestiture and Halff East Divestiture. During the second quarter of 2018, the Company completed the Divide County Divestiture and the Halff East Divestiture, for combined net divestiture proceeds of $252.2 million , and recorded a combined final net gain of $15.4 million for the year ended December 31, 2018 . A portion of these assets were recorded as properties held for sale as of December 31, 2017. +The following table presents loss before income taxes from the Divide County, North Dakota assets sold for the years ended December 31, 2018 , 2017 , and 2016 . The Divide County Divestiture was considered a disposal of a significant asset group. +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Loss before income taxes (1) +$ +(28,975 +) +$ +(468,786 +) +$ +(50,034 +) +____________________________________________ +(1) +Loss before income taxes reflects oil, gas, and NGL production revenue, less oil, gas, and NGL production expense, depletion, depreciation, amortization, and asset retirement obligation liability accretion expense, impairment expense, and net loss on divestiture activity. During the year ended December 31, 2017 , the Company recorded a write-down of $523.6 million on these assets previously held for sale. +2017 Divestiture Activity +Eagle Ford Divestiture. On March 10, 2017, the Company divested its outside-operated Eagle Ford shale assets, including its ownership interest in related midstream assets, for final net divestiture proceeds of $744.1 million . The Company recorded a final net gain of $396.8 million related to these divested assets for the year ended December 31, 2017. +The following table presents income (loss) before income taxes from the outside-operated Eagle Ford shale assets sold for the years ended December 31, 2018 , 2017 , and 2016 . This divestiture was considered a disposal of a significant asset group. +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Income (loss) before income taxes (1) +$ +— +$ +24,324 +$ +(218,506 +) +____________________________________________ +(1) +Income (loss) before income taxes reflects oil, gas, and NGL production revenue, less oil, gas, and NGL production expense, and depletion, depreciation, amortization, and asset retirement obligation liability accretion. Additionally, income (loss) before income taxes includes $269.6 million of impairment of proved properties expense for the year ended December 31, 2016 . +Rocky Mountain and Permian Divestitures. During 2017, the Company divested certain non-core properties in its Rocky Mountain and Permian regions for net divestiture proceeds of $36.2 million and recognized an insignificant final net gain. +85 +2016 Divestiture Activity +Rocky Mountain Divestitures. During the third quarter of 2016, the Company divested certain non-core properties in the Williston Basin and Powder River Basin in two separate transactions for combined net divestiture proceeds of $110.3 million and a final net gain of $16.4 million . +During the fourth quarter of 2016, the Company divested certain Williston Basin assets located outside of Divide County, North Dakota (referred to as “Raven/Bear Den” throughout this report) for net divestiture proceeds of $755.7 million and a final net gain of $29.5 million . In conjunction with this divestiture, the Company closed its Billings, Montana regional office. +Permian Divestiture. During the third quarter of 2016, the Company divested its non-core properties in southeast New Mexico for net divestiture proceeds of $54.7 million and recorded a final net loss of $10.0 million . +The Company finalized these divestitures in 2017. +The Company determined that neither planned nor executed asset sales in 2018 , 2017 , and 2016 qualify for discontinued operations accounting under financial statement presentation authoritative guidance. +Properties Held for Sale +Assets are classified as held for sale when the Company commits to a plan to sell the assets and it is probable the sale will take place within one year. Upon classification as held for sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to identify and expense any excess of carrying value over fair value less estimated costs to sell. When assets no longer meet the criteria of assets held for sale, they are measured at the lower of the carrying value of the assets before being classified as held for sale, adjusted for any depletion, depreciation, and amortization expense that would have been recognized, or the fair value at the date they are reclassified to assets held for use. Any gain or loss recognized on assets held for sale or on assets held for sale that are subsequently reclassified to assets held for use is reflected in the net gain (loss) on divestiture activity line item on the accompanying statements of operations. +As of December 31, 2018 , and 2017 , there were $5.3 million and $111.7 million , respectively, of assets held for sale presented on the accompanying balance sheets. The balance as of December 31, 2017, consisted primarily of approximately 112,000 net acres in the Powder River Basin, and is presented net of accumulated depletion, depreciation, and amortization expense. As discussed above, the Company sold these assets in the first quarter of 2018. +2018 Acquisition Activity +During the year ended December 31, 2018 , the Company acquired approximately 1,030 net acres of primarily unproved properties located in Martin and Howard Counties, Texas, in two separate transactions which closed in 2018. Combined total cash consideration paid by the Company was $33.3 million . Under authoritative accounting guidance, these transactions were both individually considered to be asset acquisitions. Therefore, the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and the transaction costs were capitalized as a component of the cost of the assets acquired. +During the third quarter of 2018, the Company completed two non-monetary acreage trades of primarily unproved properties, located in Howard and Martin Counties, Texas, resulting in the Company exchanging approximately 2,650 net acres, with $95.1 million of carrying value attributed to the properties surrendered by the Company. These trades were recorded at carryover basis with no gain or loss recognized. +Subsequent to December 31, 2018 , the Company completed several non-monetary acreage trades of primarily unproved properties, located in Howard, Martin, and Upton Counties, Texas, resulting in the Company receiving approximately 1,580 net acres in exchange for approximately 1,650 net acres. +2017 Acquisition Activity +During the year ended December 31, 2017 , the Company acquired approximately 3,600 net acres of primarily unproved properties in Howard and Martin Counties, Texas, in multiple transactions for a total of $76.5 million of cash consideration. Under authoritative accounting guidance, these transactions were considered asset acquisitions and the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and transaction costs were capitalized as a component of the cost of the assets acquired. +Also, during the year ended December 31, 2017 , the Company completed several non-monetary acreage trades of primarily unproved properties in Howard and Martin Counties, Texas, resulting in the Company acquiring approximately 8,125 net acres in +86 +exchange for approximately 7,580 net acres with $294.0 million of carrying value attributed to the properties surrendered by the Company in such trades. These trades were recorded at carryover basis with no gain or loss recognized. +2016 Acquisition Activity +Rock Oil Acquisition. During the fourth quarter of 2016, the Company acquired all membership interests of JPM EOC Opal, LLC, which owned proved and unproved properties in the Midland Basin, from Rock Oil Holdings, LLC (referred to as the “Rock Oil Acquisition”). The Company finalized the Rock Oil Acquisition during 2017 by paying $7.7 million of cash consideration in addition to the initial adjusted purchase price of $991.0 million , resulting in total consideration of $998.7 million paid after final closing adjustments. The Company funded the acquisition with proceeds from divestitures in 2016, the Senior Convertible Notes and equity offerings in August 2016, and the 2026 Senior Notes offering in September 2016, as discussed in Note 5 – Long-Term Debt and Note 13 – Equity , respectively. +The Company determined that the Rock Oil Acquisition met the criteria of a business combination under ASC Topic 805, Business Combinations . The Company allocated the final adjusted purchase price to the acquired assets and liabilities based on fair value as of the acquisition date, as summarized in the table below. This measurement resulted in no goodwill or bargain purchase gain being recognized. The acquisition costs were insignificant and were expensed as incurred. +As of October 4, 2016 +(in thousands) +Cash consideration +$ +998,691 +Fair value of assets and liabilities acquired: +Wells in progress +$ +5,672 +Proved oil and gas properties +82,584 +Unproved oil and gas properties +913,819 +Other assets +5,338 +Total fair value of oil and gas properties acquired +1,007,413 +Working capital +(1,127 +) +Asset retirement obligations +(7,595 +) +Total fair value of net assets acquired +$ +998,691 +QStar Acquisition. During the fourth quarter of 2016, the Company acquired additional proved and unproved properties in the Midland Basin from QStar LLC and RRP-QStar, LLC (referred to as the “QStar Acquisition”). The Company finalized the QStar Acquisition during the third quarter of 2017 by paying $7.3 million of cash consideration in addition to the initial consideration of $1.2 billion in cash consideration and the issuance of approximately 13.4 million shares of the Company’s common stock, resulting in total consideration of approximately $1.6 billion paid after final closing adjustments. The Company funded the acquisition with proceeds from the 2016 divestitures and the December 2016 equity offering. Please refer to Note 13 – Equity for additional discussion. +87 +Under authoritative accounting guidance, the transaction was considered an asset acquisition, and therefore, the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and transaction costs were capitalized as a component of the cost of the assets acquired. The Company allocated the final adjusted purchase price to the acquired assets and liabilities, as summarized in the table below. +As of December 21, 2016 +(in thousands) +Cash consideration, including acquisition costs paid +$ +1,174,628 +Fair value of equity consideration (1) +437,194 +Total consideration +$ +1,611,822 +Assets and liabilities acquired: +Wells in progress +$ +21,812 +Proved oil and gas properties +61,239 +Unproved oil and gas properties +1,538,264 +Total oil and gas properties acquired +1,621,315 +Working capital +(1,852 +) +Asset retirement obligations +(7,641 +) +Total net assets acquired +$ +1,611,822 +____________________________________________ +(1) +The Company issued approximately 13.4 million shares of common stock, par value $0.01 per share, in a private placement to the sellers in the QStar Acquisition on December 21, 2016. The equity consideration was valued on this date using Level 1 and Level 2 inputs with a discount applied due to the lack of marketability in the near term in accordance with the Lock-Up and Registration Rights Agreement that prohibited the sale of such stock until no earlier than the 90th day after issuance. +Note 4 – Income Taxes +The provision for income taxes consists of the following: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Current portion of income tax expense (benefit) +Federal +$ +— +$ +5,698 +$ +2,932 +State +1,662 +3,398 +1,539 +Deferred portion of income tax expense (benefit) +141,708 +(192,066 +) +(448,643 +) +Total income tax expense (benefit) +$ +143,370 +$ +(182,970 +) +$ +(444,172 +) +Effective tax rate +22.0 +% +53.2 +% +37.0 +% +88 +The components of the net deferred tax liabilities are as follows: +As of December 31, +2018 +2017 +(in thousands) +Deferred tax liabilities +Oil and gas properties +$ +218,094 +$ +142,467 +Derivative assets +35,247 +— +Other +4,812 +3,412 +Total deferred tax liabilities +258,153 +145,879 +Deferred tax assets +Derivative liabilities +— +29,463 +Credit carryover +22,554 +22,537 +Pension +6,427 +7,986 +Federal and state tax net operating loss carryovers +4,217 +3,867 +Stock compensation +3,263 +3,545 +Other liabilities +1,497 +1,470 +Total deferred tax assets +37,958 +68,868 +Valuation allowance +(3,083 +) +(2,978 +) +Net deferred tax assets +34,875 +65,890 +Total net deferred tax liabilities +$ +223,278 +$ +79,989 +Current federal income tax refundable +$ +59 +$ +37 +Current state income tax payable +$ +1,331 +$ +3,009 +The enactment of the 2017 Tax Act on December 22, 2017 reduced the Company’s federal tax rate for 2018 and future years from 35 percent to 21 percent . With the conclusion of the one-year measurement period and considering subsequent guidance, the Company believes it has properly analyzed the tax accounting impacts of the 2017 Tax Act, including the $1.0 million limitation on the compensation of certain covered individuals, which impacts the Company’s tax rate. There are no new estimates or finalized income tax items associated with the 2017 Tax Act included in income tax (expense) benefit for the year ended December 31, 2018 . +As of December 31, 2018 , the Company estimated its federal net operating loss (“NOL”) carryforward at $2.3 million , which reflects the planning strategies to utilize NOLs for the 2017 and 2016 tax years. In 2017, the Company re-evaluated various factors affecting deferred tax assets related to net operating losses and tax credits and determined utilization would be appropriate. The change in the current quarter portion of income tax (expense) benefit between periods reflects the effect of this determination. The Company expects to receive the 2018 federal current portion of income tax expense as a credit against tax in a future period. See the credit discussion below. +After the adoption of ASU 2016-09 in 2017, the Company no longer records a deferred tax amount for unrecognized excess income tax benefits associated with employee share-based payment awards. A cumulative effect adjustment was recorded to the beginning deferred income tax balance and retained earnings as of January 1, 2017. Please refer to Note 1 – Summary of Significant Accounting Policies above for additional information regarding the adoption of ASU 2016-09. +The Company has federal research and development (“R&D”) and AMT credit carryforwards of $7.4 million and $15.6 million , respectively. The federal R&D credit carryforwards expire between 2028 and 2034. The Company’s AMT credit carryforwards do not expire and are expected to be fully refunded by 2022. State NOL carryforwards were $79.7 million and state tax credits were $212,000 as of December 31, 2018 . Federal and state NOLs and state credits expire between 2019 and 2038. The Company’s current valuation allowance relates to state NOL carryforwards and state tax credits, which are expected to expire before they can be utilized. The change in the valuation allowance from 2017 to 2018 primarily relates to an allocable change to the Company’s mix of state apportioned losses and anticipated utilization of state cumulative NOLs. +89 +Federal income tax expense (benefit) differs from the amount that would be provided by applying the statutory United States federal income tax rate to income before income taxes primarily due to the effect of state income taxes, excess tax benefits and deficiencies from share-based payment awards, changes in valuation allowances, R&D credits, and accumulated impacts of other smaller permanent differences, and is reported as follows: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Federal statutory tax expense (benefit) +$ +136,873 +$ +(120,335 +) +$ +(420,671 +) +Increase (decrease) in tax resulting from: +Federal tax reform changes - 2017 Tax Act +— +(63,675 +) +— +State tax expense (benefit) (net of federal benefit) +2,771 +(3,286 +) +(17,549 +) +Change in valuation allowance +105 +(2,727 +) +(5,059 +) +Employee share-based compensation +2,508 +8,190 +— +Other +1,113 +(1,137 +) +(893 +) +Income tax expense (benefit) +$ +143,370 +$ +(182,970 +) +$ +(444,172 +) +Acquisitions, divestitures, drilling activity, and basis differentials, which impact the prices received for oil, gas, and NGLs, impact the apportionment of taxable income to the states where the Company owns oil and gas properties. As these factors change, the Company’s state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax expense (benefit) reported in the current year. Items affecting state apportionment factors are evaluated upon completion of the prior year income tax return, after significant acquisitions and divestitures, if there are significant changes in drilling activity, or if estimated state revenue changes occur during the year. As a result of the 2018 divestitures, the Company’s state apportionment rate reflects its significant Texas presence. +The Company and its subsidiaries file federal income tax returns and various state income tax returns. The Company is generally no longer subject to United States federal or state income tax examinations by tax authorities for years before 2015. During the third quarter of 2018, the IRS finalized its examination of the net operating loss (“NOL”) claims back to tax years 2003 through 2005 with no changes to claimed amounts. The Company received $5.9 million and $5.5 million of cash refunds in 2018 and 2017, respectively, for NOL carryback claims. During 2016, the Company’s 2007 - 2011 IRS examination was finalized, with no material adjustments to previously recorded amounts. +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. Interest expense in the accompanying statements of operations includes a negligible amount associated with income taxes. The Company does not expect a significant change to the recorded unrecognized tax benefits in 2019 . +The total amount recorded for unrecognized tax benefits is presented below: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Beginning balance +$ +446 +$ +446 +$ +2,782 +Additions for tax positions of prior years +— +— +9 +Settlements +— +— +(2,345 +) +Ending balance +$ +446 +$ +446 +$ +446 +90 +Note 5 – Long-Term Debt +Credit Agreement +On September 28, 2018 , the Company and its lenders entered into the Sixth Amended and Restated Credit Agreement. The Credit Agreement, which replaced the Company’s Fifth Amended and Restated Credit Agreement, provides for a senior secured revolving credit facility with a maximum loan amount of $2.5 billion , an initial borrowing base of $1.5 billion , and initial aggregate lender commitments totaling $1.0 billion . The borrowing base is subject to regular, semi-annual redetermination, and considers the value of both the Company’s (a) proved oil and gas properties reflected in the Company’s most recent reserve report; and (b) commodity derivative contracts, each as determined by the Company’s lender group. The Company does not expect a material change to the borrowing base or the aggregate lender commitments during the next scheduled redetermination on April 1, 2019 . +The Credit Agreement is scheduled to mature on the earlier of September 28, 2023 , (the “Scheduled Maturity Date”), and August 16, 2022, to the extent that, on or before such date, the Company’s outstanding 2022 Senior Notes are not repurchased, redeemed, or refinanced to have a maturity date at least 91 days after the Scheduled Maturity Date unless, on August 16, 2022, both (i) the aggregate outstanding principal amount of the 2022 Senior Notes is not more than $100.0 million and (ii) after giving pro forma effect to the repayment in full at maturity of the 2022 Senior Notes then outstanding, the aggregate amount of unrestricted cash and certain types of unrestricted investments held by the Company and its Consolidated Restricted Subsidiaries plus the amount of unused availability under the Credit Agreement is at least $300.0 million . +The Company must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring the Company to maintain certain financial ratios, as defined by the Credit Agreement. The financial covenants under the Credit Agreement require that the Company’s (a) total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX ratio for the most recently ended four consecutive fiscal quarters (excluding the first three quarters which will use annualized adjusted EBITDAX), cannot be greater than 4.25 to 1.00 beginning with the quarter ending December 31, 2018, through and including the fiscal quarter ending December 31, 2019, and for each quarter ending thereafter, the ratio cannot be greater than 4.00 to 1.00; and (b) adjusted current ratio cannot be less than 1.0 to 1.0 as of the last day of any fiscal quarter. The Company was in compliance with all financial and non-financial covenants as of December 31, 2018 , and through the filing of this report. +Interest and commitment fees are accrued based on a borrowing base utilization grid set forth in the Credit Agreement. Eurodollar loans accrue interest at the London Interbank Offered Rate, plus the applicable margin from the utilization grid, and Alternate Base Rate (“ABR”) or Swingline Loans accrue interest at a market based floating rate, plus the applicable margin from the utilization grid. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount at rates from the utilization grid and are included in the interest expense line item on the accompanying statements of operations. The borrowing base utilization grid as set forth in the Credit Agreement is as follows: +Borrowing Base Utilization Percentage +<25% +≥25% <50% +≥50% <75% +≥75% <90% +≥90% +Eurodollar Loans +1.500 +% +1.750 +% +2.000 +% +2.250 +% +2.500 +% +ABR Loans or Swingline Loans +0.500 +% +0.750 +% +1.000 +% +1.250 +% +1.500 +% +Commitment Fee Rate +0.375 +% +0.375 +% +0.500 +% +0.500 +% +0.500 +% +The following table presents the outstanding balance, total amount of letters of credit outstanding, and available borrowing capacity under the Credit Agreement as of February 7, 2019 , and December 31, 2018 , and under the Company’s Fifth Amended and Restated Credit Agreement as of December 31, 2017 : +As of February 7, 2019 +As of December 31, 2018 +As of December 31, 2017 +(in thousands) +Credit facility balance (1) +$ +— +$ +— +$ +— +Letters of credit (2) +— +200 +200 +Available borrowing capacity +1,000,000 +999,800 +924,800 +Total aggregate lender commitment amount +$ +1,000,000 +$ +1,000,000 +$ +925,000 +____________________________________________ +(1) +Unamortized deferred financing costs attributable to the credit facility are presented as a component of other noncurrent assets on the accompanying balance sheets and totaled $6.4 million and $3.1 million as of December 31, 2018 , and 2017 , respectively. These costs are being amortized over the term of the credit facility on a straight-line basis. +(2) +Letters of credit outstanding reduce the amount available under the credit facility on a dollar-for-dollar basis. The letter of credit outstanding as of December 31, 2018 , was released effective January 8, 2019. +91 +Senior Notes +During the third quarter of 2018, the Company redeemed its 2021 Senior Notes, repurchased or redeemed all of its 2023 Senior Notes, repurchased a portion of its 2022 Senior Notes, and issued its 2027 Senior Notes. As of December 31, 2018 , the Company’s Senior Notes consisted of 6.125% Senior Notes due 2022, 5.0% Senior Notes due 2024 (“2024 Senior Notes”), 5.625% Senior Notes due 2025 (“2025 Senior Notes”), 6.75% Senior Notes due 2026 (“2026 Senior Notes”), and 6.625% Senior Notes due 2027 (collectively referred to as “Senior Notes”). Please refer to the discussion below for additional information. The Senior Notes, net of unamortized deferred financing costs line on the accompanying balance sheets as of December 31, 2018 , and 2017 , consisted of the following: +As of December 31, +2018 +2017 +Principal Amount +Unamortized Deferred Financing Costs +Principal Amount, Net of Unamortized Deferred Financing Costs +Principal Amount +Unamortized Deferred Financing Costs +Principal Amount, Net of Unamortized Deferred Financing Costs +(in thousands) +6.50% Senior Notes due 2021 +$ +— +$ +— +$ +— +$ +344,611 +$ +2,656 +$ +341,955 +6.125% Senior Notes due 2022 +476,796 +3,921 +472,875 +561,796 +5,800 +555,996 +6.50% Senior Notes due 2023 +— +— +— +394,985 +3,707 +391,278 +5.0% Senior Notes due 2024 +500,000 +4,688 +495,312 +500,000 +5,610 +494,390 +5.625% Senior Notes due 2025 +500,000 +5,808 +494,192 +500,000 +6,714 +493,286 +6.75% Senior Notes due 2026 +500,000 +6,407 +493,593 +500,000 +7,242 +492,758 +6.625% Senior Notes due 2027 +500,000 +7,533 +492,467 +— +— +— +Total +$ +2,476,796 +$ +28,357 +$ +2,448,439 +$ +2,801,392 +$ +31,729 +$ +2,769,663 +The Senior Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. There are no subsidiary guarantors of the Senior Notes. The Company is subject to certain covenants under the indentures governing the Senior Notes that limit the Company’s ability to incur additional indebtedness, issue preferred stock, and make restricted payments, including dividends. The Company was in compliance with all such covenants under its Senior Notes as of December 31, 2018 , and through the filing of this report. All Senior Notes are registered under the Securities Act. The Company may redeem some or all of its Senior Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest as described in the indentures governing the Senior Notes. +During the third quarter of 2018, the Company used the proceeds from the issuance of its 2027 Senior Notes, as discussed below, and cash on hand to retire $395.0 million of its 2023 Senior Notes and $85.0 million of its 2022 Senior Notes through the Tender Offer and subsequent redemption of the remaining 2023 Senior Notes not repurchased as part of the Tender Offer (“2023 Senior Notes Redemption”). Total consideration paid, including accrued interest, for the retirement of the 2023 Senior Notes and the 2022 Senior Notes was $497.8 million . As a result of the Tender Offer and the 2023 Senior Notes Redemption, the Company recorded a loss on extinguishment of debt of $16.9 million for the year ended December 31, 2018 . This amount included $12.9 million of premiums paid for the Tender Offer and 2023 Senior Notes Redemption and $4.0 million of accelerated unamortized deferred financing costs. +During the first quarter of 2016, the Company repurchased in open market transactions a total of $46.3 million in aggregate principal amount of certain of its 6.50% Senior Notes due 2021, 6.125% Senior Notes due 2022, and 6.50% Senior Notes due 2023 for a settlement amount of $29.9 million , excluding interest, which resulted in a net gain on extinguishment of debt of approximately $15.7 million . This amount includes a gain of $16.4 million associated with the discount realized upon repurchase, which was partially offset by approximately $700,000 related to the acceleration of unamortized deferred financing costs. +2021 Senior Notes. On June 15, 2018 , the Company called for redemption all of the $344.6 million principal outstanding on its 2021 Senior Notes at a redemption price of 102.167% of the principal amount, plus accrued and unpaid interest on the principal amount of the 2021 Senior Notes redeemed (“2021 Senior Notes Redemption”). On July 16, 2018, the Company completed the 2021 Senior Notes Redemption, which resulted in the payment of total cash consideration, including accrued interest, of $355.9 million . The Company recorded a loss on extinguishment of debt of $9.8 million for the year ended December 31, 2018. This amount included $7.5 million associated with the premium paid for the 2021 Senior Notes Redemption and $2.3 million of accelerated unamortized deferred financing costs. +92 +2022 Senior Notes. On November 17, 2014 , the Company issued $600.0 million in aggregate principal amount of 6.125% Senior Notes due 2022 at par, which mature on November 15, 2022 . The Company received net proceeds of $590.0 million after deducting fees of $10.0 million , which are being amortized as deferred financing costs over the life of the 2022 Notes. During the first quarter of 2016, the Company repurchased $38.2 million in aggregate principal amount of its 2022 Notes for a settlement amount of $24.3 million , excluding interest. During the third quarter of 2018, through the Tender Offer discussed above, the Company retired $85.0 million of its 2022 Senior Notes for total consideration, including accrued interest, of $89.5 million . +2023 Senior Notes. During the first quarter of 2016, the Company repurchased $5.0 million in aggregate principal amount of its 2023 Notes for a settlement amount of $3.3 million . During the third quarter of 2018, through the Tender Offer and 2023 Senior Notes Redemption discussed above, the Company redeemed the remaining outstanding $395.0 million in aggregate principal amount of its 2023 Senior Notes for total consideration, including accrued interest, of $408.3 million . +2024 Senior Notes. On May 20, 2013 , the Company issued $500.0 million in aggregate principal amount of 5.0% Senior Notes due 2024 at par, which mature on January 15, 2024 . The Company received net proceeds of $490.2 million after deducting fees of $9.8 million , which are being amortized as deferred financing costs over the life of the 2024 Notes. +2025 Senior Notes. On May 21, 2015 , the Company issued $500.0 million in aggregate principal amount of 5.625% Senior Notes due 2025 at par, which mature on June 1, 2025 . The Company received net proceeds of $491.0 million after deducting fees of $9.0 million , which are being amortized as deferred financing costs over the life of the 2025 Notes. +2026 Senior Notes. On September 12, 2016 , the Company issued $500.0 million in aggregate principal amount of 6.75% Senior Notes due 2026 , at par, which mature on September 15, 2026 . The Company received net proceeds of $491.6 million after deducting fees of $8.4 million , which are being amortized as deferred financing costs over the life of the 2026 Notes. The net proceeds were used to partially fund the Rock Oil Acquisition that closed during the fourth quarter of 2016. +2027 Senior Notes. On August 20, 2018 , the Company issued $500.0 million in aggregate principal amount of 6.625% Senior Notes due 2027. The 2027 Senior Notes were issued at par and mature on January 15, 2027 . The Company received net proceeds of $492.1 million after deducting fees of $7.9 million , which are being amortized as deferred financing costs over the life of the 2027 Senior Notes. The net proceeds were used to fund the Tender Offer and 2023 Senior Notes Redemption discussed above. +Senior Convertible Notes +On August 12, 2016 , the Company issued $172.5 million in aggregate principal amount of 1.50% Senior Convertible Notes due July 1, 2021 , unless earlier converted. The Senior Convertible Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. The Company received net proceeds of $166.6 million after deducting fees of $5.9 million , of which a portion is being amortized over the life of the Senior Convertible Notes. +Holders may convert their Senior Convertible Notes at their option at any time prior to January 1, 2021, only under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter) commencing after the calendar quarter ending on September 30, 2016, if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price (as defined in the indenture) per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after January 1, 2021, until the maturity date, holders may convert their Senior Convertible Notes at any time. The Company may not redeem the Senior Convertible Notes prior to the maturity date. Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. Holders may convert their notes based on a conversion rate of 24.6914 shares of the Company’s common stock per $1,000 principal amount of the Senior Convertible Notes, which is equal to an initial conversion price of approximately $40.50 per share, subject to adjustment. +The Company has initially elected a net-settlement method to satisfy its conversion obligation, which would result in the Company settling the principal amount in cash with any excess conversion in shares of the Company’s common stock. The Senior Convertible Notes were not convertible at the option of holders as of December 31, 2018 , or through the filing of this report. Notwithstanding the inability to convert, the if-converted value of the Senior Convertible Notes as of December 31, 2018 , did not exceed the principal amount. +Upon the issuance of the Senior Convertible Notes, the Company recorded $132.3 million as the initial carrying amount of the debt component, which approximated its fair value at issuance, and, was estimated by using an interest rate for nonconvertible debt with terms similar to the Senior Convertible Notes. The effective interest rate used was 7.25% . The $40.2 million excess of the principal amount of the Senior Convertible Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The Company incurred transaction costs of $5.9 million relating to the issuance of +93 +the Senior Convertible Notes, which were allocated between the debt and equity components in proportion to their determined fair value amounts. The debt discount and debt-related issuance costs are amortized to the principal value of the Senior Convertible Notes as interest expense through the maturity date of July 1, 2021 . Interest expense recognized on the Senior Convertible Notes related to the stated interest rate and amortization of the debt discount totaled $10.5 million , $9.9 million , and $3.7 million for the years ended December 31, 2018 , 2017 , and 2016, respectively. +The net carrying amount of the liability component of the Senior Convertible Notes, as reflected on the accompanying balance sheets, consisted of the following as of December 31, 2018 and 2017 : +As of December 31, +2018 +2017 +(in thousands) +Principal amount of Senior Convertible Notes +$ +172,500 +$ +172,500 +Unamortized debt discount +(22,313 +) +(30,183 +) +Unamortized deferred financing costs +(2,293 +) +(3,210 +) +Net carrying amount +$ +147,894 +$ +139,107 +The net carrying amount of the equity component of the Senior Convertible Notes recorded in additional paid-in capital on the accompanying balance sheets consisted of the following as of December 31, 2018 and 2017 : +As of December 31, +2018 +2017 +(in thousands) +Equity component due to allocation of proceeds to equity +$ +40,217 +$ +40,217 +Related issuance costs +(1,375 +) +(1,375 +) +Deferred tax liability +(5,267 +) +(5,267 +) +Net carrying amount +$ +33,575 +$ +33,575 +If the Company undergoes a fundamental change, as defined by the governing indenture, holders of the Senior Convertible Notes may require the Company to repurchase for cash all or any portion of their notes at a fundamental change repurchase price equal to 100% of the principal amount of the Senior Convertible Notes to be repurchased, plus accrued and unpaid interest. The indenture governing the Senior Convertible Notes contains customary events of default with respect to the Senior Convertible Notes, including that upon certain events of default, the trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding Senior Convertible Notes by notice to the Company, may declare 100% of the principal and accrued and unpaid interest, if any, due and payable immediately. In case of certain events of bankruptcy, insolvency or reorganization involving the Company or a significant subsidiary, 100% of the principal and accrued and unpaid interest on the Senior Convertible Notes will automatically become due and payable. +The Company is subject to certain covenants under the indenture governing the Senior Convertible Notes and was in compliance with all covenants as of December 31, 2018 , and through the filing of this report. +Capped Call Transactions +In connection with the issuance of the Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters of such issuance. The aggregate cost of the capped call transactions was approximately $24.2 million . The capped call transactions are generally expected to reduce the potential dilution upon conversion of the Senior Convertible Notes and/or partially offset any cash payments the Company is required to make in excess of the principal amount of converted Senior Convertible Notes in the event that the market price per share of the Company’s common stock is greater than the strike price of the capped call transactions, which initially corresponds to the approximate $40.50 per share conversion price of the Senior Convertible Notes. The cap price of the capped call transactions is initially $60.00 per share. If the market price per share exceeds the cap price of the capped call transactions, there could be dilution or there would not be an offset of such potential cash payments. +The Company evaluated the capped call transactions under authoritative accounting guidance and determined that they should be accounted for as separate transactions and classified as equity instruments with no recurring fair value measurement recorded. +Capitalized Interest +Capitalized interest costs for the Company for the years ended December 31, 2018 , 2017 , and 2016 , were $20.6 million , $12.6 million , and $17.0 million , respectively. +94 +Note 6 – Commitments and Contingencies +Commitments +The Company has entered into various agreements, which include drilling rig and completion service contracts of $86.9 million , gathering, processing, transportation throughput, and delivery commitments of $287.8 million , office leases, including maintenance, of $35.5 million , fixed price contracts to purchase electricity of $29.0 million , and other miscellaneous contracts and leases of $18.3 million . The annual minimum payments for the next five years and total minimum payments thereafter are presented below: +Years Ending December 31, +Amount +(in thousands) +2019 +$ +132,502 +2020 +103,169 +2021 +88,785 +2022 +70,741 +2023 +37,334 +Thereafter +24,931 +Total +$ +457,462 +Drilling Rig and Completion Service Contracts +The Company has several drilling rig and completion service contracts in place to facilitate drilling and completion plans. Early termination of these contracts as of December 31, 2018 , would have resulted in termination penalties of $45.9 million , which would be in lieu of paying the remaining commitments of $86.9 million included in the table above. For the year ended December 31, 2016 , the Company incurred $8.7 million of expenses related to the early termination of drilling rig contracts or fees incurred for rigs placed on standby, which are recorded in the other operating expenses line item in the accompanying statements of operations. No material expenses related to early termination or standby fees were recorded by the Company for the years ended December 31, 2018 , or 2017. +Pipeline Transportation Commitments +The Company has gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum amount of oil, gas, and produced water. As of December 31, 2018 , the Company has commitments to deliver a minimum of 29 MMBbl of oil, 595 Bcf of gas, and 21 MMBbl of produced water through 2027 . The Company will be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. As of December 31, 2018 , if the Company fails to deliver any product, as applicable, the aggregate undiscounted deficiency payments total approximately $287.8 million . This amount does not include deficiency payment estimates associated with approximately 18.6 MMBbl of future oil delivery commitments where we cannot predict with accuracy the amount and timing of these payments, as such payments are dependent upon the price of oil in effect at the time of settlement. Under certain of the Company’s commitments, if the Company is unable to deliver the minimum quantity from its production, it may deliver production acquired from third-parties to satisfy its minimum volume commitments. As of the filing of this report, the Company does not expect to incur any material shortfalls with regard to these commitments. +Drilling and Completion Commitments +In December 2018, the Company entered into an agreement that included minimum drilling and completion requirements for certain existing leases. If these minimum requirements are not satisfied by March 31, 2020, the Company would be required to pay penalties based on the difference between actual development progress and the minimum development requirements. The penalties could range from zero to a maximum of $60.0 million , with the maximum exposure assuming no development activity occurred prior to March 31, 2020. As of the filing of this report, the Company is committed to and expects to meet the minimum development requirements set forth in the agreement. +Office Leases +The Company leases office space under various operating leases with terms extending as far as 2026 . Rent expense, net of sublease income, for the years ended December 31, 2018 , 2017 , and 2016 , was $4.5 million , $4.8 million , and $5.2 million , respectively. During the third quarter of 2015, the Company closed its office in Tulsa, Oklahoma and has subleased the space through the expiration of the lease. In the fourth quarter of 2018, the Company paid $1.3 million to the lessor to terminate the lease effective September 2019. The Company closed its office in Billings, Montana in November 2016 and paid $3.2 million to the lessor to terminate the lease. These lease termination fees are not reflected in the rent expense amounts above. +95 +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the anticipated results of any pending litigation and claims are not expected to have a material effect on the results of operations, the financial position, or the cash flows of the Company. +Note 7 – Compensation Plans +Equity Incentive Compensation Plan +There are several components to the Company’s Equity Plan that are described in this section. Various types of equity awards have been granted by the Company in different periods. +As of December 31, 2018 , approximately 5.9 million shares of common stock were available for grant under the Equity Plan. The issuance of a direct share benefit, such as a share of common stock, a stock option, a restricted share, an RSU, or a PSU, counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. +Performance Share Units +The Company grants PSUs to eligible employees as part of its Equity Plan. The number of shares of the Company’s common stock issued to settle PSUs ranges from zero to two times the number of PSUs awarded and is determined based on certain performance criteria over a three -year performance period. PSUs generally vest on the third anniversary of the date of the grant. +The fair value of PSUs is measured at the grant date with a stochastic Monte Carlo simulation using geometric Brownian motion (“GBM Model”). A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for those iterations. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will take over the three -year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the path the stock price may take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +PSUs issued in 2017 and 2016, which the Company has determined to be equity awards, are subject to a combination of market and service vesting criteria. These awards are based on annualized Total Shareholder Return (“TSR”) for the performance period and the relative performance of the Company’s TSR compared with the annualized TSR of the Company’s peer group for the performance period. The fair value of these PSUs is measured at the grant date using the GBM Model. Compensation expense for these market-based PSUs is recognized on a straight-line basis within general and administrative expense and exploration expense over the vesting periods of the respective awards. +Beginning in 2018, PSUs awarded to employees include both a market criteria component and a performance criteria component. For the performance criteria component, the grant-date fair value is equal to the Company's stock price on the grant date, and compensation expense for the performance-based PSUs will be recorded over the vesting period of the award. The value being recorded will be evaluated on a quarterly basis and may be adjusted as the number of units expected to vest increases or decreases. For awards granted in 2018, the Company uses relative debt adjusted per share cash flow growth (“DACFG”) compared with the DACFG, as calculated by the Company, of its peer group as the performance criteria that is evaluated over the three-year performance period for these PSUs. +The Company records compensation expense associated with the issuance of PSUs based on the fair value of the awards as of the date of grant. Total compensation expense recorded for PSUs was $10.3 million , $9.7 million , and $11.0 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. As of December 31, 2018 , there was $19.0 million of total unrecognized expense related to PSUs, which is being amortized through 2021 . +96 +A summary of the status and activity of non-vested PSUs is presented in the following table: +For the Years Ended December 31, +2018 +2017 +2016 +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +Non-vested at beginning of year +1,533,491 +$ +22.97 +828,923 +$ +43.25 +626,328 +$ +61.81 +Granted +572,924 +$ +24.45 +977,731 +$ +15.86 +447,971 +$ +26.56 +Vested +(233,102 +) +$ +44.25 +(94,338 +) +$ +85.85 +(130,353 +) +$ +64.17 +Forfeited +(162,054 +) +$ +21.79 +(178,825 +) +$ +44.99 +(115,023 +) +$ +55.59 +Non-vested at end of year +1,711,259 +$ +20.68 +1,533,491 +$ +22.97 +828,923 +$ +43.25 +____________________________________________ +(1) +The number of awards assumes a multiplier of one . The final number of shares of common stock issued may vary depending on the three -year performance multiplier, which ranges from zero to two . +The fair value of the PSUs granted in 2018 , 2017 , and 2016 was $14.0 million , $15.5 million , and $11.9 million , respectively. The PSUs fully vest on the third anniversary of the date of the grant; however, employees who are retirement eligible at the time a PSU award was granted, vest in each portion of that award equally in six -month increments over a three -year period beginning at grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of a PSU award will be forfeited when the employee leaves the Company. +During the year ended December 31, 2018 , the Company granted 572,924 PSUs to eligible employees (“2018 PSU Grant”). As outlined in the award agreement for the 2018 PSU Grant, performance measurements affecting vesting are based on a combination of relative performance of the Company’s annualized TSR compared with the annualized TSR of the Company’s peer group over the three-year performance period, and relative performance of the Company’s DACFG compared with its peer group DACFG over the three-year performance period. In addition to these performance measures, the award agreement for the 2018 PSU Grant also stipulates that if the Company’s absolute TSR is negative over the three -year performance period, the maximum number of shares of common stock that can be issued to settle outstanding PSUs is capped at one times the number of PSUs granted on the award date, regardless of the Company’s TSR and DACFG performance relative to its peer group. +During the years ended December 31, 2018 and 2017, PSUs that were granted in 2015 and 2014, respectively did not satisfy the minimum performance requirements. This resulted in a multiplier of zero times and therefore no shares of common stock were issued upon settlement. A summary of the shares of common stock issued to settle PSUs for the year ended December 31, 2016 , is presented in the table below: +For the Year Ended December 31, 2016 +Shares of common stock issued to settle PSUs (1) +44,870 +Less: shares of common stock withheld for income and payroll taxes +(14,809 +) +Net shares of common stock issued +30,061 +Multiplier earned +0.2 +____________________________________________ +(1) +During the year ended December 31, 2016 , the Company issued shares of common stock to settle PSUs that related to awards granted in 2013. The Company and a majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of PSUs that vested during the years ended December 31, 2018 , 2017 , and 2016 was $10.3 million , $8.1 million , and $8.4 million , respectively. +Employee Restricted Stock Units +The Company grants RSUs to eligible persons as part of its long-term Equity Plan. Each RSU represents a right to receive one share of the Company’s common stock upon settlement of the award at the end of the specified vesting period. Compensation expense for RSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. +Total compensation expense recorded for employee RSUs for the years ended December 31, 2018 , 2017 , and 2016 , was $10.8 million , $10.3 million , and $11.9 million , respectively. As of December 31, 2018 , there was $20.0 million of total unrecognized +97 +compensation expense related to non-vested RSU awards, which is being amortized through 2021 . The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the date of grant. The fair value of an RSU is equal to the closing price of the Company’s common stock on the day of the grant. +A summary of the status and activity of non-vested RSUs granted to employees is presented in the following table: +For the Years Ended December 31, +2018 +2017 +2016 +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +Non-vested at beginning of year +1,244,262 +$ +20.25 +604,116 +$ +37.39 +543,737 +$ +55.01 +Granted +583,552 +$ +25.77 +1,020,780 +$ +16.64 +417,065 +$ +28.08 +Vested +(407,529 +) +$ +24.30 +(246,025 +) +$ +43.99 +(241,363 +) +$ +58.06 +Forfeited +(177,122 +) +$ +17.26 +(134,609 +) +$ +26.38 +(115,323 +) +$ +43.52 +Non-vested at end of year +1,243,163 +$ +21.50 +1,244,262 +$ +20.25 +604,116 +$ +37.39 +The fair value of RSUs granted to eligible employees in 2018 , 2017 , and 2016 was $15.0 million , $17.0 million , and $11.7 million , respectively. The RSUs granted generally vest one-third of the total grant on each anniversary of the grant dates, unless the employee is retirement eligible, in which case the RSUs generally vest in each portion of that award equally in six -month increments over a three -year period beginning at grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of an RSU award will be forfeited when the employee leaves the Company. +A summary of the shares of common stock issued to settle employee RSUs is presented in the table below: +For the Years Ended December 31, +2018 +2017 +2016 +Shares of common stock issued to settle RSUs (1) +407,529 +246,025 +241,363 +Less: shares of common stock withheld for income and payroll taxes +(115,784 +) +(74,747 +) +(72,181 +) +Net shares of common stock issued +291,745 +171,278 +169,182 +____________________________________________ +(1) +During the years ended December 31, 2018 , 2017 , and 2016 , the Company issued shares of common stock to settle RSUs that related to awards granted in previous years. The Company and a majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of employee RSUs that vested during the years ended December 31, 2018 , 2017 , and 2016 was $9.9 million , $10.8 million , and $14.0 million , respectively. +Director Shares +In 2018 , 2017 , and 2016 , the Company issued 63,741 , 71,573 , and 53,473 shares, respectively, of its common stock to its non-employee directors under the Equity Plan. In 2017, the Company issued 8,794 RSUs to a non-employee director. For the years ended December 31, 2018 , 2017 , and 2016 , the Company recorded $1.7 million , $1.6 million , and $2.0 million , respectively, of compensation expense related to director shares and RSUs issued. +All shares issued to non-employee directors fully vest on December 31 of the year granted. The RSUs issued to a non-employee director in 2017 fully vested on December 31, 2017, and will settle upon the earlier to occur of May 25, 2027, or the director resigning from the Board of Directors. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation, without accruing in excess of $25,000 in value from purchases for each calendar year. The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on either the first or last day of the purchase period. The ESPP is intended to qualify under Section 423 of the Internal Revenue Code (the “IRC”). The Company had approximately 1.6 million shares of its common stock available for issuance under the ESPP as of December 31, 2018 . There were 199,464 , 186,665 , and 218,135 shares issued under the ESPP in 2018 , 2017 , and 2016 , respectively. +98 +Total proceeds to the Company for the issuance of these shares were $3.2 million , $2.6 million , and $4.2 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +The fair value of ESPP grants is measured at the date of grant using the Black-Scholes option-pricing model. Expected volatility is calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six-month vesting period. +The fair value of ESPP shares issued during the periods reported were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2018 +2017 +2016 +Risk free interest rate +1.8 +% +0.9 +% +0.4 +% +Dividend yield +0.4 +% +0.5 +% +0.4 +% +Volatility factor of the expected market +price of the Company’s common stock +55.9 +% +62.5 +% +95.0 +% +Expected life (in years) +0.5 +0.5 +0.5 +The Company expensed $1.1 million , $1.0 million , and $2.0 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively, based on the estimated fair value of the ESPP grants. +401(k) Plan +The Company has a defined contribution plan (the “401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. For employees hired before December 31, 2014, the Company matches 100 percent of each employee’s contribution in cash on a dollar for dollar basis, up to six percent of the employee’s base salary and performance bonus, and may make additional contributions at its discretion. The Company matches 150 percent of contributions made by employees hired after December 31, 2014, up to six percent of the employee’s base salary and performance bonus in lieu of pension plan benefits, and may make additional contributions at its discretion. Please refer to Note 8 – Pension Benefits for additional discussion of pension benefits. The Company’s matching contributions to the 401(k) Plan were $4.9 million , $4.5 million , and $5.4 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +Net Profits Plan +Under the Company’s Net Profits Plan, all oil and gas wells that were completed or acquired during each year were designated within a specific pool with key employees designated as participants that became entitled to payments under the Net Profits Plan after the Company has received net cash flows returning 100 percent of all costs associated with that pool. Thereafter, 10 percent of future net cash flows generated by the pool are allocated among the participants and distributed at least annually. The portion of net cash flows from the pool to be allocated among the participants increases to 20 percent after the Company has recovered 200 percent of the total costs for the pool, including payments made under the Net Profits Plan at the 10 percent level. In December 2007, the Board of Directors discontinued the creation of new pools under the Net Profits Plan. As a result, the 2007 pool was the last Net Profits Plan pool established by the Company. +The following table presents cash payments made or accrued under the Net Profits Plan related to periodic operations, of which the majority is recorded as general and administrative expense, and cash payments made or accrued as a result of divestitures of properties subject to the Net Profits Plan, which are recorded as a reduction to the net gain (loss) on divestiture activity line item in the accompanying statements of operations. +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Cash payments made or accrued related to operations +$ +63 +$ +(54 +) +$ +6,608 +Cash payments made or accrued related to divestitures +— +2,753 +24,349 +Total net settlements +$ +63 +$ +2,699 +$ +30,957 +99 +Note 8 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering employees who meet age and service requirements and who began employment with the Company prior to January 1, 2016 (the “Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (the “Nonqualified Pension Plan” and together with the Qualified Pension Plan, the “Pension Plans”). The Company froze the Pension Plans to new participants, effective as of January 1, 2016. Employees participating in the Pension Plans prior to it being frozen will continue to earn benefits. +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status (i.e. the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment to other comprehensive income (loss), net of tax, in the accompanying statements of comprehensive income. The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation, but excludes the effects of assumed future salary increases. The Company’s measurement date for plan assets and obligations is December 31. +For the Years Ended December 31, +2018 +2017 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year +$ +71,937 +$ +69,659 +Service cost +6,730 +6,638 +Interest cost +2,622 +2,689 +Actuarial (gain) loss +(7,155 +) +3,708 +Benefits paid +(8,048 +) +(10,757 +) +Projected benefit obligation at end of year +66,086 +71,937 +Change in plan assets: +Fair value of plan assets at beginning of year +30,978 +31,731 +Actual return on plan assets +(964 +) +2,956 +Employer contribution +8,134 +7,048 +Benefits paid +(8,048 +) +(10,757 +) +Fair value of plan assets at end of year +30,100 +30,978 +Funded status at end of year +$ +(35,986 +) +$ +(40,959 +) +The Company’s underfunded status for the Pension Plans as of December 31, 2018 , and 2017 , was $36.0 million and $41.0 million , respectively, and is recognized in the accompanying balance sheets as a portion of other noncurrent liabilities. There are no plan assets in the Nonqualified Pension Plan. +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2018 +2017 +(in thousands) +Projected benefit obligation +$ +66,086 +$ +71,937 +Accumulated benefit obligation +$ +52,368 +$ +56,045 +Less: fair value of plan assets +(30,100 +) +(30,978 +) +Underfunded accumulated benefit obligation +$ +22,268 +$ +25,067 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is +100 +intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of the unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for the year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +The pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in accumulated other comprehensive loss as of December 31, 2018 , and 2017 , were as follows: +As of December 31, +2018 +2017 +(in thousands) +Unrecognized actuarial losses +$ +15,741 +$ +21,397 +Unrecognized prior service costs +48 +66 +Accumulated other comprehensive loss +$ +15,789 +$ +21,463 +The pension liability adjustments recognized in other comprehensive income (loss) during 2018 , 2017 , and 2016 , were as follows: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Net actuarial gain (loss) +$ +4,329 +$ +(2,995 +) +$ +(3,322 +) +Amortization of prior service cost +18 +17 +16 +Amortization of net actuarial loss +1,327 +1,297 +1,582 +Settlements +— +3,009 +— +Total pension liability adjustment, pre-tax +5,674 +1,328 +(1,724 +) +Tax (expense) benefit +(4,265 +) +(561 +) +570 +Cumulative effect of accounting change (1) +2,969 +— +— +Total pension liability adjustment, net +$ +4,378 +$ +767 +$ +(1,154 +) +_________________________________________ +(1) +Refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies and Statements of Stockholders’ Equity for additional information. +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Components of net periodic benefit cost: +Service cost +$ +6,730 +$ +6,638 +$ +8,200 +Interest cost +2,622 +2,689 +2,908 +Expected return on plan assets that reduces periodic pension benefit cost +(1,862 +) +(2,244 +) +(2,235 +) +Amortization of prior service cost +18 +17 +16 +Amortization of net actuarial loss +1,327 +1,297 +1,582 +Settlements +— +3,009 +— +Net periodic benefit cost +$ +8,835 +$ +11,406 +$ +10,471 +101 +Pension Plan Assumptions +The weighted-average assumptions used to measure the Company’s projected benefit obligation are as follows: +As of December 31, +2018 +2017 +Projected benefit obligation: +Discount rate +4.4% +3.8% +Rate of compensation increase +6.2% +6.2% +The weighted-average assumptions used to measure the Company’s net periodic benefit cost are as follows: +For the Years Ended December 31, +2018 +2017 +2016 +Net periodic benefit cost: +Discount rate +3.8% +4.2% +4.7% +Expected return on plan assets (1) +5.5% +6.5% +7.5% +Rate of compensation increase +6.2% +6.2% +6.2% +____________________________________________ +(1) +There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy prohibits the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting the optimal expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. +The weighted-average asset allocation of the Qualified Pension Plan is as follows: +Target +As of December 31, +Asset Category +2019 +2018 +2017 +Equity securities +35.0 +% +31.8 +% +38.4 +% +Fixed income securities +43.0 +% +41.3 +% +39.8 +% +Other securities +22.0 +% +26.9 +% +21.8 +% +Total +100.0 +% +100.0 +% +100.0 +% +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in the plan. An expected return on plan assets of 5.5 percent , 6.5 percent , and 7.5 percent was used to calculate the Company’s net periodic pension cost under the Qualified Pension Plan for the years ended December 31, 2018 , 2017 , and 2016 respectively. The expected long-term rate of return assumption of the Qualified Pension Plan is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the expected rate of return on plan assets assumption on an annual basis. +102 +Pension Plan Assets +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2018 , and 2017 , utilizing the fair value hierarchy discussed in Note 11 – Fair Value Measurements are as follows: +Fair Value Measurements Using: +Actual Asset Allocation (1) +Total +Level 1 Inputs +Level 2 Inputs +Level 3 Inputs +(in thousands) +As of December 31, 2018 +Cash +— +% +$ +— +$ +— +$ +— +$ +— +Equity securities: +Domestic (2) +15.4 +% +4,639 +3,197 +1,442 +— +International (3) +16.4 +% +4,941 +3,642 +1,299 +— +Total equity securities +31.8 +% +9,580 +6,839 +2,741 +— +Fixed income securities: +High-yield bonds (4) +— +% +— +— +— +— +Core fixed income (5) +34.4 +% +10,342 +10,342 +— +— +Floating rate corporate loans (6) +6.9 +% +2,078 +2,078 +— +— +Total fixed income securities +41.3 +% +12,420 +12,420 +— +— +Other securities: +Commodities (7) +— +% +— +— +— +— +Real estate (8) +6.0 +% +1,820 +— +— +1,820 +Collective investment trusts (9) +3.1 +% +934 +— +934 +— +Hedge fund (10) +17.8 +% +5,346 +— +1,659 +3,687 +Total other securities +26.9 +% +8,100 +— +2,593 +5,507 +Total investments +100.0 +% +$ +30,100 +$ +19,259 +$ +5,334 +$ +5,507 +As of December 31, 2017 +Cash +— +% +$ +— +$ +— +$ +— +$ +— +Equity securities: +Domestic (2) +22.2 +% +6,865 +4,805 +2,060 +— +International (3) +16.2 +% +5,032 +3,806 +1,226 +— +Total equity securities +38.4 +% +11,897 +8,611 +3,286 +— +Fixed income securities: +High-yield bonds (4) +2.8 +% +876 +876 +— +— +Core fixed income (5) +28.6 +% +8,842 +8,842 +— +— +Floating rate corporate loans (6) +8.4 +% +2,607 +2,607 +— +— +Total fixed income securities +39.8 +% +12,325 +12,325 +— +— +Other securities: +Commodities (7) +1.9 +% +588 +588 +— +— +Real estate (8) +5.6 +% +1,735 +— +— +1,735 +Collective investment trusts (9) +3.1 +% +959 +— +959 +— +Hedge fund (10) +11.2 +% +3,474 +— +— +3,474 +Total other securities +21.8 +% +6,756 +588 +959 +5,209 +Total investments +100.0 +% +$ +30,978 +$ +21,524 +$ +4,245 +$ +5,209 +____________________________________________ +(1) +Percentages may not calculate due to rounding. +(2) +Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold upon demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of these funds is to approximate the S&P 500 by investing in one or more collective investment funds. +103 +(3) +International equity securities consists of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets and believed to have strong sustainable financial productivity at attractive valuations. +(4) +High-yield bonds consist of non-investment grade fixed income securities. The investment objective is to obtain high current income. Due to the increased level of default risk, security selection focuses on credit-risk analysis. +(5) +The objective of core fixed income funds is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay’s Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +(6) +Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +(7) +Investments with exposure to commodity price movements, primarily through the use of futures, swaps, and other commodity-linked securities. +(8) +The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(9) +Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +(10) +The hedge fund portfolio includes investments in actively traded global mutual funds that focus on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +Included below is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2017 +$ +5,214 +Purchases +300 +Realized gain on assets +130 +Unrealized gain on assets +120 +Disposition +(555 +) +Balance at December 31, 2017 +$ +5,209 +Purchases +— +Realized gain on assets +191 +Unrealized gain on assets +152 +Disposition +(45 +) +Balance at December 31, 2018 +$ +5,507 +Contributions +The Company contributed $8.1 million , $7.0 million , and $11.0 million to the Pension Plans for the years ended December 31, 2018 , 2017 , and 2016 , respectively. The Company expects to make a $4.0 million contribution to the Pension Plans in 2019 . +Benefit Payments +The Pension Plans made actual benefit payments of $8.0 million , $10.8 million , and $6.7 million in the years ended December 31, 2018 , 2017 , and 2016 , respectively. Expected benefit payments over the next 10 years are as follows: +Years Ending December 31, +(in thousands) +2019 +$ +5,429 +2020 +$ +5,066 +2021 +$ +4,913 +2022 +$ +5,715 +2023 +$ +7,693 +2024 through 2028 +$ +30,400 +104 +Note 9 - Earnings Per Share +Basic net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average number of common shares outstanding for the respective period. Diluted net income or loss per common share is calculated by dividing adjusted net income or loss by the diluted weighted-average number of common shares outstanding, which includes the effect of potentially dilutive securities. Potentially dilutive securities for this calculation consist primarily of non-vested RSUs, contingent PSUs, and shares into which the Senior Convertible Notes are convertible, which are measured using the treasury stock method. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three -year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 7 – Compensation Plans under the heading Performance Share Units . +On August 12, 2016 , the Company issued $172.5 million in aggregate principal amount of Senior Convertible Notes due 2021 . Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. The Company has initially elected a net-settlement method to satisfy its conversion obligation, which would result in the Company settling the principal amount of the Senior Convertible Notes in cash and the excess conversion value in shares. However, the Company has not made an irrevocable election and thereby reserves the right to settle the Senior Convertible Notes in any manner allowed under the indenture as business circumstances warrant. Shares of the Company’s common stock traded at an average closing price below the $40.50 conversion price for the years ended December 31, 2018 , and 2017 , and for the portion of the year ended December 31, 2016 , during which the Senior Convertible Notes were outstanding; therefore, the Senior Convertible Notes had no dilutive impact. In connection with the offering of the Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters that would effectively prevent dilution upon settlement up to the $60.00 cap price. The capped call transactions will always be anti-dilutive and therefore will never be reflected in diluted net income or loss per share. Please refer to Note 5 – Long-Term Debt for additional discussion. +When the Company recognizes a net loss from continuing operations, as was the case for the years ended December 31, 2017 , and 2016 , all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of diluted net loss per common share. +The following table details the weighted-average dilutive and anti-dilutive securities for the years presented: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Dilutive +1,590 +— +— +Anti-dilutive +— +264 +280 +The following table sets forth the calculations of basic and diluted net income (loss) per common share: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands, except per share data) +Net income (loss) +$ +508,407 +$ +(160,843 +) +$ +(757,744 +) +Basic weighted-average common shares outstanding +111,912 +111,428 +76,568 +Dilutive effect of non-vested RSUs and contingent PSUs +1,590 +— +— +Dilutive effect of Senior Convertible Notes +— +— +— +Diluted weighted-average common shares outstanding +113,502 +111,428 +76,568 +Basic net income (loss) per common share +$ +4.54 +$ +(1.44 +) +$ +(9.90 +) +Diluted net income (loss) per common share +$ +4.48 +$ +(1.44 +) +$ +(9.90 +) +105 +Note 10 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company has entered into various commodity derivative contracts to mitigate a portion of its exposure to potentially adverse market changes in commodity prices and the associated impact on cash flows. As of December 31, 2018 , all derivative counterparties were members of the Company’s Credit Agreement lender group and all contracts were entered into for other-than-trading purposes. The Company’s commodity derivative contracts consist of swap and collar arrangements for oil and gas production, and swap arrangements for NGL production. In a typical commodity swap agreement, if the agreed upon published third-party index price (“index price”) is lower than the swap fixed price, the Company receives the difference between the index price and the agreed upon swap fixed price. If the index price is higher than the swap fixed price, the Company pays the difference. For collar arrangements, the Company receives the difference between an agreed upon index and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +The Company has also entered into fixed price oil basis swaps in order to mitigate exposure to adverse pricing differentials between certain industry benchmark prices and the actual physical pricing points where the Company’s production volumes are sold. Currently, the Company has basis swap contracts with fixed price differentials between NYMEX WTI and WTI Midland for a portion of its Midland Basin production with sales contracts that settle at WTI Midland prices. The Company also has basis swaps with fixed price differentials between NYMEX WTI and Intercontinental Exchange Brent Crude (“ICE Brent”) for a portion of its Midland Basin oil production with sales contracts that settle at ICE Brent prices. +As of December 31, 2018 , the Company had commodity derivative contracts outstanding through the fourth quarter of 2022 , as summarized in the tables below. +Oil Swaps +Contract Period +NYMEX WTI Volumes +Weighted-Average +Contract Price +(MBbl) +(per Bbl) +First quarter 2019 +826 +$ +60.16 +Second quarter 2019 +575 +$ +55.52 +Third quarter 2019 +1,217 +$ +61.41 +Fourth quarter 2019 +1,115 +$ +59.97 +2020 +2,491 +$ +65.68 +Total +6,224 +Oil Collars +Contract Period +NYMEX WTI Volumes +Weighted-Average +Floor Price +Weighted-Average +Ceiling Price +(MBbl) +(per Bbl) +(per Bbl) +First quarter 2019 +2,503 +$ +51.66 +$ +64.32 +Second quarter 2019 +2,802 +$ +52.18 +$ +64.61 +Third quarter 2019 +2,364 +$ +49.07 +$ +62.67 +Fourth quarter 2019 +2,386 +$ +49.08 +$ +62.65 +2020 +1,165 +$ +55.00 +$ +66.47 +Total +11,220 +106 +Oil Basis Swaps +Contract Period +WTI Midland-NYMEX WTI Volumes +Weighted-Average +Contract Price (1) +NYMEX WTI-ICE Brent Volumes +Weighted-Average +Contract Price (2) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +First quarter 2019 +2,433 +$ +(4.44 +) +— +$ +— +Second quarter 2019 +2,571 +$ +(4.49 +) +— +$ +— +Third quarter 2019 +3,291 +$ +(2.86 +) +— +$ +— +Fourth quarter 2019 +3,338 +$ +(2.87 +) +— +$ +— +2020 +11,601 +$ +(1.03 +) +2,750 +$ +(8.03 +) +2021 +— +$ +— +3,650 +$ +(7.86 +) +2022 +— +$ +— +3,650 +$ +(7.78 +) +Total +23,234 +10,050 +____________________________________________ +(1) +Represents the price differential between WTI Midland (Midland, Texas) and NYMEX WTI (Cushing, Oklahoma). +(2) +Represents the price differential between NYMEX WTI (Cushing, Oklahoma) and ICE Brent (North Sea). +Gas Swaps +Contract Period +IF HSC Volumes +Weighted-Average +Contract Price +WAHA Volumes +Weighted-Average +Contract Price +(BBtu) +(per MMBtu) +(BBtu) +(per MMBtu) +First quarter 2019 +19,805 +$ +2.99 +— +$ +— +Second quarter 2019 +10,439 +$ +2.82 +2,803 +$ +0.69 +Third quarter 2019 +12,531 +$ +2.82 +2,984 +$ +1.28 +Fourth quarter 2019 +14,433 +$ +2.88 +2,962 +$ +1.75 +2020 +9,123 +$ +2.98 +2,060 +$ +2.20 +Total (1) +66,331 +10,809 +____________________________________________ +(1) +The Company has natural gas swaps in place that settle against Inside FERC Houston Ship Channel (“IF HSC”), Inside FERC West Texas (“IF WAHA”), and Platt’s Gas Daily West Texas (“GD WAHA”). As of December 31, 2018, total volumes for gas swaps are comprised of 86 percent IF HSC , four percent IF Waha , and 10 percent GD Waha . +Gas Collars +Contract Period +IF HSC Volumes +Weighted- +Average Floor +Price +Weighted- +Average Ceiling +Price +(BBtu) +(per MMBtu) +(per MMBtu) +First quarter 2019 +— +$ +— +$ +— +Second quarter 2019 +4,358 +$ +2.50 +$ +2.83 +Third quarter 2019 +5,066 +$ +2.50 +$ +2.83 +Fourth quarter 2019 +4,818 +$ +2.50 +$ +2.83 +Total +14,242 +107 +NGL Swaps +OPIS Ethane Purity Mont Belvieu +OPIS Propane Mont Belvieu Non-TET +OPIS Normal Butane Mont Belvieu Non-TET +OPIS Isobutane Mont Belvieu +Non-TET +OPIS Natural Gasoline Mont Belvieu Non-TET +Contract Period +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +Volumes +Weighted-Average +Contract Price +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +First quarter 2019 +853 +$ +12.25 +540 +$ +28.72 +38 +$ +35.64 +29 +$ +35.70 +48 +$ +50.93 +Second quarter 2019 +877 +$ +12.29 +561 +$ +31.32 +38 +$ +35.64 +29 +$ +35.70 +49 +$ +50.93 +Third quarter 2019 +907 +$ +12.34 +637 +$ +31.29 +39 +$ +35.64 +30 +$ +35.70 +50 +$ +50.93 +Fourth quarter 2019 +896 +$ +12.36 +651 +$ +31.64 +39 +$ +35.64 +29 +$ +35.70 +50 +$ +50.93 +2020 +539 +$ +11.13 +— +$ +— +— +$ +— +— +$ +— +— +$ +— +Total +4,072 +2,389 +154 +117 +197 +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities. The Company does not designate its derivative commodity contracts as hedging instruments. The fair value of the derivative commodity contracts was a net asset of $158.3 million at December 31, 2018 , and net liability of $139.4 million at December 31, 2017 . +The following tables detail the fair value of derivatives recorded in the accompanying balance sheets, by category: +As of December 31, 2018 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity contracts +Current assets +$ +175,130 +Current liabilities +$ +62,853 +Commodity contracts +Noncurrent assets +58,499 +Noncurrent liabilities +12,496 +Total commodity contracts +$ +233,629 +$ +75,349 +As of December 31, 2017 +Derivative Assets +Derivative Liabilities +Balance Sheet +Classification +Fair Value +Balance Sheet +Classification +Fair Value +(in thousands) +Commodity contracts +Current assets +$ +64,266 +Current liabilities +$ +172,582 +Commodity contracts +Noncurrent assets +40,362 +Noncurrent liabilities +71,402 +Total commodity contracts +$ +104,628 +$ +243,984 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2018 , and 2017 , all derivative instruments held by the Company were subject to master netting arrangements with various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that settle on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +108 +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s derivative contracts: +Derivative Assets +Derivative Liabilities +As of December 31, +As of December 31, +Offsetting of Derivative Assets and Liabilities +2018 +2017 +2018 +2017 +(in thousands) +Gross amounts presented in the accompanying balance sheets +$ +233,629 +$ +104,628 +$ +(75,349 +) +$ +(243,984 +) +Amounts not offset in the accompanying balance sheets +(56,041 +) +(100,035 +) +56,041 +100,035 +Net amounts +$ +177,588 +$ +4,593 +$ +(19,308 +) +$ +(143,949 +) +The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income (loss). The Company had no derivatives designated as hedging instruments for the years ended December 31, 2018 , 2017 , and 2016 . Please refer to Note 11 – Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +The following table summarizes the components of the net derivative (gain) loss line item presented in the accompanying statements of operations: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Derivative settlement (gain) loss: +Oil contracts +$ +68,860 +$ +31,176 +$ +(243,102 +) +Gas contracts +13,029 +(87,857 +) +(94,936 +) +NGL contracts +53,914 +35,447 +8,560 +Total derivative settlement (gain) loss +$ +135,803 +$ +(21,234 +) +$ +(329,478 +) +Net derivative (gain) loss: +Oil contracts +$ +(192,002 +) +$ +71,502 +$ +85,370 +Gas contracts +35,411 +(76,315 +) +81,060 +NGL contracts +(5,241 +) +31,227 +84,203 +Total net derivative (gain) loss +$ +(161,832 +) +$ +26,414 +$ +250,633 +Credit Related Contingent Features +As of December 31, 2018 , and through the filing of this report, all of the Company’s derivative counterparties were members of the Company’s Credit Agreement lender group. Under the Credit Agreement, the Company is required to provide mortgage liens on assets having a value equal to at least 85 percent of the total PV-9 of the Company’s proved oil and gas properties evaluated in the most recent reserve report. Collateral securing indebtedness under the Credit Agreement also secures the Company’s derivative agreement obligations. +Note 11 – Fair Value Measurements +The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• +Level 1 – quoted prices in active markets for identical assets or liabilities +• +Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +109 +• +Level 3 – significant inputs to the valuation model are unobservable +Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on the Company’s policies for determining fair value for the categories discussed below. +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2018 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +233,629 +$ +— +Liabilities: +Derivatives (1) +$ +— +$ +75,349 +$ +— +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2017 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +104,628 +$ +— +Liabilities: +Derivatives (1) +$ +— +$ +243,984 +$ +— +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivatives. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The commodity derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any commodity derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current credit facility margins, and any change in such margins since the last measurement date. +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and other marketplace participants, the Company recognizes that third-parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Refer to Note 10 – Derivative Financial Instruments for more information regarding the Company’s derivative instruments. +110 +Proved and Unproved Oil and Gas Properties +Proved oil and gas properties . Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that associated carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique to measure the fair value of proved properties through an application of discount rates and price forecasts representative of the current operating environment, as selected by the Company’s management. There were no material proved oil and gas properties recorded at fair value on the accompanying balance sheets as of December 31, 2018 , or December 31, 2017 . The Company recorded impairment of proved properties expense of $354.6 million for the year ended December 31, 2016 , related primarily to the decline in expected reserve cash flows from the Company’s outside-operated Eagle Ford shale assets driven by commodity price declines during the first quarter of 2016, and downward performance reserve revisions in the fourth quarter of 2016 for the Company’s Powder River Basin assets. +Unproved oil and gas properties . Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +The following table presents abandonment and impairment of unproved properties expense recorded for the periods presented: +For the Years Ended December 31, +2018 +2017 +2016 +(in millions) +Abandonment and impairment of unproved properties +$ +49.9 +$ +12.3 +$ +80.4 +Abandonment and impairment of unproved properties expense recorded during the years ended December 31, 2018 , and 2017 , related primarily to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. During the year ended December 31, 2016 , abandonment and impairment expense related primarily to a decrease in the fair value of the Company’s unproved Powder River Basin properties due to downward performance reserve revisions and lower market prices based on third-party acreage transactions. +Long-Term Debt +The following table reflects the fair value of the Company’s unsecured senior note obligations measured using Level 1 inputs based on quoted secondary market trading prices. These notes were not presented at fair value on the accompanying balance sheets as of December 31, 2018 , or 2017 , as they were recorded at carrying value, net of any unamortized discounts and deferred financing costs. Please refer to Note 5 – Long-Term Debt for additional discussion. +As of December 31, +2018 +2017 +Principal Amount +Fair Value +Principal Amount +Fair Value +(in thousands) +6.50% Senior Notes due 2021 +$ +— +$ +— +$ +344,611 +$ +351,682 +6.125% Senior Notes due 2022 +$ +476,796 +$ +452,336 +$ +561,796 +$ +571,627 +6.50% Senior Notes due 2023 +$ +— +$ +— +$ +394,985 +$ +403,434 +5.0% Senior Notes due 2024 +$ +500,000 +$ +439,265 +$ +500,000 +$ +483,440 +5.625% Senior Notes due 2025 +$ +500,000 +$ +436,460 +$ +500,000 +$ +494,355 +6.75% Senior Notes due 2026 +$ +500,000 +$ +448,305 +$ +500,000 +$ +516,350 +6.625% Senior Notes due 2027 +$ +500,000 +$ +442,500 +$ +— +$ +— +1.50% Senior Convertible Notes due 2021 +$ +172,500 +$ +158,614 +$ +172,500 +$ +168,291 +The carrying value of the Company’s credit facility approximates its fair value, as the applicable interest rates are floating, based on prevailing market rates. +111 +Note 12 – Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2018 , 2017 , and 2016 . The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Beginning balance +$ +49,446 +$ +19,846 +$ +11,952 +Additions to capitalized exploratory well costs pending the determination of proved reserves +11,197 +49,446 +19,846 +Divestitures +(109 +) +— +— +Reclassifications to wells, facilities, and equipment based on the determination of proved reserves +(49,337 +) +(19,846 +) +(11,952 +) +Capitalized exploratory well costs charged to expense +— +— +— +Ending balance +$ +11,197 +$ +49,446 +$ +19,846 +As of December 31, 2018 , there were no exploratory well costs that were capitalized for more than one year. +Note 13 – Equity +On August 12, 2016 , the Company completed an underwritten public offering of approximately 18.4 million shares of its common stock at an offering price of $30.00 per share. Net proceeds from the offering totaled $530.9 million , after deducting underwriting discounts and commissions and offering expenses, which the Company used to partially fund the Rock Oil Acquisition that closed during the fourth quarter of 2016. +On December 7, 2016 , the Company completed an underwritten public offering of approximately 10.9 million shares of its common stock at an offering price of $38.25 per share. Net proceeds from the offering totaled $403.2 million , after deducting underwriting discounts and commissions and offering expenses, which the Company used to partially fund the QStar Acquisition that also closed during the fourth quarter of 2016. +The Company’s 2016 public equity offerings were made pursuant to an effective shelf registration statement on Form S-3 filed with the SEC. +On December 21, 2016, and as part of the QStar Acquisition, the Company issued approximately 13.4 million shares of its common stock valued at approximately $437.2 million in a private placement to the sellers as partial consideration for the acquired properties. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional discussion. +The Company did not conduct any equity offerings during 2018 or 2017. +112 +Note 14 – Asset Retirement Obligations +Please refer to Asset Retirement Obligations in Note 1 – Summary of Significant Accounting Policies for a discussion of the initial and subsequent measurements of asset retirement obligation liabilities and the significant assumptions used in the estimates. +A reconciliation of the Company’s total asset retirement obligation liability is as follows: +As of December 31, +2018 +2017 +(in thousands) +Beginning asset retirement obligations +$ +114,470 +$ +123,307 +Liabilities incurred (1) +4,054 +7,588 +Liabilities settled (2) +(33,024 +) +(30,432 +) +Accretion expense +4,438 +5,988 +Revision to estimated cash flows +4,256 +8,019 +Ending asset retirement obligations (3)(4) +$ +94,194 +$ +114,470 +____________________________________________ +(1) +Reflects liabilities incurred through drilling activities and acquisitions of drilled wells. +(2) +Reflects liabilities settled through plugging and abandonment activities and divestitures of properties. +(3) +Balance as of December 31, 2017 , included $11.4 million of asset retirement obligations associated with oil and gas properties held for sale. +(4) +Balances as of December 31, 2018 , and 2017 , included $2.3 million and $75,000 , respectively, related to the Company’s current asset retirement obligation liability, which is recorded in the accounts payable and accrued expenses line item on the accompanying balance sheets. +Note 15 – Accounts Receivable and Accounts Payable and Accrued Expenses +Accounts receivable are comprised of the following accruals: +As of December 31, +2018 +2017 +(in thousands) +Oil, gas, and NGL production revenue +$ +107,230 +$ +96,610 +Amounts due from joint interest owners +31,497 +56,929 +State severance tax refunds +4,415 +2,276 +Derivative settlements +9,475 +99 +Other +14,919 +4,240 +Total accounts receivable +$ +167,536 +$ +160,154 +Accounts payable and accrued expenses are comprised of the following accruals: +As of December 31, +2018 +2017 +(in thousands) +Drilling and lease operating cost accruals +$ +139,711 +$ +126,500 +Trade accounts payable +56,047 +77,573 +Revenue and severance tax payable +94,806 +60,328 +Property taxes +18,694 +13,222 +Compensation +31,486 +39,471 +Derivative settlements +1,287 +12,644 +Interest +40,840 +45,057 +Other +20,328 +11,835 +Total accounts payable and accrued expenses +$ +403,199 +$ +386,630 +113 +Supplemental Oil and Gas Information (unaudited) +Costs Incurred in Oil and Gas Producing Activities +Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Development costs (1) +$ +1,147,574 +$ +675,523 +$ +595,331 +Exploration costs +184,930 +271,502 +118,224 +Acquisitions (2) +Proved properties +1,312 +1,602 +201,672 +Unproved properties (3) +55,688 +91,420 +2,458,667 +Total, including asset retirement obligations (4)(5) +$ +1,389,504 +$ +1,040,047 +$ +3,373,894 +____________________________________________ +(1) +Includes facility costs of $72.6 million , $43.8 million , and $25.9 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +(2) +Balances at December 31, 2016, include $437.2 million of value attributed to the equity consideration given to the sellers of the assets acquired in the QStar Acquisition. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional discussion. +(3) +Includes amounts related to leasing activity and acquiring surface rights outside of acquisitions of proved and unproved properties totaling $23.4 million , $12.8 million , and $7.5 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +(4) +Includes amounts relating to estimated asset retirement obligations of $7.1 million , $13.6 million , and $32.1 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +(5) +Includes capitalized interest of $20.6 million , $12.6 million , and $17.0 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting of reserve estimation and disclosure. +Proved reserves are the estimated quantities of oil, gas, and NGLs, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated proved reserves are located in the United States. +114 +The table below presents a summary of changes in the Company’s estimated proved reserves for each of the years in the three-year period ended December 31, 2018 . The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company’s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +For the Years Ended December 31, +2018 (1) +2017 (2) +2016 (3) +Oil +Gas +NGLs +Oil +Gas +NGLs +Oil +Gas +NGLs +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +Total proved reserves: +Beginning of year +158.2 +1,280.1 +96.5 +104.9 +1,111.1 +105.7 +145.3 +1,264.0 +115.4 +Revisions of previous estimate +(24.0 +) +(219.5 +) +(8.0 +) +1.0 +63.8 +4.9 +(36.0 +) +(249.8 +) +(18.6 +) +Discoveries and extensions +9.3 +20.3 +0.5 +11.5 +21.9 +— +7.8 +42.5 +4.1 +Infill reserves in an existing proved field +80.4 +391.5 +29.0 +79.0 +347.4 +22.9 +32.3 +228.1 +18.9 +Sales of +reserves (4) +(29.6 +) +(48.1 +) +(2.7 +) +(25.3 +) +(143.8 +) +(26.7 +) +(40.0 +) +(46.7 +) +— +Purchases of minerals in place (4) +0.2 +0.7 +— +0.8 +2.7 +— +12.1 +19.9 +0.1 +Production +(18.8 +) +(103.2 +) +(7.9 +) +(13.7 +) +(123.0 +) +(10.3 +) +(16.6 +) +(146.9 +) +(14.2 +) +End of year +175.7 +1,321.8 +107.4 +158.2 +1,280.1 +96.5 +104.9 +1,111.1 +105.7 +Proved developed reserves: +Beginning of year +58.6 +642.9 +49.0 +48.5 +609.1 +58.6 +75.6 +644.4 +61.5 +End of year +68.2 +699.1 +60.1 +58.6 +642.9 +49.0 +48.5 +609.1 +58.6 +Proved undeveloped reserves: +Beginning of year +99.6 +637.2 +47.6 +56.4 +502.0 +47.1 +69.6 +619.7 +53.9 +End of year +107.6 +622.7 +47.2 +99.6 +637.2 +47.6 +56.4 +502.0 +47.1 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) +For the year ended December 31, 2018 , the Company added 188.0 MMBOE from its drilling program and through development plan optimization. The Company divested 40.3 MMBOE during 2018, primarily as a result of the PRB Divestiture, Divide County Divestiture, and Half East Divestiture. The Company also had net downward revisions of 68.8 MMBOE, which resulted primarily from changes in development plans in its Eagle Ford shale program. +(2) +For the year ended December 31, 2017 , the Company added 175.0 MMBOE from its drilling program. The Company divested 76.0 MMBOE during 2017, including 72.5 MMBOE related to its outside-operated Eagle Ford shale assets. +(3) +For the year ended December 31, 2016 , the Company added 108.2 MMBOE from its drilling program and acquired 15.5 MMBOE. These additions were offset by net downward revisions of 96.2 MMBOE, consisting of 18.1 MMBOE of performance revisions, a 35.1 MMBOE price revision, and the removal of 43.0 MMBOE of proved undeveloped reserves to reflect the Company’s shift to develop its predominately unproven Midland Basin properties. Additionally, the Company divested 47.7 MMBOE during 2016. +(4) +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional information. +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of future net cash flows (“Standardized Measure”) and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +115 +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the estimated proved reserves in place at the end of the period using year end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities. +The assumptions used to compute the Standardized Measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the Standardized Measure computations since these reserve quantity estimates are the basis for the valuation process. The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the Standardized Measure: +For the Years Ended December 31, +2018 +2017 +2016 +Oil (per Bbl) +$ +57.76 +$ +48.57 +$ +37.22 +Gas (per Mcf) +$ +3.49 +$ +3.20 +$ +2.45 +NGLs (per Bbl) +$ +26.23 +$ +23.33 +$ +16.38 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the Standardized Measure. +As of December 31, +2018 +2017 +2016 +(in thousands) +Future cash inflows +$ +17,579,432 +$ +14,035,704 +$ +8,359,938 +Future production costs +(5,386,264 +) +(5,594,226 +) +(4,634,649 +) +Future development costs +(2,679,488 +) +(2,638,459 +) +(1,636,077 +) +Future income taxes (1) +(1,012,209 +) +(205,694 +) +— +Future net cash flows +8,501,471 +5,597,325 +2,089,212 +10 percent annual discount +(3,847,088 +) +(2,573,183 +) +(937,099 +) +Standardized measure of discounted future net cash flows +$ +4,654,383 +$ +3,024,142 +$ +1,152,113 +___________________________________________ +(1) +Regarding the calculations as of December 31, 2016, after evaluating all factors and giving effect to tax basis, future tax deductions, and available tax credits, the Company determined that at price levels for each respective period, future net cash flows would not be subject to federal or state income tax for the projected life of the reserves under authoritative tax legislation. +The principle sources of changes in the Standardized Measure were: +For the Years Ended December 31, +2018 +2017 +2016 +(in thousands) +Standardized Measure, beginning of year +$ +3,024,142 +$ +1,152,113 +$ +1,790,526 +Sales of oil, gas, and NGLs produced, net of production costs +(1,148,991 +) +(745,877 +) +(580,861 +) +Net changes in prices and production costs +1,010,335 +1,181,447 +(315,725 +) +Extensions, discoveries and other including infill reserves in an existing proved field, net of related costs +2,218,475 +1,638,734 +242,556 +Sales of reserves in place +(147,887 +) +(226,528 +) +(377,607 +) +Purchase of reserves in place +1,818 +12,032 +115,270 +Previously estimated development costs incurred during the period +445,638 +121,879 +290,837 +Changes in estimated future development costs +(34,871 +) +(116,609 +) +27,961 +Revisions of previous quantity estimates +(611,168 +) +103,916 +(124,845 +) +Accretion of discount +305,657 +115,211 +179,050 +Net change in income taxes +(449,884 +) +(32,426 +) +— +Changes in timing and other +41,119 +(179,750 +) +(95,049 +) +Standardized Measure, end of year +$ +4,654,383 +$ +3,024,142 +$ +1,152,113 +116 +Quarterly Financial Information (unaudited) +The Company’s quarterly financial information for fiscal years 2018 and 2017 is as follows (in thousands, except per share data): +First +Second +Third +Fourth +Quarter +Quarter +Quarter +Quarter +Year Ended December 31, 2018 (2) +Total operating revenues and other income +$ +769,595 +$ +443,916 +$ +459,369 +$ +394,192 +Total operating expenses +310,527 +387,768 +568,013 +(35,573 +) +Income (loss) from operations +$ +459,068 +$ +56,148 +$ +(108,644 +) +$ +429,765 +Income (loss) before income taxes +$ +416,392 +$ +16,296 +$ +(172,671 +) +$ +391,760 +Net income (loss) +$ +317,401 +$ +17,197 +$ +(135,923 +) +$ +309,732 +Basic net income (loss) per common share (1) +$ +2.84 +$ +0.15 +$ +(1.21 +) +$ +2.76 +Diluted net income (loss) per common share (1) +$ +2.81 +$ +0.15 +$ +(1.21 +) +$ +2.73 +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +Year Ended December 31, 2017 (3) +Total operating revenues and other income +$ +372,738 +$ +120,721 +$ +295,379 +$ +340,538 +Total operating expenses (4) +206,577 +268,047 +380,531 +437,942 +Income (loss) from operations (4) +$ +166,161 +$ +(147,326 +) +$ +(85,152 +) +$ +(97,404 +) +Income (loss) before income taxes +$ +118,940 +$ +(190,968 +) +$ +(128,382 +) +$ +(143,403 +) +Net income (loss) +$ +74,434 +$ +(119,907 +) +$ +(89,112 +) +$ +(26,258 +) +Basic net income (loss) per common share (1) +$ +0.67 +$ +(1.08 +) +$ +(0.80 +) +$ +(0.24 +) +Diluted net income (loss) per common share (1) +$ +0.67 +$ +(1.08 +) +$ +(0.80 +) +$ +(0.24 +) +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +For the first quarter of 2018, the Company recorded an estimated $409.2 million net pre-tax gain on divestiture activity related to the PRB Divestiture, which was partially offset by a $24.1 million write-down on certain assets previously held for sale. During the second quarter of 2018, the Company recorded an estimated $15.7 million net pre-tax gain on divestiture activity related to the Divide County Divestiture and Halff East Divestiture (see Note 3 – Divestitures, Assets Held for Sale, and Acquisitions ). During the third quarter of 2018, the Company recorded a $26.7 million loss on the early extinguishment of its 2021 Senior Notes, 2023 Senior Notes, and a portion of its 2022 Senior Notes (see Note 5 – Long-Term Debt ). For the first, second, third, and fourth quarters of 2018, the Company recorded net derivative losses of $7.5 million , $63.7 million , $178.0 million , and a net derivative gain of $411.1 million , respectively (see Note 10 – Derivative Financial Instruments ). +(3) +During the first quarter of 2017, the Company recorded an estimated $37.5 million net pre-tax gain on divestiture activity related to the sale of the Company’s outside-operated Eagle Ford shale assets partially offset by a write-down of the Company’s Divide County, North Dakota assets, which were previously classified as held for sale. During the second quarter of 2017, the Company recorded a $167.1 million net pre-tax loss on divestiture activity related primarily to an additional write-down of the Company’s retained Divide County, North Dakota assets upon reclassification as assets held for use. For the first, second, third, and fourth quarters of 2017, the Company recorded a $114.8 million net derivative gain, a $55.2 million net derivative gain, an $80.6 million net derivative loss, and a $115.8 million net derivative loss, respectively (see Note 10 – Derivative Financial Instruments ). +(4) +Amounts have been adjusted to conform to the current period presentation on the consolidated financial statements. Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies for additional discussion. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +117 +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +118 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2018 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +119 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated February 21, 2019 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 21, 2019 +120 +ITEM 9B. OTHER INFORMATION +None. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning the Company’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about Executive Officers,” and “Corporate Governance” in the Company’s definitive proxy statement for the 2019 annual meeting of stockholders to be filed within 120 days from December 31, 2018 . +The information required by this Item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the information provided under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement for the 2019 annual meeting of stockholders to be filed within 120 days from December 31, 2018 . +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation” and “Director Compensation” in the Company’s definitive proxy statement for the 2019 annual meeting of stockholders to be filed within 120 days from December 31, 2018 . +121 +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s definitive proxy statement for the 2019 annual meeting of stockholders to be filed within 120 days from December 31, 2018 . +Securities Authorized for Issuance Under Equity Compensation Plans. The Company has equity compensation plans under which options and shares of the Company’s common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. The Company’s stockholders have approved these plans. See Note 7 – Compensation Plans included in Part II, Item 8 of this report for further information about the material terms of the Company’s equity compensation plans. The following table is a summary of the shares of common stock authorized for issuance under equity compensation plans as of December 31, 2018 : +(a) +(b) +(c) +Plan category +Number of securities to be issued upon exercise of outstanding options, warrants, and rights +Weighted-average exercise price of outstanding options, warrants, and rights +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan +Stock options and incentive stock options (1) +— +$ +— +Restricted stock units (1)(2) +1,251,957 +N/A +Performance share units (1)(2)(3) +1,725,044 +N/A +Total for Equity Incentive Compensation Plan +2,977,001 +$ +— +5,877,607 +Employee Stock Purchase Plan (4) +— +— +1,613,871 +Equity compensation plans not approved by security holders +— +— +— +Total for all plans +2,977,001 +$ +— +7,491,478 +____________________________________________ +(1) +In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of the Company or any affiliate of the Company. The Company’s Board of Directors approved amendments to the Equity Plan in 2009, 2010, 2013, 2016, and 2018 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The number of shares of the Company’s common stock underlying awards granted in 2018 , 2017 , and 2016 under the Equity Plan were 1,220,217 , 2,078,878 , and 918,509 , respectively. +(2) +RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per unit fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per unit fair value for the outstanding RSUs and PSUs was $21.49 and $20.68, respectively. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for additional discussion. +(3) +The number of awards vested assumes a one multiplier. The final number of shares of the Company’s common stock issued upon settlement may vary depending on the three -year multiplier determined at the end of the performance period under the Equity Plan, which ranges from zero to two . +(4) +Under the ESPP, eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their eligible compensation. The purchase price of the common stock is 85 percent of the lower of the fair market value of the common stock on the first or last day of the six-month offering period, and shares issued under the ESPP on or after December 31, 2011, have no minimum restriction period. The ESPP is intended to qualify under Section 423 of the IRC. The number of shares of the Company’s common stock issued in 2018 , 2017 , and 2016 under the ESPP were 199,464 , 186,665 , and 218,135 , respectively. +122 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s definitive proxy statement for the 2019 annual meeting of stockholders to be filed within 120 days from December 31, 2018 . +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “ Independent Registered Public Accounting Firm ” and “ Audit Committee Preapproval Policy and Procedures ” in the Company’s definitive proxy statement for the 2019 annual meeting of stockholders to be filed within 120 days from December 31, 2018 . +123 +PART IV +ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Consolidated Financial Statements and Financial Statement Schedules: +Report of Independent Registered Public Accounting Firm +70 +Consolidated Balance Sheets +71 +Consolidated Statements of Operations +72 +Consolidated Statements of Comprehensive Income (Loss) +73 +Consolidated Statements of Stockholders’ Equity +74 +Consolidated Statements of Cash Flows +75 +Notes to Consolidated Financial Statements +77 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +2.1 +Membership Interest Purchase Agreement dated August 8, 2016 between SM Energy Company and Rock Oil Holdings LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on August 8, 2016, and incorporated herein by reference) +2.2 +Purchase and Sale Agreement, dated October 17, 2016, by and between SM Energy Company and QStar LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +2.3 +Letter Agreement dated October 17, 2016, by and among SM Energy Company, QStar LLC, and RRP-QStar, LLC (filed as Exhibit 2.2 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +2.4 +Purchase and Sale Agreement dated October 17, 2016, by and between SM Energy Company and Oasis Petroleum North America LLC (filed as Exhibit 2.3 to the registrant’s Current Report on Form 8-K filed on October 21, 2016, and incorporated herein by reference) +2.5 +Membership Interest Purchase Agreement dated January 1, 2017 between SM Energy Company and Venado EF LLC (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, and incorporated herein by reference) +2.6 +Second Amendment to Membership Interest Purchase Agreement dated March 4, 2017 between SM Energy and Venado EF L.P. (filed as Exhibit 2.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, and incorporated herein by reference) +2.7 +Purchase and Sale Agreement dated January 8, 2018 by and between SM Energy Company and Converse Energy Acquisitions, LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on January 11, 2018 and incorporated herein by reference) +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +3.2 +Amended and Restated By-Laws of SM Energy Company, effective as of February 21, 2017 (filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +4.1 +Indenture related to the 5.0% Senior Notes due 2024, dated May 20, 2013, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on May 20, 2013, and incorporated herein by reference) +4.2 +Indenture related to the 6.125% Senior Notes due 2022, dated November 17, 2014, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 18, 2014, and incorporated herein by reference) +4.3 +Indenture related to senior debt securities of SM Energy Company by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-3 filed on May 7, 2015 (Registration No. 333-203936) and incorporated herein by reference) +124 +4.4 +2025 Notes Supplemental Indenture (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on May 21, 2015, and incorporated herein by reference) +4.5 +Base Indenture, dated as of May 21, 2015, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.6 +Second Supplemental Indenture, dated August 12, 2016, by and between SM Energy Company and U.S. Bank, National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.7 +Third Supplemental Indenture, dated September 12, 2016 by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +4.8 +Fourth Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +4.9 +Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.3 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +4.10† +SM Energy Company Equity Incentive Compensation Plan, amended and restated effective as of May 22, 2018 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 12, 2018, and incorporated herein by reference) +4.11 +Lock-Up and Registration Rights Agreement, dated December 21, 2016, by and among SM Energy Company, QStar LLC and RRP-QStar, LLC (filed as Exhibit 4.13 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +10.1 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.2 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.3† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +10.4*** +Gas Services Agreement effective as of July 1, 2010 between SM Energy Company and Eagle Ford Gathering LLC (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, and incorporated herein by reference) +10.5†† +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.6† +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.7+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of December 31, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.8 +Gas Gathering Agreement dated May 31, 2011 between Regency Field Services LLC and SM Energy Company (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.9 +Gathering and Natural Gas Services Agreement effective as of April 1, 2011 between SM Energy Company and ETC Texas Pipeline, Ltd. (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.10 +Gas Processing Agreement effective as of April 1, 2011 between ETC Texas Pipeline, Ltd. and SM Energy Company (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.11† +Employee Stock Purchase Plan, As Amended and Restated as of June 10, 2011 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.12† +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +125 +10.13† +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.14† +Performance Stock Unit Award Agreement as of July 1, 2016 (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.15† +Restricted Stock Unit Award Agreement as of July 1, 2016 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.16† +Non-Employee Director Restricted Stock Award Agreement as of May 25, 2016 (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, and incorporated herein by reference) +10.17† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.18† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.19† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.20*† +Summary of Compensation Arrangements for Non-Employee Directors +10.21 +Sixth Amended and Restated Credit Agreement dated as of September 28, 2018, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 4, 2018, and incorporated herein by reference) +10.22† +Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 20, 2015, and incorporated herein by reference) +10.23† +Amendment No. 3 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2016 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2015, and incorporated herein by reference) +10.24*** +Amendment to Amended and Restated Gas Gathering Agreement, effective as of September 1, 2015, by and between SM Energy Company and Regency Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on September 15, 2015, and incorporated herein by reference) +10.25 +Amendment to Amended and Restated Gas Gathering Agreement, effective as of February 1, 2016, by and between SM Energy Company and ETC Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on February 22, 2016, and incorporated herein by reference) +10.26 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.27 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.28 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.29 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.30 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.5 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.31 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.6 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.32† +SM Energy Company Employee Stock Purchase Plan, amended and restated effective as of April 6, 2017 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 13, 2017, and incorporated herein by reference) +10.33† +Performance Share Unit Award Agreement as of July 1, 2018 (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, and incorporated herein by reference) +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Ryder Scott Company L.P. +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +126 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +99.1* +Ryder Scott Audit Letter +101.INS* +XBRL Instance Document +101.SCH* +XBRL Schema Document +101.CAL* +XBRL Calculation Linkbase Document +101.LAB* +XBRL Label Linkbase Document +101.PRE* +XBRL Presentation Linkbase Document +101.DEF* +XBRL Taxonomy Extension Definition Linkbase Document +* Filed with this report. +** Furnished with this report. +*** +Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Exchange Act. +† +Exhibit constitutes a management contract or compensatory plan or agreement. +†† +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on +November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal +Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. See Item 15(a) above. +ITEM 16. FORM 10-K SUMMARY +None. +127 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: +February 21, 2019 +By: +/s/ JAVAN D. OTTOSON +Javan D. Ottoson +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Javan D. Ottoson and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2018 , and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ JAVAN D. OTTOSON +President, Chief Executive Officer, and Director +February 21, 2019 +Javan D. Ottoson +(Principal Executive Officer) +/s/ A. WADE PURSELL +Executive Vice President and Chief Financial Officer +February 21, 2019 +A. Wade Pursell +(Principal Financial Officer) +/s/ PATRICK A. LYTLE +Controller and Assistant Secretary +February 21, 2019 +Patrick A. Lytle +(Principal Accounting Officer) +128 +Signature +Title +Date +/s/ WILLIAM D. SULLIVAN +Chairman of the Board of Directors +February 21, 2019 +William D. Sullivan +/s/ CARLA J. BAILO +Director +February 21, 2019 +Carla J. Bailo +/s/ LARRY W. BICKLE +Director +February 21, 2019 +Larry W. Bickle +/s/ STEPHEN R. BRAND +Director +February 21, 2019 +Stephen R. Brand +/s/ LOREN M. LEIKER +Director +February 21, 2019 +Loren M. Leiker +/s/ RAMIRO G. PERU +Director +February 21, 2019 +Ramiro G. Peru +/s/ JULIO M. QUINTANA +Director +February 21, 2019 +Julio M. Quintana +/s/ ROSE M. ROBESON +Director +February 21, 2019 +Rose M. Robeson +129 \ No newline at end of file diff --git a/raw/filings/0000893538/2018/0000893538-19-000012/filing_metadata.csv b/raw/filings/0000893538/2018/0000893538-19-000012/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..c5a170b875e30475c7647ad12093781d36de07c6 --- /dev/null +++ b/raw/filings/0000893538/2018/0000893538-19-000012/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2019-02-21,2018-12-31,2019-02-21T13:56:41.000Z,0000893538-19-000012,sm-20181231x10k.htm,10-K,17070343,1,0,https://www.sec.gov/Archives/edgar/data/893538/000089353819000012/sm-20181231x10k.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353819000012/,2018,2018,1 diff --git a/raw/filings/0000893538/2018/0000893538-19-000012/item1.txt b/raw/filings/0000893538/2018/0000893538-19-000012/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2018/0000893538-19-000012/item13.txt b/raw/filings/0000893538/2018/0000893538-19-000012/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..75387b045047afc91d9e8503aa8b1fc0f3c37189 --- /dev/null +++ b/raw/filings/0000893538/2018/0000893538-19-000012/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s definitive proxy statement for the 2019 annual meeting of stockholders to be filed within 120 days from December 31, 2018 . \ No newline at end of file diff --git a/raw/filings/0000893538/2018/0000893538-19-000012/item9a.txt b/raw/filings/0000893538/2018/0000893538-19-000012/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..3cceb3646a730a3774d85e761de631449a8a7f08 --- /dev/null +++ b/raw/filings/0000893538/2018/0000893538-19-000012/item9a.txt @@ -0,0 +1,37 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +118 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2018 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +119 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated February 21, 2019 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 21, 2019 +120 \ No newline at end of file diff --git a/raw/filings/0000893538/2018/0000893538-19-000012/rp_note.txt b/raw/filings/0000893538/2018/0000893538-19-000012/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2018/0000893538-19-000012/rpt_disclosure.txt b/raw/filings/0000893538/2018/0000893538-19-000012/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4b2c1eac45c5613d270a6a96d3f702d7155a2ae4 --- /dev/null +++ b/raw/filings/0000893538/2018/0000893538-19-000012/rpt_disclosure.txt @@ -0,0 +1,11 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee’s review of any transaction, arrangement, or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, (b) the aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of our Related Person Transactions Policy, a “related person” means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more than 5% of our outstanding shares of common stock, and (iii) any immediate family member of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it determines in good faith are in, or are not inconsistent with, our best interests and the best interests of our stockholders. +In determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director’s independence in the event the related person is a director, and the extent of the related person’s interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in compliance with the policy and remain appropriate. +In addition, our By-Laws provide that a director, officer, or employee of our Company may not pursue for his or her own account a business or investment opportunity that he or she learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than 1% of the publicly traded stock of another company. +Transactions with Related Persons +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are consistent with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when our Board, acting through the Audit Committee or as otherwise described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, but are not limited to, situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we obtain products or services from, or provide products or services to, related persons on an arm’s length basis on terms comparable to those obtained from or provided to unrelated third parties or on terms comparable to those obtained from or provided to employees generally. With the exception of the transaction described in the following paragraph, which was approved by our Audit Committee, we had no transactions that required approval under our Related Person Transactions Policy. +Dean Lutey, the spouse of Ms. Mary Ellen Lutey, our Senior Vice President—Development and Environmental, Health and Safety, joined the Company in 2008 and has been the Vice President—Information Technology of the Company since May 2013. During the fiscal year ended December 31, 2019, Mr. Lutey earned total compensation of $753,374, which included his base salary, annual bonus, LTIP awards, benefits under our qualified and non-qualified benefit plans, and matching contributions by the Company under its 401(k) Profit Sharing Plan and Non-Qualified Deferred Compensation Plan. Mr. Lutey also participated in the Company’s benefit programs for its employees. +Compensation Committee Interlocks and Insider Participation +None of the directors who served on the Compensation Committee during fiscal year 2019 has ever served as one of our officers or employees. During fiscal year 2019, there were no Compensation Committee interlocks. +66 \ No newline at end of file diff --git a/raw/filings/0000893538/2019/0000893538-20-000009/filing.txt b/raw/filings/0000893538/2019/0000893538-20-000009/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..31e5f79ce55afa940c51c0ca66e60a0aba254295 --- /dev/null +++ b/raw/filings/0000893538/2019/0000893538-20-000009/filing.txt @@ -0,0 +1,9255 @@ +Document +false --12-31 FY 2019 0000893538 P0Y0M5D P0Y0M5D 0 0 0 0 0 0.33 P6M P6M 1100000 0.10 0.10 0.10 0.01 0.01 200000000 200000000 112241966 112987952 112241966 112987952 33600000 0.015 0.05 0.06125 0.0675 0 0 0 0 0 0 3200000 57102000 64032000 P3Y P3Y 0 0 446000 446000
Components of the Company’s total lease cost, whether capitalized or expensed, for the year ended December 31, 2019, were as follows:
For the Year Ended December 31, 2019
Operating lease cost
$
35,570

Short-term lease cost (1)
301,373

Variable lease cost (2)
106,006

Total lease cost (3)
$
442,949

____________________________________________
(1)
Costs associated with short-term lease agreements relate primarily to operational activities where underlying lease terms are less than one year. This amount is significant as it includes drilling and completion activities and field equipment rentals, most of which are contracted for 12 months or less. It is expected that this amount will fluctuate primarily with the number of drilling rigs and completion crews the Company is operating under short-term agreements.
(2)
Variable lease payments include additional payments made that were not included in the initial measurement of the ROU asset and corresponding liability for lease agreements with terms longer than 12 months. Variable lease payments relate to the actual volumes transported under certain midstream agreements, actual usage associated with drilling rigs, completion crews, and vehicles, and variable utility costs associated with the Company’s leased office space. Fluctuations in variable lease payments are driven by actual volumes delivered and the number of drilling rigs and completion crews operating under long-term agreements.
(3)
Lease costs are either expensed on the accompanying statements of operations or capitalized on the accompanying balance sheets depending on the nature and use of the underlying ROU asset.
Other information related to the Company’s leases for the year ended December 31, 2019, was as follows:
For the Year Ended December 31, 2019
(in thousands)
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
12,074

Investing cash flows from operating leases
$
24,129

Right-of-use assets obtained in exchange for new operating lease liabilities
$
25,360

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+Washington, D.C. 20549 +FORM 10-K +☑ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +For the fiscal year ended December 31, 2019 +or +☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +Commission file number 001-31539 +SM ENERGY CO MPANY +(Exact name of registrant as specified in its charter) +Delaware +41-0518430 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +1775 Sherman Street, Suite 1200, +Denver, +Colorado +80203 +(Address of principal executive offices) +(Zip Code) +( 303 ) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common stock, $.01 par value +SM +New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer +☑ +Accelerated filer +☐ +Non-accelerated filer +☐ +Smaller reporting company +☐ +Emerging growth company +☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑ +The aggregate market value of the 111,242,033 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock on June 28, 2019 , the last business day of the registrant’s most recently completed second fiscal quarter, of $12.52 per share, as reported on the New York Stock Exchange, was $ 1,392,750,253 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 6, 2020 , the registrant had 112,988,364 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III is incorporated by reference from portions of the registrant’s Definitive Proxy Statement on Schedule 14A relating to its 2020 annual meeting of stockholders to be filed within 120 days after December 31, 2019 . +1 +TABLE OF CONTENTS +Item +Page +Cautionary Information about Forward-Looking Statements +4 +Glossary of Oil and Gas Terms +4 +Part I +7 +Items 1. and 2. +Business and Properties +7 +General +7 +Strategy +7 +Significant Developments in 2019 +7 +Outlook for 2020 +8 +Areas of Operation +8 +Reserves +9 +Production +13 +Productive Wells +13 +Drilling and Completion Activity +14 +Acreage +15 +Delivery Commitments +15 +Major Customers +15 +Employees and Office Space +16 +Title to Properties +16 +Seasonality +16 +Competition +17 +Government Regulations +17 +Available Information +20 +Item 1A. +Risk Factors +20 +Item 1B. +Unresolved Staff Comments +36 +Item 3. +Legal Proceedings +36 +Item 4. +Mine Safety Disclosures +36 +Part II +37 +Item 5. +Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +37 +Item 6. +Selected Financial Data +39 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +41 +Overview of the Company +41 +Financial Results of Operations and Additional Comparative Data +45 +Comparison of Financial Results and Trends Between 2019 and 2018 and Between 2018 and 2017 +48 +Overview of Liquidity and Capital Resources +52 +Critical Accounting Policies and Estimates +56 +Accounting Matters +59 +Environmental +59 +Non-GAAP Financial Measures +60 +2 +TABLE OF CONTENTS +(Continued) +Item +Page +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk (included within the content of Item 7) +62 +Item 8. +Consolidated Financial Statements and Supplementary Data +63 +Item 9. +Changes In and Disagreements With Accountants on Accounting and Financial Disclosure +107 +Item 9A. +Controls and Procedures +107 +Item 9B. +Other Information +111 +Part III +111 +Item 10. +Directors, Executive Officers, and Corporate Governance +111 +Item 11. +Executive Compensation +111 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +112 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +113 +Item 14. +Principal Accountant Fees and Services +113 +Part IV +114 +Item 15. +Exhibits and Consolidated Financial Statement Schedules +114 +Item 16. +Form 10-K Summary +117 +3 +Cautionary Information about Forward-Looking Statements +This Annual Report on Form 10-K (“Form 10-K”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements, other than statements of historical facts, included in this report that address activities, events, or developments with respect to our financial condition, results of operations, business prospects or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “could,” “estimate,” “expect,” “forecast,” “intend,” “pending,” “plan,” “potential,” “project,” “target,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this report, and include statements about such matters as: +• +the amount and nature of future capital expenditures and the availability of liquidity and capital resources to fund capital expenditures; +• +any changes to the borrowing base or aggregate lender commitments under our Sixth Amended and Restated Credit Agreement, as amended (the “Credit Agreement”); +• +our outlook on future crude oil, natural gas, and natural gas liquids (also respectively referred to as “oil,” “gas,” and “NGLs” throughout this document) prices, well costs, service costs, lease operating costs, and general and administrative costs; +• +the drilling of wells and other exploration and development activities, the ability to obtain permits and governmental approvals, and plans by us, our joint development partners, and/or other third-party operators; +• +possible or expected acquisitions and divestitures, including the possible divestiture or farm-down of, or joint venture relating to, certain properties; +• +oil, gas, and NGL reserve estimates and the estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates; +• +future oil, gas, and NGL production estimates, identified drilling locations, as well as drilling prospects, inventories, projects and programs; +• +cash flows, anticipated liquidity, interest and related debt service expenses, changes in our effective tax rate, and the future repayment of debt; +• +business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, plans with respect to future dividend payments, and our outlook on our future financial condition or results of operations; +• +plans, objectives, expectations and intentions; and +• +other similar matters, such as those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. These statements are subject to known and unknown risks and uncertainties, which may cause our actual results and performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Factors that may cause our financial condition, results of operations, business prospects or economic performance to differ from expectations include the factors discussed in Part I, Item 1A, Risk Factors - Risks Related to Our Business below and elsewhere in this report. The forward-looking statements in this report speak as of the filing of this report. Although, we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by applicable securities laws. +Glossary of Oil and Gas Terms +The oil and gas terms defined in this section are used throughout this report. The definitions of the terms developed reserves, exploratory well, field, proved reserves, and undeveloped reserves have been abbreviated from the respective definitions under Rule 4-10(a) of Regulation S-X. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +BBtu. One billion British thermal units. +Bcf . One billion cubic feet, used in reference to gas. +4 +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of gas to one Bbl of oil or NGLs. +Btu. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. A well found to be incapable of producing either oil, gas, and/or NGLs in commercial quantities. +Exploratory well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and gas) rights. +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +Gross acre. An acre in which a working interest is owned. +Gross well. A well in which a working interest is owned. +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses. The expenses incurred in the lifting of oil, gas, and/or NGLs from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels of oil, NGLs, water, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to gas. +MMBbl. One million barrels of oil, NGLs, water, or other liquid hydrocarbons. +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +NGLs. The combination of ethane, propane, isobutane, normal butane, and natural gasoline that when removed from gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for oil. +NYMEX Henry Hub . New York Mercantile Exchange Henry Hub, a common industry benchmark price for gas. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +5 +PV-10 (Non-GAAP). PV-10 is a non-GAAP measure. The present value of estimated future revenue to be generated from the production of estimated net proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. +Productive well. A well that is producing oil, gas, and/or NGLs or that is capable of commercial production of those products. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +Reserve life index. Expressed in years, represents the estimated net proved reserves at a specified date divided by actual production for the preceding 12-month period. +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil, gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of oil, gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from oil, gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +Royalty interest. An interest in an oil and gas property entitling the owner to shares of oil, gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +Standardized measure of discounted future net cash flows. The discounted future net cash flows related to estimated proved reserves based on prices used in estimating the reserves, year end costs, and statutory tax rates, at a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information (unaudited) located in Part II, Item 8 of this report. +Track record. Current year conversions of proved undeveloped reserves to proved developed reserves, divided by beginning of the year proved undeveloped reserves. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and NGLs regardless of whether such acreage contains estimated net proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +6 +PART I +When we use the terms “SM Energy,” the “Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business in the Glossary of Oil and Gas Terms section of this report. Throughout this document we make statements and projections that address future expectations, possibilities, or events, all of which may be classified as “forward-looking.” Please refer to the Cautionary Information about Forward-Looking Statements section of this report for an explanation of these types of statements and the associated risks and uncertainties. +ITEMS 1. AND 2. BUSINESS AND PROPERTIES +General +We are an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. SM Energy was founded in 1908, incorporated in Delaware in 1915, and our initial public offering of common stock was in December 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal office is located at 1775 Sherman Street, Suite 1200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +At SM Energy, our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to domestic energy security and prosperity, and having a positive impact in the communities where we live and work. Our long-term vision for the Company is to sustainably grow value for all of our stakeholders. We believe that in order to accomplish this vision, we must be a premier operator of top tier assets. Our current energy project development portfolio is focused on oil and gas producing properties in the state of Texas. +Significant Developments in 2019 +Strategic Transformation. During 2019, we completed our strategic transformation, which commenced in 2016 through a series of asset acquisitions and divestitures. For the fourth quarter of 2019, we passed an important milestone by achieving a positive difference between our net cash provided by operating activities and our net cash used in investing activities. Our operational execution in 2019 was outstanding, achieving our objectives in important industry metrics, including key top-quartile benchmarks for environmental, health, and safety performance. We were also successful in proving up additional investment opportunities on our existing acreage positions. +Production. Our average daily production in 2019 consisted of 59.9 MBbl of oil, 300.8 MMcf of gas, and 22.2 MBbl of NGLs, for an average net daily equivalent production rate of 132.3 MBOE, which represented a 10 percent increase compared with 2018 . This increase was primarily driven by a 25 percent increase in production volumes from our Midland Basin assets as a result of strong well performance, increased drilling and completion efficiencies, improved completion designs, and longer laterals. We completed more lateral feet in 2019 compared with 2018 , driving continued increases in volumes at a lower average drilling and completion cost. On a retained asset basis, our production volumes increased 13 percent in 2019 . As a result of the above, oil production revenue was approximately 75 percent of total production revenue for the year ended December 31, 2019 , compared with 65 percent and 52 percent for the years ended December 31, 2018 and 2017 , respectively. Please refer to Areas of Operation below for additional discussion. +Reserves and Capital Investment. Our estimated proved reserves decreased eight percent to 462.0 MMBOE at December 31, 2019 , from 503.4 MMBOE at December 31, 2018 . Reserve additions from discoveries, extensions, and infills totaled 98.4 MMBOE and were a result of our successful development programs, completion optimizations that resulted in improved well performance, and development plan improvements that we believe will enhance inventory value. The 2019 reserve additions were offset by 2019 production volumes of 48.3 MMBOE and by downward revisions of 94.7 MMBOE, which resulted primarily from the impact of lower commodity prices. Our proved reserve life index decreased to 9.6 years as of December 31, 2019 , compared with 11.5 years as of December 31, 2018 . Costs incurred for development and exploration activities, excluding acquisitions, decreased 23 percent from the prior year to $1.0 billion in 2019 . Please refer to Areas of Operation and Reserves below, and to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Net Cash Provided by Operating Activities. Net cash provided by operating activities was $823.6 million for the year ended December 31, 2019 , compared with $720.6 million for the year ended December 31, 2018 , which was an increase of 14 percent year-over-year. Oil, gas, and NGL production revenues decreased for the year ended December 31, 2019 , compared with 2018 , as the impact from higher production volumes was offset by lower commodity prices. However, the impact of lower commodity prices in 2019 was offset by a net derivative cash settlement gain of $39.2 million for the year ended December 31, 2019 , compared to a net derivative cash settlement loss of $135.8 million for 2018 . Please refer to Analysis of Cash Flow Changes Between 2019 and 2018 and Between +7 +2018 and 2017 in Overview of Liquidity and Capital Resources in Part II, Item 7, and to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Outlook +Our business outlook for the next several years is a continuation of our trajectory of improving operating margins and cash flows while strengthening our balance sheet through absolute debt reduction and improved leverage metrics. Our total capital program in 2020, is budgeted to be between $825.0 million and $850.0 million, and is expected to be approximately 20% lower compared with 2019, in large part due to significant cost reductions and efficiencies that were achieved in 2019. Our 2020 program will be focused on highly economic oil development projects in both our Midland Basin and South Texas assets. We expect total production volumes in 2020 to decrease slightly compared with 2019 as expected continued growth in our oil production volumes will not completely offset expected decreases in gas and NGL production volumes. +Sustainability is a key focus of our plans, in terms of positioning ourselves financially to participate in future energy investment opportunities, and executing our strategy of being a premier operator with high standards for corporate responsibility. We are committed to exceptional safety, health, and environmental stewardship; supporting the professional development of a diverse and thriving team of employees; making a positive difference in the communities where we live and work; and transparency in reporting on our progress in these areas. +Please refer to Overview of Liquidity and Capital Resources in Part II, Item 7 of this report for discussion of how we expect to fund our 2020 capital program. +Areas of Operation +Our 2019 operations were concentrated in the Midland Basin and South Texas, as further described below. The following table summarizes estimated proved reserves, production, and costs incurred in oil and gas producing activities (“costs incurred”) for the year ended December 31, 2019 , for these areas: +Midland Basin +South Texas +Total (1) +Proved reserves +Oil (MMBbl) +167.5 +16.6 +184.1 +Gas (Bcf) +398.8 +824.4 +1,223.2 +NGLs (MMBbl) +0.1 +73.9 +74.0 +MMBOE (1) +234.1 +227.8 +462.0 +Relative percentage +51 +% +49 +% +100 +% +Proved developed % +49 +% +58 +% +53 +% +Production +Oil (MMBbl) +20.5 +1.3 +21.9 +Gas (Bcf) +34.4 +75.4 +109.8 +NGLs (MMBbl) +— +8.1 +8.1 +MMBOE (1) +26.3 +22.0 +48.3 +Avg. daily equivalents (MBOE/d) (1) +72.0 +60.3 +132.3 +Relative percentage +54 +% +46 +% +100 +% +Costs incurred (in millions) (2) (3) +$ +859.6 +$ +160.9 +$ +1,040.2 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +Regional costs incurred do not sum to total costs incurred due primarily to corporate overhead charges incurred on exploration activities that are excluded from this regional table. Please refer to Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +(3) +Costs incurred for 2019 included $11.3 million related to acquisitions of primarily unproved oil and gas properties in the Midland Basin. Please refer to Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Excluding acquisition activity, costs incurred decreased in 2019 by 23 percent compared with 2018 primarily due to increased operational efficiencies and decreased drilling, completion crew, and sand costs incurred in developing our Midland Basin assets. Total estimated proved reserves at year end 2019 decreased eight percent from 2018 . Production increased 10 percent on an equivalent basis for the year ended December 31, 2019 , compared with 2018 , and increased 13 percent on a retained assets basis. +8 +Midland Basin. Our Midland Basin assets are located within the Permian Basin in Western Texas and are comprised of approximately 80,000 net acres (“Midland Basin”). In 2019 , we focused on continuing to delineate, develop, and expand our Midland Basin position. Our current Midland Basin position provides substantial future development opportunities within multiple oil-rich intervals, including the Spraberry and Wolfcamp formations. +In 2019, we incurred $859.6 million of costs and averaged six drilling rigs and three completion crews. The majority of our Midland Basin capital was deployed on projects targeting the Lower Spraberry and Wolfcamp A and B intervals on our RockStar assets in Howard and Martin Counties, Texas and Sweetie Peck assets in Upton and Midland Counties, Texas. We completed 123 gross ( 111 net) wells and full-year production increased 25 percent year-over-year to 26.3 MMBOE for 2019 . As of December 31, 2019 , there were 51 gross ( 48 net) wells that had been drilled but not completed in our Midland Basin program. Estimated proved reserves increased nine percent to 234.1 MMBOE at year end 2019 , from 214.3 MMBOE at year end 2018 . This increase was driven by additions of 58.9 MMBOE from discoveries, extensions and infill, and acquisitions, partially offset by 12.6 MMBOE of downward revisions from price, performance, and aged proved undeveloped reserves. +South Texas. Our South Texas assets are comprised of approximately 158,900 net acres located in Dimmit and Webb Counties, Texas (“South Texas”). Our current operations in South Texas are focused on developing the Eagle Ford shale formation and delineating the Austin Chalk formation. Our overlapping acreage position in the Eagle Ford shale and Austin Chalk formations covers a significant portion of the western Eagle Ford shale and Maverick Basin Austin Chalk (“Eagle Ford shale”) and includes acreage across the oil, gas-condensate, and dry gas windows with gas composition amenable to processing for NGL extraction. +In 2019 , we incurred $160.9 million of costs and averaged one drilling rig and one completion crew. We completed 31 gross ( 20 net) wells during 2019 , and full-year regional production increased one percent year-over-year to 22.0 MMBOE for 2019 . As of December 31, 2019 , there were 21 gross ( 21 net) wells that had been drilled but not completed in our South Texas program. +Certain drilling and completion activities in the northern portion of our South Texas acreage position were primarily funded by a third party pursuant to our joint development agreement. The agreement provided that the third party carried substantially all drilling and completion costs and receives a majority of the working and revenue interest in these wells until certain payout thresholds are reached. This arrangement allowed us to leverage third-party capital to prove up the value of our Eagle Ford North area, while also allowing us to test cutting edge technology, capture additional technical data, satisfy certain lease obligations, and potentially expand economic drilling inventory in the future. All wells subject to this agreement were drilled and completed as of December 31, 2019 . +During 2019, we added 43.0 MMBOE of estimated proved reserves, offset by downward revisions of 82.1 MMBOE, of which 68.5 MMBOE resulted from decreased commodity pricing and 10.3 MMBOE resulted from performance revisions. As a result, estimated proved reserves decreased 21 percent to 227.8 MMBOE at year end 2019 , from 289.1 MMBOE at year end 2018 . +Reserves +Reserve estimates are inherently imprecise and estimates for new discoveries and undeveloped locations are more imprecise than reserve estimates for producing oil and gas properties. Accordingly, we expect these estimates to change as new information becomes available. The following table presents the standardized measure of discounted future net cash flows and pre-tax PV-10 (“PV-10”). PV-10 is a non-GAAP financial measure, and generally differs from the standardized measure of discounted future net cash flows, the most directly comparable GAAP financial measure, because it does not include the effects of income taxes on future net revenues. Neither the standardized measure of discounted future net cash flows nor PV-10 represents the fair market value of our oil and gas properties. We and others in the oil and gas industry use PV-10 as a measure to compare the relative size and value of proved reserves held without regard to the specific tax characteristics of such entities. Please refer to the Glossary of Oil and Gas Terms section of this report for additional information regarding these measures and refer to the reconciliation of the standardized measure of discounted future net cash flows to PV-10 set forth below. The actual quantities and present value of our estimated proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The following table should be read along with the section entitled Risk Factors – Risks Related to Our Business below. +Our ability to replace production with new oil and gas reserves is critical to the future success of our business. Please refer to the reserve life index term in the Glossary of Oil and Gas Terms section of this report for information describing how this metric is calculated. +9 +The following table summarizes estimated proved reserves, the standardized measure of discounted future net cash flows (GAAP), PV-10 (non-GAAP), the prices used in the calculation of proved reserves estimates, and reserve life index as of December 31, 2019 , 2018 , and 2017 : +As of December 31, +2019 +2018 +2017 +Reserve data: +Proved developed +Oil (MMBbl) +85.0 +68.2 +58.6 +Gas (Bcf) +712.1 +699.1 +642.9 +NGLs (MMBbl) +43.4 +60.1 +49.0 +MMBOE (1) +247.0 +244.8 +214.7 +Proved undeveloped +Oil (MMBbl) +99.1 +107.6 +99.6 +Gas (Bcf) +511.1 +622.7 +637.2 +NGLs (MMBbl) +30.6 +47.2 +47.6 +MMBOE (1) +214.9 +258.6 +253.4 +Total proved (1) +Oil (MMBbl) +184.1 +175.7 +158.2 +Gas (Bcf) (2) +1,223.2 +1,321.8 +1,280.1 +NGLs (MMBbl) +74.0 +107.4 +96.5 +MMBOE +462.0 +503.4 +468.1 +Proved developed reserves % +53 +% +49 +% +46 +% +Proved undeveloped reserves % +47 +% +51 +% +54 +% +Reserve data (in millions): +Standardized measure of discounted future net cash flows (GAAP) +$ +4,104.0 +$ +4,654.4 +$ +3,024.1 +PV-10 (non-GAAP): +Proved developed PV-10 +$ +2,830.4 +$ +3,084.2 +$ +1,984.2 +Proved undeveloped PV-10 +1,532.4 +2,020.1 +1,072.3 +Total proved PV-10 (non-GAAP) +$ +4,362.8 +$ +5,104.3 +$ +3,056.5 +12-month trailing average prices (3) +Oil (per Bbl) +$ +55.69 +$ +65.56 +$ +51.34 +Gas (per MMBtu) +$ +2.58 +$ +3.10 +$ +3.00 +NGLs (per Bbl) +$ +22.68 +$ +33.45 +$ +27.69 +Reserve life index (years) +9.6 +11.5 +10.5 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +For the years ended December 31, 2019 , 2018 , and 2017 , proved gas reserves contained 44.9 Bcf, 59.1 Bcf, and 48.1 Bcf of gas, respectively, that we expect to produce and use as a field equipment fuel source (primarily to power compressors). +(3) +The prices used in the calculation of proved reserve estimates reflect the 12-month average of the first-day-of-the-month prices in accordance with SEC rules. We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. +10 +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the PV-10 (non-GAAP) of total estimated proved reserves. Please refer to the Glossary of Oil and Gas Terms section of this report for the definitions of standardized measure of discounted future net cash flows and PV-10. +As of December 31, +2019 +2018 +2017 +(in millions) +Standardized measure of discounted future net cash flows (GAAP) +$ +4,104.0 +$ +4,654.4 +$ +3,024.1 +Add: 10 percent annual discount, net of income taxes +2,955.3 +3,847.1 +2,573.2 +Add: future undiscounted income taxes +579.8 +1,012.2 +205.7 +Pre-tax undiscounted future net cash flows +7,639.1 +9,513.7 +5,803.0 +Less: 10 percent annual discount without tax effect +(3,276.3 +) +(4,409.4 +) +(2,746.5 +) +PV-10 (non-GAAP) +$ +4,362.8 +$ +5,104.3 +$ +3,056.5 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from future wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of production when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time. As of December 31, 2019 , we did not have any proved undeveloped reserves that had been on our books in excess of five years, and none of our proved undeveloped reserves were on acreage expected to expire or on acreage that was not expected to be held through renewal before the targeted completion date. +For proved undeveloped locations that are more than one development spacing area from developed producing locations, we utilized reliable geologic and engineering technology when booking estimated proved undeveloped reserves. Of the 214.9 MMBOE of total proved undeveloped reserves as of December 31, 2019 , approximately 60.1 MMBOE of proved undeveloped reserves in the Midland Basin and 68.7 MMBOE of proved undeveloped reserves in our South Texas position were offset by more than one development spacing area from the nearest developed producing location. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected) and petrophysical analysis of that log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. In all other areas, we restricted proved undeveloped locations to development spacing areas that are immediately adjacent to developed spacing areas. +As of December 31, 2019 , estimated proved undeveloped reserves decreased 43.7 MMBOE, or 17 percent compared with December 31, 2018 . The following table provides a reconciliation of our proved undeveloped reserves for the year ended December 31, 2019 : +Total +(MMBOE) +Total proved undeveloped reserves: +Beginning of year +258.6 +Revisions of previous estimates +(47.6 +) +Additions from discoveries, extensions, and infill +78.5 +Purchases of minerals in place +1.9 +Removed for five-year rule +(9.8 +) +Conversions to proved developed +(66.7 +) +End of year +214.9 +Revisions of previous estimates. Revisions of previous estimates includes a downward pricing revision of 42.3 MMBOE from our South Texas program as a result of decreased gas and NGL prices. In addition, we had downward performance revisions of 6.0 MMBOE in our Midland Basin program as we updated certain assumptions based on future well spacing. +11 +Additions from discoveries, extensions, and infill. We added 40.8 MMBOE and 30.4 MMBOE of infill estimated proved undeveloped reserves in our Midland Basin and South Texas assets, respectively, in 2019 . We added an additional 3.1 MMBOE and 4.1 MMBOE of estimated proved undeveloped reserves in the Midland Basin and South Texas, respectively, through various extensions and discoveries. The majority of additions in our Midland Basin and South Texas programs resulted from future development projects identified by our on-going development and portfolio optimization activities. +Removed for five-year rule. As a result of our testing and delineation efforts in 2019, we revised certain aspects of our future development plans to focus on maximizing returns and the value of our assets. As a result, we removed 9.8 MMBOE of estimated proved undeveloped reserves and reclassified these locations to unproved reserve categories. The reclassified locations were generally replaced by locations with higher quality proved undeveloped reserves, which are reflected as additions from discoveries, extensions, and infill. +Conversions to proved developed. Our 2019 conversion rate was 26 percent . During 2019 , we incurred $686.3 million on projects with reserves booked as proved undeveloped at the end of 2018 , of which $611.1 million was spent on converting proved undeveloped reserves to proved developed reserves by December 31, 2019 . At December 31, 2019 , drilled but not completed wells represented 26.8 MMBOE of total estimated proved undeveloped reserves. We expect to incur $182.0 million of capital expenditures in completing these drilled but not completed wells, and we expect all estimated proved undeveloped reserves to be converted to proved developed reserves within five years from their initial booking as proved undeveloped reserves. +As of December 31, 2019 , estimated future development costs relating to our proved undeveloped reserves were $591.5 million , $615.6 million , and $458.1 million in 2020 , 2021 , and 2022 , respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group and is coordinated by our Corporate Engineering Manager, subject to the oversight of our management and the Audit Committee of our Board of Directors, as discussed below. Our Corporate Engineering Manager has approximately 12 years of experience in the energy industry and has been employed by the Company for 10 years. He holds a Bachelor of Science Degree in Petroleum Engineering from Montana Tech of the University of Montana and is a Registered Professional Petroleum Engineer in the states of Texas, Wyoming and Montana. He is also a member of the Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the year by our regional staff. Data, obtained from these reviews, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our regional engineering technical staff do not report directly to our Corporate Engineering Manager; they report to either their respective regional technical managers or directly to the regional manager. This design is intended to promote objective and independent analysis within our regions in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world for over 70 years. Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are required, per our policy, to be within 10 percent of our proved reserve amounts for the total Company, as well as for each respective region. The technical person at Ryder Scott primarily responsible for overseeing our reserves audit is an Advising Senior Vice President who received a Bachelor of Science degree in Chemical Engineering from Purdue University in 1979 and a Master of Science degree in Chemical Engineering from the University of California, Berkeley, in 1981. He is a licensed Professional Engineer in the State of Texas and a member of the Society of Petroleum Engineers and the Society of Petroleum Evaluation Engineers. The 2019 Ryder Scott report concerning our reserves is included as Exhibit 99.1. +In addition to a third-party audit, our reserves are reviewed by our management with the Audit Committee of our Board of Directors. Our management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Executive Vice President and Chief Operating Officer, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives, apart from our management, from time to time to discuss processes and findings. +12 +Production +The following table summarizes the volumes and realized prices of oil, gas, and NGLs produced and sold from properties in which we held an interest during the periods presented. Realized prices presented below exclude the effects of derivative contract settlements. Also presented is a summary of related production expense on a per BOE basis. +For the Years Ended December 31, +2019 +2018 +2017 +Net production volumes +Oil (MMBbl) +21.9 +18.8 +13.7 +Gas (Bcf) +109.8 +103.2 +123.0 +NGLs (MMBbl) +8.1 +7.9 +10.3 +Equivalent (MMBOE) (1) +48.3 +43.9 +44.5 +Midland Basin net production volumes (2) +Oil (MMBbl) +20.5 +16.6 +8.5 +Gas (Bcf) +34.4 +25.8 +14.7 +NGLs (MMBbl) +— +— +— +Equivalent (MMBOE) (1) +26.3 +20.9 +11.0 +Eagle Ford shale net production volumes (2)(3) +Oil (MMBbl) +1.3 +1.2 +1.9 +Gas (Bcf) +75.4 +76.1 +104.0 +NGLs (MMBbl) +8.1 +7.9 +10.1 +Equivalent (MMBOE) (1) +21.9 +21.8 +29.3 +Realized price, before the effect of derivative settlements +Oil (per Bbl) +$ +54.10 +$ +56.80 +$ +47.88 +Gas (per Mcf) +$ +2.39 +$ +3.43 +$ +3.00 +NGLs (per Bbl) +$ +17.26 +$ +27.22 +$ +22.35 +Per BOE +$ +32.84 +$ +37.27 +$ +28.20 +Production expense per BOE +Lease operating expense +$ +4.67 +$ +4.74 +$ +4.43 +Transportation costs +$ +3.88 +$ +4.36 +$ +5.48 +Production taxes +$ +1.35 +$ +1.52 +$ +1.18 +Ad valorem tax expense +$ +0.48 +$ +0.48 +$ +0.34 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +For each of the years ended December 31, 2019 , 2018 , and 2017 , total estimated proved reserves attributed to our Midland Basin assets and our Eagle Ford shale assets exceeded 15 percent of our total estimated proved reserves expressed on an equivalent basis. +(3) +During the first quarter of 2017, we completed the divestiture of our outside-operated Eagle Ford shale assets. These assets represented approximately 1.5 MMBOE of net production on an equivalent basis for the year ended December 31, 2017. +Productive Wells +As of December 31, 2019 , we had working interests in 807 gross (758 net) productive oil wells and 519 gross (487 net) productive gas wells. Productive wells are exploratory, development, or extension wells that are producing, or are capable of commercial production of oil, gas, and/or NGLs. Productive wells may be temporarily shut-in. Multiple completions in the same wellbore are counted as one well. As of December 31, 2019 , two of these wells had multiple completions. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil when it first commenced production, but such designation may not be indicative of current or future production composition. +13 +Drilling and Completion Activity +All of our drilling and completion activities are conducted by independent contractors. We do not own any drilling or completion equipment. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2019 , 2018 , and 2017 , excluding non-consented projects, active injector wells, salt water disposal wells, or wells in which we own only a royalty interest: +For the Years Ended December 31, +2019 +2018 +2017 +Gross +Net +Gross +Net +Gross +Net +Development wells +Oil +119 +107 +103 +92 +56 +46 +Gas +27 +16 +39 +24 +38 +35 +Non-productive +1 +1 +— +— +4 +3 +147 +124 +142 +116 +98 +84 +Exploratory wells +Oil +4 +4 +18 +14 +32 +29 +Gas +4 +4 +1 +1 +— +— +Non-productive +1 +1 +— +— +1 +— +9 +9 +19 +15 +33 +29 +Total +156 +133 +161 +131 +131 +113 +A productive well is an exploratory, development, or extension well that is producing or is capable of commercial production of oil, gas, and/or NGLs. A non-productive well, frequently referred to within the industry as a dry hole, is an exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in sufficient commercial quantities to justify completion, or upon completion, the economic operation of a well. +As defined by the SEC, an exploratory well is a well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. A development well is a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. Completion refers to the installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry hole, the reporting to the appropriate authority that the well has been abandoned. +In addition to the wells drilled and completed in 2019 (included in the table above), we were actively participating in the drilling of 22 gross (20 net) wells and had 66 gross (63 net) drilled but not completed wells as of January 31, 2020. These drilled but not completed wells represent wells that were being completed or were waiting on completion as of January 31, 2020. +14 +Acreage +The following table sets forth the number of gross and net surface acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes that we held as of December 31, 2019 . Undeveloped acreage includes leasehold interests containing proved undeveloped reserves. +Developed Acres (1) +Undeveloped Acres (2)(3) +Total +Gross +Net +Gross +Net +Gross +Net +Midland Basin: +RockStar +67,113 +59,589 +4,966 +4,217 +72,079 +63,806 +Sweetie Peck +17,007 +15,782 +2,835 +251 +19,842 +16,033 +Midland Basin Total (4) +84,120 +75,371 +7,801 +4,468 +91,921 +79,839 +Eagle Ford shale +74,247 +71,296 +88,058 +87,631 +162,305 +158,927 +Other (5) +16,259 +11,363 +90,415 +25,599 +106,674 +36,962 +Total +174,626 +158,030 +186,274 +117,698 +360,900 +275,728 +____________________________________________ +(1) +Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations but has been included only as developed acreage in the table above. +(2) +Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) +As of February 6, 2020 , approximately 1,354 , 184 , and 155 net acres of undeveloped acreage are scheduled to expire by December 31, 2020 , 2021 , and 2022 , respectively, if production is not established or we take no other action to extend the terms of the applicable leases. Certain of our Eagle Ford shale acreage is subject to lease consolidation agreements containing drilling, completion, and other obligations that we currently intend to satisfy. Failure to meet these obligations results in termination of the lease consolidation agreements, which could result in additional future lease expirations if continuous development obligations required by individual leases are not met. +(4) +As of December 31, 2019 , total Midland Basin acreage excludes approximately 1,940 net acres associated with drill-to-earn opportunities that we intend to pursue. +(5) +Includes other non-core acreage located in Louisiana, Montana, North Dakota, Texas, Utah, and Wyoming. +Delivery Commitments +As of December 31, 2019 , we had gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum quantity of 24 MMBbl of oil and 424 Bcf of gas through 2023 , and 18 MMBbl of produced water through 2027 . We are required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. We expect to fulfill our delivery commitments from a combination of production from our existing productive wells, future development of our proved undeveloped reserves, and future development of resources not yet characterized as proved reserves. Under certain of our commitments, if we are unable to deliver the minimum quantity from our production, we may deliver production acquired from third-parties to satisfy our minimum volume commitments. +As of December 31, 2019 , in the event that no additional volumes are delivered in accordance with these agreements, the aggregate undiscounted future deficiency payments would total $218.5 million . This amount does not include deficiency payment estimates associated with approximately 16.5 MMBbl of future oil delivery commitments where we cannot predict with accuracy the amount and timing of these payments, as such payments are dependent upon the price of oil in effect at the time of settlement. +As of the filing of this report, we do not expect to incur any material shortfalls with regard to these commitments. +Major Customers +We do not believe the loss of any single purchaser of our production would materially impact our operating results, as oil, gas, and NGLs are products with well-established markets and other viable purchaser options are available in our operating regions. +15 +The following major customers and entities under common control accounted for 10 percent or more of our total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2019 +2018 +2017 +Major customer #1 (1) +18 +% +18 +% +6 +% +Major customer #2 (1) +14 +% +5 +% +1 +% +Major customer #3 (1) +13 +% +7 +% +— +% +Major customer #4 (1) +9 +% +10 +% +10 +% +Group #1 of entities under common control (2) +13 +% +18 +% +17 +% +Group #2 of entities under common control (2) +11 +% +12 +% +8 +% +____________________________________________ +(1) +These major customers are purchasers of a portion of our production from our Midland Basin assets. +(2) +In the aggregate, these groups of entities under common control represented purchasers of more than 10 percent of total oil, gas, and NGL production revenue for at least one of the periods presented; however, no individual entity comprising either group was a purchaser of more than 10 percent of our total oil, gas, and NGL production revenue. +Employees and Office Space +As of February 6, 2020 , we had 530 full-time employees. This is a 13 percent decrease from the 611 full-time employees that we reported as of February 7, 2019 . None of our employees are subject to a collective bargaining agreement. +The following table summarizes the approximate square footage of office space leased by us, as of December 31, 2019 , including our corporate headquarters and regional offices: +Approximate Square Footage Leased +Corporate +107,000 +Midland Basin +59,000 +South Texas +62,000 +Total +228,000 +In addition to the leased office space summarized in the table above, as of December 31, 2019 , we owned approximately 12,000 square feet of office space in South Texas. +Title to Properties +Substantially all of our oil and gas producing assets are held pursuant to oil and gas leases from third-party mineral owners. We obtain title opinions prior to commencing initial drilling operations on the properties we operate. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such properties. Most of our producing properties are subject to mortgages securing indebtedness under our Credit Agreement, royalty and overriding royalty interests, liens for current taxes, and other ordinary course burdens that we believe do not materially interfere with the development of such properties. We typically perform title investigation in accordance with standards generally accepted in the oil and gas industry before acquiring developed and undeveloped leasehold acreage. +Seasonality +The price of crude oil is primarily driven by global socioeconomic factors and is less affected by seasonal fluctuations; however, demand for energy is generally higher in the winter and the summer driving season. The demand and price for gas frequently increases during winter months and decreases during summer months. To lessen the impact of seasonal gas demand and price fluctuations, pipelines, utilities, local distribution companies, and industrial users regularly utilize gas storage facilities and forward purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can divert gas that is traditionally placed into storage which, in turn, may increase the typical winter seasonal price. Seasonal anomalies, such as mild winters, sometimes lessen these fluctuations. +Certain of our drilling, completion, and other operations are also subject to seasonal limitations. Seasonal weather conditions, government regulations, and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. Please refer to Risk Factors - Risks Related to Our Business below for additional discussion. +16 +Competition +The oil and gas industry is intensely competitive, particularly with respect to acquiring prospective oil and gas properties. We believe our acreage positions provide a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from a substantial number of major and independent oil and gas companies, which in some cases have larger technical teams and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and gas reserves, but also have gathering, processing or refining operations, market refined products, provide, dispose of and transport fresh and produced water, own drilling rigs or production equipment, or generate electricity. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting, and processing of oil, gas, NGLs and water. Consequently, we may face shortages, delays, or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including renewable energy sources such as solar and wind-generated energy, and other fossil fuels such as coal. Competitive conditions may be affected by future energy, climate-related, financial, or other policies, legislation, and regulations. +In addition, we compete for people, including experienced geologists, geophysicists, engineers, and other professionals. Throughout the oil and gas industry, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. We are not insulated from competition for quality people, and we must compete effectively in order to be successful. +Government Regulations +Nearly every aspect of our business is subject to expansive federal, state, and local laws and governmental regulations. These laws and regulations frequently change in response to economic or political conditions, or other developments, and our regulatory burden may increase in the future. Laws and regulations have the potential to increase our cost of doing business and consequently could affect our profitability. However, we do not believe that we are affected to a materially greater or lesser extent than others in our industry. +Energy Regulations +Texas, the state where we conduct operations and own nearly all of our oil and gas assets, has adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, imposing bond requirements in order to drill or operate wells, governing the timing of drilling and location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to Texas conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, Texas conservation laws establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Our sales of gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for gas production. +Environmental, Health and Safety Matters +General. Our operations are subject to stringent and complex federal, state, and local laws and regulations governing protection of the environment and worker health and safety as well as the discharge of materials into the environment. These laws and regulations may, among other things: +• +require the acquisition of various permits before drilling commences; +• +restrict the types, quantities and concentration of various substances that can be released into the environment in connection with oil and gas drilling and production and saltwater disposal activities; +• +limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +17 +• +require remedial measures to mitigate pollution from former and ongoing operations, such as closing pits and plugging abandoned wells. +These laws, rules, and regulations may also restrict the rate of oil and gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent, or different permitting, waste handling, disposal, and cleanup requirements for the oil and gas industry and could have a significant impact on our operating costs. +The following is a summary of some of the existing laws, rules, and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation, and Liability Act. The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release or threatened release of a hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +We currently own, lease, or operate numerous properties that have been used for oil and gas exploration and production for many years. Although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third-parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, or analogous state agencies. The Clean Water Act also prohibits discharge of dredged or fill material into waters of the United States, including wetlands, except in accordance with the terms of a permit issued by the United States Army Corps of Engineers, or a state if the state has assumed authority to issue such permits. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for containment and removal costs, natural resource damages and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of toxic air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane, and other “greenhouse gases” (“GHG”) present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on these findings, the EPA began adopting and implementing a comprehensive suite of regulations to restrict emissions of GHGs under existing provisions of the CAA. The Trump administration has taken steps to rescind or review many of these regulations. Legislative and regulatory initiatives related to climate +18 +change could have an adverse effect on our operations and the demand for oil and gas. Please refer to Risk Factors - Risks Related to Our Business - Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs. In addition to the effects of regulation, the meteorological effects of global climate change could pose additional risks to our operations, including physical damage risks associated with more frequent, more intensive storms and flooding, and could adversely affect the demand for our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +National Environmental Policy Act. Oil and gas exploration and production activities on federal lands are subject to the National Environmental Policy Act (“NEPA”). NEPA requires federal agencies, including the Department of Interior, to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an environmental assessment to determine the potential direct, indirect, and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed environmental impact statement that may be made available for public review and comment. The Trump administration has taken steps to modify NEPA’s implementing regulations intended to streamline the NEPA process. No new regulations have yet been finalized. Judicial and regulatory challenges are expected, and we cannot predict the outcome of any such challenges. All of our current exploration and production activities, as well as proposed exploration and development plans, on federal lands require governmental permits subject to the requirements of NEPA. This process has the potential to delay development of some of our oil and gas projects. +OSHA and other laws and regulations. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand, and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions. However, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition to oil and gas activities using hydraulic fracturing techniques, which could potentially cause a decrease in the completion of new oil and gas wells, an increase in compliance costs, and delays, all of which could adversely affect our financial position, results of operations and cash flows. As new laws or regulations that significantly restrict hydraulic fracturing are adopted at the state and local levels, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and gas that we are ultimately able to produce from our reserves. +We believe it is reasonably likely that the trend in local and state environmental legislation and regulation will continue toward stricter standards, while the trend in federal environmental legislation and regulation faces an uncertain future under the Trump administration. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health and Safety Initiatives. We are committed to exceptional safety, health, and environmental stewardship; making a positive difference in the communities where we live and work; and transparency in reporting on our progress in these areas. We set annual goals for our environmental, health and safety program focused on reducing the number of safety related incidents and the number and impact of spills of produced fluids. In addition, we set annual goals for GHG emissions intensity and methane emissions as a percentage of total methane produced. We also periodically conduct audits of our operations to ensure regulatory compliance and we strive to provide appropriate training for our employees. Reducing air emissions as a result of leaks, venting, or +19 +flaring of gas during operations has become a major focus area for regulatory efforts and for our compliance efforts. While flaring is sometimes necessary, reducing these volumes is a priority for us. To avoid flaring when possible, we restrict testing periods and connect our production to gas pipeline infrastructure as quickly as possible after well completions. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC, and can be located at www.sec.gov. We also make available through our website our Corporate Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, and the Charters of the Audit, Compensation, Executive, and Nominating and Corporate Governance Committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in us. +Risks Related to Our Business +Oil, gas, and NGL prices are volatile, and declines in prices adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and gas properties depend heavily on the prices we receive for oil, gas, and NGL sales. Oil, gas, and NGL prices also affect our cash flows available for capital expenditures and other items, our borrowing capacity, and the volume and value of our oil, gas, and NGL reserves. For example, the amount of our borrowing base under our Credit Agreement is subject to periodic redetermination based on oil, gas, and NGL prices specified by our bank group at the time of redetermination. In addition, we may have oil and gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. Please refer to Significant Developments in 2019 and Reserves in Part I, Items 1 and 2 Comparison of Financial Results and Trends Between 2019 and 2018 and Between 2018 and 2017 in Part II, Item 7, and Note 1 – Summary of Significant Accounting Policies , Note 11 – Fair Value Measurements , and Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 for specific discussion. +Historically, the markets for oil, gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in oil, gas, and NGL prices may result from relatively minor changes in the supply of and demand for oil, gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• +global and domestic supplies of oil, gas, and NGLs, and the productive capacity of the industry as a whole; +• +the level of consumer demand for oil, gas, and NGLs; +• +overall global and domestic economic conditions; +• +weather conditions; +• +the availability and capacity of gathering, transportation, processing, and/or refining facilities in regional or localized areas; +• +liquefied natural gas deliveries to and from the United States; +• +the price and availability of alternative fuels; +• +technological advances and regulations affecting energy consumption and conservation; +• +the ability of the members of the Organization of Petroleum Exporting Countries and other exporting countries to maintain effective oil price and production controls; +• +political instability or armed conflict in oil or gas producing regions; +• +actual or perceived epidemic risks, such as the Coronavirus outbreak in early 2020; +• +strengthening and weakening of the United States dollar relative to other currencies; +• +stockholder activism or activities by non-governmental organizations to limit sources of funding or restrict the exploration and production of oil, gas, and NGLs and related infrastructure; and +• +governmental regulations and taxes. +20 +Declines in oil, gas, and NGL prices would reduce our revenues and could also reduce the amount of oil, gas, and NGLs that we can produce economically, which could have a materially adverse effect on us. +Weakness in economic conditions or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +In the last decade, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, and an unprecedented level of intervention by the United States federal government and other governments. Weakness or uncertainty in the United States economy or other large economies could materially adversely affect our business and financial condition. For example: +• +the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• +the liquidity available under our Credit Agreement could be reduced if any lender is unable to fund its commitment; +• +our ability or the ability of our suppliers or contractors to access the capital markets may be restricted or non-existent at a time when we or they would like, or need, to raise capital for our or their business, including for the exploration and/or development of reserves; +• +our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; and +• +variable interest rate spread levels, including for LIBOR (or any applicable replacement rate) and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our Credit Agreement. +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find, develop, and acquire oil, gas, and NGL reserves that are economically producible. Our properties produce oil, gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate, develop and acquire new oil, gas, and NGL reserves to replace those being depleted by production. Competition for oil and gas properties is intense, and many of our competitors have financial, technical, human, and other resources necessary to evaluate and integrate acquisitions that are substantially greater than those available to us. +For our prior acquisitions, as well as any future acquisitions we may complete, a successful outcome for our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price and transaction costs for the acquisition, future oil, gas, and NGL prices, the ability to reasonably estimate the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves, actual future production rates, and associated costs and potential liabilities with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. Our customary review in connection with acquisitions will not necessarily reveal, or allow us to fully assess, all existing or potential problems and deficiencies with such properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. We often acquire interests in properties on an “as-is” basis with limited remedies for breaches of representations and warranties. +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of unique risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce oil, gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for oil, gas, and NGL sales, our success in locating, developing and acquiring new reserves, and the orderly functioning of +21 +credit and capital markets. If our cash flows from operations are less than expected, we may reduce our planned capital expenditures unless we can raise additional funds through debt or equity financing or the divestment of assets. Debt or equity financing may not always be available to us in sufficient amounts or on acceptable terms, and the proceeds offered to us for potential divestitures may not always be acceptable to us. Any downgrades to our credit ratings may make it more difficult or expensive for us to borrow additional funds. +If our revenues decrease in the future due to lower oil, gas, or NGL prices, decreased production, or other reasons, and if we cannot access sufficient liquidity under our Credit Agreement, other acceptable debt or equity financing arrangements, or through the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Our ability to sell oil, gas, and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third-parties or by other interruptions beyond our control, which could obstruct, limit, or eliminate our access to oil, gas, and NGL markets. +The marketability of our oil, gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems, which are generally owned or operated by third-parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay, or discontinuance of development plans for our properties, or lower price realizations. Although we have some influence over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of oil, gas, and NGL production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines or processing facilities, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, transport, or market oil, gas, and NGLs. +In particular, if production from the Midland Basin continues to grow, the amount of oil, gas, and NGLs being produced by us and others could exceed the capacity of, and result in constraints on, available gathering and transportation systems, pipelines, processing facilities, and other infrastructure. In such circumstances, it will be necessary for pipelines, gathering and transportation systems, processing facilities, and additional infrastructure to be expanded, built, or developed to accommodate anticipated production. Certain processing, pipeline, and other gathering, transportation, and infrastructure projects that might be, or are being, considered for these areas may not be developed timely or at all due to lack of financing or other constraints, including regulatory constraints. Capital and other constraints could also limit our ability to build or access intrastate gathering and transportation systems necessary to transport our production to interstate pipelines or other points of sale or delivery. In such event, we might have to delay or discontinue development activities or shut in our wells to wait for sufficient infrastructure development or capacity expansion and/or sell production at significantly lower prices, which would adversely affect our results of operations and cash flows. In addition, the operations of the third-parties on whom we rely for gathering, processing, and transportation services are subject to complex and stringent laws and regulations, which require obtaining and maintaining numerous permits, approvals, and certifications from various federal, state, and local government authorities. These third-parties may incur substantial costs in order to comply with existing and future laws and regulations. If existing laws and regulations governing such third-party services are revised or reinterpreted, or if new laws and regulations become applicable to their operations, these changes may affect the availability and costs of such services. Similarly, a failure to comply with such laws and regulations by the third-parties on whom we rely could have a material adverse effect on our business, financial condition, and results of operations. +A portion of our production in any region may be interrupted, or shut in, from time to time for numerous reasons, including as a result of weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market or other conditions. If a substantial amount of our production is interrupted at the same time, it could adversely affect our cash flows and results of operations. +Downgrades in our credit ratings by various credit rating agencies could impact our access to capital and materially adversely affect our business and financial condition. +Our debt rating levels could have materially adverse consequences on our business and future prospects and could: +• +limit our ability to access debt markets, including for the purpose of refinancing our existing debt; +• +cause us to refinance or issue debt with less favorable terms and conditions, which debt may restrict, among other things, our ability to make any dividend distributions or repurchase shares; +• +negatively impact current and prospective customers’ willingness to transact business with us; +• +impose additional insurance, guarantee and collateral requirements; +• +limit our access to bank and third-party guarantees, surety bonds and letters of credit; and +22 +• +cause our suppliers and financial institutions to lower or eliminate the level of credit provided through payment terms or intraday funding when dealing with us, thereby increasing the need for higher levels of cash on hand, which would decrease our ability to repay outstanding indebtedness. +We cannot provide assurance that any of our current Debt Ratings will remain in effect for any given period of time or that a Debt Rating will not be further lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances warrant. +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from major oil and gas companies, independent oil and gas exploration and production companies, and institutional and individual investors who seek oil and gas investments throughout the world, as well as the equipment, expertise, labor, and materials required to operate oil and gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many oil and gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. We may not be successful in acquiring and developing profitable properties in the face of this competition. In addition, other companies may have a greater ability to continue drilling activities during periods of low oil or gas prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition, and results of operations. +The loss of key personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team and other key personnel. The loss of their services could adversely affect our business. Our drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen, and other professionals. Competition for many of these professionals can be intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +The actual quantities and present value of our proved oil, gas, and NGL reserves may be less than we have estimated. +This report and certain of our other SEC filings contain estimates of our proved oil, gas, and NGL reserves and the estimated future net revenues from those reserves. These estimates are based on various assumptions, including assumptions required by the SEC relating to oil, gas, and NGL prices, drilling and completion costs, gathering and transportation costs, operating expenses, capital expenditures, effects of governmental regulation, taxes, timing of operations, and availability of funds. The process of estimating oil, gas, and NGL reserves is complex and involves significant decisions and assumptions in the evaluation of available geological, geophysical, engineering, and economic data for each reservoir. These estimates depend on many variables, and changes often occur as our knowledge of these variables evolves. Therefore, these estimates are inherently imprecise. In addition, our reserve estimates for properties that do not have a significant production history may be less reliable than estimates for properties with lengthy production histories. A lack of production history may contribute to inaccuracy in our estimates of proved reserves, future production rates, and the timing and/or amount of development expenditures. +Actual future production; prices for oil, gas, and NGLs; revenues; production taxes; development expenditures; operating expenses; and quantities of producible oil, gas, and NGL reserves will most likely vary from those estimated. Any significant variance of any nature could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than what we have previously estimated. In addition, we may adjust estimates of proved reserves to reflect production history, results of operations, results of exploration and development activity, prevailing oil, gas, and NGL prices, costs to develop and operate properties, and other factors, many of which are beyond our control. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2019 , 47 percent , or 214.9 MMBOE, of our estimated proved reserves were proved undeveloped. In order to develop our proved undeveloped reserves, as of December 31, 2019 , we estimate approximately $2.0 billion of capital expenditures would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +You should not assume that the standardized measure of discounted future net cash flows or PV-10 included in this report represent the current market value of our estimated proved oil, gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. For example, the present value of our proved reserves as of December 31, 2019 , was estimated using 12-month average sales prices of $55.69 per Bbl of oil (NYMEX WTI spot price), $2.58 per MMBtu of gas (NYMEX Henry Hub spot price), and $22.68 per Bbl of NGL (OPIS spot price). We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. During 2019 , our monthly average realized oil prices before the +23 +effect of derivative settlements were as high as $61.66 per Bbl and as low as $42.28 per Bbl for oil, were as high as $3.33 per Mcf and as low as $2.05 per Mcf for gas, and were as high as $20.06 per Bbl and as low as $13.84 per Bbl for NGLs. Many other factors will affect actual future net cash flows, including: +• +amount and timing of actual production; +• +supply and demand for oil, gas, and NGLs; +• +curtailments or increases in consumption by oil purchasers and gas pipelines; +• +changes in government regulations or taxes, including severance and excise taxes; and +• +escalations or reductions in service provider and equipment costs resulting from changes in supply and demand. +The timing of production from oil and gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to be used to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and gas industry in general are subject. +Our disposition activities may be subject to factors beyond our control, and in certain cases we may retain unforeseen liabilities for certain matters . +We regularly sell non-core assets in order to increase capital resources available for core assets and other purposes and to create organizational and operational efficiencies. We also occasionally sell interests in core assets for the purpose of accelerating the development and increasing efficiencies in other core assets. Various factors could materially affect our ability to dispose of such assets, including the approvals of governmental agencies or third-parties, the availability of purchasers willing to acquire the assets on terms we deem acceptable, or other matters or uncertainties that could impact such dispositions, including whether transactions could be consummated or completed in the form or timing and for the value that we anticipate. We at times may be required to retain certain liabilities or agree to indemnify buyers for certain matters related to the sold assets. The magnitude of any such retained liabilities or of the indemnification obligations may be difficult to quantify at the time of the transaction and ultimately could be material. +We have limited control over the activities on properties we do not operate. +Some of our properties are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs and materially and adversely affect our financial condition and results of operations. +We rely on third-party service providers to conduct drilling and completion and other related operations on properties we operate. +Where we are the operator of a property, we rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, gas, and NGLs, prevailing economic conditions and financial, business, and other factors. In addition, sustained low commodity prices could cause third-party service providers to consolidate or declare bankruptcy, which could limit our options for engaging such providers. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title reports in acquiring oil and gas leasehold interests. We obtain title opinions prior to commencing initial drilling operations on the properties we operate. Undeveloped acreage has greater risk of title defects than developed acreage and title insurance is not generally available for oil and gas properties. As is customary in our industry, we rely upon the judgment of staff and independent landmen who perform the field work of examining records in the appropriate governmental offices and title abstract facilities before acquiring a specific mineral interest and/or undertaking drilling activities. We, in some cases, perform curative work to correct deficiencies in the marketability of the title. Generally, under the terms of the operating agreements affecting our properties, any monetary loss attributable to a loss of title is to be borne by all parties to any such agreement in proportion to their interests in such property. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our financial condition, results of operations, and operating cash flow if such property is of sufficient value. +24 +Exploration and development drilling may not result in commercially producible reserves. +Oil and gas drilling, completion, and production activities are subject to numerous risks, including the risk that no commercially producible oil, gas, or NGLs will be found. The cost of drilling and completing wells is often uncertain, and oil, gas, or NGLs drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors may include, but are not limited to: +• +unexpected adverse drilling or completion conditions; +• +title problems; +• +disputes with owners or holders of surface interests on or near areas where we operate; +• +pressure or geologic irregularities in formations; +• +engineering and construction delays; +• +equipment failures or accidents; +• +hurricanes, tornadoes, flooding, or other adverse weather conditions; +• +governmental permitting delays; +• +compliance with environmental and other governmental requirements; and +• +shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +The prevailing prices for oil, gas, and NGLs affect the cost of and the demand for drilling rigs, completion and production equipment, and other related services. However, changes in costs may not occur simultaneously with corresponding changes in commodity prices. The availability of drilling rigs can vary significantly from region to region at any particular time. Although land drilling rigs can be moved from one region to another in response to changes in levels of demand, an undersupply of rigs in any region may result in drilling delays and higher drilling costs for the available rigs in that region. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a materially adverse effect on our ability to explore or develop our properties. +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if oil, gas, or NGLs are present, or whether they can be produced economically. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of oil, gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +Results in newer resource plays may be more uncertain than results in resource plays that are more developed and have longer established production histories. We and the industry generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +In addition, a significant part of our strategy involves increasing our inventory of drilling locations. Such multi-year drilling inventories can be more susceptible to long-term uncertainties that could materially alter the occurrence or timing of actual drilling. Because of these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled, although we have the present intent to do so for locations booked as proved undeveloped locations, or if we will be able to produce oil, gas, or NGLs from these potential drilling locations. +We may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire and we will lose our right to develop the related properties. Our total net acreage as of February 6, 2020 , that is scheduled to expire over the next three years, represents approximately one percent of our total net undeveloped acreage as of December 31, 2019 . Although we have identified numerous potential drilling locations, we may not be able to economically drill for and produce oil, gas, or NGLs from all of them, and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +25 +Part of our strategy involves drilling in existing or emerging resource plays using some of the latest available horizontal drilling and completion techniques. The results of our planned exploratory and delineation drilling in these plays are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us, other operators and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +Ultimately, the success of these drilling and completion techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for oil, gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing, or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids toward the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, result in increased lease operating expenses and adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in oil, gas, and NGL prices and the associated impact on cash flows, we have entered into various derivative contracts. Our derivative contracts in place include swap and collar arrangements for oil, and swap arrangements for gas and NGLs. We have also entered into basis swap arrangements for a portion of our expected Midland Basin oil production to reduce volatility associated with location differentials between where these volumes are sold and NYMEX WTI. As of December 31, 2019 , we were in a net accrued asset position of $21.5 million with respect to our oil, gas, and NGL derivative activities. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• +our production is less than expected; +• +one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +• +there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +In addition, commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from oil, gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other market conditions, including declines in oil, gas, and NGL prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. We do not believe the loss of any single purchaser would materially impact our operating results, as we have numerous options for purchasers in each of our operating areas for our oil, gas, and NGL production. Please refer to Concentration of Credit Risk and Major Customers in Note 1 – Summary of Significant Accounting Policies , in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. Additionally, the inability of our co-owners to pay joint interest billings could negatively impact our cash flows and financial ability to drill and complete current and future wells. +26 +We have entered into firm transportation contracts that require us to pay fixed sums of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of oil, gas, NGL, or produced water to our counterparties, our results of operations, financial position, and liquidity could be adversely affected. +As of December 31, 2019 , we were contractually committed to deliver 24 MMBbl of oil and 424 Bcf of gas through 2023 , and 18 MMBbl of produced water through 2027 . We may enter into additional firm transportation agreements as we expand the development of our resource plays. At the current time, we do not have enough proved developed reserves to offset these contractual liabilities, but we expect to develop reserves that will meet or exceed the commitments and therefore do not expect any material shortfalls. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, or if we further limit our capital expenditures due to future commodity price declines or for other reasons, the requirements to pay for quantities not delivered could have a material impact on our results of operations, financial position, and liquidity. +Future oil, gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our oil and gas properties. All property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending the determination of whether proved reserves have been discovered. If commercial quantities of hydrocarbons are not discovered with an exploratory well, the costs of drilling the well are expensed. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net cash flows, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Write downs for unproved properties are also evaluated for carrying costs in excess of fair value. This evaluation considers the potential for abandonment due to lease expirations, losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. For the years ended December 31, 2019 , 2018 , and 2017 , we incurred impairment of oil and gas properties expense totaling $33.8 million , $49.9 million , and $16.1 million , respectively. If the prices of oil, gas, or NGLs decline, or we have unsuccessful exploration efforts, it could cause additional proved and/or unproved property impairments in the future. +We review the carrying values of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and gas properties held for use cannot be reversed at a later date, even if oil, gas, or NGL prices increase. +Lower oil, gas, or NGL prices could limit our ability to borrow under our Credit Agreement. +Our Credit Agreement has a current commitment amount of $1.2 billion , subject to a borrowing base that the lenders redetermine semi-annually based on the bank group’s assessment of the value of our proved reserves, which in turn is impacted by oil, gas, and NGL prices. The borrowing base under our Credit Agreement is $1.6 billion , up from $1.5 billion at December 31, 2018 . The next semi-annual redetermination date is scheduled for April 1, 2020 . Divestitures of additional properties, incurrence of additional debt, or declines in commodity prices could limit our borrowing base and reduce the amount we can borrow under our Credit Agreement. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2019 , we had the following outstanding long-term debt: +• +$476.8 million of long-term senior unsecured debt relating to our 6.125% Senior Notes due 2022 (“2022 Senior Notes”) that we issued on November 17, 2014 ; +• +$500.0 million of long-term senior unsecured debt relating to our 5.0% Senior Notes due 2024 (“2024 Senior Notes”) that we issued on May 20, 2013 ; +• +$500.0 million of long-term senior unsecured debt relating to our 5.625% Senior Notes due 2025 (“2025 Senior Notes”) that we issued on May 21, 2015 ; +• +$500.0 million of long-term senior unsecured debt relating to our 6.75% Senior Notes due 2026 (“2026 Senior Notes”) that we issued on September 12, 2016 ; +• +$500.0 million of long-term senior unsecured debt relating to our 6.625% Senior Notes due 2027 (“2027 Senior Notes”, and all senior notes collectively referred to as the “Senior Notes”) that we issued on August 20, 2018 ; and, +• +$172.5 million in aggregate principal amount of long-term senior unsecured convertible debt relating to our 1.50% Senior Convertible Notes due July 1, 2021 (“Senior Convertible Notes”) that we issued on August 12, 2016 . +27 +Additionally, we had $122.5 million of outstanding borrowings under our Credit Agreement as of December 31, 2019 , resulting in $1.1 billion of available borrowing capacity under our secured credit facility. Our long-term debt represented 50 percent of our total book capitalization as of December 31, 2019 . +Our indebtedness could have important consequences for our operations, including: +• +making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• +requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to productive investments; +• +limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• +placing us at a competitive disadvantage compared to our competitors with less debt; and +• +making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our Credit Agreement or from other sources, we might not be able to service our debt, issue additional debt, or fund our planned capital expenditures and other liquidity needs. If we are unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our Credit Agreement and any future credit agreements, may prohibit us from pursuing any of these alternatives. Further, changes in the credit ratings of our debt may negatively affect the cost, terms, conditions, and availability of future financing. +Our debt agreements, including our Credit Agreement and the indentures governing our Senior Notes and our Senior Convertible Notes, permit us to incur additional debt in the future, subject to compliance with restrictive covenants under those agreements. In addition, entities we may acquire in the future could have significant amounts of debt outstanding that we could be required to assume, and in some cases accelerate repayment thereof, in connection with the acquisition, or we may incur our own significant indebtedness to consummate an acquisition. +As discussed above, our Credit Agreement is subject to periodic borrowing base redeterminations. We could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate adjustments to our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt arrangements contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements, including our Credit Agreement and the indentures governing our Senior Notes and our Senior Convertible Notes, contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our ability to borrow under our Credit Agreement is subject to compliance with certain financial covenants. Financial covenants under the Credit Agreement require that our (a) total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX ratio for the most recently ended four consecutive fiscal quarters (excluding the first three quarters which will use annualized adjusted EBITDAX), cannot be greater than 4.25 to 1.00 beginning with the quarter ending December 31, 2018, through and including the fiscal quarter ending December 31, 2019, and for each quarter ending thereafter, the ratio cannot be greater than 4.00 to 1.00; and (b) adjusted current ratio cannot be less than 1.0 to 1.0 as of the last day of any fiscal quarter. Our Credit Agreement also requires us to comply with certain additional financial covenants, including a requirement that we limit our annual cash dividends to no more than $50.0 million . These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. We were in compliance with all financial and non-financial covenants as of December 31, 2019 , and through the filing of this report. Please refer to Non-GAAP Financial Measures in Part II, Item 7 of this report for our definition of adjusted EBITDAX. +The respective indentures governing the Senior Notes and Senior Convertible Notes also contain covenants that, among other things, limit our ability and the ability of our subsidiaries to: +• +incur additional debt; +• +make certain dividends or pay dividends or distributions on our capital stock or purchase, redeem, or retire common stock; +• +sell assets, including common stock of our subsidiaries; +• +restrict dividends or other payments of our subsidiaries; +28 +• +create liens that secure debt; +• +enter into transactions with affiliates; and +• +merge or consolidate with, or transfer or lease all or substantially all of our assets to another company. +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +Our increasing dependence on digital technologies puts us at risk for a cyber incident that could result in information theft, data corruption, operational disruptions or financial loss. +We are subject to cybersecurity risks. The oil and gas industry is increasingly dependent on digital technology in all aspects of our business. We use digital technology to conduct certain of our drilling development, production and gathering activities, manage drilling rigs and completion equipment, gather and interpret seismic data, conduct reservoir modeling, record financial and operating data, and maintain employee and other databases. Our service providers, including those who gather, process and market our oil, gas and NGLs, are also increasingly reliant on digital technology. Our and their reliance on this technology increasingly puts us at risk for technology system failures, data or network disruptions, cyberattacks and other breaches in cybersecurity. Power failures, telecommunication or other system failures due to hardware or software malfunctions, computer viruses, vandalism, terrorism, natural disasters, fire, flood, human error or other means could significantly impair our ability to conduct our business. +Cybersecurity attacks in particular are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data. Deliberate attacks on, or security breaches in our systems, infrastructure, the systems and infrastructure of third-parties, or cloud-based applications could lead to disclosure of confidential information, a corruption or loss of our proprietary data, delays in production or exploration activities, difficulty in completing or settling transactions, challenges in maintaining our books and records, environmental damage, communication or other operational disruptions, and liability to third parties. Any insurance we might obtain in the future may not provide adequate protection from these risks. Any such events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. As these cyber risks continue to evolve and our dependence on digital technologies grows, we may be required to expend significant additional resources to continue to modify or enhance our protective measures and remediate cyber vulnerabilities. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As an oil, gas, and NGL producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third-party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel, or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +The threat of terrorism and the impact of military and other actions have caused instability in world financial markets and could lead to increased volatility in prices for oil, gas, and NGLs, all of which could adversely affect the markets for our production. Energy assets might be specific targets of terrorist attacks. While we currently maintain some insurance that provides coverage against terrorist attacks, such insurance has become increasingly expensive and difficult to obtain. As a result, insurance providers may not continue to offer this coverage to us on terms we consider reasonable, or at all. In addition, this insurance may not cover all of our losses for a terrorist attack. These developments have subjected our operations to increased risk and, depending on their occurrence and ultimate magnitude, could have a material adverse effect on our business, financial condition, or results of operations. +Negative public perception and investor sentiment regarding our business and the oil and gas industry as a whole could adversely affect our business, operations and our ability to attract capital. +Certain segments of the public as a whole, and the investment community in particular, have developed negative sentiment towards our industry. Recent equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. In addition, some investors, including investment management firms, sovereign wealth and pension funds, university endowments and other investment advisors, have adopted policies to discontinue or reduce their investments in the oil and gas sector based on social and environmental considerations. Furthermore, other influential stakeholders have pressured commercial and investment banks to reduce or cease financing of oil and gas companies and related infrastructure projects. +Such developments, including environmental activism and initiatives aimed at limiting climate change and reducing air pollution, could result in downward pressure on the stock prices of oil and gas companies, including ours. This may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +29 +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of oil, gas and NGLs, or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, seismic events, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occurs, we could sustain substantial losses. +Furthermore, if we experience any of the problems with well stimulation and completion activities referenced above, our ability to explore for and produce oil, gas, or NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shut down, abandon, or relocate drilling operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling, and disposal of materials, including produced water, solid and hazardous wastes, and petroleum hydrocarbons. We may incur joint and several, and/or strict liability under applicable United States federal and state environmental laws in connection with releases of petroleum hydrocarbons and other hazardous substances at, on, under or from our leased or owned properties, some of which have been used for oil and gas exploration and production activities for a number of years, often by third-parties not under our control. For our outside-operated properties, we are dependent on the operator for operational and regulatory compliance and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or therefrom could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including CERCLA or the Superfund law, RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under various implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury or property damage, including induced seismicity damage, allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third-parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer a material loss. +Our operations are subject to complex laws and regulations, including environmental regulations that result in substantial costs and other risks. +Federal, state, and local authorities extensively regulate the oil and gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing, or marketing of oil, gas, and NGL production. Non-compliance with statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +Governmental authorities regulate various aspects of drilling for and the production of oil, gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in oil and gas properties, rights-of-way and easements, disposal of produced water, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, restoration standards, and oil and gas operations. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Federal authorities also may require any of our ongoing or planned operations on federal leases to be delayed, suspended, or terminated. Any such delay, suspension, or termination could have a materially adverse effect on our operations. +30 +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate in, could result in material costs or claims with respect to properties we own or have owned. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, and local environmental laws for emissions and for discharges of oil, gas, and NGLs or other pollutants into the air, soil, surface water, or groundwater. We could be required to spend substantial amounts on investigations, litigation, and remediation for these emissions and discharges and other compliance issues. Any unpermitted release of petroleum or other pollutants from our operations could result not only in cleanup costs, but also natural resources, real or personal property and other damages and civil and criminal liabilities. The listing of additional wildlife or plant species as federally endangered or threatened could result in limitations on exploration and production activities in certain locations. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a materially adverse effect on us. +The impact of extreme weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Our operations on our Midland Basin and South Texas assets are adversely affected by the impact of extreme weather conditions and lease stipulations designed to protect various wildlife or plant species. In certain areas, drilling and other oil and gas activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs and completion equipment, oil field equipment, services, supplies and qualified personnel, which may lead to periodic shortages. Wildlife seasonal restrictions may limit access to federal leases or across federal lands. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing, air quality, and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays . +Hydraulic fracturing is a common practice in the oil and gas industry used to stimulate the production of oil, gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and gas properties, including our unconventional resource plays within our Midland Basin and South Texas assets. Hydraulic fracturing involves injecting water, sand, and certain chemicals under pressure to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities, as outlined below. +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the Safe Drinking Water Act. The EPA has published an interpretive memorandum and permitting guidance related to regulation of fracturing fluids using this regulatory authority. In June 2016, the EPA issued regulations under the Federal Clean Water Act establishing federal pre-treatment standards for wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process. Under a recent settlement, the EPA had until March 2019 to decide whether to initiate rulemaking governing the disposal of wastewater from oil and gas development under RCRA Subtitle D. In April 2019, the EPA released its review, concluding that no new regulations were needed for managing wastewater based on the EPA’s conclusion that existing state regulations and best management practices are sufficiently protective of human health and the environment. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states, including Texas, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict, or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event that state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +In the recent past, several federal governmental agencies were actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. For example, in December 2016, the EPA issued a final assessment of potential impacts to drinking water resources from hydraulic fracturing. On March 28, 2017, President Trump issued Executive Order 13783 entitled “Promoting Energy Independence and Economic Growth” (“Executive Order 13783”). Executive Order 13783 directed executive departments and agencies to review regulations that potentially burden the development or use of +31 +domestically produced energy resources and, as appropriate, suspend, revise, or rescind those that unduly burden domestic energy resources development. +We will continue to be subject to uncertainty associated with new regulatory suspensions, revisions or rescissions and inconsistent state and federal regulatory mandates that could adversely affect our production. +Further, as to air quality and GHG regulation of oil and gas sources, the overall trend has been toward increased regulation and requirements for reduced emissions. The Trump administration has taken steps toward rescinding or reviewing many of those regulations, but any deregulation will likely face immediate judicial challenges. The Obama administration took several actions to regulate air quality and GHGs, many of which remain in effect. For example, on August 16, 2012, the EPA issued final rules subjecting all new and modified oil and gas operations (production, processing, transmission, storage, and distribution) to regulation under the New Source Performance Standards (“NSPS”) and all existing and new operations to the National Emission Standards for Hazardous Air Pollutants (“NESHAP”) programs. The EPA rules also include NSPS standards for completions of hydraulically fractured gas wells. These standards require the use of reduced emission completion (“REC”) techniques developed in the EPA’s Natural Gas STAR program along with the pit flaring of gas not sent to the gathering line beginning in January 2015. The standards are applicable to newly drilled and fractured wells as well as existing wells that are refractured. Further, the regulations under NESHAP include maximum achievable control technology (“MACT”) standards for those glycol dehydrators and certain storage vessels at major sources of hazardous air pollutants not previously subject to MACT standards. These rules require additional control equipment, changes to procedure, and extensive monitoring and reporting. In September 2013 and December 2014, the EPA published technical fixes to the 2012 NSPS, including standards for storage tanks subject to the NSPS. The amendments clarified stages for flowback and the point at which green completion equipment is required and updated requirements for storage tanks and leak detection requirements for processing plants. As part of the EPA’s strategy during the Obama administration to reduce methane and ozone-forming volatile organic compound (“VOC”) emissions from the oil and gas industry, on May 12, 2016, the EPA issued final regulations that amend and expand the 2012 regulations. The 2016 NSPS requires reduction of GHGs in the form of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The final regulation requires, among other things, GHG and VOC standards for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and natural gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. Both the 2012 and 2016 rules are the subjects of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia, though the litigation of both rules has been stayed. In June 2017, the EPA proposed a 2-year stay of the compliance requirements in the 2016 NSPS. In a related action in March 2017, the EPA withdrew the final information request it had issued in 2016 as part of an effort to develop standards under the CAA NSPS provisions for methane and other emissions from existing sources in the oil and natural gas industry. In September 2018, the EPA proposed changes to the 2016 NSPS amending specific provisions related to, among other things, fugitive emissions requirements. On August 29, 2019, the EPA proposed amendments to the 2012 and 2016 NSPS that would remove transmission and storage infrastructure from regulation of methane emissions and other VOCs. The amendments would also rescind methane requirements for oil and gas production and processing equipment. As an alternative, the EPA proposed to rescind the methane requirements for oil and gas altogether and sought comment on alternative interpretations of its authority to regulate pollutants under Section 111 of the Clean Air Act. +In October 2015, the EPA revised and lowered the ambient air quality standard for ozone in the U.S. under the CAA, from 75 parts per billion to 70 parts per billion, which is likely to result in more, and expanded, ozone non-attainment areas, which in turn will require states to adopt implementation plans to reduce emissions of ozone-forming pollutants, like VOCs and nitrogen oxides, that are emitted from, among others, the oil and gas industry. Opponents to the new ozone standards challenged the agency’s action in federal court. In August 2019, the D.C. Court of Appeals upheld the health-based ozone standards, but remanded to the EPA the secondary, public welfare standards designed to protect environmental values. The 2015 ozone standard is being implemented pursuant to the EPA’s December 2018 final implementation rule. In October 2016, the EPA finalized Control Techniques Guidelines for VOC emissions from existing oil and natural gas equipment and processes in moderate ozone non-attainment areas. These Control Techniques Guidelines provide recommendations for states and local air agencies to consider when determining what emissions requirements apply to sources in the non-attainment areas. The EPA has proposed to completely withdraw the rules. On May 12, 2016, the EPA also issued a final rule named the “Source Determination Rule” that was issued to clarify when multiple pieces of oil and gas equipment and activities must be aggregated as a single source for determining whether major source permitting programs apply. This action can expand the permitting and related control requirements to sources that were not previously subject to permitting requirements. However, more recently, the EPA has issued several guidance documents and memorandums related to aggregation of facilities that may narrow the effect of the Source Determination Rule. +Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third-parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. In 2013, a court in California held that the Bureau of Land Management (“BLM”) did not comply with NEPA because it did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. Courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing, +32 +including damages from induced seismicity, could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for, and production of, oil, gas, and NGLs, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional state or local laws, or the implementation of new regulations regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +Requirements to reduce gas flaring could have an adverse effect on our operations. +Wells in the Midland Basin in Texas, where we have significant operations, produce natural gas, as well as oil and NGLs. Constraints in the gas gathering and processing network in certain areas of the Midland Basin have resulted in significant quantities of that gas being flared instead of gathered, processed, and sold. Further, we are subject to laws established by state and other regulatory agencies that restrict the duration and amount of natural gas that can be legally flared. These laws and regulations, including potential future regulations that may impose further restrictions on flaring, could limit the amount of oil and gas we can produce from our wells or may limit the number of wells or the locations that we can drill. Any future laws and regulations may increase our operational costs, or restrict our production, which could materially and adversely affect our financial condition, results of operations and cash flows. +Our ability to produce oil, gas, and NGLs economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the water we use at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of oil, gas, and NGLs requires the use and disposal of significant quantities of water. +Our inability to secure sufficient amounts of water, or to dispose of or recycle the water produced from our wells, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of oil, gas, and NGLs. +Compliance with environmental regulations and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs. +In December 2009, the EPA made a finding that emissions of carbon dioxide, methane, and other GHGs endanger public health and the environment because emissions of such gases contribute to warming of the earth’s atmosphere and other climatic changes. Based on this finding, the EPA adopted and implemented a comprehensive suite of regulations to restrict and otherwise regulate emissions of GHGs under existing provisions of the CAA. In particular, the EPA adopted two sets of rules regulating GHG emissions under the CAA. One rule requires a reduction in GHG emissions from motor vehicles, and the other regulates permitting and GHG emissions from certain large stationary sources. These EPA regulatory actions have been challenged by various industry groups, initially in the D.C. Circuit, which in 2012 ruled in favor of the EPA in all respects. However, in June 2014, the United States Supreme Court reversed the D.C. Circuit and struck down the EPA’s GHG permitting rules to the extent they impose a requirement to obtain a permit based solely on emissions of GHGs. The EPA proposed a rule in 2016 to comply with the U.S. Supreme Court’s ruling by limiting the requirement to obtain permits addressing emissions of GHGs to large sources of other air pollutants, such as volatile organic compounds or nitrogen oxides, which also emit 100,000 tons per year or more of CO 2 (or modifications of these sources that result in an emissions increase of 75,000 tons per year or more of CO 2 e). If finalized, large sources of air pollutants other than GHGs will be required to implement the best available capture technology for GHGs. However, the EPA has not taken action on the proposed rule and is unlikely to do so under the Trump administration. The EPA has also adopted reporting rules for GHG emissions from specified GHG emission sources in the United States, including petroleum refineries as well as certain onshore oil and gas extraction and production facilities. +Several other cases regarding GHGs have been heard by the courts in recent years. While courts have generally declined to assign direct liability for climate change to large sources of GHG emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant GHG emissions, and new claims for damages and increased government scrutiny, especially from state and local governments, will likely continue. Such cases often seek to challenge air emissions permits that GHG emitters apply for, seek to force emitters to reduce their emissions, or seek damages for alleged climate change impacts to the environment, people, and property. Any court rulings, laws, or regulations that restrict or require reduced emissions of GHGs could lead to increased operating and compliance costs and could have an adverse effect on demand for the oil and gas that we produce. +33 +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and almost one-half of the states have already taken measures to reduce emissions of GHGs, primarily through the planned development of GHG emission inventories and/or regional GHG “cap and trade” programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall GHG emission reduction goal. In 2013, the Congressional Budget Office provided Congress with a study on the potential effects on the United States economy of a tax on GHG emissions and recently summarized the impact of imposition of a tax on GHG emissions for reducing the deficit. While “carbon tax” legislation has been introduced in Congress, the prospects for passage of such legislation are uncertain at this time. +On June 25, 2013, President Obama issued a Climate Action Plan to address climate change through a variety of executive actions, including reduction of methane emissions from oil and gas production and processing operations as well as pipelines and coal mines (the “Climate Action Plan”). Please refer to Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing, air quality, and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays for more information on EPA actions to implement the Climate Action Plan. The focus on legislating and/or regulating methane could eventually result in: +• +requirements for methane emission reductions from existing oil and gas equipment; +• +increased scrutiny for sources emitting high levels of methane, including during permitting processes; +• +analysis, regulation and reduction of methane emissions as a requirement for project approval; and +• +actions taken by one agency for a specific industry establishing precedents for other agencies and industry sectors. +In relation to the Climate Action Plan, both assumed global warming potential (“GWP”) and assumed social costs associated with methane and other GHG emissions have been finalized, including a 20% increase in the GWP of methane. Changes to these measurement tools could adversely impact permitting requirements, application of agencies’ existing regulations for source categories with high methane emissions, and determinations of whether a source qualifies for regulation under the CAA. However, in Executive Order 13783, President Trump ordered a review of the use of social cost of carbon for regulatory impact analysis. Therefore, the continued use of the social cost of carbon under the Trump administration is uncertain. +Finally, it should be noted that scientists have predicted that increasing concentrations of GHGs in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies, or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses, or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements. +New technologies may cause our current exploration and drilling methods to become obsolete. +The oil and gas industry is subject to rapid and significant advancements in technology, including the introduction of new products and services that use new technologies. As competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, competitors may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. One or more of the technologies we currently use or implement in the future may become obsolete. We cannot be certain we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. If we are unable to maintain technological advancements consistent with industry standards, our operations, and financial condition may be adversely affected. +Risks Related to Our Common Stock +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2019 , to February 6, 2020 , the intraday trading prices per share of our common stock as reported by the New York Stock Exchange ranged from a low of $6.85 per share in October 2019 to a high of $21.19 per share in January 2019 . We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include, in addition to the other risk factors set forth herein, the following: +• +changes in oil, gas, or NGL prices; +34 +• +changes in the outlook for regional, national, or global commodity supply and demand; +• +variations in drilling, recompletion, and operating activity; +• +changes in financial estimates by securities analysts; +• +changes in market valuations of comparable companies; +• +additions or departures of key personnel; +• +increased volatility due to the impacts of algorithmic trading practices; +• +future sales of our common stock; +• +changes in the national and global economic outlook, including potential impacts from trade agreements; and +• +international trade relationships, potentially including the effects of trade restrictions or tariffs affecting the raw materials we utilize and the commodities we produce in our business. +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +In addition, stockholder activism in our industry has been increasing, and if investors seek to exert influence or affect changes to our business that we do not believe are in the long-term best interests of our stockholders, such actions could adversely impact our business by, among other things, distracting our Board of Directors and management team, causing us to incur unexpected advisory fees and other related costs, impacting execution of our strategic objectives, and creating unnecessary market uncertainty. +We may not always pay dividends on our common stock. +Payment of future dividends remains at the discretion of our Board of Directors, and will continue to depend on our earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to a covenant in our Credit Agreement limiting our annual cash dividends to no more than $50.0 million , and to covenants in the indentures for our Senior Notes and Senior Convertible Notes that limit our ability to pay dividends beyond a certain amount. Our Board of Directors may determine in the future to reduce the current semi-annual dividend rate of $0.05 per share or discontinue the payment of dividends altogether. +35 +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Exchange Act. +ITEM 3. LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our business and operations in the normal course of business. As of the filing of this report, no legal proceedings are pending against us that we believe individually or collectively are likely to have a materially adverse effect upon our financial condition, results of operations or cash flows. +Chieftain Royalty Company v. SM Energy Company, Case No. CIV-11-D, In the United States District Court, Western District of Oklahoma. On January 27, 2011, Chieftain Royalty Company (“Plaintiff”) commenced a putative class action lawsuit against the Company by filing a Petition in the District Court of Beaver County, Oklahoma, in the matter originally styled Chieftain Royalty Company v. SM Energy Company (including predecessors, successors and affiliates), Case No. CJ-201104, alleging that the Company had improperly deducted post-production costs from royalty payments due on production from wells located throughout Oklahoma, and asserting claims against the Company for breach of contract, tortious breach of contract, breach of fiduciary or quasi-fiduciary duty, fraud (actual and constructive), deceit, conversion and conspiracy. The Company removed the case to the United States District Court for the Western District of Oklahoma. +On August 2, 2018, the Court required that Plaintiff file any motion to certify a class by February 8, 2019. Plaintiff filed such motion but limited to royalty owners in wells related to the Coal County, Oklahoma pipeline system, which was owned by the Company’s affiliate, Four Winds Marketing, LLC, until 2015, when the subject wells and pipeline system were sold to a third party. The Company opposed the Motion and it remains at issue and pending. +This case involves complex legal and factual issues and uncertainties as to Oklahoma law and federal law concerning class certification under the circumstances of this case, and has resulted in a significant amount of discovery. The Company believes that it has properly paid royalties under Oklahoma law and that the class as proposed by Plaintiff should not be certified. The Company has and will continue to vigorously defend this case. +SPM NAM LLC. et al., v. SM Energy Company , Case No. 2018-07160, in the 189th Judicial District of Harris County, Texas (the “Lawsuit”). Plaintiff SPM NAM LLC (“SPM”) filed the Lawsuit against the Company on February 1, 2018. The Lawsuit concerns the Acquisition and Development Funding Agreement dated August 2, 2016 (together with its amendments, the “ADFA”). The parties to the ADFA (and its amendments) are the Company; SPM; and certain affiliates of SPM-(1) Schlumberger Technology Corporation; (2) Smith International, Inc.; (3) M-I, L.L.C.; and (4) Cameron International Corporation (the “Schlumberger Service Providers”). In the Lawsuit, SPM and the Schlumberger Service Providers are the plaintiffs, and the Company is the defendant. +In the Lawsuit, SPM alleges that the Company breached the ADFA in connection with the Company’s agreement to sell its interests in the Powder River Basin (collectively, the “Company Interests”) to a third party (“Buyer”). SPM alleges that pursuant to the ADFA, SPM was entitled to sell its related wellbore interests to Buyer on the same terms and conditions that the Company Interests were to be sold, through a “tag-along” process. SPM alleges that the Company failed to honor the tag-along provisions of the ADFA. The Lawsuit further alleges that the Company fraudulently induced SPM to enter an amendment to the ADFA in connection with its sale. SPM brings claims for rescission, fraud, breach of contract, unjust enrichment, breach of good faith and fair dealing, and declaratory judgment. SPM has not specified the damages it seeks in its pleadings, except to state that they are more than $1,000,000. +The Company has asserted affirmative defenses and counterclaims, that in part allege that: (1) SPM has breached the ADFA by filing an action for rescission, when any rescission remedy is expressly barred by the ADFA; and (2) the Company is entitled to a declaration that the Company has complied with the ADFA; and (3) SPM’s tag-along rights under the ADFA expired. +The case is in discovery, and trial is scheduled for June 22, 2020. The Company believes it has complied with the terms of the ADFA, intends to vigorously defend against SPM’s claims, and intends to vigorously prosecute its own claims. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +36 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information. Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2014 , and ending December 31, 2019 , with the cumulative total returns of the Dow Jones Exploration and Production Index (“DJUSOS”), and the Standard & Poor’s 500 Stock Index (“SPX”). +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +Holders. As of February 6, 2020 , the number of record holders of our common stock was 75. Based upon inquiry, management believes that the number of beneficial owners of our common stock is approximately 17,350. +Purchases of Equity Securities by Issuer and Affiliated Purchasers. The following table provides information about purchases made by us and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and year ended December 31, 2019 , of shares of our common stock, which is the sole class of equity securities registered by us pursuant to Section 12 of the Exchange Act. +37 +PURCHASES OF EQUITY SECURITIES BY ISSUER AND AFFILIATED PURCHASERS +Period +Total Number of Shares Purchased (1) +Weighted Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program +Maximum Number of Shares that May Yet be Purchased Under the Program (2) +01/01/2019 - +03/31/2019 +990 +$ +17.82 +— +3,072,184 +04/01/2019 - +06/30/2019 +154 +$ +14.91 +— +3,072,184 +07/01/2019 - +09/30/2019 +130,992 +$ +12.52 +— +3,072,184 +10/01/2019 - +12/31/2019 +— +$ +— +— +3,072,184 +Total +132,136 +$ +12.56 +— +3,072,184 +____________________________________________ +(1) +All shares purchased by us in 2019 were to offset tax withholding obligations that occurred upon the delivery of outstanding shares underlying Restricted Stock Units (“RSUs”) issued under the terms of award agreements granted under the SM Energy Equity Incentive Compensation Plan, as amended and restated effective as of May 22, 2018 (the “Equity Plan”). +(2) +In July 2006, our Board of Directors approved an increase in the number of shares that may be repurchased under the original August 1998 authorization to 6,000,000 as of the effective date of the resolution. Accordingly, as of the filing of this report, subject to the approval of our Board of Directors, we may repurchase up to 3,072,184 shares of common stock on a prospective basis. The shares may be repurchased from time to time in open market transactions or privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes and Senior Convertible Notes, and compliance with securities laws. Stock repurchases may be funded with existing cash balances, internal cash flows, or borrowings under our Credit Agreement. The stock repurchase program may be suspended or discontinued at any time. +38 +ITEM 6. SELECTED FINANCIAL DATA +The following table sets forth selected supplemental financial and operating data as of the dates or for the years indicated. The financial data for each of the five years presented was derived from our consolidated financial statements. The following data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report, which includes a discussion of factors materially affecting the comparability of the information presented, and in conjunction with our consolidated financial statements included in this report. +As of or for the Years Ended December 31, +2019 +2018 +2017 +2016 +2015 +(in millions, except per share data) +Statement of operations data: +Total operating revenues and other income +$ +1,590.1 +$ +2,067.1 +$ +1,129.4 +$ +1,217.5 +$ +1,557.0 +Net income (loss) +$ +(187.0 +) +$ +508.4 +$ +(160.8 +) +$ +(757.7 +) +$ +(447.7 +) +Net income (loss) per share: +Basic +$ +(1.66 +) +$ +4.54 +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +Diluted +$ +(1.66 +) +$ +4.48 +$ +(1.44 +) +$ +(9.90 +) +$ +(6.61 +) +Cash dividends declared and paid per common share +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +$ +0.10 +Balance sheet data: +Total assets +$ +6,292.2 +$ +6,352.9 +$ +6,176.8 +$ +6,393.5 +$ +5,621.6 +Long-term debt: +Revolving credit facility +$ +122.5 +$ +— +$ +— +$ +— +$ +202.0 +Senior Notes, net of unamortized deferred financing costs +$ +2,453.0 +$ +2,448.4 +$ +2,769.7 +$ +2,766.7 +$ +2,316.0 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +$ +157.3 +$ +147.9 +$ +139.1 +$ +130.9 +$ +— +39 +Supplemental Selected Financial and Operations Data +As of or for the Years Ended December 31, +2019 +2018 +2017 +2016 +2015 +Balance sheet data (in millions): +Total working capital (deficit) +$ +(219.4 +) +$ +(36.8 +) +$ +(10.1 +) +$ +(190.5 +) +$ +216.5 +Total stockholders’ equity +$ +2,749.0 +$ +2,920.3 +$ +2,394.6 +$ +2,497.1 +$ +1,852.4 +Weighted-average common shares outstanding (in thousands): +Basic +112,544 +111,912 +111,428 +76,568 +67,723 +Diluted +112,544 +113,502 +111,428 +76,568 +67,723 +Reserves: +Oil (MMBbl) +184.1 +175.7 +158.2 +104.9 +145.3 +Gas (Bcf) +1,223.2 +1,321.8 +1,280.1 +1,111.1 +1,264.0 +NGLs (MMBbl) +74.0 +107.4 +96.5 +105.7 +115.4 +MMBOE (1) +462.0 +503.4 +468.1 +395.8 +471.3 +Production and operations (in millions): +Oil, gas, and NGL production revenue +$ +1,585.8 +$ +1,636.4 +$ +1,253.8 +$ +1,178.4 +$ +1,499.9 +Oil, gas, and NGL production expense +$ +500.7 +$ +487.4 +$ +507.9 +$ +597.6 +$ +723.6 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +823.8 +$ +665.3 +$ +557.0 +$ +790.7 +$ +921.0 +General and administrative (2) +$ +132.8 +$ +116.5 +$ +117.3 +$ +124.8 +$ +156.1 +Production volumes: +Oil (MMBbl) +21.9 +18.8 +13.7 +16.6 +19.2 +Gas (Bcf) +109.8 +103.2 +123.0 +146.9 +173.6 +NGLs (MMBbl) +8.1 +7.9 +10.3 +14.2 +16.1 +MMBOE (1) +48.3 +43.9 +44.5 +55.3 +64.2 +Realized price, before the effect of derivative settlements: +Oil (per Bbl) +$ +54.10 +$ +56.80 +$ +47.88 +$ +36.85 +$ +41.49 +Gas (per Mcf) +$ +2.39 +$ +3.43 +$ +3.00 +$ +2.30 +$ +2.57 +NGLs (per Bbl) +$ +17.26 +$ +27.22 +$ +22.35 +$ +16.16 +$ +15.92 +Per BOE +$ +32.84 +$ +37.27 +$ +28.20 +$ +21.32 +$ +23.36 +Expense per BOE: +Lease operating expense +$ +4.67 +$ +4.74 +$ +4.43 +$ +3.51 +$ +3.73 +Transportation costs +$ +3.88 +$ +4.36 +$ +5.48 +$ +6.16 +$ +6.02 +Production taxes +$ +1.35 +$ +1.52 +$ +1.18 +$ +0.94 +$ +1.13 +Ad valorem tax expense +$ +0.48 +$ +0.48 +$ +0.34 +$ +0.21 +$ +0.39 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +17.06 +$ +15.15 +$ +12.53 +$ +14.30 +$ +14.34 +General and administrative (2) +$ +2.75 +$ +2.65 +$ +2.64 +$ +2.26 +$ +2.43 +Statement of cash flows data (in millions): +Provided by operating activities (2) +$ +823.6 +$ +720.6 +$ +515.4 +$ +552.8 +$ +990.8 +Used in investing activities (2) +$ +(1,013.3 +) +$ +(587.9 +) +$ +(201.5 +) +$ +(1,867.6 +) +$ +(1,144.6 +) +Provided by (used in) financing activities (2) +$ +111.8 +$ +(368.7 +) +$ +(12.3 +) +$ +1,327.2 +$ +153.7 +____________________________________________ +(1) +Amounts may not calculate due to rounding. +(2) +As a result of adopting new accounting standards in prior periods, certain prior period amounts have been reclassified to conform to the current period presentation on the consolidated financial statements. +40 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion includes forward-looking statements. Please refer to the Cautionary Information about Forward-Looking Statements section of this report for important information about these types of statements. +Overview of the Company +General Overview +Our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to energy security and prosperity, and having a positive impact in the communities where we live and work. Our long-term vision for the Company is to sustainably grow value for all of our stakeholders. We believe that in order to accomplish this vision, we must be a premier operator of top tier assets. At present, our investment portfolio is focused on high quality oil and gas producing assets in the state of Texas, specifically in the Midland Basin of West Texas and in South Texas. +2019 Financial and Operational Highlights +We remain focused on maximizing returns and increasing the value of our top tier Midland Basin and South Texas assets. We expect to do this through continued development optimization and delineation. We believe our assets provide significant production growth potential and strong returns that are capable of increasing internally generated cash flows and support our priorities of improving credit metrics and maintaining strong financial flexibility. +Financial and Operational Results. Average net daily production for the year ended December 31, 2019 , was 132.3 MBOE, compared with 120.3 MBOE for the same period in 2018 . This increase was primarily driven by a 25 percent increase in production volumes from our Midland Basin assets. Realized prices before the effects of derivative settlements for oil, gas, and NGLs decreased five percent , 30 percent , and 37 percent , respectively, for the year ended December 31, 2019 , compared with the year ended December 31, 2018 . As a result of decreased realized prices, oil, gas, and NGL production revenue decreased three percent to $1.59 billion for the year ended December 31, 2019 , compared with $1.64 billion for 2018 . The decrease in oil, gas, and NGL production revenue due to pricing was largely offset by increased production. We recorded a net derivative loss of $97.5 million for the year ended December 31, 2019 , compared to a net derivative gain of $161.8 million for the same period in 2018 . Included within these derivative amounts is a gain of $39.2 million on derivative contracts that settled during the year ended December 31, 2019 , and a loss of $135.8 million for the same period in 2018 . Overall financial and operational activities during the year ended December 31, 2019 , resulted in the following: +• +net loss of $187.0 million , or $1.66 per diluted share, for the year ended December 31, 2019 , compared with net income of $508.4 million , or $4.48 per diluted share, for the year ended December 31, 2018 . Please refer to Comparison of Financial Results and Trends Between 2019 and 2018 and Between 2018 and 2017 below for additional discussion regarding the components of net income (loss) for each period presented; +• +net cash provided by operating activities was $823.6 million for the year ended December 31, 2019 , compared with $720.6 million in 2018 , which was an increase of 14 percent year-over-year. Please refer to Analysis of Cash Flow Changes Between 2019 and 2018 and Between 2018 and 2017 below for additional discussion; and +• +adjusted EBITDAX, a non-GAAP financial measure, for the year ended December 31, 2019 , was $993.4 million , compared with $900.4 million for the same period in 2018 . Please refer to Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and reconciliations to our net income (loss) and net cash provided by operating activities. +Total estimated proved reserves as of December 31, 2019 decreased eight percent from December 31, 2018 to 462.0 MMBOE, of which, 56 percent were liquids (oil and NGLs) and 53 percent were characterized as proved developed. During 2019 , we added 98.4 MMBOE through our Midland Basin and South Texas development activities. The 2019 results were partially offset by downward revisions of 94.7 MMBOE primarily resulting from lower commodity prices. Lower commodity prices were also the primary factor in our decreased estimated proved reserve life index, which was 9.6 years at December 31, 2019 , compared to 11.5 years at December 31, 2018 . Please refer to Reserves in Part I, Items 1 and 2 of this report for additional discussion. The standardized measure of discounted future net cash flows was $4.1 billion as of December 31, 2019 , compared with $4.7 billion as of December 31, 2018 , which was a decrease of 12 percent year-over-year. Please refer to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Operational Activities . The performance of the RockStar area of our Midland Basin position continues to exceed our pre-acquisition expectations and was key to driving significant growth in our operating margin and cash flows from operations in 2019 due to the high percentage of oil that these wells produce. Our operational execution and development strategy in this region have resulted in strong well performance due to enhanced completion designs and our ability to drill longer laterals given the increasingly contiguous nature of our acreage position as a result of successful infill leasing and acreage trades. Efficiency in completions and operations +41 +continued in 2019 , as a large portion of our water transportation and disposal needs continue to be satisfied by the water facilities we operate in a core area of our RockStar acreage. We also continued to increase our use of locally sourced sand in our well completions, which has resulted in further cost savings and improved returns for our program. +Our Midland Basin program averaged six drilling rigs and three completion crews during 2019 . We completed 123 gross ( 111 net) operated wells during 2019 and increased production volumes year-over-year by 25 percent to 26.3 MMBOE, 78 percent of which was oil. 82 percent of our total 2019 costs incurred in our oil and gas producing activities was incurred in our Midland Basin program. Drilling and completion activities within our RockStar and Sweetie Peck positions in the Midland Basin continue to focus primarily on delineating and developing the Lower Spraberry and Wolfcamp A and B shale intervals. +Our South Texas program averaged one drilling rig and one completion crew during 2019 . We completed 31 gross ( 20 net) wells during 2019 . Total production for 2019 was 22.0 MMBOE, a one percent increase from 2018 . 16 percent of our total 2019 costs incurred in our oil and gas producing activities was incurred in our South Texas program. Drilling and completion activities in South Texas continue to focus on developing the Eagle Ford shale formation and delineating the Austin Chalk formation. +Certain drilling and completion activities in the northern portion of our South Texas acreage position were primarily funded by a third party pursuant to our joint development agreement. The agreement provided that the third party would carry substantially all drilling and completion costs and receive a majority of the working and revenue interest in these wells until certain payout thresholds are reached. This arrangement allowed us to leverage third-party capital to prove up the value of our Eagle Ford North area, while also allowing us to test cutting edge technology, capture additional technical data, and satisfy certain lease obligations. All wells subject to this agreement were drilled and completed as of December 31, 2019 . +The table below provides a summary of changes in our drilled but not completed well count and current year drilling and completion activity in our operated programs for the year ended December 31, 2019 : +Midland Basin +South Texas +Total +Gross +Net +Gross +Net +Gross +Net +Wells drilled but not completed at December 31, 2018 +61 +55 +29 +23 +90 +78 +Wells drilled +113 +104 +25 +20 +138 +124 +Wells completed +(123 +) +(111 +) +(31 +) +(20 +) +(154 +) +(131 +) +Other (1) +— +— +(2 +) +(2 +) +(2 +) +(2 +) +Wells drilled but not completed at December 31, 2019 +51 +48 +21 +21 +72 +69 +_____________________________________ +(1) +Includes adjustments related to previously drilled wells that we no longer intend to complete. +Costs Incurred in Oil and Gas Producing Activities. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended +December 31, 2019 +(in millions) +Development costs +$ +914.0 +Exploration costs +115.0 +Acquisitions +Proved properties +(0.3 +) +Unproved properties +11.6 +Total, including asset retirement obligations (1) +$ +1,040.2 +____________________________________________ +Note: Total may not calculate due to rounding. +(1) +Please refer to the caption Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +All of our development and exploration costs were incurred in our Midland Basin and South Texas programs for the year ended December 31, 2019 . Of these costs, $848.6 million was directed to the development of our Midland Basin assets, which resulted in 104 net wells drilled and 111 net wells completed. Comparatively, for the year ended December 31, 2018 , $1.1 billion was directed to the development of our Midland Basin assets, which resulted in 117 net wells drilled and 104 net wells completed. Costs incurred for acquisitions during the year related to transactions in the Midland Basin, as well as payments made to extend certain lease terms and to acquire new leases. Please refer to Operational Activities above and Acquisition Activity below for additional information on our regional activities. +42 +Production Results. The table below presents the disaggregation of our production by product type for each of our operating regions for the year ended December 31, 2019 : +Midland Basin +South Texas +Total +Production: +Oil (MMBbl) +20.5 +1.3 +21.9 +Gas (Bcf) +34.4 +75.4 +109.8 +NGLs (MMBbl) +— +8.1 +8.1 +Equivalent (MMBOE) +26.3 +22.0 +48.3 +Avg. daily equivalents (MBOE/d) +72.0 +60.3 +132.3 +Relative percentage +54 +% +46 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +Production increased 10 percent for the year ended December 31, 2019 , compared with 2018 . The increase in overall production volumes was primarily attributable to our Midland Basin assets, which had an increase in production volumes of 25 percent for the year ended December 31, 2019 , compared with 2018 . Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends and Comparison of Financial Results and Trends Between 2019 and 2018 and Between 2018 and 2017 below for additional discussion on production. +Acquisition Activity. During 2019 , while no significant acquisition activity occurred, we completed several non-monetary acreage trades of undeveloped properties located in Howard, Martin, and Midland Counties, Texas, to continue maximizing our operational efficiencies in our Midland Basin program. Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effects of derivative settlements, unless otherwise indicated. While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location, and transportation differentials for these products. +The following table summarizes commodity price data, as well as the effects of derivative settlements, for the years ended December 31, 2019 , 2018 , and 2017 : +For the Years Ended December 31, +2019 +2018 +2017 +Oil (per Bbl): +Average NYMEX contract monthly price +$ +57.03 +$ +64.77 +$ +50.95 +Realized price, before the effect of derivative settlements +$ +54.10 +$ +56.80 +$ +47.88 +Effect of oil derivative settlements +$ +(0.90 +) +$ +(3.67 +) +$ +(2.28 +) +Gas: +Average NYMEX monthly settle price (per MMBtu) +$ +2.63 +$ +3.09 +$ +3.11 +Realized price, before the effect of derivative settlements (per Mcf) +$ +2.39 +$ +3.43 +$ +3.00 +Effect of gas derivative settlements (per Mcf) +$ +0.21 +$ +(0.12 +) +$ +0.72 +NGLs (per Bbl): +Average OPIS price (1) +$ +22.34 +$ +32.96 +$ +27.63 +Realized price, before the effect of derivative settlements +$ +17.26 +$ +27.22 +$ +22.35 +Effect of NGL derivative settlements +$ +4.43 +$ +(6.78 +) +$ +(3.44 +) +____________________________________________ +(1) +Average OPIS prices per barrel of NGL, historical or strip, are based on a product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline for all periods presented. This product mix represents the industry standard composite barrel and does not necessarily represent our product mix for NGL production. Realized prices reflect our actual product mix. +43 +We expect future benchmark prices for oil, gas, and NGLs to continue to be volatile due to uncertainty in global supply and demand. In addition to supply and demand fundamentals, as a global commodity, the price of oil is affected by real or perceived geopolitical risks in various regions of the world as well as the relative strength of the United States dollar compared to other currencies. Increased demand for liquefied natural gas and gas exports to Mexico are expected to help balance natural gas supply. NGL prices may continue to benefit from increased demand from export and petrochemical markets while being offset by increased drilling activity. Our realized prices at local sales points may also be affected by infrastructure capacity in the area of our operations and beyond. +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs (same product mix as discussed under the table above) as of February 6, 2020 , and December 31, 2019 : +As of February 6, 2020 +As of December 31, 2019 +NYMEX WTI oil (per Bbl) +$ +51.46 +$ +59.01 +NYMEX Henry Hub gas (per MMBtu) +$ +2.15 +$ +2.28 +OPIS NGLs (per Bbl) +$ +18.09 +$ +20.00 +We use financial derivative instruments as part of our financial risk management program. We have a financial risk management policy governing our use of derivatives, and decisions regarding entering into derivative commodity contracts are overseen by a financial risk management committee consisting of senior executive officers and finance personnel. The amount of our production covered by derivatives is driven by the amount of debt on our balance sheet, the level of capital commitments and long-term obligations we have in place, and our ability to enter into favorable derivative commodity contracts. With our current derivative commodity contracts, we believe we have partially reduced our exposure to volatility in commodity prices and location differentials in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil and gas prices while also setting a price floor for a portion of our oil and gas production. +Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and to Commodity Price Risk in Overview of Liquidity and Capital Resources below for additional information regarding our oil, gas, and NGL derivatives. +Outlook +Please refer to Outlook in Part I, Item 1 of this report for discussion of our financing and capital plans for 2020 , and refer to Overview of Liquidity and Capital Resources below for discussion of how we expect to fund our 2020 capital program. +44 +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the three months ended December 31, 2019 , and the preceding three quarters. +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2019 +2019 +2019 +2019 +(in millions) +Production (MMBOE) +12.8 +12.4 +12.4 +10.7 +Oil, gas, and NGL production revenue +$ +449.0 +$ +389.4 +$ +406.9 +$ +340.5 +Oil, gas, and NGL production expense +$ +127.3 +$ +129.0 +$ +123.1 +$ +121.3 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +228.7 +$ +211.1 +$ +206.3 +$ +177.7 +Exploration +$ +17.7 +$ +11.6 +$ +10.9 +$ +11.3 +General and administrative +$ +37.2 +$ +32.6 +$ +30.9 +$ +32.1 +Net income (loss) +$ +(102.1 +) +$ +42.2 +$ +50.4 +$ +(177.6 +) +__________________________________________ +Note: Amounts may not calculate due to rounding. +Selected Performance Metrics +For the Three Months Ended +December 31, +September 30, +June 30, +March 31, +2019 +2019 +2019 +2019 +Average net daily production equivalent (MBOE per day) +138.8 +134.9 +136.5 +118.7 +Lease operating expense (per BOE) +$ +4.67 +$ +4.73 +$ +4.16 +$ +5.20 +Transportation costs (per BOE) +$ +3.46 +$ +4.00 +$ +4.00 +$ +4.08 +Production taxes as a percent of oil, gas, and NGL production revenue +4.2 +% +4.1 +% +4.0 +% +4.1 +% +Ad valorem tax expense (per BOE) +$ +0.37 +$ +0.39 +$ +0.44 +$ +0.76 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) +$ +17.91 +$ +17.02 +$ +16.61 +$ +16.63 +General and administrative (per BOE) +$ +2.92 +$ +2.63 +$ +2.49 +$ +3.00 +45 +A Year-to-Year Overview of Selected Production and Financial Information, Including Trends +For the Years Ended +December 31, +Amount Change Between +Percent Change Between +2019 +2018 +2017 +2019/2018 +2018/2017 +2019/2018 +2018/2017 +Net production volumes: (1) +Oil (MMBbl) +21.9 +18.8 +13.7 +3.1 +5.1 +17 +% +37 +% +Gas (Bcf) +109.8 +103.2 +123.0 +6.6 +(19.8 +) +6 +% +(16 +)% +NGLs (MMBbl) +8.1 +7.9 +10.3 +0.2 +(2.4 +) +2 +% +(23 +)% +Equivalent (MMBOE) +48.3 +43.9 +44.5 +4.4 +(0.6 +) +10 +% +(1 +)% +Average net daily production: (1) +Oil (MBbl per day) +59.9 +51.4 +37.4 +8.5 +14.0 +17 +% +37 +% +Gas (MMcf per day) +300.8 +282.7 +337.0 +18.1 +(54.3 +) +6 +% +(16 +)% +NGLs (MBbl per day) +22.2 +21.8 +28.2 +0.5 +(6.4 +) +2 +% +(23 +)% +Equivalent (MBOE per day) +132.3 +120.3 +121.8 +12.0 +(1.5 +) +10 +% +(1 +)% +Oil, gas, and NGL production revenue (in millions): (1) +Oil production revenue +$ +1,183.2 +$ +1,065.7 +$ +654.3 +$ +117.5 +$ +411.4 +11 +% +63 +% +Gas production revenue +262.5 +354.5 +369.4 +(91.9 +) +(15.0 +) +(26 +)% +(4 +)% +NGL production revenue +140.0 +216.2 +230.1 +(76.2 +) +(13.9 +) +(35 +)% +(6 +)% +Total oil, gas, and NGL production revenue +$ +1,585.8 +$ +1,636.4 +$ +1,253.8 +$ +(50.6 +) +$ +382.6 +(3 +)% +31 +% +Oil, gas, and NGL production expense (in millions): (1) +Lease operating expense +$ +225.5 +$ +208.1 +$ +196.9 +$ +17.4 +$ +11.2 +8 +% +6 +% +Transportation costs +187.1 +191.5 +243.6 +(4.4 +) +(52.1 +) +(2 +)% +(21 +)% +Production taxes +65.0 +66.9 +52.4 +(1.9 +) +14.5 +(3 +)% +28 +% +Ad valorem tax expense +23.1 +20.9 +15.0 +2.2 +5.9 +10 +% +39 +% +Total oil, gas, and NGL production expense +$ +500.7 +$ +487.4 +$ +507.9 +$ +13.3 +$ +(20.5 +) +3 +% +(4 +)% +Realized price, before the effect of derivative settlements: +Oil (per Bbl) +$ +54.10 +$ +56.80 +$ +47.88 +$ +(2.70 +) +$ +8.92 +(5 +)% +19 +% +Gas (per Mcf) +$ +2.39 +$ +3.43 +$ +3.00 +$ +(1.04 +) +$ +0.43 +(30 +)% +14 +% +NGLs (per Bbl) +$ +17.26 +$ +27.22 +$ +22.35 +$ +(9.96 +) +$ +4.87 +(37 +)% +22 +% +Per BOE +$ +32.84 +$ +37.27 +$ +28.20 +$ +(4.43 +) +$ +9.07 +(12 +)% +32 +% +Per BOE data: +Production costs: +Lease operating expense +$ +4.67 +$ +4.74 +$ +4.43 +$ +(0.07 +) +$ +0.31 +(1 +)% +7 +% +Transportation costs +$ +3.88 +$ +4.36 +$ +5.48 +$ +(0.48 +) +$ +(1.12 +) +(11 +)% +(20 +)% +Production taxes +$ +1.35 +$ +1.52 +$ +1.18 +$ +(0.17 +) +$ +0.34 +(11 +)% +29 +% +Ad valorem tax expense +$ +0.48 +$ +0.48 +$ +0.34 +$ +— +$ +0.14 +— +% +41 +% +Total production costs (1) +$ +10.38 +$ +11.10 +$ +11.43 +$ +(0.72 +) +$ +(0.33 +) +(6 +)% +(3 +)% +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +17.06 +$ +15.15 +$ +12.53 +$ +1.91 +$ +2.62 +13 +% +21 +% +General and administrative +$ +2.75 +$ +2.65 +$ +2.64 +$ +0.10 +$ +0.01 +4 +% +— +% +Derivative settlement gain (loss) (2) +$ +0.81 +$ +(3.09 +) +$ +0.48 +$ +3.90 +$ +(3.57 +) +126 +% +(744 +)% +Earnings per share information: +Basic weighted-average common shares outstanding (in thousands) +112,544 +111,912 +111,428 +632 +484 +1 +% +— +% +Diluted weighted-average common shares outstanding (in thousands) +112,544 +113,502 +111,428 +(958 +) +2,074 +(1 +)% +2 +% +Basic net income (loss) per common share +$ +(1.66 +) +$ +4.54 +$ +(1.44 +) +$ +(6.20 +) +$ +5.98 +(137 +)% +415 +% +Diluted net income (loss) per common share +$ +(1.66 +) +$ +4.48 +$ +(1.44 +) +$ +(6.14 +) +$ +5.92 +(137 +)% +411 +% +____________________________________________ +(1) +Amounts and percentage changes may not calculate due to rounding. +(2) +Derivative settlements for the years ended December 31, 2019 , 2018 , and 2017 , are included within the net derivative (gain) loss line item in the accompanying consolidated statements of operations (“accompanying statements of operations”). +46 +Average net equivalent daily production for the year ended December 31, 2019 , increased 10 percent compared with 2018 . This increase was primarily driven by a 25 percent increase in production volumes from our Midland Basin assets for the year ended December 31, 2019 , compared with 2018 . Production volumes from our South Texas assets for the year ended December 31, 2019 , were relatively flat compared with 2018 . We divested our remaining producing assets in the Rocky Mountain region in the first half of 2018 . We expect total production volumes in 2020 to decline slightly compared with 2019; however, we expect total oil volumes to increase. As a result, we expect oil volumes to be approximately 50 percent of our total production mix in 2020. Please refer to Comparison of Financial Results and Trends Between 2019 and 2018 and Between 2018 and 2017 below for additional discussion. +We present certain information on a per BOE basis in order to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis and discussion. +Our realized price before the effect of derivative settlements on a per BOE basis decreased 12 percent for the year ended December 31, 2019 , compared with 2018 . This decrease was primarily driven by lower benchmark commodity prices for oil, gas, and NGLs, as well as increased regional differentials in the Midland Basin for natural gas caused by tight takeaway capacity. In the first half of 2019, certain third-party midstream force majeure events negatively affected the price we received for our Midland Basin gas production. Regional differentials for gas in the Midland Basin are expected to continue to negatively affect our realized prices in 2020. Additional expected take-away capacity is anticipated to come online in early 2021. For the year ended December 31, 2019 , we recognized a gain of $0.81 per BOE on the settlement of our derivative contracts, compared to a recognized loss of $3.09 per BOE in 2018 . +Lease operating expense (“LOE”) on a per BOE basis was relatively flat for the year ended December 31, 2019 , compared with 2018 , despite the increase in oil production as a percentage of our total production. The increase in absolute LOE was primarily driven by increased production. We expect LOE on a per BOE basis to be higher in 2020 compared with 2019 as our product mix continues to shift towards more oil production. We anticipate volatility in LOE on a per BOE basis as a result of changes in total production, our overall production mix, timing of workover projects, and industry activity, all of which impacts service provider costs. +Transportation costs on a per BOE basis decreased 11 percent for the year ended December 31, 2019 , compared with 2018 . The decrease was driven primarily by an increase in the percentage of production generated from our Midland Basin assets, as production from these assets is typically sold at or near the wellhead and incurs minimal transportation costs. We expect total transportation costs to fluctuate relative to changes in production from our South Texas assets, which incur the majority of our transportation costs. On a per BOE basis, we expect transportation costs to decrease in 2020 , compared with 2019 , as production from our Midland Basin assets continues to become a larger portion of our total production. +Production taxes on a per BOE basis for the year ended December 31, 2019 , decreased 11 percent compared with 2018 , primarily due to a 12 percent decrease in our realized price on a per BOE basis before the effect of derivative settlements for the year ended December 31, 2019 , compared with 2018 . Our overall production tax rate for each of the years ended December 31, 2019 , and 2018 was 4.1 percent . We expect our overall production tax rate to remain consistent in 2020 , compared with 2019 . We generally expect production tax expense to trend with oil, gas, and NGL production revenue on an absolute and per BOE basis. Product mix, the location of production, and incentives to encourage oil and gas development can also impact the amount of production tax we recognize. +Ad valorem tax expense on a per BOE basis for the year ended December 31, 2019 , was flat compared with 2018 , as the increases on an absolute basis, resulting from changes in our asset and production base, were consistent with higher production volumes. We anticipate volatility in ad valorem tax expense on a per BOE and absolute basis as a result of continuing changes in the valuation of our producing properties. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (“DD&A”) expense on a per BOE basis increased 13 percent for the year ended December 31, 2019 , compared with 2018 . The increase was driven by our focus on developing oil producing assets in the Midland Basin, which have higher depletion rates than our primarily gas and NGL producing assets in South Texas. Our DD&A rate fluctuates as a result of impairments, divestiture activity, carrying cost funding and sharing arrangements with third parties, changes in our production mix, and changes in our total estimated proved reserve volumes. In general, we expect DD&A expense on a per BOE basis in 2020 to increase compared with 2019 as production from our Midland Basin assets continues to become a larger portion of our total production. +General and administrative (“G&A”) expense on a per BOE basis for the year ended December 31, 2019 , increased four percent compared with 2018 . The increase was primarily due to a reduction in the amount of employee compensation that was reclassified to exploration expense as compared with the prior year, as more employee time was allocated to development activities in 2019 . During the fourth quarter of 2019 , we announced the reorganization of certain functions to eliminate duplicative regional operational functions and reduce overhead costs, which we expect will result in reduced G&A expense in future years. As a result, we expect to incur total charges related to this reorganization ranging from $8.0 million to $8.5 million, including $4.2 million incurred in the fourth quarter of 2019 . We expect G&A expense to decrease in total and on a per BOE basis in 2020 compared with 2019 . +Please refer to Note 9 - Earnings Per Share in Part II, Item 8 of this report for additional discussion on the types of shares included in our basic and diluted net income (loss) per common share calculations. We recorded a net loss for each of the years ended +47 +December 31, 2019 , and 2017 . Consequently, all potentially dilutive shares were anti-dilutive and were excluded from the calculation of diluted net loss per common share for the years ended December 31, 2019 , and 2017 . For the year ended December 31, 2018 , we recorded net income and thus considered dilutive shares in the calculation of diluted net income per common share as of December 31, 2018 . +Comparison of Financial Results and Trends Between 2019 and 2018 and Between 2018 and 2017 +Please refer to Comparison of Financial Results and Trends Between 2018 and 2017 and Between 2017 and 2016 in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2018 Annual Report on Form 10-K, filed with the SEC on February 21, 2019, for a detailed discussion of certain comparisons of our financial results and trends for the year ended December 31, 2018 , compared with the year ended December 31, 2017 . +Net equivalent production, production revenue, and production expense +The following table presents the regional changes in our net equivalent production, production revenue, and production expense between the years ended December 31, 2019 , and 2018 : +Net Equivalent Production Increase (Decrease) +Production Revenue Increase (Decrease) +Production Expense Increase (Decrease) +(MBOE per day) +(in millions) +(in millions) +Midland Basin +14.6 +$ +131.1 +$ +31.5 +South Texas +0.4 +(124.5 +) +5.2 +Rocky Mountain (1) +(3.1 +) +(57.2 +) +(23.3 +) +Total +12.0 +$ +(50.6 +) +$ +13.3 +__________________________________________ +Note: Amounts may not calculate due to rounding. +(1) +We divested all remaining producing assets in the Rocky Mountain region in the first half of 2018. As a result, there have been no production volumes from this region after the second quarter of 2018. +We experienced a 10 percent increase in net equivalent production in 2019 compared with 2018 , primarily as a result of increased production from our Midland Basin assets. As a result of increased Midland Basin production, oil production as a percentage of our overall product mix increased from 43 percent in 2018 , to 45 percent in 2019 . Oil, gas, and NGL production revenues decreased three percent for the year ended December 31, 2019 , compared with 2018 , as a result of lower commodity pricing and the divestiture in the first half of 2018 of our remaining producing assets in the Rocky Mountain region. Total production expense for the year ended December 31, 2019 , increased three percent compared with 2018 , due to increased LOE and ad valorem tax expense, partially offset by decreased production taxes and transportation costs. Production expense on a per BOE basis decreased six percent for the year ended December 31, 2019 , compared with 2018 , primarily due to increased production volumes, decreased transportation costs, and decreased production taxes resulting from lower oil, gas, and NGL production revenues. +The following table presents the regional changes in our net equivalent production, production revenue, and production expense between the years ended December 31, 2018 and 2017 : +Net Equivalent Production Increase (Decrease) +Production Revenue Increase (Decrease) +Production Expense Increase (Decrease) +(MBOE per day) +(in millions) +(in millions) +Midland Basin +27.4 +$ +582.5 +$ +89.5 +South Texas +(20.8 +) +(95.9 +) +(64.5 +) +Rocky Mountain (1) +(8.1 +) +(104.0 +) +(45.5 +) +Total +(1.5 +) +$ +382.6 +$ +(20.5 +) +__________________________________________ +Note: Amounts may not calculate due to rounding. +(1) +We divested all remaining producing assets in the Rocky Mountain region in the first half of 2018. As a result, there have been no production volumes from this region after the second quarter of 2018. +We experienced a one percent decrease in net equivalent production in 2018 compared with 2017 . The decrease in overall production volumes was a result of decreased production from our operated Eagle Ford shale assets as a result of reduced capital investment, the divestiture of our outside-operated Eagle Ford shale assets which occurred in the first quarter of 2017, and the divestiture of our remaining producing assets in the Rocky Mountain region in the first half of 2018. Production decreases in the South Texas and Rocky Mountain regions were predominately offset by the 91 percent production volume increase in our Midland Basin assets for the year ended December 31, 2018 , compared with 2017 . Increased production in the Midland Basin also drove oil +48 +production as a percentage of our overall product mix to increase from 31 percent in 2017 , to 43 percent in 2018 . The increase in higher margin oil production also increased realized prices, before the effects of derivative settlements, on a per BOE basis by 32 percent in 2018 , resulting in a 31 percent increase in oil, gas, and NGL production revenue for the year ended 2018 compared with 2017 . Production expense in 2018 , compared with 2017 , decreased four percent , and was primarily driven by the divestiture of the remaining assets in our Rocky Mountain region in the first half of 2018, which had the highest average production costs in our portfolio. +Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of trends on a per BOE basis for the years ended December 31, 2019 , 2018 , and 2017 . +Net gain (loss) on divestiture activity +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Net gain (loss) on divestiture activity +$ +0.9 +$ +426.9 +$ +(131.0 +) +No material divestitures occurred during 2019 . The $426.9 million net gain on divestiture activity recorded for the year ended December 31, 2018 , was the result of a total net gain of $410.6 million recorded for the divestiture of our Powder River Basin assets (the “PRB Divestiture”), which closed in the first quarter of 2018, and a combined total net gain of $15.4 million recorded for the completed divestitures of our remaining assets in the Williston Basin located in Divide County, North Dakota (the “Divide County Divestiture”) and our Halff East assets in the Midland Basin (the “Halff East Divestiture”), which closed in the second quarter of 2018. +The net loss on divestiture activity recorded for the year ended December 31, 2017 , was primarily the result of $526.5 million of write-downs recorded on certain retained North Dakota assets. These assets were divested in the second quarter of 2018, as discussed above. Partially offsetting these write-downs recorded during 2017, was a $396.8 million total net gain recorded on the sale of our outside-operated Eagle Ford shale assets. +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions in Part II, Item 8 of this report for additional discussion. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +$ +823.8 +$ +665.3 +$ +557.0 +DD&A expense for the year ended December 31, 2019 , increased 24 percent compared with 2018 . DD&A expense for the year ended December 31, 2018 , increased 19 percent compared with 2017 . These increases are directly related to the 25 percent and 91 percent increase s for the years ended December 31, 2019 , and 2018 , respectively, in production volumes from our Midland Basin assets as these assets have higher depletion rates than our assets in South Texas. +Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of DD&A expense on a per BOE basis. +Exploration +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Geological and geophysical expenses +$ +2.9 +$ +5.6 +$ +4.0 +Exploratory dry hole +4.8 +— +2.4 +Overhead and other expenses +43.8 +49.6 +48.3 +Total +$ +51.5 +$ +55.2 +$ +54.7 +Exploration expense decreased seven percent for the year ended December 31, 2019 , compared with 2018 . The decrease was primarily driven by a reduction in the amount of employee compensation reclassified to exploration expense as more employee time is being allocated to development activities, which is recognized as G&A expense. Exploration expense is impacted by actual geological and geophysical studies we perform and the potential for exploratory dry hole expense. +49 +Impairment of oil and gas properties +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Impairment of proved properties +$ +— +$ +— +$ +3.8 +Abandonment and impairment of unproved properties +33.8 +49.9 +12.3 +Total +$ +33.8 +$ +49.9 +$ +16.1 +There was no impairment of proved properties expense recognized for the years ended December 31, 2019 , and 2018 . Unproved property abandonments and impairments recorded for the years ended December 31, 2019 , and 2018 related to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. +We expect proved property impairments to occur more frequently in periods of declining or depressed commodity prices, and that the frequency of unproved property abandonments and impairments will fluctuate with the timing of lease expirations or defects, and changing economics associated with decreases in commodity prices. Additionally, changes in drilling plans, unsuccessful exploration activities, and downward engineering revisions may result in proved and unproved property impairments. Future impairments of proved and unproved properties are difficult to predict; however, based on our updated commodity price assumptions as of February 6, 2020 , we do not expect any material impairments in the first quarter of 2020 resulting from commodity price impacts. Please refer to Critical Accounting Policies and Estimates below for additional discussion. +General and administrative +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +General and administrative +$ +132.8 +$ +116.5 +$ +117.3 +G&A expense increased 14 percent for the year ended December 31, 2019 , compared with 2018 . Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of G&A expense. +Net derivative (gain) loss +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Net derivative (gain) loss +$ +97.5 +$ +(161.8 +) +$ +26.4 +We recognized a net derivative loss of $97.5 million for the year ended December 31, 2019 . For contracts that settled during 2019 , the fair value was a net asset of $112.2 million at December 31, 2018 , and net cash settlements received totaled $39.2 million , resulting in a $73.0 million net loss. Additionally, we recorded a $24.5 million mark-to-market loss on remaining contracts as of December 31, 2019 , resulting from an increase in commodity strip prices toward the end of 2019. +We recognized a net derivative gain of $161.8 million for the year ended December 31, 2018 . For contracts that settled during 2018 , the fair value was a net liability of $108.3 million at December 31, 2017 , and net cash settlements paid totaled $135.8 million, resulting in a $27.5 million loss. Offsetting this loss was a $189.3 million mark-to-market gain on remaining contracts as of December 31, 2018 , resulting from a decrease in commodity strip prices toward the end of 2018. +We recognized a net derivative loss of $26.4 million for the year ended December 31, 2017 . For contracts that settled during 2017 , the fair value was a net liability of $60.9 million at December 31, 2016, and net cash settlements received totaled $21.2 million, resulting in an $82.1 million gain. Offsetting this gain was a $108.5 million mark-to-market loss on remaining contracts as of December 31, 2017 , resulting from an increase in commodity strip prices. +Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +50 +Interest expense +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Interest expense +$ +(159.1 +) +$ +(160.9 +) +$ +(179.3 +) +Interest expense for the year ended December 31, 2019 , was relatively flat compared with 2018 . We expect interest expense related to our Senior Notes to be relatively flat in 2020 compared with 2019; however, total interest expense can vary based on the timing and amount of any borrowings against our credit facility. +The $18.4 million , or 10 percent , decrease in interest expense for the year ended December 31, 2018 , compared with 2017 , was driven in part by the redemption of our 6.50% Senior Notes due 2021 (“2021 Senior Notes”), which reduced interest expense related to debt in 2018 by $9.4 million compared with 2017. In addition to the overall reduction in debt, interest expense was also reduced as the amount of interest we capitalized increased given our higher level of development activity in 2018 compared with 2017. +Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report and Overview of Liquidity and Capital Resources below for additional discussion. +Loss on extinguishment of debt +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Loss on extinguishment of debt +$ +— +$ +(26.7 +) +$ +— +For the year ended December 31, 2018 , we recorded a $26.7 million net loss on the early extinguishment of our 2021 Senior Notes, 6.50% Senior Notes due 2023 (“2023 Senior Notes”), and a portion of our 6.125% Senior Notes due 2022 (“2022 Senior Notes”). The net loss on extinguishment of debt included $20.4 million associated with the premiums paid upon redemption and repurchase, and $6.3 million related to the acceleration of unamortized deferred financing costs. +Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Income tax (expense) benefit +For the Years Ended December 31, +2019 +2018 +2017 +(in millions, except tax rate) +Income tax (expense) benefit +$ +44.0 +$ +(143.4 +) +$ +183.0 +Effective tax rate +19.1 +% +22.0 +% +53.2 +% +The decrease in the effective tax rate for the year ended December 31, 2019 , compared with 2018 , was primarily due to the differing effects of permanent items on the loss before income taxes for the year ended December 31, 2019 , compared to the impact of these items on income before income taxes for 2018 . Excess tax deficiencies from stock-based compensation awards, limits on expensing of certain covered individual’s compensation, and other permanent expense items reduced the tax benefit rate for the year ended December 31, 2019 . These same items increased the tax expense rate for the year ended December 31, 2018 . The reduction in the tax expense rate also reflects a cumulative effect in 2018 from divestitures, and the impact of a correlative change to our state apportionment rate. +The decrease in the effective tax rate for the year ended December 31, 2018 , compared with 2017 was primarily due to the impacts of the Tax Cuts and Jobs Act (the “2017 Tax Act”). The 18.5 percent increase in 2017 from a nonrecurring deferred tax adjustment was caused by the 14 percent decrease in the highest marginal corporate rate from 35 percent to 21 percent beginning in 2018. The effect for 2017 was cumulatively added to a tax benefit calculated for that year. The 14 percent decrease is reflected in the 2018 income tax expense rate. In addition, the year-over-year tax rate decreased due to effects related to an excess tax deficiency from stock-based compensation awards, which had the effect of increasing the 2018 tax rate and partially offsetting the year-over-year decrease. Other nominal 2018 tax rate decreases included effects from property sales, net apportionment changes, research credits, and percentage depletion offset by the effects from limits to certain covered individual’s compensation. +Please refer to Overview of Liquidity and Capital Resources and Critical Accounting Policies and Estimates below as well as Note 4 – Income Taxes in Part II, Item 8 of this report for further discussion. +51 +Overview of Liquidity and Capital Resources +Based on the current commodity price environment, we believe we have sufficient liquidity and capital resources to execute our business plan for the foreseeable future. We continue to manage the duration and level of our drilling and completion service commitments in order to maintain flexibility with regard to our activity level and capital expenditures. +Sources of Cash +We currently expect our 2020 capital program to be funded by cash flows from operations with any remaining cash needs being funded by borrowings under our credit facility. During the year ended December 31, 2019 , we generated $823.6 million of cash flows from operating activities. As of December 31, 2019 , the remaining available borrowing capacity under our Credit Agreement provided $1.1 billion in liquidity; however, our borrowing base can be adjusted as a result of changes in commodity prices, acquisitions or divestitures of proved properties, or financing activities. +Although we expect cash flows from these sources to be sufficient to fund our expected 2020 capital program, we may also elect to raise funds through new debt or equity offerings or from other sources of financing. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders could be diluted, and these newly-issued securities may have rights, preferences, or privileges senior to those of existing stockholders. Future downgrades in our credit ratings could make it more difficult or expensive for us to borrow additional funds. Additionally, we may enter into carrying cost and sharing arrangements with third parties for certain exploration or development programs. All of our sources of liquidity can be affected by the general conditions of the broader economy, force majeure events, and fluctuations in commodity prices, operating costs, and volumes produced, all of which affect us and our industry. +We have no control over the market prices for oil, gas, or NGLs, although we may be able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of derivative contracts as part of our commodity price risk management program. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional information about our oil, gas, and NGL derivative contracts currently in place and the timing of settlement of those contracts . +The enactment of the 2017 Tax Act reduced our highest marginal corporate tax rate for 2018 and future years from 35 percent to 21 percent, however future deductibility of interest expense may be limited. In general, the enactment of the 2017 Tax Act has had a positive impact on operating cash flows, and we believe it will positively impact future operating cash flows. +Credit Agreement +Our Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $2.5 billion and is scheduled to mature on September 28, 2023 . The maturity date could, however, occur earlier on August 16, 2022, if we have not completed certain repurchase, redemption, or refinancing activities associated with our 2022 Senior Notes, as outlined in the Credit Agreement. No individual bank participating in our Credit Agreement represents more than 10 percent of the lender commitments under the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion as well as the presentation of the outstanding balance, total amount of letters of credit, and available borrowing capacity under our Credit Agreement as of February 6, 2020 , December 31, 2019 , and December 31, 2018 . +The borrowing base under the Credit Agreement is subject to regular, semi-annual redetermination, and considers the value of both our (a) proved oil and gas properties reflected in the most recent reserve report provided to our lenders under the Credit Agreement; and (b) commodity derivative contracts, each as determined by our lender group. The next scheduled borrowing base redetermination date is April 1, 2020 . +We must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring that we maintain certain financial ratios, as defined by the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional detail regarding our financial covenants. We were in compliance with all financial and non-financial covenants as of December 31, 2019 , and through the filing of this report. +Our daily weighted-average credit facility debt balance was approximately $115.2 million and $13.1 million for the years ended December 31, 2019 , and 2017 , respectively. We had no credit facility borrowing activity during 2018 as a result of cash on hand and cash proceeds received during 2018 from divestitures. Cash flows provided by our operating activities, divestiture proceeds, capital markets activities, and the amount of our capital expenditures, including acquisitions, all impact the amount we borrow under our credit facility. +Under our Credit Agreement, borrowings in the form of Eurodollar loans accrue interest based on the London Interbank Offered Rate (“LIBOR”). The use of LIBOR as a global reference rate is expected to be discontinued after 2021. Our Credit Agreement specifies that in the event that LIBOR is no longer a widely used benchmark rate, or that it shall no longer be used for determining interest rates for loans in the United States, a replacement interest rate that fairly reflects the cost to the lenders of funding loans shall be established by the Administrative Agent, as defined in the Credit Agreement, in consultation with us. We +52 +currently do not expect the transition from LIBOR to have a material impact on interest expense or borrowing activities under the Credit Agreement, or to otherwise have a material adverse impact on our business. +Weighted-Average Interest and Weighted-Average Borrowing Rates +Our weighted-average interest rate includes paid and accrued interest, fees on the unused portion of the aggregate commitment amount under the Credit Agreement, letter of credit fees, the non-cash amortization of deferred financing costs, and the non-cash amortization of the discount related to the Senior Convertible Notes. Our weighted-average borrowing rate includes paid and accrued interest only. +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2019 , 2018 , and 2017 . +For the Years Ended December 31, +2019 +2018 +2017 +Weighted-average interest rate +6.4 +% +6.4 +% +6.4 +% +Weighted-average borrowing rate +5.7 +% +5.8 +% +5.8 +% +Our weighted-average interest rates and weighted average borrowing rates for the years ended December 31, 2019 , 2018 , and 2017 , were impacted by the timing of long-term debt issuances and redemptions and the average outstanding balance on our revolving credit facility. Additionally, our weighted-average interest rates were impacted by the fees paid on the unused portion of our aggregate lender commitments. There was no material change in our weighted-average interest rates or weighted-average borrowing rates for the years ended December 31, 2019 , 2018 , and 2017 . The rates disclosed in the above table do not reflect amounts associated with the repurchase of Senior Notes, such as the discount realized or premium paid upon repurchase, or the acceleration of unamortized deferred financing costs expensed upon repurchase. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Uses of Cash +We use cash for the development, exploration, and acquisition of oil and gas properties and for the payment of operating and general and administrative costs, income taxes, dividends, and debt obligations, including interest. Expenditures for the development, exploration, and acquisition of oil and gas properties are the primary use of our capital resources. During 2019 , we spent approximately $1.0 billion on capital expenditures. This amount slightly differs from the costs incurred amount as costs incurred is an accrual-based amount that also includes asset retirement obligations, geological and geophysical expenses, acquisitions of oil and gas properties, and exploration overhead amounts. Please refer to Costs Incurred in Oil and Gas Producing Activities in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +The amount and allocation of our future capital expenditures will depend upon a number of factors, including the number and size of acquisitions, our cash flows from operating, investing, and financing activities, and our ability to execute our development program. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, and the timing and results of our exploration and development activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget to assess changes in current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. +We may from time to time repurchase or redeem all or portions of our outstanding debt securities for cash, through exchanges for other securities, or a combination of both. Such repurchases or redemptions may be made in open market transactions, privately negotiated transactions, or otherwise. Any such repurchases or redemptions will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. Repurchases or redemptions are reviewed as part of the allocation of our capital. During the third quarter of 2018, we redeemed our 2021 Senior Notes, repurchased or redeemed all of our 2023 Senior Notes, repurchased a portion of our 2022 Senior Notes, and issued our 2027 Senior Notes. We did not conduct similar debt transactions during 2019 , or through the filing of this report. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. As part of our strategy for 2020, we will continue to focus on improving our debt metrics, which could include reducing the amount of our outstanding debt. +As of the filing of this report, we could repurchase up to 3,072,184 shares of our common stock under our stock repurchase program, subject to the approval of our Board of Directors. Shares may be repurchased from time to time in the open market, or in privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes, the indenture governing our Senior Convertible Notes, compliance with securities laws, and the terms and provisions of our stock repurchase program. Our Board of Directors periodically reviews this program as part of the allocation of our capital. During 2019 , we did not repurchase any shares of our common stock, and we currently do not plan to repurchase any outstanding shares of our common stock during 2020 . +53 +During the years ended December 31, 2019 , 2018 , and 2017 , we paid $11.3 million , $11.2 million , and $11.1 million , respectively, in dividends to our stockholders, reflecting a dividend of $0.10 per share each year. Our current intention is to continue to make dividend payments for the foreseeable future, subject to our future earnings, our financial condition, Credit Agreement, indentures governing our Senior Notes and Senior Convertible Notes, other covenants, and other factors which could arise. The payment and amount of future dividends remains at the discretion of our Board of Directors. +Analysis of Cash Flow Changes Between 2019 and 2018 and Between 2018 and 2017 +The following tables present changes in cash flows between the years ended December 31, 2019 , 2018 , and 2017 , for our operating, investing, and financing activities. The analysis following each table should be read in conjunction with our accompanying consolidated statements of cash flows (“accompanying statements of cash flows”) in Part II, Item 8 of this report. +Operating Activities +For the Years Ended December 31, +Amount Change Between +2019 +2018 +2017 +2019/2018 +2018/2017 +(in millions) +Net cash provided by operating activities +$ +823.6 +$ +720.6 +$ +515.4 +$ +103.0 +$ +205.2 +Derivative settlements increased $202.9 million for the year ended December 31, 2019 , compared with 2018 . This increase was partially offset by decreased cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes of $73.4 million, and increased cash paid for LOE and ad valorem taxes of $22.0 million for the year ended December 31, 2019 , compared with 2018 . Cash paid for interest decreased $8.8 million for the year ended December 31, 2019 , compared with 2018 , due to the redemption and repurchase of certain senior notes in the third quarter of 2018, partially offset by increased interest paid on the 2027 Senior Notes and interest paid on credit facility borrowings during the year ended December 31, 2019 . Net cash provided by operating activities is also affected by working capital changes and the timing of cash receipts and disbursements. +Cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, including derivative cash settlements, increased $196.0 million for the year ended December 31, 2018 , compared with 2017 , primarily as a result of an increase in our realized price, after the effect of derivative settlements. Interest paid decreased $13.4 million for the year ended December 31, 2018 , compared with 2017 , due to the redemption and repurchase of certain of our senior notes in the third quarter of 2018. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Investing Activities +For the Years Ended December 31, +Amount Change Between +2019 +2018 +2017 +2019/2018 +2018/2017 +(in millions) +Net cash used in investing activities +$ +(1,013.3 +) +$ +(587.9 +) +$ +(201.5 +) +$ +(425.4 +) +$ +(386.4 +) +Net cash used in investing activities increased for the year ended December 31, 2019 , compared with 2018 . Proceeds received from the sale of oil and gas properties were $735.5 million lower in 2019 than in 2018 as no material divestitures occurred during 2019 . This was partially offset by lower capital expenditures and less cash paid to acquire proved and unproved oil and gas properties of $279.4 million and $30.7 million , respectively. +Net cash used in investing activities increased for the year ended December 31, 2018 , compared with 2017 . Capital expenditures in 2018 increased $414.8 million compared with 2017 , from $888.4 million to $1.3 billion as a result of increased drilling and completion activities. During 2018 , cash paid to acquire proved and unproved properties decreased $56.6 million compared with 2017 . Further, net proceeds from the sale of oil and gas properties decreased $28.2 million in 2018 , compared with 2017 . During 2018 , net proceeds were primarily from the PRB Divestiture, Divide County Divestiture, and Halff East Divestiture. During 2017 , net proceeds were primarily from the sale of our outside-operated Eagle Ford shale assets. +54 +Financing Activities +For the Years Ended December 31, +Amount Change Between +2019 +2018 +2017 +2019/2018 +2018/2017 +(in millions) +Net cash provided by (used in) financing activities +$ +111.8 +$ +(368.7 +) +$ +(12.3 +) +$ +480.5 +$ +(356.4 +) +Net cash provided by (used in) financing activities increased $480.5 million for year ended December 31, 2019 , compared with 2018 . During the year ended December 31, 2019 , net borrowings under our credit facility increased $122.5 million . We had a zero balance on our credit facility throughout 2018 due to our cash balance resulting from the proceeds received from divestitures in the first half of 2018. During the year ended December 31, 2018 , we redeemed or repurchased $824.6 million principal outstanding of certain of our senior notes, and paid premiums totaling $20.4 million in connection with these redemptions and repurchases. Additionally, we issued our 2027 Senior Notes for net proceeds of $492.1 million. There were no such debt transactions during 2019 . Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Interest Rate Risk +We are exposed to market risk due to the floating interest rate associated with any outstanding balance on our revolving credit facility. As of December 31, 2019 , we had a $122.5 million balance on our credit facility. Our Credit Agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the credit facility’s fair value but will not impact results of operations or cash flows. Conversely, for the portion of the credit facility that has a floating interest rate, interest rate changes will not affect the fair value but will impact future results of operations and cash flows. Changes in interest rates do not impact the amount of interest we pay on our fixed-rate Senior Notes or fixed-rate Senior Convertible Notes but can impact their fair values. As of December 31, 2019 , our outstanding principal amount of fixed-rate debt totaled $2.6 billion and our floating-rate debt outstanding totaled $122.5 million . Please refer to Note 11 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion on the fair values of our Senior Notes and Senior Convertible Notes. +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly impact our revenue, profitability, access to capital, and future rate of growth. Oil, gas, and NGL prices are subject to unpredictable fluctuations resulting from a variety of factors, including changes in supply and demand, all of which are typically beyond our control. The markets for oil, gas, and NGLs have been volatile, especially over the last several years, and these markets will likely continue to be volatile in the future. The realized prices we receive for our production also depend on numerous factors that are typically beyond our control. Based on our 2019 production, a 10 percent decrease in our average realized oil, gas, and NGL prices, before the effects of derivative settlements, would have reduced our oil, gas, and NGL production revenues by approximately $118.3 million , $26.3 million , and $14.0 million , respectively. If commodity prices had been 10 percent lower, our net derivative settlements for the year ended December 31, 2019 would have offset the declines in oil, gas, and NGL production revenue by approximately $75.9 million. +We enter into commodity derivative contracts in order to reduce the risk of fluctuations in commodity prices. The fair value of our commodity derivative contracts is largely determined by estimates of the forward curves of the relevant price indices. As of December 31, 2019 , a 10 percent increase or decrease in the forward curves associated with our oil, gas, and NGL commodity derivative instruments would have changed our net derivative positions for these products by approximately $113.4 million , $6.4 million , and $3.6 million , respectively. +Schedule of Contractual Obligations +The following table summarizes our contractual obligations at December 31, 2019 , for the periods specified (in millions): +Contractual Obligations +Total +Less than 1 year +1-3 years +3-5 years +More than 5 years +Long-term debt (1) +$ +2,771.8 +$ +— +$ +649.3 +$ +622.5 +$ +1,500.0 +Interest payments (2) +832.7 +160.4 +313.2 +222.4 +136.7 +Delivery commitments (3) +218.5 +46.3 +133.7 +32.5 +6.0 +Operating leases and contracts (3) +131.1 +56.3 +34.6 +21.5 +18.7 +Asset retirement obligations (4) +114.4 +3.1 +6.2 +36.0 +69.1 +Derivative liabilities (5) +54.6 +51.1 +3.5 +— +— +Other (6) +35.6 +5.6 +14.9 +15.1 +— +Total +$ +4,158.7 +$ +322.8 +$ +1,155.4 +$ +950.0 +$ +1,730.5 +55 +____________________________________________ +(1) +Long-term debt consists of the $122.5 million balance on our revolving credit facility, our Senior Notes, and our Senior Convertible Notes and assumes no principal repayment until the maturity dates of these instruments. The actual payment dates may vary significantly. +(2) +Interest payments on our Senior Notes and Senior Convertible Notes are estimated assuming no principal repayment until the maturity dates of these instruments. Interest payments on our credit facility have been estimated using the rate applicable to the outstanding balance on our credit facility as of December 31, 2019 , and assume no future borrowings or repayments until the September 28, 2023 maturity date of the Credit Agreement. The actual interest payments on our Senior Notes, Senior Convertible Notes, and our credit facility may vary significantly. +(3) +Please refer to Note 6 – Commitments and Contingencies in Part II, Item 8 of this report for additional discussion regarding our operating leases, contracts, and gathering, processing, transportation throughput, and delivery commitments. The amount relating to our gathering, processing, transportation throughput, and delivery commitments reflects the aggregate undiscounted deficiency payments assuming we delivered no product. This amount does not include any costs that may be incurred for certain contracts where we cannot predict with accuracy the amount and timing of any payments that may be incurred for not meeting certain minimum commitments, as such payments are dependent upon the price of oil in effect at the time of settlement. +(4) +Amounts shown represent estimated future undiscounted plugging and abandonment costs. The discounted obligations are recorded as liabilities on our accompanying consolidated balance sheets (“accompanying balance sheets”) as of December 31, 2019 . The timing and amount of the ultimate settlement of these obligations is unknown and can be impacted by economic factors, a change in development plans, and federal and state regulations. Please refer to Note 14 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +(5) +Amounts shown represent only the liability portion of the marked-to-market value of our commodity derivatives based on future market prices as of December 31, 2019 , and exclude estimated oil, gas, and NGL commodity derivative receipts. This amount varies from the liability amounts presented on the accompanying balance sheets, as those amounts are presented at fair value, which considers time value, volatility, and the risk of non-performance for us and for our counterparties. The ultimate settlement amounts under our derivative contracts are unknown, as they are subject to continuing market risk and commodity price volatility. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +(6) +The majority of this amount is related to the unfunded portion of our estimated pension liability of $35.2 million , for which we have estimated the timing of future payments based on historical annual contribution amounts. +Off-Balance Sheet Arrangements +As part of our ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +We evaluate our transactions to determine if any variable interest entities exist. If we determine that we are the primary beneficiary of a variable interest entity, that entity is consolidated into our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions during 2019 or 2018 , or through the filing of this report. +Critical Accounting Policies and Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our consolidated financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate due to changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below, those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Successful Efforts Method of Accounting . GAAP provides for two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method. Both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report. +Oil and Gas Reserve Quantities . Our estimated proved reserve quantities and future net cash flows are critical to understanding the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our consolidated financial statements, including the calculations of depletion and impairment of proved and unproved oil +56 +and gas properties. Please refer to Oil and Gas Producing Activities in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report for additional discussion on our accounting policies impacted by estimated reserve quantities. +Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure of discounted future net cash flows calculation requires that a 10 percent discount rate be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir evaluation consulting firm, to audit at least 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year end. It should not be assumed that the standardized measure of discounted future net cash flows (GAAP) or PV-10 (non-GAAP) as of December 31, 2019 , is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based these measures on a 12-month average of the first-day-of-the-month prices for the year ended December 31, 2019 . Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimates. Please refer to Risk Factors - Risks Related to Our Business in Part I, Item 1A of this report. +If the estimates of proved reserves decline, the rate at which we record depletion expense will increase, which would reduce future net income. Changes in depletion rate calculations caused by changes in reserve quantities are made prospectively. In addition, a decline in reserve estimates may impact the outcome of our assessment of proved and unproved properties for impairment. Impairments are recorded in the period in which they are identified. +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2019 +2018 +2017 +MMBOE Change +MMBOE Change +MMBOE Change +Revisions resulting from performance +(14.9 +) +(59.7 +) +7.4 +Removal of proved undeveloped reserves no longer in our five-year development plan +(9.8 +) +(22.6 +) +(13.9 +) +Revisions resulting from price changes +(70.0 +) +13.5 +23.1 +Total +(94.7 +) +(68.8 +) +16.6 +As previously noted, commodity prices are volatile and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. +We cannot reasonably predict future commodity prices, although we believe that together, the below analyses provide reasonable information regarding the impact of changes in pricing and trends on total estimated proved reserves. The following table reflects the estimated MMBOE change and percentage change to our total reported estimated proved reserve volumes from the described hypothetical changes: +For the year ended December 31, 2019 +MMBOE Change +Percentage Change +10 percent decrease in SEC pricing (1) +(7.2 +) +(2 +)% +Average NYMEX strip pricing as of fiscal year end (2) +(5.2 +) +(1 +)% +10 percent decrease in proved undeveloped reserves (3) +(21.5 +) +(5 +)% +___________________________________________ +(1) +The change solely reflects the impact of a 10 percent decrease in SEC pricing to the total reported estimated proved reserve volumes as of December 31, 2019 , and does not include additional impacts to our estimated proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. +(2) +The change solely reflects the impact of replacing SEC pricing with the five-year average NYMEX strip pricing as of December 31, 2019 . SEC pricing of $55.69 per Bbl for oil, $2.58 per MMBtu for gas, and $22.68 per Bbl for NGLs as of December 31, 2019 , compared to the five-year average NYMEX strip pricing of $53.65 per Bbl for oil, $2.42 per MMBtu for gas, and $19.67 per Bbl for NGLs as of December 31, 2019 , would result in a one percent decrease to our total reported estimated proved reserve volumes. +(3) +The change solely reflects a 10 percent decrease in proved undeveloped reserves as of December 31, 2019 , and does not include any additional impacts to our estimated proved reserves. +57 +Additional reserve information can be found in Reserves in Part I, Items 1 and 2 of this report, and in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Impairment of Oil and Gas Properties . Proved properties are evaluated periodically for impairment on a pool-by-pool basis when events or changes in circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected future cash flows of our oil and gas properties and compare these undiscounted cash flows to the carrying amount to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the oil and gas properties to fair value (or discounted future cash flows). Management estimates future cash flows from all proved reserves and risk adjusted probable and possible reserves using various factors, which are subject to our judgment and expertise, and include, but are not limited to, commodity price forecasts, estimated future operating and capital costs, development plans, and discount rates to incorporate the risk and current market conditions associated with realizing the expected cash flows. +Unproved oil and gas properties are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by prospect and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and our intent to renew leases. We estimate the fair value of unproved properties using a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by us or other market participants. +We cannot predict when or if future impairment charges will be recorded because of the uncertainty in the factors discussed above. Despite any amount of future impairment being difficult to predict, based on our commodity price assumptions as of February 6, 2020 , we do not expect any material property impairments in the first quarter of 2020 resulting from commodity price impacts. +Please refer to Note 1 – Summary of Significant Accounting Policies and Note 11 – Fair Value Measurements in Part II, Item 8 of this report for discussion of impairments of oil and gas properties recorded for the years ended December 31, 2019 , 2018 , and 2017 . +Asset Retirement Obligations . We are required to recognize an estimated liability for future costs associated with the abandonment of our oil and gas properties. We base our estimate of the liability on our historical experience in abandoning oil and gas wells and our current understanding of federal and state regulatory requirements. Our present value calculations require us to estimate the cost, the economic lives and timing of abandonment of our properties, future inflation rates, and the appropriate credit-adjusted risk-free discount rate to use. The impact to the accompanying statements of operations from these estimates is reflected in our depletion, depreciation, and amortization calculations and occurs over the remaining life of our respective oil and gas properties. Please refer to Note 14 – Asset Retirement Obligations in Part II, Item 8 of this report for additional discussion. +Revenue Recognition . Effective January 1, 2018, our revenue recognition policy was updated to reflect the adoption of new accounting guidance. Our revenue recognition policy is a critical accounting policy because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. Our primary source of revenue is derived by the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when custody and title (“control”) of the product, as defined by contractual terms, transfers to the purchaser. Payment for these sales is typically received between 30 and 90 days after the date of production. At the end of each month, we make estimates of the amount of production delivered to the purchaser and the price we will receive. We use our knowledge of our properties, contractual arrangements, historical performance, NYMEX, local spot market, and OPIS prices, and other factors as the basis for these estimates. Variances between our estimates and the actual amounts received are recorded in the month payment is received. A 10 percent change in our revenue accrual at year end 2019 would have impacted total operating revenues by approximately $14.6 million in 2019 . Please refer to Note 2 - Revenue from Contracts with Customers in Part II, Item 8 of this report for additional discussion. +Derivative Financial Instruments . We periodically enter into commodity derivative contracts to manage our exposure to oil, gas, and NGL price volatility and location differentials. We recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income (loss). The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our consolidated financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Income Taxes . We provide for deferred income taxes on the difference between the tax basis of an asset or liability and its carrying amount in our consolidated financial statements. This difference will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period, as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are +58 +recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax expense by approximately $2.3 million for the year ended December 31, 2019 . Please refer to Note 1 – Summary of Significant Accounting Policies and Note 4 – Income Taxes in Part II, Item 8 of this report for additional discussion. +Accounting Matters +Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for information on new authoritative accounting guidance. +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes, and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +Hydraulic Fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, please refer to Risk Factors – Risks Related to Our Business – Proposed federal and state legislative and regulatory initiatives relating to hydraulic fracturing, air quality, and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays . +Climate Change. In June 2013, President Obama announced a Climate Action Plan designed to further reduce GHG emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Climate Action Plan targeted methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. As part of the Climate Action Plan, on May 12, 2016, the EPA issued final regulations that amend and expand 2012 regulations for the oil and gas sector by setting emission limits for VOCs and methane, a GHG, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The regulation requires, among other things, GHG and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly boosting and garnering compressor stations and gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. Both the 2012 and 2016 rules are the subject of Petitions for Review before the U.S. Circuit Court of Appeals for the District of Columbia, although the litigation of both rules has been stayed. In October 2018, the EPA proposed scaling back provisions of the 2016 NSPS directed toward cutting leaks of methane, including proposing allowing only annual inspections for many sites. The rule does not extend to existing sources and the Trump EPA has rescinded the Information Collection Request that was intended to gather information to develop existing source standards. On August 29, 2019, the EPA proposed amendments to the 2012 and 2016 NSPS that would remove transmission and storage infrastructure from regulation of methane emissions and other VOCs. The amendments would also rescind methane requirements for oil and gas production and processing equipment. As an alternative, the EPA proposed to rescind the methane requirements for oil and gas altogether and sought comment on alternative interpretations of its authority to regulate pollutants under Section 111 of the Clean Air Act. On November 16, 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands, as part of President Obama’s Climate Action Plan. The regulations were intended to reduce the waste of gas from flaring, venting, and leaks by oil and gas production. The rule included requirements that prohibits venting of gas except in limited circumstances and limits flaring of gas and includes requirements for leak detection and repair. The rule also increased royalty payments for “waste” gas that is released in contravention of the rule requirements. After continuous court challenges, the BLM issued a final rule in September 2018 that rescinded most of the 2016 rule, including most of the methane control requirements. Any future regulations requiring similar capture standards may increase our operational costs, or restrict our production, which could materially and adversely affect our financial condition, results of operations, and cash flows. +In August of 2015, the EPA finalized existing source performance standards as stringent state emission “goals” for utilities to reduce GHG emissions. The proposed standards focus on re-dispatching electricity from coal-fired units to gas combined cycle plants and renewables. In February 2016, however, the Supreme Court stayed these rules pending judicial review. The EPA has proposed a repeal of the rule based on a new legal interpretation of the EPA’s authority. The EPA proposed a replacement rule, the Affordable Clean Energy Rule, in August 2018 and finalized the rule in June 2019. +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs and almost one-half of the states have already taken legal measures to reduce emissions of GHGs primarily through the planned development of GHG emission inventories and/or regional GHG cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall GHG emission reduction goal. In addition, there have been international conventions and efforts to establish standards for the reduction of GHGs globally, including the Paris accords in December 2015. The conditions for entry into force of the +59 +Paris accords were met on October 5, 2016 and the Agreement went into force 30 days later on November 4, 2016. However, in August 2017, the U.S. notified the United Nations Secretary-General that it intends to withdraw from the agreement as soon as it is able to do so, or November 2019. On November 4, 2019, President Trump formally notified the United Nations that the United States would withdraw from the Paris Agreement. The November 4, 2019 formal notice triggered the start of a year-long withdrawal process. +The adoption of legislation or regulatory programs to reduce emissions of GHGs could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and gas we produce. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. Judicial challenges to new regulatory measures are likely and we cannot predict the outcome of such challenges. New regulatory suspensions, revisions, or rescissions and conflicting state and federal regulatory mandates may inhibit our ability to accurately forecast the costs associated with future regulatory compliance. Finally, scientists have concluded that increasing concentrations of GHGs in the earth’s atmosphere produce climate changes that likely have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. Such effects could have an adverse effect on our financial condition and results of operations. +In terms of opportunities, the regulation of GHG emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and gas that we produce, the relative demand for gas may increase because the burning of gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources, such as wind or solar power become more prevalent, gas-fired electric plants may provide an alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, gas may become a more attractive transportation fuel. Approximately 38 percent and 39 percent of our production on a BOE basis in 2019 and 2018 , respectively, was gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and gas reservoirs, could also benefit us through the potential to obtain GHG emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +Non-GAAP Financial Measures +Adjusted EBITDAX represents net income (loss) before interest expense, interest income, income taxes, depletion, depreciation, amortization and asset retirement obligation liability accretion expense, exploration expense, property abandonment and impairment expense, non-cash stock-based compensation expense, derivative gains and losses net of settlements, gains and losses on divestitures, gains and losses on extinguishment of debt, and certain other items. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally non-recurring in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that we believe provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for development, exploration, acquisitions, and to service debt. We are also subject to financial covenants under our Credit Agreement based on adjusted EBITDAX ratios as further described in the Credit Agreement section in Overview of Liquidity and Capital Resources above. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or other profitability or liquidity measures prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. Our credit facility provides a material source of liquidity for us. Under the terms of our Credit Agreement, if we failed to comply with the covenants that establish a maximum permitted ratio of total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX, we would be in default, an event that would prevent us from borrowing under our credit facility and would therefore materially limit our sources of liquidity. In addition, if we are in default under our credit facility and are unable to obtain a waiver of that default from our lenders, lenders under the credit facility and under the indentures governing our outstanding Senior Notes and Senior Convertible Notes would be entitled to exercise all of their remedies for default. +60 +The following table provides reconciliations of our net income (loss) (GAAP) and net cash provided by operating activities (GAAP) to adjusted EBITDAX (non-GAAP) for the periods presented: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Net income (loss) (GAAP) +$ +(187,001 +) +$ +508,407 +$ +(160,843 +) +Interest expense +159,102 +160,906 +179,257 +Income tax expense (benefit) +(44,043 +) +143,370 +(182,970 +) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +823,798 +665,313 +557,036 +Exploration (1) +46,995 +49,627 +48,413 +Impairment of oil and gas properties +33,842 +49,889 +16,078 +Stock-based compensation expense +24,318 +23,908 +22,700 +Net derivative (gain) loss +97,539 +(161,832 +) +26,414 +Derivative settlement gain (loss) +39,222 +(135,803 +) +21,234 +Net (gain) loss on divestiture activity +(862 +) +(426,917 +) +131,028 +Loss on extinguishment of debt +— +26,740 +35 +Other, net +481 +(3,214 +) +4,852 +Adjusted EBITDAX (non-GAAP) +993,391 +900,394 +663,234 +Interest expense +(159,102 +) +(160,906 +) +(179,257 +) +Income tax (expense) benefit +44,043 +(143,370 +) +182,970 +Exploration (1) +(46,995 +) +(49,627 +) +(48,413 +) +Amortization of debt discount and deferred financing costs +15,474 +15,258 +16,276 +Deferred income taxes +(41,835 +) +141,708 +(192,066 +) +Other, net +1,739 +3,501 +3,033 +Changes in current assets and liabilities +16,852 +13,671 +69,613 +Net cash provided by operating activities (GAAP) +$ +823,567 +$ +720,629 +$ +515,390 +____________________________________________ +(1) +Stock-based compensation expense is a component of the exploration expense and general and administrative expense line items on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration expense. +61 +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this item is provided under the captions Commodity Price Risk and Interest Rate Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place in Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +62 +ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries (the Company) as of December 31, 2019 and 2018 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 20, 2020 expressed an unqualified opinion thereon. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +63 +Depletion, depreciation and amortization (‘DD&A’) of proved oil and gas properties +Description of the Matter +At December 31, 2019, the net book value of the Company’s proved oil and gas properties was $4.8 billion, and depletion, depreciation and amortization (DD&A) expense was $823.8 million for the year then ended. As described in Note 1 to the consolidated financial statements, under the successful efforts method of accounting, the costs of development wells are capitalized whether those wells are successful or unsuccessful. Capitalized drilling and completion costs, including lease and well equipment, intangible development costs, and operational support facilities in the field are depleted as a group of assets using the units-of-production method based on proved developed oil and gas reserves, as estimated by the Company’s engineering technical team. Similarly, proved leasehold costs are depleted on the same group asset basis; however, the units-of-production method is based on total proved oil and gas reserves, as estimated by the Company’s engineering technical team. Significant judgment is required by the Company’s engineering technical team in evaluating geoscience and engineering data when estimating proved oil and gas reserves. Estimating reserves also requires the use of inputs, including oil and gas prices and operating and capital costs assumptions, among others. Because of the complexity involved in estimating oil and gas reserves, management used an independent petroleum engineering consulting firm to audit the estimates prepared by the Company’s engineering technical team for at least 80% of the Company’s total calculated proved reserve PV-10 as of December 31, 2019. +Auditing the Company’s DD&A calculation is especially complex and judgmental because of our use of the work of the Company’s engineering technical team and independent petroleum engineering consulting firm and the evaluation of management’s determination of the inputs described above used by the engineering technical team and independent petroleum engineering consulting firm in estimating proved oil and gas reserves. +How We Addressed the Matter in Our Audit +We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s process to calculate DD&A, including management’s controls over the completeness and accuracy of the financial data provided to the Company’s engineering technical team and independent petroleum engineering consulting firm for use in estimating the proved oil and gas reserves. +Our audit procedures included, among others, evaluating the professional qualifications and objectivity of the engineering technical team primarily responsible for overseeing the preparation of the reserve estimates and the independent petroleum engineering consulting firm used to audit the estimates. In addition, in assessing whether we can use the work of the Company’s engineering technical team and independent petroleum engineering consulting firm we evaluated the completeness and accuracy of the financial data and inputs described above used by the engineering technical team and independent petroleum engineering consulting firm in estimating proved oil and gas reserves by agreeing them to source documentation and we identified and evaluated corroborative and contrary evidence. We also tested the mathematical accuracy of the DD&A calculations, including comparing the proved oil and gas reserve amounts used to the Company’s reserve report. +/s/ Ernst & Young LLP +We have served as the Company’s auditor since 2012. +Denver, Colorado +February 20, 2020 +64 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2019 +2018 +ASSETS +Current assets: +Cash and cash equivalents +$ +10 +$ +77,965 +Accounts receivable +184,732 +167,536 +Derivative assets +55,184 +175,130 +Prepaid expenses and other +12,708 +8,632 +Total current assets +252,634 +429,263 +Property and equipment (successful efforts method): +Proved oil and gas properties +8,934,020 +7,278,362 +Accumulated depletion, depreciation, and amortization +( 4,177,876 +) +( 3,417,953 +) +Unproved oil and gas properties +1,005,887 +1,581,401 +Wells in progress +118,769 +295,529 +Other property and equipment, net of accumulated depreciation of $64,032 and $57,102, respectively +72,848 +93,826 +Total property and equipment, net +5,953,648 +5,831,165 +Noncurrent assets: +Derivative assets +20,624 +58,499 +Other noncurrent assets +65,326 +33,935 +Total noncurrent assets +85,950 +92,434 +Total assets +$ +6,292,232 +$ +6,352,862 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable and accrued expenses +$ +402,008 +$ +403,199 +Derivative liabilities +50,846 +62,853 +Other current liabilities +19,189 +— +Total current liabilities +472,043 +466,052 +Noncurrent liabilities: +Revolving credit facility +122,500 +— +Senior Notes, net of unamortized deferred financing costs +2,453,035 +2,448,439 +Senior Convertible Notes, net of unamortized discount and deferred financing costs +157,263 +147,894 +Asset retirement obligations +84,134 +91,859 +Deferred income taxes +189,386 +223,278 +Derivative liabilities +3,444 +12,496 +Other noncurrent liabilities +61,433 +42,522 +Total noncurrent liabilities +3,071,195 +2,966,488 +Commitments and contingencies (note 6) +Stockholders’ equity: +Common stock, $0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 112,987,952 and 112,241,966 shares, respectively +1,130 +1,122 +Additional paid-in capital +1,791,596 +1,765,738 +Retained earnings +967,587 +1,165,842 +Accumulated other comprehensive loss +( 11,319 +) +( 12,380 +) +Total stockholders’ equity +2,748,994 +2,920,322 +Total liabilities and stockholders’ equity +$ +6,292,232 +$ +6,352,862 +The accompanying notes are an integral part of these consolidated financial statements. +65 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +For the Years Ended +December 31, +2019 +2018 +2017 +Operating revenues and other income: +Oil, gas, and NGL production revenue +$ +1,585,750 +$ +1,636,357 +$ +1,253,783 +Net gain (loss) on divestiture activity +862 +426,917 +( 131,028 +) +Other operating revenues +3,493 +3,798 +6,621 +Total operating revenues and other income +1,590,105 +2,067,072 +1,129,376 +Operating expenses: +Oil, gas, and NGL production expense +500,709 +487,367 +507,906 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +823,798 +665,313 +557,036 +Exploration +51,500 +55,166 +54,713 +Impairment of oil and gas properties +33,842 +49,889 +16,078 +General and administrative +132,797 +116,504 +117,283 +Net derivative (gain) loss +97,539 +( 161,832 +) +26,414 +Other operating expenses, net +19,888 +18,328 +13,667 +Total operating expenses +1,660,073 +1,230,735 +1,293,097 +Income (loss) from operations +( 69,968 +) +836,337 +( 163,721 +) +Interest expense +( 159,102 +) +( 160,906 +) +( 179,257 +) +Loss on extinguishment of debt +— +( 26,740 +) +( 35 +) +Other non-operating income (expense), net +( 1,974 +) +3,086 +( 800 +) +Income (loss) before income taxes +( 231,044 +) +651,777 +( 343,813 +) +Income tax (expense) benefit +44,043 +( 143,370 +) +182,970 +Net income (loss) +$ +( 187,001 +) +$ +508,407 +$ +( 160,843 +) +Basic weighted-average common shares outstanding +112,544 +111,912 +111,428 +Diluted weighted-average common shares outstanding +112,544 +113,502 +111,428 +Basic net income (loss) per common share +$ +( 1.66 +) +$ +4.54 +$ +( 1.44 +) +Diluted net income (loss) per common share +$ +( 1.66 +) +$ +4.48 +$ +( 1.44 +) +The accompanying notes are an integral part of these consolidated financial statements. +66 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +For the Years Ended +December 31, +2019 +2018 +2017 +Net income (loss) +$ +( 187,001 +) +$ +508,407 +$ +( 160,843 +) +Other comprehensive income, net of tax: +Pension liability adjustment (1) +1,061 +4,378 +767 +Total other comprehensive income, net of tax +1,061 +4,378 +767 +Total comprehensive income (loss) +$ +( 185,940 +) +$ +512,785 +$ +( 160,076 +) +____________________________________________ +(1) +Please refer to Note 8 – Pension Benefits for additional discussion on the pension liability adjustment. +The accompanying notes are an integral part of these consolidated financial statements. +67 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share data and dividends per share) +Additional Paid-in Capital +Accumulated Other Comprehensive Loss +Total Stockholders’ Equity +Common Stock +Retained Earnings +Shares +Amount +Balances, January 1, 2017 +111,257,500 +$ +1,113 +$ +1,716,556 +$ +794,020 +$ +( 14,556 +) +$ +2,497,133 +Net loss +— +— +— +( 160,843 +) +— +( 160,843 +) +Other comprehensive income +— +— +— +— +767 +767 +Cash dividends, $ 0.10 per share +— +— +— +( 11,144 +) +— +( 11,144 +) +Issuance of common stock under Employee Stock Purchase Plan +186,665 +2 +2,621 +— +— +2,623 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings +171,278 +1 +( 1,241 +) +— +— +( 1,240 +) +Stock-based compensation expense +71,573 +1 +22,699 +— +— +22,700 +Cumulative effect of accounting change (1) +— +— +1,108 +43,624 +— +44,732 +Other +— +— +( 120 +) +— +— +( 120 +) +Balances, December 31, 2017 +111,687,016 +$ +1,117 +$ +1,741,623 +$ +665,657 +$ +( 13,789 +) +$ +2,394,608 +Net income +— +— +— +508,407 +— +508,407 +Other comprehensive income +— +— +— +— +4,378 +4,378 +Cash dividends, $0.10 per share +— +— +— +( 11,191 +) +— +( 11,191 +) +Issuance of common stock under Employee Stock Purchase Plan +199,464 +2 +3,185 +— +— +3,187 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings +291,745 +3 +( 2,978 +) +— +— +( 2,975 +) +Stock-based compensation expense +63,741 +— +23,908 +— +— +23,908 +Cumulative effect of accounting change (1) +— +— +— +2,969 +( 2,969 +) +— +Balances, December 31, 2018 +112,241,966 +$ +1,122 +$ +1,765,738 +$ +1,165,842 +$ +( 12,380 +) +$ +2,920,322 +Net loss +— +— +— +( 187,001 +) +— +( 187,001 +) +Other comprehensive income +— +— +— +— +1,061 +1,061 +Cash dividends declared, $0.10 per share +— +— +— +( 11,254 +) +— +( 11,254 +) +Issuance of common stock under Employee Stock Purchase Plan +314,868 +3 +3,206 +— +— +3,209 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings +334,399 +4 +( 1,665 +) +— +— +( 1,661 +) +Stock-based compensation expense +96,719 +1 +24,317 +— +— +24,318 +Balances, December 31, 2019 +112,987,952 +$ +1,130 +$ +1,791,596 +$ +967,587 +$ +( 11,319 +) +$ +2,748,994 +____________________________________________ +(1) +Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies for additional information. +The accompanying notes are an integral part of these consolidated financial statements. +68 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2019 +2018 +2017 +Cash flows from operating activities: +Net income (loss) +$ +( 187,001 +) +$ +508,407 +$ +( 160,843 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Net (gain) loss on divestiture activity +( 862 +) +( 426,917 +) +131,028 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +823,798 +665,313 +557,036 +Impairment of oil and gas properties +33,842 +49,889 +16,078 +Stock-based compensation expense +24,318 +23,908 +22,700 +Net derivative (gain) loss +97,539 +( 161,832 +) +26,414 +Derivative settlement gain (loss) +39,222 +( 135,803 +) +21,234 +Amortization of debt discount and deferred financing costs +15,474 +15,258 +16,276 +Loss on extinguishment of debt +— +26,740 +35 +Deferred income taxes +( 41,835 +) +141,708 +( 192,066 +) +Other, net +2,220 +287 +7,885 +Changes in current assets and liabilities: +Accounts receivable +( 39,556 +) +( 20,775 +) +20,410 +Prepaid expenses and other +6,130 +( 729 +) +( 1,953 +) +Accounts payable and accrued expenses +50,278 +35,175 +51,156 +Net cash provided by operating activities +823,567 +720,629 +515,390 +Cash flows from investing activities: +Net proceeds from the sale of oil and gas properties +13,059 +748,509 +776,719 +Capital expenditures +( 1,023,769 +) +( 1,303,188 +) +( 888,353 +) +Acquisition of proved and unproved oil and gas properties +( 2,581 +) +( 33,255 +) +( 89,896 +) +Net cash used in investing activities +( 1,013,291 +) +( 587,934 +) +( 201,530 +) +Cash flows from financing activities: +Proceeds from credit facility +1,589,000 +— +406,000 +Repayment of credit facility +( 1,466,500 +) +— +( 406,000 +) +Net proceeds from Senior Notes +— +492,079 +— +Cash paid to repurchase Senior Notes, including premium +— +( 845,002 +) +( 2,357 +) +Net proceeds from sale of common stock +3,209 +3,187 +2,623 +Dividends paid +( 11,254 +) +( 11,191 +) +( 11,144 +) +Other, net +( 2,686 +) +( 7,746 +) +( 1,411 +) +Net cash provided by (used in) financing activities +111,769 +( 368,673 +) +( 12,289 +) +Net change in cash, cash equivalents, and restricted cash +( 77,955 +) +( 235,978 +) +301,571 +Cash, cash equivalents, and restricted cash at beginning of period +77,965 +313,943 +12,372 +Cash, cash equivalents, and restricted cash at end of period +$ +10 +$ +77,965 +$ +313,943 +Supplemental schedule of additional cash flow information and non-cash activities: +Operating activities: +Cash paid for interest, net of capitalized interest +$ +( 141,902 +) +$ +( 150,727 +) +$ +( 164,097 +) +Net cash (paid) refunded for income taxes +$ +6,109 +$ +( 2,995 +) +$ +( 5,986 +) +Investing activities: +Changes in capital expenditure accruals and other +$ +( 24,289 +) +$ +( 2,774 +) +$ +7,309 +Supplemental non-cash investing activities: +Carrying value of properties exchanged +$ +73,442 +$ +95,121 +$ +293,963 +Supplemental non-cash financing activities: +Non-cash loss on extinguishment of debt, net +$ +— +$ +6,334 +$ +22 +The accompanying notes are an integral part of these consolidated financial statements. +69 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company, together with its consolidated subsidiaries, is an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Intercompany accounts and transactions have been eliminated. In connection with the preparation of the consolidated financial statements, the Company evaluated events subsequent to the balance sheet date of December 31, 2019 , through the filing of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the consolidated financial statements. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of depletion, depreciation, and amortization expense, impairment of proved properties, and asset retirement obligations, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents +The Company considers all liquid investments purchased with an initial maturity of three months or less to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. +Accounts Receivable +The Company’s accounts receivable consists mainly of receivables from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables due from joint interest owners, the Company generally has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil, gas, and NGL receivables are collected within 30 to 90 days and the Company has had minimal bad debts. +Although diversified among many companies, collectibility is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. Please refer to Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses for additional disclosure. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to regular review. +70 +The Company does not believe the loss of any single purchaser of its production would materially impact its operating results, as oil, gas, and NGLs are products with well-established markets and numerous purchasers in the Company’s operating regions. The following major customers and entities under common control accounted for 10 percent or more of its total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2019 +2018 +2017 +Major customer #1 (1) +18 +% +18 +% +6 +% +Major customer #2 (1) +14 +% +5 +% +1 +% +Major customer #3 (1) +13 +% +7 +% +— +% +Major customer #4 (1) +9 +% +10 +% +10 +% +Group #1 of entities under common control (2) +13 +% +18 +% +17 +% +Group #2 of entities under common control (2) +11 +% +12 +% +8 +% +____________________________________________ +(1) +These major customers are purchasers of a portion of the Company’s production from its Midland Basin assets. +(2) +In the aggregate, these groups of entities under common control represented purchasers of more than 10 percent of total oil, gas, and NGL production revenue for at least one of the periods presented; however, no individual entity comprising either group was a purchaser of more than 10 percent of the Company’s total oil, gas, and NGL production revenue. +The Company generally contracts with the affiliates of the lenders under its Credit Agreement as its derivative counterparties, and the Company’s policy is that each counterparty must have investment grade senior unsecured debt ratings. +The Company maintains its primary bank accounts with a large, multinational bank that has branch locations in the Company’s areas of operations. The Company’s policy is to diversify its concentration of cash and cash equivalent investments among multiple institutions and investment products to limit the amount of credit exposure to any single institution or investment. The Company maintains investments in highly rated, highly liquid investment products with numerous banks that are party to its revolving credit facility. +Oil and Gas Producing Activities +Proved properties . The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, the costs of development wells are capitalized whether those wells are successful or unsuccessful. Capitalized drilling and completion costs, including lease and well equipment, intangible development costs, and operational support facilities in the field, are depleted on a group basis (properties aggregated based on geographical and geological characteristics) using the units-of-production method based on estimated proved developed oil and gas reserves. Similarly, proved leasehold costs are depleted on the same group asset basis; however, the units-of-production method is based on estimated total proved oil and gas reserves. The computation of DD&A takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. +Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that associated carrying costs may not be recoverable. The Company uses an income valuation technique, which converts future cash flow to a single present value amount, to measure the fair value of proved properties through an application of discount rates and price forecasts, as selected by the Company’s management. The Company uses discount rates that are representative of current market conditions and considers estimates of future cash payments, reserve categories, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk. The discount rates typically range from 10 percent to 15 percent based on the reservoir specific weightings of future estimated proved and unproved cash flows. The prices for oil and gas are forecasted based on NYMEX strip pricing, adjusted for basis differentials, for the first five years , after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecasted using OPIS pricing, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. +The partial sale of a proved property within an existing field is accounted for as a normal retirement and no net gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A net gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of proved properties. +Unproved properties . The unproved oil and gas properties line item on the accompanying balance sheets consists of costs incurred to acquire unproved leases. Leasehold costs allocated to those leases, or partial leases that have associated proved reserves recorded, are reclassified to proved properties and depleted on a units-of-production basis. Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by prospect and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and the Company’s intent to renew leases. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant +71 +assumptions: remaining lease terms, future development plans, risk-weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +For the sale of unproved properties where the original cost has been partially or fully amortized by providing a valuation allowance on a group basis, neither a gain nor loss is recognized unless the sales price exceeds the original cost of the property, in which case a gain shall be recognized in the accompanying statements of operations in the amount of such excess. +Exploratory . Exploratory geological and geophysical, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Under the successful efforts method, exploratory well costs are capitalized pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are found, exploratory wells costs will be capitalized as proved properties and will be accounted for following the successful efforts method of accounting described above. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that economic proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in the cash flows from investing activities section as part of capital expenditures within the accompanying statements of cash flows. +Other Property and Equipment +Other property and equipment such as facilities, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing, and installation activities. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from 3 to 30 years, or the unit of output method when appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the accounts. +Other property and equipment costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. To measure the fair value of other property and equipment, the Company uses an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. The valuation includes consideration of the proved and unproved assets supported by the property and equipment, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties, including facilities requiring decommissioning. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired, or a facility is constructed. The increase in carrying value is included in the proved oil and gas properties line item in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and gas properties. Cash paid to settle asset retirement obligations is included in the cash flows from operating activities section of the accompanying statements of cash flows. +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent . In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or economic life, or changes in inflation factors or the Company’s credit-adjusted risk-free rate as market conditions warrant. Please refer to Note 14 – Asset Retirement Obligations for a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2019 , and 2018 . +Derivative Financial Instruments +The Company periodically enters into commodity derivative instruments to mitigate a portion of its exposure to potentially adverse market changes in commodity prices for its expected future oil, natural gas, and NGL production and the associated impact on cash flows. These instruments typically include commodity price swaps and costless collars, as well as, basis differential swaps. Commodity derivative instruments are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its derivative commodity contracts as hedging instruments. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its accompanying statements of operations as they occur. Gains and losses on derivatives +72 +are included within the cash flows from operating activities section of the accompanying statements of cash flows. For additional discussion on derivatives, please refer to Note 10 – Derivative Financial Instruments . +Revenue Recognition +The Company derives revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when custody and title (“control”) of the product transfers to the purchaser, which may differ depending on the applicable contractual terms. Revenue accruals are recorded monthly and are based on estimated production delivered to a purchaser and the expected price to be received. Variances between estimates and the actual amounts received are recorded in the month payment is received. Please refer to Note 2 - Revenue from Contracts with Customers for additional discussion. +Stock-Based Compensation +At December 31, 2019 , the Company had stock-based employee compensation plans that included restricted stock units (“RSUs”) and performance share units (“PSUs”) issued to employees, RSUs and restricted stock issued to non-employee directors, and an employee stock purchase plan available to eligible employees. These are more fully described in Note 7 – Compensation Plans . The Company records expense associated with the fair value of stock-based compensation in accordance with authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant, and is included within the general and administrative and exploration expense line items in the accompanying statements of operations. For stock-based compensation awards containing non-market based performance conditions, the Company evaluates the probability of the number of shares that are expected to vest, and then adjusts the expense to reflect the number of shares expected to vest and the cumulative vesting period met to date. Further, the Company accounts for forfeitures of stock-based compensation awards as they occur. +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the consolidated financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. Please refer to Note 4 – Income Taxes for additional disclosure. +Earnings per Share +The Company uses the treasury stock method to determine the potential dilutive effect of non-vested RSUs, contingent PSUs, and Senior Convertible Notes. Please refer to Note 9 - Earnings Per Share for additional discussion. +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income (loss) (“accompanying statements of comprehensive income (loss)”). The Company’s policy for releasing income tax effects within accumulated other comprehensive loss is an incremental, unit-of-account approach. Please refer to Note 8 – Pension Benefits for detail on the changes in the balances of components comprising other comprehensive income (loss). +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The recorded value of the Company’s credit facility approximates its fair value as it bears interest at a floating rate that approximates a current market rate. The Company had a $ 122.5 million balance under its credit facility as of December 31, 2019 , compared with a zero balance as of December 31, 2018 . The Company’s Senior Notes and Senior Convertible Notes are recorded at cost, net of any unamortized discount and deferred financing costs, and their respective fair values are disclosed in Note 11 – Fair Value Measurements . Additionally, the Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry, onshore in the United States. The Company reports as a single industry segment. +73 +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or SPEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that the Company is the primary beneficiary of a variable interest entity, that entity is consolidated. The Company has not been involved in any unconsolidated SPE transactions in 2019 or 2018 . +Recently Issued Accounting Standards +Effective January 1, 2017, the Company adopted, using various transition methods, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 is meant to simplify certain aspects of accounting for share-based arrangements, including income tax effects, accounting for forfeitures, and net share settlements. The Company adopted the various applicable amendments, which are summarized as follows: +• +On January 1, 2017, a $ 44.3 million cumulative-effect adjustment was made to retained earnings and a corresponding deferred tax asset was recorded for previously unrecognized excess tax benefits using a modified retrospective transition method. Effective January 1, 2017, excess tax benefits are presented in net cash provided by operating activities on the accompanying statements of cash flows. +• +On January 1, 2017, the Company elected to change its policy to account for forfeitures of share-based payment awards as they occur, rather than applying an estimated forfeiture rate. This change was made using a modified retrospective transition method and resulted in an increase in additional paid-in capital of $ 1.1 million , a decrease in deferred tax assets of $ 400,000 , and a net $ 700,000 cumulative effect decrease to retained earnings. +• +Under this new guidance, excess tax benefits and deficiencies from share-based payments impact the Company’s effective tax rate between periods. +In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) , followed by other related ASUs that provided targeted improvements and additional practical expedient options (collectively “ASU 2016-02” or “Topic 842”). The Company adopted ASU 2016-02 on January 1, 2019, using the modified retrospective method. The Company elected as part of its adoption to also use the optional transition methodology whereby lease accounting for previously reported periods continues to be reported in accordance with historical accounting guidance for leases in effect for those prior periods. Policy elections and practical expedients the Company implemented in connection with the adoption of ASU 2016-02 include (a) excluding from the balance sheet leases with terms that are less than one year, (b) for agreements that contain both lease and non-lease components, combining these components together and accounting for them as a single lease, (c) the package of practical expedients, which among other requirements, allows the Company to avoid reassessing contracts that commenced prior to adoption that were properly evaluated under legacy GAAP, and (d) excluding land easements that existed or expired before adoption of ASU 2016-02. The scope of ASU 2016-02 does not apply to leases used in the exploration or use of minerals, oil, natural gas, or other similar non-regenerative resources. +Upon adoption on January 1, 2019, the Company recognized approximately $ 50.0 million in right-of-use (“ROU”) assets and related lease liabilities for its operating leases. There was no cumulative effect adjustment to retained earnings upon the adoption of this guidance. Please refer to Note 12 - Leases for additional discussion. +In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , followed by other related ASUs that provided targeted improvements (collectively “ASU 2016-13”). ASU 2016-13 provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The guidance is to be applied using a modified retrospective method and is effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company adopted ASU 2016-13 on January 1, 2020. The adoption of ASU 2016-13 is not expected to result in a material impact to the Company’s consolidated financial statements or disclosures. +In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”). ASU 2017-07 requires presentation of service cost in the same line item(s) as other compensation costs arising from services rendered by employees during the period, and presentation of the remaining components of net benefit cost in a separate line item, outside operating items. In addition, only the service cost component of net benefit cost is eligible for capitalization. The Company adopted ASU 2017-07 on the effective date of January 1, 2018, with retrospective application of the service cost component and the other components of net benefit cost in the consolidated statements of operations, and prospective application for the capitalization of the service cost component of net benefit costs in assets. While the adoption of ASU 2017-07 resulted in the Company reclassifying certain amounts from operating expenses to non-operating expenses, ASU 2017-07 did not result in a material impact to the Company’s consolidated financial statements or disclosures. +74 +In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”). ASU 2018-02 permits entities to reclassify tax effects stranded in accumulated other comprehensive income (loss) to retained earnings as a result of the 2017 Tax Act. The Company early adopted ASU 2018-02 effective January 1, 2018 using a retrospective method. As a result of adopting ASU 2018-02, the Company reclassified $ 3.0 million of tax effects stranded in accumulated other comprehensive loss to retained earnings as of January 1, 2018. The Company’s policy for releasing income tax effects within accumulated other comprehensive loss is an incremental, unit-of-account approach. +In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company adopted ASU 2018-15 on January 1, 2020, with prospective application. The adoption of ASU 2018-15 is not expected to have a material impact to the Company’s consolidated financial statements or disclosures. +In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 was issued as a means to reduce the complexity of accounting for income taxes for those entities that fall within the scope of the accounting standard. The guidance is to be applied using a prospective method, excluding amendments related to franchise taxes, which should be applied on either a retrospective basis for all periods presented or a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company is evaluating the impact of ASU 2019-12 on its consolidated financial statements. +There are no other ASUs applicable to the Company that would have a material effect on the Company’s consolidated financial statements and related disclosures that have been issued but not yet adopted by the Company as of December 31, 2019 , and through the filing of this report. +Note 2 - Revenue from Contracts with Customers +The Company recognizes its share of revenue from the sale of produced oil, gas, and NGLs in its Midland Basin and South Texas assets. Following the divestiture of the Company’s remaining assets in the Rocky Mountain region during the first half of 2018, there has been no production revenue from this region after the second quarter of 2018. Oil, gas, and NGL production revenue presented within the accompanying statements of operations is reflective of the revenue generated from contracts with customers. +The tables below present the oil, gas, and NGL production revenue by product type for each of the Company’s operating regions for the years ended December 31, 2019 , 2018 , and 2017 : +For the year ended December 31, 2019 +Midland Basin +South Texas +Total +(in thousands) +Oil production revenue +$ +1,119,786 +$ +63,426 +$ +1,183,212 +Gas production revenue +75,827 +186,702 +262,529 +NGL production revenue +123 +139,886 +140,009 +Total +$ +1,195,736 +$ +390,014 +$ +1,585,750 +Relative percentage +75 +% +25 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +75 +For the year ended December 31, 2018 +Midland Basin +South Texas +Rocky Mountain +Total +(in thousands) +Oil production revenue +$ +938,004 +$ +72,821 +$ +54,851 +$ +1,065,676 +Gas production revenue +125,603 +227,252 +1,595 +354,450 +NGL production revenue +1,000 +214,441 +790 +216,231 +Total +$ +1,064,607 +$ +514,514 +$ +57,236 +$ +1,636,357 +Relative percentage +65 +% +32 +% +3 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +For the year ended December 31, 2017 +Midland Basin +South Texas +Rocky Mountain +Total +(in thousands) +Oil production revenue +$ +419,732 +$ +82,674 +$ +151,844 +$ +654,250 +Gas production revenue +61,781 +301,780 +5,849 +369,410 +NGL production revenue +547 +226,031 +3,545 +230,123 +Total +$ +482,060 +$ +610,485 +$ +161,238 +$ +1,253,783 +Relative percentage +38 +% +49 +% +13 +% +100 +% +____________________________________________ +Note: Amounts may not calculate due to rounding. +The Company recognizes oil, gas, and NGL production revenue at the point in time when control of the product transfers to the purchaser, which differs depending on the applicable contractual terms. Transfer of control drives the presentation of transportation, gathering, processing, and other post-production expenses (“fees and other deductions”) within the accompanying statements of operations. Fees and other deductions incurred by the Company prior to control transfer are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. When control is transferred at or near the wellhead, sales are based on a wellhead market price that is impacted by fees and other deductions incurred by the purchaser subsequent to the transfer of control. In general, the Company generates production revenue from a combination of the following types of contracts: +• +The Company sells oil and gas production at or near the wellhead and receives an agreed-upon market price from the purchaser. Under this type of arrangement, control transfers at or near the wellhead. +• +The Company has certain processing arrangements that include the delivery of unprocessed gas to the inlet of a midstream processor’s facility for processing. Upon completion of processing, the midstream processor purchases the NGLs and redelivers residue gas back to the Company in-kind. For the NGLs extracted during processing, the midstream processor remits payment to the Company based on the proceeds the processor realizes from selling the NGLs to third parties. For the residue gas taken in-kind, the Company has separate sales contracts where control transfers at points downstream of the processing facility. Given the structure of these arrangements and where control transfers, the Company separately recognizes fees and other deductions incurred prior to control transfer. These fees are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. +Significant judgments made in applying the guidance in ASC Topic 606, Revenue from Contracts with Customers, relate to the point in time when control transfers to customers in gas processing arrangements with midstream processors. The Company does not believe that significant judgments are required with respect to the determination of the transaction price, including amounts that represent variable consideration, as volume and price carry a low level of estimation uncertainty given the precision of volumetric measurements and the use of index pricing with generally predictable differentials. Accordingly, the Company does not consider estimates of variable consideration to be constrained. +The Company’s performance obligations arise upon the production of hydrocarbons from wells in which the Company has an ownership interest. The performance obligations are considered satisfied upon control transferring to a purchaser at the wellhead, inlet, or tailgate of the midstream processor’s processing facility, or other contractually specified delivery point. The time period between production and satisfaction of performance obligations is generally less than one day; thus, there are no material unsatisfied or partially unsatisfied performance obligations at the end of the reporting period. +76 +Revenue is recorded in the month when performance obligations are satisfied. However, settlement statements from the purchasers of hydrocarbons and the related cash consideration are received 30 to 90 days after production has occurred. As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the product. Estimated revenue due to the Company is recorded within the accounts receivable line item on the accompanying balance sheets until payment is received. The accounts receivable balances from contracts with customers within the accompanying balance sheets as of December 31, 2019 , and 2018 , were $ 146.3 million and $ 107.2 million , respectively. To estimate accounts receivable from contracts with customers, the Company uses knowledge of its properties, historical performance, contractual arrangements, index pricing, quality and transportation differentials, and other factors as the basis for these estimates. Differences between estimates and actual amounts received for product sales are recorded in the month that payment is received from the purchaser. +Note 3 – Divestitures, Assets Held for Sale, and Acquisitions +2019 Divestiture Activity +No material divestitures occurred during 2019 . +2018 Divestiture Activity +PRB Divestiture. On March 26, 2018 , the Company completed the PRB Divestiture, divesting of approximately 112,000 net acres for total cash received at closing, net of costs (referred to throughout this report as “net divestiture proceeds”), of $ 492.2 million , and recorded a final net gain of $ 410.6 million for the year ended December 31, 2018 . +Divide County Divestiture and Halff East Divestiture. During the second quarter of 2018, the Company completed the Divide County Divestiture and the Halff East Divestiture, for combined net divestiture proceeds of $ 252.2 million , and recorded a combined final net gain of $ 15.4 million for the year ended December 31, 2018 . +The following table presents loss before income taxes from the Divide County, North Dakota assets sold for the years ended December 31, 2019 , 2018 , and 2017 . The Divide County Divestiture was considered a disposal of a significant asset group. +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Loss before income taxes (1) +$ +— +$ +( 28,975 +) +$ +( 468,786 +) +____________________________________________ +(1) +Loss before income taxes reflects oil, gas, and NGL production revenue, less oil, gas, and NGL production expense, depletion, depreciation, amortization, and asset retirement obligation liability accretion expense, impairment expense, and net loss on divestiture activity. During the year ended December 31, 2017 , the Company recorded a write-down of $ 523.6 million on these assets. +2017 Divestiture Activity +Eagle Ford Divestiture. On March 10, 2017, the Company divested its outside-operated Eagle Ford shale assets, including its ownership interest in related midstream assets, for final net divestiture proceeds of $ 744.1 million . The Company recorded a final net gain of $ 396.8 million related to these divested assets for the year ended December 31, 2017 . This divestiture was considered a disposal of a significant asset group. For the year ended December 31, 2017 , income before income taxes from the outside-operated Eagle Ford shale assets sold was $ 24.3 million . This amount reflects oil, gas, and NGL production revenue, less oil, gas, and NGL production expense, and depletion, depreciation, amortization, and asset retirement obligation liability accretion expense. +During 2017, the Company divested certain non-core properties for net divestiture proceeds of $ 36.2 million and recognized an insignificant final net gain. +The Company determined that executed asset sales in 2018 and 2017 did not qualify for discontinued operations accounting under financial statement presentation authoritative guidance. +2019 Acquisition Activity +During 2019 , the Company completed several non-monetary acreage trades of primarily undeveloped properties located in Howard, Martin, and Midland Counties, Texas, resulting in the exchange of approximately 2,200 net acres, with $ 73.4 million of carrying value attributed to the properties transferred by the Company. These trades were recorded at carryover basis with no gain or loss recognized. +77 +2018 Acquisition Activity +During the year ended December 31, 2018 , the Company acquired approximately 1,030 net acres of primarily unproved properties located in Martin and Howard Counties, Texas, in two separate transactions which closed in 2018. Combined total cash consideration paid by the Company was $ 33.3 million . Under authoritative accounting guidance, these transactions were both individually considered to be asset acquisitions. Therefore, the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and the transaction costs were capitalized as a component of the cost of the assets acquired. +During the third quarter of 2018, the Company completed two non-monetary acreage trades of primarily undeveloped properties located in Howard and Martin Counties, Texas, which resulted in the exchange of approximately 2,650 net acres, with $ 95.1 million of carrying value attributed to the properties transferred by the Company. These trades were recorded at carryover basis with no gain or loss recognized. +2017 Acquisition Activity +During the year ended December 31, 2017 , the Company acquired approximately 3,600 net acres of primarily unproved properties in Howard and Martin Counties, Texas, in multiple transactions for a total of $ 76.5 million of cash consideration. Under authoritative accounting guidance, these transactions were individually considered to be asset acquisitions. Therefore, the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and the transaction costs were capitalized as a component of the cost of the assets acquired. +Also during the year ended December 31, 2017 , the Company completed several non-monetary acreage trades of primarily unproved properties in Howard and Martin Counties, Texas, resulting in the exchange of approximately 8,125 net acres for approximately 7,580 net acres with $ 294.0 million of carrying value attributed to the properties transferred by the Company in such trades. These trades were recorded at carryover basis with no gain or loss recognized. +Note 4 – Income Taxes +The provision for income taxes consists of the following: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Current portion of income tax expense (benefit) +Federal +$ +( 3,826 +) +$ +— +$ +5,698 +State +1,618 +1,662 +3,398 +Deferred portion of income tax expense (benefit) +( 41,835 +) +141,708 +( 192,066 +) +Income tax expense (benefit) +$ +( 44,043 +) +$ +143,370 +$ +( 182,970 +) +Effective tax rate +19.1 +% +22.0 +% +53.2 +% +78 +The components of the net deferred tax liabilities are as follows: +As of December 31, +2019 +2018 +(in thousands) +Deferred tax liabilities +Oil and gas properties +$ +205,028 +$ +218,094 +Derivative assets +4,646 +35,247 +Other +12,361 +4,812 +Total deferred tax liabilities +222,035 +258,153 +Deferred tax assets +Credit carryover +11,270 +22,554 +Pension +5,971 +6,427 +Federal and state tax net operating loss carryovers +4,172 +4,217 +Stock compensation +3,503 +3,263 +Other liabilities +10,803 +1,497 +Total deferred tax assets +35,719 +37,958 +Valuation allowance +( 3,070 +) +( 3,083 +) +Net deferred tax assets +32,649 +34,875 +Total net deferred tax liabilities +$ +189,386 +$ +223,278 +Current federal income tax refundable +$ +3,885 +$ +59 +Current state income tax payable +$ +1,404 +$ +1,331 +As of December 31, 2019 , the Company estimated its federal net operating loss (“NOL”) carryforward at $ 3.3 million and state NOL carryforwards at $ 77.8 million . The Company has federal research and development (“R&D”) and AMT credit carryforwards of $ 7.4 million and $ 4.3 million , respectively. The majority of federal NOLs do not expire but the state NOLs and state tax credits expire between 2021 and 2038. The federal R&D credit carryforwards expire between 2028 and 2035. The Company’s AMT credit carryforwards are expected to be fully refunded by 2022. The Company’s current valuation allowance relates to state NOL carryforwards and state tax credits, which are expected to expire before they can be utilized. +Recorded income tax expense or benefit differs from the amount that would be provided by applying the statutory United States federal income tax rate to income before income taxes. These differences primarily relate to the effect of state income taxes, excess tax benefits and deficiencies from stock-based compensation awards, tax limitations on compensation of covered individuals, changes in valuation allowances, and the cumulative impact of other smaller permanent differences, and is reported as follows: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Federal statutory tax expense (benefit) +$ +( 48,519 +) +$ +136,873 +$ +( 120,335 +) +Increase (decrease) in tax resulting from: +Federal tax reform changes - 2017 Tax Act +— +— +( 63,675 +) +State tax expense (benefit) (net of federal benefit) +260 +2,771 +( 3,286 +) +Change in valuation allowance +( 13 +) +105 +( 2,727 +) +Employee share-based compensation +3,346 +2,508 +8,190 +Other +883 +1,113 +( 1,137 +) +Income tax expense (benefit) +$ +( 44,043 +) +$ +143,370 +$ +( 182,970 +) +Acquisitions, divestitures, drilling activity, and basis differentials, which impact the prices received for oil, gas, and NGLs, impact the apportionment of taxable income to the states where the Company owns oil and gas properties. As these factors change, the Company’s state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax expense (benefit) reported in the current year. Items affecting state apportionment factors are evaluated upon completion of the prior year income tax return, after significant acquisitions and divestitures, if there are significant changes in drilling activity, or if estimated state revenue changes occur during the year. As a result of the 2018 divestitures, the Company’s state apportionment rate reflects its significant Texas presence. +79 +During the fourth quarter of 2019, the Company claimed and received a $ 7.7 million refund for a portion of its deferred AMT credit carryover. An additional refund of $ 3.8 million is expected to be claimed in 2020. For all years before 2015, the Company is generally no longer subject to United States federal or state income tax examinations by tax authorities. +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. Interest expense in the accompanying statements of operations includes a negligible amount associated with income taxes. The Company does not expect a significant change to the recorded unrecognized tax benefits in 2020 . +The total amount recorded for unrecognized tax benefits for each of the years ended December 31, 2019 , 2018 , and 2017 , was $ 446,000 . +Note 5 – Long-Term Debt +Credit Agreement +On September 19, 2019, the Company and its lenders entered into the Second Amendment to the Sixth Amended and Restated Credit Agreement which permitted the Company to enter into swap agreements with respect to the price of electricity in order to minimize exposure to electrical price volatility. As of December 31, 2019 , the Credit Agreement provided for a senior secured revolving credit facility with a maximum loan amount of $ 2.5 billion , a borrowing base of $ 1.6 billion , and aggregate lender commitments of $ 1.2 billion . The borrowing base is subject to regular, semi-annual redetermination, and considers the value of both the Company’s (a) proved oil and gas properties reflected in the Company’s most recent reserve report; and (b) commodity derivative contracts, each as determined by the Company’s lender group. The next scheduled borrowing base redetermination date is April 1, 2020 . +The Credit Agreement is scheduled to mature on the earlier of September 28, 2023 , (the “Scheduled Maturity Date”), and August 16, 2022 , to the extent that, on or before such date, the Company’s outstanding 2022 Senior Notes are not repurchased, redeemed, or refinanced to have a maturity date at least 91 days after the Scheduled Maturity Date unless, on August 16, 2022 , both (i) the aggregate outstanding principal amount of the 2022 Senior Notes is not more than $ 100.0 million and (ii) after giving pro forma effect to the repayment in full at maturity of the 2022 Senior Notes then outstanding, the aggregate amount of unrestricted cash and certain types of unrestricted investments held by the Company and its Consolidated Restricted Subsidiaries plus the amount of unused availability under the Credit Agreement is at least $ 300.0 million . +The Company must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring the Company to maintain certain financial ratios, as defined by the Credit Agreement. The financial covenants under the Credit Agreement require that the Company’s (a) total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX ratio for the most recently ended four consecutive fiscal quarters (excluding the first three quarters which used annualized adjusted EBITDAX), cannot be greater than 4.25 to 1.00 beginning with the quarter ending December 31, 2018, through and including the fiscal quarter ending December 31, 2019, and for each quarter ending thereafter, the ratio cannot be greater than 4.00 to 1.00; and (b) adjusted current ratio cannot be less than 1.0 to 1.0 as of the last day of any fiscal quarter. The Company was in compliance with all financial and non-financial covenants as of December 31, 2019 , and through the filing of this report. +Interest and commitment fees associated with the credit facility are accrued based on a borrowing base utilization grid set forth in the Credit Agreement. At the Company’s election, borrowings under the Credit Agreement may be in the form of Eurodollar, Alternate Base Rate (“ABR”), or Swingline loans. Eurodollar loans accrue interest at LIBOR, plus the applicable margin from the utilization grid, and ABR and Swingline loans accrue interest at a market-based floating rate, plus the applicable margin from the utilization grid. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount at rates from the utilization grid and are included in the interest expense line item on the accompanying statements of operations. The borrowing base utilization grid as set forth in the Credit Agreement is as follows: +Borrowing Base Utilization Percentage +<25% +≥25% <50% +≥50% <75% +≥75% <90% +≥90% +Eurodollar Loans (1) +1.500 +% +1.750 +% +2.000 +% +2.250 +% +2.500 +% +ABR Loans or Swingline Loans +0.500 +% +0.750 +% +1.000 +% +1.250 +% +1.500 +% +Commitment Fee Rate +0.375 +% +0.375 +% +0.500 +% +0.500 +% +0.500 +% +____________________________________________ +(1) +The Company’s Credit Agreement specifies that in the event that LIBOR is no longer a widely used benchmark rate, or that it shall no longer be used for determining interest rates for loans in the United States, a replacement interest rate that fairly reflects the cost to the lenders of funding loans shall be established by the Administrative Agent, as defined in the Credit Agreement, in consultation with the borrower. +80 +The following table presents the outstanding balance, total amount of letters of credit outstanding, and available borrowing capacity under the Credit Agreement as of February 6, 2020 , December 31, 2019 , and December 31, 2018 : +As of February 6, 2020 +As of December 31, 2019 +As of December 31, 2018 +(in thousands) +Revolving credit facility (1) +$ +113,500 +$ +122,500 +$ +— +Letters of credit (2) +— +— +200 +Available borrowing capacity +1,086,500 +1,077,500 +999,800 +Total aggregate lender commitment amount +$ +1,200,000 +$ +1,200,000 +$ +1,000,000 +____________________________________________ +(1) +Unamortized deferred financing costs attributable to the revolving credit facility are presented as a component of the other noncurrent assets line item on the accompanying balance sheets and totaled $ 5.9 million and $ 6.4 million as of December 31, 2019 , and 2018 , respectively. These costs are being amortized over the term of the credit facility on a straight-line basis. +(2) +Letters of credit outstanding reduce the amount available under the credit facility on a dollar-for-dollar basis. The letter of credit outstanding as of December 31, 2018 , was released effective January 8, 2019. +Senior Notes +The Senior Notes, net of unamortized deferred financing costs line item on the accompanying balance sheets as of December 31, 2019 , and 2018 , consisted of the following: +As of December 31, +2019 +2018 +Principal Amount +Unamortized Deferred Financing Costs +Principal Amount, Net of Unamortized Deferred Financing Costs +Principal Amount +Unamortized Deferred Financing Costs +Principal Amount, Net of Unamortized Deferred Financing Costs +(in thousands) +6.125% Senior Notes due 2022 +$ +476,796 +$ +2,920 +$ +473,876 +$ +476,796 +$ +3,921 +$ +472,875 +5.0% Senior Notes due 2024 +500,000 +3,766 +496,234 +500,000 +4,688 +495,312 +5.625% Senior Notes due 2025 +500,000 +4,903 +495,097 +500,000 +5,808 +494,192 +6.75% Senior Notes due 2026 +500,000 +5,571 +494,429 +500,000 +6,407 +493,593 +6.625% Senior Notes due 2027 +500,000 +6,601 +493,399 +500,000 +7,533 +492,467 +Total +$ +2,476,796 +$ +23,761 +$ +2,453,035 +$ +2,476,796 +$ +28,357 +$ +2,448,439 +The Senior Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. There are no subsidiary guarantors of the Senior Notes. The Company is subject to certain covenants under the indentures governing the Senior Notes that limit the Company’s ability to incur additional indebtedness, issue preferred stock, and make restricted payments, including dividends. The Company was in compliance with all such covenants under its Senior Notes as of December 31, 2019 , and through the filing of this report. All Senior Notes are registered under the Securities Act. The Company may redeem some or all of its Senior Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest as described in the indentures governing the Senior Notes. +On July 16, 2018, the Company redeemed its 2021 Senior Notes which resulted in the payment of total cash consideration, including accrued interest, of $ 355.9 million . Additionally, during the third quarter of 2018, the Company used the proceeds from the issuance of its 2027 Senior Notes, as discussed below, and cash on hand to fund the cash tender offer and redemption of $ 395.0 million of its 2023 Senior Notes and $ 85.0 million of its 2022 Senior Notes. The Company paid total consideration, including accrued interest, of $ 497.8 million to complete these transactions. As a result of the redemption of the 2021 Senior Notes, and the cash tender offer and redemption of all of the 2023 Senior Notes and a portion of the 2022 Senior Notes, the Company recorded a combined loss on extinguishment of debt of $ 26.7 million for the year ended December 31, 2018 . This amount included combined premiums paid of $ 20.4 million and $ 6.3 million of accelerated unamortized deferred financing costs for the redemption. +2022 Senior Notes. On November 17, 2014 , the Company issued $ 600.0 million in aggregate principal amount of 6.125 % Senior Notes due 2022 at par, which mature on November 15, 2022 . The Company received net proceeds of $ 590.0 million after deducting fees of $ 10.0 million , which are being amortized as deferred financing costs over the life of the 2022 Senior Notes. During the first quarter of 2016, the Company repurchased $ 38.2 million in aggregate principal amount of its 2022 Senior Notes for a +81 +settlement amount of $ 24.3 million , excluding interest. During the third quarter of 2018, through the tender offer discussed above, the Company retired $ 85.0 million of its 2022 Senior Notes for total consideration, including accrued interest, of $ 89.5 million . +2024 Senior Notes. On May 20, 2013 , the Company issued $ 500.0 million in aggregate principal amount of 5.0 % Senior Notes due 2024 at par, which mature on January 15, 2024 . The Company received net proceeds of $ 490.2 million after deducting fees of $ 9.8 million , which are being amortized as deferred financing costs over the life of the 2024 Senior Notes. +2025 Senior Notes. On May 21, 2015 , the Company issued $ 500.0 million in aggregate principal amount of 5.625 % Senior Notes due 2025 at par, which mature on June 1, 2025 . The Company received net proceeds of $ 491.0 million after deducting fees of $ 9.0 million , which are being amortized as deferred financing costs over the life of the 2025 Senior Notes. +2026 Senior Notes. On September 12, 2016 , the Company issued $ 500.0 million in aggregate principal amount of 6.75 % Senior Notes due 2026 , at par, which mature on September 15, 2026 . The Company received net proceeds of $ 491.6 million after deducting fees of $ 8.4 million , which are being amortized as deferred financing costs over the life of the 2026 Senior Notes. +2027 Senior Notes. On August 20, 2018 , the Company issued $ 500.0 million in aggregate principal amount of 6.625 % Senior Notes due 2027, at par, which mature on January 15, 2027 . The Company received net proceeds of $ 492.1 million after deducting fees of $ 7.9 million , which are being amortized as deferred financing costs over the life of the 2027 Senior Notes. As discussed above, the net proceeds were used to fund the tender offer and redemption of all of the Company’s 2023 Senior Notes and a portion of its 2022 Senior Notes. +Senior Convertible Notes +On August 12, 2016 , the Company issued $ 172.5 million in aggregate principal amount of 1.50 % Senior Convertible Notes due July 1, 2021 , unless earlier converted. The Senior Convertible Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. The Company received net proceeds of $ 166.6 million after deducting fees of $ 5.9 million , of which a portion is being amortized over the life of the Senior Convertible Notes. +Holders may convert their Senior Convertible Notes at their option at any time prior to January 1, 2021, only under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter) commencing after the calendar quarter ending on September 30, 2016, if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130 % of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price (as defined in the indenture) per $ 1,000 principal amount of Notes for each trading day of the measurement period was less than 98 % of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after January 1, 2021, until the maturity date, holders may convert their Senior Convertible Notes at any time. The Company may not redeem the Senior Convertible Notes prior to the maturity date. Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. Holders may convert their notes based on a conversion rate of 24.6914 shares of the Company’s common stock per $ 1,000 principal amount of the Senior Convertible Notes, which is equal to an initial conversion price of approximately $ 40.50 per share, subject to adjustment. +The Company has initially elected a net-settlement method to satisfy its conversion obligation, which would result in the Company settling the principal amount in cash with any excess conversion in shares of the Company’s common stock. The Senior Convertible Notes were not convertible at the option of holders as of December 31, 2019 , or through the filing of this report. Notwithstanding the inability to convert, the if-converted value of the Senior Convertible Notes as of December 31, 2019 , did not exceed the principal amount. +Upon the issuance of the Senior Convertible Notes, the Company recorded $ 132.3 million as the initial carrying amount of the debt component, which approximated its fair value at issuance, and, was estimated by using an interest rate for nonconvertible debt with terms similar to the Senior Convertible Notes. The effective interest rate used was 7.25 % . The $ 40.2 million excess of the principal amount of the Senior Convertible Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The Company incurred transaction costs of $ 5.9 million relating to the issuance of the Senior Convertible Notes, which were allocated between the debt and equity components in proportion to their determined fair value amounts. The debt discount and debt-related issuance costs are amortized to the principal value of the Senior Convertible Notes as interest expense through the maturity date of July 1, 2021 . Interest expense recognized on the Senior Convertible Notes related to the stated interest rate and amortization of the debt discount totaled $ 11.0 million , $ 10.5 million , and $ 9.9 million for the years ended December 31, 2019 , 2018 , and 2017, respectively. +82 +The Senior Convertible Notes, net of unamortized discount and deferred financing costs line on the accompanying balance sheets consisted of the following as of December 31, 2019 and 2018 : +As of December 31, +2019 +2018 +(in thousands) +Principal amount of Senior Convertible Notes +$ +172,500 +$ +172,500 +Unamortized debt discount +( 13,861 +) +( 22,313 +) +Unamortized deferred financing costs +( 1,376 +) +( 2,293 +) +Senior Convertible Notes, net of unamortized discount and deferred financing costs +$ +157,263 +$ +147,894 +As of both December 31, 2019 and 2018, the net carrying amount of the equity component of the Senior Convertible Notes recorded in additional paid-in capital on the accompanying balance sheets was $ 33.6 million . There have been no changes to this amount since issuance. +If the Company undergoes a fundamental change, as defined by the governing indenture, holders of the Senior Convertible Notes may require the Company to repurchase for cash all or any portion of their notes at a fundamental change repurchase price equal to 100% of the principal amount of the Senior Convertible Notes to be repurchased, plus accrued and unpaid interest. The indenture governing the Senior Convertible Notes contains customary events of default with respect to the Senior Convertible Notes, including that upon certain events of default, the trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding Senior Convertible Notes by notice to the Company, may declare 100% of the principal and accrued and unpaid interest, if any, due and payable immediately. In case of certain events of bankruptcy, insolvency or reorganization involving the Company or a significant subsidiary, 100% of the principal and accrued and unpaid interest on the Senior Convertible Notes will automatically become due and payable. +The Company is subject to certain covenants under the indenture governing the Senior Convertible Notes and was in compliance with all covenants as of December 31, 2019 , and through the filing of this report. +Capped Call Transactions +In connection with the issuance of the Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters of such issuance. The aggregate cost of the capped call transactions was approximately $ 24.2 million . The capped call transactions are generally expected to reduce the potential dilution upon conversion of the Senior Convertible Notes and/or partially offset any cash payments the Company is required to make in excess of the principal amount of converted Senior Convertible Notes in the event that the market price per share of the Company’s common stock is greater than the strike price of the capped call transactions, which initially corresponds to the approximate $ 40.50 per share conversion price of the Senior Convertible Notes. The cap price of the capped call transactions is initially $ 60.00 per share. If the market price per share exceeds the cap price of the capped call transactions, there could be dilution or there would not be an offset of such potential cash payments. The Company classified the costs associated with the capped call transactions as equity instruments with no recurring fair value measurement recorded. +Capitalized Interest +Capitalized interest costs for the Company for the years ended December 31, 2019 , 2018 , and 2017 , totaled $ 18.5 million , $ 20.6 million , and $ 12.6 million , respectively. Capitalized interest costs are included in total costs incurred. Please refer to Costs Incurred in Oil and Gas Producing Activities in Overview of the Company in Part II, Item 7, and Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +83 +Note 6 – Commitments and Contingencies +Commitments +The Company has entered into various agreements, which include drilling rig and completion service contracts of $ 34.1 million , gathering, processing, transportation throughput, and delivery commitments of $ 218.5 million , office leases, including maintenance, of $ 28.3 million , fixed price contracts to purchase electricity of $ 53.2 million , and other miscellaneous contracts and leases of $ 15.5 million . The annual minimum payments for the next five years and total minimum payments thereafter are presented below: +Years Ending December 31, +Amount +(in thousands) +2020 +$ +102,550 +2021 +94,494 +2022 +73,826 +2023 +41,661 +2024 +12,349 +Thereafter +24,697 +Total +$ +349,577 +Drilling Rig and Completion Service Contracts. The Company has several drilling rig and completion service contracts in place to facilitate its drilling and completion plans. As of December 31, 2019 , the Company’s drilling rig and completion service contract commitments totaled $ 34.1 million , included in the table above. If all of these contracts were terminated as of December 31, 2019 , the Company would avoid a portion of the contractual service commitments; however, the Company would be required to pay $ 26.3 million in early termination fees. Excluded from these amounts are variable commitments and potential penalties determined by the number of completion crews the Company has in operation in a particular area under a completion service arrangement. As of December 31, 2019 , potential penalties under this completion service agreement, which expires on December 31, 2023, range from zero to a maximum of $ 13.4 million . +Pipeline Transportation Commitments. The Company has gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum amount of oil, gas, and produced water. As of December 31, 2019 , the Company has commitments to deliver a minimum of 24 MMBbl of oil and 424 Bcf of gas through 2023 , and 18 MMBbl of produced water through 2027 . The Company will be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. As of December 31, 2019 , if the Company fails to deliver any product, as applicable, the aggregate undiscounted deficiency payments total approximately $ 218.5 million . This amount does not include deficiency payment estimates associated with approximately 16.5 MMBbl of future oil delivery commitments where the Company cannot predict with accuracy the amount and timing of these payments, as such payments are dependent upon the price of oil in effect at the time of settlement. Under certain of the Company’s commitments, if the Company is unable to deliver the minimum quantity from its production, it may deliver production acquired from third-parties to satisfy its minimum volume commitments. +Office Leases. The Company leases office space under various operating leases with terms extending as far as 2026 . Rent expense for the years ended December 31, 2019 , 2018 , and 2017 , was $ 5.5 million , $ 4.5 million , and $ 4.8 million , respectively. +Electrical Power Purchase Contracts. During the second quarter of 2019, the Company entered into a fixed price contract for the purchase of electrical power that increased the purchase commitment under an existing agreement. As of December 31, 2019 , the Company had a commitment to purchase electrical power through 2027 with a total remaining obligation of $ 53.2 million . +Delivery and Purchase Commitments. During the second quarter of 2019, the Company executed an amendment to its existing sand sourcing agreement that created certain commitments and potential penalties that vary based on the amount of sand the Company uses in well completions occurring in a particular area. This amended sand sourcing agreement expires on December 31, 2023. As of December 31, 2019 , potential penalties under this sand sourcing agreement range from zero to a maximum of $ 10.0 million . +Drilling and Completion Commitments. The Company has an agreement in place that includes minimum drilling and completion requirements on certain leases. If these minimum requirements are not satisfied by March 31, 2020, the Company would be required to make a liquidated damage payment based on the difference between actual development progress and the minimum development requirements. As of December 31, 2019 , the Company did not expect to meet certain minimum development requirements. +84 +In the fourth quarter of 2019, the Company recognized one-time charges associated with expected payments to lessors related to drilling and completion obligations and early termination fees for drilling rigs totaling $ 18.2 million . These amounts are included in the other operating expense line item on the accompanying statements of operations. +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the anticipated results of any pending litigation and claims are not expected to have a material effect on the results of operations, the financial position, or the cash flows of the Company. +Note 7 – Compensation Plans +Equity Incentive Compensation Plan +There are several components to the Company’s Equity Incentive Compensation Plan (“Equity Plan”) that are described in this section. Various types of equity awards have been granted by the Company in different periods. +As of December 31, 2019 , approximately 4.4 million shares of common stock were available for grant under the Equity Plan. The issuance of a direct share benefit, such as a share of common stock, a stock option, a restricted share, an RSU, or a PSU, counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. +Performance Share Units +The Company grants PSUs to eligible employees as part of its Equity Plan. The number of shares of the Company’s common stock issued to settle PSUs ranges from zero to two times the number of PSUs awarded and is determined based on certain performance criteria over a three -year performance period. PSUs generally vest on the third anniversary of the date of the grant or upon other triggering events as set forth in the Equity Plan. Employees who are retirement eligible at the time a PSU award was granted, vest in each portion of that award equally in six -month increments over a three -year period beginning at grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of a PSU award will be forfeited when the employee leaves the Company. +The fair value of PSUs is measured at the grant date with a stochastic Monte Carlo simulation using geometric Brownian motion (“GBM Model”). A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for those iterations. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will take over the three -year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the path the stock price may take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +For PSUs granted in 2017, which the Company has determined to be equity awards, the settlement criteria include a combination of the Company’s Total Shareholder Return (“TSR”) on an absolute basis, and the Company’s TSR relative to the TSR of certain peer companies over the associated three-year performance period. The fair value of the PSUs granted in 2017 was measured on the grant date using the GBM Model. As these awards depend entirely on market-based settlement criteria, the associated compensation expense is recognized on a straight-line basis within general and administrative expense and exploration expense over the vesting period of the awards. +For PSUs granted in 2018 and 2019, the settlement criteria include a combination of the Company’s TSR relative to the TSR of certain peer companies and the Company’s cash return on total capital invested (“CRTCI”) relative to the CRTCI of certain peer companies over the associated three-year performance period. In addition to these performance measures, the award agreements for these grants also stipulate that if the Company’s absolute TSR is negative over the three -year performance period, the maximum number of shares of common stock that can be issued to settle outstanding PSUs is capped at one times the number of PSUs granted on the award date, regardless of the Company’s TSR and CRTCI performance relative to its peer group. The fair value of the PSUs granted in 2018 and 2019 was measured on the applicable grant dates using the GBM Model, with the assumption that the associated CRTCI performance condition will be met at the target amount at the end of the respective performance periods. Compensation expense for PSUs granted in 2018 and 2019 is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. As these awards depend on a combination of performance-based settlement criteria and market-based settlement criteria, compensation expense may be adjusted in future periods as the number of units expected to vest increases or decreases based on the Company’s expected CRTCI performance relative to the applicable peer companies. +85 +The Company records compensation expense associated with the issuance of PSUs based on the fair value of the awards as of the date of grant. Total compensation expense recorded for PSUs was $ 10.9 million , $ 10.3 million , and $ 9.7 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. As of December 31, 2019 , there was $ 15.9 million of total unrecognized expense related to PSUs, which is being amortized through 2022 . +A summary of the status and activity of non-vested PSUs is presented in the following table: +For the Years Ended December 31, +2019 +2018 +2017 +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +Non-vested at beginning of year +1,711,259 +$ +20.68 +1,533,491 +$ +22.97 +828,923 +$ +43.25 +Granted +793,125 +$ +12.80 +572,924 +$ +24.45 +977,731 +$ +15.86 +Vested +( 346,021 +) +$ +26.32 +( 233,102 +) +$ +44.25 +( 94,338 +) +$ +85.85 +Forfeited +( 135,778 +) +$ +16.98 +( 162,054 +) +$ +21.79 +( 178,825 +) +$ +44.99 +Non-vested at end of year +2,022,585 +$ +16.87 +1,711,259 +$ +20.68 +1,533,491 +$ +22.97 +____________________________________________ +(1) +The number of awards assumes a multiplier of one . The final number of shares of common stock issued may vary depending on the three -year performance multiplier, which ranges from zero to two . +The fair value of the PSUs granted in 2019 , 2018 , and 2017 was $ 10.2 million , $ 14.0 million , and $ 15.5 million , respectively. +During the years ended December 31, 2019 , 2018, and 2017, PSUs that were granted in 2016, 2015, and 2014, respectively did not satisfy the minimum performance requirements. This resulted in a multiplier of zero times and therefore no shares of common stock were issued upon settlement. +The total fair value of PSUs that vested during the years ended December 31, 2019 , 2018 , and 2017 was $ 9.1 million , $ 10.3 million , and $ 8.1 million , respectively. +Employee Restricted Stock Units +The Company grants RSUs to eligible persons as part of its Equity Plan. Each RSU represents a right to receive one share of the Company’s common stock upon settlement of the award at the end of the specified vesting period. RSUs generally vest one-third of the total grant on each anniversary date of the grant over a three-year vesting period or upon other triggering events as set forth in the Equity Plan. Employees who are retirement eligible at the time an RSU award is granted, vest in each portion of that award equally in six -month increments over a three -year period beginning at grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of an RSU award will be forfeited when the employee leaves the Company. +The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the date of grant. The fair value of an RSU is equal to the closing price of the Company’s common stock on the day of the grant. Compensation expense for RSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. Total compensation expense recorded for employee RSUs for the years ended December 31, 2019 , 2018 , and 2017 , was $ 11.1 million , $ 10.8 million , and $ 10.3 million , respectively. As of December 31, 2019 , there was $ 16.9 million of total unrecognized compensation expense related to non-vested RSU awards, which is being amortized through 2022 . +86 +A summary of the status and activity of non-vested RSUs granted to employees is presented in the following table: +For the Years Ended December 31, +2019 +2018 +2017 +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +RSUs +Weighted- +Average +Grant-Date +Fair Value +Non-vested at beginning of year +1,243,163 +$ +21.50 +1,244,262 +$ +20.25 +604,116 +$ +37.39 +Granted +978,932 +$ +12.36 +583,552 +$ +25.77 +1,020,780 +$ +16.64 +Vested +( 466,535 +) +$ +21.94 +( 407,529 +) +$ +24.30 +( 246,025 +) +$ +43.99 +Forfeited +( 223,429 +) +$ +18.16 +( 177,122 +) +$ +17.26 +( 134,609 +) +$ +26.38 +Non-vested at end of year +1,532,131 +$ +16.01 +1,243,163 +$ +21.50 +1,244,262 +$ +20.25 +The fair value of RSUs granted to eligible employees in 2019 , 2018 , and 2017 was $ 12.1 million , $ 15.0 million , and $ 17.0 million , respectively. +A summary of the shares of common stock issued to settle employee RSUs is presented in the table below: +For the Years Ended December 31, +2019 +2018 +2017 +Shares of common stock issued to settle RSUs (1) +466,535 +407,529 +246,025 +Less: shares of common stock withheld for income and payroll taxes +( 132,136 +) +( 115,784 +) +( 74,747 +) +Net shares of common stock issued +334,399 +291,745 +171,278 +____________________________________________ +(1) +During the years ended December 31, 2019 , 2018 , and 2017 , the Company issued shares of common stock to settle RSUs that related to awards granted in previous years. The Company and a majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of employee RSUs that vested during the years ended December 31, 2019 , 2018 , and 2017 was $ 10.2 million , $ 9.9 million , and $ 10.8 million , respectively. +Director Shares +In 2019 , 2018 , and 2017 , the Company issued 96,719 , 63,741 , and 71,573 shares, respectively, of its common stock to its non-employee directors under the Equity Plan. In 2017, the Company issued 8,794 RSUs to a non-employee director. For the years ended December 31, 2019 , 2018 , and 2017 , the Company recorded $ 1.2 million , $ 1.7 million , and $ 1.6 million , respectively, of compensation expense related to director shares and RSUs issued. +All shares issued to non-employee directors fully vest on December 31 of the year granted. The RSUs issued to a non-employee director in 2017 fully vested on December 31, 2017, and will settle upon the earlier to occur of May 25, 2027, or the director resigning from the Board of Directors. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation, without accruing in excess of $ 25,000 in value from purchases for each calendar year. The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on either the first or last day of the purchase period. The ESPP is intended to qualify under Section 423 of the Internal Revenue Code (the “IRC”). The Company had approximately 1.3 million shares of its common stock available for issuance under the ESPP as of December 31, 2019 . There were 314,868 , 199,464 , and 186,665 shares issued under the ESPP in 2019 , 2018 , and 2017 , respectively. Total proceeds to the Company for the issuance of these shares were $ 3.2 million for each of the years ended December 31, 2019 , and 2018 , respectively, and $ 2.6 million for the year ended December 31, 2017 . +The fair value of ESPP grants is measured at the date of grant using the Black-Scholes option-pricing model. Expected volatility is calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six-month vesting period. +87 +The fair value of ESPP shares issued during the periods reported were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2019 +2018 +2017 +Risk free interest rate +2.3 +% +1.8 +% +0.9 +% +Dividend yield +0.7 +% +0.4 +% +0.5 +% +Volatility factor of the expected market +price of the Company’s common stock +56.6 +% +55.9 +% +62.5 +% +Expected life (in years) +0.5 +0.5 +0.5 +The Company expensed $ 1.1 million for each of the years ended December 31, 2019 , and 2018 , respectively, and $ 1.0 million for the year ended December 31, 2017 , based on the estimated fair value of the ESPP grants. +401(k) Plan +The Company has a defined contribution plan (the “401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. For employees hired before December 31, 2014, the Company matches 100 percent of each employee’s contribution in cash on a dollar for dollar basis, up to six percent of the employee’s base salary and performance bonus, and may make additional contributions at its discretion. The Company matches 150 percent of contributions made by employees hired after December 31, 2014, up to six percent of the employee’s base salary and performance bonus in lieu of pension plan benefits, and may make additional contributions at its discretion. Please refer to Note 8 – Pension Benefits for additional discussion of pension benefits. The Company’s matching contributions to the 401(k) Plan were $ 5.1 million , $ 4.9 million , and $ 4.5 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. +88 +Note 8 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering employees who meet age and service requirements and who began employment with the Company prior to January 1, 2016 (the “Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (the “Nonqualified Pension Plan” and together with the Qualified Pension Plan, the “Pension Plans”). The Company froze the Pension Plans to new participants, effective as of January 1, 2016. Employees participating in the Pension Plans prior to the plans being frozen will continue to earn benefits. +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status (i.e. the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment within the other comprehensive income (loss), net of tax, line item in the accompanying statements of comprehensive income (loss). The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation, but excludes the effects of assumed future salary increases. The Company’s measurement date for plan assets and obligations is December 31. +For the Years Ended December 31, +2019 +2018 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year +$ +66,086 +$ +71,937 +Service cost +5,582 +6,730 +Interest cost +2,791 +2,622 +Actuarial (gain) loss +2,035 +( 7,155 +) +Benefits paid +( 5,651 +) +( 8,048 +) +Projected benefit obligation at end of year +70,843 +66,086 +Change in plan assets: +Fair value of plan assets at beginning of year +30,100 +30,978 +Actual return (loss) on plan assets +3,985 +( 964 +) +Employer contribution +7,200 +8,134 +Benefits paid +( 5,651 +) +( 8,048 +) +Fair value of plan assets at end of year +35,634 +30,100 +Funded status at end of year +$ +( 35,209 +) +$ +( 35,986 +) +The Company’s underfunded status for the Pension Plans as of December 31, 2019 , and 2018 , was $ 35.2 million and $ 36.0 million , respectively, and is recognized in the accompanying balance sheets within the other noncurrent liabilities line item. There are no plan assets in the Nonqualified Pension Plan. +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2019 +2018 +(in thousands) +Projected benefit obligation +$ +70,843 +$ +66,086 +Accumulated benefit obligation +$ +60,877 +$ +52,368 +Less: fair value of plan assets +( 35,634 +) +( 30,100 +) +Underfunded accumulated benefit obligation +$ +25,243 +$ +22,268 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is +89 +intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of the unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for the year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +The pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in the accumulated other comprehensive loss line item within the accompanying balance sheets as of December 31, 2019 , and 2018 , were as follows: +As of December 31, +2019 +2018 +(in thousands) +Unrecognized actuarial losses +$ +14,406 +$ +15,741 +Unrecognized prior service costs +31 +48 +Accumulated other comprehensive loss +$ +14,437 +$ +15,789 +The pension liability adjustments recognized in other comprehensive income (loss) during 2019 , 2018 , and 2017 , were as follows: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Net actuarial gain (loss) +$ +377 +$ +4,329 +$ +( 2,995 +) +Amortization of prior service cost +17 +18 +17 +Amortization of net actuarial loss +958 +1,327 +1,297 +Settlements +— +— +3,009 +Total pension liability adjustment, pre-tax +1,352 +5,674 +1,328 +Tax expense +( 291 +) +( 4,265 +) +( 561 +) +Cumulative effect of accounting change (1) +— +2,969 +— +Total pension liability adjustment, net +$ +1,061 +$ +4,378 +$ +767 +_________________________________________ +(1) +Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies and Statements of Stockholders’ Equity for additional information. +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Components of net periodic benefit cost: +Service cost +$ +5,582 +$ +6,730 +$ +6,638 +Interest cost +2,791 +2,622 +2,689 +Expected return on plan assets that reduces periodic pension benefit cost +( 1,574 +) +( 1,862 +) +( 2,244 +) +Amortization of prior service cost +17 +18 +17 +Amortization of net actuarial loss +958 +1,327 +1,297 +Settlements +— +— +3,009 +Net periodic benefit cost +$ +7,774 +$ +8,835 +$ +11,406 +90 +Pension Plan Assumptions +The weighted-average assumptions used to measure the Company’s projected benefit obligation are as follows: +As of December 31, +2019 +2018 +Projected benefit obligation: +Discount rate +3.6 % +4.4 % +Rate of compensation increase +4.5 % +6.2 % +The weighted-average assumptions used to measure the Company’s net periodic benefit cost are as follows: +For the Years Ended December 31, +2019 +2018 +2017 +Net periodic benefit cost: +Discount rate +4.4 % +3.8 % +4.2 % +Expected return on plan assets (1) +5.0 % +5.5 % +6.5 % +Rate of compensation increase +6.2 % +6.2 % +6.2 % +____________________________________________ +(1) +There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy prohibits the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting the optimal expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. +The weighted-average asset allocation of the Qualified Pension Plan is as follows: +Target +As of December 31, +Asset Category +2020 +2019 +2018 +Equity securities +35.0 +% +36.9 +% +31.8 +% +Fixed income securities +40.0 +% +38.1 +% +41.3 +% +Other securities +25.0 +% +25.0 +% +26.9 +% +Total +100.0 +% +100.0 +% +100.0 +% +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in the plan. An expected return on plan assets of 5.0 percent , 5.5 percent , and 6.5 percent was used to calculate the Company’s net periodic pension cost under the Qualified Pension Plan for the years ended December 31, 2019 , 2018 , and 2017 respectively. The expected long-term rate of return assumption of the Qualified Pension Plan is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. The Company evaluates the expected rate of return on plan assets assumption on an annual basis. +91 +Pension Plan Assets +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2019 , and 2018 , utilizing the fair value hierarchy discussed in Note 11 – Fair Value Measurements are as follows: +Fair Value Measurements Using: +Actual Asset Allocation (1) +Total +Level 1 Inputs +Level 2 Inputs +Level 3 Inputs +(in thousands) +As of December 31, 2019 +Equity securities: +Domestic (2) +17.3 +% +$ +6,176 +$ +4,130 +$ +2,046 +$ +— +International (3) +19.6 +% +6,958 +6,958 +— +— +Total equity securities +36.9 +% +13,134 +11,088 +2,046 +— +Fixed income securities: +Core fixed income (4) +31.4 +% +11,199 +11,199 +— +— +Floating rate corporate loans (5) +6.7 +% +2,379 +2,379 +— +— +Total fixed income securities +38.1 +% +13,578 +13,578 +— +— +Other securities: +Real estate (6) +5.4 +% +1,929 +— +— +1,929 +Collective investment trusts (7) +3.3 +% +1,168 +— +1,168 +— +Hedge fund (8) +16.3 +% +5,825 +2,006 +— +3,819 +Total other securities +25.0 +% +8,922 +2,006 +1,168 +5,748 +Total investments +100.0 +% +$ +35,634 +$ +26,672 +$ +3,214 +$ +5,748 +As of December 31, 2018 +Equity securities: +Domestic (2) +15.4 +% +$ +4,639 +$ +3,197 +$ +1,442 +$ +— +International (3) +16.4 +% +4,941 +3,642 +1,299 +— +Total equity securities +31.8 +% +9,580 +6,839 +2,741 +— +Fixed income securities: +Core fixed income (4) +34.4 +% +10,342 +10,342 +— +— +Floating rate corporate loans (5) +6.9 +% +2,078 +2,078 +— +— +Total fixed income securities +41.3 +% +12,420 +12,420 +— +— +Other securities: +Real estate (6) +6.0 +% +1,820 +— +— +1,820 +Collective investment trusts (7) +3.1 +% +934 +— +934 +— +Hedge fund (8) +17.8 +% +5,346 +— +1,659 +3,687 +Total other securities +26.9 +% +8,100 +— +2,593 +5,507 +Total investments +100.0 +% +$ +30,100 +$ +19,259 +$ +5,334 +$ +5,507 +____________________________________________ +(1) +Percentages may not calculate due to rounding. +(2) +Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold upon demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of these funds is to approximate the S&P 500 by investing in one or more collective investment funds. +(3) +International equity securities consists of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets and believed to have strong sustainable financial productivity at attractive valuations. +(4) +The objective of core fixed income funds is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay’s Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +(5) +Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +92 +(6) +The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(7) +Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +(8) +The hedge fund portfolio includes investments in actively traded global mutual funds that focus on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +Included below is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2018 +$ +5,209 +Purchases +— +Realized gain on assets +191 +Unrealized gain on assets +152 +Disposition +( 45 +) +Balance at December 31, 2018 +$ +5,507 +Purchases +— +Realized gain on assets +190 +Unrealized gain on assets +51 +Disposition +— +Balance at December 31, 2019 +$ +5,748 +Contributions +The Company contributed $ 7.2 million , $ 8.1 million , and $ 7.0 million to the Pension Plans for the years ended December 31, 2019 , 2018 , and 2017 , respectively. The Company expects to make a $ 5.6 million contribution to the Pension Plans in 2020 . +Benefit Payments +The Pension Plans made actual benefit payments of $ 5.7 million , $ 8.0 million , and $ 10.8 million in the years ended December 31, 2019 , 2018 , and 2017 , respectively. Expected benefit payments over the next 10 years are as follows: +Years Ending December 31, +(in thousands) +2020 +$ +7,609 +2021 +$ +3,914 +2022 +$ +4,022 +2023 +$ +6,308 +2024 +$ +4,939 +2025 through 2029 +$ +25,065 +Note 9 - Earnings Per Share +Basic net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average number of common shares outstanding for the respective period. Diluted net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the diluted weighted-average number of common shares outstanding, which includes the effect of potentially dilutive securities. Potentially dilutive securities for this calculation consist primarily of non-vested RSUs, contingent PSUs, and shares into which the Senior Convertible Notes are convertible, which are measured using the treasury stock method. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three -year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 7 – Compensation Plans under the heading Performance Share Units . +On August 12, 2016 , the Company issued $ 172.5 million in aggregate principal amount of Senior Convertible Notes due 2021 . Upon conversion, the Senior Convertible Notes may be settled, at the Company’s election, in shares of the Company’s common stock, cash, or a combination of cash and common stock. The Company has initially elected a net-settlement method to satisfy its conversion obligation, which would result in the Company settling the principal amount of the Senior Convertible Notes in cash and the excess +93 +conversion value in shares. However, the Company has not made an irrevocable election and thereby reserves the right to settle the Senior Convertible Notes in any manner allowed under the indenture as business circumstances warrant. Shares of the Company’s common stock traded at an average closing price below the $ 40.50 conversion price for the years ended December 31, 2019 , 2018 , and 2017 , therefore, the Senior Convertible Notes had no dilutive impact. In connection with the offering of the Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters that would effectively prevent dilution upon settlement up to the $ 60.00 cap price. The capped call transactions will always be anti-dilutive and therefore will never be reflected in diluted net income or loss per share. Please refer to Note 5 – Long-Term Debt for additional discussion. +When the Company recognizes a net loss from continuing operations, as was the case for the years ended December 31, 2019 , and 2017 , all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of diluted net loss per common share. +The following table details the weighted-average anti-dilutive securities for the years presented: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Anti-dilutive +684 +— +264 +The following table sets forth the calculations of basic and diluted net income (loss) per common share: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands, except per share data) +Net income (loss) +$ +( 187,001 +) +$ +508,407 +$ +( 160,843 +) +Basic weighted-average common shares outstanding +112,544 +111,912 +111,428 +Dilutive effect of non-vested RSUs and contingent PSUs +— +1,590 +— +Diluted weighted-average common shares outstanding +112,544 +113,502 +111,428 +Basic net income (loss) per common share +$ +( 1.66 +) +$ +4.54 +$ +( 1.44 +) +Diluted net income (loss) per common share +$ +( 1.66 +) +$ +4.48 +$ +( 1.44 +) +Note 10 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company has entered into various commodity derivative contracts to mitigate a portion of its exposure to potentially adverse market changes in commodity prices and the associated impact on cash flows. As of December 31, 2019 , all derivative counterparties were members of the Company’s Credit Agreement lender group and all contracts were entered into for other-than-trading purposes. The Company’s commodity derivative contracts consist of swap and collar arrangements for oil and gas production, and swap arrangements for NGL production. In a typical commodity swap agreement, if the agreed upon published third-party index price (“index price”) is lower than the swap fixed price, the Company receives the difference between the index price and the agreed upon swap fixed price. If the index price is higher than the swap fixed price, the Company pays the difference. For collar arrangements, the Company receives the difference between an agreed upon index price and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +The Company has also entered into fixed price oil basis swaps in order to mitigate exposure to adverse pricing differentials between certain industry benchmark prices and the actual physical pricing points where the Company’s production volumes are sold. Currently, the Company has basis swap contracts with fixed price differentials between NYMEX WTI and WTI Midland for a portion of its Midland Basin production with sales contracts that settle at WTI Midland prices. The Company also has basis swaps with fixed price differentials between NYMEX WTI and Intercontinental Exchange Brent Crude (“ICE Brent”) for a portion of its Midland Basin oil production with sales contracts that settle at ICE Brent prices. +As of December 31, 2019 , the Company had commodity derivative contracts outstanding through the fourth quarter of 2022, as summarized in the tables below. +94 +Oil Swaps +Contract Period +NYMEX WTI Volumes +Weighted-Average +Contract Price +(MBbl) +(per Bbl) +First quarter 2020 +2,486 +$ +59.65 +Second quarter 2020 +2,838 +$ +58.81 +Third quarter 2020 +3,361 +$ +56.43 +Fourth quarter 2020 +3,937 +$ +56.94 +2021 +667 +$ +56.00 +Total +13,289 +Oil Collars +Contract Period +NYMEX WTI Volumes +Weighted-Average +Floor Price +Weighted-Average +Ceiling Price +(MBbl) +(per Bbl) +(per Bbl) +First quarter 2020 +2,267 +$ +55.00 +$ +63.91 +Second quarter 2020 +1,881 +$ +55.00 +$ +62.17 +Third quarter 2020 +1,252 +$ +55.00 +$ +62.90 +Fourth quarter 2020 +610 +$ +55.00 +$ +61.90 +2021 +329 +$ +55.00 +$ +56.70 +Total +6,339 +Oil Basis Swaps +Contract Period +WTI Midland-NYMEX WTI Volumes +Weighted-Average +Contract Price (1) +NYMEX WTI-ICE Brent Volumes +Weighted-Average Contract Price (2) +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +First quarter 2020 +4,193 +$ +( 0.68 +) +— +$ +— +Second quarter 2020 +3,495 +$ +( 0.68 +) +910 +$ +( 8.06 +) +Third quarter 2020 +3,325 +$ +( 0.74 +) +920 +$ +( 8.01 +) +Fourth quarter 2020 +3,261 +$ +( 0.73 +) +920 +$ +( 8.01 +) +2021 +5,954 +$ +0.59 +3,650 +$ +( 7.86 +) +2022 +— +$ +— +3,650 +$ +( 7.78 +) +Total +20,228 +10,050 +____________________________________________ +(1) +Represents the price differential between WTI Midland (Midland, Texas) and NYMEX WTI (Cushing, Oklahoma). +(2) +Represents the price differential between NYMEX WTI (Cushing, Oklahoma) and ICE Brent (North Sea). +Gas Swaps +Contract Period +IF HSC Volumes +Weighted-Average Contract Price +WAHA Volumes +Weighted-Average Contract Price +(BBtu) +(per MMBtu) +(BBtu) +(per MMBtu) +First quarter 2020 +9,123 +$ +2.98 +3,099 +$ +1.93 +Second quarter 2020 +4,160 +$ +2.20 +3,196 +$ +0.56 +Third quarter 2020 +4,493 +$ +2.41 +3,268 +$ +1.03 +Fourth quarter 2020 +3,722 +$ +2.36 +3,419 +$ +1.17 +2021 +— +$ +— +4,224 +$ +1.51 +Total (1) +21,498 +17,206 +____________________________________________ +(1) +The Company has natural gas swaps in place that settle against Inside FERC Houston Ship Channel (“IF HSC”), Inside FERC West Texas (“IF WAHA”), and Platt’s Gas Daily West Texas (“GD WAHA”). As of December 31, 2019 , WAHA volumes were comprised of 92 percent IF WAHA and eight percent GD WAHA . +95 +NGL Swaps +OPIS Ethane Purity Mont Belvieu +OPIS Propane Mont Belvieu Non-TET +Contract Period +Volumes +Weighted-Average Contract Price +Volumes +Weighted-Average Contract Price +(MBbl) +(per Bbl) +(MBbl) +(per Bbl) +First quarter 2020 +447 +$ +11.53 +382 +$ +22.64 +Second quarter 2020 +264 +$ +11.13 +382 +$ +22.34 +Third quarter 2020 +— +$ +— +409 +$ +22.33 +Fourth quarter 2020 +— +$ +— +466 +$ +22.29 +Total +711 +1,639 +Commodity Derivative Contracts Entered Into Subsequent to December 31, 2019 +Subsequent to December 31, 2019 , the Company entered into the following commodity derivative contracts: +• +fixed price NYMEX WTI oil swap contracts for the fourth quarter of 2020 through January 2021 for a total of 0.6 MMBbl of oil production at a weighted-average contract price of $ 57.82 per Bbl; and +• +fixed price WTI Midland-NYMEX WTI oil basis swap contracts for the second quarter of 2020 through the fourth quarter of 2022 for a total of 16.3 MMBbl of oil production at a weighted-average contract price of $ 1.14 per Bbl. +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its derivative commodity contracts as hedging instruments. The fair value of the commodity derivative contracts at December 31, 2019 , and 2018 , was a net asset of $ 21.5 million and $ 158.3 million , respectively. +The following table details the fair value of commodity derivative contracts recorded in the accompanying balance sheets, by category: +As of December 31, 2019 +As of December 31, 2018 +(in thousands) +Derivative assets: +Current assets +$ +55,184 +$ +175,130 +Noncurrent assets +20,624 +58,499 +Total derivative assets +$ +75,808 +$ +233,629 +Derivative liabilities: +Current liabilities +$ +50,846 +$ +62,853 +Noncurrent liabilities +3,444 +12,496 +Total derivative liabilities +$ +54,290 +$ +75,349 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2019 , and 2018 , all derivative instruments held by the Company were subject to master netting arrangements with various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that settle on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +96 +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s commodity derivative contracts: +Derivative Assets +Derivative Liabilities +As of December 31, +As of December 31, +2019 +2018 +2019 +2018 +(in thousands) +Gross amounts presented in the accompanying balance sheets +$ +75,808 +$ +233,629 +$ +( 54,290 +) +$ +( 75,349 +) +Amounts not offset in the accompanying balance sheets +( 35,075 +) +( 56,041 +) +35,075 +56,041 +Net amounts +$ +40,733 +$ +177,588 +$ +( 19,215 +) +$ +( 19,308 +) +The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring such amounts in accumulated other comprehensive income (loss). The Company had no derivatives designated as hedging instruments for the years ended December 31, 2019 , 2018 , and 2017 . Please refer to Note 11 – Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +The following table summarizes the commodity components of the net derivative (gain) loss line item presented in the accompanying statements of operations: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Derivative settlement (gain) loss: +Oil contracts +$ +19,685 +$ +68,860 +$ +31,176 +Gas contracts +( 23,008 +) +13,029 +( 87,857 +) +NGL contracts +( 35,899 +) +53,914 +35,447 +Total derivative settlement (gain) loss +$ +( 39,222 +) +$ +135,803 +$ +( 21,234 +) +Net derivative (gain) loss: +Oil contracts +$ +172,055 +$ +( 192,002 +) +$ +71,502 +Gas contracts +( 41,205 +) +35,411 +( 76,315 +) +NGL contracts +( 33,311 +) +( 5,241 +) +31,227 +Total net derivative (gain) loss +$ +97,539 +$ +( 161,832 +) +$ +26,414 +Credit Related Contingent Features +As of December 31, 2019 , and through the filing of this report, all of the Company’s derivative counterparties were members of the Company’s Credit Agreement lender group. Under the Credit Agreement, the Company is required to provide mortgage liens on assets having a value equal to at least 85 percent of the total PV-9, as defined in the Credit Agreement, of the Company’s proved oil and gas properties evaluated in the most recent reserve report. Collateral securing indebtedness under the Credit Agreement also secures the Company’s derivative agreement obligations. +Note 11 – Fair Value Measurements +The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• +Level 1 – quoted prices in active markets for identical assets or liabilities +• +Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +• +Level 3 – significant inputs to the valuation model are unobservable +97 +Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on the Company’s policies for determining fair value for the categories discussed below. +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2019 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +75,808 +$ +— +Liabilities: +Derivatives (1) +$ +— +$ +54,290 +$ +— +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2018 : +Level 1 +Level 2 +Level 3 +(in thousands) +Assets: +Derivatives (1) +$ +— +$ +233,629 +$ +— +Liabilities: +Derivatives (1) +$ +— +$ +75,349 +$ +— +____________________________________________ +(1) +This represents a financial asset or liability that is measured at fair value on a recurring basis. +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivatives. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The commodity derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any commodity derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current credit facility margins, and any change in such margins since the last measurement date. +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and other marketplace participants, the Company recognizes that third-parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Refer to Note 10 – Derivative Financial Instruments for more information regarding the Company’s derivative instruments. +98 +Oil and Gas Properties +Proved oil and gas properties . Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that associated carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique to measure the fair value of proved properties through an application of discount rates and price forecasts representative of the current operating environment, as selected by the Company’s management. +Unproved oil and gas properties . Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +There were no proved or unproved oil and gas properties recorded at fair value on the accompanying balance sheets as of December 31, 2019 , or December 31, 2018 . +The following table presents impairment of proved properties expense and abandonment and impairment of unproved properties expense recorded for the periods presented: +For the Years Ended December 31, +2019 +2018 +2017 +(in millions) +Impairment of proved properties +$ +— +$ +— +$ +3.8 +Abandonment and impairment of unproved properties +33.8 +49.9 +12.3 +Impairment of oil and gas properties +$ +33.8 +$ +49.9 +$ +16.1 +Abandonment and impairment of unproved properties expense recorded during the years ended December 31, 2019 , 2018 , and 2017 primarily related to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. +Long-Term Debt +The following table reflects the fair value of the Company’s unsecured senior note obligations measured using Level 1 inputs based on quoted secondary market trading prices. These notes were not presented at fair value on the accompanying balance sheets as of December 31, 2019 , or 2018 , as they were recorded at carrying value, net of any unamortized discounts and deferred financing costs. Please refer to Note 5 – Long-Term Debt for additional discussion. +As of December 31, +2019 +2018 +Principal Amount +Fair Value +Principal Amount +Fair Value +(in thousands) +6.125% Senior Notes due 2022 +$ +476,796 +$ +481,564 +$ +476,796 +$ +452,336 +5.0% Senior Notes due 2024 +$ +500,000 +$ +479,815 +$ +500,000 +$ +439,265 +5.625% Senior Notes due 2025 +$ +500,000 +$ +475,835 +$ +500,000 +$ +436,460 +6.75% Senior Notes due 2026 +$ +500,000 +$ +494,860 +$ +500,000 +$ +448,305 +6.625% Senior Notes due 2027 +$ +500,000 +$ +493,750 +$ +500,000 +$ +442,500 +1.50% Senior Convertible Notes due 2021 +$ +172,500 +$ +164,430 +$ +172,500 +$ +158,614 +The carrying value of the Company’s credit facility approximates its fair value, as the applicable interest rates are floating, based on prevailing market rates. +99 +Note 12 - Leases +Effective January 1, 2019, the Company adopted Topic 842, which requires lessees to recognize operating and finance leases with terms greater than 12 months on the balance sheet. The Company adopted this standard using the modified retrospective method and elected to use the optional transition methodology whereby reporting periods prior to adoption continue to be presented in accordance with legacy accounting guidance. As of December 31, 2019 , the Company did not have any agreements in place that were classified as finance leases under Topic 842. Arrangements classified as operating leases are included on the accompanying balance sheets within the other noncurrent assets, other current liabilities, and other noncurrent liabilities line items. For any agreement that contains both lease and non-lease components, such as a service arrangement that also includes an identifiable ROU asset, the Company’s policy for all asset classes is to combine lease and non-lease components together and account for the arrangement as a single lease. Aside from the recognition of ROU assets and corresponding lease liabilities on the accompanying balance sheets, Topic 842 does not have a material impact on the timing or classification of costs incurred for those agreements considered to be leases. +As outlined in Topic 842, a ROU asset represents a lessee’s right to use an underlying asset for the lease term, while the associated lease liability represents the lessee’s obligations to make lease payments. At the commencement date, which is the date on which a lessor makes an underlying asset available for use by a lessee, a lease ROU asset and corresponding lease liability is recognized based on the present value of the future lease payments. The initial measurement of lease payments may also be adjusted for certain items, including options that are reasonably certain to be exercised, such as options to purchase the asset at the end of the lease term, or options to extend or early terminate the lease. Excluded from the initial measurement of a ROU asset and corresponding lease liability are certain variable lease payments, such as payments made that vary depending on actual usage or performance. +The Company evaluates a contractual arrangement at its inception to determine if it is a lease or contains an identifiable lease component as defined by Topic 842. When evaluating a contract to determine appropriate classification and recognition under Topic 842, significant judgment may be necessary to determine, among other criteria, if an embedded leasing arrangement exists, the length of the term, classification as either an operating or financing lease, which options are reasonably likely to be exercised, fair value of the underlying ROU asset or assets, upfront costs, and future lease payments that are included or excluded in the initial measurement of the ROU asset. Certain assumptions and judgments made by the Company when evaluating a contract that meets the definition of a lease under Topic 842 include: +• +Discount Rate - Unless implicitly defined, the Company determines the present value of future lease payments using an estimated incremental borrowing rate based on a yield curve analysis that factors in certain assumptions, including the term of the lease and credit rating of the Company at lease inception. +• +Lease Term - The Company evaluates each contract containing a lease arrangement at inception to determine the length of the lease term when recognizing a ROU asset and corresponding lease liability. When determining the lease term, options available to extend or early terminate the arrangement are evaluated and included when it is reasonably certain an option will be exercised. Because of the Company’s intent to maintain financial and operational flexibility, there are no available options to extend that the Company is reasonably certain it will exercise. Additionally, based on expectations for those agreements with early termination options, there are no leases in which material early termination options are reasonably certain to be exercised by the Company. +Currently, the Company has operating leases for asset classes that include office space, office equipment, drilling rigs, midstream agreements, vehicles, and equipment rentals used in field operations. For those operating leases included on the accompanying balance sheets, which only includes leases with terms greater than 12 months at commencement, remaining lease terms range from less than one year to approximately six years . The weighted-average lease term remaining for these leases is approximately three years . Certain leases also contain optional extension periods that allow for terms to be extended for up to an additional 10 years . An early termination option also exists for certain leases, some of which allow for the Company to terminate a lease within one year. Exercising an early termination option may also result in an early termination penalty depending on the terms of the underlying agreement. +Subsequent to initial measurement, costs associated with the Company’s operating leases are either expensed or capitalized depending on how the underlying ROU asset is utilized and in accordance with GAAP requirements. For example, costs associated with drilling rigs and completion crews that are considered ROU assets are typically capitalized as part of the development of the Company’s oil and gas properties. Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on its accounting policies for oil and gas development and producing activities. When calculating the Company’s ROU asset and liability for a contractual arrangement that qualifies as an operating lease, the Company considers all of the necessary payments made or that are expected to be made upon commencement of the lease. Excluded from the initial measurement are certain variable lease payments, which for the Company’s drilling rigs, completion crews, and midstream agreements, may be a significant component of the total lease costs. +For the year ended December 31, 2019 , total costs related to operating leases, including short-term leases, and variable lease payments made for leases with initial lease terms greater than 12 months, were $ 442.9 million . This total does not reflect amounts that may be reimbursed by other third parties in the normal course of business, such as non-operating working interest owners. +100 +Components of the Company’s total lease cost, whether capitalized or expensed, for the year ended December 31, 2019 , were as follows: +For the Year Ended December 31, 2019 +Operating lease cost +$ +35,570 +Short-term lease cost (1) +301,373 +Variable lease cost (2) +106,006 +Total lease cost (3) +$ +442,949 +____________________________________________ +(1) +Costs associated with short-term lease agreements relate primarily to operational activities where underlying lease terms are less than one year. This amount is significant as it includes drilling and completion activities and field equipment rentals, most of which are contracted for 12 months or less. It is expected that this amount will fluctuate primarily with the number of drilling rigs and completion crews the Company is operating under short-term agreements. +(2) +Variable lease payments include additional payments made that were not included in the initial measurement of the ROU asset and corresponding liability for lease agreements with terms longer than 12 months. Variable lease payments relate to the actual volumes transported under certain midstream agreements, actual usage associated with drilling rigs, completion crews, and vehicles, and variable utility costs associated with the Company’s leased office space. Fluctuations in variable lease payments are driven by actual volumes delivered and the number of drilling rigs and completion crews operating under long-term agreements. +(3) +Lease costs are either expensed on the accompanying statements of operations or capitalized on the accompanying balance sheets depending on the nature and use of the underlying ROU asset. +Other information related to the Company’s leases for the year ended December 31, 2019 , was as follows: +For the Year Ended December 31, 2019 +(in thousands) +Cash paid for amounts included in the measurement of lease liabilities: +Operating cash flows from operating leases +$ +12,074 +Investing cash flows from operating leases +$ +24,129 +Right-of-use assets obtained in exchange for new operating lease liabilities +$ +25,360 +Maturities for the Company’s operating lease liabilities included on the accompanying balance sheets as of December 31, 2019 , were as follows: +As of December 31, 2019 +(in thousands) +2020 +$ +21,102 +2021 +12,600 +2022 +5,749 +2023 +3,602 +2024 +2,081 +Thereafter +1,639 +Total Lease payments +$ +46,773 +Less: Imputed interest (1) +( 4,447 +) +Total +$ +42,326 +____________________________________________ +(1) +The weighted-average discount rate used to determine the operating lease liability as of December 31, 2019 was 6.6 percent . +101 +Amounts recorded on the accompanying balance sheets for operating leases as of December 31, 2019 , were as follows: +As of December 31, 2019 +(in thousands) +Other noncurrent assets +$ +39,717 +Other current liabilities +$ +19,189 +Other noncurrent liabilities +$ +23,137 +As of December 31, 2019 , and through the filing of this report, the Company has no material lease arrangements which are scheduled to commence in the future. +Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses +Accounts receivable are comprised of the following accruals: +As of December 31, +2019 +2018 +(in thousands) +Oil, gas, and NGL production revenue +$ +146,308 +$ +107,230 +Amounts due from joint interest owners +22,681 +31,497 +State severance tax refunds +4,069 +4,415 +Derivative settlements +6,868 +9,475 +Other +4,806 +14,919 +Total accounts receivable +$ +184,732 +$ +167,536 +Accounts payable and accrued expenses are comprised of the following accruals: +As of December 31, +2019 +2018 +(in thousands) +Drilling and lease operating cost accruals +$ +96,925 +$ +139,711 +Trade accounts payable +52,094 +56,047 +Revenue and severance tax payable +109,847 +94,806 +Property taxes +24,535 +18,694 +Compensation +41,540 +31,486 +Derivative settlements +5,851 +1,287 +Interest +44,175 +40,840 +Other +27,041 +20,328 +Total accounts payable and accrued expenses +$ +402,008 +$ +403,199 +102 +Note 14 – Asset Retirement Obligations +Please refer to Asset Retirement Obligations in Note 1 – Summary of Significant Accounting Policies for a discussion of the initial and subsequent measurements of asset retirement obligation liabilities and the significant assumptions used in the estimates. +A reconciliation of the Company’s total asset retirement obligation liability is as follows: +As of December 31, +2019 +2018 +(in thousands) +Beginning asset retirement obligations +$ +94,194 +$ +114,470 +Liabilities incurred (1) +3,927 +4,054 +Liabilities settled (2) +( 4,105 +) +( 33,024 +) +Accretion expense +4,016 +4,438 +Revision to estimated cash flows +( 11,186 +) +4,256 +Ending asset retirement obligations (3) +$ +86,846 +$ +94,194 +____________________________________________ +(1) +Reflects liabilities incurred through drilling activities and acquisitions of drilled wells. +(2) +Reflects liabilities settled through plugging and abandonment activities and divestitures of properties. +(3) +Balances as of December 31, 2019 , and 2018 , included $ 2.7 million and $ 2.3 million , respectively, related to the Company’s current asset retirement obligation liability, which is recorded in the accounts payable and accrued expenses line item on the accompanying balance sheets. +Note 15 – Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2019 , 2018 , and 2017 . The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Beginning balance +$ +11,197 +$ +49,446 +$ +19,846 +Additions to capitalized exploratory well costs pending the determination of proved reserves +11,925 +11,197 +49,446 +Divestitures +— +( 109 +) +— +Reclassifications to wells, facilities, and equipment based on the determination of proved reserves +( 11,197 +) +( 49,337 +) +( 19,846 +) +Capitalized exploratory well costs charged to expense +— +— +— +Ending balance +$ +11,925 +$ +11,197 +$ +49,446 +As of December 31, 2019 , there were no exploratory well costs that were capitalized for more than one year. +103 +Supplemental Oil and Gas Information (unaudited) +Costs Incurred in Oil and Gas Producing Activities +Costs incurred in oil and gas property acquisition, exploration and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Development costs (1) +$ +913,959 +$ +1,147,574 +$ +675,523 +Exploration costs +114,957 +184,930 +271,502 +Acquisitions +Proved properties +(310 +) +1,312 +1,602 +Unproved properties (2) +11,633 +55,688 +91,420 +Total, including asset retirement obligations (3)(4) +$ +1,040,239 +$ +1,389,504 +$ +1,040,047 +____________________________________________ +(1) +Includes facility costs of $28.3 million , $72.6 million , and $43.8 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. +(2) +Includes amounts related to leasing activity and acquiring surface rights outside of acquisitions of proved and unproved properties totaling $8.7 million , $23.4 million , and $12.8 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. +(3) +Includes amounts relating to estimated asset retirement obligations of $(9.9) million , $7.1 million , and $13.6 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. +(4) +Includes capitalized interest of $18.5 million , $20.6 million , and $12.6 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting of reserve estimation and disclosure. +Proved reserves are the estimated quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated proved reserves are located in the United States. +104 +The table below presents a summary of changes in the Company’s estimated proved reserves for each of the years in the three-year period ended December 31, 2019 . The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company’s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +For the Years Ended December 31, +2019 (1) +2018 (2) +2017 (3) +Oil +Gas +NGLs +Oil +Gas +NGLs +Oil +Gas +NGLs +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +(MMBbl) +(Bcf) +(MMBbl) +Total proved reserves: +Beginning of year +175.7 +1,321.8 +107.4 +158.2 +1,280.1 +96.5 +104.9 +1,111.1 +105.7 +Revisions of previous estimate +(19.2 +) +(212.5 +) +(40.0 +) +(24.0 +) +(219.5 +) +(8.0 +) +1.0 +63.8 +4.9 +Discoveries and extensions +5.4 +28.8 +2.9 +9.3 +20.3 +0.5 +11.5 +21.9 +— +Infill reserves in an existing proved field +41.8 +190.2 +11.8 +80.4 +391.5 +29.0 +79.0 +347.4 +22.9 +Sales of reserves (4) +(0.2 +) +(0.7 +) +— +(29.6 +) +(48.1 +) +(2.7 +) +(25.3 +) +(143.8 +) +(26.7 +) +Purchases of minerals in place (4) +2.5 +5.4 +— +0.2 +0.7 +— +0.8 +2.7 +— +Production +(21.9 +) +(109.8 +) +(8.1 +) +(18.8 +) +(103.2 +) +(7.9 +) +(13.7 +) +(123.0 +) +(10.3 +) +End of year +184.1 +1,223.2 +74.0 +175.7 +1,321.8 +107.4 +158.2 +1,280.1 +96.5 +Proved developed reserves: +Beginning of year +68.2 +699.1 +60.1 +58.6 +642.9 +49.0 +48.5 +609.1 +58.6 +End of year +85.0 +712.1 +43.4 +68.2 +699.1 +60.1 +58.6 +642.9 +49.0 +Proved undeveloped reserves: +Beginning of year +107.6 +622.7 +47.2 +99.6 +637.2 +47.6 +56.4 +502.0 +47.1 +End of year +99.1 +511.1 +30.6 +107.6 +622.7 +47.2 +99.6 +637.2 +47.6 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) +For the year ended December 31, 2019 , the Company added 98.4 MMBOE from its drilling program and further development plan optimization. These additions were offset by net downward revisions of 94.7 MMBOE, which were primarily driven by declining commodity prices during 2019. Please refer to Areas of Operation in Part I, Items 1 and 2 of this report, and to Oil and Gas Reserve Quantities in Critical Accounting Policies and Estimates in Part II, Item 7 of this report for additional information. +(2) +For the year ended December 31, 2018 , the Company added 188.0 MMBOE from its drilling program and through development plan optimization. The Company divested 40.3 MMBOE during 2018, primarily as a result of the PRB Divestiture, Divide County Divestiture, and Halff East Divestiture. The Company also had net downward revisions of 68.8 MMBOE, which resulted primarily from changes in development plans in its Eagle Ford shale program. +(3) +For the year ended December 31, 2017 , the Company added 175.0 MMBOE from its drilling program. The Company divested 76.0 MMBOE during 2017, including 72.5 MMBOE related to its outside-operated Eagle Ford shale assets. +(4) +Please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions for additional information. +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of future net cash flows (“Standardized Measure”) and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the estimated proved reserves in place at the end of the period using year end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities. +105 +The assumptions used to compute the Standardized Measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the Standardized Measure computations since these reserve quantity estimates are the basis for the valuation process. The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the Standardized Measure: +For the Years Ended December 31, +2019 +2018 +2017 +Oil (per Bbl) +$ +53.68 +$ +57.76 +$ +48.57 +Gas (per Mcf) +$ +2.49 +$ +3.49 +$ +3.20 +NGLs (per Bbl) +$ +18.88 +$ +26.23 +$ +23.33 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the Standardized Measure. +As of December 31, +2019 +2018 +2017 +(in thousands) +Future cash inflows +$ +14,327,131 +$ +17,579,432 +$ +14,035,704 +Future production costs +(4,579,119 +) +(5,386,264 +) +(5,594,226 +) +Future development costs +(2,108,859 +) +(2,679,488 +) +(2,638,459 +) +Future income taxes +(579,815 +) +(1,012,209 +) +(205,694 +) +Future net cash flows +7,059,338 +8,501,471 +5,597,325 +10 percent annual discount +(2,955,340 +) +(3,847,088 +) +(2,573,183 +) +Standardized measure of discounted future net cash flows +$ +4,103,998 +$ +4,654,383 +$ +3,024,142 +The principle sources of changes in the Standardized Measure were: +For the Years Ended December 31, +2019 +2018 +2017 +(in thousands) +Standardized Measure, beginning of year +$ +4,654,383 +$ +3,024,142 +$ +1,152,113 +Sales of oil, gas, and NGLs produced, net of production costs +(1,085,041 +) +(1,148,991 +) +(745,877 +) +Net changes in prices and production costs +(1,539,042 +) +1,010,335 +1,181,447 +Extensions, discoveries and other including infill reserves in an existing proved field, net of related costs +887,254 +2,218,475 +1,638,734 +Sales of reserves in place +(2,788 +) +(147,887 +) +(226,528 +) +Purchase of reserves in place +57,519 +1,818 +12,032 +Previously estimated development costs incurred during the period +736,770 +445,638 +121,879 +Changes in estimated future development costs +132,825 +(34,871 +) +(116,609 +) +Revisions of previous quantity estimates +(398,409 +) +(611,168 +) +103,916 +Accretion of discount +510,427 +305,657 +115,211 +Net change in income taxes +191,040 +(449,884 +) +(32,426 +) +Changes in timing and other +(40,940 +) +41,119 +(179,750 +) +Standardized Measure, end of year +$ +4,103,998 +$ +4,654,383 +$ +3,024,142 +106 +Quarterly Financial Information (unaudited) +The Company’s quarterly financial information for fiscal years 2019 and 2018 is as follows (in thousands, except per share data): +First +Second +Third +Fourth +Quarter +Quarter +Quarter +Quarter +Year Ended December 31, 2019 (1) +Total operating revenues and other income +$ +340,930 +$ +407,172 +$ +390,317 +$ +451,686 +Total operating expenses +526,239 +303,005 +290,840 +539,989 +Income (loss) from operations +$ +(185,309 +) +$ +104,167 +$ +99,477 +$ +(88,303 +) +Income (loss) before income taxes +$ +(223,606 +) +$ +63,978 +$ +58,345 +$ +(129,761 +) +Net income (loss) +$ +(177,568 +) +$ +50,388 +$ +42,234 +$ +(102,055 +) +Basic net income (loss) per common share +$ +(1.58 +) +$ +0.45 +$ +0.37 +$ +(0.90 +) +Diluted net income (loss) per common share +$ +(1.58 +) +$ +0.45 +$ +0.37 +$ +(0.90 +) +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +Year Ended December 31, 2018 (2) +Total operating revenues and other income +$ +769,595 +$ +443,916 +$ +459,369 +$ +394,192 +Total operating expenses +310,527 +387,768 +568,013 +(35,573 +) +Income (loss) from operations +$ +459,068 +$ +56,148 +$ +(108,644 +) +$ +429,765 +Income (loss) before income taxes +$ +416,392 +$ +16,296 +$ +(172,671 +) +$ +391,760 +Net income (loss) +$ +317,401 +$ +17,197 +$ +(135,923 +) +$ +309,732 +Basic net income (loss) per common share +$ +2.84 +$ +0.15 +$ +(1.21 +) +$ +2.76 +Diluted net income (loss) per common share +$ +2.81 +$ +0.15 +$ +(1.21 +) +$ +2.73 +Dividends declared per common share +$ +0.05 +$ +— +$ +0.05 +$ +— +____________________________________________ +(1) +Results of operations during 2019 were primarily impacted by the following: +• a net derivative loss of $177.1 million recorded in the first quarter of 2019, +• a net derivative gain of $79.7 million recorded in the second quarter of 2019, +• a net derivative gain of $100.9 million recorded in the third quarter of 2019, and +• a net derivative loss of $101.0 million recorded in the fourth quarter of 2019. +Please refer to Note 10 – Derivative Financial Instruments for greater detail. +(2) +For the first quarter of 2018, the Company recorded an estimated $409.2 million net pre-tax gain on divestiture activity related to the PRB Divestiture, which was partially offset by a $24.1 million write-down on certain assets. During the second quarter of 2018, the Company recorded an estimated $15.7 million net pre-tax gain on divestiture activity related to the Divide County Divestiture and Halff East Divestiture (please refer to Note 3 – Divestitures, Assets Held for Sale, and Acquisitions ). During the third quarter of 2018, the Company recorded a $26.7 million loss on the early extinguishment of its 2021 Senior Notes, 2023 Senior Notes, and a portion of its 2022 Senior Notes (please refer to Note 5 – Long-Term Debt ). For the first, second, third, and fourth quarters of 2018, the Company recorded net derivative losses of $7.5 million , $63.7 million , $178.0 million , and a net derivative gain of $411.1 million . Please refer to Note 10 – Derivative Financial Instruments for greater detail. +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, +107 +assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +108 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2019 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +109 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated February 20, 2020 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 20, 2020 +110 +ITEM 9B. OTHER INFORMATION +None. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning the Company’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about Executive Officers,” and “Corporate Governance” in the Company’s definitive proxy statement for the 2020 annual meeting of stockholders to be filed within 120 days from December 31, 2019 . +The information required by this Item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the information provided under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement for the 2020 annual meeting of stockholders to be filed within 120 days from December 31, 2019 . +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation” and “Director Compensation” in the Company’s definitive proxy statement for the 2020 annual meeting of stockholders to be filed within 120 days from December 31, 2019 . +111 +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s definitive proxy statement for the 2020 annual meeting of stockholders to be filed within 120 days from December 31, 2019 . +Securities Authorized for Issuance Under Equity Compensation Plans. The Company has equity compensation plans under which options and shares of the Company’s common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. The Company’s stockholders have approved these plans. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for further information about the material terms of the Company’s equity compensation plans. The following table is a summary of the shares of common stock authorized for issuance under equity compensation plans as of December 31, 2019 : +(a) +(b) +(c) +Plan category +Number of securities to be issued upon exercise of outstanding options, warrants, and rights +Weighted-average exercise price of outstanding options, warrants, and rights +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan (1) +Restricted stock units (2) +1,540,925 +N/A +Performance share units (2)(3) +2,044,882 +N/A +Total for Equity Incentive Compensation Plan +3,585,807 +$ +— +4,385,709 +Employee Stock Purchase Plan (4) +— +— +1,299,003 +Equity compensation plans not approved by security holders +— +— +— +Total for all plans +3,585,807 +$ +— +5,684,712 +____________________________________________ +(1) +In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of the Company or any affiliate of the Company. The Company’s Board of Directors approved amendments to the Equity Plan in 2009, 2010, 2013, 2016, and 2018 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The number of shares of the Company’s common stock underlying awards granted in 2019 , 2018 , and 2017 under the Equity Plan were 1,868,776 , 1,220,217 , and 2,078,878 , respectively. +(2) +RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per unit fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per unit fair value for the outstanding RSUs and PSUs was $16.04 and $16.89, respectively. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for additional discussion. +(3) +The number of awards to be issued assumes a one multiplier. The final number of shares of the Company’s common stock issued upon settlement may vary depending on the three -year multiplier determined at the end of the performance period under the Equity Plan, which ranges from zero to two . +(4) +Under the ESPP, eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their eligible compensation. The purchase price of the common stock is 85 percent of the lower of the fair market value of the common stock on the first or last day of the six-month offering period, and shares issued under the ESPP on or after December 31, 2011, have no minimum restriction period. The ESPP is intended to qualify under Section 423 of the IRC. The number of shares of the Company’s common stock issued in 2019 , 2018 , and 2017 under the ESPP were 314,868 , 199,464 , and 186,665 , respectively. +112 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s definitive proxy statement for the 2020 annual meeting of stockholders to be filed within 120 days from December 31, 2019 . +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “ Independent Registered Public Accounting Firm ” and “ Audit Committee Pre-approval Policy and Procedures ” in the Company’s definitive proxy statement for the 2020 annual meeting of stockholders to be filed within 120 days from December 31, 2019 . +113 +PART IV +ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Consolidated Financial Statements and Financial Statement Schedules: +Report of Independent Registered Public Accounting Firm +63 +Consolidated Balance Sheets +65 +Consolidated Statements of Operations +66 +Consolidated Statements of Comprehensive Income (Loss) +67 +Consolidated Statements of Stockholders’ Equity +68 +Consolidated Statements of Cash Flows +69 +Notes to Consolidated Financial Statements +70 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +2.1 +Membership Interest Purchase Agreement dated January 1, 2017 between SM Energy Company and Venado EF LLC (filed as Exhibit 2.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, and incorporated herein by reference) +2.2 +Second Amendment to Membership Interest Purchase Agreement dated March 4, 2017 between SM Energy and Venado EF L.P. (filed as Exhibit 2.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, and incorporated herein by reference) +2.3 +Purchase and Sale Agreement dated January 8, 2018 by and between SM Energy Company and Converse Energy Acquisitions, LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on January 11, 2018 and incorporated herein by reference) +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +3.2 +Amended and Restated By-Laws of SM Energy Company, effective as of February 21, 2017 (filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +4.1 +Indenture related to the 5.0% Senior Notes due 2024, dated May 20, 2013, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on May 20, 2013, and incorporated herein by reference) +4.2 +Indenture related to the 6.125% Senior Notes due 2022, dated November 17, 2014, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 18, 2014, and incorporated herein by reference) +4.3 +Indenture related to senior debt securities of SM Energy Company by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-3 filed on May 7, 2015 (Registration No. 333-203936) and incorporated herein by reference) +4.4 +2025 Notes Supplemental Indenture (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on May 21, 2015, and incorporated herein by reference) +4.5 +Base Indenture, dated as of May 21, 2015, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.6 +Second Supplemental Indenture, dated August 12, 2016, by and between SM Energy Company and U.S. Bank, National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.7 +Third Supplemental Indenture, dated September 12, 2016 by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +4.8 +Fourth Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +114 +4.9 +Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.3 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +4.10† +SM Energy Company Equity Incentive Compensation Plan, amended and restated effective as of May 22, 2018 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 12, 2018, and incorporated herein by reference) +4.11* +Description of Securities +10.1 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.2 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.3† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +10.4*** +Gas Services Agreement effective as of July 1, 2010 between SM Energy Company and Eagle Ford Gathering LLC (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, and incorporated herein by reference) +10.5†† +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.6† +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.7+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of December 31, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.8*** +Gas Gathering Agreement dated May 31, 2011 between Regency Field Services LLC and SM Energy Company (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.9*** +Gathering and Natural Gas Services Agreement effective as of April 1, 2011 between SM Energy Company and ETC Texas Pipeline, Ltd. (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.10*** +Gas Processing Agreement effective as of April 1, 2011 between ETC Texas Pipeline, Ltd. and SM Energy Company (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.11† +Employee Stock Purchase Plan, As Amended and Restated as of June 10, 2011 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.12† +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.13† +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.14† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.15† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.16† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.17*† +Summary of Compensation Arrangements for Non-Employee Directors +10.18 +Sixth Amended and Restated Credit Agreement dated as of September 28, 2018, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 4, 2018, and incorporated herein by reference) +10.19† +Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 20, 2015, and incorporated herein by reference) +115 +10.20† +Amendment No. 3 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2016 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2015, and incorporated herein by reference) +10.21*** +Amendment to Amended and Restated Gas Gathering Agreement, effective as of September 1, 2015, by and between SM Energy Company and Regency Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on September 15, 2015, and incorporated herein by reference) +10.22 +Amendment to Amended and Restated Gas Gathering Agreement, effective as of February 1, 2016, by and between SM Energy Company and ETC Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on February 22, 2016, and incorporated herein by reference) +10.23 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.24 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.25 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.26 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.27 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.5 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.28 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.6 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.29† +SM Energy Company Employee Stock Purchase Plan, amended and restated effective as of April 6, 2017 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 13, 2017, and incorporated herein by reference) +10.30† +Performance Share Unit Award Agreement as of July 1, 2018 (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, and incorporated herein by reference) +10.31 +First Amendment to Sixth Amended and Restated Credit Agreement, dated April 18, 2019 among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on April 18, 2019, and incorporated herein by reference) +10.32† +Performance Share Unit Award Agreement as of July 1, 2019 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2019, and incorporated herein by reference) +10.33 +Second Amendment to Sixth Amended and Restated Credit Agreement, dated September 19, 2019 among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on September 24, 2019, and incorporated herein by reference) +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Ryder Scott Company L.P. +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +99.1* +Ryder Scott Audit Letter +101.INS +Inline XBRL Instance Document - The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH* +Inline XBRL Schema Document +101.CAL* +Inline XBRL Calculation Linkbase Document +101.LAB* +Inline XBRL Label Linkbase Document +101.PRE* +Inline XBRL Presentation Linkbase Document +101.DEF* +Inline XBRL Taxonomy Extension Definition Linkbase Document +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101.INS) +116 +* Filed with this report. +** Furnished with this report. +*** +Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Exchange Act. +† +Exhibit constitutes a management contract or compensatory plan or agreement. +†† +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ +Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on +November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal +Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. Please refer to Item 15(a) above. +ITEM 16. FORM 10-K SUMMARY +None. +117 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: +February 20, 2020 +By: +/s/ JAVAN D. OTTOSON +Javan D. Ottoson +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Javan D. Ottoson and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2019 , and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ JAVAN D. OTTOSON +President, Chief Executive Officer, and Director +February 20, 2020 +Javan D. Ottoson +(Principal Executive Officer) +/s/ A. WADE PURSELL +Executive Vice President and Chief Financial Officer +February 20, 2020 +A. Wade Pursell +(Principal Financial Officer) +/s/ PATRICK A. LYTLE +Controller and Assistant Secretary +February 20, 2020 +Patrick A. Lytle +(Principal Accounting Officer) +118 +Signature +Title +Date +/s/ WILLIAM D. SULLIVAN +Chairman of the Board of Directors +February 20, 2020 +William D. Sullivan +/s/ CARLA J. BAILO +Director +February 20, 2020 +Carla J. Bailo +/s/ LARRY W. BICKLE +Director +February 20, 2020 +Larry W. Bickle +/s/ STEPHEN R. BRAND +Director +February 20, 2020 +Stephen R. Brand +/s/ LOREN M. LEIKER +Director +February 20, 2020 +Loren M. Leiker +/s/ RAMIRO G. PERU +Director +February 20, 2020 +Ramiro G. Peru +/s/ JULIO M. QUINTANA +Director +February 20, 2020 +Julio M. Quintana +/s/ ROSE M. ROBESON +Director +February 20, 2020 +Rose M. Robeson +119 \ No newline at end of file diff --git a/raw/filings/0000893538/2019/0000893538-20-000009/filing_metadata.csv b/raw/filings/0000893538/2019/0000893538-20-000009/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..8179d71da03c0b58d7324750eb9b35ab190adaba --- /dev/null +++ b/raw/filings/0000893538/2019/0000893538-20-000009/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2020-02-20,2019-12-31,2020-02-20T13:57:52.000Z,0000893538-20-000009,sm-20191231x10k.htm,10-K,17137319,1,1,https://www.sec.gov/Archives/edgar/data/893538/000089353820000009/sm-20191231x10k.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353820000009/,2019,2019,1 diff --git a/raw/filings/0000893538/2019/0000893538-20-000009/item1.txt b/raw/filings/0000893538/2019/0000893538-20-000009/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2019/0000893538-20-000009/item13.txt b/raw/filings/0000893538/2019/0000893538-20-000009/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..ec237d1efeabb49337ed377e70ab315dfadc75d7 --- /dev/null +++ b/raw/filings/0000893538/2019/0000893538-20-000009/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s definitive proxy statement for the 2020 annual meeting of stockholders to be filed within 120 days from December 31, 2019 . \ No newline at end of file diff --git a/raw/filings/0000893538/2019/0000893538-20-000009/item9a.txt b/raw/filings/0000893538/2019/0000893538-20-000009/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..0cc6793e4ccdda42f27648ebdaaac4088d0a41b0 --- /dev/null +++ b/raw/filings/0000893538/2019/0000893538-20-000009/item9a.txt @@ -0,0 +1,39 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, +107 +assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +108 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) +pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) +provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2019 . +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +109 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018 , the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated February 20, 2020 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 20, 2020 +110 \ No newline at end of file diff --git a/raw/filings/0000893538/2019/0000893538-20-000009/rp_note.txt b/raw/filings/0000893538/2019/0000893538-20-000009/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2019/0000893538-20-000009/rpt_disclosure.txt b/raw/filings/0000893538/2019/0000893538-20-000009/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4382bce65d2ae481a565c6743b7c53378ee49753 --- /dev/null +++ b/raw/filings/0000893538/2019/0000893538-20-000009/rpt_disclosure.txt @@ -0,0 +1,11 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee’s review of any transaction, arrangement, or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, (b) the aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of our Related Person Transactions Policy, a “related person” means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more than 5 percent of our outstanding shares of common stock, and (iii) any immediate family member of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it determines in good faith are in, or are not inconsistent with, our best interests and the best interests of our stockholders. +In determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director’s independence in the event the related person is a director, and the extent of the related person’s interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in compliance with the policy and remain appropriate. +In addition, our By-Laws provide that a director, officer, or employee of our Company may not pursue for his or her own account a business or investment opportunity that he or she learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than 1 percent of the publicly traded stock of another company. +Transactions with Related Persons +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are consistent with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when our Board, acting through the Audit Committee or as otherwise described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, but are not limited to, situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we obtain products or services from, or provide products or services to, related persons on an arm’s length basis on terms comparable to those obtained from or provided to unrelated third parties or on terms comparable to those obtained from or provided to employees generally. With the exception of the transaction described in the following paragraph, which was approved by our Audit Committee, we had no transactions that required approval under our Related Person Transactions Policy. +Dean Lutey, the spouse of Ms. Mary Ellen Lutey, our Senior Vice President—Exploration, Development and EHS, joined the Company in 2008. Mr Lutey was appointed Vice President—Chief Information Officer since April, 2021. Prior to this appointment, Mr. Lutey served as the Company’s Vice President—Information Technology since May 2013. During the fiscal year ended December 31, 2020, Mr. Lutey earned total compensation of $588,518, which included his base salary, annual bonus, LTIP awards, benefits under our qualified and non-qualified benefit plans, and matching contributions by the Company under its 401(k) Profit Sharing Plan and Non-Qualified Deferred Compensation Plan. Mr. Lutey also participated in the Company’s benefit programs for its employees. +66 +Compensation Committee Interlocks and Insider Participation +None of the directors who served on the Compensation Committee during fiscal year 2020 has ever served as one of our officers or employees. 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2020-06-17 0000893538 sm:DueFromJointInterestOwnersMember 2020-12-31 0000893538 sm:DueFromJointInterestOwnersMember 2019-12-31 0000893538 sm:TaxesReceivableMember 2020-12-31 0000893538 sm:TaxesReceivableMember 2019-12-31 0000893538 sm:DerivativeSettlementReceivableMember 2020-12-31 0000893538 sm:DerivativeSettlementReceivableMember 2019-12-31 0000893538 sm:OtherReceivablesMember 2020-12-31 0000893538 sm:OtherReceivablesMember 2019-12-31 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +☑ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +For the fiscal year ended December 31, 2020 +or +☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +Commission file number 001-31539 +SM ENERGY CO MPANY +(Exact name of registrant as specified in its charter) +Delaware 41-0518430 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +1775 Sherman Street, Suite 1200 , Denver , Colorado +80203 +(Address of principal executive offices) (Zip Code) +( 303 ) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common stock, $.01 par value SM New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ Accelerated filer ☑ +Non-accelerated filer ☐ Smaller reporting company ☐ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C.7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☑ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑ +The aggregate market value of the 111,761,892 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock on June 30, 2020, the last business day of the registrant’s most recently completed second fiscal quarter, of $3.75 per share, as reported on the New York Stock Exchange, was $ 419,107,095 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 4, 2021, the registrant had 114,742,304 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III of this report is incorporated by reference from portions of the registrant’s Definitive Proxy Statement on Schedule 14A relating to its 2021 annual meeting of stockholders, to be filed within 120 days after December 31, 2020. +1 +TABLE OF CONTENTS +Item Page +Cautionary Information about Forward-Looking Statements +4 +Glossary of Oil and Gas Terms +4 +Part I +8 +Items 1. and 2. +Business and Properties +8 +General +8 +Strategy +8 +Significant Developments in 2020 +8 +Outlook +9 +Areas of Operation +10 +Reserves +11 +Production +15 +Productive Wells +15 +Drilling and Completion Activity +16 +Title to Properties +16 +Acreage +17 +Delivery Commitments +17 +Major Customers +17 +Human Capital +17 +Seasonality +18 +Competition +18 +Government Regulations +18 +Available Information +21 +Item 1A. +Risk Factors +21 +Item 1B. +Unresolved Staff Comments +34 +Item 3. +Legal Proceedings +34 +Item 4. +Mine Safety Disclosures +35 +Part II +36 +Item 5. +Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +36 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +38 +Overview of the Company +38 +Financial Results of Operations and Additional Comparative Data +43 +Comparison of Financial Results and Trends Between 2020 and 2019 and Between 2019 and 2018 +46 +Overview of Liquidity and Capital Resources +50 +Critical Accounting Policies and Estimates +54 +Accounting Matters +56 +Environmental +56 +Non-GAAP Financial Measures +59 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +60 +Item 8. +Consolidated Financial Statements and Supplementary Data +61 +Item 9. +Changes In and Disagreements With Accountants on Accounting and Financial Disclosure +108 +Item 9A. +Controls and Procedures +109 +Item 9B. +Other Information +112 +2 +TABLE OF CONTENTS +(Continued) +Item Page +Part III +112 +Item 10. +Directors, Executive Officers, and Corporate Governance +112 +Item 11. +Executive Compensation +112 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +113 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +114 +Item 14. +Principal Accountant Fees and Services +114 +Part IV +115 +Item 15. +Exhibits and Consolidated Financial Statement Schedules +115 +Item 16. +Form 10-K Summary +118 +Signatures +119 +3 +Cautionary Information about Forward-Looking Statements +This Annual Report on Form 10-K (“Form 10-K” or “this report”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements included in this report, other than statements of historical facts, that address activities, conditions, events, or developments with respect to our financial condition, results of operations, business prospects or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “could,” “estimate,” “expect,” “forecast,” “intend,” “pending,” “plan,” “potential,” “project,” “target,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this report, and include statements about such matters as: +• the impacts of the global COVID-19 pandemic (“Pandemic”) on us, our industry, our financial condition, and our results of operations; +• the amount and nature of future capital expenditures and the availability of liquidity and capital resources to fund capital expenditures; +• any changes to the borrowing base or aggregate lender commitments under our Sixth Amended and Restated Credit Agreement, as amended (“Credit Agreement”); +• our outlook on future crude oil, natural gas, and natural gas liquids (also referred to throughout this report as “oil,” “gas,” and “NGLs,” respectively) prices, well costs, service costs, lease operating costs, and general and administrative costs; +• our drilling and completion activities and other exploration and development activities, our ability to obtain permits and governmental approvals, and plans by us, our joint development partners, and/or other third-party operators; +• possible or expected acquisitions and divestitures, including the possible divestiture or farmout of, or joint development of, certain properties; +• oil, gas, and NGL reserve estimates and estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates; +• our expected future production volumes, identified drilling locations, as well as drilling prospects, inventories, projects and programs; +• cash flows, liquidity, interest and related debt service expenses, changes in our effective tax rate, and our ability to repay debt in the future; +• business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, plans with respect to future dividend payments, and our outlook on our future financial condition or results of operations; and +• other similar matters, such as those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. These statements are subject to known and unknown risks and uncertainties, which may cause our actual results and performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Factors that may cause our financial condition, results of operations, business prospects or economic performance to differ from expectations include the factors discussed in Part I, Item 1A, Risk Factors below and elsewhere in this report. +We caution you that forward-looking statements are not guarantees of future performance and actual results or performance may be materially different from those expressed or implied in forward-looking statements. The forward-looking statements in this report speak only as of the filing of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by applicable securities laws. +4 +Glossary of Oil and Gas Terms +The oil and gas terms defined in this section are used throughout this report. The definitions of the terms “developed reserves,” “exploratory well,” “field,” “proved reserves,” and “undeveloped reserves” have been abbreviated from the respective definitions under Rule 4-10(a) of Regulation S-X. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +BBtu. One billion British thermal units. +Bcf . One billion cubic feet, used in reference to gas. +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of gas to one Bbl of oil or NGLs. +Btu. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Completion. The installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry hole, the reporting to the applicable authority that the well has been abandoned. +Conversion rate. Current year conversions of proved undeveloped reserves to proved developed reserves, divided by beginning of the year proved undeveloped reserves (also commonly referred to in our industry as track record ). +Costs incurred. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. An exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in sufficient commercial quantities to justify completion, or upon completion, the economic operation of a well (also referred to as non-productive well ). +Exploratory well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and gas) rights. +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +GAAP. Accounting principles generally accepted in the United States. +Gross acres or gross wells. Acres or wells in which a working interest is owned. +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses. The expenses incurred in the lifting of oil, gas, and/or NGLs from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, +5 +maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to gas. +MMBbl. One million barrels, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +NGLs. The combination of ethane, propane, isobutane, normal butane, and natural gasoline that when removed from gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for oil. +NYMEX Henry Hub . New York Mercantile Exchange Henry Hub, a common industry benchmark price for gas. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +PV-10. PV-10 is a non-GAAP measure. The present value of estimated future revenue to be generated from the production of estimated net proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. +Productive well. An exploratory, development, or extension well that is producing or is capable of commercial production of oil, gas, and/or NGLs. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +Reserve life index. Expressed in years, represents the estimated net proved reserves at a specified date divided by actual production for the preceding 12-month period. +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil, gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of oil, gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from oil, gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +6 +Royalty interest. An interest in an oil and gas property entitling the owner to shares of oil, gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +Standardized measure of discounted future net cash flows. The discounted future net cash flows related to estimated proved reserves based on prices used in estimating the reserves, year-end costs, and statutory tax rates, at a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information (unaudited) located in Part II, Item 8 of this report. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and NGLs regardless of whether such acreage contains estimated net proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +7 +PART I +When we use the terms “SM Energy,” the “Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business in the Glossary of Oil and Gas Terms section of this report. Throughout this document we make statements and projections that address future expectations, possibilities, or events, all of which may be classified as “forward-looking statements.” Please refer to the Cautionary Information about Forward-Looking Statements section of this report for an explanation of these types of statements and the associated risks and uncertainties. +ITEMS 1. AND 2. BUSINESS AND PROPERTIES +General +We are an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. SM Energy was founded in 1908, incorporated in Delaware in 1915, and our initial public offering of common stock was in December 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal office is located at 1775 Sherman Street, Suite 1200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +Our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to domestic energy security and prosperity, and having a positive impact in the communities where we live and work. Our short-term operational and financial goals include generating positive cash flows while strengthening our balance sheet through absolute debt reduction and improved leverage metrics, and increasing the value of our capital project inventory through exploration and development optimization. Our long-term vision is to sustainably grow value for all of our stakeholders. We believe that in order to accomplish this vision, we must be a premier operator of top tier assets. Our investment portfolio is comprised of oil and gas producing assets in the state of Texas, specifically in the Midland Basin of West Texas and in the Maverick Basin of South Texas. +Significant Developments in 2020 +Pandemic Response. During 2020, the Pandemic and associated macroeconomic events affected supply and demand for oil, gas, and NGLs, and the realized prices we received for our production throughout 2020. Despite continuing negative impacts and future uncertainty, we expect to maintain our ability to sustain strong operational performance and financial stability while maximizing returns, improving leverage metrics, and increasing the value of our top tier Midland Basin and South Texas assets. +The safety of our employees, contractors, and the communities where we work remains our first priority as we continue to operate during the Pandemic. While our core business operations require certain individuals to be physically present at well site locations, substantially all of our office-based employees have continued working remotely in order to limit physical interactions and to mitigate the spread of COVID-19, and will continue to do so well into 2021. For individuals who are unable to perform their jobs remotely, we maintain and continually assess procedures designed to limit the spread of COVID-19, including social distancing and enhanced sanitization measures, and we continue to communicate to and train all of our employees regarding best practices for maintaining a healthy and safe work environment. We believe that we meet or exceed Centers for Disease Control and Prevention (“CDC”) and federal Occupational Safety and Health Act (“OSHA”) guidelines related to the prevention of the transmission of COVID-19. Since these measures were initially implemented in the first quarter of 2020, we have continued to operate without significant disruptions to our business operations. Our pre-existing control environment and internal controls continue to be effective and we continue to address new risks directly related to the Pandemic as we identify them. +Cash Flows and Debt Reduction. We decreased our total outstanding long-term debt principal balance by 18 percent to $2.3 billion as of December 31, 2020, from $2.8 billion as of December 31, 2019. This decrease was primarily driven by the Exchange Offers and open market repurchases of certain of our senior notes at a discount, and net cash provided by operating activities of $790.9 million, which was in excess of net cash used in investing activities of $555.6 million for the year ended December 31, 2020. Please refer to Analysis of Cash Flow Changes Between 2020 and 2019 and Between 2019 and 2018 in Overview of Liquidity and Capital Resources in Part II, Item 7, and to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definition of Exchange Offers. +Reserves and Capital Investment. Total estimated proved reserves were 404.6 MMBOE as of December 31, 2020, which was a decrease of 12 percent from 462.0 MMBOE as of December 31, 2019. This decrease primarily related to 46.4 MMBOE produced during 2020 and 32.6 MMBOE removed as a result of lower commodity prices experienced in 2020 compared with 2019, using pricing estimates determined in accordance with SEC rules. Our proved reserve life index decreased to 8.7 years as of December 31, 2020, compared with 9.6 years as of December 31, 2019. Please refer to Areas of Operation and Reserves below for additional discussion regarding additions from extensions, discoveries, and infill, the removal of certain proved undeveloped reserve cases that are no longer +8 +within our development plan over the next five years, and certain performance revisions. Costs incurred decreased 44 percent from the prior year to $585.3 million in 2020 in response to lower commodity prices. Please refer to Areas of Operation below, and to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Production. Our average net daily production in 2020 was 126.9 MBOE and consisted of 62.9 MBbl of oil, 283.9 MMcf of gas, and 16.7 MBbl of NGLs, which represented a four percent decrease compared with 2019. This decrease was driven by a 21 percent decrease in daily production volumes from our South Texas assets, partially offset by a 10 percent increase in daily production volumes from our Midland Basin assets. During the year ended December 31, 2020, as compared with 2019, net daily production volumes decreased four percent as a result of proactive measures taken to respond to the lower commodity price environment experienced in 2020 compared with 2019. This included voluntary production curtailments and less costs incurred as a result of intentionally reducing the number of new wells completed and brought on production. Oil production as a percentage of total production increased to 50 percent in 2020 from 45 percent in 2019. Please refer to Areas of Operation below for additional discussion. +Pricing. Realized prices before the effects of derivative settlements for oil, gas, and NGLs decreased 31 percent, 25 percent, and 19 percent, respectively, for the year ended December 31, 2020, compared with 2019. As a result of decreased realized prices, oil, gas, and NGL production revenue decreased 29 percent to $1.1 billion for the year ended December 31, 2020, compared with $1.6 billion for 2019. Oil production revenue was 76 percent and 75 percent of total production revenue for the years ended December 31, 2020, and 2019, respectively. We recorded a net derivative gain of $161.6 million for the year ended December 31, 2020, compared to a net derivative loss of $97.5 million for 2019. These amounts include derivative settlement gains of $351.3 million and $39.2 million for the years ended December 31, 2020, and 2019, respectively. Please refer to Overview of the Company in Part II, Item 7 of this report for additional discussion. +Outlook +Our vision to sustainably grow value for all of our stakeholders includes near-term operational and financial goals of generating positive cash flows while strengthening our balance sheet through absolute debt reduction and improved leverage metrics. Our long-term plan is to deliver cash flow growth that is supported by our high-quality asset base and ability to generate favorable returns. We remain committed to exceptional safety, health, and environmental stewardship; supporting the professional development of a diverse and thriving team of employees; making a positive difference in the communities where we live and work; and transparency in reporting on our progress in these areas. The Environmental, Social and Governance Committee of our Board of Directors oversees, among other things, the development and implementation of the Company’s environmental, social and governance policies, programs and initiatives, and reports to our Board of Directors regarding such matters. +We expect to focus our strategy on continuing to improve operating margins and cash flows while strengthening our balance sheet through absolute debt reduction and improved leverage metrics. Our total 2021 capital program is budgeted between $650.0 million and $675.0 million, which we expect to fund with cash flows from operations. We expect to focus our 2021 capital program on highly economic oil development projects in both our Midland Basin assets and our South Texas assets. In South Texas, we intend to primarily target the Austin Chalk formation. None of these assets are located on federal lands, and therefore our operations will not be impacted by the recent suspension of the issuance of federal drilling permits. +Please refer to Overview of Liquidity and Capital Resources in Part II, Item 7 of this report for discussion of how we expect to fund our 2021 capital program. +9 +Areas of Operation +____________________________________________ +(1) As of December 31, 2020. +Our 2020 operations were concentrated in the Midland Basin and South Texas, as described below. The following table summarizes estimated proved reserves, production, and costs incurred for the year ended December 31, 2020, for these areas: +Midland Basin +South Texas +Total (1) +Proved reserves +Oil (MMBbl) 150.9 21.8 172.7 +Gas (Bcf) 425.3 626.8 1,052.0 +NGLs (MMBbl) 0.2 56.4 56.6 +MMBOE (1) +222.0 182.6 404.6 +Relative percentage +55 % 45 % 100 % +Proved developed % 58 % 55 % 57 % +Production +Oil (MMBbl) 21.3 1.7 23.0 +Gas (Bcf) 46.6 57.3 103.9 +NGLs (MMBbl) — 6.1 6.1 +MMBOE (1) +29.1 17.3 46.4 +Avg. daily equivalents (MBOE/d) (1) +79.5 47.4 126.9 +Relative percentage +63 % 37 % 100 % +Costs incurred (in millions) (2)(3) +$ 470.6 $ 75.3 $ 585.3 +___________________________________________ +(1) Amounts may not calculate due to rounding. +(2) Asset costs incurred do not sum to total costs incurred primarily due to corporate overhead charges incurred on exploration activities that are excluded from this table. Please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +(3) Costs incurred for 2020 included $16.4 million related to acquisitions of primarily unproved oil and gas properties in the Midland Basin. Please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Total estimated proved reserves at year end 2020 decreased 12 percent from year end 2019. Production decreased four percent on an equivalent basis for the year ended December 31, 2020, compared with 2019. Costs incurred decreased in 2020 by 44 percent compared with 2019 primarily due to the decrease in our capital activity, increased operational efficiencies, and lower service provider costs. +Midland Basin. Our Midland Basin assets are comprised of approximately 81,000 net acres located in the Permian Basin in West Texas (“Midland Basin”). In 2020, drilling and completion activities within our RockStar and Sweetie Peck positions in the Midland Basin continued to focus primarily on delineating, developing, and expanding our Midland Basin position. Our current Midland Basin position provides substantial future development opportunities within multiple oil-rich intervals, including the Spraberry and Wolfcamp formations. We expect 2021 capital activity in the Midland Basin to be focused on highly economic oil development projects. +10 +In 2020, we incurred $470.6 million of costs and averaged four drilling rigs and two completion crews. The majority of our Midland Basin capital was deployed on projects targeting the Spraberry and Wolfcamp formations on our RockStar assets in Howard and Martin Counties, Texas and Sweetie Peck assets in Upton and Midland Counties, Texas. We completed 80 gross (73 net) wells and full-year production increased 11 percent year-over-year to 29.1 MMBOE for 2020. As of December 31, 2020, 66 gross (58 net) wells had been drilled but not completed in our Midland Basin program. Estimated proved reserves decreased five percent to 222.0 MMBOE at year end 2020, from 234.1 MMBOE at year end 2019, as a result of 29.1 MMBOE produced during 2020, and the impacts of development plan changes and decreased commodity pricing. During 2020, we had downward reserve revisions of 28.6 MMBOE, of which 21.5 MMBOE resulted from the removal of certain longer term proved undeveloped reserves that are no longer within our development plan over the next five years, and 7.1 MMBOE resulted from decreased commodity pricing. These revisions were offset by additions of 45.5 MMBOE, of which 36.8 MMBOE resulted from infill, extensions, and discoveries and 8.7 MMBOE resulted from positive performance revisions. +South Texas. Our South Texas assets are comprised of approximately 158,000 net acres located in Dimmit and Webb Counties, Texas (“South Texas”). Our current operations in South Texas are focused on production from the Eagle Ford shale formation and further development of the Austin Chalk formation. 2021 capital activity in South Texas is expected to be concentrated on the Austin Chalk formation given the higher liquids content of production and favorable economics. Our overlapping acreage position in the Maverick Basin covers a significant portion of the western Eagle Ford shale and Austin Chalk formations (“Maverick Basin”) and includes acreage across the oil, gas-condensate, and dry gas windows with gas composition amenable to processing for NGL extraction. +In 2020, we incurred $75.3 million of costs, averaged one drilling rig, and operated one completion crew at times during the year. We completed 4 gross (4 net) wells during 2020, and full-year production decreased 21 percent year-over-year to 17.3 MMBOE for 2020, from 22.0 MMBOE for 2019. While natural decline and deferral of activity led to a decrease in total production volumes, oil production volumes increased 28 percent year-over-year as a result of the higher liquids content from our Austin Chalk completions. As of December 31, 2020, 31 gross (28 net) wells had been drilled but not completed in our South Texas program. Estimated proved reserves decreased 20 percent to 182.6 MMBOE at year end 2020, from 227.8 MMBOE at year end 2019, as a result of 17.3 MMBOE produced during 2020, and the impacts of development changes and decreased commodity prices. During 2020, we had downward reserves revisions of 77.1 MMBOE, of which 43.5 MMBOE resulted from the removal of certain longer term proved undeveloped reserves, 25.5 MMBOE resulted from decreased commodity pricing, 5.1 MMBOE resulted from performance revisions, and 3.0 MMBOE resulted from divestitures. These revisions were partially offset by additions of 49.3 MMBOE of estimated proved reserves from discoveries, extensions and infills. +Office Space. As of December 31, 2020, we leased and owned office space as summarized in the table below: +Approximate Square Footage Leased Approximate Square Footage Owned +Corporate 107,000 — +Midland Basin 59,000 — +South Texas 62,000 12,000 +Total 228,000 12,000 +Reserves +Reserve estimates are inherently imprecise and estimates for new discoveries and undeveloped locations are more imprecise than reserve estimates for producing oil and gas properties. Accordingly, we expect these estimates to change as new information becomes available. The following table presents the standardized measure of discounted future net cash flows and pre-tax PV-10. PV-10 is a non-GAAP financial measure, and generally differs from the standardized measure of discounted future net cash flows, the most directly comparable GAAP financial measure, because it does not include the effects of income taxes on future net revenues. Neither the standardized measure of discounted future net cash flows nor PV-10 represents the fair market value of our oil and gas properties. We and others in the oil and gas industry use PV-10 as a measure to compare the relative size and value of proved reserves held without regard to the specific tax characteristics of such entities. Please refer to the Glossary of Oil and Gas Terms section of this report for additional information regarding these measures and refer to the reconciliation of the standardized measure of discounted future net cash flows to PV-10 set forth below. The actual quantities and present value of our estimated proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The following table should be read along with the Risk Factors section below. +11 +The following table summarizes estimated proved reserves, the standardized measure of discounted future net cash flows (GAAP), PV-10 (non-GAAP), the prices used in the calculation of proved reserves estimates, and reserve life index as of December 31, 2020, 2019, and 2018: +As of December 31, +2020 2019 2018 +Reserve data: +Proved developed +Oil (MMBbl) 89.8 85.0 68.2 +Gas (Bcf) 643.9 712.1 699.1 +NGLs (MMBbl) 32.1 43.4 60.1 +MMBOE (1) +229.3 247.0 244.8 +Proved undeveloped +Oil (MMBbl) 82.9 99.1 107.6 +Gas (Bcf) 408.1 511.1 622.7 +NGLs (MMBbl) 24.4 30.6 47.2 +MMBOE (1) +175.3 214.9 258.6 +Total proved (1) +Oil (MMBbl) 172.7 184.1 175.7 +Gas (Bcf) (2) +1,052.0 1,223.2 1,321.8 +NGLs (MMBbl) 56.6 74.0 107.4 +MMBOE 404.6 462.0 503.4 +Proved developed reserves % 57 % 53 % 49 % +Proved undeveloped reserves % 43 % 47 % 51 % +Reserve data (in millions): +Standardized measure of discounted future net cash flows (GAAP) $ 2,682.5 $ 4,104.0 $ 4,654.4 +PV-10 (non-GAAP): +Proved developed PV-10 $ 1,848.8 $ 2,830.4 $ 3,084.2 +Proved undeveloped PV-10 833.7 1,532.4 2,020.1 +Total proved PV-10 (non-GAAP) $ 2,682.5 $ 4,362.8 $ 5,104.3 +12-month trailing average prices (3) +Oil (per Bbl) +$ 39.57 $ 55.69 $ 65.56 +Gas (per MMBtu) +$ 1.99 $ 2.58 $ 3.10 +NGLs (per Bbl) +$ 17.64 $ 22.68 $ 33.45 +Reserve life index (years) (4) +8.7 9.6 11.5 +____________________________________________ +(1) Amounts may not calculate due to rounding. +(2) For the years ended December 31, 2020, 2019, and 2018, proved gas reserves contained 38.4 Bcf, 44.9 Bcf, and 59.1 Bcf of gas, respectively, that we expect to produce and use as a field equipment fuel source (primarily to power compressors). +(3) The prices used in the calculation of proved reserve estimates reflect the unweighted arithmetic average of the first-day-of-the-month price of each month within the trailing 12-month period in accordance with SEC rules. We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. +(4) Our ability to replace production with new oil and gas reserves is critical to the future success of our business. Please refer to the reserve life index term in the Glossary of Oil and Gas Terms section of this report for information describing how this metric is calculated. +12 +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the PV-10 (non-GAAP) of total estimated proved reserves. Please refer to the Glossary of Oil and Gas Terms section of this report for the definitions of standardized measure of discounted future net cash flows and PV-10. +As of December 31, +2020 2019 2018 +(in millions) +Standardized measure of discounted future net cash flows (GAAP) +$ 2,682.5 $ 4,104.0 $ 4,654.4 +Add: 10 percent annual discount, net of income taxes +1,856.3 2,955.3 3,847.1 +Add: future undiscounted income taxes +— 579.8 1,012.2 +Pre-tax undiscounted future net cash flows +4,538.8 7,639.1 9,513.7 +Less: 10 percent annual discount without tax effect +(1,856.3) (3,276.3) (4,409.4) +PV-10 (non-GAAP) $ 2,682.5 $ 4,362.8 $ 5,104.3 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from future wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of production when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time. As of December 31, 2020, we did not have any proved undeveloped reserves that had been on our books in excess of five years, and none of our proved undeveloped reserves were on acreage expected to expire or on acreage that was not expected to be held through renewal before the targeted completion date. +For proved undeveloped locations that are more than one development spacing area from developed producing locations, we utilized reliable geologic and engineering technology when booking estimated proved undeveloped reserves. Of the 175.3 MMBOE of total proved undeveloped reserves as of December 31, 2020, approximately 36.8 MMBOE of proved undeveloped reserves in the Midland Basin and 64.5 MMBOE of proved undeveloped reserves in our South Texas position were offset by more than one development spacing area from the nearest developed producing location. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected) and petrophysical analysis of that log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. +As of December 31, 2020, estimated proved undeveloped reserves decreased 39.6 MMBOE, or 18 percent compared with December 31, 2019. The following table provides a reconciliation of our proved undeveloped reserves for the year ended December 31, 2020: +Total +(MMBOE) +Total proved undeveloped reserves: +Beginning of year 214.9 +Additions from extensions, discoveries, and infill 74.8 +Removed for five-year rule (65.0) +Conversions to proved developed (33.2) +Revisions of previous estimates (13.5) +Sales of reserves (3.0) +Purchases of minerals in place 0.3 +End of year 175.3 +Additions from extensions, discoveries, and infill. We added 8.1 MMBOE and 32.7 MMBOE of estimated proved undeveloped reserves in the Midland Basin and South Texas, respectively, through various extensions and discoveries in 2020. We added an additional 23.1 MMBOE and 10.9 MMBOE of infill estimated proved undeveloped reserves in our Midland Basin and South Texas assets, respectively. The majority of additions in our Midland Basin program resulted from future development projects identified by our +13 +on-going development and portfolio optimization activities. The majority of additions in our South Texas program resulted from our efforts to further develop the Austin Chalk formation. +Removed for five-year rule. As a result of our testing and delineation efforts in 2020, we revised certain aspects of our future development plans to focus on maximizing returns and the value of our assets. As a result, we removed 65.0 MMBOE of estimated proved undeveloped reserves and reclassified these locations to unproved reserve categories, of which 43.5 MMBOE related to our Eagle Ford shale proved undeveloped reserves that reflects our shift to further develop the Austin Chalk formation and 21.5 MMBOE related to slowing the pace of our future development plan in our Midland Basin program to align spending with operating cash flow. The Eagle Ford shale future development locations were replaced by Austin Chalk locations which are reflected as additions from extensions, discoveries, and infill. +Conversions to proved developed. Our 2020 conversion rate was 15 percent primarily due to our drilling and completion activity on our Austin Chalk locations that were not classified as proved reserves as of year end 2019. During 2020, we incurred $357.9 million on projects with reserves booked as proved undeveloped at the end of 2019, of which $271.9 million was spent on converting proved undeveloped reserves to proved developed reserves by December 31, 2020. At December 31, 2020, drilled but not completed wells represented 46.4 MMBOE of total estimated proved undeveloped reserves. We expect to incur $220.2 million of capital expenditures in completing these drilled but not completed wells, and we expect all estimated proved undeveloped reserves to be converted to proved developed reserves within five years from their initial booking as proved undeveloped reserves. +Revisions of previous estimates. Revisions of previous estimates includes downward pricing revisions of 12.1 MMBOE as a result of lower commodity pricing. In addition, we had downward performance revisions of 1.4 MMBOE. +As of December 31, 2020, estimated future development costs relating to our proved undeveloped reserves totaled $1.1 billion, and we expect to incur approximately $399.5 million, $245.0 million, and $239.8 million in 2021, 2022, and 2023, respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group and is coordinated by our Corporate Engineering Manager, subject to the oversight of our management and the Audit Committee of our Board of Directors, as discussed below. Our Corporate Engineering Manager has worked in the energy industry since 2008 and has been employed by the Company since 2010. He holds a Bachelor of Science Degree in Petroleum Engineering from Montana Technological University and is a Registered Professional Petroleum Engineer in the states of Texas, Wyoming, and Montana. He is also a member of the Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the year by our staff. Data, obtained from these reviews, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our asset team’s engineering technical staff do not report directly to our Corporate Engineering Manager; they report to either their respective asset technical managers or directly to the Senior Vice President of Exploration, Development and EHS. This design is intended to promote objective and independent analysis within our asset teams in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world for over 80 years. Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are required, per our policy, to be within 10 percent of our proved reserve amounts for the total Company, as well as for each respective major asset. The technical engineer at Ryder Scott primarily responsible for overseeing our reserves audit is a Managing Senior Vice President who received a Bachelor of Science degree in Chemical Engineering from Brigham Young University in 2003. He is a licensed Professional Engineer in the State of Texas and a member of the Society of Petroleum Engineers. The 2020 Ryder Scott report concerning our reserves is included as Exhibit 99.1. +In addition to a third-party audit, our reserves are reviewed by our management with the Audit Committee of our Board of Directors. Our management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Senior Vice President of Exploration, Development and EHS, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives, separate from our management, from time to time to discuss processes and findings. +14 +Production +The following table summarizes our net production volumes and realized prices for oil, gas, and NGLs produced and sold during the periods presented. Realized prices presented below exclude the effects of derivative contract settlements. Also presented is a summary of related production expense on a per BOE basis. +For the Years Ended December 31, +2020 2019 2018 +Net production volumes +Oil (MMBbl) 23.0 21.9 18.8 +Gas (Bcf) 103.9 109.8 103.2 +NGLs (MMBbl) 6.1 8.1 7.9 +Equivalent (MMBOE) (1) +46.4 48.3 43.9 +Midland Basin net production volumes (2) +Oil (MMBbl) 21.3 20.5 16.6 +Gas (Bcf) 46.6 34.4 25.8 +NGLs (MMBbl) — — — +Equivalent (MMBOE) (1) +29.1 26.3 20.9 +Maverick Basin net production volumes (2) +Oil (MMBbl) 1.7 1.3 1.2 +Gas (Bcf) 57.2 75.4 76.1 +NGLs (MMBbl) 6.1 8.1 7.9 +Equivalent (MMBOE) (1) +17.3 21.9 21.8 +Realized price, before the effect of derivative settlements +Oil (per Bbl) $ 37.08 $ 54.10 $ 56.80 +Gas (per Mcf) $ 1.80 $ 2.39 $ 3.43 +NGLs (per Bbl) $ 13.96 $ 17.26 $ 27.22 +Per BOE $ 24.26 $ 32.84 $ 37.27 +Production expense per BOE +Lease operating expense $ 3.97 $ 4.67 $ 4.74 +Transportation costs $ 3.06 $ 3.88 $ 4.36 +Production taxes $ 0.99 $ 1.35 $ 1.52 +Ad valorem tax expense $ 0.41 $ 0.48 $ 0.48 +____________________________________________ +(1) Amounts may not calculate due to rounding. +(2) For each of the years ended December 31, 2020, 2019, and 2018, total estimated proved reserves attributed to our Midland Basin field and our Maverick Basin field exceeded 15 percent of our total estimated proved reserves expressed on an equivalent basis. +Productive Wells +As of December 31, 2020, we had working interests in 801 gross (720 net) productive oil wells and 498 gross (468 net) productive gas wells. Productive wells may be temporarily shut-in. Multiple completions in the same wellbore are counted as one well, and as of December 31, 2020, two of these wells had multiple completions. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil when it first commenced production, but such designation may not be indicative of current or future production composition. +15 +Drilling and Completion Activity +All of our drilling and completion activities are conducted by independent contractors using equipment they own and operate. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2020, 2019, and 2018, excluding non-consented projects, active injector wells, saltwater disposal wells, or wells in which we own only a royalty interest: +For the Years Ended December 31, +2020 2019 2018 +Gross Net Gross Net Gross Net +Development wells +Oil 78 71 119 107 103 92 +Gas — — 27 16 39 24 +Non-productive — — 1 1 — — +78 71 147 124 142 116 +Exploratory wells +Oil 5 5 4 4 18 14 +Gas 1 1 4 4 1 1 +Non-productive — — 1 1 — — +6 6 9 9 19 15 +Total 84 77 156 133 161 131 +____________________________________________ +Note: The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. +In addition to the wells drilled and completed in 2020 (included in the table above), we were actively participating in the drilling of 6 gross (5 net) wells and had 105 gross (93 net) drilled but not completed wells as of January 31, 2021. Drilled but not completed wells as of January 31, 2021, represent wells that were being completed or were waiting on completion. The drilled but not completed well count as of January 31, 2021, includes 13 gross (13 net) wells that are not included in our five-year development plan, 12 of which are in the Eagle Ford shale. +Title to Properties +Over 97 percent of our operated oil and gas producing assets are located on private lands, are held pursuant to oil and gas leases from private mineral owners, and are not located on federal lands or leased from the federal government. The remainder of our operated oil and gas producing assets are located on Texas state lands. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such properties. We obtain new or updated title opinions prior to commencing initial drilling operations on the properties that we operate. Most of our producing properties are subject to mortgages securing indebtedness under our Credit Agreement and Senior Secured Notes, royalty and overriding royalty interests, liens for current taxes, and other ordinary course burdens that we believe do not materially interfere with the development of such properties. We typically perform title investigations in accordance with standards generally accepted in the oil and gas industry before acquiring developed and undeveloped leasehold acreage. +16 +Acreage +The following table sets forth the number of gross and net surface acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes that we held as of December 31, 2020. Undeveloped acreage includes leasehold interests containing proved undeveloped reserves. +Developed Acres (1) +Undeveloped Acres (2)(3) +Total +Gross Net Gross Net Gross Net +Midland Basin: +RockStar 67,475 61,376 3,258 2,898 70,733 64,274 +Sweetie Peck 19,226 15,958 2,401 342 21,627 16,300 +Midland Basin Total (4) +86,701 77,334 5,659 3,240 92,360 80,574 +South Texas 80,506 80,215 80,896 77,809 161,402 158,024 +Other (5) +16,259 11,363 89,691 25,306 105,950 36,669 +Total 183,466 168,912 176,246 106,355 359,712 275,267 +____________________________________________ +(1) Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations but has been included only as developed acreage in the table above. +(2) Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) As of February 4, 2021, approximately 16, 119, and 45 net acres of undeveloped acreage are scheduled to expire by December 31, 2021, 2022, and 2023, respectively, if production is not established or we take no other action to extend the terms of the applicable leases. Certain of our acreage, primarily in South Texas, is subject to lease consolidation agreements containing drilling, completion, and other obligations that we currently intend to satisfy. Failure to meet these obligations results in payments to lessors, or termination of the lease consolidation agreements, which could result in additional future lease expirations if continuous development obligations required by individual leases are not met. +(4) As of December 31, 2020, total Midland Basin acreage excludes approximately 1,726 net acres associated with drill-to-earn opportunities that we intend to pursue. +(5) Includes other non-core acreage located in Louisiana, Montana, North Dakota, Texas, Utah, and Wyoming. +Delivery Commitments +For gathering, processing, transportation throughput, and delivery commitments, please refer to Pipeline Transportation Commitments within Note 6 – Commitments and Contingencies in Part II, Item 8 of this report. +Major Customers +For major customers and entities under common control that accounted for 10 percent or more of our total oil, gas, and NGL production revenue for at least one of the years ended December 31, 2020, 2019, and 2018, please refer to Concentration of Credit Risk and Major Customers within Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. +Human Capital +We believe that our relationship with our employees is strong. As of February 4, 2021, we had 503 full-time employees, none of whom were subject to a collective bargaining agreement. +Our Company culture, which seeks to recognize our employees as our most valuable asset, drives the manner in which we pursue our short-term and long-term goals, as well as our efforts to attract and retain talent. Through our culture, we work to promote: +• integrity and ethical behavior in the conduct of our business; +• environmental, health and safety priorities; +• prioritizing the success of others and the team; +• understanding and communicating why we do what we do and how every employee contributes to achieving success; +• collaboration and openness to new ideas and technologies that serve business improvement, +• support for team members’ professional and personal development; and +• support for the communities where we live and work. +17 +The core values of integrity and ethical behavior are the pillars of our culture, and as a result, the health and safety of our employees and contractors is our highest priority. All employees are responsible for upholding Company-wide standards and values. We have many long-standing policies designed to promote ethical conduct and integrity, that employees are required to read and acknowledge on an annual basis. Employees are consistently provided training opportunities to develop skills in leadership, safety, and technical acumen, which help strengthen our efforts in conducting business with high ethical standards. +We strive to provide competitive, performance-based compensation and benefits to our employees, including market-competitive pay, short-term and long-term incentive compensation plans, an employee stock purchase program, and various healthcare, retirement, and other benefit packages. Compensation for our executives and employees under our short-term and long-term incentive plans is determined based on individual performance and Company performance with respect to qualitative and quantitative metrics that include environmental, health, and safety measures. The Compensation Committee of our Board of Directors oversees our compensation programs and regularly modifies program design to incentivize achievement of our corporate strategy and the matters of importance to our stakeholders. Significant planning for succession of key personnel is performed each year, or more frequently as deemed necessary by management. On an annual basis, we retain a third party to analyze our workforce demographics and conduct discrimination and pay equity testing. No discriminatory practices have been identified and no evidence of discrimination or pay inequity has been found. Additionally, we have established procedures and controls designed to support our objective of remaining, at all times, in material compliance with federal, state, and local laws and governmental regulations. +Seasonality +The price of crude oil is primarily driven by global socioeconomic factors and is less affected by seasonal fluctuations; however, demand for energy is generally higher in the winter and the summer driving season. The demand and price for gas frequently increases during winter months and decreases during summer months. To lessen the impact of seasonal gas demand and price fluctuations, pipelines, utilities, local distribution companies, and industrial users regularly utilize gas storage facilities and forward purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can divert gas that is traditionally placed into storage which, in turn, may increase the typical winter seasonal price. Seasonal anomalies, such as mild winters, or other unexpected impacts, such as the Pandemic, sometimes lessen or exacerbate these fluctuations. +Certain of our drilling, completion, and other operations are also subject to seasonal limitations. Seasonal weather conditions, government regulations, and lease stipulations could adversely affect our ability to conduct drilling activities in some of the areas where we operate. Please refer to Risk Factors in Part I, Item 1A of this report for additional discussion. +Competition +The oil and gas industry is intensely competitive, particularly with respect to acquiring prospective oil and gas properties. We believe our acreage positions provide a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from many major and independent oil and gas companies, which in some cases have larger technical teams and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and gas reserves, but also have gathering, processing or refining operations, market refined products, provide, dispose of and transport fresh and produced water, own drilling rigs or production equipment, or generate electricity, all of which, individually or in the aggregate, could provide such companies with a competitive advantage. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting, and processing of oil, gas, NGLs and water. Consequently, we may face shortages, delays, or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including renewable energy sources such as solar and wind-generated energy, and other fossil fuels such as coal. Competitive conditions may be affected by future energy, climate-related, financial, or other policies, legislation, and regulations. +In addition, we compete for people, including experienced geologists, geophysicists, engineers, and other professionals. Throughout the oil and gas industry, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. We are not insulated from competition for quality people, and we must compete effectively to be successful. Please refer to Human Capital above for additional discussion. +Government Regulations +Although our regulatory compliance obligations are mitigated by the fact that we do not own or operate oil and gas properties on federal lands, nearly every aspect of our business is subject to expansive federal, state, and local laws and governmental regulations. These laws and regulations frequently change in response to economic or political conditions, or other developments, and +18 +our regulatory burden may increase in the future. Laws and regulations have the potential to increase our cost of conducting business and consequently could affect our profitability. +Energy Regulations +Texas, the state where we conduct operations and own nearly all of our oil and gas assets, has adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, imposing bond requirements in order to drill or operate wells, governing the timing of drilling and location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to Texas conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, Texas conservation laws establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Our sales of gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for gas production. +Environmental, Health and Safety Matters +General. Our operations are subject to stringent and complex federal, state, and local laws and regulations governing protection of the environment and worker health and safety as well as the discharge of materials into the environment. These laws and regulations may, among other things: +• require the acquisition of various permits before drilling commences; +• restrict the types, quantities and concentration of various substances that may be released into the environment in connection with oil and gas drilling and production and saltwater disposal activities; +• limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +• require remedial measures to mitigate pollution from former and ongoing operations, such as closing pits and plugging abandoned wells. +These laws, rules, and regulations may also restrict the rate of oil and gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of conducting business and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent, or different permitting, waste handling, disposal, and cleanup requirements for the oil and gas industry and could have a significant impact on our operating costs. +The following is a summary of some of the existing laws, rules, and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation, and Liability Act. The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release or threatened release of a hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of environmental investigation and certain health studies. In addition, it is not uncommon for third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +19 +We currently own, lease, or operate numerous properties that have been used for oil and gas exploration and production for many years. Although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third-parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties and the substances disposed or released on them may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, or analogous state agencies. In addition, the Clean Water Act regulates wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process and discharged to publicly-owned wastewater treatment facilities. The Clean Water Act also prohibits discharge of dredged or fill material into waters of the United States, including wetlands, except in accordance with the terms of a permit issued by the United States Army Corps of Engineers, or a state if the state has assumed authority to issue such permits. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for containment and removal costs, natural resource damages and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”) and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements, such as requirements for emission capture and control. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of hazardous air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane, and other “greenhouse gases” (“GHG”) present an endangerment to public health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. Based on these findings, the EPA began adopting and implementing a comprehensive suite of regulations to restrict emissions of GHGs under existing provisions of the CAA. While the Trump administration had taken steps to rescind or review many of these regulations, the Biden administration has ordered a review of agency actions taken under the Trump administration, specifically targeting, among other things, the Trump administration’s actions on regulation of methane emissions from the oil and gas sector. Legislative and regulatory initiatives related to climate change could have an adverse effect on our operations and the demand for oil and gas. Please refer to Risk Factors - Risks Related to Oil and Gas Operations and the Industry - Legislative and regulatory initiatives and litigation related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs. In addition to the effects of regulation, the meteorological effects of global climate change could pose additional risks to our operations, including physical damage risks associated with more frequent, more intensive storms and flooding, and could adversely affect the demand for our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +OSHA and other laws and regulations. We are subject to the requirements of OSHA and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight shale formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand, and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions. However, even on private lands, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s +20 +Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and scrutiny on oil and gas activities involving hydraulic fracturing techniques could potentially lead to a decrease in the completion of new oil and gas wells, an increase in compliance costs, delays, and changes in federal income tax laws, all of which could adversely affect our financial position, results of operations and cash flows. As new laws or regulations that significantly restrict hydraulic fracturing are adopted at the state and local levels, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and gas that we are ultimately able to produce from our reserves. +We believe the trend in local, state, and federal environmental legislation and regulation will continue toward stricter standards. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health and Safety Initiatives. We are committed to exceptional safety, health, and environmental stewardship; making a positive difference in the communities where we live and work; and transparency in reporting on our progress in these areas. We set annual goals for our environmental, health and safety program focused on reducing the number of safety related incidents and the number and impact of spills of produced fluids. In addition, we set annual goals for GHG emissions intensity and methane emissions as a percentage of total methane produced. We also periodically conduct audits of our operations to ensure regulatory compliance and we strive to provide appropriate training for our employees. Reducing air emissions as a result of leaks, venting, or flaring of gas during operations has become a major focus area as we consider this a best practice and seek to comply with regulations. While flaring is sometimes necessary, reducing these volumes is a priority for us. To avoid flaring when possible, we restrict testing periods and connect our production to gas pipeline infrastructure as quickly as possible after well completions. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC, and can be located at www.sec.gov. We also make available through our website our Corporate Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, and the Charters of the Audit, Compensation, Executive, and Environmental, Social and Governance Committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in us. +Risks Related to Commodity Prices and Global Macroeconomics +Oil, gas, and NGL prices are volatile, and declines in prices may adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and gas properties depend heavily on the prices we receive for oil, gas, and NGL sales. Oil, gas, and NGL prices also affect our cash flows available for capital expenditures, debt reductions, and other expenditures, our borrowing capacity, and the volume and value of our oil, gas, and NGL reserves. In addition, we may have oil and gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. Please refer to Significant Developments in 2020 and Reserves in Part I, Items 1 and 2, Comparison of Financial Results and Trends Between 2020 and 2019 and Between 2019 and 2018 in Part II, Item 7, and Note 1 – Summary of Significant Accounting Policies , Note 11 – Fair Value Measurements , and Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 for specific discussion. +21 +Historically, the markets for oil, gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in oil, gas, and NGL prices often result from relatively minor changes in the supply of and demand for oil, gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• global and domestic supplies of oil, gas, and NGLs, and the productive capacity of the industry as a whole; +• the level of consumer demand for oil, gas, and NGLs; +• overall global and domestic economic conditions; +• weather conditions; +• the availability and capacity of gathering, transportation, processing, and/or refining facilities in asset-specific or localized areas; +• liquefied natural gas deliveries to and from the United States; +• the price and availability of alternative fuels or sources of energy; +• technological advances in, and regulations affecting, energy consumption and conservation; +• the ability of the members of the Organization of Petroleum Exporting Countries and other exporting countries to maintain effective oil price and production controls; +• political instability or armed conflict in oil or gas producing regions; +• actual or perceived epidemic or pandemic risks; +• strengthening and weakening of the United States dollar relative to other currencies; +• stockholder activism or activities by non-governmental organizations to limit sources of funding or restrict the exploration and production of oil, gas, and NGLs and related infrastructure; and +• governmental regulations and taxes. +Declines in oil, gas, and NGL prices would reduce our revenues and could also reduce the amount of oil, gas, and NGLs that we can produce economically, which could have a material adverse effect on our business, financial condition, liquidity, results of operations, and prospects. +The global COVID-19 Pandemic has impacted and will likely continue to impact us, and could have a material adverse effect on our business, financial condition, liquidity, results of operations and prospects. +Since the beginning of 2020, the Pandemic has spread across the globe and disrupted economies around the world, including the oil, gas and NGL industry in which we operate. The rapid spread of the virus has led to the implementation of various responses, including federal, state and local government-imposed quarantines, shelter-in-place recommendations and mandates, sweeping restrictions on travel, and other public health and safety measures, nearly all of which have materially reduced global demand for crude oil and could continue to result in decreased demand for our oil, gas, and NGL production. The extent to which the Pandemic will continue to affect our business, financial condition, liquidity, results of operations, prospects, and the demand for our production will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration or any recurrence of the outbreak and responsive measures, additional or modified government actions, new information which may emerge concerning the severity of the Pandemic, and the effectiveness of actions taken to contain COVID-19 or treat its impact, such as vaccine or other treatment protocol, now or in the future, among others. In addition to the risks directly related to the Pandemic that are discussed throughout this report, the Pandemic is likely to increase the likelihood and magnitude of the other risk factors described in this section. +Weakness in economic conditions or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +In the last decade, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, and an unprecedented level of intervention by the United States federal government and other governments. Weakness or uncertainty in the United States economy or other large economies could materially adversely affect our business and financial condition. For example: +• the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• the liquidity available under our Credit Agreement could be reduced if any lender is unable to fund its commitment; +• our ability or the ability of our suppliers or contractors to access the capital markets may be restricted or non-existent at a time when we or they would like, or need, to raise capital for our or their business, including for the exploration and/or development of reserves; +• our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; and +22 +• variable interest rate spread levels, including for London Interbank Offered Rate (“LIBOR”) (or any applicable replacement rate) and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our Credit Agreement. +Risks Related to Oil and Gas Operations and the Industry +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find or acquire and develop oil, gas, and NGL reserves that are economically producible. Our properties produce oil, gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate or acquire and develop new oil, gas, and NGL reserves to replace those being depleted by production. +For our prior acquisitions, as well as any future acquisitions we may complete, a successful outcome for our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price and transaction costs for the acquisition, future oil, gas, and NGL prices, the ability to reasonably estimate the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating these variables with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. Our customary review in connection with acquisitions will not necessarily reveal, or allow us to fully assess, all existing or potential problems and deficiencies with such properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. We often acquire interests in properties on an “as-is” basis with limited remedies for breaches of representations and warranties. +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of unique risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +Our ability to sell oil, gas, and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third-parties or by other interruptions beyond our control, which could obstruct, limit, or eliminate our access to oil, gas, and NGL markets. +The marketability of our oil, gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems, which are generally owned or operated by third parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay, or discontinuance of development plans for our properties, or lower price realizations. Although we have some influence over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of oil, gas, and NGL production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines or processing facilities, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, transport, or market oil, gas, and NGLs. +Production may be interrupted, or shut in, from time to time for numerous reasons, including as a result of weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market or other conditions. If a substantial amount of our production is interrupted at the same time, it could adversely affect our cash flows and results of operations. +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from oil and gas exploration and production companies of all sizes, and institutional and individual investors who seek oil and gas investments throughout the world, as well as for the equipment, expertise, labor, and materials required to operate oil and gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many oil and gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. As a result, we may not be successful in acquiring and developing profitable properties. In addition, other companies may have a greater ability to continue drilling activities during +23 +periods of low oil or gas prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition, and results of operations. +The loss of key personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team and other key personnel. The loss of their services could adversely affect our business. Our drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen, and other professionals. Competition for many of these professionals can be intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +The actual quantities and present value of our proved oil, gas, and NGL reserves may be less than we have estimated. +This report and certain of our other SEC filings contain estimates of our proved oil, gas, and NGL reserves and the present value of estimated future net revenues from those reserves. The process of estimating reserves is complex and estimates are based on various assumptions, including geological and geophysical characteristics, future oil, gas, and NGL prices, drilling and completion costs, gathering and transportation costs, operating expenses, capital expenditures, effects of governmental regulation, taxes, timing of operations, and availability of funds. Therefore, these estimates are inherently imprecise. In addition, our reserve estimates for properties with limited production history may be less reliable than estimates for properties with lengthy production histories. +Actual future production; prices for oil, gas, and NGLs; revenues; production taxes; development expenditures; operating expenses; and quantities of producible oil, gas, and NGL reserves will most likely vary from those estimated. Any significant variance could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than what we have previously estimated. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2020, 43 percent, or 175.3 MMBOE, of our estimated proved reserves were proved undeveloped. In order to develop our proved undeveloped reserves, as of December 31, 2020, we estimate approximately $1.1 billion of capital expenditures would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +One should not assume that the standardized measure of discounted future net cash flows or PV-10 included in this report represent the current market value of our estimated proved oil, gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. Please refer to Reserves in Part I, Items 1 and 2 of this report for discussion regarding the prices used in estimating the present value of our proved reserves as of December 31, 2020, and to the caption Oil and Gas Reserve Quantities under Critical Accounting Policies and Estimates in Part II, Item 7 of this report for additional information. +The timing of production from oil and gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to be used to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and gas industry in general are subject. +Our disposition activities may be subject to factors beyond our control, and in certain cases we may retain unforeseen liabilities for certain matters . +We regularly sell non-core assets in order to increase capital resources available for core assets and other purposes and to create organizational and operational efficiencies. We also occasionally sell interests in core assets for the purpose of accelerating the development and increasing efficiencies in other core assets. Various factors could materially affect our ability to dispose of such assets, including the approvals of governmental agencies or third parties, the availability of purchasers willing to acquire the assets on terms we deem acceptable, or other matters or uncertainties that could impact such dispositions, including whether transactions could be consummated or completed in the form or timing and for the value that we anticipate. At times we may be required to retain certain liabilities or agree to indemnify buyers in connection with such asset sales. The magnitude of such retained liabilities or of the indemnification obligations may be difficult to quantify at the time of the transaction and ultimately could be material. +We rely on third-party service providers to conduct drilling and completion and other related operations. +We rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain +24 +qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, gas, and NGLs, prevailing economic conditions, and financial, business, and other factors. In addition, sustained low commodity prices could cause third-party service providers to consolidate or declare bankruptcy, which could limit our options for engaging such providers. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title due diligence reports when acquiring oil and gas leasehold interests, and we obtain title opinions prior to commencing initial drilling operations on the properties we operate. Title to the properties in which we have an interest may be impaired by title defects that may not be identified in the due diligence title reports or title opinions we obtain, or such defects may not be cured following identification. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our oil and gas reserves, financial condition, results of operations, and operating cash flow, and may also impair the value of or render adjacent properties uneconomic to develop. Undeveloped acreage has greater risk of title defects than developed acreage and title insurance is not generally available for oil and gas properties. +Oil and gas drilling, completion, and production activities are subject to numerous risks, including the risk that no commercially producible oil, gas, or NGLs will be found. +The cost of drilling and completing wells is often uncertain, and oil, gas, or NGLs drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors may include, but are not limited to: +• unexpected adverse drilling or completion conditions; +• title problems; +• disputes with owners or holders of surface interests on or near areas where we operate; +• pressure or geologic irregularities in formations; +• engineering and construction delays; +• equipment failures or accidents; +• hurricanes, tornadoes, flooding, or other adverse weather conditions; +• governmental permitting delays; +• compliance with environmental and other governmental requirements; and +• shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if oil, gas, or NGLs are present, or whether they can be produced economically. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of oil, gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a materially adverse effect on our ability to explore or develop our properties. +Results in newer resource plays may be more uncertain than results in resource plays that are more developed and have longer established production histories. We, and the industry, generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +We may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire and we will lose our right to develop the related properties. Our total net acreage as of February 4, 2020, that is scheduled to expire over the next three years, represents less than one percent of our total net undeveloped acreage as of December 31, 2020. Although we have identified numerous potential drilling locations, we may not be able to economically drill for and produce +25 +oil, gas, or NGLs from all of them, and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +The results of our operations are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us, other operators and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +In addition, exploration and drilling technologies we currently use or implement in the future may become obsolete. If we are unable to maintain technological advancements consistent with industry standards, our operations and financial condition may be adversely affected. We cannot be certain we will be able to implement exploration and drilling technologies on a timely basis or at a cost that is acceptable to us. +Ultimately, the success of exploration, drilling, and completion technologies and techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for oil, gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing, or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids toward the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, result in increased lease operating expenses and adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from oil, gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other market conditions, including declines in oil, gas, and NGL prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. We do not believe the loss of any single purchaser would materially impact our operating results, as we have numerous options for purchasers in each of our operating areas for our oil, gas, and NGL production. Please refer to Concentration of Credit Risk and Major Customers in Note 1 – Summary of Significant Accounting Policies, in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. Additionally, the inability of our co-owners to pay joint interest billings could negatively impact our cash flows and financial ability to drill and complete current and future wells. +We have entered into firm transportation contracts that require us to pay fixed sums of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of oil, gas, NGL, or produced water to our counterparties, our results of operations, financial position, and liquidity could be adversely affected. +As of December 31, 2020, we were contractually committed to deliver a minimum of 16 MMBbl of oil and 257 Bcf of gas through 2024, and 17 MMBbl of produced water through 2027. We may enter into additional firm transportation agreements as we expand the development of our resource plays. We do not expect to incur any material shortfalls related to our existing contractual commitments. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, or if we further limit our capital expenditures due to future commodity price declines or for other reasons, the requirements to pay for quantities not delivered could have a material impact on our results of operations, financial position, and liquidity. +26 +Negative public perception and investor sentiment regarding our business and the oil and gas industry as a whole could adversely affect our business, operations, and our ability to attract capital. +Certain segments of the public as a whole, and the investment community in particular, have developed negative sentiment towards our industry. Recent equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. In addition, some investors, including investment management firms, sovereign wealth and pension funds, university endowments and other investment advisors, have adopted policies to discontinue or reduce their investments in the oil and gas sector based on social and environmental considerations. Furthermore, other influential stakeholders have pressured commercial and investment banks to reduce or cease financing of oil and gas companies and related infrastructure projects. +Such developments, including increased focus on environmental, social and governance matters and initiatives aimed at limiting climate change and reducing air pollution, and changes in federal income tax laws could result in downward pressure on the stock prices of oil and gas companies, including ours. This may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of oil, gas and NGLs, or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, seismic events, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occurs, we could sustain substantial losses. +Furthermore, if we experience any of the problems with well stimulation and completion activities referenced above, our ability to explore for and produce oil, gas, or NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shut down, abandon, or relocate drilling operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling, and disposal of materials, including produced water, solid and hazardous wastes, and petroleum hydrocarbons. We may incur joint and several, and/or strict liability under applicable United States federal and state environmental laws in connection with releases of petroleum hydrocarbons and other hazardous substances at, on, under or from our leased or owned properties, some of which have been used for oil and gas exploration and production activities for a number of years, often by third-parties not under our control. For our outside-operated properties, we are dependent on the operator for operational and regulatory compliance and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or therefrom could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including CERCLA or the Superfund law, RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under various implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury or property damage, including induced seismicity damage, allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third-parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer an uninsured material loss. +Our operations are subject to complex laws and regulations, including environmental regulations that result in substantial costs and other risks. +Federal, state, and local authorities extensively regulate the oil and gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing, or marketing of oil, gas, and NGL production. Non-compliance with +27 +statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to increased operational and compliance costs, substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +Governmental authorities regulate various aspects of drilling for and the production of oil, gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in oil and gas properties, rights-of-way and easements, disposal of produced water, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, restoration standards, and oil and gas operations. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Any such delay, suspension, or termination could have a materially adverse effect on our operations. +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate in, could result in material costs or claims with respect to properties we own or have owned or limitations on exploration and production activities in certain locations. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, and local environmental laws for emissions and for discharges of oil, gas, and NGLs or other pollutants into the air, soil, surface water, or groundwater as described in Government Regulations in Part I, Items 1 and 2 of this report. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a materially adverse effect on us. +The impact of extreme weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Our operations may be adversely affected by the impact of extreme weather conditions and lease stipulations designed to protect various wildlife or plant species. In certain areas, drilling and other oil and gas activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs and completion equipment, oil field equipment, services, supplies and qualified personnel, which may lead to periodic shortages. Wildlife seasonal restrictions may limit access to federal leases or across federal lands. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Hydraulic fracturing is a common practice in the oil and gas industry used to stimulate the production of oil, gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and gas properties, including our unconventional resource plays within our Midland Basin and South Texas assets. Hydraulic fracturing involves injecting water, sand, and certain chemicals under pressure to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities, as outlined below. +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the Safe Drinking Water Act. The EPA also has authority under the Clean Water Act to regulate wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process and discharged to publicly-owned wastewater treatment facilities. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states, including Texas, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict, or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event that state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +28 +In the recent past, several federal governmental agencies were actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. In 2013, a court in California, and in 2020 the United States District Court for the District of Montana each held that the Bureau of Land Management (“BLM”) did not comply with NEPA because it did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. Similar cases continue to be filed. Courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing, including damages from induced seismicity, could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for, and production of, oil, gas, and NGLs, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional state or local laws, or the implementation of new regulations regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +We will continue to be subject to uncertainty associated with new regulatory suspensions, revisions or rescissions and inconsistent state and federal regulatory mandates that could adversely affect our production. +Federal and state regulatory initiatives relating to air quality and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays. +There has been a trend toward increased air quality and GHG regulation and reduced emissions from oil and gas sources. These regulations include the New Source Performance Standards (“NSPS”), the National Emission Standards for Hazardous Air Pollutants (“NESHAP”) programs, and ozone standards, among others. The adoption of additional state or local laws, or the implementation of new regulations could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. Please refer to the Environmental section in Part II, Item 7 of this report for additional information about the regulation of methane emissions from the oil and gas sector. +Requirements to reduce gas flaring could have an adverse effect on our operations. +Wells in the Midland Basin in Texas, where we have significant operations, produce natural gas, as well as oil and NGLs. Constraints in the gas gathering and processing network in certain areas of the Midland Basin have resulted in significant quantities of that gas being flared instead of gathered, processed, and sold. Further, we are subject to laws established by state and other regulatory agencies that restrict the duration and amount of natural gas that can be legally flared. These laws and regulations, including potential future regulations that may impose further restrictions on flaring, could limit the amount of oil and gas we can produce from our wells or may limit the number of wells or the locations that we can drill. Any future laws and regulations may increase our operational costs, or restrict our production, which could materially and adversely affect our financial condition, results of operations and cash flows. +Our ability to produce oil, gas, and NGLs economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling operations and/or completions or are unable to dispose of or recycle the water we use at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of oil, gas, and NGLs requires the use and disposal of significant quantities of water. +Our inability to secure sufficient amounts of water, or to dispose of, or recycle, the water produced from our wells, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of oil, gas, and NGLs. +Compliance with environmental regulations, surface use agreements, and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +29 +Legislative and regulatory initiatives and litigation related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs. +In December 2009, the EPA made a finding that emissions of carbon dioxide, methane, and other GHGs endanger public health and the environment. While courts have generally declined to assign direct liability for climate change to large sources of GHG emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant GHG emissions, and new claims for damages and increased government scrutiny, especially from state and local governments, will likely continue. +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and almost one-half of the states have already taken measures to reduce emissions of GHGs through various measures, including, primarily through the planned development of GHG emission inventories, participation in and/or regional GHG “cap and trade” programs, and/or transition to clean energy. The focus on legislating and/or regulating methane could eventually result in requirements for methane emission reductions from existing oil and gas equipment, increased scrutiny for sources emitting high levels of methane, including during permitting processes, analysis, regulation and reduction of methane emissions as a requirement for project approval, and actions taken by one agency for a specific industry establishing precedents for other agencies and industry sectors. +Any court rulings, laws, or regulations that restrict or require reduced emissions of GHGs could lead to increased operating and compliance costs and could have an adverse effect on demand for the oil and gas that we produce. +Scientists have predicted that increasing concentrations of GHGs in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies, or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses, or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements because emissions of such gases contribute to warming of the earth’s atmosphere and other climatic changes. +We have limited control over the activities on properties we do not operate. +Some of our properties are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs. +Risks Related to Debt, Liquidity, and Access to Capital +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce oil, gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for oil, gas, and NGL sales, our success in locating, developing and acquiring new reserves, and the orderly functioning of credit and capital markets. If our cash flows from operations are less than expected, we may reduce our planned capital expenditures. If we cannot access sufficient liquidity under our Credit Agreement, or raise additional funds through debt or equity financing or the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Downgrades in our credit ratings by various credit rating agencies could impact our access to capital and materially adversely affect our business and financial condition. +In 2020, Moody’s Investor Services, Standard & Poor’s, and Fitch Ratings, Inc. downgraded our credit ratings. Further downgrades to our credit rating levels could have material adverse consequences on our business and future prospects and could: +• limit our ability to access debt markets, including for the purpose of refinancing our existing debt; +• cause us to refinance or issue debt with less favorable terms and conditions, which debt may restrict, among other things, our ability to make any dividend distributions or repurchase shares; +30 +• negatively impact current and prospective customers’ willingness to transact business with us; +• impose additional insurance, guarantee, bonding, and collateral requirements; +• limit our access to bank and third-party guarantees, surety bonds, and letters of credit; and +• cause our suppliers and financial institutions to lower or eliminate the level of credit provided through payment terms or intraday funding when dealing with us, thereby increasing the need for higher levels of cash on hand, which would decrease our ability to repay outstanding indebtedness. +We cannot provide assurance that any of our current credit ratings will remain in effect for any given period of time or that a credit rating will not be further lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances warrant. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in oil, gas, and NGL prices and the associated impact on cash flows, we regularly enter into commodity derivative contracts. Our commodity derivative contracts include swap and collar arrangements for oil, and swap arrangements for gas and NGLs. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional detail regarding our commodity derivative contracts. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• our production is less than expected; +• one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +• there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +In addition, commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. +Future oil, gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our oil and gas properties. All property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending the determination of whether proved reserves have been discovered. If commercial quantities of hydrocarbons are not discovered with an exploratory well, the costs of drilling the well are expensed. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net cash flows, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Write downs for unproved properties are also evaluated for carrying costs in excess of fair value. This evaluation considers the potential for abandonment due to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. Declines in the prices of oil, gas, or NGLs, or unsuccessful exploration efforts, could cause proved and/or unproved property impairments in the future. +We review the carrying values of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and gas properties held for use cannot be reversed at a later date, even if oil, gas, or NGL prices increase. +Lower oil, gas, or NGL prices could limit our ability to borrow under our Credit Agreement. +As of December 31, 2020, both the borrowing base and aggregate lender commitments under our Credit Agreement were $ 1.1 billion. The borrowing base is subject to semi-annual redetermination based on the bank group’s assessment of the value of our proved reserves, which in turn is impacted by oil, gas, and NGL prices. The next scheduled borrowing base redetermination date is scheduled for April 1, 2021. Divestitures of additional properties, incurrence of additional debt, or declines in commodity prices could limit our borrowing base and reduce the amount we can borrow under our Credit Agreement, which could in turn impact, among other things, our ability to service our debt, fund our capital program, or compete for the acquisition of new properties. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2020, we had $2.2 billion of outstanding aggregate principal amount of Senior Notes with maturities through 2027, as further discussed and defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. Additionally, we had $93.0 million of outstanding borrowings under our Credit Agreement and $ 965.0 million of available borrowing capacity under our secured revolving credit facility as of December 31, 2020. Our long-term debt represented 53 percent of our total book capitalization as of December 31, 2020. +31 +Our indebtedness could have important consequences for our operations, including: +• making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to productive investments; +• limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• placing us at a competitive disadvantage compared to our competitors with less debt; and +• making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our Credit Agreement or from other sources, we might not be able to service our debt, issue additional debt, or fund our planned capital expenditures and other liquidity needs. If we are unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our Credit Agreement and any future credit agreements, may prohibit us from pursuing any of these alternatives. +As discussed above, our Credit Agreement is subject to periodic borrowing base redeterminations. We could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate adjustments to our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt arrangements contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements, including our Credit Agreement and the indentures governing our Senior Notes, contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests, including restrictions on incurring debt, issuing dividends, redeeming common stock, selling assets, creating liens, entering into transactions with affiliates, and merging, consolidating, or selling our assets. Our ability to borrow under our Credit Agreement is subject to compliance with certain financial and non-financial covenants, as outlined in the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. These restrictions on our ability to operate our business could significantly harm our business by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. We were in compliance with all financial and non-financial covenants as of December 31, 2020, and through the filing of this report. +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +Risks Related to Corporate Governance and Ownership of Public Equity Securities +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2020, to February 4, 2021, the intraday trading prices per share of our common stock as reported by the New York Stock Exchange ranged from a low of $0.90 per share in March 2020 to a high of $12.40 per share in January 2020. We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include, in addition to the other risk factors set forth herein, the following: +• changes in oil, gas, or NGL prices; +• changes in the outlook for regional, national, or global commodity supply and demand; +• variations in drilling, recompletion, and operating activity; +• changes in financial estimates by securities analysts; +• changes in market valuations of comparable companies; +• additions or departures of key personnel; +• increased volatility due to the impacts of algorithmic trading practices; +• future sales of our common stock; +• changes in the national and global economic outlook, including potential impacts from trade agreements; and +• international trade relationships, potentially including the effects of trade restrictions or tariffs affecting the raw materials we utilize and the commodities we produce in our business. +32 +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +In addition, stockholder activism in our industry has been increasing, and if investors seek to exert influence or affect changes to our business that we do not believe are in the long-term best interests of our stockholders, such actions could adversely impact our business by, among other things, distracting our Board of Directors and management team, causing us to incur unexpected advisory fees and other related costs, impacting execution of our strategic objectives, and creating unnecessary market uncertainty. +The depressed price of our common stock and market capitalization, resulting from the current macroeconomic environment and historically low commodity prices, could cause the Company to be subject to an unsolicited or hostile acquisition bid, which could result in substantial costs and diversion of management attention. +Due to the constrained macroeconomic environment and depressed commodity prices, the price of our common stock and our market capitalization have been volatile, and reached historic lows in 2020. A relatively low stock price may cause us to become subject to an unsolicited or hostile acquisition bid, or other change in control. There can be no assurance that a third-party will not make an unsolicited takeover proposal in the future or take other action to acquire control of us or to otherwise influence our management and policies. Although we have certain anti-takeover measures in place, we have not adopted a shareholder rights plan, commonly known as a poison pill. The lack of this particular anti-takeover measure could make a change in control of us easier to accomplish. +Considering and responding to any future acquisition proposal or other stockholder action designed to acquire control, including the litigation that often accompanies such actions, is likely to be costly and time-consuming. Evaluating and addressing these overtures would require the time and attention of our management and Board of Directors, divert them from their focus on our business, and require us to incur additional expenses on outside legal, financial and other advisors, all of which could materially and adversely affect our business, financial condition and results of operations. Further, in the event that such an unsolicited or hostile bid is publicly disclosed, it may result in increased speculation and volatility in the price of our common stock. +We may not always pay dividends on our common stock. +Payment of future dividends remains at the discretion of our Board of Directors, and will continue to depend on our earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to a covenant in our Credit Agreement limiting our annual cash dividends to no more than $12.0 million, and to covenants in the indentures governing our Senior Notes that limit our ability to pay dividends beyond a certain amount. In 2020, our Board of Directors reduced the semi-annual dividend from our historical rate of $0.05 per share to $0.01 per share and, in the future, may further reduce the semi-annual dividend or discontinue the payment of dividends altogether. +General Risk Factors +Our increasing dependence on digital technologies puts us at risk for a cyber incident that could result in information theft, data corruption, operational disruptions or financial loss. +We are subject to cybersecurity risks. The oil and gas industry is increasingly dependent on digital technology in all aspects of our business. We use digital technology to conduct certain aspects of our drilling development, production and gathering activities, manage drilling rigs and completion equipment, gather and interpret seismic data, conduct reservoir modeling, record financial and operating data, and maintain employee and other databases. Our service providers, including those who gather, process and market our oil, gas and NGLs, are also increasingly reliant on digital technology. Our and their reliance on this technology increasingly puts us at risk for technology system failures, data or network disruptions, cyberattacks and other breaches in cybersecurity. Power failures, telecommunication or other system failures due to hardware or software malfunctions, computer viruses, vandalism, terrorism, natural disasters, fire, flood, human error or other means could significantly impair our ability to conduct our business. +33 +Cybersecurity attacks are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data. Deliberate attacks on, or security breaches in our systems, infrastructure, the systems and infrastructure of third-parties, or cloud-based applications could lead to disclosure of confidential information, a corruption or loss of our proprietary data, delays in production or exploration activities, difficulty in completing or settling transactions, challenges in maintaining our books and records, environmental damage, communication or other operational disruptions, and liability to third parties. Any insurance we might obtain in the future may not provide adequate protection from these risks. Any such events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. As these cyber risks continue to evolve and our dependence on digital technologies grows, we may be required to expend significant additional resources to continue to modify or enhance our protective measures and remediate cyber vulnerabilities. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As an oil, gas, and NGL producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third-party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel, or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +The threat of terrorism and the impact of military and other actions have caused instability in world financial markets and could lead to increased volatility in prices for oil, gas, and NGLs, all of which could adversely affect the markets for our production. Energy assets might be specific targets of terrorist attacks. While we currently maintain insurance that provides limited coverage against terrorist attacks, such insurance has become increasingly expensive and difficult to obtain. As a result, insurance providers may not continue to offer this coverage to us on terms we consider reasonable, or at all. In addition, this insurance may not cover all of our losses for a terrorist attack. These developments have subjected our operations to increased risk and, depending on their occurrence and ultimate magnitude, could have a material adverse effect on our business, financial condition, or results of operations. +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Exchange Act. +ITEM 3. LEGAL PROCEEDINGS +At times, we may be involved in litigation relating to claims arising out of our business and operations in the normal course of business. As of the filing of this report, no legal proceedings are pending against us that we believe individually or collectively are likely to have a materially adverse effect upon our financial condition, results of operations or cash flows. +Chieftain Royalty Company v. SM Energy Company, Case No. CIV-18-1225-J, In the United States District Court, Western District of Oklahoma . On January 27, 2011, Chieftain Royalty Company (“Plaintiff”) commenced a putative class action lawsuit against the Company by filing a Petition in the District Court of Beaver County, Oklahoma, in the matter originally styled Chieftain Royalty Company v. SM Energy Company (including predecessors, successors and affiliates), Case No. CJ-2011-04, alleging that the Company had improperly deducted post-production costs from royalty payments due on production from wells located throughout Oklahoma, and asserting claims against the Company for breach of contract, tortious breach of contract, breach of fiduciary or quasi-fiduciary duty, fraud (actual and constructive), deceit, conversion and conspiracy. The Company removed the case to the United States District Court for the Western District of Oklahoma. +This case involves complex legal and factual issues and uncertainties as to Oklahoma law and federal law concerning class certification under the circumstances of this case. While the Company believes that it has properly paid royalties under Oklahoma law and that the class as proposed by Plaintiff should not be certified, the Company and the Plaintiff entered into an agreement on January 8, 2021, that, if finally approved by the Court, will resolve all of the issues in, and bring an end to, the litigation. In the event the settlement is not approved for any reason, the Company has and will continue to vigorously defend this case. +SPM NAM LLC. et al., v. SM Energy Company, Case No. 2018-07160, in the 189th Judicial District of Harris County, Texas (the “Lawsuit”). Plaintiff SPM NAM LLC (“SPM”) filed the Lawsuit against the Company on February 1, 2018. The Lawsuit concerns the Acquisition and Development Funding Agreement dated August 2, 2016 (together with its amendments, the “ADFA”). The parties to the ADFA (and its amendments) are the Company; SPM; and certain affiliates of SPM: (1) Schlumberger Technology Corporation; (2) Smith International, Inc.; (3) M-I, L.L.C.; and (4) Cameron International Corporation (the “Schlumberger Service Providers”). SPM and the Schlumberger Service Providers are the plaintiffs, and the Company is the defendant. +34 +SPM alleges that the Company breached the ADFA in connection with the Company’s agreement to sell its interests in the Powder River Basin (collectively, the “Company Interests”) to a third party (“Buyer”). SPM alleges that pursuant to the ADFA, SPM was entitled to sell its related wellbore interests to Buyer on the same terms and conditions that the Company Interests were to be sold, through a “tag-along” process. SPM alleges that the Company failed to honor the tag-along provisions of the ADFA. The Lawsuit further alleges that the Company fraudulently induced SPM to enter an amendment to the ADFA in connection with its sale. SPM brings claims for rescission, fraud, breach of contract, unjust enrichment, breach of good faith and fair dealing, and declaratory judgment. SPM has not specified the damages it seeks in its pleadings, except to state that they are more than $1,000,000. +The Company has asserted affirmative defenses and counterclaims, alleging in part that: (1) SPM has breached the ADFA by filing an action for rescission, when any rescission remedy is expressly barred by the ADFA; and (2) the Company is entitled to a declaration that the Company has complied with the ADFA; and (3) SPM’s tag-along rights under the ADFA expired. +The case is in discovery, and trial was scheduled for June 22, 2020, but continued as a result of the Pandemic. The parties have filed a joint motion seeking a trial date in late 2021 or early 2022. The Company believes it has complied with the terms of the ADFA, intends to vigorously defend against SPM’s claims, and intends to vigorously prosecute its own claims. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +35 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” For dividend information, please refer to the caption Uses of Cash in Overview of Liquidity and Capital Resources in Item 7 of this report. Information regarding the SM Energy Equity Incentive Compensation Plan, as amended and restated effective as of May 22, 2018 (the “Equity Plan”), and the securities authorized under the Equity Plan is included below. +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2015, and ending December 31, 2020, with the cumulative total returns of the Dow Jones Exploration and Production Index (“DJUSOS”), and the Standard & Poor’s 500 Stock Index (“SPX”). +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +Holders. As of February 4, 2021, the number of record holders of our common stock was 101. A substantially greater number of holders of our common stock are beneficial holders, whose shares of record are held by banks, brokers, and other financial institutions. +36 +Purchases of Equity Securities by Issuer and Affiliated Purchasers. The following table provides information about purchases made by us and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and year ended December 31, 2020, of shares of our common stock, which is the sole class of equity securities registered by us pursuant to Section 12 of the Exchange Act. +PURCHASES OF EQUITY SECURITIES BY ISSUER AND AFFILIATED PURCHASERS +Period +Total Number of Shares Purchased (1) +Weighted Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program +Maximum Number of Shares that May Yet be Purchased Under the Program (2) +First quarter of 2020 341 $ 9.07 — 3,072,184 +Second quarter of 2020 — $ — — 3,072,184 +Third quarter of 2020 424,236 $ 3.67 — 3,072,184 +10/01/2020 - 10/31/2020 — — — 3,072,184 +11/01/2020 - 11/30/2020 — — — 3,072,184 +12/01/2020 - 12/31/2020 47 $ 6.67 — 3,072,184 +Total 424,624 $ 3.67 — 3,072,184 +____________________________________________ +(1) All shares purchased by us in 2020 were to offset tax withholding obligations that occurred upon the delivery of outstanding shares underlying Restricted Stock Units (“RSUs”) and Performance Share Units (“PSUs”) issued under the terms of award agreements granted under the Equity Plan. +(2) In July 2006, our Board of Directors approved an increase in the number of shares of common stock that may be repurchased under the original August 1998 authorization to 6,000,000 as of the effective date of the resolution. Accordingly, as of the filing of this report, subject to the approval of our Board of Directors, we may repurchase up to 3,072,184 shares of common stock on a prospective basis. The shares may be repurchased from time to time in open market transactions or privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing our Senior Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, and compliance with securities laws. Stock repurchases may be funded with existing cash balances, internal cash flows, or borrowings under our Credit Agreement. The stock repurchase program may be suspended or discontinued at any time. During 2020, we did not repurchase any shares of our common stock pursuant to this Board of Director’s approval. +37 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion includes forward-looking statements. Please refer to the Cautionary Information about Forward-Looking Statements section of this report for important information about these types of statements. +Overview of the Company +General Overview +Our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to domestic energy security and prosperity, and having a positive impact in the communities where we live and work. Our short-term operational and financial goals include generating positive cash flows while strengthening our balance sheet through absolute debt reduction and improved leverage metrics, and increasing the value of our capital project inventory through exploration and development optimization. Our long-term vision is to sustainably grow value for all of our stakeholders. We believe that in order to accomplish this vision, we must be a premier operator of top tier assets. Our investment portfolio is comprised of oil and gas producing assets in the state of Texas, specifically in the Midland Basin of West Texas and in the Maverick Basin of South Texas. +The Pandemic and associated macroeconomic events have had a significant impact on supply and demand for oil, gas, and NGLs, and affected the realized prices we received for our production throughout 2020. These impacts continue to be unpredictable, and given the dynamic nature of the Pandemic, we are unable to reasonably estimate the period of time that the related market conditions will exist or the extent to which they will continue to impact our business, results of operations, and financial condition, or the timing of any further recovery. Future infection rate surges or outbreaks could have further negative impacts, and as a result, we may be required to adjust our business plan. For additional detail, please refer to Risk Factors in Part I, Item 1A of this report. +The safety of our employees, contractors, and the communities where we work remains our first priority as we continue to operate during the Pandemic. While our core business operations require certain individuals to be physically present at well site locations, substantially all of our office-based employees have continued working remotely in order to limit physical interactions and to mitigate the spread of COVID-19, and will continue to do so well into 2021. For individuals who are unable to perform their jobs remotely, we maintain and continually assess procedures designed to limit the spread of COVID-19, including social distancing and enhanced sanitization measures, and we continue to communicate to and train all of our employees regarding best practices for maintaining a healthy and safe work environment. We believe that we meet or exceed CDC and OSHA guidelines related to the prevention of the transmission of COVID-19. Since these measures were initially implemented in the first quarter of 2020, we have continued to operate without significant disruptions to our business operations. Our pre-existing control environment and internal controls continue to be effective and we continue to address new risks directly related to the Pandemic as we identify them. +Despite continuing negative impacts and future uncertainty, we expect to maintain our ability to sustain strong operational performance and financial stability while maximizing returns, improving leverage metrics, and increasing the value of our top tier Midland Basin and South Texas assets. Our financial risk management program significantly reduced the impact of substantially lower oil prices in 2020, and as a result of this program, we recorded a net oil derivative settlement gain of $14.40 per barrel for the year ended December 31, 2020. Our realized oil price before the effects of derivative settlements was $37.08 per barrel for the year ended December 31, 2020. In response to the economic environment during 2020, we renegotiated certain contracts resulting in realized and future cost savings that directly support our objective of maximizing cash flows. As a result of these cost saving measures and improving operational efficiencies, average well costs for 2020 were lower than our preliminary expectations for the year. We entered 2020 with a total capital program budget between $825 million and $850 million. However, given the impacts of the Pandemic and the related circumstances discussed above, we reduced our 2020 capital program by more than 25 percent. Please refer to the caption Costs Incurred below for additional discussion. +Our vision to sustainably grow value for all of our stakeholders includes near-term operational and financial goals of generating positive cash flows while strengthening our balance sheet through absolute debt reduction and improved leverage metrics. Our long-term plan is to deliver cash flow growth that is supported by our high-quality asset base and ability to generate favorable returns. We remain committed to exceptional safety, health, and environmental stewardship; supporting the professional development of a diverse and thriving team of employees; making a positive difference in the communities where we live and work; and transparency in reporting on our progress in these areas. The Environmental, Social and Governance Committee of our Board of Directors oversees, among other things, the development and implementation of the Company’s environmental, social and governance policies, programs and initiatives, and reports to our Board of Directors regarding such matters. Further demonstrating our commitment to sustainable operations, compensation for our executives and employees under our short-term and long-term incentive plans is calculated based on metrics that include environmental, health, and safety measures. Please refer to our Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders to be filed within 120 days from December 31, 2020, for additional discussion. +2020 Financial and Operational Highlights +We remain focused on maximizing returns and increasing the value of our top tier Midland Basin and South Texas assets. We expect to do this through continued development optimization of our Midland Basin assets and through further development of our Austin Chalk formation in South Texas. We believe our assets provide strong returns and are capable of providing for growth of +38 +internally generated cash flows while allowing for flexibility of production levels, which aligns with our priorities of improving leverage metrics and maintaining strong financial flexibility. +The financial results and operational activities discussed throughout this report reflect the impacts of the Pandemic during 2020, and the misalignment of supply and demand caused by competition among oil producing nations for crude oil market share during the first half of 2020. We will continue to monitor the macroeconomic environment and maintain flexibility to adjust our financial and operational plans as warranted. +Financial and Operational Results. Average net daily production for the year ended December 31, 2020, was 126.9 MBOE, compared with 132.3 MBOE for 2019. This decrease was primarily driven by a 21 percent decrease in daily production volumes from our South Texas assets, partially offset by a 10 percent increase in daily production volumes from our Midland Basin assets. During the year ended December 31, 2020, as compared with 2019, net daily production volumes decreased four percent as a result of proactive measures taken to respond to the lower commodity price environment experienced in 2020 compared with 2019. This included voluntary production curtailments and less costs incurred as a result of intentionally reducing the number of new wells completed and brought on production. Realized prices before the effects of derivative settlements for oil, gas, and NGLs decreased 31 percent, 25 percent, and 19 percent, respectively, for the year ended December 31, 2020, compared with 2019. As a result of decreased realized prices, oil, gas, and NGL production revenue decreased 29 percent to $1.1 billion for the year ended December 31, 2020, compared with $1.6 billion for 2019. We recorded a net derivative gain of $161.6 million for the year ended December 31, 2020, compared to a net derivative loss of $97.5 million for 2019. These amounts include derivative settlement gains of $351.3 million and $39.2 million for the years ended December 31, 2020, and 2019, respectively. Overall financial and operational activities during the year ended December 31, 2020, resulted in the following: +• a net loss of $764.6 million, or $6.72 per diluted share, for the year ended December 31, 2020, compared with a net loss of $187.0 million, or $1.66 per diluted share, for 2019. The net loss for the year ended December 31, 2020, was primarily driven by impairment expense of $1.0 billion, partially offset by a net gain on extinguishment of debt of $280.1 million, and a net derivative gain of $161.6 million. Please refer to Comparison of Financial Results and Trends Between 2020 and 2019 and Between 2019 and 2018 below for additional discussion regarding the components of net income (loss) for each period presented; +• a $492.1 million decrease in the principal balance of our total outstanding long-term debt from December 31, 2019, to December 31, 2020, primarily driven by the Exchange Offers and open market repurchases of certain of our senior notes at a discount and net cash provided by operating activities of $790.9 million for the year ended December 31, 2020, which was in excess of net cash used in investing activities of $555.6 million for the year ended December 31, 2020. Please refer to Analysis of Cash Flow Changes Between 2020 and 2019 and Between 2019 and 2018 and to Note 5 – Long-Term Debt in Part II, Item 8 of this report below for additional discussion including the definition of Exchange Offers; +• adjusted EBITDAX, a non-GAAP financial measure, for the year ended December 31, 2020, of $975.4 million, compared with $993.4 million for 2019, primarily resulted from decreased revenue resulting from depressed commodity prices during the year ended December 31, 2020, largely offset by increased derivative settlement gains, combined with lower operating costs during 2020. Please refer to Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and reconciliations to our net income (loss) and net cash provided by operating activities; and +• total estimated proved reserves as of December 31, 2020, decreased 12 percent from December 31, 2019, to 404.6 MMBOE, of which, 57 percent were liquids (oil and NGLs) and 57 percent were characterized as proved developed. The decrease in total proved reserves primarily related to 46.4 MMBOE produced during 2020 and 32.6 MMBOE removed as a result of lower commodity prices experienced in 2020 compared with 2019, using pricing estimates determined in accordance with SEC rules. Our proved reserve life index decreased to 8.7 years as of December 31, 2020, compared with 9.6 years as of December 31, 2019. Please refer to Reserves in Part I, Items 1 and 2 of this report for additional discussion. The standardized measure of discounted future net cash flows was $2.7 billion as of December 31, 2020, compared with $4.1 billion as of December 31, 2019, which was a decrease of 35 percent year-over-year. Please refer to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Operational Activities. The performance of the RockStar area of our Midland Basin position continues to exceed our pre-acquisition expectations and was key to driving significant growth in our operating margin and cash flows from operations in 2020 due to the high percentage of oil that wells in this area produce. Our operational execution and development strategy in this area have resulted in strong well performance due to enhanced completion designs and our ability to drill long laterals given the increasingly contiguous nature of our acreage position as a result of successful infill leasing and acreage trades. Efficiency and optimization in completions and operations continued in 2020. A large portion of our water transportation and disposal needs continue to be satisfied by the water facilities we operate in a core area of our RockStar acreage, and strong partnerships with our key service providers allowed us to maintain continuity of operations during the lower commodity price environment and the Pandemic. +Our Midland Basin program averaged four drilling rigs and two completion crews during 2020. We completed 80 gross (73 net) operated wells during 2020 and increased production volumes year-over-year by 11 percent to 29.1 MMBOE, 73 percent of which +39 +was oil production. 80 percent of our total 2020 costs incurred related to our Midland Basin program. Drilling and completion activities within our RockStar and Sweetie Peck positions in the Midland Basin continue to focus primarily on delineating and developing the Spraberry and Wolfcamp formations. +Our South Texas program averaged one drilling rig and operated one completion crew at times during 2020. We completed 4 gross (4 net) wells during 2020. Total production for 2020 was 17.3 MMBOE, a 21 percent decrease from 2019. 13 percent of our total 2020 costs incurred related to our South Texas program. Drilling and completion activities in South Texas during 2020 primarily focused on delineating and developing the Austin Chalk formation. +The table below provides a summary of changes in our drilled but not completed well count and current year drilling and completion activity in our operated programs for the year ended December 31, 2020: +Midland Basin South Texas Total +Gross Net Gross Net Gross Net +Wells drilled but not completed at December 31, 2019 51 48 21 21 72 69 +Wells drilled 95 84 14 14 109 98 +Wells completed (80) (73) (4) (4) (84) (77) +Other (1) +— (1) — (3) — (4) +Wells drilled but not completed at December 31, 2020 (2) +66 58 31 28 97 86 +____________________________________________ +(1) Includes adjustments related to normal business activities, including working interest changes for existing drilled but not completed wells. Working interest changes can result from divestitures, joint development agreements, farmouts, and other activities. +(2) The South Texas drilled but not completed well count as of December 31, 2020, includes 13 gross (13 net) wells that are not included in our five-year development plan, 12 of which are in the Eagle Ford shale. +Costs Incurred. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended +December 31, 2020 +(in millions) +Development costs $ 490.9 +Exploration costs 77.9 +Acquisitions +Proved properties 5.6 +Unproved properties 10.9 +Total, including asset retirement obligations (1) +$ 585.3 +____________________________________________ +Note: Total may not calculate due to rounding. +(1) Please refer to the caption Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +The majority of our development and exploration costs were incurred in our Midland Basin and South Texas programs for the year ended December 31, 2020. Of these costs, $454.5 million was incurred in the development of our Midland Basin assets, which resulted in 84 net wells drilled and 73 net wells completed, while $75.0 million was incurred in the development of our South Texas assets, which resulted in 14 net wells drilled and 4 net wells completed. Costs incurred for acquisitions during the year related to transactions in the Midland Basin, as well as payments made to extend certain lease terms and to acquire new leases. Please refer to Operational Activities above and Acquisition Activity below for additional information. +40 +Production Results. The table below presents the disaggregation of our production by product type for each of our programs for the year ended December 31, 2020: +Midland Basin South Texas Total +Production: +Oil (MMBbl) 21.3 1.7 23.0 +Gas (Bcf) 46.6 57.3 103.9 +NGLs (MMBbl) — 6.1 6.1 +Equivalent (MMBOE) 29.1 17.3 46.4 +Avg. daily equivalents (MBOE/d) 79.5 47.4 126.9 +Relative percentage 63 % 37 % 100 % +____________________________________________ +Note: Amounts may not calculate due to rounding. +Production decreased four percent for the year ended December 31, 2020, compared with 2019. This decrease was primarily driven by a 21 percent decrease in production volumes from our South Texas assets, partially offset by an 11 percent increase in production volumes from our Midland Basin assets for the year ended December 31, 2020, compared with 2019. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends and Comparison of Financial Results and Trends Between 2020 and 2019 and Between 2019 and 2018 below for additional discussion on production. +Acquisition Activity. During 2020, we completed a non-monetary acreage trade of primarily undeveloped properties located in Upton County, Texas, as well as acreage acquisitions in Martin County, Texas, in order to continue maximizing our operational efficiencies in our Midland Basin program. Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effects of derivative settlements, unless otherwise indicated. While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location and transportation differentials, and contracted pricing benchmarks for these products. +41 +The following table summarizes commodity price data, as well as the effects of derivative settlements, for the years ended December 31, 2020, 2019, and 2018: +For the Years Ended December 31, +2020 2019 2018 +Oil (per Bbl): +Average NYMEX contract monthly price $ 39.40 $ 57.03 $ 64.77 +Realized price, before the effect of derivative settlements $ 37.08 $ 54.10 $ 56.80 +Effect of oil derivative settlements $ 14.40 $ (0.90) $ (3.67) +Gas: +Average NYMEX monthly settle price (per MMBtu) $ 2.08 $ 2.63 $ 3.09 +Realized price, before the effect of derivative settlements (per Mcf) $ 1.80 $ 2.39 $ 3.43 +Effect of gas derivative settlements (per Mcf) $ 0.11 $ 0.21 $ (0.12) +NGLs (per Bbl): +Average OPIS price (1) +$ 17.96 $ 22.34 $ 32.96 +Realized price, before the effect of derivative settlements $ 13.96 $ 17.26 $ 27.22 +Effect of NGL derivative settlements $ 1.28 $ 4.43 $ (6.78) +____________________________________________ +(1) Average OPIS prices per barrel of NGL, historical or strip, assumes a composite barrel product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline for all periods presented. This product mix represents the industry standard composite barrel and does not necessarily represent our product mix for NGL production. Realized prices reflect our actual product mix. +During 2020, benchmark prices for oil were impacted by the misalignment of supply and demand caused by the Pandemic and other macroeconomic events. In addition to supply and demand fundamentals, as a global commodity, the price of oil is affected by real or perceived geopolitical risks in various regions of the world as well as the relative strength of the United States dollar compared to other currencies. We expect future benchmark prices for oil, gas, and NGLs to remain volatile for the foreseeable future. Our realized prices at local sales points may also be affected by infrastructure capacity in the area of our operations and beyond. +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs as of February 4, 2021, and December 31, 2020: +As of February 4, 2021 As of December 31, 2020 +NYMEX WTI oil (per Bbl) $ 54.27 $ 48.36 +NYMEX Henry Hub gas (per MMBtu) $ 3.03 $ 2.65 +OPIS NGLs (per Bbl) $ 26.27 $ 22.99 +We use financial derivative instruments as part of our financial risk management program. We have a financial risk management policy governing our use of derivatives, and decisions regarding entering into commodity derivative contracts are overseen by a financial risk management committee consisting of senior executive officers and finance personnel. The amount of our production covered by derivatives is driven by the amount of debt on our balance sheet, the level of capital commitments and long-term obligations we have in place, and our ability to enter into favorable commodity derivative contracts. With our current commodity derivative contracts, we believe we have partially reduced our exposure to volatility in commodity prices and basis differentials in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil and gas prices while also setting a price floor for a portion of our oil and gas production. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and to Commodity Price Risk in Overview of Liquidity and Capital Resources below for additional information regarding our oil, gas, and NGL derivatives. +Outlook +Our total 2021 capital program is budgeted between $650.0 million and $675.0 million, which we expect to fund with cash flows from operations. We expect to focus our 2021 capital program on highly economic oil development projects in both our Midland Basin assets and our South Texas assets. In South Texas, we intend to primarily target the Austin Chalk formation. None of these assets are located on federal lands, and therefore our operations will not be impacted by the recent suspension of the issuance of federal drilling permits. +42 +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the three months ended December 31, 2020, and the preceding three quarters. +For the Three Months Ended +December 31, September 30, June 30, March 31, +2020 2020 2020 2020 +(in millions) +Production (MMBOE) 11.3 11.6 11.2 12.4 +Oil, gas, and NGL production revenue +$ 320.2 $ 282.0 $ 169.8 $ 354.2 +Oil, gas, and NGL production expense $ 96.0 $ 95.3 $ 80.4 $ 119.6 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 188.9 $ 181.7 $ 180.9 $ 233.5 +Exploration $ 11.3 $ 8.5 $ 9.8 $ 11.3 +General and administrative $ 20.0 $ 24.5 $ 27.2 $ 27.4 +Net loss $ (165.2) $ (98.3) $ (89.3) $ (411.9) +____________________________________________ +Note: Amounts may not calculate due to rounding. +Selected Performance Metrics +For the Three Months Ended +December 31, September 30, June 30, March 31, +2020 2020 2020 2020 +Average net daily equivalent production (MBOE per day) 122.4 126.3 122.9 135.9 +Lease operating expense (per BOE) $ 4.10 $ 3.65 $ 3.30 $ 4.75 +Transportation costs (per BOE) $ 2.89 $ 3.11 $ 3.12 $ 3.11 +Production taxes as a percent of oil, gas, and NGL production revenue 4.0 % 4.3 % 3.7 % 4.2 % +Ad valorem tax expense (per BOE) $ 0.38 $ 0.40 $ 0.22 $ 0.60 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) $ 16.77 $ 15.64 $ 16.17 $ 18.88 +General and administrative (per BOE) $ 1.78 $ 2.10 $ 2.43 $ 2.22 +____________________________________________ +Note: Amounts may not calculate due to rounding. +43 +A Year-to-Year Overview of Selected Production and Financial Information, Including Trends +For the Years Ended +December 31, Amount Change Between Percent Change Between +2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018 +Net production volumes: (1) +Oil (MMBbl) 23.0 21.9 18.8 1.1 3.1 5 % 17 % +Gas (Bcf) 103.9 109.8 103.2 (5.9) 6.6 (5) % 6 % +NGLs (MMBbl) 6.1 8.1 7.9 (2.0) 0.2 (25) % 2 % +Equivalent (MMBOE) 46.4 48.3 43.9 (1.9) 4.4 (4) % 10 % +Average net daily production: (1) +Oil (MBbl per day) 62.9 59.9 51.4 3.0 8.5 5 % 17 % +Gas (MMcf per day) 283.9 300.8 282.7 (17.0) 18.1 (6) % 6 % +NGLs (MBbl per day) 16.7 22.2 21.8 (5.6) 0.5 (25) % 2 % +Equivalent (MBOE per day) 126.9 132.3 120.3 (5.4) 12.0 (4) % 10 % +Oil, gas, and NGL production revenue (in millions): (1) +Oil production revenue $ 853.6 $ 1,183.2 $ 1,065.7 $ (329.6) $ 117.5 (28) % 11 % +Gas production revenue 187.5 262.5 354.5 (75.1) (91.9) (29) % (26) % +NGL production revenue 85.2 140.0 216.2 (54.8) (76.2) (39) % (35) % +Total oil, gas, and NGL production revenue $ 1,126.2 $ 1,585.8 $ 1,636.4 $ (459.6) $ (50.6) (29) % (3) % +Oil, gas, and NGL production expense (in millions): (1) +Lease operating expense $ 184.2 $ 225.5 $ 208.1 $ (41.3) $ 17.4 (18) % 8 % +Transportation costs 142.0 187.1 191.5 (45.1) (4.4) (24) % (2) % +Production taxes 46.1 65.0 66.9 (18.9) (1.9) (29) % (3) % +Ad valorem tax expense 18.9 23.1 20.9 (4.2) 2.2 (18) % 10 % +Total oil, gas, and NGL production expense $ 391.2 $ 500.7 $ 487.4 $ (109.5) $ 13.3 (22) % 3 % +Realized price, before the effect of derivative settlements: +Oil (per Bbl) $ 37.08 $ 54.10 $ 56.80 $ (17.02) $ (2.70) (31) % (5) % +Gas (per Mcf) $ 1.80 $ 2.39 $ 3.43 $ (0.59) $ (1.04) (25) % (30) % +NGLs (per Bbl) $ 13.96 $ 17.26 $ 27.22 $ (3.30) $ (9.96) (19) % (37) % +Per BOE $ 24.26 $ 32.84 $ 37.27 $ (8.58) $ (4.43) (26) % (12) % +Per BOE data: (1) +Production costs: +Lease operating expense $ 3.97 $ 4.67 $ 4.74 $ (0.70) $ (0.07) (15) % (1) % +Transportation costs 3.06 3.88 4.36 (0.82) (0.48) (21) % (11) % +Production taxes 0.99 1.35 1.52 (0.36) (0.17) (27) % (11) % +Ad valorem tax expense 0.41 0.48 0.48 (0.07) — (15) % — % +Total production costs $ 8.43 $ 10.38 $ 11.10 $ (1.95) $ (0.72) (19) % (6) % +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 16.91 $ 17.06 $ 15.15 $ (0.15) $ 1.91 (1) % 13 % +General and administrative $ 2.14 $ 2.75 $ 2.65 $ (0.61) $ 0.10 (22) % 4 % +Derivative settlement gain (loss) (2) +$ 7.57 $ 0.81 $ (3.09) $ 6.76 $ 3.90 835 % 126 % +Earnings per share information: +Basic weighted-average common shares outstanding (in thousands) 113,730 112,544 111,912 1,186 632 1 % 1 % +Diluted weighted-average common shares outstanding (in thousands) 113,730 112,544 113,502 1,186 (958) 1 % (1) % +Basic net income (loss) per common share $ (6.72) $ (1.66) $ 4.54 $ (5.06) $ (6.20) (305) % (137) % +Diluted net income (loss) per common share $ (6.72) $ (1.66) $ 4.48 $ (5.06) $ (6.14) (305) % (137) % +____________________________________________ +(1) Amounts and percentage changes may not calculate due to rounding. +(2) Derivative settlements for the years ended December 31, 2020, 2019, and 2018, are included within the net derivative (gain) loss line item in the accompanying consolidated statements of operations (“accompanying statements of operations”). +44 +Average net daily equivalent production for the year ended December 31, 2020, decreased four percent compared with 2019, as a result of proactive measures taken to respond to the lower commodity price environment experienced in 2020 compared with 2019. This included voluntary production curtailments and less costs incurred as a result of intentionally reducing the number of new wells completed and brought on production. The decrease in average net daily equivalent production volumes was primarily driven by a 21 percent decrease in daily production volumes from our South Texas assets, partially offset by a 10 percent increase in daily production volumes from our Midland Basin assets. We expect both total production volumes and oil volumes as a percentage of our total production mix to increase in 2021 compared with 2020. Please refer to Comparison of Financial Results and Trends Between 2020 and 2019 and Between 2019 and 2018 below for additional discussion. +We present certain information on a per BOE basis in order to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis and discussion. +Our realized price before the effect of derivative settlements on a per BOE basis decreased $8.58 per BOE for the year ended December 31, 2020, compared with 2019, primarily driven by lower benchmark commodity prices for oil, gas, and NGLs resulting from the Pandemic and other macroeconomic events. Regional pricing differentials in the Midland Basin negatively affected our realized prices in 2020 and 2019. The negative impacts on revenue associated with the decrease in our realized price before the effect of derivative settlements on a per BOE basis was partially offset by an increase in the gain we recognized on the settlement of our derivative contracts of $6.76 per BOE for the year ended December 31, 2020, compared with 2019. Benchmark commodity prices improved toward the end of 2020 and into early 2021, however, negative impacts on our realized pricing resulting from the Pandemic and associated macroeconomic events could occur during 2021. +Lease operating expense (“LOE”) on a per BOE basis decreased 15 percent for the year ended December 31, 2020, compared with 2019. This decrease was primarily driven by reduced costs, reduced workover activity, and increased operational efficiencies during 2020. For 2021, we expect LOE on a per BOE basis to be relatively flat, compared with 2020, as we expect the benefit received from our cost reduction efforts and operational efficiencies to be offset by the expected increase in oil volumes as a percentage of our 2021 total production mix. +Transportation costs on a per BOE basis decreased 21 percent for the year ended December 31, 2020, compared with 2019. This decrease was driven by a 21 percent reduction in production volumes from our South Texas assets, which incur the majority of our transportation costs, for the year ended December 31, 2020, compared with 2019. We expect total transportation costs to fluctuate relative to changes in production from our South Texas assets. On a per BOE basis, we expect transportation costs to decrease in 2021, compared with 2020, as production from our Midland Basin assets, which is sold at or near the wellhead and incurs minimal transportation costs, continues to become a larger portion of our total production. Further, we anticipate natural declines in production from our Eagle Ford shale wells in South Texas, which incur higher transportation costs on a per BOE basis, and we intend to focus on new wells with higher liquids content in the Austin Chalk, which have lower transportation costs on a per BOE basis. In addition, we expect to benefit from certain transportation contract cost reductions which are expected to further reduce our transportation expense per BOE in 2021. +Production taxes on a per BOE basis for the year ended December 31, 2020, decreased 27 percent compared with 2019, primarily driven by a decrease in realized prices. Our overall production tax rate for both of the years ended December 31, 2020, and 2019, was 4.1 percent. We expect our total production tax expense to increase in 2021, compared with 2020, as we expect oil, gas, and NGL production revenue to increase due to higher expected pricing based on 12-month strip prices as of February 4, 2021, and increased volumes. We generally expect production tax expense to correlate with oil, gas, and NGL production revenue on an absolute and per BOE basis. Product mix, the location of production, and incentives to encourage oil and gas development can also impact the amount of production tax we recognize. +Ad valorem tax expense on a per BOE basis decreased 15 percent for the year ended December 31, 2020, compared with 2019, primarily due to changes in the assessed values of our producing properties recognized by respective tax authorities in 2020. We anticipate volatility in ad valorem tax expense on a per BOE and absolute basis as the valuation of our producing properties change. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (“DD&A”) expense on a per BOE basis remained relatively flat for the year ended December 31, 2020, compared with 2019. During 2020, decreases in DD&A expense, which were driven by the reduction in the depletable cost basis of our South Texas proved oil and gas properties as a result of proved property impairments recognized during the first quarter of 2020, were partially offset by higher production volumes from our oil producing Midland Basin assets as these assets have higher depletion rates than our primarily gas and NGL producing South Texas assets. Our DD&A rate fluctuates as a result of impairments, divestiture activity, carrying cost funding and sharing arrangements with third parties, changes in our production mix, and changes in our total estimated proved reserve volumes. In general, we expect the DD&A rate for 2021 to be relatively flat compared with 2020 and DD&A expense on an absolute basis to be higher compared with 2020, primarily as a result of anticipated higher production volumes. +General and administrative (“G&A”) expense on a per BOE basis for the year ended December 31, 2020, decreased 22 percent, compared with 2019. This decrease was primarily due to reduced overhead costs resulting from the reorganization of certain functions in the fourth quarter of 2019 that eliminated duplicative regional operational functions, as well as actions taken to reduce costs +45 +as a result of the Pandemic. For 2021, we expect G&A expense to remain relatively flat on an absolute basis and to decrease on a per BOE basis, compared with 2020. +Please refer to Comparison of Financial Results and Trends Between 2020 and 2019 and Between 2019 and 2018 for additional discussion of operating expenses. +Please refer to Note 9 - Earnings Per Share in Part II, Item 8 of this report for additional discussion on the types of shares included in our basic and diluted net income (loss) per common share calculations. We recorded a net loss for each of the years ended December 31, 2020, and 2019. Consequently, all potentially dilutive shares were anti-dilutive and were excluded from the calculation of diluted net loss per common share for the years ended December 31, 2020, and 2019. For the year ended December 31, 2018, we recorded net income and thus, considered dilutive shares in the calculation of diluted net income per common share. +Comparison of Financial Results and Trends Between 2020 and 2019 and Between 2019 and 2018 +Please refer to Comparison of Financial Results and Trends Between 2019 and 2018 and Between 2018 and 2017 in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2019 Annual Report on Form 10-K, filed with the SEC on February 20, 2020, for a detailed discussion of certain comparisons of our financial results and trends for the year ended December 31, 2019, compared with the year ended December 31, 2018. +Net equivalent production, production revenue, and production expense +The following table presents the changes in our net equivalent production, production revenue, and production expense, by area, between the years ended December 31, 2020, and 2019: +Net Equivalent Production Increase (Decrease) Production Revenue Decrease Production Expense Decrease +(MBOE per day) (in millions) (in millions) +Midland Basin 7.5 $ (316.2) $ (34.1) +South Texas (12.9) (143.4) (75.4) +Total (5.4) $ (459.6) $ (109.5) +____________________________________________ +Note: Amounts may not calculate due to rounding. +Average net daily equivalent production volumes for the year ended December 31, 2020, decreased four percent compared with 2019. Realized prices before the effects of derivative settlements for oil, gas, and NGLs decreased 31 percent, 25 percent, and 19 percent, respectively, for the year ended December 31, 2020, compared with 2019. As a result of the decreases in production and pricing, oil, gas, and NGL production revenue decreased 29 percent for the year ended December 31, 2020, compared with 2019. Total production expense for the year ended December 31, 2020, decreased 22 percent, compared with 2019. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends for additional discussion of the components of production expense. +The following table presents the changes in our net equivalent production, production revenue, and production expense, by area, between the years ended December 31, 2019, and 2018: +Net Equivalent Production Increase (Decrease) Production Revenue Increase (Decrease) Production Expense Increase (Decrease) +(MBOE per day) (in millions) (in millions) +Midland Basin 14.6 $ 131.1 $ 31.5 +South Texas 0.4 (124.5) 5.2 +Rocky Mountain (1) +(3.1) (57.2) (23.3) +Total 12.0 $ (50.6) $ 13.3 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) We divested all remaining producing assets in the Rocky Mountain region in the first half of 2018. As a result, there have been no production volumes from this region after the second quarter of 2018. +Average net daily equivalent production volumes for the year ended December 31, 2019, increased 10 percent compared with 2018, primarily as a result of increased production from our Midland Basin assets. As a result of increased Midland Basin production, oil production as a percentage of our overall product mix increased from 43 percent in 2018, to 45 percent in 2019. Oil, gas, and NGL production revenues decreased three percent for the year ended December 31, 2019, compared with 2018, as a result of lower +46 +commodity pricing and the divestiture in the first half of 2018 of our remaining producing assets in the Rocky Mountain region. Total production expense for the year ended December 31, 2019, increased three percent compared with 2018, due to increased LOE and ad valorem tax expense, partially offset by decreased production taxes and transportation costs. Production expense on a per BOE basis decreased six percent for the year ended December 31, 2019, compared with 2018, primarily due to increased production volumes, decreased transportation costs, and decreased production taxes resulting from lower oil, gas, and NGL production revenues. +Net gain on divestiture activity +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Net gain on divestiture activity $ 0.1 $ 0.9 $ 426.9 +No material divestitures occurred during 2020 or 2019. For the year ended December 31, 2018, we recorded a total net gain of $410.6 million for the divestiture of our Powder River Basin assets (the “PRB Divestiture”), and a combined total net gain of $15.4 million for the completed divestitures of our remaining assets in the Williston Basin located in Divide County, North Dakota (the “Divide County Divestiture”) and our Halff East assets in the Midland Basin (the “Halff East Divestiture”). Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale in Part II, Item 8 of this report for additional discussion. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 785.0 $ 823.8 $ 665.3 +DD&A expense for the year ended December 31, 2020, decreased five percent compared with 2019. The decrease was primarily driven by the reduction in the depletable cost basis of our South Texas proved oil and gas properties as a result of proved property impairments recognized during the first quarter of 2020, partially offset by higher production volumes from our oil producing Midland Basin assets as these assets have higher depletion rates than our primarily gas and NGL producing South Texas assets. DD&A expense for the year ended December 31, 2019, increased 24 percent compared with 2018, primarily driven by a 25 percent increase in production volumes from our Midland Basin assets during the same period. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of DD&A expense on a per BOE basis. +Exploration +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Geological and geophysical expenses $ 4.3 $ 2.9 $ 5.6 +Exploratory dry hole — 4.8 — +Overhead and other expenses 36.7 43.8 49.6 +Total $ 41.0 $ 51.5 $ 55.2 +Exploration expense decreased 20 percent for the year ended December 31, 2020, compared with 2019. The decrease for the year ended December 31, 2020, was primarily driven by the reorganization of certain functions in the fourth quarter of 2019 that eliminated duplicative regional operational functions and reduced overhead costs. Exploration expense is impacted by actual geological and geophysical studies we perform and the potential for exploratory dry hole expense. +47 +Impairment +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Impairment of proved oil and gas properties and related support equipment $ 956.7 $ — $ — +Abandonment and impairment of unproved properties 59.3 33.8 49.9 +Total $ 1,016.0 $ 33.8 $ 49.9 +As a result of the decrease in commodity price forecasts at the end of the first quarter of 2020, specifically decreases in oil and NGL prices, we recorded impairment expense related to our South Texas proved oil and gas properties and related support facilities. There were no proved oil and gas property impairments recorded in 2019, and 2018. Unproved property abandonments and impairments recorded during the years ended December 31, 2020, 2019, and 2018, related to actual and anticipated lease expirations, as well as actual and anticipated losses of acreage due to title defects, changes in development plans, and other inherent acreage risks. +We expect proved property impairments to occur more frequently in periods of declining or depressed commodity prices, and that the frequency of unproved property abandonments and impairments will fluctuate with the timing of lease expirations or title defects, and changing economics associated with decreases in commodity prices. Additionally, changes in drilling plans, unsuccessful exploration activities, and downward engineering revisions may result in proved and unproved property impairments. +Reserve estimates and related impairments of proved and unproved properties are difficult to predict in a volatile price environment. If commodity prices for the products we produce decline as a result of supply and demand fundamentals associated with the Pandemic or other macroeconomic events, we may experience additional proved and unproved property impairments in the future. Future impairments of proved and unproved properties are difficult to predict; however, based on our commodity price assumptions as of February 4, 2021, we do not expect any material oil and gas property impairments in the first quarter of 2021 resulting from commodity price impacts. +Please refer to Critical Accounting Policies and Estimates below for additional discussion. +General and administrative +For the Years Ended December 31, +2020 2019 2018 +(in millions) +General and administrative $ 99.2 $ 132.8 $ 116.5 +G&A expense decreased 25 percent for the year ended December 31, 2020, compared with 2019. Please refer to A Year-to-Year Overview of Selected Production and Financial Information, Including Trends above for discussion of G&A expense. +Net derivative (gain) loss +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Net derivative (gain) loss $ (161.6) $ 97.5 $ (161.8) +We recognized a net derivative gain of $161.6 million for the year ended December 31, 2020. The gain was primarily driven by gains on the settlement of derivative contracts of $351.3 million offset by $189.7 million in downward mark-to-market adjustments due to the strengthening of commodity prices towards the end of 2020. +We recognized a net derivative loss of $97.5 million for the year ended December 31, 2019. The loss was primarily driven by $136.7 million in downward mark-to-market adjustments offset by gains on the settlement of derivative contracts of $39.2 million. +We recognized a net derivative gain of $161.8 million for the year ended December 31, 2018. The gain was primarily driven by upward mark-to market adjustments of $297.6 million offset by losses on the settlement of derivative contracts of $135.8 million. +Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +48 +Interest expense +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Interest expense $ (163.9) $ (159.1) $ (160.9) +Interest expense increased three percent for the year ended December 31, 2020, compared with 2019, primarily due to an increase in interest expense associated with borrowings under our revolving credit facility and a decrease in interest expense capitalized to wells. We expect interest expense related to our Senior Notes to be relatively flat in 2021 compared with 2020 as the increase related to the higher interest rate on the 2025 Senior Secured Notes will be mostly offset by the decreased interest associated with the reduction in the aggregate principal amount of Senior Notes resulting from exchanges and redemptions in 2020. Total interest expense is impacted by, and can vary based on, the timing and amount of borrowings under our revolving credit facility. Please refer to Overview of Liquidity and Capital Resources below, and to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definitions of 2025 Senior Secured Notes and Senior Notes. +Net gain (loss) on extinguishment of debt +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Net gain (loss) on extinguishment of debt $ 280.1 $ — $ (26.7) +The Exchange Offers executed during the second quarter of 2020 resulted in a net gain on extinguishment of debt of $227.3 million, which was primarily comprised of the gain on the partial principal redemption of Old Notes and the debt discount associated with the issuance of the 2025 Senior Secured Notes. Additionally, during the year ended December 31, 2020, we repurchased certain of our 6.125% Senior Notes due 2022 (“2022 Senior Notes”) and 5.0% Senior Notes due 2024 (“2024 Senior Notes”) in open market transactions, resulting in a net gain on extinguishment of debt of $52.8 million, $15.5 million of which was recorded in the fourth quarter of 2020. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definitions of Exchange Offers and Old Notes. +Income tax (expense) benefit +For the Years Ended December 31, +2020 2019 2018 +(in millions, except tax rate) +Income tax (expense) benefit $ 192.1 $ 44.0 $ (143.4) +Effective tax rate 20.1 % 19.1 % 22.0 % +The increase in the effective tax benefit rate for the year ended December 31, 2020, compared with 2019, was primarily due to the differing effects of permanent items on the loss before income taxes for each of the years ended December 31, 2020, and 2019. The valuation allowance recorded on our deferred tax assets combined with the effects of excess tax deficiencies from stock-based compensation awards, limits on expensing of certain covered individuals’ compensation, and other permanent expense items decreased the tax benefit rate for the year ended December 31, 2020, compared with 2019. This decrease was partially offset by state permanent items reflecting state planning strategies which increased the tax benefit rate for the year ended December 31, 2020. Changes to the Internal Revenue Code (“IRC”) could eliminate or reduce certain oil and gas industry deductions and could increase the overall corporate income tax rate. +The decrease in the effective tax rate for the year ended December 31, 2019, compared with 2018, was primarily due to the differing effects of permanent items on the loss before income taxes for the year ended December 31, 2019, compared to the impact of these items on income before income taxes for 2018. Excess tax deficiencies from stock-based compensation awards, limits on expensing of certain covered individual’s compensation, and other permanent expense items reduced the tax benefit rate for the year ended December 31, 2019. These same items increased the tax expense rate for the year ended December 31, 2018. The reduction in the tax expense rate also reflects a cumulative effect in 2018 from divestitures, and the impact of a correlative change to our state apportionment rate. +Please refer to Overview of Liquidity and Capital Resources and Critical Accounting Policies and Estimates below as well as Note 4 – Income Taxes in Part II, Item 8 of this report for further discussion. +49 +Overview of Liquidity and Capital Resources +Based on the current commodity price environment, we believe we have sufficient liquidity and capital resources to execute our business plan while continuing to meet our current financial obligations in a challenging commodity price environment. We continue to manage the duration and level of our drilling and completion service commitments in order to maintain flexibility with regard to our activity level and capital expenditures, and we have successfully renegotiated certain contracts allowing us to realize cost savings that directly support our objective of maximizing cash flows. +Sources of Cash +We expect our 2021 capital program to be funded by cash flows from operations. Although we expect cash flows from operations to be sufficient to fund our expected 2021 capital program, we may also use borrowings under our revolving credit facility or may elect to raise funds through new debt or equity offerings or from other sources of financing. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders could be diluted, and these newly issued securities may have rights, preferences, or privileges senior to those of existing stockholders and bondholders. Additionally, we may enter into carrying cost and sharing arrangements with third parties for certain exploration or development programs. All of our sources of liquidity can be affected by the general conditions of the broader economy, force majeure events, fluctuations in commodity prices, operating costs, tax law changes and volumes produced, all of which affect us and our industry. +As a result of the current macroeconomic environment, our credit ratings were downgraded during 2020 by three major credit rating agencies. These downgrades and any future downgrades in our credit ratings could make it more difficult or expensive for us to borrow additional funds. +We have no control over the market prices for oil, gas, or NGLs, although we may be able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of derivative contracts as part of our commodity price risk management program. Commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional information about our oil, gas, and NGL derivative contracts currently in place and the timing of settlement of those contracts . +Credit Agreement +Our Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $2.5 billion, and a borrowing base and aggregate lender commitments of $1.1 billion. The borrowing base under the Credit Agreement is subject to regular, semi-annual redetermination, and considers the value of both our (a) proved oil and gas properties reflected in the most recent reserve report provided to our lenders under the Credit Agreement; and (b) commodity derivative contracts, each as determined by our lender group. During the fourth quarter of 2020, we completed the fall semi-annual borrowing base redetermination with our lenders, and entered into the Fifth Amendment to the Credit Agreement, which among other items, reaffirmed the borrowing base and aggregate lender commitments at existing levels and extended the date through which we may incur Permitted Second Lien Debt, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. As of December 31, 2020, we had $380.8 million of Permitted Second Lien Debt capacity available until the next scheduled redetermination date of April 1, 2021, provided that all principal amounts of such debt are used to redeem unsecured senior debt of the Company for less than or equal to 80% of par value. As of December 31, 2020, the remaining available borrowing capacity under our Credit Agreement provided $965.0 million in liquidity. Our borrowing base can be adjusted as a result of changes in commodity prices, acquisitions or divestitures of proved properties, or financing activities, all as provided for in the Credit Agreement. No individual bank participating in our Credit Agreement represents more than 10 percent of the lender commitments under the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion as well as the presentation of the outstanding balance, total amount of letters of credit, and available borrowing capacity under our Credit Agreement as of February 4, 2021, December 31, 2020, and December 31, 2019. +We must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring that we maintain certain financial ratios, as set forth in the Credit Agreement. We were in compliance with all financial and non-financial covenants as of December 31, 2020, and through the filing of this report. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. +Our daily weighted-average revolving credit facility debt balance was approximately $145.6 million and $115.2 million for the years ended December 31, 2020, and 2019, respectively. Cash flows provided by our operating activities, proceeds received from divestitures of properties, capital markets activities, including open market debt repurchases, repayment of scheduled debt maturities, and our capital expenditures, including acquisitions, all impact the amount we borrow under our revolving credit facility. +Under our Credit Agreement, borrowings in the form of Eurodollar loans accrue interest based on LIBOR. The use of LIBOR as a global reference rate is expected to be discontinued after 2021. Our Credit Agreement specifies that if LIBOR is no longer a widely used benchmark rate, or if it is no longer used for determining interest rates for loans in the United States, a replacement interest rate that fairly reflects the cost to the lenders of funding loans shall be established by the Administrative Agent, as defined in the Credit Agreement, in consultation with us. We currently do not expect the transition from LIBOR to have a material impact on interest expense +50 +or borrowing activities under the Credit Agreement, or to otherwise have a material adverse impact on our business. Please refer to Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for discussion of FASB ASU 2020-04 which provides guidance related to reference rate reform. +Weighted-Average Interest and Weighted-Average Borrowing Rates +Our weighted-average interest rate includes paid and accrued interest, fees on the unused portion of the aggregate commitment amount under the Credit Agreement, letter of credit fees, the non-cash amortization of deferred financing costs, and the non-cash amortization of the discounts related to the 2025 Senior Secured Notes and 2021 Senior Secured Convertible Notes, each as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. Our weighted-average borrowing rate includes paid and accrued interest only. +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2020, 2019, and 2018: +For the Years Ended December 31, +2020 2019 2018 +Weighted-average interest rate 7.0 % 6.4 % 6.4 % +Weighted-average borrowing rate 6.1 % 5.7 % 5.8 % +Our weighted-average interest rates and weighted-average borrowing rates are impacted by the timing of long-term debt issuances and redemptions and the average outstanding balance on our revolving credit facility. Additionally, our weighted-average interest rates are impacted by the fees paid on the unused portion of our aggregate lender commitments. For the year ended December 31, 2020, our weighted-average interest rate and our weighted-average borrowing rate increased, compared with 2019, primarily as a result of the higher interest rate on our 2025 Senior Secured Notes issued during the second quarter of 2020. The rates disclosed in the above table do not reflect amounts associated with the early redemption of certain of our Old Notes, such as the acceleration of unamortized deferred financing costs, as these amounts are netted against the associated gain or loss on extinguishment of debt. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion including the definition of Old Notes. +Uses of Cash +We use cash for the development, exploration, and acquisition of oil and gas properties and for the payment of operating and general and administrative costs, income taxes, dividends, and debt obligations, including interest. Expenditures for the development, exploration, and acquisition of oil and gas properties are the primary use of our capital resources. During 2020, we spent approximately $555.7 million on capital expenditures and on acquiring proved and unproved oil and gas properties. This amount differs from the costs incurred amount of $585.3 million for the year ended December 31, 2020, as costs incurred is an accrual-based amount that also includes asset retirement obligations, geological and geophysical expenses, and exploration overhead amounts. Please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +The amount and allocation of our future capital expenditures will depend upon a number of factors, including our cash flows from operating, investing, and financing activities, our ability to execute our development program, and the number and size of acquisitions. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, tax law changes, and the timing and results of our exploration and development activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget to assess if changes are necessary based on current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. The macroeconomic events discussed throughout this report impacted our capital program in 2020. We are unable to reasonably estimate the period of time that these market conditions will exist, the extent of the impact they will have on our business, liquidity, results of operations, financial condition, or the timing of any subsequent recovery. +Changes to the IRC could increase the corporate income tax rate and could eliminate or reduce current tax deductions for intangible drilling costs, depreciation of equipment costs, and other deductions which currently reduce our taxable income. Future legislation regarding these issues could reduce our net cash provided by operating activities over time, and could therefore result in a reduction of funding available for the items discussed above. +We may from time to time repurchase or redeem all or portions of our outstanding debt securities for cash, through exchanges for other securities, or a combination of both. Such repurchases or redemptions may be made in open market transactions, privately negotiated transactions, or otherwise. Any such repurchases or redemptions will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. During 2020, we completed the Exchange Offers, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, and we repurchased certain of our 2022 Senior Notes and 2024 Senior Notes in open market transactions. +51 +The balance of our revolving credit facility decreased $29.5 million from $122.5 million at December 31, 2019, to $93.0 million at December 31, 2020, notwithstanding repurchases of $243.8 million in aggregate principal amount of our Senior Unsecured Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, and 2021 Senior Convertible Notes for $190.0 million in cash during the twelve months ended December 31, 2020. +Please refer to Note 5 – Long-Term Debt and Note 11 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion. As part of our strategy for 2021, we will continue to focus on improving our debt metrics, which may include reducing the amount of our outstanding debt. +As of the filing of this report, we could repurchase up to 3,072,184 shares of our common stock under our stock repurchase program, subject to the approval of our Board of Directors. Shares may be repurchased from time to time in the open market, or in privately negotiated transactions, subject to market conditions and other factors, including certain provisions of our Credit Agreement, the indentures governing each series of our outstanding Senior Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, compliance with securities laws, and the terms and provisions of our stock repurchase program. Our Board of Directors periodically reviews this program as part of the allocation of our capital. During 2020, we did not repurchase any shares of our common stock, and we currently do not plan to repurchase any outstanding shares of our common stock during 2021. +During the years ended December 31, 2020, 2019, and 2018, we paid $2.3 million, $11.3 million, and $11.2 million, respectively, in dividends to our stockholders. These amounts reflect a dividend of $0.02 per share for the year ended December 31, 2020, and a dividend of $0.10 per share for each of the years ended December 31, 2019, and 2018. Our current intention is to continue to make dividend payments for the foreseeable future, subject to our future earnings, our financial condition, covenants under our Credit Agreement and indentures governing each series of our outstanding Senior Notes, other covenants, and other factors that could arise. The payment and amount of future dividends remains at the discretion of our Board of Directors. +Analysis of Cash Flow Changes Between 2020 and 2019 and Between 2019 and 2018 +The following tables present changes in cash flows between the years ended December 31, 2020, 2019, and 2018, for our operating, investing, and financing activities. The analysis following each table should be read in conjunction with our accompanying consolidated statements of cash flows (“accompanying statements of cash flows”) in Part II, Item 8 of this report. +Operating Activities +For the Years Ended December 31, Amount Change Between +2020 2019 2018 2020/2019 2019/2018 +(in millions) +Net cash provided by operating activities $ 790.9 $ 823.6 $ 720.6 $ (32.7) $ 103.0 +Net cash provided by operating activities decreased for the year ended December 31, 2020, compared with the same period in 2019 primarily due to a $316.9 million decrease in cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, offset by an increase in cash received from settled derivative trades of $290.7 million. Net cash provided by operating activities is affected by working capital changes and the timing of cash receipts and disbursements. +Derivative settlements increased $202.9 million for the year ended December 31, 2019, compared with 2018. This increase was partially offset by decreased cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes of $73.4 million, and increased cash paid for LOE and ad valorem taxes of $22.0 million for the year ended December 31, 2019, compared with 2018. Cash paid for interest decreased $8.8 million for the year ended December 31, 2019, compared with 2018, due to the redemption and repurchase of certain senior notes in the third quarter of 2018, partially offset by increased interest paid on our 6.625% Senior Notes due 2027 (“2027 Senior Notes”) and interest paid on revolving credit facility borrowings during the year ended December 31, 2019. +52 +Investing Activities +For the Years Ended December 31, Amount Change Between +2020 2019 2018 2020/2019 2019/2018 +(in millions) +Net cash used in investing activities $ (555.6) $ (1,013.3) $ (587.9) $ 457.7 $ (425.4) +Net cash used in investing activities decreased for the year ended December 31, 2020, compared with the same period in 2019, primarily due to reduced capital expenditures of $476.0 million. Net cash used in investing activities during the year ended December 31, 2020, was funded by net cash provided by operating activities. +Net cash used in investing activities increased for the year ended December 31, 2019, compared with 2018. Proceeds received from the sale of oil and gas properties were $735.5 million lower in 2019 than in 2018 as no material divestitures occurred during 2019. This was partially offset by lower capital expenditures of $279.4 million and less cash paid to acquire proved and unproved oil and gas properties of $30.7 million. +Financing Activities +For the Years Ended December 31, Amount Change Between +2020 2019 2018 2020/2019 2019/2018 +(in millions) +Net cash provided by (used in) financing activities $ (235.4) $ 111.8 $ (368.7) $ (347.2) $ 480.5 +During the year ended December 31, 2020, we paid $136.5 million to repurchase certain of our 2022 Senior Notes and 2024 Senior Notes in open market transactions, and we paid $53.5 million to certain holders of the 2021 Senior Convertible Notes in connection with the Private Exchange. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions. For the year ended December 31, 2020, we had net repayments to our revolving credit facility of $29.5 million, compared to net borrowings of $122.5 million for the year ended December 31, 2019. +During the year ended December 31, 2018, we paid approximately $845.0 million, including premiums, to redeem or repurchase certain of our senior notes, and we received net proceeds of $492.1 million upon the issuance of our 2027 Senior Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. There were no such debt transactions during 2019. Net borrowings under our revolving credit facility were $122.5 million for the year ended December 31, 2019, compared with no borrowings on our revolving credit facility during 2018. +Interest Rate Risk +We are exposed to market risk due to the floating interest rate associated with any outstanding balance on our revolving credit facility. As of December 31, 2020, we had a $93.0 million balance on our revolving credit facility. Our Credit Agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the revolving credit facility’s fair value but will not impact results of operations or cash flows. Conversely, for the portion of the revolving credit facility that has a floating interest rate, interest rate changes will not affect the fair value but will impact future results of operations and cash flows. Changes in interest rates do not impact the amount of interest we pay on our fixed-rate Senior Unsecured Notes or fixed-rate Senior Secured Notes but can impact their fair values. As of December 31, 2020, our outstanding principal amount of fixed-rate debt totaled $2.2 billion and our floating-rate debt outstanding totaled $93.0 million. Please refer to Note 11 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion on the fair values of our Senior Notes. +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly impact our revenue, profitability, access to capital, and future rate of growth. Oil, gas, and NGL prices are subject to unpredictable fluctuations resulting from a variety of factors, including changes in supply and demand and the macroeconomic environment, all of which are typically beyond our control. The markets for oil, gas, and NGLs have been volatile, especially over the last several years. During the first half of 2020, oil, gas, and NGL prices weakened to historic lows as a result of the Pandemic and other macroeconomic events and will likely continue to be volatile in the future. The realized prices we receive for our production also depend on numerous factors that are typically beyond our control. Based on our 2020 production, a 10 percent decrease in our average realized oil, gas, and NGL prices, before the effects of derivative settlements, would have reduced our oil, gas, and NGL production revenues by approximately $85.4 million, $18.7 million, and $8.5 million, respectively. If commodity prices had been 10 percent lower, our net derivative settlements for the year ended December 31, 2020, would have offset the declines in oil, gas, and NGL production revenue by approximately $85.2 million. +53 +We enter into commodity derivative contracts in order to reduce the risk of fluctuations in commodity prices. The fair value of our commodity derivative contracts is largely determined by estimates of the forward curves of the relevant price indices. As of December 31, 2020, a 10 percent increase or decrease in the forward curves associated with our oil, gas, and NGL commodity derivative instruments would have changed our net derivative positions for these products by approximately $135.3 million, $28.0 million, and $7.5 million, respectively. +Off-Balance Sheet Arrangements +As part of our ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +We evaluate our transactions to determine if any variable interest entities exist. If we determine that we are the primary beneficiary of a variable interest entity, that entity is consolidated into our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions during 2020 or 2019, or through the filing of this report. +Critical Accounting Policies and Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with GAAP requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our consolidated financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate due to changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below, those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Successful Efforts Method of Accounting. GAAP provides two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method. Both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report. +Oil and Gas Reserve Quantities. Our estimated proved reserve quantities and future net cash flows are critical to understanding the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our consolidated financial statements, including the calculations of DD&A expense, impairment of proved and unproved oil and gas properties, and asset retirement obligations. Please refer to Oil and Gas Producing Activities in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report for additional discussion on our accounting policies impacted by estimated reserve quantities. +Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure of discounted future net cash flows calculation requires that a 10 percent discount rate be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir evaluation consulting firm, to audit at least 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year end. It should not be assumed that the standardized measure of discounted future net cash flows (GAAP) or PV-10 (non-GAAP) as of December 31, 2020, is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based these measures on the unweighted arithmetic average of the first-day-of-the-month price of each month within the trailing 12-month period ended December 31, 2020. Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimates. Please refer to Risk Factors in Part I, Item 1A of this report. +If the estimates of proved reserves decline, the rate at which we record DD&A expense will increase, which would reduce future net income. Changes in DD&A rate calculations caused by changes in reserve quantities are made prospectively. In addition, a decline in reserve estimates may impact the outcome of our assessment of proved and unproved properties for impairment. Impairments are recorded in the period in which they are identified. +54 +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2020 2019 2018 +MMBOE Change MMBOE Change MMBOE Change +Revisions resulting from performance 3.6 (14.9) (59.7) +Removal of proved undeveloped reserves no longer in our five-year development plan (65.0) (9.8) (22.6) +Revisions resulting from price changes (32.6) (70.0) 13.5 +Total (94.0) (94.7) (68.8) +____________________________________________ +Note: Amounts may not calculate due to rounding. +As previously noted, commodity prices are volatile and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. +We cannot reasonably predict future commodity prices, although we believe that together, the below analyses provide reasonable information regarding the impact of changes in pricing and trends on total estimated proved reserves. The following table reflects the estimated MMBOE change and percentage change to our total reported estimated proved reserve volumes from the described hypothetical changes: +For the year ended December 31, 2020 +MMBOE Change Percentage Change +10 percent decrease in SEC pricing (1) +(9.1) (2) % +Average NYMEX strip pricing as of fiscal year end (2) +13.3 3 % +10 percent decrease in proved undeveloped reserves (3) +(17.5) (4) % +____________________________________________ +(1) The change solely reflects the impact of a 10 percent decrease in SEC pricing to the total reported estimated proved reserve volumes as of December 31, 2020, and does not include additional impacts to our estimated proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. +(2) The change solely reflects the impact of replacing SEC pricing with the five-year average NYMEX strip pricing as of December 31, 2020, and does not include additional impacts to our estimated proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. As of December 31, 2020, SEC pricing was $39.57 per Bbl for oil, $1.99 per MMBtu for gas, and $17.64 per Bbl for NGLs, and five-year average NYMEX strip pricing was $46.16 per Bbl for oil, $2.54 per MMBtu for gas, and $20.45 per Bbl for NGLs. +(3) The change solely reflects a 10 percent decrease in proved undeveloped reserves as of December 31, 2020, and does not include any additional impacts to our estimated proved reserves. +Additional reserve information can be found in Reserves in Part I, Items 1 and 2 of this report, and in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Impairment of Oil and Gas Properties. Proved oil and gas properties are evaluated for impairment on a pool-by-pool basis and reduced to fair value when events or changes in circumstances indicate that their carrying amount may not be recoverable. We estimate the expected future cash flows of our proved oil and gas properties and compare these undiscounted cash flows to the carrying amount to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the proved oil and gas properties to fair value (or discounted future cash flows). Management estimates future cash flows from all proved reserves and risk adjusted probable and possible reserves using various factors, which are subject to our judgment and expertise, and include, but are not limited to, commodity price forecasts, estimated future operating and capital costs, development plans, and discount rates to incorporate the risk and current market conditions associated with realizing the expected cash flows. +Unproved oil and gas properties are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by asset group and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and our intent to renew leases. We estimate the fair value of unproved properties using a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve +55 +values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by us or other market participants. +We cannot predict when or if future impairment charges will be recorded because of the uncertainty in the factors discussed above. Despite any amount of future impairment being difficult to predict, based on our commodity price assumptions as of February 4, 2021, we do not expect any material oil and gas property impairments in the first quarter of 2021 resulting from commodity price impacts. +Please refer to Note 1 – Summary of Significant Accounting Policies and Note 11 – Fair Value Measurements in Part II, Item 8 of this report for discussion of impairments of oil and gas properties recorded for the years ended December 31, 2020, 2019, and 2018. +Fair Value of the Debt Exchange Transactions. The Exchange Offers executed in the second quarter of 2020 required significant judgment in evaluating the application of the applicable accounting guidance, and significant assumptions were made in estimating the fair value of the 2025 Senior Secured Notes and warrants issued. Please refer to Note 5 – Long-Term Debt and Note 11 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion and definitions. +Revenue Recognition. Effective January 1, 2018, our revenue recognition policy was updated to reflect the adoption of new accounting guidance. Our revenue recognition policy is a critical accounting policy because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. Our primary source of revenue is derived by the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when custody and title (“control”) of the product, as defined by contractual terms, transfers to the purchaser. Payment for these sales is typically received between 30 and 90 days after the date of production. At the end of each month, we make estimates of the amount of production delivered to the purchaser and the price we will receive. We use our knowledge of our properties, contractual arrangements, historical performance, NYMEX, local spot market, and OPIS prices, and other factors as the basis for these estimates. Variances between our estimates and the actual amounts received are recorded in the month payment is received. A 10 percent change in our revenue accrual at year end 2020 would have impacted total operating revenues by approximately $10.9 million in 2020. Please refer to Note 2 - Revenue from Contracts with Customers in Part II, Item 8 of this report for additional discussion. +Derivative Financial Instruments. We periodically enter into commodity derivative contracts to manage our exposure to oil, gas, and NGL price volatility and location differentials. We recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income (loss). The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our consolidated financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Income Taxes. We account for deferred income taxes, whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the consolidated financial statements and the tax basis of assets and liabilities, as measured using currently enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. We record deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period, as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement as well as significant enacted tax rate changes could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax benefit by approximately $9.6 million for the year ended December 31, 2020. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 4 – Income Taxes in Part II, Item 8 of this report for additional discussion. +Accounting Matters +Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for information on new authoritative accounting guidance. +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes, and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +56 +Hydraulic Fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, please refer to Risk Factors – Risks Related to Oil and Gas Operations and the Industry – Federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Climate Change. In June 2013, President Obama announced a Climate Action Plan designed to further reduce GHG emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Climate Action Plan targeted methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. As part of the Climate Action Plan, on May 12, 2016, the EPA issued final regulations that amend and expand 2012 regulations for the oil and gas sector by setting emission limits for VOCs and methane, a GHG, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The regulation requires, among other things, GHG and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly boosting and garnering compressor stations and gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. On September 14, and 15, 2020, the EPA finalized amendments to the 2012 and 2016 NSPS that removed transmission and storage infrastructure from regulation of methane emissions and other VOCs, as well as removed methane control requirements. The Biden administration has directed the EPA to review and consider revising or rescinding these 2020 amendments, which could result in reinstatement of the previously adopted regulations or potentially more stringent requirements. On November 16, 2016, the BLM finalized regulations to address methane emissions from oil and gas operations on federal and tribal lands, as part of President Obama’s Climate Action Plan. The regulations were intended to reduce the waste of gas from flaring, venting, and leaks by oil and gas production. The rule included requirements that prohibits venting of gas except in limited circumstances and limits flaring of gas and includes requirements for leak detection and repair. The rule also increased royalty payments for “waste” gas that is released in contravention of the rule requirements. After continuous court challenges, the BLM issued a final rule in September 2018 that rescinded most of the 2016 rule, including most of the methane control requirements. The 2016 rule was vacated by the District Court for the District of Wyoming. Any future regulations requiring similar capture standards may increase our operational costs, or restrict our production, which could materially and adversely affect our financial condition, results of operations, and cash flows. +In August of 2015, the EPA finalized existing source performance standards as stringent state emission “goals” for utilities to reduce GHG emissions. The proposed standards focus on re-dispatching electricity from coal-fired units to gas combined cycle plants and renewables. In February 2016, however, the Supreme Court stayed these rules pending judicial review. The Trump EPA proposed a repeal of the rule based on a new legal interpretation of the EPA’s authority. The Trump EPA also proposed a replacement rule, the Affordable Clean Energy Rule, in August 2018 and finalized the rule in June 2019. The D.C. Circuit struck down the Affordable Clean Energy Rule in January 2021. +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs and many of the states have already taken legal measures to reduce emissions of GHGs primarily through the planned development of GHG emission inventories and/or regional GHG cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall GHG emission reduction goal. In addition, there have been international conventions and efforts to establish standards for the reduction of GHGs globally, including the Paris accords in December 2015. The conditions for entry into force of the Paris accords were met on October 5, 2016 and the Agreement went into force 30 days later on November 4, 2016. On November 4, 2019, President Trump formally notified the United Nations that the United States would withdraw from the Paris Agreement. The November 4, 2019 formal notice triggered the start of a year-long withdrawal process. However, President Biden has signed a document pledging the United States’ entry back into the agreement. +The adoption of legislation or regulatory programs to reduce emissions of GHGs could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and gas we produce. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. Judicial challenges to new regulatory measures are likely and we cannot predict the outcome of such challenges. New regulatory suspensions, revisions, or rescissions and conflicting state and federal regulatory mandates may inhibit our ability to accurately forecast the costs associated with future regulatory compliance. Finally, scientists have concluded that increasing concentrations of GHGs in the earth’s atmosphere produce climate changes that likely have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. Such effects could have an adverse effect on our financial condition and results of operations. +In terms of opportunities, the regulation of GHG emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and gas that we produce, the relative demand for gas may increase because the burning of gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources, such as wind or solar power become more prevalent, gas-fired electric plants may provide an +57 +alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, gas may become a more attractive transportation fuel. Approximately 37 percent and 38 percent of our production on a BOE basis in 2020 and 2019, respectively, was gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and gas reservoirs, could also benefit us through the potential to obtain GHG emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +58 +Non-GAAP Financial Measures +Adjusted EBITDAX represents net income (loss) before interest expense, interest income, income taxes, depletion, depreciation, amortization and asset retirement obligation liability accretion expense, exploration expense, property abandonment and impairment expense, non-cash stock-based compensation expense, derivative gains and losses net of settlements, gains and losses on divestitures, gains and losses on extinguishment of debt, and certain other items. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally non-recurring in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that we believe provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for exploration, development, acquisitions, and to service debt. We are also subject to financial covenants under our Credit Agreement based on adjusted EBITDAX ratios as further described in the Credit Agreement section in Overview of Liquidity and Capital Resources above. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or other profitability or liquidity measures prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. Our revolving credit facility provides a material source of liquidity for us. Under the terms of our Credit Agreement, if we failed to comply with the covenants that establish a maximum permitted ratio of total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX, we would be in default, an event that would prevent us from borrowing under our revolving credit facility and would therefore materially limit a significant source of our liquidity. In addition, if we are in default under our revolving credit facility and are unable to obtain a waiver of that default from our lenders, lenders under the revolving credit facility and under the indentures governing each series of our outstanding Senior Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, would be entitled to exercise all of their remedies for default. +The following table provides reconciliations of our net income (loss) (GAAP) and net cash provided by operating activities (GAAP) to adjusted EBITDAX (non-GAAP) for the periods presented: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Net income (loss) (GAAP) $ (764,614) $ (187,001) $ 508,407 +Interest expense 163,892 159,102 160,906 +Income tax expense (benefit) (192,091) (44,043) 143,370 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 784,987 823,798 665,313 +Exploration (1) +37,541 46,995 49,627 +Impairment 1,016,013 33,842 49,889 +Stock-based compensation expense 14,999 24,318 23,908 +Net derivative (gain) loss (161,576) 97,539 (161,832) +Derivative settlement gain (loss) 351,261 39,222 (135,803) +Net gain on divestiture activity (91) (862) (426,917) +(Gain) loss on extinguishment of debt (280,081) — 26,740 +Other, net 5,165 481 (3,214) +Adjusted EBITDAX (non-GAAP) 975,405 993,391 900,394 +Interest expense (163,892) (159,102) (160,906) +Income tax (expense) benefit 192,091 44,043 (143,370) +Exploration (1) +(37,541) (46,995) (49,627) +Amortization of debt discount and deferred financing costs 17,704 15,474 15,258 +Deferred income taxes (192,540) (41,835) 141,708 +Other, net (11,874) 1,739 3,501 +Net change in working capital 11,591 16,852 13,671 +Net cash provided by operating activities (GAAP) $ 790,944 $ 823,567 $ 720,629 +____________________________________________ +(1) Stock-based compensation expense is a component of the exploration expense and general and administrative expense line items on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration expense. +59 +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this Item is provided under the captions Interest Rate Risk and Commodity Price Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place in Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +60 +ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries (the Company) as of December 31, 2020, and 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020, and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 18, 2021, expressed an unqualified opinion thereon. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +61 +Depletion, depreciation and amortization (‘DD&A’) of proved oil and gas properties +Description of the Matter +At December 31, 2020, the net book value of the Company’s proved oil and gas properties was $3.7 billion, and depletion, depreciation, amortization, and asset retirement obligation liability accretion was $785.0 million for the year then ended. As described in Note 1 to the consolidated financial statements, under the successful efforts method of accounting, the costs of development wells are capitalized whether those wells are successful or unsuccessful. Capitalized drilling and completion costs, including lease and well equipment, intangible development costs, and operational support facilities in the field are depleted as a group of assets using the units-of-production method based on proved developed oil and gas reserves, as estimated by the Company’s engineering technical team. Similarly, proved leasehold costs are depleted on the same group asset basis; however, the units-of-production method is based on total proved oil and gas reserves, as estimated by the Company’s engineering technical team. Significant judgment is required by the Company’s engineering technical team in evaluating geoscience and engineering data when estimating proved oil and gas reserves. Estimating reserves also requires the use of inputs, including oil and gas prices and operating and capital costs assumptions, among others. Because of the complexity involved in estimating oil and gas reserves, management used an independent petroleum engineering consulting firm to audit the estimates prepared by the Company’s engineering technical team for at least 80% of the Company’s total calculated proved reserve PV-10 as of December 31, 2020. +Auditing the Company’s DD&A calculation is especially complex and judgmental because of our use of the work of the Company’s engineering technical team and independent petroleum engineering consulting firm and the evaluation of management’s determination of the inputs described above used by the engineering technical team and independent petroleum engineering consulting firm in estimating proved oil and gas reserves. +How We Addressed the Matter in Our Audit +We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s process to calculate DD&A, including management’s controls over the completeness and accuracy of the financial data provided to the Company’s engineering technical team and independent petroleum engineering consulting firm for use in estimating proved oil and gas reserves. +Our audit procedures included, among others, evaluating the professional qualifications and objectivity of the engineering technical team primarily responsible for overseeing the preparation of the reserve estimates and the independent petroleum engineering consulting firm used to audit the estimates. In addition, in assessing whether we can use the work of the Company’s engineering technical team and independent petroleum engineering consulting firm we evaluated the completeness and accuracy of the financial data and inputs described above used by the engineering technical team and independent petroleum engineering consulting firm in estimating proved oil and gas reserves by agreeing them to source documentation and we identified and evaluated corroborative and contrary evidence. We also tested the mathematical accuracy of the DD&A calculations, including comparing the proved oil and gas reserve amounts used to the Company’s reserve report. +Impairment of proved oil and gas properties and related support equipment +Description of the Matter +As described in Note 1 and Note 11 to the consolidated financial statements, the Company concluded its South Texas proved oil and gas properties and related support facilities were impaired and recognized a $956.7 million impairment charge. Proved properties are evaluated periodically for impairment on a pool-by-pool basis when events or changes in circumstances indicate that a decline in the recoverability of their carrying value may have occurred. If the carrying amount exceeds the estimated undiscounted future cash flows, the Company will write down the carrying amount of the oil and gas properties to fair value. +Auditing the Company’s impairment analysis involved subjectivity due to the significant estimation required to estimate the fair value of the South Texas proved properties. In particular, the determination of fair value included significant judgement and assumptions including discount rate, price and cost forecasts and certain reserve risk-adjustment factors, which are affected by expectations about future market and economic conditions. In addition, the identification of proved properties and anticipated production volumes developed by the Company's engineering technical team in conjunction with the reserve estimates described in the preceding critical audit matter, are used as inputs in the cash flow model. +62 +How We Addressed the Matter in Our Audit +We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s process to determine the fair value of the assets and measure the impairment. This included controls over management's review of the significant assumptions underlying the fair value determination and of the completeness and accuracy of the data used in the determination of the fair value. +Our audit procedures included, among others, evaluating the significant assumptions and testing the completeness and accuracy of underlying data used in the calculation of the fair value, including identifying corroborative and contrary evidence. We evaluated the professional qualifications and objectivity of the engineering technical team primarily responsible for overseeing the preparation of the estimated proved reserves and risk adjusted probable and possible reserves used in the valuation. Further, we involved valuation specialists to assist in evaluating the appropriateness of the valuation methodologies applied and certain significant assumptions used to determine the fair value of the properties, including discount rate and commodity price forecasts. +Debt exchange +Description of the Matter +As described in Note 5 to the consolidated financial statements, in June 2020, the Company exchanged $611.9 million in Senior Unsecured Notes and $107.0 million in 2021 Senior Convertible Notes for $446.7 million of 2025 Senior Secured Notes, as well as (a) $53.5 million in cash to certain holders of the 2021 Senior Convertible Notes and (b) warrants to acquire up to approximately 5.9 million shares of the Company’s outstanding common stock to certain holders exercisable upon the occurrence of certain future triggering events. As a result, the Company recorded the 2025 Senior Secured Notes on the balance sheet at fair value of $405.0 million, the warrants as additional paid-in capital at a fair value of $21.5 million and recognized a gain on extinguishment of debt of $227.3 million. +Auditing the Company’s accounting for the debt exchange was especially complex and judgmental due to the significant judgement required to evaluate the Company’s application of the applicable accounting guidance and to determine the fair value of the 2025 Senior Secured Notes and warrants issued in the debt exchange. +How We Addressed the Matter in Our Audit +We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s debt issuance and settlement processes, including controls over management’s evaluation and application of the applicable accounting guidance and review of significant assumptions underlying the determination of fair value of the 2025 Senior Secured Notes and warrants issued in the debt exchange. +Our audit procedures included, among others, inspecting the relevant agreements and evaluating management’s analysis of the applicable accounting guidance. We evaluated the significant assumptions and tested the completeness and accuracy of underlying data used in the determination of the fair value of the 2025 Senior Secured Notes and warrants issued in the debt exchange. Further, we involved valuation specialists to assist in evaluating the appropriateness of the valuation methodologies applied and certain significant assumptions used to determine the fair value of the 2025 Senior Secured Notes and warrants. +/s/ Ernst & Young LLP +We have served as the Company’s auditor since 2012. +Denver, Colorado +February 18, 2021 +63 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2020 2019 +ASSETS +Current assets: +Cash and cash equivalents $ 10 $ 10 +Accounts receivable 162,455 184,732 +Derivative assets 31,203 55,184 +Prepaid expenses and other 10,001 12,708 +Total current assets 203,669 252,634 +Property and equipment (successful efforts method): +Proved oil and gas properties 8,608,522 8,934,020 +Accumulated depletion, depreciation, and amortization ( 4,886,973 ) ( 4,177,876 ) +Unproved oil and gas properties 714,602 1,005,887 +Wells in progress 233,498 118,769 +Other property and equipment, net of accumulated depreciation of $ 63,662 and $ 64,032 , respectively +32,217 72,848 +Total property and equipment, net 4,701,866 5,953,648 +Noncurrent assets: +Derivative assets 23,150 20,624 +Other noncurrent assets 47,746 65,326 +Total noncurrent assets 70,896 85,950 +Total assets $ 4,976,431 $ 6,292,232 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable and accrued expenses $ 371,670 $ 402,008 +Derivative liabilities 200,189 50,846 +Other current liabilities 11,880 19,189 +Total current liabilities 583,739 472,043 +Noncurrent liabilities: +Revolving credit facility 93,000 122,500 +Senior Notes, net 2,121,319 2,610,298 +Asset retirement obligations 83,325 84,134 +Deferred income taxes — 189,386 +Derivative liabilities 22,331 3,444 +Other noncurrent liabilities 56,557 61,433 +Total noncurrent liabilities 2,376,532 3,071,195 +Commitments and contingencies (note 6) +Stockholders’ equity: +Common stock, $ 0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 114,742,304 and 112,987,952 shares, respectively +1,147 1,130 +Additional paid-in capital 1,827,914 1,791,596 +Retained earnings 200,697 967,587 +Accumulated other comprehensive loss ( 13,598 ) ( 11,319 ) +Total stockholders’ equity 2,016,160 2,748,994 +Total liabilities and stockholders’ equity $ 4,976,431 $ 6,292,232 +The accompanying notes are an integral part of these consolidated financial statements. +64 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +For the Years Ended +December 31, +2020 2019 2018 +Operating revenues and other income: +Oil, gas, and NGL production revenue $ 1,126,188 $ 1,585,750 $ 1,636,357 +Net gain on divestiture activity 91 862 426,917 +Other operating revenues 394 3,493 3,798 +Total operating revenues and other income 1,126,673 1,590,105 2,067,072 +Operating expenses: +Oil, gas, and NGL production expense 391,217 500,709 487,367 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 784,987 823,798 665,313 +Exploration 40,997 51,500 55,166 +Impairment 1,016,013 33,842 49,889 +General and administrative 99,160 132,797 116,504 +Net derivative (gain) loss ( 161,576 ) 97,539 ( 161,832 ) +Other operating expense, net 24,825 19,888 18,328 +Total operating expenses 2,195,623 1,660,073 1,230,735 +Income (loss) from operations ( 1,068,950 ) ( 69,968 ) 836,337 +Interest expense ( 163,892 ) ( 159,102 ) ( 160,906 ) +Net gain (loss) on extinguishment of debt 280,081 — ( 26,740 ) +Other non-operating income (expense), net ( 3,944 ) ( 1,974 ) 3,086 +Income (loss) before income taxes ( 956,705 ) ( 231,044 ) 651,777 +Income tax (expense) benefit 192,091 44,043 ( 143,370 ) +Net income (loss) $ ( 764,614 ) $ ( 187,001 ) $ 508,407 +Basic weighted-average common shares outstanding 113,730 112,544 111,912 +Diluted weighted-average common shares outstanding 113,730 112,544 113,502 +Basic net income (loss) per common share $ ( 6.72 ) $ ( 1.66 ) $ 4.54 +Diluted net income (loss) per common share $ ( 6.72 ) $ ( 1.66 ) $ 4.48 +The accompanying notes are an integral part of these consolidated financial statements. +65 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +For the Years Ended +December 31, +2020 2019 2018 +Net income (loss) $ ( 764,614 ) $ ( 187,001 ) $ 508,407 +Other comprehensive income (loss), net of tax: +Pension liability adjustment (1) +( 2,279 ) 1,061 4,378 +Total other comprehensive income (loss), net of tax ( 2,279 ) 1,061 4,378 +Total comprehensive income (loss) $ ( 766,893 ) $ ( 185,940 ) $ 512,785 +____________________________________________ +(1) Please refer to Note 8 – Pension Benefits for additional discussion of the pension liability adjustment. +The accompanying notes are an integral part of these consolidated financial statements. +66 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share data and dividends per share) +Additional Paid-in Capital Accumulated Other Comprehensive Loss Total Stockholders’ Equity +Common Stock Retained Earnings +Shares Amount +Balances, January 1, 2018 111,687,016 $ 1,117 $ 1,741,623 $ 665,657 $ ( 13,789 ) $ 2,394,608 +Net income — — — 508,407 — 508,407 +Other comprehensive income — — — — 4,378 4,378 +Cash dividends, $ 0.10 per share +— — — ( 11,191 ) — ( 11,191 ) +Issuance of common stock under Employee Stock Purchase Plan 199,464 2 3,185 — — 3,187 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings 291,745 3 ( 2,978 ) — — ( 2,975 ) +Stock-based compensation expense 63,741 — 23,908 — — 23,908 +Cumulative effect of accounting change — — — 2,969 ( 2,969 ) — +Balances, December 31, 2018 112,241,966 $ 1,122 $ 1,765,738 $ 1,165,842 $ ( 12,380 ) $ 2,920,322 +Net loss — — — ( 187,001 ) — ( 187,001 ) +Other comprehensive income — — — — 1,061 1,061 +Cash dividends, $ 0.10 per share +— — — ( 11,254 ) — ( 11,254 ) +Issuance of common stock under Employee Stock Purchase Plan 314,868 3 3,206 — — 3,209 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings 334,399 4 ( 1,665 ) — — ( 1,661 ) +Stock-based compensation expense 96,719 1 24,317 — — 24,318 +Balances, December 31, 2019 112,987,952 $ 1,130 $ 1,791,596 $ 967,587 $ ( 11,319 ) $ 2,748,994 +Net loss — — — ( 764,614 ) — ( 764,614 ) +Other comprehensive loss — — — — ( 2,279 ) ( 2,279 ) +Cash dividends, $ 0.02 per share +— — — ( 2,276 ) — ( 2,276 ) +Issuance of common stock under Employee Stock Purchase Plan 464,757 4 1,460 — — 1,464 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings 1,022,019 10 ( 1,570 ) — — ( 1,560 ) +Stock-based compensation expense 267,576 3 14,996 — — 14,999 +Issuance of Warrants — — 21,520 — — 21,520 +Other — — ( 88 ) — — ( 88 ) +Balances, December 31, 2020 114,742,304 $ 1,147 $ 1,827,914 $ 200,697 $ ( 13,598 ) $ 2,016,160 +The accompanying notes are an integral part of these consolidated financial statements. +67 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2020 2019 2018 +Cash flows from operating activities: +Net income (loss) $ ( 764,614 ) $ ( 187,001 ) $ 508,407 +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Net gain on divestiture activity ( 91 ) ( 862 ) ( 426,917 ) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 784,987 823,798 665,313 +Impairment 1,016,013 33,842 49,889 +Stock-based compensation expense 14,999 24,318 23,908 +Net derivative (gain) loss ( 161,576 ) 97,539 ( 161,832 ) +Derivative settlement gain (loss) 351,261 39,222 ( 135,803 ) +Amortization of debt discount and deferred financing costs 17,704 15,474 15,258 +(Gain) loss on extinguishment of debt ( 280,081 ) — 26,740 +Deferred income taxes ( 192,540 ) ( 41,835 ) 141,708 +Other, net ( 6,709 ) 2,220 287 +Changes in working capital: +Accounts receivable 29,100 ( 39,556 ) ( 20,775 ) +Prepaid expenses and other 5,873 6,130 ( 729 ) +Accounts payable and accrued expenses ( 23,382 ) 50,278 35,175 +Net cash provided by operating activities 790,944 823,567 720,629 +Cash flows from investing activities: +Net proceeds from the sale of oil and gas properties 92 13,059 748,509 +Capital expenditures ( 547,785 ) ( 1,023,769 ) ( 1,303,188 ) +Acquisition of proved and unproved oil and gas properties ( 7,873 ) ( 2,581 ) ( 33,255 ) +Net cash used in investing activities ( 555,566 ) ( 1,013,291 ) ( 587,934 ) +Cash flows from financing activities: +Proceeds from revolving credit facility 1,447,000 1,589,000 — +Repayment of revolving credit facility ( 1,476,500 ) ( 1,466,500 ) — +Debt issuance costs related to 10.0% Senior Secured Notes due 2025 ( 13,069 ) — — +Net proceeds from Senior Notes — — 492,079 +Cash paid to repurchase Senior Notes ( 189,998 ) — ( 845,002 ) +Net proceeds from sale of common stock 1,464 3,209 3,187 +Dividends paid ( 2,276 ) ( 11,254 ) ( 11,191 ) +Other, net ( 1,999 ) ( 2,686 ) ( 7,746 ) +Net cash provided by (used in) financing activities ( 235,378 ) 111,769 ( 368,673 ) +Net change in cash, cash equivalents, and restricted cash — ( 77,955 ) ( 235,978 ) +Cash, cash equivalents, and restricted cash at beginning of period 10 77,965 313,943 +Cash, cash equivalents, and restricted cash at end of period $ 10 $ 10 $ 77,965 +Supplemental schedule of additional cash flow information and non-cash activities: +Operating activities: +Cash paid for interest, net of capitalized interest $ ( 140,493 ) $ ( 141,902 ) $ ( 150,727 ) +Net cash (paid) refunded for income taxes $ 6,664 $ 6,109 $ ( 2,995 ) +Investing activities: +Decrease in capital expenditure accruals and other $ ( 7,965 ) $ ( 24,289 ) $ ( 2,774 ) +Non-cash investing and financing activities (1)(2) +____________________________________________ +(1) Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale for discussion of the carrying value of properties exchanged during the years ended December 31, 2020, 2019, and 2018. +(2) Please refer to Note 5 – Long-Term Debt for discussion of the debt transactions executed during the years ended December 31, 2020, and 2018. +The accompanying notes are an integral part of these consolidated financial statements. +68 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company, together with its consolidated subsidiaries, is an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Intercompany accounts and transactions have been eliminated. In connection with the preparation of the accompanying consolidated financial statements, the Company evaluated events subsequent to the balance sheet date of December 31, 2020, through the filing of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the accompanying consolidated financial statements. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of DD&A expense, impairment of proved and unproved oil and gas properties, and asset retirement obligations, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents +The Company considers all liquid investments purchased with an initial maturity of three months or less to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. +Accounts Receivable +The Company’s accounts receivable primarily consists of receivables due from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables due from joint interest owners, the Company generally has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil, gas, and NGL receivables are collected within 30 to 90 days and the Company has had minimal bad debts. +Although diversified among many companies, collectibility is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. Please refer to Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses for additional disclosure. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to regular review. +69 +The Company does not believe the loss of any single purchaser of its production would materially impact its operating results, as oil, gas, and NGLs are products with well-established markets and numerous purchasers in the Company’s operating areas. The following major customers and entities under common control accounted for 10 percent or more of the Company’s total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2020 2019 2018 +Major customer #1 (1) +— % 18 % 18 % +Major customer #2 (1) +20 % 14 % 5 % +Major customer #3 (1) +24 % 13 % 7 % +Major customer #4 (1) +6 % 9 % 10 % +Major customer #5 (1) +15 % 4 % — % +Group #1 of entities under common control (2) +5 % 13 % 18 % +Group #2 of entities under common control (2) +7 % 11 % 12 % +____________________________________________ +(1) These major customers are purchasers of a portion of the Company’s production from its Midland Basin assets and South Texas assets. +(2) In the aggregate, these groups of entities under common control represented purchasers of more than 10% of total oil, gas, and NGL production revenue for at least one of the periods presented; however, no individual entity comprising either group was a purchaser of more than 10% of the Company’s total oil, gas, and NGL production revenue. +The Company generally contracts with the affiliates of the lenders under its Credit Agreement as its derivative counterparties, and the Company’s policy is that each counterparty must have certain minimum investment grade senior unsecured debt ratings. +The Company maintains its primary bank accounts with a large, multinational bank that has branch locations in the Company’s areas of operations. The Company’s policy is to diversify its concentration of cash and cash equivalent investments among multiple institutions and investment products to limit the amount of credit exposure to any single institution or investment. +Oil and Gas Producing Activities +Proved properties . The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, the costs of development wells are capitalized whether those wells are successful or unsuccessful. Capitalized drilling and completion costs, including lease and well equipment, intangible development costs, and operational support facilities in the field, are depleted on an asset group basis (properties aggregated based on geographical and geological characteristics) using the units-of-production method based on estimated proved developed oil and gas reserves. Similarly, proved leasehold costs are depleted on the same asset group basis; however, the units-of-production method is based on estimated total proved oil and gas reserves. The computation of DD&A expense takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. +Proved oil and gas property costs are evaluated for impairment on a pool-by-pool basis and reduced to fair value when there is an indication that associated carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique, which converts future cash flows to a single present value amount, to measure the fair value of proved properties using a discount rate, price and cost forecasts, and certain reserve risk-adjustment factors, as selected by the Company’s management. The Company uses a discount rate that represents a current market-based weighted average cost of capital. The discount rate typically ranges from 10 percent to 15 percent. The prices for oil and gas are forecasted based on NYMEX strip pricing, adjusted for basis differentials, for the first five years , after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecasted using OPIS Mont Belvieu pricing, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. Certain undeveloped reserve estimates are also risk-adjusted given the risk to related projected cash flows due to performance and exploitation uncertainties. +The partial sale of a proved property within an existing field is accounted for as a normal retirement and no net gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A net gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of proved properties. +Unproved properties . The unproved oil and gas properties line item on the accompanying consolidated balance sheets (“accompanying balance sheets”) consists of the costs incurred to acquire unproved leases. Leasehold costs allocated to those leases, or partial leases that have associated proved reserves recorded, are reclassified to proved properties and depleted on an asset group basis using the units-of-production method based on estimated total proved oil and gas reserves. Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by asset group and the portion of such costs estimated to be +70 +nonproductive prior to lease expiration are recognized as a valuation allowance and amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and the Company’s intent to renew leases. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk-weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +For the sale of unproved properties where the original cost has been partially or fully amortized by providing a valuation allowance on an asset group basis, neither a gain nor loss is recognized unless the sales price exceeds the original cost of the property, in which case a gain shall be recognized in the accompanying statements of operations in the amount of such excess. +Exploratory . Exploratory geological and geophysical, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Under the successful efforts method, exploratory well costs are capitalized pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are found, exploratory well costs will be capitalized as proved properties and will be accounted for following the successful efforts method of accounting described above. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that economic proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in the cash flows from investing activities section as part of capital expenditures within the accompanying statements of cash flows. +Please refer to Note 11 – Fair Value Measurements for additional information. +Other Property and Equipment +Other property and equipment such as facilities, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing, and installation activities. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from 3 to 30 years, or the unit of output method when appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the accounts. +Other property and equipment costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. To measure the fair value of other property and equipment, the Company uses an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. The valuation includes consideration of the proved and unproved assets supported by the property and equipment, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties, including facilities requiring decommissioning. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired, or a facility is constructed. The increase in carrying value is included in the proved oil and gas properties line item in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective long-lived assets. Cash paid to settle asset retirement obligations is included in the cash flows from operating activities section of the accompanying statements of cash flows. +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent. In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or economic life, or changes in inflation factors or the Company’s credit-adjusted risk-free rate as market conditions warrant. Please refer to Note 14 – Asset Retirement Obligations for a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2020, and 2019. +71 +Derivative Financial Instruments +The Company periodically enters into commodity derivative instruments to mitigate a portion of its exposure to potentially adverse market changes in commodity prices for its expected future oil, natural gas, and NGL production and the associated impact on cash flows. These instruments typically include commodity price swaps and costless collars, as well as, basis differential and roll differential swaps. Commodity derivative instruments are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its commodity derivative contracts as hedging instruments. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its accompanying statements of operations as they occur. Gains and losses on derivatives are included within the cash flows from operating activities section of the accompanying statements of cash flows. For additional discussion on derivatives, please refer to Note 10 – Derivative Financial Instruments . +Revenue Recognition +The Company derives revenue primarily from the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when custody and title (“control”) of the product transfers to the purchaser, which may differ depending on the applicable contractual terms. Revenue accruals are recorded monthly and are based on estimated production delivered to a purchaser and the expected price to be received. Variances between estimates and the actual amounts received are recorded in the month payment is received. Please refer to Note 2 - Revenue from Contracts with Customers for additional discussion. +Stock-Based Compensation +At December 31, 2020, the Company had stock-based employee compensation plans that included RSUs and PSUs issued to employees, RSUs and restricted stock issued to non-employee directors, and an employee stock purchase plan available to eligible employees. These are more fully described in Note 7 – Compensation Plans. The Company records expense associated with the fair value of stock-based compensation in accordance with authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant, and is included within the general and administrative and exploration expense line items in the accompanying statements of operations. For stock-based compensation awards containing non-market based performance conditions, the Company evaluates the probability of the number of shares that are expected to vest, and then adjusts the expense to reflect the number of shares expected to vest and the cumulative vesting period met to date. Further, the Company accounts for forfeitures of stock-based compensation awards as they occur. +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the accompanying consolidated financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. The cumulative effect of enacted tax rate changes on the net balance of reported amounts of assets and liabilities is recognized in the period of enactment. Please refer to Note 4 – Income Taxes for additional discussion. +Earnings per Share +The Company uses the treasury stock method to determine the effect of potentially dilutive instruments. Please refer to Note 9 - Earnings Per Share for additional discussion. +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income (loss) (“accompanying statements of comprehensive income (loss)”). The Company’s policy for releasing income tax effects within accumulated other comprehensive loss is an incremental, unit-of-account approach. Please refer to Note 8 – Pension Benefits for detail on the changes in the balances of components comprising other comprehensive income (loss). +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The recorded value of the Company’s revolving credit facility approximates its fair value as it bears interest at a floating rate that approximates a current market rate. The Company had a $ 93.0 million balance under its revolving credit facility as of December 31, 2020, compared with a $ 122.5 +72 +million balance as of December 31, 2019. The Company’s Senior Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, are recorded at cost, net of any unamortized discount and deferred financing costs, and their respective fair values are disclosed in Note 11 – Fair Value Measurements. The Company’s warrants were recorded at fair value upon issuance, with no recurring fair value measurement required. Additionally, the Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry, onshore in the United States. The Company reports as a single industry segment. +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or SPEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that the Company is the primary beneficiary of a variable interest entity, that entity is consolidated. The Company has not been involved in any unconsolidated SPE transactions in 2020 or 2019. +Recently Issued Accounting Standards +In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842) , followed by other related ASUs that provided targeted improvements and additional practical expedient options (collectively “ASU 2016-02” or “Topic 842”). The Company adopted ASU 2016-02 on January 1, 2019, using the modified retrospective method. The Company elected as part of its adoption to also use the optional transition methodology whereby lease accounting for previously reported periods continues to be reported in accordance with historical accounting guidance for leases in effect for those prior periods. Policy elections and practical expedients the Company implemented in connection with the adoption of ASU 2016-02 include (a) excluding from the balance sheet leases with terms that are less than one year, (b) for agreements that contain both lease and non-lease components, combining these components together and accounting for them as a single lease, (c) the package of practical expedients, which among other requirements, allows the Company to avoid reassessing contracts that commenced prior to adoption that were properly evaluated under legacy GAAP, and (d) excluding land easements that existed or expired before adoption of ASU 2016-02. The scope of ASU 2016-02 does not apply to leases used in the exploration or use of minerals, oil, natural gas, or other similar non-regenerative resources. +Upon adoption on January 1, 2019, the Company recognized approximately $ 50.0 million in right-of-use (“ROU”) assets and related lease liabilities for its operating leases. There was no cumulative effect adjustment to retained earnings upon the adoption of this guidance. Please refer to Note 12 - Leases for additional discussion. +In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , followed by other related ASUs that provided targeted improvements (collectively “ASU 2016-13”). ASU 2016-13 provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The Company adopted ASU 2016-13 on January 1, 2020, using the modified retrospective method, and there was no material impact to the Company’s accompanying consolidated financial statements or related disclosures. +In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company adopted ASU 2018-15 on January 1, 2020, with prospective application, and there was no material impact to the Company’s accompanying consolidated financial statements or related disclosures. +In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 was issued as a means to reduce the complexity of accounting for income taxes for those entities that fall within the scope of the accounting standard. The guidance is to be applied using a prospective method, excluding amendments related to franchise taxes, which should be applied on either a retrospective basis for all periods presented or a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. The Company adopted ASU 2019-12 on January 1, 2020, and there was no material impact on the Company’s accompanying consolidated financial statements or related disclosures. +73 +In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”) followed by ASU No. 2021-01, Reference Rate Reform (Topic 848): Scope (“ASU 2021-01”), issued in January 2021 to provide clarifying guidance regarding the scope of Topic 848. ASU 2020-04 was issued to provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. Generally, the guidance is to be applied as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. ASU 2020-04 and ASU 2021-01 are effective for all entities through December 31, 2022. As of December 31, 2020, the Company has not elected to use the optional guidance and continues to evaluate the options provided by ASU 2020-04 and ASU 2021-01. Please refer to Note 5 – Long-Term Debt for discussion of the use of the LIBOR in connection with borrowings under the Credit Agreement. +In August 2020, the FASB issued ASU No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40) (“ASU 2020-06”). ASU 2020-06 was issued to reduce the complexity associated with accounting for certain financial instruments with characteristics of liabilities and equity. The guidance is to be applied using either a modified retrospective or a fully retrospective method. ASU 2020-06 is effective for fiscal years beginning after December 15, 2021, with early adoption permitted. The Company plans to adopt ASU 2020-06 on January 1, 2022, and does not expect a material impact on the Company’s accompanying consolidated financial statements or related disclosures. +There are no other ASUs applicable to the Company that would have a material effect on the Company’s consolidated financial statements and related disclosures that have been issued but not yet adopted by the Company as of December 31, 2020, and through the filing of this report. +Note 2 - Revenue from Contracts with Customers +The Company recognizes its share of revenue from the sale of produced oil, gas, and NGLs from its Midland Basin and South Texas assets. Oil, gas, and NGL production revenue presented within the accompanying statements of operations is reflective of the revenue generated from contracts with customers. +The tables below present oil, gas, and NGL production revenue by product type for each of the Company’s operating areas for the years ended December 31, 2020, 2019, and 2018: +For the year ended December 31, 2020 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 802,494 $ 51,074 $ 853,568 +Gas production revenue 76,759 110,700 187,459 +NGL production revenue 324 84,837 85,161 +Total $ 879,577 $ 246,611 $ 1,126,188 +Relative percentage 78 % 22 % 100 % +____________________________________________ +Note: Amounts may not calculate due to rounding. +For the year ended December 31, 2019 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 1,119,786 $ 63,426 $ 1,183,212 +Gas production revenue 75,827 186,702 262,529 +NGL production revenue 123 139,886 140,009 +Total $ 1,195,736 $ 390,014 $ 1,585,750 +Relative percentage 75 % 25 % 100 % +____________________________________________ +Note: Amounts may not calculate due to rounding. +74 +For the year ended December 31, 2018 +Midland Basin South Texas +Rocky Mountain (1) +Total +(in thousands) +Oil production revenue $ 938,004 $ 72,821 $ 54,851 $ 1,065,676 +Gas production revenue 125,603 227,252 1,595 354,450 +NGL production revenue 1,000 214,441 790 216,231 +Total $ 1,064,607 $ 514,514 $ 57,236 $ 1,636,357 +Relative percentage 65 % 32 % 3 % 100 % +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) Following the divestiture of the Company’s remaining assets in the Rocky Mountain region during the first half of 2018, there has been no production revenue from this region after the second quarter of 2018. +The Company recognizes oil, gas, and NGL production revenue at the point in time when custody and title (“control”) of the product transfers to the purchaser, which differs depending on the applicable contractual terms. Transfer of control drives the presentation of transportation, gathering, processing, and other post-production expenses (“fees and other deductions”) within the accompanying statements of operations. Fees and other deductions incurred by the Company prior to control transfer are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. When control is transferred at or near the wellhead, sales are based on a wellhead market price that is impacted by fees and other deductions incurred by the purchaser subsequent to the transfer of control. In general, the Company generates production revenue from a combination of the following types of contracts: +• The Company sells oil and gas production at or near the wellhead and receives an agreed-upon market price from the purchaser. Under this type of arrangement, control transfers at or near the wellhead. +• The Company has certain processing arrangements that include the delivery of unprocessed gas to a midstream processor’s facility for processing. Upon completion of processing, the midstream processor purchases the NGLs and redelivers residue gas back to the Company in-kind. For the NGLs extracted during processing, the midstream processor remits payment to the Company. For the residue gas taken in-kind, the Company has separate sales contracts where control transfers at points downstream of the processing facility. The Company also has certain oil sales that occur at market locations downstream of the production area. Given the structure of these arrangements and where control transfers, the Company separately recognizes fees and other deductions incurred prior to control transfer. These fees are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. +Significant judgments made in applying the guidance in ASC Topic 606, Revenue from Contracts with Customers, relate to the point in time when control transfers to purchasers in gas processing arrangements with midstream processors. The Company does not believe that significant judgments are required with respect to the determination of the transaction price, including amounts that represent variable consideration, as volume and price carry a low level of estimation uncertainty given the precision of volumetric measurements and the use of index pricing with generally predictable differentials. Accordingly, the Company does not consider estimates of variable consideration to be constrained. +The Company’s performance obligations arise upon the production of hydrocarbons from wells in which the Company has an ownership interest. The performance obligations are considered satisfied upon control transferring to a purchaser at the wellhead, inlet, or tailgate of the midstream processor’s processing facility, or other contractually specified delivery point. The time period between production and satisfaction of performance obligations is generally less than one day; thus, there are no material unsatisfied or partially unsatisfied performance obligations at the end of the reporting period. +Revenue is recorded in the month when performance obligations are satisfied. However, settlement statements from the purchasers of hydrocarbons and the related cash consideration are received 30 to 90 days after production has occurred. As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the product. Estimated revenue due to the Company is recorded within the accounts receivable line item on the accompanying balance sheets until payment is received. The accounts receivable balances from contracts with customers within the accompanying balance sheets as of December 31, 2020, and 2019, were $ 108.9 million and $ 146.3 million, respectively. To estimate accounts receivable from contracts with customers, the Company uses knowledge of its properties, historical performance, contractual arrangements, index pricing, quality and transportation differentials, and other factors as the basis for these estimates. Differences between estimates and actual amounts received for product sales are recorded in the month that payment is received from the purchaser. +75 +Note 3 – Acquisitions, Divestitures, and Assets Held for Sale +2020 Acquisition Activity +During the third quarter of 2020, the Company completed a non-monetary acreage trade of primarily undeveloped properties located in Upton County, Texas, resulting in the exchange of approximately 535 net acres, with $ 6.5 million of carrying value attributed to the properties transferred by the Company. This trade was recorded at carryover basis with no gain or loss recognized. +During the year ended December 31, 2020, the Company acquired approximately 380 net acres of proved and unproved properties located in Martin County, Texas, in two separate transactions which closed in 2020. Combined total cash consideration paid by the Company was $ 7.9 million. +2019 Acquisition Activity +During 2019, the Company completed several non-monetary acreage trades of primarily undeveloped properties located in Howard, Martin, and Midland Counties, Texas, resulting in the exchange of approximately 2,200 net acres, with $ 73.4 million of carrying value attributed to the properties transferred by the Company. These trades were recorded at carryover basis with no gain or loss recognized. +2018 Acquisition Activity +During the year ended December 31, 2018, the Company acquired approximately 1,030 net acres of primarily unproved properties located in Howard and Martin Counties, Texas, in two separate transactions which closed in 2018. Combined total cash consideration paid by the Company was $ 33.3 million. Under authoritative accounting guidance, these transactions were both individually considered to be asset acquisitions. Therefore, the properties were recorded based on the fair value of the total consideration transferred on the acquisition date and the transaction costs were capitalized as a component of the cost of the assets acquired. +During the third quarter of 2018, the Company completed two non-monetary acreage trades of primarily undeveloped properties located in Howard and Martin Counties, Texas, which resulted in the exchange of approximately 2,650 net acres, with $ 95.1 million of carrying value attributed to the properties transferred by the Company. These trades were recorded at carryover basis with no gain or loss recognized. +2018 Divestiture Activity +PRB Divestiture. On March 26, 2018, the Company completed the PRB Divestiture, divesting of approximately 112,000 net acres for total cash received at closing, net of costs (“net divestiture proceeds”), of $ 492.2 million, and recorded a final net gain of $ 410.6 million for the year ended December 31, 2018. +Divide County Divestiture and Halff East Divestiture. During the second quarter of 2018, the Company completed the Divide County Divestiture and the Halff East Divestiture, for combined net divestiture proceeds of $ 252.2 million, and recorded a combined final net gain of $ 15.4 million for the year ended December 31, 2018. +The Divide County Divestiture was considered a disposal of a significant asset group. The loss before income taxes from the Divide County, North Dakota assets sold for the year ended December 31, 2018, was $ 29.0 million. Loss before income taxes reflects oil, gas, and NGL production revenue, less oil, gas, and NGL production expense, depletion, depreciation, amortization, and asset retirement obligation liability accretion expense, impairment expense, and net loss on divestiture activity. +The Company determined that executed asset sales in 2018 did not qualify for discontinued operations accounting under financial statement presentation authoritative guidance. +76 +Note 4 – Income Taxes +The provision for income taxes consists of the following: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Current portion of income tax (expense) benefit +Federal +$ — $ 3,826 $ — +State +( 449 ) ( 1,618 ) ( 1,662 ) +Deferred portion of income tax (expense) benefit 192,540 41,835 ( 141,708 ) +Income tax (expense) benefit $ 192,091 $ 44,043 $ ( 143,370 ) +Effective tax rate 20.1 % 19.1 % 22.0 % +The components of the net deferred tax liabilities are as follows: +As of December 31, +2020 2019 +(in thousands) +Deferred tax liabilities +Oil and gas properties excluding asset retirement obligation liabilities $ 83,816 $ 224,686 +Derivative assets +— 4,646 +Other +10,054 12,361 +Total deferred tax liabilities 93,870 241,693 +Deferred tax assets +Derivative liabilities 36,311 — +Debt discount and deferred financing costs 23,925 — +Asset retirement obligation liabilities 18,424 19,658 +Credit carryover +7,543 11,270 +Pension +7,183 5,971 +Federal and state tax net operating loss carryovers +3,898 4,172 +Stock compensation +2,701 3,503 +Other liabilities +7,273 10,803 +Total deferred tax assets 107,258 55,377 +Valuation allowance ( 13,388 ) ( 3,070 ) +Net deferred tax assets 93,870 52,307 +Total net deferred tax liabilities $ — $ 189,386 +Current federal income tax refundable $ — $ 3,885 +Current state income tax payable $ 853 $ 1,404 +As of December 31, 2020, the Company has recorded the utilization of its federal net operating loss (“NOL”) carryforward and has remaining state NOL carryforwards of $ 4.9 million. The state NOLs and de minimus state tax credits expire between 2021 and 2040. The Company has a federal research and development (“R&D”) credit carryforward of $ 7.5 million, which will expire between 2028 and 2033 if not used. The Company’s current valuation allowance relates to state NOL carryforwards and state tax credits, which are expected to expire before they can be utilized, and tax-effected unrealized derivative liabilities in excess of its net deferred liability balance. +Recorded income tax expense or benefit differs from the amount that would be provided by applying the statutory United States federal income tax rate to income or loss before income taxes. These differences primarily relate to the effect of state income taxes, excess tax benefits and deficiencies from stock-based compensation awards, tax limitations on compensation of covered individuals, changes in valuation allowances, the cumulative impact of other smaller permanent differences, and can also reflect the +77 +cumulative effect of an enacted tax rate change, in the period of enactment, on the Company’s net deferred tax asset and liability balance. These differences are reported as follows: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Federal statutory tax (expense) benefit $ 200,908 $ 48,519 $ ( 136,873 ) +(Increase) decrease in tax resulting from: +State tax (expense) benefit (net of federal benefit) 5,722 ( 260 ) ( 2,771 ) +Change in valuation allowance +( 10,318 ) 13 ( 105 ) +Employee share-based compensation ( 2,578 ) ( 3,346 ) ( 2,508 ) +Other +( 1,643 ) ( 883 ) ( 1,113 ) +Income tax (expense) benefit $ 192,091 $ 44,043 $ ( 143,370 ) +Acquisitions, divestitures, drilling activity, and basis differentials, which impact the prices received for oil, gas, and NGLs, impact the apportionment of taxable income to the states where the Company owns oil and gas properties. As these factors change, the Company’s state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax (expense) benefit reported in the current year. Items affecting state apportionment factors are evaluated upon completion of the prior year income tax return, after significant acquisitions and divestitures, if there are significant changes in drilling activity, or if estimated state revenue changes occur during the year. As a result of the 2018 divestitures, the Company’s state apportionment rate reflects its significant Texas presence. +The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020. The primary feature of the CARES Act that the Company benefited from was the acceleration of its refundable Alternative Minimum Tax (“AMT”) credits. On April 1, 2020, the Company filed an election to accelerate its remaining refundable AMT credits of $ 7.6 million. The Company received the refund in July 2020. +For all years before 2017, the Company is generally no longer subject to United States federal or state income tax examinations by tax authorities. +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. Interest expense in the accompanying statements of operations includes a negligible amount associated with income taxes. The total amount recorded for unrecognized tax benefits for each of the years ended December 31, 2020, 2019, and 2018, was $ 446,000 . The Company does not expect a significant change to the recorded unrecognized tax benefits in 2021. +Note 5 – Long-Term Debt +The following table summarizes the Company’s total outstanding balance on its revolving credit facility, Senior Secured Notes net of unamortized discount and deferred financing costs, and Senior Unsecured Notes, net of unamortized deferred financing costs, as of December 31, 2020, and 2019: +As of December 31, 2020 As of December 31, 2019 +(in thousands) +Revolving credit facility $ 93,000 $ 122,500 +Senior Secured Notes (1) +460,656 — +Senior Unsecured Notes (1) +1,660,663 2,610,298 +Total $ 2,214,319 $ 2,732,798 +____________________________________________ +(1) Senior Secured Notes and Senior Unsecured Notes are defined below. +During the year ended December 31, 2020, the Company executed multiple transactions to reduce outstanding debt. During the second quarter of 2020, the Company initiated an offer to exchange certain of its outstanding senior unsecured notes, as presented in the Senior Unsecured Notes section below (“Senior Unsecured Notes”), other than the 1.50 % Senior Convertible Notes due 2021 (“2021 Senior Convertible Notes,” and together with the Senior Unsecured Notes, “Old Notes”), and entered into a private exchange of certain of its outstanding 2021 Senior Convertible Notes and portions of its outstanding Senior Unsecured Notes (“Private Exchange”), in each case for newly issued 10.0 % Senior Secured Second Lien Notes due January 15, 2025 (“2025 Senior Secured Notes”), referred to together as “Exchange Offers.” In connection with the Exchange Offers, the Company and its lenders amended the Credit +78 +Agreement to increase the amount of permitted second lien indebtedness to an aggregate amount of $ 1.0 billion, inclusive of the 2021 Senior Convertible Notes (“Permitted Second Lien Debt”). Additionally, the Company amended the indenture governing its 2021 Senior Convertible Notes, by entering into the Third Supplemental Indenture, dated as of April 29, 2020 (“Third Supplemental Indenture”), to the original Indenture, dated as of May 21, 2015, as supplemented and amended by the Second Supplemental Indenture, dated as of August 12, 2016, collectively referred to as the (“2021 Notes Indenture”). The Third Supplemental Indenture provides that the Company will satisfy any conversion obligation solely in cash. +On June 17, 2020 (“Settlement Date”), the Company exchanged $ 611.9 million in aggregate principal amount of Senior Unsecured Notes and $ 107.0 million in aggregate principal amount of 2021 Senior Convertible Notes for $ 446.7 million in aggregate principal amount of 2025 Senior Secured Notes, as well as, in connection with the Private Exchange, (a) $ 53.5 million in cash to certain holders of the 2021 Senior Convertible Notes and (b) warrants to acquire up to an aggregate of approximately 5.9 million shares, or approximately five percent of its outstanding common stock, exercisable upon the occurrence of certain future triggering events, to certain holders who exchanged Old Notes in the Private Exchange. Please refer to Note 11 – Fair Value Measurements for more information regarding the warrants issued by the Company. Pursuant to the 2021 Notes Indenture, upon the issuance of Permitted Second Lien Debt, the remaining outstanding 2021 Senior Convertible Notes became secured and are subsequently referred to as the “2021 Senior Secured Convertible Notes,” and together with the 2025 Senior Secured Notes, the “Senior Secured Notes.” +For a summary of the principal amounts of the Senior Unsecured Notes tendered as of the Settlement Date, please refer to the Senior Unsecured Notes section below. +The Company retired $ 611.9 million and $ 107.0 million in aggregate principal amount of its Senior Unsecured Notes and 2021 Senior Convertible Notes, respectively, upon the closing of the Exchange Offers. Upon closing, the Company paid $ 8.9 million of accrued and unpaid interest and accelerated $ 5.6 million of previously unamortized deferred financing costs associated with the retired Senior Unsecured Notes and 2021 Senior Convertible Notes and accelerated $ 6.1 million of previously unamortized debt discount associated with the retired 2021 Senior Convertible Notes. The Exchange Offers resulted in a net gain on extinguishment of debt of $ 227.3 million. The Company cancelled all retired Senior Unsecured Notes and 2021 Senior Convertible Notes upon the closing of the Exchange Offers. +Additionally, during 2020, in open market transactions, the Company repurchased a total of $ 190.3 million in aggregate principal amount of its 2022 Senior Notes and 2024 Senior Notes for a total settlement amount, excluding accrued interest, of $ 136.5 million. In connection with the repurchases, the Company recorded a net gain on extinguishment of debt of $ 52.8 million for the year ended December 31, 2020. This amount included discounts realized upon repurchase of $ 53.8 million partially offset by approximately $ 1.0 million of accelerated unamortized deferred financing costs. The Company canceled all repurchased 2022 Senior Notes and 2024 Senior Notes upon settlement. +Please refer to the Credit Agreement and Senior Notes sections below for additional information. +Credit Agreement +The Company’s Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $ 2.5 billion. During the second quarter of 2020, as a result of lower commodity prices and a corresponding decrease in the value of the Company’s proved reserves, the borrowing base and aggregate lender commitments under the Credit Agreement were both reduced to $ 1.1 billion. Also during the second quarter of 2020, the Company entered into the Third Amendment and the Fourth Amendment to the Credit Agreement (collectively, the “Amendments”), which permitted the Company to incur new second lien debt of up to $ 827.5 million prior to October 1, 2020, provided that all principal amounts of such debt are used to redeem unsecured senior debt of the Company for less than or equal to 80 % of par value. The Amendments also permitted the Company to grant a second-priority security interest to the holders of the Company’s outstanding 2021 Senior Convertible Notes to secure the Company’s obligations under the 2021 Senior Convertible Notes. Additionally, the Amendments reduced the amount of dividends that the Company may declare and pay on an annual basis from $ 50.0 million to $ 12.0 million . During the fourth quarter of 2020, the Company and its lenders completed the fall semi-annual borrowing base redetermination and entered into the Fifth Amendment to the Credit Agreement, which reaffirmed the Company’s borrowing base and aggregate lender commitments at existing levels and extended the Company’s ability to incur Permitted Second Lien Debt until the next scheduled borrowing base redetermination date of April 1, 2021. As of December 31, 2020, the Company had $ 380.8 million of available Permitted Second Lien Debt capacity. +The Credit Agreement is scheduled to mature on September 28, 2023, except that, pursuant to the Amendments, newly issued Permitted Second Lien Debt used to redeem any portion of the remaining 2022 Senior Notes must have maturities on or after 180 days after September 28, 2023; otherwise, the maturity date of the Credit Agreement will be July 2, 2023. Without regard to which maturity date is in effect, the maturity date could occur earlier on August 16, 2022, if the Company has not completed certain repurchase, redemption, or refinancing activities associated with its 2022 Senior Notes, and does not have certain unused availability for borrowing under the Credit Agreement, as outlined in the Credit Agreement. +Interest and commitment fees associated with the revolving credit facility are accrued based on a borrowing base utilization grid set forth in the Credit Agreement. The Third Amendment to the Credit Agreement amended the borrowing base utilization grid as presented in the table below. At the Company’s election, borrowings under the Credit Agreement may be in the form of Eurodollar, +79 +Alternate Base Rate (“ABR”), or Swingline loans. Eurodollar loans accrue interest at LIBOR, plus the applicable margin from the utilization grid, and ABR and Swingline loans accrue interest at a market-based floating rate, plus the applicable margin from the utilization grid. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount at rates from the utilization grid and are included in the interest expense line item on the accompanying statements of operations. +Borrowing Base Utilization Percentage <25% ≥25% <50% ≥50% <75% ≥75% <90% ≥90% +Eurodollar Loans (1) +1.750 % 2.000 % 2.500 % 2.750 % 3.000 % +ABR Loans or Swingline Loans 0.750 % 1.000 % 1.500 % 1.750 % 2.000 % +Commitment Fee Rate 0.375 % 0.375 % 0.500 % 0.500 % 0.500 % +____________________________________________ +(1) The Credit Agreement specifies that if LIBOR is no longer a widely used benchmark rate, or if it is no longer used for determining interest rates for loans in the United States, a replacement interest rate that fairly reflects the cost to the lenders of funding loans shall be established by the Administrative Agent, as defined in the Credit Agreement, in consultation with the Company. Please refer to Note 1 – Summary of Significant Accounting Policies for discussion of FASB ASU 2020-04, which provides guidance related to reference rate reform . +The following table presents the outstanding balance, total amount of letters of credit outstanding, and available borrowing capacity under the Credit Agreement as of February 4, 2021, December 31, 2020, and December 31, 2019: +As of February 4, 2021 As of December 31, 2020 As of December 31, 2019 +(in thousands) +Revolving credit facility (1) +$ 121,500 $ 93,000 $ 122,500 +Letters of credit (2) +42,000 42,000 — +Available borrowing capacity 936,500 965,000 1,077,500 +Total aggregate lender commitment amount $ 1,100,000 $ 1,100,000 $ 1,200,000 +____________________________________________ +(1) Unamortized deferred financing costs attributable to the revolving credit facility are presented as a component of the other noncurrent assets line item on the accompanying balance sheets and totaled $ 4.3 million and $ 5.9 million as of December 31, 2020, and 2019, respectively. These costs are being amortized over the term of the revolving credit facility on a straight-line basis. +(2) Letters of credit outstanding reduce the amount available under the revolving credit facility on a dollar-for-dollar basis. +Senior Notes +Senior Secured Notes. Senior Secured Notes, net of unamortized debt discount and deferred financing costs, included within the Senior Notes, net line item on the accompanying balance sheets as of December 31, 2020, consisted of the following: +As of December 31, 2020 +Principal Amount Unamortized Debt Discount Unamortized Deferred Financing Costs Net +(in thousands) +10.0 % Senior Secured Notes due 2025 +$ 446,675 $ 37,943 $ 11,558 $ 397,174 +1.50 % Senior Secured Convertible Notes due 2021 (1) +65,485 1,828 175 63,482 +Total $ 512,160 $ 39,771 $ 11,733 $ 460,656 +____________________________________________ +(1) As discussed above, as required by the 2021 Notes Indenture and as permitted by the Credit Agreement, as the Company issued Permitted Second Lien Debt upon the closing of the Exchange Offers, its remaining 2021 Senior Convertible Notes contemporaneously became secured. +2025 Senior Secured Notes . On June 17, 2020, the Company issued $ 446.7 million in aggregate principal amount of 2025 Senior Secured Notes due January 15, 2025. The Company incurred fees of $ 13.1 million, which are being amortized as deferred financing costs over the life of the 2025 Senior Secured Notes. Upon the issuance of the 2025 Senior Secured Notes, the Company recorded $ 405.0 million as the initial carrying amount, which approximated their fair value at issuance. The excess of the principal amount of the 2025 Senior Secured Notes over its fair value was recorded as a debt discount. The debt discount and deferred financing costs are amortized to interest expense through the maturity date. +80 +In connection with the issuance of the 2025 Senior Secured Notes, the Company entered into an indenture dated as of June 17, 2020 with UMB Bank, N.A., as trustee, governing the 2025 Senior Secured Notes (“2025 Notes Indenture”). The Company may redeem some or all of its 2025 Senior Secured Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest as described in the 2025 Notes Indenture. +The 2025 Senior Secured Notes are senior obligations of the Company, secured on a second-priority basis, ranking junior to the Company’s obligations under the Credit Agreement and equal in priority with the 2021 Senior Secured Convertible Notes. The 2025 Senior Secured Notes rank senior in right of payment with all of the Company’s existing and any future unsecured senior or subordinated debt. +2021 Senior Secured Convertible Notes . On August 12, 2016, the Company issued $ 172.5 million in aggregate principal amount of 1.50 % Senior Convertible Notes due July 1, 2021, unless earlier converted. The Company received net proceeds of $ 166.6 million after deducting fees of $ 5.9 million, of which a portion is being amortized over the life of the 2021 Senior Convertible Notes. Upon the issuance of the 2021 Senior Convertible Notes, the Company recorded $ 132.3 million as the initial carrying amount of the debt component, which approximated its fair value at issuance, and, was estimated by using an interest rate for nonconvertible debt with terms similar to the Senior Convertible Notes. The effective interest rate used was 7.25 %. The $ 40.2 million excess of the principal amount of the 2021 Senior Convertible Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The Company incurred fees of $ 5.9 million relating to the issuance of the 2021 Senior Convertible Notes, which were allocated between the debt and equity components in proportion to their determined fair value amounts. +During the second quarter of 2020, pursuant to the Third Supplemental Indenture, the Company agreed to satisfy any conversion obligation solely in cash, resulting in reclassification of the fair value of the equity components out of additional paid-in capital. As of December 31, 2019, the net carrying amount of the equity component of the Senior Convertible Notes recorded in additional paid-in capital on the accompanying balance sheets was $ 33.6 million. The debt discount and debt-related issuance costs are being amortized to the principal value of the 2021 Senior Secured Convertible Notes as interest expense through the maturity date. Interest expense recognized on the 2021 Senior Secured Convertible Notes related to the stated interest rate and amortization of the debt discount totaled $ 7.7 million, $ 11.0 million, and $ 10.5 million for the years ended December 31, 2020, 2019, and 2018, respectively. +Upon the closing of the Exchange Offers, the Company retired $ 107.0 million in aggregate principal amount of its 2021 Senior Convertible Notes. Upon issuance of the 2025 Senior Secured Notes, which was Permitted Second Lien Debt, as required by the 2021 Notes Indenture, and as permitted by the Credit Agreement, the remaining 2021 Senior Convertible Notes became secured senior obligations of the Company on a second-priority basis, ranking junior to the Company’s obligations under the Credit Agreement and equal in priority with the 2025 Senior Secured Notes. The 2021 Senior Secured Convertible Notes rank senior in right of payment to all of the Company’s existing and any future unsecured senior or subordinated debt. +Prior to January 1, 2021, holders could convert their 2021 Senior Convertible Notes at their option only under certain circumstances as defined by the 2021 Notes Indenture. The 2021 Senior Secured Convertible Notes were not convertible at the option of holders as of December 31, 2020. Notwithstanding the inability to convert as of December 31, 2020, the if-converted value of the 2021 Senior Secured Convertible Notes did not exceed the principal amount as of December 31, 2020, or through the filing of this report. On or after January 1, 2021, until the maturity date, holders may convert their 2021 Senior Secured Convertible Notes at any time. Holders may convert their notes based on a conversion rate of 24.6914 shares of the Company’s common stock per $ 1,000 principal amount of the 2021 Senior Secured Convertible Notes, which is equal to an initial conversion price of approximately $ 40.50 per share, subject to adjustment. The Company may not redeem the 2021 Senior Convertible Notes prior to the maturity date. +The Company has the ability, and currently intends to settle its 2021 Senior Secured Convertible Notes obligation, due July 1, 2021, with borrowings under its revolving credit facility. +If the Company undergoes a fundamental change, as defined by the 2021 Notes Indenture, holders of the 2021 Senior Secured Convertible Notes may require the Company to repurchase for cash all or any portion of their notes at a fundamental change repurchase price equal to 100% of the principal amount of the 2021 Senior Secured Convertible Notes to be repurchased, plus accrued and unpaid interest. The 2021 Notes Indenture contains customary events of default with respect to the 2021 Senior Secured Convertible Notes, including that upon certain events of default, the trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding 2021 Senior Secured Convertible Notes by notice to the Company, may declare 100% of the principal and accrued and unpaid interest, if any, due and payable immediately. In case of certain events of bankruptcy, insolvency or reorganization involving the Company or a significant subsidiary, 100% of the principal and accrued and unpaid interest on the Senior Convertible Notes will automatically become due and payable. +In connection with the issuance of the 2021 Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters of such issuance. The aggregate cost of the capped call transactions was +81 +approximately $ 24.2 million. The capped call transactions are generally expected to partially offset any cash payments the Company is required to make in excess of the principal amount of converted 2021 Senior Secured Convertible Notes in the event that the market price per share of the Company’s common stock is greater than the strike price of the capped call transactions, which initially corresponds to the approximate $ 40.50 per share conversion price of the 2021 Senior Secured Convertible Notes. The cap price of the capped call transactions is initially $ 60.00 per share. If the market price per share exceeds the cap price of the capped call transactions, there would not be an offset of such potential cash payments. The Company classified the costs associated with the capped call transactions as equity instruments with no recurring fair value measurement recorded. As discussed above, during the second quarter of 2020, the fair value of this equity instrument was reclassified out of additional paid-in capital upon the Company’s agreement to satisfy any conversion obligation solely in cash. +Senior Unsecured Notes Senior Unsecured Notes, net of unamortized deferred financing costs, included within the Senior Notes, net line item on the accompanying balance sheets as of December 31, 2020, and 2019, consisted of the following: +As of December 31, 2020 As of December 31, 2019 +Principal Amount Unamortized Deferred Financing Costs Principal Amount, Net Principal Amount Unamortized Deferred Financing Costs Principal Amount, Net +(in thousands) +6.125 % Senior Notes due 2022 +$ 212,403 $ 855 $ 211,548 $ 476,796 $ 2,920 $ 473,876 +5.0 % Senior Notes due 2024 +277,034 1,576 275,458 500,000 3,766 496,234 +5.625 % Senior Notes due 2025 +349,118 2,792 346,326 500,000 4,903 495,097 +6.75 % Senior Notes due 2026 +419,235 3,970 415,265 500,000 5,571 494,429 +6.625 % Senior Notes due 2027 +416,791 4,725 412,066 500,000 6,601 493,399 +1.50 % Senior Convertible Notes due 2021 (1)(2) +— — — 172,500 15,237 157,263 +Total $ 1,674,581 $ 13,918 $ 1,660,663 $ 2,649,296 $ 38,998 $ 2,610,298 +____________________________________________ +(1) Unamortized deferred financing costs attributable to the 2021 Senior Convertible Notes include $ 13.9 million related to the unamortized debt discount as of December 31, 2019. +(2) As discussed above, as required by the 2021 Notes Indenture and as permitted by the Credit Agreement, as the Company issued Permitted Second Lien Debt upon the closing of the Exchange Offers, its remaining 2021 Senior Convertible Notes contemporaneously became secured. +The senior unsecured notes listed above (collectively referred to as “Senior Unsecured Notes,” and together with the Senior Secured Notes, “Senior Notes”) are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. The Company may redeem some or all of its Senior Unsecured Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest as described in the indentures governing the Senior Unsecured Notes. +Upon the closing of the Exchange Offers, the Company retired $ 611.9 million in aggregate principal amount of its Senior Unsecured Notes. Portions of the then-outstanding principal amount of each series of our Senior Unsecured Notes listed below were tendered and retired in connection with the Exchange Offers. The following table summarizes the principal amounts of the Senior Unsecured Notes tendered as of the Settlement Date: +Title of Senior Unsecured Notes Tendered +Principal Amount of Senior Unsecured Notes Tendered +(in thousands) +6.125 % Senior Notes due 2022 +$ 141,701 +5.0 % Senior Notes due 2024 +155,339 +5.625 % Senior Notes due 2025 +150,882 +6.75 % Senior Notes due 2026 +80,765 +6.625 % Senior Notes due 2027 +83,209 +Total +$ 611,896 +2022 Senior Notes. On November 17, 2014, the Company issued $ 600.0 million in aggregate principal amount of 6.125 % Senior Notes due 2022 at par, which mature on November 15, 2022. The Company received net proceeds of $ 590.0 million after deducting fees of $ 10.0 million, which are being amortized as deferred financing costs over the life of the 2022 Senior Notes. During 2016, the Company repurchased $ 38.2 million in aggregate principal amount of its 2022 Senior Notes +82 +for a settlement amount of $ 24.3 million, excluding accrued interest. During 2018, the Company retired $ 85.0 million of its 2022 Senior Notes for a total settlement amount of $ 88.1 million, excluding accrued interest. During 2020, the Company repurchased $ 122.7 million in aggregate principal amount of its 2022 Senior Notes for a settlement amount of $ 94.2 million, excluding accrued interest. +2024 Senior Notes. On May 20, 2013, the Company issued $ 500.0 million in aggregate principal amount of 5.0 % Senior Notes due 2024 at par, which mature on January 15, 2024. The Company received net proceeds of $ 490.2 million after deducting fees of $ 9.8 million, which are being amortized as deferred financing costs over the life of the 2024 Senior Notes. During 2020, the Company repurchased $ 67.6 million in aggregate principal amount of its 2024 Senior Notes for a total settlement amount of $ 42.3 million, excluding accrued interest. +2025 Senior Notes. On May 21, 2015, the Company issued $ 500.0 million in aggregate principal amount of 5.625 % Senior Notes due 2025 at par, which mature on June 1, 2025. The Company received net proceeds of $ 491.0 million after deducting fees of $ 9.0 million, which are being amortized as deferred financing costs over the life of the 2025 Senior Notes. +2026 Senior Notes. On September 12, 2016, the Company issued $ 500.0 million in aggregate principal amount of 6.75 % Senior Notes due 2026, at par, which mature on September 15, 2026. The Company received net proceeds of $ 491.6 million after deducting fees of $ 8.4 million, which are being amortized as deferred financing costs over the life of the 2026 Senior Notes. +2027 Senior Notes. On August 20, 2018, the Company issued $ 500.0 million in aggregate principal amount of 6.625 % Senior Notes due 2027, at par, which mature on January 15, 2027. The Company received net proceeds of $ 492.1 million after deducting fees of $ 7.9 million, which are being amortized as deferred financing costs over the life of the 2027 Senior Notes. +Covenants +The Company is subject to certain financial and non-financial covenants under the Credit Agreement and the indentures governing the Senior Notes that, among other terms, limit the Company’s ability to incur additional indebtedness, make restricted payments including dividends, sell assets, with respect to the Company’s restricted subsidiaries, permit the consensual restriction on the ability of such restricted subsidiaries to pay dividends or indebtedness owing to the Company or to any other restricted subsidiaries, create liens that secure debt, enter into transactions with affiliates, and merge or consolidate with another company. The financial covenants under the Credit Agreement require that the Company’s (a) total funded debt, as defined in the Credit Agreement, to 12-month trailing adjusted EBITDAX ratio cannot be greater than 4.00 to 1.00 on the last day of each fiscal quarter; and (b) adjusted current ratio, as defined in the Credit Agreement, cannot be less than 1.00 to 1.00 as of the last day of any fiscal quarter. The Company was in compliance with all covenants under the Credit Agreement and the indentures governing the Senior Notes as of December 31, 2020, and through the filing of this report. +Capitalized Interest +Capitalized interest costs for the years ended December 31, 2020, 2019, and 2018, totaled $ 15.8 million, $ 18.5 million, and $ 20.6 million, respectively. The amount of interest the Company capitalizes generally fluctuates based on the amount borrowed, the Company’s capital program, and the timing and amount of costs associated with capital projects that are considered in progress. Capitalized interest costs are included in total costs incurred. Please refer to Costs Incurred in Overview of the Company in Part II, Item 7, and Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +83 +Note 6 – Commitments and Contingencies +Commitments +As of December 31, 2020, the Company has entered into various agreements, which include drilling rig contracts of $ 5.9 million, gathering, processing, transportation throughput, and delivery commitments of $ 161.6 million, office leases, including maintenance, of $ 22.1 million, fixed price contracts to purchase electricity of $ 45.4 million, and other miscellaneous contracts and leases of $ 14.3 million. As of December 31, 2020, the annual minimum payments for the next five years and total minimum payments thereafter are presented below: +For the Years Ending December 31, Amount +(in thousands) +2021 $ 86,776 +2022 79,919 +2023 45,474 +2024 12,455 +2025 11,463 +Thereafter 13,233 +Total $ 249,320 +Drilling Rig and Completion Service Contracts. The Company has drilling rig and completion service contracts in place to facilitate its drilling and completion plans. During the twelve months ended December 31, 2020, and through the filing of this report, the Company entered into new and amended drilling rig contracts resulting in the reduction of day rates and potential early termination fees and the extension of contract terms. As of the filing of this report, the Company’s drilling rig commitments totaled $ 19.9 million under contract terms extending through the first quarter of 2022. If all of these contracts were terminated as of the filing of this report, the Company would avoid a portion of the contractual service commitments; however, the Company would be required to pay $ 11.6 million in early termination fees. Excluded from these amounts are variable commitments and potential penalties determined by the number of completion crews the Company has in operation in a particular area under a completion service agreement. As of December 31, 2020, potential penalties under this completion service agreement, which expires on December 31, 2023, range from zero to a maximum of $ 10.1 million. No material expenses related to early termination or standby fees were incurred by the Company during the year ended December 31, 2020, and the Company does not expect to incur material penalties with regard to its drilling rig and completion service contracts during 2021. +Pipeline Transportation Commitments. The Company has gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum amount of oil, gas, and produced water. As of December 31, 2020, the Company has commitments to deliver a minimum of 16 MMBbl of oil and 257 Bcf of gas through 2024, and 17 MMBbl of produced water through 2027. The Company will be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. As of December 31, 2020, if the Company fails to deliver any product, as applicable, the aggregate undiscounted deficiency payments total approximately $ 161.6 million. This amount does not include deficiency payment estimates associated with approximately 11.9 MMBbl of future oil delivery commitments where the Company cannot predict with accuracy the amount and timing of these payments, as such payments are dependent upon the price of oil in effect at the time of settlement. The Company expects to fulfill the delivery commitments from a combination of production from existing productive wells, future development of proved undeveloped reserves, and future development of resources not yet characterized as proved reserves. Under certain of the Company’s commitments, if the Company is unable to deliver the minimum quantity from its production, it may deliver production acquired from third-parties to satisfy its minimum volume commitments. As of the filing of this report, the Company does not expect to incur material shortfalls with regard to these commitments. +Office Leases. The Company leases office space under various operating leases with terms extending as far as 2026. Rent expense for the years ended December 31, 2020, 2019, and 2018, was $ 5.4 million, $ 5.5 million, and $ 4.5 million, respectively. +Electrical Power Purchase Contracts. As of December 31, 2020, the Company had a fixed price contract for the purchase of electrical power through 2027 with a total remaining obligation of $ 45.4 million. +Delivery and Purchase Commitments. As of December 31, 2020, the Company had a sand sourcing agreement with certain commitments and potential penalties that vary based on the amount of sand the Company uses in well completions occurring in a particular area. This sand sourcing agreement expires on December 31, 2023. As of December 31, 2020, potential penalties under this sand sourcing agreement range from zero to a maximum of $ 10.0 million. The Company does not expect to incur penalties with regard to this agreement. +Drilling and Completion Commitments. During the second quarter of 2020, the Company entered into an agreement that included minimum drilling and completion footage requirements on certain existing leases in South Texas. If these minimum +84 +requirements are not satisfied by March 31, 2021, the Company will be required to pay liquidated damages based on the difference between the actual footage drilled and completed and the minimum requirements. As of December 31, 2020, the liquidated damages could range from zero to a maximum of $ 26.9 million, with the maximum exposure assuming no additional development activity occurred prior to March 31, 2021. The Company also entered into an agreement that included a minimum number of wells drilled and completed on certain existing leases in South Texas. If these minimum requirements are not satisfied by December 31, 2021, the Company will be required to pay liquidated damages based on the difference between the actual number of wells drilled and completed and the minimum requirements. As of December 31, 2020, the liquidated damages could range from zero to a maximum of $ 11.5 million, with the maximum exposure assuming no additional development activity occurred prior to December 31, 2021. No liquidated damages related to these agreements were incurred by the Company during the year ended December 31, 2020, and the Company expects to meet its obligations under both agreements. +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the anticipated results of any pending litigation and claims are not expected to have a material effect on the results of operations, the financial position, or the cash flows of the Company. +Note 7 – Compensation Plans +Equity Incentive Compensation Plan +There are several components to the Company’s Equity Plan that are described in this section. As of December 31, 2020, approximately 3.8 million shares of common stock were available for grant under the Equity Plan. The issuance of a direct share benefit, such as a share of common stock, a stock option, a restricted share, an RSU, or a PSU, counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. +Performance Share Units +The Company generally grants PSUs to eligible employees as part of its Equity Plan. The number of shares of the Company’s common stock issued to settle PSUs ranges from zero to two times the number of PSUs awarded and is determined based on certain criteria over a three -year performance period. PSUs generally vest on the third anniversary of the date of the grant or upon other triggering events as set forth in the Equity Plan. Employees who are retirement eligible at the time a PSU award was granted, vest in each portion of that award equally in six -month increments over a three -year period beginning at grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of a PSU award will be forfeited when the employee leaves the Company. +The fair value of PSUs is measured at the grant date with a stochastic Monte Carlo simulation using geometric Brownian motion (“GBM Model”). A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for those iterations. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will take over the three -year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the path the stock price may take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +For PSUs granted in 2017, which the Company determined to be equity awards, the settlement criteria included a combination of the Company’s Total Shareholder Return (“TSR”) on an absolute basis, and the Company’s TSR relative to the TSR of certain peer companies over the associated three-year performance period. The fair value of the PSUs granted in 2017 was measured on the grant date using the GBM Model. As these awards depended entirely on market-based settlement criteria, the associated compensation expense was recognized on a straight-line basis within general and administrative expense and exploration expense over the vesting period of the awards. These awards fully vested during 2020 and were settled as discussed below. +For PSUs granted in 2018 and 2019, the settlement criteria include a combination of the Company’s TSR relative to the TSR of certain peer companies and the Company’s cash return on total capital invested (“CRTCI”) relative to the CRTCI of certain peer companies over the associated three-year performance period. In addition to these performance criteria, the award agreements for these grants also stipulate that if the Company’s absolute TSR is negative over the three -year performance period, the maximum number of shares of common stock that can be issued to settle outstanding PSUs is capped at one times the number of PSUs granted on the award date, regardless of the Company’s TSR and CRTCI performance relative to its peer group. The fair value of the PSUs granted in 2018 and 2019 was measured on the applicable grant dates using the GBM Model, with the assumption that the associated +85 +CRTCI performance condition will be met at the target amount at the end of the respective performance periods. Compensation expense for PSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. As these awards depend on a combination of performance-based settlement criteria and market-based settlement criteria, compensation expense may be adjusted in future periods as the number of units expected to vest increases or decreases based on the Company’s expected CRTCI performance relative to the applicable peer companies. +The Company records compensation expense associated with the issuance of PSUs based on the fair value of the awards as of the date of grant. Total compensation expense recorded for PSUs was $ 4.4 million, $ 10.9 million, and $ 10.3 million for the years ended December 31, 2020, 2019, and 2018, respectively. As of December 31, 2020, there was $ 4.4 million of total unrecognized expense related to PSUs, which is being amortized through 2022. +A summary of the status and activity of non-vested PSUs is presented in the following table: +For the Years Ended December 31, +2020 2019 2018 +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +Non-vested at beginning of year 2,022,585 $ 16.87 1,711,259 $ 20.68 1,533,491 $ 22.97 +Granted — $ — 793,125 $ 12.80 572,924 $ 24.45 +Vested ( 792,572 ) $ 15.85 ( 346,021 ) $ 26.32 ( 233,102 ) $ 44.25 +Forfeited ( 399,549 ) $ 17.56 ( 135,778 ) $ 16.98 ( 162,054 ) $ 21.79 +Non-vested at end of year 830,464 $ 17.52 2,022,585 $ 16.87 1,711,259 $ 20.68 +____________________________________________ +(1) The number of shares of common stock assumes a multiplier of one . The actual final number of shares of common stock to be issued will range from zero to two times the number of PSUs awarded depending on the three -year performance multiplier. +The fair value of the PSUs granted in 2019, and 2018, was $ 10.2 million and $ 14.0 million, respectively. +During the year ended December 31, 2020, the Company settled PSUs that were granted in 2017, which earned a 0.9 times multiplier. The Company and the majority of grant participants mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings, as provided for in the Equity Plan and applicable award agreements. After withholding 215,451 shares to satisfy income and payroll tax withholding obligations that occurred upon delivery of the shares underlying those PSUs, 485,060 shares of the Company’s common stock were issued in accordance with the terms of the applicable PSU awards. During the years ended December 31, 2019, and 2018, PSUs that were granted in 2016, and 2015, respectively, did not satisfy the minimum performance requirements. This resulted in a multiplier of zero times and therefore no shares of common stock were issued upon settlement. +The total fair value of PSUs that vested during the years ended December 31, 2020, 2019, and 2018, was $ 12.6 million, $ 9.1 million, and $ 10.3 million, respectively. +Employee Restricted Stock Units +The Company grants RSUs to eligible persons as part of its Equity Plan. Each RSU represents a right to receive one share of the Company’s common stock upon settlement of the award at the end of the specified vesting period. RSUs generally vest one-third of the total grant on each anniversary date of the grant over the applicable vesting period or upon other triggering events as set forth in the Equity Plan. Employees who are retirement eligible at the time an RSU award is granted, vest in each portion of that award equally in six -month increments over the applicable vesting period beginning at grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of an RSU award will be forfeited when the employee leaves the Company. +The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the date of grant. The fair value of an RSU is equal to the closing price of the Company’s common stock on the day of the grant. Compensation expense for RSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. Total compensation expense recorded for employee RSUs for the years ended December 31, 2020, 2019, and 2018, was $ 8.7 million, $ 11.1 million, and $ 10.8 million, respectively. As of December 31, 2020, there was $ 14.7 million of total unrecognized compensation expense related to non-vested RSU awards, which is being amortized through 2023. +86 +A summary of the status and activity of non-vested RSUs granted to employees is presented in the following table: +For the Years Ended December 31, +2020 2019 2018 +RSUs Weighted- +Average +Grant-Date +Fair Value RSUs Weighted- +Average +Grant-Date +Fair Value RSUs Weighted- +Average +Grant-Date +Fair Value +Non-vested at beginning of year +1,532,131 $ 16.01 1,243,163 $ 21.50 1,244,262 $ 20.25 +Granted 1,458,869 $ 5.98 978,932 $ 12.36 583,552 $ 25.77 +Vested ( 746,132 ) $ 16.74 ( 466,535 ) $ 21.94 ( 407,529 ) $ 24.30 +Forfeited ( 147,008 ) $ 15.34 ( 223,429 ) $ 18.16 ( 177,122 ) $ 17.26 +Non-vested at end of year +2,097,860 $ 8.83 1,532,131 $ 16.01 1,243,163 $ 21.50 +The fair value of RSUs granted to eligible employees in 2020, 2019, and 2018, was $ 8.7 million, $ 12.1 million, and $ 15.0 million, respectively. +A summary of the shares of common stock issued to settle employee RSUs is presented in the table below: +For the Years Ended December 31, +2020 2019 2018 +Shares of common stock issued to settle RSUs (1) +746,132 466,535 407,529 +Less: shares of common stock withheld for income and payroll taxes ( 209,173 ) ( 132,136 ) ( 115,784 ) +Net shares of common stock issued 536,959 334,399 291,745 +____________________________________________ +(1) During the years ended December 31, 2020, 2019, and 2018, the Company issued shares of common stock to settle RSUs that related to awards granted in previous years. The Company and a majority of grant recipients mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +The total fair value of employee RSUs that vested during the years ended December 31, 2020, 2019, and 2018, was $ 12.5 million, $ 10.2 million, and $ 9.9 million, respectively. +Director Shares +In 2020, 2019, and 2018, the Company issued 267,576 , 96,719 , and 63,741 shares, respectively, of its common stock to its non-employee directors under the Equity Plan. For the years ended December 31, 2020, 2019, and 2018, the Company recorded $ 990,000 , $ 1.2 million, and $ 1.7 million, respectively, of compensation expense related to director shares and RSUs issued. All shares issued to non-employee directors fully vest on December 31 of the year granted. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation, without accruing in excess of $ 25,000 in value from purchases for each calendar year. The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on either the first or last day of the purchase period. The ESPP is intended to qualify under Section 423 of the IRC. The Company had approximately 834,246 shares of its common stock available for issuance under the ESPP as of December 31, 2020. There were 464,757 , 314,868 , and 199,464 shares issued under the ESPP in 2020, 2019, and 2018, respectively. Total proceeds to the Company for the issuance of these shares was $ 1.5 million for the year ended December 31, 2020, and $ 3.2 million for each of the years ended 2019 and 2018. +The fair value of ESPP grants is measured at the date of grant using the Black-Scholes option-pricing model. Expected volatility is calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six-month vesting period. +87 +The fair value of ESPP shares issued during the periods reported were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2020 2019 2018 +Risk free interest rate 0.8 % 2.3 % 1.8 % +Dividend yield 0.7 % 0.7 % 0.4 % +Volatility factor of the expected market price of the Company’s common stock 166.2 % 56.6 % 55.9 % +Expected life (in years) 0.5 0.5 0.5 +The Company expensed $ 874,000 for the year ended December 31, 2020, and $ 1.1 million for each of the years ended December 31, 2019, and 2018, based on the estimated fair value of the ESPP grants. +401(k) Plan +The Company has a defined contribution plan (the “401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. For employees hired before December 31, 2014, the Company matches 100 percent of each employee’s contribution in cash on a dollar for dollar basis, up to six percent of the employee’s base salary and performance bonus, and may make additional contributions at its discretion. The Company matches 150 percent of contributions made by employees hired after December 31, 2014, up to six percent of the employee’s base salary and performance bonus in lieu of pension plan benefits, and may make additional contributions at its discretion. Please refer to Note 8 – Pension Benefits for additional discussion of pension benefits. The Company’s matching contributions to the 401(k) Plan were $ 4.2 million, $ 5.1 million, and $ 4.9 million for the years ended December 31, 2020, 2019, and 2018, respectively. +88 +Note 8 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering employees who meet age and service requirements and who began employment with the Company prior to January 1, 2016 (“Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (“Nonqualified Pension Plan” and together with the Qualified Pension Plan, “Pension Plans”). The Company froze the Pension Plans to new participants, effective as of January 1, 2016. Employees participating in the Pension Plans prior to the plans being frozen will continue to earn benefits. +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status (i.e. the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment within the other comprehensive income (loss), net of tax, line item in the accompanying statements of comprehensive income (loss). The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation, but excludes the effects of assumed future salary increases. The Company’s measurement date for plan assets and obligations is December 31. +For the Years Ended December 31, +2020 2019 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year $ 70,843 $ 66,086 +Service cost 4,516 5,582 +Interest cost 2,358 2,791 +Actuarial loss 7,483 2,035 +Benefits paid ( 905 ) ( 5,651 ) +Settlements ( 10,702 ) — +Projected benefit obligation at end of year 73,593 70,843 +Change in plan assets: +Fair value of plan assets at beginning of year 35,634 30,100 +Actual return on plan assets 2,837 3,985 +Employer contribution 6,030 7,200 +Benefits paid ( 905 ) ( 5,651 ) +Settlements ( 10,702 ) — +Fair value of plan assets at end of year 32,894 35,634 +Funded status at end of year $ ( 40,699 ) $ ( 35,209 ) +The Company’s underfunded status for the Pension Plans as of December 31, 2020, and 2019, was $ 40.7 million and $ 35.2 million, respectively, and is recognized in the accompanying balance sheets within the other noncurrent liabilities line item. There are no plan assets in the Nonqualified Pension Plan. +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2020 2019 +(in thousands) +Projected benefit obligation $ 73,593 $ 70,843 +Accumulated benefit obligation $ 63,934 $ 60,877 +Less: fair value of plan assets ( 32,894 ) ( 35,634 ) +Underfunded accumulated benefit obligation $ 31,040 $ 25,243 +89 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of the unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for the year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +The pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in the accumulated other comprehensive loss line item within the accompanying balance sheets as of December 31, 2020, and 2019, were as follows: +As of December 31, +2020 2019 +(in thousands) +Unrecognized actuarial losses $ 17,328 $ 14,406 +Unrecognized prior service costs 14 31 +Accumulated other comprehensive loss $ 17,342 $ 14,437 +The pension liability adjustments recognized in other comprehensive income (loss) during 2020, 2019, and 2018, were as follows: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Net actuarial gain (loss) $ ( 6,381 ) $ 377 $ 4,329 +Amortization of prior service cost 17 17 18 +Amortization of net actuarial loss 950 958 1,327 +Settlements 2,509 — — +Total pension liability adjustment, pre-tax ( 2,905 ) 1,352 5,674 +Tax (expense) benefit 626 ( 291 ) ( 4,265 ) +Cumulative effect of accounting change — — 2,969 +Total pension liability adjustment, net $ ( 2,279 ) $ 1,061 $ 4,378 +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Components of net periodic benefit cost: +Service cost $ 4,516 $ 5,582 $ 6,730 +Interest cost 2,358 2,791 2,622 +Expected return on plan assets that reduces periodic pension benefit cost ( 1,735 ) ( 1,574 ) ( 1,862 ) +Amortization of prior service cost 17 17 18 +Amortization of net actuarial loss 950 958 1,327 +Net periodic benefit cost 6,106 7,774 8,835 +Settlements 2,509 — — +Total net benefit cost $ 8,615 $ 7,774 $ 8,835 +90 +Pension Plan Assumptions +The weighted-average assumptions used to measure the Company’s projected benefit obligation are as follows: +As of December 31, +2020 2019 +Projected benefit obligation: +Discount rate 2.9 % 3.6 % +Rate of compensation increase 4.4 % 4.5 % +The weighted-average assumptions used to measure the Company’s net periodic benefit cost are as follows: +For the Years Ended December 31, +2020 2019 2018 +Net periodic benefit cost: +Discount rate 3.6 % 4.4 % 3.8 % +Expected return on plan assets (1) +5.3 % 5.0 % 5.5 % +Rate of compensation increase 4.5 % 6.2 % 6.2 % +____________________________________________ +(1) There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy prohibits the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting the optimal expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. +The weighted-average asset allocation of the Qualified Pension Plan is as follows: +Target As of December 31, +Asset Category 2021 2020 2019 +Equity securities 36.0 % 37.0 % 36.9 % +Fixed income securities 37.0 % 24.9 % 38.1 % +Other securities 27.0 % 38.1 % 25.0 % +Total 100.0 % 100.0 % 100.0 % +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in the plan. An expected return on plan assets of 5.3 percent, 5.0 percent, and 5.5 percent was used to calculate the Company’s net periodic pension cost under the Qualified Pension Plan for the years ended December 31, 2020, 2019, and 2018 respectively. The expected long-term rate of return assumption of the Qualified Pension Plan is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. The Company evaluates the expected rate of return on plan assets assumption on an annual basis. +91 +Pension Plan Assets +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2020, and 2019, utilizing the fair value hierarchy discussed in Note 11 – Fair Value Measurements are as follows: +Fair Value Measurements Using: +Actual Asset Allocation (1) +Total Level 1 Inputs Level 2 Inputs Level 3 Inputs +(in thousands) +As of December 31, 2020 +Equity securities: +Domestic (2) +18.7 % $ 6,149 $ 4,165 $ 1,984 $ — +International (3) +18.3 % 6,010 6,010 — — +Total equity securities 37.0 % 12,159 10,175 1,984 — +Fixed income securities: +Core fixed income (4) +16.6 % 5,447 5,447 — — +Floating rate corporate loans (5) +8.3 % 2,755 2,755 — — +Total fixed income securities 24.9 % 8,202 8,202 — — +Other securities: +Real estate (6) +5.7 % 1,870 — — 1,870 +Collective investment trusts (7) +4.6 % 1,498 — 1,498 — +Hedge fund (8) +27.8 % 9,165 5,299 — 3,866 +Total other securities 38.1 % 12,533 5,299 1,498 5,736 +Total investments 100.0 % $ 32,894 $ 23,676 $ 3,482 $ 5,736 +As of December 31, 2019 +Equity securities: +Domestic (2) +17.3 % $ 6,176 $ 4,130 $ 2,046 $ — +International (3) +19.6 % 6,958 6,958 — — +Total equity securities 36.9 % 13,134 11,088 2,046 — +Fixed income securities: +Core fixed income (4) +31.4 % 11,199 11,199 — — +Floating rate corporate loans (5) +6.7 % 2,379 2,379 — — +Total fixed income securities 38.1 % 13,578 13,578 — — +Other securities: +Real estate (6) +5.4 % 1,929 — — 1,929 +Collective investment trusts (7) +3.3 % 1,168 — 1,168 — +Hedge fund (8) +16.3 % 5,825 2,006 — 3,819 +Total other securities 25.0 % 8,922 2,006 1,168 5,748 +Total investments 100.0 % $ 35,634 $ 26,672 $ 3,214 $ 5,748 +____________________________________________ +(1) Percentages may not calculate due to rounding. +(2) Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold upon demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of these funds is to approximate the S&P 500 by investing in one or more collective investment funds. +(3) International equity securities consists of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets that are believed to have strong sustainable financial productivity at attractive valuations. +(4) The objective of core fixed income funds is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay’s Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +(5) Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +92 +(6) The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(7) Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +(8) The hedge fund portfolio includes investments in actively traded global mutual funds that focus on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +Included below is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2019 $ 5,507 +Purchases — +Realized gain on assets 190 +Unrealized gain on assets 51 +Disposition — +Balance at December 31, 2019 $ 5,748 +Purchases — +Realized gain on assets 526 +Unrealized gain on assets 41 +Disposition ( 579 ) +Balance at December 31, 2020 $ 5,736 +Contributions +The Company contributed $ 6.0 million, $ 7.2 million, and $ 8.1 million to the Pension Plans for the years ended December 31, 2020, 2019, and 2018, respectively. The Company expects to make a $ 7.0 million contribution to the Pension Plans in 2021. +Benefit Payments +The Pension Plans made actual benefit payments of $ 11.6 million, $ 5.7 million, and $ 8.0 million in the years ended December 31, 2020, 2019, and 2018, respectively. Expected benefit payments over the next 10 years are as follows: +For the Years Ending December 31, Amount +(in thousands) +2021 $ 9,564 +2022 $ 3,769 +2023 $ 5,390 +2024 $ 4,765 +2025 $ 5,996 +2026 through 2030 $ 24,132 +Note 9 - Earnings Per Share +Basic net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average number of common shares outstanding for the respective period. Diluted net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the diluted weighted-average number of common shares outstanding, which includes the effect of potentially dilutive securities. As of December 31, 2019, and 2018, potentially dilutive securities for this calculation consisted primarily of non-vested RSUs, contingent PSUs, and shares into which the 2021 Senior Convertible Notes were convertible, which were measured using the treasury stock method. Shares of the Company’s common stock traded at an average closing price below the $ 40.50 conversion price for the years ended December 31, 2019, and 2018, therefore, the 2021 Senior Convertible Notes had no dilutive impact. In connection with the offering of the 2021 Senior Convertible Notes, the Company entered into capped call transactions with affiliates of the underwriters that would effectively prevent dilution upon settlement up to the $ 60.00 cap price. The capped call transactions will always be anti-dilutive and therefore will never be reflected in diluted net income or loss per share. On April 29, 2020, pursuant to the Third Supplemental Indenture, the Company elected to satisfy any conversion obligation with respect to the 2021 Senior Convertible Notes solely in cash. As a result, the Company’s 2021 Senior Secured Convertible Notes are no longer convertible into shares of the Company’s common stock and thus, were not considered to be a potentially dilutive instrument as of December 31, 2020. Please refer to Note 5 – Long-Term Debt for additional discussion. +93 +On June 17, 2020, the Company issued warrants to purchase up to an aggregate of approximately 5.9 million shares, or approximately five percent of its outstanding common stock, at an exercise price of $ 0.01 per share, as discussed in Note 5 – Long-Term Debt . The Warrant Agreement dated as of June 17, 2020 (“Warrant Agreement”), states that the warrants are only exercisable upon the Triggering Date, as defined in Note 11 – Fair Value Measurements . The warrants were not exercisable for the year ended December 31, 2020, and therefore had no dilutive impact. The Triggering Date occurred on January 14, 2021, and the warrants became exercisable at the election of the holders. The warrants may be exercised either in full or from time to time in part, until their expiration on June 30, 2023. Please refer to Note 11 – Fair Value Measurements for additional detail regarding the terms of the warrants. +As of December 31, 2020, potentially dilutive securities for this calculation consist primarily of non-vested RSUs, contingent PSUs, and warrants, which were measured using the treasury stock method. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three -year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 7 – Compensation Plans under the heading Performance Share Units . +When the Company recognizes a net loss from continuing operations, all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of diluted net loss per common share. The following table details the weighted-average anti-dilutive securities for the years presented: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Anti-dilutive 265 684 — +The following table sets forth the calculations of basic and diluted net income (loss) per common share: +For the Years Ended December 31, +2020 2019 2018 +(in thousands, except per share data) +Net income (loss) $ ( 764,614 ) $ ( 187,001 ) $ 508,407 +Basic weighted-average common shares outstanding 113,730 112,544 111,912 +Dilutive effect of non-vested RSUs and contingent PSUs — — 1,590 +Diluted weighted-average common shares outstanding 113,730 112,544 113,502 +Basic net income (loss) per common share $ ( 6.72 ) $ ( 1.66 ) $ 4.54 +Diluted net income (loss) per common share $ ( 6.72 ) $ ( 1.66 ) $ 4.48 +Note 10 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company regularly enters into commodity derivative contracts to mitigate a portion of its exposure to potentially adverse market changes in commodity prices and the associated impact on cash flows. As of December 31, 2020, all derivative counterparties were members of the Company’s Credit Agreement lender group and all contracts were entered into for other-than-trading purposes. The Company’s commodity derivative contracts consist of swap and collar arrangements for oil production, and swap arrangements for gas and NGL production. In a typical commodity swap agreement, if the agreed upon published third-party index price (“index price”) is lower than the swap fixed price, the Company receives the difference between the index price and the agreed upon swap fixed price. If the index price is higher than the swap fixed price, the Company pays the difference. For collar arrangements, the Company receives the difference between an agreed upon index price and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +The Company has entered into fixed price oil basis swaps in order to mitigate exposure to adverse pricing differentials between certain industry benchmark prices and the actual physical pricing points where the Company’s production volumes are sold. +94 +Currently, the Company has basis swap contracts with fixed price differentials between NYMEX WTI and WTI Midland for a portion of its Midland Basin production with sales contracts that settle at WTI Midland prices, NYMEX WTI and Intercontinental Exchange Brent Crude (“ICE Brent”) for a portion of its Midland Basin oil production with sales contracts that settle at ICE Brent prices, and between NYMEX WTI and Argus WTI Houston Magellan East Houston Terminal ("MEH”) for a portion of its South Texas production with sales contracts that settle at Argus WTI Houston MEH prices. The Company has also entered into crude oil swap contracts to fix the differential in pricing between the NYMEX calendar month average and the physical crude oil delivery month (“Roll Differential”) in which the Company pays the periodic variable Roll Differential and receives a weighted-average fixed price differential. The weighted-average fixed price differential represents the amount of net addition (reduction) to delivery month prices for the notional volumes covered by the swap contracts. +As of December 31, 2020, the Company had commodity derivative contracts outstanding through the fourth quarter of 2023 as summarized in the tables below. +Oil Swaps +Contract Period NYMEX WTI Volumes Weighted-Average +Contract Price +(MBbl) (per Bbl) +First quarter 2021 3,613 $ 42.91 +Second quarter 2021 5,072 $ 39.90 +Third quarter 2021 4,862 $ 40.10 +Fourth quarter 2021 4,744 $ 39.85 +2022 6,601 $ 43.99 +2023 1,190 $ 45.20 +Total 26,082 +Oil Collars +Contract Period NYMEX WTI Volumes +Weighted-Average +Floor Price +Weighted-Average +Ceiling Price +(MBbl) (per Bbl) (per Bbl) +First quarter 2021 551 $ 48.97 $ 51.96 +Total 551 +Oil Basis Swaps +Contract Period +WTI Midland-NYMEX WTI Volumes +Weighted-Average Contract +Price (1) +NYMEX WTI-ICE Brent Volumes +Weighted-Average Contract +Price (2) +WTI Houston MEH-NYMEX WTI Volumes +Weighted-Average Contract +Price (3) +(MBbl) (per Bbl) (MBbl) (per Bbl) (MBbl) (per Bbl) +First quarter 2021 3,223 $ 0.79 900 $ ( 7.86 ) 173 $ 0.60 +Second quarter 2021 3,385 $ 0.78 910 $ ( 7.86 ) 493 $ 0.60 +Third quarter 2021 3,574 $ 0.74 920 $ ( 7.86 ) 356 $ 0.60 +Fourth quarter 2021 3,824 $ 0.71 920 $ ( 7.86 ) 466 $ 0.60 +2022 9,500 $ 1.15 3,650 $ ( 7.78 ) — $ — +Total 23,506 7,300 1,488 +____________________________________________ +(1) Represents the price differential between WTI Midland (Midland, Texas) and NYMEX WTI (Cushing, Oklahoma). +(2) Represents the price differential between NYMEX WTI (Cushing, Oklahoma) and ICE Brent (North Sea). +(3) Represents the price differential between Argus WTI Houston MEH (Houston, Texas) and NYMEX WTI (Cushing, Oklahoma). +95 +Oil Roll Differential Swaps +Contract Period +NYMEX WTI Volumes +Weighted-Average Contract Price +(MBbl) (per Bbl) +First quarter 2021 3,367 $ ( 0.30 ) +Second quarter 2021 4,065 $ ( 0.24 ) +Third quarter 2021 3,708 $ ( 0.25 ) +Fourth quarter 2021 3,283 $ ( 0.24 ) +2022 6,002 $ ( 0.04 ) +Total 20,425 +Gas Swaps +Contract Period IF HSC Volumes Weighted-Average Contract Price WAHA Volumes Weighted-Average Contract Price +(BBtu) (per MMBtu) (BBtu) (per MMBtu) +First quarter 2021 11,592 $ 2.48 6,544 $ 1.76 +Second quarter 2021 13,672 $ 2.45 7,230 $ 1.76 +Third quarter 2021 12,575 $ 2.40 8,086 $ 1.88 +Fourth quarter 2021 12,412 $ 2.41 7,627 $ 1.82 +2022 21,119 $ 2.48 10,066 $ 2.30 +Total (1) +71,370 39,553 +____________________________________________ +(1) The Company has natural gas swaps in place that settle against Inside FERC Houston Ship Channel (“IF HSC”), Inside FERC West Texas (“IF WAHA”), and Platt’s Gas Daily West Texas (“GD WAHA”). As of December 31, 2020, WAHA volumes were comprised of 59 percent IF WAHA and 41 percent GD WAHA. +NGL Swaps +OPIS Propane Mont Belvieu Non-TET +Contract Period Volumes Weighted-Average Contract Price +(MBbl) (per Bbl) +First quarter 2021 614 $ 21.58 +Second quarter 2021 707 $ 21.26 +Third quarter 2021 735 $ 21.26 +Fourth quarter 2021 714 $ 21.30 +2022 116 $ 21.21 +Total 2,886 +Commodity Derivative Contracts Entered Into Subsequent to December 31, 2020 +Subsequent to December 31, 2020, the Company entered into the following fixed price commodity derivative contracts: +Oil Swaps +Index Start Date Through Date Volumes +(MBbl) Weighted-Average Contract Price +(per Bbl) +NYMEX WTI First quarter 2021 Third quarter 2021 1,048 $ 51.91 +NYMEX WTI First quarter 2022 Fourth quarter 2022 1,222 $ 48.50 +96 +Oil Collars +Index Start Date Through Date Volumes +(MBbl) Weighted-Average Floor Price +(per Bbl) Weighted-Average Ceiling Price +(per Bbl) +NYMEX WTI First quarter 2022 Fourth quarter 2022 1,095 $ 50.00 $ 53.28 +Oil Basis Swaps +Index Start Date Through Date Volumes +(MBbl) Weighted-Average Contract Price +(per Bbl) +WTI Midland-NYMEX WTI First quarter 2021 Third quarter 2021 1,095 $ 0.95 +WTI Houston MEH-NYMEX WTI First quarter 2022 Fourth quarter 2022 1,329 $ 1.25 +Oil Roll Differential Swaps +Index Start Date Through Date Volumes +(MBbl) Weighted-Average Contract Price +(per Bbl) +NYMEX WTI First quarter 2021 Fourth quarter 2021 2,213 $ 0.30 +NYMEX WTI First quarter 2022 Fourth quarter 2022 5,276 $ 0.27 +Gas Swaps +Index Start Date Through Date Volumes +(BBtu) Weighted-Average Contract Price +(per MMBtu) +IF HSC First quarter 2022 Fourth quarter 2022 7,813 $ 2.64 +IF WAHA First quarter 2022 Fourth quarter 2022 3,650 $ 2.30 +NGL Swaps +Index Start Date Through Date Volumes +(MBbl) Weighted-Average Contract Price +(per Bbl) +OPIS Propane Mont Belvieu Non-TET First quarter 2021 Fourth quarter 2021 440 $ 27.72 +OPIS Propane Mont Belvieu Non-TET First quarter 2022 First quarter 2022 115 $ 24.78 +OPIS Normal Butane Mont Belvieu Non-TET First quarter 2021 Fourth quarter 2021 143 $ 30.87 +NGL Collars +Index Start Date Through Date Volumes +(MBbl) Weighted-Average Floor Price +(per Bbl) Weighted-Average Ceiling Price +(per Bbl) +OPIS Propane Mont Belvieu Non-TET First quarter 2022 Fourth quarter 2022 234 $ 22.05 $ 27.30 +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its commodity derivative contracts as hedging instruments. The fair value of the commodity derivative contracts at December 31, 2020, and 2019, was a net liability of $ 168.2 million and a net asset of $ 21.5 million, respectively. +97 +The following table details the fair value of commodity derivative contracts recorded in the accompanying balance sheets, by category: +As of December 31, 2020 As of December 31, 2019 +(in thousands) +Derivative assets: +Current assets $ 31,203 $ 55,184 +Noncurrent assets 23,150 20,624 +Total derivative assets $ 54,353 $ 75,808 +Derivative liabilities: +Current liabilities $ 200,189 $ 50,846 +Noncurrent liabilities 22,331 3,444 +Total derivative liabilities $ 222,520 $ 54,290 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2020, and 2019, all derivative instruments held by the Company were subject to master netting arrangements with various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that settle on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s commodity derivative contracts: +Derivative Assets Derivative Liabilities +As of December 31, As of December 31, +2020 2019 2020 2019 +(in thousands) +Gross amounts presented in the accompanying balance sheets $ 54,353 $ 75,808 $ ( 222,520 ) $ ( 54,290 ) +Amounts not offset in the accompanying balance sheets ( 53,598 ) ( 35,075 ) 53,598 35,075 +Net amounts $ 755 $ 40,733 $ ( 168,922 ) $ ( 19,215 ) +The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring such amounts in accumulated other comprehensive income (loss). The Company had no commodity derivative contracts designated as hedging instruments for the years ended December 31, 2020, 2019, and 2018. Please refer to Note 11 – Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +98 +The following table summarizes the commodity components of the derivative settlement (gain) loss, as well as the components of the net derivative (gain) loss line item presented in the accompanying statements of operations: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Derivative settlement (gain) loss: +Oil contracts $ ( 331,559 ) $ 19,685 $ 68,860 +Gas contracts ( 11,898 ) ( 23,008 ) 13,029 +NGL contracts ( 7,804 ) ( 35,899 ) 53,914 +Total derivative settlement (gain) loss: $ ( 351,261 ) $ ( 39,222 ) $ 135,803 +Net derivative (gain) loss: +Oil contracts $ ( 205,180 ) $ 172,055 $ ( 192,002 ) +Gas contracts 30,038 ( 41,205 ) 35,411 +NGL contracts 13,566 ( 33,311 ) ( 5,241 ) +Total net derivative (gain) loss: $ ( 161,576 ) $ 97,539 $ ( 161,832 ) +Credit Related Contingent Features +As of December 31, 2020, and through the filing of this report, all of the Company’s derivative counterparties were members of the Company’s Credit Agreement lender group. Under the Credit Agreement, the Company is required to provide mortgage liens on assets having a value equal to at least 85 percent of the total PV-9, as defined in the Credit Agreement, of the Company’s proved oil and gas properties evaluated in the most recent reserve report. Collateral securing indebtedness under the Credit Agreement also secures the Company’s derivative agreement obligations. +Note 11 – Fair Value Measurements +The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• Level 1 – quoted prices in active markets for identical assets or liabilities +• Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +• Level 3 – significant inputs to the valuation model are unobservable +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2020: +Level 1 Level 2 Level 3 +(in thousands) +Assets: +Derivatives (1) +$ — $ 54,353 $ — +Liabilities: +Derivatives (1) +$ — $ 222,520 $ — +____________________________________________ +(1) This represents a financial asset or liability that is measured at fair value on a recurring basis. +99 +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2019: +Level 1 Level 2 Level 3 +(in thousands) +Assets: +Derivatives (1) +$ — $ 75,808 $ — +Liabilities: +Derivatives (1) +$ — $ 54,290 $ — +____________________________________________ +(1) This represents a financial asset or liability that is measured at fair value on a recurring basis. +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. +Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on the Company’s policies for determining fair value for the categories discussed below. +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivatives. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The commodity derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any commodity derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current revolving credit facility margins, and any change in such margins since the last measurement date. +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and other marketplace participants, the Company recognizes that third parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Refer to Note 10 – Derivative Financial Instruments for more information regarding the Company’s derivative instruments. +Oil and Gas Properties and Other Property and Equipment +The Company had no assets included in total property and equipment, net, measured at fair value as of December 31, 2020, or December 31, 2019. +For the year ended December 31, 2020, the Company recorded impairment expense of $ 956.7 million related to its South Texas proved oil and gas properties and related support facilities due to the decrease in commodity price forecasts at the end of the first quarter of 2020, specifically decreases in oil and NGL prices. The Company used a discount rate of 11 percent in its calculation of the present value of expected future cash flows based on the prevailing market-based weighted average cost of capital as of March 31, 2020. No proved property impairment expense was recorded during the years ended December 31, 2019, or 2018. +100 +The following table presents impairment of proved properties expense and abandonment and impairment of unproved properties expense recorded for the periods presented: +For the Years Ended December 31, +2020 2019 2018 +(in millions) +Impairment of proved oil and gas properties and related support equipment $ 956.7 $ — $ — +Abandonment and impairment of unproved properties (1) +59.3 33.8 49.9 +Impairment $ 1,016.0 $ 33.8 $ 49.9 +____________________________________________ +(1) These impairments related to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. The balances in the unproved oil and gas properties line item on the accompanying balance sheets as of December 31, 2020, 2019, and 2018, are recorded at carrying value. +Please refer to Note 1 – Summary of Significant Accounting Policies for information on the Company’s policies for determining fair value of its oil and gas producing properties and related impairment expense. +Long-Term Debt +The following table reflects the fair value of the Company’s senior note obligations measured using Level 1 inputs based on quoted secondary market trading prices. These notes were not presented at fair value on the accompanying balance sheets as of December 31, 2020, or 2019, as they were recorded at carrying value, net of any unamortized discounts and deferred financing costs. Please refer to Note 5 – Long-Term Debt for additional information. +As of December 31, +2020 2019 +Principal Amount Fair Value Principal Amount Fair Value +(in thousands) +1.50 % Senior Secured Convertible Notes due 2021 (1) +$ 65,485 $ 61,449 $ — $ — +10.0 % Senior Secured Notes due 2025 +$ 446,675 $ 482,887 $ — $ — +6.125 % Senior Unsecured Notes due 2022 +$ 212,403 $ 205,379 $ 476,796 $ 481,564 +5.0 % Senior Unsecured Notes due 2024 +$ 277,034 $ 240,072 $ 500,000 $ 479,815 +5.625 % Senior Unsecured Notes due 2025 +$ 349,118 $ 289,401 $ 500,000 $ 475,835 +6.75 % Senior Unsecured Notes due 2026 +$ 419,235 $ 342,385 $ 500,000 $ 494,860 +6.625 % Senior Unsecured Notes due 2027 +$ 416,791 $ 331,220 $ 500,000 $ 493,750 +1.50 % Senior Convertible Notes due 2021 (1) +$ — $ — $ 172,500 $ 164,430 +___________________________________________ +(1) The Company’s 2021 Senior Convertible Notes became secured in the second quarter of 2020 upon the closing of the Exchange Offers. Please refer to Note 5 – Long-Term Debt for additional information. +The carrying value of the Company’s revolving credit facility approximates its fair value, as the applicable interest rates are floating, based on prevailing market rates. +Warrants +As discussed in Note 5 – Long-Term Debt , on June 17, 2020, the Company issued warrants to purchase up to an aggregate of approximately 5.9 million shares, or approximately five percent of its outstanding common stock, at an exercise price of $ 0.01 per share. The warrants are exercisable any time from and after the Triggering Date, as subsequently defined, until June 30, 2023. The Triggering Date is defined by the Warrant Agreement as the first trading day following five consecutive trading days on which the product of the number of shares of common stock issued and outstanding on four of the five trading days multiplied by the closing price per share of common stock for each such trading day exceeds $ 1.0 billion (“Triggering Date”). The warrants issued are indexed to the Company’s common stock and are required to be settled through physical settlement or net share settlement if exercised. The warrants were not exercisable during the year ended December 31, 2020. The Triggering Date occurred on January 14, 2021, and the warrants became exercisable at the election of the holders. The warrants may be exercised either in full or from time to time in part, until their expiration on June 30, 2023. +101 +The fair value of the warrants on the issuance date was determined using a stochastic Monte Carlo simulation using the GBM Model. The Company evaluated the warrants under authoritative accounting guidance and determined that they should be classified as equity instruments. Upon issuance, the warrants were recorded in additional paid-in capital on the accompanying balance sheets at a fair value of $ 21.5 million, with no recurring fair value measurement required. There have been no changes to the initial carrying amount of the warrants since issuance. +Note 12 - Leases +Topic 842 requires lessees to recognize operating and finance leases with terms greater than 12 months on the balance sheet. As of December 31, 2020, and 2019, the Company did not have any agreements in place that were classified as finance leases under Topic 842. Arrangements classified as operating leases are included on the accompanying balance sheets within the other noncurrent assets, other current liabilities, and other noncurrent liabilities line items. For any agreement that contains both lease and non-lease components, such as a service arrangement that also includes an identifiable ROU asset, the Company’s policy for all asset classes is to combine lease and non-lease components together and account for the arrangement as a single lease. Aside from the recognition of ROU assets and corresponding lease liabilities on the accompanying balance sheets, Topic 842 does not have a material impact on the timing or classification of costs incurred for those agreements considered to be leases. +As outlined in Topic 842, a ROU asset represents a lessee’s right to use an underlying asset for the lease term, while the associated lease liability represents the lessee’s obligations to make lease payments. At the commencement date, which is the date on which a lessor makes an underlying asset available for use by a lessee, a lease ROU asset and corresponding lease liability is recognized based on the present value of the future lease payments. The initial measurement of lease payments may also be adjusted for certain items, including options that are reasonably certain to be exercised, such as options to purchase the asset at the end of the lease term, or options to extend or early terminate the lease. Excluded from the initial measurement of a ROU asset and corresponding lease liability are certain variable lease payments, such as payments made that vary depending on actual usage or performance. +The Company evaluates a contractual arrangement at its inception to determine if it is a lease or contains an identifiable lease component as defined by Topic 842. When evaluating a contract to determine appropriate classification and recognition under Topic 842, significant judgment may be necessary to determine, among other criteria, if an embedded leasing arrangement exists, the length of the term, classification as either an operating or financing lease, which options are reasonably likely to be exercised, fair value of the underlying ROU asset or assets, upfront costs, and future lease payments that are included or excluded in the initial measurement of the ROU asset. Certain assumptions and judgments made by the Company when evaluating a contract that meets the definition of a lease under Topic 842 include: +• Discount Rate - Unless implicitly defined, the Company determines the present value of future lease payments using an estimated incremental borrowing rate based on a yield curve analysis that factors in certain assumptions, including the term of the lease and credit rating of the Company at lease inception. The weighted-average discount rate used to determine the operating lease liability at December 31, 2020, and 2019, was 7.0 percent and 6.6 percent, respectively. +• Lease Term - The Company evaluates each contract containing a lease arrangement at inception to determine the length of the lease term when recognizing a ROU asset and corresponding lease liability. When determining the lease term, options available to extend or early terminate the arrangement are evaluated and included when it is reasonably certain an option will be exercised. Because of the Company’s intent to maintain financial and operational flexibility, there are no available options to extend that the Company is reasonably certain it will exercise. Additionally, based on expectations for those agreements with early termination options, there are no leases in which material early termination options are reasonably certain to be exercised by the Company. Exercising an early termination option may result in an early termination penalty depending on the terms of the underlying agreement. +Currently, the Company has operating leases for asset classes that include office space, office equipment, drilling rigs, midstream agreements, vehicles, and equipment rentals used in field operations. For those operating leases included on the accompanying balance sheets, which only includes leases with terms greater than 12 months at commencement, remaining lease terms range from less than one year to approximately five years . The weighted-average lease term remaining for these leases is approximately three years as of each of the years ended December 31, 2020, and 2019. Certain leases also contain optional extension periods that allow for terms to be extended for up to an additional 10 years. An early termination option also exists for certain leases, some of which allow for the Company to terminate a lease within one year. +Subsequent to initial measurement, costs associated with the Company’s operating leases are either expensed or capitalized depending on how the underlying ROU asset is utilized and in accordance with GAAP requirements. For example, costs associated with drilling rigs and completion crews that are considered ROU assets are typically capitalized as part of the development of the Company’s oil and gas properties. Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on its accounting policies for oil and gas development and producing activities. When calculating the Company’s ROU asset and liability for a contractual arrangement that qualifies as an operating lease, the Company considers all of the necessary payments made or that are expected to be made upon commencement of the lease. As discussed above, excluded from the initial measurement are certain variable lease payments, which for the Company’s drilling rigs, completion crews, and midstream agreements, may be a significant component of the total lease costs. +102 +The following table reflects the components of the Company’s total costs, whether capitalized or expensed, related to operating leases, including short-term leases, and variable lease payments made for leases with initial lease terms greater than 12 months, for the years ended December 31, 2020, and 2019. This total does not reflect amounts that may be reimbursed by other third parties in the normal course of business, such as non-operating working interest owners. +For the Years Ended December 31, +2020 2019 +(in thousands) +Operating lease cost $ 17,980 $ 35,570 +Short-term lease cost (1) +143,892 301,373 +Variable lease cost (2) +70,858 106,006 +Total lease cost $ 232,730 $ 442,949 +____________________________________________ +(1) Costs associated with short-term lease agreements relate primarily to operational activities where underlying lease terms are less than one year. This amount includes drilling and completion activities and field equipment rentals, most of which are contracted for 12 months or less. It is expected that this amount will fluctuate primarily with the number of drilling rigs and completion crews the Company is operating under short-term agreements. +(2) Variable lease payments include additional payments made that were not included in the initial measurement of the ROU asset and corresponding liability for lease agreements with terms longer than 12 months. Variable lease payments relate to the actual volumes transported under certain midstream agreements, actual usage associated with drilling rigs, completion crews, and vehicles, and variable utility costs associated with the Company’s leased office space. Fluctuations in variable lease payments are driven by actual volumes delivered and the number of drilling rigs and completion crews operating under long-term agreements. +ROU assets obtained in exchange for new operating lease liabilities totaled $ 745,000 and $ 25.4 million for the twelve months ended December 31, 2020, and 2019, respectively. +Cash paid for amounts included in the measurement of lease liabilities for the years ended December 31, 2020, and 2019, were as follows: +For the Years Ended December 31, +2020 2019 +(in thousands) +Operating cash flows from operating leases $ 12,046 $ 12,074 +Investing cash flows from operating leases $ 7,313 $ 24,129 +Maturities for the Company’s operating lease liabilities included on the accompanying balance sheets as of December 31, 2020, were as follows: +As of December 31, 2020 +(in thousands) +2021 $ 12,781 +2022 5,891 +2023 3,591 +2024 2,081 +2025 1,222 +Thereafter 417 +Total Lease payments $ 25,983 +Less: Imputed interest (1) +( 2,426 ) +Total $ 23,557 +____________________________________________ +(1) The weighted-average discount rate used to determine the operating lease liability as of December 31, 2020, was 7.0 percent. +103 +Amounts recorded on the accompanying balance sheets for operating leases as of December 31, 2020, and 2019, were as follows: +As of December 31, +2020 2019 +(in thousands) +Other noncurrent assets $ 21,701 $ 39,717 +Other current liabilities $ 11,659 $ 19,189 +Other noncurrent liabilities $ 11,898 $ 23,137 +As of December 31, 2020, and through the filing of this report, the Company has no material lease arrangements which are scheduled to commence in the future. +Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses +Accounts receivable are comprised of the following accruals: +As of December 31, +2020 2019 +(in thousands) +Oil, gas, and NGL production revenue $ 108,928 $ 146,308 +Amounts due from joint interest owners 31,514 22,681 +State severance tax refunds 2,301 4,069 +Derivative settlements 16,348 6,868 +Other 3,364 4,806 +Total accounts receivable $ 162,455 $ 184,732 +Accounts payable and accrued expenses are comprised of the following accruals: +As of December 31, +2020 2019 +(in thousands) +Drilling and lease operating cost accruals $ 65,365 $ 96,925 +Trade accounts payable 63,006 52,094 +Revenue and severance tax payable 105,233 109,847 +Property taxes 20,584 24,535 +Compensation 30,907 41,540 +Derivative settlements 1,146 5,851 +Interest 52,802 44,175 +Other 32,627 27,041 +Total accounts payable and accrued expenses $ 371,670 $ 402,008 +104 +Note 14 – Asset Retirement Obligations +Please refer to Asset Retirement Obligations in Note 1 – Summary of Significant Accounting Policies for a discussion of the initial and subsequent measurements of asset retirement obligation liabilities and the significant assumptions used in the estimates. +The following is a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2020, and 2019: +As of December 31, +2020 2019 +(in thousands) +Beginning asset retirement obligations $ 86,846 $ 94,194 +Liabilities incurred (1) +1,018 3,927 +Liabilities settled (2) +( 1,404 ) ( 4,105 ) +Accretion expense +4,034 4,016 +Revision to estimated cash flows +( 5,169 ) ( 11,186 ) +Ending asset retirement obligations (3) +$ 85,325 $ 86,846 +____________________________________________ +(1) Reflects liabilities incurred through drilling activities and acquisitions of drilled wells. +(2) Reflects liabilities settled through plugging and abandonment activities and divestitures of properties. +(3) Balances as of December 31, 2020, and 2019, included $ 2.0 million and $ 2.7 million, respectively, related to the Company’s current asset retirement obligation liability, which is recorded in the accounts payable and accrued expenses line item on the accompanying balance sheets. +Note 15 – Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2020, 2019, and 2018. The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Beginning balance $ 11,925 $ 11,197 $ 49,446 +Additions to capitalized exploratory well costs pending the determination of proved reserves 3,346 11,925 11,197 +Divestitures +— — ( 109 ) +Reclassifications based on the determination of proved reserves ( 9,573 ) ( 11,197 ) ( 49,337 ) +Capitalized exploratory well costs charged to expense — — — +Ending balance $ 5,698 $ 11,925 $ 11,197 +As of December 31, 2020, there were no material exploratory well costs that were capitalized for more than one year. +105 +Supplemental Oil and Gas Information (unaudited) +Costs Incurred +Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Development costs (1) +$ 490,935 $ 913,959 $ 1,147,574 +Exploration costs 77,911 114,957 184,930 +Acquisitions +Proved properties +5,579 (310) 1,312 +Unproved properties (2) +10,854 11,633 55,688 +Total, including asset retirement obligations (3)(4) +$ 585,279 $ 1,040,239 $ 1,389,504 +____________________________________________ +(1) Includes facility costs of $27.2 million, $28.3 million, and $72.6 million for the years ended December 31, 2020, 2019, and 2018, respectively. +(2) Includes amounts related to leasing activity and acquiring surface rights outside of acquisitions of proved and unproved properties totaling $8.6 million, $8.7 million, and $23.4 million for the years ended December 31, 2020, 2019, and 2018, respectively. +(3) Includes amounts relating to estimated asset retirement obligations of $(4.7) million, $(9.9) million, and $7.1 million for the years ended December 31, 2020, 2019, and 2018, respectively. +(4) Includes capitalized interest of $15.8 million, $18.5 million, and $20.6 million for the years ended December 31, 2020, 2019, and 2018, respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting of reserve estimation and disclosure. +Proved reserves are the estimated quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated proved reserves are located in the United States. +The table below presents a summary of changes in the Company’s estimated proved reserves for each of the years in the three-year period ended December 31, 2020. The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company’s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +106 +For the Years Ended December 31, +2020 (1) +2019 (2) +2018 (3) +Oil Gas NGLs Oil Gas NGLs Oil Gas NGLs +(MMBbl) (Bcf) (MMBbl) (MMBbl) (Bcf) (MMBbl) (MMBbl) (Bcf) (MMBbl) +Total proved reserves: +Beginning of year 184.1 1,223.2 74.0 175.7 1,321.8 107.4 158.2 1,280.1 96.5 +Revisions of previous estimate (28.2) (246.6) (24.7) (19.2) (212.5) (40.0) (24.0) (219.5) (8.0) +Discoveries and extensions 19.6 96.5 11.5 5.4 28.8 2.9 9.3 20.3 0.5 +Infill reserves in an existing proved field 20.5 91.1 3.0 41.8 190.2 11.8 80.4 391.5 29.0 +Sales of reserves (4) +(0.5) (8.9) (1.1) (0.2) (0.7) — (29.6) (48.1) (2.7) +Purchases of minerals in place (4) +0.2 0.6 — 2.5 5.4 — 0.2 0.7 — +Production (23.0) (103.9) (6.1) (21.9) (109.8) (8.1) (18.8) (103.2) (7.9) +End of year 172.7 1,052.0 56.6 184.1 1,223.2 74.0 175.7 1,321.8 107.4 +Proved developed reserves: +Beginning of year 85.0 712.1 43.4 68.2 699.1 60.1 58.6 642.9 49.0 +End of year 89.8 643.9 32.1 85.0 712.1 43.4 68.2 699.1 60.1 +Proved undeveloped reserves: +Beginning of year 99.1 511.1 30.6 107.6 622.7 47.2 99.6 637.2 47.6 +End of year 82.9 408.1 24.4 99.1 511.1 30.6 107.6 622.7 47.2 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) For the year ended December 31, 2020, the Company added 85.8 MMBOE from its drilling program and through further development plan optimization, and had net downward revisions of 94.0 MMBOE, which were primarily driven by the removal of certain longer term proved undeveloped reserves and declining commodity prices during 2020. Please refer to Areas of Operation in Part I, Items 1 and 2 of this report, and to Oil and Gas Reserve Quantities in Critical Accounting Policies and Estimates in Part II, Item 7 of this report for additional information. +(2) For the year ended December 31, 2019, the Company added 98.4 MMBOE from its drilling program and through further development plan optimization. These additions were offset by net downward revisions of 94.7 MMBOE, which were primarily driven by declining commodity prices during 2019. +(3) For the year ended December 31, 2018, the Company added 188.0 MMBOE from its drilling program and through development plan optimization. The Company divested 40.3 MMBOE during 2018, primarily as a result of the PRB Divestiture, Divide County Divestiture, and Halff East Divestiture. The Company also had net downward revisions of 68.8 MMBOE, which resulted primarily from changes in development plans in its Eagle Ford shale program. +(4) Please refer to Note 3 – Acquisitions, Divestitures, and Assets Held for Sale for additional information. +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of future net cash flows (“Standardized Measure”) and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the estimated proved reserves in place at the end of the period using year end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities. +The assumptions used to compute the Standardized Measure are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the Standardized Measure computations since these reserve quantity estimates are the basis for the valuation process. +107 +The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the Standardized Measure: +For the Years Ended December 31, +2020 2019 2018 +Oil (per Bbl) $ 37.63 $ 53.68 $ 57.76 +Gas (per Mcf) $ 1.81 $ 2.49 $ 3.49 +NGLs (per Bbl) $ 14.64 $ 18.88 $ 26.23 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the Standardized Measure. +As of December 31, +2020 2019 2018 +(in thousands) +Future cash inflows $ 9,227,390 $ 14,327,131 $ 17,579,432 +Future production costs (3,429,288) (4,579,119) (5,386,264) +Future development costs (1,259,395) (2,108,859) (2,679,488) +Future income taxes — (579,815) (1,012,209) +Future net cash flows 4,538,707 7,059,338 8,501,471 +10 percent annual discount (1,856,250) (2,955,340) (3,847,088) +Standardized measure of discounted future net cash flows +$ 2,682,457 $ 4,103,998 $ 4,654,383 +The principle sources of changes in the Standardized Measure were: +For the Years Ended December 31, +2020 2019 2018 +(in thousands) +Standardized Measure, beginning of year $ 4,103,998 $ 4,654,383 $ 3,024,142 +Sales of oil, gas, and NGLs produced, net of production costs (734,971) (1,085,041) (1,148,991) +Net changes in prices and production costs (2,251,636) (1,539,042) 1,010,335 +Extensions, discoveries and other including infill reserves in an existing proved field, net of related costs 482,717 887,254 2,218,475 +Sales of reserves in place (10,755) (2,788) (147,887) +Purchase of reserves in place 2,120 57,519 1,818 +Previously estimated development costs incurred during the period 431,926 736,770 445,638 +Changes in estimated future development costs 215,460 132,825 (34,871) +Revisions of previous quantity estimates (172,197) (398,409) (611,168) +Accretion of discount 436,284 510,427 305,657 +Net change in income taxes 258,844 191,040 (449,884) +Changes in timing and other (79,333) (40,940) 41,119 +Standardized Measure, end of year $ 2,682,457 $ 4,103,998 $ 4,654,383 +108 +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +109 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on management’s assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020. +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +110 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020, and 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated February 18, 2021, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 18, 2021 +111 +ITEM 9B. OTHER INFORMATION +None. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning the Company’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about our Executive Officers,” and “Corporate Governance” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders, to be filed within 120 days from December 31, 2020. +The information required by this Item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders, to be filed within 120 days from December 31, 2020. +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation Tables” and “Director Compensation” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders, to be filed within 120 days from December 31, 2020. +112 +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders, to be filed within 120 days from December 31, 2020. +Securities Authorized for Issuance Under Equity Compensation Plans. The Company has equity compensation plans under which options and shares of the Company’s common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. The Company’s stockholders have approved these plans. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for further information about the material terms of the Company’s equity compensation plans. The following table is a summary of the shares of common stock authorized for issuance under equity compensation plans as of December 31, 2020: +(a) (b) (c) +Plan category Number of securities to be issued upon exercise of outstanding options, warrants, and rights Weighted-average exercise price of outstanding options, warrants, and rights Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan (1) +Restricted stock units (2) +2,106,654 N/A +Performance share units (2)(3) +867,088 N/A +Total for Equity Incentive Compensation Plan 2,973,742 $ — 3,760,838 +Employee Stock Purchase Plan (4) +— — 834,246 +Equity compensation plans not approved by security holders +— — — +Total for all plans 2,973,742 $ — 4,595,084 +____________________________________________ +(1) In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of the Company or any affiliate of the Company. The Company’s Board of Directors approved amendments to the Equity Plan in 2009, 2010, 2013, 2016, and 2018 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The number of shares of the Company’s common stock underlying awards granted in 2020, 2019, and 2018 under the Equity Plan were 1,726,445, 1,868,776, and 1,220,217, respectively. +(2) RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per unit fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per unit fair value for the outstanding RSUs and PSUs was $8.88 and $17.51, respectively. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for additional discussion. +(3) The number of awards to be issued assumes a multiplier of one. The final number of shares of the Company’s common stock issued upon settlement may vary depending on the three-year multiplier determined at the end of the performance period under the Equity Plan, which ranges from zero to two. +(4) Under the ESPP, eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their eligible compensation. The purchase price of the common stock is 85 percent of the lower of the fair market value of the common stock on the first or last day of the six-month offering period, and shares issued under the ESPP on or after December 31, 2011, have no minimum restriction period. The ESPP is intended to qualify under Section 423 of the IRC. The number of shares of the Company’s common stock issued in 2020, 2019, and 2018 under the ESPP were 464,757, 314,868, and 199,464, respectively. +113 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders, to be filed within 120 days from December 31, 2020. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “ Independent Registered Public Accounting Firm ” and “ Audit Committee Pre-approval Policy and Procedures ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders, to be filed within 120 days from December 31, 2020. +114 +PART IV +ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Consolidated Financial Statements and Financial Statement Schedules: +Report of Independent Registered Public Accounting Firm +61 +Consolidated Balance Sheets +64 +Consolidated Statements of Operations +65 +Consolidated Statements of Comprehensive Income (Loss) +66 +Consolidated Statements of Stockholders’ Equity +67 +Consolidated Statements of Cash Flows +68 +Notes to Consolidated Financial Statements +69 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +2.1 +Purchase and Sale Agreement dated January 8, 2018 by and between SM Energy Company and Converse Energy Acquisitions, LLC (filed as Exhibit 2.1 to the registrant’s Current Report on Form 8-K filed on January 11, 2018 and incorporated herein by reference) +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +3.2 +Amended and Restated By-Laws of SM Energy Company, effective as of February 21, 2017 (filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +4.1 +Indenture related to the 5.0% Senior Notes due 2024, dated May 20, 2013, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on May 20, 2013, and incorporated herein by reference) +4.2 +Indenture related to the 6.125% Senior Notes due 2022, dated November 17, 2014, by and between SM Energy Company, as issuer, and U.S. Bank National Association, as Trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on November 18, 2014, and incorporated herein by reference) +4.3 +Indenture related to senior debt securities of SM Energy Company by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-3 filed on May 7, 2015 (Registration No. 333-203936) and incorporated herein by reference) +4.4 +2025 Notes Supplemental Indenture (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on May 21, 2015, and incorporated herein by reference) +4.5 +Base Indenture, dated as of May 21, 2015, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.6 +Second Supplemental Indenture, dated August 12, 2016, by and between SM Energy Company and U.S. Bank, National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.7 +Third Supplemental Indenture, dated September 12, 2016 by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +4.8 +Fourth Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +4.9 +Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.3 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +115 +4.10 +Third Supplemental Indenture, dated as of April 29, 2020, to the Indenture, dated as of May 21, 2015, between the Company and U.S. Bank National Association, as trustee, as supplemented and amended by the Second Supplemental Indenture, dated as of August 12, 2016 governing the Company’s outstanding 1.50% Senior Convertible Notes due 2021 (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on April 29, 2020, and incorporated herein by reference) +4.11 +Indenture, dated as of June 17, 2020, between SM Energy Company and UMB Bank, N.A., as trustee, governing the Company’s outstanding 10.0% Senior Secured Notes due 2025 (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on June 17, 2020, and incorporated herein by reference) +4.12 +Warrant Agreement dated as of June 17, 2020, among SM Energy Company, Computershare Inc. and Computershare Trust Company, N.A., collectively as warrant agent (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on June 17, 2020, and incorporated herein by reference) +4.13† +SM Energy Company Equity Incentive Compensation Plan, amended and restated effective as of May 22, 2018 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 12, 2018, and incorporated herein by reference) +4.14* +Description of Securities +10.1 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.2 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.3† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +10.4*** +Gas Services Agreement effective as of July 1, 2010 between SM Energy Company and Eagle Ford Gathering LLC (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, and incorporated herein by reference) +10.5†† +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.6† +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.7+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of December 31, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.8*** +Gas Gathering Agreement dated May 31, 2011 between Regency Field Services LLC and SM Energy Company (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.9*** +Gathering and Natural Gas Services Agreement effective as of April 1, 2011 between SM Energy Company and ETC Texas Pipeline, Ltd. (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.10*** +Gas Processing Agreement effective as of April 1, 2011 between ETC Texas Pipeline, Ltd. and SM Energy Company (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.11† +Employee Stock Purchase Plan, As Amended and Restated as of June 10, 2011 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.12† +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.13† +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.14† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.15† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.16† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.17*† +Summary of Compensation Arrangements for Non-Employee Directors +116 +10.18 +Sixth Amended and Restated Credit Agreement dated as of September 28, 2018, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 4, 2018, and incorporated herein by reference) +10.19† +Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 20, 2015, and incorporated herein by reference) +10.20† +Amendment No. 3 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2016 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2015, and incorporated herein by reference) +10.21*** +Amendment to Amended and Restated Gas Gathering Agreement, effective as of September 1, 2015, by and between SM Energy Company and Regency Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on September 15, 2015, and incorporated herein by reference) +10.22 +Amendment to Amended and Restated Gas Gathering Agreement, effective as of February 1, 2016, by and between SM Energy Company and ETC Field Services LLC (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on February 22, 2016, and incorporated herein by reference) +10.23 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.24 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.25 +Call Option Confirmation, dated August 8, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.26 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Wells Fargo Bank, National Association (filed as Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.27 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and Bank of America, N.A. (filed as Exhibit 10.5 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.28 +Call Option Confirmation, dated August 10, 2016, by and between SM Energy Company and JPMorgan Chase Bank, National Association (filed as Exhibit 10.6 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +10.29† +SM Energy Company Employee Stock Purchase Plan, amended and restated effective as of April 6, 2017 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 13, 2017, and incorporated herein by reference) +10.30† +Performance Share Unit Award Agreement as of July 1, 2018 (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, and incorporated herein by reference) +10.31 +First Amendment to Sixth Amended and Restated Credit Agreement, dated April 18, 2019 among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on April 18, 2019, and incorporated herein by reference) +10.32† +Performance Share Unit Award Agreement as of July 1, 2019 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2019, and incorporated herein by reference) +10.33 +Second Amendment to Sixth Amended and Restated Credit Agreement, dated September 19, 2019 among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on September 24, 2019, and incorporated herein by reference) +10.34 +Third Amendment to the Sixth Amended and Restated Credit Agreement, dated April 29, 2020, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the institutions named therein as Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, and incorporated herein by reference) +10.35 +Fourth Amendment to the Sixth Amended and Restated Credit Agreement, dated as of May 5, 2020, by and among the Company, Wells Fargo Bank, National Association, as Administrative Agent, and the institutions named therein as Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 6, 2020, and incorporated herein by reference) +10.36 +Intercreditor Agreement dated as of June 17, 2020 among SM Energy Company, Wells Fargo Bank, National Association, as priority lien agent, and UMB Bank, N.A., as second lien collateral trustee (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on June 17, 2020, and incorporated herein by reference) +10.37 +Second Lien Pledge and Security Agreement dated as of June 17, 2020 between SM Energy Company and UMB Bank, N.A., as collateral trustee (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on June 17, 2020, and incorporated herein by reference) +10.38 +Second Lien Security Agreement dated as of June 17, 2020 between SM Energy Company and UMB Bank, N.A., as collateral trustee (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on June 17, 2020, and incorporated herein by reference) +117 +10.39 +Collateral Trust Agreement dated as of June 17, 2020 among SM Energy Company, UMB Bank, N.A., as trustee, UMB Bank, N.A., as collateral trustee, and (by joinder) U.S. Bank National Association, as trustee under the 2021 Notes Indenture (filed as Exhibit 10.4 to the registrant’s Current Report on Form 8-K filed on June 17, 2020, and incorporated herein by reference) +10.40 +Fifth Amendment to the Sixth Amended and Restated Credit Agreement, dated as of November 13, 2020, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on November 16, 2020, and incorporated herein by reference) +10.41 † +Non-Competition and Non-Solicitation Agreement dated October 26, 2020 between Javan D. Ottoson and SM Energy Company (filed as Exhibit 10.7 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, and incorporated herein by reference) +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Ryder Scott Company L.P. +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +99.1* +Ryder Scott Audit Letter +101.INS Inline XBRL Instance Document - The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH* Inline XBRL Schema Document +101.CAL* Inline XBRL Calculation Linkbase Document +101.LAB* Inline XBRL Label Linkbase Document +101.PRE* Inline XBRL Presentation Linkbase Document +101.DEF* Inline XBRL Taxonomy Extension Definition Linkbase Document +104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101.INS) +_____________________________________ +* Filed with this report. +** Furnished with this report. +*** Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Exchange Act. +† Exhibit constitutes a management contract or compensatory plan or agreement. +†† Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. Please refer to Item 15(a) above. +ITEM 16. FORM 10-K SUMMARY +None. +118 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: February 18, 2021 By: /s/ HERBERT S. VOGEL +Herbert S. Vogel +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Herbert S. Vogel and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2020, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ HERBERT S. VOGEL President, Chief Executive Officer, and Director February 18, 2021 +Herbert S. Vogel (Principal Executive Officer) +/s/ A. WADE PURSELL Executive Vice President and Chief Financial Officer February 18, 2021 +A. Wade Pursell (Principal Financial Officer) +/s/ PATRICK A. LYTLE Controller and Assistant Secretary February 18, 2021 +Patrick A. Lytle (Principal Accounting Officer) +119 +Signature Title Date +/s/ WILLIAM D. SULLIVAN Chairman of the Board of Directors February 18, 2021 +William D. Sullivan +/s/ CARLA J. BAILO Director February 18, 2021 +Carla J. Bailo +/s/ LARRY W. BICKLE Director February 18, 2021 +Larry W. Bickle +/s/ STEPHEN R. BRAND Director February 18, 2021 +Stephen R. Brand +/s/ LOREN M. LEIKER Director February 18, 2021 +Loren M. Leiker +/s/ JAVAN D. OTTOSON Director February 18, 2021 +Javan D. Ottoson +/s/ RAMIRO G. PERU Director February 18, 2021 +Ramiro G. Peru +/s/ JULIO M. QUINTANA Director February 18, 2021 +Julio M. Quintana +/s/ ROSE M. ROBESON Director February 18, 2021 +Rose M. Robeson +120 \ No newline at end of file diff --git a/raw/filings/0000893538/2020/0000893538-21-000008/filing_metadata.csv b/raw/filings/0000893538/2020/0000893538-21-000008/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..fd875cd83efd6674c96decf7eb8f7292c4b1de17 --- /dev/null +++ b/raw/filings/0000893538/2020/0000893538-21-000008/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2021-02-18,2020-12-31,2021-02-18T13:55:42.000Z,0000893538-21-000008,sm-20201231.htm,10-K,16437941,1,1,https://www.sec.gov/Archives/edgar/data/893538/000089353821000008/sm-20201231.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353821000008/,2020,2020,1 diff --git a/raw/filings/0000893538/2020/0000893538-21-000008/item1.txt b/raw/filings/0000893538/2020/0000893538-21-000008/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2020/0000893538-21-000008/item13.txt b/raw/filings/0000893538/2020/0000893538-21-000008/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..634663eec1fdc6039833de3130c8099dc221c2cb --- /dev/null +++ b/raw/filings/0000893538/2020/0000893538-21-000008/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2021 annual meeting of stockholders, to be filed within 120 days from December 31, 2020. \ No newline at end of file diff --git a/raw/filings/0000893538/2020/0000893538-21-000008/item9a.txt b/raw/filings/0000893538/2020/0000893538-21-000008/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..8d691436295732e997ade065e7e3dc43e641cf11 --- /dev/null +++ b/raw/filings/0000893538/2020/0000893538-21-000008/item9a.txt @@ -0,0 +1,34 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +109 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on management’s assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020. +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +110 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020, and 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated February 18, 2021, expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 18, 2021 +111 \ No newline at end of file diff --git a/raw/filings/0000893538/2020/0000893538-21-000008/rp_note.txt b/raw/filings/0000893538/2020/0000893538-21-000008/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2020/0000893538-21-000008/rpt_disclosure.txt b/raw/filings/0000893538/2020/0000893538-21-000008/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..3274aa1fa9578b6731a0bc5e30c11c91afa52994 --- /dev/null +++ b/raw/filings/0000893538/2020/0000893538-21-000008/rpt_disclosure.txt @@ -0,0 +1,11 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee’s review of any transaction, arrangement, or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, (b) the aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of our Related Person Transactions Policy, a “related person” means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more than five percent of our outstanding shares of common stock, and (iii) any immediate family member of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it determines in good faith are in, or are not inconsistent with, our best interests and the best interests of our stockholders. +In determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director’s independence in the event the related person is a director, and the extent of the related person’s interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in compliance with the policy and remain appropriate. +In addition, our By-Laws provide that a director, officer, or employee of our Company may not pursue for his or her own account a business or investment opportunity that he or she learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than 1 percent of the publicly traded stock of another company. +Transactions with Related Persons +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are consistent with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when our Board, acting through the Audit Committee or as otherwise described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, but are not limited to, situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we obtain products or services from, or provide products or services to, related persons on an arm’s length basis on terms comparable to those obtained from or provided to unrelated third parties or on terms comparable to those obtained from or provided to employees generally. With the exception of the transaction described in the following paragraph, which was approved by our Audit Committee, we had no transactions that required approval under our Related Person Transactions Policy. +Dean Lutey, the spouse of Ms. Mary Ellen Lutey, our Senior Vice President—Exploration, Development and EHS, joined the Company in 2008. Mr. Lutey was appointed Vice President—Chief Information Officer in April, 2021. Prior to this appointment, Mr. Lutey served as the Company’s Vice President—Information Technology since May 2013. During the fiscal year ended December 31, 2021, Mr. Lutey earned total compensation of $592,898 which included his base salary, annual bonus, LTIP awards, benefits under our qualified and non-qualified benefit plans, and matching contributions by the Company under its 401(k) Profit Sharing Plan and Non-Qualified Deferred Compensation Plan. Mr. Lutey also participated in the Company’s benefit programs for its employees. +Compensation Committee Interlocks and Insider Participation +None of the directors who served on the Compensation Committee during fiscal year 2021 has ever served as one of our officers or employees. 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0000893538 sm:OtherReceivablesMember 2022-12-31 0000893538 sm:OtherReceivablesMember 2021-12-31 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +☑ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +For the fiscal year ended December 31, 2022 +or +☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 +Commission file number 001-31539 +SM ENERGY CO MPANY +(Exact name of registrant as specified in its charter) +Delaware 41-0518430 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +1700 Lincoln Street, Suite 3200 , Denver , Colorado +80203 +(Address of principal executive offices) (Zip Code) +( 303 ) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common stock, $0.01 par value SM New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☑ Accelerated filer ☐ +Non-accelerated filer ☐ Smaller reporting company ☐ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C.7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☑ +If securities are registered pursuant to section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑ +The aggregate market value of the 120,301,526 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock on June 30, 2022, the last business day of the registrant’s most recently completed second fiscal quarter, of $34.19 per share, as reported on the New York Stock Exchange, was $ 4,113,109,174 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 9, 2023, the registrant had 121,931,676 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III of this report is incorporated by reference from portions of the registrant’s Definitive Proxy Statement on Schedule 14A relating to its 2023 annual meeting of stockholders, to be filed within 120 days after December 31, 2022. +1 +TABLE OF CONTENTS +Item Page +Cautionary Information about Forward-Looking Statements +4 +Glossary +4 +Part I +8 +Items 1. and 2. +Business and Properties +8 +General +8 +Strategy +8 +Significant Developments in 2022 +8 +Outlook +9 +Areas of Operation +10 +Reserves +11 +Production +15 +Productive Wells +15 +Drilling and Completion Activity +16 +Title to Properties +16 +Acreage +17 +Delivery Commitments +17 +Major Customers +17 +Human Capital +17 +Seasonality +19 +Competition +19 +Government Regulations +20 +Available Information +22 +Item 1A. +Risk Factors +23 +Item 1B. +Unresolved Staff Comments +36 +Item 3. +Legal Proceedings +36 +Item 4. +Mine Safety Disclosures +36 +Part II +37 +Item 5. +Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +37 +Item 6. +[Reserved] +38 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +39 +Overview of the Company +39 +Financial Results of Operations and Additional Comparative Data +43 +Comparison of Financial Results and Trends Between 2022 and 2021 and Between 2021 and 2020 +46 +Overview of Liquidity and Capital Resources +49 +Critical Accounting Estimates +54 +Accounting Matters +56 +Environmental +56 +Non-GAAP Financial Measures +57 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +58 +Item 8. +Consolidated Financial Statements and Supplementary Data +59 +Item 9. +Changes In and Disagreements With Accountants on Accounting and Financial Disclosure +102 +Item 9A. +Controls and Procedures +102 +Item 9B. +Other Information +105 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspection +105 +2 +TABLE OF CONTENTS +(Continued) +Item Page +Part III +105 +Item 10. +Directors, Executive Officers, and Corporate Governance +105 +Item 11. +Executive Compensation +105 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +105 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +106 +Item 14. +Principal Accountant Fees and Services +106 +Part IV +107 +Item 15. +Exhibits and Consolidated Financial Statement Schedules +107 +Item 16. +Form 10-K Summary +109 +Signatures +110 +3 +Cautionary Information about Forward-Looking Statements +This Annual Report on Form 10-K (“Form 10-K” or “this report”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). All statements included in this report, other than statements of historical facts, that address activities, conditions, events, or developments with respect to our financial condition, results of operations, business prospects or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “pending,” “plan,” “potential,” “projected,” “target,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this report, and include statements about such matters as: +• business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, plans with respect to future dividend payments, debt redemptions or equity repurchases, capital markets activities, environmental, social, and governance (“ESG”) goals and initiatives, and our outlook on our future financial condition or results of operations; +• the amount and nature of future capital expenditures, the resilience of our assets to declining commodity prices, and the availability of liquidity and capital resources to fund capital expenditures; +• our outlook on prices for future crude oil, natural gas, and natural gas liquids (also referred to throughout this report as “oil,” “gas,” and “NGLs,” respectively), well costs, service costs, production costs, and general and administrative costs, and the impacts of inflation on each of these; +• armed conflict, political instability, or civil unrest in oil and gas producing regions, including the ongoing conflict between Russia and Ukraine, and related potential effects on laws and regulations, or the imposition of economic or trade sanctions; +• any changes to the borrowing base or aggregate lender commitments under our Seventh Amended and Restated Credit Agreement (“Credit Agreement”); +• cash flows, liquidity, interest and related debt service expenses, changes in our effective tax rate, and our ability to repay debt in the future; +• our drilling and completion activities and other exploration and development activities, each of which could be impacted by supply chain disruptions and inflation, our ability to obtain permits and governmental approvals, and plans by us, our joint development partners, and/or other third-party operators; +• the effects of the global COVID-19 pandemic (“Pandemic”) on us, our industry, our financial condition, and our results of operations; +• possible or expected acquisitions and divestitures, including the possible divestiture or farm-out of, or farm-in or joint development of, certain properties; +• oil, gas, and NGL reserve estimates and estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates, as well as the conversion of proved undeveloped reserves to proved developed reserves; +• our expected future production volumes, identified drilling locations, as well as drilling prospects, inventories, projects and programs; and +• other similar matters, such as those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. We caution you that forward-looking statements are not guarantees of future performance and these statements are subject to known and unknown risks and uncertainties, which may cause our actual results or performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Factors that may cause our financial condition, results of operations, business prospects or economic performance to differ from expectations include the factors discussed in Part I, Item 1A, Risk Factors below and elsewhere in this report. +The forward-looking statements in this report speak only as of the filing of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by applicable securities laws. +4 +Glossary +The oil and gas terms and other terms defined in this section are used throughout this report. The definitions of the terms “developed reserves,” “exploratory well,” “field,” “proved reserves,” and “undeveloped reserves” have been abbreviated from the respective definitions under Rule 4-10(a) of Regulation S-X. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +ASC. Accounting Standards Codification. +ASU. Accounting Standards Update. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +BBtu. One billion British thermal units. +Bcf . One billion cubic feet, used in reference to gas. +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of gas to one Bbl of oil or NGLs. +Btu. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Completion. The installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry hole, the reporting to the applicable authority that the well has been abandoned. +Conversion rate. Current year conversions of proved undeveloped reserves to proved developed reserves, divided by beginning of the year proved undeveloped reserves (also commonly referred to in our industry as “ track record” ). +Costs incurred. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. An exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in sufficient commercial quantities to justify completion, or upon completion, the economic operation of a well (also referred to as “ non-productive well” ). +Exploratory well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. +FASB. Financial Accounting Standards Board. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and gas) rights. +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +GAAP. Accounting principles generally accepted in the United States. +Gross acres or gross wells. Acres or wells in which a working interest is owned. +5 +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses (“LOE ”) . The expenses incurred in the lifting of oil, gas, and/or NGLs from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to gas. +MMBbl. One million barrels, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +NGLs. The combination of ethane, propane, isobutane, normal butane, and natural gasoline that when removed from gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for oil. +NYMEX Henry Hub . New York Mercantile Exchange Henry Hub, a common industry benchmark price for gas. +OPEC+. The Organization of the Petroleum Exporting Countries (“ OPEC ”) plus other non-OPEC oil producing countries. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +PV-10. PV-10 is a non-GAAP measure. The present value of estimated future revenue to be generated from the production of estimated net proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. This measure is presented because management believes it provides useful information to investors for analysis of the Company's fundamental business on a recurring basis. +Productive well. An exploratory, development, or extension well that is producing or is capable of commercial production of oil, gas, and/or NGLs. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +Reserve life index. Expressed in years, represents the estimated net proved reserves at a specified date divided by actual production for the preceding 12-month period. +6 +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil, gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of oil, gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from oil, gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +Royalty interest. An interest in an oil and gas property entitling the owner to shares of oil, gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +SOFR. Secured Overnight Financing Rate. +Standardized measure of discounted future net cash flows. The discounted future net cash flows related to estimated proved reserves based on prices used in estimating the reserves, year-end costs, and statutory tax rates, at a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information (unaudited) located in Part II, Item 8 of this report. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and NGLs regardless of whether such acreage contains estimated net proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +7 +PART I +When we use the terms “SM Energy,” the “Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business in the Glossary section of this report. Throughout this document we make statements and projections that address future expectations, possibilities, or events, all of which may be classified as “forward-looking statements.” Please refer to the Cautionary Information about Forward-Looking Statements section of this report for an explanation of these types of statements and the associated risks and uncertainties. +ITEMS 1. AND 2. BUSINESS AND PROPERTIES +General +We are an independent energy company currently engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. SM Energy was founded in 1908, incorporated in Delaware in 1915, and our initial public offering of common stock was in December 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal office is located at 1700 Lincoln Street, Suite 3200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +Our strategy is to be a premier operator of top-tier oil and gas assets. Our team executes this strategy by prioritizing safety, technological innovation, and stewardship of natural resources, all of which are integral to our corporate culture. Our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to domestic energy security and prosperity, and having a positive impact in the communities where we live and work. Our long-term vision is to sustainably grow value for all of our stakeholders by maintaining and optimizing our high-quality asset portfolio, generating cash flows, and maintaining a strong balance sheet. Our near-term goals include returning value to stockholders through our Stock Repurchase Program and fixed dividend payments, which increased during 2022, as discussed in Significant Developments in 2022 below. Our asset portfolio is comprised of high-quality assets in the Midland Basin of West Texas and in the Maverick Basin of South Texas that present resilience to commodity price risk. We intend to achieve our goals by focusing on developing high-quality economic drilling, completion, and production opportunities, while efficiently employing capital and continuing to use innovative technologies. +We are committed to exceptional safety, health, and environmental stewardship; supporting the professional development of a diverse and thriving team of employees; building and maintaining partnerships with our stakeholders by investing in and connecting with the communities where we live and work; and transparency in reporting our progress in these areas. We have prioritized ESG initiatives by, among other things, integrating enhanced environmental and social programs throughout the organization and setting goals that include reducing flaring and greenhouse gas (“GHG” or “GHGs”) emissions intensity, and maintaining low methane emissions intensity. Additionally, we are implementing systems to track additional ESG metrics to improve future reporting and performance, and to increase employee awareness. The Environmental, Social and Governance Committee of our Board of Directors oversees, among other things, the development and implementation of the Company’s ESG policies, programs and initiatives, and, together with management, reports to our Board of Directors regarding such matters. Further demonstrating our commitment to sustainable operations and environmental stewardship, compensation for our executives and eligible employees under our long-term incentive plan, and compensation for all employees under our short-term incentive plan is calculated based on, in part, certain Company-wide, performance-based metrics that include key financial, operational, and environmental, health, and safety measures. +Significant Developments in 2022 +During 2022, we accomplished the near-term goals that we established at the beginning of the year. As a result of strong production and increased realized prices before the effect of derivative settlements (“realized price” or “realized prices”), we successfully increased our net cash provided by operating activities allowing us to reduce the principal balance of our outstanding long-term debt earlier than expected, and increased the value of our capital project inventory. Upon the achievement of these short-term goals, we initiated a return of capital program. +Production, Pricing and Revenue, and Commodity Derivatives. Our average net daily equivalent production in 2022 increased three percent compared with 2021 to 145.1 MBOE, consisting of 65.7 MBbl of oil, 345.0 MMcf of gas, and 21.9 MBbl of NGLs. This increase was a result of an increase in capital allocation to our Austin Chalk assets, which resulted in a 37 percent increase in average net daily equivalent production from our South Texas assets, which outpaced a 14 percent decrease in average net daily equivalent production from our Midland Basin assets. As a result, oil production as a percentage of total production decreased to 45 percent in 2022 from 54 percent in 2021. +Realized prices for oil, gas, and NGLs increased 40 percent, 29 percent, and six percent, respectively, for the year ended December 31, 2022, compared with 2021. As a result of increased realized prices, oil, gas, and NGL production revenue increased 29 +8 +percent to $3.3 billion for the year ended December 31, 2022, compared with $2.6 billion for 2021. Oil production revenue was 68 percent and 73 percent of total production revenue for the years ended December 31, 2022, and 2021, respectively. +We recorded net derivative losses of $374.0 million and $901.7 million for the years ended December 31, 2022, and 2021, respectively. These amounts include derivative settlement losses of $710.7 million and $749.0 million for the years ended December 31, 2022, and 2021, respectively. Please refer to Areas of Operation below and Overview of the Company in Part II, Item 7 of this report for additional discussion. +Cash Flows and Debt Reduction. For the year ended December 31, 2022, net cash provided by operating activities was $1.7 billion, which was in excess of net cash used in investing activities of $880.3 million. We used the excess of net cash provided by operating activities over net cash used in investing activities to redeem the remaining outstanding aggregate principal balance of our 2024 Senior Notes and 2025 Senior Secured Notes, reducing our total outstanding long-term debt to $1.6 billion as of December 31, 2022, from $2.1 billion as of December 31, 2021, and to return capital to our stockholders, as discussed below. Additionally, as of December 31, 2022, we had a cash and cash equivalents balance of $445.0 million. Please refer to Analysis of Cash Flow Changes Between 2022 and 2021 and Between 2021 and 2020 in Overview of Liquidity and Capital Resources in Part II, Item 7, and to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definitions of our 2024 Senior Notes and 2025 Senior Secured Notes. +Return of Capital Program . On September 7, 2022, we announced that our Board of Directors approved a stock repurchase program authorizing us to repurchase up to $500.0 million in aggregate value of our common stock through December 31, 2024 (“Stock Repurchase Program”). During 2022, we repurchased and subsequently retired 1,365,255 shares of our common stock for a total cost of $57.2 million. The Board of Directors also approved an increase to our fixed dividend to $0.60 per share annually, to be paid in quarterly increments of $0.15 per share. During the year ended December 31, 2022, we declared dividends of $0.31 per share which was an increase from $0.02 per share declared during the year ended December 31, 2021. Please refer to Note 3 - Equity in Part II, Item 8 of this report for additional discussion. +Reserves and Capital Investment. Total estimated proved reserves were 537.4 MMBOE as of December 31, 2022, which was an increase of nine percent from 492.0 MMBOE as of December 31, 2021. This increase primarily consisted of revisions of previous estimates of 103.2 MMBOE related to infill reserves in both our South Texas and Midland Basin assets, partially offset by 53.0 MMBOE of production during 2022. Our proved reserve life index increased to 10.1 years as of December 31, 2022, compared with 9.6 years as of December 31, 2021. Please refer to Areas of Operation and Reserves below for additional discussion regarding additions from extensions and discoveries, the removal of certain proved undeveloped reserve cases that are no longer within our development plan over the next five years, and revisions of previous estimates due to infill, price, and performance revisions. Costs incurred increased 34 percent from 2021 to $961.7 million in 2022. Please refer to Areas of Operation below, and to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Outlook +Our long-term vision to sustainably grow value for all of our stakeholders includes our goal of continuing to generate cash flows in order to return capital to stockholders through our Stock Repurchase Program and fixed dividend. Additionally, we are focused on increasing the value of our capital project inventory through exploration and development optimization and pursuing high-quality economic drilling, completion, and production opportunities. +Our total 2023 capital program, which we expect to fund with cash flows from operations, is expected to be approximately $1.1 billion. We plan to focus our 2023 capital program on highly economic oil development projects in both our Midland Basin and South Texas assets. We expect to repurchase additional shares of our outstanding common stock through our Stock Repurchase Program during 2023, under which $442.8 million remained available for repurchases as of December 31, 2022. +9 +Areas of Operation +____________________________________________ +(1) As of December 31, 2022. +Our 2022 operations were concentrated in the Midland Basin and South Texas, as described below. The following table summarizes estimated proved reserves, net production volumes, and costs incurred for the year ended December 31, 2022, for these areas: +Midland Basin +South Texas +Total (1) +Proved reserves +Oil (MMBbl) 153.1 52.7 205.8 +Gas (Bcf) 625.1 777.8 1,402.9 +NGLs (MMBbl) 0.2 97.6 97.8 +MMBOE (1) +257.4 280.0 537.4 +Relative percentage +48 % 52 % 100 % +Proved developed % 64 % 55 % 59 % +Net production volumes +Oil (MMBbl) 19.1 4.9 24.0 +Gas (Bcf) 63.5 62.5 125.9 +NGLs (MMBbl) — 8.0 8.0 +MMBOE (1) +29.7 23.2 53.0 +Avg. daily equivalents (MBOE/d) (1) +81.4 63.7 145.1 +Relative percentage +56 % 44 % 100 % +Costs incurred (in millions) (2) +$ 476.2 $ 431.0 $ 961.7 +___________________________________________ +(1) Amounts may not calculate due to rounding. +(2) Asset costs incurred do not sum to total costs incurred primarily due to corporate charges incurred on exploration activities and costs related to exploration efforts outside of our core areas of operation that are excluded from this table. For total costs incurred, please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Total estimated proved reserves at December 31, 2022, increased nine percent from December 31, 2021. Total net equivalent production increased three percent for the year ended December 31, 2022, compared with 2021. Costs incurred for the year ended December 31, 2022, increased 34 percent compared with 2021, primarily as a result of inflation and an increase in capital activity related to the development of our South Texas assets. +10 +Midland Basin. Our Midland Basin assets, which are located in the Permian Basin in West Texas, are comprised of approximately 80,000 net acres, and include our RockStar assets in Howard and Martin Counties, Texas and our Sweetie Peck assets in Upton and Midland Counties, Texas (“Midland Basin”). In 2022, drilling and completion activities within our RockStar and Sweetie Peck positions continued to focus primarily on development optimization and further delineating our Midland Basin position. Our current Midland Basin position provides substantial future development opportunities within multiple oil-rich intervals, including the Spraberry and Wolfcamp formations. We expect 2023 capital activity in the Midland Basin to be focused on highly economic oil development projects. +In 2022, costs incurred were $476.2 million, and we averaged three drilling rigs and one completion crew. We drilled 63 gross (50 net) wells and completed 44 gross (36 net) wells, and as of December 31, 2022, 49 gross (40 net) wells had been drilled but not completed in our operated Midland Basin program. Net equivalent production for the year ended December 31, 2022, was 29.7 MMBOE, a 14 percent decrease from 34.4 MMBOE for the year ended December 31, 2021. Estimated proved reserves increased two percent to 257.4 MMBOE at December 31, 2022, from 251.6 MMBOE at December 31, 2021, as a result of positive price, performance, and infill revisions of 41.0 MMBOE and additions of 5.6 MMBOE, partially offset by production of 29.7 MMBOE. Additionally, we removed 11.1 MMBOE of proved undeveloped reserves which were replaced by recognizing additions to proved undeveloped reserves associated with different locations that were added to our five-year development plan. Infill revisions and additions replaced converted proved undeveloped reserves. +South Texas. Our South Texas assets are comprised of approximately 155,000 net acres located in Dimmit and Webb Counties, Texas (“South Texas”). In 2022, our operations in South Texas were focused on production from the Eagle Ford shale formation and Austin Chalk formation, and further development of the Austin Chalk formation. Our overlapping acreage position in the Maverick Basin covers a significant portion of the western Eagle Ford shale and Austin Chalk formations (“Maverick Basin”) and includes acreage across the oil, gas-condensate, and dry gas windows with gas composition amenable to processing for NGL extraction. We expect 2023 capital activity in South Texas to be focused primarily on developing the Austin Chalk formation. +In 2022, costs incurred were $431.0 million, and we averaged two drilling rigs and one completion crew. We drilled 41 gross (40 net) wells and completed 43 gross (43 net) wells, and as of December 31, 2022, 29 gross (28 net) wells had been drilled but not completed in our operated South Texas program. Net equivalent production for the year ended December 31, 2022, was 23.2 MMBOE, a 37 percent increase from 16.9 MMBOE for the year ended December 31, 2021. Estimated proved reserves increased 16 percent to 280.0 MMBOE at December 31, 2022, from 240.4 MMBOE at December 31, 2021, as a result of positive infill and price revisions of 75.2 MMBOE and additions of 11.1 MMBOE, partially offset by downward revisions of 23.5 MMBOE and production of 23.2 MMBOE. Additions to proved reserves from extensions were the result of continued success in our development of the Austin Chalk formation. Downward revisions consisted of 14.7 MMBOE resulting from performance revisions and 8.8 MMBOE of proved undeveloped reserves which were replaced by recognizing additions to proved undeveloped reserves associated with different locations that were added to our five-year development plan. +Office Space. As of December 31, 2022, we leased and owned office space as summarized in the table below: +Approximate Square Footage Leased Approximate Square Footage Owned +Corporate 59,000 — +Midland Basin 59,000 — +South Texas 21,000 12,000 +Total 139,000 12,000 +Reserves +Reserve estimates are inherently imprecise and estimates for new discoveries and undeveloped locations are more imprecise than reserve estimates for producing oil and gas properties. Accordingly, we expect these estimates to change as new information becomes available. The following table presents the standardized measure of discounted future net cash flows and PV-10. PV-10 is a non-GAAP financial measure, and generally differs from the standardized measure of discounted future net cash flows, the most directly comparable GAAP financial measure, because it does not include the effects of income taxes on future net revenues. Neither the standardized measure of discounted future net cash flows nor PV-10 represents the fair market value of our oil and gas properties. We and others in the oil and gas industry use PV-10 as a measure to compare the relative size and value of proved reserves held without regard to the specific tax characteristics of such entities. Please refer to the Glossary section of this report for additional information regarding these measures and refer to the reconciliation of the standardized measure of discounted future net cash flows to PV-10 set forth below. The actual quantities and present value of our estimated proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The following table should be read along with the Risk Factors section below. +11 +The following table summarizes estimated proved reserves, the standardized measure of discounted future net cash flows (GAAP), PV-10 (non-GAAP), the prices used in the calculation of proved reserves estimates, and reserve life index as of December 31, 2022, 2021, and 2020: +As of December 31, +2022 2021 2020 +Reserve volumes: +Proved developed +Oil (MMBbl) 110.4 110.7 89.8 +Gas (Bcf) 902.1 833.0 643.9 +NGLs (MMBbl) 57.1 50.7 32.1 +MMBOE (1) +317.8 300.2 229.3 +Proved undeveloped +Oil (MMBbl) 95.4 88.8 82.9 +Gas (Bcf) 500.8 410.4 408.1 +NGLs (MMBbl) 40.7 34.5 24.4 +MMBOE (1) +219.6 191.8 175.3 +Total proved (1) +Oil (MMBbl) 205.8 199.5 172.7 +Gas (Bcf) 1,402.9 1,243.5 1,052.0 +NGLs (MMBbl) 97.8 85.2 56.6 +MMBOE 537.4 492.0 404.6 +Proved developed reserves percentage 59 % 61 % 57 % +Proved undeveloped reserves percentage 41 % 39 % 43 % +Reserve data (in millions): +Standardized measure of discounted future net cash flows (GAAP) $ 9,962.1 $ 6,962.6 $ 2,682.5 +PV-10 (non-GAAP): +Proved developed PV-10 $ 8,234.8 $ 5,407.2 $ 1,848.8 +Proved undeveloped PV-10 3,919.7 2,751.4 833.7 +Total proved PV-10 (non-GAAP) $ 12,154.5 $ 8,158.6 $ 2,682.5 +12-month trailing average prices: (2) +Oil (per Bbl) +$ 93.67 $ 66.56 $ 39.57 +Gas (per MMBtu) +$ 6.36 $ 3.60 $ 1.99 +NGLs (per Bbl) +$ 42.52 $ 36.60 $ 17.64 +Reserve life index (years) (3) +10.1 9.6 8.7 +____________________________________________ +(1) Amounts may not calculate due to rounding. +(2) The prices used in the calculation of proved reserve estimates reflect the unweighted arithmetic average of the first-day-of-the-month price of each month within the trailing 12-month period in accordance with SEC rules. We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our proved reserves. +(3) Our ability to replace production with new oil and gas reserves is critical to the future success of our business. Please refer to the reserve life index term in the Glossary section of this report for information describing how this metric is calculated. +12 +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the PV-10 (non-GAAP) of total estimated proved reserves. Please refer to the Glossary section of this report for the definitions of standardized measure of discounted future net cash flows and PV-10. +As of December 31, +2022 2021 2020 +(in millions) +Standardized measure of discounted future net cash flows (GAAP) +$ 9,962.1 $ 6,962.6 $ 2,682.5 +Add: 10 percent annual discount, net of income taxes +7,551.5 4,844.9 1,856.3 +Add: future undiscounted income taxes +3,888.3 2,130.3 — +Pre-tax undiscounted future net cash flows +21,401.9 13,937.8 4,538.8 +Less: 10 percent annual discount without tax effect +(9,247.4) (5,779.2) (1,856.3) +PV-10 (non-GAAP) $ 12,154.5 $ 8,158.6 $ 2,682.5 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from future wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of economic producibility when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time. As of December 31, 2022, we did not have any proved undeveloped reserves that had been on our books in excess of five years, and none of our proved undeveloped reserves were on acreage expected to expire or on acreage that was not expected to be held through renewal before the targeted completion date. +For proved undeveloped locations that are more than one development spacing area from developed producing locations, we utilized reliable geologic and engineering technology when booking estimated proved undeveloped reserves. Of the 219.6 MMBOE of total proved undeveloped reserves as of December 31, 2022, approximately 40.1 MMBOE of proved undeveloped reserves in the Midland Basin and 65.3 MMBOE of proved undeveloped reserves in South Texas were offset by more than one development spacing area from the nearest proved developed producing location. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected) and petrophysical analysis of that log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. +As of December 31, 2022, estimated proved undeveloped reserves increased 27.8 MMBOE, or 15 percent compared with December 31, 2021. The following table provides a reconciliation of our proved undeveloped reserves for the year ended December 31, 2022: +Total +(MMBOE) +Total proved undeveloped reserves: +Beginning of year 191.8 +Revisions of previous estimates 98.3 +Conversions to proved developed (59.7) +Removed for five-year rule (19.9) +Additions from extensions and discoveries 9.1 +End of year 219.6 +Revisions of previous estimates . During 2022, revisions of previous estimates of 98.3 MMBOE primarily related to infill reserves, of which 64.5 MMBOE and 33.8 MMBOE of estimated proved undeveloped reserves were attributable to our South Texas and Midland Basin programs, respectively. Price and performance revisions were each less than 1.0 MMBOE. +Conversions to proved developed. Our 2022 conversion rate was 31 percent and was the result of developing proved reserves in our Austin Chalk and Midland Basin assets. During 2022, we incurred $572.6 million on projects with reserves booked as proved undeveloped at the end of 2021, of which $466.5 million was spent on converting proved undeveloped reserves to proved +13 +developed reserves by December 31, 2022. At December 31, 2022, drilled but not completed wells represented 25.3 MMBOE of total estimated proved undeveloped reserves. We expect to incur $257.7 million of additional capital expenditures in completing these drilled but not completed wells, and we expect all estimated proved undeveloped reserves to be converted to proved developed reserves within five years from their initial booking as proved undeveloped reserves. +Removed for five-year rule. As a result of our testing and delineation efforts in 2022, we revised certain aspects of our future development plan to focus on maximizing returns and the value of our assets. We removed 19.9 MMBOE of estimated proved undeveloped reserves and reclassified these locations to unproved reserve categories, of which 11.1 MMBOE and 8.8 MMBOE related to development schedule optimization in our Midland Basin and South Texas programs, respectively. +Additions from extensions and discoveries. During 2022, we added 5.3 MMBOE and 3.8 MMBOE of estimated proved undeveloped reserves in South Texas and the Midland Basin, respectively. The majority of the additions in South Texas resulted from extensions from our continued success in delineating the Austin Chalk formation, while the majority of the additions in the Midland Basin resulted from further development of our assets. +As of December 31, 2022, estimated future development costs relating to our proved undeveloped reserves totaled $2.8 billion, and we expect to incur approximately $763.2 million, $679.0 million, and $604.4 million in 2023, 2024, and 2025, respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group and is coordinated by our Corporate Engineering Manager, subject to the oversight of our management and the Audit Committee of our Board of Directors, as discussed below. Our Corporate Engineering Manager has worked in the energy industry since 2008 and has been employed by the Company since 2010. He holds a Bachelor of Science degree in Petroleum Engineering from Montana Technological University and is a Registered Professional Petroleum Engineer in the states of Texas, Wyoming, and Montana. He is also a member of the Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the year by our staff. Data obtained from these reviews, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our asset teams’ engineering technical staff do not report directly to our Corporate Engineering Manager; they report to either their respective asset technical managers or directly to the Senior Vice President of Exploration, Development and EHS. This design is intended to promote objective and independent analysis within our asset teams in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world since 1937. Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are required, per our policy, to be within 10 percent of our proved reserve amounts for the total Company, as well as for each respective major asset. The technical person at Ryder Scott primarily responsible for overseeing our reserves audit is a Senior Vice President who received a Bachelor of Science degree in Petroleum Engineering and a Business Foundations Certificate from The University of Texas at Austin in 2002. She is a licensed Professional Engineer in the State of Texas and a member of the Society of Petroleum Engineers. The 2022 Ryder Scott audit report is included as Exhibit 99.1. +In addition to a third-party audit, our reserves are reviewed by our management with the Audit Committee of our Board of Directors. Our management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Senior Vice President of Exploration, Development and EHS, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives, separate from our management, from time to time to discuss processes and findings. +14 +Production +The following table summarizes our net production volumes and realized prices for oil, gas, and NGLs produced and sold during the periods presented, and related production expense on a per BOE basis: +For the Years Ended December 31, +2022 2021 2020 +Net production volumes +Oil (MMBbl) 24.0 27.9 23.0 +Gas (Bcf) 125.9 108.4 103.9 +NGLs (MMBbl) 8.0 5.4 6.1 +Equivalent (MMBOE) (1) +53.0 51.4 46.4 +Midland Basin net production volumes (2) +Oil (MMBbl) 19.1 25.2 21.3 +Gas (Bcf) 63.5 55.4 46.6 +NGLs (MMBbl) — — — +Equivalent (MMBOE) (1) +29.7 34.4 29.1 +Maverick Basin net production volumes (2) +Oil (MMBbl) 4.8 2.7 1.7 +Gas (Bcf) 62.4 52.8 57.2 +NGLs (MMBbl) 8.0 5.4 6.1 +Equivalent (MMBOE) (1) +23.2 16.9 17.3 +Realized price +Oil (per Bbl) $ 94.67 $ 67.72 $ 37.08 +Gas (per Mcf) $ 6.28 $ 4.85 $ 1.80 +NGLs (per Bbl) $ 35.66 $ 33.67 $ 13.96 +Per BOE $ 63.18 $ 50.58 $ 24.26 +Production expense per BOE +Lease operating expense $ 5.03 $ 4.39 $ 3.97 +Transportation costs $ 2.83 $ 2.71 $ 3.06 +Production taxes $ 3.07 $ 2.36 $ 0.99 +Ad valorem tax expense $ 0.79 $ 0.38 $ 0.41 +____________________________________________ +(1) Amounts may not calculate due to rounding. +(2) For each of the years ended December 31, 2022, 2021, and 2020, total estimated proved reserves attributed to our Midland Basin field and our Maverick Basin field each exceeded 15 percent of our total estimated proved reserves expressed on an equivalent basis. +Productive Wells +As of December 31, 2022, we had working interests in 859 gross (765 net) productive oil wells and 499 gross (465 net) productive gas wells. Productive wells are wells producing in commercial quantities or wells capable of commercial production that are temporarily shut-in. Multiple completions in the same wellbore are counted as one well, and as of December 31, 2022, two of these wells had multiple completions. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil when it first commenced production, but such designation may not be indicative of current or future production composition. +15 +Drilling and Completion Activity +All of our drilling and completion activities are conducted by independent contractors using equipment they own and operate. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2022, 2021, and 2020, excluding non-consented projects, active injector wells, saltwater disposal wells, or wells in which we own only a royalty interest: +For the Years Ended December 31, +2022 2021 2020 +Gross Net Gross Net Gross Net +Development wells +Oil 68 57 107 91 78 71 +Gas 18 18 11 8 — — +Non-productive — — — — — — +86 75 118 99 78 71 +Exploratory wells +Oil 4 3 2 2 5 5 +Gas 2 2 8 8 1 1 +Non-productive 1 1 — — — — +7 6 10 10 6 6 +Total 93 81 128 109 84 77 +____________________________________________ +Note: The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. +In addition to the wells completed in 2022 (included in the table above), we were actively participating in the drilling of 10 gross (nine net) wells and had 74 gross (66 net) drilled but not completed wells as of January 31, 2023. Drilled but not completed wells as of January 31, 2023, represent wells that were being completed or were waiting on completion. The drilled but not completed well count as of January 31, 2023, includes nine gross (nine net) wells that are not included in our five-year development plan, eight of which are in the Eagle Ford shale. +Title to Properties +As of December 31, 2022, over 97 percent of our operated oil and gas producing assets are located on private lands, are held pursuant to oil and gas leases from private mineral owners, and are not located on federal lands or leased from the federal government. The remainder of our operated oil and gas producing assets are located on Texas state lands. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such properties. We obtain new or updated title opinions prior to commencing initial drilling operations on the properties that we operate. Most of our producing properties are subject to mortgages securing indebtedness under our Credit Agreement, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, royalty and overriding royalty interests, liens for current taxes, and other ordinary course burdens that we believe do not materially interfere with the development of such properties. We typically perform title investigations in accordance with standards generally accepted in the oil and gas industry before acquiring developed and undeveloped leasehold acreage. +16 +Acreage +The following table sets forth the number of gross and net surface acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes that we held as of December 31, 2022: +Developed Acres (1) +Undeveloped Acres (2)(3) +Total +Gross Net Gross Net Gross Net +Midland Basin: +RockStar 68,090 61,987 2,178 1,512 70,268 63,499 +Sweetie Peck 19,793 16,437 2,567 533 22,360 16,970 +Midland Basin Total (4) +87,883 78,424 4,745 2,045 92,628 80,469 +South Texas 85,834 85,418 72,319 69,400 158,153 154,818 +Other (5) +10,499 10,499 89,691 25,306 100,190 35,805 +Total 184,216 174,341 166,755 96,751 350,971 271,092 +____________________________________________ +(1) Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations but has been included only as developed acreage in the table above. +(2) Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) As of February 9, 2023, 66, 540, and one net acre of our undeveloped acreage is scheduled to expire by December 31, 2023, 2024, and 2025, respectively, unless production is established or we take other action to extend the terms of the applicable leases. Certain of our acreage, primarily in South Texas, is subject to lease consolidation agreements containing drilling, completion, and other obligations that we currently intend to satisfy. Failure to meet these obligations results in payments to lessors, or termination of the lease consolidation agreements, which could result in additional future lease expirations if continuous development obligations required by individual leases are not met. +(4) As of December 31, 2022, total Midland Basin acreage excludes approximately 1,523 net acres associated with drill-to-earn opportunities that we intend to pursue. +(5) Includes other non-core acreage located in Colorado, Louisiana, Montana, North Dakota, Texas, Utah, and Wyoming. +Delivery Commitments +For gathering, processing, transportation throughput, and delivery commitments, please refer to Pipeline Transportation Commitments within Note 6 – Commitments and Contingencies in Part II, Item 8 of this report. +Major Customers +For major customers and entities under common control that accounted for 10 percent or more of our total oil, gas, and NGL production revenue for at least one of the years ended December 31, 2022, 2021, and 2020, please refer to Concentration of Credit Risk and Major Customers within Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. +Human Capital +Our Company culture, which seeks to recognize our employees as our most valuable asset, thrives on the strong relationships we have built with our employees and drives the manner in which we pursue our short-term and long-term goals, as well as our efforts to attract and retain talent. Through our culture, we promote: +• integrity and ethical behavior in the conduct of our business; +• environmental, health, and safety priorities; +• prioritizing the success of others and the team; +• collaboration and openness to new ideas and technologies that serve business improvement; +• support for team members’ professional and personal development; and +• support for the communities where we live and work. +The core values of integrity and ethical behavior are the pillars of our culture, and all employees are responsible for upholding Company-wide standards and values. We have many long-standing policies designed to promote ethical conduct and integrity, which employees are required to read and acknowledge on an annual basis. The health and safety of our employees and contractors is our highest priority. We strive to achieve performance excellence in environmental, health, and safety management, and compensation of +17 +all employees is tied to annual environmental, health, and safety performance goals. Personal and professional development is an important part of our culture and is employee driven, manager facilitated, and organizationally supported. Employees are routinely provided training opportunities to develop skills in leadership, safety, and technical acumen, which help strengthen our efforts to conduct business with high ethical standards. During 2022, many of our employees participated in three key leadership and talent development programs that included more than 5,800 hours of training, exclusive of safety and other specialized technical training. We measure employee engagement and satisfaction through periodic surveys, administered by an independent third-party vendor. We are proud of our many outstanding employees who invest their time, talents, and financial resources in their communities. Our charitable giving program includes a monetary match of our employees’ personal contributions to qualified organizations and up to 12 hours per employee of Company-granted time to volunteer in the communities where we live and work. +We strive to provide competitive, performance-based compensation and benefits to our employees, including market-competitive pay, short-term and long-term incentive compensation plans, an employee stock purchase program, and various healthcare, retirement, and other benefit packages such as a hybrid work environment that is guided by each employee’s job function and responsibilities. Compensation for our executives and employees under our short-term and long-term incentive plans is determined based on individual performance and Company performance with respect to qualitative and quantitative metrics that include environmental, health, and safety measures. The Compensation Committee of our Board of Directors oversees our compensation programs and regularly modifies program design to incentivize achievement of our corporate strategy and the matters of importance to our stakeholders. Significant planning for succession of key personnel is performed each year, or more frequently as deemed necessary by management. +As of February 9, 2023, we had 539 full-time employees, none of whom were subject to a collective bargaining agreement. We are committed to diversity at all levels of our organization and we strive to provide equal employment opportunities to all employees and job applicants. On an annual basis, we retain a third party to analyze our workforce demographics and conduct discrimination and pay equity testing. No discriminatory practices have been identified and no evidence of discrimination or pay inequity has been found. Additionally, we have established procedures and controls designed to support our objective of remaining, at all times, in material compliance with federal, state, and local laws and governmental regulations. +18 +The following charts present certain Board of Directors and workforce metrics as of February 9, 2023: +Board of Directors Diversity (1) +Officer Gender Diversity (2) +Employee Ethnic Diversity (1) +Employee Gender Diversity +____________________________________________ +(1) Ethnic diversity data is determined under guidelines set forth by the United States Equal Employment Opportunity Commission and includes employees in the following categories: American Indian or Alaska Native, Asian, Black or African American, Hispanic or Latino, or the combination of two or more races (not Hispanic or Latino). +(2) Includes officers at the level of Vice President and above, and reflects the recent announcements of officer retirements and new appointments. +Seasonality +The price of crude oil is primarily driven by global socioeconomic and geopolitical factors and is less affected by seasonal fluctuations; however, demand for energy is generally higher in the winter and in the summer driving season. The demand and price for gas generally increases during winter months and decreases during summer months. To lessen the impact of seasonal gas demand and price fluctuations, pipelines, utilities, local distribution companies, and industrial users regularly utilize gas storage facilities and forward purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can divert gas that is traditionally placed into storage which, in turn, may increase the typical winter seasonal price. Seasonal anomalies, such as mild or extreme winters sometimes lessen or exacerbate these fluctuations. +Certain of our drilling, completion, and other operational activities are also subject to seasonal limitations. Seasonal weather conditions, government regulations, and lease stipulations could adversely affect our ability to conduct drilling activities in some of the areas where we operate. Please refer to Risk Factors in Part I, Item 1A of this report for additional discussion. +Competition +The oil and gas industry is highly competitive, particularly with respect to acquiring prospective oil and gas properties. We believe our acreage positions provide a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from many major and independent oil and gas companies, which in some cases have larger technical teams and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and gas reserves, but also have gathering, processing or refining +19 +operations, market refined products, provide, dispose of and transport fresh and produced water, own drilling rigs or production equipment, or generate electricity, all of which, individually or in the aggregate, could provide such companies with a competitive advantage. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting, and processing of oil, gas, NGLs, and water. Consequently, we may face shortages, delays, or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including renewable energy sources such as solar and wind-generated energy, and other fossil fuels such as coal. Competitive conditions may be affected by future energy, environmental, climate-related, financial, or other policies, legislation, and regulations. +In addition, we compete for professionals in our workforce, including specialized roles in the oil and gas industry such as geologists, geophysicists, engineers, and others. Throughout the general labor market, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. The oil and gas industry is not insulated from the competition for quality people, and we must compete effectively to be successful. Please refer to Human Capital above and Risk Factors in Part I, Item 1A of this report for additional discussion. +Government Regulations +Although our regulatory compliance obligations are mitigated by the fact that we do not own or operate oil and gas properties on federal lands, nearly every aspect of our business is subject to expansive federal, state, and local laws and governmental regulations. These laws and regulations frequently change in response to economic or political conditions, or other developments, and our regulatory burden may increase in the future. Laws and regulations have the potential to increase our cost of conducting business and consequently could affect our profitability. +Energy Regulations +Texas, the state where we conduct operations and lease or own nearly all of our oil and gas assets, has adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, imposing bond requirements in order to drill or operate wells, governing the timing of drilling and location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to Texas conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, Texas conservation laws establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Our sales of gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for gas production. +Environmental, Health, and Safety Matters +General. Our operations are subject to stringent and complex federal, state, and local laws and regulations governing protection of the environment and worker health and safety, as well as the discharge of materials and emissions into the environment. These laws and regulations may, among other things: +• require the acquisition of various permits before drilling commences; +• restrict the types, quantities, and concentration of various substances and emissions that may be released into the environment in connection with oil and gas drilling and production and saltwater disposal activities; +• limit or prohibit drilling activities on certain lands lying within wilderness, wetlands, and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +• require remedial measures to mitigate pollution from former and ongoing operations, such as closing pits and plugging abandoned wells. +These laws, rules, and regulations may also restrict the rate of oil and gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of conducting business and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent, or different permitting, waste handling, disposal, and cleanup requirements for the oil and gas industry and could have a significant impact on our operating costs. +20 +The following is a summary of some of the existing laws, rules, and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation, and Liability Act. The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release or threatened release of a hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of, or transported, a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of environmental investigation and certain health studies. In addition, it is not uncommon for third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +We currently own, lease, or operate numerous properties that have been used for oil and gas exploration and production for many years. CERCLA excludes petroleum and natural gas from its definition of hazardous substances, and although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances or wastes may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third-parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties, and the substances disposed or released on them, may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, or analogous state agencies. This includes the discharge of certain storm water without a permit which requires periodic monitoring and sampling. In addition, the Clean Water Act regulates wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process and discharged to publicly-owned wastewater treatment facilities. The Clean Water Act also prohibits discharge of dredged or fill material into waters of the United States, including wetlands, except in accordance with the terms of a permit issued by the United States Army Corps of Engineers, or a state, if the state has assumed authority to issue such permits. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for containment and removal costs, natural resource damages, and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”) and comparable state laws and regulations regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements, such as requirements for emission reduction, capture and control. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of hazardous air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. Please refer to the Environmental section in Part II, Item 7 of this report for additional information about the regulation of air emissions from the oil and gas sector. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane, and other GHGs endanger public health and welfare, and as a result, began adopting and implementing a comprehensive suite of regulations to restrict emissions of GHGs under existing provisions of the CAA. While President Trump’s administration took steps to rescind or review many of these regulations, President Biden’s administration has actively been reviewing those actions and taking steps to strengthen and expand the regulations, specifically targeting, among other things, the regulation of methane emissions from the oil and gas sector. Legislative and regulatory initiatives related to climate change could have an adverse effect on our operations and the demand for oil and gas. Please refer to Risk Factors - Risks Related to Oil and Gas Operations and the Industry - Legislative and regulatory initiatives and litigation related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs, and could result in significant litigation and related expenses in Part I, Item 1A of this report. Meteorological or extreme +21 +weather events (whether or not related to climate change), pose additional risks to our operations, which have included temporary shut-in of certain wells and temporary capacity constraints at third-party purchasers to receive our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +OSHA and other laws and regulations. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight shale formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand, and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions. However, even on private lands, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and scrutiny on oil and gas activities involving hydraulic fracturing techniques could potentially lead to a decrease in the completion of new oil and gas wells, an increase in compliance costs, delays, and changes in federal income tax laws, all of which could adversely affect our financial position, results of operations, and cash flows. As new laws or regulations that significantly restrict hydraulic fracturing are adopted at the state and local levels, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and gas that we are ultimately able to produce from our reserves. +We believe the trend in local, state, and federal environmental legislation and regulation will continue toward stricter standards, particularly under President Biden’s administration. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health, and Safety Initiatives. We are committed to exceptional safety, health, and environmental stewardship; making a positive difference in the communities where we live and work; and transparency in reporting our progress in these areas. We set annual goals for our safety, health, and environmental program focused on reducing the number of safety related incidents and the number and impact of spills of produced fluids. In addition, we set annual goals for GHG emissions intensity and methane emissions as a percentage of total methane produced, and as part of our current ESG initiatives, we have set goals that include reducing flaring and GHG emissions intensity, and maintaining low methane emissions intensity. We also periodically conduct audits of our operations to ensure regulatory compliance, and we strive to provide appropriate training for our employees. Reducing air emissions as a result of leaks, venting, or flaring of gas during operations has become a major focus area as we consider this a best practice and seek to comply with regulations. While flaring is sometimes necessary, reducing these volumes is a priority for us. To avoid flaring when possible, we restrict testing periods and connect our production to gas pipeline infrastructure as quickly as possible after well completions. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC, and can also be located at www.sec.gov. We also make available through our website our Corporate +22 +Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, and the Charters of the Audit, Compensation, Executive, and Environmental, Social and Governance committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in us. +Risks Related to Commodity Prices and Global Macroeconomics +Oil, gas, and NGL prices are volatile, and declines in prices may adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and gas properties depend heavily on the prices we receive for oil, gas, and NGL sales. Oil, gas, and NGL prices also affect our cash flows available for capital expenditures, debt reductions, return of capital, and other expenditures, our borrowing capacity, and the volume and value of our oil, gas, and NGL reserves. In addition, we may have oil and gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. Please refer to Significant Developments in 2022 and Reserves in Part I, Items 1 and 2, Comparison of Financial Results and Trends Between 2022 and 2021 and Between 2021 and 2020 in Part II, Item 7, and Note 1 – Summary of Significant Accounting Policies , Note 8 – Fair Value Measurements , and Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 for specific discussion. +Historically, the markets for oil, gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in oil, gas, and NGL prices often result from relatively minor changes in the supply of and demand for oil, gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• global and domestic supplies of oil, gas, and NGLs, and the productive capacity of the industry as a whole; +• the level of consumer demand for oil, gas, and NGLs; +• overall global and domestic economic conditions; +• inflation and other economic factors that contribute to market volatility; +• weather conditions; +• the availability and capacity of gathering, transportation, processing, storage, and/or refining facilities in asset-specific or localized areas; +• liquefied natural gas deliveries to and from the United States; +• the increased demand for, price, and availability of alternative fuels or sources of energy; +• technological advances in, and regulations affecting, energy consumption and conservation; +• the ability of the members of OPEC+ to maintain effective oil price and production controls; +• political instability or armed conflict involving oil or gas producing countries or regions, such as the continued conflict occurring between Russia and Ukraine; +• actual or perceived epidemic or pandemic risks; +• strengthening and weakening of the United States dollar relative to other currencies; +• stockholder activism or activities by non-governmental organizations to limit sources of funding or restrict the exploration and production of oil, gas, and NGLs and related infrastructure; and +• governmental regulations and taxes. +Declines in oil, gas, and NGL prices would reduce our revenues and could also reduce the amount of oil, gas, and NGLs that we can produce economically, which could have a material adverse effect on our business, financial condition, liquidity, results of operations, and prospects. +Future oil, gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our oil and gas properties. All property acquisition costs and development costs are capitalized when incurred. Exploratory well costs are initially capitalized, pending the determination of whether proved reserves have been discovered. If commercial quantities of proved reserves are not discovered with an exploratory well, the costs of drilling the well are expensed as dry hole costs. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net cash flows, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Write downs for unproved +23 +properties are also evaluated for carrying costs in excess of fair value. This evaluation considers the potential for abandonment due to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. Declines in the prices of oil, gas, or NGLs, or unsuccessful exploration efforts, could cause proved and/or unproved property impairments in the future, which could have a material adverse effect on our business, financial condition, liquidity, and results of operations. +We review the carrying values of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and gas properties held for use cannot be reversed at a later date, even if oil, gas, or NGL prices increase. +Weakness in economic conditions, continued inflation, or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +Historically, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, inflation, and heightened levels of intervention by the United States federal government and other governments. Weakness or uncertainty in the United States economy or other large economies could have a material adverse effect on our business and financial condition. For example: +• inflation has increased the costs of our drilling and completion activities, and the costs of oilfield services, equipment, and materials during 2022 and could continue or worsen and further impact our financial condition, liquidity, and results of operations, and could limit our pool of economic development opportunities; +• a potential economic recession could impact demand for oil, gas, and NGLs, and cause commodity price volatility; +• the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• the liquidity available under our Credit Agreement could be reduced if one or more of our lenders is unable to fund its commitment; +• our ability, or the ability of our suppliers or contractors, to access the capital markets may be restricted or non-existent at a time when we or they would like, or need, to raise capital for our or their business, including for the exploration and/or development of reserves; +• our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; +• the Federal Reserve could continue to increase interest rates in an effort to curb inflation, as they have done during 2022 and into 2023, which could result in increased borrowing costs; +• variable interest rate spread levels, including for SOFR and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our Credit Agreement; and +• changes in tax laws and regulations could require us to adjust our business plan. +Global geopolitical tensions, specifically including the ongoing conflict between Russia and Ukraine, may create heightened volatility in oil, gas, and NGL prices and could adversely affect our business, financial condition and results of operations. +On February 24, 2022, Russian military forces commenced a military operation in Ukraine and the sustained conflict and disruption in the region that has occurred since this date is expected to continue for the foreseeable future. Although the length, impact, and outcome of the ongoing military conflict in Ukraine is highly unpredictable, this conflict could lead to significant market and other disruptions, including significant volatility in commodity prices and supply of energy resources, instability in financial markets, supply chain interruptions, political and social instability, changes in consumer or purchaser preferences, as well as increases in cyberattacks and espionage. +While it is not possible at this time to predict or determine the ultimate consequences of the conflict in Ukraine, the conflict is likely to continue for the foreseeable future and could include, among other things: additional sanctions, greater regional instability, embargoes, geopolitical shifts, and other material and adverse effects on macroeconomic conditions, supply chains, financial markets, and hydrocarbon price volatility. To the extent negotiations of a cease fire between Russia and Ukraine are unsuccessful, the potential destruction of critical oil-related infrastructure in Ukraine, and the implementation of further sanctions and other measures taken by governmental bodies and others, could have a lasting impact on the operations and financial condition of our business and the global economy. +The global COVID-19 Pandemic has impacted, and may continue to impact, us and our industry and could have a material adverse effect on our business, financial condition, liquidity, results of operations and prospects. +Beginning in 2020, the Pandemic spread across the globe and disrupted markets and economies around the world, including the oil, gas, and NGL industry in which we operate. The Pandemic continues to impact certain countries and markets to varying degrees, +24 +and as a result, the markets for the commodities produced by our industry remain subject to heightened levels of uncertainty. Volatile market conditions could continue and could impact our business, financial condition, liquidity, results of operations, prospects, or the timing of further recovery, and may require us to adjust our business plan. In addition to risks directly related to the Pandemic, the Pandemic could increase the likelihood and magnitude of the other risk factors described in this section. +Risks Related to Oil and Gas Operations and the Industry +The loss of personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team, other key personnel, and our general labor force. The loss of their services could adversely affect our business. Our success in drilling and completing new wells and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen, and other professionals. Competition for many of these professionals can be intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +Our operations are subject to complex laws and regulations, including environmental regulations, that result in substantial costs and other risks. +Federal, state, and local authorities extensively regulate the oil and gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing, or marketing of oil, gas, and NGL production. Non-compliance with statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to increased operational and compliance costs, substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +Governmental authorities regulate various aspects of drilling for and the production of oil, gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in oil and gas properties, rights-of-way and easements, disposal of produced water, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, restoration standards, and oil and gas operations. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Any such delay, suspension, or termination could have a material adverse effect on our operations. +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate in, could result in material costs or claims with respect to properties we own or have owned or limitations on exploration and production activities in certain locations. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, and local environmental laws for emissions and for discharges of oil, gas, and NGLs or other pollutants into the air, soil, surface water, or groundwater as described in Government Regulations in Part I, Items 1 and 2 of this report. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a material adverse effect on us. +Federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Hydraulic fracturing is a common practice in the oil and gas industry used to stimulate the production of oil, gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and gas properties, including our unconventional resource plays within our Midland Basin and South Texas assets. Hydraulic fracturing involves injecting water, sand, and certain chemicals under pressure to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities, as outlined below. +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the Safe Drinking Water Act. The EPA also has authority under the Clean Water Act to regulate wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process and discharged to publicly-owned wastewater treatment facilities. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, +25 +experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states, including Texas, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict, or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event that state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +In the recent past, several federal governmental agencies were actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. In 2013, a court in California, and in 2020 the United States District Court for the District of Montana each held that the Bureau of Land Management (“BLM”) did not comply with the National Environmental Policy Act (“NEPA”) because it did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. In 2022, the federal Ninth Circuit Court of Appeals held that two federal agencies violated NEPA, in part, by failing to evaluate the environmental impacts of well stimulation treatments such as hydraulic fracturing before authorizing unconventional oil drilling offshore. Similar cases continue to be filed. In addition, courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing, including damages from induced seismicity, could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for, and production of, oil, gas, and NGLs, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional state or local laws, or the implementation of new regulations regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +We will continue to be subject to uncertainty associated with new regulatory suspensions, revisions or rescissions and inconsistent state and federal regulatory mandates that could adversely affect our production. +Federal and state regulatory initiatives relating to air quality and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays. +There has been a trend toward increased air quality and GHG regulation and reduced emissions from oil and gas sources. These regulations include the New Source Performance Standards (“NSPS”), the National Emission Standards for Hazardous Air Pollutants programs, and ozone standards set under the National Ambient Air Quality Standards (“NAAQS”), among others. The adoption of additional state or local laws, or the implementation of new regulations could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. Please refer to the Environmental section in Part II, Item 7 of this report for additional information about the regulation of air emissions, particularly methane emissions from the oil and gas sector. +Legislative and regulatory initiatives and litigation related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs, and could result in significant litigation and related expenses. +While courts have generally declined to assign direct liability for climate change to large sources of GHG emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant GHG emissions, and new claims for damages and increased government scrutiny, especially from state and local governments, will likely continue. +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and the majority of states have already taken measures to reduce emissions of GHGs through various measures, including, primarily through the planned development of GHG emission inventories, participation in and/or regional GHG “cap and trade” programs, and/or transition to clean energy. The focus on legislating and/or regulating methane could result in increased scrutiny for sources emitting high levels of methane, including during permitting processes, analysis, regulation and reduction of methane emissions as a requirement for project approval, and actions taken by one agency for a specific industry establishing precedents for other agencies and industry sectors. In 2021, the EPA proposed requirements for methane emission reductions from existing oil and gas equipment. In 2022, the EPA released +26 +a supplemental proposal expanding its initial requirements as well as updating requirements to work in tandem with the programs included in the Inflation Reduction Act (“IRA”). +The IRA imposes fees on emissions of GHGs, including methane, exceeding applicable thresholds. This and any court rulings, laws, or regulations that restrict or require reduced emissions of GHGs or introduce new climate-related regulations such as a carbon pricing system, could have an adverse effect on demand for the oil and gas that we produce, and could lead to increased operating and compliance costs, and litigation costs, which could have a material adverse impact on our business. We have a long-term goal to reduce our Scope 1 and 2 GHG emissions intensity by 50 percent by 2030, compared with base year 2019 levels, and we have an annual goal to limit our methane emissions intensity at 0.04 (metric tonnes CH4/MBOE). Our GHG emissions in 2022 did not exceed the thresholds set forth by the IRA, however, there is no assurance that we will be able to meet our goals or that we will not exceed the thresholds set forth by the IRA in the future. +Scientists have predicted that increasing concentrations of GHGs in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our drilling, completion, and production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies, or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses, or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements because emissions of such gases contribute to warming of the earth’s atmosphere and other climatic changes. +Requirements to reduce gas flaring could have an adverse effect on our operations. +In the Permian Basin in Texas, where we have significant operations, there have been, and could be in the future, constraints in gas takeaway capacity which has historically led to increased gas flaring. We are subject to laws established by state and other regulatory agencies that restrict the duration and amount of natural gas that can be legally flared. These laws and regulations, including potential future regulations that may impose further restrictions on flaring, could limit the amount of oil and gas we can produce from our wells or may limit the number of wells or the locations that we can drill. We have committed to a goal of zero routine flaring at all of our operated locations, and non-routine flaring not to exceed one percent of total gas production, each by 2023 based on the full year average. Additionally, we set annual targets to limit our flaring that are tied to compensation for all employees. There is no assurance that we will be able to meet our goals with respect to flaring and any failure to meet such goals could cause reputational or other harm to our business. Any future laws or commitments may increase our operational costs, or restrict our production, which could have a material adverse effect on our financial condition, results of operations and cash flows. +The impact of extreme weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Our operations have been in the past, and may continue to be, adversely affected by the impact of extreme weather conditions. Additionally, lease stipulations designed to protect various wildlife or plant species may adversely impact our operations. In certain areas, drilling and other oil and gas activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs and completion equipment, oil field equipment, services, supplies and qualified personnel, which may lead to periodic shortages. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Our ability to produce oil, gas, and NGLs economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling and/or completions operations or are unable to dispose of or recycle the water we produce at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of oil, gas, and NGLs requires the use and disposal of significant quantities of water. Our inability to secure sufficient amounts of water, or to dispose of, or recycle, the water produced from our wells, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of oil, gas, and NGLs. +Compliance with environmental regulations, surface use agreements, and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +27 +Our ability to sell oil, gas, and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third-parties or by other interruptions beyond our control, which could obstruct, limit, or eliminate our access to oil, gas, and NGL markets. +The marketability of our oil, gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems, which are generally owned or operated by third parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay, or discontinuance of development plans for our properties, increases in costs, or lower price realizations. Although we have some influence over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of oil, gas, and NGL production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines or processing facilities, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, transport, or market oil, gas, and NGLs. +Production may be interrupted, or shut in, from time to time for numerous reasons, including weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market or other conditions. If a substantial amount of our production is interrupted at the same time, it could adversely affect our cash flows and results of operations. +We have entered into firm transportation contracts that require us to pay fixed sums of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of oil, gas, NGL, or produced water to our counterparties, our results of operations, financial position, and liquidity could be adversely affected. +As of December 31, 2022, we were contractually committed to deliver a minimum of 18 MMBbl of oil through 2026, 26 Bcf of gas through the first half of 2023, and 11 MMBbl of produced water through 2027. We may enter into additional firm transportation agreements as we expand the development of our resource plays. We do not expect to incur any material shortfalls related to our existing contractual commitments. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, or if we further limit our capital expenditures due to future commodity price declines or for other reasons, the requirements to pay for quantities not delivered could have a material impact on our results of operations, financial position, and liquidity. +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find or acquire and develop oil, gas, and NGL reserves that are economically producible. Our properties produce oil, gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate or acquire and develop new oil, gas, and NGL reserves to replace those being depleted by production. +For future acquisitions we may complete, a successful outcome for our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price and transaction costs for the acquisition, future oil, gas, and NGL prices, the ability to reasonably estimate the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating these variables with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. Our customary review in connection with acquisitions will not necessarily reveal, or allow us to fully assess, all existing or potential problems and deficiencies with such properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. We often acquire interests in properties on an “as-is” basis with limited remedies for breaches of representations and warranties. +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of unique risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems, and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +28 +The results of our operations are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us, other operators and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +In addition, exploration and drilling technologies we currently use or implement in the future may become obsolete. If we are unable to maintain technological advancements consistent with industry standards, our operations and financial condition may be adversely affected. We cannot be certain we will be able to implement exploration and drilling technologies on a timely basis or at a cost that is acceptable to us. +Ultimately, the success of exploration, drilling, and completion technologies and techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for oil, gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from oil and gas exploration and production companies of all sizes for the capital, equipment, expertise, labor, and materials required to operate oil and gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many oil and gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. As a result, we may not be successful in acquiring and developing profitable properties. In addition, other companies may have a greater ability to continue drilling activities during periods of low oil or gas prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition, and results of operations. +The actual quantities and present value of our proved oil, gas, and NGL reserves may be less than we have estimated, and the cost to develop our reserves may be more than we have estimated. +This report and certain of our other SEC filings contain estimates of our proved oil, gas, and NGL reserves and the present value of estimated future net revenues from those reserves. The process of estimating reserves is complex and estimates are based on various assumptions, including geological and geophysical characteristics, future oil, gas, and NGL prices, drilling and completion costs, gathering and transportation costs, operating expenses, capital expenditures, effects of governmental regulation, taxes, timing of operations, and availability of funds. Therefore, these estimates are inherently imprecise. In addition, our reserve estimates for properties with limited production history may be less reliable than estimates for properties with lengthy production histories. +Actual future production; prices for oil, gas, and NGLs; revenues; production taxes; development expenditures; operating expenses; and quantities of producible oil, gas, and NGL reserves will most likely vary from those estimated. Any significant variance could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than what we have previously estimated. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2022, 41 percent, or 219.6 MMBOE, of our estimated proved reserves were proved undeveloped. In order to develop our proved undeveloped reserves, as of December 31, 2022, we estimate approximately $2.8 billion of capital expenditures would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +One should not assume that the standardized measure of discounted future net cash flows or PV-10 included in this report represent the current market value of our estimated proved oil, gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. Please refer to Reserves in Part I, Items 1 and 2 of this report for discussion +29 +regarding the prices used in estimating the present value of our proved reserves as of December 31, 2022, and to the caption Oil and Gas Reserve Quantities under Critical Accounting Estimates in Part II, Item 7 of this report for additional information. +The timing of production from oil and gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and gas industry in general are subject. +Our disposition activities may be subject to factors beyond our control, and in certain cases we may retain unforeseen liabilities for certain matters . +We regularly sell non-core assets in order to increase capital resources available for core assets and other purposes and to create organizational and operational efficiencies. We also occasionally sell interests in core assets for the purpose of accelerating the development and increasing efficiencies in other core assets. Various factors could materially affect our ability to dispose of such assets, including the approvals of governmental agencies or third parties, the availability of purchaser financing and purchasers willing to acquire the assets on terms we deem acceptable, or other matters or uncertainties that could impact such dispositions, including whether transactions could be consummated or completed in the form or timing and for the value that we anticipate. At times, we may be required to retain certain liabilities or agree to indemnify buyers in connection with such asset sales. The magnitude of such retained liabilities or of the indemnification obligations may be difficult to quantify at the time of the transaction and ultimately could be material. +We rely on third-party service providers to conduct drilling and completion and other related operations. +We rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, gas, and NGLs, prevailing economic conditions, and financial, business, and other factors. Future periods of sustained low commodity prices could occur and could cause third-party service providers to consolidate or declare bankruptcy, which could limit our options for engaging such providers. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. Our costs to retain third-party service providers increased during 2022 as a result of inflation, and continued inflation could result in additional cost increases. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title due diligence reports when acquiring oil and gas leasehold interests, and we obtain title opinions prior to commencing initial drilling operations on the properties we operate. Title to the properties in which we have an interest may be impaired by title defects that may not be identified in the due diligence title reports or title opinions we obtain, or such defects may not be cured following identification. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our oil and gas reserves, financial condition, results of operations, and operating cash flow, and may also impair the value of or render adjacent properties uneconomic to develop. Undeveloped acreage has greater risk of title defects than developed acreage and title insurance is not generally available for oil and gas properties. +Oil and gas drilling, completion, and production activities are subject to numerous risks, including the risk that no commercially producible oil, gas, or NGLs will be found. +The cost of drilling and completing wells is often uncertain, and oil, gas, or NGLs drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors may include, but are not limited to: +• supply chain issues, including cost increases and availability of equipment or materials; +• unexpected adverse drilling or completion conditions; +• title problems; +• disputes with owners or holders of surface interests on or near areas where we operate; +• pressure or geologic irregularities in formations; +• engineering and construction delays; +• equipment failures or accidents; +• hurricanes, tornadoes, flooding, wildfires or other adverse weather conditions; +• operational restrictions resulting from seismicity concerns; +• governmental permitting delays; +• compliance with environmental and other governmental requirements; and +30 +• shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if oil, gas, or NGLs are present, or whether they can be produced economically. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of oil, gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a material adverse effect on our ability to explore or develop our properties. +Results in newer resource plays may be more uncertain than results in resource plays that are more developed and have longer established production histories. We, and the industry, generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +We may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire, and we will lose our right to develop the related properties. Our total net acreage as of February 9, 2023, that is scheduled to expire over the next three years, represents less than one percent of our total net undeveloped acreage as of December 31, 2022. Although we have identified numerous potential drilling locations, we may not be able to economically drill for and produce oil, gas, or NGLs from all of them, and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing, or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids toward the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, result in increased lease operating expenses and adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from oil, gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other market conditions, including declines in oil, gas, and NGL prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. We do not believe the loss of any single purchaser would materially impact our operating results, as we have numerous options for purchasers in each of our operating areas for our oil, gas, and NGL production. Please refer to Concentration of Credit Risk and Major Customers in Note 1 – Summary of Significant Accounting Policies, in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. Additionally, the inability of our co-owners to pay joint interest billings could negatively impact our cash flows and financial ability to drill and complete current and future wells. +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of oil, gas and NGLs, or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to +31 +begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, wildfires, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, seismic events, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occur, we could sustain substantial losses. +In response to increased seismic activity in the Permian Basin in Texas, the Railroad Commission of Texas (“RRC”) has developed a seismic review process for injection wells near qualifying seismic activity. As a result of the seismic review process, the RRC may declare an area to be a Seismic Response Area (“SRA”) and may adjust limits for injection rates and pressure, require bottom-hole pressure tests, or modify, suspend, or terminate injection well permits within the SRA. If an SRA is declared within an area of our operations, our ability to dispose of produced water may be adversely affected, and as a result, we may be forced to shut-in injection wells or find alternate produced water disposal options which could affect production and therefore oil, gas, and NGL production revenue, and could cause us to incur additional capital or operating expense. The declaration of SRAs has required us to adjust the areas where we seek permits for injection wells to areas or formations that are less desirable, and could further restrict the areas where we are able to obtain and operate under such permits without restrictions. Additionally, we could be subject to third-party claims and liability based on allegations that our operations caused or contributed to seismic events that resulted in damage to property or personal injury, or that are otherwise related to seismic events. +If we experience any of the problems with well stimulation, completion activities, and disposal referenced above, our ability to explore for and produce oil, gas, and NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shut down, abandon, or relocate drilling operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling, and disposal of materials, including produced water, solid and hazardous wastes, and petroleum hydrocarbons. We may incur joint and several, and/or strict liability under applicable United States federal and state environmental laws in connection with releases of hazardous substances at, on, under, or from our leased or owned properties, some of which have been used for oil and gas exploration and production activities for a number of years, often by third-parties not under our control. For our outside-operated properties, we are dependent on the operator for operational and regulatory compliance and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or therefrom could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including CERCLA or the Superfund law, RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under various implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury or property damage, including induced seismicity damage, allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third-parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer an uninsured material loss. +We have limited control over the activities on properties we do not operate. +Some of our properties are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs. +Risks Related to Debt, Liquidity, and Access to Capital +Lower oil, gas, or NGL prices could limit our ability to borrow under our Credit Agreement. +As of December 31, 2022, the borrowing base and aggregate lender commitments under our Credit Agreement were $2.5 billion and $1.25 billion, respectively. The borrowing base is subject to semi-annual redetermination based on the bank group’s assessment of the value of our proved reserves, which in turn is impacted by oil, gas, and NGL prices. The next borrowing base +32 +redetermination date is scheduled for April 1, 2023. Divestitures of additional properties, incurrence of additional debt, or declines in commodity prices could limit our borrowing base and reduce the amount we can borrow under our Credit Agreement, which could in turn impact, among other things, our ability to service our debt, fund our capital program, or compete for the acquisition of new properties. +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce oil, gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for oil, gas, and NGL sales, our success in locating, developing, and acquiring new reserves, and the orderly functioning of credit and capital markets. If our cash flows from operations are less than expected, we may reduce our planned capital expenditures. If we cannot access sufficient liquidity under our Credit Agreement, or raise additional funds through debt or equity financing or the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Downgrades in our credit ratings by various credit rating agencies could impact our access to capital and have a material adverse effect on our business and financial condition. +Downgrades of our credit rating levels could have material adverse consequences on our business and future prospects and could: +• limit our ability to access capital markets, including for the purpose of refinancing our existing debt; +• cause us to refinance or issue debt with less favorable terms and conditions, which debt may restrict, among other things, our ability to make any dividend distributions or repurchase shares; +• negatively impact lenders’ willingness to transact business with us, which could impact our ability to obtain favorable terms and conditions under our Credit Agreement; +• negatively impact current and prospective customers’ willingness to transact business with us; +• impose additional insurance, guarantee, bonding, and collateral requirements; +• limit our access to bank and third-party guarantees, surety bonds, and letters of credit; and +• cause our suppliers and financial institutions to lower or eliminate the level of credit provided through payment terms or intraday funding when dealing with us, thereby increasing the need for higher levels of cash on hand, which would decrease our ability to repay outstanding indebtedness. +We cannot provide assurance that any of our current credit ratings will remain in effect for any given period of time or that a credit rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances warrant. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in oil, gas, and NGL prices and the associated impact on cash flows, we regularly enter into commodity derivative contracts. Our commodity derivative contracts typically include price swap and collar arrangements for oil, gas, and NGLs. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• our production is less than expected; +• one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +• there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +In addition, commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract, which we experienced in 2022. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional detail regarding our commodity derivative contracts. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2022, we had $1.6 billion of aggregate principal amount outstanding of Senior Notes with maturities through 2028, as further discussed and defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. Additionally, we had no outstanding balance on our revolving credit facility and $1.2 billion of available borrowing capacity under our Credit Agreement as of December 31, 2022. Our long-term debt represented 34 percent of our total book capitalization as of December 31, 2022. +33 +The amounts of our indebtedness could have important consequences for our operations, including: +• making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to capital investments; +• limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• placing us at a competitive disadvantage compared to our competitors with less debt; and +• making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our Credit Agreement or from other sources, we might not be able to service our debt, issue additional debt, or fund our planned capital expenditures and other liquidity needs. If we are unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our Credit Agreement and any future credit agreements, may prohibit us from pursuing any of these alternatives. +As discussed above, our Credit Agreement is subject to periodic borrowing base redeterminations. At times when we have an outstanding balance, we could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate adjustments to our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt arrangements contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements, including our Credit Agreement and the indentures governing our Senior Notes, contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests, including restrictions on incurring debt, issuing dividends, repurchasing common stock, selling assets, creating liens, entering into transactions with affiliates, and merging, consolidating, or selling our assets. Our ability to borrow under our Credit Agreement is subject to compliance with certain financial and non-financial covenants, as outlined in the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. These restrictions on our ability to operate our business could significantly harm us by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +Negative public perception and investor sentiment regarding our business and the oil and gas industry as a whole could adversely affect our business, operations, and our ability to attract capital. +Certain segments of the public as a whole, and the investment community in particular, have developed negative sentiment toward our industry. In recent years, equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. In addition, some investors, including investment management firms, sovereign wealth and pension funds, university endowments and other investment advisors, have adopted policies to discontinue or reduce their investments in the oil and gas sector based on social and environmental considerations. Furthermore, other influential stakeholders have pressured commercial and investment banks and other service providers to reduce or cease financing of oil and gas companies and related infrastructure projects. +Such developments, including increased focus on environmental, social and governance matters and initiatives aimed at limiting climate change and reducing air pollution, and changes in federal income tax laws could result in downward pressure on the stock prices of oil and gas companies, including ours. This may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +Risks Related to Corporate Governance and Ownership of Public Equity Securities +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in +34 +the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +In addition, stockholder activism in our industry has been present in recent years, and if investors seek to exert influence or affect changes to our business that we do not believe are in the long-term best interests of our stockholders, such actions could adversely impact our business by, among other things, distracting our Board of Directors and management team, causing us to incur unexpected advisory fees and other related costs, impacting execution of our strategic objectives, and creating unnecessary market uncertainty. +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2022, to February 9, 2023, the intraday trading prices per share of our common stock as reported by the New York Stock Exchange ranged from a low of $28.91 per share in January 2022 to a high of $54.97 per share in June 2022. We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include, in addition to the other risk factors set forth herein, the following: +• changes in oil, gas, or NGL prices; +• changes in the outlook for regional, national, or global commodity supply and demand; +• variations in drilling, recompletion, and operating activity; +• inflation; +• changes in financial estimates by securities analysts; +• changes in market valuations of comparable companies; +• additions or departures of key personnel; +• increased volatility due to the impacts of algorithmic trading practices; +• future sales of our common stock; +• negative public perception and investor sentiment regarding our business and the oil and gas industry as a whole; +• changes in the national and global economic outlook, including potential impacts from trade agreements; and +• international trade relationships, potentially including the effects of trade restrictions or tariffs affecting the raw materials we utilize and the commodities we produce in our business. +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +We may not always pay dividends on our common stock or repurchase common stock under our Stock Repurchase Program. +Payment of future dividends remains at the discretion of our Board of Directors, and common stock repurchases under our Stock Repurchase Program remain at the discretion of our Board of Directors and certain authorized officers of the Company. Decisions regarding the payment of dividends and the repurchase of common stock will continue to depend on our earnings, capital requirements, financial condition, general market and economic conditions, applicable legal requirements, the market price of our common stock, and other factors. The payment of dividends and the repurchase of our common stock are each subject to covenants in our Credit Agreement and in the indentures governing our Senior Notes that could limit our ability to make certain restricted payments including dividends and common stock repurchases. Our Board of Directors may determine in the future to reduce the current annual dividend rate or discontinue the payment of dividends altogether. The value of shares authorized for repurchase by the Board of Directors does not require us to repurchase such shares or guarantee that such shares will be repurchased, and the Stock Repurchase Program may be suspended, modified, or discontinued at any time without prior notice. No assurance can be given that any particular number or dollar value of our shares will be repurchased. +General Risk Factors +Our increasing dependence on digital technologies puts us at risk for a cyber incident that could result in information theft, data corruption, operational disruptions or financial loss. +We are subject to cybersecurity risks. The oil and gas industry is increasingly dependent on digital technology in all aspects of our business. We use digital technology to conduct certain aspects of our drilling development, production and gathering activities, manage drilling rigs and completion equipment, gather and interpret seismic data, conduct reservoir modeling, record financial and operating data, and maintain employee and other databases. Our service providers, including those who gather, process, and market our oil, gas, and NGLs, are also increasingly reliant on digital technology. Our and their reliance on this technology increasingly puts us +35 +at risk for technology system failures, data or network disruptions, cyberattacks and other breaches in cybersecurity. Power failures, telecommunication or other system failures due to hardware or software malfunctions, computer viruses, vandalism, terrorism, natural disasters, fire, flood, human error or other means could significantly impair our ability to conduct our business. +Cybersecurity attacks are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, cash, or other assets, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data. Deliberate attacks on, or security breaches in our systems, infrastructure, the systems and infrastructure of third-parties, or cloud-based applications could lead to disclosure of confidential information, a corruption or loss of our proprietary data, delays in production or exploration activities, difficulty in completing or settling transactions, challenges in maintaining our books and records, environmental damage, communication or other operational disruptions, and liability to third parties. Any insurance we might obtain in the future may not provide adequate protection from these risks. Any such events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. As these cyber risks continue to evolve and our dependence on digital technologies grows, we may be required to expend significant additional resources to continue to modify or enhance our protective measures and remediate cyber vulnerabilities. +The Audit Committee of our Board of Directors receives a quarterly cybersecurity report and update from management, discusses any relevant issues related thereto, and generally oversees and contributes to our Board of Director’s understanding of information technology and cybersecurity risks, among others that may be relevant at any given time. Upon the recommendation of the Audit Committee, we have taken a preventative approach with respect to cybersecurity threats by building a resilient cybersecurity culture through training and other forms of awareness for our employees and by creating and testing various response plans to hypothetical cybersecurity attacks to quickly assess and respond to potential and actual threats. We did not experience any material cybersecurity incidents during 2022, however there can be no assurance that the measures we have taken to address information technology and cybersecurity risks will prove effective in the future. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As an oil, gas, and NGL producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third-party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel, or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +The threat of terrorism and the impact of military and other actions have caused instability in world financial markets and could lead to increased volatility in prices for oil, gas, and NGLs, all of which could adversely affect the markets for our production. Energy assets might be specific targets of terrorist attacks. While we currently maintain insurance that provides limited coverage against terrorist attacks, such insurance has become increasingly expensive and difficult to obtain. As a result, insurance providers may not continue to offer this coverage to us on terms we consider reasonable, or at all. In addition, this insurance may not cover all of our losses for a terrorist attack. These developments have subjected our operations to increased risk and, depending on their occurrence and ultimate magnitude, could have a material adverse effect on our business, financial condition, or results of operations. +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Exchange Act. +ITEM 3. LEGAL PROCEEDINGS +At times, we may be involved in litigation relating to claims arising out of our business and operations in the normal course of business. As of the filing of this report, no legal proceedings are pending against us that we believe individually or collectively are likely to have a material adverse effect upon our financial condition, results of operations, or cash flows. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +36 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” For dividend information, please refer to the caption Uses of Cash in Overview of Liquidity and Capital Resources in Item 7 of this report. Information regarding the SM Energy Equity Incentive Compensation Plan, as amended and restated effective as of May 22, 2018 (the “Equity Plan”), and the securities authorized under the Equity Plan is included below. +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2017, and ending December 31, 2022, with the cumulative total returns of the Dow Jones Exploration and Production Index (“DJUSOS”), and the Standard & Poor’s 500 Stock Index (“SPX”). +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +Holders. As of February 9, 2023, the number of record holders of our common stock was 102. A substantially greater number of holders of our common stock are beneficial holders, whose shares of record are held by banks, brokers, and other financial institutions. +37 +Purchases of Equity Securities by Issuer and Affiliated Purchasers. The following table provides information about purchases made by us and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and months, and the year ended December 31, 2022, of shares of our common stock, which is the sole class of equity securities registered by us pursuant to Section 12 of the Exchange Act: +PURCHASES OF EQUITY SECURITIES BY ISSUER AND AFFILIATED PURCHASERS +Period +Total Number of +Shares +Purchased (1) +Weighted +Average Price +Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program (2) +Maximum Number or Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (as of the period end date) (2)(3) +First quarter of 2022 +623 $ 38.02 — 3,072,184 +Second quarter of 2022 +— $ — — 3,072,184 +Third quarter of 2022 +1,086,021 $ 41.75 452,734 $ 479,767,724 +10/01/2022 - 10/31/2022 — $ — — $ 479,767,724 +11/01/2022 - 11/30/2022 362,521 $ 44.07 362,521 $ 463,792,716 +12/01/2022 - 12/31/2022 550,000 $ 38.13 550,000 $ 442,820,671 +Total 1,999,165 $ 41.17 1,365,255 +____________________________________________ +(1) 633,910 shares purchased by us in 2022 were to offset tax withholding obligations that occurred upon the delivery of outstanding shares underlying Restricted Stock Units (“RSU” or “RSUs”) and Performance Share Units (“PSU” or “PSUs”) issued under the terms of award agreements granted under the Equity Plan. +(2) On September 7, 2022, we announced that our Board of Directors approved the Stock Repurchase Program authorizing us to repurchase up to $500.0 million in aggregate value of our common stock through December 31, 2024. The Stock Repurchase Program permits us to repurchase our shares from time to time in open market transactions, through privately negotiated transactions or by other means in accordance with federal securities laws and subject to certain provisions of our Credit Agreement and the indentures governing our Senior Notes. We intend to fund repurchases with net cash provided by operating activities. Stock repurchases may also be funded with borrowings under our Credit Agreement. The timing, as well as the number and value of shares repurchased under the Stock Repurchase Program, will be determined by certain authorized officers of the Company at their discretion and will depend on a variety of factors, including the market price of our common stock, general market and economic conditions and applicable legal requirements. The value of shares authorized for repurchase by our Board of Directors does not require us to repurchase such shares or guarantee that such shares will be repurchased, and the Stock Repurchase Program may be suspended, modified, or discontinued at any time without prior notice. No assurance can be given that any particular number or dollar value of our shares will be repurchased. During the year ended December 31, 2022, we repurchased and subsequently retired 1,365,255 shares of our common stock under the Stock Repurchase Program at a weighted-average share price of $41.88 for a total cost of $57.2 million, excluding commissions and fees. +(3) The Stock Repurchase Program terminates and supersedes the August 1998 authorization to repurchase common stock, under which 3,072,184 shares remained available for repurchase prior to termination. +Our payment of cash dividends to our stockholders and repurchases of our common stock are each subject to certain covenants under the terms of our Credit Agreement and Senior Notes. Based on our current performance, we do not anticipate that any of these covenants will limit our potential repurchases of our common stock or our payment of dividends at our current rate for the foreseeable future if any dividends are declared by our Board of Directors. +ITEM 6. [RESERVED] +38 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion includes forward-looking statements. Please refer to the Cautionary Information about Forward-Looking Statements section of this report for important information about these types of statements. +Overview of the Company +General Overview +Our strategy is to be a premier operator of top-tier oil and gas assets. Our team executes this strategy by prioritizing safety, technological innovation, and stewardship of natural resources, all of which are integral to our corporate culture. Our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to domestic energy security and prosperity, and having a positive impact in the communities where we live and work. Our long-term vision is to sustainably grow value for all of our stakeholders by maintaining and optimizing our high-quality asset portfolio, generating cash flows, and maintaining a strong balance sheet. Our near-term goals include returning value to stockholders through our Stock Repurchase Program and fixed dividend payments, which increased during 2022. +Our asset portfolio is comprised of high-quality assets in the Midland Basin of West Texas and in the Maverick Basin of South Texas that are capable of generating strong returns in the current macroeconomic environment, and present resilience to commodity price risk. We remain focused on maximizing returns and increasing the value of our top-tier assets through continued development and optimization of our Midland Basin assets and through continued delineation of the Austin Chalk formation in South Texas. We believe that our high-quality asset base provides for a sustainable and repeatable approach to prioritizing operational execution, maintaining strong cash flows, returning capital to stockholders, continuing to improve leverage metrics, and maintaining strong financial flexibility. +We are committed to exceptional safety, health, and environmental stewardship; supporting the professional development of a diverse and thriving team of employees; building and maintaining partnerships with our stakeholders by investing in and connecting with the communities where we live and work; and transparency in reporting our progress in these areas. The Environmental, Social and Governance Committee of our Board of Directors oversees, among other things, the development and implementation of the Company’s ESG policies, programs and initiatives, and, together with management, reports to our Board of Directors regarding such matters. Further demonstrating our commitment to sustainable operations and environmental stewardship, compensation for our executives and eligible employees under our long-term incentive plan, and compensation for all employees under our short-term incentive plan is calculated based on, in part, certain Company-wide, performance-based metrics that include key financial, operational, and environmental, health, and safety measures. Please refer to our Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders to be filed within 120 days from December 31, 2022, for additional discussion. +Global commodity and financial markets remain subject to high levels of macroeconomic uncertainty and volatility as a result of inflation, the ongoing conflict between Russia and Ukraine and associated economic and trade sanctions on Russia, and the Pandemic. These events have been drivers of volatile commodity prices and contributed to increased service provider costs, instances of supply chain disruptions, and a rise in interest rates, and could have further industry-specific impacts that may require us to adjust our business plan. Future impacts of these and other events on commodity and financial markets are inherently unpredictable. Despite continuing uncertainty, we expect to maximize the value of our high-quality asset base and sustain strong operational performance and financial stability. We are focused on returning capital to shareholders through increasing returns and cash flow generation. +2022 Financial and Operational Highlights +During 2022, we accomplished the near-term goals established at the beginning of the year to improve our leverage metrics by reducing the principal balance of our outstanding debt through cash flow generation and increasing the value of our capital project inventory. For the year ended December 31, 2022, net cash provided by operating activities exceeded net cash used in investing activities by $806.1 million, and we reduced the principal balance of our total outstanding long-term debt by $551.4 million by redeeming the remaining outstanding aggregate principal balance of our 2024 Senior Notes and our 2025 Senior Secured Notes. Our Board of Directors authorized the Stock Repurchase Program and increased our fixed dividend to $0.60 per share annually, to be paid in quarterly increments of $0.15 per share, both of which align with our goal to implement a sustainable and repeatable capital return program that creates long-term value for our stockholders. During the year ended December 31, 2022, we repurchased and subsequently retired 1,365,255 shares of our common stock at a cost of $57.2 million. Please refer to Note 3 - Equity and Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions. +Financial and Operational Results. Average net daily equivalent production for the year ended December 31, 2022, increased three percent to 145.1 MBOE, compared with 140.7 MBOE for 2021. The total increase consisted of a 37 percent increase from our South Texas assets, which outpaced a 14 percent decrease from our Midland Basin assets, as a result of increased capital allocation to our Austin Chalk assets. Realized prices for oil, gas, and NGLs increased 40 percent, 29 percent, and six percent, respectively, for the year ended December 31, 2022, compared with 2021. As a result of increased realized prices, oil, gas, and NGL production revenue increased 29 percent to $3.3 billion for the year ended December 31, 2022, compared with $2.6 billion for 2021. We recorded a net derivative loss of $374.0 million for the year ended December 31, 2022, compared with a $901.7 million net derivative loss for 2021. +39 +These amounts include derivative settlement losses of $710.7 million and $749.0 million for the years ended December 31, 2022, and 2021, respectively. Operational activities during the year ended December 31, 2022, resulted in the following financial and operational results: +• Net cash provided by operating activities of $1.7 billion for the year ended December 31, 2022, compared with $1.2 billion for 2021. +• Net income of $1.1 billion, or $8.96 per diluted share, for the year ended December 31, 2022, compared with net income of $36.2 million, or $0.29 per diluted share for 2021. +• Adjusted EBITDAX, a non-GAAP financial measure, for the year ended December 31, 2022, of $1.9 billion, compared with $1.2 billion for 2021. Please refer to Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and reconciliations to net income (loss) and net cash provided by operating activities. +• Total estimated proved reserves as of December 31, 2022, increased nine percent from December 31, 2021, to 537.4 MMBOE, of which, 56 percent were liquids (oil and NGLs) and 59 percent were proved developed reserves. The increase to total estimated proved reserves was primarily driven by 103.2 MMBOE of infill reserves, partially offset by 53.0 MMBOE of production during 2022 and the removal of 19.9 MMBOE of proved undeveloped reserves reclassified to unproved reserves categories as a result of development plan optimization. Our proved reserve life index increased to 10.1 years as of December 31, 2022, compared with 9.6 years as of December 31, 2021. Please refer to Reserves in Part I, Items 1 and 2 of this report for additional discussion. The standardized measure of discounted future net cash flows was $10.0 billion as of December 31, 2022, compared with $7.0 billion as of December 31, 2021, which was an increase of 43 percent year-over-year. Please refer to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Operational Activities. During 2022, we continued to experience strong well performance in the RockStar area of our Midland Basin position due to successful operational execution, enhanced drilling and completion designs, and our focus on capital efficiency. Our South Texas program benefited from continued successful delineation and development of the Austin Chalk formation in addition to the sustained strong performance of our Eagle Ford shale wells. Our continued success in both our Midland Basin and South Texas programs is attributable to our top-tier assets and our continued commitment to geoscience, technology, and innovation. +Our Midland Basin program averaged three drilling rigs and one completion crew during 2022. We drilled 63 gross (50 net) wells and completed 44 gross (36 net) wells during 2022, and net equivalent production decreased year-over-year by 14 percent to 29.7 MMBOE. Costs incurred during 2022 totaled $476.2 million, or 50 percent of our total 2022 costs incurred. Drilling and completion activities within our RockStar and Sweetie Peck positions in the Midland Basin continue to focus primarily on developing the Spraberry and Wolfcamp formations. +Our South Texas program averaged two drilling rigs and one completion crew during 2022. We drilled 41 gross (40 net) wells and completed 43 gross (43 net) wells during 2022, and net equivalent production increased year-over-year by 37 percent to 23.2 MMBOE. Costs incurred during 2022 totaled $431.0 million, or 45 percent of our total 2022 costs incurred. Drilling and completion activities in South Texas during 2022 were primarily focused on developing the Austin Chalk formation. +The table below provides a summary of changes in our drilled but not completed well count and current year drilling and completion activity in our operated programs for the year ended December 31, 2022: +Midland Basin South Texas Total +Gross Net Gross Net Gross Net +Wells drilled but not completed at December 31, 2021 (1) +30 27 32 32 62 59 +Wells drilled (2) +63 50 41 40 104 90 +Wells completed (2) +(44) (36) (43) (43) (87) (79) +Other (3) +— — (1) (1) (1) (1) +Wells drilled but not completed at December 31, 2022 (4)(5) +49 40 29 28 78 69 +____________________________________________ +(1) The South Texas drilled but not completed well count as of December 31, 2021, included 11 gross (11 net) wells that were not included in our five-year development plan as of December 31, 2021, 10 of which were in the Eagle Ford shale. +(2) Wells drilled and completed during the year ended December 31, 2022, exclude one drilled and completed well that was subsequently abandoned, outside of our core areas of operation. +(3) In 2022, we drilled a science well to study and monitor Austin Chalk reservoir activity during and after development. We do not intend to complete this well. +(4) The South Texas drilled but not completed well count as of December 31, 2022, includes nine gross (nine net) wells that are not included in our five-year development plan, eight of which are in the Eagle Ford shale. +(5) Amounts may not calculate due to rounding. +40 +Costs Incurred. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended +December 31, 2022 +(in millions) +Development costs $ 810.5 +Exploration costs 147.0 +Acquisitions +Proved properties — +Unproved properties 4.2 +Total, including asset retirement obligations (1) +$ 961.7 +____________________________________________ +(1) Please refer to the caption Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Production Results. The table below presents the disaggregation of our net production volumes by product type for each of our assets for the year ended December 31, 2022: +Midland Basin South Texas Total +Net production volumes: +Oil (MMBbl) 19.1 4.9 24.0 +Gas (Bcf) 63.5 62.5 125.9 +NGLs (MMBbl) — 8.0 8.0 +Equivalent (MMBOE) 29.7 23.2 53.0 +Average net daily equivalent (MBOE per day) 81.4 63.7 145.1 +Relative percentage 56 % 44 % 100 % +____________________________________________ +Note: Amounts may not calculate due to rounding. +Net equivalent production increased three percent for the year ended December 31, 2022, compared with 2021, comprised of a 37 percent increase from our South Texas assets, partially offset by a 14 percent decrease from our Midland Basin assets. Please refer to Overview of Selected Production and Financial Information, Including Trends and Comparison of Financial Results and Trends Between 2022 and 2021 and Between 2021 and 2020 below for additional discussion on production. +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effect of derivative settlements. While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location and transportation differentials, and contracted pricing benchmarks for these products. +41 +The following table summarizes commodity price data, as well as the effect of derivative settlements, for the years ended December 31, 2022, 2021, and 2020: +For the Years Ended December 31, +2022 2021 2020 +Oil (per Bbl): +Average NYMEX contract monthly price $ 94.23 $ 67.92 $ 39.40 +Realized price $ 94.67 $ 67.72 $ 37.08 +Effect of oil derivative settlements $ (21.46) $ (18.73) $ 14.40 +Gas: +Average NYMEX monthly settle price (per MMBtu) $ 6.64 $ 3.84 $ 2.08 +Realized price (per Mcf) $ 6.28 $ 4.85 $ 1.80 +Effect of gas derivative settlements (per Mcf) $ (1.36) $ (1.41) $ 0.11 +NGLs (per Bbl): +Average OPIS price (1) +$ 43.48 $ 36.65 $ 17.96 +Realized price $ 35.66 $ 33.67 $ 13.96 +Effect of NGL derivative settlements $ (3.06) $ (13.68) $ 1.28 +____________________________________________ +(1) Average OPIS prices per barrel of NGL, historical or strip, assumes a composite barrel product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline for all periods presented. This product mix represents the industry standard composite barrel and does not necessarily represent our product mix for NGL production. Realized prices reflect our actual product mix. +Commodity prices increased in 2022 compared with both 2021 and 2020. However, given the uncertainty surrounding the ongoing conflict between Russia and Ukraine, the economic and trade sanctions that certain countries have imposed on Russia, production output from OPEC+, and the potential impacts of these issues on global commodity and financial markets, we expect benchmark prices for oil, gas, and NGLs to remain volatile for the foreseeable future. We cannot reasonably predict the timing or likelihood of any future commodity prices fluctuations that could be caused by further inflation, supply chain disruptions, a continued rise in interest rates, and industry-specific impacts. In addition to supply and demand fundamentals, as global commodities, the prices for oil, gas, and NGLs are affected by real or perceived geopolitical risks in various regions of the world as well as the relative strength of the United States dollar compared to other currencies. Our realized prices at local sales points may also be affected by infrastructure capacity in the areas of our operations and beyond. +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs as of February 9, 2023, and December 31, 2022: +As of February 9, 2023 As of December 31, 2022 +NYMEX WTI oil (per Bbl) $ 77.05 $ 79.47 +NYMEX Henry Hub gas (per MMBtu) $ 3.19 $ 4.26 +OPIS NGLs (per Bbl) $ 31.09 $ 29.85 +We use financial derivative instruments as part of our financial risk management program. We have a financial risk management policy governing our use of derivatives, and decisions regarding entering into commodity derivative contracts are overseen by a financial risk management committee consisting of certain senior executive officers and finance personnel. We make decisions about the amount of our expected production that we cover by derivatives based on the amount of debt on our balance sheet, the level of capital commitments and long-term obligations we have in place, and the terms and futures prices that are made available by our approved counterparties. With our current commodity derivative contracts, we believe we have partially reduced our exposure to volatility in commodity prices and basis differentials in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil and gas prices while also setting a price floor below which we are insulated from further price decreases. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and to Commodity Price Risk in Overview of Liquidity and Capital Resources below for additional information regarding our oil, gas, and NGL derivatives. +42 +Outlook +Our total 2023 capital program, which we expect to fund with cash flows from operations, is expected to be approximately $1.1 billion. We plan to focus our 2023 capital program on highly economic oil development projects in both our Midland Basin and South Texas assets. We expect to repurchase additional shares of our outstanding common stock through our Stock Repurchase Program during 2023, under which $442.8 million remained available for repurchases as of December 31, 2022. +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the three months ended December 31, 2022, and the preceding three quarters: +For the Three Months Ended +December 31, September 30, June 30, March 31, +2022 2022 2022 2022 +(in millions) +Production (MMBOE) 13.1 12.7 13.3 13.8 +Oil, gas, and NGL production revenue +$ 669.3 $ 827.6 $ 990.4 $ 858.7 +Oil, gas, and NGL production expense $ 150.7 $ 160.0 $ 165.6 $ 144.7 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 143.6 $ 145.9 $ 154.8 $ 159.5 +Exploration $ 10.8 $ 14.2 $ 20.9 $ 9.0 +General and administrative $ 32.8 $ 28.4 $ 28.3 $ 25.0 +Net income $ 258.5 $ 481.2 $ 323.5 $ 48.8 +____________________________________________ +Note: Amounts may not calculate due to rounding. +Selected Performance Metrics +For the Three Months Ended +December 31, September 30, June 30, March 31, +2022 2022 2022 2022 +Average net daily equivalent production (MBOE per day) 142.9 137.8 146.6 153.3 +Lease operating expense (per BOE) $ 5.20 $ 5.64 $ 5.11 $ 4.25 +Transportation costs (per BOE) $ 2.86 $ 2.87 $ 2.87 $ 2.74 +Production taxes as a percent of oil, gas, and NGL production revenue 4.8 % 4.9 % 5.1 % 4.7 % +Ad valorem tax expense (per BOE) $ 0.97 $ 0.93 $ 0.69 $ 0.58 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) $ 10.93 $ 11.50 $ 11.60 $ 11.56 +General and administrative (per BOE) $ 2.50 $ 2.24 $ 2.12 $ 1.81 +____________________________________________ +Note: Amounts may not calculate due to rounding. +43 +Overview of Selected Production and Financial Information, Including Trends +For the Years Ended +December 31, Amount Change Between Percent Change Between +2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020 +Net production volumes: (1) +Oil (MMBbl) 24.0 27.9 23.0 (4.0) 4.9 (14) % 21 % +Gas (Bcf) 125.9 108.4 103.9 17.6 4.5 16 % 4 % +NGLs (MMBbl) 8.0 5.4 6.1 2.6 (0.7) 49 % (12) % +Equivalent (MMBOE) 53.0 51.4 46.4 1.6 4.9 3 % 11 % +Average net daily production: (1) +Oil (MBbl per day) 65.7 76.5 62.9 (10.8) 13.6 (14) % 22 % +Gas (MMcf per day) 345.0 296.9 283.9 48.1 13.0 16 % 5 % +NGLs (MBbl per day) 21.9 14.7 16.7 7.2 (2.0) 49 % (12) % +Equivalent (MBOE per day) 145.1 140.7 126.9 4.4 13.9 3 % 11 % +Oil, gas, and NGL production revenue (in millions): (1) +Oil production revenue $ 2,270.1 $ 1,891.8 $ 853.6 $ 378.2 $ 1,038.3 20 % 122 % +Gas production revenue 790.9 525.5 187.5 265.4 338.0 51 % 180 % +NGL production revenue 285.0 180.6 85.2 104.3 95.4 58 % 112 % +Total oil, gas, and NGL production revenue $ 3,345.9 $ 2,597.9 $ 1,126.2 $ 748.0 $ 1,471.7 29 % 131 % +Oil, gas, and NGL production expense (in millions): (1) +Lease operating expense $ 266.5 $ 225.5 $ 184.2 $ 41.0 $ 41.2 18 % 22 % +Transportation costs 150.0 139.4 142.0 10.6 (2.6) 8 % (2) % +Production taxes 162.6 121.1 46.1 41.5 75.0 34 % 163 % +Ad valorem tax expense 41.7 19.4 18.9 22.3 0.5 115 % 3 % +Total oil, gas, and NGL production expense $ 620.9 $ 505.4 $ 391.2 $ 115.5 $ 114.2 23 % 29 % +Realized price: +Oil (per Bbl) $ 94.67 $ 67.72 $ 37.08 $ 26.95 $ 30.64 40 % 83 % +Gas (per Mcf) $ 6.28 $ 4.85 $ 1.80 $ 1.43 $ 3.05 29 % 169 % +NGLs (per Bbl) $ 35.66 $ 33.67 $ 13.96 $ 1.99 $ 19.71 6 % 141 % +Per BOE $ 63.18 $ 50.58 $ 24.26 $ 12.60 $ 26.32 25 % 108 % +Per BOE data: (1) +Oil, gas, and NGL production expense: +Lease operating expense $ 5.03 $ 4.39 $ 3.97 $ 0.64 $ 0.42 15 % 11 % +Transportation costs 2.83 2.71 3.06 0.12 (0.35) 4 % (11) % +Production taxes 3.07 2.36 0.99 0.71 1.37 30 % 138 % +Ad valorem tax expense 0.79 0.38 0.41 0.41 (0.03) 108 % (7) % +Total oil, gas, and NGL production expense $ 11.72 $ 9.84 $ 8.43 $ 1.88 $ 1.41 19 % 17 % +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 11.40 $ 15.08 $ 16.91 $ (3.68) $ (1.83) (24) % (11) % +General and administrative $ 2.16 $ 2.18 $ 2.14 $ (0.02) $ 0.04 (1) % 2 % +Derivative settlement gain (loss) (2) +$ (13.42) $ (14.58) $ 7.57 $ 1.16 $ (22.15) 8 % (293) % +Earnings per share information (in thousands, except per share data): (3) +Basic weighted-average common shares outstanding 122,351 119,043 113,730 3,308 5,313 3 % 5 % +Diluted weighted-average common shares outstanding 124,084 123,690 113,730 394 9,960 — % 9 % +Basic net income (loss) per common share $ 9.09 $ 0.30 $ (6.72) $ 8.79 $ 7.02 2,930 % 104 % +Diluted net income (loss) per common share $ 8.96 $ 0.29 $ (6.72) $ 8.67 $ 7.01 2,990 % 104 % +44 +____________________________________________ +(1) Amounts and percentage changes may not calculate due to rounding. +(2) Derivative settlements for the years ended December 31, 2022, 2021, and 2020, are included within the net derivative (gain) loss line item in the accompanying consolidated statements of operations (“accompanying statements of operations”). +(3) Please refer to Note 9 - Earnings Per Share in Part II, Item 8 of this report for additional discussion. +Average net daily equivalent production for the year ended December 31, 2022, increased three percent compared with 2021, as a result of a 37 percent increase in average net daily equivalent production from our South Texas assets outpacing a 14 percent decrease in average net daily equivalent production from our Midland Basin assets, as a result of increased capital allocation to our Austin Chalk assets. In 2023, we expect total production volumes to remain relatively flat compared with 2022, and we expect a slight decrease in oil as a percentage of total production. Please refer to Comparison of Financial Results and Trends Between 2022 and 2021 and Between 2021 and 2020 below for additional discussion. +We present certain information on a per BOE basis in order to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis and discussion. +Our realized price on a per BOE basis increased $12.60 for the year ended December 31, 2022, compared with 2021, primarily as a result of increased benchmark commodity prices. The loss on settlement of our commodity derivative contracts decreased $1.16 per BOE resulting from a lower percentage of production volumes covered by commodity derivative contracts that settled during the year ended December 31, 2022, compared with 2021. +LOE on a per BOE basis increased 15 percent for the year ended December 31, 2022, compared with 2021, primarily driven by increases in workover activity, and service provider costs that were impacted by inflation. For 2023, we expect LOE on a per BOE basis to increase, compared with 2022, primarily as a result of anticipated increases in service provider costs attributable to inflation, and increased workover activity, which we expect to be partially offset by increasing activity in the Austin Chalk, where operating costs are lower than in the Midland Basin. We anticipate volatility in LOE on a per BOE basis as a result of changes in total production, changes in our overall production mix, timing of workover projects, inflation, and industry activity, all of which impact total LOE. +Transportation costs on a per BOE basis increased four percent for the year ended December 31, 2022, compared with 2021. This increase was the result of a 37 percent increase in net daily equivalent production volumes from our South Texas assets which was partially offset by transportation contract cost reductions. In general, we expect total transportation costs to fluctuate relative to changes in gas and NGL production from our South Texas assets, where we incur a majority of our transportation costs. For 2023, we expect transportation costs on a per BOE basis to decrease compared with 2022 as a result of transportation cost reductions in the second half of 2023 resulting from the expiration of a long-term contract in South Texas. +Production tax expense on a per BOE basis for the year ended December 31, 2022, increased 30 percent compared with 2021, primarily driven by increases in realized prices. Our overall production tax rate was 4.9 percent and 4.7 percent for the years ended December 31, 2022, and 2021, respectively. We generally expect production tax expense to correlate with oil, gas, and NGL production revenue on an absolute and per BOE basis. Product mix, the location of production, and incentives to encourage oil and gas development can also impact the amount of production tax expense that we recognize. +Ad valorem tax expense on a per BOE basis increased 108 percent for the year ended December 31, 2022, compared with 2021, as a result of increases to the assessed values of our producing properties, driven by increases in commodity prices. We anticipate volatility in ad valorem tax expense on a per BOE and absolute basis as the valuation of our producing properties changes. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (“DD&A”) expense on a per BOE basis decreased 24 percent for the year ended December 31, 2022, compared with 2021, as a result of increased estimated proved reserves at the end of 2021 and during 2022, and increased activity in our Austin Chalk program, which has lower DD&A rates compared to our Midland Basin assets. We expect DD&A expense per BOE and on an absolute basis to increase slightly in 2023, compared with 2022, primarily as a result of inflation, partially offset by increased activity in our Austin Chalk program. Our DD&A rate fluctuates as a result of changes in our production mix, changes in our total estimated proved reserve volumes, changes in capital allocation, impairments, divestiture activity, and carrying cost funding and sharing arrangements with third parties. +General and administrative (“G&A”) expense on a per BOE basis remained relatively flat for the year ended December 31, 2022, compared with 2021. For 2023, we expect G&A expense per BOE and on an absolute basis to increase compared with 2022, primarily as a result of expected increases in compensation expense. +Please refer to Comparison of Financial Results and Trends Between 2022 and 2021 and Between 2021 and 2020 for additional discussion of operating expenses. +45 +Comparison of Financial Results and Trends Between 2022 and 2021 and Between 2021 and 2020 +Please refer to Comparison of Financial Results and Trends Between 2021 and 2020 and Between 2020 and 2019 in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2021 Annual Report on Form 10-K, filed with the SEC on February 25, 2022, for a detailed discussion of certain comparisons of our financial results and trends for the year ended December 31, 2021, compared with the year ended December 31, 2020. +Average net daily equivalent production, production revenue, and production expense +The following table presents the changes in our average net daily equivalent production, production revenue, and production expense, by area, between the years ended December 31, 2022, and 2021: +Net Equivalent Production Increase (Decrease) Production Revenue Increase Production Expense Increase +(MBOE per day) (in millions) (in millions) +Midland Basin (13.0) $ 222.0 $ 55.5 +South Texas 17.3 526.0 60.0 +Total 4.4 $ 748.0 $ 115.5 +____________________________________________ +Note: Amounts may not calculate due to rounding. +Average net daily equivalent production volumes for the year ended December 31, 2022, increased three percent compared with 2021, comprised of a 37 percent increase from our South Texas assets, partially offset by a 14 percent decrease from our Midland Basin assets. Realized prices for oil, gas, and NGLs increased 40 percent, 29 percent, and six percent, respectively, for the year ended December 31, 2022, compared with 2021. As a result of increased production and pricing, production revenue for oil, gas, and NGLs increased 29 percent for the year ended December 31, 2022, compared with 2021. Total production expense for the year ended December 31, 2022, increased 23 percent, compared with 2021, primarily as a result of increased production taxes and LOE. +The following table presents the changes in our average net daily equivalent production, production revenue, and production expense, by area, between the years ended December 31, 2021, and 2020: +Net Equivalent Production Increase (Decrease) Production Revenue Increase Production Expense Increase +(MBOE per day) (in millions) (in millions) +Midland Basin 14.9 $ 1,148.8 $ 95.0 +South Texas (1.0) 322.9 19.2 +Total 13.9 $ 1,471.7 $ 114.2 +____________________________________________ +Note: Amounts may not calculate due to rounding. +Average net daily equivalent production volumes for the year ended December 31, 2021, increased 11 percent compared with 2020, comprised of a 19 percent increase from our Midland Basin assets, partially offset by a two percent decrease from our South Texas assets. Realized prices for oil, gas, and NGLs increased 83 percent, 169 percent, and 141 percent, respectively, for the year ended December 31, 2021, compared with 2020. As a result of increased production and pricing, production revenue for oil, gas, and NGLs increased 131 percent for the year ended December 31, 2021, compared with 2020. Total production expense for the year ended December 31, 2021, increased 29 percent compared with 2020, primarily as a result of increased production taxes and LOE. +Please refer to Overview of Selected Production and Financial Information, Including Trends for additional discussion, including discussion of trends on a per BOE basis. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +For the Years Ended December 31, +2022 2021 2020 +(in millions) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 603.8 $ 774.4 $ 785.0 +46 +DD&A expense for the year ended December 31, 2022, decreased 22 percent compared with 2021, primarily as a result of increased estimated proved reserves at the end of 2021 and during 2022, and increased activity in our Austin Chalk program, which has lower DD&A rates compared to our Midland Basin assets. DD&A expense for the year ended December 31, 2021, remained flat compared with 2020. Please refer to Overview of Selected Production and Financial Information, Including Trends above for discussion of DD&A expense on a per BOE basis. +Exploration +For the Years Ended December 31, +2022 2021 2020 +(in millions) +Geological, geophysical, and other expenses $ 24.7 $ 7.0 $ 11.6 +Overhead 30.2 32.3 29.4 +Total $ 54.9 $ 39.3 $ 41.0 +__________________________________________ +Note: Prior periods have been adjusted to conform to the current period presentation. +Exploration expense increased 40 percent for the year ended December 31, 2022, compared with 2021, primarily as a result of unsuccessful exploration activity related to one drilled and completed well that was subsequently abandoned outside of our core areas of operation. Exploration expense fluctuates based on actual geological and geophysical studies we perform within an exploratory area, exploratory dry hole expense incurred, and changes in the amount of allocated overhead. +Impairment +For the Years Ended December 31, +2022 2021 2020 +(in millions) +Abandonment and impairment of unproved properties $ 7.5 $ 35.0 $ 59.3 +Impairment of proved oil and gas properties and related support equipment — — 956.7 +Total $ 7.5 $ 35.0 $ 1,016.0 +Unproved property abandonments and impairments recorded during the years ended December 31, 2022, 2021, and 2020, related to actual and anticipated lease expirations, as well as actual and anticipated losses of acreage due to title defects, changes in development plans, and other inherent acreage risks. Impairment expense decreased 79 percent for the year ended December 31, 2022, compared with 2021, as a result of fewer actual and anticipated lease expirations and title defects. +During the year ended December 31, 2020, we recorded impairment expense related to our South Texas proved oil and gas properties and related support facilities as a result of the decrease in commodity price forecasts at the end of the first quarter of 2020, specifically decreases in oil and NGL prices. +We expect proved property impairments to occur more frequently in periods of declining or depressed commodity prices, and that the frequency of unproved property abandonments and impairments will fluctuate with the timing of lease expirations or title defects, and changing economics associated with decreases in commodity prices. Additionally, changes in drilling plans, unsuccessful exploration activities, and downward engineering revisions may result in proved and unproved property impairments. +Reserve estimates and related impairments of proved and unproved properties are difficult to predict in a volatile price environment. If commodity prices for the products we produce decline as a result of supply and demand fundamentals associated with geopolitical or macroeconomic events, we may experience additional proved and unproved property impairments in the future. Future impairments of proved and unproved properties are difficult to predict; however, based on our commodity price assumptions as of February 9, 2023, we do not expect any material oil and gas property impairments in the first quarter of 2023 resulting from commodity price impacts. +Please refer to Critical Accounting Estimates below and Note 8 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion. +47 +General and administrative +For the Years Ended December 31, +2022 2021 2020 +(in millions) +General and administrative $ 114.6 $ 111.9 $ 99.2 +G&A expense remained flat for the year ended December 31, 2022, compared with 2021, and increased 13 percent for the year ended December 31, 2021, compared with 2020, primarily as a result of increased compensation expense. Please refer to Overview of Selected Production and Financial Information, Including Trends above for discussion of G&A expense. +Net derivative (gain) loss +For the Years Ended December 31, +2022 2021 2020 +(in millions) +Net derivative (gain) loss $ 374.0 $ 901.7 $ (161.6) +Net derivative (gain) loss is a result of changes in derivative fair values associated with fluctuations in the forward price curves for the commodities underlying our outstanding derivative contracts and the monthly cash settlements of our derivative positions during the period. The net derivative losses for the years ended December 31, 2022, and 2021, resulted from increases in benchmark commodity prices during those years. The net derivative gain for the year ended December 31, 2020, resulted from decreases in benchmark commodity prices during 2020. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Other operating expense, net +For the Years Ended December 31, +2022 2021 2020 +(in millions) +Other operating expense, net $ 3.5 $ 46.1 $ 24.8 +Other operating expense, net, recorded in 2021 and 2020, primarily consisted of legal settlements. +Interest expense +For the Years Ended December 31, +2022 2021 2020 +(in millions) +Interest expense $ (120.3) $ (160.4) $ (163.9) +Interest expense decreased 25 percent for the year ended December 31, 2022, compared with 2021, as a result of the reduction in the aggregate principal amount of our Senior Notes through various transactions in 2022 and 2021. Total interest expense is impacted by, and can vary based on, the timing and amount of borrowings under our revolving credit facility. Please refer to Overview of Liquidity and Capital Resources below, and to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definition of Senior Notes. +Net gain (loss) on extinguishment of debt +For the Years Ended December 31, +2022 2021 2020 +(in millions) +Net gain (loss) on extinguishment of debt $ (67.6) $ (2.1) $ 280.1 +48 +The redemption of our 2025 Senior Secured Notes during 2022 resulted in a net loss on extinguishment of debt of $67.2 million, which included $33.5 million of premium paid, $26.3 million of accelerated expense recognition of the unamortized debt discount, and $7.4 million of accelerated expense recognition of the unamortized deferred financing costs. +The Exchange Offers executed during 2020 resulted in a net gain on extinguishment of debt of $227.3 million, which was primarily comprised of the gain on the partial principal redemption of Old Notes and the debt discount associated with the issuance of the 2025 Senior Secured Notes. Additionally, during the year ended December 31, 2020, we repurchased certain of our 2022 Senior Notes and 2024 Senior Notes in open market transactions, resulting in a net gain on extinguishment of debt of $52.8 million. +Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definitions of Exchange Offers, Old Notes, 2025 Senior Secured Notes, 2022 Senior Notes, and 2024 Senior Notes. +Income tax (expense) benefit +For the Years Ended December 31, +2022 2021 2020 +(in millions, except tax rate) +Income tax (expense) benefit $ (283.8) $ (9.9) $ 192.1 +Effective tax rate 20.3 % 21.5 % 20.1 % +The decrease in the effective tax rate for the year ended December 31, 2022, compared with 2021, primarily resulted from the release of the valuation allowance recorded against the derivative deferred tax asset recognized in prior periods. As a result of the increase in income before income taxes for the year ended December 31, 2022, compared with 2021, the Company’s permanent items, including excess tax benefits from stock-based compensation and limits on expensing of certain individual’s compensation, had less of an impact on the effective tax rate for the year ended December 31, 2022, compared with 2021. +The increase in the effective tax rate for the year ended December 31, 2021, compared with 2020, was primarily due to the differing effects of permanent items on income before income taxes for the year ended December 31, 2021, compared to a loss before income taxes in 2020. During 2021, an additional valuation allowance recorded against tax effected net derivative liabilities partially offset by an excess tax benefit from stock-based compensation awards and other deferred tax adjustments, resulted in an increase in the tax rate year-over-year. +During 2022, we made federal estimated tax payments of $10.0 million. During the fourth quarter of 2022, we commissioned a multi-year research and development (“R&D") credit study which is expected to be completed in late 2023. We expect that this study will result in a favorable impact to our effective tax rate when the results are recorded. +Changes in federal income tax laws or enactment of proposed legislation to increase the corporate tax rate and eliminate or reduce certain oil and gas industry deductions could have a material impact on our effective tax rate and current tax expense. Effective for tax years beginning after December 31, 2022, the IRA creates a 15 percent corporate alternative minimum tax (“CAMT”) on average annual adjusted financial statement income exceeding $1.0 billion over any three-year period. The CAMT is currently not expected to have a material effect on our consolidated financial statements in future periods. +Please refer to Overview of Liquidity and Capital Resources and Critical Accounting Estimates below as well as Note 4 – Income Taxes in Part II, Item 8 of this report for further discussion. +Overview of Liquidity and Capital Resources +Based on the current commodity price environment, we believe we have sufficient liquidity and capital resources to execute our business plan while continuing to meet our current financial obligations. We continue to manage the duration and level of our drilling and completion service commitments in order to maintain flexibility with regard to our activity level and capital expenditures. +Sources of Cash +We expect our 2023 capital expenditure and return of capital programs to be funded by cash flows from operations. Although we expect cash flows from operations to be sufficient to fund our 2023 programs, we may also use borrowings under our revolving credit facility or raise funds through new debt or equity offerings or from other sources of financing. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders could be diluted, and these newly issued securities may have rights, preferences, or privileges senior to those of existing stockholders and bondholders. Additionally, we may enter into carrying cost and sharing arrangements with third parties for certain exploration or development programs. All of our sources of liquidity can be affected by the general conditions of the broader economy, force majeure events, +49 +fluctuations in commodity prices, operating costs, interest rate changes, tax law changes, and volumes produced, all of which affect us and our industry. +Our credit ratings impact the availability of and cost for us to borrow additional funds. Three major credit rating agencies upgraded our credit ratings during 2022, reflecting our top-tier assets and operational performance, our priority of improving our leverage metrics, our ability to consistently generate cash flows and our decision to use a portion of the proceeds to reduce total debt, our strong liquidity profile, and our use of financial derivative instruments as part of our financial risk management program. +We have no control over the market prices for oil, gas, and NGLs, although we may be able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of commodity derivative contracts as part of our commodity price risk management program. Commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. Please refer to Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional information about our commodity derivative contracts currently in place and the timing of settlement of those contracts . +Credit Agreement +Our Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $3.0 billion, a borrowing base of $2.5 billion, and aggregate lender commitments totaling $1.25 billion. The borrowing base is subject to regular, semi-annual redetermination, and considers the value of both our proved oil and gas properties reflected in our most recent reserve report and commodity derivative contracts, each as determined by our lender group. The next scheduled borrowing base redetermination date is April 1, 2023. No individual bank participating in our Credit Agreement represents more than 10 percent of the lender commitments under the Credit Agreement. We must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring that we maintain certain financial ratios, as set forth in the Credit Agreement. We were in compliance with all financial and non-financial covenants as of December 31, 2022, and through the filing of this report. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, as well as the presentation of the outstanding balance, total amount of letters of credit, and available borrowing capacity under the Credit Agreement as of February 9, 2023, December 31, 2022, and December 31, 2021. +We had no revolving credit facility borrowings during the year ended December 31, 2022. Our daily weighted-average revolving credit facility debt balance was $106.0 million for the year ended December 31, 2021. Cash flows provided by our operating activities, proceeds received from divestitures of properties, capital markets activities including open market debt repurchases, debt redemptions, repayment of scheduled debt maturities, our capital expenditures, including acquisitions, and other financing activities, all impact the amount we borrow under our revolving credit facility. +Weighted-Average Interest and Weighted-Average Borrowing Rates +Our weighted-average interest rate includes paid and accrued interest, fees on the unused portion of the aggregate commitment amount under the Credit Agreement, letter of credit fees, the non-cash amortization of deferred financing costs, and for the periods during which they were outstanding, the non-cash amortization of the discounts related to the 2021 Senior Secured Convertible Notes and 2025 Senior Secured Notes, each as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. Our weighted-average borrowing rate includes paid and accrued interest only. +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2022, 2021, and 2020: +For the Years Ended December 31, +2022 2021 2020 +Weighted-average interest rate 7.6 % 7.7 % 7.0 % +Weighted-average borrowing rate 6.8 % 6.8 % 6.1 % +Our weighted-average interest rate remained flat for the year ended December 31, 2022, compared with 2021, as an increase in deferred financing costs and higher commitment fees resulting from the increase in aggregate lender commitments under the Credit Agreement were offset by decreases related to the redemption of the 2025 Senior Secured Notes. Our weighted-average borrowing rate remained flat for the year ended December 31, 2022, compared with 2021, as a result of the timing of redemptions of our Senior Notes during 2022 and 2021. Our weighted-average interest and weighted-average borrowing rates increased for the year ended December 31, 2021, compared with 2020, primarily as a result of the higher interest rate on our 2025 Senior Secured Notes issued during 2020. +Our weighted-average interest and weighted-average borrowing rates are impacted by the occurrence and timing of long-term debt issuances and redemptions and the average outstanding balance on our revolving credit facility. Additionally, our weighted-average interest rate is impacted by the fees paid on the unused portion of our aggregate lender commitments. The rates disclosed in +50 +the above table do not reflect certain amounts associated with the repurchase or redemption of Senior Notes, such as the accelerated expense recognition of the unamortized deferred financing costs and unamortized discounts, as these amounts are netted against the associated gain or loss on extinguishment of debt. The 2021 Senior Secured Convertible Notes were retired upon maturity on July 1, 2021, the 2024 Senior Notes were redeemed on February 14, 2022, and the 2025 Senior Secured Notes were redeemed on June 17, 2022. After these dates, the weighted-average interest rate was no longer impacted by the non-cash amortization of deferred financing costs for the redeemed or retired notes, or for 2021 Senior Secured Convertible Notes and the 2025 Senior Secured Notes, the non-cash amortization of the discounts. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions. +Uses of Cash +We use cash for the development, exploration, and acquisition of oil and gas properties; for the payment of operating and general and administrative costs, income taxes, dividends, and debt obligations, including interest and early repayments or redemptions; and for repurchases of shares of our common stock under the Stock Repurchase Program. Expenditures for the development, exploration, and acquisition of oil and gas properties are the primary use of our capital resources. During 2022, we spent approximately $879.9 million on capital expenditures. This amount differs from the costs incurred amount of $961.7 million for the year ended December 31, 2022, as costs incurred is an accrual-based amount that also includes asset retirement obligations, geological and geophysical expenses, acquisitions of oil and gas properties, and exploration overhead amounts. Please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +The amount and allocation of our future capital expenditures will depend upon a number of factors, including our cash flows from operating, investing, and financing activities, our ability to execute our development program, inflation, and the number and size of acquisitions that we complete. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, tax law changes, and the timing and results of our exploration and development activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget to assess if changes are necessary based on current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. +Changes to the Internal Revenue Code (“IRC“), such as the CAMT enacted pursuant to the IRA, effective for tax years beginning after December 31, 2022, could increase the corporate income tax rate and could eliminate or reduce current tax deductions for intangible drilling costs, depreciation of equipment costs, and other deductions which currently reduce our taxable income. While the CAMT is not currently applicable to us, it and other future legislation could reduce our net cash provided by operating activities over time, and could therefore result in a reduction of funding available for the items discussed above. +We may from time to time repurchase shares of our common stock, or repurchase or redeem all or portions of our outstanding debt securities, for cash, through exchanges for other securities, or a combination of both. Such repurchases or redemptions may be made in open market transactions, privately negotiated transactions, tender offers, pursuant to contractual provisions, or otherwise. Any such repurchases or redemptions will depend on prevailing market conditions, our liquidity requirements, contractual restrictions or covenants, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. +On September 7, 2022, we announced that our Board of Directors approved the Stock Repurchase Program authorizing us to repurchase up to $500.0 million in aggregate value of our common stock through December 31, 2024. We intend to fund repurchases with net cash provided by operating activities. Stock repurchases may also be funded with borrowings under the Credit Agreement. The timing, as well as the number and value of our shares repurchased under the Stock Repurchase Program, will be determined by certain authorized officers of the Company at their discretion and will depend on a variety of factors, including the market price of our common stock, general market and economic conditions and applicable legal requirements. During the year ended December 31, 2022, we repurchased and subsequently retired 1,365,255 shares of our common stock at a cost of $57.2 million, and as of December 31, 2022, $442.8 million remained available under the Stock Repurchase Program for repurchases of our common stock. Effective January 1, 2023, shares of common stock repurchased, net of shares of common stock issued, will be subject to a one percent excise tax imposed by the IRA. The Stock Repurchase Program terminates and supersedes the August 1998 authorization to repurchase common stock, under which 3,072,184 shares remained available for repurchase prior to termination. Please refer to Note 3 - Equity in Part II, Item 8 of this report for additional discussion. +During 2022, we redeemed all of the aggregate principal amount outstanding of our 2024 Senior Notes and our 2025 Senior Secured Notes. During 2021, we issued our 2028 Senior Notes and with the proceeds, repurchased certain of our then outstanding 2022 Senior Notes and 2024 Senior Notes through the Tender Offer. Subsequently, we redeemed the remaining 2022 Senior Notes then outstanding through the 2022 Senior Notes Redemption. The 2021 Senior Secured Convertible Notes matured on July 1, 2021, and on that day, we used borrowings under our revolving credit facility to retire, at par, the outstanding principal amount. These transactions were completed as part of our strategy to reduce absolute debt and improve our leverage metrics. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions. +During the years ended December 31, 2022, 2021, and 2020, we paid $19.6 million, $2.4 million, and $2.3 million, respectively, in dividends to our stockholders. During 2022, our Board of Directors approved an increase to our fixed dividend to $0.60 per share annually, to be paid in quarterly increments of $0.15 per share. Dividends paid reflects $0.16 per share paid during the year ended December 31, 2022, and $0.02 per share paid during each of the years ended December 31, 2021, and 2020. Our current +51 +intention is to continue to make dividend payments for the foreseeable future, subject to our future earnings, our financial condition, covenants under our Credit Agreement and indentures governing each series of our outstanding Senior Notes, other covenants, and other factors that could arise. The payment and amount of future dividends remains at the discretion of our Board of Directors. +Analysis of Cash Flow Changes Between 2022 and 2021 and Between 2021 and 2020 +The following tables present changes in cash flows between the years ended December 31, 2022, 2021, and 2020, for our operating, investing, and financing activities. The analysis following each table should be read in conjunction with our accompanying consolidated statements of cash flows (“accompanying statements of cash flows”) in Part II, Item 8 of this report. +Operating Activities +For the Years Ended December 31, Amount Change Between +2022 2021 2020 2022/2021 2021/2020 +(in millions) +Net cash provided by operating activities $ 1,686.4 $ 1,159.8 $ 790.9 $ 526.6 $ 368.9 +Net cash provided by operating activities increased for the year ended December 31, 2022, compared with 2021, primarily as a result of an $833.2 million increase in cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, partially offset by an increase in cash paid for LOE and G&A expense of $70.7 million and an increase of $69.2 million in cash paid on settled derivative trades. +Net cash provided by operating activities increased for the year ended December 31, 2021, compared with 2020, primarily as a result of a $1.3 billion increase in cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, partially offset by an increase of $1.0 billion in cash paid on settled derivative trades. +Net cash provided by operating activities is affected by working capital changes and the timing of cash receipts and disbursements. +Investing Activities +For the Years Ended December 31, Amount Change Between +2022 2021 2020 2022/2021 2021/2020 +(in millions) +Net cash used in investing activities $ (880.3) $ (667.2) $ (555.6) $ (213.1) $ (111.6) +Net cash used in investing activities increased for the year ended December 31, 2022, compared with 2021, primarily as a result of a $205.1 million increase in capital expenditures. Net cash used in investing activities during the year ended December 31, 2022, was funded by net cash provided by operating activities. +Net cash used in investing activities increased for the year ended December 31, 2021, compared with 2020, primarily as a result of a $127.1 million increase in capital expenditures. Net cash used in investing activities during the year ended December 31, 2021, was funded by net cash provided by operating activities. +Financing Activities +For the Years Ended December 31, Amount Change Between +2022 2021 2020 2022/2021 2021/2020 +(in millions) +Net cash used in financing activities $ (693.9) $ (159.8) $ (235.4) $ (534.1) $ 75.6 +Net cash used in financing activities for the year ended December 31, 2022, related to $480.2 million of cash paid, including premium, to redeem our 2025 Senior Secured Notes, and $104.8 million of cash paid to redeem our 2024 Senior Notes. These redemptions were made using cash on hand. Additionally, we paid $57.2 million to repurchase and subsequently retire 1,365,255 shares of our common stock under the Stock Repurchase Program, $25.1 million for the net share settlement of employee and director stock awards, and $19.6 million in dividends to our stockholders. Please refer to Note 3 - Equity in Part II, Item 8 of this report for additional discussion of our Stock Repurchase Program. +52 +During the year ended December 31, 2021, we paid $385.3 million, including net premiums, to fund the Tender Offer and the 2022 Senior Notes Redemption, and we received net cash proceeds of $392.8 million from the issuance of our 2028 Senior Notes. Additionally, we paid $65.5 million to retire our 2021 Senior Secured Convertible Notes and had net repayments under our revolving credit facility of $93.0 million. +During the year ended December 31, 2020, we paid $136.5 million to repurchase certain of our 2022 Senior Notes and 2024 Senior Notes in open market transactions, we paid $53.5 million to certain holders of the 2021 Senior Secured Convertible Notes in connection with the Private Exchange, and we had net repayments under our revolving credit facility of $29.5 million. +Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions. +Interest Rate Risk +We are exposed to risk due to the floating interest rate associated with any outstanding balance on our revolving credit facility. Our Credit Agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the revolving credit facility’s fair value but will not impact results of operations or cash flows. Conversely, for the portion of the revolving credit facility that has a floating interest rate, interest rate changes will not affect the fair value but will impact future results of operations and cash flows. Changes in interest rates do not impact the amount of interest we pay on our fixed-rate Senior Notes, but can impact their fair values. As of December 31, 2022, our outstanding principal amount of fixed-rate debt totaled $1.6 billion and we had no floating-rate debt outstanding. As we had no borrowings under our revolving credit facility during 2022, we had no exposure to variable interest rates during the year ended December 31, 2022. Please refer to Note 8 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion on the fair values of our Senior Notes. +The Federal Reserve increased short-term interest rates throughout 2022 and into early 2023. These increases, and any future increases, could impact the cost and our ability to borrow funds. +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly impact our revenue, profitability, access to capital, ability to execute our Stock Repurchase Program and pay dividends, and future rate of growth. Oil, gas, and NGL prices are subject to unpredictable fluctuations resulting from a variety of factors that are typically beyond our control, including changes in supply and demand associated with the broader macroeconomic environment, constraints on gathering systems, processing facilities, pipelines, and other transportation systems, and weather-related events. The markets for oil, gas, and NGLs have been volatile, especially over the last decade, and remain subject to high levels of uncertainty and volatility related to the ongoing conflict between Russia and Ukraine, the economic and trade sanctions that certain countries have imposed on Russia, production output from OPEC+, and the associated potential impacts of these issues on global commodity and financial markets. These issues have contributed to inflation, supply chain disruptions, a rise in interest rates, and could have further industry-specific impacts, which may require us to adjust our business plan. The realized prices we receive for our production also depend on numerous factors that are typically beyond our control. Based on our 2022 production, a 10 percent decrease in our average realized prices for oil, gas, and NGLs, would have reduced our oil, gas, and NGL production revenues by approximately $227.0 million, $79.1 million, and $28.5 million, respectively. If commodity prices had been 10 percent lower, our net derivative settlements for the year ended December 31, 2022, would have offset the declines in oil, gas, and NGL production revenue by approximately $157.9 million. +We enter into commodity derivative contracts in order to reduce the risk of fluctuations in commodity prices. The fair value of our commodity derivative contracts is largely determined by estimates of the forward curves of the relevant price indices. As of December 31, 2022, a 10 percent increase or decrease in the forward curves associated with our oil and gas commodity derivative instruments would have changed our net derivative positions for these products by approximately $61.1 million and $1.9 million, respectively. +Off-Balance Sheet Arrangements +We have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPE” or “SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +We evaluate our transactions to determine if any variable interest entities exist. If we determine that we are the primary beneficiary of a variable interest entity, that entity is consolidated into our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions during 2022 or 2021, or through the filing of this report. +53 +Critical Accounting Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with GAAP requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our consolidated financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate as a result of changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below, those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Successful Efforts Method of Accounting. GAAP provides two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method, and both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report. +Oil and Gas Reserve Quantities. Our estimated proved reserve quantities and future net cash flows are critical to understanding the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our consolidated financial statements, including the calculations of DD&A expense, impairment of proved and unproved oil and gas properties, and asset retirement obligations. Please refer to Oil and Gas Producing Activities in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report for additional discussion on our accounting policies impacted by estimated reserve quantities. +Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure of discounted future net cash flows calculation requires that a 10 percent discount rate be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir evaluation consulting firm, to audit a minimum of 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year end. It should not be assumed that the standardized measure of discounted future net cash flows (GAAP) or PV-10 (non-GAAP) as of December 31, 2022, is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based these measures on the unweighted arithmetic average of the first-day-of-the-month price of each month within the trailing 12-month period ended December 31, 2022. Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimates. Please refer to Risk Factors in Part I, Item 1A of this report for additional discussion. +If the estimates of proved reserves decline, the rate at which we record DD&A expense will increase, which would reduce future net income. Changes in DD&A rate calculations caused by changes in reserve quantities are made prospectively. In addition, a decline in reserve estimates may impact the outcome of our assessment of proved and unproved properties for impairment. Impairments are recorded in the period in which they are identified. +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2022 2021 2020 +MMBOE Change +Revisions resulting from performance (11.1) 3.4 3.6 +Removal of proved undeveloped reserves no longer in our five-year development plan (19.9) (40.6) (65.0) +Revisions resulting from price changes 9.5 37.2 (32.6) +Total (21.5) — (94.0) +____________________________________________ +Note: Amounts may not calculate due to rounding. +54 +As previously noted, commodity prices are volatile and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. +We cannot reasonably predict future commodity prices, although we believe that together, the below analyses provide reasonable information regarding the impact of changes in pricing and trends on total estimated proved reserves. The following table reflects the estimated MMBOE change and percentage change to our total reported estimated proved reserve volumes from the described hypothetical changes: +For the year ended December 31, 2022 +MMBOE Change Percentage Change +10 percent decrease in SEC pricing (1) +(3.7) (1) % +Average NYMEX strip pricing as of fiscal year end (2) +(14.3) (3) % +10 percent decrease in proved undeveloped reserves (3) +(22.0) (4) % +____________________________________________ +(1) The change solely reflects the impact of a 10 percent decrease in SEC pricing to the total reported estimated proved reserve volumes as of December 31, 2022, and does not include additional impacts to our estimated proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. +(2) The change solely reflects the impact of replacing SEC pricing with the five-year average NYMEX strip pricing as of December 31, 2022, and does not include additional impacts to our estimated proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. As of December 31, 2022, SEC pricing was $93.67 per Bbl for oil, $6.36 per MMBtu for gas, and $42.52 per Bbl for NGLs, and five-year average NYMEX strip pricing was $71.02 per Bbl for oil, $4.38 per MMBtu for gas, and $28.05 per Bbl for NGLs. +(3) The change solely reflects a 10 percent decrease in proved undeveloped reserves as of December 31, 2022, and does not include any additional impacts to our estimated proved reserves. +Additional reserve information can be found in Reserves in Part I, Items 1 and 2 of this report, and in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Impairment of Oil and Gas Properties. Proved oil and gas properties are evaluated for impairment on a pool-by-pool basis and reduced to fair value when events or changes in circumstances indicate that their carrying amount may not be recoverable. We estimate the expected future cash flows of our proved oil and gas properties and compare these undiscounted cash flows to the carrying amount to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the proved oil and gas properties to fair value (or discounted future cash flows). Management estimates future cash flows from all proved reserves and risk adjusted probable and possible reserves using various factors, which are subject to our judgment and expertise, and include, but are not limited to, commodity price forecasts, estimated future operating and capital costs, development plans, and discount rates to incorporate the risk and current market conditions associated with realizing the expected cash flows. +Unproved oil and gas properties are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by asset group and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and our intent to renew leases. We estimate the fair value of unproved properties using a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by us or other market participants. +We cannot predict when or if future impairment charges will be recorded because of the uncertainty in the factors discussed above. Despite any amount of future impairment being difficult to predict, based on our commodity price assumptions as of February 9, 2023, we do not expect any material oil and gas property impairments in the first quarter of 2023 resulting from commodity price impacts. +Please refer to Note 1 – Summary of Significant Accounting Policies and Note 8 – Fair Value Measurements in Part II, Item 8 of this report for discussion of impairments of oil and gas properties recorded for the years ended December 31, 2022, 2021, and 2020. +Revenue Recognition. We predominately derive our revenue from the sale of produced oil, gas, and NGLs. Our revenue recognition policy is a critical accounting estimate because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. A 10 percent change in our revenue accrual at year-end 2022 would have impacted total operating revenues by approximately $18.4 million for the year ended December 31, 2022. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 2 - Revenue from Contracts with Customers in Part II, Item 8 of this report for additional discussion. +55 +Derivative Financial Instruments. We periodically enter into commodity derivative contracts to mitigate a portion of our exposure to oil, gas, and NGL price volatility and location differentials. We recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income (loss). The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our consolidated financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Income Taxes. We account for deferred income taxes, whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the consolidated financial statements and the tax basis of assets and liabilities, as measured using currently enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. We record deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period, as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement as well as significant enacted tax rate changes could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax expense by approximately $14.0 million for the year ended December 31, 2022. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 4 – Income Taxes in Part II, Item 8 of this report for additional discussion. +Accounting Matters +Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for information on new authoritative accounting guidance. +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes, and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +Hydraulic Fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, please refer to Risk Factors – Risks Related to Oil and Gas Operations and the Industry – Federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Climate Change and Air Quality. In June 2013, President Obama announced a Climate Action Plan designed to further reduce GHG emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Climate Action Plan targeted methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. As part of the Climate Action Plan, on May 12, 2016, the EPA issued final regulations applicable to new, modified, or reconstructed sources that amended and expanded 2012 regulations for the oil and gas sector by, among other things, setting emission limits for volatile organic compounds (“VOCs” or “VOC”) and methane, a GHG, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The regulation requires, among other things, GHG and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. On September 14, and 15, 2020, the EPA finalized amendments to the 2012 and 2016 NSPS that removed transmission and storage infrastructure from regulation of methane emissions and other VOCs, as well as removed methane control requirements. The portion of the 2020 amendments that removed the transmission and storage infrastructure from the regulations was disapproved by the Congressional Review Act in 2021. In November 2021, the EPA proposed to expand the requirements of the 2012 and 2016 NSPS and also include requirements for states to develop performance standards to control methane emissions from existing sources. In December 2022, the EPA issued a supplemental proposal to update, strengthen, and expand the 2021 proposed rules. The EPA is expected to finalize the rule in 2023. +States are also required to comply with the NAAQS. The oil and gas sector is often subjected to additional controls when areas within states are not attaining the ozone NAAQS as the VOCs emitted by the oil and gas sector are a precursor to ozone formation. The ozone NAAQS was set at 70 parts per billion (“ppb”) in 2015. The EPA maintained the standard in 2020, but in 2021 the EPA communicated that it is reconsidering the 2020 decision with the intention of completing the reconsideration by the end of 2023. If +56 +the ozone NAAQS is lowered, it may result in additional actions by states requiring further emission controls and associated costs. Oil and gas facilities operating in areas that are determined to be out of compliance with the 70 ppb requirement or a lowered ozone NAAQS may be subject to increased emission controls and associated costs of compliance. +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs and many of the states have already taken legal measures to reduce emissions of GHGs primarily through the planned development of GHG emission inventories and/or regional GHG cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall GHG emission reduction goal. In addition, there have been international conventions and efforts to establish standards for the reduction of GHGs globally, including the Paris accords in December 2015. The conditions for entry into force of the Paris accords were met on October 5, 2016 and the Agreement went into force 30 days later on November 4, 2016. At the United Nations Climate Change Conference in Glasgow in 2021, the United States and the European Union announced the Global Methane Pledge that aims to reduce methane emissions by 30 percent compared with 2020 levels. +The adoption of legislation or regulatory programs to reduce emissions of GHGs could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and gas we produce. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. Judicial challenges to new regulatory measures are likely and we cannot predict the outcome of such challenges. New regulatory suspensions, revisions, or rescissions and conflicting state and federal regulatory mandates may inhibit our ability to accurately forecast the costs associated with future regulatory compliance. Finally, scientists have concluded that increasing concentrations of GHGs in the earth’s atmosphere produce climate changes that likely have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. Such effects could have an adverse effect on our financial condition and results of operations. +In terms of opportunities, the regulation of GHG emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and gas that we produce, the relative demand for gas may increase because the burning of gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources such as wind or solar power become more prevalent, gas-fired electric plants may provide an alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, gas may become a more attractive transportation fuel. Approximately 40 percent and 35 percent of our production on a BOE basis in 2022 and 2021, respectively, was gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and gas reservoirs, could also benefit us through the potential to obtain GHG emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +Non-GAAP Financial Measures +Adjusted EBITDAX represents net income (loss) before interest expense, interest income, income taxes, depletion, depreciation, amortization and asset retirement obligation liability accretion expense, exploration expense, property abandonment and impairment expense, non-cash stock-based compensation expense, derivative gains and losses net of settlements, gains and losses on divestitures, gains and losses on extinguishment of debt, and certain other items. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally non-recurring in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that we believe provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for exploration, development, acquisitions, and to service debt. We are also subject to financial covenants under our Credit Agreement as further described in Note 5 – Long-Term Debt in Part II, Item 8 of this report. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or other profitability or liquidity measures prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. Our revolving credit facility provides a material source of liquidity for us. Under the terms of our Credit Agreement, if we failed to comply with the covenants that establish a maximum permitted ratio of total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX, we would be in default, an event that would prevent us from borrowing under our revolving credit facility and would therefore materially limit a significant source of our liquidity. In addition, if we are in default under our revolving credit facility and are unable to obtain a waiver of that default from our lenders, lenders under that facility and under the indentures governing each series of our outstanding Senior Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, would be entitled to exercise all of their remedies for default. +57 +The following table provides reconciliations of our net income (loss) (GAAP) and net cash provided by operating activities (GAAP) to adjusted EBITDAX (non-GAAP) for the periods presented: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Net income (loss) (GAAP) $ 1,111,952 $ 36,229 $ (764,614) +Interest expense 120,346 160,353 163,892 +Income tax expense (benefit) 283,818 9,938 (192,091) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 603,780 774,386 784,987 +Exploration (1) +50,978 35,346 37,541 +Impairment 7,468 35,000 1,016,013 +Stock-based compensation expense 18,772 18,819 14,999 +Net derivative (gain) loss 374,012 901,659 (161,576) +Derivative settlement gain (loss) (710,700) (748,958) 351,261 +Net (gain) loss on extinguishment of debt 67,605 2,139 (280,081) +Other, net (9,743) 507 5,074 +Adjusted EBITDAX (non-GAAP) 1,918,288 1,225,418 975,405 +Interest expense (120,346) (160,353) (163,892) +Income tax (expense) benefit (283,818) (9,938) 192,091 +Exploration (1)(2) +(36,810) (35,346) (37,541) +Amortization of debt discount and deferred financing costs 10,281 17,275 17,704 +Deferred income taxes 269,057 9,565 (192,540) +Other, net 1,817 (4,260) (11,874) +Net change in working capital (72,063) 117,411 11,591 +Net cash provided by operating activities (GAAP) $ 1,686,406 $ 1,159,772 $ 790,944 +____________________________________________ +(1) Stock-based compensation expense is a component of the exploration expense and general and administrative expense line items on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration expense. +(2) For the year ended December 31, 2022, amount is net of certain capital expenditures related to unsuccessful exploration efforts outside of our core areas of operation. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this Item is provided under the captions Interest Rate Risk and Commodity Price Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place in Note 10 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +58 +ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 23, 2023 expressed an unqualified opinion thereon. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or is required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +59 +Depletion, Depreciation and Amortization (“DD&A”) of Proved Oil and Gas Properties +Description of the Matter +At December 31, 2022, the net book value of the Company’s proved oil and gas properties was $4.1 billion, and depletion, depreciation, amortization, and asset retirement obligation liability accretion was $603.8 million for the year then ended. As described in Note 1, under the successful efforts method of accounting, capitalized costs of proved properties are depleted using the units-of-production method based on proved reserves, as estimated by the Company’s engineers. Proved reserve estimates are impacted by various inputs, including historical production, oil and gas price assumptions, and future operating and capital cost assumptions, among others, and requires the expertise of the Company’s engineers in evaluating and interpreting the relevant data. Because of the complexity involved in estimating oil and gas reserves, management used independent petroleum engineers to audit the estimates prepared by the Company's engineers as of December 31, 2022. +Auditing the Company’s DD&A calculation is especially complex because of the use of the work of the Company’s engineers and the independent petroleum engineers and the evaluation of management’s determination of the inputs described above used by the engineers in estimating proved oil and gas reserves. +How We Addressed the Matter in Our Audit +We obtained an understanding, evaluated the design and tested the operating effectiveness of the Company’s controls that address the risk of material misstatement relating to proved oil and gas reserves as an input to the DD&A expense calculations, including management’s controls over the completeness and accuracy of the financial data used in estimating proved oil and gas reserves. +Our audit procedures included, among others, evaluating the professional qualifications and objectivity of the Company’s engineers responsible for the preparation of the reserve estimates and the independent petroleum engineers used to audit the estimates. In addition, in assessing whether we can use the work of the engineers, we evaluated the completeness and accuracy of the financial data used by the engineers, in estimating proved oil and gas reserves by agreeing significant inputs to source documentation, where available, on a sample basis, and we assessed the inputs for reasonableness based on our review of corroborative evidence and consideration of any contrary evidence. We also tested that the DD&A expense calculations, are based on appropriate proved oil and gas reserves amounts from the Company’s reserve report. +/s/ Ernst & Young LLP +We have served as the Company’s auditor since 2012. +Denver, Colorado +February 23, 2023 +60 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2022 2021 +ASSETS +Current assets: +Cash and cash equivalents $ 444,998 $ 332,716 +Accounts receivable 233,297 247,201 +Derivative assets 48,677 24,095 +Prepaid expenses and other 10,231 9,175 +Total current assets 737,203 613,187 +Property and equipment (successful efforts method): +Proved oil and gas properties 10,258,368 9,397,407 +Accumulated depletion, depreciation, and amortization ( 6,188,147 ) ( 5,634,961 ) +Unproved oil and gas properties, net of valuation allowance of $ 38,008 and $ 34,934 , respectively +487,192 629,098 +Wells in progress 287,267 148,394 +Other property and equipment, net of accumulated depreciation of $ 56,512 and $ 62,359 , respectively +38,099 36,060 +Total property and equipment, net 4,882,779 4,575,998 +Noncurrent assets: +Derivative assets 24,465 239 +Other noncurrent assets 71,592 44,553 +Total noncurrent assets 96,057 44,792 +Total assets $ 5,716,039 $ 5,233,977 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable and accrued expenses $ 532,289 $ 563,306 +Derivative liabilities 56,181 319,506 +Other current liabilities 10,114 6,515 +Total current liabilities 598,584 889,327 +Noncurrent liabilities: +Revolving credit facility — — +Senior Notes, net 1,572,210 2,081,164 +Asset retirement obligations 108,233 97,324 +Deferred income taxes 280,811 9,769 +Derivative liabilities 1,142 25,696 +Other noncurrent liabilities 69,601 67,566 +Total noncurrent liabilities 2,031,997 2,281,519 +Commitments and contingencies (note 6) +Stockholders’ equity: +Common stock, $ 0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 121,931,676 and 121,862,248 shares, respectively +1,219 1,219 +Additional paid-in capital 1,779,703 1,840,228 +Retained earnings 1,308,558 234,533 +Accumulated other comprehensive loss ( 4,022 ) ( 12,849 ) +Total stockholders’ equity 3,085,458 2,063,131 +Total liabilities and stockholders’ equity $ 5,716,039 $ 5,233,977 +The accompanying notes are an integral part of these consolidated financial statements. +61 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +For the Years Ended +December 31, +2022 2021 2020 +Operating revenues and other income: +Oil, gas, and NGL production revenue $ 3,345,906 $ 2,597,915 $ 1,126,188 +Other operating income 12,741 24,979 485 +Total operating revenues and other income 3,358,647 2,622,894 1,126,673 +Operating expenses: +Oil, gas, and NGL production expense 620,912 505,416 391,217 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 603,780 774,386 784,987 +Exploration 54,943 39,296 40,997 +Impairment 7,468 35,000 1,016,013 +General and administrative 114,558 111,945 99,160 +Net derivative (gain) loss 374,012 901,659 ( 161,576 ) +Other operating expense, net 3,493 46,069 24,825 +Total operating expenses 1,779,166 2,413,771 2,195,623 +Income (loss) from operations 1,579,481 209,123 ( 1,068,950 ) +Interest expense ( 120,346 ) ( 160,353 ) ( 163,892 ) +Net gain (loss) on extinguishment of debt ( 67,605 ) ( 2,139 ) 280,081 +Other non-operating income (expense), net 4,240 ( 464 ) ( 3,944 ) +Income (loss) before income taxes 1,395,770 46,167 ( 956,705 ) +Income tax (expense) benefit ( 283,818 ) ( 9,938 ) 192,091 +Net income (loss) $ 1,111,952 $ 36,229 $ ( 764,614 ) +Basic weighted-average common shares outstanding 122,351 119,043 113,730 +Diluted weighted-average common shares outstanding 124,084 123,690 113,730 +Basic net income (loss) per common share $ 9.09 $ 0.30 $ ( 6.72 ) +Diluted net income (loss) per common share $ 8.96 $ 0.29 $ ( 6.72 ) +The accompanying notes are an integral part of these consolidated financial statements. +62 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +For the Years Ended +December 31, +2022 2021 2020 +Net income (loss) $ 1,111,952 $ 36,229 $ ( 764,614 ) +Other comprehensive income (loss), net of tax: +Pension liability adjustment (1) +8,827 749 ( 2,279 ) +Total other comprehensive income (loss), net of tax 8,827 749 ( 2,279 ) +Total comprehensive income (loss) $ 1,120,779 $ 36,978 $ ( 766,893 ) +____________________________________________ +(1) Please refer to Note 11 – Pension Benefits for additional discussion of the pension liability adjustment. +The accompanying notes are an integral part of these consolidated financial statements. +63 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share data and dividends per share) +Additional Paid-in Capital Accumulated Other Comprehensive Loss Total Stockholders’ Equity +Common Stock Retained Earnings +Shares Amount +Balances, January 1, 2020 112,987,952 $ 1,130 $ 1,791,596 $ 967,587 $ ( 11,319 ) $ 2,748,994 +Net loss — — — ( 764,614 ) — ( 764,614 ) +Other comprehensive loss — — — — ( 2,279 ) ( 2,279 ) +Cash dividends declared, $ 0.02 per share +— — — ( 2,276 ) — ( 2,276 ) +Issuance of common stock under Employee Stock Purchase Plan 464,757 4 1,460 — — 1,464 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings 1,022,019 10 ( 1,570 ) — — ( 1,560 ) +Stock-based compensation expense 267,576 3 14,996 — — 14,999 +Issuance of Warrants — — 21,520 21,520 +Other — — ( 88 ) — — ( 88 ) +Balances, December 31, 2020 114,742,304 $ 1,147 $ 1,827,914 $ 200,697 $ ( 13,598 ) $ 2,016,160 +Net income — — — 36,229 — 36,229 +Other comprehensive income — — — — 749 749 +Cash dividends declared, $ 0.02 per share +— — — ( 2,393 ) — ( 2,393 ) +Issuance of common stock under Employee Stock Purchase Plan 313,773 3 2,636 — — 2,639 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings 827,572 9 ( 9,081 ) — — ( 9,072 ) +Stock-based compensation expense 60,510 1 18,818 — — 18,819 +Issuance of common stock through cashless exercise of Warrants 5,918,089 59 ( 59 ) — — — +Balances, December 31, 2021 121,862,248 $ 1,219 $ 1,840,228 $ 234,533 $ ( 12,849 ) $ 2,063,131 +Net income — — — 1,111,952 — 1,111,952 +Other comprehensive income — — — — 8,827 8,827 +Cash dividends declared, $ 0.31 per share +— — — ( 37,927 ) — ( 37,927 ) +Issuance of common stock under Employee Stock Purchase Plan 113,785 1 3,038 — — 3,039 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings 1,291,427 13 ( 25,142 ) — — ( 25,129 ) +Stock-based compensation expense 29,471 — 18,772 — — 18,772 +Purchase of shares under Stock Repurchase Program ( 1,365,255 ) ( 14 ) ( 57,193 ) — — ( 57,207 ) +Balances, December 31, 2022 121,931,676 $ 1,219 $ 1,779,703 $ 1,308,558 $ ( 4,022 ) $ 3,085,458 +The accompanying notes are an integral part of these consolidated financial statements. +64 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2022 2021 2020 +Cash flows from operating activities: +Net income (loss) $ 1,111,952 $ 36,229 $ ( 764,614 ) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 603,780 774,386 784,987 +Impairment 7,468 35,000 1,016,013 +Stock-based compensation expense 18,772 18,819 14,999 +Net derivative (gain) loss 374,012 901,659 ( 161,576 ) +Derivative settlement gain (loss) ( 710,700 ) ( 748,958 ) 351,261 +Amortization of debt discount and deferred financing costs 10,281 17,275 17,704 +Net (gain) loss on extinguishment of debt 67,605 2,139 ( 280,081 ) +Deferred income taxes 269,057 9,565 ( 192,540 ) +Other, net 6,242 ( 3,753 ) ( 6,800 ) +Changes in working capital: +Accounts receivable 38,554 ( 101,047 ) 29,100 +Prepaid expenses and other ( 1,055 ) 220 5,873 +Accounts payable and accrued expenses ( 109,562 ) 218,238 ( 23,382 ) +Net cash provided by operating activities 1,686,406 1,159,772 790,944 +Cash flows from investing activities: +Capital expenditures ( 879,934 ) ( 674,841 ) ( 547,785 ) +Other, net ( 329 ) 7,606 ( 7,781 ) +Net cash used in investing activities ( 880,263 ) ( 667,235 ) ( 555,566 ) +Cash flows from financing activities: +Proceeds from revolving credit facility — 1,832,500 1,447,000 +Repayment of revolving credit facility — ( 1,925,500 ) ( 1,476,500 ) +Net proceeds from Senior Notes — 392,771 — +Cash paid to repurchase Senior Notes ( 584,946 ) ( 450,776 ) ( 189,998 ) +Repurchase of common stock ( 57,207 ) — — +Net proceeds from sale of common stock 3,039 2,639 1,464 +Dividends paid ( 19,637 ) ( 2,393 ) ( 2,276 ) +Net share settlement from issuance of stock awards ( 25,129 ) ( 9,072 ) ( 1,560 ) +Other, net ( 9,981 ) — ( 13,508 ) +Net cash used in financing activities ( 693,861 ) ( 159,831 ) ( 235,378 ) +Net change in cash, cash equivalents, and restricted cash 112,282 332,706 — +Cash, cash equivalents, and restricted cash at beginning of period 332,716 10 10 +Cash, cash equivalents, and restricted cash at end of period $ 444,998 $ 332,716 $ 10 +Supplemental schedule of additional cash flow information and non-cash activities: +Operating activities: +Cash paid for interest, net of capitalized interest $ ( 134,240 ) $ ( 136,606 ) $ ( 140,493 ) +Net cash (paid) refunded for income taxes $ ( 10,576 ) $ ( 864 ) $ 6,664 +Investing activities: +Increase (decrease) in capital expenditure accruals and other $ 29,789 $ ( 10,826 ) $ ( 7,965 ) +Non-cash financing activities (1) +____________________________________________ +(1) Please refer to Note 5 – Long-Term Debt for discussion of the debt transactions completed during the years ended December 31, 2022, 2021, and 2020. +The accompanying notes are an integral part of these consolidated financial statements. +65 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company, together with its consolidated subsidiaries, is an independent energy company currently engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Intercompany accounts and transactions have been eliminated. In connection with the preparation of the accompanying consolidated financial statements, the Company evaluated events subsequent to the balance sheet date of December 31, 2022, through the filing of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the accompanying consolidated financial statements. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of DD&A expense, impairment of proved and unproved oil and gas properties, and asset retirement obligations, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents +The Company considers all liquid investments purchased with an initial maturity of three months or less and deposits in money market mutual funds that are readily convertible into cash to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. +Accounts Receivable +The Company’s accounts receivable primarily consist of receivables due from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables due from joint interest owners, the Company generally has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil, gas, and NGL receivables are collected within 30 to 90 days and the Company has had minimal bad debts. Although diversified among many companies, collectability is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. Please refer to Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses for additional disclosure. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to regular review. +The Company does not believe the loss of any single purchaser of its production would materially impact its operating results, as oil, gas, and NGLs are products with well-established markets and numerous purchasers in the Company’s operating areas. The following major customers and entities under common control accounted for 10 percent or more of the Company’s total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2022 2021 2020 +Major customer #1 24 % 27 % 15 % +Major customer #2 8 % 15 % 24 % +Major customer #3 7 % 9 % 20 % +Group #1 of entities under common control 24 % 18 % 6 % +66 +The Company only contracts with the affiliates of the lenders under its Credit Agreement as its derivative counterparties, and the Company’s policy is that each counterparty must have certain minimum investment grade senior unsecured debt ratings. +The Company maintains its primary bank accounts with a large, multinational bank that has branch locations in the Company’s areas of operation. The Company’s policy is to diversify its concentration of cash and cash equivalent investments among multiple institutions and investment products to limit the amount of credit exposure to any single institution or investment. +Oil and Gas Producing Activities +Proved properties . The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, property acquisition costs and development costs are capitalized when incurred. Capitalized drilling and completion costs, including lease and well equipment, intangible development costs, and operational support facilities in the field, are depleted on an asset group basis (properties aggregated based on geographical and geological characteristics) using the units-of-production method based on estimated proved developed oil and gas reserves. Similarly, proved leasehold costs are depleted on the same asset group basis; however, the units-of-production method is based on estimated total proved oil and gas reserves. The computation of DD&A expense takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. +Proved oil and gas property costs are evaluated for impairment on a pool-by-pool basis and reduced to fair value when there is an indication that associated carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique, which converts future cash flows to a single present value amount, to measure the fair value of proved properties using a discount rate, price and cost forecasts, and certain reserve risk-adjustment factors, as selected by the Company’s management. The Company uses a discount rate that represents a current market-based weighted average cost of capital. The discount rate typically ranges from 10 percent to 15 percent. The prices for oil and gas are forecast based on NYMEX strip pricing, adjusted for basis differentials, for the first five years , after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecast using OPIS Mont Belvieu pricing, adjusted for basis differentials, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. Certain undeveloped reserve estimates are also risk-adjusted given the risk to related projected cash flows due to performance and exploitation uncertainties. +The partial sale of a proved property within an existing field is accounted for as a normal retirement and no net gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A net gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of proved properties. +Unproved properties . The unproved oil and gas properties line item on the accompanying consolidated balance sheets (“accompanying balance sheets”) consists of the costs incurred to acquire unproved leases. Leasehold costs allocated to those leases, or partial leases that have associated proved reserves recorded, are reclassified to proved properties and depleted on an asset group basis using the units-of-production method based on estimated total proved oil and gas reserves. Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by asset group and the portion of such costs estimated to be nonproductive prior to lease expiration are recognized as a valuation allowance and amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and the Company’s intent to renew leases. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk-weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +For the sale of unproved properties where the original cost has been partially or fully amortized by providing a valuation allowance on an asset group basis, neither a gain nor loss is recognized unless the sales price exceeds the original cost of the property, in which case a gain shall be recognized in the accompanying statements of operations in the amount of such excess. +Exploratory . Exploratory geological and geophysical, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Under the successful efforts method of accounting for oil and gas properties, exploratory well costs are initially capitalized pending the determination of whether proved reserves have been discovered. If proved reserves are discovered, exploratory well costs will be capitalized as proved properties and will be accounted for following the successful efforts method of accounting described above. If proved reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in the cash flows from investing activities section as part of capital expenditures within the accompanying statements of cash flows. +Please refer to Note 8 – Fair Value Measurements for additional information. +67 +Other Property and Equipment +Other property and equipment such as facilities, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing, and installation activities. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from three to 30 years, or the unit of output method when appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the Company’s accounts. +Other property and equipment costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. To measure the fair value of other property and equipment, the Company uses an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. The valuation includes consideration of the proved and unproved assets supported by the property and equipment, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties, including facilities requiring decommissioning. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired, or a facility is constructed. The increase in carrying value is included in the proved oil and gas properties line item in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective long-lived assets. Cash paid to settle asset retirement obligations is included in the cash flows from operating activities section of the accompanying statements of cash flows. +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent. In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or economic life, changes in inflation factors, or the Company’s credit-adjusted risk-free rate as market conditions warrant. Please refer to Note 14 – Asset Retirement Obligations for a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2022, and 2021. +Derivative Financial Instruments +The Company periodically enters into commodity derivative instruments to mitigate a portion of its exposure to oil, gas, and NGL price volatility and location differentials for its expected future oil, gas, and NGL production, and the associated impact on cash flows. These instruments typically include commodity price swaps and collar arrangements, as well as, basis swaps and roll differential swaps. Commodity derivative instruments are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its commodity derivative contracts as hedging instruments. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its accompanying statements of operations as they occur. Gains and losses on derivatives are included within the cash flows from operating activities section of the accompanying statements of cash flows. Please refer to Note 10 – Derivative Financial Instruments for additional discussion. +Revenue Recognition +The Company derives revenue predominately from the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when custody and title (“control”) of the product transfers to the purchaser, which may differ depending on the applicable contractual terms. Revenue accruals are recorded monthly and are based on estimated production delivered to a purchaser and the expected price to be received. The Company uses knowledge of its properties, contractual arrangements, historical performance, NYMEX, local spot market, and OPIS prices, and other factors as the basis of these estimates. Variances between estimates and the actual amounts received are recorded in the month payment is received. Please refer to Note 2 - Revenue from Contracts with Customers for additional discussion. +Stock-Based Compensation +At December 31, 2022, the Company had stock-based employee compensation plans that included RSUs and PSUs issued to employees, RSUs and restricted stock issued to non-employee directors, and an employee stock purchase plan available to eligible employees. The Company records expense associated with the fair value of stock-based compensation in accordance with +68 +authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant, and is included within the general and administrative and exploration expense line items in the accompanying statements of operations. For stock-based compensation awards containing non-market based performance conditions, the Company evaluates the probability of the number of shares that are expected to vest, and then adjusts the expense to reflect the number of shares expected to vest and the cumulative vesting period met to date. Further, the Company accounts for forfeitures of stock-based compensation awards as they occur. Please refer to Note 7 – Compensation Plans for additional discussion . +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the accompanying consolidated financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. The cumulative effect of enacted tax rate changes on the net balance of reported amounts of assets and liabilities is recognized in the period of enactment. Please refer to Note 4 – Income Taxes for additional discussion. +Earnings per Share +The Company uses the treasury stock method to determine the effect of potentially dilutive instruments. Please refer to Note 9 - Earnings Per Share for additional discussion. +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income (loss). The Company’s policy for releasing income tax effects within accumulated other comprehensive loss is an incremental, unit-of-account approach. Please refer to Note 11 – Pension Benefits for detail on the changes in the balances of components comprising other comprehensive income (loss). +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The Company’s Senior Notes, as defined in Note 5 – Long-Term Debt , are recorded at cost, net of any unamortized discount and deferred financing costs, and their respective fair values are disclosed in Note 8 – Fair Value Measurements. The Company’s Warrants, as defined in Note 3 - Equity , were recorded at fair value upon issuance, with no recurring fair value measurement required. Additionally, the Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +Leases +The Company accounts for leases in accordance with ASC Topic 842, Leases , (“Topic 842”), which requires lessees to recognize operating and finance leases with terms greater than 12 months on the balance sheet. The Company evaluates a contractual arrangement at its inception to determine if it is a lease or contains an identifiable lease component. Certain leases may contain both lease and non-lease components. The Company’s policy for all asset classes is to combine lease and non-lease components together and account for the arrangement as a single lease. +Certain assumptions and judgments made by the Company when evaluating a contract that meets the definition of a lease under Topic 842 include those to determine the discount rate and lease term. Unless implicitly defined, the Company determines the present value of future lease payments using an estimated incremental borrowing rate based on a yield curve analysis that factors in certain assumptions, including the term of the lease and credit rating of the Company at lease inception. The Company evaluates each contract containing a lease arrangement at inception to determine the length of the lease term when recognizing a right-of-use (“ROU”) asset and corresponding lease liability. When determining the lease term, options available to extend or early terminate the arrangement are evaluated and included when it is reasonably certain an option will be exercised. Exercising an early termination option may result in an early termination penalty depending on the terms of the underlying agreement. The Company excludes from the balance sheet leases with terms that are less than one year. +An ROU asset represents a lessee’s right to use an underlying asset for the lease term, while the associated lease liability represents the lessee’s obligations to make lease payments. At the commencement date, which is the date on which a lessor makes an underlying asset available for use by a lessee, a lease ROU asset and corresponding lease liability is recognized based on the +69 +present value of the future lease payments. The initial measurement of lease payments may also be adjusted for certain items, including options that are reasonably certain to be exercised, such as options to purchase the asset at the end of the lease term, or options to extend or early terminate the lease. Excluded from the initial measurement of an ROU asset and corresponding lease liability are certain variable lease payments, such as payments made that vary depending on actual usage or performance. +Subsequent to initial measurement, costs associated with the Company’s operating leases are either expensed or capitalized depending on how the underlying ROU asset is utilized and in accordance with GAAP requirements. When calculating the Company’s ROU asset and liability for a contractual arrangement that qualifies as an operating lease, the Company considers all of the necessary payments made or that are expected to be made upon commencement of the lease. As discussed above, excluded from the initial measurement are certain variable lease payments, which for the Company’s drilling rigs, completion crews, and midstream agreements, may be a significant component of the total lease costs. Please refer to Note 12 - Leases for additional discussion. +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry, onshore in the United States. The Company reports as a single industry segment. +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or SPEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that the Company is the primary beneficiary of a variable interest entity, that entity is consolidated into the Company’s consolidated financial statements. The Company has not been involved in any unconsolidated SPE transactions during 2022 or 2021, or through the filing of this report. +Recently Issued Accounting Standards +In September 2022, the FASB issued ASU No. 2022-04, Liabilities - Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations (“ASU 2022-04”) . ASU 2022-04 was issued to enhance the transparency of supplier finance programs and implement explicit GAAP disclosure requirements for those programs. The guidance is to be applied retrospectively to each period in which a balance sheet is presented, except for the amendment on rollforward information, which is to be applied prospectively. ASU 2022-04 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on rollforward information, which is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. ASU 2022-04 is currently not applicable to the Company. +As of December 31, 2022, and through the filing of this report, no other ASUs have been issued and not yet adopted that are applicable to the Company and that would have a material effect on the Company’s consolidated financial statements and related disclosures. +Note 2 - Revenue from Contracts with Customers +The Company recognizes its share of revenue from the sale of produced oil, gas, and NGLs from its Midland Basin and South Texas assets. Oil, gas, and NGL production revenue presented within the accompanying statements of operations is reflective of the revenue generated from contracts with customers. +The tables below present oil, gas, and NGL production revenue by product type for each of the Company’s operating areas for the years ended December 31, 2022, 2021, and 2020: +For the year ended December 31, 2022 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 1,816,597 $ 453,471 $ 2,270,068 +Gas production revenue 432,831 358,049 790,880 +NGL production revenue 986 283,972 284,958 +Total $ 2,250,414 $ 1,095,492 $ 3,345,906 +Relative percentage 67 % 33 % 100 % +70 +For the year ended December 31, 2021 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 1,701,915 $ 189,911 $ 1,891,826 +Gas production revenue 326,115 199,364 525,479 +NGL production revenue 381 180,229 180,610 +Total $ 2,028,411 $ 569,504 $ 2,597,915 +Relative percentage 78 % 22 % 100 % +For the year ended December 31, 2020 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 802,494 $ 51,074 $ 853,568 +Gas production revenue 76,759 110,700 187,459 +NGL production revenue 324 84,837 85,161 +Total $ 879,577 $ 246,611 $ 1,126,188 +Relative percentage 78 % 22 % 100 % +The Company recognizes oil, gas, and NGL production revenue at the point in time when control of the product transfers to the purchaser, which differs depending on the applicable contractual terms. Transfer of control drives the presentation of transportation, gathering, processing, and other post-production expenses (“fees and other deductions”) within the accompanying statements of operations. Fees and other deductions incurred by the Company prior to control transfer are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. When control is transferred at or near the wellhead, sales are based on a wellhead market price that is impacted by fees and other deductions incurred by the purchaser subsequent to the transfer of control. In general, the Company generates production revenue from a combination of the following types of contracts: +• The Company sells oil and gas production at or near the wellhead and receives an agreed-upon market price from the purchaser. Under this type of arrangement, control transfers at or near the wellhead. +• The Company has certain processing arrangements that include the delivery of unprocessed gas to a midstream processor’s facility for processing. Upon completion of processing, the midstream processor purchases the NGLs and redelivers residue gas back to the Company in-kind. For the NGLs extracted during processing, the midstream processor remits payment to the Company. For the residue gas taken in-kind, the Company has separate sales contracts where control transfers at points downstream of the processing facility. The Company also has certain oil sales that occur at market locations downstream of the production area. Given the structure of these arrangements and where control transfers, the Company separately recognizes fees and other deductions incurred prior to control transfer. These fees are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. +Significant judgments made in applying the guidance in ASC Topic 606, Revenue from Contracts with Customers, relate to the point in time when control transfers to purchasers in gas processing arrangements with midstream processors. The Company does not believe that significant judgments are required with respect to the determination of the transaction price, including amounts that represent variable consideration, as volume and price carry a low level of estimation uncertainty given the precision of volumetric measurements and the use of index pricing with generally predictable differentials. Accordingly, the Company does not consider estimates of variable consideration to be constrained. +The Company’s performance obligations arise upon the production of hydrocarbons from wells in which the Company has an ownership interest. The performance obligations are considered satisfied upon control transferring to a purchaser at the wellhead, inlet, or tailgate of the midstream processor’s processing facility, or other contractually specified delivery point. The time period between production and satisfaction of performance obligations is generally less than one day; thus, there are no material unsatisfied or partially unsatisfied performance obligations at the end of the reporting period. +Revenue is recorded in the month when performance obligations are satisfied. However, settlement statements from the purchasers of hydrocarbons and the related cash consideration are received 30 to 90 days after production has occurred. As a result, the Company must estimate the amount of production delivered to its customers and the consideration that will ultimately be received for sale of the product. Estimated revenue due to the Company is recorded within the accounts receivable line item on the accompanying balance sheets until payment is received. The accounts receivable balances from contracts with customers within the accompanying balance sheets as of December 31, 2022, and 2021, were $ 184.5 million and $ 215.6 million, respectively. To estimate accounts receivable from contracts with customers, the Company uses knowledge of its properties, historical performance, contractual arrangements, index pricing, quality and transportation differentials, and other factors as the basis for these estimates. Differences +71 +between estimates and actual amounts received for product sales are recorded in the month that payment is received from the purchaser. +Note 3 - Equity +Stock Repurchase Program +On September 7, 2022, the Company announced that its Board of Directors approved the Stock Repurchase Program authorizing the Company to repurchase up to $ 500.0 million in aggregate value of its common stock through December 31, 2024 . The Stock Repurchase Program permits the Company to repurchase shares of its common stock from time to time in open market transactions, through privately negotiated transactions or by other means in accordance with federal securities laws and subject to certain provisions of the Credit Agreement and the indentures governing the Senior Notes, as defined in Note 5 – Long-Term Debt . The Company intends to fund repurchases with net cash provided by operating activities. Stock repurchases may also be funded with borrowings under the Credit Agreement. The timing, as well as the number and value of shares repurchased under the Stock Repurchase Program, will be determined by certain authorized officers of the Company at their discretion and will depend on a variety of factors, including the market price of the Company’s common stock, general market and economic conditions and applicable legal requirements. The value of shares authorized for repurchase by the Board of Directors does not require the Company to repurchase such shares or guarantee that such shares will be repurchased, and the Stock Repurchase Program may be suspended, modified, or discontinued at any time without prior notice. No assurance can be given that any particular number or dollar value of its shares will be repurchased by the Company. The Stock Repurchase Program terminates and supersedes the August 1998 authorization to repurchase common stock, under which 3,072,184 shares remained available for repurchase prior to termination. +During the year ended December 31, 2022, the Company repurchased and subsequently retired 1,365,255 shares of its common stock at a weighted-average share price of $ 41.88 for a total cost of $ 57.2 million, excluding commissions and fees. As of December 31, 2022, $ 442.8 million remained available for repurchases of the Company’s outstanding common stock under the Stock Repurchase Program. Effective January 1, 2023, shares of common stock repurchased, net of shares of common stock issued, will be subject to a one percent excise tax imposed by the IRA. +Warrants +On June 17, 2020, in connection with the Exchange Offers described below in Note 5 – Long-Term Debt , the Company issued warrants to purchase up to an aggregate of approximately 5.9 million shares, or approximately five percent of its then outstanding common stock, at an exercise price of $ 0.01 per share (“Warrants”). The Warrants became exercisable at the election of the holders on January 15, 2021 , pursuant to the terms of the Warrant Agreement, dated June 17, 2020 (“Warrant Agreement”), and the remaining unexercised warrants remain exercisable at the election of the holders until their expiration on June 30, 2023 . The Warrants are indexed to the Company’s common stock and are required to be settled through physical settlement or net share settlement, if exercised. +Upon issuance, the $ 21.5 million fair value of the Warrants was recorded in additional paid-in capital on the accompanying balance sheets, and was determined using a stochastic Monte Carlo simulation using geometric Brownian motion (“GBM Model”). The Company evaluated the Warrants under authoritative accounting guidance and determined that they should be classified as equity instruments, with no recurring fair value measurement required. There have been no changes to the initial carrying amount of the Warrants since issuance. +No Warrants were exercised during the year ended December 31, 2022. During 2021, the Company issued 5,918,089 shares of common stock as a result of the cashless exercise of 5,922,260 Warrants at a weighted-average share price of $ 15.45 per share, as determined under the terms of the Warrant Agreement. At the request of stockholders and pursuant to the Company’s obligations under the Warrant Agreement, a registration statement covering the resale of a majority of these shares was filed with the SEC on June 11, 2021. +Dividends +During the third quarter of 2022, the Company’s Board of Directors approved an increase to the Company’s fixed dividend to $ 0.60 per share annually, to be paid in quarterly increments of $ 0.15 per share. During the year ended December 31, 2022, cash dividends declared totaled $ 37.9 million. +72 +Note 4 – Income Taxes +The provision for income taxes consists of the following: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Current portion of income tax (expense) benefit +Federal $ ( 9,230 ) $ — $ — +State ( 5,531 ) ( 373 ) ( 449 ) +Deferred portion of income tax (expense) benefit ( 269,057 ) ( 9,565 ) 192,540 +Income tax (expense) benefit $ ( 283,818 ) $ ( 9,938 ) $ 192,091 +Effective tax rate 20.3 % 21.5 % 20.1 % +The components of the net deferred tax liabilities are as follows: +As of December 31, +2022 2021 +(in thousands) +Deferred tax liabilities +Oil and gas properties excluding asset retirement obligation liabilities $ 358,537 $ 117,085 +Derivative assets 3,416 — +Other 6,059 4,835 +Total deferred tax liabilities 368,012 121,920 +Deferred tax assets +Federal and state tax net operating loss carryovers 28,151 3,299 +Asset retirement obligation liabilities 24,899 21,899 +Interest carryforward 22,667 — +Lease liabilities 4,525 4,496 +Pension 3,970 7,413 +Stock compensation 567 2,246 +Credit carryover 161 897 +Debt discount and deferred financing costs 59 20,551 +Derivative liabilities — 69,283 +Other liabilities 3,818 528 +Total deferred tax assets 88,817 130,612 +Valuation allowance ( 1,616 ) ( 18,461 ) +Net deferred tax assets 87,201 112,151 +Total net deferred tax liabilities $ 280,811 $ 9,769 +Current federal income tax refundable $ 770 $ — +Current state income tax payable $ 5,316 $ 362 +As of December 31, 2022, the Company had estimated federal net operating loss (“NOL”) carryforwards of $ 121.7 million, state NOL carryforwards of $ 3.3 million that expire between 2023 and 2037, and de minimus state tax credits that expire between 2023 and 2031. The Company expects to utilize the federal R&D credit carryforward from 2021. The Company commissioned a multi-year R&D credit study, which is expected to be completed in late 2023, and is likely to favorably impact the Company’s effective tax rate when the results are recorded. The Company’s policy is to not record an R&D credit until it is claimed on a filed tax return, which had not occurred at the time of this filing. +73 +The Company’s current valuation allowance includes an amount for state NOL carryforwards and state tax credits, which are expected to expire before they can be utilized. The change in the valuation allowance as of December 31, 2021, compared with December 31, 2022, primarily relates to the change in the Company’s net derivative position from liabilities to assets and to estimated future reversals of existing taxable temporary differences, which support the realization of the remaining deductible temporary differences and carryforwards. Cumulative financial statement income exceeds cumulative financial statement losses for the periods included in the Company’s accompanying statements of operations, which reinforces the Company’s decision to not maintain a valuation allowance for certain deferred tax assets as of December 31, 2022. +Recorded income tax expense or benefit differs from the amount that would be provided by applying the statutory United States federal income tax rate to income or loss before income taxes. These differences primarily relate to the effect of state income taxes, excess tax benefits and deficiencies from stock-based compensation awards, tax deduction limitations on compensation of covered individuals, changes in valuation allowances, the cumulative impact of other smaller permanent differences, and can also reflect the cumulative effect of an enacted tax rate change, in the period of enactment, on the Company’s net deferred tax asset and liability balances. These differences are reported as follows: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Federal statutory tax (expense) benefit $ ( 293,112 ) $ ( 9,695 ) $ 200,908 +(Increase) decrease in tax resulting from: +Change in valuation allowance 16,845 ( 5,073 ) ( 10,318 ) +Employee share-based compensation 10,861 3,080 ( 2,578 ) +Return to provision ( 2,183 ) 1,230 ( 857 ) +Compensation of covered individuals ( 6,297 ) ( 1,216 ) ( 719 ) +State tax (expense) benefit (net of federal benefit) ( 9,870 ) ( 211 ) 5,722 +Other +( 62 ) 1,947 ( 67 ) +Income tax (expense) benefit $ ( 283,818 ) $ ( 9,938 ) $ 192,091 +Acquisitions, divestitures, drilling activity, and basis differentials, which impact the prices received for oil, gas, and NGLs, impact the apportionment of taxable income to the states where the Company owns oil and gas properties. As these factors change, the Company’s state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax (expense) benefit reported in the current year. Items affecting state apportionment factors are evaluated upon completion of the prior year income tax return, after significant acquisitions and divestitures, if there are significant changes in drilling activity, or if estimated state revenue changes occur during the year. +For all years before 2019, the Company is generally no longer subject to United States federal or state income tax examinations by tax authorities. +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. Interest expense in the accompanying statements of operations includes a negligible amount associated with income taxes. The total amount recorded for unrecognized tax benefits for each of the years ended December 31, 2022, 2021, and 2020, was $ 0.4 million. The Company does not expect a significant change to the recorded unrecognized tax benefits in 2023, except for any potential change related to the Company’s R&D credit study discussed above. +Note 5 – Long-Term Debt +Credit Agreement +On August 2, 2022, the Company entered into a Seventh Amended and Restated Credit Agreement by and among the Company, Wells Fargo Bank, National Association, as Administrative Agent and Swingline Lender, and the institutions named therein as lenders. The Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $ 3.0 billion. As of December 31, 2022, the borrowing base and aggregate lender commitments were $ 2.5 billion and $ 1.25 billion, respectively. The revolving credit facility is secured by substantially all of the Company’s proved oil and gas properties. The borrowing base is subject to regular, semi-annual redetermination, and considers the value of both the Company’s proved oil and gas properties reflected in the Company’s most recent reserve report; and commodity derivative contracts, each as determined by the Company’s lender group. The next scheduled borrowing base redetermination date is April 1, 2023. The Credit Agreement is scheduled to mature on the earlier of August 2, 2027 (“Stated Maturity Date”), or 91 days prior to the maturity date of any of the Company’s outstanding Senior Notes, as defined below, to the extent that, on or before such date, the respective Senior Notes have not been repaid, exchanged, repurchased, refinanced, or otherwise redeemed in full, and, if refinanced or exchanged, with a scheduled maturity date that is not earlier than at +74 +least 180 days after the Stated Maturity Date. In addition to other terms, conditions, agreements, and provisions, the Credit Agreement establishes SOFR as the benchmark for determining interest rates. The financial covenants under the Credit Agreement are discussed under Covenants below. +Interest and commitment fees associated with the revolving credit facility are accrued based on a borrowing base utilization grid set forth in the Credit Agreement, as presented in the table below. At the Company’s election, borrowings under the Credit Agreement may be in the form of SOFR, Alternate Base Rate (“ABR”), or Swingline loans. SOFR loans accrue interest at SOFR plus the applicable margin from the utilization grid, and ABR and Swingline loans accrue interest at a market-based floating rate, plus the applicable margin from the utilization grid. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount at rates from the utilization grid. +Borrowing Base Utilization Percentage <25% ≥25% <50% ≥50% <75% ≥75% <90% ≥90% +SOFR Loans +2.000 % 2.250 % 2.500 % 2.750 % 3.000 % +ABR Loans or Swingline Loans +1.000 % 1.250 % 1.500 % 1.750 % 2.000 % +Commitment Fee Rate 0.375 % 0.375 % 0.500 % 0.500 % 0.500 % +The following table presents the outstanding balance, total amount of letters of credit outstanding, and available borrowing capacity under the Credit Agreement as of February 9, 2023, December 31, 2022, and December 31, 2021: +As of February 9, 2023 As of December 31, 2022 As of December 31, 2021 +(in thousands) +Revolving credit facility (1) +$ — $ — $ — +Letters of credit (2) +6,000 6,000 2,500 +Available borrowing capacity 1,244,000 1,244,000 1,097,500 +Total aggregate lender commitment amount $ 1,250,000 $ 1,250,000 $ 1,100,000 +____________________________________________ +(1) Unamortized deferred financing costs attributable to the revolving credit facility are presented as a component of the other noncurrent assets line item on the accompanying balance sheets and totaled $ 10.8 million and $ 2.7 million as of December 31, 2022, and 2021, respectively. These costs are being amortized over the term of the revolving credit facility on a straight-line basis. +(2) Letters of credit outstanding reduce the amount available under the revolving credit facility on a dollar-for-dollar basis. +Senior Secured Notes +No Senior Secured Notes were outstanding as of December 31, 2022. Senior Secured Notes, net of unamortized discount and deferred financing costs, included within the Senior Notes, net line item on the accompanying balance sheets as of December 31, 2021, consisted of the following: +As of December 31, 2021 +(in thousands) +Principal amount of 10.0 % Senior Secured Notes due 2025 +$ 446,675 +Unamortized debt discount 30,236 +Unamortized deferred financing costs 8,727 +10.0 % Senior Secured Notes due 2025, net of unamortized debt discount and deferred financing costs +$ 407,712 +2025 Senior Secured Notes . On June 17, 2020, the Company issued $ 446.7 million in aggregate principal amount of 10.0 % Senior Secured Notes (“2025 Senior Secured Notes” or “Senior Secured Notes”), at par, with a maturity date of January 15, 2025. The Company incurred fees of $ 13.1 million, and recorded $ 405.0 million as the initial carrying amount, which approximated the fair value of the 2025 Senior Secured Notes at issuance. The excess of the principal amount of the 2025 Senior Secured Notes over its fair value was recorded as a debt discount. The debt discount and deferred financing costs were being amortized to interest expense until the early redemption of the 2025 Senior Secured Notes in 2022, as discussed below. +2021 Senior Secured Convertible Notes . On August 12, 2016, the Company issued $ 172.5 million in aggregate principal amount of 1.50 % Senior Convertible Notes with a maturity date of July 1, 2021 (“2021 Senior Convertible Notes”). Upon issuance of the 2021 Senior Convertible Notes, the Company received net proceeds of $ 166.6 million after deducting fees of $ 5.9 million. The Company recorded $ 132.3 million as the initial carrying amount of the debt component, which approximated its fair value at issuance, and the $ 40.2 million excess of the principal amount of the 2021 Senior Convertible Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The debt discount and deferred financing +75 +costs were amortized to interest expense through the maturity date. Upon the closing of the Exchange Offers, discussed and defined below, on June 17, 2020, the remaining outstanding 2021 Senior Convertible Notes became secured and are subsequently referred to as “2021 Senior Secured Convertible Notes”. The 2021 Senior Secured Convertible Notes were fully redeemed in 2021, as discussed below. +Interest expense recognized on the 2021 Senior Secured Convertible Notes related to the stated interest rate and amortization of the debt discount and debt related issuance costs totaled $ 2.3 million and $ 7.7 million for the years ended December 31, 2021, and 2020, respectively. +Senior Unsecured Notes +Senior Unsecured Notes, net of unamortized deferred financing costs, included within the Senior Notes, net line item on the accompanying balance sheets as of December 31, 2022, and 2021, consisted of the following (collectively referred to as “Senior Unsecured Notes”, and together with the 2025 Senior Secured Notes, “Senior Notes”): +As of December 31, 2022 As of December 31, 2021 +Principal Amount Unamortized Deferred Financing Costs Principal Amount, Net Principal Amount Unamortized Deferred Financing Costs Principal Amount, Net +(in thousands) +5.0 % Senior Notes due 2024 +$ — $ — $ — $ 104,769 $ 403 $ 104,366 +5.625 % Senior Notes due 2025 +349,118 1,528 347,590 349,118 2,160 346,958 +6.75 % Senior Notes due 2026 +419,235 2,569 416,666 419,235 3,270 415,965 +6.625 % Senior Notes due 2027 +416,791 3,172 413,619 416,791 3,949 412,842 +6.5 % Senior Notes due 2028 +400,000 5,665 394,335 400,000 6,679 393,321 +Total $ 1,585,144 $ 12,934 $ 1,572,210 $ 1,689,913 $ 16,461 $ 1,673,452 +The Senior Unsecured Notes listed above are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. The Company may redeem some or all of its Senior Unsecured Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest as described in the indentures governing the Senior Unsecured Notes. Fees incurred upon issuance of each series of Senior Unsecured Notes are being amortized as deferred financing costs over the life of the respective notes, unless earlier redeemed or retired, in which case amortization has been proportionately accelerated. +2022 Senior Notes. On November 17, 2014, the Company issued $ 600.0 million in aggregate principal amount of 6.125 % Senior Notes due 2022, at par, with a maturity date of November 15, 2022 (“2022 Senior Notes”). The Company received net proceeds of $ 590.0 million after deducting fees of $ 10.0 million. The 2022 Senior Notes were fully redeemed in 2021, as discussed below. +2024 Senior Notes. On May 20, 2013, the Company issued $ 500.0 million in aggregate principal amount of 5.0 % Senior Notes due 2024, at par, with a maturity date of January 15, 2024 (“2024 Senior Notes”). The Company received net proceeds of $ 490.2 million after deducting fees of $ 9.8 million. The 2024 Senior Notes were fully redeemed in 2022, as discussed below. +2025 Senior Notes. On May 21, 2015, the Company issued $ 500.0 million in aggregate principal amount of 5.625 % Senior Notes due 2025, at par, which mature on June 1, 2025. The Company received net proceeds of $ 491.0 million after deducting fees of $ 9.0 million. +2026 Senior Notes. On September 12, 2016, the Company issued $ 500.0 million in aggregate principal amount of 6.75 % Senior Notes due 2026, at par, which mature on September 15, 2026 (“2026 Senior Notes”). The Company received net proceeds of $ 491.6 million after deducting fees of $ 8.4 million. +2027 Senior Notes. On August 20, 2018, the Company issued $ 500.0 million in aggregate principal amount of 6.625 % Senior Notes due 2027, at par, which mature on January 15, 2027 (“2027 Senior Notes”). The Company received net proceeds of $ 492.1 million after deducting fees of $ 7.9 million. +2028 Senior Notes. On June 23, 2021, the Company issued $ 400.0 million in aggregate principal amount of 6.5 % Senior Notes due 2028, at par, which mature on July 15, 2028 (“2028 Senior Notes”). The Company received net proceeds of $ 392.8 million after deducting fees of $ 7.2 million. +76 +Senior Notes Activity +2022 Senior Notes Transactions. On February 14, 2022, the Company redeemed the remaining $ 104.8 million of aggregate principal amount outstanding of its 2024 Senior Notes, with cash on hand, pursuant to the terms of the indenture governing the 2024 Senior Notes which provided for a redemption price equal to 100 percent of the principal amount of the 2024 Senior Notes on the date of redemption, plus accrued and unpaid interest. The Company canceled all redeemed 2024 Senior Notes upon settlement. +On June 17, 2022, the Company redeemed all of the $ 446.7 million of aggregate principal amount outstanding of its 2025 Senior Secured Notes with cash on hand, at a redemption price equal to 107.5 percent of the principal amount outstanding on the date of the redemption, plus accrued and unpaid interest. Upon redemption, the Company recorded a net loss on extinguishment of debt of $ 67.2 million which included $ 33.5 million of premium paid, $ 26.3 million of accelerated expense recognition of the unamortized debt discount, and $ 7.4 million of accelerated expense recognition of the remaining unamortized deferred financing costs. The Company canceled all redeemed 2025 Senior Secured Notes upon settlement. +2021 Senior Notes Transactions. On June 23, 2021, the Company issued $ 400.0 million in aggregate principal amount of its 2028 Senior Notes, as described above. The net proceeds of $ 392.8 million were used to repurchase $ 193.1 million and $ 172.3 million of outstanding principal amount of the Company’s 2022 Senior Notes and 2024 Senior Notes, respectively, through a cash tender offer (“Tender Offer”), and to redeem the remaining $ 19.3 million of 2022 Senior Notes not repurchased as part of the Tender Offer (“2022 Senior Notes Redemption”). The Company paid total consideration, excluding accrued interest, of $ 385.3 million, and recorded a net loss on extinguishment of debt of $ 2.1 million for the year ended December 31, 2021, which included the accelerated expense recognition of $ 1.5 million of the remaining unamortized deferred financing costs and $ 0.6 million of net premiums. The Company canceled all repurchased and redeemed 2022 Senior Notes and 2024 Senior Notes upon settlement. +The 2021 Senior Secured Convertible Notes matured on July 1, 2021, and on that day, the Company used borrowings under its revolving credit facility to retire, at par, the remaining outstanding principal amount of $ 65.5 million. +2020 Senior Notes Transactions. During the second quarter of 2020, the Company initiated an offer to exchange certain of its then outstanding Senior Unsecured Notes, other than its 2021 Senior Convertible Notes, (and together with the Senior Unsecured Notes, “Old Notes”), and entered into a private exchange of certain of its then outstanding 2021 Senior Convertible Notes and portions of its then outstanding Senior Unsecured Notes (“Private Exchange”), in each case, for newly issued 2025 Senior Secured Notes, referred to together as “Exchange Offers.” +On June 17, 2020, the Company exchanged $ 611.9 million in aggregate principal amount of Senior Unsecured Notes and $ 107.0 million in aggregate principal amount of 2021 Senior Convertible Notes for $ 446.7 million in aggregate principal amount of 2025 Senior Secured Notes. Further, in connection with the Private Exchange, the Company tendered $ 53.5 million in cash to certain holders of the 2021 Senior Convertible Notes and issued the Warrants. Please refer to Note 3 - Equity for more information regarding the Warrants. Upon the closing of the Exchange Offers, the Company recorded a net gain on extinguishment of debt of $ 227.3 million which included the accelerated expense recognition of $ 6.1 million and $ 5.6 million of previously unamortized debt discount and deferred financing costs, respectively. +Upon the closing of the Exchange Offers, the Company retired $ 611.9 million in aggregate principal amount of its Senior Unsecured Notes. Portions of the then-outstanding principal amount of each series of the Senior Unsecured Notes listed below were tendered and retired in connection with the Exchange Offers. The following table summarizes the principal amounts of the Senior Unsecured Notes tendered as of the Settlement Date: +Title of Senior Unsecured Notes Tendered Principal Amount of Senior Unsecured Notes Tendered +(in thousands) +6.125 % Senior Notes due 2022 +$ 141,701 +5.0 % Senior Notes due 2024 +155,339 +5.625 % Senior Notes due 2025 +150,882 +6.75 % Senior Notes due 2026 +80,765 +6.625 % Senior Notes due 2027 +83,209 +Total +$ 611,896 +The Company canceled all 2021 Senior Convertible Notes and Senior Unsecured Notes that were retired upon closing of the Exchange Offers. +Additionally, during 2020, in open market transactions, the Company repurchased a total of $ 122.7 million and $ 67.6 million in aggregate principal amount of its 2022 Senior Notes and 2024 Senior Notes, respectively, for a total settlement amount, excluding accrued interest, of $ 136.5 million. In connection with the repurchases, the Company recorded a net gain on extinguishment of debt of +77 +$ 52.8 million for the year ended December 31, 2020. This amount included discounts realized upon repurchase of $ 53.8 million partially offset by approximately $ 1.0 million related to the accelerated expense recognition of the previously unamortized deferred financing costs. The Company canceled all repurchased 2022 Senior Notes and 2024 Senior Notes upon settlement. +Covenants +The Company is subject to certain financial and non-financial covenants under the Credit Agreement and the indentures governing the Senior Notes that, among other terms, limit the Company’s ability to incur additional indebtedness, make restricted payments including dividends, sell assets, create liens that secure debt, enter into transactions with affiliates, merge or consolidate with other entities, and with respect to the Company’s restricted subsidiaries, permit the consensual restriction on the ability of such restricted subsidiaries to pay dividends or indebtedness owing to the Company or to any other restricted subsidiaries. The financial covenants under the Credit Agreement require that the Company’s (a) total funded debt, as defined in the Credit Agreement, to 12-month trailing adjusted EBITDAX ratio cannot be greater than 3.50 to 1.00 on the last day of each fiscal quarter; and (b) adjusted current ratio, as defined in the Credit Agreement, cannot be less than 1.00 to 1.00 as of the last day of any fiscal quarter. The Company was in compliance with all covenants under the Credit Agreement and the indentures governing the Senior Notes as of December 31, 2022, and through the filing of this report. +Capitalized Interest +Capitalized interest costs for the years ended December 31, 2022, 2021, and 2020, totaled $ 17.6 million, $ 15.0 million, and $ 15.8 million, respectively. The amount of interest the Company capitalizes generally fluctuates based on the amount borrowed, the Company’s capital program, and the timing and amount of costs associated with capital projects that are considered in progress. Capitalized interest costs are included in total costs incurred. Please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Note 6 – Commitments and Contingencies +Commitments +As of December 31, 2022, the Company had entered into various agreements, which included drilling rig contracts of $ 24.7 million, gathering, processing, transportation throughput, and delivery commitments of $ 45.7 million, office leases, including maintenance, of $ 36.8 million, fixed price contracts to purchase electricity of $ 31.0 million, sand sourcing agreements of approximately $ 20.8 million, compression service contracts of $ 13.2 million, and other miscellaneous contracts and leases of $ 13.8 million. As of December 31, 2022, the annual minimum payments for the next five years and total minimum payments thereafter are presented below: +For the Years Ending December 31, Amount +(in thousands) +2023 $ 98,286 +2024 26,837 +2025 22,229 +2026 16,317 +2027 6,372 +Thereafter 15,947 +Total $ 185,988 +Drilling Rig and Completion Service Contracts. The Company has drilling rig and completion service contracts in place to facilitate its drilling and completion plans. As of December 31, 2022, the Company’s drilling rig commitments totaled $ 24.7 million under contract terms extending through the third quarter of 2023. If all of these contracts were terminated as of December 31, 2022, the Company would avoid a portion of the contractual service commitments; however, the Company would be required to pay $ 14.7 million in early termination fees. Excluded from these amounts are variable commitments and potential penalties determined by the number of completion crews the Company has in operation in a particular area under a completion service agreement. As of December 31, 2022, potential penalties under this completion service agreement, which expires on December 31, 2023, range from zero to a maximum of $ 3.4 million. No material expenses related to early termination or standby fees were incurred by the Company during the year ended December 31, 2022, and the Company does not expect to incur material penalties with regard to its drilling rig and completion service contracts during 2023. +Pipeline Transportation Commitments. The Company has gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum amount of oil, gas, and produced water. As of December 31, 2022, the Company had commitments to deliver a minimum of 18 MMBbl of oil through 2026, 26 Bcf of gas through the first half of 2023, and 11 MMBbl of produced water through 2027. The Company would be required to make periodic deficiency payments for any +78 +shortfalls in delivering the minimum volume commitments under certain agreements. As of December 31, 2022, if the Company failed to deliver any product, as applicable, the aggregate undiscounted deficiency payments would total approximately $ 45.7 million. This amount does not include deficiency payment estimates associated with approximately 5 MMBbl of future oil delivery commitments where the Company cannot predict with accuracy the amount and timing of these payments, as such payments are dependent upon the price of oil in effect at the time of settlement. The Company expects to fulfill the delivery commitments from a combination of production from existing productive wells, future development of proved undeveloped reserves, and future development of resources not yet characterized as proved reserves. Under certain of the Company’s commitments, if the Company is unable to deliver the minimum quantity from its production, it may deliver production acquired from third-parties to satisfy its minimum volume commitments. As of the filing of this report, the Company does not expect to incur material shortfalls with regard to these commitments. +Office Leases. The Company leases office space under various operating leases totaling $ 36.8 million, including maintenance, with certain terms extending into 2033. Rent expense for the years ended December 31, 2022, 2021, and 2020, was $ 3.5 million, $ 4.8 million, and $ 5.4 million, respectively. +Electrical Power Purchase Contracts. As of December 31, 2022, the Company had fixed price contracts for the purchase of electrical power through 2027 with a total remaining obligation of $ 31.0 million. +Sand Purchase Commitments. As of December 31, 2022, the Company had a sand purchase agreement with a minimum purchase commitment of approximately $ 20.8 million through December 31, 2023. As of December 31, 2022, if the Company failed to purchase the minimum amount required by the contract, it would be subject to penalties of up to $ 4.9 million. Additionally, as of December 31, 2022, the Company had a sand sourcing agreement with potential penalties ranging from zero to a maximum of $ 10.0 million that vary based on the amount of sand the Company uses in well completions occurring in certain areas through March 31, 2024. As of the filing of this report, the Company does not expect to incur penalties with regard to these agreements. +Compression Service Contracts . As of December 31, 2022, the Company had compression service contracts with terms extending through 2025 for equipment being used in field operations with a total remaining obligation of $ 13.2 million. +Drilling and Completion Commitments. During 2022, the Company entered into an agreement that includes minimum drilling and completion footage requirements on certain existing leases. If these minimum requirements are not satisfied by March 31, 2024, the Company will be required to pay liquidated damages based on the difference between the actual footage drilled and completed and the minimum requirements. As of December 31, 2022, the liquidated damages could range from zero to a maximum of $ 60.3 million, with the maximum exposure assuming no additional development activity occurred prior to March 31, 2024. As of the filing of this report, the Company does not expect to incur material liquidated damages with regard to this agreement. +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the anticipated results of any pending litigation and claims are not expected to have a material effect on the results of operations, the financial position, or the cash flows of the Company. +Note 7 – Compensation Plans +As of December 31, 2022, approximately 3.8 million shares of common stock were available for grant under the Equity Plan. The issuance of a direct share benefit, such as a share of common stock, a stock option, a restricted share, an RSU or a PSU, counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. The Company may also grant other types of long-term incentive-based awards, such as cash awards and performance-based cash awards, to eligible employees. +Performance Share Units +The Company has granted PSUs to eligible employees as part of its Equity Plan. The number of shares of the Company’s common stock issued to settle PSUs ranges from zero to two times the number of PSUs awarded and is determined based on certain criteria over a three -year performance period. PSUs generally vest on the third anniversary of the date of the grant or upon other triggering events as set forth in the Equity Plan. Employees who were retirement eligible on the grant date of the 2022 PSU award vest in pro-rata increments on a daily basis over the three -year performance period beginning at the grant date, and any non-vested portions of a PSU award will be forfeited if the employee leaves the Company. +The fair value of PSUs is measured at the grant date using a stochastic Monte Carlo simulation using the GBM Model. A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for each iteration. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will +79 +take over the three -year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the path the stock price may take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +For PSUs granted in 2019, which the Company determined to be equity awards, the settlement criteria included a combination of the Company’s Total Shareholder Return (“TSR”) relative to the TSR of certain peer companies and the Company’s cash return on total capital invested (“CRTCI”) relative to the CRTCI of certain peer companies over the associated three -year performance period. In addition to these performance criteria, the award agreements for these grants also stipulated that if the Company’s absolute TSR was negative over the three -year performance period, the maximum number of shares of common stock that could be issued to settle outstanding PSUs was capped at one times the number of PSUs granted on the award date, regardless of the Company’s TSR and CRTCI performance relative to its peer group. The fair value of the PSUs granted in 2019 was measured on the grant date using the GBM Model, with the assumption that the associated CRTCI performance condition would be met at the target amount at the end of the performance period. PSUs granted in 2019 fully vested in 2022 and were settled as presented below. +For PSUs granted in 2022, which the Company determined to be equity awards, settlement will be determined based on a combination of the following criteria measured over the three -year performance period: the Company’s TSR relative to the TSR of certain peer companies, the Company’s absolute TSR, free cash flow (“FCF”) generation, and the achievement of certain ESG targets, in each case as defined by the award agreement. The relative and absolute TSR portions of the fair value of the PSUs granted in 2022 were measured on the grant date using the GBM Model. The portion of the awards associated with FCF generation and ESG performance conditions assumes that target amounts will be met at the end of the performance period. As these awards depend on a combination of performance-based settlement criteria and market-based settlement criteria, compensation expense may be adjusted in future periods because the number of units expected to vest increases or decreases based on the Company’s expected FCF generation and achievement of certain ESG targets. +The Company initially records compensation expense associated with the issuance of PSUs based on the fair value of the awards as of the grant date and may adjust compensation expense in future periods as discussed above. Compensation expense for PSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. Total compensation expense recorded for PSUs was $ 2.6 million, $ 6.0 million, and $ 4.4 million for the years ended December 31, 2022, 2021, and 2020, respectively. As of December 31, 2022, there was $ 6.1 million of total unrecognized expense related to non-vested PSUs, which is being amortized through mid-2025. +The fair value of PSUs granted in 2022 was $ 7.4 million and the fair value of PSUs that vested during the years ended December 31, 2022, 2021, and 2020, was $ 12.3 million, $ 8.4 million, and $ 12.6 million, respectively. +A summary of activity is presented in the following table: +For the Years Ended December 31, +2022 2021 2020 +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +PSUs (1) +Weighted-Average Grant-Date Fair Value +Non-vested at beginning of year 464,483 $ 12.80 830,464 $ 17.52 2,022,585 $ 16.87 +Granted 276,010 $ 26.67 — $ — — $ — +Vested ( 461,387 ) $ 12.81 ( 352,395 ) $ 23.81 ( 792,572 ) $ 15.85 +Forfeited ( 5,848 ) $ 18.24 ( 13,586 ) $ 15.46 ( 399,549 ) $ 17.56 +Non-vested at end of year 273,258 $ 26.67 464,483 $ 12.80 830,464 $ 17.52 +____________________________________________ +(1) The number of shares of common stock assumes a multiplier of one . The actual final number of shares of common stock to be issued will range from zero to two times the number of PSUs awarded depending on the three -year performance multiplier. +80 +A summary of the shares of common stock issued to settle PSUs is presented in the table below: +For the Years Ended December 31, +2022 2021 2020 +Shares of common stock issued to settle PSUs (1) +1,004,410 347,742 700,511 +Less: shares of common stock withheld for income and payroll taxes ( 349,487 ) ( 112,919 ) ( 215,451 ) +Net shares of common stock issued 654,923 234,823 485,060 +Multiplier earned +2.0 +1.0 +0.9 +____________________________________________ +(1) During the years ended December 31, 2022, 2021, and 2020, the Company settled PSUs that were granted in 2019, 2018, and 2017, respectively. The Company and all eligible recipients in 2022 and 2021, and the majority of eligible recipients in 2020, mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings, as provided for in the Equity Plan and applicable award agreements. +Employee Restricted Stock Units +The Company has granted RSUs to eligible employees as part of its Equity Plan. Each RSU represents a right to receive one share of the Company’s common stock upon settlement of the award at the end of the specified vesting period. RSUs generally vest in one-third increments on each anniversary date of the grant date over the applicable vesting period or upon other triggering events as set forth in the Equity Plan. Employees who are retirement eligible at the time an RSU award is granted generally vest in six -month increments over the applicable vesting period beginning at the grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of an RSU award will be forfeited when the employee leaves the Company. +The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the grant date. The fair value of an RSU is equal to the closing price of the Company’s common stock on the date of the grant. Compensation expense for RSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. Total compensation expense recorded for RSUs for the years ended December 31, 2022, 2021, and 2020, was $ 13.5 million, $ 10.2 million, and $ 8.7 million, respectively. As of December 31, 2022, there was $ 24.4 million of total unrecognized compensation expense related to non-vested RSUs, which is being amortized through mid-2025. +The fair value of RSUs granted to eligible employees in 2022, 2021 and 2020, was $ 18.0 million, $ 17.0 million, and $ 8.7 million, respectively, and the fair value of RSUs that vested during the years ended December 31, 2022, 2021, and 2020, was $ 11.2 million, $ 9.3 million, and $ 12.5 million, respectively. +A summary of activity is presented in the following table: +For the Years Ended December 31, +2022 2021 2020 +RSUs Weighted- +Average +Grant-Date +Fair Value RSUs Weighted- +Average +Grant-Date +Fair Value RSUs Weighted- +Average +Grant-Date +Fair Value +Non-vested at beginning of year +1,841,237 $ 13.79 2,097,860 $ 8.83 1,532,131 $ 16.01 +Granted 526,776 $ 34.08 666,052 $ 25.52 1,458,869 $ 5.98 +Vested ( 920,927 ) $ 12.17 ( 843,098 ) $ 11.00 ( 746,132 ) $ 16.74 +Forfeited ( 72,034 ) $ 18.24 ( 79,577 ) $ 10.64 ( 147,008 ) $ 15.34 +Non-vested at end of year +1,375,052 $ 22.42 1,841,237 $ 13.79 2,097,860 $ 8.83 +81 +A summary of the shares of common stock issued to settle RSUs is presented in the table below: +For the Years Ended December 31, +2022 2021 2020 +Shares of common stock issued to settle RSUs (1) +920,927 843,098 746,132 +Less: shares of common stock withheld for income and payroll taxes ( 284,423 ) ( 250,349 ) ( 209,173 ) +Net shares of common stock issued 636,504 592,749 536,959 +____________________________________________ +(1) During the years ended December 31, 2022, 2021, and 2020, the Company issued shares of common stock to settle RSUs that related to awards granted in previous years. The Company and all eligible recipients in 2022 and 2021, and the majority of eligible recipients in 2020, mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +Director Shares +In 2022, 2021, and 2020, the Company issued a total of 29,471 , 60,510 , and 267,576 shares, respectively, of its common stock to its non-employee directors under the Equity Plan. For the years ended December 31, 2022, 2021, and 2020, the Company recorded $ 1.5 million, $ 1.2 million, and $ 1.0 million, respectively, of compensation expense related to director shares. All shares issued to non-employee directors fully vest on December 31 of the year granted. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation, subject to a maximum of 2,500 shares per offering period and a maximum of $ 25,000 in value related to purchases for each calendar year. The purchase price of the common stock is 85 percent of the lower of the trading price of the common stock on either the first or last day of the six-month offering period. The ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the IRC. The Company had approximately 3.4 million shares of its common stock available for issuance under the ESPP as of December 31, 2022. There were a total of 113,785 , 313,773 , and 464,757 shares issued under the ESPP in 2022, 2021, and 2020, respectively. Total proceeds to the Company for the issuance of these shares was $ 3.0 million, $ 2.6 million, and $ 1.5 million, for the years ended December 31, 2022, 2021, and 2020, respectively. +The fair value of ESPP grants is measured at the grant date using the Black-Scholes option-pricing model. Expected volatility is calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six-month vesting period. +The fair value of ESPP shares issued during the periods reported above were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2022 2021 2020 +Risk free interest rate 1.2 % 0.8 % 0.8 % +Dividend yield 0.1 % 0.3 % 0.7 % +Volatility factor of the expected market price of the Company’s common stock 69.1 % 106.1 % 166.2 % +Expected life (in years) 0.5 0.5 0.5 +For the years ended December 31, 2022, 2021, and 2020, the Company expensed $ 1.2 million, $ 1.4 million, and $ 0.9 million, respectively, based on the estimated fair value of the ESPP grants. +401(k) Plan +The Company has a defined contribution plan (“401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. The Company matches either 100 percent or 150 percent of each employee’s contributions, depending on pension plan eligibility, up to six percent of the employee’s base salary and performance bonus, and may make additional contributions at its discretion. Please refer to Note 11 – Pension Benefits for additional discussion of pension benefits. The Company’s matching contributions to the 401(k) Plan were $ 5.5 million, $ 3.9 million, and $ 4.2 million for the years ended December 31, 2022, 2021, and 2020, respectively. +82 +Note 8 – Fair Value Measurements +The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• Level 1 – quoted prices in active markets for identical assets or liabilities +• Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +• Level 3 – significant inputs to the valuation model are unobservable +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2022: +Level 1 Level 2 Level 3 +(in thousands) +Assets: +Derivatives (1) +$ — $ 73,142 $ — +Liabilities: +Derivatives (1) +$ — $ 57,323 $ — +____________________________________________ +(1) This represents a financial asset or liability that is measured at fair value on a recurring basis. +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of December 31, 2021: +Level 1 Level 2 Level 3 +(in thousands) +Assets: +Derivatives (1) +$ — $ 24,334 $ — +Liabilities: +Derivatives (1) +$ — $ 345,202 $ — +____________________________________________ +(1) This represents a financial asset or liability that is measured at fair value on a recurring basis. +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on the Company’s policies for determining fair value for the categories discussed below. +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivative instruments. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The commodity derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. +83 +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any commodity derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current revolving credit facility margins, and any change in such margins since the last measurement date. +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and other marketplace participants, the Company recognizes that third parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Please refer to Note 10 – Derivative Financial Instruments for more information regarding the Company’s derivative instruments. +Oil and Gas Properties and Other Property and Equipment +The Company had no assets included in total property and equipment, net, measured at fair value as of December 31, 2022, or 2021. +The following table presents impairment of proved properties expense and abandonment and impairment of unproved properties expense recorded for the periods presented: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Impairment of proved oil and gas properties and related support equipment $ — $ — $ 956,650 +Abandonment and impairment of unproved properties (1) +7,468 35,000 59,363 +Impairment $ 7,468 $ 35,000 $ 1,016,013 +____________________________________________ +(1) These impairments related to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. The balances in the unproved oil and gas properties line item on the accompanying balance sheets as of December 31, 2022, and 2021, are recorded at carrying value. +No proved property impairment expense was recorded during the years ended December 31, 2022, or 2021. For the year ended December 31, 2020, the Company recorded impairment expense of $ 956.7 million related to its South Texas proved oil and gas properties and related support facilities due to the decrease in commodity price forecasts at the end of the first quarter of 2020, specifically decreases in oil and NGL prices. The Company used a discount rate of 11 percent in its calculation of the present value of expected future cash flows based on the prevailing market-based weighted average cost of capital as of March 31, 2020. +Please refer to Note 1 – Summary of Significant Accounting Policies for information on the Company’s policies for determining fair value of its oil and gas producing properties and related impairment expense. +84 +Long-Term Debt +The following table reflects the fair value of the Company’s Senior Notes obligations measured using Level 1 inputs based on quoted secondary market trading prices. These notes were not presented at fair value on the accompanying balance sheets as of December 31, 2022, or 2021, as they were recorded at carrying value, net of any unamortized discounts and deferred financing costs. Please refer to Note 5 – Long-Term Debt for additional information. +As of December 31, +2022 2021 +Principal Amount Fair Value Principal Amount Fair Value +(in thousands) +10.0 % Senior Secured Notes due 2025 +$ — $ — $ 446,675 $ 491,628 +5.0 % Senior Notes due 2024 +$ — $ — $ 104,769 $ 104,583 +5.625 % Senior Notes due 2025 +$ 349,118 $ 337,821 $ 349,118 $ 353,091 +6.75 % Senior Notes due 2026 +$ 419,235 $ 409,484 $ 419,235 $ 431,787 +6.625 % Senior Notes due 2027 +$ 416,791 $ 402,120 $ 416,791 $ 432,783 +6.5 % Senior Notes due 2028 +$ 400,000 $ 384,520 $ 400,000 $ 417,284 +Note 9 - Earnings Per Share +Basic net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average number of common shares outstanding for the respective period. Diluted net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the diluted weighted-average number of common shares outstanding, which includes the effect of potentially dilutive securities. +For the years ended December 31, 2022, 2021, and 2020, potentially dilutive securities for this calculation consisted primarily of non-vested RSUs, contingent PSUs, and Warrants, all of which were measured using the treasury stock method. The Warrants became exercisable at the election of the holders on January 15, 2021 , and as a result, they were included as potentially dilutive securities on an adjusted weighted-average basis for the portion of the year ended December 31, 2021, for which they were outstanding. A majority of the Warrants were exercised during 2021, and the remaining outstanding Warrants were dilutive during the year ended December 31, 2022, as presented below. The Warrants were not exercisable for the year ended December 31, 2020, and therefore had no dilutive impact. Please refer to Note 3 - Equity for additional detail regarding the terms of the Warrants. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three -year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 7 – Compensation Plans under the heading Performance Share Units . +When the Company recognizes a net loss from continuing operations, all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of diluted net loss per common share. The following table details the weighted-average number of anti-dilutive securities for the years presented: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Anti-dilutive — — 265 +85 +The following table sets forth the calculations of basic and diluted net income (loss) per common share: +For the Years Ended December 31, +2022 2021 2020 +(in thousands, except per share data) +Net income (loss) $ 1,111,952 $ 36,229 $ ( 764,614 ) +Basic weighted-average common shares outstanding 122,351 119,043 113,730 +Dilutive effect of non-vested RSUs and contingent PSUs 1,714 2,582 — +Dilutive effect of Warrants 19 2,065 — +Diluted weighted-average common shares outstanding 124,084 123,690 113,730 +Basic net income (loss) per common share $ 9.09 $ 0.30 $ ( 6.72 ) +Diluted net income (loss) per common share $ 8.96 $ 0.29 $ ( 6.72 ) +Note 10 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company regularly enters into commodity derivative contracts to mitigate a portion of its exposure to oil, gas, and NGL price volatility and location differentials, and the associated impact on cash flows. As of the filing of this report, all contracts were entered into for other-than-trading purposes. The Company’s commodity derivative contracts consist of price swap and collar arrangements for oil, gas, and NGL production. In a typical commodity swap agreement, if the agreed upon published third-party index price (“index price”) is lower than the swap price, the Company receives the difference between the index price and the agreed upon swap price. If the index price is higher than the swap price, the Company pays the difference. For collar arrangements, the Company receives the difference between an agreed upon index price and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +The Company has entered into fixed price oil and gas basis swaps in order to mitigate exposure to adverse pricing differentials between certain industry benchmark prices and the actual physical pricing points where the Company’s production is sold. As of December 31, 2022, the Company had basis swap contracts with fixed price differentials between: +• NYMEX WTI and WTI Midland for a portion of its Midland Basin oil production with sales contracts that settle at WTI Midland prices; +• NYMEX WTI and Argus WTI Houston Magellan East Houston Terminal ("MEH”) for a portion of its South Texas oil production with sales contracts that settle at Argus WTI Houston MEH (“WTI Houston MEH”) prices; +• NYMEX HH and Inside FERC West Texas (“IF Waha”) for a portion of its Midland Basin gas production with sales contracts that settle at IF Waha prices; and +• NYMEX HH and Inside FERC Houston Ship Channel (“IF HSC”) for a portion of its South Texas gas production with sales contracts that settle at IF HSC prices. +The Company has also entered into oil swap contracts to fix the differential in pricing between the NYMEX calendar month average and the physical crude oil delivery month (“Roll Differential”) in which the Company pays the periodic variable Roll Differential and receives a weighted-average fixed price differential. The weighted-average fixed price differential represents the amount of net addition (reduction) to delivery month prices for the notional volumes covered by the swap contracts. +86 +As of December 31, 2022, the Company had commodity derivative contracts outstanding through the fourth quarter of 2025 as summarized in the table below: +Contract Period +First Quarter Second Quarter Third Quarter Fourth Quarter +2023 2023 2023 2023 2024 2025 +Oil Derivatives (volumes in MBbl and prices in $ per Bbl): +Swaps +NYMEX WTI Volumes 294 333 304 259 — — +Weighted-Average Contract Price $ 45.20 $ 45.18 $ 45.20 $ 45.23 $ — $ — +ICE Brent Volumes +900 910 920 920 910 — +Weighted-Average Contract Price $ 86.50 $ 86.50 $ 86.50 $ 86.50 $ 85.50 $ — +Collars +NYMEX WTI Volumes 577 464 291 — 919 — +Weighted-Average Floor Price $ 60.00 $ 67.85 $ 75.00 $ — $ 75.00 $ — +Weighted-Average Ceiling Price $ 74.02 $ 81.53 $ 93.05 $ — $ 81.47 $ — +Basis Swaps +WTI Midland-NYMEX WTI Volumes 1,294 1,357 1,414 1,294 893 — +Weighted-Average Contract Price $ 0.99 $ 0.99 $ 0.88 $ 0.88 $ 1.10 $ — +WTI Houston MEH-NYMEX WTI Volumes +390 431 361 296 297 — +Weighted-Average Contract Price $ 1.65 $ 1.68 $ 1.59 $ 1.53 $ 1.75 $ — +Roll Differential Swaps +NYMEX WTI Volumes 1,220 1,243 1,304 1,201 — — +Weighted-Average Contract Price $ 0.60 $ 0.62 $ 0.64 $ 0.62 $ — $ — +Gas Derivatives (volumes in BBtu and prices in $ per MMBtu): +Swaps +NYMEX HH Volumes +— 1,420 1,470 — — — +Weighted-Average Contract Price $ — $ 5.05 $ 5.11 $ — $ — $ — +IF Waha Volumes +900 — — — — — +Weighted-Average Contract Price $ 3.98 $ — $ — $ — $ — $ — +Collars +NYMEX HH Volumes +7,919 5,181 6,194 8,362 13,722 — +Weighted-Average Floor Price $ 3.84 $ 3.83 $ 3.75 $ 3.90 $ 4.00 $ — +Weighted-Average Ceiling Price $ 9.75 $ 4.68 $ 4.62 $ 5.70 $ 6.39 $ — +IF HSC Volumes +900 1,345 1,389 1,451 — — +Weighted-Average Floor Price $ 3.38 $ 4.25 $ 4.25 $ 4.25 $ — $ — +Weighted-Average Ceiling Price $ 7.75 $ 5.00 $ 4.95 $ 5.55 $ — $ — +Basis Swaps +IF Waha-NYMEX HH Volumes +1,816 2,462 2,442 2,337 20,958 20,501 +Weighted-Average Contract Price $ ( 0.81 ) $ ( 1.93 ) $ ( 1.05 ) $ ( 1.01 ) $ ( 0.86 ) $ ( 0.66 ) +IF HSC-NYMEX HH Volumes +6,737 1,774 1,813 2,008 — — +Weighted-Average Contract Price $ 0.19 $ ( 0.25 ) $ ( 0.25 ) $ ( 0.25 ) $ — $ — +87 +Commodity Derivative Contracts Entered Into Subsequent to December 31, 2022 +Subsequent to December 31, 2022, and through the filing of this report, the Company entered into the following commodity derivative contracts: +• NYMEX WTI price swap contracts for the third and fourth quarters of 2023 for a total of 0.6 MMBbl of oil production at a weighted-average contract price of $ 73.89 per Bbl; +• WTI Midland-NYMEX WTI basis swap contracts for 2024 for a total of 2.1 MMBbl of oil production at a weighted-average contract price of $ 1.20 per Bbl; +• WTI Houston MEH-NYMEX WTI basis swap contract for 2024 for a total of 0.6 MMBbl of oil production at a contract price of $ 1.90 per Bbl; +• NYMEX WTI Roll Differential swap contracts for 2024 for a total of 2.2 MMBbl of oil production at a weighted-average contract price of $ 0.42 per Bbl; +• NYMEX HH collar contracts for 2024 for a total of 5,735 BBtu of gas production at a weighted-average floor contract price of $ 3.00 per MMBtu and a weighted-average ceiling contract price of $ 4.70 per MMBtu; and +• OPIS Propane Mont Belvieu Non-TET swap contract for the second through fourth quarters of 2023 for a total of 0.4 MMBbl of NGL production at a contract price of $ 36.12 per Bbl. +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its commodity derivative contracts as hedging instruments. The fair value of the commodity derivative contracts at December 31, 2022, and 2021, was a net asset of $ 15.8 million and a net liability of $ 320.9 million, respectively. +The following table details the fair value of commodity derivative contracts recorded in the accompanying balance sheets, by category: +As of December 31, 2022 As of December 31, 2021 +(in thousands) +Derivative assets: +Current assets $ 48,677 $ 24,095 +Noncurrent assets 24,465 239 +Total derivative assets $ 73,142 $ 24,334 +Derivative liabilities: +Current liabilities $ 56,181 $ 319,506 +Noncurrent liabilities 1,142 25,696 +Total derivative liabilities $ 57,323 $ 345,202 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2022, and 2021, all derivative instruments held by the Company were subject to master netting arrangements with various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that settle on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +88 +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s commodity derivative contracts: +Derivative Assets as of Derivative Liabilities as of +December 31, +2022 December 31, +2021 December 31, +2022 December 31, +2021 +(in thousands) +Gross amounts presented in the accompanying balance sheets +$ 73,142 $ 24,334 $ ( 57,323 ) $ ( 345,202 ) +Amounts not offset in the accompanying balance sheets +( 26,136 ) ( 22,862 ) 26,136 22,862 +Net amounts $ 47,006 $ 1,472 $ ( 31,187 ) $ ( 322,340 ) +The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring such amounts in accumulated other comprehensive loss. The Company had no commodity derivative contracts designated as hedging instruments for the years ended December 31, 2022, 2021, and 2020. Please refer to Note 8 – Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +The following table summarizes the commodity components of the derivative settlement (gain) loss, and the net derivative (gain) loss line items presented within the accompanying statements of cash flows and the accompanying statements of operations, respectively: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Derivative settlement (gain) loss: +Oil contracts $ 514,641 $ 523,245 $ ( 331,559 ) +Gas contracts 171,598 152,361 ( 11,898 ) +NGL contracts 24,461 73,352 ( 7,804 ) +Total derivative settlement (gain) loss: $ 710,700 $ 748,958 $ ( 351,261 ) +Net derivative (gain) loss: +Oil contracts $ 284,863 $ 650,959 $ ( 205,180 ) +Gas contracts 82,769 172,248 30,038 +NGL contracts 6,380 78,452 13,566 +Total net derivative (gain) loss: $ 374,012 $ 901,659 $ ( 161,576 ) +Credit Related Contingent Features +As of December 31, 2022, all of the Company’s derivative counterparties were members of the Company’s Credit Agreement lender group. The Company does not enter into derivative contracts with counterparties that are not part of the lender group. Under the Credit Agreement, the Company is required to provide mortgage liens on assets having a value equal to at least 85 percent of the total PV-9, as defined in the Credit Agreement, of the Company’s proved oil and gas properties evaluated in the most recent reserve report. Collateral securing indebtedness under the Credit Agreement also secures the Company’s derivative agreement obligations. +Note 11 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering employees who meet age and service requirements and who began employment with the Company prior to January 1, 2016 (“Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (“Nonqualified Pension Plan” and together with the Qualified Pension Plan, “Pension Plans”). The Company froze the Pension Plans to new participants, effective January 1, 2016. Employees participating in the Pension Plans prior to the plans being frozen will continue to earn benefits. +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status (i.e. the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment within the other comprehensive income (loss), net of tax, line item in the accompanying consolidated +89 +statements of comprehensive income (loss). The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation, but excludes the effects of assumed future salary increases. The Company’s measurement date for plan assets and obligations is December 31. +For the Years Ended December 31, +2022 2021 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year $ 75,760 $ 73,593 +Service cost 4,652 4,455 +Interest cost 2,314 2,089 +Actuarial (gain) loss ( 15,567 ) 1,914 +Benefits paid ( 1,998 ) ( 4,630 ) +Settlements — ( 1,661 ) +Projected benefit obligation at end of year 65,161 75,760 +Change in plan assets: +Fair value of plan assets at beginning of year 35,941 32,894 +Actual return on plan assets ( 3,529 ) 2,777 +Employer contribution 6,000 6,561 +Benefits paid ( 1,998 ) ( 4,630 ) +Settlements — ( 1,661 ) +Fair value of plan assets at end of year 36,414 35,941 +Funded status at end of year $ ( 28,747 ) $ ( 39,819 ) +The Company’s underfunded status for the Pension Plans as of December 31, 2022, and 2021, was $ 28.7 million and $ 39.8 million, respectively, and is recognized in the accompanying balance sheets within the other noncurrent liabilities line item. There are no plan assets in the Nonqualified Pension Plan. +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2022 2021 +(in thousands) +Projected benefit obligation $ 65,161 $ 75,760 +Accumulated benefit obligation $ 55,712 $ 64,325 +Less: fair value of plan assets ( 36,414 ) ( 35,941 ) +Underfunded accumulated benefit obligation $ 19,298 $ 28,384 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of the unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for the year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +90 +The pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in the accumulated other comprehensive loss line item within the accompanying balance sheets as of December 31, 2022, and 2021, were as follows: +As of December 31, +2022 2021 +(in thousands) +Unrecognized actuarial losses $ 5,130 $ 16,388 +Accumulated other comprehensive loss (pre-tax) $ 5,130 $ 16,388 +The pension liability adjustments recognized in other comprehensive income (loss) during 2022, 2021, and 2020, were as follows: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Net actuarial gain (loss) $ 10,327 $ ( 612 ) $ ( 6,381 ) +Amortization of prior service cost — 13 17 +Amortization of net actuarial loss 931 1,240 950 +Settlements — 312 2,509 +Total pension liability adjustment, pre-tax 11,258 953 ( 2,905 ) +Tax (expense) benefit ( 2,431 ) ( 204 ) 626 +Total pension liability adjustment, net $ 8,827 $ 749 $ ( 2,279 ) +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Components of net periodic benefit cost: +Service cost $ 4,652 $ 4,455 $ 4,516 +Interest cost 2,314 2,089 2,358 +Expected return on plan assets that reduces periodic pension benefit cost ( 1,711 ) ( 1,474 ) ( 1,735 ) +Amortization of prior service cost — 13 17 +Amortization of net actuarial loss 931 1,240 950 +Net periodic benefit cost 6,186 6,323 6,106 +Settlements — 312 2,509 +Total net benefit cost $ 6,186 $ 6,635 $ 8,615 +Pension Plan Assumptions +The weighted-average assumptions used to measure the Company’s projected benefit obligation are as follows: +As of December 31, +2022 2021 +Projected benefit obligation: +Discount rate 5.2 % 3.1 % +Rate of compensation increase 3.5 % 3.6 % +91 +The weighted-average assumptions used to measure the Company’s net periodic benefit cost are as follows: +For the Years Ended December 31, +2022 2021 2020 +Net periodic benefit cost: +Discount rate 3.1 % 2.9 % 3.6 % +Expected return on plan assets (1) +3.6 % 4.4 % 5.3 % +Rate of compensation increase 4.8 % 4.4 % 4.5 % +____________________________________________ +(1) There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy prohibits the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting the optimal expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. +The weighted-average asset allocation of the Qualified Pension Plan is as follows: +Target As of December 31, +Asset Category 2023 2022 2021 +Equity securities 45.0 % 47.1 % 39.0 % +Fixed income securities 30.0 % 21.0 % 27.9 % +Other securities 25.0 % 31.9 % 33.1 % +Total 100.0 % 100.0 % 100.0 % +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in the plan. The assumption of the expected long-term rate of return on plan assets of the Qualified Pension Plan is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. The Company evaluates the expected rate of return on plan assets assumption on an annual basis. +92 +Pension Plan Assets +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2022, and 2021, utilizing the fair value hierarchy discussed in Note 8 – Fair Value Measurements are as follows: +Fair Value Measurements Using: +Actual Asset Allocation (1) +Total Level 1 Inputs Level 2 Inputs Level 3 Inputs +(in thousands) +As of December 31, 2022 +Equity securities: +Domestic (2) +20.7 % $ 7,533 $ 5,012 $ 2,521 $ — +International (3) +26.4 % 9,594 9,594 — — +Total equity securities 47.1 % 17,127 14,606 2,521 — +Fixed income securities: +Core fixed income (4) +14.3 % 5,220 5,220 — — +Floating rate corporate loans (5) +6.7 % 2,450 2,450 — — +Total fixed income securities 21.0 % 7,670 7,670 — — +Other securities: +Real estate (6) +6.8 % 2,476 — — 2,476 +Collective investment trusts (7) +1.9 % 687 — 687 — +Hedge fund (8) +23.2 % 8,454 4,133 — 4,321 +Total other securities 31.9 % 11,617 4,133 687 6,797 +Total investments 100.0 % $ 36,414 $ 26,409 $ 3,208 $ 6,797 +As of December 31, 2021 +Equity securities: +Domestic (2) +19.1 % $ 6,860 $ 4,909 $ 1,951 $ — +International (3) +19.9 % 7,138 7,138 — — +Total equity securities 39.0 % 13,998 12,047 1,951 — +Fixed income securities: +Core fixed income (4) +18.8 % 6,770 6,770 — — +Floating rate corporate loans (5) +9.1 % 3,272 3,272 — — +Total fixed income securities 27.9 % 10,042 10,042 — — +Other securities: +Real estate (6) +5.1 % 1,833 — — 1,833 +Collective investment trusts (7) +1.4 % 499 — 499 — +Hedge fund (8) +26.6 % 9,569 5,207 — 4,362 +Total other securities 33.1 % 11,901 5,207 499 6,195 +Total investments 100.0 % $ 35,941 $ 27,296 $ 2,450 $ 6,195 +____________________________________________ +(1) Percentages may not calculate due to rounding. +(2) Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold on demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of these funds is to approximate the S&P 500 by investing in one or more collective investment funds. +(3) International equity securities consist of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets that are believed to have strong sustainable financial productivity at attractive valuations. +(4) The objective of core fixed income funds is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay’s Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +93 +(5) Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +(6) The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(7) Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +(8) The hedge fund portfolio includes investments in actively traded global mutual funds that focus on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +The following is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2021 $ 5,736 +Purchases 250 +Realized gain on assets 132 +Unrealized gain on assets 298 +Disposition ( 221 ) +Balance at December 31, 2021 $ 6,195 +Purchases 400 +Realized gain on assets 259 +Unrealized loss on assets ( 57 ) +Disposition — +Balance at December 31, 2022 $ 6,797 +Contributions +The Company contributed $ 6.0 million, $ 6.6 million, and $ 6.0 million to the Pension Plans for the years ended December 31, 2022, 2021, and 2020, respectively. The Company expects to make a $ 10.2 million contribution to the Pension Plans in 2023. +Benefit Payments +The Pension Plans made actual benefit payments of $ 2.0 million, $ 6.3 million, and $ 11.6 million for the years ended December 31, 2022, 2021, and 2020, respectively. Expected benefit payments over the next 10 years are as follows: +For the Years Ending December 31, Amount +(in thousands) +2023 $ 7,996 +2024 $ 4,181 +2025 $ 4,835 +2026 $ 7,112 +2027 $ 5,103 +2028 through 2032 $ 26,981 +Note 12 - Leases +As of December 31, 2022, and 2021, the Company had operating leases for asset classes that include office space, office equipment, drilling rigs, midstream agreements, vehicles, and equipment rentals used in field operations. For operating leases recorded on the accompanying balance sheets, remaining lease terms range from less than one year to approximately 10 years. Certain leases contain optional extension periods that allow for terms to be extended for up to an additional 10 years, however in order to maintain financial and operational flexibility, there are no available options to extend that the Company is reasonably certain it will exercise. An early termination option exists for certain leases, some of which allow the Company to terminate a lease within one year, however, there are no leases in which material early termination options are reasonably certain to be exercised by the Company. As of December 31, 2022, and 2021, the Company did not have any agreements in place that were classified as finance leases under Topic 842. As of December 31, 2022, and through the filing of this report, the Company has no material lease arrangements which are scheduled to commence in the future. Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on the Company’s policies for lease determination and classification. +94 +The following table reflects the components of the Company’s total costs, whether capitalized or expensed, related to operating leases, including short-term leases, and variable lease payments made for leases with initial lease terms greater than 12 months, for the years ended December 31, 2022, and 2021. This total does not reflect amounts that may be reimbursed by other third parties in the normal course of business, such as non-operating working interest owners. +For the Years Ended December 31, +2022 2021 +(in thousands) +Operating lease cost $ 10,174 $ 12,825 +Short-term lease cost (1) +175,098 145,052 +Variable lease cost (2) +7,085 48,931 +Total lease cost $ 192,357 $ 206,808 +____________________________________________ +(1) Costs associated with short-term lease agreements relate primarily to operational activities where underlying lease terms are less than one year. This amount includes drilling and completion activities and field equipment rentals, most of which are contracted for 12 months or less. It is expected that this amount will fluctuate primarily with the number of drilling rigs and completion crews the Company is operating under short-term agreements. +(2) Variable lease payments include additional payments made that were not included in the initial measurement of the ROU asset and corresponding liability for lease agreements with terms longer than 12 months. Variable lease payments relate to the actual volumes transported under certain midstream agreements, actual usage associated with drilling rigs, completion crews, and vehicles, and variable utility costs associated with the Company’s leased office space. Fluctuations in variable lease payments are driven by actual volumes delivered and the number of drilling rigs and completion crews operating under long-term agreements. +Cash paid for amounts included in the measurement of lease liabilities for the years ended December 31, 2022, and 2021, were as follows: +For the Years Ended December 31, +2022 2021 +(in thousands) +Operating cash flows from operating leases $ 4,718 $ 11,286 +Investing cash flows from operating leases $ 5,042 $ 2,316 +Maturities for the Company’s operating lease liabilities included on the accompanying balance sheets as of December 31, 2022, were as follows: +As of December 31, 2022 +(in thousands) +2023 $ 11,164 +2024 8,520 +2025 5,808 +2026 2,931 +2027 2,008 +Thereafter 8,957 +Total Lease payments $ 39,388 +Less: Imputed interest (1) +( 5,654 ) +Total $ 33,734 +____________________________________________ +(1) The weighted-average discount rate used to determine the operating lease liability as of December 31, 2022, was 5.8 percent. +95 +The following table presents supplemental accompanying balance sheet information for operating leases as of December 31, 2022, and 2021: +As of December 31, +2022 2021 +(in thousands, except discount rate and lease term) +Balance sheet classifications of operating leases: +Other noncurrent assets $ 26,368 $ 19,026 +Other current liabilities $ 10,114 $ 6,516 +Other noncurrent liabilities $ 23,621 $ 19,440 +ROU assets obtained in exchange for operating lease liabilities $ 16,186 $ 13,018 +Weighted-average discount rate +5.8 % +5.4 % +Weighted-average remaining lease term (years) 5 7 +Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses +The components of accounts receivable are as follows: +As of December 31, +2022 2021 +(in thousands) +Oil, gas, and NGL production revenue $ 184,458 $ 215,630 +Amounts due from joint interest owners 45,997 23,782 +Other 2,842 7,789 +Total accounts receivable $ 233,297 $ 247,201 +The components of accounts payable and accrued expenses are as follows: +As of December 31, +2022 2021 +(in thousands) +Drilling and lease operating cost accruals $ 125,570 $ 71,012 +Trade accounts payable 43,898 25,072 +Revenue and severance tax payable 182,744 254,422 +Property taxes 43,066 20,250 +Compensation 35,799 47,037 +Derivative settlements 22,745 57,186 +Interest 35,992 60,273 +Dividends payable 18,290 — +Other 24,185 28,054 +Total accounts payable and accrued expenses $ 532,289 $ 563,306 +Note 14 – Asset Retirement Obligations +Please refer to Asset Retirement Obligations in Note 1 – Summary of Significant Accounting Policies for a discussion of the initial and subsequent measurements of asset retirement obligation liabilities and the significant assumptions used in the estimates. +96 +The following is a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2022, and 2021: +As of December 31, +2022 2021 +(in thousands) +Beginning asset retirement obligations $ 101,424 $ 85,325 +Liabilities incurred (1) +2,086 1,715 +Liabilities settled (2) +( 6,356 ) ( 1,948 ) +Accretion expense +5,344 4,159 +Revision to estimated cash flows +12,815 12,173 +Ending asset retirement obligations (3) +$ 115,313 $ 101,424 +____________________________________________ +(1) Reflects liabilities incurred through drilling activities. +(2) Reflects liabilities settled through plugging and abandonment activities and divestitures of properties. +(3) Balances as of December 31, 2022, and 2021, included $ 7.1 million and $ 4.1 million, respectively, related to the Company’s current asset retirement obligation liability, which is recorded in the accounts payable and accrued expenses line item on the accompanying balance sheets. +Note 15 – Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2022, 2021, and 2020. The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Beginning balance $ 15,576 $ 5,698 $ 11,925 +Additions to capitalized exploratory well costs pending the determination of proved reserves 49,047 15,576 3,346 +Reclassifications based on the determination of proved reserves ( 14,721 ) ( 5,698 ) ( 9,573 ) +Capitalized exploratory well costs charged to expense (1) +( 855 ) — — +Ending balance $ 49,047 $ 15,576 $ 5,698 +____________________________________________ +(1) Relates to unsuccessful exploration activity outside of the Company’s core areas of operation. +As of December 31, 2022, there were no exploratory well costs that were capitalized for more than one year. +97 +Supplemental Oil and Gas Information (unaudited) +Costs Incurred +Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Development costs (1) +$ 810,520 $ 583,527 $ 490,935 +Exploration costs 147,042 125,415 77,911 +Acquisitions +Proved properties +18 71 5,579 +Unproved properties (2) +4,153 9,036 10,854 +Total, including asset retirement obligations (3)(4) +$ 961,733 $ 718,049 $ 585,279 +____________________________________________ +(1) Includes facility costs of $30.0 million, $18.2 million, and $27.2 million for the years ended December 31, 2022, 2021, and 2020, respectively. +(2) Includes amounts related to leasing activity and acquiring surface rights outside of acquisitions of proved and unproved properties totaling $4.2 million, $5.8 million, and $8.6 million for the years ended December 31, 2022, 2021, and 2020, respectively. +(3) Includes amounts relating to estimated asset retirement obligations of $15.1 million, $12.8 million, and $(4.7) million for the years ended December 31, 2022, 2021, and 2020, respectively. +(4) Includes capitalized interest of $17.6 million, $15.0 million, and $15.8 million for the years ended December 31, 2022, 2021, and 2020, respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting of reserve estimation and disclosure. +Proved reserves are the estimated quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated proved reserves are located in the United States. +The tables below present a summary of changes in the Company’s estimated proved reserves for each of the years ended December 31, 2022, 2021, and 2020. The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company’s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +98 +For the Year Ended December 31, 2022 +Oil Gas NGLs Total +(MMBbl) (Bcf) (MMBbl) (MMBOE) +Total proved reserves: +Beginning of year 199.5 1,243.5 85.2 492.0 +Revisions of previous estimates (1) +23.7 248.2 16.7 81.7 +Discoveries and extensions 6.6 37.2 3.9 16.7 +Sales of reserves — — — — +Purchases of minerals in place — — — — +Production (24.0) (125.9) (8.0) (53.0) +End of year 205.8 1,402.9 97.8 537.4 +Proved developed reserves: +Beginning of year 110.7 833.0 50.7 300.2 +End of year 110.4 902.1 57.1 317.8 +Proved undeveloped reserves: +Beginning of year 88.8 410.4 34.5 191.8 +End of year 95.4 500.8 40.7 219.6 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) Revisions of previous estimates consist of 103.2 MMBOE of infill reserves, positive price revisions of 9.5 MMBOE, the removal of 19.9 MMBOE of estimated proved undeveloped reserves reclassified to unproved reserves categories as a result of revising certain aspects of the Company’s future development plans, and negative performance revisions of 11.1 MMBOE. Please refer to Areas of Operation in Part I, Items 1 and 2 of this report, and to Oil and Gas Reserve Quantities in Critical Accounting Estimates in Part II, Item 7 of this report for additional information. +For the Year Ended December 31, 2021 +Oil Gas NGLs Total +(MMBbl) (Bcf) (MMBbl) (MMBOE) +Total proved reserves: +Beginning of year 172.7 1,052.0 56.6 404.6 +Revisions of previous estimates (1)(2) +35.7 158.9 12.2 74.4 +Discoveries and extensions 19.3 141.4 21.9 64.7 +Sales of reserves (0.3) (0.5) (0.1) (0.4) +Purchases of minerals in place 0.1 0.1 — 0.1 +Production (27.9) (108.4) (5.4) (51.4) +End of year 199.5 1,243.5 85.2 492.0 +Proved developed reserves: +Beginning of year 89.8 643.9 32.1 229.3 +End of year 110.7 833.0 50.7 300.2 +Proved undeveloped reserves: +Beginning of year 82.9 408.1 24.4 175.3 +End of year 88.8 410.4 34.5 191.8 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) Revisions of previous estimates consist of 74.4 MMBOE of infill reserves, positive price and performance revisions of 37.2 MMBOE and 3.4 MMBOE, respectively, and the removal of 40.6 MMBOE of estimated proved undeveloped reserves reclassified to unproved reserves categories as a result of revising certain aspects of the Company’s future development plans. +(2) Amounts have been adjusted to conform to the current period presentation. +99 +For the Year Ended December 31, 2020 +Oil Gas NGLs Total +(MMBbl) (Bcf) (MMBbl) (MMBOE) +Total proved reserves: +Beginning of year 184.1 1,223.2 74.0 462.0 +Revisions of previous estimates (1)(2) +(7.7) (155.5) (21.7) (55.3) +Discoveries and extensions 19.6 96.5 11.5 47.1 +Sales of reserves (0.5) (8.9) (1.1) (3.0) +Purchases of minerals in place 0.2 0.6 — 0.4 +Production (23.0) (103.9) (6.1) (46.4) +End of year 172.7 1,052.0 56.6 404.6 +Proved developed reserves: +Beginning of year 85.0 712.1 43.4 247.0 +End of year 89.8 643.9 32.1 229.3 +Proved undeveloped reserves: +Beginning of year 99.1 511.1 30.6 214.9 +End of year 82.9 408.1 24.4 175.3 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) Revisions of previous estimates consist of the removal of 65.0 MMBOE of certain longer term estimated proved undeveloped reserves, 32.6 MMBOE of negative price revisions resulting from declining commodity prices during 2020, 38.7 MMBOE of infill reserves, and 3.6 MMBOE of positive performance revisions. +(2) Amounts have been adjusted to conform to the current period presentation. +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of discounted future net cash flows and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year-end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the estimated proved reserves in place at the end of the period using year end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities and estimated abandonment costs. +The assumptions used to compute the standardized measure of discounted future net cash flows are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure of discounted future net cash flows computations since these reserve quantity estimates are the basis for the valuation process. The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the standardized measure of discounted future net cash flows: +For the Years Ended December 31, +2022 2021 2020 +Oil (per Bbl) $ 95.02 $ 66.21 $ 37.63 +Gas (per Mcf) $ 6.39 $ 4.28 $ 1.81 +NGLs (per Bbl) $ 35.88 $ 29.31 $ 14.64 +100 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the standardized measure of discounted future net cash flows: +As of December 31, +2022 2021 2020 +(in thousands) +Future cash inflows $ 32,024,639 $ 21,027,406 $ 9,227,390 +Future production costs (7,672,906) (5,498,098) (3,429,288) +Future development costs (2,949,871) (1,591,550) (1,259,395) +Future income taxes (3,888,342) (2,130,280) — +Future net cash flows 17,513,520 11,807,478 4,538,707 +10 percent annual discount (7,551,454) (4,844,871) (1,856,250) +Standardized measure of discounted future net cash flows +$ 9,962,066 $ 6,962,607 $ 2,682,457 +The principal sources of changes in the standardized measure of discounted future net cash flows were: +For the Years Ended December 31, +2022 2021 2020 +(in thousands) +Standardized measure of discounted future net cash flows, beginning of year +$ 6,962,607 $ 2,682,457 $ 4,103,998 +Sales of oil, gas, and NGLs produced, net of production costs (2,724,994) (2,092,499) (734,971) +Net changes in prices and production costs 4,428,804 5,242,783 (2,251,636) +Extensions and discoveries, net of related costs (1) +424,463 783,215 271,897 +Sales of reserves in place — (4,361) (10,755) +Purchase of reserves in place — 1,565 2,120 +Previously estimated development costs incurred during the period 423,527 426,120 431,926 +Changes in estimated future development costs (462,015) (25,355) 215,460 +Revisions of previous quantity estimates (1) +1,327,530 1,015,539 38,623 +Accretion of discount 815,862 268,246 436,284 +Net change in income taxes (996,437) (1,196,013) 258,844 +Changes in timing and other (237,281) (139,090) (79,333) +Standardized measure of discounted future net cash flows, end of year +$ 9,962,066 $ 6,962,607 $ 2,682,457 +____________________________________________ +(1) Prior periods have been adjusted to conform to the current period presentation. +101 +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer (Principal Executive Officer) and our Chief Financial Officer (Principal Financial Officer), as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +102 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2022. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on management’s assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2022. +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +103 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control Over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and our report dated February 23, 2023 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 23, 2023 +104 +ITEM 9B. OTHER INFORMATION +None. +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +These disclosures are not applicable to the Company. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning the Company’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about our Executive Officers,” and “Corporate Governance” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders, to be filed within 120 days from December 31, 2022. +The information required by this Item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders, to be filed within 120 days from December 31, 2022. +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation Tables” and “Director Compensation” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders, to be filed within 120 days from December 31, 2022. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders, to be filed within 120 days from December 31, 2022. +Securities Authorized for Issuance Under Equity Compensation Plans. The Company has equity compensation plans under which options and shares of the Company’s common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. The Company’s stockholders have approved these plans. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for further information about the material terms of the Company’s equity +105 +compensation plans. The following table is a summary of the shares of common stock authorized for issuance under equity compensation plans as of December 31, 2022: +(a) (b) (c) +Plan category Number of securities to be issued upon exercise of outstanding options, warrants, and rights Weighted-average exercise price of outstanding options, warrants, and rights Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan (1) +Restricted stock units (2) +1,383,846 N/A +Performance share units (2)(3) +273,717 N/A +Total for Equity Incentive Compensation Plan 1,657,563 $ — 3,786,016 +Employee Stock Purchase Plan (4) +— — 3,425,107 +Equity compensation plans not approved by security holders +— — — +Total for all plans 1,657,563 $ — 7,211,123 +____________________________________________ +(1) In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of the Company or any affiliate of the Company. The Company’s Board of Directors approved amendments to the Equity Plan in 2009, 2010, 2013, 2016, and 2018 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The total number of shares of the Company’s common stock underlying awards granted in 2022, 2021, and 2020 under the Equity Plan were 832,257, 726,562, and 1,726,445, respectively. +(2) RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per unit fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per unit fair value for the outstanding RSUs and PSUs was $22.41 and $26.67, respectively. Please refer to Note 7 – Compensation Plans in Part II, Item 8 of this report for additional discussion. +(3) The number of shares of common stock assumes a multiplier of one. The actual final number of shares of common stock to be issued will range from zero to two times the number of PSUs awarded depending on the three-year performance multiplier. +(4) Under the ESPP, eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their eligible compensation. The purchase price of the common stock is 85 percent of the lower of the trading price of the common stock on either the first or last day of the six-month offering period. The ESPP is intended to qualify under Section 423 of the IRC. The total number of shares of the Company’s common stock issued in 2022, 2021, and 2020 under the ESPP were 113,785, 313,773, and 464,757, respectively. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders, to be filed within 120 days from December 31, 2022. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “ Independent Registered Public Accounting Firm ” and “ Audit Committee Pre-approval Policy and Procedures ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders, to be filed within 120 days from December 31, 2022. +106 +PART IV +ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Consolidated Financial Statements and Financial Statement Schedules: +Report of Independent Registered Public Accounting Firm (PCAOB ID 42 ) +59 +Consolidated Balance Sheets +61 +Consolidated Statements of Operations +62 +Consolidated Statements of Comprehensive Income (Loss) +63 +Consolidated Statements of Stockholders’ Equity +64 +Consolidated Statements of Cash Flows +65 +Notes to Consolidated Financial Statements +66 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +3.2 +Amended and Restated By-Laws of SM Energy Company, effective as of February 21, 2017 (filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +4.1 +Indenture related to senior debt securities of SM Energy Company by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-3 filed on May 7, 2015 (Registration No. 333-203936) and incorporated herein by reference) +4.2 +2025 Notes Supplemental Indenture (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on May 21, 2015, and incorporated herein by reference) +4.3 +Base Indenture, dated as of May 21, 2015, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.4 +Third Supplemental Indenture, dated September 12, 2016 by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +4.5 +Fourth Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +4.6 +Warrant Agreement dated as of June 17, 2020, among SM Energy Company, Computershare Inc. and Computershare Trust Company, N.A., collectively as warrant agent (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on June 17, 2020, and incorporated herein by reference) +4.7 +Fifth Supplemental Indenture, dated as of June 23, 2021, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on June 23, 2021, and incorporated herein by reference) +4.8* +Description of Securities +10.1 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.2 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.3 +Seventh Amended and Restated Credit Agreement dated as of August 2, 2022, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent and Swingline Lender, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, and incorporated herein by reference) +107 +10.4†† +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.5† +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.6† +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.7† +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.8† +Amendment No. 3 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2016 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2015, and incorporated herein by reference) +10.9+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of December 31, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.10† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.11† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.12† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.13† +Performance Share Unit Award Agreement as of July 1, 2019 (filed as Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2019, and incorporated herein by reference) +10.14† +SM Energy Company Employee Stock Purchase Plan, amended and restated effective as of April 5, 2021 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 16, 2021, and incorporated herein by reference) +10.15† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +10.16*† +Summary of Compensation Arrangements for Non-Employee Directors +10.17† +Change of Control Executive Severance Agreement (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on October 20, 2015, and incorporated herein by reference) +10.18† +Change of Control Severance Agreement dated December 18, 2022 between Lehman E. Newton, III and SM Energy Company. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on December 21, 2022, and incorporated herein by reference) +10.19† +Change of Control Severance Agreement dated December 29, 2022 between David Copeland and SM Energy Company. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on December 30, 2022, and incorporated herein by reference) +10.20† +Non-Competition and Non-Solicitation Agreement dated December 18, 2022 between Lehman E. Newton , III and SM Energy Company (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on December 21, 2022, and incorporated herein by reference) +10.21† +Non-Competition and Non-Solicitation Agreement dated December 29, 2022 between David Copeland and SM Energy Company (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on December 30, 2022, and incorporated herein by reference) +10.22† +SM Energy Company Equity Incentive Compensation Plan, amended and restated effective as of May 22, 2018 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 12, 2018, and incorporated herein by reference) +10.23*** +Gathering and Natural Gas Services Agreement effective as of April 1, 2011 between SM Energy Company and ETC Texas Pipeline, Ltd. (filed as Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +10.24*** +Gas Processing Agreement effective as of April 1, 2011 between ETC Texas Pipeline, Ltd. and SM Energy Company (filed as Exhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and incorporated herein by reference) +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Ryder Scott Company L.P. +108 +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +99.1* +Ryder Scott Audit Letter +101.INS Inline XBRL Instance Document - The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH* Inline XBRL Schema Document +101.CAL* Inline XBRL Calculation Linkbase Document +101.LAB* Inline XBRL Label Linkbase Document +101.PRE* Inline XBRL Presentation Linkbase Document +101.DEF* Inline XBRL Taxonomy Extension Definition Linkbase Document +104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101.INS) +_____________________________________ +* Filed with this report. +** Furnished with this report. +*** +Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Exchange Act. +† Exhibit constitutes a management contract or compensatory plan or agreement. +†† Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. Please refer to Item 15(a) above. +ITEM 16. FORM 10-K SUMMARY +None. +109 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: February 23, 2023 By: /s/ HERBERT S. VOGEL +Herbert S. Vogel +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Herbert S. Vogel and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2022, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ HERBERT S. VOGEL President, Chief Executive Officer, and Director February 23, 2023 +Herbert S. Vogel (Principal Executive Officer) +/s/ A. WADE PURSELL Executive Vice President and Chief Financial Officer February 23, 2023 +A. Wade Pursell (Principal Financial Officer) +/s/ PATRICK A. LYTLE Vice President - Chief Accounting Officer and Controller February 23, 2023 +Patrick A. Lytle (Principal Accounting Officer) +110 +Signature Title Date +/s/ WILLIAM D. SULLIVAN Chairman of the Board of Directors February 23, 2023 +William D. Sullivan +/s/ CARLA J. BAILO Director February 23, 2023 +Carla J. Bailo +/s/ STEPHEN R. BRAND Director February 23, 2023 +Stephen R. Brand +/s/ RAMIRO G. PERU Director February 23, 2023 +Ramiro G. Peru +/s/ ANITA M. POWERS Director February 23, 2023 +Anita M. Powers +/s/ JULIO M. QUINTANA Director February 23, 2023 +Julio M. Quintana +/s/ ROSE M. ROBESON Director February 23, 2023 +Rose M. Robeson +111 \ No newline at end of file diff --git a/raw/filings/0000893538/2022/0000893538-23-000014/filing_metadata.csv b/raw/filings/0000893538/2022/0000893538-23-000014/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..baab7ea5374e91657c3fcc4cf50e7eafe30a3142 --- /dev/null +++ b/raw/filings/0000893538/2022/0000893538-23-000014/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2023-02-23,2022-12-31,2023-02-23T14:02:19.000Z,0000893538-23-000014,sm-20221231.htm,10-K,16613391,1,1,https://www.sec.gov/Archives/edgar/data/893538/000089353823000014/sm-20221231.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353823000014/,2022,2022,1 diff --git a/raw/filings/0000893538/2022/0000893538-23-000014/item1.txt b/raw/filings/0000893538/2022/0000893538-23-000014/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2022/0000893538-23-000014/item13.txt b/raw/filings/0000893538/2022/0000893538-23-000014/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..caef243e7113de4008c64c6dabfc090b13c2ef15 --- /dev/null +++ b/raw/filings/0000893538/2022/0000893538-23-000014/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2023 annual meeting of stockholders, to be filed within 120 days from December 31, 2022. \ No newline at end of file diff --git a/raw/filings/0000893538/2022/0000893538-23-000014/item9a.txt b/raw/filings/0000893538/2022/0000893538-23-000014/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..04ac38f63faed48e4b9294596fc38fbdde8b25e2 --- /dev/null +++ b/raw/filings/0000893538/2022/0000893538-23-000014/item9a.txt @@ -0,0 +1,34 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer (Principal Executive Officer) and our Chief Financial Officer (Principal Financial Officer), as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +102 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2022. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on management’s assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2022. +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +103 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control Over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and our report dated February 23, 2023 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 23, 2023 +104 \ No newline at end of file diff --git a/raw/filings/0000893538/2022/0000893538-23-000014/rp_note.txt b/raw/filings/0000893538/2022/0000893538-23-000014/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2022/0000893538-23-000014/rpt_disclosure.txt b/raw/filings/0000893538/2022/0000893538-23-000014/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..d88b73245ca65c9d20c8852238cd7dbe1f598afa --- /dev/null +++ b/raw/filings/0000893538/2022/0000893538-23-000014/rpt_disclosure.txt @@ -0,0 +1,11 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee’s review of any transaction, arrangement, or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, (b) the aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of our Related Person Transactions Policy, a “related person” means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more than five percent of our outstanding shares of common stock, and (iii) any immediate family member of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it determines in good faith are in, or are not inconsistent with, our best interests and the best interests of our stockholders. +In determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director’s independence in the event the related person is a director, and the extent of the related person’s interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in compliance with the policy and remain appropriate. +In addition, our By-Laws provide that a director, officer, or employee of our Company may not pursue for his or her own account a business or investment opportunity that he or she learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than one percent of the publicly traded stock of another company. +Transactions with Related Persons +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are consistent with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when our Board, acting through the Audit Committee or as otherwise described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, but are not limited to, situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we obtain products or services from, or provide products or services to, related persons on an arm’s length basis on terms comparable to those obtained from or provided to unrelated third parties or on terms comparable to those obtained from or provided to employees generally. With the exception of the transaction described in the following paragraph, which was approved by our Audit Committee, we had no transactions that required approval under our Related Person Transactions Policy. +Dean Lutey, the spouse of Ms. Mary Ellen Lutey, our Senior Vice President—Exploration, Development and EHS, joined the Company in 2008. Mr. Lutey was appointed Vice President—Chief Information Officer in April 2021. Prior to this appointment, Mr. Lutey served as the Company’s Vice President—Information Technology since May 2013. During the fiscal year ended December 31, 2023, Mr. Lutey earned total compensation of $903,749 which included his base salary, annual bonus, LTIP awards, benefits under our qualified and non-qualified benefit plans, and matching contributions by the Company under its 401(k) Profit Sharing Plan and Non-Qualified Deferred Compensation Plan. Mr. Lutey also participated in the Company’s benefit programs for its employees. +Compensation Committee Interlocks and Insider Participation +None of the directors who served on the Compensation Committee during fiscal year 2023 has ever served as one of our officers or employees. 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of incorporation or organization) (I.R.S. Employer Identification No.) +1700 Lincoln Street, Suite 3200 , Denver , Colorado +80203 +(Address of principal executive offices) (Zip Code) +( 303 ) 861-8140 +(Registrant’s telephone number, including area code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class Trading Symbol(s) Name of each exchange on which registered +Common stock, $0.01 par value SM New York Stock Exchange +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☑ Accelerated filer ☐ +Non-accelerated filer ☐ Smaller reporting company ☐ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C.7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☑ +If securities are registered pursuant to section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑ +The aggregate market value of the 116,456,585 shares of voting stock held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock on June 30, 2023, the last business day of the registrant’s most recently completed second fiscal quarter, of $31.63 per share, as reported on the New York Stock Exchange, was $ 3,683,521,784 . Shares of common stock held by each director and executive officer and by each person who owns 10 percent or more of the outstanding common stock or who is otherwise believed by the registrant to be in a control position have been excluded. This determination of affiliate status is not necessarily a conclusive determination for other purposes. +As of February 8, 2024, the registrant had 115,746,540 shares of common stock outstanding. +DOCUMENTS INCORPORATED BY REFERENCE +Certain information required by Items 10, 11, 12, 13, and 14 of Part III of this report is incorporated by reference from portions of the registrant’s Definitive Proxy Statement on Schedule 14A relating to its 2024 annual meeting of stockholders, to be filed within 120 days after December 31, 2023. +1 +TABLE OF CONTENTS +Item Page +Cautionary Information about Forward-Looking Statements +4 +Glossary +4 +Part I +8 +Items 1. and 2. +Business and Properties +8 +General +8 +Strategy +8 +Significant Developments in 2023 +8 +Outlook +9 +Areas of Operation +10 +Reserves +11 +Production +15 +Productive Wells +15 +Drilling and Completion Activity +15 +Title to Properties +16 +Acreage +17 +Delivery Commitments +17 +Major Customers +17 +Human Capital +17 +Seasonality +18 +Competition +19 +Government Regulations +19 +Available Information +22 +Item 1A. +Risk Factors +22 +Item 1B. +Unresolved Staff Comments +35 +I tem 1C. +Cybersecurity Risk Management, Strategy, and Governance +35 +Item 3. +Legal Proceedings +37 +Item 4. +Mine Safety Disclosures +37 +Part II +38 +Item 5. +Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +38 +Item 6. +[Reserved] +39 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +40 +Overview of the Company +40 +Financial Results of Operations and Additional Comparative Data +44 +Comparison of Financial Results and Trends Between 2023 and 2022 , and Between 2022 and 2021 +46 +Overview of Liquidity and Capital Resources +50 +Critical Accounting Estimates +54 +Accounting Matters +57 +Environmental +57 +Non-GAAP Financial Measures +58 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +59 +Item 8. +Consolidated Financial Statements and Supplementary Data +60 +Item 9. +Changes In and Disagreements With Accountants on Accounting and Financial Disclosure +104 +Item 9A. +Controls and Procedures +104 +Item 9B. +Other Information +107 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +107 +2 +TABLE OF CONTENTS +(Continued) +Item Page +Part III +107 +Item 10. +Directors, Executive Officers, and Corporate Governance +107 +Item 11. +Executive Compensation +107 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +107 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +108 +Item 14. +Principal Accountant Fees and Services +108 +Part IV +109 +Item 15. +Exhibits and Consolidated Financial Statement Schedules +109 +Item 16. +Form 10-K Summary +111 +Signatures +112 +3 +Cautionary Information about Forward-Looking Statements +This Annual Report on Form 10-K (“Form 10-K” or “this report”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). All statements included in this report, other than statements of historical facts, that address activities, conditions, events, or developments with respect to our financial condition, results of operations, business prospects or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “pending,” “plan,” “potential,” “projected,” “seek,” “target,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this report, and include statements about such matters as: +• business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, plans with respect to future dividend payments, debt redemptions or equity repurchases, capital markets activities, environmental, social, and governance (“ESG”) goals and initiatives, and our outlook on our future financial condition or results of operations; +• the amount and nature of future capital expenditures, the resilience of our assets to declining commodity prices, and the availability of liquidity and capital resources to fund capital expenditures; +• our outlook on prices for future crude oil, natural gas, and natural gas liquids (also referred to throughout this report as “oil,” “gas,” and “NGLs,” respectively), well costs, service costs, production costs, and general and administrative costs, and the effects of inflation on each of these; +• armed conflict, political instability, or civil unrest in oil and gas producing regions and transportation channels, including instability in the Middle East, the wars between Russia and Ukraine and Israel and Hamas, and related potential effects on laws and regulations, or the imposition of economic or trade sanctions; +• any changes to the borrowing base or aggregate lender commitments under our Seventh Amended and Restated Credit Agreement (“Credit Agreement”); +• cash flows, liquidity, interest and related debt service expenses, changes in our effective tax rate, and our ability to repay debt in the future; +• our drilling and completion activities and other exploration and development activities, each of which could be affected by supply chain disruptions and inflation, our ability to obtain permits and governmental approvals, and plans by us, our joint development partners, and/or other third-party operators; +• possible or expected acquisitions and divestitures, including the possible divestiture or farm-out of, or farm-in or joint development of, certain properties; +• oil, gas, and NGL reserve estimates and estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates, as well as the conversion of proved undeveloped reserves to proved developed reserves; +• our expected future production volumes, identified drilling locations, as well as drilling prospects, inventories, projects and programs; and +• other similar matters, such as those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report. +Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. We caution you that forward-looking statements are not guarantees of future performance and these statements are subject to known and unknown risks and uncertainties, which may cause our actual results or performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Factors that may cause our financial condition, results of operations, business prospects or economic performance to differ from expectations include the factors discussed in Part I, Item 1A, Risk Factors below and elsewhere in this report. +The forward-looking statements in this report speak only as of the filing of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by applicable securities laws. +4 +Glossary +The oil and gas terms and other terms defined in this section are used throughout this report. The definitions of the terms “developed reserves,” “exploratory well,” “field,” “proved reserves,” and “undeveloped reserves” have been abbreviated from the respective definitions under Rule 4-10(a) of Regulation S-X. The entire definitions of those terms under Rule 4-10(a) of Regulation S-X can be located through the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov. +Ad valorem tax. A tax based on the value of real estate or personal property. +ASC. Accounting Standards Codification. +ASU. Accounting Standards Update. +Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +BBtu. One billion British thermal units. +Bcf . One billion cubic feet, used in reference to gas. +BOE. Barrels of oil equivalent. Oil equivalents are determined using the ratio of six Mcf of gas to one Bbl of oil or NGLs. +Btu. One British thermal unit, the quantity of heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit. +Completion. The installation of equipment for production of oil, gas, and/or NGLs, or in the case of a dry hole, the reporting to the applicable authority that the well has been abandoned. +Conversion rate. Current year conversions of proved undeveloped reserves to proved developed reserves, divided by beginning of the year proved undeveloped reserves (also commonly referred to in our industry as “ track record” ). +Costs incurred. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed. +Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production. +Developed reserves. Reserves that can be expected to be recovered: (i) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. +Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. +Dry hole. An exploratory, development, or extension well that proves to be incapable of producing oil, gas, and/or NGLs in sufficient commercial quantities to justify completion, or upon completion, the economic operation of a well (also referred to as “ non-productive well” ). +Exploratory well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir. +Extension well . A well drilled to extend the limits of a known reservoir. +FASB. Financial Accounting Standards Board. +Fee properties. The most extensive interest that can be owned in land, including surface and mineral (including oil and gas) rights. +Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. +Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions. +GAAP. Accounting principles generally accepted in the United States. +5 +Gross acres or gross wells. Acres or wells in which a working interest is owned. +Horizontal wells. Wells that are drilled at angles greater than 70 degrees from vertical. +Lease operating expenses (“LOE ”) . The expenses incurred in the lifting of oil, gas, and/or NGLs from a producing formation to the surface, constituting part of the current operating expenses of a working interest, and also including labor, superintendence, supplies, repairs, maintenance, allocated overhead costs, and other expenses incidental to production, but not including lease acquisition, drilling, or completion costs. +MBbl. One thousand barrels, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +MBOE. One thousand barrels of oil equivalent. +Mcf. One thousand cubic feet, used in reference to gas. +MMBbl. One million barrels, used in reference to oil, NGLs, water, or other liquid hydrocarbons. +MMBOE. One million barrels of oil equivalent. +MMBtu. One million British thermal units. +MMcf. One million cubic feet, used in reference to gas. +Net acres or net wells. Sum of our fractional working interests owned in gross acres or gross wells. +NGLs. The combination of ethane, propane, isobutane, normal butane, and natural gasoline that when removed from gas become liquid under various levels of higher pressure and lower temperature. +NYMEX WTI. New York Mercantile Exchange West Texas Intermediate, a common industry benchmark price for oil. +NYMEX Henry Hub (“HH”). New York Mercantile Exchange Henry Hub, a common industry benchmark price for gas. +OPEC+. The Organization of the Petroleum Exporting Countries (“ OPEC ”) plus other non-OPEC oil producing countries. +OPIS . Oil Price Information Service, a common industry benchmark for NGL pricing at Mont Belvieu, Texas. +PV-10. PV-10 is a non-GAAP measure. The present value of estimated future revenue to be generated from the production of estimated proved reserves, net of estimated production and future development costs, based on prices used in estimating the proved reserves and costs in effect as of the date indicated (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses, or depreciation, depletion, and amortization, discounted using an annual discount rate of 10 percent. While this measure does not include the effect of income taxes as it would in the use of the standardized measure of discounted future net cash flows calculation, it does provide an indicative representation of the relative value of the Company on a comparative basis to other companies and from period to period. This measure is presented because management believes it provides useful information to investors for analysis of the Company's fundamental business on a recurring basis. +Productive well. An exploratory, development, or extension well that is producing or is capable of commercial production of oil, gas, and/or NGLs. +Proved reserves. Those quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. +Recompletion. The completion of an existing wellbore in a formation other than that in which the well has previously been completed. +Reserve life index. Expressed in years, represents the estimated proved reserves as of the end of the year divided by actual production for the preceding 12-month period. +6 +Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil, gas, and/or associated liquid resources that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs. +Resource play. A term used to describe an accumulation of oil, gas, and/or associated liquid resources known to exist over a large areal expanse, which when compared to a conventional play typically has lower expected geological risk. +Royalty. The amount or fee paid to the owner of mineral rights, expressed as a percentage or fraction of gross income from oil, gas, and NGLs produced and sold unencumbered by expenses relating to the drilling, completing, and operating of the affected well. +Royalty interest. An interest in an oil and gas property entitling the owner to shares of oil, gas, and NGL production free of costs of exploration, development, and production operations. +Seismic. The sending of energy waves or sound waves into the earth and analyzing the wave reflections to infer the type, size, shape, and depth of subsurface rock formations. +Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock. +SOFR. Secured Overnight Financing Rate. +Standardized measure of discounted future net cash flows. The discounted future net cash flows related to estimated proved reserves based on prices used in estimating the reserves, year-end costs, and statutory tax rates, at a 10 percent annual discount rate. The information for this calculation is included in Supplemental Oil and Gas Information (unaudited) located in Part II, Item 8 of this report. +Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and NGLs regardless of whether such acreage contains estimated proved reserves. +Undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. The applicable SEC definition of undeveloped reserves provides that undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. +Working interest. The operating interest that gives the owner the right to drill, produce, and conduct operating activities on the property and to share in the production, sales, and costs. +7 +PART I +When we use the terms “SM Energy,” the “Company,” “we,” “us,” or “our,” we are referring to SM Energy Company and its subsidiaries unless the context otherwise requires. We have included certain technical terms important to an understanding of our business in the Glossary section of this report. Throughout this document we make statements and projections that address future expectations, possibilities, or events, all of which may be classified as “forward-looking statements.” Please refer to the Cautionary Information about Forward-Looking Statements section of this report for an explanation of these types of statements and the associated risks and uncertainties. +ITEMS 1. AND 2. BUSINESS AND PROPERTIES +General +We are an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. SM Energy was founded in 1908, incorporated in Delaware in 1915, and our initial public offering of common stock was in 1992. Our common stock trades on the New York Stock Exchange under the ticker symbol “SM.” +Our principal office is located at 1700 Lincoln Street, Suite 3200, Denver, Colorado 80203, and our telephone number is (303) 861-8140. +Strategy +Our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to domestic energy security and prosperity, and having a positive impact in the communities where we live and work. Our long-term vision and strategy is to sustainably grow value for all of our stakeholders as a premier operator of top-tier assets by maintaining and optimizing our high-quality asset portfolio, generating cash flows, and maintaining a strong balance sheet. Our team executes this strategy by prioritizing safety, technological innovation, and stewardship of natural resources, all of which are integral to our corporate culture. Our near-term goals include continuing to return value to stockholders through our Stock Repurchase Program, as defined below, and fixed dividend payments, and by focusing on continued operational excellence. +Our asset portfolio is comprised of high-quality assets in the Midland Basin of West Texas and in the Maverick Basin of South Texas that we believe are capable of generating strong returns in the current macroeconomic environment and provide resilience to commodity price risk and volatility. We seek to maximize returns and increase the value of our top-tier assets through disciplined capital spending, strategic acquisitions, and continued development and optimization of our existing assets. We believe that our high-quality assets facilitate a sustainable approach to prioritizing operational execution, maintaining a strong balance sheet, generating cash flows, returning capital to stockholders, and maintaining financial flexibility. +We are committed to exceptional safety, health, and environmental stewardship; supporting the professional development of a diverse and thriving team of employees; building and maintaining partnerships with our stakeholders by investing in and connecting with the communities where we live and work; and transparency in reporting our progress in these areas. We have prioritized ESG initiatives by, among other things, integrating enhanced environmental and social programs throughout the organization and setting goals that include safety and spill metrics, minimizing flaring and reducing greenhouse gas (“GHG” or “GHGs”) emissions intensity, and maintaining low methane emissions intensity. Additionally, we are implementing systems and technologies to track ESG metrics to improve future reporting and performance and to increase employee awareness. The Environmental, Social and Governance Committee of our Board of Directors oversees, among other things, the effectiveness of our ESG policies, programs and initiatives, monitors and responds to emerging issues, and, together with management, reports to our Board of Directors regarding such matters. Further demonstrating our commitment to sustainable operations and environmental stewardship, compensation for our executives and eligible employees under our long-term incentive plan, and compensation for all employees under our short-term incentive plan is calculated based on, in part, certain Company-wide, performance-based metrics that include key financial, operational, environmental, health, and safety measures. +Significant Developments in 2023 +Return of Capital Program . In 2023, we continued to execute on our goal of sustainably returning capital to our stockholders through our Stock Repurchase Program and fixed quarterly dividend payments. Our Stock Repurchase Program commenced in September 2022, and originally authorized the repurchase of up to $500.0 million in aggregate value of our common stock through December 31, 2024 (“Stock Repurchase Program”). During the year ended December 31, 2023, we repurchased and subsequently retired 6.9 million shares of our common stock at a cost of $228.0 million, excluding excise taxes, commissions, and fees. As of the filing of this report, $214.9 million remains available for repurchases of our outstanding common stock under the Stock Repurchase Program. During the year ended December 31, 2023, we paid dividends of $0.60 per share, an increase from $0.16 per share paid during the year ended December 31, 2022. Additionally, in November 2023, we announced a 20 percent increase to our fixed dividend to $0.72 per share annually, to be paid in quarterly increments of $0.18 per share, beginning in the first quarter of 2024. Please refer to Note 3 – Equity in Part II, Item 8 of this report for additional discussion. +8 +Acquisition Activity . During 2023, we acquired approximately 20,000 net acres of oil and gas properties in Dawson and northern Martin counties, Texas. Additionally, in the Midland Basin, we added approximately 9,100 net acres through organic leasing activity, we completed an asset exchange, and we acquired additional working interests in certain wells. Please refer to Note 16 – Acquisitions in Part II, Item 8 of this report for additional discussion. +Reserves and Capital Investment. Our total estimated net proved reserves were 604.9 MMBOE as of December 31, 2023, which was an increase of 13 percent from 537.4 MMBOE as of December 31, 2022. This increase primarily consisted of revisions of previous estimates of 113.9 MMBOE related to infill reserves in both our South Texas and Midland Basin programs, partially offset by 55.5 MMBOE of production during 2023. Our proved reserve life index increased to 10.9 years as of December 31, 2023, compared with 10.1 years as of December 31, 2022. Please refer to Areas of Operation and Reserves below for additional discussion regarding revisions of previous estimates due to infill, price, and performance revisions, the removal of certain proved undeveloped reserve cases that are no longer within our development plan over the next five years, and additions from extensions and discoveries. Costs incurred increased 28 percent from 2022 to $1.2 billion in 2023. Please refer to Areas of Operation below, and to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Production, Pricing and Revenue, and Commodity Derivatives. Our average net daily equivalent production in 2023 increased five percent compared with 2022 to 152.0 MBOE, consisting of 65.1 MBbl of oil, 362.7 MMcf of gas, and 26.4 MBbl of NGLs, as a result of an increased number of completions. Oil production as a percentage of total production decreased to 43 percent in 2023 from 45 percent in 2022, as a result of production from our South Texas assets becoming a higher percentage of total production in 2023. +Realized prices before the effect of net derivative settlements (“realized price” or “realized prices”) for oil, gas, and NGLs decreased 19 percent, 61 percent, and 35 percent, respectively, for the year ended December 31, 2023, compared with 2022. As a result of decreased realized prices, oil, gas, and NGL production revenue decreased 29 percent to $2.4 billion for the year ended December 31, 2023, compared with $3.3 billion for 2022. Oil production revenue was 77 percent and 68 percent of total production revenue for the years ended December 31, 2023, and 2022, respectively. +We recorded a net derivative gain of $68.2 million for the year ended December 31, 2023, compared to a net derivative loss of $374.0 million for the year ended December 31, 2022. These amounts include a net derivative settlement gain of $26.9 million for the year ended December 31, 2023, and a net derivative settlement loss of $710.7 million for the year ended December 31, 2022. +Please refer to Areas of Operation below and Overview of the Company in Part II, Item 7 of this report for additional discussion. +Outlook +Our long-term vision and strategy is to sustainably grow value for all of our stakeholders as a premier operator of top-tier assets. We are focused on operational execution, maintaining and expanding our portfolio quality and depth, and returning capital to stockholders through our Stock Repurchase Program and fixed dividend, while maintaining a strong balance sheet. +We expect our total 2024 capital program to be between $1.16 billion and $1.20 billion, excluding acquisitions, which we expect to fund with cash flows from operations and cash on hand. We plan to focus our 2024 capital program on highly economic oil development projects in both our Midland Basin and South Texas assets, including the assets we acquired during 2023. We expect to repurchase additional shares of our outstanding common stock through our Stock Repurchase Program during 2024, under which $214.9 million remains available for repurchases through December 31, 2024, as of the filing of this report. +9 +Areas of Operation +____________________________________________ +(1) As of December 31, 2023. +Our 2023 operations were concentrated in the Midland Basin and South Texas, as described below. The following table summarizes estimated net proved reserves, net production volumes, and costs incurred for the year ended December 31, 2023, for these areas: +Midland Basin +South Texas +Total (1) +Net proved reserves +Oil (MMBbl) 159.2 70.9 230.1 +Gas (Bcf) 654.8 877.2 1,532.0 +NGLs (MMBbl) 0.2 119.3 119.5 +MMBOE (1) +268.5 336.4 604.9 +Relative percentage +44 % 56 % 100 % +Proved developed % 62 % 52 % 56 % +Net production volumes +Oil (MMBbl) 17.5 6.3 23.8 +Gas (Bcf) 59.8 72.6 132.4 +NGLs (MMBbl) — 9.6 9.7 +MMBOE (1) +27.5 28.0 55.5 +Avg. daily equivalents (MBOE/d) (1) +75.4 76.7 152.0 +Relative percentage +50 % 50 % 100 % +Costs incurred (in millions) (2) +$ 768.1 $ 423.5 $ 1,235.0 +___________________________________________ +(1) Amounts may not calculate due to rounding. +(2) Asset costs incurred do not sum to total costs incurred primarily due to corporate charges incurred on exploration activities and costs related to exploration efforts outside of our core areas of operation that are excluded from this table. For total costs incurred, please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Total estimated net proved reserves at December 31, 2023, increased 13 percent from December 31, 2022. Total net equivalent production increased five percent for the year ended December 31, 2023, compared with 2022. Costs incurred for the year ended December 31, 2023, increased 28 percent compared with 2022, primarily as a result of increases in capital activity related to the development of both our Midland Basin and South Texas assets, acquisitions of proved and unproved properties and leasing activity in the Midland Basin, and inflation. +10 +Midland Basin. Our Midland Basin assets, located in the Permian Basin in West Texas, are comprised of approximately 110,000 net acres, and include our RockStar assets in Howard and Martin counties, our Sweetie Peck assets in Upton and Midland counties, and our Klondike assets, which we acquired in 2023, in Dawson and northern Martin counties (“Midland Basin”). In 2023, drilling and completion activities were focused within our RockStar and Sweetie Peck assets, and we began drilling on our newly acquired Klondike acreage. Our current Midland Basin position provides substantial future development opportunities within multiple oil-rich intervals, including the Spraberry and Wolfcamp formations. We expect our 2024 capital activity in the Midland Basin to be focused on highly economic oil development projects. +In 2023, costs incurred were $768.1 million, and we averaged three drilling rigs and one completion crew. We drilled 54 gross (37 net) wells, completed 64 gross (54 net) wells, and acquired additional working interests in five net wells during the year ended December 31, 2023. As of December 31, 2023, 39 gross (29 net) wells had been drilled but not completed in our operated Midland Basin program. Net equivalent production for the year ended December 31, 2023, was 27.5 MMBOE, a seven percent decrease from 29.7 MMBOE for the year ended December 31, 2022. Estimated net proved reserves increased four percent to 268.5 MMBOE at December 31, 2023, from 257.4 MMBOE at December 31, 2022. Positive revisions of previous estimates primarily consisted of 43.4 MMBOE of infill and 21.3 MMBOE resulting from changes to decline curve estimates based on reservoir engineering analysis, partially offset by negative revisions of 18.2 MMBOE related to well performance and production of 27.5 MMBOE. +South Texas. Our South Texas assets are comprised of approximately 155,000 net acres located in Dimmit and Webb counties, Texas (“South Texas”). In 2023, our operations in South Texas were focused on production from the Austin Chalk formation and the Eagle Ford shale formation, and further development of the Austin Chalk formation. Our overlapping acreage position in the Maverick Basin in South Texas covers a significant portion of the western Eagle Ford shale and Austin Chalk formations (“Maverick Basin”) and includes acreage across the oil, gas-condensate, and dry gas windows with gas composition amenable to processing for NGL extraction. We expect our 2024 capital activity in South Texas to be focused primarily on developing the Austin Chalk formation. +In 2023, costs incurred were $423.5 million, and we averaged two drilling rigs and one completion crew. We drilled 46 gross (46 net) wells and completed 38 gross (37 net) wells, and as of December 31, 2023, 37 gross (37 net) wells had been drilled but not completed in our operated South Texas program. Net equivalent production for the year ended December 31, 2023, was 28.0 MMBOE, a 20 percent increase from 23.2 MMBOE for the year ended December 31, 2022. Estimated net proved reserves increased 20 percent to 336.4 MMBOE at December 31, 2023, from 280.0 MMBOE at December 31, 2022. Positive revisions of previous estimates consisted of 70.4 MMBOE of infill and 44.0 MMBOE of performance revisions resulting from changes to decline curve estimates based on reservoir engineering analysis. Additions of 30.1 MMBOE were the result of continued success in our development of the Austin Chalk formation. These increases were partially offset by production of 28.0 MMBOE, negative price revisions of 24.5 MMBOE, and negative revisions of 9.9 MMBOE related to well performance. As a result of revising our development plan, partially in response to decreased benchmark gas prices and certain lease obligations, we removed 25.8 MMBOE of net proved undeveloped reserves that were no longer in our five-year development plan. These net proved undeveloped reserves primarily related to our Eagle Ford assets and were replaced with certain infill revisions to net proved undeveloped reserves associated with different locations that were added to our five-year development plan. Additionally, infill revisions replaced converted net proved undeveloped reserves. +Office Space. As of December 31, 2023, we leased and owned office space as summarized in the table below: +Approximate Square Footage Leased Approximate Square Footage Owned +Corporate - Denver, CO +59,000 — +Midland, TX +59,000 — +Houston, TX and Catarina, TX, respectively +21,000 12,000 +Total 139,000 12,000 +Reserves +Reserve estimates are inherently imprecise. Estimates for new discoveries and undeveloped locations are considered more imprecise than reserve estimates for producing oil and gas properties. Accordingly, we expect these estimates to change as new information becomes available. The table below presents the standardized measure of discounted future net cash flows and PV-10. PV-10 is a non-GAAP financial measure that is reconciled to the standardized measure of discounted future net cash flows, the most directly comparable GAAP financial measure. PV-10 does not include the effects of income taxes on future net revenues. Neither the standardized measure of discounted future net cash flows nor PV-10 represents the fair market value of our oil and gas properties. We and others in the oil and gas industry use PV-10 as a measure to compare the relative size and value of proved reserves held before consideration of tax characteristics specific to individual entities. Please refer to the Glossary section of this report for additional information regarding these measures and refer to the reconciliation of the standardized measure of discounted future net cash flows to PV-10 set forth below. The actual quantities and present value of our estimated net proved reserves may be more or less than we have estimated. No estimates of our proved reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since the beginning of the last fiscal year. The table below should be read along with Risk Factors in Part I, Item 1A of this report. +11 +The following table summarizes estimated net proved reserves, the standardized measure of discounted future net cash flows (GAAP), PV-10 (non-GAAP), the prices used in the calculation of net proved reserves estimates, and reserve life index as of December 31, 2023, 2022, and 2021: +As of December 31, +2023 2022 2021 +Net reserve volumes: +Proved developed +Oil (MMBbl) 118.5 110.4 110.7 +Gas (Bcf) 948.5 902.1 833.0 +NGLs (MMBbl) 64.7 57.1 50.7 +MMBOE (1) +341.2 317.8 300.2 +Proved undeveloped +Oil (MMBbl) 111.6 95.4 88.8 +Gas (Bcf) 583.5 500.8 410.4 +NGLs (MMBbl) 54.8 40.7 34.5 +MMBOE (1) +263.6 219.6 191.8 +Total proved (1) +Oil (MMBbl) 230.1 205.8 199.5 +Gas (Bcf) 1,532.0 1,402.9 1,243.5 +NGLs (MMBbl) 119.5 97.8 85.2 +MMBOE 604.9 537.4 492.0 +Net proved developed reserves percentage +56 % 59 % 61 % +Net proved undeveloped reserves percentage +44 % 41 % 39 % +Reserve data (in millions): +Standardized measure of discounted future net cash flows (GAAP) $ 6,280.1 $ 9,962.1 $ 6,962.6 +PV-10 (non-GAAP): +Proved developed PV-10 +$ 4,965.1 $ 8,234.8 $ 5,407.2 +Proved undeveloped PV-10 +2,411.4 3,919.7 2,751.4 +Total proved PV-10 (non-GAAP) $ 7,376.5 $ 12,154.5 $ 8,158.6 +12-month trailing average prices: (2) +Oil (per Bbl) +$ 78.22 $ 93.67 $ 66.56 +Gas (per MMBtu) +$ 2.64 $ 6.36 $ 3.60 +NGLs (per Bbl) +$ 27.72 $ 42.52 $ 36.60 +Reserve life index (years) (3) +10.9 10.1 9.6 +____________________________________________ +(1) Amounts may not calculate due to rounding. +(2) The prices used in the calculation of proved reserve estimates reflect the unweighted arithmetic average of the first-day-of-the-month price of each month within the trailing 12-month period in accordance with SEC rules. We then adjust these prices to reflect appropriate quality and location differentials over the period in estimating our net proved reserves. +(3) Please refer to the reserve life index term in the Glossary section of this report for information describing how this metric is calculated. +12 +The following table reconciles the standardized measure of discounted future net cash flows (GAAP) to the PV-10 (non-GAAP) of total estimated net proved reserves. Please refer to the Glossary section of this report for the definitions of standardized measure of discounted future net cash flows and PV-10. +As of December 31, +2023 2022 2021 +(in millions) +Standardized measure of discounted future net cash flows (GAAP) +$ 6,280.1 $ 9,962.1 $ 6,962.6 +Add: 10 percent annual discount, net of income taxes +5,294.5 7,551.5 4,844.9 +Add: future undiscounted income taxes +2,000.0 3,888.3 2,130.3 +Pre-tax undiscounted future net cash flows +13,574.6 21,401.9 13,937.8 +Less: 10 percent annual discount without tax effect +(6,198.1) (9,247.4) (5,779.2) +PV-10 (non-GAAP) $ 7,376.5 $ 12,154.5 $ 8,158.6 +Proved Undeveloped Reserves +Proved undeveloped reserves include those reserves that are expected to be recovered from future wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Undeveloped reserves may be classified as proved reserves on undrilled acreage directly offsetting development areas that are reasonably certain of economic producibility when drilled or where reliable technology provides reasonable certainty of economic producibility. Undrilled locations may be classified as having proved undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless specific circumstances justify a longer time. As of December 31, 2023, we did not have any net proved undeveloped reserves that had been on our books in excess of five years, and substantially all of our net proved undeveloped reserves were on acreage that was not expected to expire, or that was expected to be held through renewal, before the targeted completion date. +For proved undeveloped locations that are more than one development spacing area from developed producing locations, we utilized reliable geologic and engineering technology when booking estimated net proved undeveloped reserves. Of the 263.6 MMBOE of total net proved undeveloped reserves as of December 31, 2023, approximately 36.8 MMBOE of net proved undeveloped reserves in the Midland Basin and 87.3 MMBOE of net proved undeveloped reserves in South Texas were offset by more than one development spacing area from the nearest proved developed producing location. We incorporated public and proprietary data from multiple sources to establish geologic continuity of each formation and their producing properties. This included seismic data and interpretations (3-D and micro seismic), open hole log information (both vertically and horizontally collected) and petrophysical analysis of that log data, mud logs, gas sample analysis, measurements of total organic content, thermal maturity, test production, fluid properties, and core data as well as statistical performance data yielding predictable and repeatable reserve estimates within certain analogous areas. These locations were limited to only those areas where both established geologic consistency and sufficient statistical performance data could be demonstrated to provide reasonably certain results. +As of December 31, 2023, estimated net proved undeveloped reserves increased 44.1 MMBOE, or 20 percent, compared with December 31, 2022. The following table provides a reconciliation of our net proved undeveloped reserves for the year ended December 31, 2023: +Total +(MMBOE) +Total net proved undeveloped reserves: +Beginning of year 219.6 +Revisions of previous estimates 98.8 +Conversions to proved developed (43.1) +Removed for five-year rule (30.8) +Additions from extensions and discoveries 22.7 +Sales of reserves (5.3) +Purchases of minerals in place 1.8 +End of year (1) +263.6 +____________________________________________ +(1) Amount may not calculate due to rounding. +Revisions of previous estimates . During 2023, revisions of previous estimates totaled 98.8 MMBOE. Positive revisions consisted of 103.8 MMBOE of infill reserves, of which 60.5 MMBOE and 43.3 MMBOE of estimated net proved undeveloped reserves +13 +were attributable to our South Texas and Midland Basin programs, respectively, and 13.3 MMBOE of performance revisions resulted from changes to decline curve estimates based on reservoir engineering analysis. Negative revisions consisted of 14.2 MMBOE that resulted from well performance related to infill development, and price revisions of 4.0 MMBOE that resulted primarily from decreases in benchmark gas and NGL prices. +Conversions to proved developed. Our 2023 conversion rate was 20 percent and primarily resulted from the development of proved reserves in our Midland Basin program and in our Austin Chalk assets in our South Texas program. During 2023, we incurred $740.2 million on projects with reserves booked as proved undeveloped at the end of 2022, of which $515.9 million was spent on converting net proved undeveloped reserves to proved developed reserves by December 31, 2023. At December 31, 2023, drilled but not completed wells represented 41.2 MMBOE of total estimated net proved undeveloped reserves. We expect to incur $212.6 million of additional capital expenditures in completing these drilled but not completed wells, and we expect all estimated net proved undeveloped reserves to be converted to proved developed reserves within five years from their initial booking as net proved undeveloped reserves. +Removed for five-year rule. As a result of our testing and delineation efforts in 2023, we revised certain aspects of our future development plan to focus on maximizing returns and the value of our assets. We removed 30.8 MMBOE of estimated net proved undeveloped reserves and reclassified these locations to unproved reserve categories based on development schedule revisions made partially in response to decreased benchmark gas prices and certain lease obligations. Of the 30.8 MMBOE, 25.8 MMBOE primarily related to our Eagle Ford assets in our South Texas program, and 5.0 MMBOE related to our Midland Basin program. +Additions from extensions and discoveries. During 2023, we added 22.7 MMBOE of estimated net proved undeveloped reserves, of which 21.9 MMBOE were in South Texas, and resulted from extensions from our continued success in delineating the Austin Chalk formation. +As of December 31, 2023, estimated future development costs relating to our net proved undeveloped reserves totaled $2.8 billion, and we expect to incur approximately $860.6 million, $585.6 million, and $555.7 million in 2024, 2025, and 2026, respectively. +Internal Controls Over Proved Reserves Estimates +Our internal controls over the recording of proved reserves are structured to objectively and accurately estimate our reserve quantities and values in compliance with the SEC’s regulations. Our process for managing and monitoring our proved reserves is delegated to our corporate reserves group and is coordinated by our Corporate Engineering Manager, subject to the oversight of our management and the Audit Committee of our Board of Directors (“Audit Committee”), as discussed below. Our Corporate Engineering Manager has worked in the energy industry since 2008 and has been employed by the Company since 2010. He holds a Bachelor of Science degree in Petroleum Engineering from Montana Technological University and is a Registered Professional Petroleum Engineer in the states of Texas, Wyoming, and Montana. He is also a member of the Society of Petroleum Engineers. Technical, geological, and engineering reviews of our assets are performed throughout the year by our staff. Data obtained from these reviews, in conjunction with economic data and our ownership information, is used in making a determination of estimated proved reserve quantities. Our asset teams’ engineering technical staff do not report directly to our Corporate Engineering Manager; they report to either their respective asset technical managers or directly to the Senior Vice President of Exploration, Development and EHS. This design is intended to promote objective and independent analysis within our asset teams in the proved reserves estimation process. +Third-party Reserves Audit +Ryder Scott is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services throughout the world since 1937. Ryder Scott performed an independent audit using its own engineering assumptions, but with economic and ownership data we provided. Ryder Scott audits a minimum of 80 percent of our total calculated proved reserve PV-10. In the aggregate, the proved reserve amounts of our audited properties determined by Ryder Scott are required, per our policy, to be within 10 percent of our proved reserve amounts for the total Company, as well as for each respective major asset. The technical person at Ryder Scott primarily responsible for overseeing our reserves audit is a Senior Vice President who received a Bachelor of Science degree in Petroleum Engineering and a Business Foundations Certificate from The University of Texas at Austin in 2002. She is a registered Professional Engineer in the State of Texas and a member of the Society of Petroleum Engineers. The 2023 Ryder Scott audit report is included as Exhibit 99.1. +In addition to a third-party audit, our reserves are reviewed by our management with the Audit Committee. Our management, which includes our President and Chief Executive Officer, Executive Vice President and Chief Financial Officer, and Senior Vice President of Exploration, Development and EHS, is responsible for reviewing and verifying that the estimate of proved reserves is reasonable, complete, and accurate. The Audit Committee reviews a summary of the final reserves estimate in conjunction with Ryder Scott’s results and also meets with Ryder Scott representatives, separate from our management, from time to time to discuss processes and findings. +14 +Production +The following table summarizes our net production volumes and realized prices for oil, gas, and NGLs produced and sold during the periods presented, and related production expense on a per BOE basis: +For the Years Ended December 31, +2023 2022 2021 +Net production volumes +Oil (MMBbl) 23.8 24.0 27.9 +Gas (Bcf) 132.4 125.9 108.4 +NGLs (MMBbl) 9.7 8.0 5.4 +Equivalent (MMBOE) (1) +55.5 53.0 51.4 +Midland Basin net production volumes (2) +Oil (MMBbl) 17.5 19.1 25.2 +Gas (Bcf) 59.8 63.5 55.4 +NGLs (MMBbl) — — — +Equivalent (MMBOE) (1) +27.5 29.7 34.4 +Maverick Basin net production volumes (2) +Oil (MMBbl) 6.2 4.8 2.7 +Gas (Bcf) 72.5 62.4 52.8 +NGLs (MMBbl) 9.6 8.0 5.4 +Equivalent (MMBOE) (1) +27.9 23.2 16.9 +Realized price +Oil (per Bbl) $ 76.28 $ 94.67 $ 67.72 +Gas (per Mcf) $ 2.48 $ 6.28 $ 4.85 +NGLs (per Bbl) $ 23.02 $ 35.66 $ 33.67 +Per BOE $ 42.60 $ 63.18 $ 50.58 +Production expense per BOE +Lease operating expense $ 5.13 $ 5.03 $ 4.39 +Transportation costs $ 2.46 $ 2.83 $ 2.71 +Production taxes $ 1.89 $ 3.07 $ 2.36 +Ad valorem tax expense $ 0.67 $ 0.79 $ 0.38 +____________________________________________ +(1) Amounts may not calculate due to rounding. +(2) For each of the years ended December 31, 2023, 2022, and 2021, total estimated net proved reserves attributed to our Midland Basin field and our Maverick Basin field each exceeded 15 percent of our total estimated net proved reserves expressed on an equivalent basis. +Productive Wells +As of December 31, 2023, we had working interests in 898 gross (795 net) productive oil wells and 528 gross (494 net) productive gas wells. Productive wells are wells producing in commercial quantities or wells capable of commercial production that are temporarily shut-in. Multiple completions in the same wellbore are counted as one well, and as of December 31, 2023, two of these wells had multiple completions. A well is categorized under state reporting regulations as an oil well or a gas well based on the ratio of gas to oil when it first commenced production, but such designation may not be indicative of current or future production composition. +15 +Drilling and Completion Activity +All of our drilling and completion activities are conducted by independent contractors using equipment they own and operate. The following table summarizes the number of operated and outside-operated wells drilled and completed or recompleted on our properties in 2023, 2022, and 2021, excluding non-consented projects, active injector wells, saltwater disposal wells, or wells in which we own only a royalty interest: +For the Years Ended December 31, +2023 2022 2021 +Gross Net Gross Net Gross Net +Development wells +Oil 74 62 68 57 107 91 +Gas 21 21 18 18 11 8 +Non-productive — — — — — — +95 83 86 75 118 99 +Exploratory wells +Oil 5 4 4 3 2 2 +Gas 5 5 2 2 8 8 +Non-productive (1) +1 1 1 1 — — +11 10 7 6 10 10 +Total 106 93 93 81 128 109 +____________________________________________ +Note: The number of wells drilled refers to the number of wells completed at any time during the respective year, regardless of when drilling was initiated. +(1) For the year ended December 31, 2023, one gross (one net) well was unsuccessful due to technical issues during the drilling phase and was not included in the drilled or completed well counts. +In addition to the wells completed in 2023 (included in the table above), we were actively participating in the drilling of seven gross (seven net) wells and had 81 gross (70 net) drilled but not completed wells as of January 31, 2024. Drilled but not completed wells as of January 31, 2024, represent wells that were being completed or were waiting on completion. The drilled but not completed well count as of January 31, 2024, includes nine gross (nine net) wells that were not included in our five-year development plan as of December 31, 2023, eight of which are in the Eagle Ford shale. +Title to Properties +As of December 31, 2023, over 97 percent of our operated oil and gas producing assets are located on private lands, are held pursuant to oil and gas leases from private mineral owners, and are not located on federal lands or leased from the federal government. The remainder of our operated oil and gas producing assets are located on Texas state lands. We have obtained title opinions or have conducted other title review on substantially all of our producing properties and believe we have satisfactory title to such properties. We obtain new or updated title opinions prior to commencing initial drilling operations on the properties that we operate. Most of our producing properties are subject to mortgages securing indebtedness under our Credit Agreement, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, royalty and overriding royalty interests, liens for current taxes, and other ordinary course burdens that we believe do not materially interfere with the development of such properties. We typically perform title investigations in accordance with standards generally accepted in the oil and gas industry before acquiring developed and undeveloped leasehold acreage. +16 +Acreage +The following table sets forth the number of gross and net surface acres of developed and undeveloped oil and gas leasehold, fee properties, and mineral servitudes that we held as of December 31, 2023: +Developed Acres (1) +Undeveloped Acres (2)(3) +Total +Gross Net Gross Net Gross Net +Midland Basin: +RockStar 69,938 63,204 384 368 70,322 63,572 +Sweetie Peck 19,905 16,854 13,513 9,038 33,418 25,892 +Klondike +6,619 5,687 18,107 15,008 24,726 20,695 +Midland Basin Total (4) +96,462 85,745 32,004 24,414 128,466 110,159 +South Texas 89,703 89,107 68,470 65,730 158,173 154,837 +Other (5) +10,499 10,499 90,078 25,606 100,577 36,105 +Total 196,664 185,351 190,552 115,750 387,216 301,101 +____________________________________________ +(1) Developed acreage is acreage assigned to producing wells for the state approved spacing unit for the producing formation. Our developed acreage that includes multiple formations with different well spacing requirements may be considered undeveloped for certain formations but has been included only as developed acreage in the table above. +(2) Undeveloped acreage is acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, gas, and/or NGLs regardless of whether such acreage contains estimated net proved reserves. +(3) As of February 8, 2024, 2,077, 7,946, and 12,131 net acres of our undeveloped acreage is scheduled to expire by December 31, 2024, 2025, and 2026, respectively, unless production is established or we take other action to extend the terms of the applicable leases. Certain of our acreage, primarily in South Texas, is subject to lease consolidation agreements containing drilling, completion, and other obligations that we currently intend to satisfy. Failure to meet these obligations results in payments to lessors, or termination of the lease consolidation agreements, which could result in additional future lease expirations if continuous development obligations required by individual leases are not met. +(4) As of December 31, 2023, total Midland Basin acreage excludes 1,213 net acres associated with drill-to-earn opportunities that we intend to pursue. +(5) Includes other non-core acreage located in Colorado, Louisiana, Montana, North Dakota, Texas, Utah, and Wyoming. +Delivery Commitments +For gathering, processing, transportation throughput, and delivery commitments, please refer to Delivery Commitments within Note 6 – Commitments and Contingencies in Part II, Item 8 of this report. +Major Customers +For major customers and entities under common control that accounted for 10 percent or more of our total oil, gas, and NGL production revenue for at least one of the years ended December 31, 2023, 2022, and 2021, please refer to Concentration of Credit Risk and Major Customers within Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. +Human Capital +Our Company culture recognizes our employees as our most valuable assets, encourages personal and professional development, promotes innovation and leadership among all employees and, in turn, supports our efforts to attract and retain talent. Through our culture, we promote: +• integrity and ethical behavior in the conduct of our business; +• environmental, health, and safety priorities; +• prioritizing the success of others and the team; +• collaboration and openness to new ideas and technologies that serve business improvement; +• support for team members’ professional and personal development; and +• support for the communities where we live and work. +The core values of integrity and ethical behavior are the pillars of our culture, and all employees are responsible for upholding Company-wide standards and values. We have policies designed to promote ethical conduct and integrity, which employees are +17 +required to read and acknowledge on an annual basis. The health and safety of our employees and contractors is our highest priority. We strive to achieve performance excellence in environmental, health, and safety management, and compensation of all employees is tied to annual environmental, health, and safety performance goals. +Personal and professional development is an important part of our culture and is employee driven, manager facilitated, and organizationally supported. Employees are routinely provided training opportunities to develop skills in leadership, safety, and technical acumen, which help strengthen our efforts to conduct business with high ethical standards. During 2023, many of our employees participated in two leadership and talent development programs that included more than 4,300 hours of aggregate training, exclusive of safety and other specialized technical training. +We measure employee engagement and satisfaction through periodic surveys, administered by an independent third-party vendor. +We are proud of our many outstanding employees who invest their time, talents, and financial resources in their communities. Our annual charitable giving program includes a monetary match of our employees’ personal contributions to qualified organizations and up to 12 hours per employee of Company-granted time to volunteer in the communities where we live and work. +We strive to provide competitive, performance-based compensation and benefits to our employees, including market-competitive pay, short-term and long-term incentive compensation plans, an employee stock purchase program, and various healthcare, retirement, and other benefit packages such as a hybrid work environment that is guided by each employee’s job function and responsibilities. Compensation for our executives and employees under our short-term and long-term incentive plans is determined based on individual performance and Company performance with respect to qualitative and quantitative metrics that include environmental, health, and safety measures. The Compensation Committee of our Board of Directors oversees our compensation programs and regularly modifies program design to incentivize achievement of our corporate strategy and the matters of importance to our stakeholders. Significant planning for succession of key personnel is performed each year, or more frequently as deemed necessary by management. +As of February 8, 2024, we had 544 full-time employees, none of whom were subject to a collective bargaining agreement. We are committed to diversity at all levels of our organization, and we strive to provide equal employment opportunities to all employees and job applicants. We regularly perform internal analyses of our workforce demographics and, at times, we retain a third party to conduct discrimination and pay equity testing. No discriminatory practices have been identified and no evidence of discrimination or pay inequity has been found. Additionally, we have established procedures and controls designed to support our objective of remaining, at all times, in material compliance with applicable federal, state, and local laws and governmental regulations. +The following charts present certain Board of Directors and workforce metrics as of February 8, 2024: +Board of Directors Diversity +Officer Diversity (1) +Employee Diversity +____________________________________________ +Note: Ethnic diversity data is determined under guidelines set forth by the United States Equal Employment Opportunity Commission and includes the following categories: American Indian or Alaska Native, Asian, Black or African American, Hispanic or Latino, or the combination of two or more races (not Hispanic or Latino). +(1) Includes officers at the level of Vice President and above. +Seasonality +The price of crude oil is primarily driven by global socioeconomic and geopolitical factors and is less affected by seasonal fluctuations; however, demand for energy is generally higher in the winter and in the summer driving season. The demand and price for gas generally increases during winter months and decreases during summer months. To lessen the effect of seasonal gas demand and price fluctuations, pipelines, utilities, local distribution companies, and industrial users regularly utilize gas storage facilities and forward +18 +purchase some of their anticipated winter requirements during the summer. However, increased summertime demand for electricity can divert gas that is traditionally placed into storage which, in turn, may increase the typical winter seasonal price. Seasonal anomalies, such as mild or extreme winters sometimes lessen or exacerbate these fluctuations. +Certain of our drilling, completion, and other operational activities are also subject to seasonal limitations. Seasonal weather conditions, government regulations, and lease stipulations could adversely affect our ability to conduct drilling activities in some of the areas where we operate. Please refer to Risk Factors in Part I, Item 1A of this report for additional discussion. +Competition +The oil and gas industry is highly competitive, particularly with respect to acquiring prospective oil and gas properties. We believe our acreage positions provide a foundation for development activities that we expect to fuel our future growth. Our competitive position also depends on our geological, geophysical, and engineering expertise, as well as our financial resources. We believe the location of our acreage; our exploration, drilling, operational, and production expertise; available technologies; our financial resources and expertise; and the experience and knowledge of our management and technical teams enable us to compete in our core operating areas. However, we face intense competition from many major and independent oil and gas companies, which in some cases have larger technical teams and greater financial and operational resources than we do. Many of these companies not only engage in the acquisition, exploration, development, and production of oil and gas reserves, but also have gathering, processing or refining operations, market refined products, provide, dispose of and transport fresh and produced water, own drilling rigs or production equipment, or generate electricity, all of which, individually or in the aggregate, could provide such companies with a competitive advantage. +We also compete with other oil and gas companies in securing drilling rigs and other equipment and services necessary for the drilling, completion, and maintenance of wells, as well as for the gathering, transporting, and processing of oil, gas, NGLs, and water. Consequently, we may face shortages, delays, or increased costs in securing these services from time to time. The oil and gas industry also faces competition from alternative fuel sources, including renewable energy sources such as solar and wind-generated energy, and other fossil fuels such as coal. Competitive conditions may be affected by future energy, environmental, climate-related, financial, or other policies, legislation, and regulations. +In addition, we compete for professionals in our workforce, including specialized roles in the oil and gas industry such as geologists, geophysicists, engineers, and others. Throughout the general labor market, the need to attract and retain talented people has grown at a time when the availability of individuals with these skills is becoming more limited due to the evolving demographics of our industry. The oil and gas industry is not insulated from the competition for quality people, and we must compete effectively to be successful. Please refer to Human Capital above and Risk Factors in Part I, Item 1A of this report for additional discussion. +Government Regulations +Although our regulatory compliance obligations are mitigated by the fact that we do not own or operate oil and gas properties on federal lands, nearly every aspect of our business is subject to expansive federal, state, and local laws and governmental regulations. These laws and regulations frequently change in response to economic or political conditions, or other developments, and our regulatory burden may increase in the future. Laws and regulations have the potential to increase our cost of conducting business and consequently could affect our profitability. +Energy Regulations +Texas, the state where we conduct operations and lease or own nearly all of our oil and gas assets, has adopted laws and regulations governing the exploration for and production of oil, gas, and NGLs, including laws and regulations requiring permits for the drilling of wells, imposing bond requirements in order to drill or operate wells, governing the timing of drilling and location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandonment of wells. Our operations are also subject to Texas conservation laws and regulations, including regulations governing the size of drilling and spacing units or proration units, the number of wells that may be drilled in an area, the spacing of wells, and the unitization or pooling of oil and gas properties. In addition, Texas conservation laws establish maximum rates of production from oil and gas wells, generally limit or prohibit the venting or flaring of gas, and may impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells. +Our sales of gas are affected by the availability, terms, and cost of gas pipeline transportation. The Federal Energy Regulatory Commission (“FERC”) has jurisdiction over the transportation and sale for resale of gas in interstate commerce. FERC’s current regulatory framework generally provides for a competitive and open access market for sales and transportation of gas. However, FERC regulations continue to affect the midstream and transportation segments of the industry, and thus can indirectly affect the sales prices we receive for gas production. +19 +Environmental, Health, and Safety Matters +General. Our operations are subject to stringent and complex federal, state, and local laws and regulations governing protection of the environment and worker health and safety, as well as the discharge of materials and emissions into the environment. These laws and regulations may, among other things: +• require the acquisition of various permits before drilling commences; +• restrict the types, quantities, and concentration of various substances and emissions that may be released into the environment in connection with oil and gas drilling and production and saltwater disposal activities; +• limit or prohibit drilling activities on certain lands lying within wilderness, wetlands, and other protected areas, including areas containing certain wildlife or threatened and endangered plant and animal species; and +• require remedial measures to mitigate pollution from former and ongoing operations, such as closing pits and plugging abandoned wells. +These laws, rules, and regulations may also restrict the rate of oil and gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of conducting business and consequently affects profitability. Additionally, environmental laws and regulations are revised frequently, and any changes may result in more stringent, or different permitting, waste handling, disposal, and cleanup requirements for the oil and gas industry and could have a significant impact on our operating costs. +The following is a summary of some of the existing laws, rules, and regulations to which our business is subject. +Waste handling. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes regulate the generation, transportation, treatment, storage, disposal, and cleanup of hazardous and non-hazardous wastes. Under the auspices of the United States Environmental Protection Agency (“EPA”), individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced water, and most of the other wastes associated with the exploration, development, and production of oil or gas are currently regulated under RCRA’s non-hazardous waste provisions. However, it is possible that certain oil and gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position. +Comprehensive Environmental Response, Compensation, and Liability Act. The Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release or threatened release of a hazardous substance into the environment. These persons include the owner or operator of the site where the release occurred, and anyone who disposed or arranged for the disposal of, or transported, a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of environmental investigation and certain health studies. In addition, it is not uncommon for third-parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. +We currently own, lease, or operate numerous properties that have been used for oil and gas exploration and production for many years. CERCLA excludes petroleum and natural gas from its definition of hazardous substances, and although we believe we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances or wastes may have been released on or under the properties owned or leased by us, or on or under other locations, including off-site locations, where such substances have been taken for disposal. In addition, some of our properties have been operated by third-parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons were not under our control. These properties, and the substances disposed or released on them, may be subject to CERCLA, RCRA, and analogous state laws. Under such laws, we could be required to remove previously disposed substances and wastes, pay fines, remediate contaminated property, or perform remedial operations to prevent future contamination. +Water discharges. The federal Water Pollution Control Act (“Clean Water Act”) and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into waters of the United States and states. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA, or analogous state agencies. This includes the discharge of certain storm water without a permit which requires periodic monitoring and sampling. In addition, the Clean Water Act regulates wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process and discharged to publicly-owned wastewater treatment facilities. The Clean Water Act also prohibits discharge of dredged or fill material into waters of the United States, including wetlands, except in accordance with the terms of a permit issued by the United States Army Corps of Engineers, or a state, if the state has assumed authority to issue such permits. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations. +20 +The Oil Pollution Act of 1990 (“OPA”) addresses prevention, containment and cleanup, and liability associated with oil pollution. OPA applies to vessels, offshore platforms, and onshore facilities. OPA subjects owners of such facilities to strict liability for containment and removal costs, natural resource damages, and certain other consequences of oil spills into jurisdictional waters. Any unpermitted release of petroleum or other pollutants from our operations could result in governmental penalties and civil liability. +Air emissions. The federal Clean Air Act (“CAA”) and comparable state laws and regulations regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements, such as requirements for emission reduction, capture and control. In addition, the EPA has developed, and continues to develop, stringent regulations governing emissions of hazardous air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil, and criminal penalties for non-compliance with air permits or other requirements of the CAA and associated state laws and regulations. Please refer to the Environmental section in Part II, Item 7 of this report for additional information about the regulation of air emissions from the oil and gas sector. +Climate change. In December 2009, the EPA determined that emissions of carbon dioxide, methane, and other GHGs endanger public health and welfare, and as a result, began adopting and implementing a comprehensive suite of regulations to restrict emissions of GHGs under existing provisions of the CAA. While President Trump’s administration took steps to rescind or review many of these regulations, President Biden’s administration has actively been reviewing those actions and taking steps to strengthen and expand the regulations, specifically targeting, among other things, the regulation of methane emissions from the oil and gas sector. Legislative and regulatory initiatives related to climate change could have an adverse effect on our operations and the demand for oil and gas. Please refer to Risk Factors - Risks Related to Oil and Gas Operations and the Industry - Legislative and regulatory initiatives and litigation related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs, and could result in significant litigation and related expenses in Part I, Item 1A of this report. Meteorological or extreme weather events (whether or not related to climate change), pose additional risks to our operations, which have included temporary shut-ins of certain wells and temporary capacity constraints at third-party purchasers impacting their ability to take delivery of our products. +Endangered species. The federal Endangered Species Act and analogous state laws regulate activities that could have an adverse effect on threatened or endangered species. Some of our operations are conducted in areas where protected species are known to exist. In these areas, we may be obligated to develop and implement plans to avoid potential adverse impacts on protected species, and we may be prohibited from conducting operations in certain locations or during certain seasons, such as breeding and nesting seasons, when our operations could have an adverse effect on these species. It is also possible that a federal or state agency could order a complete halt to activities in certain locations if it is determined that such activities may have a serious adverse effect on a protected species. The presence of a protected species in areas where we perform drilling, completion, and production activities could impair our ability to timely complete well drilling and development and could adversely affect our future production from those areas. +OSHA and other laws and regulations. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations. Also, pursuant to OSHA, the Occupational Safety and Health Administration has established a variety of standards relating to workplace exposure to hazardous substances and employee health and safety. We believe we are in substantial compliance with the applicable requirements of OSHA and comparable laws. +Hydraulic fracturing. Hydraulic fracturing is an important and common practice used to stimulate production of hydrocarbons from tight shale formations. We routinely utilize hydraulic fracturing techniques in most of our drilling and completion programs. The process involves the injection of water, sand, and chemicals under pressure into the formation to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions. However, even on private lands, the EPA has asserted federal regulatory authority over hydraulic fracturing involving diesel additives under the Safe Drinking Water Act’s Underground Injection Control Program. The federal Safe Drinking Water Act protects the quality of the nation’s public drinking water through the adoption of drinking water standards and controlling the injection of waste fluids, including saltwater disposal fluids, into below-ground formations that may adversely affect drinking water sources. +Increased regulation and scrutiny on oil and gas activities involving hydraulic fracturing techniques could potentially lead to a decrease in the completion of new oil and gas wells, an increase in compliance costs, delays, and changes in federal income tax laws, all of which could adversely affect our financial position, results of operations, and cash flows. As new laws or regulations that significantly restrict hydraulic fracturing are adopted at the state and local levels, such laws could make it more difficult or costly for us to perform fracturing to stimulate production from tight formations. In addition, if hydraulic fracturing becomes regulated at the federal level as a result of federal legislation or regulatory initiatives by the EPA or other federal agencies, our fracturing activities could become subject to additional permitting requirements, which could result in additional permitting delays and potential increases in costs. Restrictions on hydraulic fracturing could also reduce the amount of oil and gas that we are ultimately able to produce from our reserves. +We believe the trend in local, state, and federal environmental legislation and regulation will continue toward stricter standards, particularly under President Biden’s administration. While we believe we are in substantial compliance with existing environmental laws and regulations applicable to our current operations and that our continued compliance with existing requirements will not have a +21 +material adverse impact on our financial condition and results of operations, we cannot give any assurance that we will not be adversely affected in the future. +Environmental, Health, and Safety Initiatives. We are committed to exceptional safety, health, and environmental stewardship; making a positive difference in the communities where we live and work; and transparency in reporting our progress in these areas. We set annual goals for our safety, health, and environmental program focused on minimizing the number of safety related incidents and the number and impact of spills of produced fluids. In addition, we set annual goals for GHG emissions intensity and methane emissions as a percentage of total methane produced, and as part of our current ESG initiatives, we have set goals that include minimizing flaring, reducing GHG emissions intensity, and maintaining low methane emissions intensity. We also periodically conduct audits of our operations to ensure regulatory compliance, and we strive to provide appropriate training for our employees. Minimizing air emissions as a result of leaks, venting, or flaring of gas during operations has become a major focus area as we consider this a best practice and seek to comply with regulations. While flaring is sometimes necessary, minimizing these volumes is a priority for us. To avoid flaring when possible, we restrict testing periods and connect our production to gas pipeline infrastructure as quickly as possible after well completions. We have incurred in the past, and expect to incur in the future, capital costs related to environmental compliance. Such expenditures are included within our overall capital budget and are not separately itemized. +Available Information +Our internet website address is www.sm-energy.com. We routinely post important information for investors on our website. Within our website’s investor relations section, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC under applicable securities laws. These materials are made available as soon as reasonably practical after we electronically file such materials with or furnish such materials to the SEC, and can also be located at www.sec.gov. We also make available through our website our Corporate Governance Guidelines, Code of Business Conduct and Conflict of Interest Policy, Financial Code of Ethics, Human Rights Policy, and the Charters of the Audit, Compensation, Executive, and Environmental, Social and Governance committees of our Board of Directors. Information on our website is not incorporated by reference into this report and should not be considered part of this document. +ITEM 1A. RISK FACTORS +In addition to the other information included in this report, the following risk factors should be carefully considered when evaluating an investment in SM Energy. +Risks Related to Commodity Prices and Global Macroeconomics +Oil, gas, and NGL prices are volatile, and declines in prices may adversely affect our profitability, financial condition, cash flows, access to capital, and ability to grow. +Our revenues, operating results, profitability, future rate of growth, and the carrying value of our oil and gas properties depend heavily on the prices we receive for oil, gas, and NGL sales. Oil, gas, and NGL prices also affect our cash flows available for capital expenditures, debt reductions, return of capital, and other expenditures, our borrowing capacity, and the volume and value of our oil, gas, and NGL reserves. In addition, we may have oil and gas property impairments or downward revisions of estimates of proved reserves if prices fall significantly. Please refer to Significant Developments in 2023 and Reserves in Part I, Items 1 and 2, Comparison of Financial Results and Trends Between 2023 and 2022 and Between 2022 and 2021 in Part II, Item 7, and Note 1 – Summary of Significant Accounting Policies , Note 8 – Fair Value Measurements , and Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 for specific discussion. +Historically, the markets for oil, gas, and NGLs have been volatile, and they are likely to continue to be volatile. Wide fluctuations in oil, gas, and NGL prices often result from relatively minor changes in the supply of and demand for oil, gas, and NGLs, market uncertainty, and other factors that are beyond our control, including: +• global and domestic supplies of oil, gas, and NGLs, and the productive capacity of the industry as a whole; +• the level of consumer demand for oil, gas, and NGLs; +• overall global and domestic economic conditions; +• inflation and other economic factors that contribute to market volatility; +• weather conditions; +• the availability and capacity of gathering, transportation, processing, storage, and/or refining facilities in asset-specific or localized areas; +• liquefied natural gas deliveries to and from the United States; +• the increased demand for, price, and availability of alternative fuels or sources of energy; +• technological advances in, and regulations affecting, energy consumption and conservation; +• the ability of the members of OPEC+ to maintain effective oil price and production controls; +22 +• political instability or armed conflict involving oil or gas producing countries or regions, such as instability in the Middle East, and the wars between Russia and Ukraine and Israel and Hamas; +• shipping channel constraints and disruptions to and from oil and gas producing countries or regions; +• actual or perceived epidemic or pandemic risks; +• strengthening and weakening of the United States dollar relative to other currencies; +• stockholder activism or activities by non-governmental organizations to limit sources of funding or restrict the exploration and production of oil, gas, and NGLs and related infrastructure; and +• governmental regulations and taxes. +Declines in oil, gas, and NGL prices would reduce our revenues and could also reduce the amount of oil, gas, and NGLs that we can produce economically, which could have a material adverse effect on our business, financial condition, liquidity, results of operations, and prospects. +Future oil, gas, and NGL price declines or unsuccessful exploration efforts may result in write-downs of our asset carrying values. +We follow the successful efforts method of accounting for our oil and gas properties. All property acquisition costs and development costs are capitalized when incurred. Exploratory well costs are initially capitalized, pending the determination of whether proved reserves have been discovered. If commercial quantities of proved reserves are not discovered with an exploratory well, the costs initially capitalized are expensed as dry hole costs. During the years ended December 31, 2023, and 2022, we recorded amounts related to certain unsuccessful exploration activity to exploration expense. +The capitalized costs of our oil and gas properties, on a depletion pool basis, cannot exceed the estimated undiscounted future net cash flows of that depletion pool. If net capitalized costs exceed undiscounted future net cash flows, we generally must write down the costs of each depletion pool to the estimated discounted future net cash flows of that depletion pool. Write downs for unproved properties are also evaluated for carrying costs in excess of fair value. This evaluation considers the potential for abandonment due to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. Declines in the prices of oil, gas, or NGLs, or unsuccessful exploration efforts, could cause proved and/or unproved property impairments in the future, which could have a material adverse effect on our business, financial condition, liquidity, and results of operations. +We review the carrying values of our properties for indicators of impairment on a quarterly basis using the prices in effect as of the end of each quarter. Once incurred, a write-down of oil and gas properties held for use cannot be reversed at a later date, even if oil, gas, or NGL prices increase. +Weakness in economic conditions, continued inflation, or uncertainty in financial markets may have material adverse impacts on our business that we cannot predict. +Historically, the United States and global economies and financial systems have experienced turmoil and upheaval characterized by extreme volatility in prices of equity and debt securities, periods of diminished liquidity and credit availability, inability to access capital markets, the bankruptcy, failure, collapse, or sale of financial institutions, inflation, and heightened levels of intervention by the United States federal government and other governments. Weakness or uncertainty in the United States economy or other large economies could have a material adverse effect on our business and financial condition. For example: +• inflation has increased the costs of our drilling and completion activities, and the costs of oilfield services, equipment, and materials in recent years and could continue or worsen and further impact our financial condition, liquidity, and results of operations, and could limit our pool of economic development opportunities; +• a potential economic recession could impact demand for oil, gas, and NGLs, and cause commodity price volatility; +• the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our trade receivables; +• the liquidity available under our Credit Agreement could be reduced if one or more of our lenders is unable to fund its commitment; +• our ability, or the ability of our suppliers or contractors, to access the capital markets may be restricted or non-existent at a time when we or they would like, or need, to raise capital for our or their business, including for the exploration and/or development of reserves; +• our commodity derivative contracts could become economically ineffective if our counterparties are unable to perform their obligations or seek bankruptcy protection; +• the Federal Reserve could change interest rates, as they did during 2022 and 2023, which could impact borrowing costs; +• variable interest rate spread levels, including for SOFR and the prime rate, could increase significantly, resulting in higher interest costs for unhedged variable interest rate based borrowings under our Credit Agreement; and +• changes in tax laws and regulations could require us to adjust our business plan. +23 +Global geopolitical tensions may create heightened volatility in oil, gas, and NGL prices and could adversely affect our business, financial condition and results of operations. +Global geopolitical tensions, including instability in the Middle East, and the wars between Russia and Ukraine and Israel and Hamas, could lead to significant market and other disruptions, including, but not limited to: significant volatility in commodity prices and supply of energy resources, instability in financial markets, supply chain interruptions, shipping channel constraints and disruptions, political and social instability, political and economic sanctions, geopolitical shifts, embargoes, changes in consumer or purchaser preferences, the potential destruction of critical oil-related infrastructure, as well as increases in cyberattacks and espionage. These factors could impact our operations and the financial condition of our business as well as the global economy. +Risks Related to Oil and Gas Operations and the Industry +The loss of personnel could adversely affect our business. +We depend to a large extent on the efforts and continued employment of our executive management team, other key personnel, and our general labor force. The loss of their services could adversely affect our business. Our success in drilling and completing new wells and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced geologists, engineers, landmen, and other professionals. Competition for many of these professionals can be intense. If we cannot retain our technical personnel or attract additional experienced technical personnel and professionals, our ability to compete could be harmed. +Our operations are subject to complex laws and regulations, including environmental regulations, that result in substantial costs and other risks. +Federal, state, and local authorities extensively regulate the oil and gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may become more stringent and, as a result, may affect, among other things, the pricing, or marketing of oil, gas, and NGL production. Non-compliance with statutes and regulations and more vigorous enforcement of such statutes and regulations by regulatory agencies may lead to increased operational and compliance costs, substantial administrative, civil, and criminal penalties, including the assessment of natural resource damages, the imposition of significant investigatory and remedial obligations and may also result in the suspension or termination of our operations. The overall regulatory burden on the industry increases the cost to place, design, drill, complete, install, operate, and abandon wells and related facilities and, in turn, decreases profitability. +Governmental authorities regulate various aspects of drilling for and the production of oil, gas, and NGLs, including the permit and bonding requirements of drilling wells, the spacing of wells, the unitization or pooling of interests in oil and gas properties, rights-of-way and easements, disposal of produced water, environmental matters, occupational health and safety, the sharing of markets, production limitations, plugging, abandonment, restoration standards, and oil and gas operations. Public interest in environmental protection has increased in recent years, and environmental organizations have opposed, with some success, certain projects. Under certain circumstances, regulatory authorities may deny a proposed permit or right-of-way grant or impose conditions of approval to mitigate potential environmental impacts, which could, in either case, negatively affect our ability to explore or develop certain properties. Any such delay, suspension, or termination could have a material adverse effect on our operations. +Our operations are also subject to complex and constantly changing environmental laws and regulations adopted by federal, state, and local governmental authorities in jurisdictions where we are engaged in exploration or production operations. New laws or regulations, or changes to current requirements, including the designation of previously unprotected wildlife or plant species as threatened or endangered in areas we operate in, could result in material costs or claims with respect to properties we own or have owned or limitations on exploration and production activities in certain locations. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. Under existing or future environmental laws and regulations, we could incur significant liability, including joint and several, strict liability under federal, state, and local environmental laws for emissions and for discharges of oil, gas, and NGLs or other pollutants into the air, soil, surface water, or groundwater as described in Government Regulations in Part I, Items 1 and 2 of this report. Existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced, or altered in the future, may have a material adverse effect on us. +Federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Hydraulic fracturing is a common practice in the oil and gas industry used to stimulate the production of oil, gas, and NGLs from dense subsurface rock formations. We routinely apply hydraulic fracturing techniques to many of our oil and gas properties, including our unconventional resource plays within our Midland Basin and South Texas assets. Hydraulic fracturing involves injecting water, sand, and certain chemicals under pressure to fracture the hydrocarbon-bearing rock formation to allow the flow of hydrocarbons into the wellbore. The process is typically regulated by state oil and gas commissions. However, the EPA and other federal agencies have asserted federal regulatory authority over certain aspects of hydraulic fracturing activities, as outlined below. +24 +The EPA has authority to regulate underground injections that contain diesel in the fluid system under the Safe Drinking Water Act. The EPA also has authority under the Clean Water Act to regulate wastewater generated by unconventional oil and gas operations during the hydraulic fracturing process and discharged to publicly-owned wastewater treatment facilities. If the EPA implements further regulations of hydraulic fracturing, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +Certain states, including Texas, have adopted, and other states are considering adopting, regulations that could impose more stringent permitting, public disclosure, waste disposal, and well construction requirements on hydraulic fracturing operations or otherwise seek to ban fracturing activities altogether. In addition to state laws, local land use restrictions, such as city ordinances, may restrict, or prohibit the performance of drilling in general and/or hydraulic fracturing in particular. Recently, municipalities have passed or proposed zoning ordinances that ban or strictly regulate hydraulic fracturing within city boundaries, setting the stage for challenges by state regulators and third-parties. Similar events and processes are playing out in several cities, counties, and townships across the United States. In the event that state, local, or municipal legal restrictions are adopted in areas where we are currently conducting, or in the future plan to conduct, operations, we may incur additional costs to comply with such requirements that may be significant in nature, experience delays or curtailment in the pursuit of exploration, development, or production activities, and could even be prohibited from drilling and/or completing certain wells. +In the recent past, several federal governmental agencies were actively involved in studies or reviews that focus on environmental aspects and impacts of hydraulic fracturing practices. Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Disclosure of chemicals used in the hydraulic fracturing process could make it easier for third parties opposing such activities to pursue legal proceedings against producers and service providers based on allegations that specific chemicals used in the fracturing process could adversely affect human health or the environment, including groundwater. In 2013, a court in California, and in 2020, the United States District Court for the District of Montana, each held that the Bureau of Land Management (“BLM”) did not comply with the National Environmental Policy Act (“NEPA”) because it did not adequately consider the impact of hydraulic fracturing and horizontal drilling before issuing leases. In 2022, the federal Ninth Circuit Court of Appeals held that two federal agencies violated NEPA, in part, by failing to evaluate the environmental impacts of well stimulation treatments such as hydraulic fracturing before authorizing unconventional oil drilling offshore. Similar cases continue to be filed. In addition, courts in New York and Colorado reduced the level of evidence required before a court will agree to consider alleged damage claims from hydraulic fracturing by property owners. Litigation resulting in financial compensation for damages linked to hydraulic fracturing, including damages from induced seismicity, could spur future litigation and bring increased attention to the practice of hydraulic fracturing. Judicial decisions could also lead to increased regulation, permitting requirements, enforcement actions, and penalties. Additional legislation or regulation could also lead to operational delays or restrictions or increased costs in the exploration for, and production of, oil, gas, and NGLs, including from the development of shale plays, or could make it more difficult to perform hydraulic fracturing. The adoption of additional state or local laws, or the implementation of new regulations regarding hydraulic fracturing could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. +We will continue to be subject to uncertainty associated with new regulatory suspensions, revisions or rescissions and inconsistent state and federal regulatory mandates that could adversely affect our production. +Federal and state regulatory initiatives relating to air quality and greenhouse gas emissions could result in increased costs and additional operating restrictions or delays. +There has been a trend toward increased air quality and GHG regulation and reduced emissions from oil and gas sources. These regulations include the New Source Performance Standards (“NSPS”), the National Emission Standards for Hazardous Air Pollutants programs, and ozone standards set under the National Ambient Air Quality Standards (“NAAQS”), among others. The adoption of additional state or local laws, or the implementation of new regulations could potentially cause a decrease in the completion of new oil and gas wells, or an increase in compliance costs and delays, which could adversely affect our financial position, results of operations, and cash flows. Please refer to the Environmental section in Part II, Item 7 of this report for additional information about the regulation of air emissions, particularly methane emissions from the oil and gas sector. +Legislative and regulatory initiatives and litigation related to global warming and climate change could have an adverse effect on our operations and the demand for oil, gas, and NGLs, and could result in significant litigation and related expenses. +While courts have generally declined to assign direct liability for climate change to large sources of GHG emissions, some have required increased scrutiny of such emissions by federal agencies and permitting authorities. There is a continuing risk of claims being filed against companies that have significant GHG emissions, and new claims for damages and increased government scrutiny, especially from state and local governments, will likely continue. +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs, and the majority of states have already taken measures to reduce emissions of GHGs through various measures, including, primarily through the planned development of GHG emission inventories, participation in and/or regional GHG “cap and trade” programs, and/or transition +25 +to clean energy. The focus on legislating and/or regulating methane could result in increased scrutiny for sources emitting high levels of methane, including during permitting processes, analysis, regulation and reduction of methane emissions as a requirement for project approval, and actions taken by one agency for a specific industry establishing precedents for other agencies and industry sectors. In 2021, the EPA proposed requirements for methane emission reductions from existing oil and gas equipment. In 2022, the EPA released a supplemental proposal expanding its initial requirements as well as updating requirements, and in 2023, proposed updates to GHG reporting requirements. The 2022 and 2023 proposals are meant to work in tandem with the programs included in the Inflation Reduction Act of 2022 (“IRA”). +The IRA imposes fees on emissions of GHGs, including methane, that exceed applicable thresholds. Our GHG emissions in 2023 did not exceed the thresholds set forth by the IRA, however, there is no assurance that we will be able to meet our goals or that we will not exceed the thresholds set forth by the IRA in the future. This and any court rulings, laws, or regulations that restrict or require reduced emissions of GHGs or introduce new climate-related regulations such as a carbon pricing system, could have an adverse effect on demand for the oil and gas that we produce, and could lead to increased operating and compliance costs, and litigation costs, which could have a material adverse impact on our business. We have a long-term goal to reduce our Scope 1 and 2 GHG emissions intensity by 50 percent by 2030, compared with base year 2019 levels, and we have an annual goal to limit our methane emissions intensity to 0.04 (metric tonnes CH4/MBOE). +Scientists have predicted that increasing concentrations of GHGs in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, and floods and other climatic events. If such effects were to occur, our operations could be adversely affected. Potential adverse effects could include disruption of our drilling, completion, and production activities, including, for example, damages to our facilities from flooding or increases in our costs of operation or reductions in the efficiency of our operations, as well as potentially increased costs for insurance coverage in the aftermath of such events. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies, or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses, or costs that may result from potential physical effects of climate change. Federal regulations or policy changes regarding climate change preparation requirements could also impact our costs and planning requirements because emissions of such gases contribute to warming of the earth’s atmosphere and other climatic changes. +Requirements to reduce gas flaring could have an adverse effect on our operations. +In the Permian Basin in Texas, where we have significant operations, there have been, and could be in the future, constraints in gas takeaway capacity which has historically led to increased gas flaring. We are subject to laws established by state and other regulatory agencies that restrict the duration and amount of natural gas that can be legally flared. These laws and regulations, including potential future regulations that may impose further restrictions on flaring, could limit the amount of oil and gas we can produce from our wells or may limit the number of wells or the locations that we can drill. We have committed to zero routine flaring at all of our operated locations, and non-routine flaring not to exceed one percent of total annual gas production, based on the full year average. Additionally, we set annual targets to limit our flaring that are tied to compensation for all employees. There is no assurance that we will be able to meet our goals with respect to flaring and any failure to meet such goals could cause reputational or other harm to our business. Any future laws or commitments may increase our operational costs, or restrict our production, which could have a material adverse effect on our financial condition, results of operations and cash flows. +The impact of extreme weather conditions and lease stipulations adversely affect our ability to conduct drilling activities in some of the areas where we operate. +Our operations have been in the past, and may continue to be, adversely affected by the impact of extreme weather conditions. Additionally, lease stipulations designed to protect various wildlife or plant species may adversely impact our operations. In certain areas, drilling and other oil and gas activities can only be conducted during limited times of the year. This limits our ability to operate in those areas and can intensify competition during those times for drilling rigs and completion equipment, oil field equipment, services, supplies and qualified personnel, which may lead to periodic shortages. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. +Our ability to produce oil, gas, and NGLs economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our drilling and/or completions operations or are unable to dispose of or recycle the water we produce at a reasonable cost and in accordance with applicable environmental rules. +The hydraulic fracturing process on which we and others in our industry depend to complete wells that will produce commercial quantities of oil, gas, and NGLs requires the use and disposal of significant quantities of water. Our inability to secure sufficient amounts of water, or to dispose of, or recycle, the water produced from our wells, could adversely impact our operations. Moreover, the imposition of new environmental initiatives and regulations could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of wastes, including, but not limited to, produced water, drilling fluids, and other wastes associated with the exploration, development, or production of oil, gas, and NGLs. +26 +Compliance with environmental regulations, surface use agreements, and permit requirements governing the withdrawal, storage, and use of surface water or groundwater necessary for hydraulic fracturing of wells may increase our operating costs and cause delays, interruptions, or termination of our operations, the extent of which cannot be predicted, all of which could have an adverse effect on our operations and financial condition. +Our ability to sell oil, gas, and NGLs, and/or receive market prices for our production, may be adversely affected by constraints on gathering systems, processing facilities, pipelines, and other transportation systems owned or operated by third-parties or by other interruptions beyond our control, which could obstruct, limit, or eliminate our access to oil, gas, and NGL markets. +The marketability of our oil, gas, and NGL production depends in part on the availability, proximity, and capacity of gathering systems, processing facilities, pipelines, and other transportation systems, which are generally owned or operated by third parties. Any significant interruption in service from, damage to, or lack of available capacity in these systems and facilities can result in the shutting-in of producing wells, the delay, or discontinuance of development plans for our properties, increases in costs, or lower price realizations. Although we have some influence over the processing and transportation of our operated production, material changes in these business relationships could materially affect our operations. Federal and state regulation of oil, gas, and NGL production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines or processing facilities, infrastructure or capacity constraints, and general economic conditions could adversely affect our ability to produce, gather, process, transport, or market oil, gas, and NGLs. +Production may be interrupted, or shut in, from time to time for numerous reasons, including weather conditions, accidents, loss of pipeline, gathering, processing or transportation system access or capacity, field labor issues or strikes, or we might voluntarily curtail production in response to market or other conditions. If a substantial amount of our production is interrupted at the same time, it could adversely affect our cash flows and results of operations. +We have entered into firm transportation contracts that require us to pay fixed sums of money to our counterparties regardless of quantities actually shipped, processed, or gathered. If we are unable to deliver the necessary quantities of oil, gas, NGL, or produced water to our counterparties, our results of operations, financial position, and liquidity could be adversely affected. +As of December 31, 2023, we were contractually committed to deliver a minimum of 5 MMBbl of oil through July of 2026 and 11 MMBbl of produced water through June of 2027. We may enter into additional firm transportation agreements as we expand the development of our resource plays. We do not expect to incur any material shortfalls related to our existing contractual commitments. In the event we encounter delays in drilling and completing our wells or otherwise due to construction, interruptions of operations, or delays in connecting new volumes to gathering systems or pipelines for an extended period of time, or if we further limit our capital expenditures due to future commodity price declines or for other reasons, the requirements to pay for quantities not delivered could have a material impact on our results of operations, financial position, and liquidity. +If we are unable to replace reserves, we will not be able to sustain production. +Our future operations depend on our ability to find or acquire and develop oil, gas, and NGL reserves that are economically producible. Our properties produce oil, gas, and NGLs at a declining rate over time. In order to maintain current production rates, we must locate or acquire and develop new oil, gas, and NGL reserves to replace those being depleted by production. +For future acquisitions we may complete, a successful outcome for our business will depend on a number of factors, many of which are beyond our control. These factors include the purchase price and transaction costs for the acquisition, future oil, gas, and NGL prices, the ability to reasonably estimate the recoverable volumes of reserves, rates of future production and future net revenues attainable from reserves, future operating and capital costs, results of future exploration, exploitation, and development activities on the acquired properties, and future abandonment and possible future environmental or other liabilities. There are numerous uncertainties inherent in estimating these variables with respect to prospective acquisition targets. Actual results may vary substantially from those assumed in the estimates. Our customary review in connection with acquisitions will not necessarily reveal, or allow us to fully assess, all existing or potential problems and deficiencies with such properties. We do not inspect every well, and even when we inspect a well, we may not discover structural, subsurface, or environmental problems that may exist or arise. We may not be entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities. We often acquire interests in properties on an “as-is” basis with limited remedies for breaches of representations and warranties. +Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties if they have substantially different operating and geological characteristics or are in different geographic locations than our existing properties. To the extent that acquired properties are substantially different than our existing properties, our ability to efficiently realize the expected economic benefits of such transactions may be limited. +Integrating acquired businesses and properties involves a number of unique risks. These risks include the possibility that management may be distracted from regular business concerns by the need to integrate operations and systems and that unforeseen difficulties can arise in integrating operations and systems, and in retaining and assimilating employees. Any of these or other similar risks could lead to potential adverse short-term or long-term effects on our operating results and may cause us to not be able to realize any or all of the anticipated benefits of the acquisitions. +27 +The results of our operations are subject to drilling and completion technique risks, and results may not meet our expectations for reserves or production. As a result, we may incur material write-downs, and the value of our undeveloped acreage could decline if drilling results are unsuccessful. +Many of our operations involve utilizing the latest drilling and completion techniques as developed by us, other operators and our service providers in order to maximize production and ultimate recoveries and therefore generate the highest possible returns. Risks we face while drilling include, but are not limited to, landing our well bore outside the desired drilling zone, deviating from the desired drilling zone while drilling horizontally through the formation, the inability to run our casing the entire length of the well bore, and the inability to run tools and recover equipment consistently through the horizontal well bore. Risks we face while completing our wells include, but are not limited to, the inability to fracture stimulate the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore after completion of the final fracture stimulation. +In addition, exploration and drilling technologies we currently use or implement in the future may become obsolete. If we are unable to maintain technological advancements consistent with industry standards, our operations and financial condition may be adversely affected. We cannot be certain we will be able to implement exploration and drilling technologies on a timely basis or at a cost that is acceptable to us. +Ultimately, the success of exploration, drilling, and completion technologies and techniques can only be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for oil, gas, and NGLs decline, then the return on our investment for a particular project may not be as attractive as we anticipated and we could incur material write-downs of oil and gas properties and the value of our undeveloped acreage could decline in the future. +Competition in our industry is intense, and many of our competitors have greater financial, technical, and human resources than we do. +We face intense competition from oil and gas exploration and production companies of all sizes for the capital, equipment, expertise, labor, and materials required to operate oil and gas properties. Many of our competitors have financial, technical, and other resources exceeding those available to us, and many oil and gas properties are sold in a competitive bidding process in which our competitors may be able and willing to pay more for exploratory and development prospects and productive properties, or in which our competitors have technological information or expertise that is not available to us to evaluate and successfully bid for properties. As a result, we may not be successful in acquiring and developing profitable properties. In addition, other companies may have a greater ability to continue drilling activities during periods of low oil or gas prices and to absorb the burden of current and future governmental regulations and taxation. In addition, shortages of equipment, labor, or materials as a result of intense competition may result in increased costs or the inability to obtain those resources as needed. Our inability to compete effectively with companies in any area of our business could have a material adverse impact on our business activities, financial condition, and results of operations. +The actual quantities and present value of our proved oil, gas, and NGL reserves may be less than we have estimated, and the cost to develop our reserves may be more than we have estimated. +This report and certain of our other SEC filings contain estimates of our proved oil, gas, and NGL reserves and the present value of estimated future net revenues from those reserves. The process of estimating reserves is complex and estimates are based on various assumptions, including geological and geophysical characteristics, future oil, gas, and NGL prices, drilling, completion and other capital expenditures, gathering and transportation costs, operating expenses, effects of governmental regulation, taxes, timing of operations, and availability of funds. Therefore, these estimates are inherently imprecise. In addition, our reserve estimates for properties with limited production history may be less reliable than estimates for properties with lengthy production histories. +Actual future production; prices for oil, gas, and NGLs; revenues; production taxes; development expenditures; operating expenses; and quantities of producible oil, gas, and NGL reserves will most likely vary from those estimated. Any significant variance could materially affect the estimated quantities of and present value related to proved reserves disclosed by us, and the actual quantities and present value may be significantly less than what we have previously estimated. Our properties may also be susceptible to hydrocarbon drainage from production on adjacent properties, which we may not control. +As of December 31, 2023, 44 percent, or 263.6 MMBOE, of our estimated proved reserves were proved undeveloped. In order to develop our net proved undeveloped reserves, as of December 31, 2023, we estimate approximately $2.8 billion of capital expenditures would be required. Although we have estimated our proved reserves and the costs associated with these proved reserves in accordance with industry standards, estimated costs may not be accurate, development may not occur as scheduled, and actual results may not occur as estimated. +One should not assume that the standardized measure of discounted future net cash flows or PV-10 included in this report represent the current market value of our estimated proved oil, gas, and NGL reserves. Management has based the estimated discounted future net cash flows from proved reserves on price and cost assumptions required by the SEC, whereas actual future prices and costs may be materially higher or lower. Please refer to Reserves in Part I, Items 1 and 2 of this report for discussion +28 +regarding the prices used in estimating the present value of our proved reserves as of December 31, 2023, and to the caption Oil and Gas Reserve Quantities under Critical Accounting Estimates in Part II, Item 7 of this report for additional information. +The timing of production from oil and gas properties and of related expenses affects the timing of actual future net cash flows from proved reserves, and thus their actual present value. Our actual future net cash flows could be less than the estimated future net cash flows for purposes of computing PV-10. In addition, the 10 percent discount factor required by the SEC to calculate PV-10 for reporting purposes is not necessarily the most appropriate discount factor given actual interest rates, costs of capital, and other risks to which our business and the oil and gas industry in general are subject. +Our disposition activities may be subject to factors beyond our control, and in certain cases we may retain unforeseen liabilities for certain matters . +We regularly sell non-core assets in order to increase capital resources available for core assets and other purposes and to create organizational and operational efficiencies. We also occasionally sell interests in core assets for the purpose of accelerating the development and increasing efficiencies in other core assets. Various factors could materially affect our ability to dispose of such assets, including the approvals of governmental agencies or third parties, the availability of purchaser financing and purchasers willing to acquire the assets on terms we deem acceptable, or other matters or uncertainties that could impact such dispositions, including whether transactions could be consummated or completed in the form or timing and for the value that we anticipate. At times, we may be required to retain certain liabilities or agree to indemnify buyers in connection with such asset sales. The magnitude of such retained liabilities or of the indemnification obligations may be difficult to quantify at the time of the transaction and ultimately could be material. +We rely on third-party service providers to conduct drilling and completion and other related operations. +We rely on third-party service providers to perform necessary drilling and completion and other related operations. The ability of third-party service providers to perform such operations will depend on those service providers’ ability to compete for and retain qualified personnel, financial condition, economic performance, and access to capital, which in turn will depend upon the supply and demand for oil, gas, and NGLs, prevailing economic conditions, and financial, business, and other factors. Future periods of sustained low commodity prices could occur and could cause third-party service providers to consolidate or declare bankruptcy, which could limit our options for engaging such providers. The failure of a third-party service provider to adequately perform operations could delay drilling or completion or reduce production from the property and adversely affect our financial condition and results of operations. +Title to the properties in which we have an interest may be impaired by title defects. +We generally rely on title due diligence reports when acquiring oil and gas leasehold interests, and we obtain title opinions prior to commencing initial drilling operations on the properties we operate. Title to the properties in which we have an interest may be impaired by title defects that may not be identified in the due diligence title reports or title opinions we obtain, or such defects may not be cured following identification. A material title defect can reduce the value of a property or render it worthless, thus adversely affecting our oil and gas reserves, financial condition, results of operations, and operating cash flow, and may also impair the value of or render adjacent properties uneconomic to develop. Undeveloped acreage has greater risk of title defects than developed acreage and title insurance is not generally available for oil and gas properties. +Oil and gas drilling, completion, and production activities are subject to numerous risks, including the risk that no commercially producible oil, gas, or NGLs will be found. +The cost of drilling and completing wells is often uncertain, and oil, gas, or NGLs drilling and production activities may be shortened, delayed, or canceled as a result of a variety of factors, many of which are beyond our control. These factors may include, but are not limited to: +• supply chain issues, including cost increases and availability of equipment or materials; +• unexpected adverse drilling or completion conditions; +• title problems; +• disputes with owners or holders of surface interests on or near areas where we operate; +• pressure or geologic irregularities in formations; +• engineering and construction delays; +• equipment failures or accidents; +• hurricanes, tornadoes, flooding, wildfires or other adverse weather conditions; +• operational restrictions resulting from seismicity concerns; +• governmental permitting delays; +• compliance with environmental and other governmental requirements; and +• shortages or delays in the availability of or increases in the cost of drilling rigs and crews, fracture stimulation crews and equipment, pipe, chemicals, water, sand, and other supplies. +29 +The wells we drill may not be productive, and we may not recover all or any portion of our investment in such wells. The seismic data and other technologies we use do not allow us to know conclusively prior to drilling a well if oil, gas, or NGLs are present, or whether they can be produced economically. Drilling activities can result in dry holes or wells that are productive but do not produce sufficient net revenues after operating and other costs to cover drilling and completion costs. Even if sufficient amounts of oil, gas, or NGLs exist, we may damage a potentially productive hydrocarbon-bearing formation or experience mechanical difficulties while drilling or completing a well, which could result in reduced or no production from the well, significant expenditure to repair the well, and/or the loss and abandonment of the well. +Another significant risk inherent in our drilling plans is the need to obtain drilling permits from state, local, and other governmental authorities. Delays in obtaining regulatory approvals and drilling permits, including delays that jeopardize our ability to realize the potential benefits from leased properties within the applicable lease periods, the failure to obtain a drilling permit for a well, or the receipt of a permit with unreasonable conditions or costs could have a material adverse effect on our ability to explore or develop our properties. +Results in newer resource plays may be more uncertain than results in resource plays that are more developed and have longer established production histories. We, and the industry, generally have less information with respect to the ultimate recoverability of reserves and the production decline rates in newer resource plays than other areas with longer histories of development and production. Drilling and completion techniques that have proven to be successful in other resource plays are being used in the early development of new plays; however, we can provide no assurance of the ultimate success of these drilling and completion techniques. +We may not be able to obtain any options or lease rights in potential drilling locations that we identify. Unless production is established within the spacing units covering undeveloped acres on which our drilling locations are identified, the leases for such acreage will expire, and we will lose our right to develop the related properties. Our total net acreage as of February 8, 2024, that is scheduled to expire over the next three years, represents approximately 19 percent of our total net undeveloped acreage as of December 31, 2023. Although we have identified numerous potential drilling locations, we may not be able to economically drill for and produce oil, gas, or NGLs from all of them, and our actual drilling activities may materially differ from those presently identified, which could adversely affect our financial condition, results of operations and operating cash flow. +Many of our properties are in areas that may have been partially depleted or drained by offset wells and certain of our wells may be adversely affected by actions other operators may take when drilling, completing, or operating wells that they own. +Many of our properties are in areas that may have already been partially depleted or drained by earlier offset drilling. The owners of leasehold interests adjoining any of our properties could take actions, such as drilling and completing additional wells, which could adversely affect our operations. When a new well is completed and produced, the pressure differential in the vicinity of the well causes the migration of reservoir fluids toward the new wellbore (and potentially away from existing wellbores). As a result, the drilling and production of these potential locations could cause a depletion of our proved reserves and may inhibit our ability to further develop our proved reserves. In addition, completion operations and other activities conducted on adjacent or nearby wells could cause production from our wells to be shut in for indefinite periods of time, result in increased lease operating expenses and adversely affect the production and reserves from our wells after they re-commence production. We have no control over the operations or activities of offsetting operators. +The inability of customers or co-owners of assets to meet their obligations may adversely affect our financial results. +Substantially all of our accounts receivable result from oil, gas, and NGL sales or joint interest billings to co-owners of oil and gas properties we operate. This concentration of customers and joint interest owners may impact our overall credit risk because these entities may be similarly affected by various economic and other market conditions, including declines in oil, gas, and NGL prices. The loss of one or more of these customers could reduce competition for our products and negatively impact the prices of commodities we sell. We do not believe the loss of any single purchaser would materially impact our operating results, as we have numerous options for purchasers in each of our operating areas for our oil, gas, and NGL production. Please refer to Concentration of Credit Risk and Major Customers in Note 1 – Summary of Significant Accounting Policies, in Part II, Item 8 of this report for further discussion of our concentration of credit risk and major customers. Additionally, the inability of our co-owners to pay joint interest billings could negatively impact our cash flows and financial ability to drill and complete current and future wells. +We are subject to operating and environmental risks and hazards that could result in substantial losses or liabilities that may not be fully insured. +Oil and gas operations are subject to many risks, including human error and accidents, that could cause personal injury, death, property damage, well blowouts, craterings, explosions, uncontrollable flows of oil, gas and NGLs, or well fluids, releases or spills of completion fluids, spills or releases from facilities and equipment used to deliver or store these materials, spills or releases of brine or other produced or flowback water, subsurface conditions that prevent us from stimulating the planned number of completion stages, accessing the entirety of the wellbore with our tools during completion, or removing materials from the wellbore to allow production to begin, fires, adverse weather such as hurricanes or tornadoes, freezing conditions, wildfires, floods, droughts, formations with abnormal pressures, pipeline ruptures or spills, pollution, seismic events, releases of toxic gas such as hydrogen sulfide, and other environmental risks and hazards. If any of these types of events occur, we could sustain substantial losses. +30 +In response to increased seismic activity in the Permian Basin in Texas, the Railroad Commission of Texas (“RRC”) has developed a seismic review process for injection wells near qualifying seismic activity. As a result of the seismic review process, the RRC may declare an area to be a Seismic Response Area (“SRA”) and may adjust limits for injection rates and pressure, require bottom-hole pressure tests, or modify, suspend, or terminate injection well permits within the SRA. If an SRA is declared within an area of our operations, our ability to dispose of produced water may be adversely affected, and as a result, we may be forced to shut-in injection wells or find alternate produced water disposal options which could affect production and therefore oil, gas, and NGL production revenue, and could cause us to incur additional capital or operating expense. The declaration of SRAs has required us to adjust the areas where we seek permits for injection wells to areas or formations that are less desirable, and could further restrict the areas where we are able to obtain and operate under such permits without restrictions. Additionally, we could be subject to third-party claims and liability based on allegations that our operations caused or contributed to seismic events that resulted in damage to property or personal injury, or that are otherwise related to seismic events. +If we experience any of the problems with well stimulation, completion activities, and disposal referenced above, our ability to explore for and produce oil, gas, and NGLs may be adversely affected. We could incur substantial losses or otherwise fail to realize reserves in particular formations as a result of the need to shut down, abandon, or relocate drilling operations, the need to modify drill sites to lessen the risk of spills or releases, the need to investigate and/or remediate any spills, releases or ground water contamination that might have occurred, and the need to suspend our operations. +There is inherent risk of incurring significant environmental costs and liabilities in our operations due to our current and past generation, handling, and disposal of materials, including produced water, solid and hazardous wastes, and petroleum hydrocarbons. We may incur joint and several, and/or strict liability under applicable United States federal and state environmental laws in connection with releases of hazardous substances at, on, under, or from our leased or owned properties, some of which have been used for oil and gas exploration and production activities for a number of years, often by third-parties not under our control. For our outside-operated properties, we are dependent on the operator for operational and regulatory compliance and could be subject to liabilities in the event of non-compliance. These properties and the wastes disposed thereon or therefrom could be subject to stringent and costly investigatory or remedial requirements under applicable laws, some of which are strict liability laws without regard to fault or the legality of the original conduct, including CERCLA or the Superfund law, RCRA, the Clean Water Act, the CAA, the OPA, and analogous state laws. Under various implementing regulations, we could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators) or property contamination (including groundwater contamination), to perform natural resource mitigation or restoration practices, or to perform remedial plugging or closure operations to prevent future contamination. In addition, it is not uncommon for neighboring landowners and other third-parties to file claims for personal injury or property damage, including induced seismicity damage, allegedly caused by the release of petroleum hydrocarbons or other hazardous substances into the environment. As a result, we may incur substantial liabilities to third-parties or governmental entities, which could reduce or eliminate funds available for exploration, development, or acquisitions, or cause us to incur losses. +We maintain insurance against some, but not all, of these potential risks and losses. We have significant but limited coverage for sudden environmental damage. We do not believe that insurance coverage for the full potential liability that could be caused by environmental damage that occurs gradually over time is appropriate for us at this time given the nature of our operations and the nature and cost of such coverage. Further, we may elect not to obtain insurance coverage under circumstances where we believe that the cost of available insurance is excessive relative to the risks to which we are subject. Accordingly, we may be subject to liability or may lose substantial assets in the event of environmental or other damages. If a significant accident or other event occurs and is not fully covered by insurance, we could suffer an uninsured material loss. +We have limited control over the activities on properties we do not operate. +Some of our properties are operated by other companies and involve third-party working interest owners. As a result, we have limited ability to influence or control the operation or future development of such properties, including the nature and timing of drilling and operational activities, the operator’s skill and expertise, compliance with environmental, safety and other regulations, the approval of other participants in such properties, the selection and application of suitable technology, or the amount of expenditures that we will be required to fund with respect to such properties. Moreover, we are dependent on the other working interest owners of such projects to fund their contractual share of the expenditures of such properties. These limitations and our dependence on the operator and other working interest owners in these projects could cause us to incur unexpected future costs. +Risks Related to Debt, Liquidity, and Access to Capital +Lower oil, gas, or NGL prices could limit our ability to borrow under our Credit Agreement. +As of December 31, 2023, the borrowing base and aggregate lender commitments under our Credit Agreement were $2.5 billion and $1.25 billion, respectively. The borrowing base is subject to semi-annual redetermination based on the bank group’s assessment of the value of our proved reserves, which in turn is impacted by oil, gas, and NGL prices. The next borrowing base redetermination date is scheduled for April 1, 2024. Divestitures of properties, incurrence of additional debt, or declines in commodity prices could limit our borrowing base and reduce the amount we can borrow under our Credit Agreement, which could in turn impact, among other things, our ability to service our debt, fund our capital program, or compete for the acquisition of new properties. +31 +Substantial capital is required to develop and replace our reserves. +We must make substantial capital expenditures to find, acquire, develop, and produce oil, gas, and NGL reserves. Future cash flows and the availability of financing are subject to a number of factors, such as the level of production from existing wells, prices received for oil, gas, and NGL sales, our success in locating, developing, and acquiring new reserves, and the orderly functioning of credit and capital markets. If our cash flows from operations are less than expected, we may reduce our planned capital expenditures. If we cannot access sufficient liquidity under our Credit Agreement, or raise additional funds through debt or equity financing or the sale of assets, our ability to execute development plans, replace our reserves, maintain our acreage, or maintain production levels could be greatly limited. +Downgrades in our credit ratings by various credit rating agencies could impact our access to capital and have a material adverse effect on our business and financial condition. +Downgrades of our credit ratings could have material adverse consequences on our business and future prospects and could: +• limit our ability to access capital markets, including for the purpose of refinancing our existing debt; +• cause us to refinance or issue debt with less favorable terms and conditions, which may restrict, among other things, our ability to make any dividend payments or repurchase shares; +• negatively impact lenders’ willingness to transact business with us, which could impact our ability to obtain favorable terms and conditions under our Credit Agreement; +• negatively impact current and prospective customers’ willingness to transact business with us; +• impose additional insurance, guarantee, bonding, and collateral requirements; +• limit our access to bank and third-party guarantees, surety bonds, and letters of credit; and +• cause our suppliers and financial institutions to lower or eliminate the level of credit provided through payment terms or intraday funding when dealing with us, thereby increasing the need for higher levels of cash on hand, which would decrease our ability to repay outstanding indebtedness. +We cannot provide assurance that any of our current credit ratings will remain in effect for any given period of time or that a credit rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances warrant. +Our commodity derivative contract activities may result in financial losses or may limit the prices we receive for oil, gas, and NGL sales. +To mitigate a portion of the exposure to potentially adverse market changes in oil, gas, and NGL prices and the associated impact on cash flows, we regularly enter into commodity derivative contracts. Our commodity derivative contracts typically include price swap and collar arrangements for oil, gas, and NGLs. These activities may expose us to the risk of financial loss in certain circumstances, including instances in which: +• our production is less than expected; +• one or more counterparties to our commodity derivative contracts default on their contractual obligations; or +• there is a widening of price differentials between delivery points for our production and the delivery point assumed in the commodity derivative contract arrangement. +In addition, commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. Please refer to Note 7 – Derivative Financial Instruments in Part II, Item 8 of this report for additional detail regarding our commodity derivative contracts. +The amount of our debt may limit our ability to obtain financing for acquisitions, make us more vulnerable to adverse economic conditions, and make it more difficult for us to make payments on our debt. +As of December 31, 2023, we had $1.6 billion of aggregate principal amount outstanding of Senior Notes with maturities through 2028, as further discussed and defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. We had no outstanding balance on our revolving credit facility and had $1.2 billion of available borrowing capacity under our Credit Agreement as of December 31, 2023. Our long-term debt represented 30 percent of our total book capitalization as of December 31, 2023. +The amounts of our indebtedness could have important consequences for our operations, including: +• making it more difficult for us to obtain additional financing in the future for our operations and potential acquisitions, working capital requirements, capital expenditures, debt service, or other general corporate requirements; +• requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the service of interest costs associated with our debt, rather than to capital investments; +32 +• limiting our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt, making acquisitions, and paying dividends; +• placing us at a competitive disadvantage compared to our competitors with less debt; and +• making us more vulnerable in the event of adverse economic or industry conditions or a downturn in our business. +If our business does not generate sufficient cash flow from operations or future sufficient borrowings are not available to us under our Credit Agreement or from other sources, we might not be able to service our debt, issue additional debt, or fund our planned capital expenditures and other liquidity needs. If we are unable to service our debt, due to inadequate liquidity or otherwise, we may have to delay or cancel acquisitions, defer capital expenditures, sell equity securities, divest assets, and/or restructure or refinance our debt. We might not be able to sell our equity, sell our assets, or restructure or refinance our debt on a timely basis or on satisfactory terms or at all. In addition, the terms of our existing or future debt agreements, including our Credit Agreement and any future credit agreements, may prohibit us from pursuing any of these alternatives. +As discussed above, our Credit Agreement is subject to periodic borrowing base redeterminations. At times when we have an outstanding balance, we could be forced to repay a portion of our bank borrowings in the event of a downward redetermination of our borrowing base, and we may not have sufficient funds to make such repayment at that time. If we do not have sufficient funds and are otherwise unable to negotiate adjustments to our borrowing base or arrange new financing, we may be forced to sell significant assets. +The agreements governing our debt arrangements contain various covenants that limit our discretion in the operation of our business, could prohibit us from engaging in transactions we believe to be beneficial, and could lead to the accelerated repayment of our debt. +Our debt agreements, including our Credit Agreement and the indentures governing our Senior Notes, contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests, including restrictions on incurring debt, issuing dividends, repurchasing common stock, selling assets, creating liens, entering into transactions with affiliates, and merging, consolidating, or selling our assets. Our ability to borrow under our Credit Agreement is subject to compliance with certain financial and non-financial covenants, as outlined in the Credit Agreement. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion. These restrictions on our ability to operate our business could significantly harm us by, among other things, limiting our ability to take advantage of financings, mergers and acquisitions, and other corporate opportunities. +Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a portion of our indebtedness. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant portion of our outstanding indebtedness. +Negative public perception and investor sentiment regarding our business and the oil and gas industry as a whole could adversely affect our business, operations, and our ability to attract capital. +Certain segments of the public as a whole, and the investment community in particular, have developed negative sentiment toward our industry. In recent years, equity returns in the sector versus other industry sectors have led to lower oil and gas representation in certain key equity market indices. In addition, some investors, including investment management firms, sovereign wealth and pension funds, university endowments and other investment advisors, have adopted policies to discontinue or reduce their investments in the oil and gas sector based on social and environmental considerations. Furthermore, other influential stakeholders have pressured commercial and investment banks and other service providers to reduce or cease financing of oil and gas companies and related infrastructure projects. +Such developments, including increased focus on environmental, social and governance matters and initiatives aimed at limiting climate change and reducing air pollution, and changes in federal income tax laws could result in downward pressure on the stock prices of oil and gas companies, including ours. This may also potentially result in a reduction of available capital funding for potential development projects, impacting our future financial results. +Risks Related to Corporate Governance and Ownership of Public Equity Securities +Our certificate of incorporation and by-laws have provisions that discourage corporate takeovers and could prevent stockholders from receiving a takeover premium on their investment, which could adversely affect the price of our common stock. +Delaware corporate law and our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change of control of us or our management. These provisions, among other things, provide for non-cumulative voting in the election of members of the Board of Directors and impose procedural requirements on stockholders who wish to make nominations for the election of directors or propose other actions at stockholder meetings. These provisions, alone or in combination with each other, may discourage transactions involving actual or potential changes of control, including transactions that otherwise could involve payment of a premium over prevailing market prices to stockholders for their common stock. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price investors are willing to pay in the future for shares of our common stock. +33 +In addition, stockholder activism in our industry has been present in recent years, and if investors seek to exert influence or affect changes to our business that we do not believe are in the long-term best interests of our stockholders, such actions could adversely impact our business by, among other things, distracting our Board of Directors and management team, causing us to incur unexpected advisory fees and other related costs, impacting execution of our strategic objectives, and creating unnecessary market uncertainty. +The price of our common stock may fluctuate significantly, which may result in losses for investors. +From January 1, 2023, to February 8, 2024, the intraday trading prices per share of our common stock as reported by the New York Stock Exchange ranged from a low of $24.66 per share in March 2023 to a high of $43.73 per share in October 2023. We expect our stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include, in addition to the other risk factors set forth herein, the following: +• changes in oil, gas, or NGL prices; +• changes in the outlook for regional, national, or global commodity supply and demand; +• variations in drilling, recompletion, and operating activity; +• inflation; +• changes in financial estimates by securities analysts; +• changes in market valuations of comparable companies; +• additions or departures of key personnel; +• increased volatility due to the impacts of algorithmic trading practices; +• future sales of our common stock; +• negative public perception and investor sentiment regarding our business and the oil and gas industry as a whole; +• changes in the national and global economic outlook, including potential impacts from trade agreements; and +• international trade relationships, potentially including the effects of trade restrictions or tariffs affecting the raw materials we utilize and the commodities we produce in our business. +We may not meet the expectations of our stockholders and/or of securities analysts at some time in the future, and our stock price could decline as a result. +We may not always pay dividends on our common stock or repurchase common stock under our Stock Repurchase Program. +Payment of future dividends remains at the discretion of our Board of Directors, and common stock repurchases under our Stock Repurchase Program remain at the discretion of our Board of Directors and certain authorized officers of the Company. Decisions regarding the payment of dividends and the repurchase of common stock will continue to depend on our earnings, capital requirements, financial condition, general market and economic conditions, applicable legal requirements, the market price of our common stock, and other factors. The payment of dividends and the repurchase of our common stock are each subject to covenants in our Credit Agreement and in the indentures governing our Senior Notes that could limit our ability to make certain restricted payments including dividends and common stock repurchases. Our Board of Directors may determine in the future to reduce the current annual dividend rate or discontinue the payment of dividends altogether. The value of shares authorized for repurchase by the Board of Directors does not require us to repurchase such shares or guarantee that such shares will be repurchased, and the Stock Repurchase Program may be suspended, modified, or discontinued at any time without prior notice. No assurance can be given that any particular number or dollar value of our shares will be repurchased. +General Risk Factors +Our increasing dependence on digital technologies puts us at risk for a cyber incident that could result in information theft, data corruption, operational disruptions or financial loss. +We are subject to cybersecurity risks. The oil and gas industry, and our business, are increasingly dependent on digital technology. We use digital technology to conduct certain aspects of our drilling development, production and gathering activities, manage drilling rigs and completion equipment, gather and interpret seismic data, conduct reservoir modeling, record financial and operating data, and maintain employee and other databases. Our service providers, including those who gather, process, and market our oil, gas, and NGLs, are also increasingly reliant on digital technology. Our and their reliance on this technology increasingly puts us at risk for technology system failures, data or network disruptions, cyberattacks and other breaches in cybersecurity. Power failures, telecommunication or other system failures due to hardware or software malfunctions, computer viruses, vandalism, terrorism, natural disasters, fire, flood, human error or other means could significantly impair our ability to conduct our business. +Cybersecurity attacks are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, cash, or other assets, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data. Deliberate attacks on, or security +34 +breaches in our systems, infrastructure, the systems and infrastructure of third-parties, or cloud-based applications could lead to disclosure of confidential information, a corruption or loss of our proprietary data, delays in production or exploration activities, difficulty in completing or settling transactions, challenges in maintaining our books and records, environmental damage, communication or other operational disruptions, and liability to third parties. Any insurance we might obtain in the future may not provide adequate protection from these risks. Any such events could damage our reputation and lead to financial losses from remedial actions, loss of business or potential liability. As these cyber risks continue to evolve and our dependence on digital technologies grows, we may be required to expend significant additional resources to continue to modify or enhance our protective measures and remediate cyber vulnerabilities. +Please refer to Cybersecurity Risk Management, Strategy, and Governance in Item 1C of this report for discussion of the Audit Committee’s role in cybersecurity governance. We did not experience any material cybersecurity incidents during 2023, however there can be no assurance that the measures we have taken to address information technology (“IT”) and cybersecurity risks will prove effective in the future. +We are incorporating artificial intelligence technologies into our processes and these technologies may present business, compliance, and reputational risks. +Our business increasingly utilizes artificial intelligence (“AI”), machine learning, and automated decision making to improve our processes. Issues in the development and use of AI, combined with an uncertain regulatory environment, may result in new or enhanced governmental or regulatory scrutiny, litigation, confidentiality or security risks, reputational harm, liability, or other adverse consequences to our business operations, all of which could adversely affect our business, results of operations, and financial condition. +In addition, it is possible that AI and machine learning-technology could, unbeknownst to us, be improperly utilized by employees while carrying out their responsibilities. The use of AI can lead to unintended consequences, including the unauthorized use or disclosure of confidential and proprietary information, or generating content that appears correct but is factually inaccurate, misleading, or otherwise flawed, which could harm our reputation and business and expose us to risks related to inaccuracies or errors in the output of such technologies. It is not possible to predict all of the risks related to the use of AI, machine learning and automated decision making, and developments in the regulatory frameworks governing the use of such technologies and in related stakeholder expectations may adversely affect our ability to develop and use such technologies or subject us to liability. If we fail to successfully integrate AI into our business processes, or if we fail to keep pace with rapidly evolving AI technological developments, including attracting and retaining talented data scientists, data engineers, and programmers, we may face a competitive disadvantage. +Our business could be negatively impacted by security threats, including cybersecurity threats, terrorism, armed conflict, and other disruptions. +As an oil, gas, and NGL producer, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data or systems unusable; threats to the safety of our employees; threats to the security of our facilities and infrastructure or third-party facilities and infrastructure, such as processing plants and pipelines; and threats from terrorist acts, including armed attacks on shipping channels. Although we utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats, there can be no assurance that these procedures and controls will be sufficient in preventing security threats from materializing. If any of these events were to materialize, they could lead to losses of sensitive information, critical infrastructure, personnel, or capabilities essential to our operations and could have a material adverse effect on our reputation, financial position, results of operations, or cash flows. +The threat of terrorism and the impact of military and other actions have caused instability in world financial markets and could lead to increased volatility in prices for oil, gas, and NGLs, all of which could adversely affect the markets for our production. Energy assets might be specific targets of terrorist attacks. Depending on their occurrence and ultimate magnitude, terrorist threats or attacks could have a material adverse effect on our business, financial condition, or results of operations. +ITEM 1B. UNRESOLVED STAFF COMMENTS +We have no unresolved comments from the SEC staff regarding our periodic or current reports under the Exchange Act. +ITEM 1C. CYBERSECURITY RISK MANAGEMENT, STRATEGY, AND GOVERNANCE +Risk Management and Strategy +We believe that mitigating cybersecurity risks is the responsibility of every employee. We take a preventative approach with respect to cybersecurity threats by building a resilient cybersecurity culture and strong IT infrastructure. Our processes for assessing, identifying, and managing material risks from cybersecurity threats include: +• monitoring the threat landscape and taking measures to enhance our cybersecurity program to adapt to new and developing risks; +• ongoing training, testing, and utilizing other forms of social engineering awareness and education for our employees; +35 +• using cybersecurity systems and tools to monitor endpoints and environment logs in a centralized security information and event management system with capabilities for reporting and alerting on known threats and anomalous behaviors; +• assessing the cybersecurity practices and external ratings and assessments of certain of our third-party technology and data vendors and service providers, and maintaining preventative controls and monitoring systems related to these partners; +• creating and testing various incident response plans to hypothetical cybersecurity attacks in order to quickly assess and respond to potential and actual threats; +• utilizing third-party experts to perform penetration testing and scanning of our systems for vulnerabilities; +• obtaining third-party security maturity assessments, benchmarking, and security effectiveness ratings of our cybersecurity program; and +• maintaining a retainer for incident response services with a trusted cybersecurity partner in order to quickly respond, investigate, contain, and recover in the event of a cybersecurity incident. +We have structured our cybersecurity risk management program according to the National Institute of Standards and Technology Cybersecurity Framework. We strive to employ cybersecurity best practices, including implementing new technologies to proactively monitor new threats and vulnerabilities and reduce risk; maintaining a Cybersecurity Incident Response Plan, Disaster Recovery Plan, and Business Continuity Plan; and regularly updating our response planning and protocols. We have integrated our cybersecurity processes into our overall risk management program, thereby establishing a comprehensive approach by which we determine and implement strategies designed to manage external, strategic, operational and financial risks to our business, including cybersecurity threats. +We utilize a wide range of protective cybersecurity technologies and tools, including, but not limited to, encryption, firewalls, endpoint detection and response, security information and event management, multi-factor authentication, and threat intelligence feeds. In addition, we use an information security risk management approach that includes monitoring security threats and trends in the industry, analyzing potential security risks that could impact the business, partnering with industry recognized security organizations, and coordinating an appropriate response should the need arise. +Cybersecurity threats and incidents could have a material impact on our financial condition and results of operations. A successful cyber-attack could lead to operational disruptions, financial losses, regulatory penalties, reputational damage, and legal liabilities. In some cases, the costs associated with investigating and remediating a cybersecurity incident, as well as potential litigation and regulatory fines, could result in a material impact to our financial condition and results of operations. During 2023, we did not experience any cybersecurity incidents that materially affected or are reasonably likely to materially affect us, including our business strategy, results of operations or financial condition, however, there can be no assurance that the measures we have taken to address IT and cybersecurity risks will prove effective in the future. For additional discussion of the IT and cybersecurity risks facing our business, please refer to Risk Factors in Part 1, Item 1A of this report. +We prioritize investment in cybersecurity risk management and governance. We continually assess the adequacy of our resources and capabilities to address emerging threats, regulatory requirements, and changes in technology. As cybersecurity threats evolve, we may need to further enhance our processes and technologies, which could require additional financial resources. +Governance +Our Board of Directors receives regular updates on relevant IT matters affecting the Company, including cybersecurity risks and mitigation strategies. In addition to the general oversight provided by the full Board of Directors, the Audit Committee is responsible for oversight of our risk assessment and management processes, including with respect to IT and cybersecurity risks. The Audit Committee receives a quarterly cybersecurity report and regular updates from our Vice President and Chief Information Officer and our Director of Cybersecurity Risk and Business Continuity, which includes, among other information, the steps management has taken, and the specific guidelines and policies that have been established, to monitor, control, mitigate and report exposure to IT and cybersecurity risk. +We have established a Cyber Incident Response Team (“CIRT”) to provide an efficient, effective, and orderly response to technology related incidents and our Cybersecurity Incident Response Plan contains protocols for communication within this team and reporting to executive management and the Audit Committee. +The CIRT is led by our Vice President and Chief Information Officer and Director of Cybersecurity Risk and Business Continuity. Together, these professionals are responsible for assessing and managing cybersecurity risks and they lead a team of specialized technologists entrusted with ensuring the functionality, continuity, and security of our technology infrastructure and data. Our Vice President and Chief Information Officer is a seasoned IT professional with over 28 years of experience encompassing all facets of IT within the energy industry. His extensive background comprises managing IT service delivery, designing and administering secure solutions, establishing robust IT and Internet of Things infrastructures, and effectively managing technology-related risks. His skill set includes proficiency in threat mitigation, comprehensive risk assessment, and integration of cybersecurity strategies into business operations designed to safeguard critical assets and sensitive data. He reports to our Executive Vice President and Chief Financial Officer. Our Director of Cybersecurity Risk and Business Continuity has over 23 years of experience in the IT field with a +36 +majority of that time focused on designing, building and maintaining technology systems. His experience includes implementing security solutions and processes with a focus on adapting to the evolving cybersecurity threat landscape. He is a skilled leader and reports to our Executive Vice President and Chief Financial Officer. +ITEM 3. LEGAL PROCEEDINGS +At times, we may be involved in litigation relating to claims arising out of our business and operations in the normal course of business. As of the filing of this report, no legal proceedings are pending against us that we believe individually or collectively are likely to have a material adverse effect upon our financial condition, results of operations, or cash flows. +ITEM 4. MINE SAFETY DISCLOSURES +These disclosures are not applicable to us. +37 +PART II +ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Our common stock is currently traded on the New York Stock Exchange under the ticker symbol “SM.” For dividend information, please refer to the caption Uses of Cash in Overview of Liquidity and Capital Resources in Item 7 of this report. Information regarding the SM Energy Equity Incentive Compensation Plan, as amended and restated effective as of May 22, 2018 (the “Equity Plan”), and the securities authorized under the Equity Plan is included below. +PERFORMANCE GRAPH +The following performance graph compares the cumulative return on our common stock, for the period beginning December 31, 2018, and ending December 31, 2023, with the cumulative total returns of the Dow Jones Exploration and Production Index (“DJUSOS”), and the Standard & Poor’s 500 Stock Index (“SPX”). +COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURNS +The preceding information under the caption Performance Graph shall be deemed to be furnished, but not filed with the SEC. +Holders. As of February 8, 2024, the number of record holders of our common stock was 102. A substantially greater number of holders of our common stock are beneficial holders, whose shares of record are held by banks, brokers, and other financial institutions. +38 +Purchases of Equity Securities by Issuer and Affiliated Purchasers. The following table provides information about purchases made by us and any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the indicated quarters and months, and the year ended December 31, 2023, of shares of our common stock, which is the sole class of equity securities registered by us pursuant to Section 12 of the Exchange Act: +PURCHASES OF EQUITY SECURITIES BY ISSUER AND AFFILIATED PURCHASERS +Period +Total Number of +Shares +Purchased (1) +Weighted +Average Price +Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Program (2) +Maximum Number or Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (as of the period end date) (2) +First quarter of 2023 +1,413,758 $ 28.32 1,413,758 $ 402,780,476 +Second quarter of 2023 +2,550,976 $ 26.95 2,550,706 $ 334,036,922 +Third quarter of 2023 +2,600,605 $ 40.07 2,351,642 $ 237,700,848 +10/01/2023 - 10/31/2023 — $ — — $ 237,700,848 +11/01/2023 - 11/30/2023 614,729 $ 37.16 614,729 $ 214,854,687 +12/01/2023 - 12/31/2023 — $ — — $ 214,854,687 +Total 7,180,068 $ 32.85 6,930,835 +____________________________________________ +(1) 249,233 shares purchased by us in 2023 were to offset tax withholding obligations that occurred upon the delivery of outstanding shares underlying Restricted Stock Units (“RSU” or “RSUs”) issued under the terms of award agreements granted under the Equity Plan. +(2) Our Stock Repurchase Program, which authorizes us to repurchase up to $500.0 million in aggregate value of our common stock through December 31, 2024, permits us to repurchase our shares from time to time in open market transactions, through privately negotiated transactions or by other means in accordance with federal securities laws and subject to certain provisions of our Credit Agreement and the indentures governing our Senior Notes. The timing, as well as the number and value of shares repurchased under the Stock Repurchase Program, is determined by certain authorized officers of the Company at their discretion and depends on a variety of factors, including the market price of our common stock, general market and economic conditions and applicable legal requirements. The value of shares authorized for repurchase by our Board of Directors does not require us to repurchase such shares or guarantee that such shares will be repurchased, and the Stock Repurchase Program may be suspended, modified, or discontinued at any time without prior notice. No assurance can be given that any particular number or dollar value of our shares will be repurchased. During the year ended December 31, 2023, we repurchased and subsequently retired 6,930,835 shares of our common stock under the Stock Repurchase Program at a weighted-average share price of $32.89 for a total cost of $228.0 million, excluding excise taxes, commissions and fees. +Our payment of cash dividends to our stockholders and repurchases of our common stock are each subject to certain covenants under the terms of our Credit Agreement and Senior Notes. Based on our current performance, we do not anticipate that any of these covenants will limit our potential repurchases of our common stock or our payment of dividends at our current rate for the foreseeable future if any dividends are declared by our Board of Directors. +During the year ended December 31, 2023, we paid $71.6 million in dividends to our stockholders. Dividends paid reflects $0.60 per share during the year ended December 31, 2023. During 2023, our Board of Directors approved a 20 percent increase to our fixed dividend to $0.72 per share annually, to be paid in quarterly increments of $0.18 per share, beginning in the first quarter of 2024. We currently intend to continue paying dividends to our stockholders for the foreseeable future, subject to our future earnings, our financial condition, covenants under our Credit Agreement and indentures governing each series of our outstanding Senior Notes, and other factors that could arise. The payment and amount of future dividends remain at the discretion of our Board of Directors. +ITEM 6. [RESERVED] +39 +ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +The following discussion includes forward-looking statements. Please refer to the Cautionary Information about Forward-Looking Statements section of this report for important information about these types of statements. +Overview of the Company +General Overview +Our purpose is to make people’s lives better by responsibly producing energy supplies, contributing to domestic energy security and prosperity, and having a positive impact in the communities where we live and work. Our long-term vision and strategy is to sustainably grow value for all of our stakeholders as a premier operator of top-tier assets by maintaining and optimizing our high-quality asset portfolio, generating cash flows, and maintaining a strong balance sheet. Our team executes this strategy by prioritizing safety, technological innovation, and stewardship of natural resources, all of which are integral to our corporate culture. Our near-term goals include continuing to return value to stockholders through our Stock Repurchase Program and fixed dividend payments, and by focusing on continued operational excellence. +Our asset portfolio is comprised of high-quality assets in the Midland Basin of West Texas and in the Maverick Basin of South Texas that we believe are capable of generating strong returns in the current macroeconomic environment and provide resilience to commodity price risk and volatility. We seek to maximize returns and increase the value of our top-tier assets through disciplined capital spending, strategic acquisitions, and continued development and optimization of our existing assets. We believe that our high-quality assets facilitate a sustainable approach to prioritizing operational execution, maintaining a strong balance sheet, generating cash flows, returning capital to stockholders, and maintaining financial flexibility. +We are committed to exceptional safety, health, and environmental stewardship; supporting the professional development of a diverse and thriving team of employees; building and maintaining partnerships with our stakeholders by investing in and connecting with the communities where we live and work; and transparency in reporting our progress in these areas. The Environmental, Social and Governance Committee of our Board of Directors oversees, among other things, the effectiveness of our ESG policies, programs and initiatives, monitors and responds to emerging issues, and, together with management, reports to our Board of Directors regarding such matters. Further demonstrating our commitment to sustainable operations and environmental stewardship, compensation for our executives and eligible employees under our long-term incentive plan, and compensation for all employees under our short-term incentive plan is calculated based on, in part, certain Company-wide, performance-based metrics that include key financial, operational, environmental, health, and safety measures. Please refer to our Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders to be filed within 120 days from December 31, 2023, for additional discussion. +We are impacted by global commodity and financial markets that remain subject to heightened levels of uncertainty and volatility. While the rate of inflation in the United States has decreased since the beginning of the year and the average rate of inflation in 2023 was lower than it was in 2022, inflation continues to impact certain aspects of our business. Continued oil production curtailment agreements among OPEC+, instability in the Middle East, economic and trade sanctions associated with the wars between Russia and Ukraine and Israel and Hamas, United States Federal Reserve monetary policy, shipping channel constraints and disruptions, and changes in global oil inventory in storage have driven commodity price volatility, contributed to instances of supply chain disruptions and fluctuations in interest rates, and could have further industry-specific impacts that may require us to adjust our business plan. Future impacts of these and other events on commodity and financial markets are inherently unpredictable. Despite continuing uncertainty, we expect to maximize the value of our high-quality asset base and sustain strong operational performance and financial stability. We remain focused on returning capital to stockholders through cash flow generation. +Outlook +We expect our total 2024 capital program to be between $1.16 billion and $1.20 billion, excluding acquisitions, which we expect to fund with cash flows from operations and cash on hand. We plan to focus our 2024 capital program on highly economic oil development projects in both our Midland Basin and South Texas assets, including the assets we acquired during 2023. We expect to repurchase additional shares of our outstanding common stock through our Stock Repurchase Program during 2024, under which $214.9 million remains available for repurchases through December 31, 2024, as of the filing of this report. +2023 Financial and Operational Highlights +During 2023, we increased the amount of capital we returned to our stockholders, compared with 2022, through repurchases of our outstanding common stock under our Stock Repurchase Program and our fixed quarterly dividend payments, and we expanded our Midland Basin asset position. During the year ended December 31, 2023, we repurchased and subsequently retired 6.9 million shares of our common stock at a cost of $228.0 million, excluding excise taxes, commissions, and fees; we paid dividends of $0.60 per share, an increase from $0.16 per share paid during the year ended December 31, 2022; and we announced a 20 percent increase to our fixed dividend to $0.72 per share annually, to be paid in quarterly increments of $0.18 per share, beginning in the first quarter of 2024. Additionally, we executed strategic acquisitions, exchanges, and leasing activity in the Midland Basin, enabling us to enhance +40 +our capital efficiency by blocking up acreage and maintaining high working interests. Please refer to Note 3 – Equity and Note 16 – Acquisitions in Part II, Item 8 of this report for additional discussion. +Financial and Operational Results. Average net daily equivalent production for the year ended December 31, 2023, increased five percent to 152.0 MBOE, compared with 145.1 MBOE for 2022 as a result of an increased number of completions in 2023 compared with 2022. The total increase consisted of a 20 percent increase from our South Texas assets, partially offset by a seven percent decrease from our Midland Basin assets. These changes were a result of the timing of well completions, and the timing of capital expenditures during 2022 and 2023. +Realized prices for oil, gas, and NGLs decreased 19 percent, 61 percent, and 35 percent, respectively, for the year ended December 31, 2023, compared with 2022, as a result of decreases in benchmark commodity prices during 2023. Total realized price per BOE decreased 33 percent for the year ended December 31, 2023, compared with 2022, resulting in a 29 percent decrease in oil, gas, and NGL production revenue, which was $2.4 billion for the year ended December 31, 2023, compared with $3.3 billion for 2022. Oil, gas, and NGL production expense of $10.16 per BOE for the year ended December 31, 2023, decreased 13 percent compared with 2022, primarily as a result of decreases in production tax expense per BOE, transportation costs per BOE, and ad valorem tax expense per BOE, partially offset by an increase in LOE per BOE. +We recorded a net derivative gain of $68.2 million for the year ended December 31, 2023, compared to a net derivative loss of $374.0 million for 2022. These amounts include a net derivative settlement gain of $26.9 million for the year ended December 31, 2023, and a net derivative settlement loss of $710.7 million for the year ended December 31, 2022. +Operational activities during the year ended December 31, 2023, resulted in the following: +• Net cash provided by operating activities of $1.6 billion, compared with $1.7 billion for 2022. +• Net income of $817.9 million, or $6.86 per diluted share, compared with net income of $1.1 billion, or $8.96 per diluted share for 2022. +• Adjusted EBITDAX, a non-GAAP financial measure, of $1.7 billion, compared with $1.9 billion for 2022. Please refer to Non-GAAP Financial Measures below for additional discussion, including our definition of adjusted EBITDAX and reconciliations to net income and net cash provided by operating activities. +• Total estimated net proved reserves as of December 31, 2023, increased 13 percent from December 31, 2022, to 604.9 MMBOE, of which, 58 percent were liquids (oil and NGLs) and 56 percent were proved developed reserves. The increase primarily consisted of revisions of previous estimates of 113.9 MMBOE related to infill reserves in both our South Texas and Midland Basin programs, partially offset by 55.5 MMBOE of production during 2023. Our proved reserve life index increased to 10.9 years as of December 31, 2023, compared with 10.1 years as of December 31, 2022. Please refer to Reserves in Part I, Items 1 and 2 of this report for additional discussion. The standardized measure of discounted future net cash flows was $6.3 billion as of December 31, 2023, compared with $10.0 billion as of December 31, 2022, which was a decrease of 37 percent year-over-year primarily driven by decreases in benchmark commodity prices during 2023. Please refer to Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +Operational Activities. During 2023, successful operational execution resulted in strong well performance in the RockStar and Sweetie Peck areas of our Midland Basin position, and allowed us to maximize capital efficiency. Our South Texas program benefited from continued successful delineation and development of the Austin Chalk formation in addition to sustained strong performance of our Eagle Ford shale wells. Our continued success in both our Midland Basin and South Texas programs is attributable to our top-tier assets and technical teams, and our commitment to geoscience, technology, and innovation. +In our Midland Basin program, we averaged three drilling rigs and one completion crew during 2023. We added a fourth drilling rig at the end of the third quarter to begin drilling on our newly acquired Klondike acreage. We drilled 54 gross (37 net) wells, completed 64 gross (54 net) wells, and acquired additional working interests in five net wells during 2023. Average net daily equivalent production volumes decreased year-over-year by seven percent to 75.4 MBOE. Costs incurred during 2023 totaled $768.1 million, or 62 percent of our total 2023 costs incurred. Drilling and completion activities within our RockStar and Sweetie Peck positions in the Midland Basin were focused primarily on developing the Spraberry and Wolfcamp formations. +In our South Texas program, we averaged two drilling rigs and one completion crew during 2023. We drilled 46 gross (46 net) wells and completed 38 gross (37 net) wells during 2023. Average net daily equivalent production volumes increased year-over-year by 20 percent to 76.7 MBOE. Costs incurred during 2023 totaled $423.5 million, or 34 percent of our total 2023 costs incurred. Drilling and completion activities in South Texas during 2023 were primarily focused on delineating and developing the Austin Chalk formation. +41 +The table below provides a summary of changes in our drilled but not completed well count and current year drilling, completion, and acquisition activity in our operated programs for the year ended December 31, 2023: +Midland Basin +South Texas (1) +Total +Gross Net Gross Net Gross Net +Wells drilled but not completed at December 31, 2022 +49 40 29 28 78 69 +Wells drilled +54 37 46 46 100 83 +Wells completed +(64) (54) (38) (37) (102) (91) +Wells acquired (2) +— 5 — — — 5 +Wells drilled but not completed at December 31, 2023 +39 29 37 37 76 66 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) As of December 31, 2022, and 2023, the drilled but not completed well count included nine gross (nine net) wells that were not included in our five-year development plan, eight of which were in the Eagle Ford shale. +(2) Amount relates to additional working interests acquired in drilled but not completed wells during the year ended December 31, 2023. +Costs Incurred. Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Year Ended +December 31, 2023 +(in millions) +Development costs $ 931.8 +Exploration costs 172.6 +Acquisitions +Proved properties 65.0 +Unproved properties 65.6 +Total, including asset retirement obligations (1) +$ 1,235.0 +____________________________________________ +(1) Please refer to the caption Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Production Results. The table below presents the disaggregation of our net production volumes by product type for each of our assets for the year ended December 31, 2023: +Midland Basin South Texas Total +Net production volumes: +Oil (MMBbl) 17.5 6.3 23.8 +Gas (Bcf) 59.8 72.6 132.4 +NGLs (MMBbl) — 9.6 9.7 +Equivalent (MMBOE) 27.5 28.0 55.5 +Average net daily equivalent (MBOE per day) 75.4 76.7 152.0 +Relative percentage 50 % 50 % 100 % +____________________________________________ +Note: Amounts may not calculate due to rounding. +Net equivalent production increased five percent for the year ended December 31, 2023, compared with 2022, comprised of a 20 percent increase from our South Texas assets, partially offset by a seven percent decrease from our Midland Basin assets. Please refer to Overview of Selected Production and Financial Information, Including Trends and Comparison of Financial Results and Trends Between 2023 and 2022 and Between 2022 and 2021 below for additional discussion of production. +Acquisition Activity . During 2023, we acquired approximately 20,000 net acres of oil and gas properties in Dawson and northern Martin counties, Texas. Additionally, in the Midland Basin, we added approximately 9,100 net acres through organic leasing activity, we completed an asset exchange, and we acquired additional working interests in certain wells. Please refer to Note 16 – Acquisitions in Part II, Item 8 of this report for additional discussion. +42 +Oil, Gas, and NGL Prices +Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. When we refer to realized oil, gas, and NGL prices below, the disclosed price represents the average price for the respective period, before the effect of net derivative settlements. While quoted NYMEX oil and gas and OPIS NGL prices are generally used as a basis for comparison within our industry, the prices we receive are affected by quality, energy content, location and transportation differentials, and contracted pricing benchmarks for these products. +The following table summarizes commodity price data, as well as the effect of net derivative settlements, for the years ended December 31, 2023, 2022, and 2021: +For the Years Ended December 31, +2023 2022 2021 +Oil (per Bbl): +Average NYMEX contract monthly price $ 77.62 $ 94.23 $ 67.92 +Realized price $ 76.28 $ 94.67 $ 67.72 +Effect of oil net derivative settlements +$ (1.13) $ (21.46) $ (18.73) +Gas: +Average NYMEX monthly settle price (per MMBtu) $ 2.74 $ 6.64 $ 3.84 +Realized price (per Mcf) $ 2.48 $ 6.28 $ 4.85 +Effect of gas net derivative settlements (per Mcf) +$ 0.37 $ (1.36) $ (1.41) +NGLs (per Bbl): +Average OPIS price (1) +$ 27.71 $ 43.48 $ 36.65 +Realized price $ 23.02 $ 35.66 $ 33.67 +Effect of NGL net derivative settlements +$ 0.48 $ (3.06) $ (13.68) +____________________________________________ +(1) Effective January 1, 2023, average OPIS price per barrel of NGL, historical or strip, assumes a composite barrel product mix of 42% Ethane, 28% Propane, 6% Isobutane, 11% Normal Butane, and 13% Natural Gasoline. For periods prior to 2023, average OPIS price per barrel of NGL, historical or strip, assumed a composite barrel product mix of 37% Ethane, 32% Propane, 6% Isobutane, 11% Normal Butane, and 14% Natural Gasoline. These product mixes represent the industry standard composite barrel for the respective periods presented and do not necessarily represent our product mix for NGL production. Realized prices reflect our actual product mix. +Oil prices in 2023 decreased compared with 2022 and increased compared with 2021. Gas and NGL prices in 2023 decreased compared with both 2022 and 2021. Given the uncertainty surrounding global financial markets, production output from OPEC+, global shipping channel constraints and disruptions, instability in the Middle East, economic and trade sanctions associated with the wars between Russia and Ukraine and Israel and Hamas, changes in oil inventory in storage, and the potential impacts of these issues on global commodity and financial markets, we expect benchmark prices for oil, gas, and NGLs to remain volatile for the foreseeable future, and we cannot reasonably predict the timing or likelihood of any future impacts that may result, which could include further inflation, supply chain disruptions, fluctuations in interest rates, and industry-specific impacts. In addition to supply and demand fundamentals, as global commodities, the prices for oil, gas, and NGLs are affected by real or perceived geopolitical risks in various regions of the world as well as the relative strength of the United States dollar compared to other currencies. Our realized prices at local sales points may also be affected by infrastructure capacity in the areas of our operations and beyond. +The following table summarizes 12-month strip prices for NYMEX WTI oil, NYMEX Henry Hub gas, and OPIS NGLs as of February 8, 2024, and December 31, 2023: +As of February 8, 2024 As of December 31, 2023 +NYMEX WTI oil (per Bbl) $ 74.58 $ 71.53 +NYMEX Henry Hub gas (per MMBtu) $ 2.63 $ 2.67 +OPIS NGLs (per Bbl) $ 28.29 $ 25.77 +We use financial derivative instruments as part of our financial risk management program. We have a financial risk management policy governing our use of derivatives, and decisions regarding entering into commodity derivative contracts are overseen by a financial risk management committee consisting of certain senior executive officers and finance personnel. We make +43 +decisions about the amount of our expected production that we cover by derivatives based on the amount of debt on our balance sheet, the level of capital commitments and long-term obligations we have in place, and the terms and futures prices that are made available by our approved counterparties. With our current commodity derivative contracts, we believe we have partially reduced our exposure to volatility in commodity prices and basis differentials in the near term. Our use of costless collars for a portion of our derivatives allows us to participate in some of the upward movements in oil and gas prices while also setting a price floor below which we are insulated from further price decreases. Please refer to Note 7 – Derivative Financial Instruments in Part II, Item 8 of this report and to Commodity Price Risk in Overview of Liquidity and Capital Resources below for additional information regarding our oil, gas, and NGL derivatives. +Financial Results of Operations and Additional Comparative Data +The tables below provide information regarding selected production and financial information for the three months ended December 31, 2023, and the preceding three quarters: +For the Three Months Ended +December 31, September 30, June 30, March 31, +2023 2023 2023 2023 +(in millions) +Production (MMBOE) 14.1 14.1 14.1 13.2 +Oil, gas, and NGL production revenue +$ 606.9 $ 639.7 $ 546.6 $ 570.8 +Oil, gas, and NGL production expense $ 137.3 $ 138.3 $ 145.6 $ 142.3 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 189.1 $ 189.4 $ 157.8 $ 154.2 +Exploration $ 15.8 $ 10.2 $ 15.0 $ 18.4 +General and administrative $ 36.6 $ 29.3 $ 27.5 $ 27.7 +Net income $ 247.1 $ 222.3 $ 149.9 $ 198.6 +____________________________________________ +Note: Amounts may not calculate due to rounding. +Selected Performance Metrics +For the Three Months Ended +December 31, September 30, June 30, March 31, +2023 2023 2023 2023 +Average net daily equivalent production (MBOE per day) 153.5 153.7 154.4 146.4 +Lease operating expense (per BOE) $ 5.31 $ 5.08 $ 4.98 $ 5.16 +Transportation costs (per BOE) $ 2.08 $ 2.07 $ 2.89 $ 2.81 +Production taxes as a percent of oil, gas, and NGL production revenue 4.6 % 4.3 % 4.3 % 4.7 % +Ad valorem tax expense (per BOE) $ 0.37 $ 0.70 $ 0.83 $ 0.81 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (per BOE) $ 13.39 $ 13.39 $ 11.23 $ 11.70 +General and administrative (per BOE) $ 2.60 $ 2.07 $ 1.96 $ 2.10 +____________________________________________ +Note: Amounts may not calculate due to rounding. +44 +Overview of Selected Production and Financial Information, Including Trends +For the Years Ended +December 31, Amount Change Between Percent Change Between +2023 2022 2021 2023/2022 2022/2021 2023/2022 2022/2021 +Net production volumes: (1) +Oil (MMBbl) 23.8 24.0 27.9 (0.2) (4.0) (1) % (14) % +Gas (Bcf) 132.4 125.9 108.4 6.4 17.6 5 % 16 % +NGLs (MMBbl) 9.7 8.0 5.4 1.7 2.6 21 % 49 % +Equivalent (MMBOE) 55.5 53.0 51.4 2.5 1.6 5 % 3 % +Average net daily production: (1) +Oil (MBbl per day) 65.1 65.7 76.5 (0.6) (10.8) (1) % (14) % +Gas (MMcf per day) 362.7 345.0 296.9 17.6 48.1 5 % 16 % +NGLs (MBbl per day) 26.4 21.9 14.7 4.5 7.2 21 % 49 % +Equivalent (MBOE per day) 152.0 145.1 140.7 6.9 4.4 5 % 3 % +Oil, gas, and NGL production revenue (in millions): (1) +Oil production revenue $ 1,813.8 $ 2,270.1 $ 1,891.8 $ (456.3) $ 378.2 (20) % 20 % +Gas production revenue 327.9 790.9 525.5 (463.0) 265.4 (59) % 51 % +NGL production revenue 222.2 285.0 180.6 (62.7) 104.3 (22) % 58 % +Total oil, gas, and NGL production revenue $ 2,363.9 $ 3,345.9 $ 2,597.9 $ (982.0) $ 748.0 (29) % 29 % +Oil, gas, and NGL production expense (in millions): (1) +Lease operating expense $ 284.8 $ 266.5 $ 225.5 $ 18.3 $ 41.0 7 % 18 % +Transportation costs 136.2 150.0 139.4 (13.8) 10.6 (9) % 8 % +Production taxes 105.1 162.6 121.1 (57.5) 41.5 (35) % 34 % +Ad valorem tax expense 37.4 41.7 19.4 (4.3) 22.3 (10) % 115 % +Total oil, gas, and NGL production expense $ 563.5 $ 620.9 $ 505.4 $ (57.4) $ 115.5 (9) % 23 % +Realized price: +Oil (per Bbl) $ 76.28 $ 94.67 $ 67.72 $ (18.39) $ 26.95 (19) % 40 % +Gas (per Mcf) $ 2.48 $ 6.28 $ 4.85 $ (3.80) $ 1.43 (61) % 29 % +NGLs (per Bbl) $ 23.02 $ 35.66 $ 33.67 $ (12.64) $ 1.99 (35) % 6 % +Per BOE $ 42.60 $ 63.18 $ 50.58 $ (20.58) $ 12.60 (33) % 25 % +Per BOE data: (1) +Oil, gas, and NGL production expense: +Lease operating expense $ 5.13 $ 5.03 $ 4.39 $ 0.10 $ 0.64 2 % 15 % +Transportation costs 2.46 2.83 2.71 (0.37) 0.12 (13) % 4 % +Production taxes 1.89 3.07 2.36 (1.18) 0.71 (38) % 30 % +Ad valorem tax expense 0.67 0.79 0.38 (0.12) 0.41 (15) % 108 % +Total oil, gas, and NGL production expense (1) +$ 10.16 $ 11.72 $ 9.84 $ (1.56) $ 1.88 (13) % 19 % +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 12.44 $ 11.40 $ 15.08 $ 1.04 $ (3.68) 9 % (24) % +General and administrative $ 2.18 $ 2.16 $ 2.18 $ 0.02 $ (0.02) 1 % (1) % +Net derivative settlement gain (loss) (2) +$ 0.49 $ (13.42) $ (14.58) $ 13.91 $ 1.16 104 % 8 % +Earnings per share information (in thousands, except per share data): (3) +Basic weighted-average common shares outstanding 118,678 122,351 119,043 (3,673) 3,308 (3) % 3 % +Diluted weighted-average common shares outstanding 119,240 124,084 123,690 (4,844) 394 (4) % — % +Basic net income per common share $ 6.89 $ 9.09 $ 0.30 $ (2.20) $ 8.79 (24) % 2,930 % +Diluted net income per common share $ 6.86 $ 8.96 $ 0.29 $ (2.10) $ 8.67 (23) % 2,990 % +45 +____________________________________________ +(1) Amounts and percentage changes may not calculate due to rounding. +(2) Net derivative settlements for the years ended December 31, 2023, 2022, and 2021, are included within the net derivative (gain) loss line item in the accompanying consolidated statements of operations (“accompanying statements of operations”). +(3) Please refer to Note 9 – Earnings Per Share in Part II, Item 8 of this report for additional discussion. +Average net daily equivalent production for the year ended December 31, 2023, increased five percent compared with 2022, as a result of an increased number of completions. In 2024, we expect total production volumes to increase slightly compared with 2023, and we expect a slight increase in oil as a percentage of total production. Please refer to Comparison of Financial Results and Trends Between 2023 and 2022 and Between 2022 and 2021 below for additional discussion. +We present certain information on a per BOE basis in order to evaluate our performance relative to our peers and to identify and measure trends we believe may require additional analysis and discussion. +Our realized price on a per BOE basis decreased $20.58 for the year ended December 31, 2023, compared with 2022, as a result of decreases in oil, gas, and NGL benchmark prices. For the year ended December 31, 2023, we recognized a net gain on the settlement of our commodity derivative contracts of $0.49 per BOE, compared to a net loss of $13.42 per BOE for the same period in 2022. +LOE on a per BOE basis increased two percent for the year ended December 31, 2023, compared with 2022, primarily driven by increases in labor costs. For 2024, we expect LOE on a per BOE basis to increase, compared with 2023, primarily as a result of expected increases in certain operating costs associated with both our Midland Basin and South Texas assets. We anticipate volatility in LOE on a per BOE basis as a result of changes in total production, changes in our overall production mix, timing of workover projects, inflation, and industry activity, all of which affect total LOE. +Transportation costs on a per BOE basis decreased 13 percent for the year ended December 31, 2023, compared with 2022, as a result of the expiration of a long-term contract in South Texas on June 30, 2023. In general, we expect total transportation costs to fluctuate relative to changes in gas and NGL production from our South Texas assets, where we incur a majority of our transportation costs. For 2024, we expect transportation costs on a per BOE basis to decrease compared with 2023, as a result of the expiration of the long-term contract in South Texas previously discussed. +Production tax expense on a per BOE basis for the year ended December 31, 2023, decreased 38 percent compared with 2022, as a result of decreases in realized prices. Our overall production tax rate was 4.4 percent and 4.9 percent for the years ended December 31, 2023, and 2022, respectively. We generally expect production tax expense to correlate with oil, gas, and NGL production revenue on an absolute and per BOE basis. Product mix, the location of production, and incentives to encourage oil and gas development can also impact the amount of production tax expense that we recognize. +Ad valorem tax expense on a per BOE basis decreased 15 percent for the year ended December 31, 2023, compared with 2022, as we were positively impacted by a property tax relief bill that provided for a one-time benefit during 2023. We anticipate volatility in ad valorem tax expense on a per BOE and absolute basis as the valuation of our producing properties changes, which is generally driven by fluctuations in commodity prices, and can be impacted by changes in tax laws. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion (“DD&A”) expense on a per BOE basis increased nine percent for the year ended December 31, 2023, compared with 2022, due to inflation and higher drilling and completion activity in the Midland Basin, partially offset by increased production related to our South Texas assets, which have a lower DD&A rate than our Midland Basin assets. For 2024, we expect DD&A expense per BOE to remain flat, and DD&A expense on an absolute basis to increase slightly, compared with 2023, primarily as a result of expected increased production. Our DD&A rate fluctuates as a result of changes in our production mix, changes in our total estimated proved reserve volumes, changes in capital allocation, impairments, acquisition and divestiture activity, and carrying cost funding and sharing arrangements with third parties. +General and administrative (“G&A”) expense on a per BOE basis remained relatively flat for the year ended December 31, 2023, compared with 2022, as an increase in G&A expense on an absolute basis related to compensation expense was mostly offset by an increase in production volumes. Certain components of G&A expense, and G&A expense on a per BOE basis, are impacted by the Company’s full year performance against performance targets established at the beginning of the year and, therefore, are subject to variability. For 2024, we expect G&A expense per BOE to remain flat, and G&A expense on an absolute basis to increase compared with 2023, primarily as a result of expected increases in compensation expense due to inflation. +Please refer to Comparison of Financial Results and Trends Between 2023 and 2022 and Between 2022 and 2021 for additional discussion of operating expenses. +Comparison of Financial Results and Trends Between 2023 and 2022 and Between 2022 and 2021 +Please refer to Comparison of Financial Results and Trends Between 2022 and 2021 and Between 2021 and 2020 in +46 +Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2022 Annual Report on Form 10-K, filed with the SEC on February 23, 2023, for a detailed discussion of certain comparisons of our financial results and trends for the year ended December 31, 2022, compared with the year ended December 31, 2021. +Average net daily equivalent production, production revenue, and production expense +The following table presents the changes in our average net daily equivalent production, production revenue, and production expense, by area, between the years ended December 31, 2023, and 2022: +Net Equivalent Production Increase (Decrease) Production Revenue Decrease Production Expense Decrease +(MBOE per day) (in millions) (in millions) +Midland Basin (6.0) $ (726.8) $ (44.3) +South Texas 13.0 (255.3) (13.1) +Total 6.9 $ (982.0) $ (57.4) +____________________________________________ +Note: Amounts may not calculate due to rounding. +Average net daily equivalent production volumes for the year ended December 31, 2023, increased five percent compared with 2022, comprised of a 20 percent increase from our South Texas assets, partially offset by a seven percent decrease from our Midland Basin assets. As a result of decreases in benchmark commodity prices, realized prices for oil, gas, and NGLs decreased 19 percent, 61 percent, and 35 percent, respectively, resulting in a 29 percent decrease in oil, gas, and NGL production revenue. Oil, gas, and NGL production expense for the year ended December 31, 2023, decreased nine percent, compared with 2022, primarily driven by decreases in production taxes and transportation costs, partially offset by an increase in LOE. +The following table presents the changes in our average net daily equivalent production, production revenue, and production expense, by area, between the years ended December 31, 2022, and 2021: +Net Equivalent Production Increase (Decrease) Production Revenue Increase Production Expense Increase +(MBOE per day) (in millions) (in millions) +Midland Basin (13.0) $ 222.0 $ 55.5 +South Texas 17.3 526.0 60.0 +Total 4.4 $ 748.0 $ 115.5 +____________________________________________ +Note: Amounts may not calculate due to rounding. +Average net daily equivalent production volumes for the year ended December 31, 2022, increased three percent compared with 2021, comprised of a 37 percent increase from our South Texas assets, partially offset by a 14 percent decrease from our Midland Basin assets. As a result of increases in benchmark commodity prices, realized prices for oil, gas, and NGLs increased 40 percent, 29 percent, and six percent, respectively, resulting in a 29 percent increase in oil, gas, and NGL production revenue. Oil, gas, and NGL production expense for the year ended December 31, 2022, increased 23 percent, compared with 2021, primarily as a result of increased production taxes and LOE. +Please refer to Overview of Selected Production and Financial Information, Including Trends above for additional discussion, including discussion of trends on a per BOE basis. +Depletion, depreciation, amortization, and asset retirement obligation liability accretion +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Depletion, depreciation, amortization, and asset retirement obligation liability accretion $ 690.5 $ 603.8 $ 774.4 +DD&A expense for the year ended December 31, 2023, increased 14 percent, compared with 2022, primarily as a result of inflation and a five percent increase in average net daily equivalent production volumes, partially offset by a shift in production mix due to higher activity in our South Texas assets, which have a lower DD&A rate than our Midland Basin assets. DD&A expense for the year +47 +ended December 31, 2022, decreased 22 percent, compared with 2021, primarily as a result of increased estimated net proved reserves at the end of 2021 and during 2022, and increased activity in our Austin Chalk program. Please refer to Overview of Selected Production and Financial Information, Including Trends above for discussion of DD&A expense on a per BOE basis. +Exploration +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Geological, geophysical, and other expenses $ 26.4 $ 24.7 $ 7.0 +Overhead 33.1 30.2 32.3 +Total $ 59.5 $ 54.9 $ 39.3 +Exploration expense increased eight percent for the year ended December 31, 2023, compared with 2022, primarily due to increases in both overhead and geological, geophysical, and other expenses. Exploration expense fluctuates based on actual geological and geophysical studies we perform within an exploratory area, exploratory dry hole expense incurred, and changes in the amount of allocated overhead. +Impairment +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Impairment $ — $ 7.5 $ 35.0 +No impairment expense was recorded for the year ended December 31, 2023, as a result of fewer actual and anticipated lease expirations and title defects. Impairment expense recorded during the years ended December 31, 2022, and 2021, consisted of unproved property abandonments and impairments related to actual and anticipated lease expirations, as well as actual and anticipated losses of acreage due to title defects, changes in development plans, and other inherent acreage risks. +We expect proved property impairments to occur more frequently in periods of declining or depressed commodity prices, and that the frequency of unproved property abandonments and impairments will fluctuate with the timing of lease expirations or title defects, and changing economics associated with decreases in commodity prices. Additionally, changes in drilling plans, unsuccessful exploration activities, and downward engineering revisions may result in proved and unproved property impairments. +Reserve estimates and related impairments of proved and unproved properties are difficult to predict in a volatile price environment. If commodity prices for the products we produce decline as a result of supply and demand fundamentals associated with geopolitical or macroeconomic events, we may experience proved and unproved property impairments in the future. Future impairments of proved and unproved properties are difficult to predict; however, based on our commodity price assumptions as of February 8, 2024, we do not expect any material oil and gas property impairments in the first quarter of 2024 resulting from commodity price impacts. +Please refer to Critical Accounting Estimates below and Note 8 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion. +General and administrative +For the Years Ended December 31, +2023 2022 2021 +(in millions) +General and administrative $ 121.1 $ 114.6 $ 111.9 +G&A expense increased six percent for the year ended December 31, 2023, compared with 2022, primarily as a result of increased compensation expense. Please refer to Overview of Selected Production and Financial Information, Including Trends above for discussion of G&A expense, including G&A expense on a per BOE basis. +48 +Net derivative (gain) loss +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Net derivative (gain) loss $ (68.2) $ 374.0 $ 901.7 +Net derivative (gain) loss is a result of changes in fair values associated with fluctuations in the forward price curves for the commodities underlying our outstanding derivative contracts and the monthly cash settlements of our derivative positions during the period. We expect increases in benchmark commodity prices to result in net derivative losses, and decreases in benchmark commodity prices to result in net derivative gains, as measured against our derivative contract prices. Please refer to Note 7 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Other operating expense, net +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Other operating expense, net $ 20.6 $ 3.5 $ 46.1 +Other operating expense, net, recorded in 2023 and 2021, primarily related to legal matters. +Interest expense +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Interest expense $ (91.6) $ (120.3) $ (160.4) +Interest expense decreased 24 percent for the year ended December 31, 2023, compared with 2022, as a result of the reduction in the aggregate principal amount of our Senior Notes through various transactions in 2022, including the redemption of our 2024 Senior Notes on February 14, 2022, and the redemption of our 2025 Senior Secured Notes on June 17, 2022. Total interest expense can vary based on the timing and amount of borrowings under our revolving credit facility. Please refer to Overview of Liquidity and Capital Resources below, and to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definition of Senior Notes and 2025 Senior Secured Notes. +Interest income +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Interest income $ 19.9 $ 5.8 $ 1.7 +Interest income increased for the year ended December 31, 2023, compared with 2022, due to an increase in average interest rates on our interest-bearing cash equivalents and a higher average cash and cash equivalents balance during 2023. +Loss on extinguishment of debt +For the Years Ended December 31, +2023 2022 2021 +(in millions) +Loss on extinguishment of debt $ — $ (67.6) $ (2.1) +The redemption of our 2025 Senior Secured Notes during 2022 resulted in a net loss on extinguishment of debt of +49 +$67.2 million, which included $33.5 million of premium paid, $26.3 million of accelerated expense recognition of the unamortized debt discount, and $7.4 million of accelerated expense recognition of the unamortized deferred financing costs. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, including the definition of 2025 Senior Secured Notes. +Income tax expense +For the Years Ended December 31, +2023 2022 2021 +(in millions, except tax rate) +Income tax expense $ (96.3) $ (283.8) $ (9.9) +Effective tax rate 10.5 % 20.3 % 21.5 % +Our effective tax rate decreased for the year ended December 31, 2023, compared with 2022, primarily due to benefits recognized as a result of a multi-year research and development (“R&D") credit study conducted during 2023, partially offset by the release of the valuation allowance during the year ended December 31, 2023, that lowered the effective tax rate compared to no valuation benefit recognized during the year ended December 31, 2022. +The decrease in the effective tax rate for the year ended December 31, 2022, compared with 2021, primarily resulted from the release of the valuation allowance recorded against the derivative deferred tax asset recognized in prior periods. As a result of the increase in income before income taxes for the year ended December 31, 2022, compared with 2021, our permanent items, including excess tax benefits from stock-based compensation and limits on expensing of certain individual’s compensation, had less of an impact on the effective tax rate for the year ended December 31, 2022, compared with 2021. +During 2023, we made federal estimated tax payments of $3.0 million and state cash tax payments of $6.0 million, primarily related to Texas franchise taxes. +Enactment of proposed changes to federal income tax laws, specifically the Tax Relief for American Families and Workers Act of 2024, could have a material effect on our current tax expense, tax receivable, and deferred tax liabilities. +Please refer to Critical Accounting Estimates below and Note 4 – Income Taxes in Part II, Item 8 of this report for further discussion. +Overview of Liquidity and Capital Resources +Based on the current commodity price environment, we believe we have sufficient liquidity and capital resources to execute our business plan while continuing to meet our current financial obligations. We continue to manage the duration and level of our drilling and completion service commitments in order to maintain flexibility with regard to our activity level and capital expenditures. +Sources of Cash +We expect our 2024 capital expenditure and return of capital programs to be funded with cash flows from operating activities and cash on hand. We may also use borrowings under our revolving credit facility or raise funds through new debt or equity offerings or from other sources of financing. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders could be diluted, and these newly issued securities may have rights, preferences, or privileges senior to those of existing stockholders and bondholders. Additionally, we may enter into carrying cost and sharing arrangements with third parties for certain exploration or development programs. +Our credit ratings affect the availability of, and cost for us to borrow, additional funds. Two major credit rating agencies upgraded our credit ratings during 2023, citing our ability to consistently generate meaningful cash flows, disciplined capital spending, return of capital to stockholders, debt redemptions during 2022, and sustained strong operational performance, including our established inventory of drilling locations in our Midland Basin and South Texas programs, all of which contribute to our strong liquidity profile. +All of our sources of liquidity can be affected by the general conditions of the broader economy, force majeure events, fluctuations in commodity prices, operating costs, interest rate changes, tax law changes, and volumes produced, all of which affect us and our industry. +We have no control over the market prices for oil, gas, and NGLs, although we may be able to influence the amount of our realized revenues from our oil, gas, and NGL sales through the use of commodity derivative contracts as part of our commodity price risk management program. Commodity derivative contracts may limit the prices we receive for our oil, gas, and NGL sales if oil, gas, or NGL prices rise substantially over the price established by the commodity derivative contract. Please refer to Note 7 – Derivative +50 +Financial Instruments in Part II, Item 8 of this report for additional information about our commodity derivative contracts currently in place and the timing of settlement of those contracts . +Credit Agreement +Our Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $3.0 billion. As of December 31, 2023, the borrowing base and aggregate lender commitments under our Credit Agreement were $2.5 billion and $1.25 billion, respectively. The borrowing base is subject to regular, semi-annual redetermination, and considers the value of both our proved oil and gas properties reflected in our most recent reserve report and commodity derivative contracts, each as determined by our lender group. The next scheduled borrowing base redetermination date is April 1, 2024. No individual bank participating in our Credit Agreement represents more than 10 percent of the lender commitments under the Credit Agreement. We must comply with certain financial and non-financial covenants under the terms of the Credit Agreement, including covenants limiting dividend payments and requiring that we maintain certain financial ratios, as set forth in the Credit Agreement. We were in compliance with all financial and non-financial covenants as of December 31, 2023, and through the filing of this report. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion, as well as the presentation of the outstanding balance, total amount of letters of credit, and available borrowing capacity under the Credit Agreement as of February 8, 2024, December 31, 2023, and December 31, 2022. +We had no revolving credit facility borrowings during the years ended December 31, 2023, and 2022. Cash flows provided by our operating activities, proceeds received from divestitures of properties, capital markets activities including open market debt repurchases, debt redemptions, repayment of scheduled debt maturities, other financing activities, and our capital expenditures, including acquisitions, all impact the amount we borrow under our revolving credit facility. +Weighted-Average Interest and Weighted-Average Borrowing Rates +Our weighted-average interest rate includes paid and accrued interest, fees on the unused portion of the aggregate commitment amount under the Credit Agreement, letter of credit fees, the non-cash amortization of deferred financing costs, and for the periods during which they were outstanding, the non-cash amortization of the discounts related to the 2021 Senior Secured Convertible Notes and 2025 Senior Secured Notes, each as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report. Our weighted-average borrowing rate includes paid and accrued interest only. +The following table presents our weighted-average interest rates and our weighted-average borrowing rates for the years ended December 31, 2023, 2022, and 2021: +For the Years Ended December 31, +2023 2022 2021 +Weighted-average interest rate 7.1 % 7.6 % 7.7 % +Weighted-average borrowing rate 6.4 % 6.8 % 6.8 % +Our weighted-average interest rate and weighted-average borrowing rate both decreased for the year ended December 31, 2023, compared with 2022, as a result of the redemptions of our 2024 Senior Notes and 2025 Senior Secured Notes during 2022. Our weighted-average interest rate remained flat for the year ended December 31, 2022, compared with 2021, as an increase in deferred financing costs related to the Credit Agreement was offset by a decrease in interest expense resulting from the redemption of the 2025 Senior Secured Notes. Our weighted-average borrowing rate remained flat for the year ended December 31, 2022, compared with 2021, as a result of the timing of redemptions of our Senior Notes during 2022 and 2021. +Our weighted-average interest rate and weighted-average borrowing rate are affected by the occurrence and timing of long-term debt issuances and redemptions and the average outstanding balance on our revolving credit facility. Additionally, our weighted-average interest rate is affected by the fees paid on the unused portion of our aggregate lender commitments. The rates disclosed in the above table do not reflect certain amounts associated with the repurchase or redemption of Senior Notes, such as the accelerated expense recognition of the unamortized deferred financing costs and unamortized discounts, as these amounts are netted against the associated gain or loss on extinguishment of debt. The 2021 Senior Secured Convertible Notes were retired upon maturity on July 1, 2021, the 2024 Senior Notes were redeemed on February 14, 2022, and the 2025 Senior Secured Notes were redeemed on June 17, 2022. After these dates, the weighted-average interest rate was no longer affected by the non-cash amortization of deferred financing costs or, for the 2021 Senior Secured Convertible Notes and the 2025 Senior Secured Notes, the non-cash amortization of the discounts. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions. +Uses of Cash +We use cash for the development, exploration, and acquisition of oil and gas properties; for the payment of operating and general and administrative costs, income taxes, debt obligations, including interest and early repayments or redemptions, dividends, and for repurchases of shares of our outstanding common stock under the Stock Repurchase Program. Expenditures for the development, exploration, and acquisition of oil and gas properties are the primary use of our capital resources. During 2023, we spent +51 +$1.1 billion on capital expenditures and on acquisitions of proved and unproved oil and gas properties, including the acquisition of additional working interests in certain wells. This amount differs from the costs incurred amount of $1.2 billion for the year ended December 31, 2023, as costs incurred is an accrual-based amount that also includes asset retirement obligations, geological and geophysical expenses, and exploration overhead amounts. Please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional discussion. +The amount and allocation of our future capital expenditures will depend upon a number of factors, including our cash flows from operating, investing, and financing activities, our ability to execute our development program, inflation, and the number and size of acquisitions that we complete. In addition, the impact of oil, gas, and NGL prices on investment opportunities, the availability of capital, tax law and other regulatory changes, and the timing and results of our exploration and development activities may lead to changes in funding requirements for future development. We periodically review our capital expenditure budget and guidance to assess if changes are necessary based on current and projected cash flows, acquisition and divestiture activities, debt requirements, and other factors. +Changes to the Internal Revenue Code (“IRC“), could increase the corporate income tax rate and could eliminate or reduce current tax deductions for intangible drilling costs, depreciation of equipment costs, and other deductions which currently reduce our taxable income. Current and future legislation could reduce our net cash provided by operating activities over time, and could therefore result in a reduction of funding available for the items discussed above. +We may from time to time repurchase shares of our common stock, or repurchase or redeem all or portions of our outstanding debt securities, for cash, through exchanges for other securities, or a combination of both. Such repurchases or redemptions may be made in open market transactions, privately negotiated transactions, tender offers, pursuant to contractual provisions, or otherwise. Any such repurchases or redemptions will depend on our business strategy, prevailing market conditions, our liquidity requirements, contractual restrictions or covenants, compliance with securities laws, and other factors. The amounts involved in any such transaction may be material. +During the years ended December 31, 2023, and 2022, we repurchased and subsequently retired 6.9 million shares and 1.4 million shares, respectively, of our common stock at a cost, excluding excise taxes, commissions, and fees, of $228.0 million and $57.2 million, respectively. As of the filing of this report, $214.9 million remains available under the Stock Repurchase Program for repurchases of our common stock through December 31, 2024. Effective January 1, 2023, shares of common stock repurchased, net of shares of common stock issued, are subject to a one percent excise tax imposed by the IRA. We recorded an immaterial amount of excise tax related to common stock repurchases during 2023. Please refer to Note 3 – Equity in Part II, Item 8 of this report for discussion of the Stock Repurchase Program. +During the years ended December 31, 2023, 2022, and 2021, we paid $71.6 million, $19.6 million, and $2.4 million, respectively, in dividends to our stockholders. Dividends paid reflects $0.60, $0.16, and $0.02 per share during the years ended December 31, 2023, 2022, and 2021, respectively. During 2023, our Board of Directors approved a 20 percent increase to our fixed dividend to $0.72 per share annually, to be paid in quarterly increments of $0.18 per share, beginning in the first quarter of 2024. We currently intend to continue paying dividends to our stockholders for the foreseeable future, subject to our future earnings, our financial condition, covenants under our Credit Agreement and indentures governing each series of our outstanding Senior Notes, and other factors that could arise. The payment and amount of future dividends remain at the discretion of our Board of Directors. +During 2022, we redeemed all of the aggregate principal amount outstanding of our 2024 Senior Notes and our 2025 Senior Secured Notes. Please refer to Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions. +Analysis of Cash Flow Changes Between 2023 and 2022 and Between 2022 and 2021 +The following tables present changes in cash flows between the years ended December 31, 2023, 2022, and 2021, for our operating, investing, and financing activities. The analysis following each table should be read in conjunction with our accompanying consolidated statements of cash flows (“accompanying statements of cash flows”) in Part II, Item 8 of this report. +Operating Activities +For the Years Ended December 31, Amount Change Between +2023 2022 2021 +2023/2022 +2022/2021 +(in millions) +Net cash provided by operating activities $ 1,574.4 $ 1,686.4 $ 1,159.8 $ (112.0) $ 526.6 +Net cash provided by operating activities decreased for the year ended December 31, 2023, compared with 2022, primarily as a result of a $937.3 million decrease in cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes and an increase of $44.5 million in cash paid for LOE and ad valorem taxes, partially offset by a decrease of $749.3 million in cash paid on settled derivative trades and a $45.5 million decrease in cash paid for interest. +52 +Net cash provided by operating activities increased for the year ended December 31, 2022, compared with 2021, primarily as a result of an $833.2 million increase in cash received from oil, gas, and NGL production revenues, net of transportation costs and production taxes, partially offset by an increase in cash paid for LOE and G&A expense of $70.7 million and an increase of $69.2 million in cash paid on settled derivative trades. +Net cash provided by operating activities is affected by working capital changes and the timing of cash receipts and disbursements. +Investing Activities +For the Years Ended December 31, Amount Change Between +2023 2022 2021 +2023/2022 +2022/2021 +(in millions) +Net cash used in investing activities $ (1,098.7) $ (880.3) $ (667.2) $ (218.4) $ (213.1) +Net cash used in investing activities increased for the year ended December 31, 2023, compared with 2022, as a result of a $109.5 million increase in capital expenditures and $109.9 million of cash paid to acquire proved and unproved oil and gas properties in the Midland Basin, including the acquisition of additional working interests in certain wells. Please refer to Note 16 – Acquisitions in Part II, Item 8 of this report for additional discussion of the acquisition of proved and unproved oil and gas properties. +Net cash used in investing activities increased for the year ended December 31, 2022, compared with 2021, primarily as a result of a $205.1 million increase in capital expenditures. +Net cash used in investing activities during the years ended December 31, 2023, 2022, and 2021, was funded by net cash provided by operating activities. +Financing Activities +For the Years Ended December 31, Amount Change Between +2023 2022 2021 +2023/2022 +2022/2021 +(in millions) +Net cash used in financing activities $ (304.5) $ (693.9) $ (159.8) $ 389.4 $ (534.1) +Net cash used in financing activities during the year ended December 31, 2023, primarily consisted of $228.1 million of cash paid, including commission and fees, to repurchase and subsequently retire 6.9 million shares of our common stock under the Stock Repurchase Program, and $71.6 million of dividends paid to our stockholders. +Net cash used in financing activities during the year ended December 31, 2022, related to $480.2 million of cash paid, including premium, to redeem our 2025 Senior Secured Notes, and $104.8 million of cash paid to redeem our 2024 Senior Notes. Additionally, we paid $57.2 million, including commission and fees, to repurchase and subsequently retire 1.4 million shares of our common stock under the Stock Repurchase Program, $25.1 million for the net share settlement of employee stock awards, and $19.6 million of dividends paid to our stockholders. +During the year ended December 31, 2021, we paid $385.3 million, including net premiums, to fund the Tender Offer and the 2022 Senior Notes Redemption, and we received net cash proceeds of $392.8 million from the issuance of our 2028 Senior Notes. Additionally, we paid $65.5 million to retire our 2021 Senior Secured Convertible Notes and had net repayments under our revolving credit facility of $93.0 million. +Please refer to Note 3 – Equity in Part II, Item 8 of this report for additional discussion of our Stock Repurchase Program and Note 5 – Long-Term Debt in Part II, Item 8 of this report for additional discussion and definitions related to our debt transactions. +Interest Rate Risk +We are exposed to market and credit risk due to the floating interest rate associated with any outstanding balance on our revolving credit facility. Our Credit Agreement allows us to fix the interest rate for all or a portion of the principal balance of our revolving credit facility for a period up to six months. To the extent that the interest rate is fixed, interest rate changes will affect the revolving credit facility’s fair value but will not affect results of operations or cash flows. Conversely, for the portion of the revolving credit facility that has a floating interest rate, interest rate changes will not affect the fair value but will affect future results of operations and cash flows. Changes in interest rates do not affect the amount of interest we pay on our fixed-rate Senior Notes, but can affect their fair +53 +values. As of December 31, 2023, our outstanding principal amount of fixed-rate debt totaled $1.6 billion, and we had no floating-rate debt outstanding. As we had no borrowings under our revolving credit facility during 2023, we had no exposure to variable interest rates during the year ended December 31, 2023. Please refer to Note 8 – Fair Value Measurements in Part II, Item 8 of this report for additional discussion on the fair values of our Senior Notes. +The Federal Reserve increased short-term interest rates during 2023 and 2022. These increases, and any future increases, are likely to increase the cost of and affect our ability to borrow funds. +Commodity Price Risk +The prices we receive for our oil, gas, and NGL production directly affect our revenue, profitability, access to capital, ability to return capital to our stockholders, and future rate of growth. Oil, gas, and NGL prices are subject to unpredictable fluctuations resulting from a variety of factors that are typically beyond our control, including changes in supply and demand associated with the broader macroeconomic environment, constraints on gathering systems, processing facilities, pipelines, and other transportation systems, and weather-related events. The markets for oil, gas, and NGLs have been volatile, especially over the last decade, and remain subject to high levels of uncertainty and volatility related to production output from OPEC+, global shipping channel constraints and disruptions, instability in the Middle East, economic and trade sanctions associated with the wars between Russia and Ukraine and Israel and Hamas, and the potential impacts of these issues on global commodity and financial markets. These circumstances have contributed to inflation, instances of supply chain disruptions, and a rise in interest rates, and could have further industry-specific impacts that may require us to adjust our business plan. The realized prices we receive for our production also depend on numerous factors that are typically beyond our control. Based on our 2023 production, a 10 percent decrease in our average realized prices for oil, gas, and NGLs, would have reduced our oil, gas, and NGL production revenues by approximately $181.4 million, $32.8 million, and $22.2 million, respectively. If commodity prices had been 10 percent lower, our net derivative settlements for the year ended December 31, 2023, would have offset the declines in oil, gas, and NGL production revenue by approximately $61.2 million. +We enter into commodity derivative contracts in order to reduce the risk of fluctuations in commodity prices. The fair value of our commodity derivative contracts is largely determined by estimates of the forward curves of the relevant price indices. As of December 31, 2023, a 10 percent increase or decrease in the forward curves associated with our oil, gas, and NGL commodity derivative instruments would have changed our net derivative positions for these products by approximately $30.0 million, $5.2 million, and $0.7 million, respectively. +Off-Balance Sheet Arrangements +We have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPE” or “SPEs”). Please refer to Off-Balance Sheet Arrangements within Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for additional discussion. +Critical Accounting Estimates +Our discussion of financial condition and results of operations is based upon the information reported in our consolidated financial statements. The preparation of these consolidated financial statements in conformity with GAAP requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the disclosure of contingent assets and liabilities as of the date of our consolidated financial statements. We base our assumptions and estimates on historical experience and various other sources that we believe to be reasonable under the circumstances. Actual results may differ from the estimates we calculate as a result of changes in circumstances, global economics and politics, and general business conditions. A summary of our significant accounting policies is detailed in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report. We have outlined below, those policies identified as being critical to the understanding of our business and results of operations and that require the application of significant management judgment. +Successful Efforts Method of Accounting. GAAP provides two alternative methods for the oil and gas industry to use in accounting for oil and gas producing activities. These two methods are generally known in our industry as the full cost method and the successful efforts method, and both methods are widely used. The methods are different enough that in many circumstances the same set of facts will provide materially different financial statement results within a given year. We have chosen the successful efforts method of accounting for our oil and gas producing activities. A more detailed description is included in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report. +Oil and Gas Reserve Quantities. Our estimated proved reserve quantities and future net cash flows are critical to understanding the value of our business. They are used in comparative financial ratios and are the basis for significant accounting estimates in our consolidated financial statements, including the calculations of DD&A expense, impairment of proved and unproved oil and gas properties, and asset retirement obligations. Please refer to Oil and Gas Producing Activities in Note 1 – Summary of Significant Accounting Policies of Part II, Item 8 of this report for additional discussion on our accounting policies impacted by estimated reserve quantities. +54 +Future cash inflows and future production and development costs are determined by applying prices and costs, including transportation, quality differentials, and basis differentials, applicable to each period to the estimated quantities of proved reserves remaining to be produced as of the end of that period. Expected cash flows are discounted to present value using an appropriate discount rate. For example, the standardized measure of discounted future net cash flows calculation requires that a 10 percent discount rate be applied. Although reserve estimates are inherently imprecise, and estimates of new discoveries and undeveloped locations are more imprecise than those of established producing oil and gas properties, we make a considerable effort in estimating our reserves. We engage Ryder Scott, an independent reservoir evaluation consulting firm, to audit a minimum of 80 percent of our total calculated proved reserve PV-10. We expect proved reserve estimates will change as additional information becomes available and as commodity prices and operating and capital costs change. We evaluate and estimate our proved reserves each year end. It should not be assumed that the standardized measure of discounted future net cash flows (GAAP) or PV-10 (non-GAAP) as of December 31, 2023, is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based these measures on the unweighted arithmetic average of the first-day-of-the-month price of each month within the trailing 12-month period ended December 31, 2023. Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimates. Please refer to Risk Factors in Part I, Item 1A of this report for additional discussion. +If the estimates of proved reserves decline, the rate at which we record DD&A expense will increase, which would reduce future net income. Changes in DD&A rate calculations caused by changes in reserve quantities are made prospectively. In addition, a decline in reserve estimates may impact the outcome of our assessment of proved and unproved properties for impairment. Impairments are recorded in the period in which they are identified. +The following table presents information about proved reserve changes from period to period due to items we do not control, such as price, and from changes due to production history and well performance. These changes do not require a capital expenditure on our part, but may have resulted from capital expenditures we incurred to develop other estimated proved reserves. +For the Years Ended December 31, +2023 2022 2021 +MMBOE Change +Revisions resulting from performance (1) +37.2 (11.1) 3.4 +Removal of net proved undeveloped reserves no longer in our five-year development plan +(30.8) (19.9) (40.6) +Revisions resulting from price changes (28.4) 9.5 37.2 +Total (22.0) (21.5) — +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) For the year ended December 31, 2023, performance revisions consisted of positive revisions of 65.3 MMBOE resulting from changes to decline curve estimates based on reservoir engineering analysis and negative revisions of 28.0 MMBOE related to well performance. +As previously noted, commodity prices are volatile and estimates of reserves are inherently imprecise. Consequently, we expect to continue experiencing these types of changes. +55 +We cannot reasonably predict future commodity prices, although we believe that together, the below analyses provide reasonable information regarding the impact of changes in pricing and trends on total estimated net proved reserves. The following table reflects the estimated MMBOE change and percentage change to our total reported estimated proved reserve volumes from the described hypothetical changes: +For the year ended December 31, 2023 +MMBOE Change Percentage Change +10 percent decrease in SEC pricing (1) +(14.3) (2) % +Average NYMEX strip pricing as of fiscal year end (2) +2.5 — % +10 percent decrease in net proved undeveloped reserves (3) +(26.4) (4) % +____________________________________________ +(1) The change solely reflects the impact of a 10 percent decrease in SEC pricing to the total reported estimated net proved reserve volumes as of December 31, 2023, and does not include additional impacts to our estimated net proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. +(2) The change solely reflects the impact of replacing SEC pricing with the five-year average NYMEX strip pricing as of December 31, 2023, and does not include additional impacts to our estimated net proved reserves that may result from our internal intent to drill hurdles or changes in future service or equipment costs. As of December 31, 2023, SEC pricing was $78.22 per Bbl for oil, $2.64 per MMBtu for gas, and $27.72 per Bbl for NGLs, and five-year average NYMEX strip pricing was $66.11 per Bbl for oil, $3.53 per MMBtu for gas, and $25.19 per Bbl for NGLs. +(3) The change solely reflects a 10 percent decrease in net proved undeveloped reserves as of December 31, 2023, and does not include any additional impacts to our estimated net proved reserves. +Additional reserve information can be found in Reserves in Part I, Items 1 and 2 of this report, and in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report. +Impairment of Oil and Gas Properties. Proved oil and gas properties are evaluated for impairment on a depletion pool-by-pool basis and reduced to fair value when events or changes in circumstances indicate that their carrying amount may not be recoverable. We estimate the expected future cash flows of our proved oil and gas properties and compare these undiscounted cash flows to the carrying amount to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will write down the carrying amount of the proved oil and gas properties to fair value (or discounted future cash flows). Management estimates future cash flows from all proved reserves and risk adjusted probable and possible reserves using various factors, which are subject to our judgment and expertise, and include, but are not limited to, commodity price forecasts, estimated future operating and capital costs, development plans, and discount rates to incorporate the risk and current market conditions associated with realizing the expected cash flows. +Unproved oil and gas properties are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by asset group and the portion of such costs estimated to be nonproductive prior to lease expiration are amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and our intent to renew leases. We estimate the fair value of unproved properties using a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by us or other market participants. +We cannot predict when or if future impairment charges will be recorded because of the uncertainty in the factors discussed above. Despite any amount of future impairment being difficult to predict, based on our commodity price assumptions as of February 8, 2024, we do not expect any material oil and gas property impairments in the first quarter of 2024 resulting from commodity price impacts. +Please refer to Note 1 – Summary of Significant Accounting Policies and Note 8 – Fair Value Measurements in Part II, Item 8 of this report for discussion of impairments of oil and gas properties recorded for the years ended December 31, 2022, and 2021. +Revenue Recognition. We predominately derive our revenue from the sale of produced oil, gas, and NGLs. Our revenue recognition policy is a critical accounting estimate because revenue is a key component of our results of operations and our forward-looking statements contained in our analysis of liquidity and capital resources. A 10 percent change in our revenue accrual at year-end 2023 would have affected total operating revenues by approximately $17.5 million for the year ended December 31, 2023. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 2 – Revenue from Contracts with Customers in Part II, Item 8 of this report for additional discussion. +Derivative Financial Instruments. We periodically enter into commodity derivative contracts to mitigate a portion of our exposure to oil, gas, and NGL price volatility and location differentials. We recognize all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring any such amounts in accumulated other comprehensive income +56 +(loss). The estimated fair value of our derivative instruments requires substantial judgment. These values are based upon, among other things, option pricing models, futures prices, volatility, time to maturity, and credit risk. The values we report in our consolidated financial statements change as these estimates are revised to reflect actual results, changes in market conditions or other factors, many of which are beyond our control. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 7 – Derivative Financial Instruments in Part II, Item 8 of this report for additional discussion. +Income Taxes. We account for deferred income taxes, whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the consolidated financial statements and the tax basis of assets and liabilities, as measured using currently enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recovered or settled, respectively. Considerable judgment is required in predicting when these events may occur and whether recovery of an asset is more likely than not. We record deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. Additionally, our federal and state income tax returns are generally not filed before the consolidated financial statements are prepared. Therefore, we estimate the tax basis of our assets and liabilities at the end of each period, as well as the effects of tax rate changes, tax credits, and net operating and capital loss carryforwards and carrybacks. Adjustments related to differences between the estimates we use and actual amounts we report are recorded in the periods in which we file our income tax returns. These adjustments and changes in our estimates of asset recovery and liability settlement as well as significant enacted tax rate changes could have an impact on our results of operations. A one percent change in our effective tax rate would have changed our calculated income tax expense by approximately $9.1 million for the year ended December 31, 2023. Please refer to Note 1 – Summary of Significant Accounting Policies and Note 4 – Income Taxes in Part II, Item 8 of this report for additional discussion. +Accounting Matters +Please refer to Recently Issued Accounting Standards in Note 1 – Summary of Significant Accounting Policies in Part II, Item 8 of this report for information on new authoritative accounting guidance. +Environmental +We believe we are in substantial compliance with environmental laws and regulations and do not currently anticipate that material future expenditures will be required under the existing regulatory framework. However, environmental laws and regulations are subject to frequent changes, and we are unable to predict the impact that compliance with future laws or regulations, such as those currently being considered as discussed below, may have on future capital expenditures, liquidity, and results of operations. +Hydraulic Fracturing. Hydraulic fracturing is an important and common practice that is used to stimulate production of hydrocarbons from tight formations. For additional information about hydraulic fracturing and related environmental matters, please refer to Risk Factors – Risks Related to Oil and Gas Operations and the Industry – Federal and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. +Climate Change and Air Quality. In June 2013, President Obama announced a Climate Action Plan designed to further reduce GHG emissions and prepare the nation for the physical effects that may occur as a result of climate change. The Climate Action Plan targeted methane reductions from the oil and gas sector as part of a comprehensive interagency methane strategy. As part of the Climate Action Plan, on May 12, 2016, the EPA issued final regulations applicable to new, modified, or reconstructed sources that amended and expanded 2012 regulations for the oil and gas sector by, among other things, setting emission limits for volatile organic compounds (“VOCs” or “VOC”) and methane, a GHG, and added requirements for previously unregulated sources. The 2016 NSPS requires reduction of methane and VOCs from certain activities in oil and gas production, processing, transmission and storage and applies to facilities constructed, modified, or reconstructed after September 18, 2015. The regulation requires, among other things, GHG and VOC emission limits for certain equipment, such as centrifugal compressors and reciprocating compressors; semi-annual leak detection and repair for well sites and quarterly for boosting and garnering compressor stations and gas transmission compressor stations; control requirements and emission limits for pneumatic pumps; and additional requirements for control of GHGs and VOCs from well completions. On September 14, and 15, 2020, the EPA finalized amendments to the 2012 and 2016 NSPS that removed transmission and storage infrastructure from regulation of methane emissions and other VOCs, as well as removed methane control requirements. The portion of the 2020 amendments that removed the transmission and storage infrastructure from the regulations was disapproved by the Congressional Review Act in 2021. In November 2021, the EPA proposed to expand the requirements of the 2012 and 2016 NSPS and also include requirements for states to develop performance standards to control methane emissions from existing sources. In December 2022, the EPA issued a supplemental proposal to update, strengthen, and expand the 2021 proposed rules. The EPA finalized the rule in December 2023. +States are also required to comply with the NAAQS. The oil and gas sector is often subjected to additional controls when areas within states are not attaining the ozone NAAQS as the VOCs emitted by the oil and gas sector are a precursor to ozone formation. The ozone NAAQS was set at 70 parts per billion (“ppb”) in 2015. In 2023, the EPA announced its plan to perform a full and complete review of the ozone NAAQS and intends to release an integrated review plan in 2024. The results of this review could result in changes to the ozone NAAQS which, if lowered, may result in additional actions by states requiring further emission controls and associated costs. Oil and gas facilities operating in areas that are determined to be out of compliance with the 70 ppb requirement or a lowered ozone NAAQS may be subject to increased emission controls and associated costs of compliance. +57 +The United States Congress has from time to time considered adopting legislation to reduce emissions of GHGs and many of the states have already taken legal measures to reduce emissions of GHGs primarily through the planned development of GHG emission inventories and/or regional GHG cap and trade programs. Most of these cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall GHG emission reduction goal. In addition, there have been international conventions and efforts to establish standards for the reduction of GHGs globally, including the Paris accords in December 2015. The conditions for entry into force of the Paris accords were met on October 5, 2016 and the Agreement went into force 30 days later on November 4, 2016. At the United Nations Climate Change Conference in Glasgow in 2021, the United States and the European Union announced the Global Methane Pledge that aims to reduce methane emissions by 30 percent compared with 2020 levels. +The adoption of legislation or regulatory programs to reduce emissions of GHGs could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances, or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and gas we produce. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition, and results of operations. Judicial challenges to new regulatory measures are likely and we cannot predict the outcome of such challenges. New regulatory suspensions, revisions, or rescissions and conflicting state and federal regulatory mandates may inhibit our ability to accurately forecast the costs associated with future regulatory compliance. Finally, scientists have concluded that increasing concentrations of GHGs in the earth’s atmosphere produce climate changes that likely have significant physical effects, such as increased frequency and severity of storms, droughts, floods, and other climatic events. Such effects could have an adverse effect on our financial condition and results of operations. +In terms of opportunities, the regulation of GHG emissions and the introduction of alternative incentives, such as enhanced oil recovery, carbon sequestration, and low carbon fuel standards, could benefit us in a variety of ways. For example, although federal regulation and climate change legislation could reduce the overall demand for the oil and gas that we produce, the relative demand for gas may increase because the burning of gas produces lower levels of emissions than other readily available fossil fuels such as oil and coal. In addition, if renewable resources such as wind or solar power become more prevalent, gas-fired electric plants may provide an alternative backup to maintain consistent electricity supply. Also, if states adopt low-carbon fuel standards, gas may become a more attractive transportation fuel. For each of the years ended December 31, 2023, and 2022, approximately 40 percent of our production on a per BOE basis was gas. Market-based incentives for the capture and storage of carbon dioxide in underground reservoirs, particularly in oil and gas reservoirs, could also benefit us through the potential to obtain GHG emission allowances or offsets from or government incentives for the sequestration of carbon dioxide. +Non-GAAP Financial Measures +Adjusted EBITDAX represents net income (loss) before interest expense, interest income, income taxes, depletion, depreciation, amortization and asset retirement obligation liability accretion expense, exploration expense, property abandonment and impairment expense, non-cash stock-based compensation expense, derivative gains and losses net of settlements, gains and losses on divestitures, gains and losses on extinguishment of debt, and certain other items. Adjusted EBITDAX excludes certain items that we believe affect the comparability of operating results and can exclude items that are generally non-recurring in nature or whose timing and/or amount cannot be reasonably estimated. Adjusted EBITDAX is a non-GAAP measure that we believe provides useful additional information to investors and analysts, as a performance measure, for analysis of our ability to internally generate funds for exploration, development, acquisitions, and to service debt. We are also subject to financial covenants under our Credit Agreement as further described in Note 5 – Long-Term Debt in Part II, Item 8 of this report. In addition, adjusted EBITDAX is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDAX should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or other profitability or liquidity measures prepared under GAAP. Because adjusted EBITDAX excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDAX amounts presented may not be comparable to similar metrics of other companies. Our revolving credit facility provides a material source of liquidity for us. Under the terms of our Credit Agreement, if we failed to comply with the covenants that establish a maximum permitted ratio of total funded debt, as defined in the Credit Agreement, to adjusted EBITDAX, we would be in default, an event that would prevent us from borrowing under our revolving credit facility and would therefore materially limit a significant source of our liquidity. In addition, if we are in default under our revolving credit facility and are unable to obtain a waiver of that default from our lenders, lenders under that facility and under the indentures governing each series of our outstanding Senior Notes, as defined in Note 5 – Long-Term Debt in Part II, Item 8 of this report, would be entitled to exercise all of their remedies for default. +58 +The following table provides reconciliations of our net income (GAAP) and net cash provided by operating activities (GAAP) to adjusted EBITDAX (non-GAAP) for the periods presented: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Net income (GAAP) $ 817,880 $ 1,111,952 $ 36,229 +Interest expense 91,630 120,346 160,353 +Interest income +(19,854) (5,774) (1,716) +Income tax expense 96,322 283,818 9,938 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 690,481 603,780 774,386 +Exploration (1) +55,333 50,978 35,346 +Impairment — 7,468 35,000 +Stock-based compensation expense 20,250 18,772 18,819 +Net derivative (gain) loss (68,154) 374,012 901,659 +Net derivative settlement gain (loss) 26,921 (710,700) (748,958) +Loss on extinguishment of debt — 67,605 2,139 +Other, net 1,497 (3,969) 2,223 +Adjusted EBITDAX (non-GAAP) 1,712,306 1,918,288 1,225,418 +Interest expense (91,630) (120,346) (160,353) +Interest income +19,854 5,774 1,716 +Income tax expense (96,322) (283,818) (9,938) +Exploration (1) (2) +(46,467) (36,810) (35,346) +Amortization of debt discount and deferred financing costs 5,486 10,281 17,275 +Deferred income taxes 88,256 269,057 9,565 +Other, net (12,538) (3,957) (5,976) +Net change in working capital (4,551) (72,063) 117,411 +Net cash provided by operating activities (GAAP) $ 1,574,394 $ 1,686,406 $ 1,159,772 +____________________________________________ +(1) Stock-based compensation expense is a component of the exploration expense and general and administrative expense line items on the accompanying statements of operations. Therefore, the exploration line items shown in the reconciliation above will vary from the amount shown on the accompanying statements of operations for the component of stock-based compensation expense recorded to exploration expense. +(2) For the year ended December 31, 2023, amount excludes certain capital expenditures related to unsuccessful exploration activity for one well that experienced technical issues during the drilling phase. For the year ended December 31, 2022, amount excludes certain capital expenditures related to unsuccessful exploration efforts outside of our core areas of operation. +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The information required by this Item is provided under the captions Interest Rate Risk and Commodity Price Risk in Item 7 above, as well as under the section entitled Summary of Oil, Gas, and NGL Derivative Contracts in Place in Note 7 – Derivative Financial Instruments in Part II, Item 8 of this report and is incorporated herein by reference. +59 +ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of SM Energy Company and subsidiaries (the Company) as of December 31, 2023 and 2022, the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2023, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023, in conformity with U.S. generally accepted accounting principles. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 22, 2024 expressed an unqualified opinion thereon. +Basis for Opinion +These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or is required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +60 +Depletion, Depreciation and Amortization (“DD&A”) of Proved Oil and Gas Properties +Description of the Matter +At December 31, 2023, the net book value of the Company’s proved oil and gas properties was $4.6 billion, and depletion, depreciation, amortization, and asset retirement obligation liability accretion was $690.5 million for the year then ended. As described in Note 1, under the successful efforts method of accounting, capitalized costs of proved properties are depleted using the units-of-production method based on proved reserves, as estimated by the Company’s engineers. Proved reserve estimates are impacted by various inputs, including historical production, oil and gas price assumptions, and future operating and capital cost assumptions, among others, and requires the expertise of the Company’s engineers in evaluating and interpreting the relevant data. Because of the complexity involved in estimating oil and gas reserves, management used independent petroleum engineers to audit the estimates prepared by the Company's engineers as of December 31, 2023. +Auditing the Company’s DD&A calculation is especially complex because of the use of the work of the Company’s engineers and the independent petroleum engineers and the evaluation of management’s determination of the inputs described above used by the engineers in estimating proved oil and gas reserves. +How We Addressed the Matter in Our Audit +We obtained an understanding, evaluated the design and tested the operating effectiveness of the Company’s controls that address the risk of material misstatement relating to proved oil and gas reserves as an input to the DD&A expense calculations, including management’s controls over the completeness and accuracy of the financial data used in estimating proved oil and gas reserves. +Our audit procedures included, among others, evaluating the professional qualifications and objectivity of the Company’s engineers responsible for the preparation of the reserve estimates and the independent petroleum engineers used to audit the estimates. In addition, in assessing whether we can use the work of the engineers, we evaluated the completeness and accuracy of the financial data used by the engineers, in estimating proved oil and gas reserves by agreeing significant inputs to source documentation, where available, on a sample basis, and we assessed the inputs for reasonableness based on our review of corroborative evidence and consideration of any contrary evidence. We also tested that the DD&A expense calculations, are based on appropriate proved oil and gas reserves amounts from the Company’s reserve report. +/s/ Ernst & Young LLP +We have served as the Company’s auditor since 2012. +Denver, Colorado +February 22, 2024 +61 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2023 2022 +ASSETS +Current assets: +Cash and cash equivalents $ 616,164 $ 444,998 +Accounts receivable 231,165 233,297 +Derivative assets 56,442 48,677 +Prepaid expenses and other 12,668 10,231 +Total current assets 916,439 737,203 +Property and equipment (successful efforts method): +Proved oil and gas properties 11,477,358 10,258,368 +Accumulated depletion, depreciation, and amortization ( 6,830,253 ) ( 6,188,147 ) +Unproved oil and gas properties, net of valuation allowance of $ 35,362 and $ 38,008 , respectively +335,620 487,192 +Wells in progress 358,080 287,267 +Other property and equipment, net of accumulated depreciation of $ 59,669 and $ 56,512 , respectively +35,615 38,099 +Total property and equipment, net 5,376,420 4,882,779 +Noncurrent assets: +Derivative assets 8,672 24,465 +Other noncurrent assets 78,454 71,592 +Total noncurrent assets 87,126 96,057 +Total assets $ 6,379,985 $ 5,716,039 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable and accrued expenses $ 611,598 $ 532,289 +Derivative liabilities 6,789 56,181 +Other current liabilities 15,425 10,114 +Total current liabilities 633,812 598,584 +Noncurrent liabilities: +Revolving credit facility — — +Senior Notes, net 1,575,334 1,572,210 +Asset retirement obligations 118,774 108,233 +Net deferred tax liabilities 369,903 280,811 +Derivative liabilities 1,273 1,142 +Other noncurrent liabilities 65,039 69,601 +Total noncurrent liabilities 2,130,323 2,031,997 +Commitments and contingencies (note 6) +Stockholders’ equity: +Common stock, $ 0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 115,745,393 and 121,931,676 shares, respectively +1,157 1,219 +Additional paid-in capital 1,565,021 1,779,703 +Retained earnings 2,052,279 1,308,558 +Accumulated other comprehensive loss ( 2,607 ) ( 4,022 ) +Total stockholders’ equity 3,615,850 3,085,458 +Total liabilities and stockholders’ equity $ 6,379,985 $ 5,716,039 +The accompanying notes are an integral part of these consolidated financial statements. +62 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +For the Years Ended +December 31, +2023 2022 2021 +Operating revenues and other income: +Oil, gas, and NGL production revenue $ 2,363,889 $ 3,345,906 $ 2,597,915 +Other operating income 9,997 12,741 24,979 +Total operating revenues and other income 2,373,886 3,358,647 2,622,894 +Operating expenses: +Oil, gas, and NGL production expense 563,543 620,912 505,416 +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 690,481 603,780 774,386 +Exploration 59,480 54,943 39,296 +Impairment — 7,468 35,000 +General and administrative 121,063 114,558 111,945 +Net derivative (gain) loss ( 68,154 ) 374,012 901,659 +Other operating expense, net 20,567 3,493 46,069 +Total operating expenses 1,386,980 1,779,166 2,413,771 +Income from operations 986,906 1,579,481 209,123 +Interest expense ( 91,630 ) ( 120,346 ) ( 160,353 ) +Interest income 19,854 5,774 1,716 +Loss on extinguishment of debt — ( 67,605 ) ( 2,139 ) +Other non-operating expense ( 928 ) ( 1,534 ) ( 2,180 ) +Income from before income taxes 914,202 1,395,770 46,167 +Income tax expense ( 96,322 ) ( 283,818 ) ( 9,938 ) +Net income $ 817,880 $ 1,111,952 $ 36,229 +Basic weighted-average common shares outstanding 118,678 122,351 119,043 +Diluted weighted-average common shares outstanding 119,240 124,084 123,690 +Basic net income per common share $ 6.89 $ 9.09 $ 0.30 +Diluted net income per common share $ 6.86 $ 8.96 $ 0.29 +The accompanying notes are an integral part of these consolidated financial statements. +63 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(in thousands) +For the Years Ended +December 31, +2023 2022 2021 +Net income $ 817,880 $ 1,111,952 $ 36,229 +Other comprehensive income, net of tax: +Pension liability adjustment (1) +1,415 8,827 749 +Total other comprehensive income, net of tax 1,415 8,827 749 +Total comprehensive income $ 819,295 $ 1,120,779 $ 36,978 +____________________________________________ +(1) Please refer to Note 11 – Pension Benefits for additional discussion of the pension liability adjustment. +The accompanying notes are an integral part of these consolidated financial statements. +64 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands, except share data and dividends per share) +Additional Paid-in Capital Accumulated Other Comprehensive Loss Total Stockholders’ Equity +Common Stock Retained Earnings +Shares Amount +Balances, January 1, 2021 114,742,304 $ 1,147 $ 1,827,914 $ 200,697 $ ( 13,598 ) $ 2,016,160 +Net income — — — 36,229 — 36,229 +Other comprehensive income — — — — 749 749 +Net cash dividends declared, $ 0.02 per share +— — — ( 2,393 ) — ( 2,393 ) +Issuance of common stock under Employee Stock Purchase Plan 313,773 3 2,636 — — 2,639 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings 827,572 9 ( 9,081 ) — — ( 9,072 ) +Stock-based compensation expense 60,510 1 18,818 — — 18,819 +Issuance of common stock through cashless exercise of Warrants 5,918,089 59 ( 59 ) — — — +Balances, December 31, 2021 121,862,248 $ 1,219 $ 1,840,228 $ 234,533 $ ( 12,849 ) $ 2,063,131 +Net income — — — 1,111,952 — 1,111,952 +Other comprehensive income — — — — 8,827 8,827 +Net cash dividends declared, $ 0.31 per share +— — — ( 37,927 ) — ( 37,927 ) +Issuance of common stock under Employee Stock Purchase Plan 113,785 1 3,038 — — 3,039 +Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings 1,291,427 13 ( 25,142 ) — — ( 25,129 ) +Stock-based compensation expense 29,471 — 18,772 — — 18,772 +Purchase of shares under Stock Repurchase Program ( 1,365,255 ) ( 14 ) ( 57,193 ) — — ( 57,207 ) +Balances, December 31, 2022 121,931,676 $ 1,219 $ 1,779,703 $ 1,308,558 $ ( 4,022 ) $ 3,085,458 +Net income — — — 817,880 — 817,880 +Other comprehensive income — — — — 1,415 1,415 +Net cash dividends declared, $ 0.63 per share +— — — ( 74,159 ) — ( 74,159 ) +Issuance of common stock under Employee Stock Purchase Plan 114,427 1 3,057 — — 3,058 +Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings 554,216 6 ( 7,888 ) — — ( 7,882 ) +Stock-based compensation expense 56,872 1 20,249 — — 20,250 +Issuance of common stock through cashless exercise of Warrants 19,037 — — — — — +Purchase of shares under Stock Repurchase Program ( 6,930,835 ) ( 70 ) ( 230,100 ) — — ( 230,170 ) +Balances, December 31, 2023 115,745,393 $ 1,157 $ 1,565,021 $ 2,052,279 $ ( 2,607 ) $ 3,615,850 +The accompanying notes are an integral part of these consolidated financial statements. +65 +SM ENERGY COMPANY AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +For the Years Ended +December 31, +2023 2022 2021 +Cash flows from operating activities: +Net income $ 817,880 $ 1,111,952 $ 36,229 +Adjustments to reconcile net income to net cash provided by operating activities: +Depletion, depreciation, amortization, and asset retirement obligation liability accretion 690,481 603,780 774,386 +Impairment — 7,468 35,000 +Stock-based compensation expense 20,250 18,772 18,819 +Net derivative (gain) loss ( 68,154 ) 374,012 901,659 +Net derivative settlement gain (loss) 26,921 ( 710,700 ) ( 748,958 ) +Amortization of debt discount and deferred financing costs 5,486 10,281 17,275 +Loss on extinguishment of debt — 67,605 2,139 +Deferred income taxes 88,256 269,057 9,565 +Other, net ( 2,175 ) 6,242 ( 3,753 ) +Changes in working capital: +Accounts receivable ( 10,191 ) 38,554 ( 101,047 ) +Prepaid expenses and other ( 2,437 ) ( 1,055 ) 220 +Accounts payable and accrued expenses 8,077 ( 109,562 ) 218,238 +Net cash provided by operating activities 1,574,394 1,686,406 1,159,772 +Cash flows from investing activities: +Capital expenditures ( 989,411 ) ( 879,934 ) ( 674,841 ) +Acquisition of proved and unproved oil and gas properties ( 109,931 ) ( 7 ) ( 3,321 ) +Other, net 657 ( 322 ) 10,927 +Net cash used in investing activities ( 1,098,685 ) ( 880,263 ) ( 667,235 ) +Cash flows from financing activities: +Proceeds from revolving credit facility — — 1,832,500 +Repayment of revolving credit facility — — ( 1,925,500 ) +Net proceeds from Senior Notes — — 392,771 +Cash paid to repurchase Senior Notes — ( 584,946 ) ( 450,776 ) +Repurchase of common stock ( 228,105 ) ( 57,207 ) — +Net proceeds from sale of common stock 3,058 3,039 2,639 +Dividends paid ( 71,614 ) ( 19,637 ) ( 2,393 ) +Net share settlement from issuance of stock awards ( 7,882 ) ( 25,129 ) ( 9,072 ) +Other, net — ( 9,981 ) — +Net cash used in financing activities ( 304,543 ) ( 693,861 ) ( 159,831 ) +Net change in cash, cash equivalents, and restricted cash 171,166 112,282 332,706 +Cash, cash equivalents, and restricted cash at beginning of period 444,998 332,716 10 +Cash, cash equivalents, and restricted cash at end of period $ 616,164 $ 444,998 $ 332,716 +Supplemental schedule of additional cash flow information and non-cash activities: +Operating activities: +Cash paid for interest, net of capitalized interest $ ( 86,947 ) $ ( 134,240 ) $ ( 136,606 ) +Net cash paid for income taxes $ ( 8,975 ) $ ( 10,576 ) $ ( 864 ) +Investing activities: +Changes in capital expenditure accruals +$ 80,794 $ 29,789 $ ( 10,826 ) +Non-cash financing activities (1) +____________________________________________ +(1) Please refer to Note 5 – Long-Term Debt for discussion of the debt transactions completed during the years ended December 31, 2022, and 2021. +The accompanying notes are an integral part of these consolidated financial statements. +66 +SM ENERGY COMPANY AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +Note 1 – Summary of Significant Accounting Policies +Description of Operations +SM Energy Company, together with its consolidated subsidiaries, is an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the state of Texas. +Basis of Presentation +The accompanying consolidated financial statements include the accounts of the Company and have been prepared in accordance with GAAP and the instructions to Form 10-K and Regulation S-X. Intercompany accounts and transactions have been eliminated. In connection with the preparation of the accompanying consolidated financial statements, the Company evaluated events subsequent to the balance sheet date of December 31, 2023, through the filing of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the accompanying consolidated financial statements. +Use of Estimates in the Preparation of Financial Statements +The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of proved oil and gas reserves, assets and liabilities, disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates of proved oil and gas reserve quantities provide the basis for the calculation of DD&A expense, impairment of proved and unproved oil and gas properties, and asset retirement obligations, each of which represents a significant component of the accompanying consolidated financial statements. +Cash and Cash Equivalents +The Company considers all liquid investments purchased with an initial maturity of three months or less and deposits in money market mutual funds that are readily convertible into cash to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments. +Accounts Receivable +The Company’s accounts receivable primarily consist of receivables due from oil, gas, and NGL purchasers and from joint interest owners on properties the Company operates. For receivables due from joint interest owners, the Company generally has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, the Company’s oil, gas, and NGL receivables are collected within 30 to 90 days and the Company has had minimal bad debts. Although diversified among many companies, collectability is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. Please refer to Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses for additional disclosure. +Concentration of Credit Risk and Major Customers +The Company is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is regularly reviewed. +The Company does not believe the loss of any single purchaser of its production would materially affect its operating results, as oil, gas, and NGLs are products with well-established markets and numerous purchasers in the Company’s operating areas. The following major customers and entities under common control accounted for 10 percent or more of the Company’s total oil, gas, and NGL production revenue for at least one of the periods presented: +For the Years Ended December 31, +2023 2022 2021 +Major customer #1 24 % 24 % 27 % +Major customer #2 +11 % 7 % 9 % +Major customer #3 +6 % 8 % 15 % +Group #1 of entities under common control 22 % 24 % 18 % +67 +For its commodity derivative instruments, the Company’s policy is to only enter into contracts with affiliates of the lenders under its Credit Agreement as its derivative counterparties, and each counterparty must have certain minimum investment grade senior unsecured debt ratings. +The Company maintains its primary bank accounts with a large, multinational bank that has branch locations in the Company’s areas of operation. The Company’s policy is to diversify its concentration of cash and cash equivalent investments among multiple institutions and investment products to limit the amount of credit exposure to any single institution or investment. +Oil and Gas Producing Activities +Proved properties . The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, property acquisition costs and development costs are capitalized when incurred. Capitalized drilling and completion costs, including lease and well equipment, intangible development costs, and operational support facilities in the field, are depleted on an asset group basis (properties aggregated based on geographical and geological characteristics) using the units-of-production method based on estimated net proved developed oil and gas reserves. Similarly, proved leasehold costs are depleted on the same asset group basis; however, the units-of-production method is based on estimated total net proved oil and gas reserves. The computation of DD&A expense takes into consideration restoration, dismantlement, and abandonment costs as well as the anticipated proceeds from salvaging equipment. +Proved oil and gas property costs are evaluated for impairment on a depletion pool-by-pool basis and reduced to fair value when there is an indication that associated carrying costs may not be recoverable. The Company uses Level 3 inputs and the income valuation technique, which converts future cash flows to a single present value amount, to measure the fair value of proved properties using a discount rate, price and cost forecasts, and certain reserve risk-adjustment factors, as selected by the Company’s management. The Company uses a discount rate that represents a current market-based weighted average cost of capital. The discount rate typically ranges from 10 percent to 15 percent. The prices for oil and gas are forecast based on NYMEX strip pricing, adjusted for basis differentials, for the first five years , after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecast using OPIS Mont Belvieu pricing, adjusted for basis differentials, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. Certain undeveloped reserve estimates are also risk-adjusted given the risk to related projected cash flows due to performance and exploitation uncertainties. +The partial sale of a proved property within an existing field is accounted for as a normal retirement and no gain or loss on divestiture activity is recognized as long as the treatment does not significantly affect the units-of-production depletion rate. The sale of a partial interest in an individual proved property is accounted for as a recovery of cost. A gain or loss on divestiture activity is recognized in the accompanying statements of operations for all other sales of proved properties. +Unproved properties . The unproved oil and gas properties line item on the accompanying consolidated balance sheets (“accompanying balance sheets”) consists of the costs incurred to acquire unproved leases. Leasehold costs allocated to those leases, or partial leases that have associated proved reserves recorded, are reclassified to proved properties and depleted on an asset group basis using the units-of-production method based on estimated total proved oil and gas reserves. Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. Lease acquisition costs that are not individually significant are aggregated by asset group and the portion of such costs estimated to be nonproductive prior to lease expiration are recognized as a valuation allowance and amortized over the appropriate period. The estimate of what could be nonproductive is based on historical trends or other information, including current drilling plans and the Company’s intent to renew leases. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: remaining lease terms, future development plans, risk-weighted potential resource recovery, estimated reserve values, and estimated acreage value based on price(s) received for similar, recent acreage transactions by the Company or other market participants. +For the sale of unproved properties where the original cost has been partially or fully amortized by providing a valuation allowance on an asset group basis, neither a gain nor loss is recognized unless the sales price exceeds the original cost of the property, in which case a gain shall be recognized in the accompanying statements of operations in the amount of such excess. +Exploratory . Exploratory geological and geophysical, including exploratory seismic studies, and the costs of carrying and retaining unproved acreage are expensed as incurred. Under the successful efforts method of accounting for oil and gas properties, exploratory well costs are initially capitalized pending the determination of whether proved reserves have been discovered. If proved reserves are discovered, exploratory well costs will be capitalized as proved properties and will be accounted for following the successful efforts method of accounting described above. If proved reserves are not found, exploratory well costs are expensed as dry holes. The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either development or exploratory, which will ultimately determine the proper accounting treatment of costs of dry holes. Once a well is drilled, the determination that proved reserves have been discovered may take considerable time and judgment. Exploratory dry hole costs are included in the cash flows from investing activities section as part of capital expenditures within the accompanying statements of cash flows. +68 +Please refer to Note 8 – Fair Value Measurements for additional information. +Other Property and Equipment +Other property and equipment such as facilities, equipment inventory, office furniture and equipment, buildings, and computer hardware and software are recorded at cost. The Company capitalizes certain software costs incurred during the application development stage. The application development stage generally includes software design, configuration, testing, and installation activities. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repair costs are expensed when incurred. Depreciation is calculated using either the straight-line method over the estimated useful lives of the assets, which range from three to 30 years, or the unit of output method when appropriate. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the Company’s accounts. +Facilities and equipment inventory costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. To measure the fair value of facilities and equipment inventory, the Company uses an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. For facilities, the valuation includes consideration of the proved and unproved assets supported by the facilities, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. +Asset Retirement Obligations +The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and gas properties, including facilities requiring decommissioning. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired, or a facility is constructed. The increase in carrying value is included in the proved oil and gas properties line item in the accompanying balance sheets. The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective long-lived assets. Cash paid to settle asset retirement obligations is included in the cash flows from operating activities section of the accompanying statements of cash flows. +The Company’s estimated asset retirement obligation liability is based on historical experience in plugging and abandoning wells, estimated economic lives, estimated plugging and abandonment cost, and federal and state regulatory requirements. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. The credit-adjusted risk-free rates used to discount the Company’s plugging and abandonment liabilities range from 5.5 percent to 12 percent. In periods subsequent to initial measurement of the liability, the Company must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or economic life, changes in inflation factors, or the Company’s credit-adjusted risk-free rate as market conditions warrant. Please refer to Note 14 – Asset Retirement Obligations for a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2023, and 2022. +Derivative Financial Instruments +The Company periodically enters into commodity derivative instruments to mitigate a portion of its exposure to oil, gas, and NGL price volatility and location differentials for its expected future oil, gas, and NGL production, and the associated effect on cash flows. These instruments typically include commodity price swaps and collar arrangements, as well as, basis swaps and roll differential swaps. Commodity derivative instruments are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its commodity derivative contracts as hedging instruments. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its accompanying statements of operations as they occur. Gains and losses on net derivative settlements are included within the cash flows from operating activities section of the accompanying statements of cash flows. Please refer to Note 7 – Derivative Financial Instruments for additional discussion. +Revenue Recognition +The Company derives revenue predominately from the sale of produced oil, gas, and NGLs. Revenue is recognized at the point in time when custody and title (“control”) of the product transfers to the purchaser, which may differ depending on the applicable contractual terms. Revenue accruals are recorded monthly and are based on estimated production delivered to a purchaser and the expected price to be received. The Company uses knowledge of its properties, contractual arrangements, historical performance, NYMEX, local spot market, and OPIS prices, and other factors as the basis of these estimates. Variances between estimates and the actual amounts received are recorded in the month payment is received. Please refer to Note 2 – Revenue from Contracts with Customers for additional discussion. +69 +Stock-Based Compensation +At December 31, 2023, the Company had stock-based employee compensation plans that included RSUs and Performance Share Units (“PSU or “PSUs”) issued to employees, RSUs and restricted stock issued to non-employee directors, and an employee stock purchase plan available to eligible employees. The Company records expense associated with the fair value of stock-based compensation in accordance with authoritative accounting guidance, which is based on the estimated fair value of these awards determined at the time of grant, and is included within the general and administrative and exploration expense line items in the accompanying statements of operations. For stock-based compensation awards containing non-market based performance conditions, the Company evaluates the probability of the number of shares that are expected to vest, and then adjusts the expense to reflect the number of shares expected to vest and the cumulative vesting period met to date. Further, the Company accounts for forfeitures of stock-based compensation awards as they occur. Please refer to Note 10 – Compensation Plans for additional discussion . +Income Taxes +The Company accounts for deferred income taxes whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the carrying amounts on the accompanying consolidated financial statements and the tax basis of assets and liabilities, as measured using current enacted tax rates. These differences will result in taxable income or deductions in future years when the reported amounts of the assets or liabilities are recorded or settled, respectively. The Company records deferred tax assets and associated valuation allowances, when appropriate, to reflect amounts more likely than not to be realized based upon Company analysis. The cumulative effect of enacted tax rate changes on the net balance of reported amounts of assets and liabilities is recognized in the period of enactment. The Company’s policy is to record interest related to income taxes in the interest expense line item in the accompanying statements of operations, and to record penalties related to income taxes in the other non-operating expense line item in the accompanying statements of operations. Please refer to Note 4 – Income Taxes for additional discussion. +Earnings per Share +The Company uses the treasury stock method to determine the effect of potentially dilutive instruments. Please refer to Note 9 – Earnings Per Share for additional discussion. +Comprehensive Income (Loss) +Comprehensive income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that, under GAAP, are reported as separate components of stockholders’ equity instead of net income (loss). Comprehensive income (loss) is presented net of income taxes in the accompanying consolidated statements of comprehensive income. The Company’s policy for releasing income tax effects within accumulated other comprehensive loss is an incremental, unit-of-account approach. Please refer to Note 11 – Pension Benefits for detail on the changes in the balances of components comprising other comprehensive income. +Fair Value of Financial Instruments +The Company’s financial instruments including cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value due to the short-term maturity of these instruments. The Company’s Senior Notes, as defined in Note 5 – Long-Term Debt , are recorded at cost, net of unamortized deferred financing costs, and their respective fair values are disclosed in Note 8 – Fair Value Measurements. Additionally, the Company has derivative financial instruments that are recorded at fair value. Considerable judgment is required to develop estimates of fair value. The estimates provided are not necessarily indicative of the amounts the Company would realize upon the sale or refinancing of such instruments. +Leases +The Company accounts for leases in accordance with ASC Topic 842, Leases , (“Topic 842”), which requires lessees to recognize operating and finance leases with terms greater than 12 months on the balance sheet. The Company evaluates a contractual arrangement at its inception to determine if it is a lease or contains an identifiable lease component. Certain leases may contain both lease and non-lease components. The Company’s policy for all asset classes is to combine lease and non-lease components together and account for the arrangement as a single lease. +Certain assumptions and judgments made by the Company when evaluating a contract that meets the definition of a lease under Topic 842 include those to determine the discount rate and lease term. Unless implicitly defined, the Company determines the present value of future lease payments using an estimated incremental borrowing rate based on a yield curve analysis that factors in certain assumptions, including the term of the lease and credit rating of the Company at lease inception. The Company evaluates each contract containing a lease arrangement at inception to determine the length of the lease term when recognizing a right-of-use (“ROU”) asset and corresponding lease liability. When determining the lease term, options available to extend or early terminate the arrangement are evaluated and included when it is reasonably certain an option will be exercised. Exercising an early termination +70 +option may result in an early termination penalty depending on the terms of the underlying agreement. The Company excludes from the balance sheet leases with terms that are less than one year. +An ROU asset represents a lessee’s right to use an underlying asset for the lease term, while the associated lease liability represents the lessee’s obligations to make lease payments. At the commencement date, which is the date on which a lessor makes an underlying asset available for use by a lessee, a lease ROU asset and corresponding lease liability is recognized based on the present value of the future lease payments. The initial measurement of lease payments may also be adjusted for certain items, including options that are reasonably certain to be exercised, such as options to purchase the asset at the end of the lease term, or options to extend or early terminate the lease. Excluded from the initial measurement of an ROU asset and corresponding lease liability are certain variable lease payments, such as payments made that vary depending on actual usage or performance. +Subsequent to initial measurement, costs associated with the Company’s operating leases are either expensed or capitalized depending on how the underlying ROU asset is utilized and in accordance with GAAP requirements. When calculating the Company’s ROU asset and liability for a contractual arrangement that qualifies as an operating lease, the Company considers all of the necessary payments made or that are expected to be made upon commencement of the lease. As discussed above, excluded from the initial measurement are certain variable lease payments, which for the Company’s drilling rigs, completion crews, and midstream agreements, may be a significant component of the total lease costs. Please refer to Note 12 – Leases for additional discussion. +Industry Segment and Geographic Information +The Company operates in the exploration and production segment of the oil and gas industry, onshore in the United States. The Company reports as a single industry segment. +Off-Balance Sheet Arrangements +The Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or SPEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. +The Company evaluates its transactions to determine if any variable interest entities exist. If it is determined that the Company is the primary beneficiary of a variable interest entity, that entity is consolidated into the Company’s consolidated financial statements. The Company has not been involved in any unconsolidated SPE transactions during 2023 or 2022, or through the filing of this report. +Recently Issued Accounting Standards +In October 2023, the FASB issued ASU No. 2023-06, Disclosure Improvements: Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative (“ASU 2023-06”). ASU 2023-06 was issued to modify the disclosure or presentation requirements of a variety of topics in the codification. The effective date for each amendment will be the date on which the SEC’s removal of the related disclosure from Regulation S-X or Regulation S-K becomes effective, with early adoption prohibited. The Company evaluated ASU 2023-06 and does not expect the adoption of the applicable amendments to have a material effect on its consolidated financial statements and related disclosures. +In November 2023, the FASB issued ASU No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures ( “ASU 2023-07” ). ASU 2023-07 was issued to improve the disclosures about a public entity’s reportable segments and to provide additional, more detailed information about a reportable segment’s expenses. ASU 2023-07 is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. The guidance is to be applied on a retrospective basis to all prior periods presented in the financial statements. The Company is within the scope of this ASU and is evaluating the impact of this ASU on its consolidated financial statement disclosures. +In December 2023, the FASB issued ASU No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures ( “ASU 2023-09” ). ASU 2023-09 was issued to improve the disclosures related to rate reconciliations and income taxes paid. ASU 2023-09 is effective for annual periods beginning after December 15, 2024, with early adoption permitted. The guidance should be applied on a prospective basis, however, retrospective application is permitted. The Company is within the scope of this ASU and is evaluating the impact of this ASU on its consolidated financial statement disclosures. +As of the filing of this report, the Company has not elected to early adopt ASU 2023-07 or ASU 2023-09. +As of December 31, 2023, and through the filing of this report, no other ASUs have been issued and not yet adopted that are applicable to the Company and that would have a material effect on the Company’s consolidated financial statements and related disclosures. +71 +Note 2 – Revenue from Contracts with Customers +The Company recognizes its share of revenue from the sale of produced oil, gas, and NGLs from its Midland Basin and South Texas assets. Oil, gas, and NGL production revenue presented within the accompanying statements of operations reflects revenue generated from contracts with customers. +The tables below present oil, gas, and NGL production revenue by product type for each of the Company’s operating areas for the years ended December 31, 2023, 2022, and 2021: +For the year ended December 31, 2023 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 1,347,780 $ 465,995 $ 1,813,775 +Gas production revenue 175,183 152,700 327,883 +NGL production revenue 687 221,544 222,231 +Total $ 1,523,650 $ 840,239 $ 2,363,889 +Relative percentage 64 % 36 % 100 % +For the year ended December 31, 2022 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 1,816,597 $ 453,471 $ 2,270,068 +Gas production revenue 432,831 358,049 790,880 +NGL production revenue 986 283,972 284,958 +Total $ 2,250,414 $ 1,095,492 $ 3,345,906 +Relative percentage 67 % 33 % 100 % +For the year ended December 31, 2021 +Midland Basin South Texas Total +(in thousands) +Oil production revenue $ 1,701,915 $ 189,911 $ 1,891,826 +Gas production revenue 326,115 199,364 525,479 +NGL production revenue 381 180,229 180,610 +Total $ 2,028,411 $ 569,504 $ 2,597,915 +Relative percentage 78 % 22 % 100 % +The Company recognizes oil, gas, and NGL production revenue at the point in time when control of the product transfers to the purchaser, which may differ depending on the applicable contractual terms. Transfer of control determines the presentation of transportation, gathering, processing, and other post-production expenses (“fees and other deductions”) within the accompanying statements of operations. Fees and other deductions incurred by the Company prior to transfer of control are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. When control is transferred at or near the wellhead, sales are based on a wellhead market price that may be affected by fees and other deductions incurred by the purchaser subsequent to the transfer of control. In general, the Company generates production revenue from a combination of the following types of contracts: +• The Company sells oil and gas production at or near the wellhead and receives an agreed-upon market price from the purchaser. Under this type of arrangement, control transfers at or near the wellhead. +• The Company has certain processing arrangements that include the delivery of unprocessed gas to a midstream processor’s facility for processing. Upon completion of processing, the midstream processor purchases the NGLs and redelivers residue gas back to the Company in-kind. For the NGLs extracted during processing, the midstream processor remits payment to the Company. For the residue gas taken in-kind, the Company has separate sales contracts where control transfers at points downstream of the processing facility. The Company also has certain oil sales that occur at market locations downstream of the production area. Given the structure of these arrangements and where control transfers, the Company separately +72 +recognizes fees and other deductions incurred prior to control transfer. These fees are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. +Significant judgments made in applying the guidance in ASC Topic 606, Revenue from Contracts with Customers, relate to the point in time when control transfers to purchasers in gas processing arrangements with midstream processors. The Company does not believe that significant judgments are required with respect to the determination of the transaction price, including amounts that represent variable consideration, as volume and price carry a low level of estimation uncertainty given the precision of volumetric measurements and the use of index pricing with generally predictable differentials. Accordingly, the Company does not consider estimates of variable consideration to be constrained. +The Company’s performance obligations arise upon the production of hydrocarbons from wells in which the Company has an ownership interest. The performance obligations are considered satisfied upon control transferring to a purchaser at the wellhead, inlet, or tailgate of the midstream processor’s processing facility, or other contractually specified delivery point. The time period between production and satisfaction of performance obligations is generally less than one day; thus, there are no material unsatisfied or partially unsatisfied performance obligations at the end of the reporting period. +Revenue is recorded in the month when performance obligations are satisfied. However, settlement statements from the purchasers of hydrocarbons and the related cash consideration are received 30 to 90 days after production has occurred. As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the product. Estimated revenue due to the Company is recorded within the accounts receivable line item on the accompanying balance sheets until payment is received. The accounts receivable balances from contracts with customers within the accompanying balance sheets as of December 31, 2023, and 2022, were $ 175.3 million and $ 184.5 million, respectively. To estimate accounts receivable from contracts with customers, the Company uses knowledge of its properties, historical performance, contractual arrangements, index pricing, quality and transportation differentials, and other factors as the basis for these estimates. Differences between estimates and actual amounts received for product sales are recorded in the month that payment is received from the purchaser. +Note 3 – Equity +Stock Repurchase Program +During 2022, the Company’s Board of Directors approved the Stock Repurchase Program authorizing the Company to repurchase up to $ 500.0 million in aggregate value of its common stock through December 31, 2024 . The Stock Repurchase Program permits the Company to repurchase shares of its common stock from time to time in open market transactions, through privately negotiated transactions or by other means in accordance with federal securities laws and subject to certain provisions of the Credit Agreement and the indentures governing the Senior Notes, as defined in Note 5 – Long-Term Debt . The timing, as well as the number and value of shares repurchased under the Stock Repurchase Program, will be determined by certain authorized officers of the Company at their discretion and will depend on a variety of factors, including the market price of the Company’s common stock, general market and economic conditions and applicable legal requirements. The value of shares authorized for repurchase by the Board of Directors does not require the Company to repurchase such shares or guarantee that such shares will be repurchased, and the Stock Repurchase Program may be suspended, modified, or discontinued at any time without prior notice. No assurance can be given that any particular number or dollar value of its shares will be repurchased by the Company. +The following table presents the Company’s common stock repurchase activity for the years ended December 31, 2023, and 2022: +For the Years Ended December 31, +2023 2022 +(in thousands, except per share data) +Shares of common stock repurchased (1) +6,931 1,365 +Weighted-average price per share (2) +$ 32.89 $ 41.88 +Cost of shares of common stock repurchased (2) (3) +$ 227,966 $ 57,179 +____________________________________________ +(1) All repurchased shares of the Company’s common stock were retired upon repurchase. +(2) Amounts exclude excise taxes, commissions, and fees. +(3) Amounts may not calculate due to rounding. +As of the filing of this report, $ 214.9 million remains available for repurchases of the Company’s outstanding common stock through December 31, 2024, under the Stock Repurchase Program. +73 +Dividends +During 2023, the Company’s Board of Directors approved an increase to the Company’s fixed dividend to $ 0.72 per share annually, to be paid in quarterly increments of $ 0.18 per share, beginning in the first quarter of 2024. During the year ended December 31, 2023, net cash dividends declared totaled $ 74.2 million. +Warrants +On June 17, 2020, the Company issued warrants to purchase up to an aggregate of approximately 5.9 million shares, or approximately five percent of its then outstanding common stock, at an exercise price of $ 0.01 per share (“Warrants”). The Warrants became exercisable at the election of the holders on January 15, 2021 , pursuant to the terms of the Warrant Agreement, dated June 17, 2020, and all of the Warrants were exercised prior to their expiration date of June 30, 2023 . +The following table presents activity related to warrants exercised during the periods presented: +For the Years Ended December 31, +2023 2022 2021 +(in thousands, except per share data) +Warrants exercised +19 — 5,922 +Shares of common stock issued as a result of cashless exercise of warrants +19 — 5,918 +Weighted-average share price on exercise date +$ 29.09 $ — $ 15.45 +Note 4 – Income Taxes +The provision for income taxes consisted of the following: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Current portion of income tax (expense) benefit +Federal $ ( 8,461 ) $ ( 9,230 ) $ — +State 395 ( 5,531 ) ( 373 ) +Deferred portion of income tax expense ( 88,256 ) ( 269,057 ) ( 9,565 ) +Income tax expense $ ( 96,322 ) $ ( 283,818 ) $ ( 9,938 ) +Effective tax rate 10.5 % 20.3 % 21.5 % +74 +The components of the net deferred tax liabilities are as follows: +As of December 31, +2023 2022 +(in thousands) +Deferred tax liabilities: +Oil and gas properties excluding asset retirement obligation liabilities $ 450,634 $ 358,537 +Derivative assets 12,319 3,416 +Other 6,283 6,059 +Total deferred tax liabilities 469,236 368,012 +Deferred tax assets: +Credit carryover, net +56,097 161 +Asset retirement obligation liabilities 26,592 24,899 +Lease liabilities 4,454 4,525 +Federal and state tax net operating loss carryovers 3,271 28,151 +Legal liabilities +2,838 — +Pension 2,453 3,970 +Interest carryforward 1,031 22,667 +Other +4,003 4,444 +Total deferred tax assets 100,739 88,817 +Valuation allowance ( 1,406 ) ( 1,616 ) +Net deferred tax assets 99,333 87,201 +Net deferred tax liabilities +$ 369,903 $ 280,811 +Current federal income tax refundable (payable) +$ ( 4,899 ) $ 770 +Current state income tax refundable (payable) +$ 1,253 $ ( 5,316 ) +As of December 31, 2023, the Company had utilized all of its remaining federal net operating loss (“NOL”) carryovers and had gross state NOL carryforwards of $ 74.0 million. Other than in states with no NOL carryforward expiration, the Company’s state NOL carryforwards expire between 2029 and 2039. The Company’s current valuation allowance includes an amount for state NOL carryforwards and state tax credits, which are expected to expire before they can be utilized. +The Company commissioned a multi-year R&D credit study in 2022, which was completed during 2023, and resulted in a favorable adjustment to the Company’s effective tax rate and a reduction of the Company’s 2022 and 2023 tax obligations. After utilizing a portion of the credits for the 2022 and 2023 tax years, the recorded net carryover R&D credit, as of December 31, 2023, expected to be utilized in future periods totaled $ 56.1 million. The R&D credits expire between 2037 and 2043. +75 +Income tax expense or benefit differs from the amount that would be provided by applying the statutory United States federal income tax rate to income or loss before income taxes. These differences primarily relate to the effect of federal tax credits, state income taxes, changes in valuation allowances, excess tax benefits and deficiencies from stock-based compensation awards, tax deduction limitations on compensation of covered individuals, the cumulative impact of other smaller permanent differences, and can also reflect the cumulative effect of an enacted tax rate change, in the period of enactment, on the Company’s net deferred tax asset and liability balances. These differences for the years ended December 31, 2023, 2022, and 2021, are presented below: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Federal statutory tax expense $ ( 191,983 ) $ ( 293,112 ) $ ( 9,695 ) +(Increase) decrease in tax resulting from: +Net federal R&D tax credit +92,420 — — +Change in valuation allowance 210 16,845 ( 5,073 ) +State tax (expense) benefit, net of federal effect 5,166 ( 9,870 ) ( 211 ) +Other +( 2,135 ) 2,319 5,041 +Income tax expense $ ( 96,322 ) $ ( 283,818 ) $ ( 9,938 ) +Acquisitions, divestitures, drilling activity, and basis differentials, which impact the prices received for oil, gas, and NGLs, impact the apportionment of taxable income to the states where the Company owns oil and gas properties. As these factors change, the Company’s state income tax rate changes. This change, when applied to the Company’s total temporary differences, impacts the total state income tax expense reported. Items affecting state apportionment factors are evaluated upon completion of the prior year income tax return, after significant acquisitions and divestitures, if there are significant changes in drilling activity, or if estimated state revenue changes occur during the year. +For all years before 2020, the Company is generally no longer subject to United States federal or state income tax examinations by tax authorities. +The Company complies with authoritative accounting guidance regarding uncertain tax provisions. The entire amount of unrecognized tax benefit reported by the Company would affect its effective tax rate if recognized. The Company does not expect a significant change to the recorded unrecognized tax benefits in 2024, except for any potential changes related to the Company’s R&D credit study discussed above and any potential 2024 R&D credit claims. +The total amount recorded for unrecognized tax benefits is presented below: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Beginning balance $ 446 $ 446 $ 446 +Additions based on tax positions related to current year 23,713 — — +Ending balance $ 24,159 $ 446 $ 446 +Note 5 – Long-Term Debt +Credit Agreement +The Company’s Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $ 3.0 billion. As of December 31, 2023, the borrowing base and aggregate lender commitments under the Credit Agreement were $ 2.5 billion and $ 1.25 billion, respectively. The revolving credit facility is secured by substantially all of the Company’s proved oil and gas properties. The borrowing base is subject to regular, semi-annual redetermination, and considers the value of both the Company’s proved oil and gas properties reflected in the Company’s most recent reserve report; and commodity derivative contracts, each as determined by the Company’s lender group. The next scheduled borrowing base redetermination date is April 1, 2024. The Credit Agreement is scheduled to mature on the earlier of August 2, 2027 (“Stated Maturity Date”), or 91 days prior to the maturity date of any of the Company’s outstanding Senior Notes, as defined below, to the extent that, on or before such date, the respective Senior Notes have not been repaid, exchanged, repurchased, refinanced, or otherwise redeemed in full, and, if refinanced or exchanged, with a scheduled maturity date that is not earlier than at least 180 days after the Stated Maturity Date. The financial covenants under the Credit Agreement are discussed under Covenants below. +76 +Interest and commitment fees associated with the revolving credit facility are accrued based on a borrowing base utilization grid set forth in the Credit Agreement, as presented in the table below. At the Company’s election, borrowings under the Credit Agreement may be in the form of SOFR, Alternate Base Rate (“ABR”), or Swingline loans. SOFR loans accrue interest at SOFR plus the applicable margin from the utilization grid, and ABR and Swingline loans accrue interest at a market-based floating rate, plus the applicable margin from the utilization grid. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount at rates from the utilization grid. +Borrowing Base Utilization Percentage <25% ≥25% <50% ≥50% <75% ≥75% <90% ≥90% +SOFR Loans +2.000 % 2.250 % 2.500 % 2.750 % 3.000 % +ABR Loans or Swingline Loans +1.000 % 1.250 % 1.500 % 1.750 % 2.000 % +Commitment Fee Rate 0.375 % 0.375 % 0.500 % 0.500 % 0.500 % +The following table presents the outstanding balance, total amount of letters of credit outstanding, and available borrowing capacity under the Credit Agreement as of February 8, 2024, December 31, 2023, and December 31, 2022: +As of February 8, 2024 As of December 31, 2023 As of December 31, 2022 +(in thousands) +Revolving credit facility (1) +$ — $ — $ — +Letters of credit (2) +2,500 2,500 6,000 +Available borrowing capacity 1,247,500 1,247,500 1,244,000 +Total aggregate lender commitment amount $ 1,250,000 $ 1,250,000 $ 1,250,000 +____________________________________________ +(1) Unamortized deferred financing costs attributable to the revolving credit facility are presented as a component of the other noncurrent assets line item on the accompanying balance sheets and totaled $ 8.5 million and $ 10.8 million as of December 31, 2023, and 2022, respectively. These costs are being amortized over the term of the revolving credit facility on a straight-line basis. +(2) Letters of credit outstanding reduce the amount available under the revolving credit facility on a dollar-for-dollar basis. +Senior Notes +The Company’s Senior Notes, net line item on the accompanying balance sheets as of December 31, 2023, and 2022, consisted of the following (collectively referred to as “Senior Notes”): +As of December 31, 2023 As of December 31, 2022 +Principal Amount Unamortized Deferred Financing Costs Principal Amount, Net Principal Amount Unamortized Deferred Financing Costs Principal Amount, Net +(in thousands) +5.625 % Senior Notes due 2025 +$ 349,118 $ 896 $ 348,222 $ 349,118 $ 1,528 $ 347,590 +6.75 % Senior Notes due 2026 +419,235 1,868 417,367 419,235 2,569 416,666 +6.625 % Senior Notes due 2027 +416,791 2,395 414,396 416,791 3,172 413,619 +6.5 % Senior Notes due 2028 +400,000 4,651 395,349 400,000 5,665 394,335 +Total $ 1,585,144 $ 9,810 $ 1,575,334 $ 1,585,144 $ 12,934 $ 1,572,210 +The Senior Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt. The Company may redeem some or all of its Senior Notes prior to their maturity at redemption prices that may include a premium, plus accrued and unpaid interest as described in the indentures governing the Senior Notes. Fees incurred upon issuance of each series of Senior Notes are being amortized as deferred financing costs over the life of the respective notes, unless earlier redeemed or retired, in which case amortization has been proportionately accelerated. +2025 Senior Notes. On May 21, 2015, the Company issued $ 500.0 million in aggregate principal amount of 5.625 % Senior Notes due 2025, at par, which mature on June 1, 2025 (“2025 Senior Notes”). The Company received net proceeds of $ 491.0 million after deducting fees of $ 9.0 million. +77 +2026 Senior Notes. On September 12, 2016, the Company issued $ 500.0 million in aggregate principal amount of 6.75 % Senior Notes due 2026, at par, which mature on September 15, 2026 (“2026 Senior Notes”). The Company received net proceeds of $ 491.6 million after deducting fees of $ 8.4 million. +2027 Senior Notes. On August 20, 2018, the Company issued $ 500.0 million in aggregate principal amount of 6.625 % Senior Notes due 2027, at par, which mature on January 15, 2027 (“2027 Senior Notes”). The Company received net proceeds of $ 492.1 million after deducting fees of $ 7.9 million. +2028 Senior Notes. On June 23, 2021, the Company issued $ 400.0 million in aggregate principal amount of 6.5 % Senior Notes due 2028, at par, which mature on July 15, 2028 (“2028 Senior Notes”). The Company received net proceeds of $ 392.8 million after deducting fees of $ 7.2 million. +Senior Notes Activity +On February 14, 2022, the Company redeemed the $ 104.8 million of aggregate principal amount outstanding of its 5.0 % Senior Notes due 2024 (“2024 Senior Notes”), with cash on hand, pursuant to the terms of the indenture governing the 2024 Senior Notes which provided for a redemption price equal to 100 percent of the principal amount of the 2024 Senior Notes on the date of redemption, plus accrued and unpaid interest. Upon redemption, the Company accelerated the amortization of all remaining previously unamortized deferred financing costs. The Company canceled all redeemed 2024 Senior Notes upon settlement. +On June 23, 2021, the Company issued $ 400.0 million in aggregate principal amount of its 2028 Senior Notes, as described above. The net proceeds of $ 392.8 million were used to repurchase $ 193.1 million and $ 172.3 million of outstanding principal amount of the Company’s 6.125 % Senior Notes due 2022 (“2022 Senior Notes”) and 2024 Senior Notes, respectively, through a cash tender offer (“Tender Offer”), and to redeem the remaining $ 19.3 million of 2022 Senior Notes not repurchased as part of the Tender Offer (“2022 Senior Notes Redemption”). The Company paid total consideration, excluding accrued interest, of $ 385.3 million, and recorded a net loss on extinguishment of debt of $ 2.1 million for the year ended December 31, 2021, which included the accelerated expense recognition of $ 1.5 million of the remaining unamortized deferred financing costs and $ 0.6 million of net premiums. The Company canceled all repurchased and redeemed 2022 Senior Notes and 2024 Senior Notes upon settlement. +Senior Secured Notes Activity +On June 17, 2022, the Company redeemed all of the $ 446.7 million of aggregate principal amount outstanding of its 10.0 % Senior Secured Notes due 2025 (“2025 Senior Secured Notes”), with cash on hand, at a redemption price equal to 107.5 percent of the principal amount outstanding on the date of the redemption, plus accrued and unpaid interest. Upon redemption, the Company recorded a net loss on extinguishment of debt of $ 67.2 million which included $ 33.5 million of premium paid, $ 26.3 million of accelerated expense recognition of the unamortized debt discount, and $ 7.4 million of accelerated expense recognition of the remaining unamortized deferred financing costs. The Company canceled all redeemed 2025 Senior Secured Notes upon settlement. +On July 1, 2021, the 1.50 % Senior Secured Convertible Notes (“2021 Senior Secured Convertible Notes”) matured, and on that day, the Company used borrowings under its revolving credit facility to retire, at par, the outstanding principal amount of $ 65.5 million. +Covenants +The Company is subject to certain financial and non-financial covenants under the Credit Agreement and the indentures governing the Senior Notes that, among other terms, limit the Company’s ability to incur additional indebtedness, make restricted payments including dividends, sell assets, create liens that secure debt, enter into transactions with affiliates, make certain investments, or merge or consolidate with other entities. The financial covenants under the Credit Agreement require that the Company’s (a) total funded debt, as defined in the Credit Agreement, to 12-month trailing adjusted EBITDAX ratio cannot be greater than 3.50 to 1.00 on the last day of each fiscal quarter; and (b) adjusted current ratio, as defined in the Credit Agreement, cannot be less than 1.00 to 1.00 as of the last day of any fiscal quarter. The Company was in compliance with all covenants under the Credit Agreement and the indentures governing the Senior Notes as of December 31, 2023, and through the filing of this report. +Capitalized Interest +Capitalized interest costs for the years ended December 31, 2023, 2022, and 2021, totaled $ 20.4 million, $ 17.6 million, and $ 15.0 million, respectively. The amount of interest the Company capitalizes generally fluctuates based on the amount borrowed, the Company’s capital program, and the timing and amount of costs associated with capital projects that are considered in progress. Capitalized interest costs are included in total costs incurred. Please refer to Costs Incurred in Supplemental Oil and Gas Information (unaudited) in Part II, Item 8 of this report for additional information. +78 +Note 6 – Commitments and Contingencies +Commitments +As of December 31, 2023, the Company had entered into various types of agreements as discussed below. The following table presents the annual minimum payments related to these agreements for the next five years, and the total minimum payments thereafter as of December 31, 2023: +For the Years Ending December 31, Amount +(in thousands) +2024 $ 74,992 +2025 52,175 +2026 28,133 +2027 13,791 +2028 12,461 +Thereafter 14,655 +Total $ 196,207 +Drilling Rig Contracts. The Company has drilling rig contracts in place to facilitate its drilling plans. As of December 31, 2023, the Company’s drilling rig commitments totaled $ 19.1 million under contract terms extending through the third quarter of 2024. If all of these contracts were terminated as of December 31, 2023, the Company would avoid a portion of the contractual service commitments; however, the Company would be required to pay $ 12.3 million in early termination fees. Subsequent to December 31, 2023, the Company entered into a new drilling rig contract, and as of the filing of this report, the Company’s drilling rig commitments totaled $ 14.5 million under contract terms extending through the third quarter of 2024. If all of these contracts were terminated as of the filing of this report, the Company would avoid a portion of the contractual service commitments; however, the Company would be required to pay $ 8.9 million in early termination fees. No material expenses related to early termination or standby fees were incurred by the Company during the year ended December 31, 2023, and the Company does not expect to incur material penalties with regard to its drilling rig contracts during 2024. +Delivery Commitments. The Company has gathering, processing, transportation throughput, and delivery commitments with various third-parties that require delivery of a minimum amount of oil and produced water. As of December 31, 2023, the Company had commitments to deliver a minimum of 5 MMBbl of oil through July of 2026 and 11 MMBbl of produced water through June of 2027. The Company would be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments under certain agreements. As of December 31, 2023, if the Company failed to deliver any product, as applicable, the aggregate undiscounted deficiency payments would total approximately $ 11.5 million. This amount does not include deficiency payment estimates associated with approximately 1 MMBbl of future oil delivery commitments where the Company cannot predict with accuracy the amount and timing of these payments, as such payments are dependent upon the price of oil in effect at the time of settlement. The Company expects to fulfill the delivery commitments from a combination of production from existing productive wells, future development of proved undeveloped reserves, and future development of resources not yet characterized as proved reserves. Under certain of the Company’s commitments, if the Company is unable to deliver the minimum quantity from its production, it may deliver production acquired from third-parties to satisfy its minimum volume commitments. As of the filing of this report, the Company does not expect to incur material shortfalls with regard to these commitments. +Office Leases. The Company leases office space under various operating leases totaling $ 33.3 million, including maintenance, with certain terms extending into 2033. Rent expense for the years ended December 31, 2023, 2022, and 2021, was $ 2.5 million, $ 3.5 million, and $ 4.8 million, respectively. +Electrical Power Purchase Contracts. As of December 31, 2023, the Company had fixed price contracts for the purchase of electrical power through March of 2029 with a total remaining obligation of $ 41.8 million. +Sand Purchase Commitment. As of December 31, 2023, the Company had a sand purchase agreement with a minimum commitment of $ 46.8 million through March of 2026. As of December 31, 2023, if the Company failed to purchase the minimum amount required by the contract, it would be subject to penalties of up to $ 10.0 million. As of the filing of this report, the Company does not expect to incur penalties with regard to this agreement. +Compression Service Contracts . As of December 31, 2023, the Company had compression service contracts with terms extending through 2027 for equipment being used in field operations with a total remaining obligation of $ 19.5 million. +79 +Miscellaneous Contracts and Leases . As of December 31, 2023, the Company had miscellaneous contracts and leases totaling $ 24.2 million, primarily related to IT contracts, water purchase agreements, and vehicle leases, with terms extending through 2027. +Drilling and Completion Commitments. As of December 31, 2023, the Company had an agreement that includes minimum drilling and completion footage requirements on certain existing leases. If these minimum requirements are not satisfied by March 31, 2024, the Company will be required to pay liquidated damages based on the difference between the actual footage drilled and completed and the minimum requirements. As of December 31, 2023, the liquidated damages could range from zero to a maximum of $ 8.3 million, with the maximum exposure assuming no additional development activity occurred prior to March 31, 2024. As of the filing of this report, the Company does not expect to incur material liquidated damages with regard to this agreement. +Contingencies +The Company is subject to litigation and claims arising in the ordinary course of business. The Company accrues for such items when a liability is both probable and the amount can be reasonably estimated. In the opinion of management, the anticipated results of any pending litigation and claims are not expected to have a material effect on the results of operations, the financial position, or the cash flows of the Company. +Note 7 – Derivative Financial Instruments +Summary of Oil, Gas, and NGL Derivative Contracts in Place +The Company regularly enters into commodity derivative contracts to mitigate a portion of its exposure to oil, gas, and NGL price volatility and location differentials, and the associated effect on cash flows. All commodity derivative contracts that the Company enters into are for other-than-trading purposes. The Company’s commodity derivative contracts consist of price swap and collar arrangements for oil and gas production, and price swap arrangements for NGL production. In a typical commodity swap agreement, if the agreed upon published third-party index price (“index price”) is lower than the swap price, the Company receives the difference between the index price and the agreed upon swap price. If the index price is higher than the swap price, the Company pays the difference. For collar arrangements, the Company receives the difference between an agreed upon index price and the floor price if the index price is below the floor price. The Company pays the difference between the agreed upon ceiling price and the index price if the index price is above the ceiling price. No amounts are paid or received if the index price is between the floor and ceiling prices. +The Company has entered into fixed price oil and gas basis swaps in order to mitigate exposure to adverse pricing differentials between certain industry benchmark prices and the actual physical pricing points where the Company’s production is sold. As of December 31, 2023, the Company had basis swap contracts with fixed price differentials between: +• NYMEX WTI and Argus WTI Midland (“WTI Midland”) for a portion of its Midland Basin oil production with sales contracts that settle at WTI Midland prices; +• NYMEX WTI and Argus WTI Houston Magellan East Houston Terminal ("WTI Houston MEH”) for a portion of its South Texas oil production with sales contracts that settle at WTI Houston MEH prices; +• NYMEX HH and Inside FERC West Texas (“IF Waha”) for a portion of its Midland Basin gas production with sales contracts that settle at IF Waha prices; and +• NYMEX HH and Inside FERC Houston Ship Channel (“IF HSC”) for a portion of its South Texas gas production with sales contracts that settle at IF HSC prices. +The Company has also entered into oil swap contracts to fix the differential in pricing between the NYMEX calendar month average and the physical crude oil delivery month (“Roll Differential”) in which the Company pays the periodic variable Roll Differential and receives a weighted-average fixed price differential. The weighted-average fixed price differential represents the amount of net addition (reduction) to delivery month prices for the notional volumes covered by the swap contracts. +80 +As of December 31, 2023, the Company had commodity derivative contracts outstanding through the fourth quarter of 2025 as summarized in the table below: +Contract Period +First Quarter Second Quarter Third Quarter Fourth Quarter +2024 2024 2024 2024 2025 +Oil Derivatives (volumes in MBbl and prices in $ per Bbl): +Swaps +ICE Brent Volumes +910 — — — — +Weighted-Average Contract Price $ 85.50 $ — $ — $ — $ — +Collars +NYMEX WTI Volumes 795 1,846 1,669 556 — +Weighted-Average Floor Price $ 68.21 $ 67.46 $ 68.93 $ 72.86 $ — +Weighted-Average Ceiling Price $ 82.37 $ 85.53 $ 84.00 $ 79.83 $ — +Basis Swaps +WTI Midland-NYMEX WTI Volumes +1,199 1,193 1,235 1,230 1,807 +Weighted-Average Contract Price $ 1.21 $ 1.21 $ 1.21 $ 1.21 $ 1.15 +WTI Houston MEH-NYMEX WTI Volumes +256 293 332 309 729 +Weighted-Average Contract Price $ 1.83 $ 1.82 $ 1.82 $ 1.82 $ 1.85 +Roll Differential Swaps +NYMEX WTI Volumes 1,415 1,792 1,964 1,877 — +Weighted-Average Contract Price $ 0.57 $ 0.57 $ 0.57 $ 0.57 $ — +Gas Derivatives (volumes in BBtu and prices in $ per MMBtu): +Swaps +NYMEX HH Volumes +— 4,186 1,393 — 5,891 +Weighted-Average Contract Price $ — $ 3.17 $ 3.39 $ — $ 4.20 +Collars +NYMEX HH Volumes +8,382 4,432 4,612 5,716 13,217 +Weighted-Average Floor Price $ 3.57 $ 3.69 $ 3.68 $ 3.48 $ 3.44 +Weighted-Average Ceiling Price $ 7.82 $ 4.00 $ 4.21 $ 5.24 $ 5.06 +Basis Swaps +IF Waha-NYMEX HH Volumes +5,089 5,285 5,344 5,240 20,501 +Weighted-Average Contract Price $ ( 0.61 ) $ ( 1.09 ) $ ( 0.99 ) $ ( 0.73 ) $ ( 0.66 ) +IF HSC-NYMEX HH Volumes +4,957 3,310 3,426 5,750 — +Weighted-Average Contract Price $ ( 0.01 ) $ ( 0.34 ) $ ( 0.30 ) $ ( 0.38 ) $ — +NGL Derivatives (volumes in MBbl and prices in $ per Bbl): +Swaps +OPIS Propane Mont Belvieu Non-TET Volumes 62 65 68 70 — +Weighted-Average Contract Price $ 28.56 $ 28.56 $ 28.56 $ 28.56 $ — +81 +Commodity Derivative Contracts Entered Into Subsequent to December 31, 2023 +Subsequent to December 31, 2023, and through the filing of this report, the Company entered into the following commodity derivative contracts: +Contract Period +First Quarter Second Quarter Third Quarter Fourth Quarter +2024 2024 2024 2024 2025 2026 +Oil Derivatives (volumes in MBbl and prices in $ per Bbl): +Swaps +NYMEX WTI Volumes — — — 344 — — +Weighted-Average Contract Price $ — $ — $ — $ 71.00 $ — $ — +Collars +NYMEX WTI Volumes — — 335 344 — — +Weighted-Average Floor Price $ — $ — $ 65.00 $ 65.00 $ — $ — +Weighted-Average Ceiling Price $ — $ — $ 78.61 $ 76.45 $ — $ — +Basis Swaps +WTI Midland-NYMEX WTI Volumes +— — — — 941 — +Weighted-Average Contract Price $ — $ — $ — $ — $ 1.15 $ — +WTI Houston MEH-NYMEX WTI Volumes +— — — — 684 816 +Weighted-Average Contract Price $ — $ — $ — $ — $ 1.95 $ 2.10 +Gas Derivatives (volumes in BBtu and prices in $ per MMBtu): +Swaps +NYMEX HH Volumes +— — 1,530 — — — +Weighted-Average Contract Price $ — $ — $ 2.99 $ — $ — $ — +Collars +NYMEX HH Volumes +— — — 1,612 4,838 — +Weighted-Average Floor Price $ — $ — $ — $ 3.00 $ 3.00 $ — +Weighted-Average Ceiling Price $ — $ — $ — $ 4.02 $ 4.22 $ — +Basis Swaps +IF HSC-NYMEX HH Volumes +— — — — 946 — +Weighted-Average Contract Price $ — $ — $ — $ — $ 0.0025 $ — +NGL Derivatives (volumes in MBbl and prices in $ per Bbl): +Swaps +OPIS Propane Mont Belvieu Non-TET Volumes 254 322 336 364 396 — +Weighted-Average Contract Price $ 32.33 $ 32.57 $ 32.54 $ 32.49 $ 32.86 $ — +OPIS Normal Butane Mont Belvieu Non-TET Volumes +28 44 46 49 45 — +Weighted-Average Contract Price $ 39.48 $ 39.48 $ 39.48 $ 39.48 $ 39.48 $ — +OPIS Isobutane Mont Belvieu Non-TET Volumes +15 24 25 28 25 — +Weighted-Average Contract Price $ 41.58 $ 41.58 $ 41.58 $ 41.58 $ 41.58 $ — +Derivative Assets and Liabilities Fair Value +The Company’s commodity derivatives are measured at fair value and are included in the accompanying balance sheets as derivative assets and liabilities, with the exception of derivative instruments that meet the “normal purchase normal sale” exclusion. The Company does not designate its commodity derivative contracts as hedging instruments. The fair value of the commodity derivative contracts at December 31, 2023, and 2022, was a net asset of $ 57.1 million and $ 15.8 million, respectively. +82 +The following table details the fair value of commodity derivative contracts recorded in the accompanying balance sheets, by category: +As of December 31, 2023 As of December 31, 2022 +(in thousands) +Derivative assets: +Current assets $ 56,442 $ 48,677 +Noncurrent assets 8,672 24,465 +Total derivative assets $ 65,114 $ 73,142 +Derivative liabilities: +Current liabilities $ 6,789 $ 56,181 +Noncurrent liabilities 1,273 1,142 +Total derivative liabilities $ 8,062 $ 57,323 +Offsetting of Derivative Assets and Liabilities +As of December 31, 2023, and 2022, all derivative instruments held by the Company were subject to master netting arrangements with various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between it and the counterparty, at the election of both parties, for transactions that settle on the same date and in the same currency. The Company’s agreements also provide that in the event of an early termination, the counterparties have the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to not offset these positions in its accompanying balance sheets. +The following table provides a reconciliation between the gross assets and liabilities reflected on the accompanying balance sheets and the potential effects of master netting arrangements on the fair value of the Company’s commodity derivative contracts: +Derivative Assets as of Derivative Liabilities as of +December 31, +2023 December 31, +2022 December 31, +2023 December 31, +2022 +(in thousands) +Gross amounts presented in the accompanying balance sheets +$ 65,114 $ 73,142 $ ( 8,062 ) $ ( 57,323 ) +Amounts not offset in the accompanying balance sheets +( 7,362 ) ( 26,136 ) 7,362 26,136 +Net amounts $ 57,752 $ 47,006 $ ( 700 ) $ ( 31,187 ) +The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings rather than deferring such amounts in accumulated other comprehensive loss. The Company had no commodity derivative contracts designated as hedging instruments for the years ended December 31, 2023, 2022, and 2021. Please refer to Note 8 – Fair Value Measurements for more information regarding the Company’s derivative instruments, including its valuation techniques. +83 +The following table summarizes the commodity components of the net derivative settlement (gain) loss, and the net derivative (gain) loss line items presented within the accompanying statements of cash flows and the accompanying statements of operations, respectively: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Net derivative settlement (gain) loss: +Oil contracts $ 26,873 $ 514,641 $ 523,245 +Gas contracts ( 49,156 ) 171,598 152,361 +NGL contracts ( 4,638 ) 24,461 73,352 +Total net derivative settlement (gain) loss: $ ( 26,921 ) $ 710,700 $ 748,958 +Net derivative (gain) loss: +Oil contracts $ ( 20,813 ) $ 284,863 $ 650,959 +Gas contracts ( 42,713 ) 82,769 172,248 +NGL contracts ( 4,628 ) 6,380 78,452 +Total net derivative (gain) loss: $ ( 68,154 ) $ 374,012 $ 901,659 +Credit Related Contingent Features +As of December 31, 2023, all of the Company’s derivative counterparties were members of the Company’s Credit Agreement lender group. The Company does not enter into derivative contracts with counterparties that are not part of the lender group. Under the Credit Agreement, the Company is required to provide mortgage liens on assets having a value equal to at least 85 percent of the total PV-9, as defined in the Credit Agreement, of the Company’s proved oil and gas properties evaluated in the most recent reserve report. Collateral securing indebtedness under the Credit Agreement also secures the Company’s derivative agreement obligations. +Note 8 – Fair Value Measurements +The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs: +• Level 1 – quoted prices in active markets for identical assets or liabilities +• Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable +• Level 3 – significant inputs to the valuation model are unobservable +The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy: +As of December 31, 2023 As of December 31, 2022 +Level 1 Level 2 Level 3 Level 1 Level 2 Level 3 +(in thousands) +Assets: +Derivatives (1) +$ — $ 65,114 $ — $ — $ 73,142 $ — +Liabilities: +Derivatives (1) +$ — $ 8,062 $ — $ — $ 57,323 $ — +____________________________________________ +(1) This represents a financial asset or liability that is measured at fair value on a recurring basis. +84 +Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy. Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on the Company’s policies for determining fair value for the categories discussed below. +Derivatives +The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivative instruments. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The commodity derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active. +Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty. +Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any commodity derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current revolving credit facility margins, and any change in such margins since the last measurement date. +The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and other marketplace participants, the Company recognizes that third parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date. +Please refer to Note 7 – Derivative Financial Instruments for more information regarding the Company’s derivative instruments. +Oil and Gas Properties and Other Property and Equipment +The Company had no assets included in total property and equipment, net, measured at fair value as of December 31, 2023, or 2022. +No impairment expense was recorded for the year ended December 31, 2023. Impairment expense for the years ended December 31, 2022, and 2021, was $ 7.5 million and $ 35.0 million, respectively, and consisted of unproved property abandonments and impairments related to actual and anticipated lease expirations, as well as actual and anticipated losses on acreage due to title defects, changes in development plans, and other inherent acreage risks. The balances in the unproved oil and gas properties line item on the accompanying balance sheets as of December 31, 2023, and 2022, are recorded at carrying value. Please refer to Note 1 – Summary of Significant Accounting Policies for information on the Company’s policies for determining fair value of its oil and gas producing properties and related impairment expense. +85 +Long-Term Debt +The following table reflects the fair value of the Company’s Senior Notes obligations measured using Level 1 inputs based on quoted secondary market trading prices. These notes were not presented at fair value on the accompanying balance sheets as of December 31, 2023, or 2022, as they were recorded at carrying value, net of any unamortized deferred financing costs. Please refer to Note 5 – Long-Term Debt for additional information. +As of December 31, +2023 2022 +Principal Amount Fair Value Principal Amount Fair Value +(in thousands) +5.625 % Senior Notes due 2025 +$ 349,118 $ 348,189 $ 349,118 $ 337,821 +6.75 % Senior Notes due 2026 +$ 419,235 $ 420,660 $ 419,235 $ 409,484 +6.625 % Senior Notes due 2027 +$ 416,791 $ 416,549 $ 416,791 $ 402,120 +6.5 % Senior Notes due 2028 +$ 400,000 $ 401,372 $ 400,000 $ 384,520 +Note 9 – Earnings Per Share +Basic net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the basic weighted-average number of common shares outstanding for the respective period. Diluted net income or loss per common share is calculated by dividing net income or loss available to common stockholders by the diluted weighted-average number of common shares outstanding, which includes the effect of potentially dilutive securities. +For the years ended December 31, 2023, 2022, and 2021, potentially dilutive securities for this calculation consisted primarily of non-vested RSUs, contingent PSUs, and Warrants, all of which were measured using the treasury stock method. The Warrants became exercisable at the election of the holders on January 15, 2021 , and all of the Warrants were exercised prior to their expiration date of June 30, 2023 . The Warrants were included as potentially dilutive securities on an adjusted weighted-average basis for the portions of the years ended December 31, 2023, 2022, and 2021, during which they were outstanding but not yet exercised. Please refer to Note 3 – Equity for additional detail regarding the terms of the Warrants. +PSUs represent the right to receive, upon settlement of the PSUs after the completion of the three -year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSUs granted on the award date. The number of potentially dilutive shares related to PSUs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period applicable to such PSUs. For additional discussion on PSUs, please refer to Note 10 – Compensation Plans under the heading Performance Share Units . +The following table sets forth the calculations of basic and diluted net income per common share: +For the Years Ended December 31, +2023 2022 2021 +(in thousands, except per share data) +Net income $ 817,880 $ 1,111,952 $ 36,229 +Basic weighted-average common shares outstanding 118,678 122,351 119,043 +Dilutive effect of non-vested RSUs, contingent PSUs, and other +553 1,714 2,582 +Dilutive effect of Warrants +9 19 2,065 +Diluted weighted-average common shares outstanding 119,240 124,084 123,690 +Basic net income per common share $ 6.89 $ 9.09 $ 0.30 +Diluted net income per common share $ 6.86 $ 8.96 $ 0.29 +86 +Note 10 – Compensation Plans +The Company may grant various types of both short-term and long-term incentive-based awards under its compensation plans, such as cash awards, performance-based cash awards, and equity awards to eligible employees. Additionally, the Company grants stock-based compensation to its Board of Directors, and provides an employee stock purchase plan and a 401(k) plan to eligible employees. +As of December 31, 2023, approximately 2.8 million shares of common stock were available for grant under the Equity Plan. The issuance of a direct share benefit, such as a share of common stock, a stock option, a restricted share, an RSU or a PSU, counts as one share against the number of shares available to be granted under the Equity Plan. Each PSU has the potential to count as two shares against the number of shares available to be granted under the Equity Plan based on the final performance multiplier. +Performance Share Units +The Company has granted PSUs to eligible employees as part of its Equity Plan. The number of shares of the Company’s common stock issued to settle PSUs ranges from zero to two times the number of PSUs awarded and is determined based on certain criteria over a three -year performance period. PSUs generally vest on the third anniversary of the grant date or upon other triggering events as set forth in the Equity Plan. Employees who meet retirement eligibility criteria, as defined by the applicable grant agreement, on the grant date of a PSU award vest in pro-rata increments on a daily basis over the three -year performance period beginning at the grant date, and any non-vested portions of a PSU award will be forfeited if the employee leaves the Company. +The fair value of PSUs is measured at the grant date using a stochastic Monte Carlo simulation using geometric Brownian motion (“GBM Model”). A stochastic process is a mathematically defined equation that can create a series of outcomes over time. These outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for each iteration. In the case of the Company’s PSUs, the Company cannot predict with certainty the path its stock price or the stock prices of its peers will take over the three -year performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the path the stock price may take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the GBM Model, is deemed an appropriate method by which to determine the fair value of the PSUs. Significant assumptions used in this simulation include the Company’s expected volatility, dividend yield, and risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with a three-year vesting period, as well as the volatilities and dividend yields for each of the Company’s peers. +For PSUs granted in 2023 and 2022, which the Company determined to be equity awards, settlement will be determined based on a combination of the following criteria measured over the three -year performance period: the Company’s Total Shareholder Return (“TSR”) relative to the TSR of certain peer companies, the Company’s absolute TSR, free cash flow (“FCF”) generation, and the achievement of certain ESG targets, in each case as defined by the award agreement. The relative and absolute TSR portions of the fair value of the PSUs granted in 2023 and 2022, were measured on the grant date using the GBM Model. The portion of the awards associated with FCF generation and ESG performance conditions assumes that target amounts will be met at the end of the performance period. As a portion of these awards depends on performance-based settlement criteria, compensation expense may be adjusted in future periods as the expected number of shares of the Company’s common stock issued to settle the units increases or decreases based on the Company’s expected FCF generation and achievement of certain ESG targets. +The Company initially records compensation expense associated with the issuance of PSUs based on the fair value of the awards as of the grant date and may adjust compensation expense in future periods as discussed above. Compensation expense for PSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. Total compensation expense recorded for PSUs was $ 2.8 million, $ 2.6 million, and $ 6.0 million for the years ended December 31, 2023, 2022, and 2021, respectively. As of December 31, 2023, there was $ 8.6 million of total unrecognized expense related to non-vested PSUs, which is being amortized through mid-2026. +The fair value of PSUs granted in 2023 and 2022 was $ 7.7 million and $ 7.4 million, respectively. The fair value of PSUs that vested during the years ended December 31, 2022, and 2021, was $ 12.3 million and $ 8.4 million, respectively. +87 +A summary of activity is presented in the following table: +For the Years Ended December 31, +2023 2022 2021 +PSUs (1) +Weighted-Average Grant-Date Fair Value (2) +PSUs (1) +Weighted-Average Grant-Date Fair Value (2) +PSUs (1) +Weighted-Average Grant-Date Fair Value (2) +Non-vested at beginning of year 273,258 $ 26.67 464,483 $ 12.80 830,464 $ 17.52 +Granted 256,633 $ 29.93 276,010 $ 26.67 — $ — +Vested ( 15,950 ) $ 25.50 ( 461,387 ) $ 12.81 ( 352,395 ) $ 23.81 +Forfeited ( 44,509 ) $ 26.45 ( 5,848 ) $ 18.24 ( 13,586 ) $ 15.46 +Non-vested at end of year 469,432 $ 27.83 273,258 $ 26.67 464,483 $ 12.80 +____________________________________________ +(1) The number of PSUs presented assumes a multiplier of one . The actual final number of shares of common stock to be issued at the end of the three -year performance period will range from zero to two times the number of PSUs awarded depending on the three -year performance multiplier. +(2) Amounts represent price per unit. +A summary of the shares of common stock issued to settle PSUs is presented in the table below: +For the Years Ended December 31, +2022 2021 +Shares of common stock issued to settle PSUs (1) +1,004,410 347,742 +Less: shares of common stock withheld for income and payroll taxes ( 349,487 ) ( 112,919 ) +Net shares of common stock issued 654,923 234,823 +Multiplier earned +2.0 +1.0 +____________________________________________ +(1) During the year ended December 31, 2023, there were no shares of common stock issued to settle PSUs. During the years ended December 31, 2022, and 2021, the Company settled PSUs that were granted in 2019 and 2018, respectively. The Company and all eligible recipients in 2022 and 2021 mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings, as provided for in the Equity Plan and applicable award agreements. +Employee Restricted Stock Units +The Company has granted RSUs to eligible employees as part of its Equity Plan. Each RSU represents a right to receive one share of the Company’s common stock upon settlement of the award at the end of the specified vesting period. RSUs generally vest in one-third increments on each anniversary of the applicable grant date over the applicable vesting period or upon other triggering events as set forth in the Equity Plan. Employees who meet retirement eligibility criteria, as defined by the applicable grant agreement, at the time an RSU award is granted generally vest in six -month increments over the applicable vesting period beginning at the grant date. Retirement eligible employees must stay with the Company through the entire six -month vesting period to receive that increment of vesting and any non-vested portions of an RSU award will be forfeited when the employee leaves the Company. +The Company records compensation expense associated with the issuance of RSUs based on the fair value of the awards as of the grant date. The fair value of an RSU is equal to the closing price of the Company’s common stock on the grant date. Compensation expense for RSUs is recognized within general and administrative expense and exploration expense over the vesting periods of the respective awards. Total compensation expense recorded for RSUs for the years ended December 31, 2023, 2022, and 2021, was $ 14.8 million, $ 13.5 million, and $ 10.2 million, respectively. As of December 31, 2023, there was $ 25.7 million of total unrecognized compensation expense related to non-vested RSUs, which is being amortized through mid-2026. +The fair value of RSUs granted to eligible employees in 2023, 2022 and 2021, was $ 20.2 million, $ 18.0 million, and $ 17.0 million, respectively, and the fair value of RSUs that vested during the years ended December 31, 2023, 2022, and 2021, was $ 13.5 million, $ 11.2 million, and $ 9.3 million, respectively. +88 +A summary of activity is presented in the following table: +For the Years Ended December 31, +2023 2022 2021 +RSUs +Weighted- +Average +Grant-Date +Fair Value (1) +RSUs +Weighted- +Average +Grant-Date +Fair Value (1) +RSUs +Weighted- +Average +Grant-Date +Fair Value (1) +Non-vested at beginning of year +1,375,052 $ 22.42 1,841,237 $ 13.79 2,097,860 $ 8.83 +Granted 630,474 $ 32.03 526,776 $ 34.08 666,052 $ 25.52 +Vested ( 805,205 ) $ 16.75 ( 920,927 ) $ 12.17 ( 843,098 ) $ 11.00 +Forfeited ( 119,777 ) $ 29.26 ( 72,034 ) $ 18.24 ( 79,577 ) $ 10.64 +Non-vested at end of year +1,080,544 $ 31.49 1,375,052 $ 22.42 1,841,237 $ 13.79 +____________________________________________ +(1) Amounts represent price per unit. +A summary of the shares of common stock issued to settle RSUs is presented in the table below: +For the Years Ended December 31, +2023 2022 2021 +Shares of common stock issued to settle RSUs (1) +803,449 920,927 843,098 +Less: shares of common stock withheld for income and payroll taxes ( 249,233 ) ( 284,423 ) ( 250,349 ) +Net shares of common stock issued 554,216 636,504 592,749 +____________________________________________ +(1) During the years ended December 31, 2023, 2022, and 2021, the Company issued shares of common stock to settle RSUs that related to awards granted in previous years. The Company and a majority of eligible recipients in 2023, and all eligible recipients in 2022 and 2021, mutually agreed to net share settle a portion of the awards to cover income and payroll tax withholdings in accordance with the Company’s Equity Plan and individual award agreements. +Director Shares +In 2023, 2022, and 2021, the Company issued a total of 56,872 , 29,471 , and 60,510 shares, respectively, of its common stock to its non-employee directors under the Equity Plan. For the years ended December 31, 2023, 2022, and 2021, the Company recorded $ 1.6 million, $ 1.5 million, and $ 1.2 million, respectively, of compensation expense related to director shares. All shares issued to non-employee directors fully vested on December 31 of the year granted. +Employee Stock Purchase Plan +Under the Company’s Employee Stock Purchase Plan (“ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their eligible compensation, subject to a maximum of 2,500 shares per offering period and a maximum of $ 25,000 in value related to purchases for each calendar year. The purchase price of the common stock is 85 percent of the lower of the trading price of the common stock on either the first or last day of the six-month offering period. The ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the IRC. +A total of 114,427 , 113,785 , and 313,773 shares were issued under the ESPP in 2023, 2022, and 2021, respectively. Total proceeds to the Company for the issuance of these shares was $ 3.1 million, $ 3.0 million, and $ 2.6 million, for the years ended December 31, 2023, 2022, and 2021, respectively. As of December 31, 2023, the Company had approximately 3.3 million shares of its common stock available for issuance under the ESPP. The Company records compensation expense associated with the ESPP based on the estimated fair value of the ESPP grants as of the beginning of the offering period, and the expense is recognized within general and administrative expense and exploration expense over the six-month offering period. Total compensation expense recorded for the ESPP for the years ended December 31, 2023, 2022, and 2021, was $ 1.1 million, $ 1.2 million, and $ 1.4 million, respectively. +The fair value of ESPP grants is measured at the grant date using the Black-Scholes option-pricing model. Expected volatility is calculated based on the Company’s historical daily common stock price, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with a six-month vesting period. +89 +The fair value of ESPP shares issued during the periods reported above were estimated using the following weighted-average assumptions: +For the Years Ended December 31, +2023 2022 2021 +Risk free interest rate 5.1 % 1.2 % 0.8 % +Dividend yield 1.8 % 0.1 % 0.3 % +Volatility factor of the expected market price of the Company’s common stock 53.6 % 69.1 % 106.1 % +Expected life (in years) 0.5 0.5 0.5 +401(k) Plan +The Company has a defined contribution plan (“401(k) Plan”) that is subject to the Employee Retirement Income Security Act of 1974. The 401(k) Plan allows eligible employees to contribute a maximum of 60 percent of their base salaries up to the contribution limits established under the IRC. The Company matches either 100 percent or 150 percent of each employee’s contributions, depending on pension plan eligibility, up to six percent of the employee’s base salary and short-term incentive bonus, and may make additional contributions at its discretion. Please refer to Note 11 – Pension Benefits for additional discussion of pension benefits. The Company’s matching contributions to the 401(k) Plan were $ 5.7 million, $ 5.5 million, and $ 3.9 million for the years ended December 31, 2023, 2022, and 2021, respectively. +Note 11 – Pension Benefits +The Company has a non-contributory defined benefit pension plan covering employees who met age and service requirements and began employment with the Company prior to January 1, 2016 (“Qualified Pension Plan”). The Company also has a supplemental non-contributory pension plan covering certain management employees (“Nonqualified Pension Plan” and together with the Qualified Pension Plan, “Pension Plans”). The Company froze the Pension Plans to new participants, effective January 1, 2016. Employees participating in the Pension Plans prior to the plans being frozen continue to earn benefits. +Obligations and Funded Status for the Pension Plans +The Company recognizes the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligation) of the Company’s Pension Plans in the accompanying balance sheets as either an asset or a liability and recognizes a corresponding adjustment within the other comprehensive income, net of tax, line item in the accompanying consolidated statements of comprehensive income. The projected benefit obligation is the actuarial present value of the benefits earned to date by plan participants based on employee service and compensation including the effect of assumed future salary increases. The accumulated benefit obligation uses the same factors as the projected benefit obligation, but excludes the effects of assumed future salary increases. +90 +The Company’s measurement date for plan assets and obligations is December 31. +For the Years Ended December 31, +2023 2022 +(in thousands) +Change in benefit obligation: +Projected benefit obligation at beginning of year $ 65,161 $ 75,760 +Service cost 3,706 4,652 +Interest cost 3,200 2,314 +Actuarial (gain) loss 84 ( 15,567 ) +Benefits paid ( 4,883 ) ( 1,998 ) +Projected benefit obligation at end of year 67,268 65,161 +Change in plan assets: +Fair value of plan assets at beginning of year 36,414 35,941 +Actual return on plan assets 4,161 ( 3,529 ) +Employer contribution 10,000 6,000 +Benefits paid ( 4,883 ) ( 1,998 ) +Fair value of plan assets at end of year 45,692 36,414 +Funded status at end of year $ ( 21,576 ) $ ( 28,747 ) +The Company’s underfunded status for the Pension Plans as of December 31, 2023, and 2022, was $ 21.6 million and $ 28.7 million, respectively, and is recognized in the accompanying balance sheets within the other noncurrent liabilities line item. There are no plan assets in the Nonqualified Pension Plan. +Accumulated Benefit Obligation in Excess of Plan Assets for the Pension Plans +As of December 31, +2023 2022 +(in thousands) +Projected benefit obligation $ 67,268 $ 65,161 +Accumulated benefit obligation $ 55,557 $ 55,712 +Less: fair value of plan assets ( 45,692 ) ( 36,414 ) +Underfunded accumulated benefit obligation $ 9,865 $ 19,298 +Pension expense is determined based upon the annual service cost of benefits (the actuarial cost of benefits earned during a period) and the interest cost on those liabilities, less the expected return on plan assets. The expected long-term rate of return on plan assets is applied to a calculated value of plan assets that recognizes changes in fair value over a five-year period. This practice is intended to reduce year-to-year volatility in pension expense, but it can have the effect of delaying recognition of differences between actual returns on assets and expected returns based on long-term rate of return assumptions. Amortization of the unrecognized net gain or loss resulting from actual experience different from that assumed and from changes in assumptions (excluding asset gains and losses not yet reflected in market-related value) is included as a component of net periodic benefit cost for the year. If, as of the beginning of the year, the unrecognized net gain or loss exceeds 10 percent of the greater of the projected benefit obligation and the market-related value of plan assets, then the amortization is the excess divided by the average remaining service period of participating employees expected to receive benefits under the plan. +The pre-tax amounts not yet recognized in net periodic pension costs, but rather recognized in the accumulated other comprehensive loss line item within the accompanying balance sheets as of December 31, 2023, and 2022, totaled $ 3.3 million and $ 5.1 million, respectively, and related to unrecognized actuarial losses. +91 +The pension liability adjustments recognized in other comprehensive income during 2023, 2022, and 2021, were as follows: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Net actuarial gain (loss) $ 1,737 $ 10,327 $ ( 612 ) +Amortization of prior service cost — — 13 +Amortization of net actuarial loss 68 931 1,240 +Settlements — — 312 +Total pension liability adjustment, pre-tax 1,805 11,258 953 +Tax expense ( 390 ) ( 2,431 ) ( 204 ) +Total pension liability adjustment, net $ 1,415 $ 8,827 $ 749 +Components of Net Periodic Benefit Cost for the Pension Plans +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Components of net periodic benefit cost: +Service cost $ 3,706 $ 4,652 $ 4,455 +Interest cost 3,200 2,314 2,089 +Expected return on plan assets that reduces periodic pension benefit cost ( 2,340 ) ( 1,711 ) ( 1,474 ) +Amortization of prior service cost — — 13 +Amortization of net actuarial loss 68 931 1,240 +Net periodic benefit cost 4,634 6,186 6,323 +Settlements — — 312 +Total net benefit cost $ 4,634 $ 6,186 $ 6,635 +Pension Plan Assumptions +The weighted-average assumptions used to measure the Company’s projected benefit obligation are as follows: +As of December 31, +2023 2022 +Projected benefit obligation: +Discount rate 5.0 % 5.2 % +Rate of compensation increase 3.5 % 3.5 % +The weighted-average assumptions used to measure the Company’s net periodic benefit cost are as follows: +For the Years Ended December 31, +2023 2022 2021 +Net periodic benefit cost: +Discount rate 5.2 % 3.1 % 2.9 % +Expected return on plan assets (1) +6.3 % 3.6 % 4.4 % +Rate of compensation increase 3.5 % 4.8 % 4.4 % +____________________________________________ +(1) There is no assumed expected return on plan assets for the Nonqualified Pension Plan because there are no plan assets in the Nonqualified Pension Plan. +92 +The Company’s pension investment policy includes various guidelines and procedures designed to ensure that assets are prudently invested in a manner necessary to meet the future benefit obligation of the Pension Plans. The policy prohibits the direct investment of plan assets in the Company’s securities. The Qualified Pension Plan’s investment horizon is long-term and accordingly the target asset allocations encompass a strategic, long-term perspective of capital markets, expected risk and return behavior and perceived future economic conditions. The key investment principles of diversification, assessment of risk, and targeting of expected returns for given levels of risk are applied. +The Qualified Pension Plan’s investment portfolio contains a diversified blend of investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. This portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate investment performance. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. +The weighted-average asset allocation of the Qualified Pension Plan is as follows: +Target As of December 31, +Asset Category 2024 2023 2022 +Equity securities 49.0 % 43.0 % 47.1 % +Fixed income securities 26.0 % 25.5 % 21.0 % +Other securities 25.0 % 31.5 % 31.9 % +Total 100.0 % 100.0 % 100.0 % +There is no asset allocation of the Nonqualified Pension Plan since there are no plan assets in the plan. The assumption of the expected long-term rate of return on plan assets of the Qualified Pension Plan is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. The Company evaluates the expected rate of return on plan assets assumption on an annual basis. +93 +Pension Plan Assets +The fair values of the Company’s Qualified Pension Plan assets as of December 31, 2023, and 2022, utilizing the fair value hierarchy discussed in Note 8 – Fair Value Measurements are as follows: +Fair Value Measurements Using: +Actual Asset Allocation (1) +Total Level 1 Inputs Level 2 Inputs Level 3 Inputs +(in thousands) +As of December 31, 2023 +Equity securities: +Domestic (2) +20.3 % $ 9,280 $ 6,097 $ 3,183 $ — +International (3) +22.7 % 10,349 10,349 — — +Total equity securities 43.0 % 19,629 16,446 3,183 — +Fixed income securities: +Core fixed income (4) +25.5 % 11,646 11,646 — — +Floating rate corporate loans (5) +— % — — — — +Total fixed income securities 25.5 % 11,646 11,646 — — +Other securities: +Real estate (6) +4.6 % 2,116 — — 2,116 +Collective investment trusts (7) +13.6 % 6,206 — 6,206 — +Hedge fund (8) +13.3 % 6,095 1,498 — 4,597 +Total other securities 31.5 % 14,417 1,498 6,206 6,713 +Total investments 100.0 % $ 45,692 $ 29,590 $ 9,389 $ 6,713 +As of December 31, 2022 +Equity securities: +Domestic (2) +20.7 % $ 7,533 $ 5,012 $ 2,521 $ — +International (3) +26.4 % 9,594 9,594 — — +Total equity securities 47.1 % 17,127 14,606 2,521 — +Fixed income securities: +Core fixed income (4) +14.3 % 5,220 5,220 — — +Floating rate corporate loans (5) +6.7 % 2,450 2,450 — — +Total fixed income securities 21.0 % 7,670 7,670 — — +Other securities: +Real estate (6) +6.8 % 2,476 — — 2,476 +Collective investment trusts (7) +1.9 % 687 — 687 — +Hedge fund (8) +23.2 % 8,454 4,133 — 4,321 +Total other securities 31.9 % 11,617 4,133 687 6,797 +Total investments 100.0 % $ 36,414 $ 26,409 $ 3,208 $ 6,797 +____________________________________________ +(1) Percentages may not calculate due to rounding. +(2) Level 1 equity securities consist of United States large and small capitalization companies, which are actively traded securities that can be sold on demand. Level 2 equity securities are investments in a collective investment fund that is valued at net asset value based on the value of the underlying investments and total units outstanding on a daily basis. The objective of these funds is to approximate the S&P 500 by investing in one or more collective investment funds. +(3) International equity securities consist of a well-diversified portfolio of holdings of mostly large issuers organized in developed countries with liquid markets, commingled with investments in equity securities of issuers located in emerging markets that are believed to have strong sustainable financial productivity at attractive valuations. +(4) The objective of core fixed income funds is to achieve value added from sector or issue selection by constructing a portfolio to approximate the investment results of the Barclay’s Capital Aggregate Bond Index with a modest amount of variability in duration around the index. +94 +(5) Investments consist of floating rate bank loans. The interest rates on these loans are typically reset on a periodic basis to account for changes in the level of interest rates. +(6) The investment objective of direct real estate is to provide current income with the potential for long-term capital appreciation. Ownership in real estate entails a long-term time horizon, periodic valuations, and potentially low liquidity. +(7) Collective investment trusts invest in short-term investments and are valued at the net asset value of the collective investment trust. The net asset value, as provided by the trustee, is used as a practical expedient to estimate fair value. The net asset value is based on the fair value of the underlying investments held by the fund less its liabilities. +(8) The hedge fund portfolio includes investments in actively traded global mutual funds that focus on alternative investments and a hedge fund of funds that invests both long and short using a variety of investment strategies. +The following is a summary of the changes in Level 3 plan assets (in thousands): +Balance at January 1, 2022 $ 6,195 +Purchases 400 +Realized gain on assets 259 +Unrealized loss on assets ( 57 ) +Disposition — +Balance at December 31, 2022 $ 6,797 +Purchases — +Realized gain on assets 364 +Unrealized loss on assets ( 448 ) +Disposition — +Balance at December 31, 2023 $ 6,713 +Contributions +The Company contributed $ 10.0 million, $ 6.0 million, and $ 6.6 million to the Pension Plans for the years ended December 31, 2023, 2022, and 2021, respectively. The Company expects to make a $ 10.6 million contribution to the Pension Plans in 2024. +Benefit Payments +The Pension Plans made actual benefit payments of $ 4.9 million, $ 2.0 million, and $ 6.3 million for the years ended December 31, 2023, 2022, and 2021, respectively. Expected benefit payments over the next 10 years are as follows: +For the Years Ending December 31, Amount +(in thousands) +2024 $ 6,865 +2025 $ 4,455 +2026 $ 7,064 +2027 $ 5,026 +2028 $ 5,281 +2029 through 2033 $ 25,587 +Note 12 – Leases +As of December 31, 2023, and 2022, the Company had operating leases for asset classes that include office space, office equipment, drilling rigs, midstream agreements, vehicles, and equipment rentals used in field operations. For operating leases recorded on the accompanying balance sheets, remaining lease terms range from less than one year to approximately nine years . Certain leases contain optional extension periods that allow for terms to be extended for up to an additional 10 years, however in order to maintain financial and operational flexibility, there are no available options to extend that the Company is reasonably certain it will exercise. An early termination option exists for certain leases, some of which allow the Company to terminate a lease within one year, however, there are no leases in which material early termination options are reasonably certain to be exercised by the Company. As of December 31, 2023, and 2022, the Company did not have any agreements in place that were classified as finance leases under Topic 842. As of December 31, 2023, and through the filing of this report, the Company has no material lease arrangements which are scheduled to commence in the future. Please refer to Note 1 – Summary of Significant Accounting Policies for additional information on the Company’s policies for lease determination and classification. +95 +The following table reflects the components of the Company’s total lease costs, whether capitalized or expensed, related to operating leases, including short-term leases, and variable lease payments made for both short-term and long-term leases for the years ended December 31, 2023, and 2022. This total does not reflect amounts that may be reimbursed by other third parties in the normal course of business, such as non-operating working interest owners. +For the Years Ended December 31, +2023 2022 +(in thousands) +Operating lease cost $ 15,625 $ 10,174 +Short-term lease cost (1) +251,628 175,098 +Variable lease cost (2) +11,838 7,085 +Total lease cost $ 279,091 $ 192,357 +____________________________________________ +(1) Costs associated with short-term lease agreements relate primarily to operational activities where underlying lease terms are less than one year. This amount includes drilling and completion activities and field equipment rentals, most of which are contracted for 12 months or less. It is expected that this amount will fluctuate primarily with the number of drilling rigs and completion crews the Company is operating under short-term agreements. +(2) Variable lease payments relate to the actual usage associated with drilling rigs, completion crews, and vehicles, and variable utility costs associated with the Company’s leased office space. Fluctuations in variable lease payments are primarily driven by the number of drilling rigs and completion crews operating. +Cash paid for amounts included in the measurement of lease liabilities for the years ended December 31, 2023, and 2022, were as follows: +For the Years Ended December 31, +2023 2022 +(in thousands) +Operating cash flows related to operating leases +$ 4,181 $ 4,718 +Investing cash flows related to operating leases +$ 11,300 $ 5,042 +Maturities for the Company’s operating lease liabilities included on the accompanying balance sheets as of December 31, 2023, were as follows: +As of December 31, 2023 +(in thousands) +2024 $ 17,208 +2025 11,242 +2026 4,793 +2027 2,685 +2028 2,054 +Thereafter 6,906 +Total Lease payments $ 44,888 +Less: Imputed interest (1) +( 5,110 ) +Total $ 39,778 +____________________________________________ +(1) The weighted-average discount rate used to determine the operating lease liability as of December 31, 2023, was 6.2 percent. +96 +The following table presents supplemental accompanying balance sheet information for operating leases as of December 31, 2023, and 2022: +As of December 31, +2023 2022 +(in thousands, except discount rate and lease term) +Balance sheet classifications of operating leases: +Other noncurrent assets $ 32,264 $ 26,368 +Other current liabilities $ 15,425 $ 10,114 +Other noncurrent liabilities $ 24,352 $ 23,621 +ROU assets obtained in exchange for operating lease liabilities $ 19,341 $ 16,186 +Weighted-average discount rate +6.2 % +5.8 % +Weighted-average remaining lease term (years) 4 5 +Note 13 – Accounts Receivable and Accounts Payable and Accrued Expenses +The components of accounts receivable are as follows: +As of December 31, +2023 2022 +(in thousands) +Oil, gas, and NGL production revenue $ 175,334 $ 184,458 +Amounts due from joint interest owners 46,289 45,997 +Other 9,542 2,842 +Total accounts receivable $ 231,165 $ 233,297 +The components of accounts payable and accrued expenses are as follows: +As of December 31, +2023 2022 +(in thousands) +Drilling and lease operating cost accruals $ 144,707 $ 125,570 +Trade accounts payable 107,315 43,898 +Revenue and severance tax payable 186,663 182,744 +Property taxes 43,406 43,066 +Compensation 54,819 35,799 +Net derivative settlements +1,129 22,745 +Interest 35,976 35,992 +Dividends payable 20,834 18,290 +Other 16,749 24,185 +Total accounts payable and accrued expenses $ 611,598 $ 532,289 +97 +Note 14 – Asset Retirement Obligations +Please refer to Asset Retirement Obligations in Note 1 – Summary of Significant Accounting Policies for a discussion of the initial and subsequent measurements of asset retirement obligation liabilities and the significant assumptions used in the estimates. +The following is a reconciliation of the Company’s total asset retirement obligation liability as of December 31, 2023, and 2022: +As of December 31, +2023 2022 +(in thousands) +Beginning asset retirement obligations $ 115,313 $ 101,424 +Liabilities incurred (1) +4,062 2,086 +Liabilities settled (2) +( 4,489 ) ( 6,356 ) +Accretion expense +6,330 5,344 +Revision to estimated cash flows +1,938 12,815 +Ending asset retirement obligations (3) +$ 123,154 $ 115,313 +____________________________________________ +(1) Reflects liabilities incurred through drilling activities and acquisitions of drilled wells. +(2) Reflects liabilities settled through plugging and abandonment activities and divestitures of properties. +(3) Balances as of December 31, 2023, and 2022, included $ 4.4 million and $ 7.1 million, respectively, related to the Company’s current asset retirement obligation liability, which is recorded in the accounts payable and accrued expenses line item on the accompanying balance sheets. +Note 15 – Suspended Well Costs +The following table reflects the net changes in capitalized exploratory well costs during 2023, 2022, and 2021. The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same year: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Beginning balance $ 49,047 $ 15,576 $ 5,698 +Additions to capitalized exploratory well costs pending the determination of net proved reserves +70,762 49,047 15,576 +Reclassifications based on the determination of net proved reserves +( 47,985 ) ( 14,721 ) ( 5,698 ) +Capitalized exploratory well costs charged to expense (1) +( 455 ) ( 855 ) — +Ending balance $ 71,369 $ 49,047 $ 15,576 +____________________________________________ +(1) For the year ended December 31, 2023, amount relates to one well that experienced technical issues during the drilling phase. For the year ended December 31, 2022, amount relates to unsuccessful exploration activity outside of the Company’s core areas of operation. +As of December 31, 2023, there were no material exploratory well costs that were capitalized for more than one year. +Note 16 – Acquisitions +On June 30, 2023 , the Company acquired approximately 20,000 net acres of oil and gas properties in Dawson and northern Martin counties, Texas. Under authoritative accounting guidance, this transaction was considered to be an asset acquisition. Therefore, the properties were recorded based on the total consideration paid after purchase price adjustments and the transaction costs were capitalized as a component of the cost of the assets acquired. During the third quarter of 2023, the Company acquired additional working interests in certain wells. Total consideration paid for these transactions, after purchase price adjustments, was $ 109.9 million. +Additionally, during the year ended December 31, 2023, the Company completed a non-monetary asset exchange of proved properties in Upton County, Texas. This exchange was recorded at carryover basis with no gain or loss recognized. +98 +Supplemental Oil and Gas Information (unaudited) +Costs Incurred +Costs incurred in oil and gas property acquisition, exploration, and development activities, whether capitalized or expensed, are summarized as follows: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Development costs (1) +$ 931,803 $ 810,520 $ 583,527 +Exploration costs 172,590 147,042 125,415 +Acquisitions +Proved properties +65,019 18 71 +Unproved properties (2) +65,570 4,153 9,036 +Total, including asset retirement obligations (3)(4) +$ 1,234,982 $ 961,733 $ 718,049 +____________________________________________ +(1) Includes facility costs of $24.1 million, $30.0 million, and $18.2 million for the years ended December 31, 2023, 2022, and 2021, respectively. +(2) Includes amounts related to leasing activity and acquiring surface rights outside of acquisitions of proved and unproved properties totaling $18.1 million, $4.2 million, and $5.8 million for the years ended December 31, 2023, 2022, and 2021, respectively. +(3) Includes amounts related to estimated asset retirement obligations of $6.0 million, $15.1 million, and $12.8 million for the years ended December 31, 2023, 2022, and 2021, respectively. +(4) Includes capitalized interest of $20.4 million, $17.6 million, and $15.0 million for the years ended December 31, 2023, 2022, and 2021, respectively. +Oil and Gas Reserve Quantities +The reserve estimates presented below were made in accordance with GAAP requirements for disclosures about oil and gas producing activities and SEC rules for oil and gas reporting of reserve estimation and disclosure. +Proved reserves are the estimated quantities of oil, gas, and NGLs which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Existing economic conditions include prices and costs at which economic producibility from a reservoir is to be determined, and the price to be used is the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. All of the Company’s estimated net proved reserves are located in the United States. +The tables below present a summary of changes in the Company’s estimated net proved reserves for each of the years ended December 31, 2023, 2022, and 2021. The Company engaged Ryder Scott to audit internal engineering estimates for at least 80 percent of the Company’s total calculated proved reserve PV-10 for each year presented. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries and undeveloped locations are more imprecise than estimates of established producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. +99 +For the Year Ended December 31, 2023 +Oil Gas NGLs Total +(MMBbl) (Bcf) (MMBbl) (MMBOE) +Total net proved reserves: +Beginning of year 205.8 1,402.9 97.8 537.4 +Revisions of previous estimates (1) +38.7 194.2 20.8 91.9 +Discoveries and extensions 8.9 69.1 10.5 30.9 +Sales of reserves (3.2) (13.1) — (5.4) +Purchases of minerals in place 3.6 11.2 — 5.5 +Production (23.8) (132.4) (9.7) (55.5) +End of year 230.1 1,532.0 119.5 604.9 +Net proved developed reserves: +Beginning of year 110.4 902.1 57.1 317.8 +End of year 118.5 948.5 64.7 341.2 +Net proved undeveloped reserves: +Beginning of year 95.4 500.8 40.7 219.6 +End of year 111.6 583.5 54.8 263.6 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) Revisions of previous estimates consist of: +• 113.9 MMBOE of infill reserves; +• 65.3 MMBOE of positive performance revisions resulting from changes to decline curve estimates based on reservoir engineering analysis; +• 28.0 MMBOE of negative performance revisions related to well performance; +• 30.8 MMBOE of estimated net proved undeveloped reserves reclassified to unproved reserves categories resulting from revising certain aspects of the Company’s future development plans, and due to certain lease obligations; and +• 28.4 MMBOE of negative price revisions resulting primarily from decreases in gas and NGL prices. +Please refer to Areas of Operation in Part I, Items 1 and 2 of this report, and to Oil and Gas Reserve Quantities in Critical Accounting Estimates in Part II, Item 7 of this report for additional information. +100 +For the Year Ended December 31, 2022 +Oil Gas NGLs Total +(MMBbl) (Bcf) (MMBbl) (MMBOE) +Total net proved reserves: +Beginning of year 199.5 1,243.5 85.2 492.0 +Revisions of previous estimates (1) +23.7 248.2 16.7 81.7 +Discoveries and extensions 6.6 37.2 3.9 16.7 +Sales of reserves — — — — +Purchases of minerals in place — — — — +Production (24.0) (125.9) (8.0) (53.0) +End of year 205.8 1,402.9 97.8 537.4 +Net proved developed reserves: +Beginning of year 110.7 833.0 50.7 300.2 +End of year 110.4 902.1 57.1 317.8 +Net proved undeveloped reserves: +Beginning of year 88.8 410.4 34.5 191.8 +End of year 95.4 500.8 40.7 219.6 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) Revisions of previous estimates consist of: +• 103.2 MMBOE of infill reserves; +• 9.5 MMBOE of positive price revisions; +• 19.9 MMBOE of estimated net proved undeveloped reserves reclassified to unproved reserves categories resulting from revising certain aspects of the Company’s future development plans; and +• 11.1 MMBOE of negative performance revisions. +For the Year Ended December 31, 2021 +Oil Gas NGLs Total +(MMBbl) (Bcf) (MMBbl) (MMBOE) +Total net proved reserves: +Beginning of year 172.7 1,052.0 56.6 404.6 +Revisions of previous estimates (1) +35.7 158.9 12.2 74.4 +Discoveries and extensions 19.3 141.4 21.9 64.7 +Sales of reserves (0.3) (0.5) (0.1) (0.4) +Purchases of minerals in place 0.1 0.1 — 0.1 +Production (27.9) (108.4) (5.4) (51.4) +End of year 199.5 1,243.5 85.2 492.0 +Net proved developed reserves: +Beginning of year 89.8 643.9 32.1 229.3 +End of year 110.7 833.0 50.7 300.2 +Net proved undeveloped reserves: +Beginning of year 82.9 408.1 24.4 175.3 +End of year 88.8 410.4 34.5 191.8 +____________________________________________ +Note: Amounts may not calculate due to rounding. +(1) Revisions of previous estimates consist of: +• 74.4 MMBOE of infill reserves; +• 37.2 MMBOE and 3.4 MMBOE of positive price and performance revisions, respectively; and +• 40.6 MMBOE of estimated net proved undeveloped reserves reclassified to unproved reserves categories resulting from revising certain aspects of the Company’s future development plans. +101 +Standardized Measure of Discounted Future Net Cash Flows +The Company computes a standardized measure of discounted future net cash flows and changes therein relating to estimated proved reserves in accordance with authoritative accounting guidance. Future cash inflows and production and development costs are determined by applying prices and costs, including transportation, quality, and basis differentials, to the year-end estimated future reserve quantities. Each property the Company operates is also charged with field-level overhead in the estimated reserve calculation. Estimated future income taxes are computed using the current statutory income tax rates, including consideration for estimated future statutory depletion. The resulting future net cash flows are reduced to present value amounts by applying a 10 percent annual discount factor. +Future operating costs are determined based on estimates of expenditures to be incurred in developing and producing the estimated proved reserves in place at the end of the period using year end costs and assuming continuation of existing economic conditions, plus Company overhead incurred by the central administrative office attributable to operating activities and estimated abandonment costs. +The assumptions used to compute the standardized measure of discounted future net cash flows are those prescribed by the FASB and the SEC. These assumptions do not necessarily reflect the Company’s expectations of actual revenues to be derived from those reserves, nor their present value amount. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure of discounted future net cash flows computations since these reserve quantity estimates are the basis for the valuation process. The following prices as adjusted for transportation, quality, and basis differentials were used in the calculation of the standardized measure of discounted future net cash flows: +For the Years Ended December 31, +2023 2022 2021 +Oil (per Bbl) $ 77.96 $ 95.02 $ 66.21 +Gas (per Mcf) $ 2.52 $ 6.39 $ 4.28 +NGLs (per Bbl) $ 22.35 $ 35.88 $ 29.31 +The following summary sets forth the Company’s future net cash flows relating to proved oil, gas, and NGL reserves based on the standardized measure of discounted future net cash flows: +As of December 31, +2023 2022 2021 +(in thousands) +Future cash inflows $ 24,466,288 $ 32,024,639 $ 21,027,406 +Future production costs (7,894,043) (7,672,906) (5,498,098) +Future development costs (2,997,545) (2,949,871) (1,591,550) +Future income taxes (2,000,016) (3,888,342) (2,130,280) +Future net cash flows 11,574,684 17,513,520 11,807,478 +10 percent annual discount (5,294,535) (7,551,454) (4,844,871) +Standardized measure of discounted future net cash flows +$ 6,280,149 $ 9,962,066 $ 6,962,607 +102 +The principal sources of changes in the standardized measure of discounted future net cash flows were: +For the Years Ended December 31, +2023 2022 2021 +(in thousands) +Standardized measure of discounted future net cash flows, beginning of year +$ 9,962,066 $ 6,962,607 $ 2,682,457 +Sales of oil, gas, and NGLs produced, net of production costs (1,800,346) (2,724,994) (2,092,499) +Net changes in prices and production costs (5,649,606) 4,428,804 5,242,783 +Extensions and discoveries, net of related costs +280,545 424,463 783,215 +Sales of reserves in place (83,850) — (4,361) +Purchase of reserves in place 151,263 — 1,565 +Previously estimated development costs incurred during the period 772,602 423,527 426,120 +Changes in estimated future development costs 99,974 (462,015) (25,355) +Revisions of previous quantity estimates +537,502 1,327,530 1,015,539 +Accretion of discount 1,215,452 815,862 268,246 +Net change in income taxes 1,096,099 (996,437) (1,196,013) +Changes in timing and other (301,552) (237,281) (139,090) +Standardized measure of discounted future net cash flows, end of year +$ 6,280,149 $ 9,962,066 $ 6,962,607 +103 +ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE +None. +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer (Principal Executive Officer) and our Chief Financial Officer (Principal Financial Officer), as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +104 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2023. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on management’s assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2023. +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +105 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company +Opinion on Internal Control Over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2023 and 2022, the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2023, and the related notes and our report dated February 22, 2024 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 22, 2024 +106 +ITEM 9B. OTHER INFORMATION +As part of its regular, annual evaluation of peer compensation practices, the Compensation Committee of the Board of Directors determined that changes were necessary for the Change of Control Executive Severance Agreement for the Company’s Senior Vice Presidents, Executive Vice Presidents, and CEO. The Board of Directors approved these recommended changes, and on February 21, 2024, the Company’s Senior Vice Presidents, Executive Vice Presidents, and CEO each executed a new Change of Control Executive Severance Agreement, the template of which is filed as Exhibit 10.16 to this report. +ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS +These disclosures are not applicable to the Company. +PART III +ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE +The information required by this Item concerning the Company’s Directors, Executive Officers, and corporate governance is incorporated by reference to the information provided under the captions “Proposal 1 - Election of Directors,” “Information about our Executive Officers,” and “Corporate Governance” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders, to be filed within 120 days from December 31, 2023. +The information required by this Item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders, to be filed within 120 days from December 31, 2023. +ITEM 11. EXECUTIVE COMPENSATION +The information required by this Item is incorporated by reference to the information provided under the captions “Executive Compensation Tables” and “Director Compensation” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders, to be filed within 120 days from December 31, 2023. +ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The information required by this Item concerning security ownership of certain beneficial owners and management is incorporated by reference to the information provided under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders, to be filed within 120 days from December 31, 2023. +107 +Securities Authorized for Issuance Under Equity Compensation Plans. The Company has equity compensation plans under which options and shares of the Company’s common stock are authorized for grant or issuance as compensation to eligible employees, consultants, and members of the Board of Directors. The Company’s stockholders have approved these plans. Please refer to Note 10 – Compensation Plans in Part II, Item 8 of this report for further information about the material terms of the Company’s equity compensation plans. The following table is a summary of the shares of common stock authorized for issuance under equity compensation plans as of December 31, 2023: +(a) (b) (c) +Plan category Number of securities to be issued upon exercise of outstanding options, warrants, and rights Weighted-average exercise price of outstanding options, warrants, and rights Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +Equity Incentive Compensation Plan (1) +Restricted stock units (2) +1,091,094 N/A +Performance share units (2) (3) +485,382 N/A +Total for Equity Incentive Compensation Plan 1,576,476 $ — 2,808,286 +Employee Stock Purchase Plan (4) +— — 3,310,680 +Equity compensation plans not approved by security holders +— — — +Total for all plans 1,576,476 $ — 6,118,966 +____________________________________________ +(1) In May 2006, the stockholders approved the Equity Plan to authorize the issuance of restricted stock, restricted stock units, non-qualified stock options, incentive stock options, stock appreciation rights, performance shares, performance units, and stock-based awards to key employees, consultants, and members of the Board of Directors of the Company or any affiliate of the Company. The Company’s Board of Directors approved amendments to the Equity Plan in 2009, 2010, 2013, 2016, and 2018 and each amended plan was approved by stockholders at the respective annual stockholders’ meetings. The total number of shares of the Company’s common stock underlying awards granted in 2023, 2022, and 2021 under the Equity Plan were 943,979, 832,257, and 726,562, respectively. +(2) RSUs and PSUs do not have exercise prices associated with them, but rather a weighted-average per unit fair value, which is presented in order to provide additional information regarding the potential dilutive effect of the awards. The weighted-average grant date per unit fair value for the outstanding RSUs and PSUs was $31.40 and $27.75, respectively. Please refer to Note 10 – Compensation Plans in Part II, Item 8 of this report for additional discussion. +(3) The number of shares of common stock assumes a multiplier of one. The actual final number of shares of common stock to be issued will range from zero to two times the number of PSUs awarded depending on the three-year performance multiplier. +(4) Under the ESPP, eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their eligible compensation, subject to certain limitations discussed in Note 10 – Compensation Plans in Part II, Item 8 of this report. The purchase price of the common stock is 85 percent of the lower of the trading price of the common stock on either the first or last day of the six-month offering period. The ESPP is intended to qualify under Section 423 of the IRC. The total number of shares of the Company’s common stock issued in 2023, 2022, and 2021 under the ESPP were 114,427, 113,785, and 313,773, respectively. +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders, to be filed within 120 days from December 31, 2023. +ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES +The information required by this Item is incorporated by reference to the information provided under the captions “ Independent Registered Public Accounting Firm ” and “ Audit Committee Pre-approval Policy and Procedures ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders, to be filed within 120 days from December 31, 2023. +108 +PART IV +ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES +(a)(1) and (a)(2) Consolidated Financial Statements and Financial Statement Schedules: +Report of Independent Registered Public Accounting Firm (PCAOB ID 42 ) +60 +Consolidated Balance Sheets +62 +Consolidated Statements of Operations +63 +Consolidated Statements of Comprehensive Income +64 +Consolidated Statements of Stockholders’ Equity +65 +Consolidated Statements of Cash Flows +66 +Notes to Consolidated Financial Statements +67 +All schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the Consolidated Financial Statements and Notes thereto. +(b) Exhibits. The following exhibits are filed or furnished with or incorporated by reference into this report on Form 10-K: +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010 (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +3.2 +Certificate of Amendment of Restated Certificate of Incorporation of SM Energy Company, as amended through June 1, 2010, dated May 25, 2023 (filed as Exhibit 3.1 to the registrant’s Current Report on Form 8-K filed on May 30, 2023, and incorporated herein by reference) +3.3 +Amended and Restated By-Laws of SM Energy Company, effective as of February 21, 2017 (filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the year ended December 31, 2016, and incorporated herein by reference) +4.1 +Indenture related to senior debt securities of SM Energy Company by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-3 filed on May 7, 2015 (Registration No. 333-203936) and incorporated herein by reference) +4.2 +2025 Notes Supplemental Indenture (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on May 21, 2015, and incorporated herein by reference) +4.3 +Base Indenture, dated as of May 21, 2015, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed on August 12, 2016, and incorporated herein by reference) +4.4 +Third Supplemental Indenture, dated September 12, 2016 by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on September 12, 2016, and incorporated herein by reference) +4.5 +Fourth Supplemental Indenture, dated as of August 20, 2018, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on August 20, 2018, and incorporated herein by reference) +4. 6 +Fifth Supplemental Indenture, dated as of June 23, 2021, by and between SM Energy Company and U.S. Bank National Association, as trustee (filed as Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed on June 23, 2021, and incorporated herein by reference) +4. 7 * +Description of Securities +10.1 +Deed of Trust to Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.2 +Supplement and Amendment to Deed of Trust, Mortgage, Line of Credit Mortgage, Assignment, Security Agreement, Fixture Filing and Financing Statement for the benefit of Wachovia Bank, National Association, as Administrative Agent, dated effective as of April 14, 2009 (filed as Exhibit 10.3 to the registrant’s Current Report on Form 8-K filed on April 20, 2009, and incorporated herein by reference) +10.3 +Seventh Amended and Restated Credit Agreement dated as of August 2, 2022, among SM Energy Company, Wells Fargo Bank, National Association, as Administrative Agent and Swingline Lender, and the Lenders party thereto (filed as Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, and incorporated herein by reference) +109 +10.4†† +Net Profits Interest Bonus Plan, As Amended by the Board of Directors on July 30, 2010 (filed as Exhibit 10.6 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference) +10.5† +Pension Plan for Employees of SM Energy Company as Amended and Restated as of January 1, 2010 (filed as Exhibit 10.30 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.6† +Amendment No. 1 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2011 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.7† +Amendment No. 2 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2012 (filed as Exhibit 10.42 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2011, and incorporated herein by reference) +10.8† +Amendment No. 3 to the Pension Plan for Employees of SM Energy Company amended as of January 1, 2016 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2015, and incorporated herein by reference) +10.9+ +SM Energy Company Non-Qualified Unfunded Supplemental Retirement Plan as Amended as of December 31, 2010 (filed as Exhibit 10.31 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2010, and incorporated herein by reference) +10.10† +SM Energy Company Non-Qualified Deferred Compensation Plan as of March 10, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on January 24, 2014, and incorporated herein by reference) +10.11† +Cash Bonus Plan, As Amended and Restated as of February 1, 2014 (filed as Exhibit 10.41 to the registrant’s Annual Report on Form 10-K filed for the year ended December 31, 2013, and incorporated herein by reference) +10.12† +Section 162(m) Cash Bonus Plan, effective as of May 21, 2014 (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on May 28, 2014, and incorporated herein by reference) +10.13† +SM Energy Company Employee Stock Purchase Plan, amended and restated effective as of April 5, 2021 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 16, 2021, and incorporated herein by reference) +10.14† +Form of Non-Employee Director Restricted Stock Award Agreement as of May 27, 2010 (filed as Exhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, and incorporated herein by reference) +10.15*† +Summary of Compensation Arrangements for Non-Employee Directors +10.16 * † +Change of Control Executive Severance Agreement +10.17† +Change of Control Severance Agreement dated December 18, 2022 between Lehman E. Newton, III and SM Energy Company. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on December 21, 2022, and incorporated herein by reference) +10.18† +Change of Control Severance Agreement dated December 29, 2022 between David Copeland and SM Energy Company. (filed as Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed on December 30, 2022, and incorporated herein by reference) +10.19† +Non-Competition and Non-Solicitation Agreement dated December 18, 2022 between Lehman E. Newton, III and SM Energy Company (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on December 21, 2022, and incorporated herein by reference) +10.20† +Non-Competition and Non-Solicitation Agreement dated December 29, 2022 between David Copeland and SM Energy Company (filed as Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed on December 30, 2022, and incorporated herein by reference) +10.21† +SM Energy Company Equity Incentive Compensation Plan, amended and restated effective as of May 22, 2018 (filed as Annex A in the registrant’s Definitive Proxy Statement on Schedule 14A, filed on April 12, 2018, and incorporated herein by reference) +10.2 2* † +F orm of Per formance Share Unit Award Agreement as of July 1, 202 3 +10.2 3 *† +F orm of Restricted Stock Unit Award Agreement as of July 1, 2023 +21.1* +Subsidiaries of Registrant +23.1* +Consent of Ernst & Young LLP +23.2* +Consent of Ryder Scott Company L.P. +24.1* +Power of Attorney +31.1* +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +31.2* +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002 +32.1** +Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 +97.1*† +Policy Relating to Recovery of Erroneously Awarded Compensation +110 +99.1* +Ryder Scott Audit Letter +101.INS Inline XBRL Instance Document - The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH* Inline XBRL Schema Document +101.CAL* Inline XBRL Calculation Linkbase Document +101.LAB* Inline XBRL Label Linkbase Document +101.PRE* Inline XBRL Presentation Linkbase Document +101.DEF* Inline XBRL Taxonomy Extension Definition Linkbase Document +104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101.INS) +_____________________________________ +* Filed with this report. +** Furnished with this report. +*** +Certain portions of this exhibit have been redacted and are subject to a confidential treatment order granted by the Securities and Exchange Commission pursuant to Rule 24b-2 under the Exchange Act. +† Exhibit constitutes a management contract or compensatory plan or agreement. +†† Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on July 30, 2010 primarily to reflect the change in the name of the registrant from St. Mary Land & Exploration Company to SM Energy Company. There were no material changes to the substantive terms and conditions in this document. ++ Exhibit constitutes a management contract or compensatory plan or agreement. This document was amended on November 9, 2010, in order to make technical revisions to ensure compliance with Section 409A of the Internal Revenue Code. There were no material changes to the substantive terms and conditions in this document. +(c) Financial Statement Schedules. Please refer to Item 15(a) above. +ITEM 16. FORM 10-K SUMMARY +None. +111 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +SM ENERGY COMPANY +(Registrant) +Date: February 22, 2024 By: /s/ HERBERT S. VOGEL +Herbert S. Vogel +President and Chief Executive Officer +(Principal Executive Officer) +GENERAL POWER OF ATTORNEY +KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Herbert S. Vogel and A. Wade Pursell his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, and each with full power to act alone, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any amendments to this Annual Report on Form 10-K for the fiscal year ended December 31, 2023, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. +Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ HERBERT S. VOGEL President, Chief Executive Officer, and Director February 22, 2024 +Herbert S. Vogel (Principal Executive Officer) +/s/ A. WADE PURSELL Executive Vice President and Chief Financial Officer February 22, 2024 +A. Wade Pursell (Principal Financial Officer) +/s/ PATRICK A. LYTLE Vice President - Chief Accounting Officer and Controller February 22, 2024 +Patrick A. Lytle (Principal Accounting Officer) +112 +Signature Title Date +/s/ JULIO M. QUINTANA +Chairman of the Board of Directors February 22, 2024 +Julio M. Quintana +/s/ CARLA J. BAILO Director February 22, 2024 +Carla J. Bailo +/s/ STEPHEN R. BRAND Director February 22, 2024 +Stephen R. Brand +/s/ RAMIRO G. PERU Director February 22, 2024 +Ramiro G. Peru +/s/ ANITA M. POWERS Director February 22, 2024 +Anita M. Powers +/s/ ROSE M. ROBESON Director February 22, 2024 +Rose M. Robeson +/s/ WILLIAM D. SULLIVAN +Director February 22, 2024 +William D. Sullivan +113 \ No newline at end of file diff --git a/raw/filings/0000893538/2023/0000893538-24-000009/filing_metadata.csv b/raw/filings/0000893538/2023/0000893538-24-000009/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..1f300ff36f8e99a8b2a42fafb57a3ba2e2ef686c --- /dev/null +++ b/raw/filings/0000893538/2023/0000893538-24-000009/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000893538,SM,SM Energy Co,10-K,2024-02-22,2023-12-31,2024-02-22T13:54:52.000Z,0000893538-24-000009,sm-20231231.htm,10-K,15891776,1,1,https://www.sec.gov/Archives/edgar/data/893538/000089353824000009/sm-20231231.htm,https://www.sec.gov/Archives/edgar/data/893538/000089353824000009/,2023,2023,1 diff --git a/raw/filings/0000893538/2023/0000893538-24-000009/item1.txt b/raw/filings/0000893538/2023/0000893538-24-000009/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2023/0000893538-24-000009/item13.txt b/raw/filings/0000893538/2023/0000893538-24-000009/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..bb23db720f99da85f5fbfa3f7d364f69c5379bf9 --- /dev/null +++ b/raw/filings/0000893538/2023/0000893538-24-000009/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +The information required by this Item is incorporated by reference to the information provided under the captions “ Certain Relationships and Related Transactions ” and “ Corporate Governance ” in the Company’s Definitive Proxy Statement on Schedule 14A for the 2024 annual meeting of stockholders, to be filed within 120 days from December 31, 2023. \ No newline at end of file diff --git a/raw/filings/0000893538/2023/0000893538-24-000009/item9a.txt b/raw/filings/0000893538/2023/0000893538-24-000009/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..7c7084e8b210c726383f8f5bdb521c778d491bd5 --- /dev/null +++ b/raw/filings/0000893538/2023/0000893538-24-000009/item9a.txt @@ -0,0 +1,34 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer (Principal Executive Officer) and our Chief Financial Officer (Principal Financial Officer), as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes during the fourth quarter of 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +104 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2023. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on management’s assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2023. +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +105 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company +Opinion on Internal Control Over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on the COSO criteria. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2023 and 2022, the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2023, and the related notes and our report dated February 22, 2024 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 22, 2024 +106 \ No newline at end of file diff --git a/raw/filings/0000893538/2023/0000893538-24-000009/rp_note.txt b/raw/filings/0000893538/2023/0000893538-24-000009/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2023/0000893538-24-000009/rpt_disclosure.txt b/raw/filings/0000893538/2023/0000893538-24-000009/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..368bc8244d0f3cb78d240af6a2c440f353080f1c --- /dev/null +++ b/raw/filings/0000893538/2023/0000893538-24-000009/rpt_disclosure.txt @@ -0,0 +1,11 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Policies and Procedures on Transactions with Related Persons +Our Related Person Transactions Policy sets forth the policies and procedures for the Audit Committee’s review of any transaction, arrangement, or relationship (including any indebtedness or guarantee of indebtedness) or series of similar transactions, arrangements, or relationships in which (a) we are a participant, (b) the aggregate amount involved will or may be expected to exceed $120,000 per annum, and (c) a related person has or will have a direct or indirect material interest. For purposes of our Related Person Transactions Policy, a “related person” means (i) any of our directors, executive officers, or nominees for director, (ii) any stockholder that beneficially owns more than five percent of our outstanding shares of common stock, and (iii) any immediate family member of any of the foregoing. The Audit Committee approves or ratifies only those transactions that it determines in good faith are in, or are not inconsistent with, our best interests and the best interests of our stockholders. +In determining whether to approve or ratify a transaction with a related person, the Audit Committee takes into account the factors it deems appropriate, which may include, among others, the benefits to us, the availability of other sources for comparable products or services, the impact on a director’s independence in the event the related person is a director, and the extent of the related person’s interest in the transaction. The Audit Committee reviews and assesses ongoing relationships with a related person on at least an annual basis to ensure that they are in compliance with the policy and remain appropriate. +In addition, our By-Laws provide that a director, officer, or employee of our Company may not pursue for his or her own account a business or investment opportunity that he or she learned about through his or her affiliation with us. These restrictions do not apply to the acquisition of less than one percent of the publicly traded stock of another company. +Transactions with Related Persons +We recognize that transactions with related persons may raise questions among stockholders regarding whether those transactions are consistent with our best interests and the best interests of our stockholders. It is our policy to enter into or ratify such transactions only when our Board, acting through the Audit Committee or as otherwise described herein, determines that the transaction in question is in, or is not inconsistent with, our best interests and the best interests of our stockholders. Such transactions include, but are not limited to, situations where we may obtain products or services of a nature, quantity or quality, or on other terms, that are not readily available from alternate sources, or when we obtain products or services from, or provide products or services to, related persons on an arm’s length basis on terms comparable to those obtained from or provided to unrelated third parties or on terms comparable to those obtained from or provided to employees generally. Since January 1, 2024, with the exception of the transaction described in the following paragraph, which was approved by our Audit Committee, we had no transactions that required approval under our Related Person Transactions Policy. +Dean Lutey, the spouse of Ms. Mary Ellen Lutey, our Senior Vice President - Texas, joined the Company in 2008. Mr. Lutey was appointed Senior Vice President - Chief Information Officer in March 2025. Prior to this appointment, Mr. Lutey served as the Company’s Vice President - Chief Information Officer since April 2021 and as Vice President - Information Technology since May 2013. During the fiscal year ended December 31, 2024, Mr. Lutey earned total compensation of $1,136,048, which included his base salary, annual bonus, LTIP awards, benefits under our qualified and non-qualified benefit plans, and matching contributions by the Company under its 401(k) Profit Sharing Plan and Non-Qualified Deferred Compensation Plan. Mr. Lutey also participated in the Company’s benefit programs for its employees. +Compensation Committee Interlocks and Insider Participation +None of the directors who served on the Compensation Committee during fiscal year 2024 has ever served as one of our officers or employees. During fiscal year 2024, there were no Compensation Committee interlocks. +79 \ No newline at end of file diff --git a/raw/filings/0000893538/2024/0000893538-25-000008/item1.txt b/raw/filings/0000893538/2024/0000893538-25-000008/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000893538/2024/0000893538-25-000008/item9a.txt b/raw/filings/0000893538/2024/0000893538-25-000008/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e066b622c9ebd26c3fa5acc443eaf2533db78fbc --- /dev/null +++ b/raw/filings/0000893538/2024/0000893538-25-000008/item9a.txt @@ -0,0 +1,36 @@ +ITEM 9A. CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +We maintain a system of disclosure controls and procedures that are designed to reasonably ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and to reasonably ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer (Principal Executive Officer) and our Chief Financial Officer (Principal Financial Officer), as appropriate, to allow for timely decisions regarding required disclosure. +Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) (“Disclosure Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We monitor our Disclosure Controls and make modifications as necessary; our intent in this regard is that the Disclosure Controls will be modified as systems change and conditions warrant. +An evaluation of the effectiveness of the design and operation of our Disclosure Controls was performed as of the end of the period covered by this report. This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Disclosure Controls are effective at a reasonable assurance level. +Changes in Internal Control Over Financial Reporting +There have been no changes to our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fourth quarter of 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +107 +Management’s Report on Internal Control over Financial Reporting +Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: +(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that have a material effect on the financial statements. +Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. +Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2024. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 framework) . +Based on management’s assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2024. +The Uinta Basin Acquisition was considered the acquisition of a business as defined by Article 11-01(d) of Regulation S-X. As permitted by the SEC, management’s assessment and conclusion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2024, excludes an assessment of the internal controls over the oil and gas properties acquired in the Uinta Basin Acquisition. Due to the recent nature of the acquisition, it was not practical from a timing or resource perspective for management to conduct a thorough assessment of the internal control over financial reporting related to the Uinta Basin Acquisition prior to December 31, 2024. The Uinta Basin Acquisition is included in our 2024 consolidated financial statements and represents approximately 27 percent of the total assets of the consolidated Company as of December 31, 2024, and approximately seven percent of consolidated revenues for the year then ended. Refer to Note 17 – Acquisitions in Part II, Item 8 of this report for additional discussion of the Uinta Basin Acquisition. +The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. That report immediately follows this report. +108 +Report of Independent Registered Public Accounting Firm +To the Stockholders and the Board of Directors of SM Energy Company and subsidiaries +Opinion on Internal Control Over Financial Reporting +We have audited SM Energy Company and subsidiaries’ internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, SM Energy Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2024, based on the COSO criteria. +As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls over the oil and natural gas properties the Company acquired on October 1, 2024 in the Uinta Basin (the “Uinta Basin Acquisition”). The Uinta Basin Acquisition was included in the 2024 consolidated financial statements of the Company and represented 27% of total consolidated assets as of December 31, 2024 and 7% of consolidated revenues for the year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of the Uinta Basin Acquisition. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2024 and 2023, the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2024, and the related notes and our report dated February 20, 2025 expressed an unqualified opinion thereon. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. +Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control Over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Ernst & Young LLP +Denver, Colorado +February 20, 2025 +109 \ No newline at end of file diff --git a/raw/filings/0000893538/2024/0000893538-25-000008/rp_note.txt b/raw/filings/0000893538/2024/0000893538-25-000008/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2014/0001017303-15-000021/filing.txt b/raw/filings/0001017303/2014/0001017303-15-000021/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..11cec2d75fd494875050e477a7fb26b7497ae412 --- /dev/null +++ b/raw/filings/0001017303/2014/0001017303-15-000021/filing.txt @@ -0,0 +1,3375 @@ +10-K +1 +form10k2014.htm +FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2014 +form10k2014.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2014 +or +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to . +Commission file number: 0-21121 +______________________________________________________________________ +______________________________________________________________________ +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT +06518 +(Address of principal executive offices) +(Zip Code) +Registrant's telephone number, including area code 203-859-6800 +______________________________________________________________________ +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class - Common Stock, par value $.01 per share +Name of Exchange on which Registered - NASDAQ Global Market +______________________________________________________________________ +Securities registered pursuant to Section 12(g) of the Act : None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. +Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o +Accelerated filer ý +Non-accelerated filer o (Do not check if a smaller reporting company) +Smaller reporting company o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý +The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the Registrant was approximately $82,400,000 based on the last sale price on June 30, 2014. +As of February 27, 2015, the number of shares outstanding of the Registrant’s common stock, $0.01 par value, was 7,784,804. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to the 2015 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +4 +Item 1B. +Unresolved Staff Comments +9 +Item 2. +Properties +9 +Item 3. +Legal Proceedings +9 +Item 4. +Mine Safety Disclosures +9 +PART II. +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +9 +Item 6. +Selected Financial Data +11 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +11 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +23 +Item 8. +Financial Statements and Supplementary Data +23 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +23 +Item 9A. +Controls and Procedures +23 +Item 9B. +Other Information +24 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +24 +Item 11. +Executive Compensation +25 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +25 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +25 +Item 14. +Principal Accounting Fees and Services +25 +PART IV. +Item 15. +Exhibits +25 +SIGNATURES +Signatures +26 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +EXHIBITS +Index to Exhibits +PART I +Item 1. Business. +The Company +TransAct Technologies Incorporated (“TransAct” or the “Company”) was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct designs, develops and sells market-specific solutions, including printers, terminals, software and other products for transaction-based and other industries. These world-class products are sold under the Epic, EPICENTRAL®, Ithaca®, RESPONDER® and Printrex® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality labels and transaction records such as receipts, tickets, coupons, register journals and other documents as well as printed logging and plotting of data. We focus on the following core markets: food safety, banking and point-of-sale (“POS”), casino and gaming, lottery, and Printrex (which serves the oil and gas, medical and mobile printing markets). We sell our products to original equipment manufacturers (“OEMs”), value-added resellers ("VARs"), selected distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class printer service, spare parts, accessories and printing supplies to its growing worldwide installed base of printers. Through our TransAct Services Group (“TSG”) we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the on-line demand for these products. We have one primary operating,global research and development and eastern region service center located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters and western region service center in Las Vegas, NV, a sales and service center for the oil and gas industry in Houston, TX, a European sales and service center in the United Kingdom, a sales office located in Macau and two other sales offices located in the United States. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT , 06518, with a telephone number of (203) 859-6800. +On August 19, 2011, we completed the acquisition of Printrex, Inc. (“Printrex”) for $4,000,000 in cash and potential future contingent consideration. Printrex is a leading manufacturer of specialty printers primarily sold into the oil and gas exploration and medical and mobile printing markets. Printrex serves commercial and industrial customers primarily in the United States, Canada, Europe and Asia. This acquisition was completed to complement our existing product offerings. +Financial Information about Segments +We operate in one reportable segment, the design, development, assembly and marketing of transaction printers and terminals and providing related software, services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements on pages F-3 and F-4 hereof. +Products, Services and Distribution Methods +Printers and terminals +TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing inkjet, thermal and impact printing technology for applications, primarily in the food safety, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers. +Food safety, banking and POS: During 2012 in an effort to address the Food Safety Modernization Act, we developed a food safety terminal, a hardware device that consists of a touchscreen and one or two thermal print mechanisms, that prints easy-to-read expiration and "enjoy by" date labels to help restaurants effectively manage food rotation and spoilage. In the food safety market, we use an internal sales representative to manage sales of our terminals through distribution, as well as a dedicated internal sales force to solicit sales directly from end-users. +Our banking and POS printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the banking market, we sell printers that are used by banks, credit unions and other financial institutions to print receipts and/ or validate checks at bank teller stations. In the POS market, we sell several models of printers utilizing inkjet, thermal and impact printing technology. Our printers are used primarily by retailers in the restaurant (including fine dining, casual dining, and fast food), hospitality, and specialty retail industries to print receipts for consumers, validate checks, or print on linerless labels or other inserted media. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force. +Lottery: We supply lottery printers to Lottomattica’s GTECH Corporation (“GTECH”), our largest customer and the world’s largest provider of lottery terminals. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to GTECH and managed by an internal sales representative. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLT’s”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks (“racinos”) and other gaming venues worldwide. These printers utilize thermal printing technology and can print tickets or receipts in monochrome or two-color (depending upon the model), and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal printing technology for use in non-casino establishments, including game types such as Amusements with Prizes (“AWP”), Skills with Prizes (“SWP”), Fixed Odds Betting Terminals (“FOBT”) and other off-premise gaming type machines around the world. We sell our products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through our primary worldwide distributor, Suzo-Happ Group. We also maintain a dedicated internal sales force to solicit sales from slot manufacturers and casinos, as well as to manage sales through our distributor. +1 +We also offer a software solution, the EPICENTRAL TM Print System (“EPICENTRAL TM ”), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. With EPICENTRAL TM , casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +Printrex: Printrex printers include wide format, rack mounted and vehicle mounted thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. During 2012, we launched two new color printers for this market, the Printrex 920 and Printrex 980. The Printrex 920 is the first full-color printer designed from the ground up to perform in the adverse environment of a well logging truck or off-shore platform. Using thermal printer technology, it can print in black and white, or in full color using proprietary color paper, without the need for inkjet cartridges or ribbons. The Printrex 980 is the fastest full color printer available for plotting continuous logs in the data centers of the large oil field service companies. This printer uses proprietary inkjet cartridges. In 2015, we expect to launch the Responder MP2™, our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery. In addition, we sell wide format thermal printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM’s, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated internal sales force with a sales office located in Houston, Texas. +TSG: Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor’s products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress SM , and other repair services for our printers. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY, our western region service center in Las Vegas, NV and our oil and gas industry service center in Houston, TX. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and our services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 95% of our printer production is primarily through one third-party contract manufacturer in Asia and to a lesser extent one other in Asia and one in Mexico. The remaining 5% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include inkjet, thermal and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, purchases of component parts have declined while purchases of fully-assembled printers produced by our contract manufacturers have increased. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer models, from one foreign contract manufacturer, and to a much lesser extent, two other foreign contract manufacturers. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have a supply agreement with our foreign contract manufacturers, our relationship with them remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms to us during 2015 or that their terms to us will be any less favorable than they have been historically. +Hewlett-Packard Company (“HP”) is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the banking and POS market, but also in other manufacturer’s printing devices across several other markets. +ZINK Imaging Inc. (“ZINK”) is the sole supplier of proprietary color thermal paper used in our Printrex 920 oil and gas printer. We had a supply agreement with ZINK to exclusively supply us with ZINK color thermal paper for the oil and gas industry at fixed prices through December 31, 2014. We plan to renew this agreement during 2015. The loss of the supply of ZINK color thermal paper would have a material adverse effect on the sale of Printrex 920 printers and ZINK color thermal paper. +2 +Canon, Inc. (“Canon”) is the sole supplier of inkjet cartridges and other consumable items (“Canon Consumables”) that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2017. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 29 United States and 30 foreign patents and have 8 United States and 12 foreign patent applications pending pertaining to our products. The duration of these patents range from 3 to 17 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Seasonality +Restaurants typically reduce purchases of new food safety equipment in the fourth quarter due to the increased volume of transactions in that holiday period. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +GTECH has been our most significant customer. In December 2009, we signed a new five-year agreement effective November 20, 2009, with GTECH (the “GTECH Thermal Printer Agreement”). Under the terms of the agreement, we provide GTECH with their latest generation thermal lottery printers for various lottery applications. The terms of the agreement require that GTECH exclusively purchase all of its requirements for thermal on-line lottery printers from us and that we exclusively sell such printers to GTECH through May 8, 2015. We are currently in negotiations with GTECH to extend the agreement. +Sales to GTECH and other customers representing 10% or more of our total net sales were as follows: +Year ended December 31, +2014 +2013 +2012 +GTECH +16% +12% +18% +Eurocoin Ltd. +11% +12% +15% +Backlog +Our backlog of firm orders was approximately $11,356,000 as of February 27, 2015, compared to $4,778,000 as of February 28, 2014. Based on customers’ current delivery requirements, we expect to ship our entire current backlog during 2015. +Competition +The market for transaction-based and specialty printing solutions is extremely competitive, and we expect such competition to continue in the future. We compete with a number of companies, many of which have greater financial, technical and marketing resources than us. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the food safety market, we compete with Avery Dennison Corporation, Ecolab Inc. and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the banking and POS market, our major competitor is Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. +In the casino and gaming market (consisting principally of slot machine and video lottery terminal transaction printing and promotional coupon printing), we compete with several companies including FutureLogic, Inc., Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we hold a leading position, based largely on our long-term purchase agreement with GTECH. We compete in this market based solely on our ability to provide specialized, custom-engineered products to GTECH. +In the Printrex market, we compete with the Imaging Systems Group, Inc. (“iSys”), Neuralog Inc., GSI Group and others. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +3 +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, depending on the geographic area. +Our strategy for competing in our markets is to continue to develop new products (hardware and software) and product line extensions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain inkjet, thermal and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $4,302,000, $4,065,000, and $4,239,000 in 2014, 2013 and 2012, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for sale to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010 we began the development of EPICENTRAL TM, , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $169,000 and $370,000 as of December 31, 2014 and 2013, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $201,000, $199,000, and $189,000 in 2014, 2013 and 2012, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2014, TransAct and our subsidiaries employed 129 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 16 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, EPICENTRAL®, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Available Information +We make available free of charge through our internet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. +We maintain a Code of Business Conduct that includes our code of ethics that is applicable to all employees, including our Chief Executive Officer, Chief Financial Officer and Controller. This Code, which requires continued observance of high ethical standards such as honesty, integrity and compliance with the law in the conduct of our business, is available for public access on our internet website. Any person may request a copy of our Code of Business Conduct free of charge by calling (203) 859-6800. +Item 1A. Risk Factors +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are not the only ones facing our Company. Additional risks not known to us now or that we currently deem immaterial may also impair our business operations. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking statements contained in this Annual Report to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +4 +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are likely to continue to vary due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical operating results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may be due to a number of factors, including, but not limited to, those identified throughout this “Risk Factors” section: +· +market acceptance of our products, both domestically and internationally; +· +development of new competitive products by others; +· +our responses to price competition; +· +our level of research and development activities; +· +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +· +changes in the amount we spend to promote our products and services; +· +changes in the cost of satisfying our warranty obligations and servicing our installed base of printers; +· +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +· +the geographic distribution of our sales; +· +availability of third-party components at reasonable prices; +· +general economic and industry conditions, including changes in interest rates affecting returns on cash balances and investments, that affect customer demand; +· +severe weather events (such as hurricanes) that can disrupt or interrupt the operation of our customers or suppliers facilities; and +· +changes in accounting rules. +Due to all of the foregoing factors, and the other risks discussed in this report, quarter-to-quarter comparisons of our operating results may not be an indicator of future performance. +Our revenue and profitability depend on our ability to continue to develop, on a timely basis, new products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated. +The success of newer products such as the Ithaca® 9700 food safety terminal and the Printrex® 920 and Printrex® 980 oil and gas color printers is dependent on how quickly customers in the related markets accept them given the very little market penetration these products have experienced since they are new and innovative and have limited competition. Additionally, the success of innovative technology, such as printing coupons and promotions at the slot machine using EPICENTRAL™, is dependent on our casino customers' acceptance of such technology. While we have designed EPICENTRAL™ to support our customers' existing investment in our Epic 950® thermal casino printers, such acceptance may nevertheless only build gradually over time or not at all. Delays in acceptance by our customers of new technologies may adversely affect our operations. +Our success depends upon our ability to adapt our capabilities and processes to meet the demands of producing new and innovative products. Because our newer products are generally more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product innovation. If we cannot efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +Infringement on the proprietary rights of others could put us at a competitive disadvantage, and any related litigation could be time consuming and costly. +Third parties may claim that we violated their intellectual property rights. To the extent of a violation of a third party’s patent or other intellectual property right, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish our objectives. Any of these claims, with or without merit, could result in costly litigation and divert the attention of key personnel. If such claims are successful, they could result in costly judgments or settlements. Refer to Item 3. “Legal Proceedings” for discussion surrounding litigation we were involved in regarding alleged misappropriation of unspecified trade secrets and confidential information. +General economic conditions could have a material adverse effect on our business, operating results and financial condition. +Global economic growth has slowed and has resulted in recessions in numerous countries, including many of those in North America, Europe and Asia, where the Company does substantially all of its business. If these economic conditions continue to persist, or if they worsen, a number of negative effects on our business could result, including customers or potential customers reducing or delaying orders, the insolvency of key suppliers which could result in production delays, the inability of customers to obtain credit, and the insolvency of one or more customers. Any of these effects could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including write-downs of assets. +We rely on resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market our products. We may be adversely impacted by any conflicts that could arise between and among our various sales channels. +Our dependence upon resellers exposes us to numerous risks, including: +· +loss of channel and the ability to bring new products to market; +· +concentration of credit risk, including disruption in distribution should the resellers’ financial condition deteriorate; +· +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +· +resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +· +direct competition should a reseller decide to manufacture printers internally or source printers from a competitor. +5 +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon the business, consolidated results of operations and financial condition. +We have outsourced a large portion of the assembly of our printers to four contract manufacturers and will be dependent on them for the manufacturing of such printers. A failure by these contract manufacturers, or any disruption in such manufacturing or the flow of product from these manufacturers, may adversely affect our business results. +In an effort to achieve additional cost savings and operation benefits, we have continued to outsource the manufacturing and assembly of our printers to contract manufacturers in Asia. Approximately 80% of our printer manufacturing is conducted by one third party manufacturer in Asia. +However, to the extent we rely on a third-party service provider for manufacturing services, we may incur increased business continuity risks. We will no longer be able to exercise control over the assembly of certain of our products or any related operations or processes, including the internal controls associated with operations and processes conducted and the quality of our products assembled by contract manufacturers. If we are unable to effectively develop and implement our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially adversely affected. +In addition, if any of our contract manufacturers experiences business difficulties or fails to meet our manufacturing needs, then we may be unable to meet production requirements, may lose revenue and may not be able to maintain relationships with our customers. Without the contract manufacturers continuing to manufacture our products and the continuing operation of the contract manufacturers’ facilities, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing facility, which could be costly and time consuming and have a material adverse effect on our operating and financial results. +The increased elements of risk that arise from conducting certain operating processes in foreign jurisdictions may lead to an increase in reputational risk. +Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing customers resulting from our inability to produce products for them. +The contract manufacturers have access to our intellectual property, which increases the risk of infringement or misappropriation of this intellectual property. +Political, social or economic instability in regions in which our manufacturers are located, could cause disruptions in trade, including exports to the U.S. +A significant portion of our printers are manufactured by contract manufacturers overseas and are exported to the U.S. Any such disruption in trade, including exports to the U.S., could adversely affect our business results. Events that could cause disruptions to such exports to the U.S. include: +· +the imposition of additional trade law provisions or regulations; +· +reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; +· +the imposition of additional duties, tariffs and other charges on imports and exports; +· +economic uncertainties and adverse economic conditions (including inflation and recession); +· +fluctuations in the value of the U.S. Dollar against foreign currencies; +· +significant labor disputes, such as dock strikes; +· +significant delays in the delivery of cargo due to port security considerations; +· +financial or political instability in any of the countries in which our printers are manufactured. +We source some of our component parts and consumable products from sole source suppliers; any disruptions may impact our ability to manufacture and sell our products. +A disruption in the supply of such component parts and consumable products could have a material adverse effect on our operations and financial results. +We sell a significant portion of our products internationally and purchase important components from foreign suppliers. These circumstances create a number of risks. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. Risks associated with sales and purchases outside the United States include: +· +fluctuating foreign currency rates could restrict sales, or increase costs of purchasing, in foreign countries; +· +foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers or capital flow restrictions; +· +political and economic instability may reduce demand for our products or put our foreign assets at risk; +· +restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets; and +· +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from selling in certain geographic territories. +We face risks associated with manufacturing forecasts. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays, which could cause us to lose orders or customers and result in lower net sales. We currently use a rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our requirements for components and materials. It is very important that we accurately predict both the demand for our products and the lead-time required to obtain the necessary components and raw materials. +6 +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size of the order, contract terms, and demand for each component at a given time. If we underestimate our requirements, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and result in delays in shipments and net sales. If we overestimate our requirements, we could have excess inventory of parts. In addition, delays in the manufacturing of our products could cause us to lose orders or customers. +In the lottery market, we have been dependent on sales to one large customer; the loss of this customer or reduction in orders from this customer could materially affect our sales. +We expect that sales to one large customer will continue to represent a material percentage of our net sales for the foreseeable future. A reduction, delay or cancellation in orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Our success will depend on our ability to sustain and manage growth. +As part of our business strategy, we intend to pursue a growth strategy. Assuming this growth occurs, it will require the expansion of distribution relationships in international markets, the successful development and marketing of new products for our existing and new markets, expanded customer service and support, and the continued implementation and improvement of our operational, financial and management information systems. +To the extent that we seek growth through acquisitions, our ability to manage our growth will also depend on our ability to integrate businesses that have previously operated independently. We may not be able to achieve this integration without encountering difficulties or experiencing the loss of key employees, customers or suppliers. It may be difficult to design and implement effective financial controls for combined operations and differences in existing controls for each business may result in weaknesses that require remediation when the financial controls and reporting functions are combined. As we pursue acquisitions, we may incur legal, accounting and other transaction related expenses for unsuccessful acquisition attempts that could adversely affect our results of operations in the period in which they are incurred. +There can be no assurance that we will be able to successfully implement our growth strategy, or that we can successfully manage expanded operations, if they occur. As we expand, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our results of operations and financial condition. +We compete in highly competitive markets, which are likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, transaction supplies and services. Our principal competitors have substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +· +technologically advanced products that satisfy the user demands; +· +superior customer service; +· +high levels of quality and reliability; and +· +dependable and efficient distribution networks. +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products. Any of these factors could reduce our earnings. +We depend on key personnel, the loss of which could materially impact our business. +Our future success will depend in significant part upon the continued service of certain key management and other personnel and our continuing ability to attract and retain highly qualified managerial, technical and sales and marketing personnel. There can be no assurance that we will be able to recruit and retain such personnel. The loss of either Bart C. Shuldman, the Company's Chairman of the Board and Chief Executive Officer, or Steven A. DeMartino, the Company’s President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, could have a material adverse effect on our results of operations. +If we are unable to enforce our patents or if it is determined that we infringe patents held by others it could damage our business. +Prosecuting and defending patent lawsuits is very expensive. We are committed to aggressively asserting and defending our technology and related intellectual property, which we have spent a significant amount of money to develop. These factors could cause us to become involved in new patent litigation in the future. The expense of prosecuting or defending these future lawsuits could also have a material adverse effect on our business, financial condition and results of operations. +If we were to lose a patent lawsuit in which another party is asserting that our products infringe its patents, we would likely be prohibited from marketing those products and could also be liable for significant damages. Either or both of these results may have a material adverse effect on our business, financial condition and results of operations. If we lose a patent lawsuit in which we are claiming that another party’s products are infringing our patents and thus, are unable to enforce our patents, it may have a material adverse effect on our business, financial condition and results of operations. In addition to disputes relating to the validity or alleged infringement of other parties' rights, we may become involved in disputes relating to our assertion of our own intellectual property rights. Whether we are defending the assertion of intellectual property rights against us or asserting our intellectual property rights against others, intellectual property litigation can be complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. Plaintiffs in intellectual property cases often seek injunctive relief, and the measures of damages in intellectual property litigation are complex and often subjective or uncertain. Thus, any adverse determinations in this type of litigation could subject us to significant liabilities and costs. During the course of these lawsuits there may be public announcements of the results of hearings, motions, and other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could harm the market price of our stock. +7 +The inability to protect intellectual property could harm our reputation, and our competitive position may be materially damaged. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trade secrets and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without authorization, to obtain and use information which we regard as trade secrets. +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as: +· +changes in our business, operations or prospects; +· +developments in our relationships with our customers; +· +announcements of new products or services by us or by our competitors; +· +announcement or completion of acquisitions by us or by our competitors; +· +changes in existing or adoption of additional government regulations; +· +unfavorable or reduced analyst coverage; and +· +prevailing domestic and international market and economic conditions. +In addition, the stock market has experienced significant price fluctuations in recent years. Broad market fluctuations, general economic conditions and specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Limited trading volume and a reduction in analyst coverage of our capital stock may contribute to its price volatility. +Our common stock is traded on the NASDAQ Global Market. During the year ended December 31, 2014, the average daily trading volume for our common stock as reported by the NASDAQ Global Market was approximately 24,000 shares. We are uncertain whether a more active trading market in our common stock will develop. In addition, many investment banks no longer find it profitable to provide securities research on micro-cap and small-cap companies. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the price of our common stock. +Future sales of our common stock may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, and we may also issue additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future sale pursuant to stock options that we have granted to our employees, and in the future we may grant additional stock options and other forms of equity compensation to our employees. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. +If market conditions deteriorate or future results of operations are less than expected, a valuation allowance may be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred tax assets on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions deteriorate or future results of operations are less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are not realizable. As a result, we may need to establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +We cannot provide any assurance that current laws, or any laws enacted in the future, will not have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements in each of the jurisdictions in which we conduct business. Changes in laws, rules, regulations, policies or requirements could result in the need to modify our products and could affect the demand for our products, which may have an adverse impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +Intangible computer software costs may not be recoverable. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. To the extent technological feasibility of products is not achieved, related capitalized computer software costs may not be recoverable. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. It is possible that terrorist attacks could be directed at important locations for the gaming industry. Heightened security measures and other efforts to combat terrorism may also have an adverse effect on the gaming industry by reducing tourism. Any of these developments could also negatively affect the general economy and consumer confidence. Any downturn in the economy or in the gaming industry in particular could reduce demand for our products and adversely affect our business and results of operations. In addition, heightened security measures may cause certain governments to restrict the import/export of goods, which may have an adverse effect on our ability to buy/sell goods. +8 +Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely impact our business. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on our business, financial condition, and results of operations. +Item 1B. Unresolved Staff Comments. +Not applicable. +Item 2. Properties. +Our principal facilities as of December 31, 2014 are listed below and we believe that all facilities generally are in good condition, adequately maintained and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. Ft.) +Owned or +Leased +Lease Expiration +Date +Hamden, Connecticut +Executive offices and Printrex and TSG sales office +11,100 +Leased +April 23, 2017 +Ithaca, New York +Global engineering, design, assembly and service facility +73,900 +Leased +May 31, 2016 +Las Vegas, Nevada +Service center and casino and gaming sales office +13,700 +Leased +December 31, 2016 +Doncaster, United Kingdom +Sales office and service center +2,800 +Leased +August 1, 2016 +Houston, Texas +Sales office and service center +1,350 +Leased +April 30, 2015 +Georgia and New York +Two regional sales offices +300 +Leased +Various +Macau, China +Sales office +180 +Leased +June 30, 2015 +103,330 +Item 3. Legal Proceedings. +On June 8, 2012, Avery Dennison Corporation (“AD”) filed a civil complaint against the Company and a former employee of the Company and of AD, in the Court of Common Pleas (the “Court”) in Lake County, Ohio (the “AD Lawsuit”). The complaint alleged that this former employee and the Company misappropriated unspecified trade secrets and confidential information from AD related to the design of our food safety terminals. The complaint requested a preliminary and permanent injunction against the Company from manufacturing and selling our Ithaca® 9700 and 9800 food safety terminals. On July 16, 2012, the Company filed its answer, affirmative defenses and counterclaims, seeking all available damages including legal fees. A hearing on the plaintiff's motion for preliminary injunction took place in August 2012, and in November 2012, the Court denied this request. AD filed an appeal of the Court’s ruling to the Eleventh Appellate District, which heard oral arguments on the appeal on July 16, 2013. On July 23, 2013, AD requested that the Eleventh Appellate District enjoin the Company’s further sale and marketing of the food safety terminals, pending the appeals court's decision. On July 29, 2013, the Company opposed this request. On October 15, 2013, the Eleventh District Court of Appeals affirmed the lower court’s decision in the Company’s favor and denied AD’s further request of an injunction pending the Court of Appeal’s decision. On October 24, 2013, AD filed a motion seeking that the Court of Appeals reconsider its decision. On April 16, 2014, the Court of Appeals denied AD’s motion to reconsider its decision. On July 28, 2014, AD filed a motion requesting leave from the Court to file an amended complaint and indicating that it has elected to pursue only its claim for damages, dropping its claim for injunctive relief. On September 4, 2014, the Court granted AD’s motion to file an amended complaint. On September 25, 2014, the Company filed its answer, affirmative defenses and counterclaims with respect to the amended complaint, seeking all available damages including legal fees. On January 30, 2015, the Company filed a motion for summary judgment seeking judgment in favor of the Company on all counts as to the Company. On the same day, AD filed two motions for partial summary judgment. On February 17, 2015, the Company opposed both of AD’s motions, and AD opposed the Company’s motion. On February 23, 2015, the Company filed a reply brief in support of its motion for summary judgment. A trial was scheduled to begin on April 21, 2015, however, on March 25, 2015 the parties executed a confidential settlement agreement and release (the “Settlement Agreement”) in which the parties mutually agreed to resolve the dispute that was the subject of the lawsuit filed by AD against the Company to the parties’ mutual satisfaction. Under the terms of the Settlement Agreement, the Company agreed to pay AD $3,600,000 payable on or before April 8, 2015 and also to qualify certain AD labels for use on the Company’s food safety terminals at an estimated cost of $25,000. The Company recorded the total expense of $3,625,000 in the fourth quarter 2014 as an operating expense included in the line item “Legal fees and settlement expenses associated with lawsuit” on the Consolidated Statement of Operations and as a current liability included in the line item “Accrued lawsuit settlement expenses” on the Consolidated Balance Sheet. +Item 4. Mine Safety Disclosures. +Not applicable. +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +Our common stock is traded on the NASDAQ Global Market under the symbol TACT. As of February 27, 2015, there were 379 holders of record of the common stock. The high and low bid sales prices of the common stock reported during each quarter of the years ended December 31, 2014 and 2013 were as follows: +Year Ended +Year Ended +December 31, 2014 +December 31, 2013 +High +Low +High +Low +First Quarter +$ +12.99 +$ +9.80 +$ +8.20 +$ +7.15 +Second Quarter +11.50 +9.12 +8.50 +7.22 +Third Quarter +10.44 +6.45 +13.19 +7.75 +Fourth Quarter +6.95 +5.19 +15.23 +11.54 +In September 2012, we announced that our Board of Directors approved the initiation of a quarterly cash dividend program which is subject to the Board’s approval each quarter. On May 6, 2014, our Board of Directors declared an increase to the quarterly cash dividend from $0.07 per share to $0.08 per share. Dividends declared and paid on our common stock totaled $2,556,000 or $0.31 per share and $2,317,000 or $0.27 per share, in 2014 and 2013, respectively . On February 4, 2015, our Board of Directors approved the first quarter 2015 dividend in the amount of $0.08 per share payable on or about March 13, 2015 to common shareholders of record at the close of business on February 20, 2015. +9 +Issuer Purchases of Equity Securities +On August 11, 2014, our Board of Directors approved a new stock repurchase program (the “Stock Repurchase Program”). Under the Stock Repurchase Program, we are authorized to repurchase up to $7,500,000 of our outstanding shares of common stock from time to time in the open market through July 31, 2015, depending on market conditions, share price and other factors. On November 3, 2014, our Board of Directors modified the Stock Repurchase Program to include the repurchase of up to $4,000,000 of the Company’s outstanding shares through April 30, 2015 pursuant to a Rule 10b5-1 trading plan though our Board ended this trading plan effective March 31, 2015. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From August 11, 2014 through December 31, 2014, we purchased 434,998 shares of our common stock for approximately $2,634,000 at an average price per share of $6.06. In 2013, under a prior purchase program and an open market transaction, we purchased 604,161 shares of common stock for approximately $5,194,000 at an average price of $8.60. From January 1, 2005 through December 31, 2014, we repurchased a total of 3,222,036 shares of common stock for approximately $25,161,000, at an average price of $7.81 per share. See “Liquidity and Capital Resources” below for more information. +CORPORATE PERFORMANCE GRAPH +The following graph compares the cumulative total return on the Company’s Common Stock from December 31, 2009 through December 31, 2014, with the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Manufacturer Stocks Index. The graph assumes that $100 was invested on December 31, 2009 in each of TransAct’s common stock, the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Manufacturer Stocks Index, and that all dividends were reinvested. +COMPARISON OF CUMULATIVE TOTAL RETURN AMONG +TRANSACT TECHNOLOGIES INCORPORATED COMMON STOCK, +THE CRSP TOTAL RETURN INDEX FOR THE NASDAQ STOCK MARKET (U.S.), +AND THE NASDAQ COMPUTER MANUFACTURER STOCKS INDEX +12/31/09 +12/31/10 +12/31/11 +12/31/12 +12/31/13 +12/31/14 +TransAct Technologies Incorporated Common Stock +$ +100.00 +$ +135.73 +$ +104.61 +$ +104.03 +$ +180.55 +$ +78.82 +CRSP Total Return Index for the Nasdaq Stock Market (U.S.) +$ +100.00 +$ +117.55 +$ +117.91 +$ +137.29 +$ +183.26 +$ +206.09 +Nasdaq Computer Manufacturer Stocks Index +$ +100.00 +$ +123.53 +$ +129.51 +$ +155.26 +$ +182.65 +$ +247.60 +10 +Item 6. Selected Financial Data (in thousands, except per share amounts) +The following is summarized from our audited financial statements of the past five years: +Year ended December 31, +2014 +2013 +2012 +2011 +2010 +Consolidated Statement of Operations Data: +Net sales +$ +53,108 +$ +60,141 +$ +68,386 +$ +65,969 +$ +63,194 +Gross profit +21,711 +25,092 +25,982 +24,626 +22,548 +Operating expenses +25,483 +18,475 +20,380 +17,637 +16,687 +Operating (loss) income +(3,772) +6,617 +5,602 +6,989 +5,861 +Net (loss) income +(2,421) +4,935 +3,621 +4,676 +3,904 +Net (loss) income per share: +Basic +(0.29) +0.57 +0.40 +0.50 +0.42 +Diluted +(0.29) +0.57 +0.40 +0.49 +0.41 +Dividends declared and paid per share +0.31 +0.27 +0.06 +- +- +December 31, +2014 +2013 +2012 +2011 +2010 +Consolidated Balance Sheet Data: +Total assets +$ +35,491 +$ +40,408 +$ +45,228 +$ +42,740 +$ +43,621 +Working capital +18,361 +24,871 +25,492 +27,222 +25,525 +Shareholders’ equity +25,394 +32,521 +33,369 +35,313 +31,134 +Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Forward Looking Statements +Certain statements included in this report, including without limitation statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally can be identified by the use of forward-looking terminology, such as “may”, “will”, “expect”, “intend”, ”estimate”, “anticipate”, “believe”, “project” or “continue” or the negative thereof or other similar words. All forward-looking statements involve risks and uncertainties, including, but not limited to those listed in Item 1A of this Annual Report. Actual results may differ materially from those discussed in, or implied by, the forward-looking statements. The forward-looking statements speak only as of the date of this report and we assume no duty to update them. +Overview +During 2014, we completed the transition of our business towards new, value-added products and technologies that address large and diversified growth markets while moving away from the low margin, commoditized POS market. During the past three years we have spent significant time and resources developing new products such as the Ithaca® 9700 food safety terminal, EPICENTRAL™ software for the casino and gaming industry and our Printrex® 920 and 980 color printers for the oil and gas industry. With this development phase now behind us, we can reduce these expenses going forward as we believe we now have the right products to effectively compete in our markets. +During 2014, our sales and operating results declined due mainly to what we believe is a general weakness in the replacement cycle in the domestic casino and gaming market. In an effort to address the ongoing challenges of the domestic casino market and the related impact to our operating results, during the fourth quarter of 2014 we initiated cost reduction actions that will reduce expenses by at least $1 million on an annual basis beginning in the first quarter of 2015. While it is difficult to predict when a rebound will occur in the domestic casino and gaming market, with a lower overall cost structure and focus on sales execution we expect 2015 to be a much improved year.. +During 2014, our total net sales decreased 12% to approximately $53,108,000. See the table below for a breakdown of our sales by market: +Year ended +Year ended +Change +(In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Food safety, banking and POS +$ +9,308 +17.5% +$ +11,296 +18.8% +$ +(1,988) +(17.6%) +Casino and gaming +22,731 +42.8% +27,300 +45.4% +(4,569) +(16.7%) +Lottery +4,761 +9.0% +4,450 +7.4% +311 +7.0% +Printrex +3,910 +7.4% +4,335 +7.2% +(425) +(9.8%) +TSG +12,398 +23.3% +12,760 +21.2% +(362) +(2.8%) +Total net sales +$ +53,108 +100.0% +$ +60,141 +100.0% +$ +(7,033) +(11.7%) +Sales of our food safety, banking and POS products decreased 18% in 2014 compared to 2013. During 2014, our Ithaca® 9700 food safety terminal sales declined 50% due to a large initial stocking order to a distributor that occurred in 2013 that did not repeat in 2014. However, we expect this distributor to begin ordering product again in 2015. However, we have received corporate approval from a growing number of large, national brand restaurants for the Ithaca 9700 and we expect this product to be a significant contributor to our revenue growth in 2015 and beyond. In the banking market, we focus mainly on supplying printers for use in bank teller stations at banks and financial institutions primarily in the U.S. Opportunities in the banking market are project oriented and, as a result, our banking printer sales can fluctuate significantly year-to-year. During 2014, our banking printer sales decreased 31%. In the POS market, we focus primarily on supplying printers that print receipts or linerless labels for customers in the restaurant, hospitality and specialty retail markets. Sales of our POS printers increased 9% in 2014 primarily driven by sales of our Ithaca ® 9000 printers to McDonald’s as they accelerated a rollout of these printers for a new initiative. Our focus for 2015 will be on sales execution with the goal of increasing market penetration with each of our new products. +11 +Sales of our casino and gaming products decreased 17% in 2014 compared to 2013. In our casino and gaming market, our focus lies primarily in supplying printers for use in slot machines at casinos and racetracks, as well as in other electronic gaming devices that print tickets or receipts, worldwide. Additionally, we supplement these printer sales with revenue from EPICENTRAL™ - our promotional printing system that enables casino operators to create promotional coupons and marketing messages and print them real time at the slot machine. Domestic casino and gaming sales decreased 32%, from general weakness in the replacement cycle in the domestic casino market, as well as a large replacement of a certain OEM’s slot machines at a multi-property casino group in 2013 that did not repeat in 2014. In addition, EPICENTRAL ™ software sales decreased 47% due to only one installation 2014 compared to six completed installations during 2013. International sales increased by 3%, primarily due to a 3% increase in sales of our thermal casino printers when compared to 2013 and the sale of an EPICENTRAL™ software system internationally during 2014. These increases were partially offset by a 13% decline in sales of our off-premises thermal gaming printers, mainly from our European distributor and Australian and Asian customers. +In the lottery market, we continue to hold a leading position based on our long-term exclusive relationship with GTECH, our largest customer and the world’s largest provider of lottery terminals. GTECH has been our customer since 1995, and we continue to maintain a good relationship with them. In 2009 we expanded our long-standing relationship with GTECH by executing a new exclusive purchase agreement to develop and supply them with their next generation online thermal lottery printer. Pursuant to this agreement, GTECH exclusively purchases all of its requirements for thermal on-line lottery printers from us and we exclusively sell such printers to GTECH through May 8, 2015. Currently, we fulfill substantially all of GTECH’s printer requirements for lottery terminal installations and upgrades worldwide. During 2014, total printer sales to GTECH increased approximately 7%, compared to 2013. Our sales to GTECH each year are directly dependent on the timing and number of new and upgraded lottery terminal installations GTECH performs and are not indicative of GTECH’s overall business or revenue. However based on current orders and forecasts from GTECH, we expect sales in 2015 to be higher than in 2014, especially during the first half of 2015. +Sales of our Printrex branded printers include wide format, rack mounted and vehicle mounted thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. Sales in this market also includes wide format printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. During 2014, we had solid revenue contributions from our new Printrex® 920 and Printrex® 980 oil and gas color printers developed in 2012. We believe that over time, sales of our color printers will increase as these printers provide customers with more value as data printed in color is easier to read and analyze than the same data printed in black and white. Despite the increase in color printer sales, Printrex printer sales for 2014 decreased by approximately 10% primarily due to the negative impact of steeply declining worldwide oil prices, as well as an 11% decline in the medical and mobile market. In 2015, we expect initial revenue contributions from the Responder MP2™, as we plan to introduce our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery. +Our TSG group, which sells service, replacement parts and consumable products, including receipt paper, ribbons and inkjet cartridges, continues to offer a recurring revenue stream for the Company. TSG sales decreased 3% in 2014 from 2013 primarily due to lower sales of non-Printrex consumables compared to 2013 from the effect of lower HP inkjet cartridge sales as we deemphasize our focus on this commoditized product. This decrease was partially offset by higher replacement part sales and Printrex color printer consumable sales which should continue to increase as the installed base of these printers grows. +Operationally, our gross margin declined to 40.9% from 41.7% in 2013. Our gross margin for 2014 was impacted by lower sales of our higher margin value-added casino printers, food safety terminals and EPICENTRAL® installations compared to 2013. In 2014 we incurred a negative operating margin of 7.1% compared to a positive operating margin of 11.0% in 2013. The negative operating margin in 2014 resulted mainly from $5.5 million in legal and settlement expenses we incurred related to the AD Lawsuit that we settled in March 2015 and to a lesser extent, lower gross margins due to sales declines. +We reported a net loss of $2,421,000 and net loss per diluted share of $0.29 for 2014, compared to net income of $4,935,000 and net income per diluted share of $0.57 in 2013. In terms of cash flow for 2014, we experienced a very strong year, generating over $6.0 million of cash from operating activities. We also returned almost $5,200,000 to our shareholders in the form of $2,634,000 for treasury share repurchases and $2,556,000 for cash dividends while still finishing the year with cash and cash equivalents of $3,131,000 and no debt on our Consolidated Balance Sheet at December 31, 2014. +Critical Accounting Policies and Estimates +The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Income categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances. We evaluate our assumptions on an ongoing basis by comparing actual results with our estimates. Actual results may differ from the original estimates. +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These items utilize assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Please refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial Statements for a complete listing of our accounting policies. +Revenue Recognition – Our typical contracts include the sale of printers and terminals, which are sometimes accompanied by separately-priced extended warranty contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within Accounting Standards Codification (“ASC”) 605, “Revenue Recognition” (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms which are generally FOB shipping point) has occurred, the selling price is fixed and determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +12 +Our software solution, EPICENTRAL TM , enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. R evenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, “Multiple-Element Arrangements” and ASC 985-605, “Software.” EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system’s full functionality. These arrangements are accounted for in accordance with ASC 605-25, “Multiple-Element Arrangements”. EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, “Software” as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level GAAP and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence (“VSOE”) if available, third party evidence (“TPE”) if VSOE is not available, or best estimate of selling price (“BESP”) to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, “Separately Priced Extended Warranty and Product Maintenance Contracts.” Pursuant to this guidance, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established, but we cannot guarantee that we will continue to experience return rates consistent with historical patterns. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. However, we cannot guarantee that this minimal level will continue. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +Accounts Receivable – We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on available credit information; and adjustments to credit limits based upon payment history and the customer’s current creditworthiness. We also provide an estimate of doubtful accounts based on historical experience and specific customer collection issues. Our allowance for doubtful accounts as of December 31, 2014 was approximately $100,000, or approximately 1.1% of outstanding accounts receivable, which we feel is appropriate considering the overall quality of our accounts receivable. While credit losses have historically been within expectations and the reserves established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience. +Inventories – Our inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market. We review market value based on historical usage and estimates of future demand. Assumptions are reviewed at least quarterly and adjustments are made, as necessary, to reflect changing market conditions. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and market value. Should circumstances change and we determine that additional inventory is subject to obsolescence, additional write-downs of inventory could result in a charge to income. +Goodwill and Intangible Asse t s – We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with Accounting Standards Codification (“ASC”) 350-20 “Goodwill”, acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Definite lived intangible assets are amortized and are tested for impairment when appropriate. We reported $2,621,000 of goodwill and $1,341,000 of unamortized definite-lived intangible assets at December 31, 2014. We have determined that no goodwill impairment has occurred based on our assessment as of December 31, 2014 when the impairment review is performed. +Income Taxes – In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing temporary differences between the tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. +13 +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax reserves with respect to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this forecast against the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance or tax reserve, in the event we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future deferred tax assets in excess of its net recorded amount, an adjustment to the valuation allowance or tax reserves would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, “Income Taxes.” Among other things this provision prescribes a minimum recognition threshold that an income tax position must meet before it is recorded in the reporting entity’s financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet reporting date, it is “more likely than not” (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing authority will examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between the amount claimed, or expected to be claimed, on a company’s income tax returns and the benefits recognized in the financial statements. +Warranty – We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. If actual future product repair rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability and related warranty expense would be made. +Contingencies – We record an estimated liability related to contingencies based on our estimates of the probable outcomes pursuant to ASC 450, “Contingencies.” On a quarterly basis, we assess the potential liability related to pending litigation, audits and other contingencies and confirm or revise estimates and reserves as appropriate. If the actual liabilities are settled in an amount greater than those recorded on the balance sheet, a charge to income would be recorded. As of December 31, 2014 and 2013, a contingent liability of $0 and $60,000, respectively, was recorded in connection with a contingent consideration arrangement entered into as part of the Printrex acquisition. The decrease of $60,000 was the result of our revised estimate of the expected payout in connection with this arrangement primarily due to changes in probabilities and decreases in revenue and gross margin estimates, and was credited to general and administrative expense during 2014. See Note 3 to the Consolidated Financial Statements for further discussion. +Share-Based Compensation – We calculate share-based compensation expense in accordance with ASC 718, “Compensation – Stock Compensation” using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, dividend yield, and forfeiture rate. The determination of these assumptions is based on past history and future expectations, and is subject to judgment. To the extent any of the assumptions were to change from year to year, the fair value of new option grants may vary significantly. +Results of Operations: Year ended December 31, 2014 compared to year ended December 31, 2013 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2014 and 2013 were as follows: +Year ended +Year ended +Change +( In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Food safety, banking and POS +$ +9,308 +17.5% +$ +11,296 +18.8% +$ +(1,988) +(17.6%) +Casino and gaming +22,731 +42.8% +27,300 +45.4% +(4,569) +(16.7%) +Lottery +4,761 +9.0% +4,450 +7.4% +311 +7.0% +Printrex +3,910 +7.4% +4,335 +7.2% +(425) +(9.8%) +TSG +12,398 +23.3% +12,760 +21.2% +(362) +(2.8%) +$ +53,108 +100.0% +$ +60,141 +100.0% +$ +(7,033) +(11.7%) +International* +$ +14,541 +27.4% +$ +13,764 +22.9% +$ +777 +5.6% +* +International sales do not include sales of printers made to domestic distributors or other customers who in turn ship those printers to international destinations. +Net sales for 2014 decreased $7,033,000, or 12%, from 2013. Printer and terminal sales volume decreased 10% to approximately 138,000 units primarily due to declines in the casino and gaming, and food safety, banking and POS markets, of 15% and 7%, respectively. The average selling price of our printers decreased approximately 3% from 2013 to 2014 due primarily to lower sales of our food safety terminals which have a significantly higher average selling price than most of our other printers. Overall, international sales increased $777,000, or 6%, primarily driven by higher sales in both the international casino and gaming and TSG markets. +14 +Food safety, banking and POS: Revenue from the food safety, banking and POS market includes sales of food safety terminals-hardware devices that consist of a touchscreen and one or two thermal print mechanisms, that print easy-to-read expiration and "enjoy by" date labels to help restaurants effectively manage food rotation and spoilage. Revenue from this market also includes sales of inkjet, thermal and impact printers used primarily by retailers in the restaurant (including fine dining, casual dining and fast food), hospitality, and specialty retail industries to print receipts for consumers, validate checks, or print on linerless labels or other inserted media. In addition, revenue includes sales of printers used by banks, credit unions and other financial institutions to print receipts and/ or validate checks at bank teller stations. A summary of sales of our worldwide food safety, banking and POS products for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +( In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +8,984 +96.5% +$ +10,956 +97.0% +$ +(1,972) +(18.0%) +International +324 +3.5% +340 +3.0% +(16) +(4.7%) +$ +9,308 +100.0% +$ +11,296 +100.0% +$ +(1,988) +(17.6%) +The decrease in domestic food safety, banking and POS product revenue from 2013 was primarily driven by lower sales from our Ithaca® 9700 food safety terminal due to a large initial stocking order to a distributor that occurred in 2013 and did not repeat in 2014. We expect this distributor to begin ordering products again in 2015. This decrease was partially offset by higher sales of our Ithaca® 9000 printers to McDonald’s during 2014 compared to 2013, as they accelerated a rollout of these printers for a new initiative. +International food safety, banking and POS printer sales for 2014 were relatively consistent with 2013 . +Casino and gaming: Revenue from the casino and gaming market includes sales of printers used in slot machines, video lottery terminals (“VLTs”), and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos and racetracks (“racinos”) and other gaming venues worldwide. Revenue from this market also includes sales of printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes (“AWP”), Skills with Prizes (“SWP”) and Fixed Odds Betting Terminals (“FOBT”) at non-casino gaming establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of our software solution, EPICENTRAL TM , that enables casino operators to create promotional coupons and marketing messages and to print them real-time at the slot machine. A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +( In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +10,437 +45.9% +$ +15,367 +56.3% +$ +(4,930) +(32.1%) +International +12,294 +54.1% +11,933 +43.7% +361 +3.0% +$ +22,731 +100.0% +$ +27,300 +100.0% +$ +(4,569) +(16.7%) +The decrease in both domestic hardware and software casino and gaming sales from 2013 resulted primarily from general weakness in the replacement cycle in the domestic casino market, as well as a large replacement of a certain OEM’s slot machines at a multi-property casino group in 2013 that did not repeat in 2014. Domestic sales of our thermal Epic 950 gaming printer decreased 27% in 2014 compared to 2013. In addition EPICENTRAL™ software sales fell 78% in 2014 compared to 2013 due to no new domestic installations occurring in 2014 compared to five installations in 2013. +The increase in international sales is due to an increase in sales of our thermal EPIC 950 printer and EPICENTRAL TM software sales of 4% and 106%, respectively. The increase in EPICENTRAL™ software sales is due to one large multi-property installation for a customer in South America in 2014 compared to two smaller installations in 2013. These increases were partially offset by decreased sales of our off-premises thermal gaming printers of 13% in 2014 when compared to 2013. Sales of our off-premise gaming printers are largely project-oriented, and we therefore cannot predict the level of future sales. +Lottery : Revenue from the lottery market includes sales of thermal on-line and other lottery printers to GTECH and its subsidiaries for various lottery applications. A summary of sales of our worldwide lottery printers for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +( In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +4,682 +98.3% +$ +4,417 +99.3% +$ +265 +6.0% +International +79 +1.7% +33 +0.7% +46 +139.4% +$ +4,761 +100.0% +$ +4,450 +100.0% +$ +311 +7.0% +Our sales to GTECH are directly dependent on the timing and number of new and upgraded lottery terminal installations GTECH performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of GTECH’s overall business or revenue. Based on our backlog of orders and customer’s forecast, we expect total sales to GTECH for 2015 to be higher than those reported in 2014, especially in the first half of 2015. +Printrex: Printrex branded printers are sold into markets that include wide format, rack mounted and vehicle mounted black/white and color thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. Revenue in this market also includes sales of wide format printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. A summary of sales of our worldwide Printrex printers for the years ended December 31, 2014 and 2013 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +( In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +3,352 +85.7% +$ +3,712 +85.6% +$ +(360) +(9.7%) +International +558 +14.3% +623 +14.4% +(65) +(10.4%) +$ +3,910 +100.0% +$ +4,335 +100.0% +$ +(425) +(9.8%) +15 +The decrease in Printrex printers is primarily due to 9% lower worldwide sales of printers in the oil and gas market due to the negative impact of steeply declining worldwide oil prices which we expect will continue to negatively impact our sales during 2015. In addition, worldwide sales of our medical and mobile printers declined 11% due to lower sales to a medical printer customer that began to phase out the use of our printer during 2014. We expect our last sale to this customer to occur in the first quarter of 2015 with no future expected shipments. Due to the low margin on this product, we do not believe the loss of this customer will have a material adverse impact to our 2014 operating results. +TSG: Revenue from TSG includes sales of consumable products (inkjet cartridges, ribbons, receipt paper, color thermal paper and other printing supplies), replacement parts, maintenance and repair services, testing services, refurbished printers, and shipping and handling charges. A summary of sales in our worldwide TSG market for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +( In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +11,112 +89.6% +$ +11,925 +93.5% +$ +(813) +(6.8%) +International +1,286 +10.4% +835 +6.5% +451 +54.0% +$ +12,398 +100.0% +$ +12,760 +100.0% +$ +(362) +(2.8%) +The decrease in domestic revenue from TSG is primarily due to a 15% decrease in sales of non-Printrex consumables, largely from the decline of HP inkjet cartridges, as we continue to deemphasize this commoditized consumable product. As a result, we expect sales of HP inkjet cartridges to continue to decline in 2015. In addition, service revenue declined by 29%, largely due to a 57% decline in paper testing service revenue as we performed fewer tests in 2014 than in 2013, as well as lower maintenance and repair revenue from fewer service contracts. These decreases were partially offset by a 10% increase in sales of replacement parts as well as a 78% increase of consumables for our new Printrex color printers, which we expect to continue to increase during 2015 as the installed base of these printers grows. +Internationally, TSG revenue increased due primarily to higher sales of replacement parts and accessories as compared to 2013. We expect TSG sales in 2015 to be relatively consistent with 2014, as we expect lower HP inkjet cartridges will offset higher expected sales of consumables from our newly launched Printrex color oil and gas printers. +Gross Profit. Gross profit information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +21,711 +$ +25,092 +(13.5%) +40.9% +41.7% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, direct labor, manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers and expenses associated with installations and maintenance of EPICENTRAL®. Gross profit decreased $3,381,000, or 14%, on 12% lower sales volume and a slightly less favorable sales mix. Additionally, our gross margin declined by 80 basis points due to lower sales contributions from our value-added Ithaca® 9700 food safety terminals, casino printers and EPICENTRAL™ software. We expect our gross margin for 2015 to increase as we expect to benefit from increased sales of our newer, value-added products, as well as cost reduction initiatives we initiated in the fourth quarter 2014. +Engineering, Design and Product Development. Engineering, design and product development information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +4,302 +$ +4,065 +5.8% +8.1% +6.8% +Engineering, design and product development expenses primarily include salary and payroll related expenses for our engineering staff, depreciation and design expenses (including prototype printer expenses, outside design and testing services, and supplies). Such expenses increased $237,000, or 6%, due primarily to additional engineering staff and higher pre-production expenses related to new product development for the new products we launched in 2014. We expect engineering, design and product development expenses in 2015 to be lower than in 2014 due to staff reductions and lower product development expenses resulting from cost reduction actions we initiated in the fourth quarter 2014. +Selling and Marketing. Selling and marketing information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +7,920 +$ +7,346 +7.8% +14.9% +12.2% +Selling and marketing expenses primarily include salaries and payroll related expenses for our sales and marketing staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, e-commerce and other promotional marketing expenses. Such expenses increased $574,000, or 8%, primarily due to the planned investment in new sales and marketing staff to support our new products, a full year of commissions to our new casino and gaming distributor added in late 2013, Suzo Happ, and increased marketing spend to support our newly launched products in 2014. +16 +General and Administrative. General and administrative information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +7,756 +$ +6,588 +17.7% +14.6% +11.0% +General and administrative expenses primarily include salaries and payroll related expenses for our executive, accounting, human resource, business development and information technology staff, expenses for our corporate headquarters, professional and legal expenses, telecommunication expenses, and other expenses related to being a publicly-traded company. General and administrative expenses increased $1,168,000, or 18%, due primarily to changes in the accrued contingent consideration liability to be paid in connection with the acquisition of Printrex. In 2014, we reduced the contingent consideration liability by $60,000 to zero, compared to a reduction of $900,000 in 2013. Excluding the changes we recorded to the contingent consideration liability, general and administrative expenses increased $328,000, or 4% in 2014 compared to 2013. This increase is primarily due to higher severance costs related to the cost reduction initiatives we initiated in the fourth quarter 2014. We expect general and administrative expenses to be relatively consistent with 2014. +Legal Fees and Settlement Expenses Associated with Lawsuit . Legal fees and settlement expenses information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +5,505 +$ +476 +1,056.5% +10.4% +0.8% +As disclosed in Note 11 to the Consolidated Financial Statements, in June 2012, AD filed a civil complaint against the Company, which we settled in March 2015. In connection with this lawsuit, we incurred legal fees and settlement expenses of $5,505,000 and $476,000 in 2014 and 2013, respectively. We expect legal fees related to the lawsuit will be approximately $2,000,000 for the first quarter of 2015. Due to the settlement of the AD lawsuit in March 2015, we do not expect to incur any additional expenses related to the lawsuit beyond the first quarter of 2015. +Operating Income (Loss). Operating income information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales – 2014 +Total Sales – 2013 +Year ended +$ +(3,772) +$ +6,617 +(157.0%) +(7.1%) +11.0% +The decrease in our operating income and operating margin was primarily due to higher legal fees and $3,625,000 of settlement expenses related to the lawsuit with AD that we settled in March 2015 as well as a 12% decline in sales. In addition, our operating margin for 2013 benefited by 150 basis points from the $900,000 reduction in the Printrex accrued contingent consideration liability. +Interest. We recorded net interest expense of $49,000 in 2014 compared to net interest expense of $23,000 in 2013. The increase in net interest expense is primarily due to lower interest income earned on a lower average cash balance during 2014, as we used a significant amount of our cash to repurchase our common stock and pay cash dividends during the latter half of 2013 and 2014. Interest expense related to the unused revolving credit line fee and amortization of deferred financing costs on our revolving credit facility with TD Bank remained consistent in 2014 and 2013. See “Liquidity and Capital Resources” below for more information. +Other, net. We recorded other expense of $33,000 in 2014 compared to $63,000 in 2013. The change was primarily due to a $60,000 loss from the disposal of certain tooling equipment during 2013 somewhat offset by higher foreign currency transaction exchange losses recorded by our U.K. subsidiary in 2014 compared to 2013. +Income Taxes . We recorded an income tax benefit for 2014 of $1,433,000 at an effective tax rate of 37.2% compared to an income tax provision of $1,596,000 at an effective tax rate of 24.4% for 2013. Our effective tax rate for 2013 was unusually low because it included; (1) a $224,000 reduction in tax liabilities for unrecognized tax benefits resulting from the completion of an audit of our 2010 federal income tax return and (2) the benefit from both the 2012 and 2013 R&D credit, as the credit for 2012 was not renewed until January 2, 2013. We expect our annual effective tax rate for 2015 to be between 35% and 36%. +Net Income . We reported a net loss during 2014 of $2,421,000, or $(0.29), per diluted share, compared to net income of $4,935,000, or $0.57, per diluted share, for 2013. +17 +Results of Operations: Year ended December 31, 2013 compared to year ended December 31, 2012 +Net Sales . Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2013 and 2012 were as follows: +Year ended +Year ended +Change +( In thousands) +December 31, 2013 +December 31, 2012 +$ +% +Food safety, banking and POS +$ +11,296 +18.8% +$ +9,484 +13.9% +$ +1,812 +19.1% +Casino and gaming +27,300 +45.4% +29,129 +42.6% +(1,829) +(6.3%) +Lottery +4,450 +7.4% +11,634 +17.0% +(7,184) +(61.8%) +Printrex +4,335 +7.2% +4,673 +6.8% +(338) +(7.2%) +TSG +12,760 +21.2% +13,466 +19.7% +(706) +(5.2%) +$ +60,141 +100.0% +$ +68,386 +100.0% +$ +(8,245) +(12.1%) +International* +$ +13,764 +22.9% +$ +18,454 +27.0% +$ +(4,690) +(25.4%) +* +International sales do not include sales of printers made to domestic distributors or other customers who in turn ship those printers to international destinations. +Net sales for 2013 decreased $8,245,000, or 12%, from 2012. Printer and terminal sales volume decreased 23% to approximately 153,000 units primarily due to declines in the lottery and casino and gaming markets of 60% and 11%, respectively. The average selling price of our printers increased approximately 7% from 2012 to 2013 due primarily to higher sales of our food safety terminals which have a significantly higher average selling price than most of our other printers. Also contributing to our higher average selling price was a significant reduction in lottery printer sales volume due to a large order by GTECH in 2012 which was not repeated in 2013. Overall, international sales decreased $4,690,000, or 25%, primarily driven by lower sales in both the international casino and gaming and lottery markets. +Food safety, banking and POS : A summary of sales of our worldwide food safety, banking and POS products for the years ended December 31, 2013 and 2012 is as follows: +Year ended +Year ended +Change +( In thousands ) +December 31, 2013 +December 31, 2012 +$ +% +Domestic +$ +10,956 +97.0% +$ +8,876 +93.6% +$ +2,080 +23.4% +International +340 +3.0% +608 +6.4% +(268) +(44.1%) +$ +11,296 +100.0% +$ +9,484 +100.0% +$ +1,812 +19.1% +The increase in domestic food safety, banking and POS product revenue from 2012 was primarily driven by higher sales from our newly launched Ithaca® 9700 food safety terminal and Ithaca® 9000 printer. This was partially offset by lower sales of our banking printers mainly due to the shipment of a large order for our Ithaca® 280 thermal receipt printer to a banking customer in 2012 that did not repeat in 2013 as well as lower sales of our legacy POS printers as we continue to decrease our focus on this commoditized market. +International banking and POS printer sales for 2013 decreased 44% from 2012 due primarily to lower sales for the McDonald’s POS system upgrade and grill initiative in its Canadian stores in 2013 compared to 2012, partially offset by higher sales of our Ithaca® 9700 food safety terminal. +Casino and gaming : A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2013 and 2012 is as follows: +Year ended +Year ended +Change +( In thousands ) +December 31, 2013 +December 31, 2012 +$ +% +Domestic +$ +15,367 +56.3% +$ +14,283 +49.0% +$ +1,084 +7.6% +International +11,933 +43.7% +14,846 +51.0% +(2,913) +(19.6%) +$ +27,300 +100.0% +$ +29,129 +100.0% +$ +(1,829) +(6.3%) +The increase in domestic sales is primarily due to an increase in EPICENTRAL TM software sales partially offset by a 3% decline in sales of our thermal casino printers mainly due to fewer new casino openings during 2013 compared to 2012. +International casino and gaming product sales decreased due primarily to a 38% decrease in sales of our off-premise thermal gaming printers mainly from a 35% decrease in sales to our European distributor and a 35% decrease in sales to our customers in Australia and Asia. Sales of our off-premise gaming printers are largely project-oriented, and we therefore cannot predict the level of future sales. Additionally, sales of our thermal casino printers decreased by 12% primarily from 20% lower sales to our European distributor. This decline in sales of our thermal casino printers resulted primarily from fewer installations of VLT gaming machines in Italy as the government approved rollout of these games was substantially completed during 2012, and we therefore shipped fewer printers in 2013. The decrease in thermal casino printers was partially offset by higher international EPICENTRAL TM software sales in 2013. +18 +Lottery : A summary of sales of our worldwide lottery printers for the years ended December 31, 2013 and 2012 is as follows: +Year ended +Year ended +Change +( In thousands ) +December 31, 2013 +December 31, 2012 +$ +% +Domestic +$ +4,417 +99.3% +$ +10,574 +90.9% +$ +(6,157) +(58.2%) +International +33 +0.7% +1,060 +9.1% +(1,027) +(96.9%) +$ +4,450 +100.0% +$ +11,634 +100.0% +$ +(7,184) +(61.8%) +Our sales to GTECH are directly dependent on the timing and number of new and upgraded lottery terminal installations GTECH performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of GTECH’s overall business or revenue. However, sales for 2012 were unusually high as GTECH made a final purchase for an older generation lottery printer that we discontinued production for at the end of 2012. . +Printrex: A summary of sales of our worldwide Printrex printers for the years ended December 31, 2013 and 2012 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +( In thousands ) +December 31, 2013 +December 31, 2012 +$ +% +Domestic +$ +3,712 +85.6% +$ +3,915 +83.8% +$ +(203) +(5.2%) +International +623 +14.4% +758 +16.2% +(135) +(17.8%) +$ +4,335 +100.0% +$ +4,673 +100.0% +$ +(338) +(7.2%) +The decrease in Printrex printers is primarily due to lower sales of black and white printers in the oil and gas market, partially offset by higher sales of our two new color printers, the Printrex® 920 and Printrex® 980, into the worldwide oil and gas market. +TSG : A summary of sales in our worldwide TSG market for the years ended December 31, 2013 and 2012 is as follows: +Year ended +Year ended +Change +( In thousands ) +December 31, 2013 +December 31, 2012 +$ +% +Domestic +$ +11,925 +93.5% +$ +12,284 +91.2% +$ +(359) +(2.9%) +International +835 +6.5% +1,182 +8.8% +(347) +(29.4%) +$ +12,760 +100.0% +$ +13,466 +100.0% +$ +(706) +(5.2%) +The decrease in domestic revenue from TSG is primarily due to a 25% decrease in sales of consumables, largely HP inkjet cartridges, as we continue to deemphasize this commoditized consumable product. In addition, paper testing service revenue declined by 38% as we performed fewer tests in 2013 than in 2012. These decreases were partially offset by a 45% increase in sales of replacement parts as well as first year sales contributions from consumables for our new Printrex color printers. Internationally, TSG revenue decreased due primarily to lower sales of replacement parts and accessories as compared to 2012. +Gross Profit . Gross profit information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2013 +2012 +Change +Total Sales - 2013 +Total Sales - 2012 +Year ended +$ +25,092 +$ +25,982 +(3.4%) +41.7% +38.0% +Gross profit decreased $890,000, or 3%, while gross margin improved 370 basis points as we continued to transition of business towards a more favorable sales mix of new value-added products. During 2013 our gross margin primarily benefited from sales contributions from our Ithaca® 9700 food safety terminals in addition to significantly higher EPICENTRAL™ software sales combined with lower lottery printer sales. +Engineering, Design and Product Development . Engineering, design and product development information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2013 +2012 +Change +Total Sales - 2013 +Total Sales - 2012 +Year ended +$ +4,065 +$ +4,239 +(4.1%) +6.8% +6.2% +Engineering, design and product development expenses decreased $174,000, or 4%, due primarily to lower outside testing and pre-production expenses related to new product development from the four new products we launched in 2012. +Selling and Marketing . Selling and marketing information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2013 +2012 +Change +Total Sales - 2013 +Total Sales - 2012 +Year ended +$ +7,346 +$ +6,637 +10.7% +12.2% +9.7% +Selling and marketing expenses increased $709,000, or 11%, primarily due to the addition of new sales staff and increased marketing spend to support our newly launched products. +19 +General and Administrative . General and administrative information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2013 +2012 +Change +Total Sales - 2013 +Total Sales - 2012 +Year ended +$ +6,588 +$ +7,833 +(15.9%) +11.0% +11.5% +General and administrative expenses decreased $1,245,000, or 16%, due primarily to a reduction in the accrued contingent consideration liability to be paid in connection with the acquisition of Printrex of $900,000 (as discussed in more detail in Note 3 to the Consolidated Financial Statements) in addition to lower incentive compensation-related expenses for executive and administrative employees. These decreases were partially offset by higher recruitment fees of $160,000 due to the additional sales and engineering staff as previously discussed, as compared to 2012. +Legal Fees Associated with Lawsuit . Legal fee information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2013 +2012 +Change +Total Sales - 2013 +Total Sales - 2012 +Year ended +$ +476 +$ +1,533 +(68.9%) +0.8% +2.2% +As disclosed in Note 11 to the Consolidated Financial Statements, in June 2012, AD filed a civil complaint against the Company. In connection with this lawsuit, we incurred legal fees and other related expenses of $476,000 and $1,533,000 in 2013 and 2012, respectively. +Business Consolidation and Restructuring . Business consolidation and restructuring information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2013 +2012 +Change +Total Sales - 2013 +Total Sales - 2012 +Year ended +$ +- +$ +138 +(100.0%) +-% +0.2% +As disclosed in Note 8 to the Consolidated Financial Statements, in January 2012, we determined that we no longer needed to maintain the existing Printrex manufacturing facility in San Jose, California, along with certain redundant headcount. During 2012, we recorded a restructuring charge of $138,000 for employee termination benefits related to these employee reductions as well as moving costs. The closing of the San Jose manufacturing operations was completed as of December 31, 2012. We did not incur any restructuring charges during 2013. +Operating Income . Operating income information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2013 +2012 +Change +Total Sales - 2013 +Total Sales - 2012 +Year ended +$ +6,617 +$ +5,602 +18.1% +11.0% +8.2% +The increase in our operating income and operating margin was primarily due to the 370 basis point improvement in gross margin in 2013 as compared to 2012 as well as to lower legal fees incurred from the AD lawsuit as previously discussed. In addition, our operating margin for 2013 benefited by 150 basis points from the $900,000 reduction in the Printrex accrued contingent consideration liability. +Interest . We recorded net interest expense of $23,000 in 2013 compared to net interest income of $6,000 in 2012. The decrease in net interest income was primarily due to lower interest income earned on a lower average cash balance, as we used a significant amount of our cash (approximately $7,511,000) to repurchase our common stock and pay cash dividends in 2013. Interest expense related to the unused revolving credit line fee and amortization of deferred financing costs on our revolving credit facility with TD Bank remained consistent in 2013 and 2012. See “Liquidity and Capital Resources” below for more information. +Other, net . We recorded other expense of $63,000 in 2013 compared to $23,000 in 2012. The change was primarily due to a loss from the disposal of certain tooling equipment during 2013 of $60,000 offset by lower foreign currency transaction exchange losses recorded by our U.K. subsidiary in 2013 compared to 2012. +Income Taxes . We recorded an income tax provision for 2013 of $1,596,000 at an effective tax rate of 24.4% compared to $1,964,000 at an effective tax rate of 35.2% for 2012. Our effective tax rate for 2013 was unusually low because it included: 1) a $224,000 reduction in tax liabilities for unrecognized tax benefits resulting from the completion of an audit of our 2010 federal income tax return and 2) the benefit from the 2012 R&D credit of approximately $220,000 as this credit was not renewed until January 2, 2013 as a component of the American Taxpayer Relief Act of 2012 +Net Income. We reported net income during 2013 of $4,935,000, or $0.57, per diluted share, compared to $3,621,000, or $0.40, per diluted share, for 2012. +20 +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors affecting the management of liquidity are cash flows from operating activities, capital expenditures, treasury share repurchases, dividend payments, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to access credit lines, if needed, are expected to be sufficient to fund operations, capital expenditures, treasury share repurchases, dividend payments and any increase in working capital that would be required to accommodate a higher level of business activity. We actively seek to expand by acquisition as well as through the growth of our current business. While a significant acquisition may require additional debt and/or equity financing, although no assurances can be given, we believe that we would be able to obtain additional financing based on our historical earnings performance. +Cash Flow +During 2014, our cash balance increased $195,000, or 7%, from December 31, 2013 as we returned a substantial portion of our cash flow to shareholders in the form of $2,634,000 of repurchases of our common stock and $2,556,000 of cash dividends paid to common shareholders. Even after funding these items and our capital expenditures, we still ended 2014 with $3,131,000 in cash and cash equivalents and no debt outstanding. +Operating activities : The following significant factors primarily affected our cash provided by operating activities of $6,053,000 in 2014 as compared to $2,493,000 in 2013. During 2014: +· +We reported a net loss of $2,421,000. +· +We recorded depreciation, amortization and share-based compensation expense of $1,951,000. +· +Accounts receivable decreased $4,139,000 due primarily to lower sales volume during the fourth quarter 2014 compared to the fourth quarter of 2013 in addition to improved collections. +· +Inventories decreased $1,703,000 due to the sell through of inventory on hand during 2014 compared to increasing stocking levels of our new food safety and Printrex products during 2013. We expect our inventories to steadily decline in 2015, beginning in the second quarter, as we sell through this inventory buildup. +· +Accounts payable decreased $2,384,000 due to primarily to lower inventory purchases made during the fourth quarter of 2014 compared to the fourth quarter of 2013, as well as the timing of payments. +· +Accrued liabilities and other liabilities increased $1,022,000 due primarily to higher legal expenses related to the AD Lawsuit and higher accrued incentive compensation in 2014 compared to 2013. +· +We recorded accrued lawsuit settlement expenses of $3,625,000 related to the settlement with AD. See N ote 11 – Commitments and Contingencies in the Notes to the Consolidated Financial Statements for further information on the settlement charges recorded. +During 2013: +· +We reported net income of $4,935,000. +· +We recorded depreciation, amortization and share-based compensation expense of $2,262,000. +· +Accounts receivable decreased $2,685,000 due primarily to significantly lower sales volume during the fourth quarter of 2013 compared to the fourth quarter of 2012. +· +Inventories increased $3,189,000 as we increased stocking levels of our new food safety and Printrex products during 2013 in anticipation of higher expected sales volume. +· +Accounts payable decreased $1,674,000 due to primarily to lower inventory purchases made during the fourth quarter of 2013 compared to the fourth quarter of 2012, as well as the timing of payments. +· +Accrued liabilities and other liabilities decreased $2,156,000 due primarily to a decrease in our estimate of accrued contingent consideration associated with the acquisition of Printrex of $900,000 during 2013 based on our revised estimate of the expected payout. Additionally, income taxes payable decreased by approximately $603,000 resulting from the overpayment of our 2013 tax liability. Correspondingly, we recorded prepaid income taxes of $390,000. +Investing activities : Our capital expenditures were $660,000 and $709,000 in 2014 and 2013, respectively. Expenditures in 2014 included approximately $385,000 for costs incurred for the purchase of new product tooling, $39,000 for costs incurred in connection with an enhancement to the Company’s ERP software and the remaining amount primarily for the purchase of manufacturing equipment and computer equipment. Additionally, our capitalized software development costs for EPICENTRAL™ were $0 and $42,000 in 2014 and 2013, respectively. +Capital expenditures for 2015 are expected to be approximately $800,000, primarily for new product tooling, and tooling enhancements for our existing products, as well as for new computer equipment purchases. +Financing activities : We used $5,178,000 of cash from financing activities during 2014 to purchase $2,634,000 of common stock for treasury, to pay cash dividends of $2,556,000 to common shareholders and $8,000 in financing costs associated with our amended TD Bank Credit Facility (as discussed below), partially offset by proceeds and tax benefits from stock option exercises of $20,000. During 2013, we used $6,334,000 of cash from financing activities during 2014 to purchase $5,194,000 of common stock for treasury and to pay cash dividends of $2,317,000 to common shareholders partially offset by proceeds and tax benefits from stock option exercises of $1,177,000. +Working Capital +Our working capital decreased approximately 26% to $18,361,000 at December 31, 2014 from $24,871,000 at December 31, 2013. Our current ratio of current assets to current liabilities decreased from 4.4 at December 31, 2013 to 2.9 at December 2014. The decrease in both our working capital and current ratio was primarily due to the settlement accrual related to the AD Lawsuit in 2014, as well as lower accounts receivable resulting from lower sales in 2014 and declining inventory levels. +Resource Sufficiency +We believe that our cash and cash equivalents on hand, cash flows generated from operating activities and borrowings available under our TD Bank Credit Facility will provide sufficient resources to meet our working capital needs, fund $3,625,000 of accrued settlement expenses related to the settlement of the AD Lawsuit, finance our capital expenditures, treasury stock repurchases, dividend payments and meet our liquidity requirements through at least the next twelve months. +21 +Credit Facility and Borrowings +We maintain a credit facility (the “TD Bank Credit Facility”) with TD Bank N.A. (“TD Bank”) which provides for a $20,000,000 revolving credit line. On November 26, 2014, we signed an amendment to renew the TD Bank Credit Facility through November 28, 2017. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.15% on unused borrowings under the revolving credit line. The total deferred financing costs relating to expenses incurred to complete the TD Bank Credit Facility was $8,000. The amendment increases the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $10,000,000 from $5,000,000. The amendment also modified the definition of EBITDA to exclude certain non-recurring expenses, including without limitation, non-recurring litigation and acquisition expenses (including the $3,625,000 of accrued settlement expenses related to the AD Lawsuit; and modified the definition of Operating Cash Flow to exclude unfinanced capital expenditures for the quarters ending December 31, 2014, March 31, 2015 and June 30, 2015. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2014. The following table lists the financial covenants and the performance measurements at December 31, 2014: +Financial Covenant +Requirement/Restriction +Calculation at December 31, 2014 +Operating cash flow / Total debt service +Minimum of 1.25 times +16.0 times +Funded debt / EBITDA +Maximum of 3.0 times +0 times +As of December 31, 2014, undrawn commitments under the TD Bank Credit facility were $20,000,000. +Shareholder Dividend Payments +In September 2012, we announced that our Board of Directors approved the initiation of a quarterly cash dividend program which is subject to the Board’s approval each quarter. On May 6, 2014, our Board of Directors declared an increase to the quarterly cash dividend from $0.07 per share to $0.08 per share. Dividends declared and paid on our common stock totaled $2,556,000 or $0.31 per share and $2,317,000 or $0.27 per share, in 2014 and 2013, respectively. On February 4, 2015, our Board of Directors approved the first quarter 2015 dividend in the amount of $0.08 per share payable on or about March 13, 2015 to common shareholders of record at the close of business on February 20, 2015. We expect to pay approximately $2,500,000 in cash dividends to our common shareholders during 2015. +Stock Repurchase Program +On August 11, 2014, our Board of Directors approved a new stock repurchase program (the “Stock Repurchase Program”). Under the Stock Repurchase Program, we are authorized to repurchase up to $7,500,000 of our outstanding shares of common stock from time to time in the open market through July 31, 2015, depending on market conditions, share price and other factors. On November 3, 2014, our Board of Directors modified the Stock Repurchase Program (the “10b5-1 Plan) to include the repurchase of up to $4,000,000 of the Company’s outstanding shares through April 30, 2015 pursuant to a Rule 10b5-1 trading plan though our Board ended this trading plan effective March 31, 2015. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From August 11, 2014 through December 31, 2014, we purchased 434,998 shares of our common stock for approximately $2,634,000 at an average price per share of $6.06. In 2013, under a prior repurchase program and an open market transaction, we repurchased 604,161 shares of common stock for approximately $5,194,000 at an average price of $8.60. From January 1, 2005 through December 31, 2014, we repurchased a total of 3,222,036 shares of common stock for approximately $25,161,000, at an average price of $7.81 per share. As of December 31, 2014, approximately $4,866,000 and $2,192,000 remains authorized for future repurchases under the Stock Repurchase Program and 10b5-1 Plan, respectively. The following table summarizes the repurchase of our common stock for the year ended December 31, 2014: +Period +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs +Approximate Dollar Value of Shares that May Yet Be Purchased under the August 2014 Program +July 1, 2014 –July 31, 2014 +- +- +- +$ +7,500,000 +August 1, 2014 – August 31, 2014 +66,771 +7.49 +66,771 +$ +7,000,000 +September 1, 2014 – September 30, 2014 +42,192 +7.72 +42,192 +$ +6,674,000 +October 1, 2014 – October 31, 2014 +- +- +- +$ +6,674,000 +November 1, 2014 – November 30, 2014 +215,400 +5.54 +215,400 +$ +5,481,000 +December 1, 2014 – December 31, 2014 +110,635 +5.56 +110,635 +$ +4,866,000 +Total +434,998 +$ +6.06 +434,998 +Shareholders’ Equity +Shareholders’ equity decreased $7,127,000 to $25,394,000 at December 31, 2014 from $32,521,000 at December 31, 2013. The decrease was primarily due to our purchase of 434,998 shares of treasury stock for $2,634,000, dividend payments of $2,556,000 and a net loss of $2,421,000. These decreases were partially offset by proceeds and the associated incremental tax benefits of approximately $20,000 from the issuance of 6,000 shares of common stock from stock option exercises, share-based compensation expense related to stock options of $506,000 and approximately $56,000 from the issuance of 9,939 shares of deferred stock units, net of relinquishments. +Off Balance Sheet Arrangements +As of December 31, 2014, we had no off balance sheet arrangements that have had or that we expect would be reasonably likely to have a future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. +22 +Contractual Obligations +Our contractual obligations as of December 31, 2014 were as follows: +Payments due by period +( In thousands) +Total +< 1 year +1-3 years +3-5 years +> 5 years +Operating lease obligations +$ +1,525 +$ +850 +$ +670 +$ +5 +$ +- +Purchase obligations +6,963 +$ +6,833 +$ +130 +- +- +Lawsuit settlement obligations +3,600 +3,600 +- +- +- +Total +$ +12,088 +$ +11,283 +$ +800 +$ +5 +$ +- +Purchase obligations are for purchases made in the normal course of business to meet operational requirements, primarily of fully assembled printers and component part inventory. Lawsuit settlement obligations relate to amounts due to AD pursuant to a confidential settlement and release agreement. +Impact of Inflation +We believe that our business has not been affected to a significant degree by inflationary trends during the past three years. However, inflation is still a factor in the worldwide economy and may increase the cost of purchasing products from our contract manufacturers in Asia, as well as the cost of certain raw materials, component parts and labor used in the production of our products. It also may increase our operating expenses, manufacturing overhead expenses and the cost to acquire or replace fixed assets. Despite continued growing transportation and commodity costs, we have generally been able to maintain or improve our profit margins through productivity and efficiency improvements, cost reduction programs and to a lesser extent, price increases, and we expect to be able to do the same during 2015. As such, we do not believe that inflation will have a significant impact on our business during 2015. +Item 7A. Quantitative and Qualitative Disclosures about Market Risk. +Interest Rate Risk +Our exposure to market risk for changes in interest rates relates primarily to the investment of our available cash and cash equivalents. In accordance with our investment policy, we strive to achieve above market rates of return in exchange for accepting a prudent amount of incremental risk, which includes the risk of interest rate movements. Risk tolerance is constrained by an overriding objective to preserve capital. An increase or decrease of 10% in effective interest rates would not have a material effect on our results of operations or cash flows. +Foreign Currency Exchange Risk +A substantial portion of our sales are denominated in U.S. dollars and, as a result, we have relatively little exposure to foreign currency exchange risk with respect to sales made. This exposure may change over time as business practices evolve and could have a material adverse impact on our financial results in the future. We do not use forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. We estimate that the combined translational and transactional impact of a 10% overall movement in exchange rates from December 31, 2014 (principally the U.K. Pound Sterling) would not have a material impact on our results of operations or cash flows. +Item 8. Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this report as pages F-3 through F-17. An index to such materials appears on page F-1. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2014. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2014, our disclosure controls and procedures are effective. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +23 +Management assessed our internal control over financial reporting as of December 31, 2014. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2014. +The effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. +Item 9B. Other Information. +Not applicable. +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +Set forth below is certain information regarding our executive officers. The remaining information in response to this item will be contained in our Proxy Statement for our 2015 Annual Meeting of Stockholders (the “Proxy Statement”), which will be filed within 120 days after the year covered by this Form 10-K and is incorporated herein by reference. +Executive Officers of the Registrant +The following list is included as an unnumbered item in Part III of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 14, 2015. +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +57 +Chairman of the Board and Chief Executive Officer +Steven A. DeMartino +45 +President, Chief Financial Officer, Treasurer and Secretary +Donald E. Brooks +62 +Senior Vice President-Engineering +Tracey S. Chernay +55 +Executive Vice President, Casino,Gaming Sales and Lottery +Andrew J. Hoffman +57 +Senior Vice President, Operations +Andrew J. Newmark +56 +Executive Vice President, Sales and Marketing +Bart C. Shuldman has been Chief Executive Officer, President and a Director of the Company since its formation in June 1996. In February 2001, Mr. Shuldman was elected Chairman of the Board. Mr. Shuldman relinquished the President title, effective June 1, 2010, to focus on new products and markets, international expansion and potential acquisitions. +Steven A. DeMartino was named as TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Donald E. Brooks was appointed Senior Vice President of Engineering in April 2012. Previously, Mr. Brooks served as Vice President, Engineering from September 2004 to April 2012, Senior Project Engineer from February 1998 to September 2004, Project Engineer from June 1997 to February 1998, Director of Electrical Engineering from March 1986 to June 1997 and Manager of Electronic Development from December 1983 to March 1986. +Tracey S. Chernay was appointed Executive Vice President, Casino and Gaming Sales and Marketing in June 2010, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Chernay served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing & Sales, POS & Banking with the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Chernay was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Andrew J. Hoffman was appointed Senior Vice President, Operations for TransAct worldwide in November 2004. He served as Vice President, Operations from September 1994 to November 2004. +Andrew Newmark joined TransAct on January 12, 2014 as Executive Vice President, Sales and Marketing with responsibility for the sales and marketing of all TransAct products. Prior to joining TransAct, Mr. Newmark was an investor and consultant with Newmark Capital Management from 2009 to 2015. From 2005 to 2009, Mr. Newmark was employed by Newell Rubbermaid as Vice President, Business Development and Strategy. Until 2005, Mr. Newmark held the role of Senior Vice President with DYMO after CoStar, a company he co-founded in 1989, was purchased by DYMO. +24 +Item 11. Executive Compensation. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +Information regarding our equity compensation plans as of December 31, 2014 is as follows: +Plan category +(a) +Number of securities to be issued upon exercise of outstanding options, warrants and rights +(b) +Weighted-average exercise price of outstanding options, warrants and rights +(c) +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +808,306 +$ +8.33 +- +2014 Equity Incentive Plan +34,000 +9.87 +566,000 +Total +842,306 +$ +8.39 +566,000 +In May 2014, our shareholders approved the adoption of the 2014 Equity Incentive Plan. The Company also maintains the 2005 Equity Incentive Plan which was approved by our shareholders, however no new awards will be available for future issuance under this Plan. The number of shares of common stock which may be subject to awards granted under the 2014 Equity Incentive Plan is 600,000. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services. +The information in response to this item will be contained in the Proxy Statement section and is incorporated herein by reference. +PART IV +Item 15. Exhibits and Financial Statement Schedules. +The exhibits filed as a part of this report are listed in the accompanying Index to Exhibits. +25 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ Bart C. Shuldman +Name: +Bart C. Shuldman +Title: +Chairman of the Board and Chief Executive Officer +Date: March 30, 2015 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Bart C. Shuldman +Chairman of the Board +March 30, 2015 +Bart C. Shuldman +and Chief Executive Officer, +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, +March 30, 2015 +Steven A. DeMartino +Treasurer and Secretary +(Principal Financial and Accounting Officer) +/s/ John M. Dillon +Director +March 30, 2015 +John M. Dillon +/s/ Thomas R. Schwarz +Director +March 30, 2015 +Thomas R. Schwarz +/s/ Graham Y. Tanaka +Director +March 30, 2015 +Graham Y. Tanaka +26 +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO FINANCIAL STATEMENTS +Financial Statements +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Balance Sheets as of December 31, 2014 and 2013 +F-3 +Consolidated Statements of Operations for the years ended December 31, 2014, 2013 and 20 12 +F-4 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2014, 2013 and 20 12 +F-5 +Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2014, 2013 and 2 0 12 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and 20 12 +F-7 +Notes to Consolidated Financial Statements +F-8 +All other financial statement schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto. +F-1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Shareholders of TransAct Technologies Incorporated: +In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of TransAct Technologies Incorporated and its subsidiaries at December 31, 2014 and December 31, 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.. +/s/ PricewaterhouseCoopers LLP +Hartford, Connecticut +March 30, 2015 +F-2 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +December 31, +2014 +2013 +Assets: +Current assets: +Cash and cash equivalents +$ +3,131 +$ +2,936 +Accounts receivable, net +9,094 +13,234 +Inventories +11,806 +13,509 +Prepaid income taxes +409 +390 +Deferred tax assets +3,068 +1,655 +Other current assets +489 +497 +Total current assets +27,997 +32,221 +Fixed assets, net +2,438 +2,732 +Goodwill +2,621 +2,621 +Deferred tax assets +1,068 +920 +Intangible assets, net of accumulated amortization of $2,326 and $1,811, respectively +1,341 +1,856 +Other assets +26 +58 +7,494 +8,187 +Total assets +$ +35,491 +$ +40,408 +Liabilities and Shareholders’ Equity: +Current liabilities: +Accounts payable +$ +2,365 +$ +4,749 +Accrued liabilities +3,320 +2,215 +Income taxes payable +13 +26 +Accrued contingent consideration (Note 3) +- +60 +Accrued lawsuit settlement expenses (Note 11) +3,625 +- +Deferred revenue +313 +300 +Total current liabilities +9,636 +7,350 +Deferred revenue, net of current portion +64 +103 +Deferred rent, net of current portion +172 +244 +Other liabilities +225 +190 +461 +537 +Total liabilities +10,097 +7,887 +Commitments and contingencies (Note 11) +Shareholders’ equity: +Preferred stock, $0.01 par value, 4,800,000 authorized, none issued and outstanding +- +- +Preferred stock, Series A, $0.01 par value, 200,000 authorized, none issued and outstanding +- +- +Common stock, $0.01 par value, 20,000,000 authorized at December 31, 2014 and 2013; 11,122,293 and 11,106,354 shares issued; 7,900,257 and 8,319,316 shares outstanding, at December 31, 2014 and 2013, respectively +111 +111 +Additional paid-in capital +28,167 +27,674 +Retained earnings +22,349 +27,326 +Accumulated other comprehensive loss, net of tax +(72) +(63) +Treasury stock, 3,222,036 and 2,787,038 shares, at cost +(25,161) +(22,527) +Total shareholders’ equity +25,394 +32,521 +Total liabilities and shareholders’ equity +$ +35,491 +$ +40,408 +See accompanying notes to Consolidated Financial Statements. +F-3 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except per share data) +Year Ended December 31, +2014 +2013 +2012 +Net sales +$ +53,108 +$ +60,141 +$ +68,386 +Cost of sales +31,397 +35,049 +42,404 +Gross profit +21,711 +25,092 +25,982 +Operating expenses: +Engineering, design and product development +4,302 +4,065 +4,239 +Selling and marketing +7,920 +7,346 +6,637 +General and administrative +7,756 +6,588 +7,833 +Legal fees and settlement expenses associated with lawsuit (Note 11) +5,505 +476 +1,533 +Business consolidation and restructuring (Note 8) +- +- +138 +25,483 +18,475 +20,380 +Operating income (loss) +(3,772) +6,617 +5,602 +Interest and other income (expense): +Interest expense +(61) +(64) +(61) +Interest income +12 +41 +67 +Other, net +(33) +(63) +(23) +(82) +(86) +(17) +Income (loss) before income taxes +(3,854) +6,531 +5,585 +Income tax (benefit) provision +(1,433) +1,596 +1,964 +Net (loss) income +$ +(2,421) +$ +4,935 +$ +3,621 +Net income(loss) per common share: +Basic +$ +(0.29) +$ +0.57 +$ +0.40 +Diluted +$ +(0.29) +$ +0.57 +$ +0.40 +Shares used in per-share calculation: +Basic +8,307 +8,589 +9,032 +Diluted +8,307 +8,703 +9,121 +Dividends declared and paid per common share: +$ +0.31 +$ +0.27 +$ +0.06 +See accompanying notes to Consolidated Financial Statements. +F-4 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(In thousands, except share data) +Year Ended December 31, +2014 +2013 +2012 +Net (loss) income +$ +(2,421) +$ +4,935 +$ +3,621 +Foreign currency translation adjustment, net of tax +(9) +(8) +16 +Comprehensive (loss) income +$ +(2,430) +$ +4,927 +$ +3,637 +See accompanying notes to Consolidated Financial Statements. +F-5 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY +(In thousands, except share data) +Common Stock +Shares Amount +Additional Paid-in +Capital +Retained +Earnings +Treasury +Stock +Accumulated Other Comprehensive +Income (Loss) +Total +Equity +Balance, December 31, 2011 +9,390,262 +$ +108 +$ +25,058 +$ +21,613 +$ +(11,395) +$ +(71) +$ +35,313 +Issuance of shares from exercise of stock options +51,122 +1 +171 +- +- +- +172 +Issuance of deferred stock units +- +- +134 +- +- +- +134 +Tax benefit related to employee stock sales +- +- +57 +- +- +- +57 +Purchase of treasury stock +(721,184) +- +- +- +(5,938) +- +(5,938) +Dividends declared and paid on common stock +- +- +- +(526) +- +- +(526) +Share-based compensation expense +- +- +520 +- +- +- +520 +Foreign currency translation adj., net of tax +- +- +- +- +- +16 +16 +Net income +- +- +- +3,621 +- +- +3,621 +Balance, December 31, 2012 +8,720,200 +$ +109 +$ +25,940 +$ +24,708 +$ +(17,333) +$ +(55) +$ +33,369 +Issuance of shares from exercise of stock options +196,358 +2 +1,043 +- +- +- +1,045 +Issuance of deferred stock units +- +- +139 +- +- +- +139 +Issuance of common stock on deferred +stock units, net of relinquishments +6,919 +- +(28) +- +- +- +(28) +Tax benefit related to employee stock sales +- +- +132 +- +- +- +132 +Purchase of treasury stock +(604,161) +- +- +- +(5,194) +- +(5,194) +Dividends declared and paid on common stock +- +- +- +(2,317) +- +- +(2,317) +Share-based compensation expense +- +- +521 +- +- +- +521 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(73) +- +- +- +(73) +Foreign currency translation adj., net of tax +- +- +- +- +- +(8) +(8) +Net income +- +- +- +4,935 +- +- +4,935 +Balance, December 31, 2013 +8,319,316 +$ +111 +$ +27,674 +$ +27,326 +$ +(22,527) +$ +(63) +$ +32,521 +Issuance of shares from exercise of stock options +6,000 +- +13 +- +- +- +13 +Issuance of deferred stock units +- +- +100 +- +- +- +100 +Issuance of common stock on deferred +stock units, net of relinquishments +9,939 +- +(44) +- +- +- +(44) +Tax benefit related to employee stock sales +- +- +7 +- +- +- +7 +Purchase of treasury stock +(434,998) +- +- +- +(2,634) +- +(2,634) +Dividends declared and paid on common stock +- +- +- +(2,556) +- +- +(2,556) +Share-based compensation expense +- +- +506 +- +- +- +506 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(89) +- +- +- +(89) +Foreign currency translation adj., net of tax +- +- +- +- +- +(9) +(9) +Net loss +- +- +- +(2,421) +- +- +(2,421) +Balance, December 31, 2014 +7,900,257 +$ +111 +$ +28,167 +$ +22,349 +$ +(25,161) +$ +(72) +$ +25,394 +See accompanying notes to Consolidated Financial Statements. +F-6 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2014 +2013 +2012 +Cash flows from operating activities: +Net (loss) income +$ +(2,421) +$ +4,935 +$ +3,621 +Adjustments to reconcile net (loss) income to net cash provided by operating activities: +Share-based compensation expense +506 +521 +520 +Incremental tax benefits from stock options exercised +(7) +(132) +(57) +Depreciation and amortization +1,445 +1,741 +1,758 +Deferred income tax (benefit) provision +(1,558) +46 +(95) +Loss (gain) on sale of fixed assets +28 +60 +(13) +Foreign currency transaction losses +7 +3 +34 +Changes in operating assets and liabilities: +Accounts receivable +4,139 +2,685 +(6,332) +Inventories +1,703 +(3,189) +3,684 +Prepaid income taxes +(98) +(367) +479 +Other current and long term assets +46 +20 +(154) +Accounts payable +(2,384) +(1,674) +3,403 +Accrued lawsuit settlement expenses +3,625 +- +- +Accrued liabilities and other liabilities +1,022 +(2,156) +1,182 +Net cash provided by operating activities +6,053 +2,493 +8,030 +Cash flows from investing activities: +Capital expenditures +(660) +(709) +(1,082) +Additions to capitalized software +- +(42) +(35) +Proceeds from sale of fixed assets +- +5 +15 +Net cash used in investing activities +(660) +(746) +(1,102) +Cash flows from financing activities: +Proceeds from stock option exercises +13 +1,045 +172 +Purchases of common stock for treasury +(2,634) +(5,194) +(5,938) +Payment of dividends on common stock +(2,556) +(2,317) +(526) +Incremental tax benefits from stock options exercised +7 +132 +57 +Payment of deferred financing costs +(8) +- +(7) +Net cash used in financing activities +(5,178) +(6,334) +(6,242) +Effect of exchange rate changes on cash and cash equivalents +(20) +(14) +(12) +Increase (decrease) in cash and cash equivalents +195 +(4,601) +674 +Cash and cash equivalents, beginning of period +2,936 +7,537 +6,863 +Cash and cash equivalents, end of period +$ +3,131 +$ +2,936 +$ +7,537 +Supplemental cash flow information: +Interest paid +$ +49 +$ +51 +$ +51 +Income taxes paid +173 +2,585 +912 +See accompanying notes to Consolidated Financial Statements. +F-7 +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated (“TransAct” or the “Company”), which has its headquarters in Hamden, CT and its primary operating facility in Ithaca, NY, operates in one operating segment: market specific solutions, including printers, terminals, software and other products for transaction-based and other industries. These industries include casino, gaming, lottery, banking, point-of-sale, food safety, oil and gas and medical and mobile. Our printers are designed based on market-specific requirements and are sold under the Ithaca®, RESPONDER®, Epic, EPICENTRAL® and Printrex® product brands. We distribute our products through OEMs, value-added resellers, selected distributors, and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. We also generate revenue from the after-market side of the business, providing printer service, supplies and spare parts in addition to revenue from our software solution, the EPICENTRAL® Print System (“EPICENTRAL®”), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. +2. Summary of significant accounting policies +Principles of consolidation: The accompanying Consolidated Financial Statements include the accounts of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized profit. +Use of estimates : The accompanying Consolidated Financial Statements were prepared using estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting.” We view our operations and manage our business as one segment: the design, development, assembly and marketing of transaction printers and terminals and providing printer-related software, services, supplies and spare parts . Factors used to identify TransAct’s single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief operating decision-maker in making decisions about how to allocate resources and assess performance. +Cash and cash equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Allowance for doubtful accounts: We establish an allowance for doubtful accounts to ensure trade receivables are valued appropriately. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events and historical experience. We record a specific allowance for individual accounts when we become aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. If circumstances related to customers change, we would further adjust estimates of the recoverability of receivables. Allowances for doubtful accounts on accounts receivable balances were $100,000 as of December 31, 2014 and $63,000 as of December 31, 2013. +The following table summarizes the activity recorded in the valuation account for accounts receivable: +Year ended December 31, +( In thousands) +2014 +2013 +2012 +Balance, beginning of period +$ +63 +$ +66 +$ +70 +Additions charged to costs and expenses +37 +- +- +Deductions +- +(3) +(4) +Balance, end of period +$ +100 +$ +63 +$ +66 +Inventories: Inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market. We review market value based on historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and market value. +Fixed assets : Fixed assets are stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years; machinery and equipment is ten years; furniture and office equipment is five to ten years; and computer software and equipment is three to seven years. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $925,000, $1,216,000 and $1,183,000 in 2014, 2013 and 2012, respectively. +Leases : Rent expense under non-cancelable operating leases with scheduled rent increases or free rent periods are accounted for on a straight-line basis over the lease term, beginning on the date of control of physical use of the asset or of initial possession. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred liability. Construction allowances and other such lease incentives are recorded as deferred credits, and are amortized on a straight-line basis as a reduction of rent expense beginning in the period they are deemed to be earned, which generally coincides with the occupancy date. +F-8 +2. Summary of significant accounting policies (continued) +Goodwill and Intangible assets : We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with Accounting Standards Codification (“ASC”) 350-20 “Goodwill”, acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Definite lived intangible assets are amortized and are tested for impairment when appropriate. We have determined that no goodwill impairment has occurred based on our assessment as of December 31, 2014 when the impairment review is performed. +Revenue recognition : Our typical contracts include the sale of printers, which are sometimes accompanied by separately-priced extended warranty contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within ASC 605, “Revenue Recognition” (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms, which are generally FOB shipping point) has occurred, the selling price is fixed and determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +We have developed a software solution, EPICENTRAL™, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. Revenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, “Multiple-Element Arrangements” and ASC 985-605, “Software.” EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system’s full functionality. These arrangements are accounted for in accordance with ASC 605-25, “Multiple-Element Arrangements”. EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, “Software” as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level GAAP and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence (“VSOE”) if available, third party evidence (“TPE”) if VSOE is not available, or best estimate of selling price (“BESP”) to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, “Separately Priced Extended Warranty and Product Maintenance Contracts.” Pursuant to this provision, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +F-9 +2. Summary of significant accounting policies (continued) +Concentration of credit risk : Financial instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable were as follows: +December 31, +2014 +2013 +GTECH +15% +21% +Eurocoin +11% +22% +Suzo-Happ +23% +6% +CMC Daymark +11% +19% +Sales to customers representing 10% or more of total net sales were as follows: +Year ended December 31, +2014 +2013 +2012 +GTECH +16% +12% +18% +Eurocoin +11% +12% +15% +Warranty : We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. +The following table summarizes the activity recorded in the accrued product warranty liability: +Year ended December 31, +( In thousands ) +2014 +2013 +2012 +Balance, beginning of period +$ +366 +$ +274 +$ +421 +Warranties issued +183 +492 +104 +Warranty settlements +(262) +(400) +(251) +Balance, end of period +$ +287 +$ +366 +$ +274 +Approximately $207,000 and $282,000 of the accrued product warranty liability were classified as current in Accrued liabilities at December 31, 2014 and 2013, respectively. The remaining $80,000 and $84,000 of the accrued product warranty liability is classified as long-term in Other liabilities. +Engineering, design and product development : Research and development expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as a component of operating expenses as incurred. We recorded approximately $4,302,000, $4,065,000 and $4,239,000 of research and development expenses in 2014, 2013 and 2012, respectively. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010 we began the development of EPICENTRAL TM and unamortized development costs for such software were approximately $169,000 and $370,000 as of December 31, 2014 and 2013, respectively. The total amount charged to cost of sales for capitalized software development costs was approximately $201,000, $199,000 and $189,000 in 2014, 2013 and 2012, respectively. The weighted-average amortization period of unamortized capitalized software developments costs is approximately one year. +Advertising: Advertising costs are expensed as incurred. Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Operations, for 2014, 2013 and 2012 totaled $1,191,000, $1,058,000 and $949,000, respectively. These expenses include items such as consulting and professional services, tradeshows, and print advertising. +Restructuring : We continually evaluate our cost structure to ensure that it is appropriately positioned to respond to changing market conditions. We record pre-tax restructuring charges in accordance with ASC 420-10-25-4, “Exit or Disposal Cost Obligations.” See Note 8 for further discussion. +Income taxes : The income tax amounts reflected in the accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, “Income Taxes.” Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. See Note 13 for information regarding our accounting for income taxes. +F-10 +2. Summary of significant accounting policies (continued) +Foreign currency translation : The financial position and results of operations of our foreign subsidiary in the United Kingdom are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars at the year-end exchange rate, related sales and expenses have been translated at the average exchange rate for the year, and shareholders’ equity has been translated at historical exchange rates. The resulting translation gains or losses, net of tax, are recorded in shareholders’ equity as a cumulative translation adjustment, which is a component of +accumulated other comprehensive income. Foreign currency transaction gains and losses, including those related to intercompany balances, are recognized in Other, net on the Consolidated Statements of Operations. +Share-based payments : At December 31, 2014, we had share-based employee compensation plans, which are described more fully in Note 12 - Stock incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, “Compensation – Stock Compensation.” Share-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee’s requisite service period. We have no awards with market or performance conditions. +We use the Black-Scholes option-pricing model to calculate the fair value of share based awards. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. In addition, we estimate forfeitures when recognizing compensation expense, and we adjust our estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures are recognized through a cumulative true-up adjustment in the period of change and also impacts the amount of compensation expense to be recognized in future periods. +Net income and loss per share : We report net income or loss per share in accordance with ASC 260, “Earnings per Share (EPS).” Under this guidance, basic EPS, which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these instruments are excluded from the computation of dilutive EPS. See Note 14 - Earnings per share. +3. Contingent Consideration +In connection with a business acquisition on August 19, 2011, whereby we purchased substantially all of the assets of Printrex, Inc (“Printrex”), we entered into a contingent consideration arrangement with Printrex as part of the acquisition for 30% of the gross profit for a three-year period related to new products under development, less certain other adjustments, beginning on the earlier of 1) January 1, 2012 or 2) the date of first commercial introduction of the new products under development. As of December 31, 2014, the undiscounted fair value related to the contingent liability was estimated to be zero and we do not expect to make a contingent consideration payment. The fair value of the contingent consideration arrangement was $0 and $60,000 at December 31, 2014 and 2013, respectively, which were estimated by applying the income approach. That measure is based on significant inputs that are not observable in the market, which fair value measurement guidance refers to as Level 3 inputs. During 2014 and 2013, the fair value of the contingent consideration was decreased by $60,000 and $900,000, respectively, and this credit is included in general and administrative expenses on the Consolidated Statements of Operations. No payments were made under the arrangement during 2014 as the underlying conditions of the contingent consideration arrangement were not satisfied. +4. Inventories +The components of inventories are: +December 31, +(In thousands) +2014 +2013 +Raw materials and purchased component parts +$ +6,183 +$ +7,263 +Work-in-process +4 +31 +Finished goods +5,619 +6,215 +$ +11,806 +$ +13,509 +5. Fixed assets +The components of fixed assets, net are: +December 31, +( In thousands ) +2014 +2013 +Tooling, machinery and equipment +$ +10,620 +$ +12,066 +Furniture and office equipment +1,489 +1,492 +Computer software and equipment +6,132 +5,986 +Leasehold improvements +1,952 +1,926 +20,193 +21,470 +Less: Accumulated depreciation and amortization +(17,858) +(18,989) +2,335 +2,481 +Construction in-process +103 +251 +$ +2,438 +$ +2,732 +F-11 +6. Intangible assets +Identifiable intangible assets are recorded in Intangible assets in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2014 +2013 +( In thousands ) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,604 +$ +(1,172) +$ +1,604 +$ +(924) +Customer relationships +1,300 +(729) +1,300 +(513) +Trademark +480 +(162) +480 +(113) +Covenant not to compete +146 +(146) +146 +(146) +Patents +57 +(37) +57 +(35) +Other +80 +(80) +80 +(80) +Total +$ +3,667 +$ +(2,326) +$ +3,667 +$ +(1,811) +Amortization expense was $515,000 in 2014, $513,000 in 2013 and $568,000 in 2012. Amortization expense for each of the next five years ending December 31 is expected to be as follows: $456,000 in 2015; $333,000 in 2016; $244,000 in 2017; $102,000 in 2018; $99,000 in 2019 and $107,000 thereafter. +7. Accrued liabilities +The components of accrued liabilities are: +December 31, +( In thousands ) +2014 +2013 +Salaries and compensation related +$ +1,852 +$ +1,447 +Warranty +207 +282 +Professional and consulting +959 +139 +Other +302 +347 +$ +3,320 +$ +2,215 +8. Restructuring activities +In January 2012, we determined that we no longer needed to maintain the existing Printrex manufacturing facility in San Jose, California, along with certain redundant headcount. As a result, we incurred expenses of $138,000 in 2012 for employee termination benefits related to these employee reductions as well as moving costs and the closing of the San Jose manufacturing operations that was completed as of December 31, 2012. This restructuring charge was recorded in accordance with ASC 420-10-25-4 “Exit or Disposal Cost Obligations” and is included within Business consolidation and restructuring expenses in the accompanying Consolidated Statements of Operations. Cash payments made under this restructuring plan were completed by October 2012. +9. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of each month immediately following their date of hire. We match employees’ contributions at a rate of 50% of employees’ contributions up to the first 6% of the employees’ compensation contributed to the 401(k) plan. Our matching contributions were $282,000, $265,000 and $280,000 in 2014, 2013 and 2012, respectively. +10. Borrowings +We maintain a credit facility (the “TD Bank Credit Facility”) with TD Bank N.A. (“TD Bank) which provides for a $20,000,000 revolving credit line. On November 26, 2014, we signed an amendment to the TD Bank Credit Facility through November 28, 2017. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.15% on unused borrowings under the revolving credit line. The total deferred financing costs relating to expenses incurred to complete the TD Bank Credit +Facility was $8,000 which will be amortized over the three year term. The amendment increased the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $10,000,000 from $5,000,000. The amendment also modified the definition of EBITDA to exclude certain non-recurring expenses, including without limitation, non-recurring litigation and acquisition expenses; and modified the definition of Operating Cash Flow to exclude unfinanced capital expenditures for the quarters ending December 31, 2014, March 31, 2015 and June 30, 2015. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2014. +As of December 31, 2014, undrawn commitments under the TD Bank Credit facility were $20,000,000. +F-12 +11. Commitments and contingencies +On June 8, 2012, Avery Dennison Corporation (“AD”) filed a civil complaint against the Company and a former employee of the Company and of AD, in the Court of Common Pleas (the “Court”) in Lake County, Ohio. The complaint alleged that this former employee and the Company misappropriated unspecified trade secrets and confidential information from AD related to the design of our food safety terminals. The complaint requested a preliminary and permanent injunction against the Company from manufacturing and selling our Ithaca® 9700 and 9800 food safety terminals. On July 16, 2012, the Company filed its answer, affirmative defenses and counterclaims, seeking all available damages including legal fees. A hearing on the plaintiff's motion for preliminary injunction took place in August 2012, and in November 2012, the Court denied this request. AD filed an appeal of the Court’s ruling to the Eleventh Appellate District, which heard oral arguments on the appeal on July 16, 2013. On July 23, 2013, AD requested that the Eleventh Appellate District enjoin the Company’s further sale and marketing of the food safety terminals, pending the appeals court's decision. On July 29, 2013, the Company opposed this request. On October 15, 2013, the Eleventh District Court of Appeals affirmed the lower court’s decision in the Company’s favor and denied AD’s further request of an injunction pending the Court of Appeal’s decision. On October 24, 2013, AD filed a motion seeking that the Court of Appeals reconsider its decision. On April 16, 2014, the Court of Appeals denied AD’s motion to reconsider its decision. On July 28, 2014, AD filed a motion requesting leave from the Court to file an amended complaint and indicating that it has elected to pursue only its claim for damages, dropping its claim for injunctive relief. On September 4, 2014, the Court granted AD’s motion to file an amended complaint. On September 25, 2014, the Company filed its answer, affirmative defenses and counterclaims with respect to the amended complaint, seeking all available damages including legal fees. On January 30, 2015, the Company filed a motion for summary judgment seeking judgment in favor of the Company on all counts as to the Company. On the same day, AD filed two motions for partial summary judgment. On February 17, 2015, the Company opposed both of AD’s motions, and AD opposed the Company’s motion. On February 23, 2015, the Company filed a reply brief in support of its motion for summary judgment. A trial was scheduled to begin on April 21, 2015, however, on March 25, 2015 the parties executed a confidential settlement agreement and release (the “Settlement Agreement”) in which the parties mutually agreed to resolve the dispute that was the subject of the lawsuit filed by AD against the Company to the parties’ mutual satisfaction. Under the terms of the Settlement Agreement, the Company agreed to pay AD $3,600,000 payable on or before April 8, 2015 and also to qualify certain AD labels for use on the Company’s food safety terminals at an estimated cost of $25,000. The Company recorded the total expense of $3,625,000 in the fourth quarter as an operating expense included in the line item “Legal fees and settlement expenses associated with lawsuit” on the Consolidated Statement of Operations and as a current liability included in the line item “Accrued lawsuit settlement expenses” on the Consolidated Balance Sheet. +At December 31, 2014, we were the lessee on operating leases for equipment and real property. Rent expense was approximately $918,000, $918,000 and $1,005,000 in 2014, 2013 and 2012, respectively. Minimum aggregate rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2014 are as follows: $850,000 in 2015; $584,000 in 2016; $86,000 in 2017; $4,000 in 2018 and $1,000 in 2019. +12. Stock incentive plans +Stock incentive plans . We currently have two primary stock incentive plans: the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan, which provides for awards to executives, key employees, directors and consultants. We previously maintained two other stock incentive plans, the 1996 Director’s Stock Plan and the 2001 Employee Stock Plan, both of which expired during 2014. The plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units, (v) stock appreciation rights or (vi) limited stock appreciation rights. Options granted under these plans have exercise prices equal to 100% of the fair market value of the common stock at the date of grant. Options granted have a ten-year term and generally vest over a three- to five-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards will be made under the 2005 Equity Incentive Plan. Under our 2014 Equity Incentive Plan, we may authorize up to 600,000 shares of TransAct common stock. At December 31, 2014, 566,000 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average fair value of stock option grants for 2014, 2013 and 2012 was $11.11, $7.94 and $6.91, respectively. The table below indicates the key assumptions used in the option valuation calculations for options granted in 2014, 2013 and 2012 and a discussion of our methodology for developing each of the assumptions used in the valuation model: +Year ended December 31, +2014 +2013 +2012 +Expected option term +6.6 years +6.8 years +6.7 years +Expected volatility +53.8% +56.5% +57.8% +Risk-free interest rate +1.6% +0.8% +0.8% +Dividend yield +2.6% +3.1% +-% +Expected Option Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility – The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An increase in the expected volatility factor will increase compensation expense. +Risk-Free Interest Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +Dividend Yield – We began paying a quarterly dividend to common shareholders in December 2012,. The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation expense. +F-13 +12. Stock incentive plans (continued) +For 2014, 2013 and 2012, we recorded $506,000, $521,000, and $520,000 of share-based compensation expense, respectively, included primarily in general and administrative expense in our Consolidated Statements of Operations. We also recorded income tax benefits of approximately $377,000, $127,000, and $183,000 in 2014, 2013, and 2012 respectively, related to such share-based compensation. At December 31, 2014, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Option activity in the 1996 Directors’ Stock Plan, 2001 Employee Stock Plan, 2005 Equity Incentive Plan and 2014 Equity Incentive Plan is summarized below: +Number of Shares +Weighted Average Exercise Price +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at December 31, 2013 +718,475 +$ +8.49 +Granted +169,500 +11.11 +Exercised +(6,000) +2.18 +Forfeited +(62,500) +8.51 +Expired +(23,500) +31.58 +Outstanding at December 31, 2014 +795,975 +$ +8.41 +5.7 years +$ +87,000 +Options exercisable at December 31, 2014 +490,725 +$ +7.72 +4.1 years +$ +87,000 +Options vested or expected to vest +784,108 +$ +8.39 +6.0 years +$ +87,000 +Shares that are issued upon exercise of employee stock options are newly issued shares and not issued from treasury stock. As of December 31, 2014, unrecognized compensation cost related to stock options is approximately $955,000, which is expected to be recognized over a weighted average period of 2.5 years. +The total intrinsic value of stock options exercised was $20,000, $910,000 and $222,000 and the total fair value of stock options vested was $943,000, $815,000, and $641,000 during 2014, 2013 and 2012, respectively. Cash received from option exercises was $13,000, $1,045,000 and $172,000 for 2014, 2013 and 2012, respectively. We recorded a realized tax benefit in 2014, 2013 and 2012 from equity-based awards of $7,000, $132,000 and $57,000, respectively, related to options exercised which has been included as a component of cash flows from financing activities in the Consolidated Statements of Cash Flows. +Restricted stock : We paid a portion of the 2013, 2012 and 2011 incentive bonus for the chief executive officer and chief financial officer in the form of 8,663, 17,613 and 20,055 deferred stock units, respectively, with a corresponding credit recorded to Additional Paid in Capital (net of share relinquishments) in the amounts of $56,000, $111,000 and $134,000 in 2014, 2013 and 2012, respectively. Such deferred stock units were granted in March 2014, 2013 and 2012, respectively, and were fully vested at the time of grant. These units will be converted three years from the grant date to shares of the Company’s common stock on a one-for-one basis. The weighted average exercise price of the deferred stock units was $8.07. +13. Income taxes +The components of the income tax provision are as follows: +Year Ended December 31, +( In thousands) +2014 +2013 +2012 +Current: +Federal +$ +176 +$ +1,479 +$ +1,973 +State +15 +38 +46 +Foreign +12 +33 +40 +203 +1,550 +2,059 +Deferred: +Federal +(1,653) +80 +(116) +State +17 +(34) +21 +Foreign +- +- +- +(1,636) +46 +(95) +Income tax (benefit) provision +$ +(1,433) +$ +1,596 +$ +1,964 +F-14 +13. Income taxes (continued) +Our effective tax rates were 37.2%, 24.4%, and 35.2% for 2014, 2013 and 2012, respectively. Our effective tax rate for 2013 was unusually low because it included: 1) a $224,000 reduction in tax liabilities for unrecognized tax benefits resulting from the completion of an audit of our 2010 federal income tax return and 2) the benefit from the 2012 federal research and development credit (“R&D credit”) of approximately $220,000 as this credit was not renewed until January 2, 2013 as a component of the American Taxpayer Relief Act of 2012. +At December 31, 2014, we have no federal or state net operating loss carryforwards. We have approximately $104,000 in R&D credit carryforwards that expire in 2034 and approximately $3,000 in state tax credit carryforwards that begin to expire in 2019. Foreign (loss) income before taxes was $(56,000), $(29,000), and $92,000 in 2014, 2013, and 2012, respectively. +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Our deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2014 +2013 +Deferred tax assets: +Foreign net operating losses +$ +282 +$ +242 +Capitalized research and development +- +68 +Accrued lawsuit settlement expenses +1,262 +- +Inventory reserves +1,063 +1,050 +Deferred revenue +56 +59 +Warranty reserve +100 +127 +Stock compensation expense +1,049 +956 +Other accrued compensation +406 +- +Foreign tax and other credits +106 +45 +Other liabilities and reserves +312 +491 +Gross deferred tax assets +4,636 +3,038 +Valuation allowance +(282) +(242) +Net deferred tax assets +4,354 +2,796 +Deferred tax liabilities: +Depreciation +142 +175 +Other +76 +46 +Net deferred tax liabilities +218 +221 +Total net deferred tax assets +4,136 +$ +2,575 +A valuation allowance of $282,000 has been established for foreign net operating loss carryforwards that are not expected to be used. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year ended December 31, +( In thousands) +2014 +2013 +2012 +Balance, beginning of period +$ +242 +$ +216 +$ +176 +Additions charged to income tax provision +40 +56 +40 +Reductions credited to income tax provision +- +(30) +- +Balance, end of period +$ +282 +$ +242 +$ +216 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2014 +2013 +2012 +Federal statutory tax rate +34.0% +34.0% +34.0% +R&D credit +6.0 +- +- +State income taxes, net of federal income taxes +(0.5) +0.1 +0.8 +Valuation allowance and tax accruals +(1.1) +0.9 +0.9 +Uncertain tax positions +(1.0) +- +- +Miscellaneous permanent items +(0.3) +(8.3) +(0.8) +Other +0.1 +(2.3) +0.3 +Effective tax rate +37.2% +24.4% +35.2% +F-15 +13. Income taxes (continued) +At December 31, 2014 and 2013, we had approximately $124,000 and $106,000 of total gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the gross amounts of unrecognized tax benefits at the beginning and end of the year is as follows: +( In thousands) +2014 +2013 +Unrecognized tax benefits as of January 1 +$ +106 +$ +251 +Tax positions taken during the current period +18 +79 +Lapse of statute of limitations +- +(224) +Unrecognized tax benefits as of December 31 +$ +124 +$ +106 +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially concluded all U.S. federal income tax, state and local, and foreign tax matters through 2010. During 2013, an examination of our 2010 federal tax return was completed. However, our federal tax returns for the years 2011 through 2013 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +We do not anticipate that the total unrecognized tax benefits of approximately $124,000 will significantly change due to the settlement of audits and the expiration of statute of limitations prior to December 31, 2015. +We recognize interest and penalties related to uncertain tax positions in the income tax provision. As of December 31, 2014 and 2013, we have approximately $20,000 and $10,000, respectively, of accrued interest and penalties related to uncertain tax positions. +14. Earnings per share +For 2014, 2013 and 2012, earnings per share were computed as follows (in thousands, except per share amounts): +Year Ended December 31, +2014 +2013 +2012 +Net (loss) income +$ +(2,421) +$ +4,935 +$ +3,621 +Shares: +Basic: Weighted average common shares outstanding +8,307 +8,589 +9,032 +Add: Dilutive effect of outstanding options as determined by the treasury stock method +- +114 +89 +Diluted: Weighted average common and common equivalent shares outstanding +8,307 +8,703 +9,121 +Net (loss) income per common share: +Basic +$ +(0.29) +$ +0.57 +$ +0.40 +Diluted +(0.29) +0.57 +0.40 +The computation of diluted earnings per share excludes the effect of the potential exercise of stock options, when the average market price of the common stock is lower than the exercise price of the related stock option during the period. These outstanding stock options are not included in the computation of diluted earnings per share because the effect would be anti-dilutive. Anti-dilutive stock options, restricted shares and deferred stock units excluded from the computation of earnings per dilutive share were 311,000, and 585,125, at December 31, 2013 and 2012 respectively. Regarding 2014, when a net loss is reported basic and diluted EPS are calculated using the same method. +15. Stock repurchase program +On August 11, 2014, our Board of Directors approved a new stock repurchase program (the “Stock Repurchase Program”). Under the Stock Repurchase Program, we are authorized to repurchase up to $7,500,000 of our outstanding shares of common stock from time to time in the open market through July 31, 2015, depending on market conditions, share price and other factors. On November 3, 2014, our Board of Directors modified the Stock Repurchase Program to include the repurchase of up to $4,000,000 of the Company’s outstanding shares through April 30, 2015 pursuant to a Rule 10b5-1 trading plan though our Board ended this trading plan effective March 31, 2015. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From August 11, 2014 through December 31, 2014, we purchased 434,998 shares of our common stock for approximately $2,634,000 at an average price per share of $6.06. In 2013, under a prior repurchase program and an open market transaction, we purchased 604,161 shares of common stock for approximately $5,194,000 at an average price of $8.60. From January 1, 2005 through December 31, 2014, we repurchased a total of 3,222,036 shares of common stock for approximately $25,161,000, at an average price of $7.81 per share. +F-16 +16. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are based on the location of the customer and vendor. +Year Ended December 31, +(In thousands) +2014 +2013 +2012 +Net sales: +United States +$ +38,567 +$ +46,377 +$ +49,932 +International +14,541 +13,764 +18,454 +Total +$ +53,108 +$ +60,141 +$ +68,386 +Fixed assets, net: +United States +$ +1,490 +$ +1,583 +$ +1,941 +International +948 +1,149 +1,361 +Total +$ +2,438 +$ +2,732 +$ +3,302 +Sales to international customers were approximately 27%, 23%, and 27% in 2014, 2013, and 2012 respectively. Sales to Europe represented 49%, 52%, and 52%, sales to the Pacific Rim (which includes Australia and Asia) represented 33%, 26%, and 18%, and sales to Canada represented 5%, 10%, and 16% of total international sales in 2014, 2013, and 2012 respectively. International long-lived assets consist of net fixed assets located at our foreign subsidiary in the United Kingdom as well as our contract manufacturers in China, Thailand, Malaysia and Mexico. +17. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2014 and 2013 are as follows: +Quarter Ended +( In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2014: +Net sales +$ +13,619 +$ +13,804 +$ +13,389 +$ +12,296 +Gross profit +5,726 +5,788 +5,286 +4,911 +Net income (loss) +394 +175 +50 +(3,040) +Net income (loss) per share: +Basic +0.05 +0.02 +0.01 +(0.37) +Diluted +0.05 +0.02 +0.01 +(0.37) +2013: +Net sales +$ +15,057 +$ +15,788 +$ +16,768 +$ +12,528 +Gross profit +6,433 +6,452 +7,206 +5,001 +Net income +1,160 +1,215 +1,451 +1,109 +Net income per share: +Basic +0.13 +0.14 +0.17 +0.13 +Diluted +0.13 +0.14 +0.17 +0.13 +F-17 +Index to Exhibits +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated (“TransAct” or the “Company”), filed with the Secretary of State of Delaware on June 17, 1996. +(2) +3.1(b) +Certificate of Amendment of Certificate of Incorporation of the Company, filed with the Secretary of State of Delaware on June 4, 1997. +(4) +3.1(c) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December 2, 1997. +(5) +3.1(d) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000. +(7) +3.2 +Amended and Restated By-laws of the Company. +(6) +4.1 +Specimen Common Stock Certificate. +(2) +10.1(x) +2005 Equity Incentive Plan +(10) +10.2(x) +2014 Equity Incentive Plan +(3) +10.3(x) +Employment Agreement, dated July 31, 1996, by and between TransAct and Bart C. Shuldman. +(2) +10.4(x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004. +(9) +10.5(x) +Severance Agreement by and between TransAct and Tracey S. Chernay, dated July 29, 2005. +(13) +10.6(x) +Amendment to Employment Agreement, effective January 1, 2008, by and between TransAct and Bart C. Shuldman. +(14) +10.7(x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008. +(14) +10.8(x) +Amendment to Severance Agreement by and between TransAct and Tracey S. Chernay, effective January 1, 2008. +(14) +10.9 +Lease Agreement by and between Bomax Properties and Ithaca, dated as of March 23, 1992. +(2) +10.10 +Second Amendment to Lease Agreement by and between Bomax Properties and Ithaca, dated December 2, 1996. +(4) +10.11 +Agreement regarding the Continuation and Renewal of Lease by and between Bomax Properties, LLC and TransAct, dated July 18, 2001. +(8) +10.12 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct. +(17) +10.13 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004. +(9) +10.14 +First Amendment to Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated August 31, 2009 +(15) +10.15 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006. +(11) +10.16 +OEM Purchase Agreement by and between GTECH Corporation and TransAct, dated November 20, 2009. (Pursuant to Rule 24-b-2 under the Exchange Act, the Company has requested confidential treatment of portions of this exhibit deleted from the filed copy) +(15) +10.17 +Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. dated November 28, 2006 +(11) +10.18 +First Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. effective September 30, 2007. +(12) +10.19 +Second Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Bank, N.A. effective November 22, 2011. +(16) +10.20 +Third Amendment to Amended and Restated Revolving Credit and Security Agreement effective September 7, 2012 +(18) +10.21 +Fourth Amendment to Amended and Restated Revolving Credit and Security Agreement effective November 26, 2014 +(19) +23.1 +Consent of PricewaterhouseCoopers LLP. +(1) +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +32.1 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +(1) +32.2 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +(1) +101.INS +XBRL Instance Document. +(1) +101.SCH +XBRL Taxonomy Extension Schema Document. +(1) +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +(1) +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +(1) +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +(1) +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +(1) +(1) +These exhibits are filed herewith. +(2) +These exhibits, which were previously filed with the Company’s Registration Statement on Form S-1 (No. 333-06895), are incorporated by reference. +(3) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed May 15, 2014 is incorporated by reference. +(4) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 1997, are incorporated by reference. +(5) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed February 18, 1999, is incorporated by reference. +(6) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 1998, is incorporated by reference. +(7) +These exhibits, which were previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended March 25, 2000, are incorporated by reference. +(8) +This exhibit, which was previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003, is incorporated by reference. +(9) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, are incorporated by reference. +(10) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed June 1, 2005, is incorporated by reference. +(11) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, are incorporated by reference. +(12) +This exhibit, which was previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 1997, is incorporated by reference. +(13) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, is incorporated by reference. +(14) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, is incorporated by reference. +(15) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, is incorporated by reference. +(16) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, is incorporated by reference. +(17) +This exhibit, which was previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2012, is incorporated by reference. +(18) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed September 11, 2012, is incorporated by reference. +(19) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed December 1, 2014, is incorporated by reference. +(x) +Management contract or compensatory plan or arrangement. +EXHIBIT LIST +The following exhibits are filed herewith. +Exhibit +23.1 +Consent of PricewaterhouseCoopers LLP. +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1 +Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +32.2 +Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. \ No newline at end of file diff --git a/raw/filings/0001017303/2014/0001017303-15-000021/filing_metadata.csv b/raw/filings/0001017303/2014/0001017303-15-000021/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..73dbe816490d3d87e90091e707560c8252c38218 --- /dev/null +++ b/raw/filings/0001017303/2014/0001017303-15-000021/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2015-03-30,2014-12-31,2015-03-30T20:31:52.000Z,0001017303-15-000021,form10k2014.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2014",8427249,1,0,https://www.sec.gov/Archives/edgar/data/1017303/000101730315000021/form10k2014.htm,https://www.sec.gov/Archives/edgar/data/1017303/000101730315000021/,2014,2014,1 diff --git a/raw/filings/0001017303/2014/0001017303-15-000021/item1.txt b/raw/filings/0001017303/2014/0001017303-15-000021/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..0045e5b8885d8c980fccc3b0f630d69580bcdd26 --- /dev/null +++ b/raw/filings/0001017303/2014/0001017303-15-000021/item1.txt @@ -0,0 +1,75 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated (“TransAct” or the “Company”) was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct designs, develops and sells market-specific solutions, including printers, terminals, software and other products for transaction-based and other industries. These world-class products are sold under the Epic, EPICENTRAL®, Ithaca®, RESPONDER® and Printrex® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality labels and transaction records such as receipts, tickets, coupons, register journals and other documents as well as printed logging and plotting of data. We focus on the following core markets: food safety, banking and point-of-sale (“POS”), casino and gaming, lottery, and Printrex (which serves the oil and gas, medical and mobile printing markets). We sell our products to original equipment manufacturers (“OEMs”), value-added resellers ("VARs"), selected distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class printer service, spare parts, accessories and printing supplies to its growing worldwide installed base of printers. Through our TransAct Services Group (“TSG”) we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the on-line demand for these products. We have one primary operating,global research and development and eastern region service center located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters and western region service center in Las Vegas, NV, a sales and service center for the oil and gas industry in Houston, TX, a European sales and service center in the United Kingdom, a sales office located in Macau and two other sales offices located in the United States. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT , 06518, with a telephone number of (203) 859-6800. +On August 19, 2011, we completed the acquisition of Printrex, Inc. (“Printrex”) for $4,000,000 in cash and potential future contingent consideration. Printrex is a leading manufacturer of specialty printers primarily sold into the oil and gas exploration and medical and mobile printing markets. Printrex serves commercial and industrial customers primarily in the United States, Canada, Europe and Asia. This acquisition was completed to complement our existing product offerings. +Financial Information about Segments +We operate in one reportable segment, the design, development, assembly and marketing of transaction printers and terminals and providing related software, services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements on pages F-3 and F-4 hereof. +Products, Services and Distribution Methods +Printers and terminals +TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing inkjet, thermal and impact printing technology for applications, primarily in the food safety, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers. +Food safety, banking and POS: During 2012 in an effort to address the Food Safety Modernization Act, we developed a food safety terminal, a hardware device that consists of a touchscreen and one or two thermal print mechanisms, that prints easy-to-read expiration and "enjoy by" date labels to help restaurants effectively manage food rotation and spoilage. In the food safety market, we use an internal sales representative to manage sales of our terminals through distribution, as well as a dedicated internal sales force to solicit sales directly from end-users. +Our banking and POS printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the banking market, we sell printers that are used by banks, credit unions and other financial institutions to print receipts and/ or validate checks at bank teller stations. In the POS market, we sell several models of printers utilizing inkjet, thermal and impact printing technology. Our printers are used primarily by retailers in the restaurant (including fine dining, casual dining, and fast food), hospitality, and specialty retail industries to print receipts for consumers, validate checks, or print on linerless labels or other inserted media. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force. +Lottery: We supply lottery printers to Lottomattica’s GTECH Corporation (“GTECH”), our largest customer and the world’s largest provider of lottery terminals. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to GTECH and managed by an internal sales representative. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLT’s”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks (“racinos”) and other gaming venues worldwide. These printers utilize thermal printing technology and can print tickets or receipts in monochrome or two-color (depending upon the model), and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal printing technology for use in non-casino establishments, including game types such as Amusements with Prizes (“AWP”), Skills with Prizes (“SWP”), Fixed Odds Betting Terminals (“FOBT”) and other off-premise gaming type machines around the world. We sell our products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through our primary worldwide distributor, Suzo-Happ Group. We also maintain a dedicated internal sales force to solicit sales from slot manufacturers and casinos, as well as to manage sales through our distributor. +1 +We also offer a software solution, the EPICENTRAL TM Print System (“EPICENTRAL TM ”), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. With EPICENTRAL TM , casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +Printrex: Printrex printers include wide format, rack mounted and vehicle mounted thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. During 2012, we launched two new color printers for this market, the Printrex 920 and Printrex 980. The Printrex 920 is the first full-color printer designed from the ground up to perform in the adverse environment of a well logging truck or off-shore platform. Using thermal printer technology, it can print in black and white, or in full color using proprietary color paper, without the need for inkjet cartridges or ribbons. The Printrex 980 is the fastest full color printer available for plotting continuous logs in the data centers of the large oil field service companies. This printer uses proprietary inkjet cartridges. In 2015, we expect to launch the Responder MP2™, our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery. In addition, we sell wide format thermal printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM’s, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated internal sales force with a sales office located in Houston, Texas. +TSG: Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor’s products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress SM , and other repair services for our printers. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY, our western region service center in Las Vegas, NV and our oil and gas industry service center in Houston, TX. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and our services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 95% of our printer production is primarily through one third-party contract manufacturer in Asia and to a lesser extent one other in Asia and one in Mexico. The remaining 5% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include inkjet, thermal and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, purchases of component parts have declined while purchases of fully-assembled printers produced by our contract manufacturers have increased. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer models, from one foreign contract manufacturer, and to a much lesser extent, two other foreign contract manufacturers. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have a supply agreement with our foreign contract manufacturers, our relationship with them remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms to us during 2015 or that their terms to us will be any less favorable than they have been historically. +Hewlett-Packard Company (“HP”) is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the banking and POS market, but also in other manufacturer’s printing devices across several other markets. +ZINK Imaging Inc. (“ZINK”) is the sole supplier of proprietary color thermal paper used in our Printrex 920 oil and gas printer. We had a supply agreement with ZINK to exclusively supply us with ZINK color thermal paper for the oil and gas industry at fixed prices through December 31, 2014. We plan to renew this agreement during 2015. The loss of the supply of ZINK color thermal paper would have a material adverse effect on the sale of Printrex 920 printers and ZINK color thermal paper. +2 +Canon, Inc. (“Canon”) is the sole supplier of inkjet cartridges and other consumable items (“Canon Consumables”) that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2017. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 29 United States and 30 foreign patents and have 8 United States and 12 foreign patent applications pending pertaining to our products. The duration of these patents range from 3 to 17 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Seasonality +Restaurants typically reduce purchases of new food safety equipment in the fourth quarter due to the increased volume of transactions in that holiday period. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +GTECH has been our most significant customer. In December 2009, we signed a new five-year agreement effective November 20, 2009, with GTECH (the “GTECH Thermal Printer Agreement”). Under the terms of the agreement, we provide GTECH with their latest generation thermal lottery printers for various lottery applications. The terms of the agreement require that GTECH exclusively purchase all of its requirements for thermal on-line lottery printers from us and that we exclusively sell such printers to GTECH through May 8, 2015. We are currently in negotiations with GTECH to extend the agreement. +Sales to GTECH and other customers representing 10% or more of our total net sales were as follows: +Year ended December 31, +2014 +2013 +2012 +GTECH +16% +12% +18% +Eurocoin Ltd. +11% +12% +15% +Backlog +Our backlog of firm orders was approximately $11,356,000 as of February 27, 2015, compared to $4,778,000 as of February 28, 2014. Based on customers’ current delivery requirements, we expect to ship our entire current backlog during 2015. +Competition +The market for transaction-based and specialty printing solutions is extremely competitive, and we expect such competition to continue in the future. We compete with a number of companies, many of which have greater financial, technical and marketing resources than us. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the food safety market, we compete with Avery Dennison Corporation, Ecolab Inc. and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the banking and POS market, our major competitor is Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. +In the casino and gaming market (consisting principally of slot machine and video lottery terminal transaction printing and promotional coupon printing), we compete with several companies including FutureLogic, Inc., Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we hold a leading position, based largely on our long-term purchase agreement with GTECH. We compete in this market based solely on our ability to provide specialized, custom-engineered products to GTECH. +In the Printrex market, we compete with the Imaging Systems Group, Inc. (“iSys”), Neuralog Inc., GSI Group and others. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +3 +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, depending on the geographic area. +Our strategy for competing in our markets is to continue to develop new products (hardware and software) and product line extensions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain inkjet, thermal and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $4,302,000, $4,065,000, and $4,239,000 in 2014, 2013 and 2012, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for sale to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010 we began the development of EPICENTRAL TM, , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $169,000 and $370,000 as of December 31, 2014 and 2013, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $201,000, $199,000, and $189,000 in 2014, 2013 and 2012, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2014, TransAct and our subsidiaries employed 129 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 16 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, EPICENTRAL®, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Available Information +We make available free of charge through our internet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. +We maintain a Code of Business Conduct that includes our code of ethics that is applicable to all employees, including our Chief Executive Officer, Chief Financial Officer and Controller. This Code, which requires continued observance of high ethical standards such as honesty, integrity and compliance with the law in the conduct of our business, is available for public access on our internet website. Any person may request a copy of our Code of Business Conduct free of charge by calling (203) 859-6800. \ No newline at end of file diff --git a/raw/filings/0001017303/2014/0001017303-15-000021/item13.txt b/raw/filings/0001017303/2014/0001017303-15-000021/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..9dda5d300f48e96600fd4bb3101f49b818372286 --- /dev/null +++ b/raw/filings/0001017303/2014/0001017303-15-000021/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2014/0001017303-15-000021/item9a.txt b/raw/filings/0001017303/2014/0001017303-15-000021/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..fcd4308eb193a8aea8d644491703f1c323b04ff1 --- /dev/null +++ b/raw/filings/0001017303/2014/0001017303-15-000021/item9a.txt @@ -0,0 +1,9 @@ +Item 9A. Controls and Procedures. +Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2014. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2014, our disclosure controls and procedures are effective. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +23 +Management assessed our internal control over financial reporting as of December 31, 2014. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2014. +The effectiveness of the Company’s internal control over financial reporting as of December 31, 2014, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. \ No newline at end of file diff --git a/raw/filings/0001017303/2014/0001017303-15-000021/rp_note.txt b/raw/filings/0001017303/2014/0001017303-15-000021/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2014/0001017303-15-000021/rpt_disclosure.txt b/raw/filings/0001017303/2014/0001017303-15-000021/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..910b2a115701fafc08e0ad098b01996989afb58d --- /dev/null +++ b/raw/filings/0001017303/2014/0001017303-15-000021/rpt_disclosure.txt @@ -0,0 +1,4 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains policies that relate to the identification, review and approval of related party transactions. As part of a review of possible related person transactions, the Company periodically distributes and collects questionnaires that solicit information about any direct or indirect transactions with the Company from each of our directors and officers. +Our Standards of Business Conduct require all directors, officers and employees to avoid any situation that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company. Under our Standards of Business Conduct, situations that involve, or may reasonably be inferred to involve, a conflict between a director, officer or employee’s personal interests and the interests of the Company should be disclosed to the Chair of the Audit Committee. The Audit Committee is then responsible for reviewing the related party transaction. No related party transaction shall be approved or ratified if such transaction is contrary to the best interests of the Company. In determining whether to approve or ratify a related party transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the related person's interest in the transaction. +From January 1, 2014 to the date of this proxy statement, there have not been any transactions subject to the Company’s related party transaction policy or of the type described in Item 404 of Regulation S-K, and currently no such transactions are proposed. \ No newline at end of file diff --git a/raw/filings/0001017303/2015/0001017303-16-000085/filing.txt b/raw/filings/0001017303/2015/0001017303-16-000085/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a1c16a9c350f1d15b621f6636c6f14e257836b7 --- /dev/null +++ b/raw/filings/0001017303/2015/0001017303-16-000085/filing.txt @@ -0,0 +1,3340 @@ +10-K +1 +form10k2015.htm +FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2015 +form10k2015.htm +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2015 +or +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to . +Commission file number: 0-21121 +______________________________________________________________________ +______________________________________________________________________ +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT +06518 +(Address of principal executive offices) +(Zip Code) +Registrant's telephone number, including area code 203-859-6800 +______________________________________________________________________ +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class - Common Stock, par value $.01 per share +Name of Exchange on which Registered - NASDAQ Global Market +______________________________________________________________________ +Securities registered pursuant to Section 12(g) of the Act : None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. +Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer o +Accelerated filer o +Non-accelerated filer o (Do not check if a smaller reporting company) +Smaller reporting company ý +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý +The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the Registrant was approximately $49,400,000 based on the last sale price on June 30, 2015. +As of February 29, 2016, the number of shares outstanding of the Registrant’s common stock, $0.01 par value, was 7,782,292. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to the 2016 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +4 +Item 1B. +Unresolved Staff Comments +9 +Item 2. +Properties +9 +Item 3. +Legal Proceedings +9 +Item 4. +Mine Safety Disclosures +9 +PART II. +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +10 +Item 6. +Selected Financial Data +12 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +12 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +23 +Item 8. +Financial Statements and Supplementary Data +24 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +24 +Item 9A. +Controls and Procedures +24 +Item 9B. +Other Information +24 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +24 +Item 11. +Executive Compensation +25 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +26 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +26 +Item 14. +Principal Accounting Fees and Services +26 +PART IV. +Item 15. +Exhibits +26 +SIGNATURES +Signatures +27 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +EXHIBITS +Index to Exhibits +PART I +Item 1. Business. +The Company +TransAct Technologies Incorporated (“TransAct” or the “Company”) was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct designs, develops and sells market-specific solutions, including printers, terminals, software and other products for transaction-based and other industries. These world-class products are sold under the AccuDate™, Ithaca®, RESPONDER®, Epic, EPICENTRAL™, and Printrex® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality food rotation date and nutritional labels, promotional coupons and transaction records such as receipts, tickets, register journals and other documents as well as printed logging and plotting of oil field and well drilling data. We focus on the following core markets: food safety, banking and point-of-sale (“POS”), casino and gaming, lottery, and Printrex (which serves the oil and gas, medical and mobile printing markets). We sell our products to original equipment manufacturers (“OEMs”), value-added resellers, selected distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of printers. Through our TransAct Services Group (“TSG”) we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the on-line demand for these products. We have one primary operating, hardware research and development and eastern region service center located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters, software research and development and western region service center in Las Vegas, NV, a sales and service center for the oil and gas industry in Houston, TX, a European sales and service center in the United Kingdom, and a sales office located in Macau. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT , 06518, with a telephone number of (203) 859-6800. +Financial Information about Segments +We operate in one reportable segment, the design, development, assembly and marketing of transaction printers and terminals and providing related software, services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements on pages F-3 and F-4 hereof. +Products, Services and Distribution Methods +Printers and terminals: TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal, inkjet and impact printing technology for applications, primarily in the food safety, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our food safety terminals also offer configurable menu options. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers. +Food safety, banking and POS: Our food safety terminals are printing devices that consist of an operating system, a touchscreen and one or two thermal print mechanisms, that print easy-to-read expiration and "enjoy by" date labels to help restaurants effectively manage food rotation and spoilage. In the food safety market, we use an internal sales force to manage sales of our terminals through distribution, as well as to solicit sales directly from end-users. +Our banking and POS printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the banking market, we sell printers that are used by banks, credit unions and other financial institutions to print receipts and/or validate checks at bank teller stations. In the POS market, we sell several models of printers utilizing inkjet, thermal and impact printing technology. Our printers are used primarily by retailers in the restaurant (including fine dining, casual dining, and fast food) and hospitality industries to print receipts for consumers, validate checks, or print on linerless labels or other inserted media. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force. +Lottery: We supply lottery printers to IGT (formerly GTECH Corporation) and its subsidiaries, our largest customer and the world’s largest provider of lottery terminals. In addition, during 2015 we launched a new lottery printer, the Epic 3000, that we will begin to sell to other lottery system customers beyond IGT. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and managed by an internal sales representative. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLT’s”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks (“racinos”) and other gaming venues worldwide. These printers utilize thermal printing technology and can print tickets or receipts in monochrome or two-color (depending upon the model), and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal printing technology for use in non-casino establishments, including game types such as Amusements with Prizes (“AWP”), Skills with Prizes (“SWP”), Fixed Odds Betting Terminals (“FOBT”) and other off-premise gaming type machines around the world. We sell our products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through our primary worldwide distributor, Suzo-Happ Group. We also maintain a dedicated internal sales force to solicit sales from slot manufacturers and casinos, as well as to manage sales through our distributor. +1 +We also offer a software solution, the EPICENTRAL TM Print System (“EPICENTRAL TM ”), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. With EPICENTRAL TM , casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +Printrex: Printrex printers include wide format, rack mounted and vehicle mounted black/white and color thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. In 2015, we launched the Responder MP2™, our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery. In addition, we sell wide format thermal printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM’s, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated internal sales representative with a sales office located in Houston, Texas. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor’s products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress SM and TransAct Care, and other repair services for our printers and terminals. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY, our western region service center in Las Vegas, NV and our oil and gas industry service center in Houston, TX. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and our services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 95% of our printer production is primarily through one third-party contract manufacturer in Asia and to a lesser extent two others in Asia. The remaining 5% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include thermal, inkjet and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, purchases of component parts have declined while purchases of fully-assembled printers produced by our contract manufacturers have increased. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer and food safety terminal models, from one foreign contract manufacturer, and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have a supply agreement with our foreign contract manufacturers, our relationship with them remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms to us during 2016 or that their terms to us will be any less favorable than they have been historically. +Hewlett-Packard Company (“HP”) is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the banking and POS market, but also in other manufacturer’s printing devices across several other markets. +Canon, Inc. (“Canon”) is the sole supplier of inkjet cartridges and other consumable items (“Canon Consumables”) that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2017. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +2 +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 33 United States and 35 foreign patents and have 4 United States and 6 foreign patent applications pending pertaining to our products. The duration of these patents range from 2 to 16 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Seasonality +Restaurants typically reduce purchases of new food safety equipment in the fourth quarter due to the increased volume of transactions during that holiday period. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT (formerly GTECH Corporation) has been our most significant customer. On May 29, 2015, we signed a new agreement with IGT to sell on-line lottery and casino printers to IGT through December 31, 2019. This new agreement replaced the previous agreement that expired on May 29, 2015. Under the terms of the new agreement, we will sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT will purchase such printers from us on a non-exclusive basis. This new agreement will allow TransAct to sell printers to other lottery system customers beyond IGT. +Sales to IGT and other customers representing 10% or more of our total net sales were as follows: +Year ended December 31, +2015 +2014 +2013 +IGT +29% +19% +19% +Suzo-Happ +14% +7% +4% +Eurocoin +0% +11% +12% +Backlog +Our backlog of firm orders was approximately $5,403,000 as of February 29, 2016, compared to $11,356,000 as of February 27, 2015. Based on customers’ current delivery requirements, we expect to ship our entire current backlog during 2016. +Competition +The market for transaction-based and specialty printers is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for our food safety terminals and EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than us. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the food safety market, we compete with Avery Dennison Corporation, Ecolab Inc. and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the banking and POS market, our major competitor is Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. However, we have and will continue to deemphasize efforts in the POS and banking markets going forward. +In the casino and gaming market (consisting principally of slot machine and VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global (formerly FutureLogic, Inc.), Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we hold a leading position, based largely on our long-term relationship with IGT. On May 29, 2015, we signed a non-exclusive agreement with IGT to provide thermal lottery printers to IGT for various lottery applications through December 31, 2019. Prior to this agreement, we had an exclusive purchase agreement whereby IGT exclusively purchased all of its requirements for thermal on-line lottery printers from us and we exclusively sold such printers to IGT. We now compete in this market with other lottery printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +In the Printrex market, we primarily compete with the Imaging Systems Group, Inc. (“iSys”), Neuralog Inc. and GSI Group. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +3 +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, depending on the geographic area. +Our strategy for competing in our markets is to continually develop new products (hardware and software) and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain thermal, inkjet and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $3,599,000, $4,302,000, and $4,065,000 in 2015, 2014 and 2013, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for sale to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $31,000 and $169,000 as of December 31, 2015 and 2014, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $138,000, $201,000, and $199,000 in 2015, 2014 and 2013, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2015, TransAct and our subsidiaries employed 125 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 15 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, AccuDate™, Epic, EPICENTRAL®, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Available Information +We make available free of charge through the “Investor Relations” tab on our internet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. +Item 1A. Risk Factors +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are not the only ones facing our Company. Additional risks not known to us now or that we currently deem immaterial may also impair our business operations. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking statements contained in this Annual Report to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are likely to continue to vary due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical operating results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may be due to a number of factors, including, but not limited to, those identified throughout this “Risk Factors” section: +4 +· +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +· +the geographic distribution of our sales; +· +market acceptance of our products, both domestically and internationally; +· +development of new competitive products by others; +· +our responses to price competition; +· +our level of research and development activities; +· +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +· +changes in the amount we spend to promote our products and services; +· +changes in the cost of satisfying our warranty obligations and servicing our installed base of printers; +· +availability of third-party components at reasonable prices; +· +general economic and industry conditions, including changes in interest rates affecting returns on cash balances and investments, that affect customer demand; +· +fluctuations of world-wide oil and gas prices; +· +severe weather events (such as hurricanes) that can disrupt or interrupt the operation of our customers or suppliers facilities; and +· +changes in accounting rules. +Due to all of the foregoing factors, and the other risks discussed in this report, quarter-to-quarter comparisons of our operating results may not be an indicator of future performance. +Our revenue and profitability depend on our ability to continue to develop, on a timely basis, new products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated. +The success of newer products such as the AccuDate™ food safety terminals and RESPONDER MP2™ is dependent on how quickly customers in the related markets accept them given the very little market penetration these products have experienced since they are new and innovative and have limited competition. Additionally, the success of innovative technology, such as printing coupons and promotions at the slot machine using EPICENTRAL™, is dependent on our casino customers' acceptance of such technology. While we have designed EPICENTRAL™ to support our customers' existing investment in our Epic 950® thermal casino printers, such acceptance may nevertheless only build gradually over time or not at all. Delays in acceptance by our customers of new technologies may adversely affect our operations. +Our success depends upon our ability to adapt our capabilities and processes to meet the demands of producing new and innovative products. Because our newer products contain software and are generally more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product innovation. If we cannot efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +Infringement on the proprietary rights of others could put us at a competitive disadvantage, and any related litigation could be time consuming and costly. +Third parties may claim that we violated their intellectual property rights. To the extent of a violation of a third party’s patent or other intellectual property right, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish our objectives. Any of these claims, with or without merit, could result in costly litigation and divert the attention of key personnel. If such claims are successful, they could result in costly judgments or settlements. Refer to Item 3. “Legal Proceedings” for discussion surrounding litigation we were involved in regarding alleged misappropriation of unspecified trade secrets and confidential information. +General economic conditions could have a material adverse effect on our business, operating results and financial condition. +Global economic growth has slowed and has resulted in recessions in numerous countries, including many of those in North America, Europe and Asia, where the Company does substantially all of its business. If these economic conditions continue to persist, or if they worsen, a number of negative effects on our business could result, including customers or potential customers reducing or delaying orders, the insolvency of key suppliers which could result in production delays, the inability of customers to obtain credit, and the insolvency of one or more customers. Any of these effects could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including write-downs of assets. +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and services. We may be adversely impacted by any conflicts that could arise between and among our various sales channels. +Our dependence upon distributors and resellers exposes us to numerous risks, including: +· +loss of channel and the ability to bring new products to market; +· +concentration of credit risk, including disruption in distribution should the distributors and / or resellers’ financial condition deteriorate; +· +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +· +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +· +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon the business, consolidated results of operations and financial condition. +5 +We have outsourced substantially all of the assembly of our printers and terminals to three contract manufacturers and will be dependent on them for the manufacturing of such products. A failure by these contract manufacturers, or any disruption in such manufacturing or the flow of product from these manufacturers, may adversely affect our business results. +In an effort to achieve additional cost savings and operation benefits, we have continued to outsource the manufacturing and assembly of our printers and terminals to contract manufacturers in Asia. Approximately 80% of our printer and terminal manufacturing is conducted by one third party manufacturer in Asia. +However, to the extent we rely on a third-party service provider for manufacturing services, we may incur increased business continuity risks. We will no longer be able to exercise control over the assembly of certain of our products or any related operations or processes, including the internal controls associated with operations and processes conducted and the quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially adversely affected. +In addition, if any of our contract manufacturers experiences business difficulties or fails to meet our manufacturing needs, then we may be unable to meet production requirements, may lose revenue and may not be able to maintain relationships with our customers. Without the contract manufacturers continuing to manufacture our products and the continuing operation of the contract manufacturers’ facilities, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing facility, which could be costly and time consuming and have a material adverse effect on our operating and financial results. +The increased elements of risk that arise from conducting certain operating processes in foreign jurisdictions may lead to an increase in reputational risk. +Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing customers resulting from our inability to produce products for them. +The contract manufacturers have access to our intellectual property, which increases the risk of infringement or misappropriation of this intellectual property. +Political, social or economic instability in regions in which our manufacturers are located, could cause disruptions in trade, including exports to the U.S. +A significant portion of our printers and terminals are manufactured by contract manufacturers overseas and are exported to the U.S. Any such disruption in trade, including exports to the U.S., could adversely affect our business results. Events that could cause disruptions to such exports to the U.S. include: +· +the imposition of additional trade law provisions or regulations; +· +reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; +· +the imposition of additional duties, tariffs and other charges on imports and exports; +· +economic uncertainties and adverse economic conditions (including inflation and recession); +· +fluctuations in the value of the U.S. Dollar against foreign currencies; +· +significant labor disputes, such as dock strikes; +· +significant delays in the delivery of cargo due to port security considerations; +· +financial or political instability in any of the countries in which our printers and terminals are manufactured. +We source some of our component parts and consumable products from sole source suppliers; any disruptions may impact our ability to manufacture and sell our products. +A disruption in the supply of such component parts and consumable products could have a material adverse effect on our operations and financial results. +We sell a significant portion of our products internationally and purchase important components from foreign suppliers. These circumstances create a number of risks. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. Risks associated with sales and purchases outside the United States include: +· +fluctuating foreign currency rates could restrict sales, or increase costs of purchasing, in foreign countries; +· +foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers or capital flow restrictions; +· +political and economic instability may reduce demand for our products or put our foreign assets at risk; +· +restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets; and +· +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from selling in certain geographic territories. +We face risks associated with manufacturing forecasts. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays, which could cause us to lose orders or customers and result in lower net sales. We currently use a rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our requirements for components and materials. It is very important that we accurately predict both the demand for our products and the lead-time required to obtain the necessary components and raw materials. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size of the order, contract terms, and demand for each component at a given time. If we underestimate our requirements, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and result in delays in shipments and net sales. If we overestimate our requirements, we could have excess inventory of parts. In addition, delays in the manufacturing of our products could cause us to lose orders or customers. +6 +In the lottery market, we have been dependent on sales to one large customer; the loss of this customer or reduction in orders from this customer could materially affect our sales. +We expect that sales to our largest customer, IGT, will continue to represent a material percentage of our net sales for the foreseeable future. A reduction, delay or cancellation in orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Our success will depend on our ability to sustain and manage growth. +As part of our business strategy, we intend to pursue a growth strategy. Assuming this growth occurs, it will require the expansion of distribution relationships in international markets, the successful development and marketing of new products for our existing and new markets, expanded customer service and support, and the continued implementation and improvement of our operational, financial and management information systems. +To the extent that we seek growth through acquisitions, our ability to manage our growth will also depend on our ability to integrate businesses that have previously operated independently. We may not be able to achieve this integration without encountering difficulties or experiencing the loss of key employees, customers or suppliers. It may be difficult to design and implement effective financial controls for combined operations and differences in existing controls for each business may result in weaknesses that require remediation when the financial controls and reporting functions are combined. As we pursue acquisitions, we may incur legal, accounting and other transaction related expenses for unsuccessful acquisition attempts that could adversely affect our results of operations in the period in which they are incurred. +There can be no assurance that we will be able to successfully implement our growth strategy, or that we can successfully manage expanded operations, if they occur. As we expand, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our results of operations and financial condition. +We compete in highly competitive markets, which are likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, transaction supplies and services. Our principal competitors have substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +· +technologically advanced products that satisfy the user demands; +· +superior customer service; +· +high levels of quality and reliability; and +· +dependable and efficient distribution networks. +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products. Any of these factors could reduce our earnings. +We depend on key personnel, the loss of which could materially impact our business. +Our future success will depend in significant part upon the continued service of certain key management and other personnel and our continuing ability to attract and retain highly qualified managerial, technical and sales and marketing personnel. There can be no assurance that we will be able to recruit and retain such personnel. The loss of either Bart C. Shuldman, the Company's Chairman of the Board and Chief Executive Officer, or Steven A. DeMartino, the Company’s President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, could have a material adverse effect on our results of operations. +If we are unable to enforce our patents or if it is determined that we infringe patents held by others it could damage our business. +Prosecuting and defending patent lawsuits is very expensive. We are committed to aggressively asserting and defending our technology and related intellectual property, which we have spent a significant amount of money to develop. These factors could cause us to become involved in new patent litigation in the future. The expense of prosecuting or defending these future lawsuits could also have a material adverse effect on our business, financial condition and results of operations. +If we were to lose a patent lawsuit in which another party is asserting that our products infringe its patents, we would likely be prohibited from marketing those products and could also be liable for significant damages. Either or both of these results may have a material adverse effect on our business, financial condition and results of operations. If we lose a patent lawsuit in which we are claiming that another party’s products are infringing our patents and thus, are unable to enforce our patents, it may have a material adverse effect on our business, financial condition and results of operations. In addition to disputes relating to the validity or alleged infringement of other parties' rights, we may become involved in disputes relating to our assertion of our own intellectual property rights. Whether we are defending the assertion of intellectual property rights against us or asserting our intellectual property rights against others, intellectual property litigation can be complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. Plaintiffs in intellectual property cases often seek injunctive relief, and the measures of damages in intellectual property litigation are complex and often subjective or uncertain. Thus, any adverse determinations in this type of litigation could subject us to significant liabilities and costs. During the course of these lawsuits there may be public announcements of the results of hearings, motions, and other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could harm the market price of our stock. +7 +The inability to protect intellectual property could harm our reputation, and our competitive position may be materially damaged. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trade secrets and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without authorization, to obtain and use information which we regard as trade secrets. +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as: +· +changes in our business, operations or prospects; +· +developments in our relationships with our customers; +· +announcements of new products or services by us or by our competitors; +· +announcement or completion of acquisitions by us or by our competitors; +· +changes in existing or adoption of additional government regulations; +· +unfavorable or reduced analyst coverage; and +· +prevailing domestic and international market and economic conditions. +In addition, the stock market has experienced significant price fluctuations in recent years. Broad market fluctuations, general economic conditions and specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Limited trading volume and a reduction in analyst coverage of our common stock may contribute to its price volatility. +Our common stock is traded on the NASDAQ Global Market. During the year ended December 31, 2015, the average daily trading volume for our common stock as reported by the NASDAQ Global Market was approximately 25,000 shares. We are uncertain whether a more active trading market in our common stock will develop. In addition, many investment banks no longer find it profitable to provide securities research on micro-cap and small-cap companies. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the price of our common stock. +Future sales of our common stock may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, and we may also issue additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future sale pursuant to stock options and other equity awards that we have granted to our employees, and in the future we may grant additional stock options and other forms of equity compensation to our employees. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. +If market conditions deteriorate or future results of operations are less than expected, a valuation allowance may be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred tax assets on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions deteriorate or future results of operations are less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are not realizable. As a result, we may need to establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +We cannot provide any assurance that current laws, or any laws enacted in the future, will not have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements in each of the jurisdictions in which we conduct business. Changes in laws, rules, regulations, policies or requirements could result in the need to modify our products and could affect the demand for our products, which may have an adverse impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +Intangible computer software costs may not be recoverable. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. To the extent technological feasibility of products is not achieved, related capitalized computer software costs may not be recoverable. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. It is possible that terrorist attacks could be directed at important locations for the gaming industry. Heightened security measures and other efforts to combat terrorism may also have an adverse effect on the gaming industry by reducing tourism. Any of these developments could also negatively affect the general economy and consumer confidence. Any downturn in the economy or in the gaming industry in particular could reduce demand for our products and adversely affect our business and results of operations. In addition, heightened security measures may cause certain governments to restrict the import/export of goods, which may have an adverse effect on our ability to buy/sell goods. +8 +Fluctuations in oil and gas prices could adversely affect drilling and exploration activities by oil and gas companies and our revenue in our Printrex market. If oil and gas prices remain volatile, or if oil or gas prices remain low or decline further, the demand for our Printrex products could be adversely affected. +The demand for our Printrex products depends on the level of spending by oil and gas companies for drilling and exploratory activities, which are affected by short-term and long-term trends in oil and gas prices, including current and anticipated oil and gas prices. Oil and gas prices, as well as the level of drilling and exploration, historically have been extremely volatile and are expected to continue to be highly volatile. If oil and gas prices continue to remain low or decline further, or if there is a further reduction in drilling and exploration activities, the demand for our Printrex products could be materially and adversely affected. +Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely impact our business. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on our business, financial condition, and results of operations. +Item 1B. Unresolved Staff Comments. +Not applicable. +Item 2. Properties. +Our principal facilities as of December 31, 2015 are listed below and we believe that all facilities generally are in good condition, adequately maintained and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. Ft.) +Owned or +Leased +Lease Expiration +Date +Hamden, Connecticut +Executive offices and TSG sales office +11,100 +Leased +April 23, 2017 +Ithaca, New York * +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2016 +Las Vegas, Nevada +Software design and development, service center and casino and gaming sales office +19,600 +Leased +October 31, 2022 +Doncaster, United Kingdom +Sales office and service center +2,800 +Leased +August 1, 2016 +Houston, Texas +Sales office and service center +100 +Leased +April 30, 2016 +Macau, China +Sales office +180 +Leased +June 30, 2016 +107,680 +*On January 14, 2016 we signed an amendment to extend our lease in Ithaca to May 31, 2021. The amendment is included as an exhibit to this 10-K. +Item 3. Legal Proceedings. +On June 8, 2012, Avery Dennison Corporation (“AD”) filed a civil complaint against us and a former employee of ours and of AD, in the Court of Common Pleas (the “Court”) in Lake County, Ohio. The complaint alleged that we and this former employee misappropriated unspecified trade secrets and confidential information from AD related to the design of our food safety terminals. The complaint requested a preliminary and permanent injunction against us from manufacturing and selling our Ithaca® 9700 and 9800 food safety terminals. On July 16, 2012, we filed our answer, affirmative defenses and counterclaims, seeking all available damages including legal fees. A hearing on the plaintiff's motion for preliminary injunction took place in August 2012, and in November 2012, the Court denied this request. AD filed an appeal of the Court’s ruling to the Eleventh Appellate District (the “Court of Appeals”), which heard oral arguments on the appeal on July 16, 2013. On July 23, 2013, AD requested that the Court of Appeals enjoin our further sale and marketing of the food safety terminals, pending the Court of Appeals’ decision. On July 29, 2013, we opposed this request. On October 15, 2013, the Court of Appeals ruled in our favor, affirming the Court’s decision and denying AD’s further request of an injunction pending the Court of Appeals’ decision. On October 24, 2013, AD filed a motion seeking that the Court of Appeals reconsider its decision. On April 16, 2014, the Court of Appeals denied AD’s motion to reconsider its decision. On July 28, 2014, AD filed a motion requesting leave from the Court to file an amended complaint and indicating that it has elected to pursue only its claim for damages, dropping its claim for injunctive relief. On September 4, 2014, the Court granted AD’s motion to file an amended complaint. On September 25, 2014, we filed our answer, affirmative defenses and counterclaims with respect to the amended complaint, seeking all available damages including legal fees. On January 30, 2015, we filed a motion for summary judgment seeking judgment in our favor on all counts as to the Company. On the same day, AD filed two motions for partial summary judgment. On February 17, 2015, we opposed both of AD’s motions, and AD opposed our motion. On February 23, 2015, the Company filed a reply brief in support of its motion for summary judgment. A trial was scheduled to begin on April 21, 2015, however, on March 25, 2015 the parties executed a confidential settlement agreement and release (the “Settlement Agreement”) in which the parties mutually agreed to resolve the dispute that was the subject of the lawsuit filed by AD against the Company to the parties’ mutual satisfaction. Under the terms of the Settlement Agreement, we agreed to pay AD $3,600,000 payable on or before April 8, 2015 and also to qualify certain AD labels for use on our food safety terminals at an estimated cost of $25,000. We made the $3,600,000 payment to AD on April 8, 2015 and borrowed $2,500,000 under our revolving credit facility with TD Bank to fund the payment. We recorded the total expense of $3,625,000 in the fourth quarter 2014 as an operating expense included in the line item “Legal fees and settlement expenses associated with lawsuit” on the Consolidated Statement of Operations and as a current liability included in the line item “Accrued lawsuit settlement expenses” on the Consolidated Balance Sheet. In the second quarter of 2015 we reversed $25,000 of this expense because AD did not provide the label testing information by the due date required per the Settlement Agreement. +Item 4. Mine Safety Disclosures. +Not applicable. +9 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +Our common stock is traded on the NASDAQ Global Market under the symbol TACT. As of February 29, 2016, there were 363 holders of record of the common stock. The high and low bid sales prices of the common stock reported during each quarter of the years ended December 31, 2015 and 2014 were as follows: +Year Ended +Year Ended +December 31, 2015 +December 31, 2014 +High +Low +High +Low +First Quarter +$ +6.85 +$ +5.46 +$ +12.99 +$ +9.80 +Second Quarter +7.50 +5.02 +11.50 +9.12 +Third Quarter +9.20 +6.40 +10.44 +6.45 +Fourth Quarter +10.46 +7.95 +6.95 +5.19 +In September 2012, we announced that our Board of Directors approved the initiation of a quarterly cash dividend program which is subject to the Board’s approval each quarter. On May 6, 2014, our Board of Directors declared an increase to the quarterly cash dividend from $0.07 per share to $0.08 per share. Dividends declared and paid on our common stock totaled $2,485,000 or $0.32 per share and $2,556,000 or $0.31 per share, in 2015 and 2014, respectively. On February 1, 2016, our Board of Directors approved the first quarter 2016 dividend in the amount of $0.08 per share payable on or about March 15, 2016 to common shareholders of record at the close of business on February 19, 2016. +Issuer Purchases of Equity Securities +Prior to its expiration on July 31, 2015, we maintained a stock repurchase program. Under this stock repurchase program, we were authorized to repurchase up to $7,500,000 of our outstanding shares of common stock from time to time in the open market, depending on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From January 1, 2015 through the expiration date of this stock repurchase program, we repurchased 166,553 shares of our common stock for approximately $1,020,000 at an average price of $6.12 per share. From the start of this stock repurchase program on August 11, 2014 through December 31, 2014, we repurchased 434,998 shares of our common stock for approximately $2,634,000 at an average price per share of $6.06. From January 1, 2005 through the expiration of the stock repurchase program on July 31, 2015, we repurchased a total of 3,388,589 shares of common stock for approximately $26,181,000, at an average price of $7.73 per share. +On February 25, 2016, our Board of Directors approved a new stock repurchase program. Under this new repurchase program, we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market through December 31, 2017 at prevailing market prices based on market conditions, share price and other factors. +Securities Authorized for Issuance under Equity Compensation Plans +For a discussion of the Company’s equity compensation plan information, please see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Form 10-K. +10 +CORPORATE PERFORMANCE GRAPH +The following graph compares the cumulative total return on the Company’s Common Stock from December 31, 2010 through December 31, 2015, with the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Hardware Stocks Index. The graph assumes that $100 was invested on December 31, 2010 in each of TransAct’s common stock, the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Manufacturer Stocks Index, and that all dividends were reinvested. +COMPARISON OF CUMULATIVE TOTAL RETURN AMONG +TRANSACT TECHNOLOGIES INCORPORATED COMMON STOCK, +THE CRSP TOTAL RETURN INDEX FOR THE NASDAQ STOCK MARKET (U.S.), +AND THE NASDAQ COMPUTER MANUFACTURER STOCKS INDEX +12/31/10 +12/31/11 +12/31/12 +12/31/13 +12/31/14 +12/31/15 +TransAct Technologies Incorporated Common Stock +$ +100.00 +$ +77.07 +$ +76.65 +$ +133.01 +$ +58.07 +$ +91.19 +CRSP Total Return Index for the Nasdaq Stock Market (U.S.) +$ +100.00 +$ +100.31 +$ +116.79 +$ +155.90 +$ +175.33 +$ +176.17 +Nasdaq Computer Hardware Stocks Index +$ +100.00 +$ +104.83 +$ +125.68 +$ +147.85 +$ +200.43 +$ +182.49 +11 +Item 6. Selected Financial Data (in thousands, except per share amounts) +The following is summarized from our audited financial statements of the past five years: +Year ended December 31, +2015 +2014 +2013 +2012 +2011 +Consolidated Statement of Operations Data: +Net sales +$ +59,676 +$ +53,108 +$ +60,141 +$ +68,386 +$ +65,969 +Gross profit +24,978 +21,711 +25,092 +25,982 +24,626 +Operating expenses +20,510 +25,483 +18,475 +20,380 +17,637 +Operating income (loss) +4,468 +(3,772) +6,617 +5,602 +6,989 +Net income (loss) +3,092 +(2,421) +4,935 +3,621 +4,676 +Net income (loss) per share: +Basic +0.40 +(0.29) +0.57 +0.40 +0.50 +Diluted +0.39 +(0.29) +0.57 +0.40 +0.49 +Dividends declared and paid per share +0.32 +0.31 +0.27 +0.06 +- +December 31, +2015 +2014 +2013 +2012 +2011 +Consolidated Balance Sheet Data: +Total assets +$ +32,569 +$ +35,491 +$ +40,408 +$ +45,228 +$ +42,740 +Working capital +18,983 +18,361 +24,871 +25,492 +27,222 +Shareholders’ equity +25,728 +25,394 +32,521 +33,369 +35,313 +Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Forward Looking Statements +Certain statements included in this report, including without limitation statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally can be identified by the use of forward-looking terminology, such as “may”, “will”, “expect”, “intend”, ”estimate”, “anticipate”, “believe”, “project” or “continue” or the negative thereof or other similar words. All forward-looking statements involve risks and uncertainties, including, but not limited to those listed in Item 1A of this Annual Report. Actual results may differ materially from those discussed in, or implied by, the forward-looking statements. The forward-looking statements speak only as of the date of this report and we assume no duty to update them. +Overview +During 2015, we focused our efforts on sales execution and growing the revenue of our new, value-added products and technologies. From 2012 to 2015, we spent significant time and resources developing new products such as the Ithaca® 9700 food safety terminal, EPICENTRAL™ software for the casino and gaming industry, RESPONDER MP2™ mobile printer for vehicles and our Printrex® 920 and 980 color printers for the oil and gas industry. With that first development phase behind us we were able to fully shift our focus to growing our revenue resulting in a 12% increase overall from the prior year. Additionally, we were able to successfully execute against our cost reduction initiatives and lowered operating expenses by over $1 million during 2015 upon completing the product development investments we made during the past three years. +During 2015, our sales increased due to continued growth of sales in our food safety terminals as well as higher lottery printer sales. The investments we have made in the food safety market have resulted in strong sales growth that we believe will continue to grow in future years. In regards to our casino and gaming markets, we continued to gain domestic market share despite a relative weak replacement cycle in the domestic casino and gaming market as well as sluggishness in the international markets. Our Printex market has seen a significant negative impact from the world-wide decline in oil and gas prices. While it is difficult to predict when a rebound of oil and gas prices will occur, with the adjustments we have made to our cost structure and focus on sales, we have experienced considerable growth during 2015. +During 2015, our total net sales increased 12% to approximately $59,676,000. See the table below for a breakdown of our sales by market: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Food safety, banking and POS +$ +13,029 +21.8% +$ +9,308 +17.5% +$ +3,721 +40.0% +Casino and gaming +21,755 +36.5% +22,731 +42.8% +(976) +(4.3%) +Lottery +9,468 +15.9% +4,761 +9.0% +4,707 +98.9% +Printrex +1,381 +2.3% +3,910 +7.4% +(2,529) +(64.7%) +TSG +14,043 +23.5% +12,398 +23.3% +1,645 +13.3% +Total net sales +$ +59,676 +100.0% +$ +53,108 +100.0% +$ +6,568 +12.4% +12 +Sales of our food safety, banking and POS products increased 40% in 2015 compared to 2014. In the food safety market, our focus lies with providing terminals that print food rotational date and nutritional labels to help restaurants and other food providing establishments effectively manage food rotation and spoilage. Sales of our food safety terminals almost doubled in 2015; increasing 92% over 2014 and also increasing sequentially each quarter of 2015. The increase resulted largely from the continued success of our AccuDate™ 9700 terminal. In addition to the continued market penetration of the AccuDate™ 9700, we introduced a new food safety terminal, the AccuDate™ Pro and experienced the first revenue contributions from this product during 2015. In the POS market, we focus primarily on supplying printers that print receipts or linerless labels for customers in the restaurant and quick serve markets. During 2015, sales of our POS printers increased 30% compared to 2014, primarily driven by sales of our Ithaca ® 9000 printers to support new initiatives at McDonald’s. We expect this level of sales to continue into 2016 . In the banking market, we focus mainly on supplying printers for use in bank teller stations at banks and financial institutions primarily in the U.S., though we have recently de-emphasized our focus on this legacy market Opportunities in the banking market are project oriented and, as a result, our banking printer sales can fluctuate significantly year-to-year. During 2015, our banking printer sales decreased 16%. Our focus for 2016 will be to continue increasing market penetration with our line of food safety terminals as well as continue to support McDonald’s initiatives and accelerated rollouts with our Ithaca® 9000 printer. However, we have aligned our sales force mostly towards food safety. +Sales of our casino and gaming products decreased 4% in 2015 compared to 2014. In our casino and gaming market, our focus lies primarily in supplying printers for use in slot machines at casinos and racetracks, as well as in other electronic gaming devices that print tickets or receipts, worldwide. Additionally, we supplement these printer sales with revenue from EPICENTRAL™, our promotional printing system that enables casino operators to create promotional coupons and marketing messages and print them real time at the slot machine. Domestic printer sales increased 6% even with a weak replacement cycle for printers, as we believe we increased market share during 2015. International printer sales declined by 11% due to sluggishness in Europe, Australia and Asia. EPICENTRAL™ software sales decreased 28% due to one installation completed in 2015 compared to a larger, multi-property installation completed during 2014. We plan to make strategic investments to improve and enhance EPICENTRAL for Aristocrat and to add features requested by our customers during 2016 which we believe will lead to future revenue growth beginning in 2016. +In the lottery market, we continue to hold a leading position based on our long-term relationship with IGT (formerly GTECH Corporation), our largest customer and the world’s largest provider of lottery terminals. IGT has been our customer since 1995, and we continue to maintain a good relationship with them. On May 29, 2015, we signed a non-exclusive agreement with IGT to provide thermal lottery printers to IGT for various lottery applications through December 31, 2019. Prior to this agreement, we had an exclusive purchase agreement whereby IGT exclusively purchased all of its requirements for thermal on-line lottery printers from us and we exclusively sold such printers to IGT. During 2015, total lottery printer sales to IGT increased approximately 99%, compared to 2014, due to a number of new installations domestically and internationally. Our sales to IGT each year are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs and are not indicative of IGT’s overall business or revenue. While we no longer have an exclusive arrangement with IGT, we do not believe this will significantly impact our business as we continue to have a good relationship with IGT and we now have the ability to sell our market leading products to other lottery system customers. In fact, we recently launched our new EPIC 3000 lottery printer for the lottery market and we expect to see our first contributions from this product during 2016. +Sales of our Printrex branded printers include wide format, rack mounted and vehicle mounted thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. Sales in this market also includes wide format printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. During 2015, we experienced a 65% lower Printrex product sales due to the negative impact on drilling activity from our customers resulting from the steep decline in worldwide oil prices. Although we are uncertain when the oil and gas market will recover, we have taken prudent steps to align our cost structure with the current revenue level while we wait for the rebound to occur. In the mobile market, we recognized the first sales contributions of the Responder MP2™, our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery. Although this is our first product entrant into this market, we remain optimistic that the Responder MP2™ will begin to add to our revenue stream in the years to come. +Our TSG group, which sells service, replacement parts and consumable products, including receipt paper, ribbons and inkjet cartridges, continues to offer a recurring revenue stream for the Company. TSG sales increased 13% in 2015 from 2014 primarily due to higher sales of replacement parts mainly to IGT for the lottery market. This increase was partially offset by a decrease in sales of Printrex consumables due to lower usage by our oil and gas customers due to depressed oil prices, as well as lower sales of HP inkjet cartridges used in our banking printers as we deemphasize our focus on this commoditized product. +Operationally, our gross margin increased to a record high 41.9% in 2015 from 40.9% in 2014. Our gross margin in 2015 improved due to a more favorable sales mix compared to 2014 as we experienced higher sales of our higher margin value-added food safety terminals and TSG products. This truly demonstrates the positive impact the transition to our new products is having on our gross margin. We believe this trend will continue in 2016 as sales of our new products continue to grow and become a larger portion of our overall sales. In 2015 we achieved operating margin of 7.5% compared to a negative operating margin of 7.1% in 2014. The negative operating margin in 2014 resulted mainly from $5.5 million in legal and settlement expenses we incurred related to the AD Lawsuit that was settled in March 2015. +We reported net income of $3,092,000 and net income per diluted share of $0.39 for 2015, compared to a net loss of $2,421,000 and net loss per diluted share of $0.29 for 2014. In terms of cash flow for 2015, we experienced a very strong year, generating $5,600,000 of cash from operating activities. We also returned $3,500,000 to our shareholders in the form of $2,485,000 for cash dividends and $1,020,000 for treasury share while still finishing the year with cash and cash equivalents of $4,473,000 and no debt on our Consolidated Balance Sheet at December 31, 2015. +13 +Critical Accounting Policies and Estimates +The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Income categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances. We evaluate our assumptions on an ongoing basis by comparing actual results with our estimates. Actual results may differ from the original estimates. +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These items utilize assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Please refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial Statements for a complete listing of our accounting policies. +Revenue Recognition – Our typical contracts include the sale of printers and terminals, which are sometimes accompanied by separately-priced extended warranty contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer or terminal sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within Accounting Standards Codification (“ASC”) 605, “Revenue Recognition” (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms which are generally FOB shipping point) has occurred, the selling price is fixed and determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +Our software solution, EPICENTRAL TM , enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. R evenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, “Multiple-Element Arrangements” and ASC 985-605, “Software.” EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system’s full functionality. These arrangements are accounted for in accordance with ASC 605-25, “Multiple-Element Arrangements”. EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, “Software” as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level GAAP and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence (“VSOE”) if available, third party evidence (“TPE”) if VSOE is not available, or best estimate of selling price (“BESP”) to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, “Separately Priced Extended Warranty and Product Maintenance Contracts.” Pursuant to this guidance, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established, but we cannot guarantee that we will continue to experience return rates consistent with historical patterns. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. However, we cannot guarantee that this minimal level will continue. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +Accounts Receivable – We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on available credit information; and adjustments to credit limits based upon payment history and the customer’s current creditworthiness. We also provide an estimate of doubtful accounts based on historical experience and specific customer collection issues. Our allowance for doubtful accounts as of December 31, 2015 was approximately $50,000, or less than 1% of outstanding accounts receivable, which we feel is appropriate considering the overall quality of our accounts receivable. While credit losses have historically been within expectations and the reserves established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience. +Inventories – Our inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market. We review market value based on historical usage and estimates of future demand. Assumptions are reviewed at least quarterly and adjustments are made, as necessary, to reflect changing market conditions. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and market value. Should circumstances change and we determine that additional inventory is subject to obsolescence, additional write-downs of inventory could result in a charge to income. +14 +Goodwill and Intangible Assets – We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with Accounting Standards Codification (“ASC”) 350-20 “Goodwill”, acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Definite lived intangible assets are amortized and are tested for impairment when appropriate. We reported $2,621,000 of goodwill and $888,000 of unamortized definite-lived intangible assets at December 31, 2015. We have determined that no goodwill impairment has occurred based on our assessment as of December 31, 2015 when the impairment review is performed. +Income Taxes – In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing temporary differences between the tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax reserves with respect to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this forecast against the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future deferred tax assets in excess of its net recorded amount, an adjustment to the valuation allowance would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, “Income Taxes.” Among other things this provision prescribes a minimum recognition threshold that an income tax position must meet before it is recorded in the reporting entity’s financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet reporting date, it is “more likely than not” (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing authority will examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between the amount claimed, or expected to be claimed, on a company’s income tax returns and the benefits recognized in the financial statements. +Warranty – We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. If actual future product repair rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability and related warranty expense would be made. +Contingencies – We record an estimated liability related to contingencies based on our estimates of the probable outcomes pursuant to ASC 450, “Contingencies.” On a quarterly basis, we assess the potential liability related to pending litigation, audits and other contingencies and confirm or revise estimates and reserves as appropriate. If the actual liabilities are settled in an amount greater than those recorded on the balance sheet, a charge to income would be recorded. As of December 31, 2014 we had reduced the contingent liability to $0 in connection with a contingent consideration arrangement entered into as part of the Printrex acquisition. The reduction made in 2014 resulted from a decrease of $60,000 that was the result of our revised estimate of the expected payout in connection with this arrangement primarily due to changes in probabilities and decreases in revenue and gross margin estimates, and was credited to general and administrative expense during 2014. No contingent liability reserve was recorded in 2015 and we will not make any further reserves in the future in regards to the Printrex acquisition as the contingent consideration measurement period expired on December 31, 2014. See Note 3 to the Consolidated Financial Statements for further discussion. +Share-Based Compensation – We calculate share-based compensation expense in accordance with ASC 718, “Compensation – Stock Compensation” using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, dividend yield, and forfeiture rate. The determination of these assumptions is based on past history and future expectations, and is subject to judgment. To the extent any of the assumptions were to change from year to year, the fair value of new option grants may vary significantly. +Results of Operations: Year ended December 31, 2015 compared to year ended December 31, 2014 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2015 and 2014 were as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Food safety, banking and POS +$ +13,029 +21.8% +$ +9,308 +17.5% +$ +3,721 +40.0% +Casino and gaming +21,755 +36.5% +22,731 +42.8% +(976) +(4.3%) +Lottery +9,468 +15.9% +4,761 +9.0% +4,707 +98.9% +Printrex +1,381 +2.3% +3,910 +7.4% +(2,529) +(64.7%) +TSG +14,043 +23.5% +12,398 +23.3% +1,645 +13.3% +$ +59,676 +100.0% +$ +53,108 +100.0% +$ +6,568 +12.4% +International* +$ +13,946 +23.4% +$ +14,541 +27.4% +$ +(595) +(4.1%) +* +International sales do not include sales of printers made to domestic distributors or other customers who in turn ship those printers to international destinations. +15 +Net sales for 2015 increased $6,568,000, or 12%, from 2014. Printer and terminal sales volume increased 22% to approximately 167,000 units primarily due to increases in the lottery and food safety, banking and POS markets, of 97% and 33%, respectively. The average selling price of our printers decreased approximately 7% from 2014 to 2015 due primarily to a large portion of our sales being generated from lower priced lottery printers. Overall, international sales decreased $595,000, or 4%, primarily driven by lower sales in the international casino and gaming, TSG and Printrex markets. The declines in the international market were partially offset by increases in both the food safety, banking and POS and lottery markets. +Food safety, banking and POS: Revenue from the food safety, banking and POS market includes sales of food safety terminals which are printing devices that consist of an operating system, a touchscreen and one or two thermal print mechanisms, that print easy-to-read expiration and "enjoy by" date labels to help restaurants effectively manage food rotation and spoilage. Revenue from this market also includes sales of thermal, inkjet and impact printers used primarily by retailers in the restaurant (including fine dining, casual dining and fast food) and hospitality industries to print receipts for consumers, validate checks, or print on linerless labels or other inserted media. In addition, revenue includes sales of printers used by banks, credit unions and other financial institutions to print receipts and/or validate checks at bank teller stations. A summary of sales of our worldwide food safety, banking and POS products for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +12,037 +92.4% +$ +8,984 +96.5% +$ +3,053 +34.0% +International +992 +7.6% +324 +3.5% +668 +206.2% +$ +13,029 +100.0% +$ +9,308 +100.0% +$ +3,721 +40.0% +The increase in both domestic and international food safety, banking and POS product revenue from 2014 was primarily driven by a 92% increase in sales of our food safety terminals due largely to the resumption of shipments to our distributor who made a large initial stocking order in 2013 and did not make any purchases during the first nine months of 2014. Also, 2015 food safety sales benefited from shipments to a large national quick service chain store as well as first revenue contributions from our newly launched AccuDate™ Pro food safety terminal. We expect sales of our food safety terminals to continue to increase during 2016. In addition to increased food safety terminal sales, sales of our Ithaca®9000 printers increased 31% due to new initiatives by McDonald’s Corporation that started and accelerated in 2015. We expect sales to McDonalds for these initiatives to continue into 2016. These increases were partially offset by lower sales of our legacy banking printers and other POS printers. We expect sales of these legacy products to continue to decline during 2016 as we shift sales focus to our new products. +Casino and gaming: Revenue from the casino and gaming market includes sales of printers used in slot machines, video lottery terminals (“VLTs”), and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos and racetracks (“racinos”) and other gaming venues worldwide. Revenue from this market also includes sales of printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes (“AWP”), Skills with Prizes (“SWP”) and Fixed Odds Betting Terminals (“FOBT”) at non-casino gaming establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of our software solution (including annual software maintenance for), the EPICENTRAL TM print system that enables casino operators to create promotional coupons and marketing messages and to print them real-time at the slot machine. A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +11,354 +52.2% +$ +10,437 +45.9% +$ +917 +8.8% +International +10,401 +47.8% +12,294 +54.1% +(1,893) +(15.4%) +$ +21,755 +100.0% +$ +22,731 +100.0% +$ +(976) +(4.3%) +During 2015, domestic printer sales increased 6% compared to 2014 which we believe is due to market share gains, as the replacement cycle for slot machines remains weak. Domestic EPICENTRAL™ software sales also increased 79% as we completed one installation during 2015 compared to no domestic installations completed in 2014. +International sales declined in 2015 due to decreases in sales of our thermal casino printer and EPICENTRAL TM software of 19% and 87%, respectively. EPICENTRAL™ software sales decreased as we had no new international installations in 2015 compared to one large multi-property installation for a customer in South America in 2014. We expect EPICENTRAL software sales to be higher in 2016 than in 2015 based on our backlog of signed contracts and pipeline of prospects. The decreases in sales of thermal casino printer and EPICENRAL™ were partially offset by a 22% increase in sales of our off-premises thermal gaming printers in 2015 compared to 2014 largely due to installations in sports betting machines in Spain. Sales of our off-premise gaming printers are largely project-oriented and therefore may fluctuate significantly from quarter to quarter and year to year. +Lottery: Revenue from the lottery market includes sales of thermal on-line and other lottery printers to IGT and its subsidiaries for various lottery applications. A summary of sales of our worldwide lottery printers for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +8,064 +85.2% +$ +4,682 +98.3% +$ +3,382 +72.2% +International +1,404 +14.8% +79 +1.7% +1,325 +1,677.2% +$ +9,468 +100.0% +$ +4,761 +100.0% +$ +4,707 +98.9% +16 +Our sales to IGT are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT (formerly GTECH Corporation) performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of IGT’s overall business or revenue. International sales increased significantly due to a one-time sale to IGT of a custom lottery printer for the Spanish lottery. +Printrex: Printrex branded printers are sold into markets that include wide format, rack mounted and vehicle mounted black/white and color thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. Revenue in this market also includes sales of wide format printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. A summary of sales of our worldwide Printrex printers for the years ended December 31, 2015 and 2014 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +1,088 +78.8% +$ +3,352 +85.7% +$ +(2,264) +(67.5%) +International +293 +21.2% +558 +14.3% +(265) +(47.5%) +$ +1,381 +100.0% +$ +3,910 +100.0% +$ +(2,529) +(64.7%) +The decrease in Printrex printers is primarily due to 67% lower worldwide sales of printers in the oil and gas market due to the continued negative impact from the decline in worldwide oil prices we expect to continue to negatively impact our sales during 2016. In addition, worldwide sales of our medical and mobile printers declined 59% due largely to the loss of a customer in the medical industry. Due to the low margin on this product, we do not believe the loss of this customer will have a material adverse impact to our 2016 operating results. This decrease was partially offset by the first contribution from our RESPONDER mobile printer in 2015. +TSG: Revenue from TSG includes sales of consumable products (inkjet cartridges, ribbons, receipt paper, color thermal paper and other printing supplies), replacement parts, maintenance and repair services, testing services, refurbished printers, and shipping and handling charges. A summary of sales in our worldwide TSG market for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +13,187 +93.9% +$ +11,112 +89.6% +$ +2,075 +18.7% +International +856 +6.1% +1,286 +10.4% +(430) +(33.4%) +$ +14,043 +100.0% +$ +12,398 +100.0% +$ +1,645 +13.3% +The increase in domestic revenue from TSG is primarily due to a 58% increase in sales of replacement parts mainly to IGT who purchased unusually high volume of spare parts for the lottery market in 2015 that is not likely to repeat in 2016 and to a lesser extent a 22% increase in services revenue largely from project oriented paper testing services. These increases were partially offset by a 9% decline in non-Printrex consumables, largely from the decline of HP inkjet cartridges, as we continue to deemphasize this commoditized consumable product. As a result, we expect sales of HP inkjet cartridges to continue to decline in 2016. In addition, consumables revenue for our Printrex color printers declined by 32%, due to lower printing usage resulting from reduced drilling activity caused by the decline in worldwide oil prices. +Internationally, TSG revenue decreased due primarily to lower sales of replacement parts and accessories in 2015 compared to 2014 due to a unusually high sales to IGT in 2014 to support international legacy lottery printers that did not reoccur in 2015. +Gross Profit. Gross profit information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +24,978 +$ +21,711 +15.0% +41.9% +40.9% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, direct labor, manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers and expenses associated with installations and maintenance of our EPICENTRAL® print system. Gross profit increased $3,267,000, or 15%, on a 12% increase in sales. Additionally, our gross margin increased by 100 basis points as we experienced a more favorable sales mix during 2015 compared to 2014. This increase in gross margin was achieved despite a large portion of our sales being generated from our lottery printers during 2015 which carry lower gross margin than our other products. The improved gross margin was attained primarily due to higher margin contributions from TSG products and food safety terminal sales. We expect our gross margin for 2016 to increase as we expect to benefit from increased sales of our newer, value-added products. +Engineering, Design and Product Development. Engineering, design and product development information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +3,599 +$ +4,302 +(16.3%) +6.0% +8.1% +17 +Engineering, design and product development expenses primarily include salary and payroll related expenses for our hardware and software engineering staff, depreciation and design expenses (including prototype printer expenses, outside design and testing services, and supplies). Such expenses decreased $703,000 or 16%, due primarily to a 17% reduction of engineering compensation costs as a result of our 2014 cost reduction initiatives as well as lower pre-production expenses during 2015 compared to 2014 when we were in the process of launching three new products. We expect engineering, design and product development expenses in 2016 to be higher than 2015 due to increased strategic investment in our EPICENTRAL™ software development and continued expansion of our line of food safety terminals. +Selling and Marketing . Selling and marketing information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +7,806 +$ +7,920 +(1.4%) +13.1% +14.9% +Selling and marketing expenses primarily include salaries and payroll related expenses for our sales and marketing staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, e-commerce and other promotional marketing expenses. Such expenses decreased $114,000, or 1%, primarily due to lower marketing expenses from cost savings initiatives as well as lower travel expenses in our Printrex markets as we consciously decided to reduce these expenses in response to the worldwide decline in the oil and gas markets. These decreases were partially offset by the planned investments we made during the second half of 2014 and early 2015 in new sales and marketing staff to focus on sales execution of our new products. We expect selling and marketing expenses to be slightly higher in 2016 compared to 2015 due to the full year impact from the investments we have made in our sales and marketing staff during 2015 to support the launch of a new food safety terminal and the growth of the food safety business. +General and Administrative. General and administrative information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +7,367 +$ +7,756 +(5.0%) +12.3% +14.6% +General and administrative expenses primarily include salaries and payroll related expenses for our executive, accounting, human resource, business development and information technology staff, expenses for our corporate headquarters, professional and legal expenses, telecommunication expenses, and other expenses related to being a publicly-traded company. General and administrative expenses decreased $389,000, or 5%, due primarily to lower salary expenses related to the departure of our VP, Business Development during the fourth quarter of 2014, who was not replaced and severance costs related to the cost reduction initiatives that were incurred during the fourth quarter of 2014. These decreases were partially offset by higher incentive compensation expenses during 2015 compared to 2014. We expect general and administrative expenses in 2016 to be slightly higher than with 2015 due to increased health care costs. +Legal Fees and Settlement Expenses Associated with Lawsuit . Legal fees and settlement expenses information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +1,738 +$ +5,505 +(68.4%) +2.9% +10.4% +As disclosed in Note 10 to the Consolidated Financial Statements, in June 2012, AD filed a civil complaint against the Company, which we settled in March 2015. In connection with this lawsuit, we incurred legal fees and settlement expenses of $1,738,000 and $5,505,000 in 2015 and 2014, respectively. Due to the settlement of the AD lawsuit in March 2015, we do not expect to incur any further expenses in the future. +Operating Income (Loss). Operating income information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales – 2015 +Total Sales – 2014 +Year ended +$ +4,468 +$ +(3,772) +218.5% +7.5% +(7.1%) +The increase in our operating income and operating margin was primarily due to lower legal fees and settlement expenses incurred in 2015 compared to 2014 as well as a 12% increase in sales during 2015. Excluding the AD legal fees, our operating income would have been $6,206,000, or 10.4% of net sales in 2015 compared to $1,733,000, or 3.3% of net sales in 2014. +Interest. We recorded net interest expense of $28,000 in 2015 compared to $49,000 in 2014. The decrease in net interest expense is due to the lower unused revolving credit line fee we are charged when we renewed the TD Bank Credit Facility on November 26, 2014. As of the renewal we are charged a fee of 0.15% on unused borrowings compared to 0.25% under the prior credit facility. “Liquidity and Capital Resources” below for more information. +18 +Other, net . We recorded other income of $2,000 in 2015 compared to other expense of $33,000 in 2014. The change was primarily due to a $27,000 loss from the disposal of equipment during 2014 in addition to lower foreign currency exchange losses recorded by our U.K. subsidiary in 2015 compared to 2014. +Income Taxes . We recorded an income tax provision for 2015 of $1,350,000 at an effective tax rate of 30.4% compared to an income tax benefit of $1,433,000 at an effective tax rate of 37.2% for 2014. The effective tax rate for 2014 is higher than our 2015 due to the impact from the net loss reported for the year ending 2014. We expect our annual effective tax rate for 2016 to be approximately 32%. +Net Income. We reported net income during 2015 of $3,092,000, or $0.39, per diluted share, compared to net loss of $2,421,000, or $(0.29), per diluted share, for 2014. +Results of Operations: Year ended December 31, 2014 compared to year ended December 31, 2013 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2014 and 2013 were as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Food safety, banking and POS +$ +9,308 +17.5% +$ +11,296 +18.8% +$ +(1,988) +(17.6%) +Casino and gaming +22,731 +42.8% +27,300 +45.4% +(4,569) +(16.7%) +Lottery +4,761 +9.0% +4,450 +7.4% +311 +7.0% +Printrex +3,910 +7.4% +4,335 +7.2% +(425) +(9.8%) +TSG +12,398 +23.3% +12,760 +21.2% +(362) +(2.8%) +$ +53,108 +100.0% +$ +60,141 +100.0% +$ +(7,033) +(11.7%) +International* +$ +14,541 +27.4% +$ +13,764 +22.9% +$ +777 +5.6% +* +International sales do not include sales of printers made to domestic distributors or other customers who in turn ship those printers to international destinations. +Net sales for 2014 decreased $7,033,000, or 12%, from 2013. Printer and terminal sales volume decreased 10% to approximately 138,000 units primarily due to declines in the casino and gaming, and food safety, banking and POS markets, of 15% and 7%, respectively. The average selling price of our printers decreased approximately 3% from 2013 to 2014 due primarily to lower sales of our food safety terminals which have a significantly higher average selling price than most of our other printers. Overall, international sales increased $777,000, or 6%, primarily driven by higher sales in both the international casino and gaming and TSG markets. +Food safety, banking and POS: A summary of sales of our worldwide food safety, banking and POS products for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +8,984 +96.5% +$ +10,956 +97.0% +$ +(1,972) +(18.0%) +International +324 +3.5% +340 +3.0% +(16) +(4.7%) +$ +9,308 +100.0% +$ +11,296 +100.0% +$ +(1,988) +(17.6%) +The decrease in domestic food safety, banking and POS product revenue from 2013 was primarily driven by lower sales from our Ithaca® 9700 food safety terminal due to a large initial stocking order to a distributor that occurred in 2013 and did not repeat in 2014. This decrease was partially offset by higher sales of our Ithaca® 9000 printers to McDonald’s during 2014 compared to 2013, as they accelerated a rollout of these printers for a new initiative. +International food safety, banking and POS printer sales for 2014 were relatively consistent with 2013 . +Casino and gaming: A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +10,437 +45.9% +$ +15,367 +56.3% +$ +(4,930) +(32.1%) +International +12,294 +54.1% +11,933 +43.7% +361 +3.0% +$ +22,731 +100.0% +$ +27,300 +100.0% +$ +(4,569) +(16.7%) +The decrease in both domestic hardware and software casino and gaming sales from 2013 resulted primarily from general weakness in the replacement cycle in the domestic casino market, as well as a large replacement of a certain OEM’s slot machines at a multi-property casino group in 2013 that did not repeat in 2014. Domestic sales of our thermal Epic 950 gaming printer decreased 27% in 2014 compared to 2013. In addition EPICENTRAL™ software sales fell 78% in 2014 compared to 2013 due to no new domestic installations occurring in 2014 compared to five installations in 2013. +The increase in international sales is due to an increase in sales of our thermal EPIC 950 printer and EPICENTRAL TM software sales of 4% and 106%, respectively. The increase in EPICENTRAL™ software sales is due to one large multi-property installation for a customer in South America in 2014 compared to two smaller installations in 2013. These increases were partially offset by decreased sales of our off-premises thermal gaming printers of 13% in 2014 when compared to 2013. +19 +Lottery: A summary of sales of our worldwide lottery printers for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +4,682 +98.3% +$ +4,417 +99.3% +$ +265 +6.0% +International +79 +1.7% +33 +0.7% +46 +139.4% +$ +4,761 +100.0% +$ +4,450 +100.0% +$ +311 +7.0% +Our sales to IGT (formerly GTECH Corporation) are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of IGT’s overall business or revenue. +Printrex: A summary of sales of our worldwide Printrex printers for the years ended December 31, 2014 and 2013 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +3,352 +85.7% +$ +3,712 +85.6% +$ +(360) +(9.7%) +International +558 +14.3% +623 +14.4% +(65) +(10.4%) +$ +3,910 +100.0% +$ +4,335 +100.0% +$ +(425) +(9.8%) +The decrease in Printrex printers is primarily due to 9% lower worldwide sales of printers in the oil and gas market due to the negative impact of steeply declining worldwide oil prices. In addition, worldwide sales of our medical and mobile printers declined 11% due to lower sales to a medical printer customer that began to phase out the use of our printer during 2014. +TSG: A summary of sales in our worldwide TSG market for the years ended December 31, 2014 and 2013 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2014 +December 31, 2013 +$ +% +Domestic +$ +11,112 +89.6% +$ +11,925 +93.5% +$ +(813) +(6.8%) +International +1,286 +10.4% +835 +6.5% +451 +54.0% +$ +12,398 +100.0% +$ +12,760 +100.0% +$ +(362) +(2.8%) +The decrease in domestic revenue from TSG is primarily due to a 15% decrease in sales of non-Printrex consumables, largely from the decline of HP inkjet cartridges, as we continue to deemphasize this commoditized consumable product. In addition, service revenue declined by 29%, largely due to a 57% decline in paper testing service revenue as we performed fewer tests in 2014 than in 2013, as well as lower maintenance and repair revenue from fewer service contracts. These decreases were partially offset by a 10% increase in sales of replacement parts as well as a 78% increase of consumables for our new Printrex color printers. Internationally, TSG revenue increased due primarily to higher sales of replacement parts and accessories as compared to 2013. +Gross Profit. Gross profit information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +21,711 +$ +25,092 +(13.5%) +40.9% +41.7% +Gross profit decreased $3,381,000, or 14%, on 12% lower sales volume and a slightly less favorable sales mix. Additionally, our gross margin declined by 80 basis points due to lower sales contributions from our value-added Ithaca® 9700 food safety terminals, casino printers and EPICENTRAL™ software. +Engineering, Design and Product Development. Engineering, design and product development information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +4,302 +$ +4,065 +5.8% +8.1% +6.8% +% +Engineering, design and product development expenses increased $237,000, or 6%, due primarily to additional engineering staff and higher pre-production expenses related to new product development for the new products we launched in 2014. +Selling and Marketing . Selling and marketing information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +7,920 +$ +7,346 +7.8% +14.9% +12.2% +Selling and marketing expenses increased $574,000, or 8%, primarily due to the planned investment in new sales and marketing staff to support our new products, a full year of commissions to our new casino and gaming distributor added in late 2013, Suzo Happ, and increased marketing spend to support our newly launched products in 2014. +20 +General and Administrative. General and administrative information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +7,756 +$ +6,588 +17.7% +14.6% +11.0% +General and administrative expenses increased $1,168,000, or 18%, due primarily to changes in the accrued contingent consideration liability to be paid in connection with the acquisition of Printrex. In 2014, we reduced the contingent consideration liability by $60,000 to zero, compared to a reduction of $900,000 in 2013. Excluding the changes we recorded to the contingent consideration liability, general and administrative expenses increased $328,000, or 4% in 2014 compared to 2013. This increase is primarily due to higher severance costs related to the cost reduction initiatives we initiated in the fourth quarter 2014. +Legal Fees and Settlement Expenses Associated with Lawsuit . Legal fees and settlement expenses information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales - 2014 +Total Sales - 2013 +Year ended +$ +5,505 +$ +476 +1,056.5% +10.4% +0.8% +As disclosed in Note 10 to the Consolidated Financial Statements, in June 2012, AD filed a civil complaint against the Company, which we settled in March 2015. In connection with this lawsuit, we incurred legal fees and settlement expenses of $5,505,000 and $476,000 in 2014 and 2013, respectively. +Operating Income (Loss). Operating income information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2014 +2013 +Change +Total Sales – 2014 +Total Sales – 2013 +Year ended +$ +(3,772) +$ +6,617 +(157.0%) +(7.1%) +11.0% +The decrease in our operating income and operating margin was primarily due to higher legal fees and $3,625,000 of settlement expenses related to the lawsuit with AD that we settled in March 2015 as well as a 12% decline in sales. In addition, our operating margin for 2013 benefited by 150 basis points from the $900,000 reduction in the Printrex accrued contingent consideration liability. +Interest. We recorded net interest expense of $49,000 in 2014 compared to $23,000 in 2013. The increase in net interest expense is primarily due to lower interest income earned on a lower average cash balance during 2014, as we used a significant amount of our cash to repurchase our common stock and pay cash dividends during the latter half of 2013 and 2014. Interest expense related to the unused revolving credit line fee and amortization of deferred financing costs on our revolving credit facility with TD Bank remained consistent in 2014 and 2013. See “Liquidity and Capital Resources” below for more information. +Other, net . We recorded other expense of $33,000 in 2014 compared to $63,000 in 2013. The change was primarily due to a $60,000 loss from the disposal of certain tooling equipment during 2013 somewhat offset by higher foreign currency transaction exchange losses recorded by our U.K. subsidiary in 2014 compared to 2013. +Income Taxes . We recorded an income tax benefit for 2014 of $1,433,000 at an effective tax rate of 37.2% compared to an income tax provision of $1,596,000 at an effective tax rate of 24.4% for 2013. Our effective tax rate for 2013 was unusually low because it included; (1) a $224,000 reduction in tax liabilities for unrecognized tax benefits resulting from the completion of an audit of our 2010 federal income tax return and (2) the benefit from both the 2012 and 2013 R&D credit, as the credit for 2012 was not renewed until January 2, 2013. +Net Income. We reported a net loss during 2014 of $2,421,000, or $(0.29), per diluted share, compared to net income of $4,935,000, or $0.57, per diluted share, for 2013. +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors affecting the management of liquidity are cash flows from operating activities, capital expenditures, treasury share repurchases, dividend payments, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to access credit lines, if needed, are expected to be sufficient to fund operations, capital expenditures, treasury share repurchases, dividend payments and any increase in working capital that would be required to accommodate a higher level of business activity. We actively seek to expand by acquisition as well as through the growth of our current business. While a significant acquisition may require additional debt and/or equity financing, although no assurances can be given, we believe that we would be able to obtain additional financing based on our historical earnings performance. +Cash Flow +During 2015, our cash balance increased $1,342,000, or 43%, from December 31, 2014 and we returned a substantial portion of our cash flow to shareholders in the form of $2,485,000 of cash dividends paid to common shareholders and $1,020,000 of repurchases of our common stock. Even after funding these items and our capital expenditures, we still ended 2015 with $4,473,000 in cash and cash equivalents and no debt outstanding. +21 +Operating activities : The following significant factors primarily affected our cash provided by operating activities of $5,547,000 in 2015 as compared to $6,053,000 in 2014. During 2015: +· +We reported a net income of $3,092,000. +· +We recorded depreciation, amortization and share-based compensation expense of $1,914,000. +· +Accounts receivable decreased $1,916,000 due primarily to improved collections during the fourth quarter of 2015 compared to the fourth quarter of 2014. +· +Inventories decreased $509,000 due to the sell through of inventory on hand during 2015. During 2016, we expect our inventory to steadily decline beginning in the second quarter. +· +Accounts payable increased $277,000 due primarily to the timing of payments. +· +Accrued liabilities and other liabilities decreased $3,487,000 due primarily to the payment of the AD lawsuit settlement in April 2015. See N ote 10 – Commitments and Contingencies in the Notes to the Consolidated Financial Statements for further information on the lawsuit. +During 2014: +· +We reported a net loss of $2,421,000. +· +We recorded depreciation, amortization and share-based compensation expense of $1,951,000. +· +Accounts receivable decreased $4,139,000 due primarily to lower sales volume during the fourth quarter of 2014 compared to the fourth quarter of 2013 in addition to improved collections. +· +Inventories decreased $1,703,000 due to the sell through of inventory on hand during 2014 compared to increasing stocking levels of our new food safety and Printrex products during 2013. +· +Accounts payable decreased $2,384,000 due primarily to lower inventory purchases made during the fourth quarter of 2014 compared to the fourth quarter of 2013, as well as the timing of payments. +· +Accrued liabilities and other liabilities increased $1,022,000 due primarily to higher legal expenses related to the AD Lawsuit and higher accrued incentive compensation in 2014 compared to 2013. +· +We recorded accrued lawsuit settlement expenses of $3,625,000 related to the settlement with AD. See N ote 10 – Commitments and Contingencies in the Notes to the Consolidated Financial Statements for further information on the settlement charges recorded. +Investing activities : Our capital expenditures were $959,000 and $660,000 in 2015 and 2014, respectively. Expenditures in 2015 included approximately $396,000 of cost incurred for the purchase of a new phone system and other computer equipment, $296,000 for leasehold improvements primarily for improvements made to our Las Vegas facility, $153,000 for costs incurred for the purchase of new product tooling, and the remaining amount primarily for the purchase of furniture and fixtures and engineering equipment. +Capital expenditures for 2016 are expected to be approximately $1,000,000, primarily for new product tooling, and tooling enhancements for our existing products, as well as for new computer software and equipment purchases. +Financing activities : We used $3,238,000 of cash from financing activities during 2015 to pay cash dividends of $2,485,000 to common shareholders and purchase $1,020,000 of common stock for treasury, partially offset by proceeds and tax benefits from stock option exercises of $267,000. Additionally, during 2015, we borrowed $2,500,000 under the TD Bank Credit Facility to partially fund the $3,600,000 settlement payment related to the AD lawsuit which we fully repaid. During 2014, we used $5,178,000 of cash from financing activities during to purchase $2,634,000 of common stock for treasury, to pay cash dividends of $2,556,000 to common shareholders and $8,000 in financing costs associated with our amended TD Bank Credit Facility (as discussed below), partially offset by proceeds and tax benefits from stock option exercises of $20,000. +Working Capital +Our working capital increased approximately 3% to $18,983,000 at December 31, 2015 from $18,361,000 at December 31, 2014. Our current ratio of current assets to current liabilities increased from 2.9 at December 31, 2014 to 4.0 at December 31, 2015. The increase in both our working capital and current ratio was primarily due to the settlement accrual related to the AD lawsuit in 2014. +Resource Sufficiency +We believe that our cash and cash equivalents on hand and cash flows generated from operating activities will provide sufficient resources to meet our working capital needs, finance our capital expenditures, dividend payments and meet our liquidity requirements through at least the next twelve months. +Credit Facility and Borrowings +We maintain a credit facility (the “TD Bank Credit Facility”) with TD Bank N.A. (“TD Bank”) which provides for a $20,000,000 revolving credit line. On November 26, 2014, we signed an amendment to renew the TD Bank Credit Facility through November 28, 2017. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.15% on unused borrowings under the revolving credit line. The total deferred financing costs relating to expenses incurred to complete the TD Bank Credit Facility was $8,000. The amendment increases the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $10,000,000 from $5,000,000. The amendment also modified the definition of EBITDA to exclude certain non-recurring expenses, including without limitation, non-recurring litigation and acquisition expenses (including the $3,625,000 expense we incurred in 2014 related to the settlement of the AD lawsuit); and modified the definition of Operating Cash Flow to exclude unfinanced capital expenditures for the quarters ending December 31, 2014, March 31, 2015 and June 30, 2015. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2015. The following table lists the financial covenants and the performance measurements at December 31, 2015: +22 +Financial Covenant +Requirement/Restriction +Calculation at December 31, 2015 +Operating cash flow / Total debt service +Minimum of 1.25 times +118.8 times +Funded debt / EBITDA +Maximum of 3.0 times +0 times +As of December 31, 2015, undrawn commitments under the TD Bank Credit facility were $20,000,000. +Shareholder Dividend Payments +In September 2012, we announced that our Board of Directors approved the initiation of a quarterly cash dividend program which is subject to the Board’s approval each quarter. On May 6, 2014, our Board of Directors declared an increase to the quarterly cash dividend from $0.07 per share to $0.08 per share. Dividends declared and paid on our common stock totaled $2,485,000 or $0.32 per share and $2,556,000 or $0.31 per share, in 2015 and 2014, respectively. On February 1, 2016, our Board of Directors approved the first quarter 2016 dividend in the amount of $0.08 per share payable on or about March 15, 2016 to common shareholders of record at the close of business on February 19, 2016. We expect to pay approximately $2,500,000 in cash dividends to our common shareholders during 2016. +Stock Repurchase Program +Prior to its expiration on July 31, 2015, we maintained a stock repurchase program. Under this stock repurchase program, we were authorized to repurchase up to $7,500,000 of our outstanding shares of common stock from time to time in the open market, depending on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From January 1, 2015 through the expiration date of this stock repurchase program, we repurchased 166,553 shares of our common stock for approximately $1,020,000 at an average price of $6.12 per share. From the start of this stock repurchase program on August 11, 2014 through December 31, 2014, we repurchased 434,998 shares of common stock for approximately $2,634,000 at an average price of $6.06 per share. From January 1, 2005 through the expiration date of the stock repurchase program on July 31, 2015, we repurchased a total of 3,388,589 shares of common stock for approximately $26,181,000, at an average price of $7.73 per share. +On February 25, 2016, our Board of Directors approved a new stock repurchase program. Under this new repurchase program, we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market through December 31, 2017 at prevailing market prices based on market conditions, share price and other factors. +Shareholders’ Equity +Shareholders’ equity increased $334,000 to $25,728,000 at December 31, 2015 from $25,394,000 at December 31, 2014. The increase was primarily due to net income of $3,092,000, share-based compensation expense related to stock options of $488,000, proceeds and the associated incremental tax benefits of approximately $267,000 from the issuance of 34,600 shares of common stock from stock option exercises and approximately $121,000 from the issuance of 13,988 shares of deferred stock units, net of relinquishments. These increases were partially offset by our payment of $2,485,000 in dividends and purchase of 166,553 shares of treasury stock for $1,020,000. +Off Balance Sheet Arrangements +As of December 31, 2015, we had no off balance sheet arrangements that have had or that we expect would be reasonably likely to have a future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. +Contractual Obligations +Our contractual obligations as of December 31, 2015 were as follows: +Payments due by period +(In thousands) +Total +< 1 year +1-3 years +3-5 years +> 5 years +Operating lease obligations +$ +1,808 +$ +618 +$ +448 +$ +377 +$ +365 +Purchase obligations +5,090 +$ +5,031 +$ +59 +- +- +Total +$ +6,898 +$ +5,649 +$ +507 +$ +377 +$ +365 +Purchase obligations are for purchases made in the normal course of business to meet operational requirements, primarily of fully assembled printers and component part inventory. +Impact of Inflation +We believe that our business has not been affected to a significant degree by inflationary trends during the past three years. However, inflation is still a factor in the worldwide economy and may increase the cost of purchasing products from our contract manufacturers in Asia, as well as the cost of certain raw materials, component parts and labor used in the production of our products. It also may increase our operating expenses, manufacturing overhead expenses and the cost to acquire or replace fixed assets. We have generally been able to maintain or improve our profit margins through productivity and efficiency improvements, cost reduction programs and to a lesser extent, price increases, and we expect to be able to do the same during 2016. As such, we do not believe that inflation will have a significant impact on our business during 2016. +Item 7A. Quantitative and Qualitative Disclosures about Market Risk. +Interest Rate Risk +Our exposure to market risk for changes in interest rates relates primarily to the investment of our available cash and cash equivalents. In accordance with our investment policy, we strive to achieve above market rates of return in exchange for accepting a prudent amount of incremental risk, which includes the risk of interest rate movements. Risk tolerance is constrained by an overriding objective to preserve capital. An increase or decrease of 10% in effective interest rates would not have a material effect on our results of operations or cash flows. +23 +Foreign Currency Exchange Risk +A substantial portion of our sales are denominated in U.S. dollars and, as a result, we have relatively little exposure to foreign currency exchange risk with respect to sales made. This exposure may change over time as business practices evolve and could have a material adverse impact on our financial results in the future. We do not use forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. We estimate that the combined translational and transactional impact of a 10% overall movement in exchange rates from December 31, 2015 (principally the U.K. Pound Sterling) would not have a material impact on our results of operations or cash flows. +Item 8 . Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this report as pages F-3 through F-18. An index to such materials appears on page F-1. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2015. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2015, our disclosure controls and procedures are effective. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2015. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2015. +Item 9B. Other Information. +Not applicable. +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +Set forth below is certain information regarding our executive officers. The remaining information in response to this item will be contained in our Proxy Statement for our 2016 Annual Meeting of Stockholders (the “Proxy Statement”), which will be filed within 120 days after the year covered by this Form 10-K and is incorporated herein by reference. +24 +Executive Officers of the Registrant +The following list is included as an unnumbered item in Part III of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 12, 2016. +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +58 +Chairman of the Board and Chief Executive Officer +Steven A. DeMartino +46 +President, Chief Financial Officer, Treasurer and Secretary +Andrew J. Newmark +57 +Executive Vice President, Sales and Marketing +Donald E. Brooks +63 +Senior Vice President-Engineering +Tracey S. Chernay +56 +Senior Vice President, Casino, Gaming Sales and Lottery +Andrew J. Hoffman +58 +Senior Vice President, Operations +Bart C. Shuldman has been Chief Executive Officer, President and a Director of the Company since its formation in June 1996. In February 2001, Mr. Shuldman was elected Chairman of the Board. Mr. Shuldman relinquished the President title, effective June 1, 2010, to focus on new products and markets, international expansion and potential acquisitions. +Steven A. DeMartino was named as TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Andrew Newmark joined TransAct on January 12, 2014 as Executive Vice President, Sales and Marketing with responsibility for the sales and marketing of all TransAct products. Prior to joining TransAct, Mr. Newmark was an investor and consultant with Newmark Capital Management from 2009 to 2015. From 2005 to 2009, Mr. Newmark was employed by Newell Rubbermaid as Vice President, Business Development and Strategy. Until 2005, Mr. Newmark held the role of Senior Vice President with DYMO after CoStar, a company he co-founded in 1989, was purchased by DYMO. +Donald E. Brooks was appointed Senior Vice President of Engineering in April 2012. Previously, Mr. Brooks served as Vice President, Engineering from September 2004 to April 2012, Senior Project Engineer from February 1998 to September 2004, Project Engineer from June 1997 to February 1998, Director of Electrical Engineering from March 1986 to June 1997 and Manager of Electronic Development from December 1983 to March 1986. +Tracey S. Chernay was appointed Senior Vice President, Casino and Gaming Sales and Marketing in June 2010, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Chernay served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing & Sales, POS & Banking with the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Chernay was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Andrew J. Hoffman was appointed Senior Vice President, Operations for TransAct worldwide in November 2004. He served as Vice President, Operations from September 1994 to November 2004. +Code of Ethics +We maintain a Code of Business Conduct that includes our code of ethics that is applicable to all employees, including our Chief Executive Officer, Chief Financial Officer and Controller. This Code, which requires continued observance of high ethical standards such as honesty, integrity and compliance with the law in the conduct of our business, is available for public access on our internet website. Any person may request a copy of our Code of Business Conduct free of charge by calling (203) 859-6800. +Item 11. Executive Compensation. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +25 +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +Information regarding our equity compensation plans as of December 31, 2015 is as follows: +Plan category +(a) +Number of securities to be issued upon exercise of outstanding options, warrants and rights +(b) +Weighted-average exercise price of outstanding options, warrants and rights +(c) +Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +707,151 +$ +8.41 +- +2014 Equity Incentive Plan +258,078 +7.15 +341,922 +Total +965,229 +$ +8.08 +341,922 +In May 2014, our shareholders approved the adoption of the 2014 Equity Incentive Plan. The Company also maintains the 2005 Equity Incentive Plan which was approved by our shareholders, however no new awards will be available for future issuance under this Plan. The number of shares of common stock which may be subject to awards granted under the 2014 Equity Incentive Plan is 600,000. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services. +The information in response to this item will be contained in the Proxy Statement section and is incorporated herein by reference. +PART IV +Item 15. Exhibits and Financial Statement Schedules. +The exhibits filed as a part of this report are listed in the accompanying Index to Exhibits. +26 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ Bart C. Shuldman +Name: +Bart C. Shuldman +Title: +Chairman of the Board and Chief Executive Officer +Date: March 11, 2016 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Bart C. Shuldman +Chairman of the Board +March 11, 2016 +Bart C. Shuldman +and Chief Executive Officer, +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, +March 11, 2016 +Steven A. DeMartino +Treasurer and Secretary +(Principal Financial and Accounting Officer) +/s/ John M. Dillon +Director +March 11, 2016 +John M. Dillon +/s/ Thomas R. Schwarz +Director +March 11, 2016 +Thomas R. Schwarz +/s/ Graham Y. Tanaka +Director +March 11, 2016 +Graham Y. Tanaka +27 +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO FINANCIAL STATEMENTS +Financial Statements +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Balance Sheets as of December 31, 2015 and 2014 +F-3 +Consolidated Statements of Operations for the years ended December 31, 2015,2014, and 2013 +F-4 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2015, 2014 and 20 13 +F-5 +Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2015, 2014 and 20 13 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014 and 20 13 +F-7 +Notes to Consolidated Financial Statements +F-8 +All other financial statement schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto. +F-1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Shareholders of TransAct Technologies Incorporated: +In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of TransAct Technologies Incorporated and its subsidiaries at December 31, 2015 and December 31, 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +/s/ PricewaterhouseCoopers LLP +Hartford, Connecticut +March 11, 2016 +F-2 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +December 31, +2015 +2014 +Assets: +Current assets: +Cash and cash equivalents +$ +4,473 +$ +3,131 +Accounts receivable, net +7,174 +9,094 +Inventories +11,296 +11,806 +Prepaid income taxes +- +409 +Deferred tax assets +1,932 +3,068 +Other current assets +437 +489 +Total current assets +25,312 +27,997 +Fixed assets, net +2,507 +2,438 +Goodwill +2,621 +2,621 +Deferred tax assets +1,213 +1,068 +Intangible assets, net of accumulated amortization of $2,779 and $2,326, respectively +888 +1,341 +Other assets +28 +26 +7,257 +7,494 +Total assets +$ +32,569 +$ +35,491 +Liabilities and Shareholders’ Equity: +Current liabilities: +Accounts payable +$ +2,642 +$ +2,365 +Accrued liabilities +2,838 +3,320 +Income taxes payable +245 +13 +Accrued lawsuit settlement expenses (Note 10) +- +3,625 +Deferred revenue +604 +313 +Total current liabilities +6,329 +9,636 +Deferred revenue, net of current portion +77 +64 +Deferred rent, net of current portion +189 +172 +Other liabilities +246 +225 +512 +461 +Total liabilities +6,841 +10,097 +Commitments and contingencies (Note 10) +Shareholders’ equity: +Preferred stock, $0.01 par value, 4,800,000 authorized, none issued and outstanding +- +- +Preferred stock, Series A, $0.01 par value, 200,000 authorized, none issued and outstanding +- +- +Common stock, $0.01 par value, 20,000,000 authorized at December 31, 2015 and 2014; 11,170,881 and 11,122,293 shares issued; 7,782,292 and 7,900,257 shares outstanding, at December 31, 2015 and 2014, respectively +112 +111 +Additional paid-in capital +28,921 +28,167 +Retained earnings +22,956 +22,349 +Accumulated other comprehensive loss, net of tax +(80) +(72) +Treasury stock, 3,388,589 and 3,222,036 shares, at cost +(26,181) +(25,161) +Total shareholders’ equity +25,728 +25,394 +Total liabilities and shareholders’ equity +$ +32,569 +$ +35,491 +See accompanying notes to Consolidated Financial Statements. +F-3 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except per share data) +Year Ended December 31, +2015 +2014 +2013 +Net sales +$ +59,676 +$ +53,108 +$ +60,141 +Cost of sales +34,698 +31,397 +35,049 +Gross profit +24,978 +21,711 +25,092 +Operating expenses: +Engineering, design and product development +3,599 +4,302 +4,065 +Selling and marketing +7,806 +7,920 +7,346 +General and administrative +7,367 +7,756 +6,588 +Legal fees and settlement expenses associated with lawsuit (Note 10) +1,738 +5,505 +476 +20,510 +25,483 +18,475 +Operating income (loss) +4,468 +(3,772) +6,617 +Interest and other income (expense): +Interest expense +(37) +(61) +(64) +Interest income +9 +12 +41 +Other, net +2 +(33) +(63) +(26) +(82) +(86) +Income (loss) before income taxes +4,442 +(3,854) +6,531 +Income tax provision (benefit) +1,350 +(1,433) +1,596 +Net income (loss) +$ +3,092 +$ +(2,421) +$ +4,935 +Net income (loss) per common share: +Basic +$ +0.40 +$ +(0.29) +$ +0.57 +Diluted +$ +0.39 +$ +(0.29) +$ +0.57 +Shares used in per-share calculation: +Basic +7,818 +8,307 +8,589 +Diluted +7,854 +8,307 +8,703 +Dividends declared and paid per common share: +$ +0.32 +$ +0.31 +$ +0.27 +See accompanying notes to Consolidated Financial Statements. +F-4 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(In thousands, except share data) +Year Ended December 31, +2015 +2014 +2013 +Net income (loss) +$ +3,092 +$ +(2,421) +$ +4,935 +Foreign currency translation adjustment, net of tax +(8) +(9) +(8) +Comprehensive income (loss) +$ +3,084 +$ +(2,430) +$ +4,927 +See accompanying notes to Consolidated Financial Statements. +F-5 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY +(In thousands, except share data) +Common Stock +Shares Amount +Additional Paid-in +Capital +Retained +Earnings +Treasury +Stock +Accumulated Other Comprehensive +Income (Loss) +Total +Equity +Balance, December 31, 2012 +8,720,200 +$ +109 +$ +25,940 +$ +24,708 +$ +(17,333) +$ +(55) +$ +33,369 +Issuance of shares from exercise of stock options +196,358 +2 +1,043 +- +- +- +1,045 +Issuance of deferred stock units +- +- +139 +- +- +- +139 +Issuance of common stock on deferred +stock units, net of relinquishments +6,919 +- +(28) +- +- +- +(28) +Tax benefit related to employee stock sales +- +- +132 +- +- +- +132 +Purchase of treasury stock +(604,161) +- +- +- +(5,194) +- +(5,194) +Dividends declared and paid on common stock +- +- +- +(2,317) +- +- +(2,317) +Share-based compensation expense +- +- +521 +- +- +- +521 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(73) +- +- +- +(73) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(8) +(8) +Net income +- +- +- +4,935 +- +- +4,935 +Balance, December 31, 2013 +8,319,316 +$ +111 +$ +27,674 +$ +27,326 +$ +(22,527) +$ +(63 +) +$ +32,521 +Issuance of shares from exercise of stock options +6,000 +- +13 +- +- +- +13 +Issuance of deferred stock units +- +- +100 +- +- +- +100 +Issuance of common stock on deferred +stock units, net of relinquishments +9,939 +- +(44) +- +- +- +(44) +Tax benefit related to employee stock sales +- +- +7 +- +- +- +7 +Purchase of treasury stock +(434,998) +- +- +- +(2,634) +- +(2,634) +Dividends declared and paid on common stock +- +- +- +(2,556) +- +- +(2,556) +Share-based compensation expense +- +- +506 +- +- +- +506 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(89) +- +- +- +(89) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(9) +(9) +Net loss +- +- +- +(2,421) +- +- +(2,421) +Balance, December 31, 2014 +7,900,257 +$ +111 +$ +28,167 +$ +22,349 +$ +(25,161) +$ +(72) +$ +25,394 +Issuance of shares from exercise of stock options +34,600 +1 +262 +- +- +- +263 +Issuance of deferred stock units +- +- +160 +- +- +- +160 +Issuance of common stock on deferred +stock units, net of relinquishments +13,988 +- +(39) +- +- +- +(39) +Tx shortfall related to employee stock sales +- +- +(48) +- +- +- +(48) +Purchase of treasury stock +(166,553) +- +- +- +(1,020) +- +(1,020) +Dividends declared and paid on common stock +- +- +- +(2,485) +- +- +(2,485) +Share-based compensation expense +- +- +488 +- +- +- +488 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(69) +- +- +- +(69) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(8) +(8) +Net income +- +- +- +3,092 +- +- +3,092 +Balance, December 31, 2015 +7,782,292 +$ +112 +$ +28,921 +$ +22,956 +$ +(26,181) +$ +(80) +$ +25,728 +See accompanying notes to Consolidated Financial Statements. +F-6 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2015 +2014 +2013 +Cash flows from operating activities: +Net income (loss) +$ +3,092 +$ +(2,421) +$ +4,935 +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Share-based compensation expense +488 +506 +521 +Incremental tax benefits from stock options exercised +(4) +(7) +(132) +Depreciation and amortization +1,426 +1,445 +1,741 +Deferred income tax provision (benefit) +878 +(1,558) +46 +(Gain) loss on sale of fixed assets +(4) +28 +60 +Foreign currency transaction (gains) losses +(1) +7 +3 +Changes in operating assets and liabilities: +Accounts receivable +1,916 +4,139 +2,685 +Inventories +509 +1,703 +(3,189) +Prepaid income taxes +407 +(98) +(367) +Other current and long term assets +50 +46 +20 +Accounts payable +277 +(2,384) +(1,674) +Accrued lawsuit settlement expenses +(3,625) +3,625 +- +Accrued liabilities and other liabilities +138 +1,022 +(2,156) +Net cash provided by operating activities +5,547 +6,053 +2,493 +Cash flows from investing activities: +Capital expenditures +(959) +(660) +(709) +Additions to capitalized software +- +- +(42) +Proceeds from sale of fixed assets +4 +- +5 +Net cash used in investing activities +(955) +(660) +(746) +Cash flows from financing activities: +Revolving credit line borrowings +2,500 +- +- +Revolving credit line payments +(2,500) +- +- +Proceeds from stock option exercises +263 +13 +1,045 +Purchases of common stock for treasury +(1,020) +(2,634) +(5,194) +Payment of dividends on common stock +(2,485) +(2,556) +(2,317) +Incremental tax benefits from stock options exercised +4 +7 +132 +Payment of deferred financing costs +- +(8) +- +Net cash used in financing activities +(3,238) +(5,178) +(6,334) +Effect of exchange rate changes on cash and cash equivalents +(12) +(20) +(14) +Increase (decrease) in cash and cash equivalents +1,342 +195 +(4,601) +Cash and cash equivalents, beginning of period +3,131 +2,936 +7,537 +Cash and cash equivalents, end of period +$ +4,473 +$ +3,131 +$ +2,936 +Supplemental cash flow information: +Interest paid +$ +34 +$ +49 +$ +51 +Income taxes paid +130 +173 +2,585 +Non-cash capital expenditure items +84 +- +- +See accompanying notes to Consolidated Financial Statements. +F-7 +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated (“TransAct” or the “Company”), which has its headquarters in Hamden, CT and its primary operating facility in Ithaca, NY, operates in one operating segment: market specific solutions, including printers, terminals, software and other products for transaction-based and other industries. These industries include casino, gaming, lottery, banking, point-of-sale, food safety, oil and gas and medical and mobile. Our printers and terminals are designed based on market-specific requirements and are sold under the AccuDate™ Ithaca®, RESPONDER®, Epic, EPICENTRAL® and Printrex® product brands. We distribute our products through OEMs, value-added resellers, selected distributors, and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. We also generate revenue from the after-market side of the business, providing printer and terminal service, supplies and spare parts in addition to revenue from our software solution, the EPICENTRAL® Print System (“EPICENTRAL®”), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. +2. Summary of significant accounting policies +Principles of consolidation: The accompanying Consolidated Financial Statements include the accounts of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized profit. +Use of estimates : The accompanying Consolidated Financial Statements were prepared using estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting.” We view our operations and manage our business as one segment: the design, development, assembly and marketing of transaction printers and terminals and providing printer and terminal related software, services, supplies and spare parts . Factors used to identify TransAct’s single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief operating decision-maker in making decisions about how to allocate resources and assess performance. +Cash and cash equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Allowance for doubtful accounts : We establish an allowance for doubtful accounts to ensure trade receivables are valued appropriately. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events and historical experience. We record a specific allowance for individual accounts when we become aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. If circumstances related to customers change, we would further adjust estimates of the recoverability of receivables. Allowances for doubtful accounts on accounts receivable balances were $50,000 as of December 31, 2015 and $100,000 as of December 31, 2014. +The following table summarizes the activity recorded in the valuation account for accounts receivable: +Year ended December 31, +(In thousands) +2015 +2014 +2013 +Balance, beginning of period +$ +100 +$ +63 +$ +66 +Additions charged to costs and expenses +7 +37 +- +Write-offs +(57) +- +(3) +Balance, end of period +$ +50 +$ +100 +$ +63 +Inventories: Inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market. We review market value based on historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and market value. +Fixed assets: Fixed assets are stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years; machinery and equipment is ten years; furniture and office equipment is five to ten years; and computer software and equipment is three to seven years. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $972,000, $925,000 and $1,216,000 in 2015, 2014, and 2013, respectively. +Leases: Rent expense under non-cancelable operating leases with scheduled rent increases or free rent periods are accounted for on a straight-line basis over the lease term, beginning on the date of control of physical use of the asset or of initial possession. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred liability. Construction allowances and other such lease incentives are recorded as deferred credits, and are amortized on a straight-line basis as a reduction of rent expense beginning in the period they are deemed to be earned, which generally coincides with the occupancy date. +F-8 +2. Summary of significant accounting policies (continued) +Goodwill and Intangible assets : We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with Accounting Standards Codification (“ASC”) 350-20 “Goodwill”, acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. We have determined that no goodwill impairment has occurred based on our assessment as of December 31, 2015 when the impairment review is performed. +Revenue recognition: Our typical contracts include the sale of printers and terminals, which are sometimes accompanied by separately-priced extended warranty contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer or terminal sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within ASC 605, “Revenue Recognition” (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms, which are generally FOB shipping point) has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +We have developed a software solution, EPICENTRAL™, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. Revenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, “Multiple-Element Arrangements” and ASC 985-605, “Software.” EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system’s full functionality. These arrangements are accounted for in accordance with ASC 605-25, “Multiple-Element Arrangements”. EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, “Software” as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level GAAP and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence (“VSOE”) if available, third party evidence (“TPE”) if VSOE is not available, or best estimate of selling price (“BESP”) to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, “Separately Priced Extended Warranty and Product Maintenance Contracts.” Pursuant to this provision, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +Concentration of credit risk: Financial instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +F-9 +2. Summary of significant accounting policies (continued) +Accounts receivable from customers representing 10% or more of total accounts receivable were as follows: +December 31, +2015 +2014 +IGT +17% +17% +CMC Daymark +13% +11% +Panasonic +11% +3% +Suzo-Happ +10% +23% +Eurocoin +-% +11% +Sales to customers representing 10% or more of total net sales were as follows: +Year ended December 31, +2015 +2014 +2013 +IGT +29% +19% +19% +Suzo-Happ +14% +7% +4% +Eurocoin +-% +11% +12% +Warranty: We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. +The following table summarizes the activity recorded in the accrued product warranty liability: +Year ended December 31, +(In thousands) +2015 +2014 +2013 +Balance, beginning of period +$ +287 +$ +366 +$ +274 +Warranties issued +267 +183 +492 +Warranty settlements +(277) +(262) +(400) +Balance, end of period +$ +277 +$ +287 +$ +366 +$164,000 and $207,000 of the accrued product warranty liability were classified as current in Accrued liabilities at December 31, 2015 and 2014, respectively. The remaining $113,000 and $80,000 of the accrued product warranty liability is classified as long-term in Other liabilities. +Engineering, design and product development: Research and development expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as a component of operating expenses as incurred. We recorded $3,599,000, $4,302,000 and $4,065,000 of research and development expenses in 2015, 2014, and 2013, respectively. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM and unamortized development costs for such software were $31,000 and $169,000 as of December 31, 2015 and 2014, respectively. The total amount charged to cost of sales for the amortization of capitalized software development costs was $138,000, $201,000 and $199,000 in 2015, 2014, and 2013, respectively. The weighted-average amortization period of unamortized capitalized software developments costs is less than one year. +Advertising: Advertising costs are expensed as incurred. Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Operations, for 2015, 2014, and 2013 totaled $858,000, $1,191,000 and $1,058,000, respectively. These expenses include items such as consulting and professional services, tradeshows, and print advertising. +Income taxes: The income tax amounts reflected in the accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, “Income Taxes.” Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. See Note 12 for information regarding our accounting for income taxes. +F-10 +2. Summary of significant accounting policies (continued) +Foreign currency translation: The financial position and results of operations of our foreign subsidiary in the United Kingdom are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars at the year-end exchange rate, related sales and expenses have been translated at the average exchange rate for the year, and shareholders’ equity has been translated at historical exchange rates. The resulting translation gains or losses, net of tax, are recorded in shareholders’ equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income. Foreign currency transaction gains and losses, including those related to intercompany balances, are recognized in Other, net on the Consolidated Statements of Operations. +Share-based payments: At December 31, 2015, we had share-based employee compensation plans, which are described more fully in Note 11 - Stock incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, “Compensation – Stock Compensation.” Share-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee’s requisite service period. We have no awards with market or performance conditions. +We use the Black-Scholes option-pricing model to calculate the fair value of share based awards. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. In addition, we estimate forfeitures when recognizing compensation expense, and we adjust our estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures are recognized through a cumulative true-up adjustment in the period of change and also impacts the amount of compensation expense to be recognized in future periods. +Net income and loss per share: We report net income or loss per share in accordance with ASC 260, “Earnings per Share (EPS).” Under this guidance, basic EPS, which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these instruments are excluded from the computation of dilutive EPS. See Note 13 - Earnings per share. +3. Contingent Consideration +In connection with a business acquisition on August 19, 2011, whereby we purchased substantially all of the assets of Printrex, Inc (“Printrex”), we entered into a contingent consideration arrangement with Printrex as part of the acquisition for 30% of the gross profit for a three-year period related to new products under development, less certain other adjustments, beginning on the earlier of 1) January 1, 2012 or 2) the date of first commercial introduction of the new products under development. As of December 31, 2014, the undiscounted fair value related to the contingent liability was estimated to be zero and we did not make a contingent consideration payment. The fair value of the contingent consideration arrangement was $0 at both December 31, 2015 and 2014, which was estimated by applying the income approach. That measure is based on significant inputs that are not observable in the market, which fair value measurement guidance refers to as Level 3 inputs. The fair value of the contingent consideration was decreased by $0, $60,000 and $900,000, in 2015, 2014 and 2013, respectively, and this credit is included in general and administrative expenses on the Consolidated Statements of Operations. No payments were made under the arrangement during 2015 as the contingent consideration measurement period expired on December 31, 2014. +4. Inventories +The components of inventories are: +December 31, +(In thousands) +2015 +2014 +Raw materials and purchased component parts +6,627 +$ +6,183 +Work-in-process +1 +4 +Finished goods +4,668 +5,619 +$ +11,296 +$ +11,806 +5. Fixed assets +The components of fixed assets, net are: +December 31, +(In thousands) +2015 +2014 +Tooling, machinery and equipment +$ +10,836 +$ +10,620 +Furniture and office equipment +1,578 +1,489 +Computer software and equipment +6,037 +6,132 +Leasehold improvements +2,318 +1,952 +20,769 +20,193 +Less: Accumulated depreciation and amortization +(18,336) +(17,858) +2,433 +2,335 +Construction in-process +74 +103 +$ +2,507 +$ +2,438 +F-11 +6. Intangible assets +Identifiable intangible assets are recorded in Intangible assets in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2015 +2014 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,604 +$ +(1,357) +$ +1,604 +$ +(1,172) +Customer relationships +1,300 +(946) +1,300 +(729) +Trademark +480 +(210) +480 +(162) +Covenant not to compete +146 +(146) +146 +(146) +Patents +57 +(40) +57 +(37) +Other +80 +(80) +80 +(80) +Total +$ +3,667 +$ +(2,779) +$ +3,667 +$ +(2,326) +Amortization expense was $454,000, $515,000 and $513,000 in 2015, 2014 and 2013, respectively. Amortization expense for each of the next five years ending December 31 is expected to be as follows: $333,000 in 2016; $245,000 in 2017; $102,000 in 2018; $99,000 in 2019; $78,000 in 2020 and $31,000 in 2021. +7. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2015 +2014 +Salaries and compensation related +$ +2,209 +$ +1,852 +Warranty +164 +207 +Professional and consulting +159 +959 +Other +306 +302 +$ +2,838 +$ +3,320 +8. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of each month immediately following their date of hire. We match employees’ contributions at a rate of 50% of employees’ contributions up to the first 6% of the employees’ compensation contributed to the 401(k) plan. Our matching contributions were $197,000, $282,000 and $265,000 in 2015, 2014, and 2013, respectively. +9. Borrowings +We maintain a credit facility (the “TD Bank Credit Facility”) with TD Bank N.A. (“TD Bank) which provides for a $20,000,000 revolving credit line. On November 26, 2014, we signed an amendment to the TD Bank Credit Facility through November 28, 2017. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.15% on unused borrowings under the revolving credit line. The total deferred financing costs relating to expenses incurred to complete the TD Bank Credit Facility was $8,000 which will be amortized over the three year term. The amendment increased the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $10,000,000 from $5,000,000. The amendment also modified the definition of EBITDA to exclude certain non-recurring expenses, including without limitation, non-recurring litigation and acquisition expenses; and modified the definition of Operating Cash Flow to exclude unfinanced capital expenditures for the quarters ending December 31, 2014, March 31, 2015 and June 30, 2015. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2015. +As of December 31, 2015, undrawn commitments under the TD Bank Credit facility were $20,000,000. +F-12 +10. Commitments and contingencies +On June 8, 2012, Avery Dennison Corporation (“AD”) filed a civil complaint against us and a former employee of ours and of AD, in the Court of Common Pleas (the “Court”) in Lake County, Ohio. The complaint alleged that we and this former employee misappropriated unspecified trade secrets and confidential information from AD related to the design of our food safety terminals. The complaint requested a preliminary and permanent injunction against us from manufacturing and selling our Ithaca® 9700 and 9800 food safety terminals. On July 16, 2012, we filed our answer, affirmative defenses and counterclaims, seeking all available damages including legal fees. A hearing on the plaintiff's motion for preliminary injunction took place in August 2012, and in November 2012, the Court denied this request. AD filed an appeal of the Court’s ruling to the Eleventh Appellate District, which heard oral arguments on the appeal on July 16, 2013. On July 23, 2013, AD requested that the Eleventh Appellate District enjoin our further sale and marketing of the food safety terminals, pending the Court of Appeals’ decision. On July 29, 2013, we opposed this request. On October 15, 2013, the Eleventh District Court of Appeals affirmed the lower court’s decision in our favor and denied AD’s further request of an injunction pending the Court of Appeals’ decision. On October 24, 2013, AD filed a motion seeking that the Court of Appeals reconsider its decision. On April 16, 2014, the Court of Appeals denied AD’s motion to reconsider its decision. On July 28, 2014, AD filed a motion requesting leave from the Court to file an amended complaint and indicating that it has elected to pursue only its claim for damages, dropping its claim for injunctive relief. On September 4, 2014, the Court granted AD’s motion to file an amended complaint. On September 25, 2014, we filed our answer, affirmative defenses and counterclaims with respect to the amended complaint, seeking all available damages including legal fees. On January 30, 2015, we filed a motion for summary judgment seeking judgment in our favor on all counts as to the Company. On the same day, AD filed two motions for partial summary judgment. On February 17, 2015, we opposed both of AD’s motions, and AD opposed our motion. On February 23, 2015, the Company filed a reply brief in support of its motion for summary judgment. A trial was scheduled to begin on April 21, 2015, however, on March 25, 2015 the parties executed a confidential settlement agreement and release (the “Settlement Agreement”) in which the parties mutually agreed to resolve the dispute that was the subject of the lawsuit filed by AD against the Company to the parties’ mutual satisfaction. Under the terms of the Settlement Agreement, we agreed to pay AD $3,600,000 payable on or before April 8, 2015 and also to qualify certain AD labels for use on our food safety terminals at an estimated cost of $25,000. We made the $3,600,000 payment to AD on April 8, 2015 and borrowed $2,500,000 under our revolving credit facility with TD Bank to fund the payment. We recorded the total expense of $3,625,000 in the fourth quarter 2014 as an operating expense included in the line item “Legal fees and settlement expenses associated with lawsuit” on the Consolidated Statement of Operations and as a current liability included in the line item “Accrued lawsuit settlement expenses” on the Consolidated Balance Sheet. In the second quarter of 2015 we reversed $25,000 of this expense because AD did not provide the label testing information by the due date required per the settlement agreement. +At December 31, 2015, we were the lessee on operating leases for equipment and real property. Rent expense was $932,000, $918,000 and $918,000 in 2015, 2014, and 2013, respectively. Minimum aggregate rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2015 are as follows: $618,000 in 2016; $264,000 in 2017; $184,000 in 2018; $186,000 in 2019, $191,000 in 2020 and $365,000 thereafter. +11. Stock incentive plans +Stock incentive plans . We currently have two primary stock incentive plans: the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan, which provide for awards to executives, key employees, directors and consultants. We previously maintained two other stock incentive plans, the 1996 Director’s Stock Plan and the 2001 Employee Stock Plan, both of which expired during 2014. The plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units, (v) stock appreciation rights or (vi) limited stock appreciation rights. Options granted under these plans have exercise prices equal to 100% of the fair market value of the common stock at the date of grant. Options granted have a ten-year term and generally vest over a three- to five-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards will be made under the 2005 Equity Incentive Plan. Under our 2014 Equity Incentive Plan, we may authorize awards for up to 600,000 shares of TransAct common stock. At December 31, 2015, 341,922 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average fair value of stock option grants for 2015, 2014, and 2013 was $6.73, $11.11 and $7.94, respectively. The table below indicates the key assumptions used in the option valuation calculations for options granted in 2015, 2014, and 2013 and a discussion of our methodology for developing each of the assumptions used in the valuation model: +Year ended December 31, +2015 +2014 +2013 +Expected option term +6.8 years +6.6 years +6.8 years +Expected volatility +50.4% +53.8% +56.5% +Risk-free interest rate +1.6% +1.6% +0.8% +Dividend yield +4.7% +2.6% +3.1% +Expected Option Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility – The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An increase in the expected volatility factor will increase compensation expense. +Risk-Free Interest Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +Dividend Yield –The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation expense. +F-13 +11. Stock incentive plans (continued) +For 2015, 2014, and 2013, we recorded $488,000, $506,000, and $521,000 of share-based compensation expense, respectively, included primarily in general and administrative expense in our Consolidated Statements of Operations. We also recorded income tax benefits of $148,000, $377,000, and $127,000 in 2015, 2014, and 2013 respectively, related to such share-based compensation. At December 31, 2015, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Option activity in the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan is summarized below: +Number of Shares +Weighted Average Exercise Price +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at December 31, 2014 +795,975 +$ +8.41 +Granted +204,000 +6.73 +Exercised +(34,600) +7.60 +Forfeited +(7,625) +8.53 +Expired +(42,375) +8.16 +Outstanding at December 31, 2015 +915,375 +$ +8.08 +6.1 years +$ +1,089,000 +Options exercisable at December 31, 2015 +517,375 +$ +7.97 +4.2 years +$ +636,000 +Options vested or expected to vest +899,028 +$ +8.08 +6.0 years +$ +1,071,000 +Shares that are issued upon exercise of employee stock options are newly issued shares and not issued from treasury stock. As of December 31, 2015, unrecognized compensation cost related to stock options is approximately $876,000, which is expected to be recognized over a weighted average period of 2.8 years. +The total intrinsic value of stock options exercised was $32,000, $20,000 and $910,000 and the total fair value of stock options vested was $944,000, $943,000, and $815,000 during 2015, 2014, and 2013, respectively. Cash received from option exercises was $263,000, $13,000 and $1,045,000 for 2015, 2014, and 2013, respectively. We recorded a realized tax benefit in 2015, 2014, and 2013 from equity-based awards of $4,000, $7,000 and $132,000, respectively, related to options exercised which has been included as a component of cash flows from financing activities in the Consolidated Statements of Cash Flows. +Restricted stock: +We paid a portion of the 2014, 2013 and 2012 incentive bonus for the chief executive officer and chief financial officer in the form of 23,578, 8,663 and 17,613 deferred stock units, respectively, with a corresponding credit recorded to Additional Paid in Capital (net of share relinquishments) in the amounts of $121,000, $56,000 and $111,000 in 2015, 2014, and 2013, respectively. Such deferred stock units were granted in February 2015, March 2014, and March 2013, respectively, and were fully vested at the time of grant. These units will be converted three years from the grant date to shares of the Company’s common stock on a one-for-one basis. The weighted average exercise price of the deferred stock units was $8.00. +12. Income taxes +The components of the income tax provision are as follows: +Year Ended December 31, +(In thousands) +2015 +2014 +2013 +Current: +Federal +$ +450 +$ +176 +$ +1,479 +State +22 +15 +38 +Foreign +- +12 +33 +472 +203 +1,550 +Deferred: +Federal +843 +(1,653) +80 +State +35 +17 +(34) +Foreign +- +- +- +878 +(1,636) +46 +Income tax (benefit) provision +$ +1,350 +$ +(1,433) +$ +1,596 +Our effective tax rates were 30.4%, 37.2%, and 24.4% for 2015, 2014, and 2013, respectively. The effective tax rate for 2014 was unusually high due to the impact from the net loss reported for the year ending 2014. Our effective tax rate for 2013 was unusually low because it included: 1) a $224,000 reduction in tax liabilities for unrecognized tax benefits resulting from the completion of an audit of our 2010 federal income tax return and 2) the benefit from the 2012 federal research and development credit (“R&D credit”) of $220,000 as this credit was not renewed until January 2, 2013 as a component of the American Taxpayer Relief Act of 2012. +At December 31, 2015, we have no federal or state net operating loss carryforwards and no R&D credit carryforwards. We have approximately $36,000 in state tax credit carryforwards that begin to expire in 2020. Foreign loss before taxes was $174,000, $56,000, and $29,000 in 2015, 2014, and 2013, respectively. +F-14 +12. Income taxes (continued) +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Our deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2015 +2014 +Deferred tax assets: +Foreign net operating losses +$ +340 +$ +282 +Accrued lawsuit settlement expenses +- +1,262 +Inventory reserves +1,312 +1,063 +Deferred revenue +25 +56 +Warranty reserve +95 +100 +Stock compensation expense +1,105 +1,049 +Other accrued compensation +475 +406 +Foreign tax and other credits +23 +106 +Other liabilities and reserves +191 +312 +Gross deferred tax assets +3,566 +4,636 +Valuation allowance +(340) +(282) +Net deferred tax assets +3,226 +4,354 +Deferred tax liabilities: +Depreciation +45 +142 +Other +36 +76 +Net deferred tax liabilities +81 +218 +Total net deferred tax assets +3,145 +4,136 +As of December 31, 2015 a valuation allowance of $340,000 has been established for foreign net operating loss carryforwards that are not expected to be used. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year ended December 31, +(In thousands) +2015 +2014 +2013 +Balance, beginning of period +$ +282 +$ +242 +$ +216 +Additions charged to income tax provision +58 +40 +56 +Reductions credited to income tax provision +- +- +(30) +Balance, end of period +$ +340 +$ +282 +$ +242 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2015 +2014 +2013 +Federal statutory tax rate +34.0% +34.0% +34.0% +Valuation allowance and tax accruals +1.3 +(1.1) +0.9 +State income taxes, net of federal income taxes +0.8 +(0.5) +0.1 +Uncertain tax positions +(0.3) +(1.0) +- +Miscellaneous permanent items +(0.7) +(0.3) +(8.3) +R&D credit +(4.9) +6.0 +- +Other +0.2 +0.1 +(2.3) +Effective tax rate +30.4% +37.2% +24.4% +At December 31, 2015 and 2014, we had $114,000 and $124,000 of total gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the gross amounts of unrecognized tax benefits at the beginning and end of the year is as follows: +(In thousands) +2015 +2014 +Unrecognized tax benefits as of January 1 +$ +124 +$ +106 +Tax positions taken during the current period +25 +18 +Lapse of statute of limitations +(35) +- +Unrecognized tax benefits as of December 31 +$ +114 +$ +124 +F-15 +12. Income taxes (continued) +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially concluded all U.S. federal income tax, state and local, and foreign tax matters through 2011. During 2013, an examination of our 2010 federal tax return was completed. However, our federal tax returns for the years 2012 through 2014 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +We do not anticipate that the total unrecognized tax benefits of $114,000 will significantly change due to the settlement of audits and the expiration of statute of limitations prior to December 31, 2016. +We recognize interest and penalties related to uncertain tax positions in the income tax provision. As of December 31, 2015 and 2014, we have $19,000 and $20,000, respectively, of accrued interest and penalties related to uncertain tax positions. +13. Earnings per share +For 2015, 2014, and 2013, earnings per share were computed as follows (in thousands, except per share amounts): +Year Ended December 31, +2015 +2014 +2013 +Net income (loss): +$ +3,092 +$ +(2,421) +$ +4,935 +Shares: +Basic: Weighted average common shares outstanding +7,818 +8,307 +8,589 +Add: Dilutive effect of outstanding options as determined by the treasury stock method +36 +- +114 +Diluted: Weighted average common and common equivalent shares outstanding +7,854 +8,307 +8,703 +Net income (loss) per common share: +Basic +$ +0.40 +$ +(0.29) +$ +0.57 +Diluted +0.39 +(0.29) +0.57 +The computation of diluted earnings per share excludes the effect of the potential exercise of stock options, when the average market price of the common stock is lower than the exercise price of the related stock option during the period. These outstanding stock options are not included in the computation of diluted earnings per share because the effect would be anti-dilutive. Anti-dilutive stock options, restricted shares and deferred stock units excluded from the computation of earnings per dilutive share were 735,000, and 311,000, at December 31, 2015 and 2013 respectively. Regarding 2014, when a net loss is reported basic and diluted EPS are calculated using the same method. +14. Stock repurchase program +Prior to its expiration on July 31, 2015, we maintained a stock repurchase program (the “Stock Repurchase Program”) whereby we were authorized to repurchase up to $7,500,000 of our outstanding shares of common stock from time to time in the open market, depending on market conditions, share price and other factors. The Stock Repurchase Program expired on July 31, 2015. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From January 1, 2015 through the expiration date of the Stock Repurchase Program, we repurchased 166,553 shares of our common stock for $1,020,000 at an average price of $6.12 per share. From the start of the Stock Repurchase Program on August 11, 2014 through December 31, 2014, we repurchased 434,998 shares of our common stock for approximately $2,634,000 at an average price per share of $6.06. From January 1, 2005 through December 31, 2015, we repurchased a total of 3,388,589 shares of common stock for $26,181,000, at an average price of $7.73 per share. +On February 25, 2016, our Board of Directors approved a new stock repurchase program. Under this new repurchase program, we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market through December 31, 2017, depending on market conditions, share price and other factors +F-16 +15. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are based on the location of the customer and asset. +Year Ended December 31, +(In thousands) +2015 +2014 +2013 +Net sales: +United States +$ +45,730 +$ +38,567 +$ +46,377 +International +13,946 +14,541 +13,764 +Total +$ +59,676 +$ +53,108 +$ +60,141 +Fixed assets, net: +United States +$ +1,769 +$ +1,490 +$ +1,583 +International +738 +948 +1,149 +Total +$ +2,507 +$ +2,438 +$ +2,732 +Sales to international customers were 23%, 27%, and 23% in 2015, 2014, and 2013 respectively. Sales to Europe represented 56%, 49%, and 52%, sales to the Pacific Rim (which includes Australia and Asia) represented 34%, 33%, and 26%, and sales to Canada represented 8%, 5%, and 10% of total international sales in 2015, 2014, and 2013 respectively. International long-lived assets consist of net fixed assets located at our foreign subsidiary in the United Kingdom as well as our contract manufacturers in China, Thailand, Malaysia and Mexico. +16. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2015 and 2014 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2015: +Net sales +$ +16,164 +$ +17,224 +$ +14,172 +$ +12,116 +Gross profit +6,492 +7,161 +6,291 +5,034 +Net income +144 +1,388 +1,028 +532 +Net income per share: +Basic +0.02 +0.18 +0.13 +0.07 +Diluted +0.02 +0.18 +0.13 +0.07 +2014: +Net sales +$ +13,619 +$ +13,804 +$ +13,389 +$ +12,296 +Gross profit +5,726 +5,788 +5,286 +4,911 +Net income (loss) +394 +175 +50 +(3,040) +Net income (loss) per share: +Basic +0.05 +0.02 +0.01 +(0.37) +Diluted +0.05 +0.02 +0.01 +(0.37) +17. Accounting pronouncements +In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers." This ASU is intended to clarify the principles for recognizing revenue by removing inconsistencies in revenue requirements; providing a more robust framework for addressing revenue issues; improving comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; and providing more useful information to users of financial statements through improved revenue disclosure requirements. In April 2015, the FASB voted to defer the effective date of the new revenue recognition standard by one year. As a result, the provisions of this ASU are now effective for interim and annual periods beginning after December 15, 2017. We are currently evaluating the impact of this ASU. +In July 2015, FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory.” This ASU changes the measurement principle for inventory from the lower of cost or market to lower of cost or net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business; less reasonably predictable costs of completion, disposal and transportation. The provisions of this ASU are effective for years beginning after December 15, 2016. This ASU is not expected to have a significant impact on our financial statements or disclosures. +In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes.” This ASU eliminates the requirement to present deferred tax assets and liabilities as current and noncurrent on the balance sheet. Instead, all deferred tax assets and liabilities are now classified as noncurrent. ASU 2015-17 is effective for fiscal years beginning after December 15, 2016 with early adoption permitted. We will prospectively adopt ASU 2015-17 as required in the first reporting period for the year ending December 31, 2017. +F-17 +17. Accounting pronouncements (continued) +Subsequent to December 31, 2015, the FASB issued ASU 2016-02, “Leases”. The core principle of this ASU requires that a lessee should recognize the assets and liabilities on the balance sheet and disclose key information about leasing arrangements. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods. We are currently evaluating the impact of this ASU. +F-18 +Index to Exhibits +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated (“TransAct” or the “Company”), filed with the Secretary of State of Delaware on June 17, 1996. +(2) +3.1(b) +Certificate of Amendment of Certificate of Incorporation of the Company, filed with the Secretary of State of Delaware on June 4, 1997. +(4) +3.1(c) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December 2, 1997. +(5) +3.1(d) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000. +(7) +3.2 +Amended and Restated By-laws of the Company. +(6) +4.1 +Specimen Common Stock Certificate. +(2) +10.1(x) +2005 Equity Incentive Plan +(10) +10.2(x) +2014 Equity Incentive Plan +(3) +10.3(x) +Employment Agreement, dated July 31, 1996, by and between TransAct and Bart C. Shuldman. +(2) +10.4(x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004. +(9) +10.5(x) +Severance Agreement by and between TransAct and Tracey S. Chernay, dated July 29, 2005. +(13) +10.6(x) +Amendment to Employment Agreement, effective January 1, 2008, by and between TransAct and Bart C. Shuldman. +(14) +10.7(x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008. +(14) +10.8(x) +Amendment to Severance Agreement by and between TransAct and Tracey S. Chernay, effective January 1, 2008. +(14) +10.9 +Lease Agreement by and between Bomax Properties and Ithaca, dated as of March 23, 1992. +(2) +10.10 +Second Amendment to Lease Agreement by and between Bomax Properties and Ithaca, dated December 2, 1996. +(4) +10.11 +Agreement regarding the Continuation and Renewal of Lease by and between Bomax Properties, LLC and TransAct, dated July 18, 2001. +(8) +10.12 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct. +(17) +10.13 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016. +(1) +10.14 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004. +(9) +10.15 +First Amendment to Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated August 31, 2009 +(15) +10.16 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, 2015. +(20) +10.17 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006. +(11) +10.18 +OEM Purchase Agreement by and between IGT (f/k/a GTECH Corporation) and TransAct, dated May 29, 2015. (Pursuant to Rule 24-b-2 under the Exchange Act, the Company has requested confidential treatment of portions of this exhibit deleted from the filed copy) +(20) +10.19 +Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. dated November 28, 2006 +(11) +10.20 +First Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. effective September 30, 2007. +(12) +10.21 +Second Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Bank, N.A. effective November 22, 2011. +(16) +10.22 +Third Amendment to Amended and Restated Revolving Credit and Security Agreement effective September 7, 2012 +(18) +10.23 +Fourth Amendment to Amended and Restated Revolving Credit and Security Agreement effective November 26, 2014 +(19) +23.1 +Consent of PricewaterhouseCoopers LLP. +(1) +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +(1) +101.INS +XBRL Instance Document. +(1) +101.SCH +XBRL Taxonomy Extension Schema Document. +(1) +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +(1) +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +(1) +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +(1) +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +(1) +(1) +These exhibits are filed herewith. +(2) +These exhibits, which were previously filed with the Company’s Registration Statement on Form S-1 (No. 333-06895), are incorporated by reference. +(3) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed May 15, 2014 is incorporated by reference. +(4) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 1997, are incorporated by reference. +(5) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed February 18, 1999, is incorporated by reference. +(6) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 1998, is incorporated by reference. +(7) +These exhibits, which were previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended March 25, 2000, are incorporated by reference. +(8) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, is incorporated by reference. +(9) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, are incorporated by reference. +(10) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed June 1, 2005, is incorporated by reference. +(11) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, are incorporated by reference. +(12) +This exhibit, which was previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2007, is incorporated by reference. +(13) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, is incorporated by reference. +(14) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, is incorporated by reference. +(15) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, is incorporated by reference. +(16) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, is incorporated by reference. +(17) +This exhibit, which was previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2012, is incorporated by reference. +(18) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed September 11, 2012, is incorporated by reference. +(19) +This exhibit, which was previously filed with the Company’s Current Report on Form 8-K filed December 1, 2014, is incorporated by reference. +(20) +This exhibit, which was previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2015, is incorporated by reference +(x) +Management contract or compensatory plan or arrangement. +EXHIBIT LIST +The following exhibits are filed herewith. +Exhibit +23.1 +Consent of PricewaterhouseCoopers LLP. +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. \ No newline at end of file diff --git a/raw/filings/0001017303/2015/0001017303-16-000085/filing_metadata.csv b/raw/filings/0001017303/2015/0001017303-16-000085/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..eef2639b94deb2ec074a19964551569c3f214684 --- /dev/null +++ b/raw/filings/0001017303/2015/0001017303-16-000085/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2016-03-11,2016-03-11,2016-03-11T22:01:03.000Z,0001017303-16-000085,form10k2015.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2015",5792615,1,0,https://www.sec.gov/Archives/edgar/data/1017303/000101730316000085/form10k2015.htm,https://www.sec.gov/Archives/edgar/data/1017303/000101730316000085/,2015,2015,1 diff --git a/raw/filings/0001017303/2015/0001017303-16-000085/item1.txt b/raw/filings/0001017303/2015/0001017303-16-000085/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..d8e9b75f72e2b0850e3f0ecbe181cf10da68c629 --- /dev/null +++ b/raw/filings/0001017303/2015/0001017303-16-000085/item1.txt @@ -0,0 +1,75 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated (“TransAct” or the “Company”) was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct designs, develops and sells market-specific solutions, including printers, terminals, software and other products for transaction-based and other industries. These world-class products are sold under the AccuDate™, Ithaca®, RESPONDER®, Epic, EPICENTRAL™, and Printrex® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality food rotation date and nutritional labels, promotional coupons and transaction records such as receipts, tickets, register journals and other documents as well as printed logging and plotting of oil field and well drilling data. We focus on the following core markets: food safety, banking and point-of-sale (“POS”), casino and gaming, lottery, and Printrex (which serves the oil and gas, medical and mobile printing markets). We sell our products to original equipment manufacturers (“OEMs”), value-added resellers, selected distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of printers. Through our TransAct Services Group (“TSG”) we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the on-line demand for these products. We have one primary operating, hardware research and development and eastern region service center located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters, software research and development and western region service center in Las Vegas, NV, a sales and service center for the oil and gas industry in Houston, TX, a European sales and service center in the United Kingdom, and a sales office located in Macau. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT , 06518, with a telephone number of (203) 859-6800. +Financial Information about Segments +We operate in one reportable segment, the design, development, assembly and marketing of transaction printers and terminals and providing related software, services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements on pages F-3 and F-4 hereof. +Products, Services and Distribution Methods +Printers and terminals: TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal, inkjet and impact printing technology for applications, primarily in the food safety, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our food safety terminals also offer configurable menu options. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers. +Food safety, banking and POS: Our food safety terminals are printing devices that consist of an operating system, a touchscreen and one or two thermal print mechanisms, that print easy-to-read expiration and "enjoy by" date labels to help restaurants effectively manage food rotation and spoilage. In the food safety market, we use an internal sales force to manage sales of our terminals through distribution, as well as to solicit sales directly from end-users. +Our banking and POS printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the banking market, we sell printers that are used by banks, credit unions and other financial institutions to print receipts and/or validate checks at bank teller stations. In the POS market, we sell several models of printers utilizing inkjet, thermal and impact printing technology. Our printers are used primarily by retailers in the restaurant (including fine dining, casual dining, and fast food) and hospitality industries to print receipts for consumers, validate checks, or print on linerless labels or other inserted media. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force. +Lottery: We supply lottery printers to IGT (formerly GTECH Corporation) and its subsidiaries, our largest customer and the world’s largest provider of lottery terminals. In addition, during 2015 we launched a new lottery printer, the Epic 3000, that we will begin to sell to other lottery system customers beyond IGT. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and managed by an internal sales representative. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLT’s”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks (“racinos”) and other gaming venues worldwide. These printers utilize thermal printing technology and can print tickets or receipts in monochrome or two-color (depending upon the model), and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal printing technology for use in non-casino establishments, including game types such as Amusements with Prizes (“AWP”), Skills with Prizes (“SWP”), Fixed Odds Betting Terminals (“FOBT”) and other off-premise gaming type machines around the world. We sell our products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through our primary worldwide distributor, Suzo-Happ Group. We also maintain a dedicated internal sales force to solicit sales from slot manufacturers and casinos, as well as to manage sales through our distributor. +1 +We also offer a software solution, the EPICENTRAL TM Print System (“EPICENTRAL TM ”), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. With EPICENTRAL TM , casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +Printrex: Printrex printers include wide format, rack mounted and vehicle mounted black/white and color thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. In 2015, we launched the Responder MP2™, our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery. In addition, we sell wide format thermal printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM’s, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated internal sales representative with a sales office located in Houston, Texas. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor’s products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress SM and TransAct Care, and other repair services for our printers and terminals. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY, our western region service center in Las Vegas, NV and our oil and gas industry service center in Houston, TX. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and our services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 95% of our printer production is primarily through one third-party contract manufacturer in Asia and to a lesser extent two others in Asia. The remaining 5% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include thermal, inkjet and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, purchases of component parts have declined while purchases of fully-assembled printers produced by our contract manufacturers have increased. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer and food safety terminal models, from one foreign contract manufacturer, and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have a supply agreement with our foreign contract manufacturers, our relationship with them remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms to us during 2016 or that their terms to us will be any less favorable than they have been historically. +Hewlett-Packard Company (“HP”) is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the banking and POS market, but also in other manufacturer’s printing devices across several other markets. +Canon, Inc. (“Canon”) is the sole supplier of inkjet cartridges and other consumable items (“Canon Consumables”) that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2017. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +2 +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 33 United States and 35 foreign patents and have 4 United States and 6 foreign patent applications pending pertaining to our products. The duration of these patents range from 2 to 16 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Seasonality +Restaurants typically reduce purchases of new food safety equipment in the fourth quarter due to the increased volume of transactions during that holiday period. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT (formerly GTECH Corporation) has been our most significant customer. On May 29, 2015, we signed a new agreement with IGT to sell on-line lottery and casino printers to IGT through December 31, 2019. This new agreement replaced the previous agreement that expired on May 29, 2015. Under the terms of the new agreement, we will sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT will purchase such printers from us on a non-exclusive basis. This new agreement will allow TransAct to sell printers to other lottery system customers beyond IGT. +Sales to IGT and other customers representing 10% or more of our total net sales were as follows: +Year ended December 31, +2015 +2014 +2013 +IGT +29% +19% +19% +Suzo-Happ +14% +7% +4% +Eurocoin +0% +11% +12% +Backlog +Our backlog of firm orders was approximately $5,403,000 as of February 29, 2016, compared to $11,356,000 as of February 27, 2015. Based on customers’ current delivery requirements, we expect to ship our entire current backlog during 2016. +Competition +The market for transaction-based and specialty printers is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for our food safety terminals and EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than us. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the food safety market, we compete with Avery Dennison Corporation, Ecolab Inc. and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the banking and POS market, our major competitor is Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. However, we have and will continue to deemphasize efforts in the POS and banking markets going forward. +In the casino and gaming market (consisting principally of slot machine and VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global (formerly FutureLogic, Inc.), Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we hold a leading position, based largely on our long-term relationship with IGT. On May 29, 2015, we signed a non-exclusive agreement with IGT to provide thermal lottery printers to IGT for various lottery applications through December 31, 2019. Prior to this agreement, we had an exclusive purchase agreement whereby IGT exclusively purchased all of its requirements for thermal on-line lottery printers from us and we exclusively sold such printers to IGT. We now compete in this market with other lottery printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +In the Printrex market, we primarily compete with the Imaging Systems Group, Inc. (“iSys”), Neuralog Inc. and GSI Group. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +3 +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, depending on the geographic area. +Our strategy for competing in our markets is to continually develop new products (hardware and software) and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain thermal, inkjet and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $3,599,000, $4,302,000, and $4,065,000 in 2015, 2014 and 2013, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for sale to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $31,000 and $169,000 as of December 31, 2015 and 2014, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $138,000, $201,000, and $199,000 in 2015, 2014 and 2013, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2015, TransAct and our subsidiaries employed 125 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 15 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, AccuDate™, Epic, EPICENTRAL®, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Available Information +We make available free of charge through the “Investor Relations” tab on our internet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. \ No newline at end of file diff --git a/raw/filings/0001017303/2015/0001017303-16-000085/item13.txt b/raw/filings/0001017303/2015/0001017303-16-000085/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..9dda5d300f48e96600fd4bb3101f49b818372286 --- /dev/null +++ b/raw/filings/0001017303/2015/0001017303-16-000085/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2015/0001017303-16-000085/item9a.txt b/raw/filings/0001017303/2015/0001017303-16-000085/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..98ae0337f04e076af93106404d74dcd7b6b63651 --- /dev/null +++ b/raw/filings/0001017303/2015/0001017303-16-000085/item9a.txt @@ -0,0 +1,7 @@ +Item 9A. Controls and Procedures. +Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2015. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2015, our disclosure controls and procedures are effective. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2015. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2015. \ No newline at end of file diff --git a/raw/filings/0001017303/2015/0001017303-16-000085/rp_note.txt b/raw/filings/0001017303/2015/0001017303-16-000085/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2015/0001017303-16-000085/rpt_disclosure.txt b/raw/filings/0001017303/2015/0001017303-16-000085/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..362afd3492ebf9131ff555c98c5f16b500ae6bc5 --- /dev/null +++ b/raw/filings/0001017303/2015/0001017303-16-000085/rpt_disclosure.txt @@ -0,0 +1,5 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains written policies that relate to the identification, review and approval of related party transactions, in addition to the requirements of NASDAQ and the SEC. As part of a review of possible related person transactions, the Company periodically distributes and collects questionnaires that solicit information about any direct or indirect transactions with the Company from each of our directors and officers. +Our Standards of Business Conduct require all directors, officers and employees to avoid any situation that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company. Under our Standards of Business Conduct, situations that involve, or may reasonably be inferred to involve, a conflict between a director, officer or employee's personal interests and the interests of the Company should be disclosed to the Chair of the Audit Committee. The Audit Committee is then responsible for reviewing the transaction. No transaction determined to be a related party transaction will be approved or ratified if the transaction is contrary to the best interests of the Company. In determining whether to approve or ratify a related party transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the related person's interest in the transaction . +From January 1, 2015 to the date of this Proxy Statement, there have not been any transactions subject to the Company's related party transaction policy or of the type described in Item 404 of Regulation S-K, and currently no such transactions are proposed. +6 \ No newline at end of file diff --git a/raw/filings/0001017303/2016/0001017303-17-000014/filing.txt b/raw/filings/0001017303/2016/0001017303-17-000014/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..9a2427fd4b9fa27418d6b816e7526da3dbd9d506 --- /dev/null +++ b/raw/filings/0001017303/2016/0001017303-17-000014/filing.txt @@ -0,0 +1,3891 @@ +10-K +1 +form10k2016.htm +FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2016 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2016 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to . +Commission file number: 0-21121 +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT +06518 +(Address of principal executive offices) +(Zip Code) +Registrant's telephone number, including area code 203-859-6800 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class - Common Stock, par value $.01 per share +Name of Exchange on which Registered - NASDAQ Global Market +Securities registered pursuant to Section 12(g) of the Act : None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☐ No ☒ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. +Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☐ (Do not check if a smaller reporting company) +Smaller reporting company ☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the Registrant was approximately $57,100,000 based on the last sale price on June 30, 2016. +As of February 28, 2017, the number of shares outstanding of the Registrant's common stock, $0.01 par value, was 7,346,459. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant's Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to the 2017 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +4 +Item 1B. +Unresolved Staff Comments +9 +Item 2. +Properties +10 +Item 3. +Legal Proceedings +10 +Item 4. +Mine Safety Disclosures +10 +PART II. +Item 5. +Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +11 +Item 6. +Selected Financial Data +13 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +13 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +25 +Item 8. +Financial Statements and Supplementary Data +25 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +25 +Item 9A. +Controls and Procedures +25 +Item 9B. +Other Information +25 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +25 +Item 11. +Executive Compensation +26 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +27 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +27 +Item 14. +Principal Accounting Fees and Services +27 +PART IV. +Item 15. +Exhibits +27 +Item 16. +Form 10-K Summary +27 +SIGNATURES +Signatures +28 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +EXHIBITS +Index to Exhibits +PART I +Item 1. Business. +The Company +TransAct Technologies Incorporated ("TransAct" or the "Company") was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high growth markets including restaurant solutions, POS automation and banking, casino and gaming, lottery, mobile and oil and gas. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the AccuDate™, Epic, EPICENTRAL™, Ithaca®, Printrex® and Responder® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality labels and transaction records such as receipts, tickets, coupons, register journals and other documents, as well as printed logging and plotting of data. We sell our products to original equipment manufacturers ("OEMs"), value-added resellers ("VARs"), select distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of products. Through our TransAct Services Group ("TSG"), we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the restaurant and hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the demand for these products. Our primary operating, hardware research and development, and eastern region service center is located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters, software research and development and western region service center in Las Vegas, NV, a sales and service center for the oil and gas industry in Houston, TX, a European sales and service center in the United Kingdom, and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT, 06518, with a telephone number of (203) 859-6800. +Financial Information about Segments +We operate in one reportable segment, the design, development, and marketing of software-driven technology and printing solutions for high growth markets, and providing related services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements beginning on page F-3 hereof. +Products, Services and Distribution Methods +Printers and terminals: TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal, inkjet and impact printing technology for applications, primarily in the restaurant solutions, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our restaurant solutions terminals also offer configurable menu options. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers tailored to our customers' business. +Restaurant Solutions: Our line of AccuDate terminals for the restaurant solutions market combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab and go labels for prepared foods, and "enjoy by" date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve and hospitality establishments) effectively manage food spoilage and automate and manage back-of-the-restaurant operations. Our newest addition to the AccuDate product line, the AccuDate XL, is a unique Android® 5.0-based restaurant management terminal specifically designed to meet the food prep management and labeling needs of the restaurant and hospitality industries. Customers buying the AccuDate XL with Jolt software can utilize the terminal for food expiration date labeling and Grab & Go labeling, along with account management and an analytics portal. TransAct's AccuDate® XL restaurant management terminal, integrated with CrunchTime's KitchenSync App, provides an innovative platform that revolutionizes food preparation, food management and other back-of-house processes. In the restaurant solutions market, we use an internal sales force that we plan to build-out in 2017, and to a lesser extent distributors, to solicit sales directly from end-users. Our restaurant solutions line of market, which we formerly referred to as our "food safety" market was rebranded this year in light of this innovative technology and opportunity for market growth. +POS automation and banking: Our POS automation and banking printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the POS market, we sell several models of printers utilizing thermal and impact printing technology. Our POS printers are used primarily by restaurants (including fine dining, casual dining, quick-serve and hospitality establishments) located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we sell inkjet printers that are used by banks, credit unions and other financial institutions to print deposit or withdrawal receipts and/or validate checks at bank teller stations. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals ("VLTs") and other gaming machines that print tickets or receipts instead of issuing coins ("ticket-in, ticket-out" or "TITO") at casinos, racetracks ("racinos") and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets or receipts in monochrome, and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal printing technology for use in non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals and other off-premise gaming type machines around the world. We sell our products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through our primary worldwide distributor, Suzo-Happ Group. We also maintain a dedicated internal sales force to solicit sales from slot manufacturers and casinos, as well as to manage sales through our distributor. +1 +We also offer a software solution, the EPICENTRAL™ Print System ("EPICENTRAL™"), that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. With EPICENTRAL™, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +Lottery: We primarily supply lottery printers to International Gaming Technology and its subsidiaries ("IGT"), our largest customer and the world's largest provider of lottery terminals. In addition, during 2015 we launched a new lottery printer, the Epic 3000, that we sell to other lottery system customers beyond IGT. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and managed by an internal sales representative. +Printrex: Printrex printers include wide format, desktop and rack mounted and vehicle mounted black/white and color thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. In 2015, we launched the Responder MP2™, our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery vehicles. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM's, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated internal sales representative with a sales office located in Houston, Texas. We primarily sell our mobile printer through a single U.S. distributor. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor's products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress™ and TransAct Care, and other repair services for our printers and terminals. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY, our western region service center in Las Vegas, NV and our oil and gas industry service center in Houston, TX. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 95% of our printer production is primarily through two third-party contract manufacturers in Asia and to a lesser extent one other also in Asia. The remaining 5% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include thermal, inkjet and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers produced by our contract manufacturers, and to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer and restaurant solutions terminal models, from one foreign contract manufacturer, and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have a supply agreement with our foreign contract manufacturers, our relationship with them remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms or fully assembled printers to us during 2017 or that their terms to us will be any less favorable than they have been historically. +Hewlett-Packard Company ("HP") is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the POS automation and banking market, but also in other manufacturer's printing devices across several other markets. +2 +Canon, Inc. ("Canon") is the sole supplier of inkjet cartridges and other consumable items ("Canon Consumables") that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2017. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 36 United States and 36 foreign patents and have 2 United States and 3 foreign patent applications pending pertaining to our products. The duration of these patents range from 1 to 16 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during that holiday period which may negatively impact sales of our restaurant solutions terminals or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT has been our most significant customer. On May 29, 2015, we signed an agreement with IGT to sell on-line lottery and casino printers to IGT through December 31, 2019. Under the terms of the agreement, we will sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT will purchase such printers from us on a non-exclusive basis. This new agreement will allow TransAct to sell printers to other lottery system customers beyond IGT. +Sales to IGT and other customers representing 10% or more of our total net sales were as follows: +Year ended December 31, +2016 +2015 +2014 +IGT +26% +29% +19% +Suzo-Happ +15% +14% +7% +Eurocoin +0% +0% +11% +Backlog +Our backlog of firm orders was approximately $16,241,000 as of February 28, 2017, compared to $5,403,000 as of February 29, 2016. Based on customers' current delivery requirements, we expect to fill and recognize as revenue $9,555,000 of our current backlog during 2017 and the remaining $6,686,000 during 2018. +Competition +The market for transaction-based and specialty printers and restaurant solutions terminals is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL TM software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than us. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the restaurant solutions market, we compete with Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the POS automation and banking market, we compete with Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. However, we have and will continue to deemphasize efforts in the POS automation and banking markets going forward. +In the casino and gaming market (consisting principally of slot machine and VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we hold a leading position, based largely on our long-term relationship with IGT. We compete in this market with other lottery printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +3 +In the Printrex market, we primarily compete with the Imaging Systems Group, Inc. ("iSys") and Neuralog Inc. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, depending on the geographic area. +Our strategy for competing in our markets is to continually develop new products (hardware and software) and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain thermal, inkjet and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $4,425,000, $3,599,000, and $4,302,000 in 2016, 2015 and 2014, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for sale to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $2,000 and $31,000 as of December 31, 2016 and 2015, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $29,000, 138,000, and $201,000 in 2016, 2015 and 2014, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2016, TransAct and our subsidiaries employed 120 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 15 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, AccuDate™, Epic, EPICENTRAL™, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Available Information +We make available free of charge through the "Investor Relations" tab on our internet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission ("SEC"). You may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. +Item 1A. Risk Factors +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Management's Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are not the only ones facing our Company. Additional risks not known to us now or that we currently deem immaterial may also impair our business operations. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking statements contained in this Annual Report to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +4 +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are likely to continue to vary due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical operating results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may be due to a number of factors, including, but not limited to, those identified throughout this "Risk Factors" section: +● +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +● +the geographic distribution of our sales; +● +market acceptance of our products, both domestically and internationally; +● +development of new competitive products by others; +● +our responses to price competition; +● +our level of research and development activities; +● +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +● +changes in the amount we spend to promote our products and services; +● +changes in the cost of satisfying our warranty obligations and servicing our installed base of products; +● +availability of third-party components at reasonable prices; +● +general economic and industry conditions, including changes in interest rates affecting returns on cash balances and investments, that affect customer demand; +● +fluctuations of world-wide oil and gas prices; +● +severe weather events (such as hurricanes) that can disrupt or interrupt the operation of our customers or suppliers facilities; and +● +changes in accounting rules. +Due to all of the foregoing factors, and the other risks discussed in this report, quarter-to-quarter comparisons of our operating results may not be an indicator of future performance. +Our revenue and profitability depend on our ability to continue to develop, on a timely basis, new products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated. +The success of newer products such as the AccuDate™ restaurant solutions terminals and RESPONDER MP2™ is dependent on how quickly customers in the related markets accept them given the very little market penetration these products have experienced since they are new and innovative and have limited competition. Additionally, the success of innovative technology, such as printing coupons and promotions at the slot machine using EPICENTRAL™, is dependent on our casino customers' acceptance of such technology. While we have designed EPICENTRAL™ to support our customers' existing investment in our Epic 950® thermal casino printers, such acceptance may nevertheless only build gradually over time or not at all. Delays in acceptance by our customers of new technologies may adversely affect our operations. +Our success depends upon our ability to adapt our capabilities and processes to meet the demands of producing new and innovative products. Because our newer products contain software and are generally more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product innovation. If we cannot efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +Significant developments stemming from the recent change in the U.S. administration or the U.K.'s referendum on membership in the EU could have a material adverse effect on us. +The new U.S. administration may revise current, or implement new, laws and regulations that impact our business and industry. In the months before and after the U.S. presidential election in November 2016, the new administration espoused antipathy towards existing trade agreements, like NAFTA, and proposed trade agreements, like TPP, from which the U.S. subsequently withdrew, and advocated greater restrictions on free trade generally and significant increases on tariffs on goods imported into the United States, particularly from China. Changes in U.S. social, political, regulatory and economic conditions or in laws and policies governing foreign trade, manufacturing, development and investment in the territories and countries where we currently develop and sell products, and any negative sentiments towards the United States as a result of such changes, could adversely affect our business. In addition, negative sentiments towards the United States among non-U.S. customers and among non-U.S. employees or prospective employees could adversely affect sales or hiring and retention, respectively. +On June 23, 2016, the United Kingdom held a referendum and voted in favor of leaving the European Union, or EU. This referendum has created political and economic uncertainty, particularly in the United Kingdom and the EU, and this uncertainty may last for years. Our business in the United Kingdom, the EU, and worldwide could be affected during this period of uncertainty, and perhaps longer, by the impact of the United Kingdom's referendum. There are many ways in which our business could be affected, only some of which we can identify as of the date of this annual report. +The referendum, and the likely withdrawal of the United Kingdom from the EU that it triggers, has caused and, along with events that could occur in the future as a consequence of the United Kingdom's withdrawal, including the possible breakup of the United Kingdom, may continue to cause significant volatility in global financial markets, including in global currency and debt markets. This volatility could cause a slowdown in economic activity in the United Kingdom, Europe or globally, which could adversely affect our operating results and growth prospects. In addition, our business could be negatively affected by new trade agreements between the United Kingdom and other countries, including the United States, and by the possible imposition of trade or other regulatory barriers in the United Kingdom. +5 +Infringement on the proprietary rights of others could put us at a competitive disadvantage, and any related litigation could be time consuming and costly. +Third parties may claim that we violated their intellectual property rights. To the extent of a violation of a third party's patent or other intellectual property right, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish our objectives. Any of these claims, with or without merit, could result in costly litigation and divert the attention of key personnel. If such claims are successful, they could result in costly judgments or settlements. Refer to Item 3. "Legal Proceedings" for discussion surrounding litigation we were involved in regarding alleged misappropriation of unspecified trade secrets and confidential information. +General economic conditions could have a material adverse effect on our business, operating results and financial condition. +Global economic growth has slowed and has resulted in recessions in numerous countries, including many of those in North America, Europe and Asia, where the Company does substantially all of its business. If these economic conditions continue to persist, or if they worsen, a number of negative effects on our business could result, including customers or potential customers reducing or delaying orders, the insolvency of key suppliers which could result in production delays, the inability of customers to obtain credit, and the insolvency of one or more customers. Any of these effects could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including write-downs of assets. +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and services. We may be adversely impacted by any conflicts that could arise between and among our various sales channels. +Our dependence upon distributors and resellers exposes us to numerous risks, including: +● +loss of channel and the ability to bring new products to market; +● +concentration of credit risk, including disruption in distribution should the distributors and / or resellers' financial condition deteriorate; +● +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +● +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +● +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon the business, consolidated results of operations and financial condition. +We have outsourced substantially all of the assembly of our printers and terminals to three contract manufacturers and will be dependent on them for the manufacturing of such products. A failure by these contract manufacturers, or any disruption in such manufacturing or the flow of product from these manufacturers, may adversely affect our business results. +In an effort to achieve additional cost savings and operation benefits, we have continued to outsource the manufacturing and assembly of our printers and terminals to contract manufacturers in Asia. Approximately 80% of our printer and terminal manufacturing is conducted by one third party manufacturer in Asia. +However, to the extent we rely on a third-party service provider for manufacturing services, we may incur increased business continuity risks. We will no longer be able to exercise control over the assembly of certain of our products or any related operations or processes, including the internal controls associated with operations and processes conducted and the quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially adversely affected. +In addition, if any of our contract manufacturers experiences business difficulties or fails to meet our manufacturing needs, then we may be unable to meet production requirements, may lose revenue and may not be able to maintain relationships with our customers. Without the contract manufacturers continuing to manufacture our products and the continuing operation of the contract manufacturers' facilities, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing facility, which could be costly and time consuming and have a material adverse effect on our operating and financial results. +The increased elements of risk that arise from conducting certain operating processes in foreign jurisdictions may lead to an increase in reputational risk. +Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing customers resulting from our inability to produce products for them. +The contract manufacturers have access to our intellectual property, which increases the risk of infringement or misappropriation of this intellectual property. +Political, social or economic instability in regions in which our manufacturers are located, could cause disruptions in trade, including exports to the U.S. +A significant portion of our printers and terminals are manufactured by contract manufacturers overseas and are exported to the U.S. Any such disruption in trade, including exports to the U.S., could adversely affect our business results. Events that could cause disruptions to such exports to the U.S. include: +● +the imposition of additional trade law provisions or regulations; +● +reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; +● +the imposition of additional duties, tariffs and other charges on imports and exports; +● +economic uncertainties and adverse economic conditions (including inflation and recession); +● +fluctuations in the value of the U.S. Dollar against foreign currencies; +● +significant labor disputes, such as dock strikes; +● +significant delays in the delivery of cargo due to port security considerations; +● +financial or political instability in any of the countries in which our printers and terminals are manufactured. +6 +We source some of our component parts and consumable products from sole source suppliers; any disruptions may impact our ability to manufacture and sell our products. +Our products rely on certain key components from third party or sole source suppliers. We do not have guaranteed supply contracts with any of our component suppliers, and our suppliers could delay shipments, increase prices or cease manufacturing such products or selling them to us at any time. A disruption in the supply of such component parts and consumable products could delay our production and/or the release of our new products and hinder our ability to meet our commitments to customers. If we are unable to obtain a sufficient quantity of these components on commercially reasonable terms or in a timely manner, or if we are unable to obtain alternative sources for the components, sales of our products could be delayed or halted entirely or we may be required to redesign our products. Any of these events could result in lost sales, reduced gross margins or damage to our end-customer relationships, which would have a material adverse effect on our operations and financial results. +We sell a significant portion of our products internationally and purchase important components from foreign suppliers. These circumstances create a number of risks. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. Risks associated with sales and purchases outside the United States include: +● +fluctuating foreign currency rates could restrict sales, or increase costs of purchasing, in foreign countries; +● +foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers or capital flow restrictions; +● +political and economic instability may reduce demand for our products or put our foreign assets at risk; +● +restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets; and +● +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from selling in certain geographic territories. +We face risks associated with manufacturing forecasts. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays, which could cause us to lose orders or customers and result in lower net sales. We currently use a rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our requirements for components and materials. It is very important that we accurately predict both the demand for our products and the lead-time required to obtain the necessary components and raw materials. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size of the order, contract terms, and demand for each component at a given time. If we underestimate our requirements, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and result in delays in shipments and net sales. If we overestimate our requirements, we could have excess inventory of parts. In addition, delays in the manufacturing of our products could cause us to lose orders or customers. +In the lottery market, we have been dependent on sales to one large customer; the loss of this customer or reduction in orders from this customer could materially affect our sales. +We expect that sales to our largest customer, IGT, will continue to represent a material percentage of our net sales for the foreseeable future. A reduction, delay or cancellation in orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Our success will depend on our ability to sustain and manage growth. +As part of our business strategy, we intend to pursue a growth strategy. Assuming this growth occurs, it will require the expansion of distribution relationships in international markets, the successful development and marketing of new products for our existing and new markets, expanded internal sales, customer service and support, and the continued implementation and improvement of our operational, financial and management information systems. +To the extent that we seek growth through acquisitions, our ability to manage our growth will also depend on our ability to integrate businesses that have previously operated independently. We may not be able to achieve this integration without encountering difficulties or experiencing the loss of key employees, customers or suppliers. It may be difficult to design and implement effective financial controls for combined operations and differences in existing controls for each business may result in weaknesses that require remediation when the financial controls and reporting functions are combined. As we pursue acquisitions, we may incur legal, accounting and other transaction related expenses for unsuccessful acquisition attempts that could adversely affect our results of operations in the period in which they are incurred. +There can be no assurance that we will be able to successfully implement our growth strategy, or that we can successfully manage expanded operations, if they occur. As we expand, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our results of operations and financial condition. +We compete in highly competitive markets, which are likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, transaction supplies and services. Our principal competitors have substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +● +technologically advanced products that satisfy the user demands; +● +superior customer service; +● +high levels of quality and reliability; and +● +dependable and efficient distribution networks. +7 +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products. Any of these factors could reduce our earnings. +We depend on key personnel, the loss of which could materially impact our business. +Our future success will depend in significant part upon the continued service of certain key management and other personnel and our continuing ability to attract and retain highly qualified managerial, technical and sales and marketing personnel. There can be no assurance that we will be able to recruit and retain such personnel. The loss of either Bart C. Shuldman, the Company's Chairman of the Board and Chief Executive Officer, or Steven A. DeMartino, the Company's President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, could have a material adverse effect on our results of operations. +If we are unable to enforce our patents or if it is determined that we infringe patents held by others it could damage our business. +Prosecuting and defending patent lawsuits is very expensive. We are committed to aggressively asserting and defending our technology and related intellectual property, which we have spent a significant amount of money to develop. These factors could cause us to become involved in new patent litigation in the future. The expense of prosecuting or defending these future lawsuits could also have a material adverse effect on our business, financial condition and results of operations. +If we were to lose a patent lawsuit in which another party is asserting that our products infringe its patents, we would likely be prohibited from marketing those products and could also be liable for significant damages. Either or both of these results may have a material adverse effect on our business, financial condition and results of operations. If we lose a patent lawsuit in which we are claiming that another party's products are infringing our patents and thus, are unable to enforce our patents, it may have a material adverse effect on our business, financial condition and results of operations. In addition to disputes relating to the validity or alleged infringement of other parties' rights, we may become involved in disputes relating to our assertion of our own intellectual property rights. Whether we are defending the assertion of intellectual property rights against us or asserting our intellectual property rights against others, intellectual property litigation can be complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. Plaintiffs in intellectual property cases often seek injunctive relief, and the measures of damages in intellectual property litigation are complex and often subjective or uncertain. Thus, any adverse determinations in this type of litigation could subject us to significant liabilities and costs. During the course of these lawsuits there may be public announcements of the results of hearings, motions, and other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could harm the market price of our stock. +The inability to protect intellectual property could harm our reputation, and our competitive position may be materially damaged. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trade secrets and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without authorization, to obtain and use information which we regard as trade secrets. +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as: +● +changes in our business, operations or prospects; +● +developments in our relationships with our customers; +● +announcements of new products or services by us or by our competitors; +● +announcement or completion of acquisitions by us or by our competitors; +● +changes in existing or adoption of additional government regulations; +● +unfavorable or reduced analyst coverage; and +● +prevailing domestic and international market and economic conditions. +In addition, the stock market has experienced significant price fluctuations in recent years. Broad market fluctuations, general economic conditions and specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Limited trading volume and a reduction in analyst coverage of our common stock may contribute to its price volatility. +Our common stock is traded on the NASDAQ Global Market. During the year ended December 31, 2016, the average daily trading volume for our common stock as reported by the NASDAQ Global Market was approximately 19,000 shares. We are uncertain whether a more active trading market in our common stock will develop. In addition, many investment banks no longer find it profitable to provide securities research on micro-cap and small-cap companies. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the price of our common stock. +Future sales of our common stock may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, and we may also issue additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future sale pursuant to stock options and other equity awards that we have granted to our employees, and in the future we may grant additional stock options and other forms of equity compensation to our employees. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. +8 +If market conditions deteriorate or future results of operations are less than expected, a valuation allowance may be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred tax assets on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions deteriorate or future results of operations are less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are not realizable. As a result, we may need to establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +We cannot provide any assurance that current laws, or any laws enacted in the future, will not have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements in each of the jurisdictions in which we conduct business. Changes in laws, rules, regulations, policies or requirements could result in the need to modify our products and could affect the demand for our products, which may have an adverse impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. It is possible that terrorist attacks could be directed at important locations for the gaming industry. Heightened security measures and other efforts to combat terrorism may also have an adverse effect on the gaming industry by reducing tourism. Any of these developments could also negatively affect the general economy and consumer confidence. Any downturn in the economy or in the gaming industry in particular could reduce demand for our products and adversely affect our business and results of operations. In addition, heightened security measures may cause certain governments to restrict the import/export of goods, which may have an adverse effect on our ability to buy/sell goods. +Fluctuations in oil and gas prices could adversely affect drilling and exploration activities by oil and gas companies and our revenue in our Printrex market. If oil and gas prices remain volatile, or if oil or gas prices remain low or decline further, the demand for our Printrex products could be adversely affected. +The demand for our Printrex products depends on the level of spending by oil and gas companies for drilling and exploratory activities, which are affected by short-term and long-term trends in oil and gas prices, including current and anticipated oil and gas prices. Oil and gas prices, as well as the level of drilling and exploration, historically have been extremely volatile and are expected to continue to be highly volatile. If oil and gas prices continue to remain low or decline further, or if there is a further reduction in drilling and exploration activities, the demand for our Printrex products could be materially and adversely affected. +Security breaches, cyber-attacks, or other disruptions could expose us to liability and affect our business and reputation. +We are increasingly dependent on our information technology systems and infrastructure for our business. We collect, store, and transmit sensitive information including intellectual property, proprietary business information and personal information in connection with business operations. The secure maintenance of this information is critical to our operations and business strategy. Some of this information could be an attractive target of criminal attack by third parties with a wide range of motives and expertise, including organized criminal groups, disgruntled current or former employees, and others. Cyber-attacks are of ever-increasing levels of sophistication, and despite our extensive security measures, our information technology and infrastructure may be vulnerable to such attacks or may be breached, including due to employee error or malfeasance. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. If our systems become compromised, we may not promptly discover the intrusion. Like other companies in our industry, we have experienced attacks to our data and systems, including malware and computer viruses that we have been able to detect and eliminate. If our systems fail or are breached or disrupted, we could lose product sales, and suffer reputational damage and loss of customer confidence. Such incidents would require notification to affected individuals, and may result in legal claims or proceedings and liability under federal and state laws that protect the privacy and security of personal information. Any one of these events could cause our business to be materially harmed and our results of operations to be adversely impacted. +Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely impact our business. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on our business, financial condition, and results of operations. +Item 1B. Unresolved Staff Comments. +Not applicable. +9 +Item 2. Properties. +Our principal facilities as of December 31, 2016 are listed below and we believe that all facilities generally are in good condition, adequately maintained and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. +Ft.) +Owned or +Leased +Lease Expiration +Date +Hamden, Connecticut * +Executive offices and TSG sales office +11,100 +Leased +April 23, 2017 +Ithaca, New York +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2021 +Las Vegas, Nevada +Software design and development, service center and casino and gaming sales office +19,600 +Leased +October 31, 2022 +Doncaster, United Kingdom +Sales office and service center +6,000 +Leased +August 26, 2026 +Houston, Texas +Sales office and service center +100 +Leased +April 30, 2017 +Macau, China +Sales office +180 +Leased +June 30, 2017 +110,880 +*On January 3, 2017 we signed an amendment to extend our lease in Hamden to April 30, 2027. The amendment is included as an exhibit to this 10-K. +Item 3. Legal Proceedings. +On June 8, 2012, Avery Dennison Corporation ("AD") filed a civil complaint against us and a former employee of ours and of AD, in the Court of Common Pleas (the "Court") in Lake County, Ohio. The complaint alleged that we and this former employee misappropriated unspecified trade secrets and confidential information from AD related to the design of our restaurant solutions terminals. The complaint requested a preliminary and permanent injunction against us from manufacturing and selling our Ithaca® 9700 and 9800 restaurant solutions terminals. On July 16, 2012, we filed our answer, affirmative defenses and counterclaim, seeking all available damages including legal fees. A hearing on the plaintiff's motion for preliminary injunction took place in August 2012, and in November 2012, the Court denied this request. AD filed an appeal of the Court's ruling to the Eleventh Appellate District, which heard oral arguments on the appeal on July 16, 2013. On July 23, 2013, AD requested that the Eleventh Appellate District enjoin our further sale and marketing of the restaurant solutions terminals, pending the Court of Appeals' decision. On July 29, 2013, we opposed this request. On October 15, 2013, the Eleventh District Court of Appeals affirmed the lower court's decision in our favor and denied AD's further request of an injunction pending the Court of Appeals' decision. On October 24, 2013, AD filed a motion seeking that the Court of Appeals reconsider its decision. On April 16, 2014, the Court of Appeals denied AD's motion to reconsider its decision. On July 28, 2014, AD filed a motion requesting leave from the Court to file an amended complaint and indicating that it has elected to pursue only its claim for damages, dropping its claim for injunctive relief. On September 4, 2014, the Court granted AD's motion to file an amended complaint. On September 25, 2014, we filed our answer, affirmative defenses and counterclaims with respect to the amended complaint, seeking all available damages including legal fees. On January 30, 2015, we filed a motion for summary judgment seeking judgment in our favor on all counts as to the Company. On the same day, AD filed two motions for partial summary judgment. On February 17, 2015, we opposed both of AD's motions, and AD opposed our motion. On February 23, 2015, the Company filed a reply brief in support of its motion for summary judgment. A trial was scheduled to begin on April 21, 2015; however, on March 25, 2015 the parties executed a confidential settlement agreement and release (the "Settlement Agreement") in which the parties mutually agreed to resolve the dispute that was the subject of the lawsuit filed by AD against the Company to the parties' mutual satisfaction. Under the terms of the Settlement Agreement, we agreed to pay AD $3,600,000 payable on or before April 8, 2015 and also to qualify certain AD labels for use on our restaurant solutions terminals at an estimated cost of $25,000. We made the $3,600,000 payment to AD on April 8, 2015 and borrowed $2,500,000 under our revolving credit facility with TD Bank to fund the payment. We recorded the total expense of $3,625,000 in the fourth quarter 2014 as an operating expense included in the line item "Legal fees and settlement expense associated with lawsuit" on the Consolidated Statement of Operations and as a current liability included in the line item "Accrued lawsuit settlement expenses" on the Consolidated Balance Sheet. In the second quarter of 2015, we reversed $25,000 of this expense because AD did not provide the label testing information by the due date required per the settlement agreement. +Item 4. Mine Safety Disclosures. +Not applicable. +10 +PART II +Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +Our common stock is traded on the NASDAQ Global Market under the symbol TACT. As of February 28, 2017, there were 316 holders of record of the common stock and the common stock was trading at $7.40. The high and low bid sales prices of the common stock reported during each quarter of the years ended December 31, 2016 and 2015 were as follows: +Year Ended +Year Ended +December 31, 2016 +December 31, 2015 +High +Low +High +Low +First Quarter +$ +9.44 +$ +6.55 +$ +6.85 +$ +5.46 +Second Quarter +8.98 +6.43 +7.50 +5.02 +Third Quarter +8.24 +7.19 +9.20 +6.40 +Fourth Quarter +7.50 +5.90 +10.46 +7.95 +In September 2012, we announced that our Board of Directors approved the initiation of a quarterly cash dividend program which is subject to the Board's approval each quarter. On May 6, 2014, our Board of Directors declared an increase to the quarterly cash dividend from $0.07 per share to $0.08 per share. Dividends declared and paid on our common stock totaled $2,416,000 or $0.32 per share and $2,485,000 or $0.32 per share, in 2016 and 2015, respectively. On February 3, 2017, our Board of Directors approved the first quarter 2017 dividend in the amount of $0.08 per share payable on or about March 15, 2017 to common shareholders of record at the close of business on February 20, 2017. +Issuer Purchases of Equity Securities +On February 25, 2016, our Board of Directors approved a new stock repurchase program (the "Stock Repurchase Program"). Under the Stock Repurchase Program, we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market through December 31, 2017 at prevailing market prices based on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From the start of the Stock Repurchase Program on February 25, 2016 through December 31, 2016, we purchased 463,378 shares of our common stock for approximately $3,571,000 at an average price of $7.71. During the fourth quarter of 2016 we purchased 50,000 shares of our common stock for approximately $329,000 at an average price of $6.58. +In 2015 and 2014, under a prior repurchase program, we purchased 166,553 and 434,998 shares of our common stock for $1,020,000 and $2,634,000 at an average price of $6.12 and $6.06 per share, respectively. From January 1, 2005 through December 31, 2016, we repurchased a total of 3,851,967 shares of common stock for $ 29,752,000, at an average price of $7.72 per share. +Securities Authorized for Issuance under Equity Compensation Plans +For a discussion of the Company's equity compensation plan information, please see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Form 10-K. +11 +CORPORATE PERFORMANCE GRAPH +The following graph compares the cumulative total return on the Company's Common Stock from December 31, 2011 through December 31, 2016, with the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Hardware Stocks Index. The graph assumes that $100 was invested on December 31, 2011 in each of TransAct's common stock, the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Manufacturer Stocks Index, and that all dividends were reinvested. +COMPARISON OF CUMULATIVE TOTAL RETURN AMONG +TRANSACT TECHNOLOGIES INCORPORATED COMMON STOCK, +THE CRSP TOTAL RETURN INDEX FOR THE NASDAQ STOCK MARKET (U.S.), +AND THE NASDAQ COMPUTER MANUFACTURER STOCKS INDEX +12/31/11 +12/31/12 +12/31/13 +12/31/14 +12/31/15 +12/31/16 +TransAct Technologies Incorporated Common Stock +$ +100.00 +$ +99.45 +$ +172.59 +$ +75.34 +$ +118.32 +$ +90.91 +CRSP Total Return Index for the Nasdaq Stock Market (U.S.) +$ +100.00 +$ +116.43 +$ +155.41 +$ +174.78 +$ +175.62 +$ +198.47 +Nasdaq Computer Hardware Stocks Index +$ +100.00 +$ +119.88 +$ +141.04 +$ +191.18 +$ +174.07 +$ +200.63 +12 +Item 6. Selected Financial Data (in thousands, except per share amounts) +The following is summarized from our audited financial statements of the past five years: +Year ended December 31, +2016 +2015 +2014 +2013 +2012 +Consolidated Statement of Operations Data: +Net sales +$ +57,235 +$ +59,676 +$ +53,108 +$ +60,141 +$ +68,386 +Gross profit +23,799 +24,978 +21,711 +25,092 +25,982 +Operating expenses +18,599 +20,510 +25,483 +18,475 +20,380 +Operating income (loss) +5,200 +4,468 +(3,772 +) +6,617 +5,602 +Net income (loss) +3,617 +3,092 +(2,421 +) +4,935 +3,621 +Net income (loss) per share: +Basic +0.48 +0.40 +(0.29 +) +0.57 +0.40 +Diluted +0.47 +0.39 +(0.29 +) +0.57 +0.40 +Dividends declared and paid per share +0.32 +0.32 +0.31 +0.27 +0.06 +December 31, +2016 +2015 +2014 +2013 +2012 +Consolidated Balance Sheet Data: +Total assets +$ +32,042 +$ +32,569 +$ +35,491 +$ +40,408 +$ +45,228 +Shareholders' equity +24,109 +25,728 +25,394 +32,521 +33,369 +Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Forward Looking Statements +Certain statements included in this report, including without limitation statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally can be identified by the use of forward-looking terminology, such as "may", "will", "expect", "intend", "estimate", "anticipate", "believe", "project" or "continue" or the negative thereof or other similar words. All forward-looking statements involve risks and uncertainties, including, but not limited to those listed in Item 1A of this Annual Report. Actual results may differ materially from those discussed in, or implied by, the forward-looking statements. The forward-looking statements speak only as of the date of this report and we assume no duty to update them. +Overview +During 2016, we continued to focus our efforts on sales execution and growing the revenue of our newer, value-added products and technologies. This resulted in higher sales in both our restaurant solutions terminals and EPICENTRAL TM casino software solution. During 2016 we also continued to develop these products by investing in engineering through the hiring of additional software engineers to enhance our EPICENTRAL™ software and expand of our line of restaurant solutions terminals. During 2017 we plan to strategically invest in our sales and marketing for the restaurant solutions market. We currently sell our restaurant solutions terminals primarily through distributors but in 2017 we will expand our internal sales force in order to further develop sales directly to the end customer. We believe these investments will strengthen our position in the restaurant solutions market and result in increased sales and margins in 2017. +During 2016, our sales decreased primarily due to lower TSG sales as our largest customer, IGT, placed a large order of replacement parts mainly for a legacy lottery printer in 2015 that did not repeat to the same extent in 2016. During 2016 we also experienced lower sales in our casino and gaming market, primarily in the international casino and gaming market due to the continued sluggishness in the international markets that started in 2015. Our Printex market has seen a significant, consisent negative impact from the world-wide decline in oil and gas prices. These decreases were partially offset by increased sales in our POS automation and banking market due to sales to McDonald's to support new initiatives that started in late 2015 and continued into 2016. Additionally, we saw continued market penetration of our restaurant solutions terminals as sales increased in 23% in 2016 compared to 2015. +During 2016, our total net sales decreased 4% to approximately $57,235,000. See the table below for a breakdown of our sales by market: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Restaurant solutions +$ +5,162 +9.0 +% +$ +4,191 +7.0 +% +$ +971 +23.2 +% +POS automation and banking +10,518 +18.4 +% +8,838 +14.8 +% +1,680 +19.0 +% +Casino and gaming +21,006 +36.7 +% +21,755 +36.5 +% +(749 +) +(3.4 +%) +Lottery +9,913 +17.3 +% +9,468 +15.9 +% +445 +4.7 +% +Printrex +540 +1.0 +% +1,381 +2.3 +% +(841 +) +(60.9 +%) +TSG +10,096 +17.6 +% +14,043 +23.5 +% +(3,947 +) +(28.1 +%) +$ +57,235 +100.0 +% +$ +59,676 +100.0 +% +$ +(2,441 +) +(4.1 +%) +Sales of our restaurant solutions products increased 23% in 2016 compared to 2015. In the restaurant solutions market, our focus lies with providing terminals that print food rotational date and nutritional labels to help restaurants and other food service establishments effectively manage food rotation and spoilage. The increase in restaurant solutions sales resulted largely from the continued success of our AccuDate™ 9700 terminal and the AccuDate™ Pro that was introduced in 2015. Our focus for 2017 will be to utilize an expanded internal sales force to continue increasing market penetration with our line of restaurant solutions terminals and make strategic investments in our sales and marketing force mentioned above. +Sales of our POS automation and banking products increased 19% in 2016 compared to 2015. In the POS market, we focus primarily on supplying printers that print receipts or linerless labels for customers in the restaurant and quick serve markets. During 2016, the increased sales of our POS automation and banking printers was driven by a 38% increase of our Ithaca® 9000 printers compared to 2015 to support new initiatives at McDonald's. We expect this level of sales to decrease in 2017 as McDonald's nears completion of the implementation of the initiatives started in 2015. The increased POS sales from our Ithaca®9000 printer was partially offset by a 51% decrease in sales of our other legacy POS printers that we have recently deemphasized. In the banking market, we focus mainly on supplying printers for use in bank teller stations at banks and financial institutions primarily in the U.S. Although we continue to provide printers to our existing banking and POS (non-McDonald's) customers, we have significantly reduced our focus on this market in order to increase our focus on the restaurant solutions market. As a result, sales of our banking printer sales decreased 27% in 2016 and we expect sales of our POS automation and banking printers to continue to decline in 2017. +13 +Sales of our casino and gaming products decreased 3% in 2016 compared to 2015. In our casino and gaming market, our focus lies primarily in supplying printers worldwidefor use in slot machines at casinos and racetracks, as well as in other electronic gaming devices that print tickets or receipts. Additionally, we supplement these printer sales with revenue from EPICENTRAL™, our promotional printing system that enables casino operators to create promotional coupons and marketing messages and print them real time at the slot machine. The decrease of casino and gaming printers is due to the 28% decrease in international sales of the EPIC 950, our thermal casino printer, due to continued sluggishness in Australia and Asia. Domestic casino and gaming printer sales have remained relatively consistent, decreasing less than 1%. Sales of our EPICENTRAL TM software have increased 46% in 2016 compared to 2015 as we completed three installations worldwide compared to one installation completed in 2015. During 2016 we made strategic investments to improve and enhance EPICENTRAL TM which has led to increased revenue growth during 2016 that we believe will continue into 2017. +In the lottery market, we continue to hold a leading position based on our long-term relationship with IGT, our largest customer and the world's largest provider of lottery terminals. IGT has been our customer since 1995, and we continue to maintain a good relationship with them. During 2016, total lottery printer sales to IGT increased approximately 5%, compared to 2015. Domestic lottery sales to IGT increased 20% but was offset by an 86% decrease in international lottery sales to IGT due a sale in 2015 for the Spanish lottery that did not repeat in 2016. Our sales to IGT each year are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs and are not indicative of IGT's overall business or revenue. Starting in 2015, we no longer have an exclusive arrangement with IGT, however, we do not believe this will significantly impact our business as we continue to have a good relationship with IGT and we now have the ability to sell our market leading products to other lottery system customers. +Sales of our Printrex branded printers include wide format, rack mounted and vehicle mounted thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. Sales in this market also includes wide format vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. During 2016, we experienced 61% lower Printrex product sales due primarily to the negative impact on drilling activity from our customers resulting from the continued decline of worldwide oil prices. Although we are uncertain when the oil and gas market will recover, we have taken prudent steps to align our cost structure with the current revenue level while we wait for the rebound to occur. +Our TSG group, which sells service, replacement parts and consumable products, including receipt paper, ribbons and inkjet cartridges, continues to offer a recurring revenue stream for the Company. TSG sales decreased 28% in 2016 from 2015 primarily due to usually high sales of replacement parts mainly to IGT for a legacy lottery printer in 2015 that did not repeat to the same extent in 2016. Additionally, we experienced a decrease in sales of Printrex consumables due to lower usage by our oil and gas customers due to depressed oil prices, as well as lower sales of HP inkjet cartridges used in our banking printers as we deemphasize our focus on this commoditized product. Despite lower TSG sales in 2016 we expect TSG sales to increase in 2017, largely in the second half of the year, due to contractual commitments for replacement part sales to IGT. +Operationally, our gross margin was 41.6% in 2016, which fell just 30 basis points shy of the record high gross margin of 41.9% we reported in 2015. We believe gross margin will increase in 2017 as our newer, higher margin products continue to grow and become a larger portion of our overall sales. In 2016 we achieved operating margin of 9.1% compared to 7.5% in 2015 primarily due to legal and settlement expenses incurred in 2015 related to the now-settled AD Lawsuit. During 2017, we expect to more significantly increase our focus on the restaurant solutions market, as we believe it represents TransAct's most significant, long term growth opportunity. To that end, we plan to build out a world-class, direct sales organization by recruiting and bringing new sales staff on board, as well as launch targeted marketing campaigns to support our restaurant solutions business. As a result of this investment, we expect our operating expenses, largely selling and marketing, to increase by approximately $2 million in 2017 compared to 2016. +We reported net income of $3,617,000 and net income per diluted share of $0.47 for 2016, compared to $3,092,000 and net income per diluted share of $0.39 for 2015. In terms of cash flow for 2016, we experienced a very strong year, generating $4,623,000 of cash from operating activities. We also returned $5,963,000 to our shareholders in the form of $3,571,000 for treasury shares and $2,416,000 for cash dividends and finishing the year with cash and cash equivalents of $2,503,000 and no debt on our Consolidated Balance Sheet at December 31, 2016. +Critical Accounting Policies and Estimates +The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Income categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances. We evaluate our assumptions on an ongoing basis by comparing actual results with our estimates. Actual results may differ from the original estimates. +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These items utilize assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Please refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial Statements for a complete listing of our accounting policies. +Revenue Recognition – Our typical contracts include the sale of printers and terminals, which are sometimes accompanied by separately-priced extended warranty contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer or terminal sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within Accounting Standards Codification ("ASC") 605, "Revenue Recognition" (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms which are generally FOB shipping point) has occurred, the selling price is fixed and determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +14 +Our software solution, EPICENTRAL TM , enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. Revenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, "Multiple-Element Arrangements" and ASC 985-605, "Software." EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system's full functionality. These arrangements are accounted for in accordance with ASC 605-25, "Multiple-Element Arrangements". EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, "Software" as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level GAAP and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence ("VSOE") if available, third party evidence ("TPE") if VSOE is not available, or best estimate of selling price ("BESP") to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, "Separately Priced Extended Warranty and Product Maintenance Contracts." Pursuant to this guidance, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established, but we cannot guarantee that we will continue to experience return rates consistent with historical patterns. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. However, we cannot guarantee that this minimal level will continue. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +Accounts Receivable – We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on available credit information; and adjustments to credit limits based upon payment history and the customer's current creditworthiness. We also provide an estimate of doubtful accounts based on historical experience and specific customer collection issues. Our allowance for doubtful accounts as of December 31, 2016 was approximately $50,000, or less than 1% of outstanding accounts receivable, which we feel is appropriate considering the overall quality of our accounts receivable. While credit losses have historically been within expectations and the reserves established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience. +Inventories – Our inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market. We review market value based on historical usage and estimates of future demand. Assumptions are reviewed at least quarterly and adjustments are made, as necessary, to reflect changing market conditions. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and market value. Should circumstances change and we determine that additional inventory is subject to obsolescence, additional write-downs of inventory could result in a charge to income. +Goodwill and Intangible Assets – We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with Accounting Standards Codification ("ASC") 350-20 "Goodwill", acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Definite lived intangible assets are amortized and are tested for impairment when appropriate. We reported $2,621,000 of goodwill and $545,000 of unamortized definite-lived intangible assets at December 31, 2016. We have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2016 when the impairment review is performed. +Income Taxes – In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing temporary differences between the tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. +15 +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax reserves with respect to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this forecast against the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future deferred tax assets in excess of its net recorded amount, an adjustment to the valuation allowance would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, "Income Taxes." Among other things this provision prescribes a minimum recognition threshold that an income tax position must meet before it is recorded in the reporting entity's financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet reporting date, it is "more likely than not" (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing authority will examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between the amount claimed, or expected to be claimed, on a company's income tax returns and the benefits recognized in the financial statements. +Warranty – We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. If actual future product repair rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability and related warranty expense would be made. +Contingencies – We record an estimated liability related to contingencies based on our estimates of the probable outcomes pursuant to ASC 450, "Contingencies." On a quarterly basis, we assess the potential liability related to pending litigation, audits and other contingencies and confirm or revise estimates and reserves as appropriate. If the actual liabilities are settled in an amount greater than those recorded on the balance sheet, a charge to income would be recorded. As of December 31, 2014 we had reduced the contingent liability to $0 in connection with a contingent consideration arrangement entered into as part of the Printrex acquisition. The reduction made in 2014 resulted from a decrease of $60,000 that was the result of our revised estimate of the expected payout in connection with this arrangement, primarily due to changes in probabilities and decreases in revenue and gross margin estimates, and was credited to general and administrative expense during 2014. No contingent liability reserve was recorded in 2016 or 2015 and we will not make any further reserves in the future in regards to the Printrex acquisition as the contingent consideration measurement period expired on December 31, 2014. See Note 3 to the Consolidated Financial Statements for further discussion. +Share-Based Compensation – We calculate share-based compensation expense in accordance with ASC 718, "Compensation – Stock Compensation" using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, dividend yield, and forfeiture rate. The determination of these assumptions is based on past history and future expectations, and is subject to judgment. To the extent any of the assumptions were to change from year to year, the fair value of new option grants may vary significantly. +Results of Operations: Year ended December 31, 2016 compared to year ended December 31, 2015 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2016 and 2015 were as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Restaurant solutions +$ +5,162 +9.0 +% +$ +4,191 +7.0 +% +$ +971 +23.2 +% +POS automation and banking +10,518 +18.4 +% +8,838 +14.8 +% +1,680 +19.0 +% +Casino and gaming +21,006 +36.7 +% +21,755 +36.5 +% +(749 +) +(3.4 +%) +Lottery +9,913 +17.3 +% +9,468 +15.9 +% +445 +4.7 +% +Printrex +540 +1.0 +% +1,381 +2.3 +% +(841 +) +(60.9 +%) +TSG +10,096 +17.6 +% +14,043 +23.5 +% +(3,947 +) +(28.1 +%) +$ +57,235 +100.0 +% +$ +59,676 +100.0 +% +$ +(2,441 +) +(4.1 +%) +International* +$ +11,693 +20.4 +% +$ +13,946 +23.4 +% +$ +(2,253 +) +(16.2 +%) +* +International sales do not include sales of products made to domestic distributors or other customers who in turn ship those products to international destinations. +Net sales for 2016 decreased $2,441,000, or 4%, from 2015. Although net sales decreased, printer and terminal sales volume increased 3% in 2016 compared to 2015. Our printer and terminal volume increased to approximately 173,000 units, primarily due to 22% increases in both the POS automation and banking and restaurant solutions markets. The average selling price of our printers decreased less than 1% from 2016 to 2015. Overall, international sales decreased $2,253,000, or 16%, primarily driven by lower sales in the international lottery and casino and gaming markets. +16 +Restaurant solutions: Revenue from the restaurant solutions market includes sales of terminals which combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab and go labels for prepared foods, and "enjoy by" date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve and hospitality establishments) effectively manage food spoilage and automate and manage back-of-the-restaurant operations. A summary of sales of our worldwide restaurant solutions products for the years ended December 31, 2016 and 2015 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +4,747 +92.0 +% +$ +3,857 +92.0 +% +$ +890 +23.1 +% +International +415 +8.0 +% +334 +8.0 +% +81 +24.3 +% +$ +5,162 +100.0 +% +$ +4,191 +100.0 +% +$ +971 +23.2 +% +The increase in domestic restaurant solutions terminal sales in 2016 compared to 2015 was primarily driven by an increase in sales of our restaurant solutions terminals to McDonald's and increased sales penetration to a growing number of existing and new end user customers through our U.S. distributor. +International restaurant solutions terminal sales increased in 2016 compared to 2015, due primarily to increased sales to our Latin American distributor. +POS automation and banking: Revenue from the POS automation and banking market includes sales of thermal and impact printers used primarily by restaurants (including fine dining, casual dining, quick serve and hospitality establishments) located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In addition, revenue includes sales of inkjet printers used by banks, credit unions and other financial institutions to print deposit or withdrawal receipts and/or validate checks at bank teller stations. A summary of sales of our worldwide POS automation and banking products for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +9,754 +92.7 +% +$ +8,180 +92.6 +% +$ +1,574 +19.2 +% +International +764 +7.3 +% +658 +7.4 +% +106 +16.1 +% +$ +10,518 +100.0 +% +$ +8,838 +100.0 +% +$ +1,680 +19.0 +% +The increase in both domestic and international POS automation and banking printer revenue in 2016 compared to 2015 was primarily driven by a 38% increase in sales of our Ithaca® 9000 printer as we continued to supply printers to support new initiatives by McDonald's that started in 2015 and accelerated in 2016. We expect sales to McDonald's to decrease in 2017 as McDonald's nears completion of the implementation of the initiatives started in 2015. This increase was partially offset by 43% lower sales of our legacy banking and other POS printers in 2016 compared to 2015 as we continue to deemphasize these products. We expect sales of these legacy products to continue to decline during 201 as we shift sales focus to our newer products. +Casino and gaming: Revenue from the casino and gaming market includes sales of thermal ticket printers used in slot machines, video lottery terminals ("VLTs"), and other gaming machines that print tickets or receipts instead of issuing coins ("ticket-in, ticket-out" or "TITO") at casinos and racetracks ("racinos") and other gaming venues worldwide. Revenue from this market also includes sales of thermal roll-fed printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes ("AWP"), Skills with Prizes ("SWP") and Fixed Odds Betting Terminals ("FOBT") at non-casino gaming establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of our software solution (including annual software maintenance for), the EPICENTRAL TM print system, that enables casino operators to create promotional coupons and marketing messages and to print them real-time at the slot machine. A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +11,553 +55.0 +% +$ +11,354 +52.2 +% +$ +199 +1.8 +% +International +9,453 +45.0 +% +10,401 +47.8 +% +(948 +) +(9.1 +%) +$ +21,006 +100.0 +% +$ +21,755 +100.0 +% +$ +(749 +) +(3.4 +%) +During 2016, domestic casino and gaming sales increased 2%, primarily due to a 37% increase in EPICENTRAL TM software sales as we completed two domestic installations in 2016 compared to one domestic installation in 2015. Domestic sales of our thermal casino printers during 2016 were consistent with sales in 2015. +International sales declined in 2016 due to 28% lower sales of our thermal casino printer in Europe and Asia compared to 2015. The decrease from our thermal casino printers was partially offset by increased off-premises thermal gaming printers and EPICENTRAL TM software sales of 38% and 121%, respectively. Sales of our off-premise gaming printers increased due to an expanding market for sports betting in Europe and Australia. However, sales of our off-premise gaming printers are largely project-oriented and therefore may fluctuate significantly from quarter to quarter and year to year. The increase in EPICENTRAL TM software sales was due to one new international installation completed in 2016 compared to no international installations completed in 2015. +Lottery: Revenue from the lottery market includes sales of thermal on-line and other lottery printers to IGT and its subsidiaries for various lottery applications. A summary of sales of our worldwide lottery printers for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +9,710 +98.0 +% +$ +8,064 +85.2 +% +$ +1,646 +20.4 +% +International +203 +2.0 +% +1,404 +14.8 +% +(1,201 +) +(85.5 +%) +$ +9,913 +100.0 +% +$ +9,468 +100.0 +% +$ +445 +4.7 +% +17 +Our sales to IGT are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of IGT's overall business or revenue. Based on our backlog of orders and customer's forecasts, we expect total lottery printer sales to IGT for 2017 to be consistent with those reported for 2016. +International lottery sales decreased due to sales of lottery printers to IGT for the Spanish lottery in 2015 and no comparable international sales occurring in 2016. +Printrex: Printrex branded printers are sold into markets that include wide format, rack mounted and vehicle mounted black/white and color thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. Revenue in this market also includes sales of wide format printers used to print test results in ophthalmology devices in the medical industry, as well as vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. A summary of sales of our worldwide Printrex printers for the years ended December 31, 2016 and 2015 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +463 +85.7 +% +$ +1,088 +78.8 +% +$ +(625 +) +(57.4 +%) +International +77 +14.3 +% +293 +21.2 +% +(216 +) +(73.7 +%) +$ +540 +100.0 +% +$ +1,381 +100.0 +% +$ +(841 +) +(60.9 +%) +The decrease in Printrex printers was primarily due to a 52% decline in domestic and international sales in the oil and gas market due to the continued impact from the decline in worldwide oil prices. In addition, we experienced a 79% decline in medical and mobile printer sales due largely to the loss of a customer in the medical industry and as we shift our sales focus towards the restaurant solutions market. Due to the low margin on this product, we believe the loss of this customer will not have a material adverse impact on our operating results in future years. +TSG: Revenue from TSG includes sales of consumable products (inkjet cartridges, ribbons, receipt paper, and other printing supplies), replacement parts, maintenance and repair services, testing services, refurbished printers, and shipping and handling charges. A summary of sales in our worldwide TSG market for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +9,315 +92.3 +% +$ +13,187 +93.9 +% +$ +(3,872 +) +(29.4 +%) +International +781 +7.7 +% +856 +6.1 +% +(75 +) +(8.8 +%) +$ +10,096 +100.0 +% +$ +14,043 +100.0 +% +$ +(3,947 +) +(28.1 +%) +The decrease in domestic revenue from TSG was due to a (1) 38% decrease in sales of replacement parts due mainly to IGT's purchase of an unusually high volume of spare parts for the lottery market in 2015 that did not repeat in 2016, (2) 19% decrease in non-Printrex consumables, largely from the decline of HP inkjet cartridges, as we continue to deemphasize the commoditized POS and banking consumable products, (3) 18% decline in service revenue, primarily due to project-oriented testing services that occurred in 2015 that did not recur to the same extent in 2016, and (4) 62% decrease of consumables sales for our Printrex color printer due to lower printing usage resulting from reduced drilling activity caused by the decline in worldwide oil prices. Based on our backlog of orders and contractual commitments from IGT for spare parts for our installed base of lottery printers, we expect TSG sales to be higher in 2017, particularly in the second half of 2017, than in 2016. +Internationally, TSG revenue decreased, primarily due to 8% and 37% lower sales of replacement parts and accessories and non-Printrex consumables, respectively, in 2016 compared to 2015. +Gross Profit. Gross profit information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +23,799 +$ +24,978 +(4.7 +%) +41.6 +% +41.9 +% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, direct labor, manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers and expenses associated with installations and maintenance of our EPICENTRAL® print system. Gross profit decreased $1,179,000, or 5%, due primarily to a 4% decrease in sales. Our gross margin remained relatively consistent, decreasing slightly by 30 basis points compared 2015, to 41.6%. +18 +Engineering, Design and Product Development. Engineering, design and product development information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +4,425 +$ +3,599 +23.0 +% +7.7 +% +6.0 +% +Engineering, design and product development expenses primarily include salary and payroll related expenses for our hardware and software engineering staff, depreciation and design expenses (including prototype printer expenses, outside design and testing services, and supplies). Such expenses increased $826,000 or 23%, due primarily to higher product development costs and the hiring of additional software engineers beginning in early 2016, as we continue to focus and strategically invest in enhancements to our EPICENTRAL™ software and expansion of our line of restaurant solutions terminals. +Selling and Marketing . Selling and marketing information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +6,907 +$ +7,806 +(11.5 +%) +12.1 +% +13.1 +% +Selling and marketing expenses primarily include salaries and payroll related expenses for our sales and marketing staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, e-commerce and other promotional marketing expenses. Such expenses decreased $899,000, or 12%, primarily due to lower compensation costs related to headcount reductions made during 2016, lower sales commission due to lower sales experienced in 2016 compared to 2015, and a decrease in travel expenses we consciously decided to reduce these expenses. We expect selling and marketing expenses to be higher in 2017 compared to 2016 due to investments that will be made in 2017 as we commit more resources and invest in our internal infrastructure dedicated to the restaurant solutions market to build a world-class sales force and implement direct market campaigns to address the significant market opportunities. +General and Administrative. General and administrative information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +7,267 +$ +7,367 +(1.4 +%) +12.7 +% +12.3 +% +General and administrative expenses primarily include salaries and payroll related expenses for our executive, accounting, human resource, and information technology staff, expenses for our corporate headquarters, professional and legal expenses, telecommunication expenses, and other expenses related to being a publicly-traded company. General and administrative expenses decreased $100,000, or 1%, due primarily to lower incentive compensation costs incurred in 2016 compared to 2015, which was largely offset by higher severance cost related to headcount reductions made during 2016. We expect general and administrative expenses in 2017 to be higher than 2016 due to recruiting costs related to the planned expansion of sales staff for our restaurant solutions market. +Legal Fees and Settlement Expenses Associated with Lawsuit . Legal fees and settlement expenses information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +- +$ +1,738 +(100.0 +%) +0.0 +% +2.9 +% +As disclosed in Note 10 to the Condensed Consolidated Financial Statements, in June 2012, AD filed a civil complaint against the Company. In connection with this lawsuit, we incurred legal fees and settlement expenses of $0 and $1,738,000 in 2016 and 2015, respectively. Due to the settlement of the AD lawsuit in March 2015, we do not expect to incur any further expenses related to this lawsuit in the future. +Operating Income. Operating income information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales – 2016 +Total Sales – 2015 +Year ended +$ +5,200 +$ +4,468 +16.4 +% +9.1 +% +7.5 +% +Our operating income increased by $732,000, or 16%, primarily due to lower legal fees and settlement expenses incurred in 2016, partially offset by 4% lower sales, compared to 2015. Excluding the AD legal fees, our operating income would have decreased $1,006,000, or 16% in 2016 compared to 2015, due primarily to a 4% decline in sales. +Interest. We recorded net interest expense of $26,000 in 2016 compared to $28,000 in 2015. Interest expense was higher in 2015 due to interest expense incurred from borrowing $2,500,000 to pay the AD lawsuit settlement in 2015. We did not borrow any funds during 2016. +Other, net . We recorded other expense of $4,000 in 2016 compared to other income of $2,000 in 2015. The change was primarily due to higher foreign currency exchange losses recorded by our U.K. subsidiary in 2016 compared to 2015. +Income Taxes . We recorded an income tax provision of $1,553,000 in 2016 compared to $1,350,000 in 2015. Our effective tax rate for 2016 of 30.0% remained relatively consistent with the effective tax rate in 2015 of 30.4%. We expect our annual effective tax rate for 2017 to be approximately 32%. +19 +Net Income. We reported net income during 2016 of $3,617,000, or $0.47 per diluted share, compared to $3,092,000, or $0.39 per diluted share, for 2015. +Results of Operations: Year ended December 31, 2015 compared to year ended December 31, 2014 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2015 and 2014 were as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Restaurant solutions +$ +4,191 +7.0 +% +$ +2,183 +4.1 +% +$ +2,008 +92.0 +% +POS automation and banking +8,838 +14.8 +% +7,125 +13.4 +% +1,713 +24.0 +% +Casino and gaming +21,755 +36.5 +% +22,731 +42.8 +% +(976 +) +(4.3 +%) +Lottery +9,468 +15.9 +% +4,761 +9.0 +% +4,707 +98.9 +% +Printrex +1,381 +2.3 +% +3,910 +7.4 +% +(2,529 +) +(64.7 +%) +TSG +14,043 +23.5 +% +12,398 +23.3 +% +1,645 +13.3 +% +$ +59,676 +100.0 +% +$ +53,108 +100.0 +% +$ +6,568 +12.4 +% +International* +$ +13,946 +23.4 +% +$ +14,541 +27.4 +% +$ +(595 +) +(4.1 +%) +* +International sales do not include sales of products made to domestic distributors or other customers who in turn ship those products to international destinations. +Net sales for 2015 increased $6,568,000, or 12%, from 2014. Printer and terminal sales volume increased 22% to approximately 167,000 units primarily due to increases in the lottery, restaurant solutions and POS automation and banking markets, of 97%, 86% and 27%, respectively. The average selling price of our printers and terminals decreased approximately 7% from 2014 to 2015, due primarily to a large portion of our sales being generated from lower priced lottery printers. Overall, international sales decreased $595,000, or 4%, primarily driven by lower sales in the international casino and gaming, TSG and Printrex markets. The declines in the international market were partially offset by increases in the restaurant solutions market, POS automation and banking market and lottery market. +Restaurant solutions: A summary of sales of our worldwide restaurant solutions products for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +3,857 +92.0 +% +$ +1,980 +90.7 +% +$ +1,877 +94.8 +% +International +334 +8.0 +% +203 +9.3 +% +131 +64.5 +% +$ +4,191 +100.0 +% +$ +2,183 +100.0 +% +$ +2,008 +92.0 +% +The increase in both domestic and international restaurant solutions product revenue from 2014 was primarily driven by the resumption of shipments to our distributor who made a large initial stocking order in 2013 and did not make any purchases during the first nine months of 2014. Also, 2015 restaurant solutions sales benefited from shipments to a large national quick service chain store as well as first revenue contributions from our newly launched AccuDate™ Pro restaurant solutions terminal. +POS automation: A summary of sales of our worldwide POS automation and banking products for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +8,180 +92.6 +% +$ +7,004 +98.3 +% +$ +1,176 +16.8 +% +International +658 +7.4 +% +121 +1.7 +% +537 +443.8 +% +$ +8,838 +100.0 +% +$ +7,125 +100.0 +% +$ +1,713 +24.0 +% +The increase in both domestic and international POS automation and banking product revenue from 2014 was primarily driven by a 31% increase in sales of our Ithaca®9000 printers due to new initiatives by McDonald's Corporation that started and accelerated in 2015. These increases were partially offset by lower sales of our legacy banking printers and other POS printers. +20 +Casino and gaming: A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +11,354 +52.2 +% +$ +10,437 +45.9 +% +$ +917 +8.8 +% +International +10,401 +47.8 +% +12,294 +54.1 +% +(1,893 +) +(15.4 +%) +$ +21,755 +100.0 +% +$ +22,731 +100.0 +% +$ +(976 +) +(4.3 +%) +During 2015, domestic printer sales increased 6% compared to 2014 which we believe was due to market share gains, as the replacement cycle for slot machines remained weak. Domestic EPICENTRAL™ software sales also increased 79% as we completed one installation during 2015 compared to no domestic installations completed in 2014. +International sales declined in 2015 due to decreased sales of our thermal casino printer and EPICENTRAL TM software of 19% and 87%, respectively. EPICENTRAL™ software sales decreased as we had no new international installations in 2015 compared to one large multi-property installation for a customer in South America in 2014. The decreases in sales of thermal casino printer and EPICENTRAL™ were partially offset by a 22% increase in sales of our off-premises thermal gaming printers in 2015 compared to 2014 largely due to installations in sports wagering machines in Spain. +Lottery: A summary of sales of our worldwide lottery printers for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +8,064 +85.2 +% +$ +4,682 +98.3 +% +$ +3,382 +72.2 +% +International +1,404 +14.8 +% +79 +1.7 +% +1,325 +1,677.2 +% +$ +9,468 +100.0 +% +$ +4,761 +100.0 +% +$ +4,707 +98.9 +% +Our sales to IGT are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of IGT's overall business or revenue. International sales increased significantly due to a one-time sale to IGT of a custom lottery printer for the Spanish lottery. +Printrex: A summary of sales of our worldwide Printrex printers for the years ended December 31, 2015 and 2014 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +1,088 +78.8 +% +$ +3,352 +85.7 +% +$ +(2,264 +) +(67.5 +%) +International +293 +21.2 +% +558 +14.3 +% +(265 +) +(47.5 +%) +$ +1,381 +100.0 +% +$ +3,910 +100.0 +% +$ +(2,529 +) +(64.7 +%) +The decrease in sales of Printrex printers was primarily due to 67% lower worldwide sales of printers in the oil and gas market due to the continued negative impact from the decline in worldwide oil prices. In addition, worldwide sales of our medical and mobile printers declined 59% due largely to the loss of a customer in the medical industry. This decrease was partially offset by the first contribution from our RESPONDER mobile printer in 2015. +TSG: A summary of sales in our worldwide TSG market for the years ended December 31, 2015 and 2014 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2015 +December 31, 2014 +$ +% +Domestic +$ +13,187 +93.9 +% +$ +11,112 +89.6 +% +$ +2,075 +18.7 +% +International +856 +6.1 +% +1,286 +10.4 +% +(430 +) +(33.4 +%) +$ +14,043 +100.0 +% +$ +12,398 +100.0 +% +$ +1,645 +13.3 +% +The increase in domestic revenue from TSG was primarily due to a 58% increase in sales of replacement parts mainly to IGT who purchased an unusually high volume of spare parts for the lottery market in 2015 and to a lesser extent a 22% increase in services revenue largely from project oriented paper testing services. These increases were partially offset by a 9% decline in non-Printrex consumables, largely from the decline of HP inkjet cartridges, as we continued to deemphasize this commoditized consumable product. In addition, consumables revenue for our Printrex color printers declined by 32%, due to lower printing usage resulting from reduced drilling activity caused by the decline in worldwide oil prices. +Internationally, TSG revenue decreased due primarily to lower sales of replacement parts and accessories in 2015 compared to 2014 due to unusually high sales to IGT in 2014 to support international legacy lottery printers that did not reoccur in 2015. +Gross Profit. Gross profit information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +24,978 +$ +21,711 +15.0 +% +41.9 +% +40.9 +% +21 +Gross profit increased $3,267,000, or 15%, on a 12% increase in sales. Additionally, our gross margin increased by 100 basis points as we experienced a more favorable sales mix during 2015 compared to 2014. This increase in gross margin was achieved despite a large portion of our sales being generated from our lottery printers during 2015 which carry lower gross margin than our other products. The improved gross margin was attained primarily due to higher margin contributions from TSG products and restaurant solutions terminal sales. +Engineering, Design and Product Development. Engineering, design and product development information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +3,599 +$ +4,302 +(16.3 +%) +6.0 +% +8.1 +% +Engineering, design and product development expenses decreased $703,000 or 16%, due primarily to a 17% reduction of engineering compensation expenses as a result of our 2014 cost reduction initiatives as well as lower pre-production expenses during 2015 compared to 2014 when we were in the process of launching three new products. +Selling and Marketing . Selling and marketing information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +7,806 +$ +7,920 +(1.4 +%) +13.1 +% +14.9 +% +Selling and marketing expenses decreased $114,000, or 1%, primarily due to lower marketing expenses from cost savings initiatives as well as lower travel expenses in our Printrex markets as we consciously decided to reduce these expenses in response to the worldwide decline in the oil and gas markets. These decreases were partially offset by the planned investments we made during the second half of 2014 and early 2015 in new sales and marketing staff to focus on sales execution of our new products. +General and Administrative. General and administrative information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +7,367 +$ +7,756 +(5.0 +%) +12.3 +% +14.6 +% +General and administrative expenses decreased $389,000, or 5%, due primarily to lower salary expenses related to the departure of our VP, Business Development during the fourth quarter of 2014, who was not replaced and severance costs related to the cost reduction initiatives that were incurred during the fourth quarter of 2014. These decreases were partially offset by higher incentive compensation expenses during 2015 compared to 2014. +Legal Fees and Settlement Expenses Associated with Lawsuit . Legal fees and settlement expenses information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales - 2015 +Total Sales - 2014 +Year ended +$ +1,738 +$ +5,505 +(68.4 +%) +2.9 +% +10.4 +% +As disclosed in Note 10 to the Consolidated Financial Statements, in June 2012, AD filed a civil complaint against the Company, which we settled in March 2015. In connection with this lawsuit, we incurred legal fees and settlement expenses of $1,738,000 and $5,505,000 in 2015 and 2014, respectively. +Operating Income (Loss). Operating income information is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2015 +2014 +Change +Total Sales – 2015 +Total Sales – 2014 +Year ended +$ +4,468 +$ +(3,772 +) +(218.5 +%) +7.5 +% +(7.1 +%) +The increase in our operating income and operating margin was primarily due to lower legal fees and settlement expenses incurred in 2015 compared to 2014 as well as a 12% increase in sales during 2015. +Interest. We recorded net interest expense of $28,000 in 2015 compared to $49,000 in 2014. The decrease in net interest expense is due to the lower unused revolving credit line fee we are charged when we renewed the TD Bank Credit Facility on November 26, 2014. As of the renewal we are charged a fee of 0.15% on unused borrowings compared to 0.25% under the prior credit facility. "Liquidity and Capital Resources" below for more information. +Other, net . We recorded other income of $2,000 in 2015 compared to other expense of $33,000 in 2014. The change was primarily due to a $27,000 loss from the disposal of equipment during 2014 in addition to lower foreign currency exchange losses recorded by our U.K. subsidiary in 2015 compared to 2014. +22 +Income Taxes . We recorded an income tax provision for 2015 of $1,350,000 at an effective tax rate of 30.4% compared to an income tax benefit of $1,433,000 at an effective tax rate of 37.2% for 2014. The effective tax rate for 2014 is higher than our 2015 effective tax rate due to the impact from the net loss reported for the year ending 2014. +Net Income. We reported net income during 2015 of $3,092,000, or $0.39, per diluted share, compared to net loss of $2,421,000, or $(0.29), per diluted share, for 2014. +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors affecting the management of liquidity are cash flows from operating activities, capital expenditures, treasury share repurchases, dividend payments, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to access credit lines, if needed, are expected to be sufficient to fund operations, capital expenditures, treasury share repurchases, dividend payments and any increase in working capital that would be required to accommodate a higher level of business activity. We actively seek to expand by acquisition as well as through the growth of our current business. While a significant acquisition may require additional debt and/or equity financing, although no assurances can be given, we believe that we would be able to obtain additional financing based on our historical earnings performance. +Cash Flow +During 2016 our cash balance decreased $1,970,000, or 44%, from December 31, 2015 and we returned a substantial portion of our cash flow to shareholders in the form of $3,571,000 of repurchases of our common stock and $2,416,000 of cash dividends paid to common shareholders. Even after funding these items and our capital expenditures, we still ended 2016 with $2,503,000 in cash and cash equivalents, of which $93,000 was held by our U.K. subsidiary, and no debt outstanding. +Operating activities : The following significant factors primarily affected our cash provided by operating activities of $4,623,000 in 2016 as compared to $5,547,000 in 2015. During 2016: +● +We reported a net income of $3,617,000. +● +We recorded depreciation, amortization and share-based compensation expense of $1,942,000. +● +Accounts receivable increased $3,434,000 due primarily to the large amount of sales occurring late in the fourth quarter of 2016 compared to the fourth quarter of 2015. +● +Inventories decreased $1,580,000 due to the sell through of inventory on hand during 2016. +● +Accounts payable increased $2,255,000 due primarily to the purchase of inventory late in the fourth quarter to support the increased fourth quarter sales in 2016. +● +Accrued liabilities and other liabilities decreased $1,088,000 due primarily to lower accrued bonus compensation cost and deferred revenue in 2016 compared to 2015. +During 2015: +● +We reported a net income of $3,092,000. +● +We recorded depreciation, amortization and share-based compensation expense of $1,914,000. +● +Accounts receivable decreased $1,916,000 due primarily to improved collections during the fourth quarter of 2015 compared to the fourth quarter of 2014. +● +Inventories decreased $509,000 due to the sell through of inventory on hand during 2015. +● +Accounts payable increased $277,000 due primarily to the timing of payments. +● +Accrued liabilities and other liabilities decreased $3,487,000 due primarily to the payment of the AD lawsuit settlement in April 2015. See Note 10 – Commitments and Contingencies in the Notes to the Consolidated Financial Statements for further information on the lawsuit. +Investing activities : Our capital expenditures were $608,000 and $959,000 in 2016 and 2015, respectively. Expenditures in 2016 were primarily for various computer and networking equipment and $84,000 in leasehold improvements for our new UK facility and to a lesser extent new product tooling equipment and purchases of furniture and fixtures. +Capital expenditures for 2017 are expected to be approximately $1,000,000, primarily for new product tooling, and tooling enhancements for our existing products, as well as for new computer software and equipment purchases. +Financing activities : We used $5,963,000 of cash from financing activities during 2016 to purchase $3,571,000 of common stock for treasury and pay cash dividends of $2,416,000 to common shareholders, partially offset by proceeds and tax benefits from stock option exercises of $24,000. During 2015, we used $3,238,000 of cash from financing activities to pay cash dividends of $2,485,000 to common shareholders and purchase $1,020,000 of common stock for treasury, partially offset by proceeds and tax benefits from stock option exercises of $267,000. Additionally, during 2015, we borrowed $2,500,000 under the TD Bank Credit Facility to partially fund the $3,600,000 settlement payment related to the AD lawsuit which we fully repaid in 2015. +Resource Sufficiency +We believe that our cash and cash equivalents on hand and cash flows generated from operating activities will provide sufficient resources to meet our working capital needs, finance our capital expenditures, dividend payments and meet our liquidity requirements through at least the next twelve months. +23 +Credit Facility and Borrowings +We maintain a credit facility (the "TD Bank Credit Facility") with TD Bank N.A. ("TD Bank") which provides for a $20,000,000 revolving credit line. On November 26, 2014, we signed an amendment to renew the TD Bank Credit Facility through November 28, 2017. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.15% on unused borrowings under the revolving credit line. The total deferred financing costs relating to expenses incurred to complete the TD Bank Credit Facility was $8,000. The amendment increases the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $10,000,000 from $5,000,000. The amendment also modified the definition of EBITDA to exclude certain non-recurring expenses, including without limitation, non-recurring litigation and acquisition expenses (including the $3,625,000 expense we incurred in 2014 related to the settlement of the AD lawsuit); and modified the definition of Operating Cash Flow to exclude unfinanced capital expenditures for the quarters ending December 31, 2014, March 31, 2015 and June 30, 2015. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2016. The following table lists the financial covenants and the performance measurements at December 31, 2016: +Financial Covenant +Requirement/Restriction +Calculation at December 31, 2016 +Operating cash flow / Total debt service +Minimum of 1.25 times +60.47 +Funded debt / EBITDA +Maximum of 3.0 times +0 times +As of December 31, 2016, undrawn commitments under the TD Bank Credit facility were $20,000,000. +Shareholder Dividend Payments +In September 2012, we announced that our Board of Directors approved the initiation of a quarterly cash dividend program which is subject to the Board's approval each quarter. On May 6, 2014, our Board of Directors declared an increase to the quarterly cash dividend from $0.07 per share to $0.08 per share. Dividends declared and paid on our common stock totaled $2,416,000 or $0.32 per share and $2,485,000 or $0.32 per share, in 2016 and 2015, respectively. On February 3, 2017, our Board of Directors approved the first quarter 2017 dividend in the amount of $0.08 per share payable on or about March 15, 2017 to common shareholders of record at the close of business on February 20, 2017. We expect to pay approximately $2,400,000 in cash dividends to our common shareholders during 2017. +Stock Repurchase Program +On February 25, 2016, our Board of Directors approved a new stock repurchase program (the "Stock Repurchase Program"). Under the Stock Repurchase Program, we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market through December 31, 2017 at prevailing market prices based on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From the start of the Stock Repurchase Program on February 25, 2016 through December 31, 2016, we purchased 463,378 shares of our common stock for approximately $3,571,000 at an average price of $7.71. In 2015, under a prior repurchase program, we purchased 166,553 shares of our common stock for $1,020,000 at an average price of $6.12 per share. From January 1, 2005 through December 31, 2016, we repurchased a total of 3,851,967 shares of common stock for $ 29,752,000, at an average price of $7.72 per share. +Shareholders' Equity +Shareholders' equity decreased $1,619,000 to $24,109,000 at December 31, 2016 from $25,728,000 at December 31, 2015. The decrease was primarily due to the purchase of 463,378 shares of treasury stock for $3,571,000 and our payment of $2,416,000 in dividends. These decreases were partially offset by net income of $3,617,000, share-based compensation expense related to stock options of $611,000 and $151,000 from the issuance 10,700 shares of deferred stock units, net of relinquishments. +Off Balance Sheet Arrangements +As of December 31, 2016, we had no off balance sheet arrangements that have had or that we expect would be reasonably likely to have a future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. +Contractual Obligations +Our contractual obligations as of December 31, 2016 were as follows: +Payments due by period +(In thousands) +Total +< 1 year +1-3 years +3-5 years +> 5 years +Operating lease obligations +$ +4,033 +$ +825 +$ +1,565 +$ +1,276 +$ +367 +Purchase obligations +8,411 +$ +8,389 +$ +22 +– +– +Total +$ +12,444 +$ +9,214 +$ +1,587 +$ +1,276 +$ +367 +Purchase obligations are for purchases made in the normal course of business to meet operational requirements, primarily of fully assembled printers and component part inventory. +Impact of Inflation +We believe that our business has not been affected to a significant degree by inflationary trends during the past three years. However, inflation is still a factor in the worldwide economy and may increase the cost of purchasing products from our contract manufacturers in Asia, as well as the cost of certain raw materials, component parts and labor used in the production of our products. It also may increase our operating expenses, manufacturing overhead expenses and the cost to acquire or replace fixed assets. We have generally been able to maintain or improve our profit margins through productivity and efficiency improvements, cost reduction programs and to a lesser extent, price increases, and we expect to be able to do the same during 2017. As such, we do not believe that inflation will have a significant impact on our business during 2017. +24 +Item 7A. Quantitative and Qualitative Disclosures about Market Risk. +Interest Rate Risk +Our exposure to market risk for changes in interest rates relates primarily to the investment of our available cash and cash equivalents. In accordance with our investment policy, we strive to achieve above market rates of return in exchange for accepting a prudent amount of incremental risk, which includes the risk of interest rate movements. Risk tolerance is constrained by an overriding objective to preserve capital. An increase or decrease of 10% in effective interest rates would not have a material effect on our results of operations or cash flows. +Foreign Currency Exchange Risk +A substantial portion of our sales are denominated in U.S. dollars and, as a result, we have relatively little exposure to foreign currency exchange risk with respect to sales made. This exposure may change over time as business practices evolve and could have a material adverse impact on our financial results in the future. We do not use forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. We estimate that the combined translational and transactional impact of a 10% overall movement in exchange rates from December 31, 2016 (principally the U.K. Pound Sterling) would not have a material impact on our results of operations or cash flows. +Item 8. Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this report as pages F-3 through F-17. An index to such materials appears on page F-1. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). This "Controls and Procedures" section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2016. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2016, our disclosure controls and procedures are effective. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management's Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2016. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("2013 COSO"). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2016. +Item 9B. Other Information. +Not applicable. +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +Set forth below is certain information regarding our executive officers. The remaining information in response to this item will be contained in our Proxy Statement for our 2017 Annual Meeting of Stockholders (the "Proxy Statement"), which will be filed within 120 days after the year covered by this Form 10-K and is incorporated herein by reference. +25 +Executive Officers of the Registrant +The following list is included as an unnumbered item in Part III of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 22, 2017. +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person's principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +59 +Chairman of the Board and Chief Executive Officer +Steven A. DeMartino +47 +President, Chief Financial Officer, Treasurer and Secretary +Andrew J. Newmark +58 +Executive Vice President, Sales and Marketing +Donald E. Brooks +64 +Senior Vice President-Engineering +Tracey S. Chernay +57 +Senior Vice President, Casino, Gaming and Lottery Sales +Andrew J. Hoffman +59 +Senior Vice President, Operations +Bart C. Shuldman has been Chief Executive Officer, President and a Director of the Company since its formation in June 1996. In February 2001, Mr. Shuldman was elected Chairman of the Board. Mr. Shuldman relinquished the President title, effective June 1, 2010, to focus on new products and markets, international expansion and potential acquisitions. +Steven A. DeMartino was named as TransAct's President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Andrew Newmark joined TransAct on January 12, 2014 as Executive Vice President, Sales and Marketing with responsibility for the sales and marketing of all TransAct products. Prior to joining TransAct, Mr. Newmark was an investor and consultant with Newmark Capital Management from 2009 to 2015. From 2005 to 2009, Mr. Newmark was employed by Newell Rubbermaid as Vice President, Business Development and Strategy. Until 2005, Mr. Newmark held the role of Senior Vice President with DYMO after CoStar, a company he co-founded in 1989, was purchased by DYMO. +Donald E. Brooks was appointed Senior Vice President of Engineering in April 2012. Previously, Mr. Brooks served as Vice President, Engineering from September 2004 to April 2012, Senior Project Engineer from February 1998 to September 2004, Project Engineer from June 1997 to February 1998, Director of Electrical Engineering from March 1986 to June 1997 and Manager of Electronic Development from December 1983 to March 1986. +Tracey S. Chernay was appointed Senior Vice President, Casino and Gaming Sales and Marketing in June 2010, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Chernay served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing & Sales, POS & Banking with the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Chernay was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Andrew J. Hoffman was appointed Senior Vice President, Operations for TransAct worldwide in November 2004. He served as Vice President, Operations from September 1994 to November 2004. +Code of Ethics +We maintain a Code of Business Conduct that includes our code of ethics that is applicable to all employees, including our Chief Executive Officer, Chief Financial Officer and Controller. This Code, which requires continued observance of high ethical standards such as honesty, integrity and compliance with the law in the conduct of our business, is available for public access on our internet website. Any person may request a copy of our Code of Business Conduct free of charge by calling (203) 859-6800. +Item 11. Executive Compensation. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +26 +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +Information regarding our equity compensation plans as of December 31, 2016 is as follows: +Plan category +(a) +Number of securities to be +issued upon exercise of +outstanding options, +warrants and rights +(b) +Weighted-average exercise +price of outstanding +options, warrants and +rights +(c) +Number of securities +remaining available for +future issuance under +equity compensation plans +(excluding securities +reflected in column (a) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +642,538 +$ +8.35 +– +2014 Equity Incentive Plan +549,234 +7.21 +25,816 +Total +1,191,772 +$ +7.83 +25,816 +In May 2014, our shareholders approved the adoption of the 2014 Equity Incentive Plan. The Company also maintains the 2005 Equity Incentive Plan which was approved by our shareholders, however no new awards will be available for future issuance under this Plan. The number of shares of common stock which may be subject to awards granted under the 2014 Equity Incentive Plan is 600,000. Both plans generally provide for award in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. The Company does not have any equity plans that have not been approved by its shareholders. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services. +The information in response to this item will be contained in the Proxy Statement section and is incorporated herein by reference. +PART IV +Item 15. Exhibits and Financial Statement Schedules. +The exhibits filed as a part of this report are listed in the accompanying Index to Exhibits. +Item 16. Form 10-K Summary. +Not applicable. +27 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ Bart C. Shuldman +Name: +Bart C. Shuldman +Title: +Chairman of the Board and Chief Executive Officer +Date: March 16, 2017 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Bart C. Shuldman +Chairman of the Board +March 16, 2017 +Bart C. Shuldman +and Chief Executive Officer, +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, +March 16, 2017 +Steven A. DeMartino +Treasurer and Secretary +(Principal Financial and Accounting Officer) +/s/ John M. Dillon +Director +March 16, 2017 +John M. Dillon +/s/ Thomas R. Schwarz +Director +March 16, 2017 +Thomas R. Schwarz +/s/ Graham Y. Tanaka +Director +March 16, 2017 +Graham Y. Tanaka +28 +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO FINANCIAL STATEMENTS +Financial Statements +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Balance Sheets as of December 31, 2016 and 2015 +F-3 +Consolidated Statements of Operations for the years ended December 31, 2016, 2015, and 2014 +F-4 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2016, 2015 and 2014 +F-5 +Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2016, 2015 and 2014 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014 +F-7 +Notes to Consolidated Financial Statements +F-8 +All other financial statement schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto. +F-1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Shareholders of TransAct Technologies Incorporated +In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of TransAct Technologies Incorporated and its subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +As discussed in Note 17 to the consolidated financial statements, the Company changed the manner in which it accounts for deferred taxes in 2016. +/s/ PricewaterhouseCoopers LLP +Hartford, Connecticut +March 16, 2017 +F-2 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +2016 +December 31, +2015 +Assets: +Current assets: +Cash and cash equivalents +$ +2,503 +$ +4,473 +Accounts receivable, net +10,585 +7,174 +Inventories +9,707 +11,296 +Other current assets +372 +437 +Total current assets +23,167 +23,380 +Fixed asset, net +2,241 +2,507 +Goodwill +2,621 +2,621 +Deferred tax asset +3,432 +3,145 +Intangible assets, net of accumulated amortization of $3,122 and $2,779, respectively +545 +888 +Other assets +36 +28 +8,875 +9,189 +Total assets +32,042 +32,569 +Liabilities and Shareholders' Equity: +Current liabilities: +Accounts payable +$ +4,894 +$ +2,642 +Accrued liabilities +2,394 +2,838 +Income taxes payable +19 +245 +Deferred revenue +117 +604 +Total current liabilities +7,424 +6,329 +Deferred revenue, net of current portion +67 +77 +Deferred rent, net of current portion +178 +189 +Other liabilities +264 +246 +509 +512 +Total liabilities +7,933 +6,841 +Commitments and contingencies (Note 10) +Shareholders' equity: +Preferred stock, $0.01 value, 4,800,000 authorized, none issued and outstanding +- +- +Preferred stock, Series A, $0.01 par value, 200,000 authorized, none issued and outstanding +- +- +Common stock, $0.01 par value, 20,000,000 authorized at December 31, 2016 and 2015; 11,185,331 and 11,170,881 shares issued; 7,333,364 and 7,782,292 shares outstanding, at December 31, 2016 and 2015, respectively +112 +112 +Additional paid-in capital +29,701 +28,921 +Retained earnings +24,157 +22,956 +Accumulated other comprehensive loss, net of tax +(109 +) +(80 +) +Treasury stock, 3,851,967 and 3,388,589 shares, at cost +(29,752 +) +(26,181 +) +Total shareholders' equity +24,109 +25,728 +Total liabilities and shareholders' equity +$ +32,042 +$ +32,569 +See accompanying notes to Consolidated Financial Statements. +F-3 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except per share data) +Year Ended December 31, +2016 +2015 +2014 +Net sales +$ +57,235 +$ +59,676 +$ +53,108 +Cost of sales +33,436 +34,698 +31,397 +Gross profit +23,799 +24,978 +21,711 +Operating expenses: +Engineering, design and product development +4,425 +3,599 +4,302 +Selling and marketing +6,907 +7,806 +7,920 +General and administrative +7,267 +7,367 +7,756 +Legal fees and settlement expenses associated with lawsuit (Note 10) +- +1,738 +5,505 +18,599 +20,510 +25,483 +Operating income (loss) +5,200 +4,468 +(3,772 +) +Interest and other income (expense): +Interest expense +(33 +) +(37 +) +(61 +) +Interest income +7 +9 +12 +Other, net +(4 +) +2 +(33 +) +(30 +) +(26 +) +(82 +) +Income (loss) before income taxes +5,170 +4,442 +(3,854 +) +Income tax provision (benefit) +1,553 +1,350 +(1,433 +) +Net income (loss) +$ +3,617 +$ +3,092 +$ +(2,421 +) +Net income (loss) per common share: +Basic +$ +0.48 +$ +0.40 +$ +(0.29 +) +Diluted +$ +0.47 +$ +0.39 +$ +(0.29 +) +Shares used in per-share calculation: +Basic +7,610 +7,818 +8,307 +Diluted +7,655 +7,854 +8,307 +Dividends declared and paid per common share: +$ +0.32 +$ +0.32 +$ +0.31 +See accompanying notes to Consolidated Financial Statements. +F-4 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(In thousands, except share data) +Year Ended December 31, +2016 +2015 +2014 +Net income (loss) +$ +3,617 +$ +3,092 +$ +(2,421 +) +Foreign currency translation adjustment, net of tax +(29 +) +(8 +) +(9 +) +Comprehensive income (loss) +$ +3,588 +$ +3,084 +$ +(2,430 +) +See accompanying notes to Consolidated Financial Statements. +F-5 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY +(In thousands, except share data) +Common Stock +Shares Amount +Additional +Paid-in +Capital +Retained +Earnings +Treasury +Stock +Accumulated +Other +Comprehensive +Income (Loss) +Total +Equity +Balance, December 31, 2013 +8,319,316 +$ +111 +$ +27,674 +$ +27,326 +$ +(22,527 +) +$ +(63 +) +$ +32,521 +Issuance of shares from exercise of stock options +6,000 +- +13 +- +- +- +13 +Issuance of deferred stock units +- +- +100 +- +- +- +100 +Issuance of common stock on deferred stock units, net of relinquishments +9,939 +- +(44 +) +- +- +- +(44 +) +Tax benefit related to employee stock sales +- +- +7 +- +- +- +7 +Purchase of treasury stock +(434,998 +) +- +- +- +(2,634 +) +- +(2,634 +) +Dividends declared and paid on common stock +- +- +- +(2,556 +) +- +- +(2,556 +) +Share-based compensation expense +- +- +506 +- +- +- +506 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(89 +) +- +- +- +(89 +) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(9 +) +(9 +) +Net loss +- +- +- +(2,421 +) +- +- +(2,421 +) +Balance, December 31, 2014 +7,900,257 +$ +111 +$ +28,167 +$ +22,349 +$ +(25,161 +) +$ +(72 +) +$ +25,394 +Issuance of shares from exercise of stock options +34,600 +1 +262 +- +- +- +263 +Issuance of deferred stock units +- +- +160 +- +- +- +160 +Issuance of common stock on deferred stock units, net of relinquishments +13,988 +- +(39 +) +- +- +- +(39 +) +Tax shortfall related to employee stock sales +- +- +(48 +) +- +- +- +(48 +) +Purchase of treasury stock +(166,553 +) +- +- +- +(1,020 +) +- +(1,020 +) +Dividends declared and paid on common stock +- +- +- +(2,485 +) +- +- +(2,485 +) +Share-based compensation expense +- +- +488 +- +- +- +488 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(69 +) +- +- +- +(69 +) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(8 +) +(8 +) +Net income +- +- +- +3,092 +- +- +3,092 +Balance, December 31, 2015 +7,782,292 +$ +112 +$ +28,921 +$ +22,956 +$ +(26,181 +) +$ +(80 +) +$ +25,728 +Issuance of shares from exercise of stock options +3,750 +- +23 +- +- +- +23 +Issuance of deferred stock units +- +- +202 +- +- +- +202 +Issuance of common stock on deferred stock units, net of relinquishments +10,700 +- +(51 +) +- +- +- +(51 +) +Tax benefit related to employee stock sales +- +- +1 +- +- +- +1 +Purchase of treasury stock +(463,378 +) +- +- +- +(3,571 +) +- +(3,571 +) +Dividends declared and paid on common stock +- +- +- +(2,416 +) +- +- +(2,416 +) +Share-based compensation expense +- +- +611 +- +- +- +611 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(6 +) +- +- +- +(6 +) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(29 +) +(29 +) +Net income +- +- +- +3,617 +- +- +3,617 +Balance, December 31, 2016 +7,333,364 +$ +112 +$ +29,701 +$ +24,157 +$ +(29,752 +) +$ +(109 +) +$ +24,109 +See accompanying notes to Consolidated Financial Statements. +F-6 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2016 +2015 +2014 +Cash flows from operating activities: +Net income (loss) +$ +3,617 +$ +3,092 +$ +(2,421 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Share-based compensation expense +611 +488 +506 +Incremental tax benefits from stock options exercised +(1 +) +(4 +) +(7 +) +Depreciation and amortization +1,331 +1,426 +1,445 +Deferred income tax (benefit) provision +(295 +) +878 +(1,558 +) +(Gain) loss on sale of fixed assets +(5 +) +(4 +) +28 +Foreign currency transaction losses (gains) +4 +(1 +) +7 +Changes in operating assets and liabilities: +Accounts receivable +(3,434 +) +1,916 +4,139 +Inventories +1,580 +509 +1,703 +Prepaid income taxes +(5 +) +407 +(98 +) +Other current and long term assets +53 +50 +46 +Accounts payable +2,255 +277 +(2,384 +) +Accrued lawsuit settlement expenses +- +(3,625 +) +3,625 +Accrued liabilities and other liabilities +(1,088 +) +138 +1,022 +Net cash provided by operating activities +4,623 +5,547 +6,053 +Cash flows from investing activities: +Capital expenditures +(608 +) +(959 +) +(660 +) +Proceeds from sale of fixed assets +8 +4 +- +Net cash used in investing activities +(600 +) +(955 +) +(660 +) +Cash flows from financing activities: +Revolving credit line borrowings +- +2,500 +- +Revolving credit line payments +- +(2,500 +) +- +Proceeds from stock option exercises +23 +263 +13 +Purchases of common stock for treasury +(3,571 +) +(1,020 +) +(2,634 +) +Payment of dividends on common stock +(2,416 +) +(2,485 +) +(2,556 +) +Incremental tax benefits from stock options exercised +1 +4 +7 +Payment of deferred financing costs +- +- +(8 +) +Net cash used in financing activities +(5,963 +) +(3,238 +) +(5,178 +) +Effect of exchange rate changes on cash and cash equivalents +(30 +) +(12 +) +(20 +) +(Decrease) increase in cash and cash equivalents +(1,970 +) +1,342 +195 +Cash and cash equivalents, beginning of period +4,473 +3,131 +2,936 +Cash and cash equivalents, end of period +$ +2,503 +$ +4,473 +$ +3,131 +Supplemental cash flow information: +Interest paid +$ +31 +$ +34 +$ +49 +Income taxes paid +2,065 +130 +173 +Non-cash capital expenditure items +113 +84 +- +See accompanying notes to Consolidated Financial Statements. +F-7 +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated ("TransAct" or the "Company"), which has its headquarters in Hamden, CT and its primary operating facility in Ithaca, NY, operates in one operating segment: software-driven technology and printing solutions for high growth markets including restaurant solutions, casino and gaming, lottery, POS automation and banking, oil and gas and mobile markets. Our solutions are designed based on market-specific requirements and are sold under the AccuDate™ Ithaca®, RESPONDER®, Epic, EPICENTRAL TM and Printrex® product brands. We distribute our products through OEMs, value-added resellers, selected distributors, and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. We also generate revenue from the after-market side of the business, providing printer and terminal service, supplies and spare parts in addition to revenue from our software solution, the EPICENTRAL TM Print System ("EPICENTRAL TM "), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. +2. Summary of significant accounting policies +Principles of consolidation: The accompanying Consolidated Financial Statements include the accounts of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized profit. +Use of estimates : The accompanying Consolidated Financial Statements were prepared using estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 280, "Segment Reporting." We view our operations and manage our business as one segment: the design, development and marketing of software-driven technology and printing solutions and providing printer and terminal related software, services, supplies and spare parts. Factors used to identify TransAct's single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief operating decision-maker in making decisions about how to allocate resources and assess performance. +Cash and cash equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Allowance for doubtful accounts : We establish an allowance for doubtful accounts to ensure trade receivables are valued appropriately. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events and historical experience. We record a specific allowance for individual accounts when we become aware of a customer's inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer's operating results or financial position. If circumstances related to customers change, we would further adjust estimates of the recoverability of receivables. Allowances for doubtful accounts on accounts receivable balances were $50,000 as of December 31, 2016 and 2015. +The following table summarizes the activity recorded in the valuation account for accounts receivable: +Year ended December 31, +(In thousands) +2016 +2015 +2014 +Balance, beginning of period +$ +50 +$ +100 +$ +63 +Additions charged to costs and expenses +- +7 +37 +Write-offs +- +(57 +) +- +Balance, end of period +$ +50 +$ +50 +$ +100 +Inventories: Inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market. We review market value based on historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and market value. +Fixed assets: Fixed assets are stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years; machinery and equipment is ten years; furniture and office equipment is five to ten years; and computer software and equipment is three to seven years. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $987,000, $972,000 and $925,000 in 2016, 2015, and 2014, respectively. +Leases: Rent expense under non-cancelable operating leases with scheduled rent increases or free rent periods are accounted for on a straight-line basis over the lease term, beginning on the date of control of physical use of the asset or of initial possession. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred liability. Construction allowances and other such lease incentives are recorded as deferred credits, and are amortized on a straight-line basis as a reduction of rent expense beginning in the period they are deemed to be earned, which generally coincides with the occupancy date. +F-8 +Goodwill and Intangible assets : We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 "Goodwill", acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. We have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2016 when the impairment review is performed. +Revenue recognition: Our typical contracts include the sale of printers and terminals, which are sometimes accompanied by separately-priced extended warranty contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer or terminal sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within ASC 605, "Revenue Recognition" (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms, which are generally FOB shipping point) has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +We also sell a software solution, EPICENTRAL™, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. Revenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, "Multiple-Element Arrangements" and ASC 985-605, "Software." EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system's full functionality. These arrangements are accounted for in accordance with ASC 605-25, "Multiple-Element Arrangements". EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, "Software" as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level GAAP and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence ("VSOE") if available, third party evidence ("TPE") if VSOE is not available, or best estimate of selling price ("BESP") to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, "Separately Priced Extended Warranty and Product Maintenance Contracts." Pursuant to this provision, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +Concentration of credit risk: Financial instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable were as follows: +December 31, +2016 +2015 +IGT +34 +% +17 +% +Suzo-Happ +18 +% +10 +% +CMC Daymark +8 +% +13 +% +Panasonic +3 +% +11 +% +F-9 +Sales to customers representing 10% or more of total net sales were as follows: +Year ended December 31, +2016 +2015 +2014 +IGT +26 +% +29 +% +19 +% +Suzo-Happ +15 +% +14 +% +7 +% +Eurocoin +- +% +- +% +11 +% +Warranty: We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. +The following table summarizes the activity recorded in the accrued product warranty liability: +Year ended December 31, +(In thousands) +2016 +2015 +2014 +Balance, beginning of period +$ +277 +$ +287 +$ +366 +Warranties issued +254 +267 +183 +Warranty settlements +(264 +) +(277 +) +(262 +) +Balance, end of period +$ +267 +$ +277 +$ +287 +$169,000 and $164,000 of the accrued product warranty liability were classified as current in Accrued liabilities at December 31, 2016 and 2015, respectively. The remaining $98,000 and $113,000 of the accrued product warranty liability is classified as long-term in Other liabilities. +Engineering, design and product development: Research and development expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as a component of operating expenses as incurred. We recorded $4,425,000, $3,599,000 and $4,302,000 of research and development expenses in 2016, 2015, and 2014, respectively. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM and unamortized development costs for such software were $2,000 and $31,000 as of December 31, 2016 and 2015, respectively. The total amount charged to cost of sales for the amortization of capitalized software development costs was $29,000, $138,000 and $201,000 in 2016, 2015, and 2014, respectively. The weighted-average amortization period of unamortized capitalized software developments costs is less than one year. +Advertising: Advertising costs are expensed as incurred. Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Operations, for 2016, 2015, and 2014 totaled $703,000, $858,000 and $1,191,000, respectively. These expenses include items such as consulting and professional services, tradeshows, and print advertising. +Income taxes: The income tax amounts reflected in the accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, "Income Taxes." Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. See Note 12 for information regarding our accounting for income taxes. +In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes ("ASU 2015-17"), which simplifies the presentation of deferred income taxes. ASU 2015-17 requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective for financial statements issued for fiscal years beginning after December 15, 2016 (and interim periods within those fiscal years) with early adoption permitted. ASU 2015-17 may be either applied prospectively to all deferred tax assets and liabilities or retrospectively to all periods presented. We have elected to early adopt ASU 2015-17 prospectively in the fourth quarter of 2016. As a result, we have presented all deferred tax assets and liabilities as noncurrent on our consolidated balance sheet as of December 31, 2016, but have not reclassified current deferred tax assets and liabilities on our consolidated balance sheet as of December 31, 2015. There was no impact on our results of operations as a result of the adoption of ASU 2015-17. +Foreign currency translation: The financial position and results of operations of our foreign subsidiary in the United Kingdom are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars at the year-end exchange rate, related sales and expenses have been translated at the average exchange rate for the year, and shareholders' equity has been translated at historical exchange rates. The resulting translation gains or losses, net of tax, are recorded in shareholders' equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income. Foreign currency transaction gains and losses, including those related to intercompany balances, are recognized in Other, net on the Consolidated Statements of Operations. +Share-based payments: At December 31, 2016, we had share-based employee compensation plans, which are described more fully in Note 11 - Stock incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, "Compensation – Stock Compensation." Share-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee's requisite service period. +F-10 +We use the Black-Scholes option-pricing model to calculate the fair value of share based awards. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. In addition, we estimate forfeitures when recognizing compensation expense, and we adjust our estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures are recognized through a cumulative true-up adjustment in the period of change and also impacts the amount of compensation expense to be recognized in future periods. +Net income and loss per share: We report net income or loss per share in accordance with ASC 260, "Earnings per Share (EPS)." Under this guidance, basic EPS, which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these instruments are excluded from the computation of dilutive EPS. See Note 13 - Earnings per share. +3. Contingent Consideration +In connection with a business acquisition on August 19, 2011, whereby we purchased substantially all of the assets of Printrex, Inc. ("Printrex"), we entered into a contingent consideration arrangement with Printrex as part of the acquisition for 30% of the gross profit for a three-year period related to new products under development, less certain other adjustments, beginning on the earlier of 1) January 1, 2012 or 2) the date of first commercial introduction of the new products under development. As of December 31, 2015, the undiscounted fair value related to the contingent liability was estimated to be zero and we did not make a contingent consideration payment. The fair value of the contingent consideration arrangement was $0 at both December 31, 2016 and 2015, which was estimated by applying the income approach. That measure is based on significant inputs that are not observable in the market, which fair value measurement guidance refers to as Level 3 inputs. The fair value of the contingent consideration was decreased by $0, $0 and $60,000, in 2016, 2015 and 2014, respectively, and this credit is included in general and administrative expenses on the Consolidated Statements of Operations. No payments were made under the arrangement during 2015 and 2016 as the contingent consideration measurement period expired on December 31, 2014. +4. Inventories, net +The components of inventories are: +December 31, +(In thousands) +2016 +2015 +Raw materials and purchased component parts +6,298 +$ +6,627 +Work-in-process +8 +1 +Finished goods +3,401 +4,668 +$ +9,707 +$ +11,296 +5. Fixed assets +The components of fixed assets, net are: +December 31, +(In thousands) +2016 +2015 +Tooling, machinery and equipment +$ +11,035 +$ +10,836 +Furniture and office equipment +1,630 +1,578 +Computer software and equipment +6,260 +6,037 +Leasehold improvements +2,361 +2,318 +21,286 +20,769 +Less: Accumulated depreciation and amortization +(19,215 +) +(18,336 +) +2,071 +2,433 +Construction in-process +170 +74 +$ +2,241 +$ +2,507 +6. Intangible assets +Identifiable intangible assets are recorded in Intangible assets in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2016 +2015 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,604 +$ +(1,433 +) +$ +1,604 +$ +(1,357 +) +Customer relationships +1,300 +(1,163 +) +1,300 +(946 +) +Trademark +480 +(257 +) +480 +(210 +) +Covenant not to compete +146 +(146 +) +146 +(146 +) +Patents +57 +(43 +) +57 +(40 +) +Other +80 +(80 +) +80 +(80 +) +Total +$ +3,667 +$ +(3,122 +) +$ +3,667 +$ +(2,779 +) +F-11 +Amortization expense was $343,000, $454,000 and $515,000 in 2016, 2015 and 2014, respectively. Amortization expense for each of the next five years ending December 31 is expected to be as follows: $236,000 in 2017; $98,000 in 2018; $98,000 in 2019; $82,000 in 2020; $31,000 in 2021 and $0 in 2022. +7. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2016 +2015 +Salaries and compensation related +$ +1,722 +$ +2,209 +Warranty +169 +164 +Professional and consulting +153 +159 +Other +350 +306 +$ +2,394 +$ +2,838 +8. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of each month immediately following their date of hire. We match employees' contributions at a rate of 50% of employees' contributions up to the first 6% of the employees' compensation contributed to the 401(k) plan. Our matching contributions were $295,000, $197,000 and $282,000 in 2016, 2015, and 2014, respectively. +9. Borrowings +We maintain a credit facility (the "TD Bank Credit Facility") with TD Bank N.A. ("TD Bank) which provides for a $20,000,000 revolving credit line. On November 26, 2014, we signed an amendment to the TD Bank Credit Facility through November 28, 2017. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate of (1.0)% and are secured by a lien on all of our assets. We also pay a fee of 0.15% on unused borrowings under the revolving credit line. The total deferred financing costs relating to expenses incurred to complete the TD Bank Credit Facility was $8,000 which will be amortized over the three year term. The amendment increased the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $10,000,000 from $5,000,000. The amendment also modified the definition of EBITDA to exclude certain non-recurring expenses, including without limitation, non-recurring litigation and acquisition expenses; and modified the definition of Operating Cash Flow to exclude unfinanced capital expenditures for the quarters ending December 31, 2014, March 31, 2015 and June 30, 2015. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2016. +As of December 31, 2016, undrawn commitments under the TD Bank Credit facility were $20,000,000. +10. Commitments and contingencies +On June 8, 2012, Avery Dennison Corporation ("AD") filed a civil complaint against us and a former employee of ours and of AD, in the Court of Common Pleas (the "Court") in Lake County, Ohio. The complaint alleged that we and this former employee misappropriated unspecified trade secrets and confidential information from AD related to the design of our restaurant solutions terminals. The complaint requested a preliminary and permanent injunction against us from manufacturing and selling our Ithaca® 9700 and 9800 restaurant solutions terminals. On July 16, 2012, we filed our answer, affirmative defenses and counterclaims, seeking all available damages including legal fees. A hearing on the plaintiff's motion for preliminary injunction took place in August 2012, and in November 2012, the Court denied this request. AD filed an appeal of the Court's ruling to the Eleventh Appellate District, which heard oral arguments on the appeal on July 16, 2013. On July 23, 2013, AD requested that the Eleventh Appellate District enjoin our further sale and marketing of the restaurant solutions terminals, pending the Court of Appeals' decision. On July 29, 2013, we opposed this request. On October 15, 2013, the Eleventh District Court of Appeals affirmed the lower court's decision in our favor and denied AD's further request of an injunction pending the Court of Appeals' decision. On October 24, 2013, AD filed a motion seeking that the Court of Appeals reconsider its decision. On April 16, 2014, the Court of Appeals denied AD's motion to reconsider its decision. On July 28, 2014, AD filed a motion requesting leave from the Court to file an amended complaint and indicating that it has elected to pursue only its claim for damages, dropping its claim for injunctive relief. On September 4, 2014, the Court granted AD's motion to file an amended complaint. On September 25, 2014, we filed our answer, affirmative defenses and counterclaims with respect to the amended complaint, seeking all available damages including legal fees. On January 30, 2015, we filed a motion for summary judgment seeking judgment in our favor on all counts as to the Company. On the same day, AD filed two motions for partial summary judgment. On February 17, 2015, we opposed both of AD's motions, and AD opposed our motion. On February 23, 2015, the Company filed a reply brief in support of its motion for summary judgment. A trial was scheduled to begin on April 21, 2015, however, on March 25, 2015 the parties executed a confidential settlement agreement and release (the "Settlement Agreement") in which the parties mutually agreed to resolve the dispute that was the subject of the lawsuit filed by AD against the Company to the parties' mutual satisfaction. Under the terms of the Settlement Agreement, we agreed to pay AD $3,600,000 payable on or before April 8, 2015 and also to qualify certain AD labels for use on our restaurant solutions terminals at an estimated cost of $25,000. We made the $3,600,000 payment to AD on April 8, 2015 and borrowed $2,500,000 under our revolving credit facility with TD Bank to fund the payment. We recorded the total expense of $3,625,000 in the fourth quarter 2014 as an operating expense included in the line item "Legal fees and settlement expenses associated with lawsuit" on the Consolidated Statement of Operations and as a current liability included in the line item "Accrued lawsuit settlement expenses" on the Consolidated Balance Sheet. In the second quarter of 2015 we reversed $25,000 of this expense because AD did not provide the label testing information by the due date required per the settlement agreement. +F-12 +At December 31, 2016, we were the lessee on operating leases for equipment and real property. Rent expense was $1,046,000, $932,000 and $918,000 in 2016, 2015, and 2014, respectively. Minimum aggregate rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2016 are as follows: $825,000 in 2017; $777,000 in 2018; $788,000 in 2019; $798,000 in 2020, $478,000 in 2021 and $367,000 thereafter. +11. Stock incentive plans +Stock incentive plans . We currently have two primary stock incentive plans: the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan, which provide for awards to executives, key employees, directors and consultants. The plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. Awards granted under these plans have exercise prices equal to 100% of the fair market value of the common stock at the date of grant. Awards granted have a ten-year term and generally vest over a two- to five-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards will be made under the 2005 Equity Incentive Plan. Under our 2014 Equity Incentive Plan, we may authorize awards for up to 600,000 shares of TransAct common stock. At December 31, 2016, 25,816 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average fair value of stock option grants for 2016, 2015, and 2014 was $1.70, $6.73 and $11.11, respectively. In 2016, we also issued restricted share units for certain executives and directors that vest over a specified period of time, and in some instances require achieving certain performance metrics. The weighted-average fair value of these restricted share units was $7.31. No restricted share units were issued in 2015 or 2014. +The table below indicates the key assumptions used in the option valuation calculations for options granted in 2016, 2015, and 2014 and a discussion of our methodology for developing each of the assumptions used in the valuation model: +Year ended December 31, +2015 +2014 +2013 +Expected option term (in years) +6.9 +6.8 +6.6 +Expected volatility +38.8 +% +50.4 +% +53.8 +% +Risk-free interest rate +1.2 +% +1.6 +% +1.6 +% +Dividend yield +4.5 +% +4.7 +% +2.6 +% +Expected Option Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility – The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An increase in the expected volatility factor will increase compensation expense. +Risk-Free Interest Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +Dividend Yield –The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation expense. +For 2016, 2015, and 2014, we recorded $611,000, $488,000, and $506,000 of share-based compensation expense, respectively, included primarily in general and administrative expense in our Consolidated Statements of Operations. We also recorded income tax benefits of $184,000, $148,000, and $377,000 in 2016, 2015, and 2014 respectively, related to such share-based compensation. At December 31, 2016, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Option activity in the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan is summarized below: +Stock Options +Restricted Share Units +Number of Shares +Average Price* +Number of Units +Average Price** +Outstanding at December 31, 2015 +915,375 +$ +8.08 +- +$ +- +Granted +233,900 +7.17 +57,400 +7.94 +Exercised +(3,750 +) +6.11 +- +- +Forfeited +(27,000 +) +8.03 +- +- +Expired +(44,625 +) +9.49 +- +- +Outstanding at December 31, 2016 +1,073,900 +$ +7.83 +57,400 +$ +7.94 +* weighted-average exercise price +** weighted-average grant stock price +F-13 +The following summarizes information about equity awards outstanding that are vested and expect to vest and equity awards that are exercisable at December 31, 2016: +Equity Awards Vested and Expected to Vest +Equity Awards That Are Exercisable +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Stock Options +1,057,720 +$ +7.83 +$ +183,000 +6.0 +587,875 +$ +7.89 +$ +182,000 +4.1 +Restricted stock units +48,769 +- +322,000 +2.5 +* weighted-average exercise price per share +** weighted-average contractual remaining term in years +Shares that are issued upon exercise of employee stock awards are newly issued shares and not issued from treasury stock. As of December 31, 2016, unrecognized compensation cost related to non-vested equity awards granted under our stock incentive plans is approximately $939,000, which is expected to be recognized over a weighted average period of 2.4 years. +The total fair value of awards vested during the years ended December 31, 2016, 2015, and 2014 was $961,000, $944,000, and $943,000, respectively. The total intrinsic value (which is the amount by which the stock price exceeded the exercise price on the date of exercise) of stock options exercised during the years ended December 31, 2016, 2015, and 2014 was $6,000, $32,000 and $20,000, respectively. As of December 31, 2016, no restricted stock units have vested. Cash received from option exercises was $23,000, $263,000 and $13,000 for 2016, 2015, and 2014, respectively. We recorded a realized tax benefit in 2016, 2015, and 2014 from equity-based awards of $1,000, $4,000 and $7,000, respectively, related to options exercised which has been included as a component of cash flows from financing activities in the Consolidated Statements of Cash Flows. +Restricted stock: +We paid a portion of the 2015, 2014 and 2013 incentive bonus for the chief executive officer and chief financial officer in the form of 28,231, 23,578 and 8,663 deferred stock units, respectively, with a corresponding credit recorded to Additional Paid in Capital (net of share relinquishments) in the amounts of $151,000, $121,000 and $56,000 in 2016, 2015, and 2014, respectively. Such deferred stock units were granted in February 2016, February 2015 and February 2014, respectively, and were fully vested at the time of grant. These units will be converted three years from the grant date to shares of the Company's common stock on a one-for-one basis. The weighted average exercise price of the deferred stock units was $7.65. Starting with the 2016 incentive bonus program, all incentive bonus payments are made in cash with no portion of the award paid in deferred stock units. +12. Income taxes +The components of the income tax provision are as follows: +Year Ended December 31, +(In thousands) +2016 +2015 +2014 +Current: +Federal +$ +1,776 +$ +450 +$ +176 +State +70 +22 +15 +Foreign +2 +- +12 +1,848 +472 +203 +Deferred: +Federal +(257 +) +843 +(1,653 +) +State +(38 +) +35 +17 +Foreign +- +- +- +(295 +) +878 +(1,636 +) +Income tax provision (benefit) +$ +1,553 +$ +1,350 +$ +(1,433 +) +Our effective tax rates were 30.0%, 30.4%, and 37.2% for 2016, 2015, and 2014, respectively. The effective tax rate for 2014 was unusually high due to the impact from the net loss reported for the year ending 2014. +At December 31, 2016, we have no federal and no state net operating loss carryforwards and no R&D credit carryforwards. We also have less than $1,000 of state tax credit carryforwards as of December 31, 2016. Foreign loss before taxes was $235,000, $174,000, and $56,000 in 2016, 2015, and 2014, respectively. +F-14 +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Our deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2016 +2015 +Deferred tax assets: +Foreign net operating losses +$ +423 +$ +340 +Depreciation +88 +- +Inventory reserves +1,264 +1,312 +Deferred revenue +31 +25 +Warranty reserve +93 +95 +Stock compensation expense +1,273 +1,105 +Other accrued compensation +387 +475 +Foreign tax and other credits +- +23 +Other liabilities and reserves +329 +191 +Gross deferred tax assets +3,888 +3,566 +Valuation allowance +(423 +) +(340 +) +Net deferred tax assets +3,465 +3,226 +Deferred tax liabilities: +Depreciation +- +45 +Other +33 +36 +Net deferred tax liabilities +33 +81 +Total net deferred tax assets +3,432 +3,145 +As of December 31, 2016 a valuation allowance of $423,000 has been established for foreign net operating loss carryforwards that are not expected to be used. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year ended December 31, +(In thousands) +2016 +2015 +2014 +Balance, beginning of period +$ +340 +$ +282 +$ +242 +Additions charged to income tax provision +83 +58 +40 +Balance, end of period +$ +423 +$ +340 +$ +282 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2016 +2015 +2014 +Federal statutory tax rate +34.0 +% +34.0 +% +34.0 +% +Valuation allowance and tax accruals +1.6 +1.3 +(1.1 +) +State income taxes, net of federal income taxes +0.4 +0.8 +(0.5 +) +Uncertain tax positions +(0.1 +) +(0.3 +) +(1.0 +) +Miscellaneous permanent items +(1.2 +) +(0.7 +) +(0.3 +) +R&D credit +(4.6 +) +(4.9 +) +6.0 +Other +(0.1 +) +0.2 +0.1 +Effective tax rate +30.0 +% +30.4 +% +37.2 +% +At December 31, 2016 and 2015, we had $111,000 and $114,000 of total gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the gross amounts of unrecognized tax benefits at the beginning and end of the year is as follows: +(In thousands) +2016 +2015 +Unrecognized tax benefits as of January 1 +$ +114 +$ +124 +Tax positions taken during the current period +27 +25 +Lapse of statute of limitations +(30 +) +(35 +) +Unrecognized tax benefits as of December 31 +$ +111 +$ +114 +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially concluded all U.S. federal income tax, state and local, and foreign tax matters through 2012. During 2013, an examination of our 2010 federal tax return was completed. However, our federal tax returns for the years 2013 through 2015 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +We expect $31,000 of the $111,000 of unrecognized tax benefits will reverse in 2017 upon the expiration of the statute of limitations. +We recognize interest and penalties related to uncertain tax positions in the income tax provision. As of December 31, 2016 and 2015, we have $18,000 and $19,000, respectively, of accrued interest and penalties related to uncertain tax positions. +F-15 +13. Earnings per share +For 2016, 2015, and 2014, earnings per share were computed as follows (in thousands, except per share amounts): +Year Ended December 31, +2016 +2015 +2014 +Net income (loss) +$ +3,617 +$ +3,092 +$ +(2,421 +) +Shares: +Basic: Weighted average common shares outstanding +7,610 +7,818 +8,307 +Add: Dilutive effect of outstanding options as determined by the treasury stock method +45 +36 +- +Diluted: Weighted average common and common equivalent shares outstanding +7,655 +7,854 +8,307 +Net income (loss) per common share: +Basic +$ +0.48 +$ +0.40 +$ +(0.29 +) +Diluted +0.47 +0.39 +(0.29 +) +The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options, restricted stock units and performance stock awards, when the average market price of the common stock is lower than the exercise price of the related stock award during the period. These outstanding stock awards are not included in the computation of diluted earnings per share because the effect would be anti-dilutive. Anti-dilutive stock awards excluded from the computation of earnings per dilutive share were 831,000, and 735,000, at December 31, 2016 and 2015 respectively. Regarding 2014, when a net loss is reported basic and diluted EPS are calculated using the same method and as a result 84,000 shares were excluded from calculating the diluted weighted average common and common equivalent shares outstanding. +14. Stock repurchase program +On February 25, 2016, our Board of Directors approved a new stock repurchase program (the "Stock Repurchase Program"). Under the Stock Repurchase Program, we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market through December 31, 2017 at prevailing market prices based on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From the start of the Stock Repurchase Program on February 25, 2016 through December 31, 2016, we purchased 463,378 shares of our common stock for $3,571,000 at an average price of $7.71 per share. +In 2015 and 2014, under a prior repurchase program, we purchased 166,553 and 434,998 shares of our common stock for $1,020,000 and $2,634,000 at an average price of $6.12 and $6.06 per share, respectively. From January 1, 2005 through December 31, 2016, we repurchased a total of 3,851,967 shares of common stock for $29,752,000, at an average price of $7.72 per share. +15. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are based on the location of the customer and asset. +Year Ended December 31, +(In thousands) +2016 +2015 +2014 +Net sales: +United States +$ +45,542 +$ +45,730 +$ +38,567 +International +11,693 +13,946 +14,541 +Total +$ +57,235 +$ +59,676 +$ +53,108 +Fixed assets, net: +United States +$ +1,581 +$ +1,769 +$ +1,490 +International +660 +738 +948 +Total +$ +2,241 +$ +2,507 +$ +2,438 +Sales to international customers were 20%, 23%, and 27% in 2016, 2015, and 2014 respectively. Sales to Europe represented 56%, 56%, and 49%, sales to the Pacific Rim (which includes Australia and Asia) represented 34%, 34%, and 33%, and sales to Canada represented 8%, 8%, and 5% of total international sales in 2016, 2015, and 2014 respectively. International long-lived assets consist of net fixed assets located at our foreign subsidiary in the United Kingdom as well as our contract manufacturers in China, Thailand, Malaysia and Mexico. +F-16 +16. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2016 and 2015 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2016: +Net sales +$ +14,357 +$ +14,801 +$ +14,474 +$ +13,603 +Gross profit +5,885 +5,983 +5,915 +6,016 +Net income +625 +753 +883 +1,356 +Net income per common share: +Basic +0.08 +0.10 +0.12 +0.18 +Diluted +0.08 +0.10 +0.12 +0.18 +2015: +Net sales +$ +16,164 +$ +17,224 +$ +14,172 +$ +12,116 +Gross profit +6,492 +7,161 +6,291 +5,034 +Net income +144 +1,388 +1,028 +532 +Net income per common share: +Basic +0.02 +0.18 +0.13 +0.07 +Diluted +0.02 +0.18 +0.13 +0.07 +17. Accounting pronouncements +In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09, "Revenue from Contracts with Customers." This ASU is intended to clarify the principles for recognizing revenue by removing inconsistencies in revenue requirements; providing a more robust framework for addressing revenue issues; improving comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; and providing more useful information to users of financial statements through improved revenue disclosure requirements. In applying the amended guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract's performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The amended guidance applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. In April 2015, the FASB voted to defer the effective date of the new revenue recognition standard by one year. As a result, the provisions of this ASU are now effective for interim and annual periods beginning after December 15, 2017. We are currently evaluating the impact this ASU may have on our consolidated financial position, results of operations or cash flows and are currently in the process of engaging a third party to assist management in implementing the new standard. Entities have the option of using either a full retrospective or modified retrospective approach to the amended guidance. The company currently anticipates adopting the amended guidance using the modified retrospective transition approach, with any cumulative effect of initially adopting this standard recognized through retained earnings at the date of adoption. We currently plan to adopt the amended guidance on January 1, 2018 at which time it becomes effective for the Company. +As noted above, we are in the process of engaging a third party to assist the Company in implementing the new standard. During 2017, we will further evaluate the impact of the standard, and if needed, establish policies, identify system impacts, integrate the standard into the financial reporting processes and systems, and develop an understanding of the financial impact of this statement on the Company's consolidated financial statements. +In July 2015, FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory." This ASU changes the measurement principle for inventory from the lower of cost or market to lower of cost or net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business; less reasonably predictable costs of completion, disposal and transportation. The provisions of this ASU are effective for years beginning after December 15, 2016. This ASU is not expected to have a significant impact on our consolidated financial statements or disclosures. +In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes ("ASU 2015-17"), which simplifies the presentation of deferred income taxes. ASU 2015-17 requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective for financial statements issued for fiscal years beginning after December 15, 2016 (and interim periods within those fiscal years) with early adoption permitted. ASU 2015-17 may be either applied prospectively to all deferred tax assets and liabilities or retrospectively to all periods presented. We have elected to early adopt ASU 2015-17 retrospectively in the fourth quarter of 2016. As a result, we have presented all deferred tax assets and liabilities as noncurrent on our consolidated balance sheet as of December 31, 2016 and 2015, We reclassified $1,900,000 and $1,932,000 of our deferred tax asset from current to noncurrent as of December 31, 2016 and 2015, respectively. +In February 2016, the FASB issued ASU 2016-02, "Leases." The core principle of this ASU requires that a lessee should recognize the assets and liabilities on the balance sheet and disclose key information about leasing arrangements. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods. We are currently evaluating the impact this ASU may have on our consolidated financial position, results of operation or cash flows. +In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting." This ASU is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows and accounting for forfeitures. The provisions of this ASU are effective for years beginning after December 15, 2016. We are currently evaluating the impact this ASU may have on our consolidated financial position, results of operation or cash flows. +F-17 +Index to Exhibits +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated ("TransAct" or the "Company"), filed with the Secretary of State of Delaware on June 17, 1996. +(2) +3.1(b) +Certificate of Amendment of Certificate of Incorporation of the Company, filed with the Secretary of State of Delaware on June 4, 1997. +(4) +3.1(c) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December 2, 1997. +(5) +3.1(d) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000. +(7) +3.2 +Amended and Restated By-laws of the Company. +(6) +4.1 +Specimen Common Stock Certificate. +(2) +10.1(x) +2005 Equity Incentive Plan +(10) +10.2(x) +2014 Equity Incentive Plan +(3) +10.3(x) +2014 Equity Incentive Plan Time-based Restricted Unit Agreement +(22) +10.4(x) +2014 Equity Incentive Plan Performance-based Restricted Stock Unit Agreement +(23) +10.5(x) +Employment Agreement, dated July 31, 1996, by and between TransAct and Bart C. Shuldman. +(2) +10.6(x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004. +(9) +10.7(x) +Severance Agreement by and between TransAct and Tracey S. Chernay, dated July 29, 2005. +(13) +10.8(x) +Amendment to Employment Agreement, effective January 1, 2008, by and between TransAct and Bart C. Shuldman. +(14) +10.9(x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008. +(14) +10.10(x) +Amendment to Severance Agreement by and between TransAct and Tracey S. Chernay, effective January 1, 2008. +(14) +10.11 +Lease Agreement by and between Bomax Properties and Ithaca, dated as of March 23, 1992. +(2) +10.12 +Second Amendment to Lease Agreement by and between Bomax Properties and Ithaca, dated December 2, 1996. +(4) +10.13 +Agreement regarding the Continuation and Renewal of Lease by and between Bomax Properties, LLC and TransAct, dated July 18, 2001. +(8) +10.14 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct. +(17) +10.15 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016. +(21) +10.16 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004. +(9) +10.17 +First Amendment to Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated August 31, 2009 +(15) +10.18 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, 2015. +(20) +10.19 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006. +(11) +10.20 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 3, 2017 +(1) +10.21 +OEM Purchase Agreement by and between IGT (f/k/a GTECH Corporation) and TransAct, dated May 29, 2015. (Pursuant to Rule 24-b-2 under the Exchange Act, the Company has requested confidential treatment of portions of this exhibit deleted from the filed copy) +(20) +10.22 +Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. dated November 28, 2006 +(11) +10.23 +First Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. effective September 30, 2007. +(12) +10.24 +Second Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Bank, N.A. effective November 22, 2011. +(16) +10.25 +Third Amendment to Amended and Restated Revolving Credit and Security Agreement effective September 7, 2012 +(18) +10.26 +Fourth Amendment to Amended and Restated Revolving Credit and Security Agreement effective November 26, 2014 +(19) +23.1 +Consent of PricewaterhouseCoopers LLP. +(1) +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +(1) +101.INS +XBRL Instance Document. +(1) +101.SCH +XBRL Taxonomy Extension Schema Document. +(1) +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +(1) +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +(1) +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +(1) +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +(1) +(1) +These exhibits are filed herewith. +(2) +These exhibits, which were previously filed with the Company's Registration Statement on Form S-1 (No. 333-06895), are incorporated by reference. +(3) +This exhibit, which was previously filed with the Company's Current Report on Form 8-K filed May 15, 2014 is incorporated by reference. +(4) +These exhibits, which were previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1997, are incorporated by reference (No. 000-21121). +(5) +This exhibit, which was previously filed with the Company's Current Report on Form 8-K filed February 18, 1999, is incorporated by reference (No. 000-21121). +(6) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1998, is incorporated by reference (No. 000-21121). +(7) +These exhibits, which were previously filed with the Company's Quarterly Report on Form 10-Q for the period ended March 25, 2000, are incorporated by reference (No. 000-21121). +(8) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2001, is incorporated by reference (No. 000-21121). +(9) +These exhibits, which were previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2004, are incorporated by reference (No. 000-21121). +(10) +This exhibit, which was previously filed with the Company's Current Report on Form 8-K filed June 1, 2005, is incorporated by reference. +(11) +These exhibits, which were previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2006, are incorporated by reference (No. 000-21121). +(12) +This exhibit, which was previously filed with the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2007, is incorporated by reference (No. 000-21121). +(13) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2007, is incorporated by reference (No. 000-21121). +(14) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2008, is incorporated by reference (No. 000-21121). +(15) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2009, is incorporated by reference (No. 000-21121). +(16) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2011, is incorporated by reference (No. 000-21121). +(17) +This exhibit, which was previously filed with the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2012, is incorporated by reference (No. 000-21121). +(18) +This exhibit, which was previously filed with the Company's Current Report on Form 8-K filed September 11, 2012, is incorporated by reference (No. 000-21121). +(19) +This exhibit, which was previously filed with the Company's Current Report on Form 8-K filed December 1, 2014, is incorporated by reference. +(20) +This exhibit, which was previously filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2015, is incorporated by reference +(21) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2015, is incorporated by reference. +(22) +This exhibit, which was previously filed with the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2016, is incorporated by reference. +(23) +This exhibit, which was previously filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2016, is incorporated by reference. +(x) +Management contract or compensatory plan or arrangement. +EXHIBIT LIST +The following exhibits are filed herewith. +Exhibit +10.20 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 2, 2017 +23.1 +Consent of PricewaterhouseCoopers LLP. +31.1 +Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. \ No newline at end of file diff --git a/raw/filings/0001017303/2016/0001017303-17-000014/filing_metadata.csv b/raw/filings/0001017303/2016/0001017303-17-000014/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..9df2c0539079d5d515dd37dda945a5e625cc8be1 --- /dev/null +++ b/raw/filings/0001017303/2016/0001017303-17-000014/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2017-03-16,2016-12-31,2017-03-16T17:55:19.000Z,0001017303-17-000014,form10k2016.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2016",7309016,1,0,https://www.sec.gov/Archives/edgar/data/1017303/000101730317000014/form10k2016.htm,https://www.sec.gov/Archives/edgar/data/1017303/000101730317000014/,2016,2016,1 diff --git a/raw/filings/0001017303/2016/0001017303-17-000014/item1.txt b/raw/filings/0001017303/2016/0001017303-17-000014/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..36e72e6516b0832497de6b5e83247a01e7172e52 --- /dev/null +++ b/raw/filings/0001017303/2016/0001017303-17-000014/item1.txt @@ -0,0 +1,75 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated ("TransAct" or the "Company") was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high growth markets including restaurant solutions, POS automation and banking, casino and gaming, lottery, mobile and oil and gas. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the AccuDate™, Epic, EPICENTRAL™, Ithaca®, Printrex® and Responder® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality labels and transaction records such as receipts, tickets, coupons, register journals and other documents, as well as printed logging and plotting of data. We sell our products to original equipment manufacturers ("OEMs"), value-added resellers ("VARs"), select distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of products. Through our TransAct Services Group ("TSG"), we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the restaurant and hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the demand for these products. Our primary operating, hardware research and development, and eastern region service center is located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters, software research and development and western region service center in Las Vegas, NV, a sales and service center for the oil and gas industry in Houston, TX, a European sales and service center in the United Kingdom, and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT, 06518, with a telephone number of (203) 859-6800. +Financial Information about Segments +We operate in one reportable segment, the design, development, and marketing of software-driven technology and printing solutions for high growth markets, and providing related services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements beginning on page F-3 hereof. +Products, Services and Distribution Methods +Printers and terminals: TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal, inkjet and impact printing technology for applications, primarily in the restaurant solutions, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our restaurant solutions terminals also offer configurable menu options. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers tailored to our customers' business. +Restaurant Solutions: Our line of AccuDate terminals for the restaurant solutions market combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab and go labels for prepared foods, and "enjoy by" date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve and hospitality establishments) effectively manage food spoilage and automate and manage back-of-the-restaurant operations. Our newest addition to the AccuDate product line, the AccuDate XL, is a unique Android® 5.0-based restaurant management terminal specifically designed to meet the food prep management and labeling needs of the restaurant and hospitality industries. Customers buying the AccuDate XL with Jolt software can utilize the terminal for food expiration date labeling and Grab & Go labeling, along with account management and an analytics portal. TransAct's AccuDate® XL restaurant management terminal, integrated with CrunchTime's KitchenSync App, provides an innovative platform that revolutionizes food preparation, food management and other back-of-house processes. In the restaurant solutions market, we use an internal sales force that we plan to build-out in 2017, and to a lesser extent distributors, to solicit sales directly from end-users. Our restaurant solutions line of market, which we formerly referred to as our "food safety" market was rebranded this year in light of this innovative technology and opportunity for market growth. +POS automation and banking: Our POS automation and banking printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the POS market, we sell several models of printers utilizing thermal and impact printing technology. Our POS printers are used primarily by restaurants (including fine dining, casual dining, quick-serve and hospitality establishments) located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we sell inkjet printers that are used by banks, credit unions and other financial institutions to print deposit or withdrawal receipts and/or validate checks at bank teller stations. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals ("VLTs") and other gaming machines that print tickets or receipts instead of issuing coins ("ticket-in, ticket-out" or "TITO") at casinos, racetracks ("racinos") and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets or receipts in monochrome, and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal printing technology for use in non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals and other off-premise gaming type machines around the world. We sell our products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through our primary worldwide distributor, Suzo-Happ Group. We also maintain a dedicated internal sales force to solicit sales from slot manufacturers and casinos, as well as to manage sales through our distributor. +1 +We also offer a software solution, the EPICENTRAL™ Print System ("EPICENTRAL™"), that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. With EPICENTRAL™, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +Lottery: We primarily supply lottery printers to International Gaming Technology and its subsidiaries ("IGT"), our largest customer and the world's largest provider of lottery terminals. In addition, during 2015 we launched a new lottery printer, the Epic 3000, that we sell to other lottery system customers beyond IGT. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and managed by an internal sales representative. +Printrex: Printrex printers include wide format, desktop and rack mounted and vehicle mounted black/white and color thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. In 2015, we launched the Responder MP2™, our first printer for the large machine-to-machine (M2M) vertical market. The Responder MP2™ is an all-in-one mobile printing solution for a number of vehicles, including fire, police, EMS, insurance, public utilities and delivery vehicles. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM's, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated internal sales representative with a sales office located in Houston, Texas. We primarily sell our mobile printer through a single U.S. distributor. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor's products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress™ and TransAct Care, and other repair services for our printers and terminals. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY, our western region service center in Las Vegas, NV and our oil and gas industry service center in Houston, TX. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 95% of our printer production is primarily through two third-party contract manufacturers in Asia and to a lesser extent one other also in Asia. The remaining 5% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include thermal, inkjet and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers produced by our contract manufacturers, and to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer and restaurant solutions terminal models, from one foreign contract manufacturer, and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have a supply agreement with our foreign contract manufacturers, our relationship with them remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms or fully assembled printers to us during 2017 or that their terms to us will be any less favorable than they have been historically. +Hewlett-Packard Company ("HP") is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the POS automation and banking market, but also in other manufacturer's printing devices across several other markets. +2 +Canon, Inc. ("Canon") is the sole supplier of inkjet cartridges and other consumable items ("Canon Consumables") that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2017. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 36 United States and 36 foreign patents and have 2 United States and 3 foreign patent applications pending pertaining to our products. The duration of these patents range from 1 to 16 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during that holiday period which may negatively impact sales of our restaurant solutions terminals or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT has been our most significant customer. On May 29, 2015, we signed an agreement with IGT to sell on-line lottery and casino printers to IGT through December 31, 2019. Under the terms of the agreement, we will sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT will purchase such printers from us on a non-exclusive basis. This new agreement will allow TransAct to sell printers to other lottery system customers beyond IGT. +Sales to IGT and other customers representing 10% or more of our total net sales were as follows: +Year ended December 31, +2016 +2015 +2014 +IGT +26% +29% +19% +Suzo-Happ +15% +14% +7% +Eurocoin +0% +0% +11% +Backlog +Our backlog of firm orders was approximately $16,241,000 as of February 28, 2017, compared to $5,403,000 as of February 29, 2016. Based on customers' current delivery requirements, we expect to fill and recognize as revenue $9,555,000 of our current backlog during 2017 and the remaining $6,686,000 during 2018. +Competition +The market for transaction-based and specialty printers and restaurant solutions terminals is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL TM software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than us. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the restaurant solutions market, we compete with Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the POS automation and banking market, we compete with Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. However, we have and will continue to deemphasize efforts in the POS automation and banking markets going forward. +In the casino and gaming market (consisting principally of slot machine and VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we hold a leading position, based largely on our long-term relationship with IGT. We compete in this market with other lottery printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +3 +In the Printrex market, we primarily compete with the Imaging Systems Group, Inc. ("iSys") and Neuralog Inc. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, depending on the geographic area. +Our strategy for competing in our markets is to continually develop new products (hardware and software) and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain thermal, inkjet and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $4,425,000, $3,599,000, and $4,302,000 in 2016, 2015 and 2014, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for sale to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $2,000 and $31,000 as of December 31, 2016 and 2015, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $29,000, 138,000, and $201,000 in 2016, 2015 and 2014, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2016, TransAct and our subsidiaries employed 120 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 15 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, AccuDate™, Epic, EPICENTRAL™, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Available Information +We make available free of charge through the "Investor Relations" tab on our internet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission ("SEC"). You may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. \ No newline at end of file diff --git a/raw/filings/0001017303/2016/0001017303-17-000014/item13.txt b/raw/filings/0001017303/2016/0001017303-17-000014/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..9dda5d300f48e96600fd4bb3101f49b818372286 --- /dev/null +++ b/raw/filings/0001017303/2016/0001017303-17-000014/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2016/0001017303-17-000014/item9a.txt b/raw/filings/0001017303/2016/0001017303-17-000014/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..f0f60c4820bddfeee09c9cf9a22eb7676206708b --- /dev/null +++ b/raw/filings/0001017303/2016/0001017303-17-000014/item9a.txt @@ -0,0 +1,7 @@ +Item 9A. Controls and Procedures. +Attached as exhibits to this Form 10-K are certifications of our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). This "Controls and Procedures" section includes information concerning the controls and controls evaluation referred to in the certifications. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2016. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2016, our disclosure controls and procedures are effective. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management's Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2016. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("2013 COSO"). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2016. \ No newline at end of file diff --git a/raw/filings/0001017303/2016/0001017303-17-000014/rp_note.txt b/raw/filings/0001017303/2016/0001017303-17-000014/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2016/0001017303-17-000014/rpt_disclosure.txt b/raw/filings/0001017303/2016/0001017303-17-000014/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..362afd3492ebf9131ff555c98c5f16b500ae6bc5 --- /dev/null +++ b/raw/filings/0001017303/2016/0001017303-17-000014/rpt_disclosure.txt @@ -0,0 +1,5 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains written policies that relate to the identification, review and approval of related party transactions, in addition to the requirements of NASDAQ and the SEC. As part of a review of possible related person transactions, the Company periodically distributes and collects questionnaires that solicit information about any direct or indirect transactions with the Company from each of our directors and officers. +Our Standards of Business Conduct require all directors, officers and employees to avoid any situation that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company. Under our Standards of Business Conduct, situations that involve, or may reasonably be inferred to involve, a conflict between a director, officer or employee's personal interests and the interests of the Company should be disclosed to the Chair of the Audit Committee. The Audit Committee is then responsible for reviewing the transaction. No transaction determined to be a related party transaction will be approved or ratified if the transaction is contrary to the best interests of the Company. In determining whether to approve or ratify a related party transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the related person's interest in the transaction . +From January 1, 2015 to the date of this Proxy Statement, there have not been any transactions subject to the Company's related party transaction policy or of the type described in Item 404 of Regulation S-K, and currently no such transactions are proposed. +6 \ No newline at end of file diff --git a/raw/filings/0001017303/2017/0001017303-18-000022/filing.txt b/raw/filings/0001017303/2017/0001017303-18-000022/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..f7c798c661b0b4803c8188c51e5bac1ccc3bed38 --- /dev/null +++ b/raw/filings/0001017303/2017/0001017303-18-000022/filing.txt @@ -0,0 +1,3902 @@ +10-K +1 +form10k2017.htm +FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2017 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2017 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to . +Commission file number: 0-21121 +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT +06518 +(Address of principal executive offices) +(Zip Code) +Registrant's telephone number, including area code 203-859-6800 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class - Common Stock, par value $.01 per share +Name of Exchange on which Registered - Nasdaq Global Market +Securities registered pursuant to Section 12(g) of the Act : None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☐ No ☒ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. +Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☐ (Do not check if a smaller reporting company) +Smaller reporting company ☒ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the Registrant was approximately $58,800,000 based on the last sale price on June 30, 2017. +As of February 28, 2018, the number of shares outstanding of the Registrant's common stock, $0.01 par value, was 7,494,228. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant's Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to the 2018 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +4 +Item 1B. +Unresolved Staff Comments +9 +Item 2. +Properties +9 +Item 3. +Legal Proceedings +10 +Item 4. +Mine Safety Disclosures +10 +PART II. +Item 5. +Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +10 +Item 6. +Selected Financial Data +12 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +12 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +24 +Item 8. +Financial Statements and Supplementary Data +24 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +24 +Item 9A. +Controls and Procedures +25 +Item 9B. +Other Information +25 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +25 +Item 11. +Executive Compensation +26 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +26 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +26 +Item 14. +Principal Accounting Fees and Services +26 +PART IV. +Item 15. +Exhibits +27 +Item 16. +Form 10-K Summary +29 +SIGNATURES +Signatures +30 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +PART I +Item 1. Business. +The Company +TransAct Technologies Incorporated ("TransAct" or the "Company") was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high growth markets including restaurant solutions, point of sale ("POS") automation and banking, casino and gaming, lottery, mobile and oil and gas. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the AccuDate™, Epic, EPICENTRAL™, Ithaca®, Printrex® and Responder® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality labels and transaction records such as receipts, tickets, coupons, register journals and other documents, as well as printed logging and plotting of data. We sell our products to original equipment manufacturers ("OEMs"), value-added resellers ("VARs"), select distributors, as well as directly to end-users. Our product distribution spans across the Americas, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of products. Through our TransAct Services Group ("TSG"), we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the restaurant and hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the demand for these products. Our primary operating, hardware research and development, and eastern region service center is located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters, software research and development and western region service center in Las Vegas, NV, a European sales and service center in the United Kingdom, and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT, 06518, with a telephone number of (203) 859-6800. +Financial Information about Segments +We operate in one reportable segment, the design, development, and marketing of software-driven technology and printing solutions for high growth markets, and providing related services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements beginning on page F-3 hereof. +Products, Services and Distribution Methods +Printers and terminals: TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal, inkjet and impact printing technology for applications, primarily in the restaurant solutions, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our restaurant solutions terminals also offer configurable menu options. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers tailored to our customers' business. +Restaurant Solutions: Our line of AccuDate terminals for the restaurant solutions market combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab and go labels for prepared foods, and "enjoy by" date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve, convince and hospitality establishments) effectively manage food spoilage and automate and manage back-of-the-restaurant operations. Our newest addition to the AccuDate product line, the AccuDate XL, is a unique Android® 5.0-based restaurant management terminal specifically designed to meet the food prep management and labeling needs of the restaurant and hospitality industries. Customers buying the AccuDate XL with Jolt software can utilize the terminal for food expiration date labeling and Grab & Go labeling, along with account management and an analytics portal. TransAct's AccuDate® XL restaurant management terminal, integrated with CrunchTime's KitchenSync App, provides an innovative platform that revolutionizes food preparation, food management and other back-of-house processes. In the restaurant solutions market, we use an internal sales force and, to a lesser extent distributors, to solicit sales directly from end-users. +POS automation and banking: Our POS automation and banking printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the POS market, we sell several models of printers utilizing thermal and impact printing technology. Our POS printers are used primarily by restaurants (including fine dining, casual dining, quick-serve and hospitality establishments) located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we sell inkjet printers that are used by banks, credit unions and other financial institutions to print deposit or withdrawal receipts and/or validate checks at bank teller stations. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force and, to a lesser extent, resellers. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals ("VLTs") and other gaming machines that print tickets or receipts instead of issuing coins ("ticket-in, ticket-out" or "TITO") at casinos, racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets or receipts in monochrome, and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through the end of 2017 our primary worldwide distributor, Suzo-Happ Group. However, effective January 1, 2018, we replaced Suzo-Happ Group with new distributors in Asia and Australia and adopted a direct selling model in Europe utilizing our UK sales office. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, as well as to manage sales through our distributors. +1 +We also offer a software solution, the EPICENTRAL™ Print System ("EPICENTRAL™" and "EPICENTRAL® SE"), including annual software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. With EPICENTRAL™, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. In 2017, we introduced EPICENTRAL ® SE a system edition version our software solution, that is specifically designed to work with the existing bonusing modules of casino slot machine management systems. In addition, EPICENTRAL® SE provides an upgrade path to a full EPICENTRAL TM implementation should an operator seek to expand their promotion and bonusing options beyond what the current slot machine management systems offer. +Lottery: We primarily supply lottery printers to International Gaming Technology and its subsidiaries ("IGT"), our largest customer and the world's largest provider of lottery terminals. In addition, during 2015 we launched a new lottery printer, the Epic 3000, that we sell to other lottery system customers beyond IGT. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and other lottery system customers, and are managed by an internal sales representative. +Printrex: Printrex printers include wide format, desktop and rack mounted and vehicle mounted black/white thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. In addition, we sell vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM's, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated Printrex internal sales representative. We primarily sell our mobile printer through a single U.S. distributor. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper, food safety labels and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor's products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress™ and TransAct Care, and other repair services for our printers and terminals. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY and our western region service center in Las Vegas, NV. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 99% of our printer and terminal production is primarily through three third-party contract manufacturers in Asia. The remaining 1% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include thermal, inkjet and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers and terminals produced by our contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer and restaurant solutions terminal models, from one foreign contract manufacturer and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have supply agreements with our foreign contract manufacturers, our relationship with our largest one remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms or fully assembled printers to us during 2018 or that their terms to us will be any less favorable than they have been historically. We are currently seeking to replace our second largest contract manufacturer in 2018 as their terms have become less competitive. +Hewlett-Packard Company ("HP") is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the POS automation and banking market, but also in other manufacturer's printing devices across several other markets. +Canon, Inc. ("Canon") is the sole supplier of inkjet cartridges and other consumable items ("Canon Consumables") that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2018. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +2 +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 36 United States and 37 foreign patents and have 4 United States and 2 foreign patent applications pending pertaining to our products. The duration of these patents range from 1 to 15 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, AccuDate™, Epic, EPICENTRAL™, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our restaurant solutions terminals or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT has been our most significant customer. On May 29, 2015, we signed an agreement with IGT to sell on-line lottery and casino printers to IGT through December 31, 2019. Under the terms of the agreement, we will sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT will purchase such printers from us on a non-exclusive basis. This agreement will allow TransAct to sell printers to other lottery system customers beyond IGT. +In September 2013, we signed an agreement with Suzo-Happ to be our exclusive worldwide distributor of casino and gaming products through December 31, 2017. We did not renew the agreement upon its expiration. Beginning January 1, 2018, we replaced Suzo-Happ with new distributors in Asia and Australia and expanded our sales office in the UK to begin selling directly to end user customers in Europe. +Sales to IGT and Suzo-Happ representing 10% or more of our total net sales were as follows: +Year ended December 31, +2017 +2016 +2015 +IGT +35 +% +26 +% +29 +% +Suzo-Happ +8 +% +15 +% +14 +% +Backlog +Our backlog of firm orders was approximately $10,349,000 as of February 28, 2018, compared to $16,241,000 as of February 28, 2017. Based on customers' current delivery requirements, we expect to fill and recognize as revenue $7,474,000 of our current backlog during 2018 and the remaining $2,875,000 during 2019. +Competition +The market for transaction-based and specialty printers and restaurant solutions terminals is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL TM software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the restaurant solutions market, we compete with Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized purpose-built products, custom engineering and ongoing technical support. +In the POS automation and banking market, we compete with Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. However, we have and will continue to deemphasize efforts in the POS automation and banking markets going forward. +In the casino and gaming market (consisting principally of slot machine and VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we compete with other lottery printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +In the Printrex market, we primarily compete with the Imaging Systems Group, Inc. ("iSys") and Neuralog Inc. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, and label converters depending on the geographic area. +3 +Our strategy for competing in our markets is to continually develop new products (hardware and software) and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain thermal, inkjet and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $4,303,000, $4,425,000, and $3,599,000 in 2017, 2016 and 2015, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $0 and $2,000 as of December 31, 2017 and 2016, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $2,000, $29,000, and $138,000 in 2017, 2016 and 2015, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2017, TransAct and our subsidiaries employed 123 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 14 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Available Information +We make available free of charge through the "Investor Relations" tab on our iInternet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission ("SEC"). You may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. +Item 1A. Risk Factors +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Management's Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are not the only ones facing our Company. Additional risks not known to us now or that we currently deem immaterial may also impair our business operations. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking statements contained in this Annual Report to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +4 +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are likely to continue to vary due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical operating results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may be due to a number of factors, including, but not limited to, those identified throughout this "Risk Factors" section: +● +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +● +the geographic distribution of our sales; +● +market acceptance of our products, both domestically and internationally; +● +development of new competitive products by others; +● +our responses to price competition; +● +our level of research and development activities; +● +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +● +changes in the amount we spend to promote our products and services; +● +changes in the cost of satisfying our warranty obligations and servicing our installed base of products; +● +availability of third-party components at reasonable prices; +● +general economic and industry conditions, including changes in interest rates affecting returns on cash balances and investments, that affect customer demand; +● +fluctuations of world-wide oil and gas prices; +● +severe weather events (such as hurricanes) that can disrupt or interrupt the operation of our customers or suppliers facilities; and +● +changes in accounting rules. +Due to all of the foregoing factors, and the other risks discussed in this report, quarter-to-quarter comparisons of our operating results may not be an indicator of future performance. +Our revenue and profitability depend on our ability to continue to develop, on a timely basis, new products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated. +The success of newer products such as the AccuDate™ restaurant solutions terminals is dependent on how quickly customers in the related markets accept them given the very little market penetration these products have experienced since they are new and innovative and have limited competition. Additionally, the success of innovative technology, such as printing coupons and promotions at the slot machine using EPICENTRAL™, is dependent on our casino customers' acceptance of such technology. While we have designed EPICENTRAL™ to support our customers' existing investment in our Epic 950® thermal casino printers, such acceptance may nevertheless only build gradually over time or not at all. Delays in acceptance by our customers of new technologies may adversely affect our operations. +Our success depends upon our ability to adapt our capabilities and processes to meet the demands of producing new and innovative products. Because our newer products contain software and are generally more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product innovation. If we cannot efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +In the lottery market, we have been dependent on sales to one large customer; the loss of this customer or reduction in orders from this customer could materially affect our sales. +Sales to IGT have represented a material percentage of our net sales since 1995. A reduction, delay or cancellation in orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Significant developments stemming from the recent change U.K.'s referendum on membership in the EU could have a material adverse effect on us. +On June 23, 2016, the United Kingdom held a referendum and voted in favor of leaving the European Union, or EU. This referendum has created political and economic uncertainty, particularly in the United Kingdom and the EU, and this uncertainty may last for years. Our business in the United Kingdom, the EU, and worldwide could be affected during this period of uncertainty, and perhaps longer, by the impact of the United Kingdom's referendum. There are many ways in which our business could be affected, only some of which we can identify as of the date of this annual report. +The referendum, and the likely withdrawal of the United Kingdom from the EU that it triggers, has caused and, along with events that could occur in the future as a consequence of the United Kingdom's withdrawal, including the possible breakup of the United Kingdom, may continue to cause significant volatility in global financial markets, including in global currency and debt markets. This volatility could cause a slowdown in economic activity in the United Kingdom, Europe or globally, which could adversely affect our operating results and growth prospects. In addition, our business could be negatively affected by new trade agreements between the United Kingdom and other countries, including the United States, and by the possible imposition of trade or other regulatory barriers in the United Kingdom. +Infringement on the proprietary rights of others could put us at a competitive disadvantage, and any related litigation could be time consuming and costly. +Third parties may claim that we violated their intellectual property rights. To the extent of a violation of a third party's patent or other intellectual property right, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish our objectives. Any of these claims, with or without merit, could result in costly litigation and divert the attention of key personnel. If such claims are successful, they could result in costly judgments or settlements. Refer to Item 3. "Legal Proceedings" for discussion surrounding litigation we were involved in regarding alleged misappropriation of unspecified trade secrets and confidential information. +General economic conditions could have a material adverse effect on our business, operating results and financial condition. +Our business is subject to general economic conditions. Uncertainty or negative trends in U.S. or international economic and investment climates could adversely affect our business. If these negative trends were to occur, a number of negative effects on our business could result, including customers or potential customers reducing or delaying orders, the insolvency of key suppliers which could result in production delays, the inability of customers to obtain credit, and the insolvency of one or more customers. Any of these effects could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including write-downs of assets. +5 +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and services. We may be adversely impacted by any conflicts that could arise between and among our various sales channels. +Our dependence upon distributors and resellers exposes us to numerous risks, including: +● +loss of channel and the ability to bring new products to market; +● +concentration of credit risk, including disruption in distribution should the distributors and / or resellers' financial condition deteriorate; +● +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +● +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +● +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon the business, consolidated results of operations and financial condition. +We have outsourced substantially all of the assembly of our printers and terminals to three contract manufacturers and will be dependent on them for the manufacturing of such products. A failure by these contract manufacturers, or any disruption in such manufacturing or the flow of product from these manufacturers, may adversely affect our business results. +In an effort to achieve additional cost savings and operation benefits, we have continued to outsource the manufacturing and assembly of our printers and terminals to contract manufacturers in Asia. Approximately 80% of our printer and terminal manufacturing is conducted by one third party manufacturer in Asia, and an additional 19% is conducted by two other third party manufacturers in Asia. +However, to the extent we rely on a third-party service provider for manufacturing services, we may incur increased business continuity risks. We will no longer be able to exercise control over the assembly of certain of our products or any related operations or processes, including the internal controls associated with operations and processes conducted and the quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially adversely affected. +In addition, if any of our contract manufacturers experiences business difficulties or fails to meet our manufacturing needs, then we may be unable to meet production requirements, may lose revenue and may not be able to maintain relationships with our customers. Without the contract manufacturers continuing to manufacture our products and the continuing operation of the contract manufacturers' facilities, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing facility, which could be costly and time consuming and have a material adverse effect on our operating and financial results. +The increased elements of risk that arise from conducting certain operating processes in foreign jurisdictions may lead to an increase in reputational risk. +Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing customers resulting from our inability to produce products for them. +The contract manufacturers have access to our intellectual property, which increases the risk of infringement or misappropriation of this intellectual property. +Political, social or economic instability in regions in which our manufacturers are located, could cause disruptions in trade, including exports to the U.S. +A significant portion of our printers and terminals are manufactured by contract manufacturers overseas and are exported to the U.S. Any such disruption in trade, including exports to the U.S., could adversely affect our business results. Events that could cause disruptions to such exports to the U.S. include: +● +the imposition of additional trade law provisions or regulations; +● +reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; +● +the imposition of additional duties, tariffs and other charges on imports and exports; +● +economic uncertainties and adverse economic conditions (including inflation and recession); +● +fluctuations in the value of the U.S. Dollar against foreign currencies; +● +significant labor disputes, such as dock strikes; +● +significant delays in the delivery of cargo due to port security considerations; and +● +financial or political instability in any of the countries in which our printers and terminals are manufactured. +We source some of our component parts and consumable products from sole source suppliers; any disruptions may impact our ability to manufacture and sell our products. +Our products rely on certain key components from third party or sole source suppliers. We do not have guaranteed supply contracts with any of our component suppliers, and our suppliers could delay shipments, increase prices or cease manufacturing such products or selling them to us at any time. A disruption in the supply of such component parts and consumable products could delay our production and/or the release of our new products and hinder our ability to meet our commitments to customers. If we are unable to obtain a sufficient quantity of these components on commercially reasonable terms or in a timely manner, or if we are unable to obtain alternative sources for the components, sales of our products could be delayed or halted entirely or we may be required to redesign our products. Any of these events could result in lost sales, reduced gross margins or damage to our end-customer relationships, which would have a material adverse effect on our operations and financial results. +6 +We sell a significant portion of our products internationally and purchase important components from foreign suppliers. These circumstances create a number of risks. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. Risks associated with sales and purchases outside the United States include: +● +fluctuating foreign currency rates could restrict sales, or increase costs of purchasing, in foreign countries; +● +foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers or capital flow restrictions; +● +political and economic instability may reduce demand for our products or put our foreign assets at risk; +● +restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets; and +● +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from selling in certain geographic territories. +If tariffs on imported steel and aluminum, such as those recently proposed by the President of the United States, are implemented, our cost of raw materials may increase, which could adversely affect our business, results of operations and financial condition. +We obtain raw materials, including stainless steel and aluminum used in the production of some of our printer products from domestic, Asian affiliated and nonaffiliated sources. The President of the United States recently announced a proposal to impose tariffs of 25 percent on imported steel and 10 percent on imported aluminum through the issuance of an executive order. If implemented, such tariffs may cause an increase in costs for all domestic entities, including TransAct, that purchase imported steel or aluminum or products manufactured using such materials. Because steel and aluminum are raw materials used in a wide-range of our printer products, a broad based cost increase would result in an increase in our cost of goods sold, which may require us to increase prices for some of our products. However, an inability by us to pass such price increases through to our customers, or an inability of our suppliers to meet our raw material requirements, may have a material adverse impact on our business, results of operations or financial condition. +The effect of comprehensive U.S. tax reform legislation on us, whether adverse or favorable, is uncertain. +In December of 2017, President Trump signed into law the Tax Cuts and Jobs Act (the "Tax Act"). Among a number of significant changes to the U.S. federal income tax rules, the Tax Act reduces the marginal U.S. corporate income tax rate from 35% to 21%, limits the deduction for net interest expense, shifts the United States toward a more territorial tax system, and imposes new rules to combat erosion of the U.S. federal income tax base. We are still evaluating the effects of the Tax Act on us and there are a number of uncertainties and ambiguities as to the interpretation and application of many of the provisions in the Tax Act. In the absence of guidance on these issues, we will use what we believe are reasonable interpretations and assumptions in interpreting and applying the Tax Act for purposes of determining our cash tax liabilities and results of operations, which may change as we receive additional clarification and implementation guidance and as the interpretation of the Tax Act evolves over time. It is possible that the Internal Revenue Service ("IRS" could issue subsequent guidance or take positions on audit that differ from the interpretations and assumptions that we previously made, which could have an adverse effect on our cash tax liabilities, results of operations and financial condition. As we collect and prepare necessary data, and interpret the Tax Act and any additional guidance issued by the IRS or other standard-setting bodies, we may make adjustments to the provisional amounts that could materially affect our financial position and results of operations, as well as our effective tax rate in the period in which the adjustments are made. +We face risks associated with manufacturing forecasts. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays, which could cause us to lose orders or customers and result in lower net sales. We currently use a rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our requirements for components and materials. It is very important that we accurately predict both the demand for our products and the lead-time required to obtain the necessary components and raw materials. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size of the order, contract terms, and demand for each component at a given time. If we underestimate our requirements, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and result in delays in shipments and net sales. If we overestimate our requirements, we could have excess inventory of parts. In addition, delays in the manufacturing of our products could cause us to lose orders or customers. +Our success will depend on our ability to sustain and manage growth. +As part of our business strategy, we intend to pursue a growth strategy. Assuming this growth occurs, it will require the expansion of customer relationships in international markets, the successful development and marketing of new products for our existing and new markets, expanded internal sales, customer service and support, and the continued implementation and improvement of our operational, financial and management information systems. +To the extent that we seek growth through acquisitions, our ability to manage our growth will also depend on our ability to integrate businesses that have previously operated independently. We may not be able to achieve this integration without encountering difficulties or experiencing the loss of key employees, customers or suppliers. It may be difficult to design and implement effective financial controls for combined operations and differences in existing controls for each business may result in weaknesses that require remediation when the financial controls and reporting functions are combined. As we pursue acquisitions, we may incur legal, accounting and other transaction related expenses for unsuccessful acquisition attempts that could adversely affect our results of operations in the period in which they are incurred. +There can be no assurance that we will be able to successfully implement our growth strategy, or that we can successfully manage expanded operations, if they occur. As we expand, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our results of operations and financial condition. +We compete in highly competitive markets, which are likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, transaction supplies and services. Our principal competitors have substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +● +technologically advanced products that satisfy the user demands; +● +superior customer service; +● +high levels of quality and reliability; and +● +dependable and efficient distribution networks. +7 +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products. Any of these factors could reduce our earnings. +We depend on key personnel, the loss of which could materially impact our business. +Our future success will depend in significant part upon the continued service of certain key management and other personnel and our continuing ability to attract and retain highly qualified managerial, technical and sales and marketing personnel. There can be no assurance that we will be able to recruit and retain such personnel. The loss of either Bart C. Shuldman, the Company's Chairman of the Board and Chief Executive Officer, or Steven A. DeMartino, the Company's President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, could have a material adverse effect on our results of operations. +If we are unable to enforce our patents or if it is determined that we infringe patents held by others it could damage our business. +Prosecuting and defending patent lawsuits is very expensive. We are committed to aggressively asserting and defending our technology and related intellectual property, which we have spent a significant amount of money to develop. These factors could cause us to become involved in new patent litigation in the future. The expense of prosecuting or defending these future lawsuits could also have a material adverse effect on our business, financial condition and results of operations. +If we were to lose a patent lawsuit in which another party is asserting that our products infringe its patents, we would likely be prohibited from marketing those products and could also be liable for significant damages. Either or both of these results may have a material adverse effect on our business, financial condition and results of operations. If we lose a patent lawsuit in which we are claiming that another party's products are infringing our patents and thus, are unable to enforce our patents, it may have a material adverse effect on our business, financial condition and results of operations. In addition to disputes relating to the validity or alleged infringement of other parties' rights, we may become involved in disputes relating to our assertion of our own intellectual property rights. Whether we are defending the assertion of intellectual property rights against us or asserting our intellectual property rights against others, intellectual property litigation can be complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. Plaintiffs in intellectual property cases often seek injunctive relief, and the measures of damages in intellectual property litigation are complex and often subjective or uncertain. Thus, any adverse determinations in this type of litigation could subject us to significant liabilities and costs. During the course of these lawsuits there may be public announcements of the results of hearings, motions, and other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could harm the market price of our stock. +The inability to protect intellectual property could harm our reputation, and our competitive position may be materially damaged. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trade secrets and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without authorization, to obtain and use information which we regard as trade secrets. +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as: +● +changes in our business, operations or prospects; +● +developments in our relationships with our customers; +● +announcements of new products or services by us or by our competitors; +● +announcement or completion of acquisitions by us or by our competitors; +● +changes in existing or adoption of additional government regulations; +● +unfavorable or reduced analyst coverage; and +● +prevailing domestic and international market and economic conditions. +In addition, the stock market may experience significant price fluctuations year-to-year. Broad market fluctuations, general economic conditions and specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Limited trading volume and a reduction in analyst coverage of our common stock may contribute to its price volatility. +Our common stock is traded on the Nasdaq Global Market. During the year ended December 31, 2017, the average daily trading volume for our common stock as reported by the Nasdaq Global Market was approximately 18,000 shares. We are uncertain whether a more active trading market in our common stock will develop. In addition, many investment banks no longer find it profitable to provide securities research on micro-cap and small-cap companies. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the price of our common stock. +Future sales of our common stock may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, and we may also issue additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future sale pursuant to stock options and other equity awards that we have granted to our employees, and in the future we may grant additional stock options and other forms of equity compensation to our employees. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. +8 +If market conditions deteriorate or future results of operations are less than expected, a valuation allowance may be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred tax assets on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions deteriorate or future results of operations are less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are not realizable. As a result, we may need to establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +We cannot provide any assurance that current laws, or any laws enacted in the future, will not have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements in each of the jurisdictions in which we conduct business. Changes in laws, rules, regulations, policies or requirements could result in the need to modify our products and could affect the demand for our products, which may have an adverse impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security measures, military actions and other efforts to combat terrorism. It is possible that terrorist attacks could be directed at important locations for the gaming industry. Heightened security measures and other efforts to combat terrorism may also have an adverse effect on the gaming industry by reducing tourism. Any of these developments could also negatively affect the general economy and consumer confidence. Any downturn in the economy or in the gaming industry in particular could reduce demand for our products and adversely affect our business and results of operations. In addition, heightened security measures may cause certain governments to restrict the import/export of goods, which may have an adverse effect on our ability to buy/sell goods. +Fluctuations in oil and gas prices could adversely affect drilling and exploration activities by oil and gas companies and our revenue in our Printrex market. If oil and gas prices remain volatile, or if oil or gas prices remain low or decline further, the demand for our Printrex products could be adversely affected. +The demand for our Printrex products depends on the level of spending by oil and gas companies for drilling and exploratory activities, which are affected by short-term and long-term trends in oil and gas prices, including current and anticipated oil and gas prices. Oil and gas prices, as well as the level of drilling and exploration, historically have been extremely volatile and are expected to continue to be highly volatile. If oil and gas prices continue to remain low or decline further, or if there is a further reduction in drilling and exploration activities, the demand for our Printrex products could be materially and adversely affected. +Security breaches, cyber-attacks, or other disruptions could expose us to liability and affect our business and reputation. +We are increasingly dependent on our information technology systems and infrastructure for our business. We collect, store, and transmit sensitive information including intellectual property, proprietary business information and personal information in connection with business operations. The secure maintenance of this information is critical to our operations and business strategy. Some of this information could be an attractive target of criminal attack by third parties with a wide range of motives and expertise, including organized criminal groups, disgruntled current or former employees, and others. Cyber-attacks are of ever-increasing levels of sophistication, and despite our extensive security measures, our information technology and infrastructure may be vulnerable to such attacks or may be breached, including due to employee error or malfeasance. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. If our systems become compromised, we may not promptly discover the intrusion. Like other companies in our industry, we have experienced attacks to our data and systems, including malware and computer viruses that we have been able to detect and eliminate. If our systems fail or are breached or disrupted, we could lose product sales, and suffer reputational damage and loss of customer confidence. Such incidents would require notification to affected individuals, and may result in legal claims or proceedings and liability under federal and state laws that protect the privacy and security of personal information. Any one of these events could cause our business to be materially harmed and our results of operations to be adversely impacted. +Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely impact our business. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on our business, financial condition, and results of operations. +Item 1B. Unresolved Staff Comments. +Not applicable. +Item 2. Properties. +Our principal facilities as of December 31, 2017 are listed below and we believe that all facilities generally are in good condition, adequately maintained and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. +Ft.) +Owned or Leased +Lease Expiration Date +Hamden, Connecticut +Executive offices and TSG sales office +11,100 +Leased +April 30, 2027 +Ithaca, New York +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2021 +Las Vegas, Nevada +Software design and development, service center and casino and gaming sales office +19,600 +Leased +October 31, 2022 +Doncaster, United Kingdom +Sales office and service center +6,000 +Leased +August 26, 2026 +Macau, China +Sales office +180 +Leased +June 30, 2018 +110,780 +9 +Item 3. Legal Proceedings. +The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. Management believes that the final outcome of such matters, if determined adversely, will not have a material adverse effect on our business, financial condition or results of operations. +Item 4. Mine Safety Disclosures. +Not applicable. +PART II +Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +Our common stock is traded on the Nasdaq Global Market under the symbol TACT. As of February 28, 2018, there were 297 holders of record of the common stock and the common stock was trading at $13.85. The high and low bid sales prices of the common stock reported during each quarter of the years ended December 31, 2017 and 2016 were as follows: +Year Ended +Year Ended +December 31, 2017 +December 31, 2016 +High +Low +High +Low +First Quarter +$ +8.70 +$ +6.43 +$ +9.44 +$ +6.55 +Second Quarter +9.40 +7.90 +8.98 +6.43 +Third Quarter +10.50 +8.35 +8.24 +7.19 +Fourth Quarter +15.55 +8.80 +7.50 +5.90 +In September 2012, our Board of Directors initiated a quarterly cash dividend program, with an initial quarterly dividend of $0.06 per share, subject to the Board's approval each quarter. Our Board of Directors declared an increase to the quarterly cash dividend from $0.06 to $0.07 per share in May 2013, from $0.07 to $0.08 per share in May 2014, and from $0.08 to $0.09 per share in May 2017. Dividends declared and paid on our common stock totaled $2,581,000 or $0.35 per share and $2,416,000 or $0.32 per share, in 2017 and 2016, respectively. On February 5, 2018, our Board of Directors approved the first quarter 2018 dividend in the amount of $0.09 per share payable on or about March 15, 2018 to common shareholders of record at the close of business on February 20, 2018. +Issuer Purchases of Equity Securities +Prior to its expiration on December 31, 2017, we maintained a stock repurchase program (the "2016 Stock Repurchase Program") whereby we were authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From January 1, 2017 through the expiration date of the 2016 Stock Repurchase Program, we purchased 36,465 shares of our common stock for $358,000 at an average price of $9.84 per share. From the start of the 2016 Stock Repurchase Program on February 25, 2016 through December 31, 2017, we purchased 499,843 shares of our common stock for $3,929,000 at an average price of $7.86 per share. +In 2015, under a prior stock repurchase program, we purchased 166,553 shares of our common stock for $1,020,000 at an average price of $6.12 per share. From January 1, 2005 through December 31, 2017, we repurchased a total of 3,888,432 shares of common stock for $30,110,000, at an average price of $7.74 per share, under such stock repurchase program. +On March 1, 2018, our Board of Directors approved a new stock repurchase program (the "2018 Stock Repurchase Program") substantially similar to the 2016 Stock Repurchase Program, whereby we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price and other factors. The 2018 Stock Repurchase Program expires on December 31, 2019, if we do not discontinue it prior to such time. +Securities Authorized for Issuance under Equity Compensation Plans +For a discussion of the Company's equity compensation plan information, please see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Form 10-K. +10 +CORPORATE PERFORMANCE GRAPH +The following graph compares the cumulative total return on the Company's Common Stock from December 31, 2012 through December 31, 2017, with the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Hardware Stocks Index. The graph assumes that $100 was invested on December 31, 2012 in each of TransAct's common stock, the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Manufacturer Stocks Index, and that all dividends were reinvested. +COMPARISON OF CUMULATIVE TOTAL RETURN AMONG +TRANSACT TECHNOLOGIES INCORPORATED COMMON STOCK, +THE CRSP TOTAL RETURN INDEX FOR THE NASDAQ STOCK MARKET (U.S.), +AND THE NASDAQ COMPUTER MANUFACTURER STOCKS INDEX +12/31/12 +12/31/13 +12/31/14 +12/31/15 +12/31/16 +12/31/17 +TransAct Technologies Incorporated Common Stock +$ +100.00 +$ +173.55 +$ +75.76 +$ +118.98 +$ +91.41 +$ +183.52 +CRSP Total Return Index for the Nasdaq Stock Market (U.S.) +$ +100.00 +$ +133.48 +$ +150.12 +$ +150.84 +$ +170.46 +$ +206.91 +Nasdaq Computer Hardware Stocks Index +$ +100.00 +$ +117.65 +$ +159.48 +$ +145.20 +$ +167.36 +$ +240.72 +11 +Item 6. Selected Financial Data (in thousands, except per share amounts) +The following is summarized from our audited financial statements of the past five years: +Year ended December 31, +2017 +2016 +2015 +2014 +2013 +Consolidated Statement of Operations Data: +Net sales +$ +56,311 +$ +57,235 +$ +59,676 +$ +53,108 +$ +60,141 +Gross profit +26,662 +23,799 +24,978 +21,711 +25,092 +Operating expenses +19,848 +18,599 +20,510 +25,483 +18,475 +Operating income (loss) +6,814 +5,200 +4,468 +(3,772 +) +6,617 +Net income (loss) +3,211 +3,617 +3,092 +(2,421 +) +4,935 +Net income (loss) per share: +Basic +0.43 +0.48 +0.40 +(0.29 +) +0.57 +Diluted +0.42 +0.47 +0.39 +(0.29 +) +0.57 +Dividends declared and paid per share +0.35 +0.32 +0.32 +0.31 +0.27 +December 31, +2017 +2016 +2015 +2014 +2013 +Consolidated Balance Sheet Data: +Total assets +$ +33,950 +$ +32,042 +$ +32,569 +$ +35,491 +$ +40,408 +Shareholders' equity +26,014 +24,109 +25,728 +25,394 +32,521 +Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Forward Looking Statements +Certain statements included in this report, including without limitation statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. (the "Exchange Act")Forward-looking statements generally can be identified by the use of forward-looking terminology, such as "may", "will", "expect", "intend", "estimate", "anticipate", "believe", "project" or "continue" or the negative thereof or other similar words. All forward-looking statements involve risks and uncertainties, including, but not limited to those listed in Item 1A of this Annual Report and such other risk and uncertainties as are described in our reports filed with the SEC from time to time.. Actual results may differ materially from those discussed in, or implied by, the forward-looking statements. The forward-looking statements speak only as of the date of this report and we assume no duty to update them. +Overview +During the year ended December 31, 2017, we continued to focus our efforts on sales execution and growing the revenue of our newer, value-added products and technologies. During the year we completed the build-out of our direct sales force and implementation of a direct marketing campaign dedicated to the restaurant solutions market. We expect the investments we have made during 2017 to result in increased sales in restaurant solutions as we begin to see significant sales contribution from our two newest products, the AccuDate Pro and AccuDate XL. +During 2018, we plan to strategically invest in our sales and marketing for our European casino and gaming market. Effective December 31, 2017, we terminated the relationship with our worldwide casino and gaming distributor and began building an internal sales team to sell directly to our slot machine manufacturers and end user casino and gaming customers in Europe. As a result of this investment we expect international casino and gaming sales will increase in 2018 compared to 2017. During 2017, sales for our POS automation and banking market decreased as sales to McDonald's began to slow during 2017 compared to the record pace experienced in 2016. We expect sales of our POS automation and banking market to decrease in 2018 as McDonald's completes the implementation of their initiatives which began in 2015 and we shift of our focus toward the restaurant solutions market and casino and gaming market. These decreases were partially offset by increased TSG sales due to higher sales of spare parts in the lottery market in 2017 to IGT compared to 2016. +During 2017, our total net sales decreased 2% to approximately $56,311,000. See the table below for a breakdown of our sales by market: +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Restaurant solutions +$ +4,758 +8.4 +% +$ +5,162 +9.0 +% +$ +(404 +) +(7.8 +%) +POS automation and banking +7,905 +14.0 +% +10,518 +18.4 +% +(2,613 +) +(24.8 +%) +Casino and gaming +18,615 +33.1 +% +21,006 +36.7 +% +(2,391 +) +(11.4 +%) +Lottery +9,805 +17.4 +% +9,913 +17.3 +% +(108 +) +(1.1 +%) +Printrex +1,052 +1.9 +% +540 +1.0 +% +512 +94.8 +% +TSG +14,176 +25.2 +% +10,096 +17.6 +% +4,080 +40.4 +% +$ +56,311 +100.0 +% +$ +57,235 +100.0 +% +$ +(924 +) +(1.6 +%) +Sales of our restaurant solutions products decreased 8% in the year ended December 31, 2017 compared to the year ended December 31, 2016. In the restaurant solutions market, our focus lies with providing terminals that print food rotational date and nutritional labels to help restaurants and other food service establishments effectively manage food rotation and safety. The decrease in restaurant solutions sales resulted from lower sales of our AccuDate™ 9700 terminal to our U.S. distributor. This decrease was partially offset by increased sales of our AccuDate Pro terminal and the initial sales of our AccuDate XL terminal in 2017. Our focus for 2018 will be to capitalize on the 2017 investments made in creating our direct selling model and in our latest terminal, the AccuDate XL. +12 +Sales of our POS automation and banking products decreased 25% in the year ended December 31, 2017 compared to the year ended December 31, 2016. In the POS market, we focus primarily on supplying printers that print receipts or linerless labels for customers in the restaurant and quick serve markets. During 2017, sales of our POS automation and banking printers declined as sales of our Ithaca® 9000 printer to McDonald's began to slow compared to the record pace experienced in 2016. We expect sales to continue to decrease in 2018 compared to 2017 as McDonald's completes the implementation of their initiatives that use the Ithaca® 9000 which began in 2015. POS automation and banking sales also decreased in 2017 due to a 37% decline in sales of our other legacy POS and banking printers. In the banking market, we focus mainly on supplying printers for use in bank teller stations at banks and financial institutions primarily in the U.S. Although we continue to provide printers to our existing banking and POS (non-McDonald's) customers, we have significantly reduced our focus on this market in order to increase our focus on the restaurant solutions market. +Sales of our casino and gaming products decreased 11% in 2017 compared to 2016. In our casino and gaming market, our focus lies primarily in supplying printers worldwide for use in slot machines at casinos and racetracks, as well as in other electronic gaming devices that print tickets or receipts. Additionally, we supplement these printer sales with revenue from EPICENTRAL™, our promotional printing system that enables casino operators to create promotional coupons and marketing messages and print them real time at the slot machine. The decrease of casino and gaming printer sales is primarily due to a 46% decrease in international sales of our off-premise gaming printers and 46% decrease in international sales of the EPIC 950, our thermal casino printer, due to continued sluggishness in Europe, Australia and Asia, including significantly lower sales to our former exclusive worldwide distributor. Effective December 31, 2017, we terminated the relationship with our worldwide casino and gaming distributor and have begun to develop an internal sales team to sell directly to our slot machine manufacturers and end user casino and gaming customers in Europe. Domestic casino and gaming printer sales increased 22% due mainly to higher sales to our OEMs to support new casino openings and market share gains. Sales of our EPICENTRAL TM software decreased 42% as we completed two installations worldwide in 2017 compared to three installations in 2016. +In the lottery market, we continue to hold a leading position based on our long-term relationship with IGT, our largest customer and the world's largest provider of lottery terminals. IGT has been our customer since 1995, and we continue to maintain a good relationship with them. During 2017, total lottery printer sales to IGT remained relatively consistent with 2016. A decrease of 11% in domestic lottery sales to IGT was almost entirely offset by a $1 million increase in international lottery sales to IGT due to a sale in 2017 for the Canadian lottery and no comparable sales in 2016. Our sales to IGT each year are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs and are not indicative of IGT's overall business or revenue. Starting in 2015, we no longer have an exclusive arrangement with IGT. However, we continue to have a good relationship with IGT which we expect to continue, and we also have the ability to sell our market leading products to other lottery system customers. +Sales of our Printrex branded printers include wide format, rack mounted and vehicle mounted thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. Sales in this market also includes wide format vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. During 2017, we experienced 95% increase in Printrex product sales due primarily to the recovery of the worldwide oil and gas market that had been negatively impacted from multiple years of declining worldwide oil prices. Although we expect to see continued modest growth in the oil and gas markets during 2018, we do not anticipate significant contribution to total sales from our Printrex products as we shift our focus towards our higher value, technology enabled restaurant solution terminals and casino and gaming products. +Our TSG group, which sells service, replacement parts and consumable products, including food safety labels, receipt paper, ribbons and inkjet cartridges, continues to offer a recurring revenue stream for the Company. TSG sales increased 40% in 2017 from 2016 primarily due to unusually high sales of replacement parts to IGT for a legacy lottery printer in 2017 that did not occur at the same level in 2016. Although the installed base of our thermal lottery printers continues to grow and lotteries continue to extend lottery contracts utilizing our existing hardware, including our printer, based on our backlog of orders and contractual commitments from IGT for spare parts, we expect TSG sales to decrease in 2018 due to the higher than normal IGT spare parts sales in 2017. +Operationally, our gross margin reached 47.3% in 2017, an increase of 570 basis points from 2016, representing the highest gross margin we have reported for a full year. We believe gross margin will continue at these levels in 2018 as our newer, technology-enabled products continue to grow and become a larger portion of our overall sales. In 2017, we achieved operating margin of 12.1% compared to 9.1% in 2016 due to our improved gross margin that was partially offset by higher operating expenses primarily to support our two high growth markets--restaurant solutions and casino and gaming. During 2018, we expect higher operating expenses compared to 2017, as we continue to increase our investments in selling and marketing in these two high growth markets, as we believe these represent TransAct's most significant, long term growth opportunity. +We reported net income of $3,211,000 and net income per diluted share of $0.42 for 2017, compared to $3,617,000 and net income per diluted share of $0.47 for 2016. In terms of cash flow for 2017, we experienced a very strong year, generating $5,918,000 of cash from operating activities. We also returned $2,939,000 to our shareholders in the form of $358,000 for treasury share repurchases and $2,581,000 for cash dividends and finishing the year with cash and cash equivalents of $5,507,000 and no debt on our Consolidated Balance Sheet at December 31, 2017. +Critical Accounting Policies and Estimates +The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Income categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances. We evaluate our assumptions on an ongoing basis by comparing actual results with our estimates. Actual results may differ from the original estimates. +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These items utilize assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Please refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial Statements for a complete listing of our accounting policies. +13 +Revenue Recognition – Our typical contracts include the sale of printers and terminals, which are sometimes accompanied by separately-priced extended warranty and technical support contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer or terminal sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within Accounting Standards Codification ("ASC") 605, "Revenue Recognition" (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms which are generally FOB shipping point) has occurred, the selling price is fixed and determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +Our software solution, EPICENTRAL TM , enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. Revenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, "Multiple-Element Arrangements" and ASC 985-605, "Software." EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system's full functionality. These arrangements are accounted for in accordance with ASC 605-25, "Multiple-Element Arrangements". EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, "Software" as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level generally accepted accounting principles ("GAAP") and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence ("VSOE") if available, third party evidence ("TPE") if VSOE is not available, or best estimate of selling price ("BESP") to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, "Separately Priced Extended Warranty and Product Maintenance Contracts." Pursuant to this guidance, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established, but we cannot guarantee that we will continue to experience return rates consistent with historical patterns. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. However, we cannot guarantee that this minimal level will continue. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +Accounts Receivable – We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on available credit information; and adjustments to credit limits based upon payment history and the customer's current creditworthiness. We also provide an estimate of doubtful accounts based on historical experience and specific customer collection issues. Our allowance for doubtful accounts as of December 31, 2017 was approximately $100,000, or less than 1% of outstanding accounts receivable, which we feel is appropriate considering the overall quality of our accounts receivable. While credit losses have historically been within expectations and the reserves established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience. +Inventories – Our inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completion, disposal and transportation, historical usage and estimates of future demand. Assumptions are reviewed at least quarterly and adjustments are made, as necessary, to reflect changing market conditions. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net realizable value. Should circumstances change and we determine that additional inventory is subject to obsolescence, additional write-downs of inventory could result in a charge to income. +Goodwill and Intangible Assets – We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 "Goodwill", acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Definite lived intangible assets are amortized and are tested for impairment when appropriate. We reported $2,621,000 of goodwill and $458,000 of unamortized definite-lived intangible assets at December 31, 2017. We have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2017 when the impairment review is performed. +14 +Income Taxes – In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing temporary differences between the tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax reserves with respect to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this forecast against the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future deferred tax assets in excess of its net recorded amount, an adjustment to the valuation allowance would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, "Income Taxes." Among other things this provision prescribes a minimum recognition threshold that an income tax position must meet before it is recorded in the reporting entity's financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet reporting date, it is "more likely than not" (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing authority will examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between the amount claimed, or expected to be claimed, on a company's income tax returns and the benefits recognized in the financial statements. See Note 11 to the consolidated financial statements for further details of the impact of the Tax Reform Act. +Warranty – We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. If actual future product repair rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability and related warranty expense would be made. +Share-Based Compensation – We calculate share-based compensation expense in accordance with ASC 718, "Compensation – Stock Compensation" using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, and dividend yield. Prior to January 1, 2017, stock-based compensation expense included estimated effects of forfeitures. Upon adoption of Accounting Standards Update ("ASU") 2016-09, "Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting", in 2017, an accounting policy election was made to account for forfeitures as they occur. The amended guidance requires that all tax effects related to share-based payments are recorded at settlement (or expiration) through the income statement, rather than through equity. Cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows. The amended guidance also allows for an employer to repurchase additional employee shares for tax withholding purposes without requiring liability accounting and clarifies that all cash payments made to tax authorities on an employee's behalf for withheld shares should be presented as a financing activity on the Consolidated Statements of Cash Flows. The presentation requirements for cash flows related to excess tax benefits and employee taxes paid for withheld shares were applied retrospectively to all periods presented. +Results of Operations: Year ended December 31, 2017 compared to Year ended December 31, 2016 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2017 and 2016 were as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Restaurant solutions +$ +4,758 +8.4 +% +$ +5,162 +9.0 +% +$ +(404 +) +(7.8 +%) +POS automation and banking +7,905 +14.0 +% +10,518 +18.4 +% +(2,613 +) +(24.8 +%) +Casino and gaming +18,615 +33.1 +% +21,006 +36.7 +% +(2,391 +) +(11.4 +%) +Lottery +9,805 +17.4 +% +9,913 +17.3 +% +(108 +) +(1.1 +%) +Printrex +1,052 +1.9 +% +540 +1.0 +% +512 +94.8 +% +TSG +14,176 +25.2 +% +10,096 +17.6 +% +4,080 +40.4 +% +$ +56,311 +100.0 +% +$ +57,235 +100.0 +% +$ +(924 +) +(1.6 +%) +International* +$ +7,591 +13.5 +% +$ +11,693 +20.4 +% +$ +(4,102 +) +(35.1 +%) +* +International sales do not include sales of products made to domestic distributors or other customers who in turn ship those products to international destinations. +15 +Net sales for 2017 decreased $924,000, or 2%, from 2016. Printer and terminal sales volume decreased by 13% to approximately 150,000 units, driven primarily by a 25% and 13% decrease in unit volume from the POS automation and banking market and casino and gaming market, respectively and, to a lesser extent a 3% decrease in the lottery market and 13% decrease in the restaurant solutions market. These decreases were partially offset by increased sales volume of 112% in the Printrex market. The average selling price of our printers and terminals increased 4% in 2017 compared to 2016, primarily due to decreased volume of POS automation and banking printers sold in 2017, which carry lower prices than our other products. +Overall, international sales decreased $4,102,000, or 35%, primarily driven by lower sales in the international casino and gaming market. This decrease was partially offset by a $1 million sales increase in our international lottery market during 2017. +Restaurant solutions: Revenue from the restaurant solutions market includes sales of terminals that combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab and go labels for prepared foods, and "enjoy by" date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve convenience and hospitality establishments) effectively manage food safety and automate and manage back-of-the-restaurant operations. A summary of sales of our worldwide restaurant solutions products for the years ended December 31, 2017 and 2016 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +4,384 +92.1 +% +$ +4,747 +92.0 +% +$ +(363 +) +(7.6 +%) +International +374 +7.9 +% +415 +8.0 +% +(41 +) +(9.9 +%) +$ +4,758 +100.0 +% +$ +5,162 +100.0 +% +$ +(404 +) +(7.8 +%) +The decrease in domestic restaurant solutions terminal sales in 2017 compared to 2016 was primarily driven by lower sales of our AccuDate 9700 terminal to our U.S. distributor. This decrease was partially offset by increased sales of our AccuDate 9700 terminal to McDonald's, increased sales of our AccuDate Pro terminal and the initial sales of our AccuDate XL terminal in 2017. We expect sales of our restaurant solutions terminals to increase in 2018 compared to 2017 as we begin to realize the benefits from the strategic selling and marketing investments made during 2017. +International restaurant solution terminals decreased during 2017 compared to 2016 due to lower sales to our Latin American and Canadian distributors. +POS automation and banking: Revenue from the POS automation and banking market includes sales of thermal and impact printers used primarily by restaurants (including fine dining, casual dining, quick serve and hospitality establishments) located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In addition, revenue includes sales of inkjet printers used by banks, credit unions and other financial institutions to print deposit or withdrawal receipts and/or validate checks at bank teller stations. A summary of sales of our worldwide POS automation and banking products for the years ended December 31, 2017 and 2016 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +7,596 +96.1 +% +$ +9,754 +92.7 +% +$ +(2,158 +) +(22.1 +%) +International +309 +3.9 +% +764 +7.3 +% +(455 +) +(59.6 +%) +$ +7,905 +100.0 +% +$ +10,518 +100.0 +% +$ +(2,613 +) +(24.8 +%) +The decrease in both domestic and international POS automation and banking printer revenue in 2017 compared to 2016 was primarily driven by a 23% decrease in sales of our Ithaca® 9000 printer, as sales to McDonald's began to slow compared to the record pace experienced in 2016. We expect sales of our Ithaca® 9000 to McDonald's to decrease in 2018 compared to 2017 as McDonald's completes the implementation of their initiatives that use the Ithaca® 9000 which began in 2015. Additionally, we experienced a 37% decline in sales of our legacy banking and other POS printers in 2017 compared to 2016. We expect sales of these legacy products to continue to decline during 2018, as we continue to deemphasize these products and shift focus to our newer restaurant solutions products. +Casino and gaming: Revenue from the casino and gaming market includes sales of thermal ticket printers used in slot machines, video lottery terminals ("VLTs"), and other gaming machines that print tickets or receipts instead of issuing coins ("ticket-in, ticket-out" or "TITO") at casinos and racetracks and other gaming venues worldwide. Revenue from this market also includes sales of thermal roll-fed printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes, Skills with Prizes and Fixed Odds Betting Terminals at non-casino gaming establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of the EPICENTRAL™ print system, our software solution (including annual software maintenance), that enables casino operators to create promotional coupons and marketing messages and to print them real-time at the slot machine. A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2017 and 2016 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +13,608 +73.1 +% +$ +11,553 +55.0 +% +$ +2,055 +17.8 +% +International +5,007 +26.9 +% +9,453 +45.0 +% +(4,446 +) +(47.0 +%) +$ +18,615 +100.0 +% +$ +21,006 +100.0 +% +$ +(2,391 +) +(11.4 +%) +16 +The increase in domestic sales of our casino and gaming products in 2017 compared to 2016 was due primarily to 26% higher sales of our thermal casino printers due mainly to market share gain, including higher sales to our OEMs to support two new casino openings. This increase was partially offset by a decrease in domestic EPICENTRAL™ software sales of 34%. We completed two EPICENTRAL™ installations in both 2017 and 2016, however in 2017 our installations consisted of one full-feature version of EPICENTRAL™ and our first EPICENTRAL® SE version compared to two full-feature versions of EPICENTRAL™ in 2016. Our EPICENTRAL® SE software is offered at a lower price compared to our full-feature version of EPICENTRAL™. Sales of EPICENTRAL™ are project based and as a result, may fluctuate significantly quarter-to-quarter and year-to-year. +International casino and gaming printer sales declined in 2017 compared to 2016 due to a 46% decrease in international sales of our thermal casino printers in Europe, Asia and Australia, as well as a 46% decrease in international sales of our off-premise gaming printers to our former exclusive worldwide distributor in Europe and Australia. Sales of our off-premise gaming printers are largely project-oriented and therefore may fluctuate significantly from quarter-to-quarter and year-to-year. International EPICENTRAL™ software sales also declined 79% as we completed no international EPICENTRAL™ installations in 2017 compared to one completed international installation in 2016. In 2018, we expect to see an increase in international casino and gaming sales as we complete the transition away from our exclusive worldwide distributor and begin to sell directly to our slot machine manufacturers and end user casino and gaming customers in Europe. +Lottery: Revenue from the lottery market includes sales of thermal on-line and other lottery printers primarily to IGT and its subsidiaries, and to a lesser extent, other lottery system companies for various lottery applications. A summary of sales of our worldwide lottery printers for the years ended December 31, 2017 and 2016 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +8,626 +88.0 +% +$ +9,710 +98.0 +% +$ +(1,084 +) +(11.2 +%) +International +1,179 +12.0 +% +203 +2.0 +% +976 +480.8 +% +$ +9,805 +100.0 +% +$ +9,913 +100.0 +% +$ +(108 +) +(1.1 +%) +Our sales to IGT are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of IGT's overall business or revenue. While we expect to increase sales of our lottery printers to other customers, based on our backlog of orders and customer forecasts, we expect lottery printer sales to be lower in 2018 compared to 2017. +International lottery sales increased due to sales of lottery printers to IGT for the Canadian lottery in 2017 and no comparable sales occurring in 2016. +Printrex: Printrex branded printers are sold into markets that include wide format, desktop and rack mounted and vehicle mounted black/white thermal printers used by customers to log and plot oil field, seismic and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at the data centers of the oil and gas field service companies. Revenue in this market also includes sales of vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. A summary of sales of our worldwide Printrex printers for the years ended December 31, 2017 and 2016 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +849 +80.7 +% +$ +463 +85.7 +% +$ +386 +83.4 +% +International +203 +19.3 +% +77 +14.3 +% +126 +163.6 +% +$ +1,052 +100.0 +% +$ +540 +100.0 +% +$ +512 +94.8 +% +The increase in Printrex printers was due to an 83% increase in domestic and international sales of our oil and gas printers due to higher demand in 2017 compared to 2016 and a 149% increase in sales of medical and mobile printers primarily due to sales of our mobile printer to one customer. We expect 2018 Printrex sales to be higher than 2017, as we expect a continued modest recovery in the oil and gas market to more than offset lower expected sales of medical and mobile printers as we shift our focus to our higher value, technology-enabled restaurant solution and casino and gaming products. +TSG: Revenue from TSG includes sales of consumable products (inkjet cartridges, ribbons, receipt paper, color thermal paper, food safety labels and other printing supplies), replacement parts, maintenance and repair services, testing services, refurbished printers, and shipping and handling charges. A summary of sales in our worldwide TSG market for the years ended December 31, 2017 and 2016 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +13,657 +96.3 +% +$ +9,315 +92.3 +% +$ +4,342 +46.6 +% +International +519 +3.7 +% +781 +7.7 +% +(262 +) +(33.5 +%) +$ +14,176 +100.0 +% +$ +10,096 +100.0 +% +$ +4,080 +40.4 +% +The increase in domestic revenue from TSG was due primarily to a 108% increase in sales of replacement parts and accessories in 2017 compared to 2016 due to higher demand for spare parts in the lottery market in 2017. The increase, to a lesser extent, was also due to a 12% increase in project-oriented testing services that occurred in 2017 but did not occur to the same extent in 2016. These increases were partially offset by a 6% decrease in non-Printrex consumables, largely for legacy POS and banking printers in 2017 compared to 2016. Based on our backlog of orders and contractual commitments from IGT for spare parts for our installed base of lottery printers, we expect TSG sales to decrease in 2018 compared to the unusually high level of IGT spare parts sales in 2017. +17 +Gross Profit. Gross profit information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +26,662 +$ +23,799 +12.0 +% +47.3 +% +41.6 +% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, direct labor, manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers and expenses associated with installations and maintenance of our EPICENTRAL® print system. Gross profit increased $2,863,000, or 12%, and our gross margin improved 570 basis points to a record 47.3%. These increases were driven by a more favorable sales mix in 2017 compared to 2016, as our 2017 sales included a greater proportion of spare parts sales and a lower portion of sales of POS automation and banking printers. +Operating Expenses - Engineering, Design and Product Development. Engineering, design and product development information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +4,303 +$ +4,425 +(2.8 +%) +7.6 +% +7.7 +% +Engineering, design and product development expenses primarily include salary and payroll related expenses for our hardware and software engineering staff, depreciation and design expenses (including prototype printer expenses, outside design and testing services, and supplies). Such expenses decreased $122,000 or 3%, due primarily to higher product development costs during 2016 related to the substantial completion of certain software development projects for our EPICENTRAL™ software compared to 2017. We expect engineering, design and product development expenses to be higher in 2018 than in 2017 as we continue to expand our engineering staff to support the restaurant solutions market. +Operating Expenses - Selling and Marketing . Selling and marketing information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +7,561 +$ +6,907 +9.5 +% +13.4 +% +12.1 +% +Selling and marketing expenses primarily include salaries and payroll related expenses for our sales and marketing staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, e-commerce and other promotional marketing expenses. Such expenses increased $654,000, or 10%, as we completed the build-out of our internal infrastructure, including the hiring of a direct sales force and implementation of a direct marketing campaign dedicated to the restaurant solutions market in 2017. We expect selling and marketing expenses to be higher in 2018 compared to 2017, as we expect to incur incremental selling and marketing expenses as we have terminated the relationship with our international casino and gaming distributor and we build-out our internal sales infrastructure to begin selling direct to slot machine manufacturers and end user casino and gaming customers in Europe in the first quarter of 2018. +Operating Expenses - General and Administrative. General and administrative information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +7,984 +$ +7,267 +9.9 +% +14.2 +% +12.7 +% +General and administrative expenses primarily include salaries and payroll related expenses for our executive, accounting, human resource and information technology staff, expenses for our corporate headquarters, professional and legal expenses, telecommunication expenses, and other expenses related to being a publicly-traded company. General and administrative expenses increased $717,000, or 10%, due primarily to higher incentive compensation expenses incurred in 2017 compared to 2016 and higher recruiting expenses related to the expansion of our sales staff for our restaurant solutions market and European casino and gaming market. We expect general and administrative expenses in 2018 to be higher than 2017 due to recruiting expenses as we continue to expand our restaurant solutions sales and engineering staff and complete the planned expansion of sales staff for our European casino and gaming market. +18 +Operating Income. Operating income information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales – 2017 +Total Sales – 2016 +Year ended +$ +6,814 +$ +5,200 +31.0 +% +12.1 +% +9.1 +% +Our operating income increased by $1,614,000, or 31%, primarily due to a 570 basis point improvement in gross margin on a favorable product mix, partially offset by a 7% increase in operating expenses in 2017 compared to 2016. +Interest. We recorded net interest expense of $33,000 in 2017 compared to $26,000 in 2016. +Other, net . We recorded other expense of $9,000 in 2017 compared to $4,000 in 2016. The change was due to higher foreign currency exchange losses recorded by our U.K. subsidiary in 2017 compared to 2016. In addition, we recorded a gain of $5,000 on the disposal of fixed assets in 2016. +Income Taxes . +In 2017, we recorded an income tax provision of $3,561,000 at an effective tax rate of 52.6% compared to an income tax provision in 2016 of $1,553,000 at an effective tax rate of 30.0%. The effective tax rate in 2017 was negatively impacted by the passage of the Tax Reform Act that was signed on December 22, 2017. The legislation significantly changes U.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax system and imposing a one-time repatriation tax on undistributed foreign earnings. The Tax Reform Act permanently reduces the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. As a result of the reduction of our U.S. corporate income tax rate from 34% to 21% under the Tax Reform Act, the Company revalued its ending net deferred tax asset at December 31, 2017 and recognized a provisional $1,315,000 charge to income tax expense in the Company's Consolidated Statements of Income for the year ended December 31, 2017. See Note 11 to the consolidated financial statements for further details of the impact of the Tax Reform Act. +On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of U.S. GAAP in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. SAB 118 provides a measurement period, not to exceed one year from the enactment of the Tax Reform Act. In accordance with SAB 118, the Company is required to reflect the income tax effects of those aspects of the Tax Reform Act for which the accounting is complete. To the extent there are areas that are incomplete, but are capable of reasonable estimates, a provisional amount is required to be recorded by the Company. If a reasonable estimate is unable to be calculated, the Company is required to disclose why. The Company has recognized provisional tax impacts related to the revaluation of deferred tax assets and liabilities and included the amount in its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions, additional regulatory guidance from Treasury, the IRS and State Governments, and actions the Company may take as a result of the Tax Reform Act. +We expect our annual effective tax rate for 2018 to be between 20% and 21%, due to the impact from the Tax Reform Act. Changes resulting from our ongoing evaluation may further impact our expected tax rate in 2018. +Net Income. We reported net income during 2017 of $3,211,000, or $0.42 per diluted share, compared to $3,617,000, or $0.47 per diluted share, for 2016. +Results of Operations: Year ended December 31, 2016 compared to year ended December 31, 2015 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2016 and 2015 were as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Restaurant solutions +$ +5,162 +9.0 +% +$ +4,191 +7.0 +% +$ +971 +23.2 +% +POS automation and banking +10,518 +18.4 +% +8,838 +14.8 +% +1,680 +19.0 +% +Casino and gaming +21,006 +36.7 +% +21,755 +36.5 +% +(749 +) +(3.4 +%) +Lottery +9,913 +17.3 +% +9,468 +15.9 +% +445 +4.7 +% +Printrex +540 +1.0 +% +1,381 +2.3 +% +(841 +) +(60.9 +%) +TSG +10,096 +17.6 +% +14,043 +23.5 +% +(3,947 +) +(28.1 +%) +$ +57,235 +100.0 +% +$ +59,676 +100.0 +% +$ +(2,441 +) +(4.1 +%) +International* +$ +11,693 +20.4 +% +$ +13,946 +23.4 +% +$ +(2,253 +) +(16.2 +%) +* +International sales do not include sales of products made to domestic distributors or other customers who in turn ship those products to international destinations. +19 +Net sales for 2016 decreased $2,441,000, or 4%, from 2015. Although net sales decreased, printer and terminal sales volume increased 3% in 2016 compared to 2015. Our printer and terminal volume increased to approximately 173,000 units, primarily due to 22% increases in both the POS automation and banking and restaurant solutions markets. The average selling price of our printers decreased less than 1% from 2016 to 2015. Overall, international sales decreased $2,253,000, or 16%, primarily driven by lower sales in the international lottery and casino and gaming markets. +Restaurant solutions: A summary of sales of our worldwide restaurant solutions products for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +4,747 +92.0 +% +$ +3,857 +92.0 +% +$ +890 +23.1 +% +International +415 +8.0 +% +334 +8.0 +% +81 +24.3 +% +$ +5,162 +100.0 +% +$ +4,191 +100.0 +% +$ +971 +23.2 +% +The increase in domestic restaurant solutions terminal sales in 2016 compared to 2015 was primarily driven by an increase in sales of our restaurant solutions terminals to McDonald's and increased sales penetration to a growing number of existing and new end user customers through our U.S. distributor. +International restaurant solutions terminal sales increased in 2016 compared to 2015, due primarily to increased sales to our Latin American distributor. +POS automation and banking: A summary of sales of our worldwide POS automation and banking products for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +9,754 +92.7 +% +$ +8,180 +92.6 +% +$ +1,574 +19.2 +% +International +764 +7.3 +% +658 +7.4 +% +106 +16.1 +% +$ +10,518 +100.0 +% +$ +8,838 +100.0 +% +$ +1,680 +19.0 +% +The increase in both domestic and international POS automation and banking printer revenue in 2016 compared to 2015 was primarily driven by a 38% increase in sales of our Ithaca® 9000 printer as we continued to supply printers to support new initiatives by McDonald's that started in 2015 and accelerated in 2016. This increase was partially offset by 43% lower sales of our legacy banking and other POS printers in 2016 compared to 2015 as we continued to deemphasize these products. +Casino and gaming: A summary of sales of our worldwide casino and gaming products for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +11,553 +55.0 +% +$ +11,354 +52.2 +% +$ +199 +1.8 +% +International +9,453 +45.0 +% +10,401 +47.8 +% +(948 +) +(9.1 +%) +$ +21,006 +100.0 +% +$ +21,755 +100.0 +% +$ +(749 +) +(3.4 +%) +During 2016, domestic casino and gaming sales increased 2%, primarily due to a 37% increase in EPICENTRAL TM software sales as we completed two domestic installations in 2016 compared to one domestic installation in 2015. Domestic sales of our thermal casino printers during 2016 were consistent with sales in 2015. +International sales declined in 2016 due to 28% lower sales of our thermal casino printer in Europe and Asia compared to 2015. The decrease from our thermal casino printers was partially offset by increased off-premises thermal gaming printers and EPICENTRAL TM software sales of 38% and 121%, respectively. Sales of our off-premise gaming printers increased due to an expanding market for sports betting in Europe and Australia. However, sales of our off-premise gaming printers are largely project-oriented and therefore may fluctuate significantly from quarter to quarter and year to year. The increase in EPICENTRAL TM software sales was due to one new international installation completed in 2016 compared to no international installations completed in 2015. +Lottery: A summary of sales of our worldwide lottery printers for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +9,710 +98.0 +% +$ +8,064 +85.2 +% +$ +1,646 +20.4 +% +International +203 +2.0 +% +1,404 +14.8 +% +(1,201 +) +(85.5 +%) +$ +9,913 +100.0 +% +$ +9,468 +100.0 +% +$ +445 +4.7 +% +20 +Our sales to IGT are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of IGT's overall business or revenue. +International lottery sales decreased due to sales of lottery printers to IGT for the Spanish lottery in 2015 and no comparable international sales occurring in 2016. +Printrex: A summary of sales of our worldwide Printrex printers for the years ended December 31, 2016 and 2015 is as follows (in thousands, except percentages): +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +463 +85.7 +% +$ +1,088 +78.8 +% +$ +(625 +) +(57.4 +%) +International +77 +14.3 +% +293 +21.2 +% +(216 +) +(73.7 +%) +$ +540 +100.0 +% +$ +1,381 +100.0 +% +$ +(841 +) +(60.9 +%) +The decrease in Printrex printers was primarily due to a 52% decline in domestic and international sales in the oil and gas market due to the continued impact from the decline in worldwide oil prices. In addition, we experienced a 79% decline in medical and mobile printer sales due largely to the loss of a customer in the medical industry and as we shifted our sales focus towards the restaurant solutions market. +TSG: A summary of sales in our worldwide TSG market for the years ended December 31, 2016 and 2015 is as follows: +Year ended +Year ended +Change +(In thousands) +December 31, 2016 +December 31, 2015 +$ +% +Domestic +$ +9,315 +92.3 +% +$ +13,187 +93.9 +% +$ +(3,872 +) +(29.4 +%) +International +781 +7.7 +% +856 +6.1 +% +(75 +) +(8.8 +%) +$ +10,096 +100.0 +% +$ +14,043 +100.0 +% +$ +(3,947 +) +(28.1 +%) +The decrease in domestic revenue from TSG was due to a (1) 38% decrease in sales of replacement parts due mainly to IGT's purchase of an unusually high volume of spare parts for the lottery market in 2015 that did not repeat in 2016, (2) 19% decrease in non-Printrex consumables, largely from the decline of HP inkjet cartridges, as we continued to deemphasize the commoditized POS and banking consumable products, (3) 18% decline in service revenue, primarily due to project-oriented testing services that occurred in 2015 that did not recur to the same extent in 2016, and (4) 62% decrease of consumables sales for our Printrex color printer due to lower printing usage resulting from reduced drilling activity caused by the decline in worldwide oil prices. +Internationally, TSG revenue decreased, primarily due to 8% and 37% lower sales of replacement parts and accessories and non-Printrex consumables, respectively, in 2016 compared to 2015. +Gross Profit. Gross profit information for the years ended December 31, 2016 and 2015 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +23,799 +$ +24,978 +(4.7 +%) +41.6 +% +41.9 +% +Gross profit decreased $1,179,000, or 5%, due primarily to a 4% decrease in sales. Our gross margin remained relatively consistent, decreasing slightly by 30 basis points compared 2015, to 41.6%. +Operating Expenses - Engineering, Design and Product Development. Engineering, design and product development information for the years ended December 31, 2016 and 2015 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +4,425 +$ +3,599 +23.0 +% +7.7 +% +6.0 +% +Engineering, design and product development expenses increased $826,000 or 23%, due primarily to higher product development costs and the hiring of additional software engineers beginning in early 2016, as we focused and strategically invested in enhancements to our EPICENTRAL™ software and expansion of our line of restaurant solutions terminals. +21 +Operating Expenses - Selling and Marketing . Selling and marketing information for the years ended December 31, 2016 and 2015 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +6,907 +$ +7,806 +(11.5 +%) +12.1 +% +13.1 +% +Selling and marketing expenses decreased $899,000, or 12%, primarily due to lower compensation costs related to headcount reductions made during 2016, lower sales commission due to lower sales experienced in 2016 compared to 2015, and a decrease in travel expenses we consciously decided to reduce these expenses. +Operating Expenses - General and Administrative. General and administrative information for the years ended December 31, 2016 and 2015 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +7,267 +$ +7,367 +(1.4 +%) +12.7 +% +12.3 +% +General and administrative expenses decreased $100,000, or 1%, due primarily to lower incentive compensation costs incurred in 2016 compared to 2015, which was largely offset by higher severance cost related to headcount reductions made during 2016. +Operating Expenses - Legal Fees and Settlement Expenses Associated with Lawsuit . Legal fees and settlement expenses information for the years ended December 31, 2016 and 2015 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales - 2016 +Total Sales - 2015 +Year ended +$ +- +$ +1,738 +(100.0 +%) +0.0 +% +2.9 +% +As disclosed in Note 9 to the Condensed Consolidated Financial Statements, in June 2012, AD filed a civil complaint against the Company. In connection with this lawsuit, we incurred legal fees and settlement expenses of $0 and $1,738,000 in 2016 and 2015, respectively. The AD lawsuit was settled in March 2015. +Operating Income (Loss). Operating income information for the years ended December 31, 2016 and 2015 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2016 +2015 +Change +Total Sales – 2016 +Total Sales – 2015 +Year ended +$ +5,200 +$ +4,468 +16.4 +% +9.1 +% +7.5 +% +Our operating income increased by $732,000, or 16%, primarily due to lower legal fees and settlement expenses incurred in 2016, partially offset by 4% lower sales, compared to 2015. +Interest. We recorded net interest expense of $26,000 in 2016 compared to $28,000 in 2015. Interest expense was higher in 2015 due to interest expense incurred from borrowing $2,500,000 to pay the AD lawsuit settlement in 2015. We did not borrow any funds during 2016. +Other, net . We recorded other expense of $4,000 in 2016 compared to other income of $2,000 in 2015. The change was primarily due to higher foreign currency exchange losses recorded by our U.K. subsidiary in 2016 compared to 2015. +Income Taxes . We recorded an income tax provision of $1,553,000 in 2016 compared to $1,350,000 in 2015. Our effective tax rate for 2016 of 30.0% remained relatively consistent with the effective tax rate in 2015 of 30.4%. +Net Income. We reported net income during 2016 of $3,617,000, or $0.47 per diluted share, compared to $3,092,000, or $0.39 per diluted share, for 2015. +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors affecting the management of liquidity are cash flows from operating activities, capital expenditures, treasury share repurchases, dividend payments, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to access credit lines, if needed, are expected to be sufficient to fund operations, capital expenditures, treasury share repurchases, dividend payments and any increase in working capital that would be required to accommodate a higher level of business activity. We actively seek to expand by acquisition as well as through the growth of our current business. While a significant acquisition may require additional debt and/or equity financing, although no assurances can be given, we believe that we would be able to obtain additional financing based on our historical earnings performance. +22 +Cash Flow +During 2017 our cash balance increased $3,004,000, or 120%, from December 31, 2016 and we returned a substantial portion of our cash flow to shareholders in the form of $2,581,000 of cash dividends paid to common shareholders and $358,000 of repurchases of our common stock. Even after funding these items and our capital expenditures, we still ended 2017 with $5,507,000 in cash and cash equivalents, of which $151,000 was held by our U.K. subsidiary, and no debt outstanding. +Operating activities : The following significant factors primarily affected our cash provided by operating activities of $5,918,000 in 2017 as compared to $4,624,000 in 2016. During 2017: +● +We reported a net income of $3,211,000. +● +We recorded depreciation and amortization of $1,081,000 and share-based compensation expense of $609,000. +● +Deferred income tax provision increased $1,117,000 largely due to a $1,315,000 charge to income tax expense in 2017 to revalue our net deferred tax asset due to the Tax Reform Act. +● +Accounts receivable increased $355,000, or 3% due to a longer than normal collection process related to sales made to our international casino and gaming distributor. +● +Inventories decreased $834,000, or 9%, due to the sell through of inventory on hand during 2017. +● +Accounts payable decreased $988,000, or 20%, due primarily to increased inventory purchases made towards the end of the fourth quarter of 2016 to support anticipated sales of our restaurant solutions terminals and subsequently paid in 2017. +● +Accrued liabilities and other liabilities increased $1,053,000, or 35%, due primarily to an increase in our accrued incentive compensation. +During 2016: +● +We reported a net income of $3,617,000. +● +We recorded depreciation and amortization of $1,31,000 and share-based compensation expense of $611,000. +● +Accounts receivable increased $3,434,000 due primarily to the large amount of sales occurring late in the fourth quarter of 2016 compared to the fourth quarter of 2015. +● +Inventories decreased $1,580,000 due to the sell through of inventory on hand during 2016. +● +Accounts payable increased $2,255,000 due primarily to the purchase of inventory late in the fourth quarter to support the increased fourth quarter sales in 2016. +● +Accrued liabilities and other liabilities decreased $1,088,000 due primarily to lower accrued incentive compensation costs and deferred revenue in 2016 compared to 2015. +Investing activities : Our capital expenditures were $835,000 and $608,000 in 2017 and 2016, respectively. Expenditures in the 2017 period were primarily for computer and networking equipment, new product tooling equipment and, to a lesser extent, leasehold improvements at our Ithaca, NY facility to upgrade to LED lighting. Expenditures in the 2016 period were primarily for computer and networking equipment and, to a lesser extent, new product tooling equipment and purchases of furniture and fixtures. During 2017 we also incurred $150,000 of additions to capitalized software for enhancements to our restaurant solutions software. +Capital expenditures and additions to capitalized software for 2018 are expected to be approximately $2,000,000, primarily for software development for our restaurant solutions products, new product tooling, and tooling enhancements for our existing products, as well as for new computer software and equipment purchases. +Financing activities : We used $1,919,000 of cash from financing activities during 2017 to pay dividends of $2,581,000 to common shareholders, purchase $358,000 of common stock for treasury and $23,000 related to the relinquishment of shares to pay for withholding taxes on stock issued from our stock compensation plan, partially offset by proceeds from stock option exercises of $1,043,000. During 2016, we used $5,964,000 of cash from financing activities to purchase $3,571,000 of common stock for treasury and pay cash dividends of $2,416,000 to common shareholders, partially offset by proceeds from stock option exercises of $23,000. +Resource Sufficiency +We believe that our cash and cash equivalents on hand and cash flows generated from operating activities will provide sufficient resources to meet our working capital needs, finance our capital expenditures and additions to capitalized software, dividend payments and meet our liquidity requirements through at least the next twelve months. +Credit Facility and Borrowings +We maintain a credit facility (the "TD Bank Credit Facility") with TD Bank N.A. ("TD Bank) which provides for a $20,000,000 revolving credit line. On November 21, 2017, we signed an amendment to the TD Bank Credit Facility through November 28, 2022. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.125% on unused borrowings under the revolving credit line. The amendment increased the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $12,500,000 from $10,000,000. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2017. +Financial Covenant +Requirement/Restriction +Calculation at December 31, 2017 +Operating cash flow / Total debt service +Minimum of 1.25 times +64.19 +Funded debt / EBITDA +Maximum of 3.0 times +0 times +As of December 31, 2017, undrawn commitments under the TD Bank Credit facility were $20,000,000. +23 +Shareholder Dividend Payments +In September 2012, our Board of Directors initiated a quarterly cash dividend program, with an initial quarterly dividend of $0.06 per share, subject to the Board's approval each quarter. Our Board of Directors declared an increase to the quarterly cash dividend $0.06 to $0.07 per share in May 2013, from $0.07 to $0.08 per share in May 2014, and from $0.08 to $0.09 per share in May 2017. Dividends declared and paid on our common stock totaled $2,581,000 or $0.35 per share and $2,416,000 or $0.32 per share, in 2017 and 2016, respectively. On February 5, 2018, our Board of Directors approved the first quarter 2018 dividend in the amount of $0.09 per share payable on or about March 15, 2018 to common shareholders of record at the close of business on February 20, 2018. +Stock Repurchase Program +Prior to its expiration on December 31, 2017, we maintained a stock repurchase program (the "2016 Stock Repurchase Program") whereby we were authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From January 1, 2017 through the expiration date of the 2016 Stock Repurchase Program, we purchased 36,465 shares of our common stock for $358,000 at an average price of $9.84 per share. From the start of the 2016 Stock Repurchase Program on February 25, 2016 through December 31, 2017, we purchased 499,843 shares of our common stock for $3,929,000 at an average price of $7.86 per share. +In 2015, under a prior stock repurchase program, we purchased 166,553 shares of our common stock for $1,020,000 at an average price of $6.12 per share. From January 1, 2005 through December 31, 2017, we repurchased a total of 3,888,432 shares of common stock for $30,110,000, at an average price of $7.74 per share, under the prior stock repurchase program. +On March 1, 2018, our Board of Directors approved a new stock repurchase program (the "2018 Stock Repurchase Program") substantially similar to the 2016 Stock Repurchase Program, whereby we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price and other factors. The 2018 Stock Repurchase Program expires on December 31, 2019, if we do not discontinue it prior to such time. +Shareholders' Equity +Shareholders' equity increased $1,905,000 to $26,014,000 at December 31, 2017 from $24,109,000 at December 31, 2016. The increase was primarily due to net income of $3,211,000, as well as $1,014,000 from the issuance of 181,195 shares of common stock related to employee stock awards, net of relinquishments and share-based compensation expense related to stock awards of $609,000. These increases were partially offset by our payment of $2,581,000 in dividends and the purchase of 36,465 shares of treasury stock for $358,000. +Off-Balance Sheet Arrangements +As of December 31, 2017, we had no off-balance sheet arrangements that have had or that we expect would be reasonably likely to have a future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. +Contractual Obligations +Our contractual obligations as of December 31, 2017 were as follows: +Payments due by period +(In thousands) +Total +< 1 year +1-3 years +3-5 years +> 5 years +Operating lease obligations +$ +5,305 +$ +1,000 +$ +2,029 +$ +1,121 +$ +1,155 +Purchase obligations +12,296 +$ +12,285 +$ +11 +– +– +Total +$ +17,601 +$ +13,285 +$ +2,040 +$ +1,121 +$ +1,155 +Purchase obligations are for purchases made in the normal course of business to meet operational requirements, primarily of fully assembled printers and component part inventory. +Impact of Inflation +We believe that our business has not been affected to a significant degree by inflationary trends during the past three years. However, inflation is still a factor in the worldwide economy and may increase the cost of purchasing products from our contract manufacturers in Asia, as well as the cost of certain raw materials, component parts and labor used in the production of our products. It also may increase our operating expenses, manufacturing overhead expenses and the cost to acquire or replace fixed assets. We have generally been able to maintain or improve our profit margins through productivity and efficiency improvements, cost reduction programs and to a lesser extent, price increases, and we expect to be able to do the same during 2018. As such, we do not believe that inflation will have a significant impact on our business during 2018. +Item 7A. Quantitative and Qualitative Disclosures about Market Risk. +Interest Rate Risk +Our exposure to market risk for changes in interest rates relates primarily to the investment of our available cash and cash equivalents. In accordance with our investment policy, we strive to achieve above market rates of return in exchange for accepting a prudent amount of incremental risk, which includes the risk of interest rate movements. Risk tolerance is constrained by an overriding objective to preserve capital. An increase or decrease of 10% in effective interest rates would not have a material effect on our results of operations or cash flows. +Foreign Currency Exchange Risk +A substantial portion of our sales are denominated in U.S. dollars and, as a result, we currently have relatively little exposure to foreign currency exchange risk with respect to sales made. This exposure may change over time as business practices evolve and could have a material adverse impact on our financial results in the future, especially as we adopt a direct selling model for our casino and gaming business in Europe utilizing our UK sales office. We do not use forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. We estimate that the combined translational and transactional impact of a 10% overall movement in exchange rates from December 31, 2017 (principally the U.K. Pound Sterling) would not have a material impact on our results of operations or cash flows. +Item 8. Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this report as pages F-3 through F-18. An index to such materials appears on page F-1. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +24 +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2017. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2017, our disclosure controls and procedures are effective. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management's Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2017. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("2013 COSO"). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2017. +Changes in Internal Control Over Financial Reporting +There has been no change in the Company's internal control over financial reporting that occurred during the quarter ended December 31, 2017 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. +Item 9B. Other Information. +Not applicable. +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +Set forth below is certain information regarding our executive officers. The remaining information in response to this item will be contained in our Proxy Statement for our 2018 Annual Meeting of Stockholders (the "Proxy Statement") under the headings "Section 16(a) Beneficial Ownership Reporting Compliance," "Corporate Governance," "Proposal 1: Election of Directors," "Audit Committee Report," "Executive Compensation – Compensation Committee Report," "Compensation Committee Interlocks and Insider Participation," "Stockholder Proposals for 2019 Annual Meeting," "Procedures for Submitted Director Nominations and Recommendations" and "Stockholder Communications with the Board of Directors Policy," which will be filed within 120 days after the end of the year covered by this Form 10-K and is incorporated herein by reference. +Executive Officers of the Registrant +The following list is included as an unnumbered item in Part III of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 21, 2018. +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person's principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +60 +Chairman of the Board and Chief Executive Officer +Steven A. DeMartino +48 +President, Chief Financial Officer, Treasurer and Secretary +Donald E. Brooks +65 +Senior Vice President-Engineering +Tracey S. Chernay +58 +Senior Vice President, Casino, Gaming and Lottery Sales +Andrew J. Hoffman +60 +Senior Vice President, Operations +David B. Peters +39 +Vice President and Chief Accounting Officer +Bart C. Shuldman has been Chief Executive Officer, President and a Director of the Company since its formation in June 1996. In February 2001, Mr. Shuldman was elected Chairman of the Board. Mr. Shuldman relinquished the President title, effective June 1, 2010, to focus on new products and markets, international expansion and potential acquisitions. +Steven A. DeMartino was named as TransAct's President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Donald E. Brooks was appointed Senior Vice President of Engineering in April 2012. Previously, Mr. Brooks served as Vice President, Engineering from September 2004 to April 2012, Senior Project Engineer from February 1998 to September 2004, Project Engineer from June 1997 to February 1998, Director of Electrical Engineering from March 1986 to June 1997 and Manager of Electronic Development from December 1983 to March 1986. +25 +Tracey S. Chernay was appointed Senior Vice President, Casino and Gaming Sales and Marketing in June 2010, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Chernay served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing & Sales, POS & Banking with the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Chernay was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Andrew J. Hoffman was appointed Senior Vice President, Operations for TransAct worldwide in November 2004. He served as Vice President, Operations from September 1994 to November 2004. +David B. Peters was appointed Vice President and Chief Accounting Officer on March 1, 2018. Previously, Mr. Peters served as Director, SEC and Financial Reporting since joining TransAct in March 2014. Prior to joining TransAct, Mr. Peters was employed with United Technologies Corporation from November 2006 to March 2014 where he served in various financial management positions. Mr. Peters is a certified public accountant. +Code of Ethics +We maintain a Code of Business Conduct that includes our code of ethics that is applicable to all employees, including our Chief Executive Officer, Chief Financial Officer and Controller. This Code of Business Conduct, which requires continued observance of high ethical standards such as honesty, integrity and compliance with the law in the conduct of our business, is available for public access on our internet website. Any person may request a copy of our Code of Business Conduct free of charge by calling (203) 859-6800. +Item 11. Executive Compensation. +The information in response to this item will be contained in the Proxy Statement under the heading "Executive Compensation," and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item will be contained in the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management," and is incorporated herein by reference. +Equity Compensation Plan Information +Information regarding our equity compensation plans as of December 31, 2017 is as follows: +Plan category +(a) +Number of securities to be +issued upon exercise of +outstanding options, +warrants and rights +(b) +Weighted-average exercise +price of outstanding +options, warrants and +rights +(c) +Number of securities +remaining available for +future issuance under +equity compensation plans +(excluding securities +reflected in column (a) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +411,375 +$ +8.91 +– +2014 Equity Incentive Plan +661,348 +6.31 +665,991 +Total +1,072,723 +$ +7.31 +665,991 +In May 2014, our shareholders approved the adoption of the 2014 Equity Incentive Plan. In May 2017, our shareholders approved an amendment to the 2014 Equity Incentive Plan to increase the number of shares of common stock which may be subject to awards granted under the plan from 600,000 to its current level of 1,400,000. The Company also maintains the 2005 Equity Incentive Plan which was approved by our shareholders, however no new awards will be available for future issuance under this Plan. Both plans generally provide for award in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. The Company does not have any equity plans that have not been approved by its shareholders. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings ["Policy Regarding Pre-Approval of Services Provided by the Independent Registered Public Accounting Firm" and "Independent Registered Public Accounting Firm's Services and Fees," and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services. +The information in response to this item will be contained in the Proxy Statement section and is incorporated herein by reference. +26 +PART IV +Item 15. Exhibits and Financial Statement Schedules. +Index to Exhibits +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated ("TransAct" or the "Company"), filed with the Secretary of State of Delaware on June 17, 1996. +(2) +3.1(b) +Certificate of Amendment of Certificate of Incorporation of the Company, filed with the Secretary of State of Delaware on June 4, 1997. +(4) +3.1(c) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December 2, 1997. +(5) +3.1(d) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000. +(7) +3.2 +Amended and Restated By-laws of the Company. +(6) +4 +Specimen Common Stock Certificate. +(2) +10.1(x) +2005 Equity Incentive Plan. +(10) +10.2(x) +2014 Equity Incentive Plan. +(3) +10.3(x) +Amendment to 2014 Equity Incentive Plan approved by Shareholders on May 22, 2017 +(25) +10.4(x) +2014 Equity Incentive Plan Time-based Restricted Unit Agreement +(22) +10.5(x) +2014 Equity Incentive Plan Performance-based Restricted Stock Unit Agreement +(23) +10.6(x) +Employment Agreement, dated July 31, 1996, by and between TransAct and Bart C. Shuldman. +(2) +10.7(x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004. +(9) +10.8(x) +Severance Agreement by and between TransAct and Tracey S. Chernay, dated July 29, 2005. +(13) +10.9(x) +Amendment to Employment Agreement, effective January 1, 2008, by and between TransAct and Bart C. Shuldman. +(14) +10.10(x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008. +(14) +10.11(x) +Amendment to Severance Agreement by and between TransAct and Tracey S. Chernay, effective January 1, 2008. +(14) +10.12 +Lease Agreement by and between Bomax Properties and Ithaca, dated as of March 23, 1992. +(2) +10.13 +Second Amendment to Lease Agreement by and between Bomax Properties and Ithaca, dated December 2, 1996. +(4) +10.14 +Agreement regarding the Continuation and Renewal of Lease by and between Bomax Properties, LLC and TransAct, dated July 18, 2001. +(8) +10.15 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct. +(17) +10.16 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016. +(21) +10.17 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004. +(9) +10.18 +First Amendment to Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated August 31, 2009. +(15) +10.19 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, 2015. +(20) +10.20 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006. +(11) +10.21 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 3, 2017 +(24) +10.22 +OEM Purchase Agreement by and between IGT (f/k/a GTECH Corporation) and TransAct, dated May 29, 2015. (Pursuant to Rule 24-b-2 under the Exchange Act, the Company has requested confidential treatment of portions of this exhibit deleted from the filed copy) +(20) +10.23 +Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. dated November 28, 2006 +(11) +10.24 +First Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. effective September 30, 2007. +(12) +10.25 +Second Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Bank, N.A. effective November 22, 2011. +(16) +10.26 +Third Amendment to Amended and Restated Revolving Credit and Security Agreement effective September 7, 2012 +(18) +10.27 +Fourth Amendment to Amended and Restated Revolving Credit and Security Agreement effective November 26, 2014 +(19) +10.28 +Fifth Amendment to Amended and Restated Revolving Credit and Security Agreement effective November 21, 2017 +(26) +23 +Consent of PricewaterhouseCoopers LLP. +(1) +31.1 +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +31.2 +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +(1) +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +(1) +101.INS +XBRL Instance Document. +(1) +101.SCH +XBRL Taxonomy Extension Schema Document. +(1) +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +(1) +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +(1) +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +(1) +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +(1) +27 +(1) +These exhibits are filed herewith. +(2) +These exhibits, which were previously filed with the Company's Registration Statement on Form S-1 (No. 333-06895), are incorporated by reference. +(3) +Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on May 19, 2014. +(4) +Incorporated by reference to Exhibit 10.27 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 31, 1998. +(5) +Incorporated by reference to Exhibit C of the Company's Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on February 18, 1999. +(6) +Incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 29, 1999. +(7) +Incorporated by reference to Exhibit 3.1(c) of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 8, 2000. +(8) +Incorporated by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 29, 2002. +(9) +These exhibits, which were previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2004, are incorporated by reference (No. 000-21121). +(10) +Incorporated by reference to Exhibit 99.1 of the Company's Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on June 1, 2005. +(11) +These exhibits, which were previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2006, are incorporated by reference (No. 000-21121). +(12) +Incorporated by reference to Exhibit 10.20 of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on November 9, 2007. +(13) +Incorporated by reference to Exhibit 10.9 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 14, 2009. +(14) +This exhibit, which was previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2008, is incorporated by reference (No. 000-21121). +(15) +Incorporated by reference to Exhibit 10.19 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2010. +(16) +Incorporated by reference to Exhibit 10.25 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2012. +(17) +Incorporated by reference to Exhibit 10.16 of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 10, 2012. +(18) +Incorporated by reference to Exhibit 10.26 of the Company's Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on September 11, 2012. +(19) +Incorporated by reference to Exhibit 99.1 of the Company's Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on December 1, 2014. +(20) +This exhibit, which was previously filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2015, is incorporated by reference +(21) +Incorporated by reference to Exhibit 10.13 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 11, 2016. +(22) +Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 6, 2016. +(23) +Incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-211121) filed with the SEC on August 8, 2016. +(24) +Incorporated by reference to Exhibit 10.20 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121). +(25) +Incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 9, 2017. +(26) +Incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on November 22, 2017. +(x) +Management contract or compensatory plan or arrangement. +28 +EXHIBIT LIST +The following exhibits are filed herewith. +Exhibit +23 +Consent of PricewaterhouseCoopers LLP. +31.1 +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +Item 16. Form 10-K Summary. +Not applicable. +29 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ Bart C. Shuldman +Name: +Bart C. Shuldman +Title: +Chairman of the Board and Chief Executive Officer +Date: March 21, 2018 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Bart C. Shuldman +Chairman of the Board +March 21, 2018 +Bart C. Shuldman +and Chief Executive Officer, +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, +March 21, 2018 +Steven A. DeMartino +Treasurer and Secretary +(Principal Financial Officer) +/s/ David B. Peters +Vice President and Chief Accounting Officer +March 21, 2018 +David B. Peters +(Principal Accounting Officer) +/s/ John M. Dillon +Director +March 21, 2018 +John M. Dillon +/s/ Thomas R. Schwarz +Director +March 21, 2018 +Thomas R. Schwarz +/s/ Graham Y. Tanaka +Director +March 21, 2018 +Graham Y. Tanaka +30 +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO FINANCIAL STATEMENTS +Financial Statements +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Balance Sheets as of December 31, 2017 and 2016 +F-3 +Consolidated Statements of Income for the years ended December 31, 2017, 2016, and 2015 +F-4 +Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016 and 2015 +F-5 +Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2017, 2016 and 2015 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +Report of Independent Registered Public Accounting Firm +To the Board of Directors and Shareholders of TransAct Technologies Incorporated: +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of TransAct Technologies Incorporated and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ PricewaterhouseCoopers LLP +Hartford, Connecticut +March 21, 2018 +We have served as the Company's auditor since 1996. +F-2 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +2017 +December 31, +2016 +Assets: +Current assets: +Cash and cash equivalents +$ +5,507 +$ +2,503 +Accounts receivable, net +10,948 +10,585 +Inventories, net +8,875 +9,707 +Prepaid income taxes +514 +- +Other current assets +517 +372 +Total current assets +26,361 +23,167 +Fixed asset, net +2,169 +2,241 +Goodwill +2,621 +2,621 +Deferred tax assets +2,308 +3,432 +Intangible assets, net +458 +545 +Other assets +33 +36 +7,589 +8,875 +Total assets +33,950 +32,042 +Liabilities and Shareholders' Equity: +Current liabilities: +Accounts payable +$ +3,841 +$ +4,894 +Accrued liabilities +3,339 +2,394 +Income taxes payable +- +19 +Deferred revenue +169 +117 +Total current liabilities +7,349 +7,424 +Deferred revenue, net of current portion +69 +67 +Deferred rent, net of current portion +271 +178 +Other liabilities +247 +264 +587 +509 +Total liabilities +7,936 +7,933 +Commitments and contingencies (Note 9) +Shareholders' equity: +Preferred stock, $0.01 value, 4,800,000 authorized, none issued and outstanding +- +- +Preferred stock, Series A, $0.01 par value, 200,000 authorized, none issued and outstanding +- +- +Common stock, $0.01 par value, 20,000,000 authorized at December 31, 2017 and 2016; 11,366,526 and 11,185,331 shares issued; 7,478,094 and 7,333,364 shares outstanding, at December 31, 2017 and 2016, respectively +114 +112 +Additional paid-in capital +31,353 +29,701 +Retained earnings +24,756 +24,157 +Accumulated other comprehensive loss, net of tax +(99 +) +(109 +) +Treasury stock, 3,888,432 and 3,851,967 shares, at cost +(30,110 +) +(29,752 +) +Total shareholders' equity +26,014 +24,109 +Total liabilities and shareholders' equity +$ +33,950 +$ +32,042 +See accompanying notes to Consolidated Financial Statements. +F-3 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF INCOME +(In thousands, except per share data) +Year Ended December 31, +2017 +2016 +2015 +Net sales +$ +56,311 +$ +57,235 +$ +59,676 +Cost of sales +29,649 +33,436 +34,698 +Gross profit +26,662 +23,799 +24,978 +Operating expenses: +Engineering, design and product development +4,303 +4,425 +3,599 +Selling and marketing +7,561 +6,907 +7,806 +General and administrative +7,984 +7,267 +7,367 +Legal fees and settlement expenses associated with lawsuit (Note 9) +- +- +1,738 +19,848 +18,599 +20,510 +Operating income +6,814 +5,200 +4,468 +Interest and other income (expense): +Interest expense +(33 +) +(33 +) +(37 +) +Interest income +- +7 +9 +Other, net +(9 +) +(4 +) +2 +(42 +) +(30 +) +(26 +) +Income before income taxes +6,772 +5,170 +4,442 +Income tax provision +3,561 +1,553 +1,350 +Net income +$ +3,211 +$ +3,617 +$ +3,092 +Net income per common share: +Basic +$ +0.43 +$ +0.48 +$ +0.40 +Diluted +$ +0.42 +$ +0.47 +$ +0.39 +Shares used in per-share calculation: +Basic +7,423 +7,610 +7,818 +Diluted +7,592 +7,655 +7,854 +Dividends declared and paid per common share: +$ +0.35 +$ +0.32 +$ +0.32 +See accompanying notes to Consolidated Financial Statements. +F-4 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands, except share data) +Year Ended December 31, +2017 +2016 +2015 +Net income +$ +3,211 +$ +3,617 +$ +3,092 +Foreign currency translation adjustment, net of tax +10 +(29 +) +(8 +) +Comprehensive income +$ +3,221 +$ +3,588 +$ +3,084 +See accompanying notes to Consolidated Financial Statements. +F-5 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY +(In thousands, except share data) +Common Stock +Shares Amount +Additional +Paid-in +Capital +Retained +Earnings +Treasury +Stock +Accumulated +Other +Comprehensive +Income (Loss) +Total +Equity +Balance, December 31, 2014 +7,900,257 +$ +111 +$ +28,167 +$ +22,349 +$ +(25,161 +) +$ +(72 +) +$ +25,394 +Issuance of shares from exercise of stock options +34,600 +1 +262 +- +- +- +263 +Issuance of deferred stock units +- +- +160 +- +- +- +160 +Issuance of common stock on deferred stock units, net of relinquishments +13,988 +- +(39 +) +- +- +- +(39 +) +Tax benefit related to employee stock sales +- +- +(48 +) +- +- +- +(48 +) +Purchase of treasury stock +(166,553 +) +- +- +- +(1,020 +) +- +(1,020 +) +Dividends declared and paid on common stock +- +- +- +(2,485 +) +- +- +(2,485 +) +Share-based compensation expense +- +- +488 +- +- +- +488 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(69 +) +- +- +- +(69 +) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(8 +) +(8 +) +Net loss +- +- +- +3,092 +- +- +3,092 +Balance, December 31, 2015 +7,782,292 +$ +112 +$ +28,921 +$ +22,956 +$ +(26,181 +) +$ +(80 +) +$ +25,728 +Issuance of shares from exercise of stock options +3,750 +- +23 +- +- +- +23 +Issuance of deferred stock units +- +- +202 +- +- +- +202 +Issuance of common stock on deferred stock units, net of relinquishments +10,700 +- +(51 +) +- +- +- +(51 +) +Tax shortfall related to employee stock sales +- +- +1 +- +- +- +1 +Purchase of treasury stock +(463,378 +) +- +- +- +(3,571 +) +- +(3,571 +) +Dividends declared and paid on common stock +- +- +- +(2,416 +) +- +- +(2,416 +) +Share-based compensation expense +- +- +611 +- +- +- +611 +Reversal of deferred tax asset in connection with stock options forfeited +- +- +(6 +) +- +- +- +(6 +) +Foreign currency translation adjustment, net of tax +- +- +- +- +- +(29 +) +(29 +) +Net income +- +- +- +3,617 +- +- +3,617 +Balance, December 31, 2016 +7,333,364 +$ +112 +$ +29,701 +$ +24,157 +$ +(29,752 +) +$ +(109 +) +$ +24,109 +Issuance of shares from exercise of stock options +166,600 +2 +1,041 +- +- +- +1,043 +Issuance of common stock on restricted stock units +8,300 +- +- +- +- +- +- +Issuance of common stock on deferred stock units +8,663 +- +- +- +- +- +- +Relinquishment of stock options and deferred stock units to pay withholding taxes +(2,368 +) +- +(29 +) +- +- +- +(29 +) +Purchase of treasury stock +(36,465 +) +- +- +- +(358 +) +- +(358 +) +Dividends declared and paid on common stock +- +- +- +(2,581 +) +- +- +(2,581 +) +Share-based compensation expense +- +- +609 +- +- +- +609 +Adjustment upon adoption of ASU 2016-09 (see Note 16) +- +- +31 +(31 +) +- +- +- +Foreign currency translation adjustment, net of tax +- +- +- +- +- +10 +10 +Net income +- +- +- +3,211 +- +- +3,211 +Balance, December 31, 2017 +7,478,094 +$ +114 +$ +31,353 +$ +24,756 +$ +(30,110 +) +$ +(99 +) +$ +26,014 +See accompanying notes to Consolidated Financial Statements. +F-6 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2017 +2016 +2015 +Cash flows from operating activities: +Net income +$ +3,211 +$ +3,617 +$ +3,092 +Adjustments to reconcile net income to net cash provided by operating activities: +Share-based compensation expense +609 +611 +488 +Depreciation and amortization +1,081 +1,331 +1,426 +Deferred income tax (benefit) provision +1,117 +(295 +) +878 +Provision for doubtful accounts +50 +- +7 +Gain on sale of fixed assets +- +(5 +) +(4 +) +Foreign currency transaction losses (gains) +11 +4 +(1 +) +Changes in operating assets and liabilities: +Accounts receivable +(405 +) +(3,434 +) +1,909 +Inventories +834 +1,580 +509 +Prepaid income taxes +(518 +) +(5 +) +407 +Other current and long term assets +(137 +) +53 +50 +Accounts payable +(988 +) +2,255 +277 +Accrued lawsuit settlement expenses +- +- +(3,625 +) +Accrued liabilities and other liabilities +1,053 +(1,088 +) +138 +Net cash provided by operating activities +5,918 +4,624 +5,551 +Cash flows from investing activities: +Capital expenditures +(835 +) +(608 +) +(959 +) +Additions to capitalized software +(150 +) +- +- +Proceeds from sale of fixed assets +- +8 +4 +Net cash used in investing activities +(985 +) +(600 +) +(955 +) +Cash flows from financing activities: +Revolving credit line borrowings +- +- +2,500 +Revolving credit line payments +- +- +(2,500 +) +Proceeds from stock option exercises +1,043 +23 +263 +Purchases of common stock for treasury +(358 +) +(3,571 +) +(1,020 +) +Payment of dividends on common stock +(2,581 +) +(2,416 +) +(2,485 +) +Withholding taxes paid on stock issuances +(23 +) +- +- +Net cash used in financing activities +(1,919 +) +(5,964 +) +(3,242 +) +Effect of exchange rate changes on cash and cash equivalents +(10 +) +(30 +) +(12 +) +Increase (decrease) in cash and cash equivalents +3,004 +(1,970 +) +1,342 +Cash and cash equivalents, beginning of period +2,503 +4,473 +3,131 +Cash and cash equivalents, end of period +$ +5,507 +$ +2,503 +$ +4,473 +Supplemental cash flow information: +Interest paid +$ +30 +$ +31 +$ +34 +Income taxes paid +2,991 +2,065 +130 +Non-cash capital expenditure items +44 +113 +84 +See accompanying notes to Consolidated Financial Statements. +F-7 +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated ("TransAct" or the "Company"), which has its headquarters in Hamden, CT and its primary operating facility in Ithaca, NY, operates in one operating segment: software-driven technology and printing solutions for high growth markets including restaurant solutions, casino and gaming, lottery, POS automation and banking, oil and gas and mobile markets. Our solutions are designed based on market-specific requirements and are sold under the AccuDate™ Ithaca®, RESPONDER®, Epic, EPICENTRAL TM and Printrex® product brands. We distribute our products through OEMs, value-added resellers, selected distributors, and directly to end-users. Our product distribution spans across the Americas, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. We also generate revenue from the after-market side of the business, providing printer and terminal service, supplies and spare parts in addition to revenue from our software solution, the EPICENTRAL TM Print System ("EPICENTRAL TM "), that enables casino operators to create promotional coupons and marketing messages and print them in real-time at the slot machine. +2. Summary of significant accounting policies +Principles of consolidation: The accompanying Consolidated Financial Statements include the accounts of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized profit. +Use of estimates : The preparations of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 280, "Segment Reporting." We view our operations and manage our business as one segment: the design, development and marketing of software-driven technology and printing solutions and providing printer and terminal related software, services, supplies and spare parts. Factors used to identify TransAct's single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief operating decision-maker in making decisions about how to allocate resources and assess performance. +Cash and cash equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Allowance for doubtful accounts : We establish an allowance for doubtful accounts to ensure trade receivables are valued appropriately. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events and historical experience. We record a specific allowance for individual accounts when we become aware of a customer's inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer's operating results or financial position. If circumstances related to customers change, we would further adjust estimates of the recoverability of receivables. Allowances for doubtful accounts on accounts receivable balances were $100,000 and $50,000 as of December 31, 2017 and 2016, respectively. +The following table summarizes the activity recorded in the valuation account for accounts receivable: +Year ended December 31, +(In thousands) +2017 +2016 +2015 +Balance, beginning of period +$ +50 +$ +50 +$ +100 +Additions charged to costs and expenses +50 +- +7 +Write-offs +- +- +(57 +) +Balance, end of period +$ +100 +$ +50 +$ +50 +Inventories: Inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completions, disposal and transportation, historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net realizable value. +Fixed assets: Fixed assets are stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years; machinery and equipment is ten years; furniture and office equipment is five to ten years; and computer software and equipment is three to seven years. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $844,000, $987,000 and $972,000 in 2017, 2016, and 2015, respectively. +Leases: Rent expense under non-cancelable operating leases with scheduled rent increases or free rent periods are accounted for on a straight-line basis over the lease term, beginning on the date of control of physical use of the asset or of initial possession. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred liability. Construction allowances and other such lease incentives are recorded as deferred credits, and are amortized on a straight-line basis as a reduction of rent expense beginning in the period they are deemed to be earned, which generally coincides with the occupancy date. +F-8 +Goodwill and Intangible assets : We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 "Goodwill", acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. We have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2017 when the impairment review is performed. +Revenue recognition: Our typical contracts include the sale of printers and terminals, which are sometimes accompanied by separately-priced extended warranty and technical support contracts. We also sell replacement parts, consumables, and other repair services (sometimes pursuant to multi-year product maintenance contracts), which are not included in the original printer or terminal sale and are ordered by the customer as needed. We recognize revenue pursuant to the guidance within ASC 605, "Revenue Recognition" (ASC 605). Specifically, revenue is recognized when evidence of an arrangement exists, delivery (based on shipping terms, which are generally FOB shipping point) has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. We recognize revenue from the sale of printers and terminals to our distributors and resellers on a sell-in basis and on substantially the same terms as we recognize revenue from all our other customers. We provide for an estimate of product returns and price protection based on historical experience at the time of revenue recognition. +We also sell a software solution, EPICENTRAL™, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. Revenue arrangements for EPICENTRAL TM include multiple deliverables and as a result such arrangements are accounted for in accordance with both ASC 605-25, "Multiple-Element Arrangements" and ASC 985-605, "Software." EPICENTRAL TM is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL™ contains both software and hardware that are integrated to deliver the system's full functionality. These arrangements are accounted for in accordance with ASC 605-25, "Multiple-Element Arrangements". EPICENTRAL™ can also include an additional software offering, Mobile Host, that allows the customer to access certain applications on mobile devices. Mobile Host is accounted for in accordance with ASC 985-605, "Software" as Mobile Host software does not function together with the hardware device to deliver its essential functionality. +Revenue, inclusive of software license fees, is generally recognized upon installation and formal acceptance by the customer with the exception of any amount allocated to free maintenance which is deferred and recognized over the initial maintenance period, generally one year. +For EPICENTRAL TM and other multiple deliverable arrangements, we consider whether the deliverables in an arrangement are within the scope of existing higher-level GAAP and apply such literature to the extent that it provides guidance regarding whether to separate multiple-deliverable arrangements and how to allocate value among those separate units of accounting. When we enter into a multiple deliverable arrangement, we also determine whether revenue arrangements consist of more than one unit of accounting. At that time, we allocate arrangement consideration to the separate units of accounting based on a relative selling price hierarchy, except where amounts allocable to the delivered units is limited to that which is contingent upon the delivery of additional deliverables or meeting other specified performance conditions. The relative selling price for each element is based upon the following selling price hierarchy: vendor specific objective evidence ("VSOE") if available, third party evidence ("TPE") if VSOE is not available, or best estimate of selling price ("BESP") to the extent that VSOE or TPE are not available. +Revenue related to extended warranty and product maintenance contracts is recognized pursuant to ASC 605-20-25, "Separately Priced Extended Warranty and Product Maintenance Contracts." Pursuant to this provision, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period. We record deferred revenue for advance payments received from customers for maintenance contracts. +Our customers have the right to return products that do not function properly within a limited time after delivery. We monitor and track product returns and record a provision for the estimated future returns based on historical experience. Returns have historically been within expectations and the provisions established. +We offer some of our customers price protection as an incentive to carry inventory of our product. These price protection plans provide that if we lower prices, we will credit them for the price decrease on inventory they hold. Our customers typically carry limited amounts of inventory, and we infrequently lower prices on current products. As a result, the amounts paid under these plans have not been material. +We charge our customers for shipping and handling services. The amounts billed to customers are recorded as revenue when the product ships. Any costs incurred related to these services are included in cost of sales. +Concentration of credit risk: Financial instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable were as follows: +December 31, +2017 +2016 +International Gaming Technology ("IGT") +48 +% +34 +% +Suzo-Happ +13 +% +18 +% +F-9 +Sales to customers representing 10% or more of total net sales were as follows: +Year ended December 31, +2017 +2016 +2015 +IGT +35 +% +26 +% +29 +% +Suzo-Happ +8 +% +15 +% +14 +% +Warranty: We generally warrant our products for up to 36 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. +The following table summarizes the activity recorded in the accrued product warranty liability: +Year ended December 31, +(In thousands) +2017 +2016 +2015 +Balance, beginning of period +$ +267 +$ +277 +$ +287 +Warranties issued +259 +254 +267 +Warranty settlements +(259 +) +(264 +) +(277 +) +Balance, end of period +$ +267 +$ +267 +$ +277 +$186,000 and $169,000 of the accrued product warranty liability were classified as current in Accrued liabilities at December 31, 2017 and 2016, respectively. The remaining $81,000 and $98,000 of the accrued product warranty liability is classified as long-term in Other liabilities. +Engineering, design and product development: Research and development ("R&D") expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as a component of operating expenses as incurred. We recorded $4,303,000, $4,425,000 and $3,599,000 of research and development expenses in 2017, 2016, and 2015, respectively. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs have been included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM and unamortized development costs for such software were $0 and $2,000 as of December 31, 2017 and 2016, respectively. The total amount charged to cost of sales for the amortization of capitalized software development costs was $2,000, $29,000 and $138,000 in 2017, 2016, and 2015, respectively. +Advertising: Advertising costs are expensed as incurred. Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Income, for 2017, 2016, and 2015 totaled $974,000, $703,000 and $858,000, respectively. These expenses include items such as consulting and professional services, tradeshows, and print advertising. +Income taxes: The income tax amounts reflected in the accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, "Income Taxes." Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. See Note 11 for information regarding our accounting for income taxes and additional provision items recorded in regards to the Tax Cuts and Jobs Act (the "Tax Reform Act"). +Foreign currency translation: The financial position and results of operations of our foreign subsidiary in the United Kingdom are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars at the year-end exchange rate, related sales and expenses have been translated at the average exchange rate for the year, and shareholders' equity has been translated at historical exchange rates. The resulting translation gains or losses, net of tax, are recorded in shareholders' equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income. Foreign currency transaction gains and losses, including those related to intercompany balances, are recognized in Other, net on the Consolidated Statements of Income. +Share-based payments: At December 31, 2017, we have share-based employee compensation plans, which are described more fully in Note 10 - Stock incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, "Compensation – Stock Compensation." Share-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee's requisite service period. +We use the Black-Scholes option-pricing model to calculate the fair value of share based awards. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. Beginning in the first quarter of 2017, we recognize forfeitures as they occur. +F-10 +Net income and loss per share: We report net income or loss per share in accordance with ASC 260, "Earnings per Share (EPS)." Under this guidance, basic EPS, which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these instruments are excluded from the computation of dilutive EPS. See Note 12 - Earnings per share. +3. Inventories, net +The components of inventories are: +December 31, +(In thousands) +2017 +2016 +Raw materials and purchased component parts +$ +6,322 +$ +6,298 +Work-in-process +- +8 +Finished goods +2,553 +3,401 +$ +8,875 +$ +9,707 +4. Fixed assets +The components of fixed assets, net are: +December 31, +(In thousands) +2017 +2016 +Tooling, machinery and equipment +$ +11,019 +$ +11,035 +Furniture and office equipment +1,651 +1,630 +Computer software and equipment +6,503 +6,260 +Leasehold improvements +2,475 +2,361 +21,648 +21,286 +Less: Accumulated depreciation and amortization +(19,752 +) +(19,215 +) +1,896 +2,071 +Construction in-process +273 +170 +$ +2,169 +$ +2,241 +5. Intangible assets +Identifiable intangible assets are recorded in Intangible assets in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2017 +2016 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,754 +$ +(1,481 +) +$ +1,604 +$ +(1,433 +) +Customer relationships +1,300 +(1,300 +) +1,300 +(1,163 +) +Trademark +480 +(306 +) +480 +(257 +) +Covenant not to compete +146 +(146 +) +146 +(146 +) +Patents +57 +(46 +) +57 +(43 +) +Other +80 +(80 +) +80 +(80 +) +Total +$ +3,817 +$ +(3,359 +) +$ +3,667 +$ +(3,122 +) +Amortization expense was $237,000, $343,000 and $454,000 in 2017, 2016 and 2015, respectively. Amortization expense for each of the next five years ending December 31 is expected to be as follows: $128,000 in 2018; $127,000 in 2019; $112,000 in 2020; $61,000 in 2021; and $30,000 in 2022. +F-11 +6. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2017 +2016 +Salaries and compensation related +$ +2,288 +$ +1,722 +Warranty +186 +169 +Professional and consulting +209 +153 +Other +656 +350 +$ +3,339 +$ +2,394 +7. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of each month immediately following their date of hire. We match employees' contributions at a rate of 50% of employees' contributions up to the first 6% of the employees' compensation contributed to the 401(k) plan. Our matching contributions were $264,000, $295,000 and $197,000 in 2017, 2016, and 2015, respectively. +8. Borrowings +We maintain a credit facility (the "TD Bank Credit Facility") with TD Bank N.A. ("TD Bank) which provides for a $20,000,000 revolving credit line. On November 21, 2017, we signed an amendment extending the term to the TD Bank Credit Facility through November 28, 2022. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.125% on unused borrowings under the revolving credit line. The amendment increased the amount of revolving credit loans we may use to fund future cash dividend payments or treasury share buybacks to $12,500,000 from $10,000,000. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2017. +As of December 31, 2017, undrawn commitments under the TD Bank Credit facility were $20,000,000. +9. Commitments and contingencies +On June 8, 2012, Avery Dennison Corporation ("AD") filed a civil complaint against us and a former employee of ours and of AD, in the Court of Common Pleas (the "Court") in Lake County, Ohio. The complaint alleged that we and this former employee misappropriated unspecified trade secrets and confidential information from AD related to the design of our restaurant solutions terminals. The complaint requested a preliminary and permanent injunction against us from manufacturing and selling our Ithaca® 9700 and 9800 restaurant solutions terminals. After more than two years of legal proceedings, on March 25, 2015 the parties executed a confidential settlement agreement and release (the "Settlement Agreement") in which the parties mutually agreed to resolve the dispute to the parties' mutual satisfaction. Under the terms of the Settlement Agreement, we agreed to pay AD $3,600,000 payable on or before April 8, 2015 and also to qualify certain AD labels for use on our restaurant solutions terminals at an estimated cost of $25,000. We recorded the total expense of $3,625,000 in the fourth quarter 2014 as an operating expense included in the line item "Legal fees and settlement expenses associated with lawsuit" on the Consolidated Statement of Operations and as a current liability included in the line item "Accrued lawsuit settlement expenses" on the Consolidated Balance Sheet. In the second quarter of 2015 we reversed $25,000 of this expense because AD did not provide the label testing information by the due date required per the settlement agreement. +At December 31, 2017, we were the lessee on operating leases for equipment and real property. Rent expense was $1,142,000, $1,046,000 and $932,000 in 2017, 2016, and 2015, respectively. Minimum aggregate rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2017 are as follows: $1,000,000 in 2018; $1,015,000 in 2019; $1,014,000 in 2020; $692,000 in 2021, $429,000 in 2022 and $1,155,000 thereafter. +10. Stock incentive plans +Stock incentive plans . We currently have two primary stock incentive plans: the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan, which provide for awards to executives, key employees, directors and consultants. The plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. Awards granted under these plans have exercise prices equal to 100% of the fair market value of the common stock at the date of grant. Awards granted have a ten-year term and generally vest over a two- to five-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards will be made under the 2005 Equity Incentive Plan. Under our 2014 Equity Incentive Plan, we may authorize awards for up to 1,400,000 shares of TransAct common stock. At December 31, 2017, 665,991 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average per share fair value of stock option grants for 2017, 2016, and 2015 was $1.95, $1.70 and $6.73, respectively. In 2017 and 2016, we also issued restricted share units for certain executives and directors that vest over a specified period of time, and in some instances require achieving certain performance metrics. The weighted-average per share fair value of these restricted share units was $7.53 and $7.31 in 2017 and 2016, respectively. No restricted share units were issued in 2015. +F-12 +The table below indicates the key assumptions used in the option valuation calculations for options granted in 2017, 2016, and 2015 and a discussion of our methodology for developing each of the assumptions used in the valuation model: +Year ended December 31, +2017 +2016 +2015 +Expected option term (in years) +6.8 +6.9 +6.8 +Expected volatility +36.2 +% +38.8 +% +50.4 +% +Risk-free interest rate +2.1 +% +1.2 +% +1.6 +% +Dividend yield +4.3 +% +4.5 +% +4.7 +% +Expected Option Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility – The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An increase in the expected volatility factor will increase compensation expense. +Risk-Free Interest Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +Dividend Yield –The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation expense. +For 2017, 2016, and 2015, we recorded $609,000, $611,000, and $488,000 of share-based compensation expense, respectively, included primarily in general and administrative expense in our Consolidated Statements of Income. We also recorded income tax benefits of $134,000, $184,000, and $148,000 in 2017, 2016, and 2015 respectively, related to such share-based compensation. At December 31, 2017, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Option activity in the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan is summarized below: +Stock Options +Restricted Share Units +Number of Shares +Average Price* +Number of Units +Average Price** +Outstanding at December 31, 2016 +1,073,900 +$ +7.83 +57,400 +$ +7.94 +Granted +169,500 +8.30 +65,600 +8.30 +Exercised +(182,811 +) +6.42 +(8,300 +) +7.44 +Forfeited +(80,763 +) +7.50 +(13,425 +) +7.98 +Expired +(60,187 +) +9.32 +- +- +Outstanding at December 31, 2017 +919,639 +$ +8.13 +101,275 +$ +8.21 +* weighted-average exercise price per share +** weighted-average grant stock price per share +The following summarizes information about equity awards outstanding that are vested and expect to vest and equity awards that are exercisable at December 31, 2017: +Equity Awards Vested and Expected to Vest +Equity Awards That Are Exercisable +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Stock Options +919,639 +$ +8.13 +$ +4,709,000 +6.4 +483,224 +$ +8.29 +$ +2,396,000 +4.8 +Restricted stock units +95,135 +- +1,261,000 +2.0 +- +- +- +- +* weighted-average exercise price per share +** weighted-average contractual remaining term in years +F-13 +Shares that are issued upon exercise of employee stock awards are newly issued shares and not issued from treasury stock. As of December 31, 2017, unrecognized compensation cost related to non-vested equity awards granted under our stock incentive plans is approximately $899,000, which is expected to be recognized over a weighted average period of 2.6 years . +The total fair value of awards vested during the years ended December 31, 2017, 2016, and 2015 was $1,104,000, $961,000, and $944,000, respectively. The total intrinsic value (which is the amount by which the stock price exceeded the exercise price on the date of exercise) of stock options exercised during the years ended December 31, 2017, 2016, and 2015 was $958,000, $6,000 and $32,000, respectively. Cash received from option exercises was $1,043,000, $23,000 and $263,000 for 2017, 2016, and 2015, respectively. We recorded a realized tax benefit in 2017, 2016, and 2015 from equity-based awards of $150,000, $1,000 and $4,000, respectively, related to options exercised. Upon adoption of ASU 2016-09 in 2017 tax benefits realized on stock options exercises are included in income tax expense and are no longer included as a component of cash flows. See Footnote 16 Accounting Pronouncements for further details regarding the adoption of ASU 2016-09. +Restricted stock: +We paid a portion of the 2015 and 2014 incentive bonus for the chief executive officer and chief financial officer in the form of 28,231 and 23,578 deferred stock units, respectively, with a corresponding credit recorded to Additional Paid in Capital (net of share relinquishments) in the amounts of $151,000 and $121,000 in 2016, and 2015, respectively. Such deferred stock units were granted in February 2016 and February 2015, respectively, and were fully vested at the time of grant. These units will be converted three years from the grant date to shares of the Company's common stock on a one-for-one basis. The weighted average exercise price of the deferred stock units was $6.98. Starting with the 2016 incentive bonus program, all incentive bonus payments are made in cash with no portion of the award paid in deferred stock units. +11. Income taxes +The components of the income tax provision are as follows: +Year Ended December 31, +(In thousands) +2017 +2016 +2015 +Current: +Federal +$ +2,379 +$ +1,776 +$ +450 +State +114 +70 +22 +Foreign +(49 +) +2 +- +2,444 +1,848 +472 +Deferred: +Federal +1,097 +(257 +) +843 +State +20 +(38 +) +35 +Foreign +- +- +- +1,117 +(295 +) +878 +Income tax provision +$ +3,561 +$ +1,553 +$ +1,350 +On December 22, 2017, the United States enacted significant changes to U.S. tax law following the passage and signing of the Tax Reform Act. The legislation significantly changes U.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax system and imposing a one-time repatriation tax on undistributed foreign earnings. The Tax Reform Act permanently reduces the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. Income tax effects resulting from changes in tax laws are accounted for by the Company in accordance with authoritative guidance, which requires that these tax effects be recognized in the period in which the law is enacted. +On December 22, 2017, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of U.S. GAAP in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. SAB 118 provides a measurement period, not to exceed one year from the enactment of the Tax Reform Act. In accordance with SAB 118, the Company is required to reflect the income tax effects of those aspects of the Tax Reform Act for which the accounting is complete. To the extent there are areas that are incomplete, but are capable of reasonable estimates, a provisional amount is required to be recorded by the Company. If a reasonable estimate is unable to be calculated, the Company is required to disclose why. The Company has recognized provisional tax impacts related to the revaluation of deferred tax assets and liabilities and included these amounts in its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions, additional regulatory guidance from Treasury, the Internal Revenue Service and State Governments, and actions the Company may take as a result of the Tax Reform Act. +F-14 +The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. As a result of the reduction of TransAct's U.S. corporate income tax rate from 34% to 21% under the Tax Reform Act, the Company revalued its ending net deferred tax assets at December 31, 2017 and recognized a provisional $1,315,000 charge to income tax expense in the Company's consolidated statement of income for the year ended December 31, 2017. +The Tax Reform Act also provided for a one-time deemed mandatory repatriation of post-1986 undistributed foreign subsidiary earnings and profits ("E&P") through the year ended December 31, 2017. The Company has no undistributed foreign E&P subject to the one-time mandatory repatriation and therefore has not recognized any income tax expense related to undistributed foreign subsidiary E&P for the year ended December 31, 2017. +While the Tax Reform Act provides for a territorial tax system, beginning in 2018, it includes two new U.S. tax base erosion provisions, the global intangible low-taxed income ("GILTI") provisions and the base-erosion and anti-abuse tax ("BEAT") provisions. The GILTI provisions require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. The BEAT provisions in the Tax Reform Act eliminate the deduction of certain base-erosion payments made to related foreign corporations, and impose a minimum tax if greater than regular tax. The Company does not expect it will be subject to these taxes and therefore has not included any tax impacts of GILTI or BEAT in its consolidated financial statements for the year ended December 31, 2017. Starting January 1, 2018, the Company will account for GILIT and BEAT in the period in which it is incurred to the extent these expectations change. +Our effective tax rates were 52.6%, 30.0%, and 30.4% for 2017, 2016, and 2015, respectively. The effective tax rate in 2017 was unusually high due to the impact of the Tax Reform Act. As explained above we recognized a provisional $1,315,000 charge to income tax expense for the year ended December 31, 2017 as a result of revaluing our net deferred tax assets using the new U.S. corporate tax rate of 21%. +At December 31, 2017, we have no federal or state net operating loss carryforwards and no R&D credit carryforwards or state tax credit carryforwards as of December 31, 2017. Foreign loss before taxes was $563,000, $235,000, and $174,000 in 2017, 2016, and 2015, respectively. +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Our deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2017 +2016 +Deferred tax assets: +Foreign net operating losses +$ +328 +$ +423 +Depreciation +107 +88 +Inventory reserves +845 +1,264 +Deferred revenue +16 +31 +Warranty reserve +59 +93 +Stock compensation expense +694 +1,273 +Other accrued compensation +363 +387 +Other liabilities and reserves +246 +329 +Gross deferred tax assets +2,658 +3,888 +Valuation allowance +(328 +) +(423 +) +Net deferred tax assets +2,330 +3,465 +Deferred tax liabilities: +Other +22 +33 +Net deferred tax liabilities +22 +33 +Total net deferred tax assets +$ +2,308 +$ +3,432 +As of December 31, 2017 a valuation allowance of $328,000 has been established for foreign net operating loss carryforwards that are not expected to be used. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year ended December 31, +(In thousands) +2017 +2016 +2015 +Balance, beginning of period +$ +423 +$ +340 +$ +282 +Additions charged to income tax provision +67 +83 +58 +Reductions credited to income tax provision +(162 +) +- +- +Balance, end of period +$ +328 +$ +423 +$ +340 +F-15 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2017 +2016 +2015 +Federal statutory tax rate +34.0 +% +34.0 +% +34.0 +% +U.S. corporate tax rate change +19.4 +0.0 +0.0 +Stock option cancellations +1.7 +0.0 +0.0 +Valuation allowance and tax accruals +1.6 +1.6 +1.3 +State income taxes, net of federal income taxes +1.3 +0.4 +0.8 +Uncertain tax positions +(0.1 +) +(0.1 +) +(0.3 +) +Miscellaneous permanent items +(1.9 +) +(1.2 +) +(0.7 +) +R&D credit +(3.3 +) +(4.6 +) +(4.9 +) +Other +(0.1 +) +(0.1 +) +0.2 +Effective tax rate +52.6 +% +30.0 +% +30.4 +% +At December 31, 2017 and 2016, we had $104,000 and $111,000 of total gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the gross amounts of unrecognized tax benefits at the beginning and end of the year is as follows: +December 31, +(In thousands) +2017 +2016 +Unrecognized tax benefits as of January 1 +$ +111 +$ +114 +Tax positions taken during the current period +24 +27 +Lapse of statute of limitations +(31 +) +(30 +) +Unrecognized tax benefits as of December 31 +$ +104 +$ +111 +We expect $28,000 of the $104,000 of unrecognized tax benefits will reverse in 2018 upon the expiration of the statute of limitations. +We recognize interest and penalties related to uncertain tax positions in the income tax provision. As of December 31, 2017 and 2016, we have $17,000 and $18,000, respectively, of accrued interest and penalties related to uncertain tax positions. +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially concluded all U.S. federal income tax, state and local, and foreign tax matters through 2013. However, our federal tax returns for the years 2014 through 2016 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +12. Earnings per share +For 2017, 2016, and 2015, earnings per share was computed as follows (in thousands, except per share amounts): +Year Ended December 31, +2017 +2016 +2015 +Net income +$ +3,211 +$ +3,617 +$ +3,092 +Shares: +Basic: Weighted average common shares outstanding +7,423 +7,610 +7,818 +Add: Dilutive effect of outstanding options as determined by the treasury stock method +169 +45 +36 +Diluted: Weighted average common and common equivalent shares outstanding +7,592 +7,655 +7,854 +Net income per common share: +Basic +$ +0.43 +$ +0.48 +$ +0.40 +Diluted +0.42 +0.47 +0.39 +The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options, restricted stock units and performance stock awards, when the average market price of the common stock is lower than the exercise price of the related stock award during the period. These outstanding stock awards are not included in the computation of diluted earnings per share because the effect would be anti-dilutive. Anti-dilutive stock awards excluded from the computation of earnings per dilutive share were 341,000, and 831,000, at December 31, 2017 and 2016 respectively. +F-16 +13. Stock repurchase program +Prior to its expiration on December 31, 2017, we maintained a stock repurchase program (the "Stock Repurchase Program") whereby we were authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price and other factors. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From January 1, 2017 through the expiration date of the Stock Repurchase Program, we purchased 36,465 shares of our common stock for $358,000 at an average price of $9.84 per share. From the start of the Stock Repurchase Program on February 25, 2016 through December 31, 2017, we purchased 499,843 shares of our common stock for $3,929,000 at an average price of $7.86 per share. +In 2015, under a prior repurchase program, we purchased 166,553 shares of our common stock for $1,020,000 at an average price of $6.12 per share. From January 1, 2005 through December 31, 2017, we repurchased a total of 3,888,432 shares of common stock for $30,110,000, at an average price of $7.74 per share. +14. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are based on the location of the customer and asset. +Year Ended December 31, +(In thousands) +2017 +2016 +2015 +Net sales: +United States +$ +48,720 +$ +45,542 +$ +45,730 +International +7,591 +11,693 +13,946 +Total +$ +56,311 +$ +57,235 +$ +59,676 +Fixed assets, net: +United States +$ +1,548 +$ +1,581 +$ +1,769 +International +621 +660 +738 +Total +$ +2,169 +$ +2,241 +$ +2,507 +Sales to international customers were 14%, 20%, and 23% of total sales in 2017, 2016, and 2015 respectively. Sales to Europe represented 44%, 56%, and 56%, sales to the Pacific Rim (which includes Australia and Asia) represented 32%, 34%, and 34%, and sales to Canada represented 18%, 8%, and 8% of total international sales in 2017, 2016, and 2015 respectively. International long-lived assets consist of net fixed assets located at our foreign subsidiary in the United Kingdom as well as our contract manufacturers in China, Thailand, Malaysia and Mexico. +15. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2017 and 2016 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2017: +Net sales +$ +13,997 +$ +13,596 +$ +15,524 +$ +13,194 +Gross profit +6,093 +6,430 +7,519 +6,620 +Net income (loss) +943 +867 +1,813 +(412 +) +Net income (loss) per common share: +Basic +0.13 +0.12 +0.24 +(0.06 +) +Diluted +0.13 +0.12 +0.24 +(0.06 +) +2016: +Net sales +$ +14,357 +$ +14,801 +$ +14,474 +$ +13,603 +Gross profit +5,885 +5,983 +5,915 +6,016 +Net income +625 +753 +883 +1,356 +Net income per common share: +Basic +0.08 +0.10 +0.12 +0.18 +Diluted +0.08 +0.10 +0.12 +0.18 +16. Accounting pronouncements +In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers." This ASU is intended to clarify the principles for recognizing revenue by removing inconsistencies in revenue requirements; providing a more robust framework for addressing revenue issues; improving comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; and providing more useful information to users of financial statements through improved revenue disclosure requirements. In applying the amended guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract's performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. Entities have the option of using either a full retrospective approach or modified retrospective approach to adopt the amended guidance. The amended guidance applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. +In the first quarter of 2018, the Company will complete its adoption activities, including the integration of the standard update into our financial reporting process and systems. The Company will adopt the amended guidance using the modified retrospective transition approach, with any cumulative effect of initially adopting this standard recognized through retained earnings at the date of adoption. The provisions of this standard are effective for interim and annual periods beginning after December 15, 2017. We will adopt the amended guidance on January 1, 2018, at which time it becomes effective for the Company. The new standard will change revenue practices for testing service contracts reported as part of our TSG market. Revenue will now be recognized at a point in time as our performance obligation is completed as opposed to our current practice of recognizing based on percentage-of-completion. As of December 31, 2017 we have no open testing service contracts that will require adjustment to retained earnings. While we are still finalizing our evaluation of the impact of the new revenue standard, the impact is not expected to be material. +F-17 +In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842 ), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. ASU 2016-02 supersedes the previous leases standard, ASC 840, Leases , and is effective for public entities for annual periods beginning after December 15, 2018 and for interim periods within those fiscal years. Early adoption is permitted. The Company does have leases for equipment and real property which exceed 12 months and we are currently evaluating the impact that the adoption of ASU 2016-02 will have on our financial statements. +In May 2017, the FASB issued ASU No. 2017-09, "Compensation-Stock Compensation: Scope of modification accounting". ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU No. 2017-09 is effective for fiscal years beginning after December 15, 2017, with early adoption permitted, including during an interim period for which financial statements have not yet been made available for issuance. The amendments should be applied prospectively to an award modified on or after the adoption date. We will adopt ASU 2017-09 in our consolidated financial statements in the first quarter of 2018 and the adoption is not expected to have an impact on our financial statements. +The following accounting pronouncements were adopted during 2017: +In July 2015, FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory." This ASU changes the measurement principle for inventory from the lower of cost or market to lower of cost or net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. The provisions of this ASU became effective for years beginning after December 15, 2016. We adopted this guidance in the first quarter of 2017 and the adoption has not resulted in a change to the value of inventory. +In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting." This ASU is intended to simplify several aspects of the accounting for share based payment transactions. The amended guidance requires that all tax effects related to share-based payments are recorded at settlement (or expiration) through the income statement, rather than through equity. Cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows. The amended guidance also allows for an employer to repurchase additional employee shares for tax withholding purposes without requiring liability accounting and clarifies that all cash payments made to tax authorities on an employee's behalf for withheld shares should be presented as a financing activity on the Consolidated Statements of Cash Flows. This ASU became effective for years beginning after December 15, 2016, and interim periods within those fiscal years, beginning after December 15, 2016. +We adopted ASU 2016-09 in the first quarter of 2017. This adoption required us to reflect any adjustments as of January 1, 2017, the beginning of the annual period that includes the interim period of adoption. In 2017, there were 166,600 options exercised that required $150,000 of excess tax benefits to be recorded in the provision for income taxes. In 2016, there were 3,750 options exercised that required $1,000 of excess tax benefits to be recorded in additional paid-in-capital, as was required pursuant to the prior accounting guidance. +In connection with the adoption of ASU 2016-09, in the first quarter of 2017, we made an accounting policy election to no longer estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. This election required the cumulative effect of the change to be recorded to retained earnings. As of January 1, 2017, we recorded $31,000 to decrease retained earnings and increase additional paid-in capital for the difference between the amount of compensation cost previously recorded and the amount that would have been recorded without assuming forfeitures. +The presentation requirements for cash flows related to excess tax benefits and employee taxes paid for withheld shares were applied retrospectively to all periods presented. This resulted in an increase in both net cash provided by operating activities and net cash used by financing activities of $23,000 for 2017. +In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment . This ASU eliminates Step 2 of the current goodwill impairment test, which requires a hypothetical purchase price allocation to measure goodwill impairment. A goodwill impairment loss will instead be measured at the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the recorded amount of goodwill. The provisions of this standard are effective for years beginning after December 15, 2019, with early adoption permitted for any impairment test performed on testing dates after January 1, 2017. We early adopted this standard as of October 1, 2017 and this ASU did not have any impact on our financial statements or disclosures. +17. Subsequent event +On March 1, 2018, our Board of Directors approved a new stock repurchase program (the "2018 Stock Repurchase Program") substantially similar to the 2016 Stock Repurchase Program disclosed in Note 13-Stock repurchase program, whereby we are authorized to repurchase up to $5,000,000 of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price and other factors. The 2018 Stock Repurchase Program expires on December 31, 2019, if we do not discontinue it prior to such time. +F-18 \ No newline at end of file diff --git a/raw/filings/0001017303/2017/0001017303-18-000022/filing_metadata.csv b/raw/filings/0001017303/2017/0001017303-18-000022/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..50e78feb460763195e3bcaadd966754711996769 --- /dev/null +++ b/raw/filings/0001017303/2017/0001017303-18-000022/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2018-03-21,2017-12-31,2018-03-21T21:03:50.000Z,0001017303-18-000022,form10k2017.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2017",7229855,1,0,https://www.sec.gov/Archives/edgar/data/1017303/000101730318000022/form10k2017.htm,https://www.sec.gov/Archives/edgar/data/1017303/000101730318000022/,2017,2017,1 diff --git a/raw/filings/0001017303/2017/0001017303-18-000022/item1.txt b/raw/filings/0001017303/2017/0001017303-18-000022/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..128aeeadf80794d00ad6a9d47d521ebf9297bab3 --- /dev/null +++ b/raw/filings/0001017303/2017/0001017303-18-000022/item1.txt @@ -0,0 +1,78 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated ("TransAct" or the "Company") was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high growth markets including restaurant solutions, point of sale ("POS") automation and banking, casino and gaming, lottery, mobile and oil and gas. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the AccuDate™, Epic, EPICENTRAL™, Ithaca®, Printrex® and Responder® brand names. Known and respected worldwide for innovative designs and real-world service reliability, our thermal, inkjet and impact printers and terminals generate top-quality labels and transaction records such as receipts, tickets, coupons, register journals and other documents, as well as printed logging and plotting of data. We sell our products to original equipment manufacturers ("OEMs"), value-added resellers ("VARs"), select distributors, as well as directly to end-users. Our product distribution spans across the Americas, the Middle East, Africa, Asia, Australia, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of products. Through our TransAct Services Group ("TSG"), we provide a complete range of supplies and consumables used in the printing and scanning activities of customers in the restaurant and hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the demand for these products. Our primary operating, hardware research and development, and eastern region service center is located in Ithaca, NY. In addition, we have a casino and gaming sales headquarters, software research and development and western region service center in Las Vegas, NV, a European sales and service center in the United Kingdom, and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT, 06518, with a telephone number of (203) 859-6800. +Financial Information about Segments +We operate in one reportable segment, the design, development, and marketing of software-driven technology and printing solutions for high growth markets, and providing related services, supplies and spare parts. Information about our net sales, gross profit and assets can be found in our Consolidated Financial Statements beginning on page F-3 hereof. +Products, Services and Distribution Methods +Printers and terminals: TransAct designs, develops, assembles and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal, inkjet and impact printing technology for applications, primarily in the restaurant solutions, banking and POS, casino and gaming, lottery, oil and gas, medical and mobile printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our restaurant solutions terminals also offer configurable menu options. In addition to our configurable printers and terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers tailored to our customers' business. +Restaurant Solutions: Our line of AccuDate terminals for the restaurant solutions market combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab and go labels for prepared foods, and "enjoy by" date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve, convince and hospitality establishments) effectively manage food spoilage and automate and manage back-of-the-restaurant operations. Our newest addition to the AccuDate product line, the AccuDate XL, is a unique Android® 5.0-based restaurant management terminal specifically designed to meet the food prep management and labeling needs of the restaurant and hospitality industries. Customers buying the AccuDate XL with Jolt software can utilize the terminal for food expiration date labeling and Grab & Go labeling, along with account management and an analytics portal. TransAct's AccuDate® XL restaurant management terminal, integrated with CrunchTime's KitchenSync App, provides an innovative platform that revolutionizes food preparation, food management and other back-of-house processes. In the restaurant solutions market, we use an internal sales force and, to a lesser extent distributors, to solicit sales directly from end-users. +POS automation and banking: Our POS automation and banking printers include hundreds of optional configurations that can be selected to meet particular customer needs. We believe that this is a significant competitive strength, as it allows us to satisfy a wide variety of printing applications that our customers request. In the POS market, we sell several models of printers utilizing thermal and impact printing technology. Our POS printers are used primarily by restaurants (including fine dining, casual dining, quick-serve and hospitality establishments) located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we sell inkjet printers that are used by banks, credit unions and other financial institutions to print deposit or withdrawal receipts and/or validate checks at bank teller stations. In the banking market, we primarily sell our products directly to end-user banks and financial institutions through the use of our internal sales force and, to a lesser extent, resellers. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals ("VLTs") and other gaming machines that print tickets or receipts instead of issuing coins ("ticket-in, ticket-out" or "TITO") at casinos, racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets or receipts in monochrome, and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily to (1) slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through the end of 2017 our primary worldwide distributor, Suzo-Happ Group. However, effective January 1, 2018, we replaced Suzo-Happ Group with new distributors in Asia and Australia and adopted a direct selling model in Europe utilizing our UK sales office. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, as well as to manage sales through our distributors. +1 +We also offer a software solution, the EPICENTRAL™ Print System ("EPICENTRAL™" and "EPICENTRAL® SE"), including annual software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. With EPICENTRAL™, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. In 2017, we introduced EPICENTRAL ® SE a system edition version our software solution, that is specifically designed to work with the existing bonusing modules of casino slot machine management systems. In addition, EPICENTRAL® SE provides an upgrade path to a full EPICENTRAL TM implementation should an operator seek to expand their promotion and bonusing options beyond what the current slot machine management systems offer. +Lottery: We primarily supply lottery printers to International Gaming Technology and its subsidiaries ("IGT"), our largest customer and the world's largest provider of lottery terminals. In addition, during 2015 we launched a new lottery printer, the Epic 3000, that we sell to other lottery system customers beyond IGT. These printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and other lottery system customers, and are managed by an internal sales representative. +Printrex: Printrex printers include wide format, desktop and rack mounted and vehicle mounted black/white thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at data centers of the oil and gas field service companies. In addition, we sell vehicle mounted printers used to print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM's, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated Printrex internal sales representative. We primarily sell our mobile printer through a single U.S. distributor. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper, food safety labels and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor's products. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress™ and TransAct Care, and other repair services for our printers and terminals. Within the United States, we provide repair services through our eastern region service center in Ithaca, NY and our western region service center in Las Vegas, NV. Internationally, we provide repair services through our European service center located in Doncaster, United Kingdom, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 99% of our printer and terminal production is primarily through three third-party contract manufacturers in Asia. The remaining 1% of our products are assembled in our Ithaca, NY facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our products in Ithaca, NY. Critical component parts and subassemblies include thermal, inkjet and impact print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers and terminals produced by our contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for several of our printer and restaurant solutions terminal models, from one foreign contract manufacturer and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material adverse effect on our operating results. Although we do not have supply agreements with our foreign contract manufacturers, our relationship with our largest one remains strong and we have no reason to believe that they will discontinue their supply of thermal print mechanisms or fully assembled printers to us during 2018 or that their terms to us will be any less favorable than they have been historically. We are currently seeking to replace our second largest contract manufacturer in 2018 as their terms have become less competitive. +Hewlett-Packard Company ("HP") is the sole supplier of inkjet cartridges that are used in all of our banking inkjet printers. In addition, we also sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges that are compatible with our banking inkjet printers are available, the loss of the supply of HP inkjet cartridges could have a material adverse effect on both the sale of our inkjet printers and TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the POS automation and banking market, but also in other manufacturer's printing devices across several other markets. +Canon, Inc. ("Canon") is the sole supplier of inkjet cartridges and other consumable items ("Canon Consumables") that are used in our Printrex 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980 printers and the Canon Consumables. We have a supply agreement with Canon to supply us with Canon Consumables until May 2018. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +2 +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 36 United States and 37 foreign patents and have 4 United States and 2 foreign patent applications pending pertaining to our products. The duration of these patents range from 1 to 15 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this annual report on Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, AccuDate™, Epic, EPICENTRAL™, Ithaca®, RESPONDER® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our restaurant solutions terminals or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT has been our most significant customer. On May 29, 2015, we signed an agreement with IGT to sell on-line lottery and casino printers to IGT through December 31, 2019. Under the terms of the agreement, we will sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT will purchase such printers from us on a non-exclusive basis. This agreement will allow TransAct to sell printers to other lottery system customers beyond IGT. +In September 2013, we signed an agreement with Suzo-Happ to be our exclusive worldwide distributor of casino and gaming products through December 31, 2017. We did not renew the agreement upon its expiration. Beginning January 1, 2018, we replaced Suzo-Happ with new distributors in Asia and Australia and expanded our sales office in the UK to begin selling directly to end user customers in Europe. +Sales to IGT and Suzo-Happ representing 10% or more of our total net sales were as follows: +Year ended December 31, +2017 +2016 +2015 +IGT +35 +% +26 +% +29 +% +Suzo-Happ +8 +% +15 +% +14 +% +Backlog +Our backlog of firm orders was approximately $10,349,000 as of February 28, 2018, compared to $16,241,000 as of February 28, 2017. Based on customers' current delivery requirements, we expect to fill and recognize as revenue $7,474,000 of our current backlog during 2018 and the remaining $2,875,000 during 2019. +Competition +The market for transaction-based and specialty printers and restaurant solutions terminals is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL TM software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the restaurant solutions market, we compete with Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized purpose-built products, custom engineering and ongoing technical support. +In the POS automation and banking market, we compete with Epson America, Inc., which holds a dominant market position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain competitors of ours have greater financial resources, lower costs attributable to higher volume production and sometimes offer lower prices than us. However, we have and will continue to deemphasize efforts in the POS automation and banking markets going forward. +In the casino and gaming market (consisting principally of slot machine and VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we compete with other lottery printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +In the Printrex market, we primarily compete with the Imaging Systems Group, Inc. ("iSys") and Neuralog Inc. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +The TSG business is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers, and label converters depending on the geographic area. +3 +Our strategy for competing in our markets is to continually develop new products (hardware and software) and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower product costs by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products utilize certain thermal, inkjet and impact printing technology. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which would have a significant negative impact on our business. +Research and Development Activities +Research, development, and engineering expenditures represent costs incurred in the experimental or laboratory sense aimed at discovery and/or application of new knowledge in developing a new product or process, or in bringing about significant improvement in an existing product or process. We spent approximately $4,303,000, $4,425,000, and $3,599,000 in 2017, 2016 and 2015, respectively, on engineering, design and product development efforts in connection with specialized engineering and design to introduce new hardware and software products and to customize or improve existing products. +Costs incurred in researching and developing a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheets until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs will be included in cost of sales over the estimated life of the product. During 2010, we began the development of EPICENTRAL TM , which enables casino customers to print coupons and promotions at the slot machine. Unamortized development costs for such software were approximately $0 and $2,000 as of December 31, 2017 and 2016, respectively. The total amount charged to cost of sales for capitalized software development costs were approximately $2,000, $29,000, and $138,000 in 2017, 2016 and 2015, respectively. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Employees +As of December 31, 2017, TransAct and our subsidiaries employed 123 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Financial Information About Geographic Areas +For financial information regarding our geographic areas see Note 14 – Geographic Area Information in the Notes to the Consolidated Financial Statements. Risks related to our foreign operations are described in Item 1A below. +Available Information +We make available free of charge through the "Investor Relations" tab on our iInternet website, www.transact-tech.com , our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission ("SEC"). You may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. \ No newline at end of file diff --git a/raw/filings/0001017303/2017/0001017303-18-000022/item13.txt b/raw/filings/0001017303/2017/0001017303-18-000022/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..6dcdfd97089d8ff1ee91dff042f62d7d12d8943a --- /dev/null +++ b/raw/filings/0001017303/2017/0001017303-18-000022/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings ["Policy Regarding Pre-Approval of Services Provided by the Independent Registered Public Accounting Firm" and "Independent Registered Public Accounting Firm's Services and Fees," and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2017/0001017303-18-000022/item9a.txt b/raw/filings/0001017303/2017/0001017303-18-000022/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..2f2f78999aabb4209b96aa57c9e3488ff9ebda5c --- /dev/null +++ b/raw/filings/0001017303/2017/0001017303-18-000022/item9a.txt @@ -0,0 +1,8 @@ +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2017. Based upon that evaluation, our management, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2017, our disclosure controls and procedures are effective. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. +Management's Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2017. Management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("2013 COSO"). Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2017. +Changes in Internal Control Over Financial Reporting +There has been no change in the Company's internal control over financial reporting that occurred during the quarter ended December 31, 2017 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001017303/2017/0001017303-18-000022/rp_note.txt b/raw/filings/0001017303/2017/0001017303-18-000022/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2017/0001017303-18-000022/rpt_disclosure.txt b/raw/filings/0001017303/2017/0001017303-18-000022/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a70027a760d63bf0c0561a3dbbe642583cbcfa6 --- /dev/null +++ b/raw/filings/0001017303/2017/0001017303-18-000022/rpt_disclosure.txt @@ -0,0 +1,12 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains written policies that relate to the identification, review and approval of +related party transactions, in addition to the requirements of Nasdaq and the SEC. As part of a review of possible related person transactions, the Company periodically distributes and collects questionnaires that solicit information about any +direct or indirect transactions with the Company from each of our directors and officers. +Our Standards of Business Conduct require all directors, officers and employees to avoid any situation +that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company. Under our Standards of Business Conduct, situations that involve, or may reasonably be +inferred to involve, a conflict between a director, officer or employee’s personal interests and the interests of the Company should be disclosed to the Chair of the Audit Committee. The Audit Committee is then responsible for reviewing the +transaction. No transaction determined to be a related party transaction will be approved or ratified if the transaction is contrary to the best interests of the Company. In determining whether to approve or ratify a related party transaction, the +Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar +circumstances and the extent of the related person's interest in the transaction. +From January 1, 2017 to the date of this Proxy Statement, there have not been any transactions subject +to the Company's related party transaction policy or of the type described in Item 404 of Regulation S-K, and currently no such transactions are proposed. \ No newline at end of file diff --git a/raw/filings/0001017303/2018/0001017303-19-000020/filing.txt b/raw/filings/0001017303/2018/0001017303-19-000020/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..9a186e44c2b1a1bd2b93f9a63c187bdada94cdf1 --- /dev/null +++ b/raw/filings/0001017303/2018/0001017303-19-000020/filing.txt @@ -0,0 +1,4761 @@ +10-K +1 +form10k2018.htm +FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2018 +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE +SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2018 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE +SECURITIES EXCHANGE ACT OF 1934 +For the transition period from +to . +Commission file number: 0-21121 +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, CT +06518 +(Address of principal executive offices) +(Zip Code) +Registrant's telephone number, including area code 203-859-6800 +Securities registered pursuant to Section 12(b) of the Act: +Title of Each Class - Common Stock, par value $.01 per share +Name of Exchange on which Registered - Nasdaq Global Market +Securities registered pursuant to Section 12(g) of the Act : None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ☐ No ☒ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of +the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be +submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this +chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated +filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☒ +Non-accelerated filer ☐ +Smaller reporting company ☒ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition +period for complying with any new or revised financial standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the Registrant was +approximately $87,900,000 based on the last sale price on June 30, 2018. +As of February 28, 2019, the number of shares outstanding of the Registrant’s common stock, $0.01 par value, was +7,450,968. +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days +after the year covered by this Form 10-K with respect to the 2019 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +4 +Item 1B. +Unresolved Staff Comments +10 +Item 2. +Properties +10 +Item 3. +Legal Proceedings +10 +Item 4. +Mine Safety Disclosures +10 +PART II. +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +11 +Item 6. +Selected Financial Data +13 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +13 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +25 +Item 8. +Financial Statements and Supplementary Data +25 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +25 +Item 9A. +Controls and Procedures +25 +Item 9B. +Other Information +26 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +26 +Item 11. +Executive Compensation +27 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +27 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +27 +Item 14. +Principal Accounting Fees and Services +27 +PART IV. +Item 15. +Exhibits +28 +Item 16. +Form 10-K Summary +30 +SIGNATURES +Signatures +31 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +PART I +Forward Looking Statements +Certain statements included in this report, including without limitation statements in this +Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of +the Securities Exchange Act of 1934, as amended. (the “Exchange Act”)Forward-looking statements generally can be identified by the use of forward-looking terminology, such as “may”, “will”, “expect”, “intend”, ”estimate”, “anticipate”, “believe”, +“project” or “continue” or the negative thereof or other similar words. All forward-looking statements involve risks and uncertainties, including, but not limited to those listed in Item 1A of this Annual Report and such other risk and +uncertainties as are described in our reports filed with the SEC from time to time.. Actual results may differ materially from those discussed in, or implied by, the forward-looking statements. The forward-looking statements speak only as of +the date of this report and we assume no duty to update them. +Item 1. Business. +The Company +TransAct Technologies Incorporated (“TransAct”, the “Company”, “we”, “us”, or “our”) was incorporated in June 1996 and +began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing +and selling software-driven technology and printing solutions for high growth markets including restaurant solutions, point of sale (“POS”) automation and banking, casino and gaming, lottery, and oil and gas. Our world-class products are +designed from the ground up based on market and customer requirements and are sold under the AccuDate™, EPICENTRAL™, Epic®, Ithaca®, and Printrex® brand names. Known and respected worldwide for innovative designs and real-world service +reliability, our thermal, and inkjet printers and terminals generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents, as well as printed logging and plotting of data. We sell our products to +original equipment manufacturers (“OEMs”), value-added resellers, select distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands +and the South Pacific. We also offer world-class service, spare parts, accessories and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a +complete range of supplies and consumables used in the printing and scanning activities of customers in the restaurant and hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the demand for these +products. Our primary operating, hardware research and development, and eastern region service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters, software research and development and western +region service center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”), and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney +Avenue, Suite 3B, Hamden, Connecticut, 06518, with a telephone number of (203) 859-6800. +Products, Services and Distribution Methods +Printers +and terminals: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal and inkjet printing technology for applications, primarily in the restaurant solutions, POS +automation and banking, casino and gaming, lottery, and oil and gas printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include +interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our restaurant solutions terminals also offer configurable menu options. In addition to our configurable printers and +terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers tailored to our +customers' business. +Restaurant +Solutions: Our line of AccuDate™ terminals for the restaurant solutions market combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food +rotation labels, grab and go labels for prepared foods, and “enjoy by” date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve, convenient stores and hospitality establishments) +effectively manage food safety and automate and manage back-of-the-restaurant operations. Our newest addition to the AccuDate™ product line, the AccuDate XL2e, is a unique Android® 5.0-based restaurant management terminal specifically designed to +meet the food preparation management and labeling needs of the restaurant and hospitality industries. In 2019, we rebranded the AccuDate XL2e as BOHA! TM . The BOHA! TM terminal can be used for food expiration date labeling and +grab and go labeling, along with account management and an analytics portal. In the restaurant solutions market, we use an internal sales force and, to a lesser extent distributors, to solicit sales directly from end-users. +POS +automation and banking: In the POS market, we sell several models of printers utilizing thermal printing technology. Our POS printers +are used primarily by quick-serve restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of +domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we sell inkjet printers that +are used by banks, credit unions and other financial institutions to print deposit and withdrawal receipts and to validate checks at bank teller stations. In the banking market, we primarily sell our products directly to end-user banks and +financial institutions through the use of our internal sales force and, to a lesser extent, resellers. We exited the banking market as of December 31, 2018 and therefore did not expect any future sales. +Casino +and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLTs”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, +racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in monochrome, and offer various other features such as jam resistant bezels and a dual port interface that enables +casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting +Terminals and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines +directly to casinos and other gaming establishments and (2) through distributors. Until December 31, 2017, the Suzo-Happ Group was our primary worldwide distributor. However, effective January 1, 2018, we replaced Suzo-Happ Group with new +distributors in Asia and Australia and adopted a direct selling model in Europe utilizing our UK sales office. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales +through our distributors. +1 +We also offer a software solution, the EPICENTRAL™ Print System (“EPICENTRAL™” and “EPICENTRAL® SE”), including annual +software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. With EPICENTRAL™, casinos can utilize the system to create multiple promotions and +incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. In 2017, we introduced EPICENTRAL® SE, a system edition version our software solution, that is +specifically designed to work with the existing bonusing modules of casino slot machine management systems. In addition, EPICENTRAL® SE provides an upgrade path to a full EPICENTRAL TM implementation in the event that an operator seeks +to expand its promotion and bonusing options beyond the slot machine management systems currently offered. +Lottery: We +primarily supply lottery printers to International Gaming Technology and its subsidiaries (“IGT”), our largest customer and the world’s largest provider of lottery terminals. We also sell the Epic 3000 printer, to our other lottery system +customers. Our lottery printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and other lottery system customers, and are managed by +an internal sales representative. +Printrex: Printrex +printers include wide format, desktop and rack mounted and vehicle mounted black and white thermal printers used by customers in the oil and gas exploration industry to log and plot oil field and down hole well drilling data. The Printrex® brand +of printers also includes high-speed color inkjet desktop printers used by oil and gas field service companies to print logs at their data centers. We primarily sell our Printrex® products directly to oil field service and drilling companies and +OEM’s, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated Printrex® internal sales representative. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper, food +safety labels and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor’s products. Our maintenance services include the sale of extended warranties, +multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress™ and TransAct Care™, and other repair services for our printers and terminals. Within the United States, we provide repair services through our +eastern region service center in Ithaca, New York and our western region service center in Las Vegas, Nevada. Internationally, we provide repair services through our European service center located in Doncaster, UK, and through partners +strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle +orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a +day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine +cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 99% of our printer and terminal production is primarily through three third-party contract manufacturers in Asia. The remaining 1% of our +products are assembled in our Ithaca, New York facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our hardware products in Ithaca, New +York. Critical component parts and subassemblies include thermal and inkjet print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained +from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers and terminals produced by our +contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or +unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and +fully assembled printers for several of our printer and restaurant solutions terminal models, from one foreign contract manufacturer and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract +manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a +material adverse effect on our operating results. Although we do not have supply agreements with our foreign contract manufacturers, our relationship with our largest one remains strong and we have no reason to believe that they will discontinue +their supply of thermal print mechanisms or fully assembled printers to us during 2019 or that their terms to us will be substantially less favorable than they have been historically. We are currently seeking to find a second source for our +largest contract manufacturer in 2020. +Hewlett-Packard Company (“HP”) is the sole supplier of inkjet cartridges that are used in all of our banking inkjet +printers. Though we have exited the banking market as of December, 31, 2018, we still sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges are compatible with our banking inkjet +printers, the loss of the supply of HP inkjet cartridges could have a material adverse effect on the sale of our TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply +of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the POS automation and banking market, but +also in other manufacturer’s printing devices across several other markets. +2 +Canon, Inc. (“Canon”) is the sole supplier of inkjet cartridges and other consumable items (“Canon Consumables”) that +are used in our Printrex® 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980® printers and the Canon Consumables. We have a supply agreement with Canon to supply us +with Canon Consumables until May 2019. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +Patents and Proprietary +Information +TransAct relies on a combination of trade secrets, patents, employee and third-party nondisclosure agreements, +copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 35 United States and 37 foreign patents and have 8 United States and 5 foreign patent applications pending pertaining to our +products. The duration of these patents range from 1 to 15 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and +attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to +our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal +protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the +operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this Annual Report on Form 10-K are the property of their respective owners. The trademarks we own +include TransAct®, BOHA! TM , AccuDate™, Epic, EPICENTRAL™, Ithaca® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without +the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions +during the holiday period, which may negatively impact sales of our restaurant solutions terminals or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are +in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT is our most significant customer and has been since 1996. On May 29, 2015, we signed an agreement with IGT to sell +on-line lottery and casino printers to IGT on a non-exclusive basis through December 31, 2019. Under the terms of the agreement, we sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT purchases such printers from us +on a non-exclusive basis. This agreement allows TransAct to sell printers to other lottery system customers beyond IGT. +In September 2013, we signed an agreement with Suzo-Happ to be our exclusive worldwide distributor of casino and gaming +products through December 31, 2017. We did not renew the agreement upon its expiration. Beginning January 1, 2018, we replaced Suzo-Happ with new distributors in Asia and Australia and expanded our sales office in the UK to begin selling directly +to end-user customers in Europe. +Sales to IGT and Suzo-Happ representing 10% or more of our total net sales were as follows: +Year Ended December 31, +2018 +2017 +2016 +IGT +18 +% +35 +% +26 +% +Suzo-Happ +1 +% +8 +% +15 +% +Backlog +Our backlog of firm orders was approximately $6.9 million as of February 28, 2019, compared to $10.3 million as of +February 28, 2018. Based on customers’ current delivery requirements, we expect to fill and recognize as revenue $5.4 million of our current backlog during 2019 and the remaining $1.5 million during 2020. +Competition +The market for transaction-based and specialty printers and restaurant solutions terminals is extremely competitive, +and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL TM software due to the highly customized nature of the product. We compete with a number of companies, many of which have +greater financial, technical and marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, +product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us +and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +3 +In the restaurant solutions market, we compete with Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, CMC +Daymark and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized software and purpose-built products and ongoing technical support. +In the POS automation and banking market, we primarily compete with Epson America, Inc., which holds a dominant market +position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain +competitors of ours have greater financial resources and lower costs attributable to higher volume production which enables them to occasionally offer lower prices than us. However, we have exited the banking market and will continue to +deemphasize efforts in the POS automation market going forward as we have shifted our focus toward our higher-value, technology enabled restaurant solutions and casino and gaming products. +In the casino and gaming market (consisting principally of slot machine printing, VLT transaction printing and +promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA, Eurocoin and others. Certain of our products sold for casino and gaming applications compete based upon our ability to +provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we compete with other lottery +printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +In the oil and gas market, our Printrex® products compete primarily with the products of Imaging Systems Group, Inc. +and Neuralog Inc. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, +including POS and internet resellers, and label converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop new products (hardware and software), such as BOHA! TM +in 2019, and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower the cost of our +product by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our +products utilize certain thermal and inkjet printing technologies. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our +products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which could have a significant negative impact on our business. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or +adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Available Information +We make available free of charge through the “Investor Relations” tab on our Internet website, www.transact-tech.com, +our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and +Exchange Commission (“SEC”). The SEC maintains all reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http;//www.sec.gov. As such, you may read any materials filed by the +Company with the SEC at http://www.sec.gov. The references to the foregoing website addresses do not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. +Employees +As of December 31, 2018, TransAct and our subsidiaries employed 126 persons, all of whom were full-time +employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +Item 1A. Risk Factors +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other +disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks +described below are not the only ones facing our Company. Additional risks not known to us at this time or that we currently deem immaterial, may also impair our business operations. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other +forward-looking statements contained in this Annual Report to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +4 +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are likely to +continue to vary due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent +historical operating results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may be due to a number of factors, including, but not limited to, those identified throughout +this “Risk Factors” section: +● +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +● +the geographic distribution of our sales; +● +market acceptance of our products, both domestically and internationally; +● +development of new competitive products by others; +● +our responses to price competition; +● +our level of research and development activities; +● +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +● +changes in the amount we spend to promote our products and services; +● +changes in the cost of satisfying our warranty obligations and servicing our installed base of products; +● +availability of third-party components at reasonable prices; +● +general economic and industry conditions, including changes in interest rates affecting returns on cash balances and investments, that affect customer demand; +● +fluctuations of world-wide oil and gas prices; +● +severe weather events (such as hurricanes) that can disrupt or interrupt the operation of our customers or suppliers facilities; and +● +changes in accounting rules. +Due to all of the foregoing factors, and the other risks discussed in this report, quarter-to-quarter comparisons of our +operating results may not be an indicator of future performance. +Our revenue and profitability depend on our ability to continue to develop, on a +timely basis, new products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated. +The success of newer products, such as the AccuDate™ restaurant solutions terminals, is dependent on how quickly +customers in the related markets accept them given the very little market penetration these products have experienced since they are new and innovative and have limited competition. Additionally, the success of innovative technology, such as our +BOHA! restaurant solution software and hardware products released in 2019, is dependent on our customers' acceptance of such technology. While the BOHA! terminals and software products were developed based on working with operators within the +restaurant industry, such acceptance may nevertheless only build gradually over time or not at all. Delays in acceptance by our customers of new technologies may adversely affect our operations. +Our success depends upon our ability to adapt our capabilities and processes to meet the demands of producing new and +innovative products. Because our newer products contain software and are generally more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product +innovation. If we cannot efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +In the lottery market, we have been dependent on sales to one large customer; +the loss of this customer or reduction in orders from this customer could materially affect our sales. +Sales to IGT have represented a material percentage of our net sales since 1995. A reduction, delay or cancellation in +orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Significant developments stemming from the UK’s membership in the EU could have +a material adverse effect on us. +In 2016, the UK held a referendum and voted in favor of leaving the European Union, or EU. This referendum has created +political and economic uncertainty, particularly in the UK and the EU. Our business in the UK, the EU, and worldwide could be affected during this period of uncertainty, and perhaps longer, by the impact of the UK’s referendum. There are many ways +in which our business could be affected, only some of which we can identify as of the date of this annual report. +The referendum, and the likely withdrawal of the UK from the EU that it triggers, has caused and, along with events +that could occur in the future as a consequence of the UK’s withdrawal, including the possible breakup of the UK, may continue to cause significant volatility in global financial markets, including in global currency and debt markets. This +volatility could cause a slowdown in economic activity in the UK, Europe or globally, which could adversely affect our operating results and growth prospects. In addition, our business could be negatively affected by new trade agreements between +the UK and other countries, including the United States, and by the possible imposition of trade or other regulatory barriers in the UK. +Infringement on the proprietary rights of others could put us at a competitive +disadvantage, and any related litigation could be time consuming and costly. +Third-parties may claim that we violated their intellectual property rights. To the extent of a violation of a +third-party’s patent or other intellectual property right, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to +accomplish our objectives. Any of these claims, with or without merit, could result in costly litigation and divert the attention of key personnel. If such claims are successful, they could result in costly judgments or settlements. +General economic conditions could have a material adverse effect on our +business, operating results and financial condition. +Our business is subject to general economic conditions. Uncertainty or negative trends in U.S. or international +economic and investment climates, including the impact of Brexit and recent developments in U.S.-China trade relations, could adversely affect our business. For example,, customers or potential customers could reduce or delay orders, key suppliers +and customers could become insolvent, which could result in production delays, and our customers may not be able to obtain credit. Any of these possible effects could impact our ability to effectively manage inventory levels and collect +receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including write-downs of assets. +5 +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and +services. We may be adversely impacted by any conflicts that could arise between and among our various sales channels. +Our dependence upon distributors and resellers exposes us to numerous risks, including: +● +loss of channel and the ability to bring new products to market; +● +concentration of credit risk, including disruption in distribution should the distributors and / or resellers’ financial condition deteriorate; +● +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +● +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +● +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material +adverse effect upon the business, consolidated results of operations and financial condition. +We have outsourced substantially all of the assembly of our printers and +terminals to three contract manufacturers and will be dependent on them for the manufacturing of such products. A failure by these contract manufacturers, or any disruption in such manufacturing or the flow of product from these manufacturers, may +adversely affect our business results. +In an effort to achieve additional cost savings and operation benefits, we have continued to outsource the +manufacturing and assembly of our printers and terminals to contract manufacturers in Asia. Approximately 80% of our printer and terminal manufacturing is conducted by one third party manufacturer in Asia, and an additional 19% is conducted by two +other third party manufacturers in Asia. +However, to the extent we rely on a third-party service provider for manufacturing services, we may incur increased +business continuity risks. We will no longer be able to exercise control over the assembly of certain of our products or any related operations or processes, including the internal controls associated with operations and processes conducted and +the quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be +materially adversely affected. +In addition, if any of our contract manufacturers experiences business difficulties or fails to meet our manufacturing +needs, then we may be unable to meet production requirements, may lose revenue and may not be able to maintain relationships with our customers. Without the contract manufacturers continuing to manufacture our products and the continuing operation +of the contract manufacturers’ facilities, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing +facility, which could be costly and time consuming and have a material adverse effect on our operating and financial results. +The increased elements of risk that arise from conducting certain operating processes in foreign jurisdictions may lead +to an increase in reputational risk. +Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, +this insurance does not cover all possible situations. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing +customers resulting from our inability to produce products for them. +The contract manufacturers have access to our intellectual property, which increases the risk of infringement or +misappropriation of this intellectual property. +Political, social or economic instability in regions in which our manufacturers +are located, could cause disruptions in trade, including exports to the U.S. +A significant portion of our printers and terminals are manufactured by contract manufacturers overseas and are +exported to the U.S. Any such disruption in trade, including exports to the U.S., could adversely affect our business results. Events that could cause disruptions to such exports to the U.S. include: +● +the imposition of additional trade law provisions or regulations; +● +reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely +manner or for an acceptable cost; +● +the imposition of additional duties, tariffs and other charges on imports and exports; +● +economic uncertainties and adverse economic conditions (including inflation and recession); +● +fluctuations in the value of the U.S. Dollar against foreign currencies; +● +significant labor disputes, such as dock strikes; +● +significant delays in the delivery of cargo due to port security considerations; +● +financial or political instability in any of the countries in which our printers and terminals are manufactured; and +● +regulatory changes and economic conditions leading up to and following Brexit in those countries that are negatively affected by Brexit and in which our +printers and terminals are manufactured. +6 +We source some of our component parts and consumable products from sole source +suppliers; any disruptions may impact our ability to manufacture and sell our products. +Our products rely on certain key components from third party or sole source suppliers. We do not have guaranteed +supply contracts with any of our component suppliers, and our suppliers could delay shipments, increase prices or cease manufacturing such products or selling them to us at any time. A disruption in the supply of such component parts and +consumable products could delay our production and/or the release of our new products and hinder our ability to meet our commitments to customers. If we are unable to obtain a sufficient quantity of these components on commercially reasonable +terms or in a timely manner, or if we are unable to obtain alternative sources for the components, sales of our products could be delayed or halted entirely or we may be required to redesign our products. Any of these events could result in lost +sales, reduced gross margins or damage to our end-customer relationships, which would have a material adverse effect on our operations and financial results. +We sell a significant portion of our products internationally and purchase +important components from foreign suppliers. These circumstances create a number of risks. +We sell a significant amount of our products to customers outside the United States. Shipments to international +customers are expected to continue to account for a material portion of net sales. Risks associated with sales and purchases outside the United States include: +● +fluctuating foreign currency rates could restrict sales, or increase costs of purchasing, in foreign countries; +● +foreign governments may impose burdensome tariffs, quotas, taxes, trade barriers or capital flow restrictions; +● +political and economic instability may reduce demand for our products or put our foreign assets at risk; +● +restrictions on the export or import of technology may reduce or eliminate the ability to sell in or purchase from certain markets; +● +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to +refrain from selling in certain geographic territories; and +● +regulatory changes and economic conditions leading up to and following, Brexit, including uncertainties as to its effect on trade laws, tariffs, instability +and volatility in the global financial and currency markets, conflicting or redundant regulatory regimes in Europe and political stability. +If tariffs on imported steel and aluminum, such as those proposed by the +President of the United States, are implemented, our cost of raw materials may increase, which could adversely affect our business, results of operations and financial condition. +We obtain raw materials, including stainless steel and aluminum, used in the production of some of our printer products +from domestic, Asian affiliated and nonaffiliated sources. The implementation of more restrictive trade policies, including the imposition of tariffs, or the renegotiation of existing trade agreements by the U.S. or by countries where we sell +large quantities of products and services or procure supplies and other materials incorporated into our products, could negatively impact our business, results of operations and financial condition. Because steel and aluminum are raw materials +used in a wide-range of our printer products, a broad based cost increase would result in an increase in our cost of goods sold, which may require us to increase prices for some of our products. However, an inability by us to pass such price +increases through to our customers, or an inability of our suppliers to meet our raw material requirements, may have a material adverse impact on our business, results of operations or financial condition. +The effect of comprehensive U.S. tax reform legislation on us, whether adverse or +favorable, is uncertain. +In December of 2017, President Trump signed into law the Tax Cuts and Jobs Reform Act (the “Tax Reform Act”). Among a +number of significant changes to the U.S. federal income tax rules, the Tax Reform Act reduces the marginal U.S. corporate income tax rate from 35% to 21%, limits the deduction for net interest expense, shifts the United States toward a more +territorial tax system, and imposes new rules to combat erosion of the U.S. federal income tax base. While we have evaluated the effects of the Tax Reform Act on us, there are a number of uncertainties and ambiguities as to the interpretation and +application of many of the provisions in the Tax Reform Act. In the absence of guidance on these issues, we will use what we believe are reasonable interpretations and assumptions in interpreting and applying the Tax Reform Act for purposes of +determining our cash tax liabilities and results of operations, which may change as we receive additional clarification and implementation guidance and as the interpretation of the Tax Reform Act evolves over time. It is possible that the Internal +Revenue Service (“IRS”) could issue subsequent guidance or take positions on audit that differ from the interpretations and assumptions that we previously made, which could have an adverse effect on our cash tax liabilities, results of operations +and financial condition. As we collect and prepare necessary data, and interpret the Tax Reform Act and any additional guidance issued by the IRS or other standard-setting bodies, we may make adjustments to the provisional amounts that could +materially affect our financial position and results of operations, as well as our effective tax rate in the period in which the adjustments are made. We recorded the impacts of the Tax Act on a provisional basis in 2017. As of December 22, 2018, +our accounting for the impact of the Tax Act was complete. See Note 1, “Income Taxes” to our consolidated financial statements. +We face risks associated with manufacturing forecasts. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience +manufacturing delays, which could cause us to lose orders or customers and result in lower net sales. We currently use a rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our +requirements for components and materials. It is very important that we accurately predict both the demand for our products and the lead-time required to obtain the necessary components and raw materials. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific +supplier, the size of the order, contract terms, and demand for each component at a given time. If we underestimate our requirements, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products +and result in delays in shipments and net sales. If we overestimate our requirements, we could have excess inventory of parts. In addition, delays in the manufacturing of our products could cause us to lose orders or customers. +Our success will depend on our ability to sustain and manage growth. +As part of our business strategy, we intend to pursue a growth strategy. Assuming this growth occurs, it will require +the expansion of customer relationships in international markets, the successful development and marketing of new products for our existing and new markets, expanded internal sales, customer service and support, and the continued implementation and +improvement of our operational, financial and management information systems. +7 +To the extent that we seek growth through acquisitions, our ability to manage our growth will also depend on our +ability to integrate businesses that have previously operated independently. We may not be able to achieve this integration without encountering difficulties or experiencing the loss of key employees, customers or suppliers. It may be difficult +to design and implement effective financial controls for combined operations and differences in existing controls for each business may result in weaknesses that require remediation when the financial controls and reporting functions are +combined. As we pursue acquisitions, we may incur legal, accounting and other transaction related expenses for unsuccessful acquisition attempts that could adversely affect our results of operations in the period in which they are incurred. +There can be no assurance that we will be able to successfully implement our growth strategy, or that we can +successfully manage expanded operations, if they occur. As we expand, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively +could adversely affect our results of operations and financial condition. +We compete in highly competitive markets, which are likely to become more +competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, transaction supplies and +services. Our principal competitors have substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +● +technologically advanced products that satisfy the user demands; +● +superior customer service; +● +high levels of quality and reliability; and +● +dependable and efficient distribution networks. +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition +may result in price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or +establish cooperative relationships with suppliers or companies that produce complementary products. Any of these factors could reduce our earnings. +We depend on key personnel, the loss of which could materially impact our business. +Our future success will depend in significant part upon the continued service of certain key management and other +personnel and our continuing ability to attract and retain highly qualified managerial, technical and sales and marketing personnel. There can be no assurance that we will be able to recruit and retain such personnel. The loss of either Bart C. +Shuldman, the Company's Chairman of the Board and Chief Executive Officer, or Steven A. DeMartino, the Company’s President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, could have a material +adverse effect on our results of operations. +If we are unable to enforce our patents or if it is determined that we infringe +patents held by others it could damage our business. +Prosecuting and defending patent lawsuits is very expensive. We are committed to aggressively asserting and defending +our technology and related intellectual property, which we have spent a significant amount of money to develop. These factors could cause us to become involved in new patent litigation in the future. The expense of prosecuting or defending these +future lawsuits could also have a material adverse effect on our business, financial condition and results of operations. +If we were to lose a patent lawsuit in which another party is asserting that our products infringe its patents, we +would likely be prohibited from marketing those products and could also be liable for significant damages. Either or both of these results may have a material adverse effect on our business, financial condition and results of operations. If we +lose a patent lawsuit in which we are claiming that another party’s products are infringing our patents and thus, are unable to enforce our patents, it may have a material adverse effect on our business, financial condition and results of +operations. In addition to disputes relating to the validity or alleged infringement of other parties' rights, we may become involved in disputes relating to our assertion of our own intellectual property rights. Whether we are defending the +assertion of intellectual property rights against us or asserting our intellectual property rights against others, intellectual property litigation can be complex, costly, protracted, and highly disruptive to business operations by diverting the +attention and energies of management and key technical personnel. Plaintiffs in intellectual property cases often seek injunctive relief, and the measures of damages in intellectual property litigation are complex and often subjective or +uncertain. Thus, any adverse determinations in this type of litigation could subject us to significant liabilities and costs. During the course of these lawsuits there may be public announcements of the results of hearings, motions, and other +interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could harm the market price of our stock. +The inability to protect intellectual property could harm our reputation, and our +competitive position may be materially damaged. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, +trademarks, service marks, trade secrets, nondisclosure agreements and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without +authorization, to obtain and use information which we regard as trade secrets. +8 +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating +results and other factors, such as: +● +changes in our business, operations or prospects; +● +developments in our relationships with our customers; +● +announcements of new products or services by us or by our competitors; +● +announcement or completion of acquisitions by us or by our competitors; +● +changes in existing or adoption of additional government regulations; +● +unfavorable or reduced analyst coverage; and +● +prevailing domestic and international market and economic conditions. +In addition, the stock market may experience significant price fluctuations year-to-year. Broad market fluctuations, +general economic conditions and specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Limited trading volume and a reduction in analyst coverage of our common stock +may contribute to its price volatility. +Our common stock is traded on the Nasdaq Global Market. During the year ended December 31, 2018 the average daily +trading volume for our common stock as reported by the Nasdaq Global Market was approximately 25,000 shares. We are uncertain whether a more active trading market in our common stock will develop. In addition, many investment banks no longer find +it profitable to provide securities research on micro-cap and small-cap companies. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the +price of our common stock. +Future sales of our common stock may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, and we may also issue +additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future sale pursuant to stock options and other equity awards that we have granted to our employees, and in the future we may +grant additional stock options and other forms of equity compensation to our employees. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could +impair our ability to raise capital through future offerings. +If market conditions deteriorate or future results of operations are less than +expected, a valuation allowance may be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the +realization of these deferred tax assets on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions +deteriorate or future results of operations are less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are +not realizable. As a result, we may need to establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +We cannot provide any assurance that current laws, or any laws enacted in the +future, will not have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and +other requirements in each of the jurisdictions in which we conduct business. Changes in laws, rules, regulations, policies or requirements could result in the need to modify our products and could affect the demand for our products, which may +have an adverse impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +Our business could be adversely affected by actual or threatened terrorist +attacks or the related heightened security measures, military actions and other efforts to combat terrorism. +Our business could be adversely affected by actual or threatened terrorist attacks or the related heightened security +measures, military actions and other efforts to combat terrorism. It is possible that terrorist attacks could be directed at important locations for the gaming industry. Heightened security measures and other efforts to combat terrorism may also +have an adverse effect on the gaming industry by reducing tourism. Any of these developments could also negatively affect the general economy and consumer confidence. Any downturn in the economy in general, or in the gaming industry in particular +could result in a reduced demand for our products and could adversely affect our business and results of operations. In addition, heightened security measures may cause certain governments to restrict the import or export of goods, which may have +an adverse effect on our ability to buy and sell goods. +Fluctuations in oil and gas prices could adversely affect drilling and +exploration activities by oil and gas companies and our revenue in our Printrex market. If oil and gas prices remain volatile, or if oil or gas prices remain low or decline further, the demand for our Printrex products could be adversely affected. +The demand for our Printrex products depends on the level of spending by oil and gas companies for drilling and +exploratory activities, which are affected by short-term and long-term trends in oil and gas prices, including current and anticipated oil and gas prices. Oil and gas prices, as well as the level of drilling and exploration, historically have been +extremely volatile and are expected to continue to be highly volatile. If oil and gas prices continue to remain low or decline further, or if there is a further reduction in drilling and exploration activities, the demand for our Printrex products +could be materially and adversely affected. +Cyber-security and privacy breaches, cyber-attacks, or other disruptions could +expose us to liability, affect our business, and damage our reputation. +We are increasingly dependent on our +information technology systems and infrastructure for our business. We collect, store, and transmit sensitive information including intellectual property, proprietary business information and personal information in connection with business +operations. The secure maintenance of this information is critical to our operations and business strategy. Some of this information could be an attractive +target of criminal attack by third parties with a wide range of motives and expertise, including organized criminal groups, disgruntled current or former employees, and others. Cyber-attacks are of ever-increasing levels of sophistication, and +despite our extensive security measures, our information technology and infrastructure may be vulnerable to such attacks or may be breached, including due to employee error or malfeasance. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. +If our systems become compromised, we may not promptly discover the intrusion. Like other companies in our industry, we have experienced attacks to our data and systems, including malware and computer viruses that we have been able to detect and +eliminate. If our systems fail or are breached or disrupted, we could lose product sales, and suffer reputational damage and loss of customer confidence. Such +incidents would require notification to affected individuals, and may result in legal claims or proceedings and liability under federal and state laws that protect the privacy and security of personal information. Any one of these events could +cause our business to be materially harmed and our results of operations to be adversely impacted. +9 +Additional risks and uncertainties may affect our business +Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may +adversely impact our business. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on our business, financial condition, and results of operations. +Item 1B. Unresolved Staff Comments. +Not applicable. +Item 2. Properties. +Our principal facilities as of December 31, 2018 are listed below. We believe that all facilities generally are in +good condition, adequately maintained and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. +Ft.) +Owned or +Leased +Lease Expiration +Date +Hamden, Connecticut +Executive offices and TSG sales office +11,100 +Leased +April 30, 2027 +Ithaca, New York +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2021 +Las Vegas, Nevada +Software design and development, service center and casino and gaming sales office +19,600 +Leased +October 31, 2022 +Doncaster, UK +Sales office and service center +6,000 +Leased +August 26, 2026 +Macau, China +Sales office +180 +Leased +June 30, 2019 +110,780 +Item 3. Legal Proceedings. +The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract +claims and other legal proceedings relating to the conduct of its business. As of December 31, 2018, we are unaware of any legal proceedings pending or threatened against us that management believes are likely to have a material adverse effect on +our business, financial condition or results of operations. +Item 4. Mine Safety Disclosures. +Not applicable. +10 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of +Equity Securities. +Our common stock is traded on the Nasdaq Global Market under the symbol TACT. As of February 28, 2019, there were 278 +holders of record of the common stock. +On February 11, 2019, our Board of Directors approved the first quarter 2019 dividend in the amount +of $0.09 per share payable on or about March 15, 2019 to common shareholders of record at the close of business on February 20, 2019. +Issuer Purchases of Equity Securities +On March 1, 2018, our Board of Directors approved a new stock repurchase program (the "2018 Stock +Repurchase Program"). Under the 2018 Stock Repurchase Program, we are authorized to repurchase up to $5 million of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, +share price and other factors. The 2018 Stock Repurchase Program expires on December 31, 2019, if we do not discontinue the repurchase program prior to such time. We use the cost method to account for treasury stock purchases, under which the +price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From the start of the 2018 Stock Repurchase Program on March 1, 2018 through December 31, 2018, we +repurchased 156,410 shares of our common stock for approximately $2 million at an average price per share of $12.79. +During 2016 and 2017, under a prior repurchase program that was in place from February 25, 2016 +through December 31, 2017, we purchased 499,843 shares of our common stock for $3.9 million at an average price of $7.86 per share. From January 1, 2005 through December 31, 2018, we repurchased a total of 4,044,842 shares of common stock for +$32.1 million, at an average price of $7.94 per share. +Sales of Unregistered Securities +None. +Securities Authorized for Issuance under Equity Compensation Plans +For a discussion of the Company’s equity compensation plan information, please see Item 12. Security Ownership of +Certain Beneficial Owners and Management and Related Stockholder Matters of this Form 10-K. +11 +CORPORATE PERFORMANCE GRAPH +The following graph compares the cumulative total return on the Company’s Common Stock from December 31, 2013 through +December 31, 2018, with the CRSP Total Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Hardware Stocks Index. The graph assumes that $100 was invested on December 31, 2013 in each of TransAct’s common stock, the CRSP Total +Return Index for the Nasdaq Stock Market (U.S.) and the Nasdaq Computer Manufacturer Stocks Index, and that all dividends were reinvested. +COMPARISON OF CUMULATIVE TOTAL RETURN AMONG +TRANSACT TECHNOLOGIES INCORPORATED COMMON STOCK, +THE CRSP TOTAL RETURN INDEX FOR THE NASDAQ STOCK MARKET (U.S.), +AND THE NASDAQ COMPUTER MANUFACTURER STOCKS INDEX +12/31/13 +12/31/14 +12/31/15 +12/31/16 +12/31/17 +12/31/18 +TransAct Technologies Incorporated Common Stock +$ +100.00 +$ +43.66 +$ +68.56 +$ +52.67 +$ +105.75 +$ +71.67 +CRSP Total Return Index for the Nasdaq Stock Market (U.S.) +$ +100.00 +$ +112.46 +$ +113.00 +$ +127.70 +$ +155.01 +$ +146.57 +Nasdaq Computer Hardware Stocks Index +$ +100.00 +$ +135.56 +$ +123.42 +$ +142.26 +$ +204.61 +$ +191.61 +12 +Item 6. Selected Financial Data (in thousands, except per share amounts) +The following is summarized from our audited financial statements of the past five years: +Year Ended December 31, +2018 +2017 +2016 +2015 +2014 +Consolidated Statement of Operations Data: +Net sales +$ +54,587 +$ +56,311 +$ +57,235 +$ +59,676 +$ +53,108 +Gross profit +26,743 +26,662 +23,799 +24,978 +21,711 +Operating expenses +19,984 +19,848 +18,599 +20,510 +25,483 +Operating income (loss) +6,759 +6,814 +5,200 +4,468 +(3,772 +) +Net income (loss) +5,426 +3,211 +3,617 +3,092 +(2,421 +) +Net income (loss) per share: +Basic +0.73 +0.43 +0.48 +0.40 +(0.29 +) +Diluted +0.70 +0.42 +0.47 +0.39 +(0.29 +) +Dividends declared and paid per share +0.36 +0.35 +0.32 +0.32 +0.31 +December 31, +2018 +2017 +2016 +2015 +2014 +Consolidated Balance Sheet Data: +Total assets +$ +34,956 +$ +33,950 +$ +32,042 +$ +32,569 +$ +35,491 +Shareholders’ equity +27,567 +26,014 +24,109 +25,728 +25,394 +Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Overview +During the year ended December 31, 2018, we continued to focus our efforts on sales execution and growing the revenue +of our newer, value-added products and technologies. In addition, on March 4, 2019 we launched our exciting new line of products for the restaurant solution’s market, the BOHA! branded suite of cloud-based applications and companion hardware +solutions. The new BOHA! products are a suite of products proving a solution to help restaurants and food service operators of any size automate back-of-house operations. +During the year ended December 31, 2018 we completed the build-out of our European casino and gaming internal sales +team and started selling directly to our slot machine manufacturers and end-user casino and gaming customers in Europe as we terminated our relationship with our worldwide casino and gaming distributor. As a result of this investment, +international casino and gaming sales increased 81% in 2018 compared to 2017. During 2018, we also recognized the initial sale of our new Epic Edge ticket-in, ticket-out (“TITO”) printer for a large domestic operator's upcoming new casino +opening. +Sales for our lottery market and TransAct Services Group (“TSG”) market decreased in 2018 compared to 2017 due to lower +sales to International Gaming Technology and its subsidiaries (“IGT”). TSG sales to IGT decreased due to lower sales of spare parts in the lottery market during 2018 compared to 2017. These sales declines were as expected as we are no longer +focusing on the lottery markets. Based on our backlog of orders and contractual commitments we expect lottery and TSG sales to continue to decrease in 2019 compared to 2018. +During the year ended December 31, 2018, our total net sales decreased 3% to approximately $54.6 million. See the +table below for a breakdown of our sales by market: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Restaurant solutions +$ +4,579 +8.4 +% +$ +4,758 +8.4 +% +$ +(179 +) +(3.8 +%) +POS automation and banking +7,273 +13.3 +% +7,905 +14.0 +% +(632 +) +(8.0 +%) +Casino and gaming +26,593 +48.7 +% +18,615 +33.1 +% +7,978 +42.9 +% +Lottery +3,093 +5.7 +% +9,805 +17.4 +% +(6,712 +) +(68.5 +%) +Printrex +1,297 +2.4 +% +1,052 +1.9 +% +245 +23.3 +% +TSG +11,752 +21.5 +% +14,176 +25.2 +% +(2,424 +) +(17.1 +%) +$ +54,587 +100.0 +% +$ +56,311 +100.0 +% +$ +(1,724 +) +(3.1 +%) +Sales of our restaurant solutions products decreased approximately 4% in the year ended December 31, 2018 compared to +the year ended December 31, 2017. In the restaurant solutions market, we continue to focus on providing terminals that print food rotational date and nutritional labels to help restaurants and other food service establishments effectively manage +food rotation and safety. The decrease in restaurant solutions sales resulted from lower sales of our AccuDate™ 9700 terminal due to lower sales to McDonald’s. This decrease was partially offset by increased sales of our newer AccuDate XL2e +terminal to three large corporate customers. In 2019, we intend to focus on developing and selling our new BOHA! cloud-based SaaS applications and hardware solutions business. +Sales of our POS automation and banking products decreased 8% in the year ended December 31, 2018 compared to the year +ended December 31, 2017. In the POS market, we focus primarily on supplying printers that print receipts or linerless labels for customers in the restaurant and quick serve markets. During the year ended December 31, 2018, the decline in sales of +our POS automation and banking printers was primarily driven by a 75% decrease in sales of our legacy banking and other POS printers as we exit these markets. In the banking market, we had focused mainly on supplying printers for use in bank +teller stations at banks and financial institutions primarily in the U.S. As we continue to shift our focus to our newer products, we do not expect any future sales of these legacy products, as we exited the banking market at the end of 2018. POS +automation and banking sales also decreased, although to a lesser extent, due to lower sales of our Ithaca 9000 printers during 2018 compared to the record sales levels of the Ithaca 9000 in 2017. +13 +Sales of our casino and gaming products increased approximately 43% in 2018 compared to 2017. In our casino and gaming +market, our focus lies primarily in supplying printers worldwide for use in slot machines at casinos and racetracks, as well as in other electronic gaming devices that print tickets or receipts. Additionally, we supplement these printer sales with +revenue from EPICENTRAL™, our promotional printing system that enables casino operators to create promotional coupons and marketing messages and print them real time at the slot machine. The increase of casino and gaming printer sales is primarily +due to increased domestic and international sales of our thermal casino printers of 20% and 143%, respectively. The increase in domestic thermal casino printers was driven primarily by increased sales to our OEMs and a large order of replacement +printers from a domestic casino operator. The increase in international thermal casino printer sales was due to the successful transition away from using our former exclusive worldwide distributor. Rather, we employed our new direct sales team to +sell to end user casino and gaming customers in Europe. Casino and gaming sales also increased due to a 58% increase in sales of our off-premise gaming printers. +During the year ended December 31, 2018, total lottery printer sales decreased approximately 69% due primarily to lower +sales to IGT. Domestic lottery sales decreased 65% in 2018 compared to 2017. International lottery sales decreased $1.1 million due to a sale to IGT in 2017 for the Canadian lottery and no comparable sales in 2018. Our sales to IGT each year are +directly dependent on the timing and number of new and upgraded lottery terminal installations IGT performs and are not indicative of IGT’s overall business or revenue. We expect lottery printer sales to be lower for 2019 compared to 2018, as we +have shifted our focus away from the lottery market to our higher-value, technology-enabled market for restaurant solutions and casino and gaming products. +Sales of our Printrex branded printers include wide format, rack mounted and vehicle mounted thermal printers used by +customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. During the year ended December 31, 2018, we experienced an approximately 23% increase in Printrex product sales due primarily to the +continued recovery of the worldwide oil and gas market that had been negatively impacted from multiple years of declining worldwide oil prices. Although we expect to see continued modest growth in the oil and gas markets during 2019, we do not +anticipate significant contribution to total sales from our Printrex products as we shift our focus towards our higher value, technology enabled restaurant solution terminals and casino and gaming products. +TSG, which sells service, replacement parts and consumable products, including food safety labels, receipt paper, +ribbons and inkjet cartridges, continues to offer a recurring revenue stream for the Company. TSG sales decreased 17% in 2018 from 2017 primarily due to unusually high sales of replacement parts to IGT for a legacy lottery printer in +2017. Although the installed base of our thermal lottery printers remains large, and lotteries continue to extend lottery contracts utilizing our existing hardware, including our printers, based on our backlog of orders and contractual +commitments, primarily from IGT for spare parts, we expect TSG sales to decrease in 2019 compared to 2018. +Operationally, our gross margin reached 49% in 2018, an increase of 170 basis points from 2017, representing the +highest gross margin we have reported for a full year. We believe gross margin will continue at similar levels in 2019 as our newer, technology-enabled products continue to grow and become a larger portion of our overall sales. In 2018, although +operating income decreased slightly by less than 1%, we achieved operating margin of 12.4% compared to 12.1% in 2017 due to our improved gross margin that was offset by slightly higher operating expenses primarily to support our two high growth +markets--restaurant solutions and casino and gaming. During 2019, we expect higher operating expenses compared to 2018, due to the full year impact of the investments made during 2018, as well as new investments, in selling and marketing for these +two high growth markets +We reported net income of $5.4 million and net income per diluted share of $0.70 for 2018, compared to $3.2 million and +net income per diluted share of $0.42 for 2017. In terms of cash flow for 2018, we experienced a very strong year, generating $5.1 million of cash from operating activities. We also returned $4.7 million to our shareholders in the form of $2 +million for treasury share repurchases and $2.7 million for cash dividends. We ended the year with cash and cash equivalents of $4.7 million and no debt on our Consolidated Balance Sheet at December 31, 2018. +Critical Accounting Policies and Estimates +The preparation of financial statements in conformity with generally accepted accounting principles requires management +to make estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Income categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in +the particular circumstances. We evaluate our assumptions on an ongoing basis by comparing actual results with our estimates. Actual results may differ from the original estimates. +The following accounting policies are those that we believe to be most critical in the preparation of our financial +statements. These items utilize assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Please refer to Note 2 – Summary of significant accounting policies in the +accompanying Consolidated Financial Statements for a complete listing of our accounting policies. +Revenue Recognition – ASU No. 2014-09, "Revenue from Contracts with Customers” and its related amendments (collectively, ASC 606) are effective for reporting periods beginning after December 15, 2017, and interim +periods therein. This ASU is intended to clarify the principles for recognizing revenue by removing inconsistencies in revenue requirements; providing a more robust framework for addressing revenue issues; improving comparability of revenue +recognition practices across entities, industries, jurisdictions and capital markets; and providing more useful information to users of financial statements through improved revenue disclosure requirements. Entities have the option of using either +a full retrospective approach or modified retrospective approach to adopt the amended guidance. We adopted ASC 606 effective January 1, 2018 and elected the modified retrospective approach. The results for periods before 2018 were not adjusted +for the new standard and there was no cumulative effect for the change in accounting at the date of adoption. +14 +In accordance with ASC 606, a performance obligation is a promise in a contract with a customer to transfer a distinct +good or service to the customer. Some of our contracts with customers contain a single performance obligation, while other contracts contain multiple performance obligations (most commonly when contracts include product and extended warranties). A +contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there are multiple performance obligations within a contract, we allocate the +transaction price to each performance obligation based on its standalone selling price. +The transaction price is determined based on the consideration to which the Company will be entitled in exchange for +transferring services to the customer. To the extent the transaction price includes variable consideration, such as price protection, reserves for returns and other allowances, the Company estimates the amount of variable consideration that should +be included in the transaction price utilizing either the “expected value” method or the “most likely amount” method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the +Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. +For a majority of our revenue, which consists of printers, terminals, consumables, and replacement parts, the Company +recognizes revenue as of a point of time. The transaction price is recognized upon shipment of the order when control of the goods is transferred to the customer and at the time the performance obligation is fulfilled. We also sell a software +solution, EPICENTRAL™, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. EPICENTRAL TM is primarily comprised of both a software component, which is +licensed to the customer, and a hardware component. EPICENTRAL™ software and hardware are integrated to deliver the system's full functionality. The transaction prices from EPICENTRAL™ software license and hardware are recognized upon +installation and formal acceptance by the customer when control of the license is transferred to the customer. For out-of-warranty repairs, the transaction price is recognized after the repair work is completed and the printer or terminal is +returned to the customer, as control of the product is transferred to the customer and our performance obligation is completed. +Performance obligations are satisfied over time if the customer receives the benefits as we perform work, if the +customer controls the asset as it is being produced, or if the product being produced for the customer has no alternative use and we have a contractual right to payment. For our separately priced extended warranty, technical support for our +restaurant solution terminals and maintenance agreements (including free one-year maintenance received by the customers upon completion of EPICENTRAL™ installation) revenue is recognized over time as the customer receives the benefit. The +transaction price from the maintenance services is recognized ratably over time, using output methods, as control of the services is transferred to the customer. For extended warranties, the transaction price is recognized ratably over the warranty +period, using output methods, as control of the services is transferred to the customer. +When there is more than one performance obligation in a customer arrangement, the Company typically uses the +“standalone selling price” method to determine the transaction price to allocate to each performance obligation. The Company sells the performance obligations separately and has established standalone selling prices for its products and services. +In the case of an overall price discount, the discount is applied to each performance obligation proportionately based on standalone selling price. To determine the standalone selling price for initial EPICENTRAL™ installations, the Company uses +the adjusted market assessment approach. +Accounts +Receivable – We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and +payment terms based on available credit information; and adjustments to credit limits based upon payment history and the customer’s current creditworthiness. We also provide an estimate of doubtful accounts based on historical experience and +specific customer collection issues. Our allowance for doubtful accounts as of December 31, 2018 was $205 thousand, or 2.5% of outstanding accounts receivable, which we believe is appropriate considering the overall quality of our accounts +receivable. Although credit losses have historically been within expectations and the reserves established, there is no assurance that our credit loss experience will continue to be consistent with historical experience. +Inventories – Our inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or net +realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completion, disposal and transportation, historical usage and estimates of future demand. Assumptions +are reviewed at least quarterly and adjustments are made, as necessary, to reflect changing market conditions. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net +realizable value. Should circumstances change and we determine that additional inventory is subject to obsolescence, additional write-downs of inventory could result in a charge to income. +Goodwill +and Intangible Assets – We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and +assumptions. In accordance with ASC 350-20 “Goodwill”, acquired goodwill is not amortized, but is subject to impairment testing at least annually and when an event occurs or circumstances change, which indicate it is more likely than not an +impairment exists. Factors considered that may trigger an impairment review are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the +strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Definite-lived intangible assets are amortized and are tested for impairment when +appropriate. We reported $2.6 million of goodwill and $797 thousand of unamortized definite-lived intangible assets at December 31, 2018. We have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill +was substantially higher than our carrying value based on our assessment as of December 31, 2018 when the impairment review is performed. +Income +Taxes – In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing +temporary differences between the tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax +assets and liabilities, which are reflected in our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not +likely, we establish a valuation allowance. +15 +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation +allowance or tax reserves with respect to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future +years, and match this forecast against the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the +deferred tax assets. Although we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize +all or part of our deferred tax assets in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able +to realize future deferred tax assets in excess of its net recorded amount, an adjustment to the valuation allowance would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, “Income Taxes.” Among other things this provision prescribes a +minimum recognition threshold that an income tax position must meet before it is recorded in the reporting entity’s financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet +reporting date, it is “more likely than not” (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing +authority will examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference +between the amount claimed, or expected to be claimed, on a company’s income tax returns and the benefits recognized in the financial statements. See Note 11 to the consolidated financial statements for further details of the impact of the Tax +Reform Act. +Warranty +– We generally warrant our products for up to 24 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related +estimated cost of labor and material to make the necessary repairs. If actual future product repair rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability and related warranty +expense would be made. +Share-Based +Compensation – We calculate share-based compensation expense in accordance with ASC 718, “Compensation – Stock Compensation” using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key +assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, and dividend yield. Prior to January 1, 2017, stock-based compensation expense included estimated effects of +forfeitures. Upon adopting ASU 2016-09, “Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting”, in 2017, an accounting policy election was made to account for forfeitures as they occur. The amended guidance +requires that all tax effects related to share-based payments are recorded at settlement (or expiration) through the income statement, rather than through equity. Cash flows related to excess tax benefits will no longer be separately classified as +a financing activity apart from other income tax cash flows. This ASU also allows for an employer to repurchase additional employee shares for tax withholding purposes without requiring liability accounting and clarifies that all cash payments +made to tax authorities on an employee's behalf for withheld shares should be presented as a financing activity on the Consolidated Statements of Cash Flows. The presentation requirements +Results of Operations: Year ended December 31, 2018 compared to Year ended December 31, 2017 +Net +Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2018 and 2017 were as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Restaurant solutions +$ +4,579 +8.4 +% +$ +4,758 +8.4 +% +$ +(179 +) +(3.8 +%) +POS automation and banking +7,273 +13.3 +% +7,905 +14.0 +% +(632 +) +(8.0 +%) +Casino and gaming +26,593 +48.7 +% +18,615 +33.1 +% +7,978 +42.9 +% +Lottery +3,093 +5.7 +% +9,805 +17.4 +% +(6,712 +) +(68.5 +%) +Printrex +1,297 +2.4 +% +1,052 +1.9 +% +245 +23.3 +% +TSG +11,752 +21.5 +% +14,176 +25.2 +% +(2,424 +) +(17.1 +%) +$ +54,587 +100.0 +% +$ +56,311 +100.0 +% +$ +(1,724 +) +(3.1 +%) +International* +$ +11,069 +20.3 +% +$ +7,591 +13.5 +% +$ +3,478 +45.8 +% +* +International sales do not include sales of products made to domestic distributors or other customers who in turn ship those products to international +destinations. +Net sales for 2018 decreased $1.7 million, or approximately 3%, from 2017. Printer and terminal sales volume decreased +by 5% to approximately 142,000 units, driven primarily by a 71% decrease in unit volume from the lottery market and, to a lesser extent, a 6% and 18% decrease in the POS automation and banking market and restaurant solutions market, respectively. +These decreases were partially offset by an increase in sales volume of 44% in the casino and gaming market. Although unit volume decreased during 2018 compared to 2017, the average selling price of our printers and terminals increased 7% during +2018 compared to 2017, due primarily to the decreased volume of lottery printers, which carry lower prices than our other products. +International sales increased $3.5 million, or 46%, primarily driven by 81% higher international sales in the casino +and gaming market. This increase was partially offset by a $1.1 million sales decrease in our international lottery market during 2018 compared to 2017. +16 +Restaurant solutions: +Revenue from the restaurant solutions market includes sales of terminals that combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food +rotation labels, grab and go labels for prepared foods, and "enjoy by" date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve convenience and hospitality establishments) effectively manage +food safety and automate and manage back-of-the-restaurant operations. A summary of sales of our worldwide restaurant solutions products for the years ended December 31, 2018 and 2017 is as follows (in thousands, except percentages): +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Domestic +$ +4,133 +90.3 +% +$ +4,384 +92.1 +% +$ +(251 +) +(5.7 +%) +International +446 +9.7 +% +374 +7.9 +% +72 +19.3 +% +$ +4,579 +100.0 +% +$ +4,758 +100.0 +% +$ +(179 +) +(3.8 +%) +The decrease in domestic restaurant solutions terminal sales in 2018 compared to 2017 was primarily driven by lower +sales of our AccuDate 9700 terminal to McDonald’s. This decrease was partially offset by increased sales of our newer AccuDate XL2e terminal to three large corporate customers. We expect sales of our restaurant solutions products to increase in +2019 compared to 2018 following the launch of our new BOHA! cloud-based applications and hardware solutions in the first quarter of 2019. The new BOHA! suite of products is designed to provide back-of-house automation solutions to restaurant and +foodservice operators. +International restaurant solutions sales increased during 2018 compared to 2017 due to increased sales of the AccuDate +9700 for McDonald’s through our Canadian distributor. +POS automation and +banking: Revenue from the POS automation and banking market includes sales of thermal printers used primarily by quick serve restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers +or print on linerless labels. In addition, revenue includes sales of inkjet printers used by banks, credit unions and other financial institutions to print deposit or withdrawal receipts and/or validate checks at bank teller stations. A summary +of sales of our worldwide POS automation and banking products for the years ended December 31, 2018 and 2017 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Domestic +$ +7,122 +97.9 +% +$ +7,596 +96.1 +% +$ +(474 +) +(6.2 +%) +International +151 +2.1 +% +309 +3.9 +% +(158 +) +(51.1 +%) +$ +7,273 +100.0 +% +$ +7,905 +100.0 +% +$ +(632 +) +(8.0 +%) +The decrease in domestic POS automation and banking sales in 2018 compared to 2017 was primarily driven by a 75% +decrease in sales of our legacy banking and other POS printers. We do not expect any future sales of these legacy products, as we exited the banking market at the end of 2018 and have shifted our focus to our newer products. These decreases were +partially offset by a slight increase in domestic sales of our Ithaca® 9000 printers of 1% during 2018 compared to 2017, as sales rebounded to prior year, near-record levels during the second and third quarters of 2018. We expect sales of our +Ithaca® 9000 for McDonald’s to decrease in 2019 compared to 2018. +International POS automation and banking sales decreased due to lower sales of our Ithaca® 9000 printer to our Canadian +distributor for McDonald’s during 2018 compared to 2017. +Casino and Gaming: Revenue +from the casino and gaming market includes sales of thermal ticket printers used in slot machines, video lottery terminals, and other gaming machines that print tickets or receipts instead of issuing coins at casinos and racetracks and other gaming +venues worldwide. Revenue from this market also includes sales of thermal roll-fed printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes, Skills with Prizes and Fixed Odds Betting Terminals +at non-casino gaming establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of the EPICENTRAL™ print system, our software +solution (including annual software maintenance), that enables casino operators to create promotional coupons and marketing messages and to print them real-time at the slot machine. A summary of sales of our worldwide casino and gaming products +for the years ended December 31, 2018 and 2017 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Domestic +$ +17,518 +65.9 +% +$ +13,608 +73.1 +% +$ +3,910 +28.7 +% +International +9,075 +34.1 +% +5,007 +26.9 +% +4,068 +81.2 +% +$ +26,593 +100.0 +% +$ +18,615 +100.0 +% +$ +7,978 +42.9 +% +The increase in domestic sales of our casino and gaming products was due primarily to a 20% increase in domestic sales +of our thermal casino printer in 2018 compared to 2017, driven primarily by increased sales to our OEMs and a large order from a domestic casino operator for replacement printers. Domestic sales also increased due to a significant sale of our +off-premise gaming printers to an OEM that we don’t expect to reoccur in 2019. During the fourth quarter of 2018, we also sold our first order of our Epic Edge, our new thermal TITO casino printer, to a large domestic operator in connection with +its upcoming casino opening. Sales of EPICENTRAL™ software during 2018 were comparable with our 2017 EPICENTRAL™ sales as we completed two new installations during both 2018 and 2017. Sales of EPICENTRAL™ are project based, and as a result, may +fluctuate significantly quarter-to-quarter and year-to-year. +17 +The increase in international sales in 2018 compared to 2017 was due to a 143% increase of thermal casino printer +sales. These increases were due to the success of the transition away from using our previous exclusive worldwide distributor whose contract ended at the end of 2017 and using our new direct sales team to sell to end user casino and gaming +customers in Europe. These increases were partially offset by a 5% decrease in international sales of off-premise gaming printers. +We expect domestic and international casino and gaming sales in 2019 to be relatively consistent with the sales levels +achieved during 2018. +Lottery: Revenue +from the lottery market includes sales of thermal on-line and other lottery printers primarily to IGT and, to a lesser extent, other lottery system companies for various lottery applications. A summary of sales of our worldwide lottery printers +for the years ended December 31, 2018 and 2017 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Domestic +$ +3,046 +98.5 +% +$ +8,626 +88.0 +% +$ +(5,580 +) +(64.7 +%) +International +47 +1.5 +% +1,179 +12.0 +% +(1,132 +) +(96.0 +%) +$ +3,093 +100.0 +% +$ +9,805 +100.0 +% +$ +(6,712 +) +(68.5 +%) +Our sales to IGT are directly dependent on the timing and number of new and upgraded lottery terminal installations +that IGT performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year. However, our lottery market sales are not indicative of IGT’s overall business or revenue. We expect lottery printer sales to be lower for 2019 +compared to 2018, as we have shifted our focus away from the lottery market to our higher-value, technology enabled restaurant solutions and casino and gaming products. +The decrease in international lottery sales in 2018 compared to 2017 was primarily due to a sale of lottery printers to +IGT for the Canadian lottery in 2017 and no comparable sale occurring in 2018. +Printrex: Printrex +branded printers are sold into markets that include wide format, desktop and rack mounted and vehicle mounted black/white thermal printers used by customers to log and plot oil field, seismic and down hole well drilling data in the oil and gas +exploration industry. It also includes high-speed color inkjet desktop printers used to print logs at the data centers of the oil and gas field service companies. Revenue in this market also includes sales of vehicle mounted printers used to +print schematics and certain other critical information in emergency services vehicles and other mobile printing applications. A summary of sales of our worldwide Printrex printers for the years ended December 31, 2018 and 2017 is as follows (in +thousands, except percentages): +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Domestic +$ +1,028 +79.3 +% +$ +849 +80.7 +% +$ +179 +21.1 +% +International +269 +20.7 +% +203 +19.3 +% +66 +32.5 +% +$ +1,297 +100.0 +% +$ +1,052 +100.0 +% +$ +245 +23.3 +% +The increase in Printrex sales in 2018 compared to 2017 resulted from a 57% increase in domestic and international +sales of our oil and gas printers due to a continued recovery in the oil and gas market. This increase was partially offset by 87% lower sales of domestic and international medical and mobile printers in 2018 compared to 2017. We expect total +Printrex sales to increase slightly in 2019 compared to 2018, as we expect oil and gas sales to continue to increase. However, we do not expect any future medical and mobile printer sales, as we exited this market at the end of 2018 in order to +focus on our higher value, technology-enabled restaurant solutions and casino and gaming products. +TSG: Revenue +generated by our TSG includes sales of consumable products (inkjet cartridges, ribbons, receipt paper, color thermal paper, food safety labels and other printing supplies), replacement parts, maintenance and repair services, testing services, +refurbished printers, and shipping and handling charges. A summary of sales in our worldwide TSG market for the years ended December 31, 2018 and 2017 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2018 +December 31, 2017 +$ +% +Domestic +$ +10,671 +90.8 +% +$ +13,657 +96.3 +% +$ +(2,986 +) +(21.9 +%) +International +1,081 +9.2 +% +519 +3.7 +% +562 +108.3 +% +$ +11,752 +100.0 +% +$ +14,176 +100.0 +% +$ +(2,424 +) +(17.1 +%) +The decrease in domestic revenue from TSG in 2018 compared to 2017 was due primarily to lower sales of replacement +parts, non-Printrex consumable products and service revenue. Replacement part sales decreased 36% due to lower sales of lottery printer spare parts to IGT. Non-Printrex consumables sales declined 10% due to lower sales of our legacy HP inkjet +cartridges used in our banking printers, as we exited the banking market at the end of 2018. Service revenue declined 10% in 2018 compared to 2017 due to paper testing sales that occurred in 2017 but did not repeat in 2018. These decreases were +partially offset by increased AccuDate label sales which more than quadrupled in 2018 compared 2017. Based on our backlog of orders and contractual commitments for replacement parts, primarily from IGT, for our installed base of lottery printers, +we expect TSG sales to decrease in 2019 compared to 2018. +Internationally, TSG revenue increased primarily due to a 134% increase in sales of replacement parts and accessories +in 2018 compared to 2017, as sales of replacement parts and accessories to international casino and gaming customers have increased upon the transition away from using our previous exclusive worldwide distributor and using our new direct sales team +to sell to end user casino and gaming customers. +18 +Gross +Profit. Gross profit information for the years ended December 31, 2018 and 2017 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2018 +2017 +Change +Total Sales - 2018 +Total Sales - 2017 +Year ended +$ +26,743 +$ +26,662 +0.3 +% +49.0 +% +47.3 +% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and +component parts, direct labor, manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers and expenses associated with installations of our EPICENTRAL™ print system. Gross profit increased $81 +thousand, or less than 1%, and gross margin increased 170 basis points due primarily to a more favorable sales mix in 2018 compared to 2017. The increased gross margin reflects a favorable shift in sales mix towards higher-value, technology driven +solutions, as well as lower sales volume of lottery and POS printers, which carry lower margins than our other products. +Operating +Expenses - Engineering, Design and Product Development. Engineering, design and product development information for the years ended December 31, 2018 and 2017 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2018 +2017 +Change +Total Sales - 2018 +Total Sales - 2017 +Year ended +$ +4,576 +$ +4,303 +6.3 +% +8.4 +% +7.6 +% +Engineering, design and product development expenses primarily include salary and payroll related +expenses for our hardware and software engineering staff, depreciation and design expenses (including prototype printer expenses, outside design, development and testing services, supplies and contracted software development expenses). +Engineering, design and product development expenses increased $273 thousand, or 6%, in 2018 compared to 2017 due primarily to the hiring of additional engineering staff and increased expenses related to product development for the restaurant +solutions and casino and gaming markets. We expect engineering, design and product development expenses in 2019 to be consistent with 2018. +Operating +Expenses - Selling and Marketing . Selling and marketing information for the years ended December 31, 2018 and 2017 is summarized below +(in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2018 +2017 +Change +Total Sales - 2018 +Total Sales - 2017 +Year ended +$ +7,203 +$ +7,561 +(4.7 +%) +13.2 +% +13.4 +% +Selling and marketing expenses primarily include salaries and payroll related expenses for our sales and marketing +staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, e-commerce and other promotional marketing expenses. Selling and marketing expenses decreased $358 thousand, or 5%, in +2018 compared to 2017 primarily due to the retirement of our EVP, Sales and Marketing in December 2017, whose position was replaced by an existing employee of TransAct, as well as the elimination of sales commission expense to our former +international casino and gaming distributor, Suzo-Happ. These decreases were partially offset by the hiring of additional sales staff to replace our former exclusive worldwide distributor with a direct selling team for our casino and gaming sales +in Europe. We expect selling and marketing expense to increase significantly in 2019 compared to 2018 due to the full year impact from the hiring of additional sales staff during the year ended December 31, 2018, as well as new investments to +support our new suite of BOHA! software and hardware solutions. +Operating +Expenses - General and Administrative. General and administrative information for the years ended December 31, 2018 and 2017 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2018 +2017 +Change +Total Sales - 2018 +Total Sales - 2017 +Year ended +$ +8,205 +$ +7,984 +2.8 +% +15.0 +% +14.2 +% +General and administrative expenses primarily include salaries, incentive compensation, and other payroll related +expenses for our executive, accounting, human resources and information technology staff, expenses for our corporate headquarters, professional and legal expenses, telecommunication expenses, and other expenses related to being a publicly-traded +company. General and administrative expenses increased $221 thousand, or 3%, in 2018 compared to 2017 due primarily to increased legal expenses and increased administrative expenses related to the expansion of our restaurant solutions sales staff +and transitioning to a direct selling model for the casino and gaming market in Europe. These increases were partially offset by lower incentive compensation expense in 2018 compared to 2017. We expect general and administrative expense to be +higher in 2019 compared to 2018 due to higher incentive compensation and additional investment to support restaurant solutions. +Operating +Income. Operating income information for the years ended December 31, 2018 and 2017 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2018 +2017 +Change +Total Sales – 2018 +Total Sales – 2017 +Year ended +$ +6,759 +$ +6,814 +(0.8 +%) +12.4 +% +12.1 +% +Our operating income decreased by $55 thousand, or 1%. Despite a sales decline of 3% our operating margin improved, +increasing 30 basis points to 12.4% in 2018 compared to 12.1% in 2017, largely due to a 170 basis point increase in gross margin somewhat offset by a 1% increase in operating expenses. +19 +Interest. We +recorded net interest expense of $27 thousand in 2018 compared to $33 thousand in 2017. +Other, +net . We recorded other expense of $266 thousand in 2018 compared to $9 thousand in 2017. The additional expense was due to higher +foreign currency exchange losses recorded by our United Kingdom (“UK”) subsidiary in 2018 compared to 2017. Going forward we may continue to experience more foreign exchange volatility as we increase our casino and gaming sales in Europe. +Income +Taxes . We recorded an income tax provision during the year ended December 31, 2018 of $1.0 million at an effective tax rate of 16.1%, +compared to an income tax provision during the year ended December 31, 2017 of $3.6 million at an effective tax rate of 52.6%. The effective tax rate in 2018 was lower than the effective tax rate in 2017 due to the enactment of the Tax Reform Act +that was signed on December 22, 2017. Additionally, the effective tax rate in 2017 was unusually high due to the initial impact of the Tax Reform Act as we recognized a provisional $1.3 million charge to income tax expense for the year ended +December 31, 2017 as a result of revaluing our net deferred tax assets using the new U.S. corporate tax rate of 21%. The Tax Reform Act significantly changed U.S. tax law by, among other things, lowering corporate income tax rates, implementing a +territorial tax system and imposing a one-time repatriation tax on undistributed foreign earnings. The Tax Reform Act reduced the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate effective January 1, 2018 and, as a result, +reduced our statutory U.S. corporate income tax rate from 34% to 21%. We expect our annual effective tax rate for 2019 to be between 12% and 14%. +Net +Income. We reported net income during 2018 of $5.4 million, or $0.70 per diluted share, compared to $3.2 million, or $0.42 per diluted share, for 2017. +Results of Operations: Year ended December 31, 2017 compared to year ended December 31, 2016 +Net +Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2017 and 2016 were as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Restaurant solutions +$ +4,758 +8.4 +% +$ +5,162 +9.0 +% +$ +(404 +) +(7.8 +%) +POS automation and banking +7,905 +14.0 +% +10,518 +18.4 +% +(2,613 +) +(24.8 +%) +Casino and gaming +18,615 +33.1 +% +21,006 +36.7 +% +(2,391 +) +(11.4 +%) +Lottery +9,805 +17.4 +% +9,913 +17.3 +% +(108 +) +(1.1 +%) +Printrex +1,052 +1.9 +% +540 +1.0 +% +512 +94.8 +% +TSG +14,176 +25.2 +% +10,096 +17.6 +% +4,080 +40.4 +% +$ +56,311 +100.0 +% +$ +57,235 +100.0 +% +$ +(924 +) +(1.6 +%) +International* +$ +7,591 +13.5 +% +$ +11,693 +20.4 +% +$ +(4,102 +) +(35.1 +%) +* +International sales do not include sales of products made to domestic distributors or other customers who in turn ship those products to international +destinations. +Net sales for 2017 decreased $924 thousand, or 2%, from 2016. Printer and terminal sales volume decreased by 13% to +approximately 150 thousand units, driven primarily by a 25% and 13% decrease in unit volume from the POS automation and banking market and casino and gaming market, respectively and, to a lesser extent a 3% decrease in the lottery market and 13% +decrease in the restaurant solutions market. These decreases were partially offset by increased sales volume of 112% in the Printrex market. The average selling price of our printers and terminals increased 4% in 2017 compared to 2016, primarily +due to decreased volume of POS automation and banking printers sold in 2017, which carry lower prices than our other products. +Overall, international sales decreased $4.1 million, or 35%, primarily driven by lower sales in the international +casino and gaming market. This decrease was partially offset by a $1 million sales increase in our international lottery market during 2017. +Restaurant solutions: A +summary of sales of our worldwide restaurant solutions products for the years ended December 31, 2017 and 2016 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +4,384 +92.1 +% +$ +4,747 +92.0 +% +$ +(363 +) +(7.6 +%) +International +374 +7.9 +% +415 +8.0 +% +(41 +) +(9.9 +%) +$ +4,758 +100.0 +% +$ +5,162 +100.0 +% +$ +(404 +) +(7.8 +%) +The decrease in domestic restaurant solutions terminal sales in 2017 compared to 2016 was primarily driven by lower +sales of our AccuDate 9700 terminal to our U.S. distributor. This decrease was partially offset by increased sales of our AccuDate 9700 terminal to McDonald’s, increased sales of our AccuDate Pro terminal and the initial sales of our AccuDate XL +terminal in 2017. +International restaurant solution terminals decreased during 2017 compared to 2016 due to lower sales to our Latin +American and Canadian distributors. +20 +POS automation and +banking: A summary of sales of our worldwide POS automation and banking products for the years ended December 31, 2017 and 2016 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +7,596 +96.1 +% +$ +9,754 +92.7 +% +$ +(2,158 +) +(22.1 +%) +International +309 +3.9 +% +764 +7.3 +% +(455 +) +(59.6 +%) +$ +7,905 +100.0 +% +$ +10,518 +100.0 +% +$ +(2,613 +) +(24.8 +%) +The decrease in both domestic and international POS automation and banking printer revenue in 2017 compared to 2016 was +primarily driven by a 23% decrease in sales of our Ithaca® 9000 printer, as sales to McDonald's began to slow compared to the record pace experienced in 2016. Additionally, we experienced a 37% decline in sales of our legacy banking and other POS +printers in 2017 compared to 2016. +Casino and gaming: A +summary of sales of our worldwide casino and gaming products for the years ended December 31, 2017 and 2016 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +13,608 +73.1 +% +$ +11,553 +55.0 +% +$ +2,055 +17.8 +% +International +5,007 +26.9 +% +9,453 +45.0 +% +(4,446 +) +(47.0 +%) +$ +18,615 +100.0 +% +$ +21,006 +100.0 +% +$ +(2,391 +) +(11.4 +%) +The increase in domestic sales of our casino and gaming products in 2017 compared to 2016 was due primarily to 26% +higher sales of our thermal casino printers due mainly to market share gain, including higher sales to our OEMs to support two new casino openings. This increase was partially offset by a decrease in domestic EPICENTRAL™ software sales of 34%. We +completed two EPICENTRAL™ installations in both 2017 and 2016, however in 2017 our installations consisted of one full-feature version of EPICENTRAL™ and our first EPICENTRAL® SE version compared to two full-feature versions of EPICENTRAL™ in +2016. Our EPICENTRAL® SE software is offered at a lower price compared to our full-feature version of EPICENTRAL™. +International casino and gaming printer sales declined in 2017 compared to 2016 due to a 46% decrease in international +sales of our thermal casino printers in Europe, Asia and Australia, as well as a 46% decrease in international sales of our off-premise gaming printers to our former exclusive worldwide distributor in Europe and Australia. Sales of our off-premise +gaming printers are largely project-oriented and therefore may fluctuate significantly from quarter-to-quarter and year-to-year. International EPICENTRAL™ software sales also declined 79% as we completed no international EPICENTRAL™ installations +in 2017 compared to one completed international installation in 2016. +Lottery: A +summary of sales of our worldwide lottery printers for the years ended December 31, 2017 and 2016 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +8,626 +88.0 +% +$ +9,710 +98.0 +% +$ +(1,084 +) +(11.2 +%) +International +1,179 +12.0 +% +203 +2.0 +% +976 +480.8 +% +$ +9,805 +100.0 +% +$ +9,913 +100.0 +% +$ +(108 +) +(1.1 +%) +Our sales to IGT are directly dependent on the timing and number of new and upgraded lottery terminal installations IGT +performs, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year and are not indicative of IGT’s overall business or revenue. +International lottery sales increased due to sales of lottery printers to IGT for the Canadian lottery in 2017 and no +comparable sales occurring in 2016. +Printrex: A +summary of sales of our worldwide Printrex printers for the years ended December 31, 2017 and 2016 is as follows (in thousands, except percentages): +Year Ended +Year Ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +849 +80.7 +% +$ +463 +85.7 +% +$ +386 +83.4 +% +International +203 +19.3 +% +77 +14.3 +% +126 +163.6 +% +$ +1,052 +100.0 +% +$ +540 +100.0 +% +$ +512 +94.8 +% +The increase in Printrex printers was due to an 83% increase in domestic and international sales of our oil and gas +printers due to higher demand in 2017 compared to 2016 and a 149% increase in sales of medical and mobile printers primarily due to sales of our mobile printer to one customer. +21 +TSG: A summary +of sales in our worldwide TSG market for the years ended December 31, 2017 and 2016 is as follows: +Year Ended +Year Ended +Change +(In thousands) +December 31, 2017 +December 31, 2016 +$ +% +Domestic +$ +13,657 +96.3 +% +$ +9,315 +92.3 +% +$ +4,342 +46.6 +% +International +519 +3.7 +% +781 +7.7 +% +(262 +) +(33.5 +%) +$ +14,176 +100.0 +% +$ +10,096 +100.0 +% +$ +4,080 +40.4 +% +The increase in domestic revenue from TSG was due primarily to a 108% increase in sales of replacement parts and +accessories in 2017 compared to 2016 due to higher demand for spare parts in the lottery market in 2017. The increase, to a lesser extent, was also due to a 12% increase in project-oriented testing services that occurred in 2017 but did not occur +to the same extent in 2016. These increases were partially offset by a 6% decrease in non-Printrex consumables, largely for legacy POS and banking printers in 2017 compared to 2016. +Gross +Profit. Gross profit information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +26,662 +$ +23,799 +12.0 +% +47.3 +% +41.6 +% +Gross profit increased $2.9 million, or 12%, and our gross margin improved 570 basis points to a record 47.3%. These +increases were driven by a more favorable sales mix in 2017 compared to 2016, as our 2017 sales included a greater proportion of spare parts sales and a lower portion of sales of POS automation and banking printers. +Operating +Expenses - Engineering, Design and Product Development. Engineering, design and product development information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +4,303 +$ +4,425 +(2.8 +%) +7.6 +% +7.7 +% +Engineering, design and product development expenses decreased $122 thousand or 3%, due primarily to higher product +development costs during 2016 related to the substantial completion of certain software development projects for our EPICENTRAL™ software compared to 2017. +Operating Expenses - Selling and Marketing . Selling and marketing information for the years ended December 31, +2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +7,561 +$ +6,907 +9.5 +% +13.4 +% +12.1 +% +Selling and marketing expenses increased $654 thousand, or 10%, as we completed the build-out of our internal +infrastructure, including the hiring of a direct sales force and implementation of a direct marketing campaign dedicated to the restaurant solutions market in 2017. +Operating +Expenses - General and Administrative. General and administrative information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales - 2017 +Total Sales - 2016 +Year ended +$ +7,984 +$ +7,267 +9.9 +% +14.2 +% +12.7 +% +General and administrative expenses increased $717 thousand, or 10%, due primarily to higher incentive compensation +expenses incurred in 2017 compared to 2016 and higher recruiting expenses related to the expansion of our sales staff for our restaurant solutions market and European casino and gaming market. +Operating +Income (Loss). Operating income information for the years ended December 31, 2017 and 2016 is summarized below (in thousands, except percentages): +December 31, +Percent +Percent of +Percent of +2017 +2016 +Change +Total Sales – 2017 +Total Sales – 2016 +Year ended +$ +6,814 +$ +5,200 +31.0 +% +12.1 +% +9.1 +% +Our operating income increased by $1.6 million, or 31%, primarily due to a 570 basis point improvement in gross margin +on a favorable product mix, partially offset by a 7% increase in operating expenses in 2017 compared to 2016. +Interest. We +recorded net interest expense of $33 thousand in 2017 compared to $26 thousand in 2016. +22 +Other, +net . We recorded other expense of $9 thousand in 2017 compared to $4 thousand in 2016. The change was due to higher foreign currency +exchange losses recorded by our UK subsidiary in 2017 compared to 2016. In addition, we recorded a gain of $5 thousand on the disposal of fixed assets in 2016. +Income +Taxes . In 2017, we recorded an income tax provision of $3.6 million at an effective tax rate of 52.6% compared to an income tax +provision in 2016 of $1.6 million at an effective tax rate of 30.0%. The effective tax rate in 2017 was negatively impacted by the passage of the Tax Reform Act. As a result of the reduction of our U.S. corporate income tax rate from 34% to 21% +under the Tax Reform Act, the Company revalued its ending net deferred tax asset at December 31, 2017 and recognized a provisional $1.3 million charge to income tax expense in the Company's Consolidated Statements of Income for the year ended +December 31, 2017. +Net +Income. We reported net income during 2017 of $3.2 million, or $0.42 per diluted share, compared to $3.6 million, or $0.47 per diluted share, for 2016. +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing +activities. Significant factors affecting the management of liquidity are cash flows from operating activities, capital expenditures, treasury share repurchases, dividend payments, access to bank lines of credit and our ability to attract +long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities +and an ability to access credit lines, if needed, are expected to be sufficient to fund operations, capital expenditures, treasury share repurchases, dividend payments and any increase in working capital that would be required to accommodate a +higher level of business activity. We actively seek to expand by acquisition as well as through the growth of our current business. While a significant acquisition may require additional debt and/or equity financing, although no assurances can be +given, we believe that we would be able to obtain additional financing based on our historical earnings performance. +Cash Flow +During 2018 our cash balance decreased $816 thousand, or 15%, from December 31, 2017 and we returned a substantial +portion of our cash flow to shareholders in the form of $2.7 million of cash dividends paid to common shareholders and $2 million of repurchases of our common stock. Even after funding these items and our capital expenditures, we still ended +2018 with $4.7 million in cash and cash equivalents, of which $2.9 million was held by our UK subsidiary, and no debt outstanding. +Operating activities : The +following significant factors primarily affected our cash provided by operating activities of $5.1 million in 2018 as compared to $5.9 million in 2017. During 2018: +● +We reported a net income of $5.4 million. +● +We recorded depreciation and amortization of $1.0 million and share-based compensation expense of $629 thousand. +● +Accounts receivable decreased $2.7 million, or 25%, due to the collection of past due receivables from 2017 sales made to our former international casino +and gaming distributor. +● +Inventories increased $4.0 million, or 46%, due to the buildup of inventory on hand to support future anticipated sales in the casino and gaming market and +restaurant solutions market. +● +Accounts payable decreased $332 thousand, or 9%, due to the timing of inventory purchases in 2017 compared to 2018. +● +Accrued liabilities and other liabilities decreased $186 thousand, or 5%, due primarily to a decrease in our accrued incentive compensation. +During 2017: +● +We reported a net income of $3.2 million. +● +We recorded depreciation and amortization of $1.1 million and share-based compensation expense of $609 thousand. +● +Deferred income tax provision increased $1.1 million largely due to a $1.3 million charge to income tax expense in 2017 to revalue our net deferred tax +asset due to the Tax Reform Act. +● +Accounts receivable increased $355 thousand, or 3% due to a longer than normal collection process related to sales made to our international casino and +gaming distributor. +● +Inventories decreased $834 thousand, or 9%, due to the sell through of inventory on hand during 2017. +● +Accounts payable decreased $988 thousand, or 20%, due primarily to increased inventory purchases made towards the end of the fourth quarter of 2016 to +support anticipated sales of our restaurant solutions terminals and subsequently paid in 2017. +● +Accrued liabilities and other liabilities increased $1.1 million, or 35%, due primarily to an increase in our accrued incentive compensation. +Investing activities : Our +capital expenditures, including capitalized software costs, were $1.5 million and $1 million in 2018 and 2017, respectively. Expenditures in the 2018 period were primarily for computer and networking equipment and furniture and fixtures purchases +related to investments made in our UK facility to support the build-out of our internal sales infrastructure to sell directly to slot machine manufacturers and end-user casino and gaming customers. To a lesser extent, expenditures in the 2018 +period included computer and networking equipment for our U.S. operations and leasehold improvements made at our Las Vegas facility. Expenditures in 2017 were primarily comprised of computer and networking equipment, new product tooling equipment +and, to a lesser extent, leasehold improvements at our Ithaca, New York facility to upgrade to LED lighting. +Capital expenditures and additions to capitalized software for 2019 are expected to be approximately $1.3 million, +primarily for software development for our new restaurant solutions BOHA! products, new product tooling, and new computer software and equipment purchases. +Financing activities : We +used $4.5 million of cash from financing activities during 2018 to pay dividends of $2.7 million to common shareholders, purchase $2 million of common stock for treasury and $265 thousand related to the relinquishment of shares to pay for +withholding taxes on stock issued from our stock compensation plan, partially offset by proceeds from stock option exercises of $416 thousand. During 2017, we used $1.9 million of cash from financing activities to pay cash dividends of $2.6 +million to common shareholders, purchase $358 thousand of common stock for treasury and $23 thousand related to the relinquishment of shares to pay for withholding taxes on stock issued from our stock compensation plan, offset by proceeds from +stock option exercises of $1 million. +23 +Resource Sufficiency +We believe that our cash and cash equivalents on hand and cash flows generated from operating activities will provide +sufficient resources to meet our working capital needs, finance our capital expenditures and additions to capitalized software, dividend payments and meet our liquidity requirements through at least the next twelve months. +Credit Facility and Borrowings +We maintain a credit facility (the “TD Bank Credit Facility”) with TD Bank N.A. (“TD Bank) which provides for a $20 +million revolving credit line. On November 21, 2017, we signed an amendment to the TD Bank Credit Facility through November 28, 2022. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate minus one percent +and are secured by a lien on all of our assets. We also pay a fee of 0.125% on unused borrowings under the revolving credit line. The amendment increased the amount of revolving credit loans we may use to fund future cash dividend payments or +treasury share buybacks to $12.5 million from $10 million. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our +ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2018. +Financial Covenant +Requirement/Restriction +Calculation at December 31, 2018 +Operating cash flow / Total debt service +Minimum of 1.25 times +117.21 +Funded debt / EBITDA +Maximum of 3.0 times +0 times +As of December 31, 2018, undrawn commitments under the TD Bank Credit facility were $20 million. +Shareholder Dividend Payments +In 2012, our Board of Directors initiated a quarterly cash dividend program which is subject to the Board’s approval +each quarter. Our Board of Directors declared an increase to the quarterly cash dividend from $0.06 to $0.07 per share in May 2013, from $0.07 to $0.08 per share in May 2014, and from $0.08 to $0.09 per share in May 2017. Dividends declared and +paid on our common stock totaled $2.7 million or $0.36 per share and $2.6 million or $0.35 per share, in 2018 and 2017, respectively. On February 11, 2019, our Board of Directors approved the first quarter 2019 dividend in the amount of $0.09 per +share payable on or about March 15, 2019 to common shareholders of record at the close of business on February 20, 2019. +Stock Repurchase Program +On March 1, 2018, our Board of Directors approved a new stock repurchase program. Under the 2018 Stock Repurchase +Program, we are authorized to repurchase up to $5 million of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price and other factors. The 2018 Stock +Repurchase Program expires on December 31, 2019, if we do not discontinue the repurchase program prior to such time. We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the +treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From the start of the 2018 Stock Repurchase Program on March 1, 2018 through December 31, 2018, we repurchased 156,410 shares of our common stock +for approximately $2 million at an average price per share of $12.79. +During 2016 and 2017, under a prior repurchase program that was in place from February 25, 2016 through December 31, +2017, we purchased 499,843 shares of our common stock for $3.9 million at an average price of $7.86 per share. From January 1, 2005 through December 31, 2018, we repurchased a total of 4,044,842 shares of common stock for $32.1 million, at an +average price of $7.94 per share. +Shareholders’ Equity +Shareholders’ equity increased $1.6 million to $27.6 million at December 31, 2018 from $26 million at December 31, +2017. The increase was primarily due to net income of $5.4 million, as well as $148 thousand from the issuance of 96,615 shares of common stock related to employee stock awards, net of relinquishments and share-based compensation expense related +to stock awards of $629 thousand. These increases were partially offset by our payment of $2.7 million in dividends and the purchase of 156,410 shares of treasury stock for $2 million. +Off-Balance Sheet Arrangements +As of December 31, 2018, we had no off-balance sheet arrangements that have had or that we expect would be reasonably +likely to have a future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. +Contractual Obligations +Our contractual obligations as of December 31, 2018 were as follows: +Payments due by period +(In thousands) +Total +Less than +1 year +1-3 years +3-5 years +More than +5 years +Operating lease obligations +$ +4,365 +$ +1,035 +$ +1,743 +$ +698 +$ +889 +Purchase obligations +7,467 +$ +7,467 +$ +- +– +– +Total +$ +11,832 +$ +8,502 +$ +1,743 +$ +698 +$ +889 +Purchase obligations are for purchases made in the normal course of business to meet operational requirements, +primarily of fully assembled printers, terminals and component part inventory. +24 +Impact of Inflation +We believe that our business has not been affected to a significant degree by inflationary trends during the past three +years. However, inflation is still a factor in the worldwide economy and may increase the cost of purchasing products from our contract manufacturers in Asia, as well as the cost of certain raw materials, component parts and labor used in the +production of our products. It also may increase our operating expenses, manufacturing overhead expenses and the cost to acquire or replace fixed assets. We have generally been able to maintain or improve our profit margins through productivity +and efficiency improvements, cost reduction programs and to a lesser extent, price increases, and we expect to be able to do the same during 2019. As such, we do not believe that inflation will have a significant impact on our business during +2019. +Item 7A. Quantitative and Qualitative Disclosures about Market Risk. +Interest Rate Risk +Our exposure to market risk for changes in interest rates relates primarily to the investment of our available cash and +cash equivalents. In accordance with our investment policy, we strive to achieve above market rates of return in exchange for accepting a prudent amount of incremental risk, which includes the risk of interest rate movements. Risk tolerance is +constrained by an overriding objective to preserve capital. An increase or decrease of 10% in effective interest rates would not have a material effect on our results of operations or cash flows. +Foreign Currency Exchange Risk +Transaction Exposure – +We transact business in foreign currencies and have international revenue, as well as costs denominated in foreign currencies which are the Euro and Pound Sterling. As a result, we are exposed to the risk of fluctuations in foreign currency +exchange rates. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, would negatively affect our revenue and other operating results as expressed in U.S. dollars. +Beginning in 2018, we have experienced increased fluctuations in our net loss as a result of transaction gains or +losses related to revaluation and ultimately settling certain asset and liability balances that are denominated in currencies other than the functional currency of our UK subsidiary, which is Pound Sterling. Net realized and unrealized foreign +currency losses were $267 thousand, $11 thousand and $9 thousand in 2018, 2017 and 2016, respectively. The increase in foreign currency losses from 2017 to 2018 is primarily a result of increased sales recognized by our UK subsidiary upon the +adoption of a direct selling model in Europe. We do not use derivative financial instruments to manage foreign currency exchange risk exposure. As a result, both positive and negative currency fluctuations against the U.S. dollar may affect our +results of operations. Based on our foreign currency exposures from monetary assets and liabilities, we estimate that a 10% change in exchange rates against the U.S. dollar would have resulted in a gain or loss of approximately $300 thousand as of +December 31, 2018. +Translation Exposure – +We are also exposed to foreign exchange rate fluctuations as we translate the financial statements of our UK subsidiary into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the translating adjustments +resulting from the conversion of our UK subsidiary into U.S. dollars would result in a gain or loss recorded as a component of accumulated other comprehensive loss which is part of stockholders’ equity. +Item 8. Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this Annual Report as pages F-3 through F-18. The “Report of +Independent Registered Public Accounting Firm” is annexed to this Annual Report as of page F-2. An index to such materials appears on page F-1. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal +executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2018. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer +concluded that, as of December 31, 2018, our disclosure controls and procedures are effective at the reasonable assurance level. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, +means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported +within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that +it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required +disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the +cost-benefit relationship of possible controls and procedures. +25 +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to +provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial +reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable +assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance +with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material +effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2018. Management based its +assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). Based on our assessment, management has concluded that our internal control +over financial reporting was effective as of December 31, 2018. +Attestation Report of the Registered Public Accounting Firm +The effectiveness of the Company’s internal control over financial reporting as of December 31, 2018 has been audited +by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in the report which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in the Company’s internal control over financial reporting that occurred during the quarter +ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. +Item 9B. Other Information. +Not applicable. +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +Set forth below is certain information regarding our executive officers. The remaining information in response to this +item will be contained in our Proxy Statement for our 2019 Annual Meeting of Stockholders (the “Proxy Statement”) under the headings, “Section 16(a) Beneficial Ownership Reporting Compliance,” “Corporate Governance,” “Proposal 1: Election of +Directors,” “Audit Committee Report,” “Executive Compensation – Compensation Committee Report,” “Compensation Committee Interlocks and Insider Participation,” “Stockholder Proposals for 2020 Annual Meeting,” “Procedures for Submitted Director +Nominations and Recommendations” and “Stockholder Communications with the Board of Directors Policy,” which will be filed within 120 days after the end of the year covered by this Form 10-K and is incorporated herein by reference. +Executive Officers of the Registrant +The following list is included as an unnumbered item in Part III of this Report in lieu of being included in the Proxy +Statement for the Annual Meeting of Stockholders to be held on May 28, 2019. +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and +offices with the registrant held by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +61 +Chairman of the Board and Chief Executive Officer +Steven A. DeMartino +49 +President, Chief Financial Officer, Treasurer and Secretary +Donald E. Brooks +66 +Senior Vice President-Engineering +Tracey S. Chernay +59 +Senior Vice President, Casino, Gaming and Lottery Sales +Andrew J. Hoffman +61 +Senior Vice President, Operations +David B. Peters +40 +Vice President and Chief Accounting Officer +Raymond T. Walsh, Jr. +33 +Senior Vice President, Global Restaurant Solution Sales +Bart C. Shuldman has been Chief Executive Officer, President and a Director of the Company since its formation in June +1996. In February 2001, Mr. Shuldman was elected Chairman of the Board. Mr. Shuldman relinquished the President title, effective June 1, 2010, to focus on new products and markets, international expansion and potential acquisitions. +Steven A. DeMartino was named as TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, +2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice +President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Donald E. Brooks was appointed Senior Vice President of Engineering in April 2012. Previously, Mr. Brooks served as +Vice President, Engineering from September 2004 to April 2012, Senior Project Engineer from February 1998 to September 2004, Project Engineer from June 1997 to February 1998, Director of Electrical Engineering from March 1986 to June 1997 and +Manager of Electronic Development from December 1983 to March 1986. +26 +Tracey S. Chernay was appointed Senior Vice President, Casino and Gaming Sales and Marketing in June 2010, with +responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Chernay served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking with +the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Chernay was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing +since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Andrew J. Hoffman was appointed Senior Vice President, Operations for TransAct worldwide in November 2004. He served +as Vice President, Operations from September 1994 to November 2004. +David B. Peters was appointed Vice President and Chief Accounting Officer on March 1, 2018. Previously, Mr. Peters +served as Director, SEC and Financial Reporting since joining TransAct in March 2014. Prior to joining TransAct, Mr. Peters was employed with United Technologies Corporation from November 2006 to March 2014 where he served in various financial +management positions. Mr. Peters is a certified public accountant. +Raymond T. Walsh, Jr. was appointed Senior Vice President, Global Restaurant Solution Sales on February 27, 2019. +Previously, Mr. Walsh served as Vice President, Global Sales since 2018. Mr. Walsh joined TransAct in 2006 and has held several sales positions of increasing responsibility with the Company. Prior to joining TranAct, Mr. Walsh served as the +Senior Manager of Business Development at Nerac. +Code of Ethics +We maintain a Code of Business Conduct that includes our code of ethics that is applicable to all employees, including +our Chief Executive Officer, Chief Financial Officer and Controller. Our Code of Business Conduct, which requires continued observance of high ethical standards, such as honesty, integrity and compliance with the law in the conduct of our +business, is available for public access on our Internet website at https://transacttech.gcs-web.com/corporate-governance. Any person may request a copy of our Code of Business Conduct free of charge by calling (203) 859-6800. +Item 11. Executive Compensation. +The information in response to this item will be contained in the Proxy Statement under the heading “Executive +Compensation,” and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response +to this item will be contained in the Proxy Statement under the heading, “Security Ownership of Certain Beneficial Owners and Management,” and is incorporated herein by reference. +Equity Compensation Plan Information +Information regarding our equity compensation plans as of December 31, 2018 is as follows: +Plan category +(a) +Number of securities to be issued upon exercise +of outstanding options, warrants and rights +(b) +Weighted-average exercise price of +outstanding options, warrants and rights +(c) +Number of securities remaining available for +future issuance under equity compensation plans +(excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +368,375 +$ +9.14 +– +2014 Equity Incentive Plan +762,749 +7.71 +495,291 +Total +1,131,124 +$ +8.17 +495,291 +In May 2014, our stockholders approved the adoption of the 2014 Equity Incentive Plan. In May 2017, our stockholders +approved an amendment to the 2014 Equity Incentive Plan to increase the number of shares of common stock which may be subject to awards granted under the plan from 600,000 to its current level of 1,400,000. The Company also maintains the 2005 +Equity Incentive Plan; however no new awards will be available for future issuance under this plan. Both plans generally provide for award in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) +restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. The Company does not have any equity plans that have not been approved by its stockholders. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain +Relationships and Related Transactions” and is incorporated herein by reference. +Item 14. Principal Accountant Fees and Services. +The information in response to this item will be contained in the Proxy Statement under the headings, “Policy Regarding +Pre-Approval of Services Provided by the Independent Registered Public Accounting Firm” and “Independent Registered Public Accounting Firm’s Services and Fee’s” and is incorporated herein by reference. +27 +PART IV +Item 15. Exhibits and Financial Statement Schedules. +Index to Exhibits +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated (“TransAct” or the “Company”), filed with +the Secretary of State of Delaware on June 17, 1996. +(2) +3.1(b) +Certificate of Amendment of Certificate of Incorporation of the Company, filed with the Secretary of State of +Delaware on June 4, 1997. +(3) +3.1(c) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December +2, 1997. +(6) +3.1(d) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, +2000. +(8) +3.2 +Amended and Restated By-laws of the Company. +(7) +4 +Specimen Common Stock Certificate. +(2) +10.1(x) +2005 Equity Incentive Plan. +(11) +10.2(x) +2014 Equity Incentive Plan. +(4) +10.3(x) +Amendment to 2014 Equity Incentive Plan approved by Shareholders on May 22, 2017 +(26) +10.4(x) +2014 Equity Incentive Plan Time-based Restricted Unit Agreement +(23) +10.5(x) +2014 Equity Incentive Plan Performance-based Restricted Stock Unit Agreement +(24) +10.6(x) +Employment Agreement, dated July 31, 1996, by and between TransAct and Bart C. Shuldman. +(2) +10.7(x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004. +(10) +10.8(x) +Severance Agreement by and between TransAct and Tracey S. Chernay, dated July 29, 2005. +(14) +10.9(x) +Amendment to Employment Agreement, effective January 1, 2008, by and between TransAct and Bart C. Shuldman. +(15) +10.10(x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008. +(15) +10.11(x) +Amendment to Severance Agreement by and between TransAct and Tracey S. Chernay, effective January 1, 2008. +(15) +10.12 +Lease Agreement by and between Bomax Properties and Ithaca, dated as of March 23, 1992. +(2) +10.13 +Second Amendment to Lease Agreement by and between Bomax Properties and Ithaca, dated December 2, 1996. +(5) +10.14 +Agreement regarding the Continuation and Renewal of Lease by and between Bomax Properties, LLC and TransAct, +dated July 18, 2001. +(9) +10.15 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct. +(18) +10.16 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016. +(22) +10.17 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004. +(10) +10.18 +First Amendment to Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated August +31, 2009. +(16) +10.19 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, +2015. +(21) +10.20 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006. +(12) +10.21 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 3, 2017 +(25) +10.22 +OEM Purchase Agreement by and between IGT (f/k/a GTECH Corporation) and TransAct, dated May 29, +2015. (Pursuant to Rule 24-b-2 under the Exchange Act, the Company has requested confidential treatment of portions of this exhibit deleted from the filed copy). +(21) +10.23 +Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Banknorth, N.A. dated +November 28, 2006. +(12) +10.24 +First Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD +Banknorth, N.A. effective September 30, 2007. +(13) +10.25 +Second Amendment to Amended and Restated Revolving Credit and Security Agreement between TransAct and TD Bank, +N.A. effective November 22, 2011. +(17) +10.26 +Third Amendment to Amended and Restated Revolving Credit and Security Agreement effective September 7, 2012. +(19) +10.27 +Fourth Amendment to Amended and Restated Revolving Credit and Security Agreement effective November 26, 2014. +(20) +10.28 +Fifth Amendment to Amended and Restated Revolving Credit and Security Agreement effective November 21, 2017. +(27) +21 +Subsidiaries of the Company +(1) +23 +Consent of PricewaterhouseCoopers LLP. +(1) +31.1 +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley +Act of 2002. +(1) +31.2 +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley +Act of 2002. +(1) +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as +adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +(1) +101.INS +XBRL Instance Document. +(1) +101.SCH +XBRL Taxonomy Extension Schema Document. +(1) +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +(1) +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +(1) +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +(1) +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +(1) +28 +(1) +These exhibits are filed herewith. +(2) +These exhibits, which were previously filed with the Company’s Registration Statement on Form S-1 (No. 333-06895), are incorporated by +reference. +(3) +Incorporated by reference to Exhibit 3.1(b) of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on May +19, 2014. +(4) +Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on May +19, 2014. +(5) +Incorporated by reference to Exhibit 10.27 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on +March 31, 1998. +(6) +Incorporated by reference to Exhibit C of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on February +18, 1999. +(7) +Incorporated by reference to Exhibit 3.2 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March +29, 1999. +(8) +Incorporated by reference to Exhibit 3.1(c) of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on +May 8, 2000. +(9) +Incorporated by reference to Exhibit 10.8 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March +29, 2002. +(10) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, are +incorporated by reference (No. 000-21121). +(11) +Incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on June +1, 2005. +(12) +These exhibits, which were previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, are +incorporated by reference (No. 000-21121). +(13) +Incorporated by reference to Exhibit 10.20 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on +November 9, 2007. +(14) +Incorporated by reference to Exhibit 10.9 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March +14, 2009. +(15) +This exhibit, which was previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, is +incorporated by reference (No. 000-21121). +(16) +Incorporated by reference to Exhibit 10.19 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on +March 16, 2010. +(17) +Incorporated by reference to Exhibit 10.25 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on +March 12, 2012. +(18) +Incorporated by reference to Exhibit 10.16 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on +May 10, 2012. +(19) +Incorporated by reference to Exhibit 10.26 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on +September 11, 2012. +(20) +Incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on +December 1, 2014. +(21) +This exhibit, which was previously filed with the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2015, is +incorporated by reference +(22) +Incorporated by reference to Exhibit 10.13 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on +March 11, 2016. +(23) +Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on +May 6, 2016. +(24) +Incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q (SEC File No. 000-211121) filed with the SEC on +August 8, 2016. +(25) +Incorporated by reference to Exhibit 10.20 of the Company's Annual Report on Form 10-K (SEC File No. 000-21121). +(26) +Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on +August 9, 2017. +(27) +Incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on +November 22, 2017. +(x) +Management contract or compensatory plan or arrangement. +29 +EXHIBIT LIST +The following exhibits are filed herewith. +Exhibit +21 +Subsidiaries of the Company +23 +Consent of PricewaterhouseCoopers LLP. +31.1 +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley +Act of 2002. +31.2 +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley +Act of 2002. +32.1 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as +adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +XBRL Instance Document. +101.SCH +XBRL Taxonomy Extension Schema Document. +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document. +Item 16. Form 10-K Summary. +Not applicable. +30 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused +this report to be signed on its behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ Bart C. Shuldman +Name: +Bart C. Shuldman +Title: +Chairman of the Board and Chief Executive Officer +Date: March 18, 2019 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following +persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Bart C. Shuldman +Chairman of the Board and Chief Executive Officer +March 18, 2019 +Bart C. Shuldman +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, Treasurer and Secretary +March 18, 2019 +Steven A. DeMartino +(Principal Financial Officer) +/s/ David B. Peters +Vice President and Chief Accounting Officer +March 18, 2019 +David B. Peters +(Principal Accounting Officer) +/s/ John M. Dillon +Director +March 18, 2019 +John M. Dillon +/s/ Haydee Olinger +Director +March 18, 2019 +Haydee Olinger +/s/ Thomas R. Schwarz +Director +March 18, 2019 +Thomas R. Schwarz +/s/ Graham Y. Tanaka +Director +March 18, 2019 +Graham Y. Tanaka +31 +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO FINANCIAL STATEMENTS +Financial Statements +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Balance Sheets as of December 31, 2018 and 2017 +F-3 +Consolidated Statements of Income for the years ended December 31, 2018, +2017, and 2016 +F-4 +Consolidated Statements of Comprehensive Income for the years ended +December 31, 2018, 2017 and 2016 +F-5 +Consolidated Statements of Changes in Shareholders' Equity for the +years ended December 31, 2018, 2017 and 2016 +F-6 +Consolidated Statements of Cash Flows for the years ended December 31, +2018, 2017 and 2016 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +Report of Independent Registered Publi c Accounting Firm +To the Board of Directors and Shareholders of TransAct Technologies Incorporated +Opinions on the Financial Statements and Internal Control over Financial Reporting +We have audited the accompanying consolidated balance sheets of TransAct Technologies Incorporated and +its subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, +2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). +In our opinion, the consolidated financial statements referred to above present fairly, in all +material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting +principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. +Basis for Opinions +The Company's management is responsible for these consolidated financial statements, for maintaining +effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control Over Financial Reporting appearing under Item +9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company +Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission +and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we +plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was +maintained in all material respects. +Our audits of the consolidated financial statements included performing procedures to assess the risks +of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and +disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial +statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and +operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our +opinions. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable +assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes +those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that +transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with +authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on +the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or +detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or +procedures may deteriorate. +/s/PricewaterhouseCoopers LLP +Hartford, Connecticut +March 18, 2019 +We have served as the Company's auditor since 1996. +F-2 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +2018 +December 31, +2017 +Assets: +Current assets: +Cash and cash equivalents +$ +4,691 +$ +5,507 +Accounts receivable, net +8,025 +10,948 +Inventories, net +12,835 +8,875 +Prepaid income taxes +809 +514 +Other current assets +677 +517 +Total current assets +27,037 +26,361 +Fixed assets, net +2,272 +2,169 +Goodwill +2,621 +2,621 +Deferred tax assets +2,198 +2,308 +Intangible assets, net +797 +458 +Other assets +31 +33 +7,919 +7,589 +Total assets +34,956 +33,950 +Liabilities and Shareholders’ Equity: +Current liabilities: +Accounts payable +$ +3,483 +$ +3,841 +Accrued liabilities +2,765 +3,339 +Deferred revenue +384 +169 +Total current liabilities +6,632 +7,349 +Deferred revenue, net of current portion +265 +69 +Deferred rent, net of current portion +250 +271 +Other liabilities +242 +247 +757 +587 +Total liabilities +7,389 +7,936 +Commitments and contingencies (Note 9) +Shareholders’ equity: +Preferred stock, $0.01 value, 4,800,000 authorized, none issued and +outstanding +– +– +Preferred stock, Series A, $0.01 par value, 200,000 authorized, none +issued and outstanding +– +– +Common stock, $0.01 par value, 20,000,000 authorized at December 31, 2018 +and 2017; 11,463,141 and 11,366,526 shares issued; 7,418,299 and 7,478,094 shares outstanding, at December 31, 2018 and 2017, respectively +115 +114 +Additional paid-in capital +32,129 +31,353 +Retained earnings +27,515 +24,756 +Accumulated other comprehensive loss, net of tax +(82 +) +(99 +) +Treasury stock, 4,044,842 and 3,888,432 shares, at cost +(32,110 +) +(30,110 +) +Total shareholders’ equity +27,567 +26,014 +Total liabilities and shareholders’ equity +$ +34,956 +$ +33,950 +See accompanying notes to Consolidated Financial Statements. +F-3 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF INCOME +(In thousands, except per share data) +Year Ended December 31, +2018 +2017 +2016 +Net sales +$ +54,587 +$ +56,311 +$ +57,235 +Cost of sales +27,844 +29,649 +33,436 +Gross profit +26,743 +26,662 +23,799 +Operating expenses: +Engineering, design and product development +4,576 +4,303 +4,425 +Selling and marketing +7,203 +7,561 +6,907 +General and administrative +8,205 +7,984 +7,267 +19,984 +19,848 +18,599 +Operating income +6,759 +6,814 +5,200 +Interest and other income (expense): +Interest expense +(27 +) +(33 +) +(33 +) +Interest income +– +– +7 +Other, net +(266 +) +(9 +) +(4 +) +(293 +) +(42 +) +(30 +) +Income before income taxes +6,466 +6,772 +5,170 +Income tax provision +1,040 +3,561 +1,553 +Net income +$ +5,426 +$ +3,211 +$ +3,617 +Net income per common share: +Basic +$ +0.73 +$ +0.43 +$ +0.48 +Diluted +$ +0.70 +$ +0.42 +$ +0.47 +Shares used in per-share calculation: +Basic +7,444 +7,423 +7,610 +Diluted +7,759 +7,592 +7,655 +Dividends declared and paid per common share: +$ +0.36 +$ +0.35 +$ +0.32 +See accompanying notes to Consolidated Financial Statements. +F-4 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands, except share data) +Year Ended December 31, +2018 +2017 +2016 +Net income +$ +5,426 +$ +3,211 +$ +3,617 +Foreign currency translation adjustment, net of tax +17 +10 +(29 +) +Comprehensive income +$ +5,443 +$ +3,221 +$ +3,588 +See accompanying notes to Consolidated Financial Statements. +F-5 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY +(In thousands, except share data) +Common Stock +Additional +Paid-in +Retained +Treasury +Accumulated +Other +Comprehensive +Total +Shares +Amount +Capital +Earnings +Stock +Income (Loss) +Equity +Balance, December 31, 2015 +7,782,292 +$ +112 +$ +28,921 +$ +22,956 +$ +(26,181 +) +$ +(80 +) +$ +25,728 +Issuance of shares from exercise of stock options +3,750 +– +23 +– +– +– +23 +Issuance of deferred stock units +– +– +202 +– +– +– +202 +Issuance of common stock on deferred stock units, net of relinquishments +10,700 +– +(51 +) +– +– +– +(51 +) +Tax shortfall related to employee stock sales +– +– +1 +– +– +– +1 +Purchase of treasury stock +(463,378 +) +– +– +– +(3,571 +) +– +(3,571 +) +Dividends declared and paid on common stock +– +– +– +(2,416 +) +– +– +(2,416 +) +Share-based compensation expense +– +– +611 +– +– +– +611 +Reversal of deferred tax asset in connection with stock options forfeited +– +– +(6 +) +– +– +– +(6 +) +Foreign currency translation adjustment, net of tax +– +– +– +– +– +(29 +) +(29 +) +Net income +– +– +– +3,617 +– +– +3,617 +Balance, December 31, 2016 +7,333,364 +$ +112 +$ +29,701 +$ +24,157 +$ +(29,752 +) +$ +(109 +) +$ +24,109 +Issuance of shares from exercise of stock options +166,600 +2 +1,041 +– +– +– +1,043 +Issuance of common stock on restricted stock units +8,300 +– +– +– +– +– +– +Issuance of common stock on deferred stock units +8,663 +– +– +– +– +– +– +Relinquishment of stock awards and deferred stock units to pay withholding +taxes +(2,368 +) +– +(29 +) +– +– +– +(29 +) +Purchase of treasury stock +(36,465 +) +– +– +– +(358 +) +– +(358 +) +Dividends declared and paid on common stock +– +– +– +(2,581 +) +– +– +(2,581 +) +Share-based compensation expense +– +– +609 +– +– +– +609 +Adjustment upon adoption of ASU 2016-09 +– +– +31 +(31 +) +– +– +– +Foreign currency translation adjustment, net of tax +– +– +– +– +– +10 +10 +Net income +– +– +– +3,211 +– +– +3,211 +Balance, December 31, 2017 +7,478,094 +$ +114 +$ +31,353 +$ +24,756 +$ +(30,110 +) +$ +(99 +) +$ +26,014 +Issuance of shares from exercise of stock options +58,146 +1 +415 +– +– +– +416 +Issuance of common stock on restricted stock units +33,935 +– +– +– +– +– +– +Issuance of common stock on deferred stock units +23,578 +– +– +– +– +– +– +Relinquishment of stock awards and deferred stock units to pay withholding +taxes +(19,044 +) +– +(268 +) +– +– +– +(268 +) +Purchase of treasury stock +(156,410 +) +– +– +– +(2,000 +) +– +(2,000 +) +Dividends declared and paid on common stock +– +– +– +(2,667 +) +– +– +(2,667 +) +Share-based compensation expense +– +– +629 +– +– +– +629 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +17 +17 +Net income +– +– +– +5,426 +– +– +5,426 +Balance, December 31, 2018 +7,418,299 +$ +115 +$ +32,129 +$ +27,515 +$ +(32,110 +) +$ +(82 +) +$ +27,567 +See accompanying notes to Consolidated Financial Statements. +F-6 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2018 +2017 +2016 +Cash flows from operating activities: +Net income +$ +5,426 +$ +3,211 +$ +3,617 +Adjustments to reconcile net income to net cash provided by operating +activities: +Share-based compensation expense +629 +609 +611 +Depreciation and amortization +997 +1,081 +1,331 +Deferred income tax (benefit) provision +(107 +) +1,117 +(295 +) +Provision for doubtful accounts +105 +50 +– +Gain on sale of fixed assets +– +– +(5 +) +Foreign currency transaction losses +199 +11 +4 +Changes in operating assets and liabilities: +Accounts receivable +2,688 +(405 +) +(3,434 +) +Inventories +(4,049 +) +834 +1,580 +Prepaid income taxes +(100 +) +(518 +) +(5 +) +Other current and long term assets +(161 +) +(137 +) +53 +Accounts payable +(332 +) +(988 +) +2,255 +Accrued liabilities and other liabilities +(186 +) +1,053 +(1,088 +) +Net cash provided by operating activities +5,109 +5,918 +4,624 +Cash flows from investing activities: +Capital expenditures +(1,007 +) +(835 +) +(608 +) +Additions to capitalized software +(466 +) +(150 +) +– +Proceeds from sale of fixed assets +– +– +8 +Net cash used in investing activities +(1,473 +) +(985 +) +(600 +) +Cash flows from financing activities: +Proceeds from stock option exercises +416 +1,043 +23 +Purchases of common stock for treasury +(2,000 +) +(358 +) +(3,571 +) +Payment of dividends on common stock +(2,667 +) +(2,581 +) +(2,416 +) +Withholding taxes paid on stock issuances +(265 +) +(23 +) +– +Net cash used in financing activities +(4,516 +) +(1,919 +) +(5,964 +) +Effect of exchange rate changes on cash and cash equivalents +64 +(10 +) +(30 +) +Increase (decrease) in cash and cash equivalents +(816 +) +3,004 +(1,970 +) +Cash and cash equivalents, beginning of period +5,507 +2,503 +4,473 +Cash and cash equivalents, end of period +$ +4,691 +$ +5,507 +$ +2,503 +Supplemental cash flow information: +Interest paid +$ +25 +$ +30 +$ +31 +Income taxes paid +1,249 +2,991 +2,065 +Non-cash capital expenditure items +21 +44 +113 +See accompanying notes to Consolidated Financial Statements. +F-7 +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated (“TransAct” or the “Company”), which has its headquarters in +Hamden, CT and its primary operating facility in Ithaca, New York, operates in one operating segment: software-driven technology and printing solutions for high growth markets including restaurant solutions, casino and gaming, lottery, POS +automation and banking, and oil and gas markets. Our solutions are designed from the ground up based on market and customer requirements and are sold under the AccuDate™ Ithaca®, Epic, EPICENTRAL TM and Printrex® product brands. We sell +our products to original equipment manufacturers, value-added resellers, select distributors, and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands +and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of products. We also generate revenue from the after-market side of the business, providing +printer and terminal service, supplies and spare parts in addition to revenue from our software solution, the EPICENTRAL TM Print System (“EPICENTRAL TM ”), that enables casino operators to create promotional coupons and +marketing messages and print them in real-time at the slot machine. +2. Summary of significant accounting policies +Principles of +consolidation: The accompanying Consolidated Financial Statements include the accounts of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized +profit. +Use of estimates : The preparations of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America +(“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements +and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting.” We +view our operations and manage our business as one segment: the design, development and marketing of software-driven technology and printing solutions and providing printer and terminal related software, services, supplies and spare parts. Factors +used to identify TransAct’s single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief operating decision-maker in making decisions about how to allocate resources +and assess performance. +Cash and cash +equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash +equivalents. +Allowance for +doubtful accounts : We establish an allowance for doubtful accounts to ensure trade receivables are valued appropriately. We maintain an +allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events and historical experience. We record a specific allowance for individual accounts when we become aware +of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. If circumstances related to customers change, we would further adjust +estimates of the recoverability of receivables. Allowances for doubtful accounts on accounts receivable balances were $205 thousand and $100 thousand as of December 31, 2018 and 2017, respectively. +The following table summarizes the activity recorded in the valuation account for accounts receivable: +Year Ended December 31, +(In thousands) +2018 +2017 +2016 +Balance, beginning of period +$ +100 +$ +50 +$ +50 +Additions charged to costs and expenses +105 +50 +– +Balance, end of period +$ +205 +$ +100 +$ +50 +Inventories: Inventories +are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business +less estimated costs of completions, disposal and transportation, historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net +realizable value. +Fixed assets: Fixed +assets are stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years; machinery and equipment is ten years; furniture and office equipment is five to +ten years; and computer software and equipment is three to seven years. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as +incurred. The costs of sold or retired assets are removed from the related asset and accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $870 thousand, $844 thousand and $987 thousand in 2018, 2017, and +2016, respectively. +Leases: Rent +expense under non-cancelable operating leases with scheduled rent increases or free rent periods are accounted for on a straight-line basis over the lease term, beginning on the date of control of physical use of the asset or of initial +possession. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred liability. Construction allowances and other such lease incentives are recorded as deferred credits, and are amortized on a +straight-line basis as a reduction of rent expense beginning in the period they are deemed to be earned, which generally coincides with the occupancy date. +F-8 +Goodwill and +Intangible assets : We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The +determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 “Goodwill”, acquired goodwill is not amortized but is subject to impairment testing at least annually and when an +event occurs or circumstances change, that indicate it is more likely than not an impairment exists. Factors considered that may trigger an impairment review of either acquired goodwill or intangible assets are: significant underperformance relative +to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market +capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. We have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill was +substantially higher than our carrying value based on our assessment as of December 31, 2018 when the impairment review is performed. +Revenue recognition: ASU No. 2014-09, "Revenue from Contracts with Customers” and its related amendments (collectively, ASC 606) are effective for reporting periods beginning after December 15, 2017, and interim periods therein. +This ASU is intended to clarify the principles for recognizing revenue by removing inconsistencies in revenue requirements; providing a more robust framework for addressing revenue issues; improving comparability of revenue recognition practices +across entities, industries, jurisdictions and capital markets; and providing more useful information to users of financial statements through improved revenue disclosure requirements. Entities have the option of using either a full retrospective +approach or modified retrospective approach to adopt the amended guidance. We adopted ASC 606 effective January 1, 2018 and elected the modified retrospective approach. The results for periods before 2018 were not adjusted for the new standard and +there was no cumulative effect for the change in accounting at the date of adoption. +In accordance with ASC 606, a performance obligation is a promise in a contract with a customer to transfer a distinct +good or service to the customer. Some of our contracts with customers contain a single performance obligation, while other contracts contain multiple performance obligations (most commonly when contracts include product and extended warranties). A +contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. When there are multiple performance obligations within a contract, we allocate the +transaction price to each performance obligation based on its standalone selling price. +The transaction price is determined based on the consideration to which the Company will be entitled in exchange for +transferring services to the customer. To the extent the transaction price includes variable consideration, such as price protection, reserves for returns and other allowances, the Company estimates the amount of variable consideration that should +be included in the transaction price utilizing either the “expected value” method or the “most likely amount” method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the +Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. +For a majority of our revenue, which consists of printers, terminals, consumables, and replacement parts, the Company +recognizes revenue as of a point of time. The transaction price is recognized upon shipment of the order when control of the goods is transferred to the customer and at the time the performance obligation is fulfilled. We also sell a software +solution, EPICENTRAL™, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. EPICENTRAL TM is primarily comprised of both a software component, which is +licensed to the customer, and a hardware component. EPICENTRAL™ software and hardware are integrated to deliver the system's full functionality. The transaction prices from EPICENTRAL™ software license and hardware are recognized upon +installation and formal acceptance by the customer when control of the license is transferred to the customer. For out-of-warranty repairs, the transaction price is recognized after completion of the repair work is completed and the printer or +terminal is returned to the customer, as control of the product is transferred to the customer and our performance obligation is completed. +Performance obligations are satisfied over time if the customer receives the benefits as we perform work, if the +customer controls the asset as it is being produced, or if the product being produced for the customer has no alternative use and we have a contractual right to payment. For our separately priced extended warranty, technical support for our +restaurant solution terminals and maintenance agreements (including free one-year maintenance received by the customers upon completion of EPICENTRAL™ installation) revenue is recognized over time as the customer receives the benefit. The +transaction price from the maintenance services is recognized ratably over time, using output methods, as control of the services is transferred to the customer. For extended warranties, the transaction price is recognized ratably over the warranty +period, using output methods, as control of the services is transferred to the customer. +In the cases where there is more than one performance obligation in a customer arrangement, the Company typically uses +the “standalone selling price” method to determine the transaction price to allocate to each performance obligation. The Company sells the performance obligations separately and has established standalone selling prices for its products and +services. In the case of an overall price discount, the discount is applied to each performance obligation proportionately based on standalone selling price. To determine the standalone selling price for initial EPICENTRAL™ installations, the +Company uses the adjusted market assessment approach. +F-9 +Disaggregation of revenue +The following table disaggregates our revenue by market-type, as we believe it best depicts how the nature, amount, +timing and uncertainty of our revenue and cash flows are affected by economic factors. Sales and usage-based taxes are excluded from revenues. +Year Ended +December 31, 2018 +United States +International +Total +(In thousands) +Restaurant solutions +$ +4,133 +$ +446 +$ +4,579 +POS Automation and Banking +7,122 +151 +7,273 +Casino and Gaming +17,518 +9,075 +26,593 +Lottery +3,046 +47 +3,093 +Printrex +1,028 +269 +1,297 +TransAct Services Group +10,671 +1,081 +11,752 +Total net sales +$ +43,518 +$ +11,069 +$ +54,587 +Changes in accounting policies and financial statement impact of adopting ASC 606 +Except for the changes below, we have consistently applied the accounting policies to all periods presented in the +consolidated financial statements. As noted above, we adopted ASC 606 using the modified retrospective approach which allows the Company to record any changes using the cumulative effect. The adoption of ASC 606 did not require the Company to +record an adjustment to retained earnings at January 1, 2018, and did not have an impact on the consolidated income statement during the year ended December 31, 2018, basic or diluted earnings per share, consolidated statement of cash flows, +consolidated statement of shareholder's equity, or consolidated balance sheet, at December 31, 2018. +Costs to Obtain a +Contract – Costs to obtain a contract, such as sales commissions, were previously expensed as incurred. The Company applied the +practical expedient for contracts with customers for a term of twelve months or less, in accordance with ASC 340-40-25-4, which allows TransAct to continue to expense sales commissions as incurred, since the expected amortization period of the cost +to obtain a contract is less than 12 months. No amounts were capitalized as of the adoption of ASC 606 or as of December 31, 2018. +Contract balances +Our contract liabilities consist of customer pre-payments and deferred revenue. Customer prepayments are reported as +“Accrued Liabilities” in current liabilities in the Condensed Consolidated Balance Sheets and represent customer payments made in advance of performance obligations in instances where credit has not been extended and is recognized as revenue when +the performance obligation is complete. Deferred revenue is reported separately in current liabilities and non-current liabilities and consists of our extended warranty contracts, technical support for our restaurant solution terminals, +EPICENTRAL™ maintenance contracts and testing service contracts, and is recognized as revenue as (or when) we perform under the contract. The increase in current and non-current deferred revenue is due to the sale of extended warranties and +technical support for our restaurant solution terminals. We do not have any contract asset balances as of December 31, 2018 or 2017. During the year ended December 31, 2018, we recognized revenue of $1.2 million related to our contract +liabilities at January 1, 2018. Total contract liabilities consist of the following: +December 31, 2018 +January 1, 2018 +(In thousands) +Customer pre-payments +$ +50 +$ +79 +Deferred revenue, current +384 +169 +Deferred revenue, non-current +265 +69 +Total contract liabilities +$ +699 +$ +317 +Remaining performance obligations +Remaining performance obligations represent the transaction price of firm orders for which a good or service has not +been delivered to our customer. As of December 31, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was $5.6 million. The Company expects to recognize revenue on $4.1 million of our remaining +performance obligations within the next 12 months, $1.4 million within the next 24 months and the balance of these remaining performance obligations recognized within the next 36 months. +F-10 +Concentration of +credit risk: Financial instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable were as follows: +December 31, +2018 +2017 +International Gaming Technology ("IGT") +21 +% +48 +% +Suzo-Happ +0 +% +13 +% +Sales to customers representing 10% or more of total net sales were as follows: +Year Ended December 31, +2018 +2017 +2016 +IGT +18 +% +35 +% +26 +% +Suzo-Happ +1 +% +8 +% +15 +% +Warranty: We +generally warrant our products for up to 24 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related estimated +cost of labor and material to make the necessary repairs. +The following table summarizes the activity recorded in the accrued product warranty liability: +Year Ended December 31, +(In thousands) +2018 +2017 +2016 +Balance, beginning of period +$ +267 +$ +267 +$ +277 +Warranties issued +269 +259 +254 +Warranty settlements +(263 +) +(259 +) +(264 +) +Balance, end of period +$ +273 +$ +267 +$ +267 +$192 thousand and $186 thousand of the accrued product warranty liability were classified as current in Accrued liabilities at +December 31, 2018 and 2017, respectively. The remaining $81 thousand of the accrued product warranty liability as of December 31, 2018 and 2017 is classified as long-term in Other liabilities. +Engineering, +design and product development: Research and development ("R&D") expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as +a component of operating expenses as incurred. We recorded $4.6 million, $4.3 million and $4.4 million of research and development expenses in 2018, 2017, and 2016, respectively. +Costs incurred in researching and developing a computer software product are charged to expense until technological +feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in +determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs have been +included in cost of sales over the estimated life of the product. During 2018, we contracted several third-parties to develop software for our restaurant solutions products. Unamortized development costs for such software were $586 thousand as of +December 31, 2018. The total amount charged to cost of sales for capitalized software development costs was $30 thousand, $2 thousand and $29 thousand in 2018, 2017, and 2016, respectively. +Advertising: Advertising +costs are expensed as incurred. Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Income, for 2018, 2017, and 2016 totaled $1.0 million, $1.0 million and $0.7 million, +respectively. These expenses include items such as consulting and professional services, tradeshows, and print advertising. +Income taxes: The +income tax amounts reflected in the accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, “Income Taxes.” Deferred tax assets and liabilities are recognized for the estimated future +tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are +measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the +extent that we believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. See Note 11 for +information regarding our accounting for income taxes and additional provision items recorded in regards to the Tax Reform Act. +Foreign currency translation: The financial position and results of operations of our foreign subsidiary in the UK are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been +translated into U.S. dollars at the year-end exchange rate, related sales and expenses have been translated at the exchange rate as of the date the transaction was recognized, and shareholders’ equity has been translated at historical exchange +rates. The resulting translation gains or losses, net of tax, are recorded in shareholders’ equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income. Foreign currency transaction gains and +losses, including those related to intercompany balances, are recognized in Other, net on the Consolidated Statements of Income. +F-11 +Share-based +payments: At December 31, 2018, we have share-based employee compensation plans, which are described more fully in Note 10 - Stock +incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, “Compensation – Stock Compensation.” Share-based compensation expense is measured at the grant date, based on the estimated fair value of the +award, and is recognized as expense over the employee’s requisite service period. +We use the Black-Scholes option-pricing model to calculate the fair value of share based awards. The key assumptions +for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions are judgmental and highly +sensitive in the determination of compensation expense. Beginning in the first quarter of 2017, we recognize forfeitures as they occur. +In May 2017, the FASB issued ASU No. 2017-09, "Compensation-Stock Compensation: Scope of modification accounting". +ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU No. 2017-09 is effective for fiscal years beginning after December 15, +2017. The amendments are applied prospectively to an award modified on or after the adoption date. We adopted this guidance in the first quarter of 2018 and the adoption has not resulted in a change to our financial statements. +Net income and +loss per share: We report net income or loss per share in accordance with ASC 260, “Earnings per Share (EPS).” Under this guidance, basic EPS, which excludes dilution, is computed by dividing income or loss available to common shareholders +by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted +EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these instruments are excluded from the computation of +dilutive EPS. See Note 12 - Earnings per share. +3. Inventories, net +The components of inventories are: +December 31, +(In thousands) +2018 +2017 +Raw materials and purchased component parts +$ +6,593 +$ +6,322 +Work-in-process +29 +– +Finished goods +6,213 +2,553 +$ +12,835 +$ +8,875 +4. Fixed assets +The components of fixed assets, net are: +December 31, +(In thousands) +2018 +2017 +Tooling, machinery and equipment +$ +11,177 +$ +11,019 +Furniture and office equipment +1,690 +1,651 +Computer software and equipment +6,930 +6,503 +Leasehold improvements +2,666 +2,475 +22,463 +21,648 +Less: Accumulated depreciation and amortization +(20,518 +) +(19,752 +) +1,945 +1,896 +Construction in-process +327 +273 +$ +2,272 +$ +2,169 +5. Intangible assets +Identifiable intangible assets are recorded in Intangible assets in the accompanying Consolidated Balance Sheets and are comprised of +the following: +December 31, +2018 +2017 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +2,221 +$ +(1,558 +) +$ +1,754 +$ +(1,481 +) +Customer relationships +1,300 +(1,300 +) +1,300 +(1,300 +) +Trademark +480 +(354 +) +480 +(306 +) +Covenant not to compete +146 +(146 +) +146 +(146 +) +Patents +57 +(49 +) +57 +(46 +) +Other +80 +(80 +) +80 +(80 +) +Total +$ +4,284 +$ +(3,487 +) +$ +3,817 +$ +(3,359 +) +Amortization expense was $128 thousand, $237 thousand and $343 thousand in 2018, 2017 and 2016, respectively. Amortization expense +for each of the next five years ending December 31 is expected to be as follows: $289 thousand in 2019; $175 thousand in 2020; $124 thousand in 2021; $93 thousand in 2022; $93 thousand in 2023; and $23 thousand thereafter. +F-12 +6. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2018 +2017 +Salaries and compensation related +$ +1,817 +$ +2,288 +Warranty +192 +186 +Professional and consulting +231 +209 +Other +525 +656 +$ +2,765 +$ +3,339 +7. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of each +month immediately following their date of hire. We match employees’ contributions at a rate of 50% of employees’ contributions up to the first 6% of the employees’ compensation contributed to the 401(k) plan. Our matching contributions were $237 +thousand, $264 thousand and $295 thousand in 2018, 2017, and 2016, respectively. +8. Borrowings +We maintain a credit facility (the “TD Bank Credit Facility”) with TD Bank N.A. (“TD Bank) which provides for a $20 +million revolving credit line. On November 21, 2017, we signed an amendment extending the term to the TD Bank Credit Facility through November 28, 2022. Borrowings under the revolving credit line bear a floating rate of interest at the prime rate +minus one percent and are secured by a lien on all of our assets. We also pay a fee of 0.125% on unused borrowings under the revolving credit line. The amendment increased the amount of revolving credit loans we may use to fund future cash +dividend payments or treasury share buybacks to $12.5 million from $10 million. +The TD Bank Credit Facility imposes certain quarterly financial covenants on us and restricts, among other things, our +ability to incur additional indebtedness and the creation of other liens. We were in compliance with all financial covenants of the TD Bank Credit Facility at December 31, 2018. +As of December 31, 2018, undrawn commitments under the TD Bank Credit facility were $20 million. +9. Commitments and contingencies +At December 31, 2018, we were the lessee on operating leases for equipment and real property. Rent expense was $1.1 +million, $1.1 million and $1.0 million in 2018, 2017, and 2016, respectively. Minimum aggregate rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2018 +are as follows: $1.0 million in 2019; $1.0 million in 2020; $0.7 million in 2021; $0.4 million in 2022, $0.3 million in 2023 and $0.9 million thereafter. +10. Stock incentive plans +Stock +incentive plans . We currently have two primary stock incentive plans: the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan, +which provide for awards to executives, key employees, directors and consultants. The plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock +units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. Awards granted under these plans have exercise prices equal to 100% of the fair market value of the common stock at the +date of grant. Awards granted have a ten-year term and generally vest over a two- to five-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards were made under the 2005 Equity Incentive +Plan. Under our 2014 Equity Incentive Plan, we may authorize awards for up to 1,400,000 shares of TransAct common stock. At December 31, 2018, 495,291 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average per share fair value of stock option grants for 2018, 2017, +and 2016 was $4.38, $1.95 and $1.70, respectively. In 2018 and 2017, we also issued restricted share units for certain executives and directors that vest over a specified period of time, and in some instances require achieving certain performance +metrics. The weighted-average per share fair value of these restricted share units was $12.91, $7.53 and $7.31 in 2018, 2017 and 2016 respectively. No restricted share units were issued in 2016. +The table below indicates the key assumptions used in the option valuation calculations for options granted in 2018, 2017, and 2016 +and a discussion of our methodology for developing each of the assumptions used in the valuation model: +Year Ended December 31, +2018 +2017 +2016 +Expected option term (in years) +6.8 +6.8 +6.9 +Expected volatility +38.0 +% +36.2 +% +38.8 +% +Risk-free interest rate +2.7 +% +2.1 +% +1.2 +% +Dividend yield +2.6 +% +4.3 +% +4.5 +% +F-13 +Expected Option +Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase +in the expected term will increase compensation expense. +Expected +Volatility – The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An +increase in the expected volatility factor will increase compensation expense. +Risk-Free +Interest Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +Dividend +Yield –The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation +expense. +For 2018, 2017, and 2016, we recorded $629 thousand, $609 thousand, and $611 thousand of share-based compensation +expense, respectively, included primarily in general and administrative expense in our Consolidated Statements of Income. We also recorded income tax benefits of $138 thousand, $134 thousand, and $184 thousand in 2018, 2017, and 2016 respectively, +related to such share-based compensation. At December 31, 2018, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Equity award activity in the 2005 Equity Incentive Plan and 2014 Equity Incentive Plan is summarized below: +Stock Options +Restricted Share Units +Number of Shares +Average Price* +Number of Units +Average Price** +Outstanding at December 31, 2017 +919,639 +$ +8.13 +101,275 +$ +8.21 +Granted +147,300 +13.65 +37,400 +13.69 +Exercised +(58,146 +) +7.16 +(33,935 +) +8.31 +Forfeited +(2,000 +) +7.63 +(6,140 +) +8.64 +Expired +(2,500 +) +5.24 +– +– +Outstanding at December 31, 2018 +1,004,293 +$ +9.00 +98,600 +$ +9.82 +* +weighted average exercise price per share +** +weighted-average grant stock price per share +The following summarizes information about equity awards outstanding that are vested and expect to vest and equity awards that are +exercisable at December 31, 2018: +Equity Awards Vested and Expected to Vest +Equity Awards That Are Exercisable +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Stock Options +1,004,293 +$ +9.00 +$ +1,051 +6.1 +562,252 +$ +8.38 +$ +656 +4.7 +Restricted stock units +82,692 +– +743 +1.9 +– +– +– +– +* +weighted average exercise price per share +** +weighted-average contractual remaining term in years +Shares that are issued upon exercise of employee stock awards are newly issued shares and not issued from treasury stock. As of +December 31, 2018, unrecognized compensation cost related to non-vested equity awards granted under our stock incentive plans is approximately $1.2 million, which is expected to be recognized over a weighted average period of 2.2 years. +The total fair value of awards vested during the years ended December 31, 2018, 2017, and 2016 was $1.1 million, $1.1 +million, and $1.0 million, respectively. The total intrinsic value (which is the amount by which the stock price exceeded the exercise price on the date of exercise) of stock options exercised during the years ended December 31, 2018, 2017, and +2016 was $280 thousand, $958 thousand and $6 thousand, respectively. Cash received from option exercises was $416 thousand, $1.0 million and $23 thousand for 2018, 2017, and 2016, respectively. We recorded a realized tax benefit in 2018, 2017, +and 2016 from equity-based awards of $17 thousand, $150 thousand and $1 thousand, respectively, related to options exercised. Upon adoption of ASU 2016-09 in 2017 tax benefits realized on stock options exercises are included in income tax expense +and are no longer included as a component of cash flows. +Restricted stock: +We paid a portion of the 2015 incentive bonus for the chief executive officer and chief financial officer in the form +of 28,231 deferred stock units, respectively, with a corresponding credit recorded to Additional Paid in Capital (net of share relinquishments) in the amount of $151 thousand in 2016. Such deferred stock units were granted in February 2016 and +were fully vested at the time of grant. These units will be converted three years from the grant date to shares of the Company’s common stock on a one-for-one basis. The weighted average exercise price of the deferred stock units was $7.17. +Starting with the 2016 incentive bonus program, all incentive bonus payments are made in cash with no portion of the award paid in deferred stock units. +F-14 +11. Income taxes +The components of the income tax provision are as follows: +Year Ended December 31, +(In thousands) +2018 +2017 +2016 +Current: +Federal +$ +1,049 +$ +2,379 +$ +1,776 +State +85 +114 +70 +Foreign +13 +(49 +) +2 +1,147 +2,444 +1,848 +Deferred: +Federal +(117 +) +1,097 +(257 +) +State +10 +20 +(38 +) +Foreign +– +– +– +(107 +) +1,117 +(295 +) +Income tax provision +$ +1,040 +$ +3,561 +$ +1,553 +On December 22, 2017, the United States enacted significant changes to U.S. tax law following the passage and signing of the Tax +Reform Act. The legislation significantly changes U.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax system and imposing a one-time repatriation tax on undistributed foreign earnings. The Tax +Reform Act permanently reduces the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. Income tax effects resulting from changes in tax laws are accounted for by the Company in accordance with +authoritative guidance, which requires that these tax effects be recognized in the period in which the law is enacted. +On December 22, 2017, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting +Bulletin No. 118 ("SAB 118") to address the application of U.S. GAAP in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax +effects of the Tax Reform Act. SAB 118 provides a measurement period, not to exceed one year from the enactment of the Tax Reform Act. In accordance with SAB 118, the Company has recognized provisional tax impacts related to the revaluation of +deferred tax assets and liabilities and included these amounts in its consolidated financial statements for the year ended December 31, 2017, and no changes were made to these provisional amounts during the year ended December 31, 2018. As of +December 22, 2018 our accounting for the impact of the Tax Reform Act was complete. +The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets +and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are +measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. As a result of the reduction of TransAct's U.S. corporate income tax rate from 34% to 21% under the Tax +Reform Act, the Company revalued its ending net deferred tax assets at December 31, 2017 and recognized a provisional $1.3 million charge to income tax expense in the Company's consolidated statement of income for the year ended December 31, 2017. +The Tax Reform Act also provided for a one-time deemed mandatory repatriation of post-1986 undistributed foreign +subsidiary earnings and profits ("E&P") through the year ended December 31, 2017. The Company had no undistributed foreign E&P subject to the one-time mandatory repatriation and, therefore, did not recognize any income tax expense related +to undistributed foreign subsidiary E&P for the year ended December 31, 2017. +While the Tax Reform Act provides for a territorial tax system, beginning in 2018, it includes two new U.S. tax base +erosion provisions, the global intangible low-taxed income ("GILTI") provisions and the base-erosion and anti-abuse tax ("BEAT") provisions. The GILTI provisions require the Company to include in its U.S. income tax return foreign subsidiary +earnings in excess of an allowable return on the foreign subsidiary's tangible assets. The BEAT provisions in the Tax Reform Act eliminate the deduction of certain base-erosion payments made to related foreign corporations, and impose a minimum tax +if greater than regular tax. The Company is not currently subject to these taxes and therefore has not included any tax impacts of GILTI or BEAT in its consolidated financial statements for the year ended December 31, 2018 or 2017. +Our effective tax rates were 16.1%, 52.6%, and 30.0% for 2018, 2017, and 2016, respectively. The effective tax rate in +2018 was significantly lower due to the impact of the Tax Reform Act. In addition to the lowering of the corporate from 34% to 21%, the Tax Reform Act also provided the Company with a new deduction, the foreign-derived intangible income deduction. +The effective tax rate in 2017 was unusually high due to the initial impact of the Tax Reform Act as we recognized a provisional $1.3 million charge to income tax expense for the year ended December 31, 2017 as a result of revaluing our net +deferred tax assets using the new U.S. corporate tax rate of 21%. +At December 31, 2018, we have no federal or state net operating loss carryforwards, no R&D credit carryforwards, +and no state tax credit carryforwards. Foreign loss before taxes was $286 thousand, $563 thousand, and $235 thousand in 2018, 2017, and 2016, respectively. +F-15 +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in +the Consolidated Financial Statements. Our deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2018 +2017 +Deferred tax assets: +Foreign net operating losses +$ +390 +$ +328 +Depreciation +71 +107 +Inventory reserves +879 +845 +Deferred revenue +16 +16 +Warranty reserve +60 +59 +Stock compensation expense +682 +694 +Other accrued compensation +233 +363 +Other liabilities and reserves +278 +246 +Gross deferred tax assets +2,609 +2,658 +Valuation allowance +(390 +) +(328 +) +Net deferred tax assets +2,219 +2,330 +Deferred tax liabilities: +Other +21 +22 +Net deferred tax liabilities +21 +22 +Total net deferred tax assets +$ +2,198 +$ +2,308 +As of December 31, 2018 a valuation allowance of $390 thousand has been established for foreign net operating loss carryforwards that +are not expected to be used. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year Ended December 31, +(In thousands) +2018 +2017 +2016 +Balance, beginning of period +$ +328 +$ +423 +$ +340 +Additions charged to income tax provision +62 +67 +83 +Reductions credited to income tax provision +– +(162 +) +– +Balance, end of period +$ +390 +$ +328 +$ +423 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2018 +2017 +2016 +Federal statutory tax rate +21.0 +% +34.0 +% +34.0 +% +State income taxes, net of federal income taxes +1.2 +1.3 +0.4 +Valuation allowance and tax accruals +1.0 +1.6 +1.6 +Miscellaneous permanent items +0.7 +(0.5 +) +(1.2 +) +U.S. corporate tax rate change +0.0 +19.4 +0.0 +Stock option cancellations +0.0 +1.7 +0.0 +Uncertain tax positions +0.0 +(0.1 +) +(0.1 +) +Stock award excess tax benefit +(1.5 +) +(1.4 +) +0.0 +Foreign-derived intangible income deduction +(1.5 +) +0.0 +0.0 +R&D credit +(4.9 +) +(3.3 +) +(4.6 +) +Other +0.1 +(0.1 +) +(0.1 +) +Effective tax rate +16.1 +% +52.6 +% +30.0 +% +At both December 31, 2018 and 2017, we had $104 thousand of total gross unrecognized tax benefits that, if recognized, would +favorably affect the effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular +reconciliation of the gross amounts of unrecognized tax benefits at the beginning and end of the year is as follows: +December 31, +(In thousands) +2018 +2017 +Unrecognized tax benefits as of January 1 +$ +104 +$ +111 +Tax positions taken during the current period +28 +24 +Lapse of statute of limitations +(28 +) +(31 +) +Unrecognized tax benefits as of December 31 +$ +104 +$ +104 +We expect $25 thousand of the $104 thousand of unrecognized tax benefits will reverse in 2019 upon the expiration of the statute of +limitations. +F-16 +We recognize interest and penalties related to uncertain tax positions in the income tax provision. We have accrued +interest and penalties related to uncertain tax positions of $17 thousand as of December 31, 2018 and 2017. +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have +substantially concluded all U.S. federal income tax, state and local, and foreign tax matters through 2014. However, our federal tax returns for the years 2015 through 2017 remain open to examination. Various state and foreign tax jurisdiction tax +years remain open to examination as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +12. Earnings per share +For 2018, 2017, and 2016, earnings per share was computed as follows (in thousands, except per share amounts): +Year Ended December 31, +2018 +2017 +2016 +Net income +$ +5,426 +$ +3,211 +$ +3,617 +Shares: +Basic: Weighted average common shares outstanding +7,444 +7,423 +7,610 +Add: Dilutive effect of outstanding equity awards as determined by the +treasury stock method +315 +169 +45 +Diluted: Weighted average common and common equivalent shares outstanding +7,759 +7,592 +7,655 +Net income per common share: +Basic +$ +0.73 +$ +0.43 +$ +0.48 +Diluted +0.70 +0.42 +0.47 +The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options, +restricted stock units and performance stock awards, when the average market price of the common stock is lower than the exercise price of the related stock award during the period. These outstanding stock awards are not included in the computation +of diluted earnings per share because the effect would be anti-dilutive. Anti-dilutive stock awards excluded from the computation of earnings per dilutive share were 149,000, and 341,000, at December 31, 2018 and 2017 respectively. +13. Stock repurchase program +On March 1, 2018, our Board of Directors approved a new stock repurchase program (the "2018 Stock Repurchase +Program"). Under the 2018 Stock Repurchase Program, we are authorized to repurchase up to $5 million of our outstanding shares of common stock from time to time in the open market at prevailing market prices based on market conditions, share price +and other factors. The 2018 Stock Repurchase Program expires on December 31, 2019, if we do not discontinue the repurchase program prior to such time. We use the cost method to account for treasury stock purchases, under which the price paid for +the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. From the start of the 2018 Stock Repurchase Program on March 1, 2018 through December 31, 2018, we repurchased +156,410 shares of our common stock for approximately $2.0 million at an average price per share of $12.79. +During 2016 and 2017, under a prior repurchase program that was in place from February 25, 2016 through December 31, +2017, we purchased 499,843 shares of our common stock for $3.9 million at an average price of $7.86 per share. From January 1, 2005 through December 31, 2018, we repurchased a total of 4,044,842 shares of common stock for $32.1 million, at an +average price of $7.94 per share. +14. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area +table are based on the location of the customer and asset. +Year Ended December 31, +(In thousands) +2018 +2017 +2016 +Net sales: +United States +$ +43,518 +$ +48,720 +$ +45,542 +International +11,069 +7,591 +11,693 +Total +$ +54,587 +$ +56,311 +$ +57,235 +Fixed assets, net: +United States +$ +1,767 +$ +1,548 +$ +1,581 +International +505 +621 +660 +Total +$ +2,272 +$ +2,169 +$ +2,241 +Sales to international customers were 20%, 14%, and 20% of total sales in 2018, 2017, and 2016 respectively. Sales to Europe +represented 56%, 44%, and 56%, sales to the Pacific Rim (which includes Australia and Asia) represented 36%, 32%, and 34%, and sales to Canada represented 6%, 18%, and 8% of total international sales in 2018, 2017, and 2016 +respectively. International long-lived assets consist of net fixed assets located at our foreign subsidiary in the UK as well as our contract manufacturers in China, Thailand, Malaysia and Mexico. +F-17 +15. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2018 and 2017 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2018: +Net sales +$ +12,243 +$ +14,751 +$ +15,838 +$ +11,755 +Gross profit +5,862 +6,991 +8,004 +5,886 +Net income +680 +1,210 +2,574 +962 +Net income per common share: +Basic +0.09 +0.16 +0.35 +0.13 +Diluted +0.09 +0.16 +0.33 +0.12 +2017: +Net sales +$ +13,997 +$ +13,596 +$ +15,524 +$ +13,194 +Gross profit +6,093 +6,430 +7,519 +6,620 +Net income (loss) +943 +867 +1,813 +(412 +) +Net income (loss) per common share: +Basic +0.13 +0.12 +0.24 +(0.06 +) +Diluted +0.13 +0.12 +0.24 +(0.06 +) +16. Accounting pronouncements +In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. +2016-02, Leases (Topic 842 ), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both +parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed +purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a +right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases +today. ASU 2016-02 supersedes the previous leases standard, ASC 840, Leases , and is effective for public entities for annual periods beginning +after December 15, 2018 and for interim periods within those fiscal years. Early adoption is permitted. The Company does have leases for equipment and real property which exceed 12 months and we are in the process of finalizing our evaluation of +the impact of Topic 842. The Company intends to elect the package of practical expedients and currently expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and +right-of-use assets upon adoption of Topic 842. While we expect to record material right-of-use assets and corresponding lease liability upon adoption of Topic 482, we do not expect adoption of the guidance will result in a material impact on the +Company's results of operations or cash flows. +F-18 \ No newline at end of file diff --git a/raw/filings/0001017303/2018/0001017303-19-000020/filing_metadata.csv b/raw/filings/0001017303/2018/0001017303-19-000020/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..31550dc70b89927e3edf426882b37f303143b8ea --- /dev/null +++ b/raw/filings/0001017303/2018/0001017303-19-000020/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2019-03-18,2018-12-31,2019-03-18T19:09:24.000Z,0001017303-19-000020,form10k2018.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2018",8497759,1,0,https://www.sec.gov/Archives/edgar/data/1017303/000101730319000020/form10k2018.htm,https://www.sec.gov/Archives/edgar/data/1017303/000101730319000020/,2018,2018,1 diff --git a/raw/filings/0001017303/2018/0001017303-19-000020/item1.txt b/raw/filings/0001017303/2018/0001017303-19-000020/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..a492a6ad78fffbdf59098ba732c0cacfcb02231e --- /dev/null +++ b/raw/filings/0001017303/2018/0001017303-19-000020/item1.txt @@ -0,0 +1,174 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated (“TransAct”, the “Company”, “we”, “us”, or “our”) was incorporated in June 1996 and +began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing +and selling software-driven technology and printing solutions for high growth markets including restaurant solutions, point of sale (“POS”) automation and banking, casino and gaming, lottery, and oil and gas. Our world-class products are +designed from the ground up based on market and customer requirements and are sold under the AccuDate™, EPICENTRAL™, Epic®, Ithaca®, and Printrex® brand names. Known and respected worldwide for innovative designs and real-world service +reliability, our thermal, and inkjet printers and terminals generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents, as well as printed logging and plotting of data. We sell our products to +original equipment manufacturers (“OEMs”), value-added resellers, select distributors, as well as directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, the Caribbean Islands +and the South Pacific. We also offer world-class service, spare parts, accessories and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a +complete range of supplies and consumables used in the printing and scanning activities of customers in the restaurant and hospitality, banking, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com , and our direct selling team, we address the demand for these +products. Our primary operating, hardware research and development, and eastern region service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters, software research and development and western +region service center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”), and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney +Avenue, Suite 3B, Hamden, Connecticut, 06518, with a telephone number of (203) 859-6800. +Products, Services and Distribution Methods +Printers +and terminals: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal and inkjet printing technology for applications, primarily in the restaurant solutions, POS +automation and banking, casino and gaming, lottery, and oil and gas printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include +interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our restaurant solutions terminals also offer configurable menu options. In addition to our configurable printers and +terminals, we design and assemble custom printers for certain OEM customers. In collaboration with these customers, we provide engineering and manufacturing expertise for the design and development of specialized printers tailored to our +customers' business. +Restaurant +Solutions: Our line of AccuDate™ terminals for the restaurant solutions market combine hardware and software in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food +rotation labels, grab and go labels for prepared foods, and “enjoy by” date labels to help food service establishments and restaurants (including fine dining, casual dining, quick-serve, convenient stores and hospitality establishments) +effectively manage food safety and automate and manage back-of-the-restaurant operations. Our newest addition to the AccuDate™ product line, the AccuDate XL2e, is a unique Android® 5.0-based restaurant management terminal specifically designed to +meet the food preparation management and labeling needs of the restaurant and hospitality industries. In 2019, we rebranded the AccuDate XL2e as BOHA! TM . The BOHA! TM terminal can be used for food expiration date labeling and +grab and go labeling, along with account management and an analytics portal. In the restaurant solutions market, we use an internal sales force and, to a lesser extent distributors, to solicit sales directly from end-users. +POS +automation and banking: In the POS market, we sell several models of printers utilizing thermal printing technology. Our POS printers +are used primarily by quick-serve restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of +domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. In the banking market, we sell inkjet printers that +are used by banks, credit unions and other financial institutions to print deposit and withdrawal receipts and to validate checks at bank teller stations. In the banking market, we primarily sell our products directly to end-user banks and +financial institutions through the use of our internal sales force and, to a lesser extent, resellers. We exited the banking market as of December 31, 2018 and therefore did not expect any future sales. +Casino +and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLTs”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, +racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in monochrome, and offer various other features such as jam resistant bezels and a dual port interface that enables +casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting +Terminals and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines +directly to casinos and other gaming establishments and (2) through distributors. Until December 31, 2017, the Suzo-Happ Group was our primary worldwide distributor. However, effective January 1, 2018, we replaced Suzo-Happ Group with new +distributors in Asia and Australia and adopted a direct selling model in Europe utilizing our UK sales office. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales +through our distributors. +1 +We also offer a software solution, the EPICENTRAL™ Print System (“EPICENTRAL™” and “EPICENTRAL® SE”), including annual +software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real-time at the slot machine. With EPICENTRAL™, casinos can utilize the system to create multiple promotions and +incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. In 2017, we introduced EPICENTRAL® SE, a system edition version our software solution, that is +specifically designed to work with the existing bonusing modules of casino slot machine management systems. In addition, EPICENTRAL® SE provides an upgrade path to a full EPICENTRAL TM implementation in the event that an operator seeks +to expand its promotion and bonusing options beyond the slot machine management systems currently offered. +Lottery: We +primarily supply lottery printers to International Gaming Technology and its subsidiaries (“IGT”), our largest customer and the world’s largest provider of lottery terminals. We also sell the Epic 3000 printer, to our other lottery system +customers. Our lottery printers are designed for high-volume, high-speed printing of lottery tickets for various lottery applications. Sales of our lottery products are made directly to IGT and other lottery system customers, and are managed by +an internal sales representative. +Printrex: Printrex +printers include wide format, desktop and rack mounted and vehicle mounted black and white thermal printers used by customers in the oil and gas exploration industry to log and plot oil field and down hole well drilling data. The Printrex® brand +of printers also includes high-speed color inkjet desktop printers used by oil and gas field service companies to print logs at their data centers. We primarily sell our Printrex® products directly to oil field service and drilling companies and +OEM’s, as well as through regional distributors in the United States, Europe, Canada and Asia. We also maintain a dedicated Printrex® internal sales representative. +TSG : Through TSG, we proactively market the sale of consumable products (including inkjet cartridges, ribbons, receipt paper, color thermal paper, food +safety labels and other printing supplies), replacement parts, maintenance and repair services and testing services for all of our products and certain competitor’s products. Our maintenance services include the sale of extended warranties, +multi-year maintenance contracts, 24-hour guaranteed replacement product service called TransAct Xpress™ and TransAct Care™, and other repair services for our printers and terminals. Within the United States, we provide repair services through our +eastern region service center in Ithaca, New York and our western region service center in Las Vegas, Nevada. Internationally, we provide repair services through our European service center located in Doncaster, UK, and through partners +strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle +orders, shipping and general information. Technical and sales support personnel receive training on all of our manufactured products and services. +In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a +day, seven days a week, via our online webstore www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine +cost efficient materials, sourcing and assembly methods with high standards of workmanship. Approximately 99% of our printer and terminal production is primarily through three third-party contract manufacturers in Asia. The remaining 1% of our +products are assembled in our Ithaca, New York facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our hardware products in Ithaca, New +York. Critical component parts and subassemblies include thermal and inkjet print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained +from domestic and foreign suppliers at competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers and terminals produced by our +contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or +unavailability. However, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy substantially all of our thermal print mechanisms, an important component of our thermal printers, and +fully assembled printers for several of our printer and restaurant solutions terminal models, from one foreign contract manufacturer and to a much lesser extent, one other foreign contract manufacturer. Although we believe that other contract +manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a +material adverse effect on our operating results. Although we do not have supply agreements with our foreign contract manufacturers, our relationship with our largest one remains strong and we have no reason to believe that they will discontinue +their supply of thermal print mechanisms or fully assembled printers to us during 2019 or that their terms to us will be substantially less favorable than they have been historically. We are currently seeking to find a second source for our +largest contract manufacturer in 2020. +Hewlett-Packard Company (“HP”) is the sole supplier of inkjet cartridges that are used in all of our banking inkjet +printers. Though we have exited the banking market as of December, 31, 2018, we still sell a substantial number of HP inkjet cartridges as a consumable product through TSG. Although other inkjet cartridges are compatible with our banking inkjet +printers, the loss of the supply of HP inkjet cartridges could have a material adverse effect on the sale of our TSG consumable products. Our relationship with HP remains stable and we have no reason to believe that HP will discontinue its supply +of inkjet cartridges to us or that their terms to us will be materially different than they have been historically. The inkjet cartridges we purchase from HP are used not only in our inkjet printers for the POS automation and banking market, but +also in other manufacturer’s printing devices across several other markets. +2 +Canon, Inc. (“Canon”) is the sole supplier of inkjet cartridges and other consumable items (“Canon Consumables”) that +are used in our Printrex® 980 oil and gas printer. The loss of supply of Canon Consumables would have a material adverse effect on the sale of Printrex 980® printers and the Canon Consumables. We have a supply agreement with Canon to supply us +with Canon Consumables until May 2019. Prices under this agreement were fixed through May 2013, but may be changed during the remainder of the agreement if the exchange rate fluctuates significantly between the Japanese yen and the U.S. dollar. +Patents and Proprietary +Information +TransAct relies on a combination of trade secrets, patents, employee and third-party nondisclosure agreements, +copyright laws and contractual rights to establish and protect its proprietary rights in its products. We hold 35 United States and 37 foreign patents and have 8 United States and 5 foreign patent applications pending pertaining to our +products. The duration of these patents range from 1 to 15 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and +attempt to protect them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to +our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal +protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the +operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this Annual Report on Form 10-K are the property of their respective owners. The trademarks we own +include TransAct®, BOHA! TM , AccuDate™, Epic, EPICENTRAL™, Ithaca® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this annual report on Form 10-K are listed without +the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions +during the holiday period, which may negatively impact sales of our restaurant solutions terminals or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are +in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +Certain Customers +IGT is our most significant customer and has been since 1996. On May 29, 2015, we signed an agreement with IGT to sell +on-line lottery and casino printers to IGT on a non-exclusive basis through December 31, 2019. Under the terms of the agreement, we sell on-line lottery and casino printers to IGT on a non-exclusive basis, and IGT purchases such printers from us +on a non-exclusive basis. This agreement allows TransAct to sell printers to other lottery system customers beyond IGT. +In September 2013, we signed an agreement with Suzo-Happ to be our exclusive worldwide distributor of casino and gaming +products through December 31, 2017. We did not renew the agreement upon its expiration. Beginning January 1, 2018, we replaced Suzo-Happ with new distributors in Asia and Australia and expanded our sales office in the UK to begin selling directly +to end-user customers in Europe. +Sales to IGT and Suzo-Happ representing 10% or more of our total net sales were as follows: +Year Ended December 31, +2018 +2017 +2016 +IGT +18 +% +35 +% +26 +% +Suzo-Happ +1 +% +8 +% +15 +% +Backlog +Our backlog of firm orders was approximately $6.9 million as of February 28, 2019, compared to $10.3 million as of +February 28, 2018. Based on customers’ current delivery requirements, we expect to fill and recognize as revenue $5.4 million of our current backlog during 2019 and the remaining $1.5 million during 2020. +Competition +The market for transaction-based and specialty printers and restaurant solutions terminals is extremely competitive, +and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL TM software due to the highly customized nature of the product. We compete with a number of companies, many of which have +greater financial, technical and marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, +product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us +and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +3 +In the restaurant solutions market, we compete with Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, CMC +Daymark and Integrated Control Corp. We compete in this market based largely on our ability to provide highly specialized software and purpose-built products and ongoing technical support. +In the POS automation and banking market, we primarily compete with Epson America, Inc., which holds a dominant market +position of the POS markets into which we sell. We also compete, to a much lesser extent, with CognitiveTPG, Star Micronics America, Inc., Citizen -- CBM America Corporation, Pertech Industries, Inc., Addmaster, and Samsung/Bixolon. Certain +competitors of ours have greater financial resources and lower costs attributable to higher volume production which enables them to occasionally offer lower prices than us. However, we have exited the banking market and will continue to +deemphasize efforts in the POS automation market going forward as we have shifted our focus toward our higher-value, technology enabled restaurant solutions and casino and gaming products. +In the casino and gaming market (consisting principally of slot machine printing, VLT transaction printing and +promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA, Eurocoin and others. Certain of our products sold for casino and gaming applications compete based upon our ability to +provide highly specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we compete with other lottery +printer providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. +In the oil and gas market, our Printrex® products compete primarily with the products of Imaging Systems Group, Inc. +and Neuralog Inc. We compete in this market based largely on our ability to provide specialized, custom-engineered products. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, +including POS and internet resellers, and label converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop new products (hardware and software), such as BOHA! TM +in 2019, and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our geographic market penetration, to take advantage of strategic relationships, and to lower the cost of our +product by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our +products utilize certain thermal and inkjet printing technologies. If other technologies, or variations to existing technologies, were to evolve or become available to us, it is possible that we would incorporate these technologies into our +products. Alternatively, if such technologies were to evolve or become available to our competitors, our products could become obsolete, which could have a significant negative impact on our business. +Environment +We are not aware of any material noncompliance with federal, state and local provisions that have been enacted or +adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. +Available Information +We make available free of charge through the “Investor Relations” tab on our Internet website, www.transact-tech.com, +our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and +Exchange Commission (“SEC”). The SEC maintains all reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http;//www.sec.gov. As such, you may read any materials filed by the +Company with the SEC at http://www.sec.gov. The references to the foregoing website addresses do not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document. +Employees +As of December 31, 2018, TransAct and our subsidiaries employed 126 persons, all of whom were full-time +employees. None of our employees are unionized, and we consider our relationships with our employees to be good. \ No newline at end of file diff --git a/raw/filings/0001017303/2018/0001017303-19-000020/item13.txt b/raw/filings/0001017303/2018/0001017303-19-000020/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..2b88c791e9783adee218ca4d7560a06b0f24c920 --- /dev/null +++ b/raw/filings/0001017303/2018/0001017303-19-000020/item13.txt @@ -0,0 +1,3 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain +Relationships and Related Transactions” and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2018/0001017303-19-000020/item9a.txt b/raw/filings/0001017303/2018/0001017303-19-000020/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e8639f2b6d234073a3e75f7fa3b718df536e330e --- /dev/null +++ b/raw/filings/0001017303/2018/0001017303-19-000020/item9a.txt @@ -0,0 +1,27 @@ +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal +executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2018. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer +concluded that, as of December 31, 2018, our disclosure controls and procedures are effective at the reasonable assurance level. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, +means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported +within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that +it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required +disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the +cost-benefit relationship of possible controls and procedures. +25 +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting to +provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial +reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable +assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance +with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material +effect on the financial statements. +Management assessed our internal control over financial reporting as of December 31, 2018. Management based its +assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). Based on our assessment, management has concluded that our internal control +over financial reporting was effective as of December 31, 2018. +Attestation Report of the Registered Public Accounting Firm +The effectiveness of the Company’s internal control over financial reporting as of December 31, 2018 has been audited +by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in the report which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in the Company’s internal control over financial reporting that occurred during the quarter +ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001017303/2018/0001017303-19-000020/rp_note.txt b/raw/filings/0001017303/2018/0001017303-19-000020/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2018/0001017303-19-000020/rpt_disclosure.txt b/raw/filings/0001017303/2018/0001017303-19-000020/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..a18480773b8bfff0ab10000bfff69055446e2430 --- /dev/null +++ b/raw/filings/0001017303/2018/0001017303-19-000020/rpt_disclosure.txt @@ -0,0 +1,16 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains a Related Party Transactions Policy relating to the identification, review and approval of related party transactions, in addition to the +requirements of The Nasdaq Global Market (“Nasdaq”) and the SEC The Related Party Transactions Policy, which is administered by our Audit Committee, is set forth in our Standards of Business Conduct and Code of Ethics available under the “Corporate +Governance” tab on the “Investor Relations” page of our website at www.transact-tech.com. +In particular, our Standards of Business Conduct and Code of Ethics requires all directors, officers and employees to avoid any situation that involves an actual +or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company, including engaging in “Related Party Transactions.” The term “Related Party Transaction” means any transaction, +arrangement or relationship, or any series of similar transactions, arrangements or relationships, in which (i) the Company or any of its subsidiaries or Controlled Affiliates (as such term is defined in the policy) is or will be a participant, (ii) +the aggregate amount involved will or may be expected to exceed $120,000 in any fiscal year, and (iii) any Related Party has or will have a direct or indirect interest. A “Related Party” is defined as any person who is or was (since the beginning of +the last fiscal year for which the Company has filed an Annual Report on Form 10-K and proxy statement, even if such person does not presently serve in that role) an executive officer, director or nominee for director of the Company, any stockholder +owning more than 5% of any class of the Company’s voting securities, or an immediate family member of any such person. +The Chair of the Audit Committee must be notified prior to a Related Party engaging in a Related Party Transaction. The Audit Committee is then responsible for +reviewing the transaction. No transaction determined to be a Related Party Transaction will be approved or ratified if the transaction is contrary to the best interests of the Company. In determining whether to approve or ratify a Related Party +Transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same +or similar circumstances and the extent of the Related Party’s interest in the transaction. +From January 1, 2018 to the date of this Proxy Statement, there have not been any transactions subject to the Company’s Related Party Transactions Policy or of +the type described in Item 404 of Regulation S-K, and currently no such transactions are proposed. \ No newline at end of file diff --git a/raw/filings/0001017303/2020/0001017303-21-000020/rpt_disclosure.txt b/raw/filings/0001017303/2020/0001017303-21-000020/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..190c9444ee25cc589712b1019e506aaf38329811 --- /dev/null +++ b/raw/filings/0001017303/2020/0001017303-21-000020/rpt_disclosure.txt @@ -0,0 +1,16 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains a Related Party Transactions Policy relating to the identification, review and approval of related party transactions, +consistent with the requirements of The Nasdaq Global Market (“Nasdaq”) and the SEC. The Related Party Transactions Policy, which is administered by our Audit Committee, is set forth in our Standards of Business Conduct and Code of Ethics available +under the “Corporate Governance” tab on the “Investor Relations” page of our website at www.transact-tech.com. +In particular, our Standards of Business Conduct and Code of Ethics requires all directors, officers and employees to avoid any situation +that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company, including engaging in “Related Party Transactions.” The term “Related Party Transaction” +means any transaction, arrangement or relationship, or any series of similar transactions, arrangements or relationships, in which (i) the Company or any of its subsidiaries or Controlled Affiliates (as such term is defined in the policy) is or will +be a participant, (ii) the aggregate amount involved will or may be expected to exceed $120,000 in any fiscal year, and (iii) any Related Party has or will have a direct or indirect interest. A “Related Party” is defined as any person who is or was +(since the beginning of the last fiscal year for which the Company has filed an Annual Report on Form 10-K and proxy statement, even if such person does not presently serve in that role) an executive officer, director or nominee for director of the +Company, any stockholder owning more than 5% of any class of the Company’s voting securities, or an immediate family member of any such person. +The Chair of the Audit Committee must be notified prior to a Related Party engaging in a Related Party Transaction. The Audit Committee is +then responsible for reviewing the transaction. No transaction determined to be a Related Party Transaction will be approved or ratified if the transaction is contrary to the best interests of the Company. In determining whether to approve or +ratify a Related Party Transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated +third party under the same or similar circumstances and the extent of the Related Party’s interest in the transaction. +From January 1, 2019 to the date of this Proxy Statement, there have not been any transactions subject to the Company’s Related Party +Transactions Policy or of the type described in Item 404 of Regulation S-K, and currently no such transactions are proposed. \ No newline at end of file diff --git a/raw/filings/0001017303/2021/0001017303-22-000014/filing.txt b/raw/filings/0001017303/2021/0001017303-22-000014/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..696c0e7cce37ecd0dccfcdd71d4b48b97054f309 --- /dev/null +++ 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REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2021 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from __________ to __________ +Commission file number: 0-21121 +TRANSACT TECHNOLOGIES INC +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center , +2319 Whitney Avenue, Suite 3B , Hamden , +CT +06518 +(Address of principal executive offices) +(Zip Code) +( 203 ) +859-6800 +(Registrant’s Telephone Number, Including Area Code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common stock, par value $0.01 per share +TACT +NASDAQ Global Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes □ No ⌧ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes □ No ⌧ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities +Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No □ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant +to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes +⌧ No □ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller +reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer □ +Accelerated filer □ +Non-accelerated filer ⌧ +Smaller reporting company ☒ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for +complying with any new or revised financial standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a +report on and attestation to its management’s assessment of the effectiveness of internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or +issued its audit report. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ⌧ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant was approximately $ 119,400,000 based on the last sale price on June 30, 2021. +As of February 28, 2022, the +number of shares outstanding of the Registrant’s common stock, $0.01 par value, was 9,889,745 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Definitive Proxy Statement related to its 2022 Annual Meeting of Stockholders (the “Proxy Statement”) to be filed with the Securities and Exchange Commission within 120 days after the Registrant’s fiscal year end of December 31, 2021 are incorporated by reference into Part III of this Annual Report on Form 10-K. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +8 +Item 1B. +Unresolved Staff Comments +19 +Item 2. +Properties +19 +Item 3. +Legal Proceedings +19 +Item 4. +Mine Safety Disclosures +19 +PART II. +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +20 +Item 6. +[Reserved] +20 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +20 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +30 +Item 8. +Financial Statements and Supplementary Data +30 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +30 +Item 9A. +Controls and Procedures +30 +Item 9B. +Other Information +31 +Item 9C. +Disclosure Regarding Foreign Jurisdiction that Prevent Inspections +31 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +32 +Item 11. +Executive Compensation +32 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +32 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +32 +Item 14. +Principal Accounting Fees and Services +32 +PART IV. +Item 15. +Exhibits and Financial Statement Schedules +33 +Item 16. +Form 10-K Summary +35 +SIGNATURES +Signatures +36 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +Smaller Reporting Company—Scaled Disclosure +Pursuant to Item 10(f) of Regulation S K promulgated under the Securities Act of 1933, as amended +(the “Securities Act”), as indicated herein, we have elected to comply with certain scaled disclosure requirements applicable to “smaller reporting companies” in this Annual Report on Form 10-K for the year ended December 31, 2021 (this “Form 10-K”). +PART I +Forward-Looking Statements +Certain statements included in this Form 10-K may include “forward-looking statements” within the meaning of the +U.S. federal securities laws, including the Private Securities Litigation Reform Act of 1995. Forward-looking statements are any statements other than statements of historical fact. Forward-looking statements represent current views about possible +future events and are often identified by the use of forward-looking terminology, such as “may,” “will,”, “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project” or “continue” or the negative thereof or other similar words. Forward-looking +statements are subject to certain risks, uncertainties and assumptions. In the event that one or more of such risks or uncertainties materialize, or one or more underlying assumptions prove incorrect, actual results may differ materially from those +expressed or implied by the forward-looking statements. +Important factors and uncertainties +that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include, but are not limited to, the following: the adverse effects of the COVID-19 pandemic on our business, operations, financial +condition, results of operations and capital resources, including difficulties or delays in manufacturing or delivery of inventory or other supply chain disruptions, shutdowns and/or operational restrictions imposed on our customers, an inability of +our customers to make payments on time or at all, diversion of management attention, necessary modifications to our business practices and operations, cost cutting measures we have made and may continue to make, a possible future reduction in the +value of goodwill or other intangible assets, inadequate manufacturing capacity or a shortfall or excess of inventory as a result of difficulty in predicting manufacturing requirements due to volatile economic conditions, price increases or decreased +availability of component parts or raw materials, exchange rate fluctuations, volatility of, and decreases in, trading prices of our common stock and the availability of needed financing on acceptable terms or at all; our ability to successfully +develop new products that garner customer acceptance and generate sales, both domestically and internationally, in the face of substantial competition; our reliance on an unrelated third-party to develop, maintain and host certain web-based food +service application software and develop and maintain selected components of our downloadable software applications pursuant to a non-exclusive license agreement, and the risk that interruptions in our relationship with that third-party could +materially impair our ability to provide services to our food service technology customers on a timely basis or at all and could require substantial expenditures to find or develop alternative software products; our ability to successfully transition our business into +the food service technology market; risks associated with potential future acquisitions; general economic conditions; our dependence on contract manufacturers for the assembly of a large portion of our products in Asia; our dependence on significant +suppliers; our ability to recruit and retain quality employees as the Company grows; our dependence on third-parties for sales outside the United States; marketplace acceptance of new products; risks associated with foreign operations; the +availability of third-party components at reasonable prices; price wars or other significant pricing pressures affecting the Company’s products in the United States or abroad; increased product costs or reduced customer demand for our products due to +changes in U.S. policy that may result in trade wars or tariffs; our ability to protect intellectual property; the effect of the United Kingdom’s withdrawal from the European Union; and other risk factors identified and discussed in Part I, Item 1A, +Risk Factors , and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , of this Form 10-K and that may be detailed from time to time in the Company’s other reports filed with the Securities and Exchange Commission (the “SEC”). +We caution readers not to place undue reliance on forward-looking statements, which speak only as of the date of +this Form 10-K. We undertake no obligation to publicly or otherwise revise any forward-looking statements, whether as a result of new information, future events or other factors, except where we are expressly required to do so by law. +Item 1. Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was +incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August +22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high growth markets +including food service technology, point of sale (“POS”) automation and casino and gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL® +Ithaca®, and Printrex® brand names. During 2019, we launched a new line of products for the food service technology market, the BOHA! branded suite of cloud-based applications and companion hardware solutions. The BOHA! software and hardware products +help restaurants, convenience stores and food service operators of all sizes automate food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and +terminals generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents, as well as printed logging and plotting of data. We sell our technology to original equipment manufacturers (“OEMs”), value-added +resellers, select distributors and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class +service, support, labels, spare parts, accessories and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables +used in the printing activities of customers in the restaurant and hospitality, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the +demand for these products. Our primary operating, hardware research and development, and U.S. service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters and software research and development in Las +Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, +06518, with a telephone number of (203) 859-6800. +1 +Impact of the COVID-19 Pandemic +During the first two months of 2020 our business trends were in line with internal expectations; however, the challenges posed by the +COVID-19 pandemic on the United States and global economy increased significantly as the first quarter of 2020 progressed and continued throughout the remainder of 2020 and into 2021. Though we have begun to experience some recovery during 2021, +unfortunately, the massive economic and social disruptions across the world persist due to COVID-19, including the emergence of virus variants, and the measures implemented to mitigate its spread. The food service, casino and gaming, and oil and gas +industries have been particularly affected by the pandemic, and we expect such disruptions to continue to negatively impact our overall business for the foreseeable future. +As a result of the COVID-19 pandemic and measures implemented to mitigate its spread, we experienced decreased demand for our products +and lower than anticipated sales beginning in the second half of March 2020 and continuing through 2021, particularly in our food service technology and casino and gaming markets. We experienced some improvement in demand during the second half of +2020 through 2021 compared to the second quarter of 2020, as state and local governments lifted certain measures implemented earlier in 2020 to mitigate the spread of the virus, but demand remained lower than 2019. While we expect this improvement to +continue during 2022, the exact timing and pace of recovery is unknown. We have also experienced supply chain disruptions, including delayed product shipments from our two contract manufacturers located in Thailand and China that conduct almost all of +our printer and BOHA! hardware manufacturing, due to reduced operations and part shortages at these facilities. Our inventory levels decreased significantly during 2021 due to these supply chain disruptions and if these delays are sustained or +additional disruptions occur we may have insufficient inventory levels and our ability to deliver products to our customers on time or at all may be impaired. Below is a discussion of the impact we have experienced from the COVID-19 pandemic, and that +we believe will continue to experience for the foreseeable future in each of our markets. +Food service +technology and POS automation . In both our food service technology and POS automation markets, many restaurants and food service +establishments that were closed during much of the second quarter of 2020 started to reopen in the third quarter of 2020 as state and local governments began to ease restrictions put in place in response to the pandemic. Many of our customers +initially opened under restrictions that limited them to providing drive-through, take-out or delivery service without dine-in options, as well as limiting the volume of customers and employees on site at any one time. During the second half of 2020 +and throughout 2021 as these food service customers reopened for business, we experienced sales improvement compared to the second quarter of 2020. However, during the fourth quarter of 2020 and early in 2021, restaurants were again impacted by a +resurgence of the pandemic. Notwithstanding the gradual resumption of operations that began in the third quarter of 2020, our food service technology and POS automation customers continue to recover from the financial impact of the pandemic and we +expect new capital expenditures to be a lower priority for them in the near term, which we believe will continue to negatively impact sales of BOHA! hardware, software and label products, as well as sales of POS printers. However, food service +providers have been and are likely to continue to be required to develop and implement new or enhanced policies and operating procedures regarding cleaning, sanitizing and social distancing to ensure the safety of their employees and customers. +Additionally, our markets have experienced labor shortages and inflation in their food and labor costs. We believe that our BOHA! hardware, software and label products could prove to be helpful to our food service customers in efficiently and +effectively managing and complying with these new procedures, while also helping to overcome staffing issues and inflation, especially as many establishments are and will likely continue to be operating with reduced staff levels due to the continuing +labor shortage. +Casino and gaming . In the casino and gaming market, most casinos and other gaming establishments were closed worldwide during most of the second quarter of 2020. Many +casinos began to reopen in late May and early June 2020, but similar to restaurants, casino openings were slow and measured, starting with reduced capacity and limited gameplay based on social distancing guidelines. During the fourth quarter of 2020, +some casinos re-closed due to a resurgence of the pandemic. However, many casinos in the U.S. reopened during the first quarter of 2021 with limited capacity and continued to remain open and further expand capacity during the remainder of 2021. We +anticipate that casinos will continue to increase capacity over time, barring any new closures or reduced capacity requirements in response to any new resurgence of the pandemic, including the emergence of variants. Though sales of our casino and +gaming products increased during 2021, and we expect this trend to continue into 2022, casinos continue to recover from the financial impact of the COVID-19 pandemic, and therefore we expect that certain casinos’ appetite for purchases of new slot +machines may be diminished, which may negatively impact sales of casino and gaming printers purchased by slot manufacturers for use in slot machines at casinos during 2022. +Lottery . We exited the lottery market at the end of 2019 and IGT made a final purchase of our lottery printer during the second quarter of 2020. Therefore, +COVID-19 has not had an impact on our lottery printer sales, and we do not anticipate that it will have an impact on our future lottery printer sales. +Printrex . The oil and gas market was negatively impacted by the decline in worldwide oil prices attributable to the COVID-19 pandemic during 2020. During the +latter half 2021, oil and gas prices began to rise again, resulting in slowly improving sales to our oil and gas customers. However, we made a strategic decision to exit the Printrex market as of December 31, 2021 and expect to have no future sales in +this market beyond 2021. +TSG . Due to closures and reduced operating capacity of restaurants, retail establishments, casinos and other gaming establishments resulting from the +COVID-19 pandemic, sales of spare parts, service and consumable products have declined, and we expect such sales to remain at reduced levels, due to lower usage while customers continue to recover from the impact of the pandemic. +Our gross margin has been negatively impacted and we expect our gross margin to continue to be negatively impacted while the COVID-19 +pandemic and its economic effects on the markets we serve persists. As a result of an expected lower sales level, as well as increased material and shipping costs resulting from worldwide supply disruptions caused by the COVID-19 pandemic, we believe +our gross margin will remain lower than pre-pandemic levels due to fixed manufacturing overhead expenses (such as facility costs, depreciation, etc.) that cannot be reduced or eliminated even with the lower sales level. +2 +While we began to experience a modest recovery starting in the second half of 2020 and continuing into 2021 and expect this recovery to +continue during 2022, the exact timing and pace of recovery is unknown given uncertainty surrounding responsive measures to potential future resurgences of the virus, vaccination rates, the emergence of virus variants and the significant disruption +that our customers and suppliers have already experienced and may continue to experience. In light of this uncertainty, we implemented a number of cost saving measures during 2020 to help mitigate the impact on our financial position and operations +and continued to limit discretionary spending during 2021. +In addition to the expense management actions implemented during 2020, we took the following actions to increase liquidity and +strengthen our financial position: +● +Public Offerings – On October 16, 2020 and August 16, 2021, the Company raised net proceeds +of $8.7 million and $11.2 million ( including the exercise of the underwriters’ overallotment options on October 16, 2020 and August 20, 2021) , respectively, +after deducting underwriting discounts, commissions and offering expenses, through underwritten public offerings and sold an aggregate of 1,380,000 and 842,375 shares of common stock, respectively. +● +PPP Loan – On May 1, 2020, the Company was granted a $2.2 million loan (the “PPP Loan”) under +the Paycheck Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”) established under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which enabled us to return +employees we furloughed earlier in 2020 to full time employment and to restore employees to full pay following certain pay cuts . On July 8, 2021, we +received notice that the PPP Loan had been forgiven as of July 1, 2021. +● +Employee Retention Credit – Under the provisions of the CARES Act, the Company is +eligible for a refundable employee retention credit subject to certain criteria. In connection with the CARES Act, the Company recognized the employee retention credit during the fourth quarter of 2021 and recorded $1.5 million as “Gain from +employee retention credit” in the Consolidated Statement of Operations and the related receivable as “Employee retention credit receivable”” in the Consolidated Balance Sheet as of December 31, 2021. We expect to receive these funds during +2022 . +● +New Credit Facility – On March 13, 2020, we entered into a new credit facility with Siena Lending Group LLC that provides a revolving credit line of up to $10.0 million, +subject to a borrowing base. +● +Reduced Capital Expenditures – We limited capital expenditures during 2020 and gradually increased expenses during 2021 as our sales improved. +Since the onset of the pandemic, our top priority has been to ensure the health and safety of our employees while continuing to provide +our customers with high-quality, personalized service. On March 20, 2020, we instituted work-from-home practices for the majority of our employees to reduce the spread of COVID-19 and to comply with government mandates. Because most of our employees +already had laptop computers with remote access into our IT systems, we experienced only minor reductions in productivity and minimal costs related to the implementation of our work-from-home practices. In addition, even with the move to a +work-from-home environment, our internal control structure remained operational and unchanged. +As of October 4, 2021, all of our employees were fully vaccinated against COVID-19 and, as a result, we implemented a return-to-work +plan, reopening all of our facilities and ending our work-from-home practices. Our distribution centers, deemed an essential service, remained operational throughout the pandemic. During 2020, we implemented new COVID-19 policies, most of which were +still in place prior to ending our work-from-home practices, to specifically address health and safety guidelines for employees to adhere to and follow when at work. These policies were based on the COVID-19 safety guidelines recommended by the +Centers for Disease Control and Prevention. +We have evaluated the recoverability of the assets on our Consolidated Balance Sheet as of December 31, 2021 in accordance with +relevant authoritative accounting literature. We considered the disruptions caused by the COVID-19 pandemic, including lower than previously forecasted sales and customer demand and macroeconomic factors potentially impacting accounts receivable, +inventory, investments, intangible assets, goodwill and other assets and liabilities. Where forward-looking estimates are required, we made a good-faith estimate based on information available as of the balance sheet date. We have continued to monitor +for indicators of impairment through the date of this Report and reflected accordingly in the accompanying consolidated financial statements. +Notwithstanding the foregoing, there is no assurance that the actions we have taken in response to the pandemic are sufficient or +adequate, and we may be required to take additional preventive or responsive measures, as the ultimate extent of the effects of the COVID-19 pandemic on the Company, our financial condition, results of operations, liquidity, and cash flows are +uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, Item 1A, Risk Factors, of this Form 10-K for further discussion of risks related to COVID-19. +3 +Products, Services and Distribution Methods +Printers, terminals +and other hardware: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal printing technology for applications, primarily in the food service technology, POS +automation, casino and gaming, and prior to exiting the market on December 31, 2021, the oil and gas printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. +Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our food service technology terminals also offer software configurable menu options. Our food service +technology market also includes sales of hardware products including temperature probes, temperature sensors and gateways. +Food Service +Technology (“FST”): The primary offering in the FST market is our BOHA! ecosystem, which combines our latest generation terminal/workstation, cloud-based software +applications and related hardware into a unique solution to automate back-of-house operations in restaurants, convenience stores and food service operations . The +software component of BOHA! consists of a suite of software-as-a-service (“SaaS”)-based applications, including applications for temperature monitoring of food and equipment, timers, food safety labeling, media libraries, checklists and task lists +and equipment service management. Any and all of these applications can be chosen by our customer and packaged into a single platform with the associated hardware, which includes the BOHA! terminal, handheld devices, tablets, temperature probes and +temperature sensors and gateways. The BOHA! terminal combines the software and hardware components in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, +grab-and-go labels for prepared foods, nutritional labels and “enjoy by” date labels. The BOHA! Workstation is a hardware device that pairs two mechanisms with an Apple iPad utilizing an iOS operating system. Both the BOHA! terminal and BOHA! +workstation are equipped with the TransAct Enterprise Management System to ensure that only approved applications and functions are available on the device and allows over-the-air updates to the applications and operating system. BOHA! helps food +service establishments and restaurants (including fine dining, casual dining, fast casual and quick-serve restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go +initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are charged to customers upfront on a per-application basis, as well as sales of +labels, extended warranty and service contracts, and technical support services. In the food service technology market, we use an internal sales force to solicit sales directly from end users. +POS automation: In the POS market, we sell a printer utilizing thermal printing technology. Our POS printer is used primarily by McDonald’s, and to a lesser extent, +other quick-serve restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and +international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. +Casino and gaming: +We sell several models of printers used in slot machines and video lottery terminals (“VLTs”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks and other gaming +venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in monochrome and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and +promotions. In addition, we sell printers using thermal roll-fed printing technology for use in international non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals, sports +betting establishments and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot +machines directly to casinos and other gaming establishments and (2) through distributors. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales through our distributors. +We also offer a software solution, the EPICENTRAL Print System, including annual software maintenance, that enables casino operators to +create promotional coupons and marketing messages and to print them in real time at the slot machine. With EPICENTRAL, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino +floor or encourage additional visits to generate more revenue to the casinos. +Lottery: +Our lottery printers were designed for high-volume, high-speed printing of lottery tickets for various lottery applications. We previously sold lottery printers to International Gaming Technology and its subsidiaries (“IGT”), our largest customer and +the world’s largest provider of lottery terminals. During 2019, we decided to exit this business and we expect no future sales beyond 2020. Sales of our lottery products were made directly to IGT and were managed by an internal sales representative +before we exited the business in 2019. +Printrex: Printrex printers include wide format, desktop and rack-mounted and vehicle-mounted black and white thermal printers used by customers to log and plot oil field, seismic +and down hole well drilling data in the oil and gas exploration industry . The Printrex brand of printers also includes high-speed color inkjet desktop printers used by oil +and gas field service companies to print logs at data centers of the oil and gas field service companies. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM’s, as well as through regional +distributors in the United States, Europe, Canada and Asia. During 2021, we decided to exit this business and in the fourth quarter of 2021 fulfilled last buy orders to our legacy customers. We expect no future sales of our Printrex products +beyond 2021. +TSG : Through TSG, we proactively market the sale of consumable products (including POS receipt paper, ribbons and other printing supplies), replacement +parts, maintenance and repair services, and shipping and handling charges. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, a 24-hour guaranteed replacement product service called TransAct Xpress™ and +other repair services for our non-FST products. Within the United States, we provide repair services through our service center in Ithaca, New York. Internationally, we provide repair services through our European service center located in Doncaster, +UK, and through partners strategically located around the world. +4 +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping +and general information. Technical and sales support personnel receive training on all our manufactured products and services. In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, +seven days a week, via our webstore, www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient +materials, sourcing and assembly methods with high standards of workmanship. Almost all of our printers and terminals are produced by two third-party manufacturers located in Thailand and China. A small portion of our products are assembled in our +Ithaca, New York facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our hardware products in Ithaca, New York. Critical component +parts and subassemblies include thermal print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at +competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers and terminals produced by our contract manufacturers and, to a much +lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or unavailability. However, we could +experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy a majority of our thermal print mechanisms, an important component of our thermal printers, and fully assembled +printers for several of our printer and food service technology terminal models, from one foreign contract manufacturer in Thailand and to a lesser extent, one other foreign contract manufacturer in China. Although we believe that other contract +manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material +adverse effect on our operating results. Although we do not have supply agreements with our foreign contract manufacturers, our relationship with both remain strong and we have no reason to believe that either will discontinue their supply of thermal +print mechanisms or fully assembled printers to us during 2022 or that their terms to us will be substantially less favorable than they have been historically. Due to the impact from Chinese tariffs starting in 2019, during 2020 and 2021, we +increasingly transferred production from our contract manufacturer in China to our contract manufacturer in Thailand. We plan to continue transferring production to our Thailand-based contract manufacturer during 2022. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third-party nondisclosure agreements, copyright laws and +contractual rights to establish and protect its proprietary rights in its products. As of February 28, 2022, we hold 37 United States and 33 foreign patents and have 3 foreign patent applications pending pertaining to our products. The remaining +duration of these patents ranges from 1 to 18 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect +them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third-parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, +information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to +protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our +business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, BOHA! TM , +AccuDate™, Epic, EPICENTRAL®, Ithaca® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest +extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the +holiday period, which may negatively impact sales of our food service technology products or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance +with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +5 +Certain Significant Customers +IGT is our most significant customer, although to a lesser extent than in previous years, and has been since 1995. We sell casino and +gaming printers and, prior to 2021, on-line lottery printers to IGT. On May 29, 2015, we signed an agreement with IGT to sell on-line lottery and casino printers to IGT on a non-exclusive basis through December 31, 2019. We decided not to renew the +agreement upon its expiration and to exit the on-line lottery market. Although we no longer have an agreement with IGT, we expect to continue selling casino and gaming printers to IGT, as well as spare parts for our remaining, but declining, installed +base of lottery printers, in the future. +Sales to IGT represented 9% and 15% of our total net sales for the years ended December 31, 2021 and 2020, respectively. +Backlog +Our backlog of firm orders was approximately $14.2 million as of February 28, 2022, compared to $3.4 million as of February 28, 2021. +The increase in firm orders as of February 28, 2022 compared to February 28, 2021 is due primarily to advance orders placed by our casino and gaming customers due to increased production lead time, resulting from worldwide supply chain shortages caused +by the pandemic. Based on customers’ current delivery requirements, we expect to fill and recognize as revenue $13.7 million of our current backlog during 2022, $0.4 million during 2023 and the remaining balance of the amount during 2024. +Competition +The market for transaction-based and specialty printers and food service technology terminals is extremely competitive, and we expect +such competition to continue in the future. However, we experience less competition for EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and +marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer +support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, +economic and political conditions and, in some cases, the uniqueness of our products. +In the food service technology market, we primarily +compete with Zenput, Squadle Inc., Jolt Software, Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, CMC Daymark, Integrated Control Corp, Digi International, and Toast. We compete in this market based largely on our ability to provide highly +specialized software and purpose-built hardware products and ongoing technical support. We rely upon third-party developed software and hosting services combined with our own proprietary hardware and software to offer a unique BOHA! branded +solution to support back-of-house operations in the food service industry. Our competitors or others may develop, or may establish relationships with developers with the capability to develop, software and services that are similar to or competitive +with ours, which may be disadvantageous to our competitive position. Certain portions of our food service technology software are licensed from a third-party developer on a non-exclusive basis through 2031 and are subject to a revenue sharing +arrangement with the developer. We are reliant upon the third-party developer to further develop and maintain its developed software, and the developer controls the software source code. The license agreement does not preclude the developer from +working with others on similar products. Also, the third-party developer hosts the web-based applications. Therefore, presently, we are highly dependent upon this third-party developer for continued service to our customers and the further development +of our food service technology software products. +In the POS automation market, we primarily compete with Epson America, Inc., which holds a dominant market position. We also compete, +to a much lesser extent, with Star Micronics America, Inc. and Citizen -- CBM America Corporation. Certain competitors of ours have greater financial resources and lower costs attributable to higher volume production which enables them to occasionally +offer lower prices than us. However, we will continue to deemphasize efforts in the POS automation market going forward as we have shifted our focus toward our higher-value, technology-enabled food service technology and casino and gaming products. +In the casino and gaming market (consisting principally of slot machine printing, VLT transaction printing and promotional coupon +printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA, Eurocoin and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly +specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we competed with other lottery printer +providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. However, we exited the lottery market in 2019 and shifted our focus toward our higher-value, technology enabled food service technology and casino and gaming products. +In the oil and gas market, our Printrex products competed primarily with the products of Imaging Systems Group, Inc. and Neuralog Inc. +However, we exited the oil and gas market at the end of 2021 in order to shift our focus toward our higher-value, technology enabled food service technology and gaming products. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, including POS and +internet resellers and paper converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop and/or license new products (hardware and software), such as +launching BOHA! in 2019, and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our market penetration, to take advantage of strategic relationships, and to lower the cost of our +products by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products +utilize certain thermal printing technologies and licensed software. If new technologies are introduced, or existing technologies evolve, we may be required to incorporate these technologies into our products. Alternatively, if such technologies were +to become available to our competitors, our products could become obsolete, which could have a significant negative impact on our business. +6 +Environmental Compliance +Our compliance with federal, state and local laws and regulations relating to environmental protection and discharge of hazardous +materials has not had a material impact on our capital expenditures, earnings or competitive position, and we do not anticipate any material impact from such compliance in the future. +Available Information +We make available free of charge through the “Investor Relations” tab on our Internet website, www.transact-tech.com, our Annual Report +on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and all amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC +pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file +electronically with the SEC at http://www.sec.gov. The content on any website referred to in this Form 10-K is not incorporated by reference in this Form 10-K unless expressly noted. +Employees +As of December 31, 2021, TransAct and our subsidiaries employed 118 persons, all of whom were full-time employees. None of our +employees are unionized, and we consider our relationships with our employees to be good. +Information about our Executive Officers +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with +the registrant held by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +64 +Chairman of the Board and Chief Executive Officer +Steven A. DeMartino +52 +President, Chief Financial Officer, Treasurer and Secretary +Tracey S. Chernay +62 +Senior Vice President, Casino, Gaming and Lottery Sales +Andrew J. Hoffman +64 +Senior Vice President, Operations +David B. Peters +43 +Vice President and Chief Accounting Officer +Brent Richtsmeier +57 +Chief Technology Officer +Bart C. Shuldman has been Chief Executive Officer and a Director of the Company since its formation in June 1996. In February 2001, +Mr. Shuldman was elected Chairman of the Board. Mr. Shuldman served as President of the Company from its formation until June 2010, when he relinquished the President title to focus on new products and markets, international expansion and potential +acquisitions. +Steven A. DeMartino was named as TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, +Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate +Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Tracey S. Chernay was appointed Senior Vice President, Casino and Gaming Sales and Marketing in June 2010, with responsibility for the +sales and marketing of all casino and gaming products. Previously, Ms. Chernay served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking with the Company from July 2006 +to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Chernay was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales +Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Andrew J. Hoffman was appointed Senior Vice President, Operations for TransAct in November 2004. He served as Vice President, +Operations from September 1994 to November 2004. +David B. Peters was appointed Vice President and Chief Accounting Officer on March 1, 2018. Previously, Mr. Peters served as Director, +SEC and Financial Reporting since joining TransAct in March 2014. Prior to joining TransAct, Mr. Peters was employed with United Technologies Corporation from November 2006 to March 2014 where he served in various financial management positions. Mr. +Peters is a certified public accountant. +Brent Richtsmeier was named as Chief Technology Officer in +September 2021. Previously, Mr. Richtsmeier served as Senior Vice President, Software Engineering since joining TransAct in December 2019 and was appointed as an officer of the Company in January 2021. Prior to joining TransAct, Mr. +Richtsmeier was employed with Samsung, an electronics corporation, from May 2004 until November 2017 as the VP of Development where he was responsible for software strategy, software development at scale and business development. In November 2017, +Samsung Electronics sold their business products division to HP Inc, and Mr. Richtsmeier transferred to HP Inc to become the Global Head of Cloud and Mobile Software Solutions until joining TransAct in 2021. +There are no family relationships between any of our executive officers and there is no arrangement or understanding between any of +such officers and any other person pursuant to which he or she was selected as an officer. Each of our executive officers was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her +earlier resignation or removal. +7 +Item 1A. Risk Factors +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are not +the only ones facing our Company. Additional risks and uncertainties not presently known to us, or that we currently believe to be immaterial, may also impair our business operations. In the event that such risks or uncertainties materialize, our +business, financial condition, and results of operations could be materially adversely affected. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking +statements contained in this Form 10-K to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +Risks Related to our Business +We experienced a net loss in 2020 and 2021, anticipate increasing expenses in the future, and we +may not be able to achieve, maintain or increase profitability in the future. +We incurred a net loss of $5.6 million and $4.1 million in 2020 and 2021, respectively,, we anticipate increasing expenses in the +future, and we may not be able to achieve, maintain or increase profitability in the future. We expect our costs to increase over time and our losses to continue as we expect to invest significant additional funds towards growing our food service +technology business and transitioning away from other lines of business. We have expended and expect to continue to expend substantial financial and other resources on developing our food service technology business, including expanding our offerings, +developing or acquiring new products and services and increasing our sales and marketing efforts. These efforts may be more costly than we expect and may not result in increased revenue or growth in our food service technology business. Any failure to +increase our revenue sufficiently to keep pace with our investments and other expenses could prevent us from achieving, maintaining or increasing profitability or positive cash flow on a consistent basis. If we are unable to successfully address these +risks and challenges as we encounter them, our business, financial condition, and results of operations could be adversely affected. If we are unable to generate adequate revenue growth and manage our expenses, we may continue to incur significant +losses in the future and may not be able to achieve, maintain or increase profitability +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter-to-quarter and year-to-year and are likely to continue to vary +due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical operating +results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may be due to a number of factors, including, but not limited to, those identified below and throughout this “Risk +Factors” section: +● +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +● +the geographic distribution of our sales and our supply chain; +● +market acceptance of our products, both domestically and internationally; +● +development of new competitive products by others; +● +our responses to price competition; +● +our level of research and development activities; +● +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +● +changes in the amount we spend to promote our products and services; +● +changes in the cost of satisfying our warranty obligations and servicing our installed base of products; +● +availability of third-party components at reasonable prices; +● +general economic and industry conditions, including changes in interest rates affecting returns on cash balances and investments, that affect customer demand; +● +the dependence of of our supply chain on a few, foreign third-party manufacturers and suppliers and the impact on our supply chain of product or component shortages and +cost increases due to events beyond our control, including the COVID-19 pandemic and political or social instability such as the ongoing Russia-Ukraine conflict; +● +severe weather events, public health crises, military actions and other external events out of our control that can disrupt our operations or the operations of our +customers’ or suppliers’ facilities; and +● +changes in accounting rules. +Due to all of the foregoing factors, and the other risks discussed in this Form 10-K, quarter-to-quarter comparisons of our operating +results may not be an indicator of future performance. +8 +The COVID-19 pandemic has had, and is likely to continue to have, an adverse impact on our +business, operations, financial condition, results of operations and capital resources, as well as on the operations and financial performance of many of our customers and +suppliers. We are unable to predict the ultimate extent to which the pandemic and related effects will adversely impact our business, operations, financial condition, results of operations, capital resources and the achievement of our strategic +objectives. +As a result of the COVID-19 pandemic and the numerous disease control measures taken to limit the spread of COVID-19, we have +experienced, and can be expected to continue to experience, disruptions to our business, our operations, the delivery of our products and customer demand for our products, including the following: +● +operating losses in excess of those we anticipated in transitioning our business focus toward the food service technology market, which, in addition to the factors +discussed below, may require us to seek to obtain additional capital through debt or equity financings or other arrangements to fund operations, or if such arrangements are not available, to take additional significant cost-cutting measures ; +● +supply chain disruptions, including delayed product shipments from two contract manufacturers located in Thailand and China that conduct substantially all of our printer +and BOHA! hardware manufacturing, which, if sustained, could lead to insufficient inventory levels and harm our ability to deliver products to our customers on time or at all, and cost increases as a result of such supply chain disruptions ; +● +continuing or new restrictions on the operations of our customers in the casino industry and food service industry, including, in some cases, partial or complete business +shutdowns, which have resulted in, and are likely to continue to result in, reduced demand for our products in the two primary markets that we serve ; +● +an inability of our customers to make payments in a timely fashion or at all, in the event that the downturn in economic conditions persist ; +● +devotion of significant time, management attention and resources to monitoring the COVID-19 pandemic and its impacts, and anticipated impacts, on our business, and +seeking to mitigate the effects of the pandemic on our business and workforce, which diverts management’s attention and resources away from strategic initiatives, new business opportunities, the transition of our business toward the food +service and casino and gaming markets, and the overall profitability of our business ; +● +a possible future reduction in the value of goodwill or other intangible assets causing the carrying value of such assets to exceed their fair value, which could require +us to recognize asset impairment ; +● +difficulty predicting our manufacturing requirements accurately due to volatile economic conditions, which could result, in the case of an underestimate, in inadequate +manufacturing capacity or inventory, interruptions in production and delayed deliveries to customers (with resulting losses in orders or customers lowering our net sales), or in the case of an overestimate, in an excess inventory of component +parts or manufactured products ; +● +increases in prices and/or decreases in availability of component parts and raw materials needed to produce our products ; +● +foreign exchange rate fluctuations due to volatile global economic conditions, which could negatively affect earnings and the value of our assets held outside the United +States, and if we increase prices to absorb a portion of the currency impact, could cause demand to decrease ; +● +volatility of, and decreases in, trading prices of our common stock ; and +● +t he possibility that we may need to raise additional capital through an equity or debt +financing to support operations but are unable to do so due to, among other things, global economic conditions, conditions in the global financing markets, trading prices of our common stock and the outlook for the industries that we serve, all +of which could be negatively impacted by the COVID-19 pandemic, such that there can be no assurance that such financing would be available to us. +If we issue equity or debt securities to raise additional funding, our existing shareholders may experience dilution and we may incur +significant financing costs. If we issue debt securities or otherwise incur additional debt, we would have additional debt service obligations, could become subject to additional restrictions limiting our ability to operate our business, and may be +required to further encumber our assets. +The resulting impacts from the COVID-19 pandemic continue to evolve rapidly, and additional material impacts and disruptions may occur. +The factors described above, which may worsen, have had and, along with other factors that we cannot predict, can be expected to continue to have, a material adverse impact on our business, operations, financial condition, results of operations and +capital resources. The ultimate impact of the COVID-19 pandemic on the Company is highly uncertain and subject to change and will depend on future developments, which cannot be accurately predicted, including the duration of the pandemic, additional +or modified government actions, new information that may emerge concerning the severity and impact of the COVID-19 pandemic, newly identified strains of COVID-19, vaccination rates and effectiveness of vaccines and treatments and the actions taken to +contain COVID-19 or address its impact in the short and long term, among others. We do not yet know and cannot predict the full extent of potential impacts on our business, operations, financial condition, results of operations and capital resources. +In addition, any of the risks and uncertainties set forth in this Form 10-K can be expected to be further heightened by the COVID-19 +pandemic and have a material adverse effect on the Company’s business, prospects, financial condition, results of operations and capital resources and the achievement of our strategic objectives +9 +We purchase component parts and consumable products from third-party and sole source suppliers, +and any interference with this supply chain may impact our ability to manufacture and sell our products. +We rely on third-party or sole source suppliers to provide certain key components for our products including BOHA! labels. We do not +have guaranteed supply contracts with any of our component suppliers, and our suppliers could delay shipments, increase prices or cease manufacturing or selling such components to us at any time, including as a result of the current global microchip +shortage. For example, in December 2021, one of our suppliers of certain printer components notified us that they would not fulfill an order. Although we were able to source the component from another supplier, the disruption resulted in a delay. +These supply chain disruptions have impacted, and are expected to continue to impact, our ability to maintain sufficient inventory on hand, which has necessitated payment of increased shipping charges to expedite products. In addition, we have +incurred increased costs to obtain certain products and components from alternate suppliers when our usual suppliers did not have products available for us. Cost increases and component shortages may be exacerbated by events beyond our control, such +as changing economic conditions, inflation, currency and commodity price fluctuations, tariffs, resource availability, transportation costs, weather conditions and natural disasters, political unrest and instability, war (such as the ongoing military +conflict between Russia and Ukraine) and other factors impacting supply and demand pressures. In particular, the conflict between Russia and Ukraine may materially and adversely affect our supply chain for materials, parts and components. Continued +or worsening disruptions in the supply chain of such component parts and consumable products could delay our production or release of our new products, cause us to incur additional freight costs and hinder our ability to meet our commitments to +customers. If we are unable to obtain sufficient quantity of these components on commercially reasonable terms or in a timely manner, or if we are unable to obtain alternative sources for the components, sales of our products could be delayed or halted +entirely or we may be required to redesign our products. There can be no assurance that any cost increases attributable to supply chain disruptions can be fully offset by price increases, or that we will continue to be able to fulfill orders on time +or at all, and continued or prolonged impacts on our supply chain may result in lost sales, reduced gross margins or damage to our end-customer relationships, which would have a material adverse effect on our financial results. +Our revenue and profitability depend on our ability to continue to develop or license, on a +timely basis, new products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated, and customer acceptance of such products. +Our success depends upon our and our development partners’ ability to timely adapt our capabilities and processes to meet the demands +of producing new and innovative products. Because our newer products contain software and generally are more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our +product innovation. If we cannot efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +In addition, even if we, or developers on our behalf, +successfully develop such products, there is no assurance that our innovations will be accepted by our customers. Developing and marketing new products, such as our BOHA! ecosystem, is costly, and our business could be materially adversely affected +if we are unable to generate sales of such products or if our existing or new customers do not quickly accept such products. Customer acceptance is crucial because new products typically have little competition and market penetration due to their +novelty. Customer acceptance of new products is never assured and may take time to materialize, even with respect to products developed with customer input. Further, technological innovation often results in unintended consequences such as bugs, +vulnerabilities, and other system failures. Any such bug, vulnerability, or failure, especially in connection with a significant technical implementation or change, could result in lost business, harm to our brand or reputation, consumer complaints, +and other adverse consequences, any of which could materially adversely affect our business, results of operations, and financial condition. +We rely on an unrelated third-party to develop, maintain and host certain portions of our food +service technology software, and any disruption in the relationship with that third-party, or any defects in the software provided by that third-party, could have a material adverse effect on our reputation, business, financial condition and results of +operations. +We rely upon third-party developed software and hosting services combined with our own proprietary hardware and software to offer our +unique BOHA! branded solution to support back-of-house operations in the food service industry. Certain web-based food service application software and selected components of our downloadable software applications are licensed from a third-party +developer on a non-exclusive basis through 2031 and are subject to a revenue sharing arrangement with the developer. We are reliant upon the third-party developer to further develop and maintain its developed software, and the developer controls the +software source code. Therefore, presently, we are highly dependent on this third-party developer for continued service to our customers and the further development of our food service technology software products. If the software provider were to +terminate operations or otherwise be unavailable to provide maintenance, hosting and development services to us and our customers, the availability or usage of our software products could be disrupted and our customers could be adversely affected. In +any such case, we may need to seek comparable software and services from other third-parties or develop it internally, which could require significant time and expense. There can be no assurance that such software or services would be available from +other sources, or that if available, they would be of comparable quality and cost. Moreover, any efforts to develop new software, whether internal or by third-parties, would require significant lead time, and there could be an interruption in service +during any period in which the software provider ceases to provide products and services and new products remain under development. Any such occurrence could materially and adversely impact our business, financial condition and results of operations. +Any errors or defects in, or failures of, third-party software or applications could result in errors or defects in or failures of our +food service technology products and services, which could be costly to correct and have a material adverse effect on our reputation, business, financial condition and results of operations +10 +We compete in highly competitive markets, which are likely to become more competitive. +Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, consumables and services. Our principal +competitors have substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +● +technologically advanced products that satisfy user demands; +● +superior customer service; +● +high levels of quality and reliability; and +● +dependable and efficient distribution networks. +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in +price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish +cooperative relationships with suppliers or companies that produce complementary products, which may include relationships with our software developer. Any of these factors could reduce our earnings. +Our success will depend on our ability to sustain and manage growth. +As part of our business strategy, we intend to pursue a growth strategy. Assuming this growth occurs, it will require the expansion of +customer relationships in international markets, the successful development and marketing of new products for our existing and new markets, expanded internal sales and marketing, customer service and support, and the continued implementation and +improvement of our operational, financial and management information systems. +To the extent that we seek growth through acquisitions, our ability to manage our growth will also depend on our ability to integrate +businesses that have previously operated independently. We may not be able to achieve this integration without encountering difficulties or experiencing the loss of key employees, customers or suppliers. It may be difficult to design and implement +effective financial controls for combined operations and differences in existing controls for each business may result in weaknesses that require remediation when the financial controls and reporting functions are combined. As we pursue acquisitions, +we may incur legal, accounting and other transaction-related expenses for unsuccessful acquisition attempts that could adversely affect our results of operations in the period in which they are incurred. +There can be no assurance that we will be able to successfully implement our growth strategy, or that we can successfully manage +expanded operations, if they occur. As we expand, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our +results of operations and financial condition. +We are dependent on sales to one large customer; the loss of this customer or reduction in +orders from this customer could materially affect our sales. +Casino and gaming sales and lottery spare part sales to IGT represent a material percentage of our net sales. A reduction, delay or +cancellation in orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +General economic conditions could have a material adverse effect on our business, operating +results and financial condition. +Our business is subject to general economic conditions. Uncertainty or negative trends in U.S. or international economic and +investment climates, including the impact of developments in U.S.-China trade relations (discussed separately below), as well as economic impacts from the Russia-Ukraine conflict (including increased fuel prices) and the current inflation surge +attributable to supply chain disruptions due to the COVID-19 pandemic, could adversely affect our business. For example, customers or potential customers could reduce or delay orders, key suppliers could become insolvent, which could result in +production delays, and our customers may become insolvent or be unable to obtain credit. Any of these possible effects could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net +sales, and ultimately decrease our net sales and profitability including write-downs of assets. +If market conditions deteriorate or future results of operations are less than expected, a +valuation allowance may be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these +deferred tax assets on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions deteriorate or future results of +operations are less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are not realizable. As a result, we may +need to establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +11 +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and services. We may be +adversely impacted by any conflicts that could arise between and among our various sales channels. +Our dependence upon distributors and resellers exposes us to numerous risks, including: +● +loss of channel and the ability to bring new products to market; +● +concentration of credit risk, including disruption in distribution should the distributors, and / or resellers’ financial condition deteriorate; +● +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +● +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +● +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon +the business, consolidated results of operations and financial condition. +We are dependent upon two manufacturers located in Thailand and China for the manufacturing and +assembly of our printers and terminals, and their operations were disrupted by the outbreak of COVID-19. The disruption adversely affected the Company’s business, financial conditions and results of operations, and any further or future disruption in +their businesses or operations, such as those caused by political, social or economic instability, war, trade restrictions or tariffs, severe weather, additional public health crises and other events out of our control, could materially adversely +affect our business, financial condition and results of operations. +In an effort to maximize cost savings and operation benefits, we have outsourced substantially all of the manufacturing and assembly of +our printers and terminals to two contract manufacturers located in Thailand and China. As a result, we are dependent on them for the manufacturing of our products, and any disruption in such manufacturing or the export of products from these +manufacturers to the U.S. may adversely affect our business, financial condition and results of operations. +Risks affecting the businesses and operations of our two manufacturers in Asia include: political and regional strife; war; labor +shortages; severe weather and natural disasters such as earthquakes, hurricanes, fires, and floods; lengthy power outages; increased pricing, financial instability and capacity constraints of shippers; and concerns with or threats of public health +crises, contagious diseases or health epidemics. The risk to our business posed by any disruption in manufacturing is exacerbated by the concentration of our manufacturing operations in two manufacturers both located in Asia. +In response to COVID-19, the Chinese government placed restrictions on travel and mandated business closures. Such restrictions and +closures disrupted our supply chain by delaying product shipments from our contract manufacturers during 2020 and is continuing into 2022. +The ultimate impact of COVID-19 on our operations will depend on future developments, which are highly uncertain and cannot be +predicted with confidence, including the duration of the outbreak and any resurgences, new information which may emerge concerning the severity of COVID-19 and newly identified strains, the rollout and effectiveness of vaccines and treatments and the +actions to contain the virus or treat its impact, among others. Without the contract manufacturers continuing to manufacture our products and the continuing operation of the contract manufacturers’ facilities, we will have limited means for the final +assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing facility, which could be costly and time consuming and have a material adverse effect on our +operating and financial results. +We may also incur increased business continuity and reputational risks to the extent that we continue to outsource the manufacturing +and assembly of our products to foreign third-party service providers. For example, outsourcing of manufacturing prevents us from exercising control over the assembly of certain of our products and related operations or processes, including the +internal controls associated with operations and processes conducted and the quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure +efficiencies and our operating and financial results could be materially adversely affected. Outsourcing also exposes us to increased risk of infringement or misappropriation of our intellectual property, to which our manufacturers have access. +Because our manufacturers are located in Asia, there is no guarantee that our intellectual property rights will be protected or enforced to the same extent as under U.S. federal and state laws. Consequently, we may not be able to prevent third-parties +from developing or selling products made using our technologies. +Overestimates or underestimates in our manufacturing forecasts could cause us to hold excess +inventory or result in delays in the manufacturing and delivery of our products, which could cause us to lose orders or customers. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays, +which could cause us to lose orders or customers and result in lower net sales. We currently use a rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our requirements for +components and materials. It is important that we accurately predict both the demand for our products and the lead-time required to obtain the necessary components and raw materials. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size +of the order, contract terms, and demand for each component at a given time, as well as supply shortages with respect to raw materials needed to produce the components. If we underestimate our requirements, or if we are unable to obtain components on +time due to supply shortages, as has occurred in the wake of the COVID-19 pandemic, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and result in delays in shipments and net sales. If we +overestimate our requirements, we could have excess inventory of parts and finished products. In addition, delays in the manufacturing of our products could cause us to lose orders or customers. +12 +In addition to maintaining offices in the UK and Macau, we sell and ship a significant portion +of our products internationally and rely on third-parties that make up our global salesforce. The international nature of our operations may expose us to certain risks associated with doing business outside of the U.S., including risks posed by +tariffs and changes in trade relations. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected +to continue to account for a material portion of net sales. In addition, our manufacturers and suppliers are largely located in Asia. As a result, our products are largely exported to one of our facilities in the United States, which makes our +operations vulnerable to disruptions in trade that could adversely affect our business results. +Our international operations, including our reliance on manufacturers and suppliers located in Asia, our worldwide sales team, and our +sales to customers located outside the United States, expose us to disruptions in trade and other associated risks such as: +● +the imposition of additional duties, tariffs, quotas, taxes, trade barriers, capital flow restrictions and other charges on imports and exports by the United States or +the governments of the countries in which we or our manufacturers and suppliers operate; +● +delays in the delivery of cargo due to port security considerations, labor disputes such as dock strikes, and our reliance on a limited number of shipping and air +carriers, which may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; +● +fluctuations in the value of the U.S. Dollar against foreign currencies, which could restrict sales, or increase costs of purchasing, in foreign countries; +● +economic or political instability in any of the countries in which we or our manufacturers or suppliers operate, which could result in a reduction in demand for our +products due to political and economic instability or impair our foreign assets; +● +a reduced ability or inability to sell in or purchase from certain markets as a result of export or import restrictions; +● +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from +selling in certain geographic territories; +● +reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for +an acceptable cost; and +● +economic uncertainties and adverse economic conditions (including inflation and recession). +Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance +does not cover all possible situations. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing customers +resulting from our inability to produce products for them. +Catastrophic events or a downturn in economic conditions may disrupt our business. +Geopolitical events, social unrest, war, including repercussions of the recent military conflict between Russia and Ukraine, terrorism, +political instability, acts of public violence, boycotts, labor discord or disruptions, hostilities, social unrest, pandemics (in addition to the COVID-19 pandemic), natural disasters or other catastrophic events may cause damage or disruption to our +operations, international commerce, and the global economy, and thus could harm our business. In particular, the reactions of governments, markets, and the general public to such events, many of which are beyond our control, may result in a number of +adverse consequences for our customers, business, operations, and results of operations. In the event of a major earthquake, hurricane or catastrophic event such as fire, power loss, telecommunications failure, cyber-attack, war or terrorist attack, we +may be unable to continue our operations and may endure system interruptions, reputational harm, breaches of data security, and loss of critical data, all of which would harm our business, results of operations, and financial condition. In addition, +the insurance we maintain would likely not be adequate to cover our losses resulting from disasters or other business interruptions. Any downturn in the economy in general, including the current economic impacts of the COVID-19 pandemic (including +inflation relating to supply chain disruptions caused by the pandemic) and the impact on fuel prices of the Russia–Ukraine conflict, or in the food service or gaming industry in particular could result in a reduced demand for our products and could +adversely affect our business and results of operations. In addition, heightened security measures or responses to hostilities may cause certain governments to restrict the import or export of goods, as has occurred with respect to the export of oil +from Russia, which may have an adverse effect on our ability to buy and sell goods or on the cost to obtain components. +We depend on key personnel, the loss of which could materially impact our business. +Our future success will depend in significant part upon the continued service of certain key management and other personnel and our +continuing ability to attract and retain highly qualified managerial, technical and sales and marketing personnel. There can be no assurance that we will be able to recruit and retain such personnel. The loss of either Bart C. Shuldman, the Company’s +Chairman of the Board and Chief Executive Officer, or Steven A. DeMartino, the Company’s President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, could have a material adverse effect on our results of +operations. +13 +The inability to protect our intellectual property rights could harm our reputation, damage our +business or interfere with our competitive position, and infringement on the intellectual property rights of others, or claims thereof, could put us at a competitive disadvantage, and any related litigation could be time consuming and costly. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trademarks, service +marks, trade secrets, technology licensing agreements, nondisclosure agreements and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third-parties to copy aspects of our products or, without +authorization, to obtain and use information which we regard as trade secrets. +In addition, prosecuting and defending infringement lawsuits is expensive. We are committed to aggressively asserting and defending +our technology and related intellectual property rights, which we have spent a significant amount of money to develop. Similarly, third-parties may claim, from time to time, that we have violated their intellectual property rights. To the extent we +violate a third-party’s patent or other intellectual property rights, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to +accomplish our objectives. Any such claims could result in costly litigation and, if successful, could result in costly judgments or settlements. +The expense of prosecuting or defending any future infringement lawsuits could have a material adverse effect on our business, +financial condition and results of operations. Intellectual property litigation is generally complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. +We currently rely on third-party service providers to host our food service technology software +and deliver certain services, and any interruptions or delays in services from these third-parties could impair the delivery of our products and services, and our business, results of operations, and financial condition could be materially adversely +affected. +We rely on a third-party service provider to host our food service technology software. Third-parties also provide services to key +aspects of our operations, including Internet connections and networking, data storage and processing, trust and safety and security infrastructure. We do not control the operation, physical security, or data security of any of these third-party +providers. Our efforts to use commercially reasonable diligence in the selection and retention of such third-party providers may be insufficient or inadequate to prevent or remediate such operational and security risks. Our third-party providers may be +subject to intrusions, computer viruses, denial-of-service attacks, sabotage, acts of vandalism, acts of terrorism or other misconduct. They are vulnerable to damage or interruption from power loss, telecommunications failures, fires, floods, +earthquakes, hurricanes, tornadoes, and similar events, and they may be subject to financial, legal, regulatory, and labor issues, each of which may impose additional costs or requirements on us or prevent these third-parties from providing services to +us or our customers on our behalf. In addition, these third-parties may breach their agreements with us, disagree with our interpretation of contract terms or applicable laws and regulations, refuse to continue or renew these agreements on commercially +reasonable terms or at all, fail to or refuse to process transactions or provide other services adequately, take actions that degrade the functionality of our platform and services, increase prices, impose additional costs or requirements on us or our +customers, or give preferential treatment to our competitors. If we are unable to procure alternatives in a timely and efficient manner and on acceptable terms, or at all, we may be subject to business disruptions, losses, or costs to remediate any of +these deficiencies. The occurrence of any of the above events could result in reputational damage, legal or regulatory proceedings, loss of customers or other adverse consequences, any of which could materially adversely affect our business, results of +operations, and financial condition. +Our food service technology business depends substantially on our customers renewing their +subscriptions with the Company. Any decline in our customer renewals would harm our food service technology business, results of operations and financial condition. +Our subscription offerings are term-based, and in order for us to maintain or improve our results of operations, it is important that +our customers renew their subscriptions with us when the existing subscription term expires and renew on the same or more favorable quantity and terms. Our customers have no obligation to renew their subscriptions and we may not be able to accurately +predict customer renewal rates. Customers may elect not to renew their subscriptions with us for a variety of reasons, including as a result of changes in their strategic priorities, budgets and costs and, in some instances, due to competing solutions. +Our retention rate may also decline or fluctuate as a result of a number of other factors, including our customers’ satisfaction or dissatisfaction with our solutions, the increase in the contract value of subscription and support contracts from new +customers, the effectiveness of our customer support services, our pricing, the prices of competing products or services, global economic conditions and the other risk factors described herein. As a result, there can be no assurance that our food +service technology customers will renew subscriptions. If our customers do not renew their subscriptions or renew on less favorable terms, our business, results of operations and financial condition may be adversely affected. +14 +If we fail to offer high quality support, our business and reputation could suffer. +Our customers rely on us and our third-party service providers for support of our software and services included in our food service +technology subscription packages. High-quality support is important for the renewal and expansion of our agreements with existing customers. The importance of high-quality support will increase as we expand our business and pursue new customers. If we +or our third-party service providers do not help our customers quickly resolve issues and provide effective ongoing support, our ability to sell new food service technology products to existing and new customers could suffer and our reputation and +relationships with existing or potential customers could be harmed. +Cyber-security and privacy breaches, cyber-attacks, or other disruptions could expose us to +liability, affect our business, and damage our reputation. +We are increasingly dependent on our information technology systems and infrastructure for our business. We collect, store, and +transmit sensitive information including intellectual property, proprietary business information and personal information in connection with business operations. The secure maintenance of this information is critical to our operations and business +strategy. Some of this information could be an attractive target of criminal attack by third-parties with a wide range of motives and expertise, including organized criminal groups, disgruntled current or former employees, and others. Cyber-attacks are +of ever-increasing levels of sophistication, and despite our extensive security measures, our information technology and infrastructure may be vulnerable to such attacks or may be breached, including due to employee error or malfeasance. Any such +breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. If our systems become compromised, we may not promptly discover the intrusion. Like other companies in our industry, we have +experienced attacks to our data and systems, including malware and computer viruses that we have been able to detect and eliminate. If our systems fail or are breached or disrupted, we could lose product sales, and suffer reputational damage and loss +of customer confidence. Such incidents would require notification to affected individuals and may result in legal claims or proceedings and liability under federal and state laws that protect the privacy and security of personal information. Any one of +these events could cause our business to be materially harmed and our results of operations to be adversely impacted. +We cannot provide any assurance that current laws, or any laws enacted in the future, will not +have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements +in each of the jurisdictions in which we conduct business. Changes in such laws, rules, regulations, policies or requirements could result in the need to modify our products and could affect the demand for our products, which may have an adverse +impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +15 +Risks Related to our Indebtedness +The agreement governing our credit facility contains restrictions and limitations that could +significantly affect our ability to operate our business, as well as significantly affect our liquidity. +The loan and security agreement (the “Loan Agreement”) governing the Siena Credit Facility contains a number of significant covenants +that could adversely affect our ability to operate our business, our liquidity, and our results of operations. These covenants restrict, among other things, our ability, and the ability of any future domestic subsidiary, to: +● +merge, consolidate, form subsidiaries or dispose of assets; +● +acquire assets outside the ordinary course of business ; +● +e nter into other transactions outside the ordinary course of busines s; +● +sell, transfer, return or dispose of collateral; +● +make loans to or investments in, or enter into transactions with, affiliates ; +● +incur or guarantee indebtedness, incur liens ; +● +redeem equity interests while borrowings are outstanding under the credit facility ; +● +change our capital structure; or +● +dissolve, divide, change our line of business or cease or suffer a disruption to all or a material portion of our business . +Additionally, the Loan Agreement requires us to comply with a minimum excess availability covenant, which requires excess borrowing +availability of at least $750 thousand. The breach of any covenants or obligations in the Loan Agreement, if not otherwise waived or amended, could result in a default under the Loan Agreement and could trigger acceleration of our obligations +thereunder and permit the lender to foreclose on the collateral securing our obligations under the Loan Agreement and exercise other rights of secured creditors. +Availability under the Siena Credit Facility is subject to a borrowing base, which is based on eligible accounts receivable and +inventory. To the extent that our eligible accounts receivable and inventory decline in value, our borrowing base will decrease, and the availability under the Siena Credit Facility currently is and may continue to be less than its stated amount and +may decrease. In addition, if at any time the amount of outstanding borrowings and letters of credit under that facility exceeds the borrowing base, we are required to prepay borrowings and/or cash collateralize letters of credit sufficient to +eliminate the excess. +Our ability to comply with the covenants under the Loan Agreement or to maintain our borrowing base may be affected by events beyond +our control, including deteriorating economic conditions and consequences of the COVID-19 crisis. For example, reductions in the value of accounts receivable and inventory have occurred and may occur in the future due to decreases in sales and +production resulting from the impact of the COVID-19 pandemic. Further, certain slow-moving inventory and accounts receivable that remain unpaid for a specified period of time are excluded from the borrowing base calculation. Thus, a decline in +economic conditions and/or a decline in the financial condition of customers in the industries we serve, such as the decline that has occurred in the casino and food service industries in connection with the COVID-19 pandemic, has impacted and may +continue to negatively impact the borrowing base both by decreasing the value of existing accounts and reducing the number and amount of new accounts. If we overestimate our inventory needs due to the uncertainty surrounding the COVID-19 pandemic and +the duration of its impact on customer closures and economic conditions, we may have inventory that is considered slow-moving and thus excluded from the borrowing base calculation, and any reduction in production in response to decreased demand would +also result in a lower inventory value and thus a lower borrowing base. +Any of these events could require us to seek waivers or amendments of covenants or alternative sources of financing or to reduce +expenditures. We cannot assure you that such waivers, amendments or alternative financing could be obtained, or if obtained, would be on terms acceptable to us, or that we would be able to reduce expenditures enough to offset any decrease in the +borrowing base, or that we could make such reductions without a material negative impact on our business. +16 +General Risk Factors +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other +factors, such as: +● +prevailing domestic and international market and economic conditions, and conditions in the industries we serve, including current market volatility and the economic +impact of COVID-19 and resulting shutdowns on the casino and food service industries and on the U.S. and global economies ; +● +adverse business conditions faced by customers, or bankruptcies or store closures of our customers resulting from adverse economic conditions due to COVID-19 or +otherwise; +● +changes in our business, operations or prospects; +● +developments in our relationships with our customers or strategic partners; +● +announcements of new products or services by us or by our competitors; +● +announcement or completion of acquisitions by us or by our competitors; +● +changes in existing or adoption of additional government regulations; and +● +unfavorable or reduced analyst coverage. +In addition, the stock market may experience significant price fluctuations year-to-year. Broad market fluctuations, general economic +conditions and specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Limited trading volume and a reduction in analyst coverage of our common stock may contribute to +its price volatility. +The limited trading volume of our common stock may contribute to its price volatility. The trading market for our common stock also +relies in part on the research and reports that industry or financial analysts may publish about us, our business, our markets and our competitors. We currently have limited analyst coverage. If securities analysts do not cover our common stock in the +future, the lack of research coverage may adversely affect the market price of our common stock. Furthermore, if one or more of the analysts who cover us downgrade our stock, or if those analysts issue other unfavorable commentary about us or our +business, our stock price may decline. +Our common stock is traded on the Nasdaq Global Market. During the year ended December 31, 2021, the average daily trading volume for +our common stock as reported by the Nasdaq Global Market was approximately 25,000 shares. We are uncertain whether a more active trading market in our common stock will develop. In addition, many investment banks no longer find it profitable to +provide securities research on micro-cap and small-cap companies. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the price of our common +stock. +Our common stock is thinly traded, and investors may be unable to sell their shares at their +desired prices, or at all, and sales of large blocks of shares may adversely affect the price of our common stock. +Our common stock has historically been sporadically or “thinly traded,” meaning that the number of persons interested in purchasing +shares of our common stock at prevailing prices at any given time may be relatively small. This could lead to wide fluctuations in our share price. Investors may be unable to sell their common stock at or above their purchase price, which may result in +substantial losses. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of shares of our common stock in either direction. The price of shares +of our common stock could, for example, decline precipitously in the event a large number of shares of our common stock are sold on the market without commensurate demand, while an issuer with a more robust daily trading volume for its common stock +might better absorb those sales without an adverse impact on its share price. +If we raise additional capital in the future, existing shareholder ownership interest in the +Company could be diluted or otherwise adversely impacted, and future sales of our common stock or other financing arrangements may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, or we may obtain funds through a +credit facility or by issuing debt or preferred securities. We may also issue additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future issuance and sale pursuant to stock options and +other equity awards that we have granted to our employees, and in the future, we may grant additional stock options, restricted stock units and other forms of equity compensation to our employees. Any issuance of equity we may undertake in the future +to raise additional capital could cause the price of our common stock to decline, or require us to issue shares at a price that is lower than that paid by holders of our common stock in the past, which would result in those newly issued shares being +dilutive. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. The lenders under our +existing debt agreements have rights that are senior to your rights as a common stockholder, and if we obtain funds in the future through a credit facility or through the issuance of debt or preferred securities, the lenders of such facility or the +holders of such securities would likely also have rights senior to the rights of our common stockholders, which could impair the value of our common stock. +17 +We take advantage of specified scaled disclosure requirements applicable to a “smaller reporting +company” under Regulation S-K, and the information that we provide to stockholders may therefore be different than they might receive from other public companies. If some investors find our shares of common stock less attractive as a result of this +scaled disclosure, there may be a less active trading market for our shares of common stock, which may increase the volatility of the market price of our common stock. +We are a “smaller reporting company,” as defined in Item 10(f)(1) of Regulation S-K. As a smaller reporting company, we take advantage +of specified scaled disclosure and other requirements that are otherwise applicable generally to public companies. +We intend to continue to take advantage of certain of the scaled disclosure requirements of +smaller reporting companies and may continue to do so until we are no longer a smaller reporting company. We will cease to be a smaller reporting company if we have (i) more than $250 million in market value of our shares held by non-affiliates as of +the last business day of our second fiscal quarter or (ii) more than $100 million of annual revenues in our most recent fiscal year completed before the last business day of our second fiscal quarter and a market value of our shares held by +non-affiliates more than $700 million as of the last business day of our second fiscal quarter. We choose to take advantage of some but not all of these scaled disclosure requirements; therefore, the information that we provide stockholders may be +different than one might get from other public companies. Further, if some investors find our shares of common stock less attractive as a result, there may be a less active trading market for our shares of common stock and the market price of such +shares of common stock may be more volatile. +Our Amended and Restated By-Laws designate certain Delaware courts as the sole +and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or +stockholders. +Our Amended and Restated By-Laws (the “By-Laws”) provide that, unless we consent in writing to the selection of an +alternative forum, to the fullest extent permitted by law, all Internal Corporate Claims must be brought solely and exclusively in the Court of Chancery of the State of Delaware (or, if such court declines to accept jurisdiction, the Superior Court of +the State of Delaware, or, if such other court declines to accept jurisdiction, the United States District Court for the District of Delaware). The By-Laws define “Internal Corporate Claims” to mean claims, including claims in the right of the Company, +brought by a current or former stockholder (including a current or former beneficial owner) (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity or (ii) as to which the General +Corporation Law of the State of Delaware confers jurisdiction upon the Court of Chancery of the State of Delaware. +This choice of forum provision may increase costs to bring a claim, discourage claims or limit a +stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other stockholders, which may discourage such lawsuits against us and our directors, officers and stockholders. +Alternatively, if a court were to find this choice of forum provision inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in +other jurisdictions, which could adversely affect our business, financial condition or results of operations. The choice of forum provision in the By-Laws will not preclude or contract the scope of exclusive federal or concurrent jurisdiction for +actions brought under the federal securities laws including the Exchange Act or the Securities Act or the respective rules and regulations promulgated thereunder. +18 +Item 1B. Unresolved Staff Comments. +Not applicable. +Item 2. Properties. +Our principal facilities as of December 31, 2021 are listed below. We believe that all facilities generally are in good condition, adequately maintained and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. Ft.) +Owned +or Leased +Lease Expiration +Date +Hamden, Connecticut +Executive offices and sales office +11,100 +Leased +October 31, 2025 +Ithaca, New York +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2025 +Las Vegas, Nevada +Software design and development and casino and gaming sales office +19,600 +Leased +October 31, 2022 +Doncaster, UK +Sales office and service center +6,000 +Leased +August 26, 2026 +Macau, China +Sales office +180 +Leased +June 30, 2022 +110,780 +Item 3. Legal Proceedings. +The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and +other legal proceedings relating to the conduct of its business. As of December 31, 2021, we are unaware of any material legal proceedings +pending or threatened against us, or any material legal proceedings contemplated by governmental authorities. +Item 4. Mine Safety Disclosures. +Not applicable. +19 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +Our common stock is traded on the Nasdaq Global Market under the symbol TACT. As of February 28, 2022, there were 246 holders of record of the common stock. +Issuer Purchases of Equity Securities +During the fourth quarter of 2021, we did not repurchase any shares of our common stock. +Dividend Policy +In 2012, our Board of Directors initiated a quarterly cash dividend program subject to the Board’s approval each quarter. On January +23, 2020, our Board of Directors announced the cessation of our quarterly cash dividend on the Company’s common stock to accelerate the investment in sales and marketing, continued product development and infrastructure of the BOHA! ecosystem. The +final dividend payment was made in December 2019. +Sales of Unregistered Securities +None. +Item 6. [Reserved] +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Overview +During the year ended December 31, 2021, we continued to +experience recovery from the negative impacts COVID-19 had on our business during 2020. While we have experienced recovery in most of our markets, there are still uncertainties on how COVID-19 will continue to impact our business, operations, supply +chain, customer and vendors. During 2021, we continued to focus our efforts on the sales execution and growing revenue of BOHA! software-as-a-service (“SaaS”)-based software and hardware ecosystem launched in 2019. Despite the negative impact from +COVID-19, food service technology sales increased 63% in 2021 compared to 2020 due primarily to sales of our BOHA! software, labels and other recurring revenue to both new customers and our existing installed base of BOHA! terminals. +During 2021, all markets other than lottery and TSG increased compared to 2020 as we have started to see recovery from the negative +impacts from the COVID-19 pandemic. POS automation sales increased primarily due to higher sales of our Ithaca 9000 printer to McDonald’s in 2021 compared to 2020. Casino and gaming sales were higher in 2021 due to casinos continuing to reopen and +increase capacity during 2021 after being closed in 2020 in response to the COVID-19 pandemic. Printrex sales increased in 2021 after being negatively impacted by lower worldwide oil prices largely attributable to the COVID-19 pandemic during 2020. +We had no lottery market sales during 2021 as we exited the lottery market in 2019 and completed our final sale of lottery printers in 2020. TSG sales decreased in 2021 compared to 2020 primarily due to lower service sales due to exiting the banking +market in 2018, lower replacement part sales and lower sales of our legacy consumable products. +During the year ended December 31, 2021, +our total net sales increased 29% to approximately $39.4 million compared to the year ended December 31, 2020. See the table below +for a breakdown of our sales by market: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Food service technology (“FST”) +$ +12,625 +32.1 +% +$ +7,734 +25.3 +% +$ +4,891 +63.2 +% +POS automation +4,825 +12.2 +% +3,770 +12.3 +% +1,055 +28.0 +% +Casino and gaming +15,302 +38.9 +% +10,979 +35.9 +% +4,323 +39.4 +% +Lottery +– +0.0 +% +817 +2.7 +% +(817 +) +(100.0 +%) +Printrex +631 +1.6 +% +300 +1.0 +% +331 +110.3 +% +TSG +6,003 +15.2 +% +6,995 +22.8 +% +(992 +) +(14.2 +%) +$ +39,386 +100.0 +% +$ +30,595 +100.0 +% +$ +8,791 +28.7 +% +Sales of our food service technology products increased 63% in the year ended December 31, 2021 compared to the year ended December 31, +2020. In the food service technology market, we focus on providing hardware products, which include terminals/workstations, temperature probes, temperature sensors and gateways in addition to cloud-based software applications, labels and other +recurring revenue items. Food service technology sales increased in 2021 primarily due to a 95% increase in BOHA! recurring revenue, which include subscriptions for the software applications, as well as sales of labels, extended warranty and service +contracts, and technical support services. Our FST hardware sales also increased by 33% as we increased our total installed base by 4,130 terminals and workstations during 2021 resulting in a total installed base of 9,818 terminals at the end of 2021. +20 +Sales of our POS automation products increased 28% in the year ended December 31, 2021 compared to the year ended December 31, 2020. +In the POS automation market, we focus primarily on supplying printers that print receipts or linerless labels to McDonald’s, and to a lesser extent other customers in the restaurant and quick serve markets. During the year ended December 31, 2021, +sales of our Ithaca 9000 printer to McDonald’s recovered from the unusually low level we experienced in 2020 due to the significant negative impact of the COVID-19 pandemic on the POS automation market. +Sales of our casino and gaming products increased 39% in 2021 compared to 2020. In our casino and gaming market, our focus lies +primarily in supplying printers worldwide for use in slot machines at casinos and racetracks, as well as in other electronic gaming devices that print tickets or receipts. Additionally, we supplement these printer sales with revenue from EPICENTRAL our +promotional printing system that enables casino operators to create promotional coupons and marketing messages and print them in real time at the slot machine. The increase of casino and gaming printers was due to the recovery of the domestic and +international casino and gaming market during 2021, as casinos continued to reopen compared to 2020 when the market was severely impacted by the COVID-19 pandemic and the related closures of casinos. +On December 31, 2019, we ended our non-exclusive agreement with IGT and exited the lottery market as we shifted our focus to our +higher-value, technology-enabled market for food service technology and casino and gaming products. During 2020, IGT made a final purchase of lottery printers and we expect no future sales of our lottery printer. +Sales of our Printrex branded printers include wide format, rack-mounted and vehicle-mounted thermal printers used by customers to log +and plot oil field and down hole well drilling data in the oil and gas exploration industry. During the year ended December 31, 2021, we experienced a 110% increase in Printrex oil and gas printer sales, as the oil and gas market recovered from the +negative impact during 2020 of lower worldwide oil prices as a result of the COVID-19 pandemic. Additionally, we fulfilled last buy orders to legacy customers during the fourth quarter of 2021, as we decided to exit this market as of December 31, +2021. We expect no future Printrex sales as we have shifted our focus away from this market and towards our higher value, technology-enabled food service technology terminals and casino and gaming products. +TSG, which sells service, replacement parts and consumable products, including receipt paper, ribbons and other printing supplies, +continues to offer a recurring revenue stream from mostly our legacy products. TSG sales decreased 14% in 2021 compared to 2020, primarily due to declining service revenue from a legacy banking customer whose service contract is expected to end during +2022, as well as lower replacement part and consumable product sales. We expect TSG sales to continue to decline in 2022 due to the ending of the service contract with a legacy banking customer and lower expected sales of our lottery printer spare +parts to IGT for our legacy lottery printer. +Operationally, our gross margin was 38.7% in 2021, a +decrease of 360 basis points from 2020, due largely to lower margin on our BOHA! hardware sales during 2021 compared to 2020, as we have reduced prices to accelerate the growth of our BOHA! installed base, as well as higher material and +shipping costs resulting from worldwide supply disruptions caused by the COVID-19 pandemic. +During 2021, our operating margin improved to negative 24.1% compared to negative 26.7% in 2020 as the 29% increase in sales more than +offset the 360 basis point decrease in gross margin and increased operating expenses. Operating expenses increased by 17% as we gradually returned to more normalized pre-COVID-19 spending levels. During 2022, we expect operating expenses to continue +to increase compared to 2021, due to the continued investment in our food service technology products. +We reported a net loss of $4.1 million and net loss per +diluted share of $0.45 for 2021, compared to a net loss of $5.6 million and net loss per diluted share of $0.72 for 2020. In terms of cash flow, for 2021 we used $2.5 million of cash in operating activities. During 2021, we also successfully +completed an underwritten public offering of our common stock which raised net proceeds of $11.2 million . We ended the year with cash and cash equivalents of $19.5 +million and no debt outstanding on our Consolidated Balance Sheet at December 31, 2021. +Critical Accounting Estimates +The preparation of financial statements in conformity with generally accepted accounting principles requires management to make use of +estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Operations categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the +particular circumstances; however, due to the inherent uncertainties in developing estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods. +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These +items utilize assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial +Statements for a complete listing of our significant accounting policies. +Revenue Recognition – Application of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, the determination of whether +revenues related to our revenue contracts should be recognized over time or at a point in time. Other significant judgments include contracts that contain multiple +performance obligations (most commonly when contracts include a hardware product, software and extended warranties) which require a contract’s transaction price to be allocated to each distinct performance obligation and recognized as revenue when, +or as, the performance obligation is satisfied. Both of these determinations impact the timing and amount of our reported revenues and net income and loss. +21 +Accounts Receivable +– We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on +available credit information; and adjustments to credit limits based upon payment history and the customer’s current creditworthiness. We also provide an estimate of doubtful accounts based on historical experience and specific customer collection +issues. Our allowance for doubtful accounts as of December 31, 2021 was $219 thousand, or 2.8% of outstanding accounts receivable, which we believe is appropriate considering the overall quality of our accounts receivable. Although credit losses have +historically been within expectations and the reserves established, there is no assurance that our credit loss experience will continue to be consistent with historical experience. +Inventories – +Our inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course +of business less estimated costs of completion, disposal and transportation, historical usage and estimates of future demand. Assumptions are reviewed at least quarterly and adjustments are made, as necessary, to reflect changing market conditions. +Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net realizable value. Should circumstances change and we determine that additional inventory is subject to obsolescence, +additional write-downs of inventory could result in a charge to income. +Goodwill and +Intangible Assets – We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of +intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 “Goodwill,” acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances +change that indicate it is more likely than not an impairment exists. We perform a fair value-based impairment test to the carrying value of goodwill and indefinite-lived intangible assets on an annual basis (as of December 31) and, if +certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. The Company utilizes the option to first assess qualitative factors to determine whether it is necessary to perform the Step 1 quantitative +goodwill impairment test in accordance with the applicable accounting standards. Under the qualitative assessment, management considers relevant events and circumstances including, but not limited to, macroeconomic conditions, industry and market +considerations, Company performance, and events directly affecting the Company. If the Company determines that the Step 1 quantitative impairment test is required, management estimates the fair value of the reporting unit primarily using the income +approach, which reflects management’s cash flow projections, and also evaluates the fair value using the market approach. Factors considered that may trigger an interim +period impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the +strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when +appropriate. +As of December 31, 2021, upon the completion of our annual assessment for impairment, we have determined that no goodwill or intangible +asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value. +Income Taxes +– In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing temporary differences +between the tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, +which are reflected in our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation +allowance. +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax +reserves with respect to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this +forecast against the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. +Although we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our +deferred tax assets in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future +deferred tax assets in excess of its net recorded amount, an adjustment to the valuation allowance would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”). Among other things this provision prescribes a +minimum recognition threshold that an income tax position must meet before it is recorded in the reporting entity’s financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet +reporting date, it is “more likely than not” (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing +authority will examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between +the amount claimed, or expected to be claimed, on a company’s income tax returns and the benefits recognized in the financial statements. +Warranty – +We generally warrant our products for up to 24 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product repairs and the related +estimated cost of labor and material to make the necessary repairs. If actual future product repair rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability and related warranty expense +would be made. +Share-Based +Compensation – We calculate share-based compensation expense in accordance with ASC 718, “Compensation – Stock Compensation” using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions +for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, and dividend yield. We account for forfeitures as they occur. +22 +Results of Operations: Year Ended December 31, 2021 Compared to Year Ended December 31, 2020 +Net Sales. +Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2021 and 2020 are detailed in the below table. +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Food service technology +$ +12,625 +32.1 +% +$ +7,734 +25.3 +% +$ +4,891 +63.2 +% +POS automation +4,825 +12.2 +% +3,770 +12.3 +% +1,055 +28.0 +% +Casino and gaming +15,302 +38.9 +% +10,979 +35.9 +% +4,323 +39.4 +% +Lottery +– +0.0 +% +817 +2.7 +% +(817 +) +(100.0 +%) +Printrex +631 +1.6 +% +300 +1.0 +% +331 +110.3 +% +TSG +6,003 +15.2 +% +6,995 +22.8 +% +(992 +) +(14.2 +%) +$ +39,386 +100.0 +% +$ +30,595 +100.0 +% +$ +8,791 +28.7 +% +International* +$ +6,986 +17.7 +% +$ +5,862 +19.2 +% +$ +1,124 +19.2 +% +* +International sales do not include sales of products to domestic distributors or other customers who in turn ship those products to international destinations. +Net sales for 2021 increased $8.8 million, or 29%, from +2020. Printer, terminal and other hardware sales volume increased by 33% to approximately 82,000 units for 2021, driven by volume increases in all our markets except the lottery market, which we exited in 2020. The primary volume increases +were a 42% increase in unit volume from the casino and gaming market and, to a lesser extent, a 26% unit volume increase in our POS automation market and a 44% increase in unit volume from the FST market. The average selling price of our printers, +terminals and other hardware increased 1% during 2021 compared to 2020. Additionally, sales of our software, labels and other recurring revenue from our FST market increased $3.6 million, or 95%, during 2021 compared to 2020. +International sales for 2021 increased $1.1 million, or 19%, compared to 2020, primarily due to a 24% increase in international casino +and gaming sales. +Food service technology: Our +primary offering in the food service technology market is our BOHA! ecosystem, which combines our latest generation terminal/workstation, cloud-based software applications and related hardware into a unique solution to automate back-of-house operations +in restaurants, convenience stores and food service operations. The software component of BOHA! consists of a suite of software-as-a-service (“SaaS”)-based applications for both Android and iOS operating systems, including applications for temperature +monitoring of food and equipment, timers, food safety labeling, media libraries, checklists and task lists, and equipment service management. These applications are combined into a single platform with the associated hardware, which includes the BOHA! +terminal/workstation, handheld devices, tablets, temperature probes and temperature sensors. The BOHA! terminal combines the software and hardware components in a device that includes an operating system, touchscreen and one or two thermal print +mechanisms that print easy-to-read food rotation labels, grab-and-go labels for prepared foods, and “enjoy by” date labels. The BOHA! workstation uses an iPad instead of an integrated touchscreen. Both the BOHA! terminal and BOHA! workstation are +equipped with the TransAct Enterprise Management System to ensure that only approved applications and functions are available on the device and allows over-the-air updates to the applications and operating system. BOHA! helps food service +establishments and restaurants (including fine dining, casual dining, fast casual and quick-serve restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go +initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as +sales of labels, extended warranty and service contracts, and technical support services. Sales of our worldwide food service technology products for the years ended December +31, 2021 and 2020 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Domestic +$ +11,738 +93.0 +% +$ +6,956 +89.9 +% +$ +4,782 +68.7 +% +International +887 +7.0 +% +778 +10.1 +% +109 +14.0 +% +$ +12,625 +100.0 +% +$ +7,734 +100.0 +% +$ +4,891 +63.2 +% +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Hardware +$ +5,226 +41.4 +% +$ +3,938 +50.9 +% +$ +1,288 +32.7 +% +Software, labels and other recurring revenue +7,399 +58.6 +% +3,796 +49.1 +% +3,603 +94.9 +% +$ +12,625 +100.0 +% +$ +7,734 +100.0 +% +$ +4,891 +63.2 +% +23 +The increase in food service technology sales in 2021 compared to 2020 was driven by an increase in sales of both hardware and BOHA! +software, labels and other recurring revenue. Hardware sales increased 33% during 2021 compared to 2020 due largely to sales to an existing national convenience store customer and a new national travel center customer, as well as higher sales of our +AccuDate 9700 terminal to McDonald’s. These increases in hardware sales were partially offset by a large sale completed in 2020 to a grab-and-go sushi chain that did not reoccur in 2021. Sales of BOHA! software recognized on a SaaS subscription +basis, labels and other recurring revenue increased by 95%, primarily due to increased label sales and, to a lesser extent, increased software sales, compared to the prior year period due principally to the growth of the installed base of our BOHA! +terminals and workstations. +POS automation: Revenue from the POS automation market includes sales of thermal printers used primarily by McDonald’s, and to a lesser extent, other quick serve restaurants either at +the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. Sales of our worldwide POS automation products for the years +ended December 31, 2021 and 2020 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Domestic +$ +4,817 +99.8 +% +$ +3,763 +99.8 +% +$ +1,054 +28.0 +% +International +8 +0.2 +% +7 +0.2 +% +1 +14.3 +% +$ +4,825 +100.0 +% +$ +3,770 +100.0 +% +$ +1,055 +28.0 +% +The increase in POS automation product revenue during 2021 compared to 2020 was driven by a 28% increase in sales of our Ithaca® 9000 +printer, primarily to McDonald’s, as POS automation sales continually improved during 2021 compared to the significant negative impact from the COVID-19 pandemic on POS automation sales during the final nine months of 2020. +Casino and Gaming: Revenue +from the casino and gaming market includes sales of thermal ticket printers used in slot machines, video lottery terminals, and other gaming machines that print tickets or receipts instead of issuing coins at casinos and racetracks and other gaming +venues worldwide. Revenue from this market also includes sales of thermal roll-fed printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes, Skills with Prizes and Fixed Odds Betting Terminals at +non-casino gaming and sports betting establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of the EPICENTRAL print system, +our software solution (including annual software maintenance), that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. Sales of our worldwide casino and gaming products for the years ended December 31, 2021 and 2020 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Domestic +$ +10,173 +66.5 +% +$ +6,852 +62.4 +% +$ +3,321 +48.5 +% +International +5,129 +33.5 +% +4,127 +37.6 +% +1,002 +24.3 +% +$ +15,302 +100.0 +% +$ +10,979 +100.0 +% +$ +4,323 +39.4 +% +The increase in domestic sales of our casino and gaming products during 2021 compared to 2020 was primarily due to a 57% increase in +domestic sales of our thermal casino printers, as we have experienced some recovery during 2021 compared to 2020, particularly the second quarter of 2020, when the casino and gaming market was most severely impacted by the COVID-19 pandemic. This +increase was partially offset by an 81% decrease in domestic EPICENTRAL sales to an existing EPICENTRAL customer during 2020 to expand its slot machine floor that did not reoccur in 2021. Sales of EPICENTRAL are project based, and as a result, may +fluctuate significantly quarter-to-quarter and year-to-year. +International sales of our casino and gaming products increased during 2021 compared to 2020, primarily due to a 40% increase in sales +of our thermal casino printers, as we experienced modest recovery during 2021, most significantly during the fourth quarter of 2021, after the significant negative impact of the COVID-19 pandemic on the international casino and gaming industry, which +is recovering at a slower pace than the domestic casino and gaming market. The increase from international sales of our thermal casino printers was partially offset by a 33% decline in sales of our off-premise gaming printers during 2021 compared to +2020. +Lottery: Revenue from the +lottery market includes sales of thermal on-line and other lottery printers to IGT for various lottery applications. Sales of our worldwide lottery printers for the years ended December 31, 2021 and 2020 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Domestic +$ +– +0.0 +% +$ +817 +100.0 +% +$ +(817 +) +(100.0 +%) +International +– +0.0 +% +– +0.0 +% +– +0.0 +% +$ +– +0.0 +% +$ +817 +100.0 +% +$ +(817 +) +(100.0 +%) +On December 31, 2019, we allowed our non-exclusive agreement to provide lottery terminal printers to IGT to expire as we decided to exit +the lottery market and shift our focus towards our higher-value, technology-enabled food service technology and casino and gaming products. As a result, IGT made a final purchase of our lottery printers during the second quarter of 2020 and we do not +expect any further lottery printer sales in the future. +24 +Printrex: Printrex branded +printers are sold into markets that include wide format, desktop and rack-mounted and vehicle-mounted black/white thermal printers used by customers to log and plot oil field, seismic and down hole well drilling data in the oil and gas exploration +industry. Sales of our worldwide Printrex printers for the years ended December 31, 2021 and 2020 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Domestic +$ +171 +27.1 +% +$ +83 +27.7 +% +$ +88 +106.0 +% +International +460 +72.9 +% +217 +72.3 +% +243 +112.0 +% +$ +631 +100.0 +% +$ +300 +100.0 +% +$ +331 +110.3 +% +The increase in sales of Printrex printers during 2021 compared to 2020 resulted from increased domestic and international sales in the +oil and gas market, which was negatively impacted during 2020 by the decline in worldwide oil prices attributable to the COVID-19 pandemic. Additionally, we decided to exit the Printrex market as of December 31, 2021 in order to shift focus towards +our higher-value, technology-enabled food service technology and casino and gaming products. As a result, we had increased sales in 2021 due to fulfilling last buy orders from legacy customers during the fourth quarter of 2021. We do not expect any +further Printrex sales beyond 2021. +TSG: Revenue generated by TSG includes sales of consumable products (POS receipt paper, inkjet cartridges, ribbons and other printing supplies for legacy products), replacement parts and +accessories, maintenance and repair services, refurbished printers, and shipping and handling charges. Sales in our worldwide TSG market for the years ended December 31, 2021 and 2020 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2021 +December 31, 2020 +$ Change +% Change +Domestic +$ +5,501 +91.6 +% +$ +6,262 +89.5 +% +$ +(761 +) +(12.2 +%) +International +502 +8.4 +% +733 +10.5 +% +(231 +) +(31.5 +%) +$ +6,003 +100.0 +% +$ +6,995 +100.0 +% +$ +(992 +) +(14.2 +%) +The decrease in domestic revenue from TSG during 2021 as compared to 2020 was due primarily to lower service revenue, lower sales of +replacement parts, and consumable products. Service revenue declined 39%, primarily related to declining revenue from a service contract with a legacy banking customer that is expected to expire during 2022. Replacement part sales decreased 4% +primarily from lower lottery printer spare part sales to IGT, which can vary significantly from quarter-to-quarter. Consumable sales declined 25%, due primarily to lower sales of HP inkjet cartridges used in our banking printers, as we exited the +banking market at the end of 2018. We expect TSG sales to continue to decrease in 2022 compared to 2021 due to lower expected sales of legacy lottery printer spare parts to IGT and lower service sales related to the banking service contract noted +above. +Internationally, TSG revenue decreased during 2021 compared to 2020, primarily due to 58% lower service revenue, a 64% decrease in +international consumable sales and a 15% decrease in sales of replacement parts and accessories to international casino and gaming customers due to the negative impact from the COVID-19 pandemic. +Gross Profit. +Gross profit information for the years ended December 31, 2021 and 2020 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2021 +2020 +Change +Total Sales - 2021 +Total Sales - 2020 +$ +15,249 +$ +12,929 +17.9 +% +38.7 +% +42.3 +% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, +direct labor, manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers, expenses associated with installations and support of our EPICENTRAL print system and BOHA! ecosystem and royalty payments to +third-parties, including to the third-party licensor of our food service technology software products. Gross profit increased $2.3 million, or 18%, in 2021 compared to 2020, primarily due to the 29% sales increase, which was largely offset by a +decrease in gross margin of 360 basis points during 2021 compared to 2020. Gross margin decreased to 38.7% in 2021 compared to 42.3% in 2020 due largely to lower margin on our BOHA! hardware sales during 2021 compared to 2020, as we have reduced +prices to accelerate the growth of our BOHA! installed base, as well as higher material and shipping costs resulting from worldwide supply disruptions caused by the COVID-19 pandemic. +25 +Operating Expenses +- Engineering, Design and Product Development. Engineering, design and product development information for the years ended December 31, 2021 and 2020 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2021 +2020 +Change +Total Sales - 2021 +Total Sales - 2020 +$ +7,475 +$ +5,703 +31.1 +% +19.0 +% +18.6 +% +Engineering, design and product development expenses primarily include salary and payroll-related expenses for our hardware and +software engineering staff, depreciation and design expenses (including prototype printer expenses, outside design, development and testing services, supplies and contract software development expenses including those to the third-party licensor of our +food service technology software products). Engineering, design and product development expenses increased $1.8 million, or 31%, in 2021 compared to 2020 as we +gradually returned to more normalized pre-COVID-19 spending levels and continued development for our food service technology products. We expect engineering, design and product development expenses to continue to increase in 2022 compared to 2021 due +to planned investments in our food service technology products. +Operating Expenses +- Selling and Marketing . Selling and marketing information for the years ended December 31, 2021 and 2020 is summarized below (in +thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2021 +2020 +Change +Total Sales - 2021 +Total Sales - 2020 +$ +7,658 +$ +6,144 +24.6 +% +19.4 +% +20.1 +% +Selling and marketing expenses primarily include salaries and payroll-related expenses for our sales, marketing and customer success +staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, public relations, e-commerce and other promotional marketing expenses. Selling and marketing expenses increased $1.5 million, or 25%, during 2021 compared to 2020 primarily due to higher trade show expense, expanded marketing expense and new sales and marketing staff as we returned +to more normalized pre-COVID-19 levels of sales and marketing expense during 2021 compared to lower costs during 2020 due to cost saving measures implemented during the second and third quarters of 2020. We expect selling and marketing expenses to increase in 2022, as we plan to make substantial strategic investments in our food service technology sales and marketing groups. +Operating Expenses +- General and Administrative. General and administrative information for the years ended December 31, 2021 and 2020 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2021 +2020 +Change +Total Sales - 2021 +Total Sales - 2020 +$ +9,626 +$ +9,255 +4.0 +% +24.4 +% +30.3 +% +General and administrative expenses primarily include salaries, incentive compensation, and other payroll-related expenses for our +executive, accounting, human resources, business development and information technology staff, expenses for our corporate headquarters, professional and legal expenses, information technology expenses, and other expenses related to being a publicly +traded company. General and administrative expenses increased $0.4 million, or 4%, during 2021 compared to 2020 due to higher recruiting fees and employee +compensation, as well as higher consulting fees related to a planned implementation of a new ERP system expected to be completed in early 2022. These increases were partially offset by lower legal and professional fees and lower severance expense +during 2021 compared to 2020. +Operating Loss. +Operating loss information for the years ended December 31, 2021 and 2020 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2021 +2020 +Change +Total Sales – 2021 +Total Sales – 2020 +$ +(9,510 +) +$ +(8,173 +) +16.4 +% +(24.1 +%) +(26.7 +%) +Our operating loss increased $1.3 million, or 16%, during 2021 compared to 2020 on 29% higher sales due to a decrease in our gross +margin of 360 basis points and increased operating expenses of $3.7 million during 2021 compared to 2020. +Interest, net. We recorded net interest expense of $96 thousand in 2021 compared to $52 thousand in 2020. The increase in net interest expense was primarily due to lower interest +income earned from the note receivable to a third-party software developer that was collected in March 2021 and the full year impact of unused borrowing fees incurred from the Siena Credit Facility that was entered into on March 13, 2020. +Other, net . We recorded other expense of $283 thousand in 2021 compared to other +income of $56 thousand in 2020 primarily due to foreign exchange losses recorded by our UK subsidiary during 2021 compared to foreign exchange gains recorded in 2020. Going forward, we may continue to experience more foreign exchange gains +or losses depending on the level of sales to European customers through our UK subsidiary and the fluctuation in exchange rates of the Euro and Pound Sterling against the U.S. Dollar, which may be impacted by volatility in global economic conditions +due to the COVID-19 pandemic and political instability such as the Russia-Ukraine conflict. +Gain from Employee +Retention Credit. We recorded a $1.5 million gain during 2021 resulting from the recognition of the employee retention credit pursuant to the CARES Act upon meeting the conditions required to claim the credit. +26 +Gain on Forgiveness +of Long-Term Debt. We recorded a $2.2 million gain in 2021 resulting from the forgiveness of the PPP Loan in July 2021. +Income Taxes . We recorded an income tax benefit during 2021 of $2.1 million at +an effective tax rate of 33.3%, compared to an income tax benefit during 2020 of $2.5 million at an effective tax rate of 31.1%. The tax benefit recorded for 2021 included the recognition of the gain on the forgiveness of the PPP Loan which is not +taxable. The effective tax rate for 2020 included the impact of the net operating loss (“NOL”) we incurred during 2020 and was carried back to prior years. The CARES Act enacted on March 27, 2020 permitted NOLs incurred in 2018, 2019 and 2020 to be +carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. We generated an NOL in 2020, which we carried back to tax years that had a federal statutory tax rate of 34% compared to 21% in 2020. +Net Loss. +We reported a net loss for the year ended December 31, 2021 of $4.1 million, or $0.45 per diluted share, compared to a net loss of $5.6 million, or $0.72 per diluted share, in 2020. +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. +Significant factors affecting the management of liquidity are cash flows from operating activities, capital expenditures, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to +access credit lines, if needed, are expected to be sufficient to fund operations, capital expenditures, and any increase in working capital that would be required to accommodate a higher level of business activity. +Cash Flow +During 2021, our cash balance increased $9.1 million, or 88%, from December 31, 2020 due primarily to financing activities providing +$11.5 million of cash primarily from the completion of an underwritten public offering. We had $19.5 million in cash and cash equivalents as of December 31, 2021, of which $1.8 million was held by our UK subsidiary. +Operating activities : The +following significant factors primarily affected our cash used in operating activities of $2.5 million in 2021 as compared to cash used in operating activities of $3.5 million in 2020. During 2021: +● +We reported a net loss of $4.1 million. +● +We recorded depreciation and amortization of $1.0 million and share-based compensation expense of $1.2 million. +● +We recorded a gain of $2.2 million from the forgiveness of the PPP loan. +● +Accounts receivable increased $4.2 million, or 125%, primarily due to increased sales volume during the fourth quarter of 2021. +● +We recorded a receivable of $1.5 million for the employee retention credit that is expected to be collected during 2022. +● +Inventories decreased $3.6 million, or 32%, primarily due to the utilization of inventory on hand to fulfill sales and significantly reduced inventory purchases +resulting from the supply chain disruptions caused by the COVID-19 pandemic. +● +Prepaid income taxes decreased $2.2 million due to receiving an income tax refund in 2021 related to the net operating loss reported for 2020 that was carried back to +prior years as permitted by the CARES Act. +● +Other current and long-term assets decreased $0.3 million, or 23%, primarily due to reduction of a contract asset related to a long-term BOHA! sales contract completed +in 2020. +● +Accounts payable increased $2.5 million, or 150%, d ue to inventory purchases made +towards the end of the fourth quarter of 2021 to support expected 2022 sales . +● +Accrued liabilities and other liabilities increased $0.6 million, or 7%, due primarily to increased deferred revenue. +During 2020: +● +We reported a net loss of $5.6 million. +● +We recorded depreciation and amortization of $1.3 million and share-based compensation expense of $0.9 million. +● +Accounts receivable decreased $3 million, or 47%, primarily due to lower sales volume during the fourth quarter of 2020 compared to the fourth quarter of 2019 due to +the pandemic. +● +Inventories decreased $0.9 million, or 7%, primarily due to the utilization of inventory on hand to fulfill sales in response to the pandemic. +● +Prepaid income taxes increased $2.2 million due to an income tax refund, subsequently received in 2021, related to the net operating loss reported for 2020 that was +carried back to prior years as permitted by the CARES Act. +● +Other current and long-term assets increased $0.2 million, or 19%, due primarily to recording a contract asset related to a long-term BOHA! sales contract which was +partially offset by the recognition of royalty expense that was prepaid in 2019 to a technology partner for food service technology. +● +Accounts payable decreased $1.3 million, or 43%, d ue to inventory purchases made +towards the end of the fourth quarter of 2019 that were subsequently paid in the first quarter of 2020 and a lower level of inventory purchases during 2020 due to the pandemic . +● +Accrued liabilities and other liabilities increased $0.2 million, or 3%, due primarily to an increase in accrued inventive compensation. +27 +Investing activities : Our capital expenditures were $1.4 million and $0.7 million in 2021 and 2020, respectively. Expenditures in 2021 were primarily related to the implementation of a new +ERP system expected to be completed in early 2022, new product tooling and computer and networking equipment. Expenditures in 2020 were primarily for new product tooling equipment, leasehold improvements at our Las Vegas facility and computer and +networking equipment. Investing activities also provided $1.6 million in 2021 upon the collection of the remaining $1.6 million note receivable balance during the first quarter of 2021 from an unaffiliated third-party software developer from whom we +license our food service technology software, compared to $0.6 million of cash used in investing activities during 2020, for the issuance of a loan to the same unaffiliated third-party. +Financing activities: Financing +activities provided $11.5 million of cash during 2021 primarily from the completion of an underwritten public offering which raised net proceeds of $11.2 million, after deducting underwriting discounts, commissions and offering expenses and, to a +lesser extent, proceeds of $0.4 million from stock option exercises. These increases were partially offset by $0.1 million for the payment of withholding taxes on stock issued from our stock compensation plans and $31 thousand on the final payment of +financing costs associated with our Siena Credit Facility. During 2020, financing activities provided $11.0 million of cash primarily from the completion of an underwritten public offering which raised net proceeds of $8.7 million, after deducting u nderwriting discounts, commissions and offering expenses, and $2.2 million in funds received from the PPP Loan and, to a lesser extent, proceeds of $0.4 million from stock +option exercises. These increases were partially offset by the payment of $0.2 million in financing costs associated with signing our Siena Credit Facility. +Resource Sufficiency +Given the unprecedented uncertainty related to the impact of the COVID-19 pandemic on the food service and casino industries, the +Company is closely monitoring its cash generation, usage and preservation including the management of working capital to generate cash. +We believe that our cash and cash equivalents on hand, our expected cash flows generated from operating activities, the proceeds raised +through the underwritten public offering during August 2021, and borrowings available under our Siena Credit Facility will provide sufficient resources to meet our working capital needs, finance our capital expenditures and meet our liquidity +requirements through at least the next twelve months. Notwithstanding this belief, the duration and extent of the pandemic remain uncertain and its ultimate impact is unknown. Further, availability under the Siena Credit Facility depends in part on +inventory levels, which have been impacted and are expected to continue to be impacted by supply chain disruptions due to the COVID-19 pandemic. As a result, we continue to evaluate several different strategies to enhance our liquidity position as a +result of the significant financial and operational impacts due to the COVID-19 pandemic. These strategies may include, but are not limited to, seeking to raise additional capital through an equity or debt financing. +Credit Facility and Borrowings +On March 13, 2020, we entered into the Siena Credit Facility with Siena Lending Group LLC and terminated our credit facility with TD +Bank N.A.. The Siena Credit Facility provides for a revolving credit line of up to $10 million expiring on March 13, 2023. Borrowings under the Siena Credit Facility bear a floating rate of interest equal to the greatest of (i) the prime rate plus +1.75%, (ii) the federal funds rate plus 2.25%, and (iii) 6.50%. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility were $245 thousand. We also pay a fee of 0.50% on unused borrowings under the Siena +Credit Facility. Borrowings under the Siena Credit Facility are secured by a lien on substantially all the assets of the Company. Borrowings under the Siena Credit Facility are subject to a borrowing base based on (i) 85% of eligible accounts +receivable plus the lesser of (a) $5 million and (b) 50% of eligible raw material and 60% of finished goods inventory. +The Siena Credit Facility imposes a financial covenant on the Company and restricts, among other things, our ability to incur +additional indebtedness and the creation of other liens. The three month period from April 1, 2020 to June 30, 2020 was the first period we were subject to the financial covenant, which required the Company to maintain a minimum EBITDA and continued +through the 12-month period from April 1, 2020 to March 31, 2021. On July 21, 2021, the Company entered into an amendment (the “Credit Facility Amendment”) to the Siena Credit Facility. The Credit Facility Amendment changed the financial covenant +under the Siena Credit Facility from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at least $750 thousand under the Siena Credit Facility, tested as of the end of each calendar +month, beginning with the calendar month ending July 31, 2021. From July 31, 2021 to December 31, 2021, we have been in compliance with our excess availability covenant. As of December 31, 2021, we had no outstanding borrowings under the Siena Credit +Facility and $5.1 million of available borrowing capacity under the Siena Credit Facility. +On May 1, 2020 (the “Loan Date”), the Company was granted the PPP Loan with Berkshire Bank in the aggregate amount of $2.2 million, +pursuant to the PPP which is administered by the SBA and was established under Division A, Title I of the CARES Act, enacted March 27, 2020. Under the terms of the PPP, the PPP Loan would be forgiven to the extent that funds from the PPP Loan were +used for payroll costs and costs to continue group health care benefits, as well as for interest on mortgage obligations incurred before February 15, 2020, rent payments under lease agreements in effect before February 15, 2020, utilities for which +service began before February 15, 2020 and interest on debt obligations incurred before February 15, 2020, subject to conditions and limitations provided in the CARES Act. At least 60% (under the PPP terms, as amended) of the proceeds of the PPP Loan +needed to have been used for eligible payroll costs for the PPP Loan to be forgiven. +28 +The PPP Loan, which was evidenced by a Note dated the Loan Date issued by the Company in favor of Berkshire Bank as a lender, was +scheduled to mature on May 1, 2022 and had a fixed interest rate of 1.0% per annum, accruing from the Loan Date and payable monthly. The Company submitted its PPP Loan forgiveness application in May 2021 to the SBA through Berkshire Bank and submitted +the related loan necessity questionnaire in June 2021. On July 8, 2021, the Company received notifications from Berkshire Bank and the SBA that its PPP Loan (including all interest accrued thereon) of $2.2. million had been fully forgiven by the SBA +and that the forgiveness payment date was July 1, 2021. No payments were due on the PPP Loan for six months from the date of first disbursement, and because a loan forgiveness application was submitted to the SBA within 10 months after the end of the +covered period, no payments were due until the date on which the SBA remitted the loan forgiveness amount to the PPP Lender, and interest that accrued during the deferment period was included in the forgiveness amount. The forgiveness of the PPP Loan +was reported as “Gain on forgiveness of long-term debt” in the Consolidated Statement of Operations during the year ending December 31, 2021. +Stock Repurchase Program +During 2021 and 2020 we did not repurchase any shares of our common stock. +Shareholders’ Equity +Shareholders’ equity increased $8.8 million, or 29%, to +$39.0 million at December 31, 2021 from $30.2 million at December 31, 2020. The increase was primarily due to the completion of an underwritten public offering during 2021 which raised net proceeds of $11.2 million, after deducting u nderwriting +discounts, commissions and offering expenses. Shareholders’ equity also increased, although to a lesser extent, from share-based compensation expense related to stock awards of $1.2 million and $0.4 million from the issuance of 97,000 shares of common +stock related to employee stock awards, net of relinquishments. These increases were partially offset by a net loss of $4.1 million. +29 +Item 7A. Quantitative and Qualitative Disclosures about Market Risk. +TransAct is a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, and is not required to provide information under +this item. +Item 8. Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this Form 10-K as pages F-4 through F-22. The “Report of Independent Registered +Public Accounting Firm” is annexed to this Form 10-K as of page F-2. An index to such materials appears on page F-1. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +Not applicable. +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief +Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15I under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of December 31, 2021. In the Amendment to our Annual Report on Form 10-K for the +year ended December 31, 2018, filed with the SEC on November 21, 2019, we disclosed that management, including our CEO and CFO, concluded that our disclosure controls and procedures were not effective as of December 31, 2018, due to material +weaknesses in our internal control over financial reporting. As of December 31, 2021, management has completed the implementation of new controls, which are described below, to fully remediate these material weaknesses. Upon completion of the +remediation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2021, our disclosure controls and procedures are effective at the reasonable assurance level. +Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly +present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles, and that they can still be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule +13a-15(f) under the Exchange Act, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in +accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a +material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2021. Our management based its assessment on +criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 +COSO”). In the opinion of management, TransAct maintained effective internal control over financial reporting as of December 31, 2021. +A material weakness is defined in Rule 12b-2 under the Exchange Act as a deficiency, or a combination of deficiencies, in internal +control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. +Material Weaknesses in Internal Control Over Financial Reporting +We identified a control deficiency that constituted a material weakness in our internal control over financial reporting as of December +31, 2020, 2019 and 2018 and has been fully remediated as of December 31, 2021. The control deficiency was that we did not design and maintain effective controls over the completeness and accuracy of information included in key spreadsheets supporting +our accounting records (the “Spreadsheet Control Weakness”). +This control deficiency constituted a material weakness, but did not result in a material +misstatement to our annual or interim consolidated financial statements. +30 +Remediation Efforts to Address Material Weaknesses +Beginning December 31, 2019, we commenced developing and implementing a plan to enhance the design and operating effectiveness of our +internal control over financial reporting, which included taking the following steps to remediate the identified control deficiency and material weakness: +For each key spreadsheet we evaluated and determined (1) if a standard Oracle report existed containing the same information as the +spreadsheet, and if so, we utilized the standard Oracle report (without modification) instead of the spreadsheet to support our accounting records, and (2) if a standard Oracle report cannot be used, we implemented a new key control whereby an employee +performs a formal validation that the information from Oracle is completely and accurately transferred (automatically or manually) to a spreadsheet by verifying totals and other information on a test basis. For all key spreadsheets, we have designed +and implemented a new key control to validate the completeness and accuracy of information supporting our accounting records. During 2020 and the first quarter of 2021, we completed the evaluation process for each key spreadsheet based on the above +criteria, and during the second quarter of 2021, we completed the implementation of new key controls for all of our key spreadsheets to validate the completeness and accuracy of the information contained within and supporting each such spreadsheet. +During the second half of 2021, we completed our evaluation of the new controls for effectiveness, and the Spreadsheet Control Weakness was deemed to be remediated as of December 31, 2021. +Changes in Internal Control over Financial Reporting +Other than the changes intended to remediate the material weakness noted above, no change in our internal control over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended December 31, 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial +reporting. +Item 9B. Other Information. +Not applicable. +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspection. +Not applicable. +31 +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +Set forth in Item 1 of this Form 10-K is certain information regarding our executive officers. The remaining information in response +to this item will be contained in our Proxy Statement for our 2022 Annual Meeting of Stockholders (the “Proxy Statement”), as applicable, under the headings, “Delinquent Section 16(a) Reports,” “Corporate Governance,” “Proposal 1: Election of +Directors,” “Audit Committee Report,” “Executive Compensation – Compensation Committee Report,” “Stockholder Proposals for 2023 Annual Meeting,” “Procedures for Submitted Director Nominations and Recommendations” and “Policy Regarding Stockholder +Communications with the Board of Directors,” which will be filed within 120 days after the end of the year covered by this Form 10-K and is incorporated herein by reference. +Code of Ethics +We maintain a Standards of Business Conduct and Code of Ethics (“Standards of Business Conduct”) that includes our code of ethics that +is applicable to all employees, including our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Controller. Our Standards of Business Conduct, which require continued observance of high ethical standards, such as honesty, +integrity and compliance with the law in the conduct of our business, are available for public access on our Internet website at https://transacttech.gcs-web.com/corporate-governance. Any person may request a copy of our Standards of Business Conduct +free of charge by calling (203) 859-6800. +Item 11. Executive Compensation. +The information in response to this item will be contained in the Proxy Statement under the heading “Executive Compensation,” and is +incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item +will be contained in the Proxy Statement under the heading, “Security Ownership of Certain Beneficial Owners and Management,” and is incorporated herein by reference. +Equity Compensation Plan Information +Information regarding our equity compensation plans as of December 31, 2021 is as follows: +Plan category +(a) +Number of securities to be +issued upon exercise of outstanding +options, warrants and rights +(b) +Weighted-average exercise price +of outstanding options, warrants and rights +(c) +Number of securities remaining available for +future issuance under equity compensation plans +(excluding securities reflected in column (a) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +195,500 +$ +9.52 +– +2014 Equity Incentive Plan +1,229,080 +7.97 +611,652 +Total +1,424,580 +$ +8.18 +611,652 +In May 2014, our stockholders approved the adoption of the 2014 Equity Incentive Plan. In May 2020, our stockholders approved an +amendment to the 2014 Equity Incentive Plan to increase the number of shares of common stock which may be subject to awards granted under the plan from 1,400,000 to its current level of 2,200,000. The Company also maintains the 2005 Equity Incentive +Plan; however no new awards will be available for future issuance under this plan. Both plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock +units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. The Company does not have any equity plans that have not been approved by its stockholders. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related +Transactions” and “Corporate Governance-Board Leadership Structure and Independence” and is incorporated herein by reference. +Item 14. Principal Accounting Fees and Services. +The information in response to this item will be contained in the Proxy Statement under the headings, “Policy Regarding Pre-Approval of +Services Provided by the Independent Registered Public Accounting Firm” and “Independent Registered Public Accounting Firm’s Services and Fees” and is incorporated herein by reference. +32 +PART IV +Item 15. Exhibits and Financial Statement Schedules. +(a) +The following documents are filed as part of this Form 10-K: +1. +Financial Statements. +Report of Independent Registered Public Accounting Firm +Consolidated Balance Sheets as of December 31, 2021 and 2020 +Consolidated Statements of Operations for the years ended December 31, 2021 and 2020 +Consolidated Statements of Comprehensive Loss for the years ended December 31, 2021 and 2020 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2021 and 2020 +Consolidated Statements of Cash Flows for the years ended December 31, 2021 and 2020 +Notes to Consolidated Financial Statements +2. +Schedules. +All schedules are omitted because they are either inapplicable or not required, or because the information required therein is included in +the Consolidated Financial Statements and Notes thereto. +3. Exhibits. +Exhibits Index +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated (conformed copy) (incorporated by reference to Exhibit 3(i) +of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 9, 2019). +3.1(b) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December 2, 1997 +(incorporated by reference to Exhibit C of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on February 18, 1999). +3.1(c) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000 +(incorporated by reference to Exhibit 3.1(c) of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 8, 2000). +3.2 +Amended and Restated By-laws of the Company (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form +8-K (SEC File No. 000-21121) filed with the SEC on August 2, 2019). +4.1 +Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form +S-1/A (No. 333-06895) filed with the SEC on August 1, 1996). +4.2 +Description of Securities (incorporated by +reference to Exhibit 4.2 of the Company’s Annual Report on Form 10-K (SEC File No. +000-21121) filed with the SEC on March 16, 2020). +10.1 (x) +2005 Equity Incentive Plan (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K (SEC File No. +000-21121) filed with the SEC on June 1, 2005). +10.2 (x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan, as Amended and Restated (incorporated by reference to Exhibit I +to the Definitive Proxy Statement on Schedule 14A filed with the Commission on April 23, 2020, File No. 000-21121). +10.3 (x) +2014 Equity Incentive Plan Time-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.2 of the +Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 6, 2016). +10.4 (x) +2014 Equity Incentive Plan Performance-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 of the +Company’s Quarterly Report on Form 10-Q (SEC File No. 000-211121) filed with the SEC on August 8, 2016). +10.5 (x) +2014 Equity Incentive Plan Nonstatutory Stock Option Agreement (incorproated by reference to Exhibit 10.2 of the Company's current +Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on May 19, 2014) . +10.6 (x) +Employment Agreement, dated July 31, 1996, by and between TransAct and Bart C. Shuldman (incorporated by reference to Exhibit +10.20 of the Company’s Registration Statement on Form S-1/A (No. 333-06895) filed with the SEC on August 1, 1996). +10.7 (x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004 (incorporated by reference to Exhibit +10.8 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2005). +10.8 (x) +Amendment to Employment Agreement, effective January 1, 2008, by and between TransAct and Bart C. Shuldman (incorporated by +reference to Exhibit 10.10 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2009). +10.9 (x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008 (incorporated by +reference to Exhibit 10.12 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2009). +10.10 (x)‡ +Severance Agreement by and between TransAct and Andrew J. Hoffman (as amended), effective December 23, 2008. +10.11 (x)‡ +Second Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective April 29, 2021 +10.12 +Lease Agreement by and between Bomax Properties and Ithaca, dated as of March 23, 1992 (incorporated by reference to Exhibit +10.14 of the Company’s Registration Statement on Form S-1 (No. 333-06895) filed with the SEC on June 26, 1996). +10.13 +Second Amendment to Lease Agreement by and between Bomax Properties and Ithaca, dated December 2, 1996 ( incorporated by reference to Exhibit 10.27 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 31, 1998). +33 +10.14 +Agreement regarding the Continuation and Renewal of Lease by and between Bomax Properties, LLC and TransAct, dated July 18, +2001 (incorporated by reference to Exhibit 10.8 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 29, 2002). +10.15 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct (incorporated by reference to Exhibit 10.16 of +the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 10, 2012). +10.16 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016 (incorporated by +reference to Exhibit 10.13 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 11, 2016). +10.17 +Amendment No. 3 to Lease Agreement between Bomax Properties, LLC and TransAct, dated February 28, 2020 (incorporated by +reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on March 4, 2020). +10.18 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004 (incorporated by reference +to Exhibit 10.13 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2005). +10.19 +First Amendment to Lease Agreement by and between CIP Hughes Center LLC and TransAct dated August 24, 2009 (incorporated by +reference to Exhibit 10.19 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2010). +10.20 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, 2015 +(incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 7, 2015). +10.21 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006 (incorporated by reference to +Exhibit 10.14 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 15, 2007). +10.22 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 3, 2017 (incorporated by +reference to Exhibit 10.20 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2017). +10.23 +Second Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct Technologies dated April 30, 2021 +(incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 13, 2021). +10.24 +Loan and Security Agreement, dated as of March 13, 2020, among Siena Lending Group LLC, TransAct Technologies Incorporated and +the other Loan Parties from time to time party thereto (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 22, 2020). +10.25 +Amendment No. 1 To Loan and Security Agreement, dated as of July 21, 2021, among Siena Lending Group and TransAct Technologies +Incorporated (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 26, 2021) +10.26 † +Master License Agreement dated February 22, 2019 and amendments thereto (incorporated by reference to Exhibit 10.24 to the +Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021). +1 0.27 † +Master Development and License Agreement dated July 20, 2018 (incorporated by reference to Exhibit 10.25 to the Company’s Annual +Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021). +21 +Subsidiaries of the Company(incorporated by reference to Exhibit 21 to the Company’s Annual Report on Form 10-K (SEC File No. +000-21121) filed with the SEC on March 12, 2021). +23.1 * +Consent of Marcum LLP +31.1 * +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 * +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +32 ‡ +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to +Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are +embedded within the Inline XBRL document). +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +(x) +Management contract or compensatory plan or arrangement. +* +These exhibits are filed herewith. +† +Certain portions of this exhibit (indicated by “[***]”) have been omitted pursuant to Item (601)(b)(10) of Regulation S-K. +‡ +Furnished herewith. +(b) +Exhibits. +The Exhibits required by Item 601 of Regulation S-K under the Exchange Act are included in the Exhibit Index above under a(3) of this Item +15. +(c) +Financial Statement Schedules. +See the Notes to the Consolidated Financial Statements included in this Form 10-K. +34 +Item 16. Form 10-K Summary. +Not applicable. +35 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to +be signed on its behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ Bart C. Shuldman +Name: +Bart C. Shuldman +Title: +Chairman of the Board and Chief Executive Officer +Date: March 24, 2022 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf +of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Bart C. Shuldman +Chairman of the Board and Chief Executive Officer +March 24, 2022 +Bart C. Shuldman +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, Treasurer and Secretary +March 24, 2022 +Steven A. DeMartino +(Principal Financial Officer) +/s/ David B. Peters +Vice President and Chief Accounting Officer +March 24, 2022 +David B. Peters +(Principal Accounting Officer) +/s/ John M. Dillon +Director +March 24, 2022 +John M. Dillon +/s/ Randall S. Friedman +Director +March 24, 2022 +Randall S. Friedman +/s/ Emanuel P. N. Hilario +Director +March 24, 2022 +Emanuel P. N. Hilario +/s/ Haydee Olinger +Director +March 24, 2022 +Haydee Olinger +36 +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 688 ) +F-2 +Consolidated Balance Sheets as of December 31, 2021 and 2020 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2021 and 2020 +F-5 +Consolidated Statements of Comprehensive Loss for the years ended December 31, 2021 and 2020 +F-6 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2021 and 2020 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2021 and 2020 +F-8 +Notes to Consolidated Financial Statements +F-9 +F-1 +Report of Independent Registered Publi c +Accounting Firm +To the Shareholders and Board of Directors of Transact Technologies Incorporated +Opinion on the Financial Statements +We have audited the +accompanying consolidated balance sheets of TransAct Technologies Incorporated and its subsidiaries (the “Company”) as of December 31, 2021 and 2020, and the related consolidated statements of operations, comprehensive loss , changes in shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2021, and the related notes (collectively referred to as the +“consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its +cash flows for each of the two years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion +on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the +Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to +obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over +financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial +reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, +whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included +evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial +statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, +or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate +opinions on the critical audit matters or on the accounts or disclosures to which they relate. +Revenue recognition – Identification of Distinct Performance Obligations and Estimate of Standalone Selling Price +As described in Note 2 to the consolidated financial statements, some of the Company’s contracts with customers contain multiple +performance obligations (most commonly when contracts include a hardware product, software and extended warranties). A contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the +performance obligation is satisfied. The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring services to the customer. For a majority of the Company’s revenue, which consists of +printers, terminals, consumables, and replacement parts, the Company recognizes revenue as of a point of time; the revenue is recognized upon shipment of the order when control of the goods is transferred to the customer and at the time the performance +obligation is fulfilled. Performance obligations are satisfied over time if the customer receives the benefits as the Company performs work. The Company’s cloud-based BOHA! software, provided on a subscription basis, allows customers to use hosted +software over the contract period without taking possession of the software and is recognized ratably over the contract period. For extended warranties, the transaction price is recognized ratably over the warranty period, using output methods, as +control of the services is transferred to the customer. When there is more than one performance obligation in a customer arrangement, the Company typically uses the “standalone selling price” method to determine the transaction price to allocate to +each performance obligation. +F-2 +In 2020, the Company launched a new service offering related to BOHA! for one customer that bundled the BOHA! products (cloud-based +SaaS software applications, hardware and after-market service) in one price payable monthly over a three-year period. During the year ended December 31, 2021, the Company recognized revenue from this contract with the customer related to this service +offering in the amount of approximately $312 thousand. Judgement was required by management to identify the performance obligations in the contract and allocate the transaction price to each performance obligation. +The principal considerations for our determination that revenue recognition, specifically related to management’s identification of +distinct performance obligations and the estimation of standalone selling prices related to this service offering, is a critical audit matter are that there was significant judgment by management in (1) the identification of distinct performance +obligations related to this service offering, specifically the determination that one distinct performance obligation existed for point in time revenue recognition and three distinct performance obligations existed for over-time revenue recognition, +(2) the estimation of the standalone selling price using market pricing conditions and other observable inputs, such as historical pricing practices, for each distinct performance obligation; (3) the determination that a significant financing +component existed in the arrangement with the customer, therefore, requiring deferral of a portion of the point in time revenue to be recognized as interest income over the contract period; (4) management’s election of the accounting policy expedient +to exclude sales taxes collected from customers from the transaction price in accordance with ASU 2016-12; and (5) the identification of costs incurred to obtain the contract and management’s decision to defer such costs and recognize the expense on +a straight-line basis over the life of the contract. This in turn led to a high degree of auditor judgment and subjectivity in performing our audit procedures, which were designed to evaluate audit evidence related to management’s identification of +distinct performance obligations within the contract with the customer related to this service offering and the judgments made by management to estimate the standalone selling prices used to allocate the transaction price to those distinct +performance obligations identified. Due to this complexity, there was significant effort in performing our audit procedures to evaluate the reasonableness of management’s estimates used in the Company’s application of the accounting standard related +to revenue recognition for this service offering. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on +the consolidated financial statements. These procedures included, among others, (i) evaluating the Company’s revenue recognition accounting policy resulting from its application of the accounting standard related to revenue recognition; (ii) +evaluating management’s identification of distinct performance obligations in its contract with the customer; (iii) evaluating management’s process for estimating the standalone selling price which included testing the completeness and accuracy of +input data used and evaluating the reasonableness of significant assumptions used by management, principally observable inputs such as historical pricing practices; and (iv) evaluation of the accuracy of management’s allocation of the transaction +price to the performance obligations contained within the related contract with the customer. +/s/ Marcum LLP +We have served as the Company’s auditor since 2020. +Hartford, Connecticut +March 24, 2022 +F-3 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +2021 +December 31, +2020 +Assets: +Current assets: +Cash and cash equivalents +$ +19,457 +$ +10,359 +Accounts receivable, net +7,593 +3,377 +Employee retention credit receivable +1,500 +– +Note receivable +– +100 +Inventories +7,720 +11,286 +Prepaid income taxes +137 +2,409 +Other current assets +738 +644 +Total current assets +37,145 +28,175 +Fixed assets, net +2,684 +1,950 +Notes receivable, net of current portion +– +1,584 +Right-of-use asset +2,553 +3,618 +Goodwill +2,621 +2,621 +Deferred tax assets +5,141 +2,939 +Intangible assets, net +397 +583 +Other assets +400 +777 +13,796 +14,072 +Total assets +$ +50,941 +$ +42,247 +Liabilities and Shareholders’ Equity: +Current liabilities: +Accounts payable +$ +4,308 +$ +1,691 +Accrued liabilities +3,894 +3,665 +Lease liability +789 +837 +Deferred revenue +805 +504 +Total current liabilities +9,796 +6,697 +Long-term debt +– +2,173 +Deferred revenue, net of current portion +186 +111 +Lease liability, net of current portion +1,781 +2,864 +Other liabilities +187 +166 +2,154 +5,314 +Total liabilities +11,950 +12,011 +Commitments and contingencies +Shareholders’ equity: +Preferred stock, $ 0.01 value, 4,800,000 authorized, none issued and outstanding +– +– +Preferred stock, Series A, $ 0.01 par value, 200,000 authorized, none issued and outstanding +– +– +Common stock, $ 0.01 par value, 20,000,000 authorized at December 31, 2021 and 2020 ; 13,917,731 and 12,976,227 shares +issued; 9,872,889 and 8,931,385 +shares outstanding, at December 31, 2021 and 2020 , respectively +139 +130 +Additional paid-in capital +55,246 +42,536 +Retained earnings +15,573 +19,718 +Accumulated other comprehensive income (loss), net of tax +143 +( 38 +) +Treasury stock, 4,044,842 shares, at cost +( 32,110 +) +( 32,110 +) +Total shareholders’ equity +38,991 +30,236 +Total liabilities and shareholders’ equity +$ +50,941 +$ +42,247 +See accompanying notes to Consolidated Financial Statements. +F-4 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except per share data) +Year Ended December 31, +2021 +2020 +Net sales +$ +39,386 +$ +30,595 +Cost of sales +24,137 +17,666 +Gross profit +15,249 +12,929 +Operating expenses: +Engineering, design and product development +7,475 +5,703 +Selling and marketing +7,658 +6,144 +General and administrative +9,626 +9,255 +24,759 +21,102 +Operating loss +( 9,510 +) +( 8,173 +) +Interest and other income (expense): +Interest expense +( 157 +) +( 130 +) +Interest income +61 +78 +Other, net +( 283 +) +56 +Gain from employee retention credit +1,500 +– +Gain on forgiveness of long-term debt +2,173 +– +3,294 +4 +Loss before income taxes +( 6,216 +) +( 8,169 +) +Income tax benefit +2,071 +2,539 +Net loss +$ +( 4,145 +) +$ +( 5,630 +) +Net loss per common share: +Basic +$ +( 0.45 +) +$ +( 0.72 +) +Diluted +$ +( 0.45 +) +$ +( 0.72 +) +Shares used in per-share calculation: +Basic +9,298 +7,827 +Diluted +9,298 +7,827 +See accompanying notes to Consolidated Financial Statements. +F-5 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS +(In thousands) +Year Ended December 31, +2021 +2020 +Net loss +$ +( 4,145 +) +$ +( 5,630 +) +Foreign currency translation adjustment, net of tax +181 +( 7 +) +Comprehensive loss +$ +( 3,964 +) +$ +( 5,637 +) +See accompanying notes to Consolidated Financial Statements. +F-6 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY +(In thousands, except share data) +Common Stock +Additional +Paid-in +Retained +Treasury +Accumulated +Other +Comprehensive +Total +Shares +Amount +Capital +Earnings +Stock +Income (Loss) +Equity +Balance, January 1, 2020 +7,470,248 +$ +115 +$ +32,604 +$ +25,348 +$ +( 32,110 +) +$ +( 31 +) +$ +25,926 +Issuance of common stock from exercise of stock options +62,500 +1 +374 +– +– +– +375 +Issuance of common stock on restricted stock units +32,725 +– +– +– +– +– +– +Issuance of common stock, net of issuance cost +1,380,000 +14 +8,723 +– +– +– +8,737 +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 14,088 +) +– +( 41 +) +– +– +– +( 41 +) +Share-based compensation expense +– +– +876 +– +– +– +876 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +( 7 +) +( 7 +) +Net loss +– +– +– +( 5,630 +) +– +– +( 5,630 +) +Balance, December 31, 2020 +8,931,385 +130 +42,536 +19,718 +( 32,110 +) +( 38 +) +30,236 +Issuance of common stock from exercise of stock options +97,000 +– +436 +– +– +– +436 +Issuance of common stock on restricted stock units +50,525 +– +– +– +– +– +– +Issuance of common stock, net of issuance cost +842,375 +9 +11,201 +– +– +– +11,210 +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 48,396 +) +– +( 133 +) +– +– +– +( 133 +) +Share-based compensation expense +– +– +1,206 +– +– +– +1,206 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +181 +181 +Net loss +– +– +– +( 4,145 +) +– +– +( 4,145 +) +Balance, December 31, 2021 +9,872,889 +$ +139 +$ +55,246 +$ +15,573 +$ +( 32,110 +) +$ +143 +$ +38,991 +See accompanying notes to Consolidated Financial Statements. +F-7 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2021 +2020 +Cash flows from operating activities: +Net loss +$ +( 4,145 +) +$ +( 5,630 +) +Adjustments to reconcile net loss to net cash used in operating activities: +Share-based compensation expense +1,206 +876 +Depreciation and amortization +957 +1,342 +Deferred income tax benefit +( 2,150 +) +( 367 +) +Loss on the sale of fixed assets +9 +– +Foreign currency transaction losses (gains) +272 +( 58 +) +Gain on forgiveness of long-term debt +( 2,173 +) +– +Changes in operating assets and liabilities: +Accounts receivable +( 4,217 +) +2,975 +Employee retention credit receivable +( 1,500 +) +– +Inventories +3,573 +876 +Prepaid income taxes +2,210 +( 2,226 +) +Other current and long-term assets +322 +( 198 +) +Accounts payable +2,534 +( 1,276 +) +Accrued liabilities and other liabilities +592 +176 +Net cash used in operating activities +( 2,510 +) +( 3,510 +) +Cash flows from investing activities: +Capital expenditures +( 1,384 +) +( 744 +) +Proceeds from the sale of fixed assets +8 +– +Collection (issuance) of note receivable +1,598 +( 600 +) +Net cash provided by (used in) investing activities +222 +( 1,344 +) +Cash flows from financing activities: +Revolving credit line borrowings +– +2,756 +Revolving credit line payments +– +( 2,756 +) +Long-term debt borrowings +– +2,173 +Proceeds from stock option exercises +436 +375 +Proceeds from the issuance of common stock +12,214 +9,798 +Payment of common stock issuance costs +( 1,014 +) +( 1,061 +) +Withholding taxes paid on stock issuance +( 133 +) +( 41 +) +Payment of bank financing costs +( 31 +) +( 213 +) +Net cash provided by financing activities +11,472 +11,031 +Effect of exchange rate changes on cash and cash equivalents +( 86 +) +( 21 +) +Increase in cash and cash equivalents +9,098 +6,156 +Cash and cash equivalents, beginning of period +10,359 +4,203 +Cash and cash equivalents, end of period +$ +19,457 +$ +10,359 +Supplemental cash flow information: +Interest paid +$ +76 +$ +64 +Income taxes paid +57 +46 +Non-cash capital expenditure items +82 +25 +See accompanying notes to Consolidated Financial Statements. +F-8 +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated (together with its subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”), which has its +headquarters in Hamden, Connecticut and its primary operating facility in Ithaca, New York, operates in one operating segment: software-driven +technology and printing solutions for high growth markets including food service technology, casino and gaming and POS automation markets. Our solutions are designed from the ground up based on market and customer requirements and are sold under the +BOHA! TM , AccuDate™, Epic, Ithaca®, EPICENTRAL and Printrex® product brands. We sell our products to original equipment manufacturers, value-added resellers, select distributors, and directly to end-users. Our product distribution spans +across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide +installed base of products. We also generate revenue from the after-market side of the business, providing printer and terminal service, consumables and spare parts in addition to revenue from our two software solutions; (i) our line of BOHA! software applications used to automate the back-of-house operations of restaurants, convenience stores and food service operators and (ii) the +EPICENTRAL Print System (“EPICENTRAL”), that enables casino operators to create promotional coupons and marketing messages and print them in real time at the slot machine. +Impact of the COVID-19 Pandemic +In the first quarter of 2020, the COVID-19 pandemic and the resulting social distancing measures, including closures and restricted +openings of restaurants and casinos implemented by federal, state and local authorities, negatively impacted customer demand and disrupted portions of our supply chain, including delayed product shipments from our two manufacturers located in Thailand and China. While we began to experience a modest recovery starting in the second half of 2020 into 2021 and expect this recovery to continue +during 2022, the exact timing and pace of recovery are unknown given uncertainty surrounding responsive measures to the spread of virus variants or any potential future resurgences of the virus and the significant disruption that our customers have +already experienced and may continue to experience. In light of this uncertainty, we implemented a number of cost saving measures during 2020 to help mitigate the impact on our financial position and operations and continued to limit discretionary +spending during 2021. We are monitoring indicators of demand recovery, including our sales pipeline, customer orders and product shipments to ascertain an estimate of the ultimate impact of the COVID-19 pandemic on our business; however, the length +and ultimate severity of the reduction in demand due to the pandemic remains uncertain. +Balance Sheet, Cash Flow and Liquidity. +In addition to the expense management actions implemented during 2020, we took the following actions to increase liquidity and strengthen our financial position. +● +Public Offering – On October 16, 2020 and August 16, 2021, the Company raised net proceeds of +$ 8.7 million and $ 11.2 million ( including the exercise of the underwriters +overallotment options on October 16, 2020 and August 20, 2021) , respectively, after deducting underwriting discounts, commissions and offering expenses, through +underwritten public offerings and sold an aggregate of 1,380,000 and 842,375 shares of common +stock, respectively. +● +PPP Loan – On May 1, 2020, the Company was granted a $ 2.2 million loan (the “PPP Loan”) under the Paycheck Protection Program +(the “PPP”) administered by the Small Business Administration (“SBA”) established under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which enabled us to return employees we furloughed earlier in +2020 to full time employment and to restore employees to full pay following certain pay cuts . On July 8, 2021, we received notice that the PPP Loan +had been forgiven as of July 1, 2021. See Note 9 for further details regarding the PPP Loan. +● +Employee Retention Credit – Under the provisions of the CARES Act, the Company is +eligible for a refundable employee retention credit subject to certain criteria. In connection with the CARES Act, the Company recognized the employee retention credit during the fourth quarter of 2021 and recorded $ 1.5 million as “Gain from employee retention credit” in the Consolidated Statement of Operations for the year ended December 31, 2021 and the +related receivable as “Employee retention credit receivable” in the Consolidated Balance Sheets as of December 31, 2021. We expect to receive these funds during 2022. +● +New Credit Facility – On March 13, 2020, we entered into a new credit facility with Siena +Lending Group LLC that provides a revolving credit line of up to $ 10.0 million, subject to a borrowing base. +● +Reduced Capital Expenditures – We limited capital expenditures during 2020 and gradually increased expenses during 2021 as our sales improved. +F-9 +We may further modify or supplement the expense management measures we have implemented and the actions we have taken to increase +liquidity as the timing and extent of customer demand recovery develops and supply chains normalize. +After reviewing whether conditions and/or events raise substantial doubt about our ability to meet future financial obligations over +the 12 months following the date on which the Consolidated Financial Statements included in this Form 10-K (this “Report”) were issued, including consideration of the actions taken to manage expenses and liquidity, we believe that our net cash to be +provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility will provide sufficient liquidity to fund our current obligations, capital spending, and working capital requirements and +to comply with the financial covenants of our credit facility over at least 12 months following the date that the Consolidated Financial Statements were issued. +Use of Assumptions and Estimates +Management’s belief that the Company will be able to fund its planned operations over the 12 months following the date on which the +Consolidated Financial Statements were issued is based on assumptions which involve significant judgment and estimates of future revenues, capital expenditures and other operating costs. Our current assumptions are that casinos and restaurants remain +open and consumer traffic continues to gradually increase during 2022, but that many casinos and restaurants may delay purchases of new slot machines and our BOHA! products, respectively, due to labor shortages and supply issues caused by the +pandemic. Based on these assumptions, we anticipate that sales in casino and gaming and food service technology may continue to be negatively impacted for the foreseeable future. We have performed a sensitivity analysis on these assumptions to +forecast the potential impact of a slower-than-anticipated recovery and believe that we are positioned to withstand the impact of lower-than-anticipated sales and that we will be able to take additional financial and operational actions to cut costs +and/or increase liquidity if necessary. These actions may include additional expense reductions and capital raising activities. +In addition, the presentation of the accompanying audited Consolidated Financial Statements requires us to make estimates and judgments +that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities. Our estimates include those related to revenue recognition, inventory obsolescence, the valuation of deferred tax +assets and liabilities, depreciable lives of equipment, warranty obligations, and contingent liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual +results could differ from those estimates used. +Smaller Reporting Company +As a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, we may choose to prepare our disclosures relying on +certain scaled disclosure requirements for smaller reporting companies in Regulation S-K and in Article 8 of Regulation S-X. +The scaled disclosure requirements for smaller reporting companies permit us (i) to include less extensive narrative disclosure than +required of other reporting companies, particularly in the description of executive compensation and (ii) to provide audited financial statements for two fiscal years, in contrast to other reporting companies, which must provide audited financial +statements for three years. +We may lose our status as a smaller reporting company on the last day of the fiscal year in which (i) our public float exceeds $250 +million as of the last day of the second fiscal quarter or (ii) if we have more than $100 million in annual revenues and (a) have no public float or (b) have a public float more than $700 million. +2. Summary of significant accounting policies +Principles of +consolidation: The accompanying Consolidated Financial Statements include the accounts of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized +profit. +Use of estimates : The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America +(“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements +and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting.” We +view our operations and manage our business as one segment: the design, development and marketing of software-driven technology and printing +solutions and providing printer and terminal related software, services, supplies and spare parts. Factors used to identify TransAct’s single operating segment include the organizational structure of the Company and the financial information available +for evaluation by the chief operating decision-maker in making decisions about how to allocate resources and assess performance. +Cash and cash equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Allowance for +doubtful accounts : We establish an allowance for doubtful accounts to ensure trade receivables are valued appropriately. We maintain an +allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events and historical experience. We record a specific allowance for individual accounts when we become aware of +a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. If circumstances related to customers change, we further adjust estimates +of the recoverability of receivables. +F-10 +The following table summarizes the activity recorded in the valuation account for accounts receivable: +Year Ended December 31, +(In thousands) +2021 +2020 +Balance, beginning of period +$ +220 +$ +221 +Additions charged to costs and expenses +– +1 +Deductions +( 1 +) +( 2 +) +Balance, end of period +$ +219 +$ +220 +Inventories: Inventories are +stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less +estimated costs of completions, disposal and transportation, historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net +realizable value. +Fixed assets: Fixed assets are +stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years ; +machinery and equipment is ten years ; furniture and office equipment is five years to ten years ; and computer software and equipment is three years to seven years . Leasehold +improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and +accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $ 0.7 million and $ 1.0 million in 2021 and 2020, respectively. +Leases: We account for leases in accordance with ASC 842, “Leases” (“ASC 842”), which requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on +the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determines whether lease expense is recognized based on an effective interest method for finance leases or on a straight-line basis over the +term of the lease for operating leases. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less are +accounted for based on existing guidance for operating leases. If risks and rewards are conveyed without the transfer of control, the lease is treated as financing. If the lessor does not convey risks and rewards or control, the lease is treated as +operating. +We have elected certain practical expedients available under ASC 842 upon adoption. We have applied the practical expedient for +short-term leases. We have lease agreements that include lease and non-lease components, and we have not elected the practical expedients to combine these components for any of our leases. +We enter into lease agreements for the use of real estate space and certain equipment under operating leases and we have no financing +leases. We determine if an arrangement contains a lease at inception. Our leases are included in “Right-of-use asset” and “Lease liability” in our Consolidated Balance Sheets. +Right of use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to +make lease payments arising from the lease. Lease right of use assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term. On February 28, 2020, we entered into an +amendment to extend the lease on our facility in Ithaca, New York, which resulted in recording an additional right-of-use-asset and lease liability of $ 1.5 +million. The lease, which was last amended on January 14, 2016, was scheduled to expire on May 31, 2021. The lease amendment provides for an extension of the lease for four additional years from June 1, 2021 to May 31, 2025. On April 30, 2021, we entered into an amendment to modify the expiration date of our lease on our Hamden, CT facility. The lease, which +was last amended on January 3, 2017, was scheduled to expire on April 30, 2027. The lease amendment modified the expiration date to October 31, 2025. The modification resulted in reducing the right-of-use-asset and lease liability by $ 0.3 million. Lease expense is recognized on a straight-line basis over the lease term. As most of our leases do not provide an implicit rate, the +Company determines its incremental borrowing rate by using the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. Our +lease right of use asset excludes lease incentives. Our leases have remaining lease terms of one year to five years , some of which include options to extend. The exercise of lease renewal options is at our sole discretion and our lease right of use assets and liabilities reflect only +the options we are reasonably certain that we will exercise. Lease expense is recognized on a straight-line basis over the lease term. +F-11 +Goodwill and +Intangible assets : We acquire businesses in purchase +transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 “Goodwill,” acquired goodwill is +not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change that indicate it is more likely than not an impairment exists. We perform a fair value-based impairment test to the +carrying value of goodwill and indefinite-lived intangible assets on an annual basis (as of December 31) and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. The Company utilizes the +option to first assess qualitative factors to determine whether it is necessary to perform the Step 1 quantitative goodwill impairment test in accordance with the applicable accounting standards. Under the qualitative assessment, management considers +relevant events and circumstances including but not limited to macroeconomic conditions, industry and market considerations, Company performance and events directly affecting the Company. If the Company determines that the Step 1 quantitative +impairment test is required, management estimates the fair value of the reporting unit primarily using the income approach, which reflects management’s cash flow projections, and also evaluates the fair value using the market approach. Factors considered that may trigger an interim period impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected +historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization +relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. +As of December 31, 2021, we have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2021 when our annual review for impairment was performed. +Revenue +recognition: We account for revenue in accordance with ASC Topic 606: Revenue from Contracts with Customers. In accordance with ASC 606, a performance obligation is a promise in a contract with a customer to transfer a distinct good or +service to the customer. Some of our contracts with customers contain a single performance obligation, while other contracts contain multiple performance obligations (most commonly when contracts include a hardware product, software and extended +warranties). A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. +The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring +services to the customer. To the extent the transaction price includes variable consideration, such as price protection, reserves for returns and other allowances, the Company estimates the amount of variable consideration that should be included in +the transaction price utilizing either the “expected value” method or the “most likely amount” method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it +is probable that a significant future reversal of cumulative revenue under the contract will not occur. +For a majority of our revenue, which consists of printers, terminals, consumables, and replacement parts, the Company recognizes +revenue as of a point of time. The transaction price is recognized upon shipment of the order when control of the goods is transferred to the customer and at the time the performance obligation is fulfilled. We also sell a software solution in our +casino and gaming market, EPICENTRAL, that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. EPICENTRAL is primarily comprised of both a software component, which is +licensed to the customer, and a hardware component. EPICENTRAL software and hardware are integrated to deliver the system’s full functionality. The transaction prices from EPICENTRAL software license and hardware are recognized upon installation and +formal acceptance by the customer when control of the license is transferred to the customer. For out-of-warranty repairs, the transaction price is recognized after the repair work is completed and the printer or terminal is returned to the customer, +as control of the product is transferred to the customer and our performance obligation is completed. +Performance obligations are satisfied over time if the customer receives the benefits as we perform work, if the customer controls the +asset as it is being produced, or if the product being produced for the customer has no alternative use and we have a contractual right to payment. For our separately priced extended warranty, BOHA! cloud-based software applications, technical support +for our food service technology terminals and maintenance agreements (including free one-year maintenance received by customers upon completion +of EPICENTRAL installation) revenue is recognized over time as the customer receives the benefit. The transaction price from the maintenance services is recognized ratably over time, using output methods, as control of the services is transferred to +the customer. Our cloud-based BOHA! software allows customers to use hosted software over the contract period on a subscription basis without taking possession of the software and the subscription price is recognized ratably over the contract period. +For extended warranties, the transaction price is recognized ratably over the warranty period, using output methods, as control of the services is transferred to the customer. +When there is more than one performance obligation in a customer arrangement, the Company typically uses the “standalone selling price” +method to determine the transaction price to allocate to each performance obligation. The Company sells the performance obligations separately and has established standalone selling prices for its products and services. In the case of an overall price +discount, the discount is applied to each performance obligation proportionately based on standalone selling price. To determine the standalone selling price for initial EPICENTRAL installations, the Company uses the adjusted market assessment +approach. +For contracts with terms of less than 12 months, the Company expenses sales commissions as they are incurred, since the expected +amortization period of the cost to obtain a contract is less than 12 months. +F-12 +Disaggregation of revenue +The following table disaggregates our revenue by market type, as we believe it best depicts how the nature, amount, timing and uncertainty of +our revenue and cash flows are affected by economic factors. Sales and usage-based taxes are excluded from revenues. +Year Ended December 31, 2021 +(In thousands) +United States +International +Total +Food service technology +$ +11,738 +$ +887 +$ +12,625 +POS automation +4,817 +8 +4,825 +Casino and gaming +10,173 +5,129 +15,302 +Printrex +171 +460 +631 +TransAct Services Group +5,501 +502 +6,003 +Total net sales +$ +32,400 +$ +6,986 +$ +39,386 +Year Ended December 31, 2020 +(In thousands) +United States +International +Total +Food service technology +$ +6,956 +$ +778 +$ +7,734 +POS automation +3,763 +7 +3,770 +Casino and gaming +6,852 +4,127 +10,979 +Lottery +817 +– +817 +Printrex +83 +217 +300 +TransAct Services Group +6,262 +733 +6,995 +Total net sales +$ +24,733 +$ +5,862 +$ +30,595 +Contract balances +Contract assets consist of unbilled receivables. Pursuant to the over-time revenue recognition model, revenue may be recognized prior +to the customer being invoiced. An unbilled receivable is recorded to reflect revenue that is recognized when such revenue exceeds the amount invoiced to the customer. Unbilled receivables are separated into current and non-current assets and included +within “Accounts Receivable” and “Other Non-Current Assets” on the Consolidated Balance Sheets. We first recorded contract assets during 2020 upon the start of a long-term BOHA! contract. +Contract liabilities consist of customer prepayments and deferred revenue. Customer prepayments are reported as “Accrued Liabilities” +in current liabilities in the Consolidated Balance Sheets and represent customer payments made in advance of performance obligations in instances where credit has not been extended and is recognized as revenue when the performance obligation is +complete. Deferred revenue is reported separately in current liabilities and non-current liabilities and consists of our extended warranty contracts, technical support for our food service technology terminals, EPICENTRAL maintenance contracts and +prepaid software subscriptions for our BOHA! software applications, and is recognized as revenue as (or when) we perform under the contract. The increase in current and non-current deferred revenue in 2021 compared to 2020 was primarily due to +increased BOHA! software subscriptions and increased extended warranty contracts on our BOHA! hardware products. During the year ended December 31, 2021, +we recognized revenue of $ 0.7 million related to our contract liabilities as of December 31, 2020. +Net contract (liabilities) assets consist of the following: +December 31, +(In thousands) +2021 +2020 +Unbilled receivables, current +$ +314 +$ +290 +Unbilled receivables, non-current +308 +591 +Customer pre-payments +( 99 +) +( 216 +) +Deferred revenue, current +( 805 +) +( 504 +) +Deferred revenue, non-current +( 186 +) +( 111 +) +Net contract (liabilities) assets +$ +( 468 +) +$ +50 +Remaining performance obligations +Remaining performance obligations represent the transaction price of firm orders for which a good or service has not been delivered to +our customer. As of December 31, 2021, the aggregate amount of the transaction price allocated to remaining performance obligations was $ 10.5 million. The Company expects to recognize revenue on $ 10.1 +million of our remaining performance obligations within the next 12 months and $ 0.4 million within the next 24 months. +F-13 +Concentration of credit +risk: Financial instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable were as follows: +December 31, +2021 +2020 +Chain Link Services +10 +% +– +International Gaming Technology (“IGT”) +3 +% +11 +% +NCR Corporation +11 +% +2 +% +Sales to customers representing 10% or more of total net sales were as follows: +December 31, +2021 +2020 +IGT +9 +% +15 +% +Warranty: We generally warrant our +products for up to 24 months and record the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty +costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs. +The following table summarizes the activity recorded in the accrued product warranty liability: +December 31, +(In thousands) +2021 +2020 +Balance, beginning of period +$ +140 +$ +215 +Warranties issued +44 +56 +Warranty settlements +( 83 +) +( 131 +) +Balance, end of period +$ +101 +$ +140 +$ 79 thousand and $ 112 thousand of the accrued product warranty liability was classified as current in Accrued liabilities at December 31, 2021 and 2020, respectively. The remaining +$ 22 thousand and $ 28 thousand of the +accrued product warranty liability as of December 31, 2021 and 2020, respectively, was classified as long-term in Other liabilities. +Engineering, +design and product development: Engineering, design and product development expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed +as a component of operating expenses as incurred. We recorded $ 7.5 million and $ 5.7 million of research and development expenses in 2021 and 2020, respectively. +Costs incurred in the engineering, design and product development of a computer software product are charged to expense until +technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is +required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs +have been included in cost of sales over the estimated life of the product. During 2019, we contracted several third-parties to develop software for our food service technology products, the cost for which we capitalized. Unamortized development +costs for such software were $ 396 thousand as of December 31, 2021. The total amount charged to cost of sales for capitalized software development costs was $ 154 +thousand and $ 153 thousand in 2021 +and 2020, respectively. +Advertising: Advertising costs are +expensed as incurred. Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Operations, for 2021 and 2020 totaled $ 1.8 million and $ 0.7 million, respectively. These expenses include items such as +consulting and professional services, tradeshows, and print advertising. +Income taxes: The income tax +amounts reflected in the accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, “Income Taxes” (“ASC 740”). Deferred tax assets and liabilities are recognized for the estimated future +tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are +measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the extent +that we believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. +Foreign currency +translation: The financial position and results of operations of our foreign subsidiary in the UK are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars +at the year-end exchange rate, related sales and expenses have been translated at the exchange rate as of the date the transaction was recognized, and shareholders’ equity has been translated at historical exchange rates. The resulting translation +gains or losses, net of tax, are recorded in shareholders’ equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income and loss. Foreign currency transaction gains and losses, including those related +to intercompany balances, are recognized in Other, net on the Consolidated Statements of Operations. +F-14 +Share-based payments: At December 31, 2021, we have share-based +employee compensation plans, which are described more fully in Note 10 - Stock incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, “Compensation – Stock Compensation.” Share-based compensation +expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee’s requisite service period. +We use the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this +valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions require judgment and are highly sensitive in +the determination of compensation expense. Forfeitures are recognized as they occur. +Net loss per +share: We report net income or loss per share in accordance with ASC 260, “Earnings per Share (EPS).” Under this guidance, basic EPS, which excludes dilution, is computed by dividing income or loss available to common shareholders by the +weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS +includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these instruments are excluded from the computation of diluted +EPS. See Note 12 - Earnings per share. +3. Note receivable +The note receivable balance relates to loans given to a +third-party software developer from whom we license our food service technology software with an interest rate of 4.5 % , which were originally due in April 2020. In March 2021, we received payment in the amount of $ 1.6 million representing the remaining principal balance and interest due from the third-party. Prior to the +payment being received, notes receivable were stated at unpaid principal balances and interest income was recognized on the accrual method. Interest income for 2021 and 2020 was $ 17 thousand and $ 67 thousand, respectively. +4. Inventories +The components of inventories are: +December 31, +(In thousands) +2021 +2020 +Raw materials and purchased component parts +$ +6,479 +$ +5,467 +Work-in-process +11 +– +Finished goods +1,230 +5,819 +$ +7,720 +$ +11,286 +5. Fixed assets, net +The components of fixed assets, net are: +December 31, +(In thousands) +2021 +2020 +Tooling, machinery and equipment +$ +6,694 +$ +9,508 +Furniture and office equipment +1,660 +1,706 +Computer software and equipment +6,973 +7,364 +Leasehold improvements +2,872 +2,873 +18,199 +21,451 +Less: Accumulated depreciation and amortization +( 16,736 +) +( 19,979 +) +1,463 +1,472 +Construction in-process +1,221 +478 +$ +2,684 +$ +1,950 +F-15 +6. Intangible assets, net +Identifiable intangible assets are recorded in Intangible assets, net in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2021 +2020 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,591 +$ +( 1,195 +) +$ +2,526 +$ +( 1,975 +) +Customer relationships +– +– +1,300 +( 1,300 +) +Trademark +– +– +480 +( 450 +) +Covenant not to compete +– +– +146 +( 146 +) +Patents +15 +( 14 +) +56 +( 54 +) +Other +– +– +80 +( 80 +) +Total +$ +1,606 +$ +( 1,209 +) +$ +4,588 +$ +( 4,005 +) +Amortization expense was $ 186 +thousand and $ 234 thousand in 2021 +and 2020, respectively. Amortization expense for each of the next five years ending December 31 is expected to be as follows: $ 155 thousand in 2022; $ 154 thousand in 2023; $ 88 thousand in 2024; and none thereafter. +7. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2021 +2020 +Salaries and compensation related +$ +2,854 +$ +2,328 +Warranty +79 +112 +Professional and consulting +285 +257 +Other +676 +968 +$ +3,894 +$ +3,665 +8. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of the month immediately +following their date of hire. We match employees’ contributions at a rate of 50 % of employees’ contributions up to the first 6 % of the employees’ compensation contributed to the 401(k) plan. Our matching contributions were $ 312 thousand and $ 270 thousand in 2021 and 2020, respectively. +9. Borrowings +On March 13, 2020, we entered into a credit facility (the “Siena Credit Facility”) with Siena Lending Group LLC. The Siena Credit +Facility provides for a revolving credit line of up to $ 10.0 million expiring on March 13, 2023 . Borrowings under the Siena Credit Facility bear a floating rate of interest equal to the greatest of (i) the prime rate plus 1.75 %, (ii) the federal funds rate plus 2.25 %, and (iii) 6.50 %. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility was $ 245 thousand, which were reported as “Other current assets” in current assets and “Other assets” in non-current assets in the Condensed Consolidated Balance Sheets. We also pay a +fee of 0.50 % on unused borrowings under the Siena Credit Facility. Borrowings under the Siena Credit Facility are secured by a lien on +substantially all the assets of the Company. +The Siena Credit Facility imposes a financial covenant on the Company and borrowings are subject to a borrowing base based on (i) 85 % of eligible accounts receivable plus the lesser of (a) $ 5.0 +million and (b) 50 % of eligible raw material and 60 % +of finished goods inventory. The three-month period from April 1, 2020 to June 30, 2020 was the first period we were subject to the financial covenant, which required the Company to maintain a minimum EBITDA and continued through the 12-month period +from April 1, 2020 to March 31, 2021. On July 21, 2021, the Company entered into an amendment (the “Credit Facility Amendment”) to the Siena Credit Facility. The Credit Facility Amendment changed the financial covenant under the Siena Credit Facility +from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at least $ 750 +thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning with the calendar month ending July 31, 2021. We have been in compliance with our excess availability covenant each month since July 31, 2021, and as of +December 31, 2021 and 2020, we had no +outstanding borrowings under the Siena Credit Facility and $ 5.1 million of borrowing capacity available under the Siena Credit Facility as of +December 31, 2021. +F-16 +On May 1, 2020 (the “Loan Date”), the Company was granted the PPP Loan from Berkshire Bank in the aggregate amount of $ 2.2 million, pursuant to the PPP. Under the terms of the PPP, the PPP Loan may be forgiven to the extent that funds from the PPP Loan were used for payroll +costs and costs to continue group health care benefits, as well as for interest on mortgage obligations incurred before February 15, 2020, rent under lease agreements in effect before February 15, 2020, utilities for which service began before February +15, 2020, and interest on debt obligations incurred before February 15, 2020, subject to conditions and limitations provided in the CARES Act. At least 60% (under the PPP terms, as amended) of the proceeds from the PPP Loan needed to have been used +for eligible payroll costs for the PPP Loan to be forgiven. +The PPP Loan, which was evidenced by a Note dated the Loan +Date issued by the Company (the “Note”) in favor of Berkshire Bank, as lender (the “PPP Lender”), was scheduled to mature on May 1, 2022 and had a fixed interest rate of 1.0 % per annum, accruing from the Loan Date and payable monthly. The Company submitted its PPP Loan forgiveness application in May 2021 to the SBA through Berkshire Bank and submitted the related loan +necessity questionnaire in June 2021. On July 8, 2021, the Company received notifications from Berkshire Bank and the SBA that its PPP Loan (including all interest accrued thereon) of $ 2.2 million had been fully forgiven by the SBA and that the forgiveness payment date was July 1, 2021. No payments +were due on the PPP Loan for six months from the date of first disbursement, and because a loan forgiveness application was submitted to the SBA within 10 months after the end of the covered period, no payments were due until the date on which the +SBA remitted the loan forgiveness amount to the PPP Lender and interest accrued during the deferment period was included in the forgiveness amount. The Note was unsecured and guaranteed by the SBA. The forgiveness of the PPP Loan was reported as “Gain on forgiveness of long-term debt” in the Consolidated Statement of Operations during the year ended December 31, 2021. +10. Stock incentive plans +Stock incentive +plans . We currently have two +stock incentive plans: the 2005 Equity Incentive Plan and the 2014 Equity Incentive Plan, which provide for awards to executives, key employees, directors and consultants. The plans generally provide for awards in the form of: (i) incentive stock +options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. Awards granted under these plans +have exercise prices equal to 100 % of the fair market value of the common stock at the date of grant. Awards granted have a ten-year term and generally vest over a two-year +to five-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards may be made under the 2005 +Equity Incentive Plan. Under our 2014 Equity Incentive Plan, as amended in May 2020, we are authorized to grant awards of up to 2,200,000 +shares of TransAct common stock. At December 31, 2021, 611,652 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average per share fair value of stock option grants for 2021 and 2020 was $ 5.41 and $ 3.19 , respectively. We also issued +restricted stock units for certain executives and directors that vest over a specified period of time, and in some instances require achieving certain performance metrics. The weighted-average per share fair value of these restricted stock units was $ 10.27 and $ 9.77 in 2021 and 2020, respectively. +The table below indicates the key assumptions used in the option valuation calculations for options granted in 2021 and 2020 and a discussion of our +methodology for developing each of the assumptions used in the valuation model: +December 31, +2021 +2020 +Expected option term (in years) +6.9 +7.0 +Expected volatility +50.5 +% +41.7 +% +Risk-free interest rate +1.2 +% +0.9 +% +Dividend yield +0.0 +% +0.0 +% +Expected Option +Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility +– The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An increase in the expected +volatility factor will increase compensation expense. +Risk-Free Interest +Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +Dividend Yield +–The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation expense. +F-17 +For 2021 and 2020, we recorded $ 1.2 million and $ 0.9 million of share-based compensation expense, respectively, included primarily in general and administrative expense in our Consolidated Statements of +Operations. We also recorded income tax benefits of $ 265 thousand and $ 193 thousand in 2021 and 2020, respectively, related to such share-based compensation. At December 31, 2021, +these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Equity award activity in the 2005 Equity Incentive Plan and the 2014 Equity Incentive Plan is summarized below: +Stock Options +Restricted Stock Units +Number of Shares +Average Price* +Number of Units +Average Price** +Outstanding at December 31, 2020 +1,287,605 +$ +8.98 +110,550 +$ +10.30 +Granted +153,000 +10.55 +95,200 +10.27 +Exercised +( 97,000 +) +8.47 +( 50,525 +) +10.29 +Forfeited +( 45,750 +) +8.87 +– +– +Expired +( 28,500 +) +10.22 +– +– +Outstanding at December 31, 2021 +1,269,355 +$ +9.18 +155,225 +$ +10.28 +* +weighted average exercise price per share +** +weighted average grant stock price per share +The following summarizes information about equity awards outstanding that are vested and expect to vest and equity awards that are exercisable at +December 31, 2021: +Equity Awards Vested and Expected to Vest +Equity Awards That Are Exercisable +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Stock Options +1,269,355 +$ +9.18 +$ +2,662 +5.6 +856,723 +$ +9.00 +$ +1,982 +4.1 +Restricted stock units +132,518 +– +1,444 +2.2 +– +– +– +– +* +weighted average exercise price per share +** +weighted-average contractual remaining term in years +Shares that are issued upon exercise of employee stock awards are newly issued shares and not issued from treasury stock. As of +December 31, 2021, unrecognized compensation cost related to non-vested equity awards granted under our stock incentive plans is approximately +$ 2.1 million, which is expected to be recognized over a weighted average period of 2.4 years. +The total fair value of awards vested was $ 1.7 million during both the years ended December 31, 2021 and 2020. The total intrinsic value (which is the amount by which the stock price exceeded the exercise price on the date of exercise) of stock options +exercised during the years ended December 31, 2021 and 2020 was $ 268 thousand and $ 174 thousand, respectively, and cash received from option exercises +was $ 436 thousand and $ 375 thousand in +2021 and 2020, respectively. 97,000 +and 62,500 stock options were exercised during the year ended December 31, 2021 and 2020, respectively. We recorded a realized tax provision in 2021 and 2020 from +equity-based awards of $ 35 thousand and $ 14 +thousand, respectively, related to options exercised. +11. Income taxes +The components of the income tax benefit are as follows: +December 31, +(In thousands) +2021 +2020 +Current: +Federal +$ +26 +$ +( 2,141 +) +State +51 +17 +Foreign +2 +( 48 +) +79 +( 2,172 +) +Deferred: +Federal +( 2,086 +) +( 483 +) +State +( 62 +) +( 36 +) +Foreign +( 2 +) +152 +( 2,150 +) +( 367 +) +Income tax benefit +$ +( 2,071 +) +$ +( 2,539 +) +Our effective tax rates were 33.3 % and 31.1 % for 2021 and 2020 , respectively. The tax benefit recorded for 2021 included the recognition of the gain on the forgiveness of the PPP Loan which is not taxable. The effective tax rate for 2020 included the impact of the net operating +loss (“NOL”) that we carried back to prior years. The CARES Act permits NOLs incurred in 2018, 2019 and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. We generated a NOL for +2020 which was carried back to tax years that had a federal statutory tax rate of 34 % compared to 21 % in 2020 and resulted in a tax refund of $2.2 million that was received in October 2021 causing a significant reduction in prepaid income taxes at December 31, 2021 compared to +December 31, 2020. +F-18 +At December 31, 2021, we +have $ 2.0 million of federal net operating loss carryforwards and $ 78 thousand of state net operating loss carryforwards, $ 901 thousand in R&D credit +carryforwards, and no state tax credit carryforwards. Foreign loss before taxes was $ 404 thousand and $ 468 thousand in 2021 and 2020, respectively. +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated +Financial Statements. Our deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2021 +2020 +Deferred tax assets: +Federal net operating losses +$ +1,976 +$ +– +Foreign net operating losses +624 +563 +Depreciation +306 +302 +Inventory reserves +710 +719 +Deferred revenue +24 +47 +Warranty reserve +22 +31 +Stock compensation expense +796 +731 +Other accrued compensation +308 +388 +R&D credit carryforward +901 +460 +Other liabilities and reserves +250 +394 +Gross deferred tax assets +5,917 +3,635 +Valuation allowance +( 733 +) +( 659 +) +Net deferred tax assets +5,184 +2,976 +Deferred tax liabilities: +Other +43 +37 +Net deferred tax liabilities +43 +37 +Total net deferred tax assets +$ +5,141 +$ +2,939 +As of December 31, 2021, a valuation allowance +of $ 733 thousand has been established for foreign net operating loss carryforwards that are not expected to be used. The following table +summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year Ended December 31, +(In thousands) +2021 +2020 +Balance, beginning of period +$ +659 +$ +444 +Additions charged to income tax provision +74 +215 +Balance, end of period +$ +733 +$ +659 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2021 +2020 +Federal statutory rate +21.0 +% +21.0 +% +PPP loan forgiveness +7.4 +– +R&D credit +7.1 +4.2 +Stock award excess tax benefit +0.3 +( 0.3 +) +State income taxes, net of federal income taxes +0.1 +0.2 +U.S. corporate tax rate change +– +9.5 +Business meals and entertainment +( 0.2 +) +0.1 +Miscellaneous permanent items +( 0.3 +) +– +Uncertain tax positions +( 0.4 +) +( 0.2 +) +Stock option cancellations +( 0.6 +) +( 0.5 +) +Valuation allowance and tax accruals +( 1.2 +) +( 2.6 +) +Other +0.1 +( 0.3 +) +Effective tax rate +33.3 +% +31.1 +% +F-19 +We had $ 144 thousand and $ 121 thousand of total gross unrecognized tax benefits at December 31, 2021 +and 2020, respectively that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not aware of +any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the gross amounts of unrecognized tax benefits at the beginning and end of +the year is as follows: +December 31, +(In thousands) +2021 +2020 +Balance, beginning of period +$ +121 +$ +107 +Tax positions taken during the current period +47 +41 +Lapse of statute of limitations +( 24 +) +( 27 +) +Balance, end of period +$ +144 +$ +121 +We expect $ 28 thousand of +the $ 144 thousand of unrecognized tax benefits will reverse in 2022 upon the expiration of the statute of limitations. +We recognize interest and penalties related to uncertain tax positions in the income tax provision. We have accrued interest and +penalties related to uncertain tax positions of $ 20 thousand and $ 19 thousand as of December 31, 2021 and 2020, respectively. +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially +concluded all U.S. federal income tax, state and local, and foreign tax matters through 2017. However, our federal tax returns for the years 2018 through 2021 remain open to examination. Various state and foreign tax jurisdiction tax years remain open +to examination as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +12. Earnings per share +Earnings per share was computed as follows (in thousands, except per share amounts): +Year Ended December 31, +2021 +2020 +Net loss +$ +( 4,145 +) +$ +( 5,630 +) +Shares: +Basic: Weighted average common shares outstanding +9,298 +7,827 +Add: Dilutive effect of outstanding equity awards as determined by the treasury stock +method +– +– +Diluted: Weighted average common and common equivalent shares outstanding +9,298 +7,827 +Net loss per common share: +Basic +$ +( 0.45 +) +$ +( 0.72 +) +Diluted +( 0.45 +) +( 0.72 +) +The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options, +restricted stock units and performance stock awards, when the average market price of the common stock is lower than the exercise price of the related stock award during the period. These outstanding stock awards are not included in the computation of +diluted earnings per share because the effect would be anti-dilutive. Furthermore, in periods when a net loss is reported, such as 2021 and 2020, basic and diluted net loss per common share are calculated using the same method. Anti-dilutive stock +awards excluded from the computation of earnings per dilutive share were 391,000 and 1,284,000 at December 31, 2021 and 2020, respectively. +13. Stock repurchase program +We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury +stock account. Repurchases of our common stock are accounted for as of the settlement date. During 2021 and 2020, we did no t repurchase any shares of +our common stock. From January 1, 2005 through December 31, 2019, we repurchased a total of 4,044,842 shares of common stock for $ 32.1 million, at an average price of $ 7.94 per +share. +F-20 +14. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are +based on the location of the customer and asset. +Year Ended December 31, +(In thousands) +2021 +2020 +Net sales: +United States +$ +32,400 +$ +24,733 +International +6,986 +5,862 +Total +$ +39,386 +$ +30,595 +Fixed assets, net: +United States +$ +1,770 +$ +1,079 +International +914 +871 +Total +$ +2,684 +$ +1,950 +Sales to international customers were 18 % +and 19 % of total sales in 2021 and +2020, respectively. Sales to Europe represented 53 % +and 45 %, sales to the Pacific Rim (which includes Australia and Asia) represented 35 % and 45 %, and sales to Canada represented 11 % and 8 % of total international sales in 2021 and 2020, respectively. International +long-lived assets consist of net fixed assets located at our foreign subsidiary in the UK as well as our contract manufacturers in China, Thailand, Malaysia and Mexico. +15. Leases +Operating lease expense was $ 1.0 million for both years ended December 31, 2021 and 2020 and is reported as “Cost of sales,” “Engineering, design and product development expense,” “Selling and +marketing expense,” and “General and administrative expense” in the Consolidated Statements of Operations. Operating costs include short-term lease costs, which were +immaterial during the period. +The following information represents supplemental disclosure for the statement of cash flows related to operating leases (in thousands): +Year Ended December 31, +2021 +2020 +Operating cash outflows from leases +$ +982 +$ +1,040 +The following summarizes additional information related to our leases as of December 31, 2021: +Year Ended December 31, +2021 +2020 +Weighted average remaining lease term (in years) +3.5 +4.9 +Weighted average discount rate +4.4 +% +4.1 +% +The maturity of the Company’s operating lease liabilities as of December 31, 2021 are as follows (in thousands): +December 31, 2021 +2022 +$ +886 +2023 +721 +2024 +721 +2025 +426 +2026 +23 +Total undiscounted lease payments +2,777 +Less imputed interest +207 +Total lease liabilities +$ +2,570 +F-21 +16. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2021 and 2020 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2021: +Net sales +$ +8,301 +$ +9,325 +$ +10,637 +$ +11,123 +Gross profit +3,189 +3,325 +4,317 +4,418 +Net (loss) income +( 2,206 +) +( 2,114 +) +910 +( 735 +) +Net (loss) income per common share: +Basic +( 0.25 +) +( 0.24 +) +0.10 +( 0.07 +) +Diluted +( 0.25 +) +( 0.24 +) +0.09 +( 0.07 +) +2020: +Net sales +$ +10,247 +$ +5,285 +$ +7,300 +$ +7,763 +Gross profit +4,918 +2,290 +3,349 +2,372 +Net loss +( 992 +) +( 1,853 +) +( 867 +) +( 1,918 +) +Net loss per common share: +Basic +( 0.13 +) +( 0.25 +) +( 0.11 +) +( 0.22 +) +Diluted +( 0.13 +) +( 0.25 +) +( 0.11 +) +( 0.22 +) +17. Subsequent events +The Company has evaluated all events or transactions that occurred up to the date the consolidated financial statements were available to +issue. Based upon this review, the Company did not identify any subsequent events that would have required adjustment or disclosure in the consolidated financial statements. +F-22 \ No newline at end of file diff --git a/raw/filings/0001017303/2021/0001017303-22-000014/filing_metadata.csv b/raw/filings/0001017303/2021/0001017303-22-000014/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b6f4d7b752df817d736bce139d69dc0f7bc79737 --- /dev/null +++ b/raw/filings/0001017303/2021/0001017303-22-000014/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2022-03-24,2021-12-31,2022-03-24T18:59:03.000Z,0001017303-22-000014,form10k2021.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2021",9806816,1,1,https://www.sec.gov/Archives/edgar/data/1017303/000101730322000014/form10k2021.htm,https://www.sec.gov/Archives/edgar/data/1017303/000101730322000014/,2021,2021,1 diff --git a/raw/filings/0001017303/2021/0001017303-22-000014/item1.txt b/raw/filings/0001017303/2021/0001017303-22-000014/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..b9339b0c03c2fe4c55dcc60db98b6b9fd8f41533 --- /dev/null +++ b/raw/filings/0001017303/2021/0001017303-22-000014/item1.txt @@ -0,0 +1,278 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was +incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August +22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high growth markets +including food service technology, point of sale (“POS”) automation and casino and gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL® +Ithaca®, and Printrex® brand names. During 2019, we launched a new line of products for the food service technology market, the BOHA! branded suite of cloud-based applications and companion hardware solutions. The BOHA! software and hardware products +help restaurants, convenience stores and food service operators of all sizes automate food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and +terminals generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents, as well as printed logging and plotting of data. We sell our technology to original equipment manufacturers (“OEMs”), value-added +resellers, select distributors and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class +service, support, labels, spare parts, accessories and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables +used in the printing activities of customers in the restaurant and hospitality, retail, casino and gaming, government and oil and gas exploration markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the +demand for these products. Our primary operating, hardware research and development, and U.S. service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters and software research and development in Las +Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, +06518, with a telephone number of (203) 859-6800. +1 +Impact of the COVID-19 Pandemic +During the first two months of 2020 our business trends were in line with internal expectations; however, the challenges posed by the +COVID-19 pandemic on the United States and global economy increased significantly as the first quarter of 2020 progressed and continued throughout the remainder of 2020 and into 2021. Though we have begun to experience some recovery during 2021, +unfortunately, the massive economic and social disruptions across the world persist due to COVID-19, including the emergence of virus variants, and the measures implemented to mitigate its spread. The food service, casino and gaming, and oil and gas +industries have been particularly affected by the pandemic, and we expect such disruptions to continue to negatively impact our overall business for the foreseeable future. +As a result of the COVID-19 pandemic and measures implemented to mitigate its spread, we experienced decreased demand for our products +and lower than anticipated sales beginning in the second half of March 2020 and continuing through 2021, particularly in our food service technology and casino and gaming markets. We experienced some improvement in demand during the second half of +2020 through 2021 compared to the second quarter of 2020, as state and local governments lifted certain measures implemented earlier in 2020 to mitigate the spread of the virus, but demand remained lower than 2019. While we expect this improvement to +continue during 2022, the exact timing and pace of recovery is unknown. We have also experienced supply chain disruptions, including delayed product shipments from our two contract manufacturers located in Thailand and China that conduct almost all of +our printer and BOHA! hardware manufacturing, due to reduced operations and part shortages at these facilities. Our inventory levels decreased significantly during 2021 due to these supply chain disruptions and if these delays are sustained or +additional disruptions occur we may have insufficient inventory levels and our ability to deliver products to our customers on time or at all may be impaired. Below is a discussion of the impact we have experienced from the COVID-19 pandemic, and that +we believe will continue to experience for the foreseeable future in each of our markets. +Food service +technology and POS automation . In both our food service technology and POS automation markets, many restaurants and food service +establishments that were closed during much of the second quarter of 2020 started to reopen in the third quarter of 2020 as state and local governments began to ease restrictions put in place in response to the pandemic. Many of our customers +initially opened under restrictions that limited them to providing drive-through, take-out or delivery service without dine-in options, as well as limiting the volume of customers and employees on site at any one time. During the second half of 2020 +and throughout 2021 as these food service customers reopened for business, we experienced sales improvement compared to the second quarter of 2020. However, during the fourth quarter of 2020 and early in 2021, restaurants were again impacted by a +resurgence of the pandemic. Notwithstanding the gradual resumption of operations that began in the third quarter of 2020, our food service technology and POS automation customers continue to recover from the financial impact of the pandemic and we +expect new capital expenditures to be a lower priority for them in the near term, which we believe will continue to negatively impact sales of BOHA! hardware, software and label products, as well as sales of POS printers. However, food service +providers have been and are likely to continue to be required to develop and implement new or enhanced policies and operating procedures regarding cleaning, sanitizing and social distancing to ensure the safety of their employees and customers. +Additionally, our markets have experienced labor shortages and inflation in their food and labor costs. We believe that our BOHA! hardware, software and label products could prove to be helpful to our food service customers in efficiently and +effectively managing and complying with these new procedures, while also helping to overcome staffing issues and inflation, especially as many establishments are and will likely continue to be operating with reduced staff levels due to the continuing +labor shortage. +Casino and gaming . In the casino and gaming market, most casinos and other gaming establishments were closed worldwide during most of the second quarter of 2020. Many +casinos began to reopen in late May and early June 2020, but similar to restaurants, casino openings were slow and measured, starting with reduced capacity and limited gameplay based on social distancing guidelines. During the fourth quarter of 2020, +some casinos re-closed due to a resurgence of the pandemic. However, many casinos in the U.S. reopened during the first quarter of 2021 with limited capacity and continued to remain open and further expand capacity during the remainder of 2021. We +anticipate that casinos will continue to increase capacity over time, barring any new closures or reduced capacity requirements in response to any new resurgence of the pandemic, including the emergence of variants. Though sales of our casino and +gaming products increased during 2021, and we expect this trend to continue into 2022, casinos continue to recover from the financial impact of the COVID-19 pandemic, and therefore we expect that certain casinos’ appetite for purchases of new slot +machines may be diminished, which may negatively impact sales of casino and gaming printers purchased by slot manufacturers for use in slot machines at casinos during 2022. +Lottery . We exited the lottery market at the end of 2019 and IGT made a final purchase of our lottery printer during the second quarter of 2020. Therefore, +COVID-19 has not had an impact on our lottery printer sales, and we do not anticipate that it will have an impact on our future lottery printer sales. +Printrex . The oil and gas market was negatively impacted by the decline in worldwide oil prices attributable to the COVID-19 pandemic during 2020. During the +latter half 2021, oil and gas prices began to rise again, resulting in slowly improving sales to our oil and gas customers. However, we made a strategic decision to exit the Printrex market as of December 31, 2021 and expect to have no future sales in +this market beyond 2021. +TSG . Due to closures and reduced operating capacity of restaurants, retail establishments, casinos and other gaming establishments resulting from the +COVID-19 pandemic, sales of spare parts, service and consumable products have declined, and we expect such sales to remain at reduced levels, due to lower usage while customers continue to recover from the impact of the pandemic. +Our gross margin has been negatively impacted and we expect our gross margin to continue to be negatively impacted while the COVID-19 +pandemic and its economic effects on the markets we serve persists. As a result of an expected lower sales level, as well as increased material and shipping costs resulting from worldwide supply disruptions caused by the COVID-19 pandemic, we believe +our gross margin will remain lower than pre-pandemic levels due to fixed manufacturing overhead expenses (such as facility costs, depreciation, etc.) that cannot be reduced or eliminated even with the lower sales level. +2 +While we began to experience a modest recovery starting in the second half of 2020 and continuing into 2021 and expect this recovery to +continue during 2022, the exact timing and pace of recovery is unknown given uncertainty surrounding responsive measures to potential future resurgences of the virus, vaccination rates, the emergence of virus variants and the significant disruption +that our customers and suppliers have already experienced and may continue to experience. In light of this uncertainty, we implemented a number of cost saving measures during 2020 to help mitigate the impact on our financial position and operations +and continued to limit discretionary spending during 2021. +In addition to the expense management actions implemented during 2020, we took the following actions to increase liquidity and +strengthen our financial position: +● +Public Offerings – On October 16, 2020 and August 16, 2021, the Company raised net proceeds +of $8.7 million and $11.2 million ( including the exercise of the underwriters’ overallotment options on October 16, 2020 and August 20, 2021) , respectively, +after deducting underwriting discounts, commissions and offering expenses, through underwritten public offerings and sold an aggregate of 1,380,000 and 842,375 shares of common stock, respectively. +● +PPP Loan – On May 1, 2020, the Company was granted a $2.2 million loan (the “PPP Loan”) under +the Paycheck Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”) established under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which enabled us to return +employees we furloughed earlier in 2020 to full time employment and to restore employees to full pay following certain pay cuts . On July 8, 2021, we +received notice that the PPP Loan had been forgiven as of July 1, 2021. +● +Employee Retention Credit – Under the provisions of the CARES Act, the Company is +eligible for a refundable employee retention credit subject to certain criteria. In connection with the CARES Act, the Company recognized the employee retention credit during the fourth quarter of 2021 and recorded $1.5 million as “Gain from +employee retention credit” in the Consolidated Statement of Operations and the related receivable as “Employee retention credit receivable”” in the Consolidated Balance Sheet as of December 31, 2021. We expect to receive these funds during +2022 . +● +New Credit Facility – On March 13, 2020, we entered into a new credit facility with Siena Lending Group LLC that provides a revolving credit line of up to $10.0 million, +subject to a borrowing base. +● +Reduced Capital Expenditures – We limited capital expenditures during 2020 and gradually increased expenses during 2021 as our sales improved. +Since the onset of the pandemic, our top priority has been to ensure the health and safety of our employees while continuing to provide +our customers with high-quality, personalized service. On March 20, 2020, we instituted work-from-home practices for the majority of our employees to reduce the spread of COVID-19 and to comply with government mandates. Because most of our employees +already had laptop computers with remote access into our IT systems, we experienced only minor reductions in productivity and minimal costs related to the implementation of our work-from-home practices. In addition, even with the move to a +work-from-home environment, our internal control structure remained operational and unchanged. +As of October 4, 2021, all of our employees were fully vaccinated against COVID-19 and, as a result, we implemented a return-to-work +plan, reopening all of our facilities and ending our work-from-home practices. Our distribution centers, deemed an essential service, remained operational throughout the pandemic. During 2020, we implemented new COVID-19 policies, most of which were +still in place prior to ending our work-from-home practices, to specifically address health and safety guidelines for employees to adhere to and follow when at work. These policies were based on the COVID-19 safety guidelines recommended by the +Centers for Disease Control and Prevention. +We have evaluated the recoverability of the assets on our Consolidated Balance Sheet as of December 31, 2021 in accordance with +relevant authoritative accounting literature. We considered the disruptions caused by the COVID-19 pandemic, including lower than previously forecasted sales and customer demand and macroeconomic factors potentially impacting accounts receivable, +inventory, investments, intangible assets, goodwill and other assets and liabilities. Where forward-looking estimates are required, we made a good-faith estimate based on information available as of the balance sheet date. We have continued to monitor +for indicators of impairment through the date of this Report and reflected accordingly in the accompanying consolidated financial statements. +Notwithstanding the foregoing, there is no assurance that the actions we have taken in response to the pandemic are sufficient or +adequate, and we may be required to take additional preventive or responsive measures, as the ultimate extent of the effects of the COVID-19 pandemic on the Company, our financial condition, results of operations, liquidity, and cash flows are +uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, Item 1A, Risk Factors, of this Form 10-K for further discussion of risks related to COVID-19. +3 +Products, Services and Distribution Methods +Printers, terminals +and other hardware: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal printing technology for applications, primarily in the food service technology, POS +automation, casino and gaming, and prior to exiting the market on December 31, 2021, the oil and gas printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. +Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our food service technology terminals also offer software configurable menu options. Our food service +technology market also includes sales of hardware products including temperature probes, temperature sensors and gateways. +Food Service +Technology (“FST”): The primary offering in the FST market is our BOHA! ecosystem, which combines our latest generation terminal/workstation, cloud-based software +applications and related hardware into a unique solution to automate back-of-house operations in restaurants, convenience stores and food service operations . The +software component of BOHA! consists of a suite of software-as-a-service (“SaaS”)-based applications, including applications for temperature monitoring of food and equipment, timers, food safety labeling, media libraries, checklists and task lists +and equipment service management. Any and all of these applications can be chosen by our customer and packaged into a single platform with the associated hardware, which includes the BOHA! terminal, handheld devices, tablets, temperature probes and +temperature sensors and gateways. The BOHA! terminal combines the software and hardware components in a device that includes an operating system, touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, +grab-and-go labels for prepared foods, nutritional labels and “enjoy by” date labels. The BOHA! Workstation is a hardware device that pairs two mechanisms with an Apple iPad utilizing an iOS operating system. Both the BOHA! terminal and BOHA! +workstation are equipped with the TransAct Enterprise Management System to ensure that only approved applications and functions are available on the device and allows over-the-air updates to the applications and operating system. BOHA! helps food +service establishments and restaurants (including fine dining, casual dining, fast casual and quick-serve restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go +initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are charged to customers upfront on a per-application basis, as well as sales of +labels, extended warranty and service contracts, and technical support services. In the food service technology market, we use an internal sales force to solicit sales directly from end users. +POS automation: In the POS market, we sell a printer utilizing thermal printing technology. Our POS printer is used primarily by McDonald’s, and to a lesser extent, +other quick-serve restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and +international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. +Casino and gaming: +We sell several models of printers used in slot machines and video lottery terminals (“VLTs”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks and other gaming +venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in monochrome and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and +promotions. In addition, we sell printers using thermal roll-fed printing technology for use in international non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals, sports +betting establishments and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot +machines directly to casinos and other gaming establishments and (2) through distributors. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales through our distributors. +We also offer a software solution, the EPICENTRAL Print System, including annual software maintenance, that enables casino operators to +create promotional coupons and marketing messages and to print them in real time at the slot machine. With EPICENTRAL, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino +floor or encourage additional visits to generate more revenue to the casinos. +Lottery: +Our lottery printers were designed for high-volume, high-speed printing of lottery tickets for various lottery applications. We previously sold lottery printers to International Gaming Technology and its subsidiaries (“IGT”), our largest customer and +the world’s largest provider of lottery terminals. During 2019, we decided to exit this business and we expect no future sales beyond 2020. Sales of our lottery products were made directly to IGT and were managed by an internal sales representative +before we exited the business in 2019. +Printrex: Printrex printers include wide format, desktop and rack-mounted and vehicle-mounted black and white thermal printers used by customers to log and plot oil field, seismic +and down hole well drilling data in the oil and gas exploration industry . The Printrex brand of printers also includes high-speed color inkjet desktop printers used by oil +and gas field service companies to print logs at data centers of the oil and gas field service companies. We primarily sell our Printrex products directly to oil field service and drilling companies and OEM’s, as well as through regional +distributors in the United States, Europe, Canada and Asia. During 2021, we decided to exit this business and in the fourth quarter of 2021 fulfilled last buy orders to our legacy customers. We expect no future sales of our Printrex products +beyond 2021. +TSG : Through TSG, we proactively market the sale of consumable products (including POS receipt paper, ribbons and other printing supplies), replacement +parts, maintenance and repair services, and shipping and handling charges. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, a 24-hour guaranteed replacement product service called TransAct Xpress™ and +other repair services for our non-FST products. Within the United States, we provide repair services through our service center in Ithaca, New York. Internationally, we provide repair services through our European service center located in Doncaster, +UK, and through partners strategically located around the world. +4 +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping +and general information. Technical and sales support personnel receive training on all our manufactured products and services. In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, +seven days a week, via our webstore, www.transactsupplies.com . +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient +materials, sourcing and assembly methods with high standards of workmanship. Almost all of our printers and terminals are produced by two third-party manufacturers located in Thailand and China. A small portion of our products are assembled in our +Ithaca, New York facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +We procure component parts and subassemblies for use in the assembly of our hardware products in Ithaca, New York. Critical component +parts and subassemblies include thermal print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at +competitive prices. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully-assembled printers and terminals produced by our contract manufacturers and, to a much +lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or unavailability. However, we could +experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy a majority of our thermal print mechanisms, an important component of our thermal printers, and fully assembled +printers for several of our printer and food service technology terminal models, from one foreign contract manufacturer in Thailand and to a lesser extent, one other foreign contract manufacturer in China. Although we believe that other contract +manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms, a change in contract manufacturers could cause a delay in manufacturing and possible loss of sales, which may have a material +adverse effect on our operating results. Although we do not have supply agreements with our foreign contract manufacturers, our relationship with both remain strong and we have no reason to believe that either will discontinue their supply of thermal +print mechanisms or fully assembled printers to us during 2022 or that their terms to us will be substantially less favorable than they have been historically. Due to the impact from Chinese tariffs starting in 2019, during 2020 and 2021, we +increasingly transferred production from our contract manufacturer in China to our contract manufacturer in Thailand. We plan to continue transferring production to our Thailand-based contract manufacturer during 2022. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third-party nondisclosure agreements, copyright laws and +contractual rights to establish and protect its proprietary rights in its products. As of February 28, 2022, we hold 37 United States and 33 foreign patents and have 3 foreign patent applications pending pertaining to our products. The remaining +duration of these patents ranges from 1 to 18 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect +them through employee and third-party nondisclosure agreements and similar means. It may be possible for unauthorized third-parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, +information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to +protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our +business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, BOHA! TM , +AccuDate™, Epic, EPICENTRAL®, Ithaca® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest +extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the +holiday period, which may negatively impact sales of our food service technology products or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance +with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +5 +Certain Significant Customers +IGT is our most significant customer, although to a lesser extent than in previous years, and has been since 1995. We sell casino and +gaming printers and, prior to 2021, on-line lottery printers to IGT. On May 29, 2015, we signed an agreement with IGT to sell on-line lottery and casino printers to IGT on a non-exclusive basis through December 31, 2019. We decided not to renew the +agreement upon its expiration and to exit the on-line lottery market. Although we no longer have an agreement with IGT, we expect to continue selling casino and gaming printers to IGT, as well as spare parts for our remaining, but declining, installed +base of lottery printers, in the future. +Sales to IGT represented 9% and 15% of our total net sales for the years ended December 31, 2021 and 2020, respectively. +Backlog +Our backlog of firm orders was approximately $14.2 million as of February 28, 2022, compared to $3.4 million as of February 28, 2021. +The increase in firm orders as of February 28, 2022 compared to February 28, 2021 is due primarily to advance orders placed by our casino and gaming customers due to increased production lead time, resulting from worldwide supply chain shortages caused +by the pandemic. Based on customers’ current delivery requirements, we expect to fill and recognize as revenue $13.7 million of our current backlog during 2022, $0.4 million during 2023 and the remaining balance of the amount during 2024. +Competition +The market for transaction-based and specialty printers and food service technology terminals is extremely competitive, and we expect +such competition to continue in the future. However, we experience less competition for EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and +marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer +support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, +economic and political conditions and, in some cases, the uniqueness of our products. +In the food service technology market, we primarily +compete with Zenput, Squadle Inc., Jolt Software, Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, CMC Daymark, Integrated Control Corp, Digi International, and Toast. We compete in this market based largely on our ability to provide highly +specialized software and purpose-built hardware products and ongoing technical support. We rely upon third-party developed software and hosting services combined with our own proprietary hardware and software to offer a unique BOHA! branded +solution to support back-of-house operations in the food service industry. Our competitors or others may develop, or may establish relationships with developers with the capability to develop, software and services that are similar to or competitive +with ours, which may be disadvantageous to our competitive position. Certain portions of our food service technology software are licensed from a third-party developer on a non-exclusive basis through 2031 and are subject to a revenue sharing +arrangement with the developer. We are reliant upon the third-party developer to further develop and maintain its developed software, and the developer controls the software source code. The license agreement does not preclude the developer from +working with others on similar products. Also, the third-party developer hosts the web-based applications. Therefore, presently, we are highly dependent upon this third-party developer for continued service to our customers and the further development +of our food service technology software products. +In the POS automation market, we primarily compete with Epson America, Inc., which holds a dominant market position. We also compete, +to a much lesser extent, with Star Micronics America, Inc. and Citizen -- CBM America Corporation. Certain competitors of ours have greater financial resources and lower costs attributable to higher volume production which enables them to occasionally +offer lower prices than us. However, we will continue to deemphasize efforts in the POS automation market going forward as we have shifted our focus toward our higher-value, technology-enabled food service technology and casino and gaming products. +In the casino and gaming market (consisting principally of slot machine printing, VLT transaction printing and promotional coupon +printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA, Eurocoin and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly +specialized products, custom engineering and ongoing technical support. +In the lottery market (consisting principally of on-line lottery transaction printing), we competed with other lottery printer +providers such as Custom Engineering SPA, Star Micronics and Wincor Nixdorf. However, we exited the lottery market in 2019 and shifted our focus toward our higher-value, technology enabled food service technology and casino and gaming products. +In the oil and gas market, our Printrex products competed primarily with the products of Imaging Systems Group, Inc. and Neuralog Inc. +However, we exited the oil and gas market at the end of 2021 in order to shift our focus toward our higher-value, technology enabled food service technology and gaming products. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, including POS and +internet resellers and paper converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop and/or license new products (hardware and software), such as +launching BOHA! in 2019, and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our market penetration, to take advantage of strategic relationships, and to lower the cost of our +products by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our products +utilize certain thermal printing technologies and licensed software. If new technologies are introduced, or existing technologies evolve, we may be required to incorporate these technologies into our products. Alternatively, if such technologies were +to become available to our competitors, our products could become obsolete, which could have a significant negative impact on our business. +6 +Environmental Compliance +Our compliance with federal, state and local laws and regulations relating to environmental protection and discharge of hazardous +materials has not had a material impact on our capital expenditures, earnings or competitive position, and we do not anticipate any material impact from such compliance in the future. +Available Information +We make available free of charge through the “Investor Relations” tab on our Internet website, www.transact-tech.com, our Annual Report +on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and all amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC +pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file +electronically with the SEC at http://www.sec.gov. The content on any website referred to in this Form 10-K is not incorporated by reference in this Form 10-K unless expressly noted. +Employees +As of December 31, 2021, TransAct and our subsidiaries employed 118 persons, all of whom were full-time employees. None of our +employees are unionized, and we consider our relationships with our employees to be good. +Information about our Executive Officers +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with +the registrant held by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +64 +Chairman of the Board and Chief Executive Officer +Steven A. DeMartino +52 +President, Chief Financial Officer, Treasurer and Secretary +Tracey S. Chernay +62 +Senior Vice President, Casino, Gaming and Lottery Sales +Andrew J. Hoffman +64 +Senior Vice President, Operations +David B. Peters +43 +Vice President and Chief Accounting Officer +Brent Richtsmeier +57 +Chief Technology Officer +Bart C. Shuldman has been Chief Executive Officer and a Director of the Company since its formation in June 1996. In February 2001, +Mr. Shuldman was elected Chairman of the Board. Mr. Shuldman served as President of the Company from its formation until June 2010, when he relinquished the President title to focus on new products and markets, international expansion and potential +acquisitions. +Steven A. DeMartino was named as TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, +Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate +Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Tracey S. Chernay was appointed Senior Vice President, Casino and Gaming Sales and Marketing in June 2010, with responsibility for the +sales and marketing of all casino and gaming products. Previously, Ms. Chernay served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking with the Company from July 2006 +to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Chernay was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales +Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Andrew J. Hoffman was appointed Senior Vice President, Operations for TransAct in November 2004. He served as Vice President, +Operations from September 1994 to November 2004. +David B. Peters was appointed Vice President and Chief Accounting Officer on March 1, 2018. Previously, Mr. Peters served as Director, +SEC and Financial Reporting since joining TransAct in March 2014. Prior to joining TransAct, Mr. Peters was employed with United Technologies Corporation from November 2006 to March 2014 where he served in various financial management positions. Mr. +Peters is a certified public accountant. +Brent Richtsmeier was named as Chief Technology Officer in +September 2021. Previously, Mr. Richtsmeier served as Senior Vice President, Software Engineering since joining TransAct in December 2019 and was appointed as an officer of the Company in January 2021. Prior to joining TransAct, Mr. +Richtsmeier was employed with Samsung, an electronics corporation, from May 2004 until November 2017 as the VP of Development where he was responsible for software strategy, software development at scale and business development. In November 2017, +Samsung Electronics sold their business products division to HP Inc, and Mr. Richtsmeier transferred to HP Inc to become the Global Head of Cloud and Mobile Software Solutions until joining TransAct in 2021. +There are no family relationships between any of our executive officers and there is no arrangement or understanding between any of +such officers and any other person pursuant to which he or she was selected as an officer. Each of our executive officers was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her +earlier resignation or removal. +7 \ No newline at end of file diff --git a/raw/filings/0001017303/2021/0001017303-22-000014/item13.txt b/raw/filings/0001017303/2021/0001017303-22-000014/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..bd58c601bfd631edc56135dd5d9657d31fe69851 --- /dev/null +++ b/raw/filings/0001017303/2021/0001017303-22-000014/item13.txt @@ -0,0 +1,3 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related +Transactions” and “Corporate Governance-Board Leadership Structure and Independence” and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2021/0001017303-22-000014/item9a.txt b/raw/filings/0001017303/2021/0001017303-22-000014/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..ec9a0990ba2f2c5ef8d6d2d6d8d8e1957e14908c --- /dev/null +++ b/raw/filings/0001017303/2021/0001017303-22-000014/item9a.txt @@ -0,0 +1,41 @@ +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief +Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15I under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of December 31, 2021. In the Amendment to our Annual Report on Form 10-K for the +year ended December 31, 2018, filed with the SEC on November 21, 2019, we disclosed that management, including our CEO and CFO, concluded that our disclosure controls and procedures were not effective as of December 31, 2018, due to material +weaknesses in our internal control over financial reporting. As of December 31, 2021, management has completed the implementation of new controls, which are described below, to fully remediate these material weaknesses. Upon completion of the +remediation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2021, our disclosure controls and procedures are effective at the reasonable assurance level. +Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly +present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles, and that they can still be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule +13a-15(f) under the Exchange Act, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. +Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) +provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in +accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a +material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2021. Our management based its assessment on +criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 +COSO”). In the opinion of management, TransAct maintained effective internal control over financial reporting as of December 31, 2021. +A material weakness is defined in Rule 12b-2 under the Exchange Act as a deficiency, or a combination of deficiencies, in internal +control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. +Material Weaknesses in Internal Control Over Financial Reporting +We identified a control deficiency that constituted a material weakness in our internal control over financial reporting as of December +31, 2020, 2019 and 2018 and has been fully remediated as of December 31, 2021. The control deficiency was that we did not design and maintain effective controls over the completeness and accuracy of information included in key spreadsheets supporting +our accounting records (the “Spreadsheet Control Weakness”). +This control deficiency constituted a material weakness, but did not result in a material +misstatement to our annual or interim consolidated financial statements. +30 +Remediation Efforts to Address Material Weaknesses +Beginning December 31, 2019, we commenced developing and implementing a plan to enhance the design and operating effectiveness of our +internal control over financial reporting, which included taking the following steps to remediate the identified control deficiency and material weakness: +For each key spreadsheet we evaluated and determined (1) if a standard Oracle report existed containing the same information as the +spreadsheet, and if so, we utilized the standard Oracle report (without modification) instead of the spreadsheet to support our accounting records, and (2) if a standard Oracle report cannot be used, we implemented a new key control whereby an employee +performs a formal validation that the information from Oracle is completely and accurately transferred (automatically or manually) to a spreadsheet by verifying totals and other information on a test basis. For all key spreadsheets, we have designed +and implemented a new key control to validate the completeness and accuracy of information supporting our accounting records. During 2020 and the first quarter of 2021, we completed the evaluation process for each key spreadsheet based on the above +criteria, and during the second quarter of 2021, we completed the implementation of new key controls for all of our key spreadsheets to validate the completeness and accuracy of the information contained within and supporting each such spreadsheet. +During the second half of 2021, we completed our evaluation of the new controls for effectiveness, and the Spreadsheet Control Weakness was deemed to be remediated as of December 31, 2021. +Changes in Internal Control over Financial Reporting +Other than the changes intended to remediate the material weakness noted above, no change in our internal control over financial +reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended December 31, 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial +reporting. \ No newline at end of file diff --git a/raw/filings/0001017303/2021/0001017303-22-000014/rp_note.txt b/raw/filings/0001017303/2021/0001017303-22-000014/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2021/0001017303-22-000014/rpt_disclosure.txt b/raw/filings/0001017303/2021/0001017303-22-000014/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..42795e61062e58b791415889bc17dfcff9ed8505 --- /dev/null +++ b/raw/filings/0001017303/2021/0001017303-22-000014/rpt_disclosure.txt @@ -0,0 +1,7 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains a Related Party Transactions Policy relating to the identification, review and approval of related party transactions, consistent with the requirements of The Nasdaq Global Market (“Nasdaq”) and the SEC. The Related Party Transactions Policy, which is administered by our Audit Committee, is set forth in our Standards of Business Conduct and Code of Ethics (the “Standards”) available under the “Corporate Governance” tab on the “Investor Relations” page of our website at www. transact -tech .com . +In particular, the Standards require all directors, officers and employees to avoid any situation that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company, including engaging in “Related Party Transactions.” The term “Related Party Transaction” means any transaction, arrangement or relationship, or any series of similar transactions, arrangements or relationships, in which (i) the Company or any of its subsidiaries or Controlled Affiliates (as such term is defined in the policy) is or will be a participant, the aggregate amount involved will or may be expected to exceed $120,000 in any fiscal year, and (iii) any Related Party has or will have a direct or indirect interest. A “Related Party” is defined as any person who is or was (since the beginning of the last fiscal year for which the Company has filed an Annual Report on Form 10 -K and proxy statement, even if such person does not presently serve in that role) an executive officer, director or nominee for director of the Company, any stockholder owning more than 5% of any class of the Company’s voting securities, or an immediate family member of any such person. +The Chair of the Audit Committee must be notified prior to a Related Party engaging in a Related Party Transaction. The Audit Committee is then responsible for reviewing the transaction. No transaction determined to be a Related Party Transaction will be approved or ratified if the transaction is contrary to the best interests of the Company and its stockholders. In determining whether to approve or ratify a Related Party Transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the transaction. +From January 1, 2021 to the date of this Proxy Statement, there have not been any transactions subject to the Company’s Related Party Transactions Policy or of the type described in Item 404 of Regulation S -K , and currently no such transactions are proposed. +9 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001017303/2022/0001140361-23-014061/filing.txt b/raw/filings/0001017303/2022/0001140361-23-014061/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..ef60b98b9d239d87845e1e8a1f4185ba8a4ed1d4 --- /dev/null +++ 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srt:ScenarioPreviouslyReportedMember 2021-12-31 0001017303 us-gaap:SubsequentEventMember 2023-01-01 2023-03-31 iso4217:USD xbrli:shares iso4217:USD xbrli:shares tact:Segment tact:Solution xbrli:pure tact:Plan +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +(Mark One) +☒ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2022 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from __________ to __________ +Commission file number: 0-21121 +TRANSACT TECHNOLOGIES INC +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center , 2319 Whitney Avenue, Suite 3B , Hamden , CT +06518 +(Address of principal executive offices) +(Zip Code) +( 203 ) 859-6800 +(Registrant’s Telephone Number, Including Area Code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common stock, par value $0.01 per share +TACT +NASDAQ Global Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☒ +Smaller reporting company ☒ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant was approximately $ 38,300,000 based on the last sale price on June 30, 2022. +As of February 28, 2023, the number of shares outstanding of the Registrant’s common stock, par value $0.01 par value, was 9,935,827 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the Registrant’s Definitive Proxy Statement related to its 2023 Annual Meeting of Stockholders (the “Proxy Statement”) to be filed with the Securities and Exchange Commission within 120 days after the Registrant’s fiscal year end of December 31, 2022 are incorporated by reference into Part III of this Annual Report on Form 10-K. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +7 +Item 1B. +Unresolved Staff Comments +18 +Item 2. +Properties +18 +Item 3. +Legal Proceedings +18 +Item 4. +Mine Safety Disclosures +18 +PART II. +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +19 +Item 6. +[Reserved] +19 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +19 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +27 +Item 8. +Financial Statements and Supplementary Data +28 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +28 +Item 9A. +Controls and Procedures +28 +Item 9B. +Other Information +28 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +28 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +29 +Item 11. +Executive Compensation +29 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +29 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +29 +Item 14. +Principal Accounting Fees and Services +29 +PART IV. +Item 15. +Exhibits and Financial Statement Schedules +30 +Item 16. +Form 10-K Summary +32 +SIGNATURES +Signatures +33 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +Smaller Reporting Company—Scaled Disclosure +Pursuant to Item 10(f) of Regulation S K promulgated under the Securities Act of 1933, as amended (the “Securities Act”), as indicated herein, we have elected to comply with certain scaled disclosure requirements applicable to “smaller reporting companies” in this Annual Report on Form 10-K for the year ended December 31, 2022 (this “Form 10-K”). +PART I +Forward-Looking Statements +Certain statements included in this Form 10-K may include “forward-looking statements” within the meaning of the U.S. federal securities laws, including the Private Securities Litigation Reform Act of 1995. Forward-looking statements are any statements other than statements of historical fact. Forward-looking statements represent current views about possible future events and are often identified by the use of forward-looking terminology, such as “may,” “will,”, “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” “plan,” “design” or “continue” or the negative thereof or other similar words. Forward-looking statements are subject to certain risks, uncertainties and assumptions. In the event that one or more of such risks or uncertainties materialize, or one or more underlying assumptions prove incorrect, actual results may differ materially from those expressed or implied by the forward-looking statements. +Important factors and uncertainties that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include, but are not limited to, the following: the adverse effects of current economic conditions, whether due to the COVID-19 pandemic or otherwise on our business, operations, financial condition, results of operations and capital resources, difficulties or delays in manufacturing or delivery of inventory or other supply chain disruptions, inflation and the Russia/Ukraine conflict, an inability of our customers to make payments on time or at all, diversion of management attention, a possible future reduction in the value of goodwill or other intangible assets, inadequate manufacturing capacity or a shortfall or excess of inventory as a result of difficulty in predicting manufacturing requirements due to volatile economic conditions, price increases or decreased availability of component parts or raw materials, exchange rate fluctuations, volatility of, and decreases in, trading prices of our common stock and the availability of needed financing on acceptable terms or at all; our ability to successfully develop new products that garner customer acceptance and generate sales, both domestically and internationally, in the face of substantial competition; our reliance on an unrelated third party to develop, maintain and host certain web-based food service application software and develop and maintain selected components of our downloadable software applications pursuant to a non-exclusive license agreement, and the risk that interruptions in our relationship with that third party could materially impair our ability to provide services to our food service technology customers on a timely basis or at all and could require substantial expenditures to find or develop alternative software products; our ability to successfully transition our business into the food service technology market; risks associated with potential future acquisitions; general economic conditions; our dependence on contract manufacturers for the assembly of a large portion of our products in Asia; our dependence on significant suppliers; our ability to recruit and retain quality employees as the Company grows; our dependence on third parties for sales outside the United States; marketplace acceptance of new products; risks associated with foreign operations; the availability of third party components at reasonable prices; price wars, supply chain disruptions or other significant pricing pressures affecting the Company’s products in the United States or abroad; increased product costs or reduced customer demand for our products due to changes in U.S. policy that may result in trade wars or tariffs; our ability to protect intellectual property; and other risk factors identified and discussed in Part I, Item 1A, Risk Factors , and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , of this Form 10-K and that may be detailed from time to time in the Company’s other reports filed with the Securities and Exchange Commission (the “SEC”). +We caution readers not to place undue reliance on forward-looking statements, which speak only as of the date of this Form 10-K. We undertake no obligation to publicly or otherwise revise any forward-looking statements, whether as a result of new information, future events or other factors, except where we are expressly required to do so by applicable law. +Item 1. Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high-growth markets including food service technology, point of sale (“POS”) automation and casino and gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL®, and Ithaca®, brand names. During 2019, we launched a new line of products for the food service technology market, the BOHA! branded suite of cloud-based applications and companion hardware solutions. The BOHA! software and hardware products help restaurants, convenience stores and food service operators of all sizes automate the food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and terminals generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents. We sell our technology to original equipment manufacturers (“OEMs”), value-added resellers, and select distributors, as well as directly to end users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class service, support, labels, spare parts, accessories and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables used in the printing activities of customers in the restaurant and hospitality, retail, casino and gaming, and government markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the demand for these products. We operate in one reportable segment: the design, development, and marketing of software-driven technology and printing solutions for high growth markets, and provide related services, supplies and spare parts. Our primary operating, hardware research and development, and U.S. service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters and software research and development center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, 06518, with a telephone number of (203) 859-6800. +1 +Impact of the COVID-19 Pandemic and Global Supply Chain Disruptions +Since early 2020, the COVID-19 pandemic has continued to cause uncertainty and disruption in the global economy and financial markets. We have also been impacted by global supply chain issues, increased shipping costs and inflationary pressures, which have increased our costs and, in some instances, slowed our ability to deliver products to our customers. During 2021, our inventory levels decreased significantly as a result of these supply chain disruptions, and we experienced significantly lower sales levels. However, during 2022 we were able to increase our inventory levels and minimize the impact to our customers by successfully modifying our products that were affected by supply chain disruptions, as well as sourcing component parts from alternate suppliers. Although we were able to increase inventory levels during 2022 and expect to continue to do so in 2023, there can be no assurance that new or continuing supply chain disruptions will not affect our products or that we will be able to make timely modifications to address any future supply chain issues that arise. Further, while we have offset most of our cost increases by increasing prices of our products, there can be no guarantee that we will be able to offset any future cost increases should they arise. After a slowdown in the first quarter of 2022 resulting from the Omicron and other variants of COVID-19, we continued to experience demand recovery during the remainder of 2022. Based on our strong backlog position and continued market share expansion, we expect this recovery to continue into 2023, though the exact timing and pace of recovery may be impacted by global economic conditions. +During 2020 and 2021, our gross margin was negatively impacted by significantly lower sales levels from the economic effects of the COVID-19 pandemic, as well as increased material and shipping costs resulting from worldwide supply chain disruptions continuing into 2022. However, we saw significant improvement in the last nine months of 2022 resulting from significantly higher sales levels and price increases instituted on our products to mitigate higher material and shipping costs. Though we expect this trend to continue into 2023, our gross margin may be negatively impacted by the economic effects of any future cost increases that cannot be predicted, supply chain disruptions, inflationary pressures and potential new COVID-19 variants on the markets we serve. +Although in 2022 we continued to gradually return to more normalized pre-COVID-19 spending levels after implementing a number of cost saving measures in 2020 through 2022, we expect to continue to closely monitor our spending levels as circumstances warrant. +Since the onset of the COVID-19 pandemic, our top priority has been to ensure the health and safety of our employees while continuing to provide our customers with high-quality, personalized service. After instituting work-from-home practices in 2020, we transitioned in 2022 to a more flexible hybrid model to accommodate both our employees and the needs of the business. In addition, even with the transition to a hybrid model, our internal control structure remains operational and unchanged. +Balance Sheet, Cash Flow and Liquidity +We have taken the following actions to increase liquidity and strengthen our financial position in an effort to mitigate the negative impacts from the COVID-19 pandemic, supply chain disruptions and inflationary pressures: +● +Public Offerings – On August 16, 2021, the Company raised net proceeds of $11.2 million (including the exercise of the underwriters’ overallotment option on August 20, 2021), after deducting underwriting discounts, commissions and offering expenses, through an underwritten public offering and sold an aggregate of 842,375 shares of common stock. +● +PPP Loan – On May 1, 2020, the Company was granted a $2.2 million loan (the “PPP Loan”) under the Paycheck Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”) established under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which enabled us to return employees we furloughed earlier in 2020 to full time employment and to restore employees to full pay following certain pay cuts. On July 8, 2021, we received notice that the PPP Loan had been forgiven as of July 1, 2021. See Note 8 for further details regarding the PPP Loan. +● +Employee Retention Credit – Under the provisions of the CARES Act, the Company was eligible for a refundable employee retention credit subject to certain criteria. In connection with the CARES Act, the Company recognized the employee retention credit during the fourth quarter of 2021 as a $1.5 million “Gain from employee retention credit” in the Consolidated Statement of Operations for the year ended December 31, 2021 and recorded a $1.5 million “Employee retention credit receivable” in the Consolidated Balance Sheets as of December 31, 2022 and December 31, 2021. We received these funds in the first quarter of 2023. +● +Credit Facility – On March 13, 2020, we entered into a new credit facility with Siena Lending Group LLC that provides a revolving credit line of up to $10.0 million, subject to a borrowing base and on July 19, 2022, we entered into an amendment to extend the maturity of the facility to March 13, 2025. See Note 8 for further details regarding this facility. +● +Reduced Capital Expenditures – We limited capital expenditures during 2020 and 2021 and gradually increased expenses during 2022 as our sales improved. +Notwithstanding the foregoing, there is no assurance that the actions we have taken in response to the pandemic, global supply chain disruptions and inflation are sufficient or adequate, and we may be required to take additional preventive or responsive measures, as the ultimate extent of the effects of these risks on the Company, our financial condition, results of operations, liquidity, and cash flows are uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, Item 1A, Risk Factors, of this Form 10-K for further discussion of risks related to COVID-19, global supply chain disruptions and inflation. +2 +Products, Services and Distribution Methods +Printers, terminals and other hardware: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal printing technology for applications, primarily in the food service technology, POS automation, casino and gaming, and prior to exiting the market on December 31, 2021, the oil and gas printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our food service technology terminals also offer software configurable menu options and our food service technology market includes sales of optional hardware products including temperature probes, temperature sensors and gateways. +Food Service Technology (“FST”): Our primary offering in the food service technology market is our line of BOHA! products, which can combine our latest generation terminal and workstation which includes one or two printers and our BOHA! Labeling, timers, and media software. In addition, customers may individually purchase cloud-based software applications that connect to a separate application on a separate mobile device into a solution to automate back-of-house operations in restaurants, convenience stores and food service operations. The additional software offering of BOHA! consists of a variety of individually purchased software-as-a-service (“SaaS”)-based applications for both Android and iOS operating systems, including applications for, temperature monitoring, temperature taking and checklists and task lists. These applications are sold separately, and customers purchase the applications they need for their back-of-house operations. Customers may also purchase associated hardware, such as handheld devices, tablets, temperature probes and temperature sensors and gateways. The BOHA! Terminal combines an operating system and hardware components in a device that includes a touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, and nutritional labels for prepared foods, and “enjoy by” date labels. The BOHA! WorkStation uses an iPad or Android tablet instead of an integrated touchscreen. The BOHA! Terminal and the BOHA! WorkStation are equipped with the TransAct Enterprise Management System to ensure that only approved touchscreen functions are available on the touchscreen device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, casual dining, fast casual and quick-service restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service contracts, and technical support services. In the food service technology market, we use an internal sales force to solicit sales directly from end users. +POS automation: In the POS market, we sell a printer utilizing thermal printing technology. Our POS printer is used primarily by McDonald’s, and to a lesser extent, other quick-service restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLTs”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in monochrome and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in international non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals, sports betting establishments and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through distributors. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales through our distributors. +We also offer a software solution, the EPICENTRAL Print System, including annual software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. With EPICENTRAL, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +TSG : Through TSG, we proactively market the sale of consumable products (including POS receipt paper, ribbons and other printing supplies), replacement parts, maintenance and repair services, and shipping and handling charges. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, a 24-hour guaranteed replacement product service called TransAct Xpress™ and other repair services for our non-FST products. Within the United States, we provide repair services through our service center in Ithaca, New York. Internationally, we provide repair services through our European service center located in Doncaster, UK, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all our products and services. In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our webstore, www.transactsupplies.com. +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Almost all of our printers and terminals are currently produced by a third party manufacturer located in Thailand. A small portion of our products are assembled in our Ithaca, New York facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +3 +We procure component parts and subassemblies for use in the assembly of a small portion of our hardware products in Ithaca, New York. Critical component parts and subassemblies include thermal print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices, subject to availability. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully assembled printers and terminals produced by our contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or unavailability. However, we have experienced and could continue to experience some disruption due to certain suppliers being unable to source specific components and we could experience temporary disruption in the availability of components. In addition, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy a majority of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for substantially all of our printer and food service technology terminal models, from a foreign contract manufacturer in Thailand. We believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms. We do not have supply agreements with foreign contract manufacturers, and we believe that our supply of thermal print mechanisms and fully assembled printers will be adequate in 2023 and the foreseeable future. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. As of January 31, 2023, we hold 34 United States and 34 foreign patents and have two foreign patent applications pending pertaining to our products. The remaining duration of these patents ranges from one to 17 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks Trade Names and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, BOHA! TM , AccuDate™, EPICENTRAL®, Ithaca® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our food service technology products or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K. +Certain Significant Customers +IGT is our most significant customer, although to a lesser extent than in previous years, and has been since 1995. We sell casino and gaming printers and, prior to 2021, online lottery printers to IGT. On May 29, 2015, we signed an agreement with IGT to sell online lottery and casino printers to IGT on a non-exclusive basis through December 31, 2019. We decided not to renew the agreement upon its expiration and to exit the online lottery market. Although we no longer have an agreement with IGT, we expect to continue selling casino and gaming printers to IGT, as well as spare parts for our remaining, but declining, installed base of lottery printers, in the future. +Sales to IGT represented 10% and 9% of our total net sales for the years ended December 31, 2022 and 2021, respectively. +Backlog +Our backlog of firm orders was approximately $27.5 million as of February 28, 2023, compared to $14.2 million as of February 28, 2022. The increase in firm orders as of February 28, 2023 compared to February 28, 2022 is due primarily to advance orders placed by our casino and gaming customers due to increased production lead time, resulting from worldwide supply chain shortages caused by the pandemic. Based on customers’ current delivery requirements, we expect to fill and recognize as revenue $26.9 million of our current backlog during 2023, $0.5 million during 2024 and the remaining balance of the amount during 2025. +Competition +The market for transaction-based and specialty printers and food service technology terminals is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +4 +In the food service technology market, we primarily compete with Zenput, Squadle Inc., Jolt Software, Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, CMC Daymark, Integrated Control Corp, Digi International, and Toast. We compete in this market based largely on our ability to provide highly specialized purpose-built hardware products, different software applications that can be chosen by a customer and ongoing technical support. We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer a unique BOHA! branded solution to support back-of-house operations in the food service industry. Our competitors or others may develop, or may establish relationships with developers with the capability to develop, software and services that are similar to or competitive with ours, which may be disadvantageous to our competitive position. Certain portions of our food service technology software are licensed from a third party developer on a non-exclusive basis through 2031 and are subject to a revenue sharing arrangement with the developer. We are reliant upon the third party developer to further develop and maintain its developed software, and the developer controls the software source code. The license agreement does not preclude the developer from working with others on similar products. Also, the third party developer hosts the web-based applications. Therefore, presently, we are highly dependent upon this third party developer for continued service to our customers and the further development of our food service technology software products. +In the POS automation market, we primarily compete with Epson America, Inc., which holds a dominant market position. We also compete, to a much lesser extent, with Star Micronics America, Inc. and Citizen -- CBM America Corporation. Certain competitors of ours have greater financial resources and lower costs attributable to higher volume production which enables them to occasionally offer lower prices than us. +In the casino and gaming market (consisting principally of slot machine printing, VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA, Eurocoin and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. In 2022, we increased our overall market share due largely to our largest competitor’s inability to supply product due to supply chain issues. +In the oil and gas market, our Printrex products competed primarily with the products of Imaging Systems Group, Inc. and Neuralog Inc. However, we exited the oil and gas market at the end of 2021 in order to shift our focus toward our higher-value, technology enabled food service technology and gaming products. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers and paper converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop and/or license new products (hardware and software), such as launching BOHA! in 2019, and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our market penetration, to take advantage of strategic relationships, and to lower the cost of our products by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our printer products utilize certain thermal printing technologies and licensed software. If new technologies are introduced, or existing technologies evolve, we may be required to incorporate these technologies into our products. Alternatively, if such technologies were to become available to our competitors, our printer products could become obsolete, which could have a significant negative impact on our business. +Environmental Compliance +Our compliance with federal, state and local laws and regulations relating to environmental protection and discharge of hazardous materials has not had a material impact on our capital expenditures, earnings or competitive position, and we do not anticipate any material impact from such compliance in the future. +Available Information +We make available free of charge through the “Investor Relations” tab on our Internet website, www.transact-tech.com, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and all amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The content on any website referred to in this Form 10-K is not incorporated by reference in this Form 10-K unless expressly noted. +Employees +As of December 31, 2022, TransAct and our subsidiaries employed 128 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +5 +Information about our Executive Officers +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +65 +Chief Executive Officer +Steven A. DeMartino +53 +President, Chief Financial Officer, Treasurer and Secretary +Tracey S. Winslow +63 +Chief Revenue Officer +Brent Richtsmeier +58 +Chief Technology Officer +Bart C. Shuldman has been Chief Executive Officer and a Director of the Company since its formation in June 1996. Mr. Shuldman served as President of the Company from its formation until June 2010, when he relinquished the President title to focus on new products and markets, international expansion and potential acquisitions. Mr. Shuldman also served as Chairman of the Board from February 2001 through March 2022. +Steven A. DeMartino was named as TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Tracey S. Winslow was appointed Chief Revenue Officer of the Company in March 2023 with responsibility for worldwide sales in all of the Company’s markets. Prior to this appointment, Ms. Winslow served as Senior Vice President, Casino and Gaming Sales from June 2010 to February 2023, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Winslow served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking with the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Winslow was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Brent Richtsmeier was named as Chief Technology Officer in September 2021. Previously, Mr. Richtsmeier served as Senior Vice President, Software Engineering since joining TransAct in December 2019 and was appointed as an officer of the Company in January 2021. Prior to joining TransAct, Mr. Richtsmeier was employed with Samsung, an electronics corporation, from May 2004 until November 2017 as the VP of Development where he was responsible for software strategy, software development at scale and business development. In November 2017, Samsung Electronics sold their business products division to HP Inc, and Mr. Richtsmeier transferred to HP Inc to become the Global Head of Cloud and Mobile Software Solutions until joining TransAct in 2019. +There are no family relationships between any of our executive officers and there is no arrangement or understanding between any of such officers and any other person pursuant to which he or she was selected as an officer. Each of our executive officers was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her earlier resignation or removal. +6 +Item 1A. Risk Factors. +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are not the only ones facing our Company. Additional risks and uncertainties not presently known to us, or that we currently believe to be immaterial, may also impair our business operations. In the event that such risks or uncertainties materialize, our business, financial condition, and results of operations could be materially adversely affected. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking statements contained in this Form 10-K to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +Risks Related to our Financial Condition and Future Operating Results +We experienced a net loss in 2020, 2021 and 2022, we anticipate making further investments in product development and may increase expenses in the future, and we may not be able to achieve, maintain or increase profitability in future periods. +We incurred a net loss of $5.9 million, $4.0 million and $5.6 million in 2022, 2021 and 2020, respectively, we anticipate making further investments in product development and may increase expenses in future periods, and we may not be able to achieve, maintain or increase profitability in the future. We have expended and expect to continue to expend substantial financial and other resources on developing our food service technology business, including expanding our offerings, developing or acquiring new products and services and increasing our sales and marketing efforts. These efforts may be more costly than we expect and may not result in increased revenue or growth in our food service technology business. Any failure to increase our revenue sufficiently to keep pace with our investments and other expenses could prevent us from achieving, maintaining or increasing profitability or positive cash flow on a consistent basis. This risk may be exacerbated by current economic conditions, which have resulted and may continue to result in increased costs and may, despite the demand recovery we experienced in 2022, result in decreased demand for our products. If we are unable to successfully address these risks and challenges as we encounter them, our business, financial condition, and results of operations could be adversely affected. +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are likely to continue to vary due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical operating results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may occur due to a number of factors, including, but not limited to, those identified below and throughout this “Risk Factors” section: +● +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +● +the geographic distribution of our sales and our supply chain; +● +market acceptance of our products, both domestically and internationally; +● +development of new competitive products by others; +● +our responses to price competition; +● +our level of research and development activities; +● +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +● +changes in the amount we spend to promote our products and services; +● +changes in the cost of satisfying our warranty obligations and servicing our installed base of products; +● +availability of third party components at reasonable prices or at all; +● +general economic and industry conditions, including inflation and changes in interest rates affecting returns on cash balances and investments, that affect customer demand; +● +the dependence of our supply chain on a few, foreign third party manufacturers and suppliers and the impact on our supply chain of product or component shortages and cost increases due to events beyond our control, including the COVID-19 pandemic, inflation and political or social instability such as the ongoing Russia-Ukraine conflict; +● +severe weather events, public health crises, military actions and other external events out of our control that can disrupt our operations or the operations of our customers’ or suppliers’ facilities; and +● +changes in accounting rules. +Due to all of the foregoing factors, and the other risks discussed in this Form 10-K, quarter-to-quarter comparisons of our operating results may not be an indicator of future performance. +7 +Risks Relating to the COVID-19 Pandemic and Global Political and Economic Conditions +The COVID-19 pandemic and the resulting economic conditions have had an adverse impact on our business, operations, financial condition, results of operations and capital resources, as well as on the operations and financial performance of many of our customers and suppliers. We are unable to predict the ultimate extent to which the pandemic and related economic effects will adversely impact our business, operations, financial condition, results of operations, capital resources and the achievement of our strategic objectives. +Since early 2020, the COVID-19 pandemic has continued to cause uncertainty and disruption in the global economy and financial markets. We have also been impacted by global supply chain issues, increased shipping costs and inflationary pressures, which have increased our costs and, in some instances, slowed our ability to deliver products to our customers. During 2021, our inventory levels decreased significantly as a result of these supply chain disruptions, and we experienced significantly lower sales levels until we were able to modify our products that were affected by supply chain disruptions or source component parts from alternate suppliers. During 2022, we were able to increase our inventory levels and reduce the impact to our customers by modifying certain products that were affected by supply chain disruptions as well as sourcing component parts from alternate suppliers. However, there can be no assurance that new or continuing supply chain disruptions will not affect our products or that we will be able to make timely modifications or find alternate suppliers to address any future supply chain issues that may arise, or that we will be able to offset any future cost increases, should they arise, by increasing prices of our products. After a slowdown in the first quarter of 2022 resulting from the Omicron and other variants of COVID-19, we continued to experience demand recovery during the remainder of 2022 and into 2023, but there can be no guarantee that this trend will continue, and the exact timing and pace of recovery may be impacted by global economic conditions. If recovery does not occur at the pace we anticipate, if we cannot offset our cost increases or otherwise manage costs, or if supply chain disruptions cause us to be unable to meet customer demand, this may have a material adverse impact on our business, operations, financial condition, results of operations and capital resources. +In addition, any of the risks and uncertainties set forth in this Form 10-K could be further heightened by the COVID-19 pandemic and the resulting economic effects, which could have a material adverse effect on the Company’s business, prospects, financial condition, results of operations and capital resources and the achievement of our strategic objectives. +We purchase component parts and consumable products from third party and sole source suppliers, and any interference with this supply chain may impact our ability to manufacture and sell our products. +We rely on third party or sole source suppliers to provide certain key components for our products. We do not have guaranteed supply contracts with any of our component suppliers, and our suppliers could delay shipments, increase prices or cease manufacturing or selling such components to us at any time, including as a result of the current global microchip shortage. Such disruptions have resulted in delays in delivery of products to customers and could in the future result in additional delays, even if we are able to source components from alternate suppliers. Supply chain disruptions have impacted, and could continue to impact, our ability to maintain sufficient inventory on hand. As a result, we have paid, and may continue to pay, increased shipping charges to expedite our receipt of components and inventory and the delivery of finished products to our customers. In addition, we have incurred increased costs to obtain certain products and components from alternate suppliers when our usual suppliers did not have products available for us, and we may incur such costs in the future if we need to seek alternate suppliers for any of our components. Cost increases and component shortages may be exacerbated by events beyond our control, such as changing economic conditions, inflation, currency and commodity price fluctuations, tariffs, resource availability, transportation costs, weather conditions and natural disasters, political unrest and instability, war (such as the ongoing military conflict between Russia and Ukraine) and other factors impacting supply and demand pressures. Continued or worsening disruptions in the supply chain of such component parts and consumable products could delay our production or release of our new products, cause us to incur additional freight costs and hinder our ability to meet our commitments to customers. If we are unable to obtain sufficient quantity of these components on commercially reasonable terms or in a timely manner, or if we are unable to obtain alternative sources for the components, sales of our products could be delayed or halted entirely or we may have to redesign our products , as we did with certain products in the recent past, to help meet market demand. There can be no assurance that any cost increases attributable to supply chain disruptions can be fully offset by price increases, or that we will continue to be able to fulfill orders on time, and continued or prolonged impacts on our supply chain may result in lost sales, reduced gross margins or damage to our end-customer relationships, which would have a material adverse effect on our financial results. +Catastrophic events, political unrest or a downturn in economic conditions may disrupt our business. +Geopolitical events, social unrest, war, including repercussions of the recent military conflict between Russia and Ukraine, terrorism, political instability, acts of public violence, boycotts, labor discord or disruptions, hostilities, social unrest, pandemics (in addition to the COVID-19 pandemic), natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce, and the global economy, and thus could harm our business. In particular, the reactions of governments, markets, and the general public to such events, many of which are beyond our control, may result in a number of adverse consequences for our customers, business, operations, and results of operations. +For example, the continuing military conflict between Ukraine and Russia, as well as the financial and trade-related restrictions associated with Russia and Belarus and economic sanctions on certain individuals and entities in Russia and Belarus, have continued to impact international trade relations, and resulted in sustained increases in the cost of materials and components, while higher oil and other commodity prices have resulted in further increased shipping and transportation costs. If the conflict persists or escalates, this may further disrupt global supply chains and could result in shortages of key materials or components that our suppliers require to satisfy our needs. Any increases in the cost, or shortages, of raw materials, components or energy may continue to create supply issues that could constrain manufacturing levels for our products. +8 +In addition, based on the complex relationships among China, Hong Kong, Taiwan, and the United States, there is risk that political, diplomatic, and national security influences might lead to trade, technology, or capital disputes, or disruptions that may affect our business or suppliers in Asia. These tensions may be exacerbated by continuing sanctions imposed in connection with the Russia–Ukraine conflict, as there continues to be uncertainty with respect to China’s willingness to support ongoing or expanded sanctions, which could distance China from its existing trade partners, potentially creating a significant negative impact on our business or on the regional or global economy. +In the event of a major earthquake, hurricane or catastrophic event such as fire, power loss, telecommunications failure, cyber-attack, war or terrorist attack, we may be unable to continue our operations and may endure system interruptions, reputational harm, breaches of data security, and loss of critical data, all of which would harm our business, results of operations, and financial condition. In addition, the insurance we maintain would likely not be adequate to cover our losses resulting from disasters or other business interruptions. Any downturn in the economy in general, including the current economic impacts of the COVID-19 pandemic (including inflation relating to supply chain disruptions caused by the pandemic) and the impact of the Russia–Ukraine conflict, or in the food service or gaming industry in particular could result in a reduced demand for our products and could adversely affect our business and results of operations. In addition, heightened security measures or responses to hostilities may cause certain governments to restrict the import or export of goods, as has occurred with respect to the export of oil from Russia, which may have an adverse effect on our ability to buy and sell goods or on the cost to obtain components. +Risks Related to Our Operations +Overestimates or underestimates in our manufacturing forecasts could cause us to hold insufficient or excess inventory or result in delays in the manufacturing and delivery of our products, which could interfere with our ability to retain orders or provide services to our customers. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays. We currently use a rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our requirements for components and materials. It is important that we accurately predict both the demand for our products and the lead-time required to obtain the necessary components and raw materials. We have also modified our products in the past to substitute available components in the place of those that have become scarce or difficult to obtain, and in some instances have identified alternate sources for certain components. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size of the order, contract terms, and demand for each component at a given time, as well as supply shortages with respect to raw materials needed to produce the components. If we underestimate our requirements, or if we are unable to obtain components on time due to supply shortages, as has occurred in the wake of the COVID-19 pandemic and global supply chain disruptions, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and interfere with our ability to timely deliver products to our customers and adversely impact our sales. If we overestimate our requirements, we could have excess inventory of parts and finished products. Some of the actions we have taken to meet customer demand in the face of supply chain disruptions have raised our costs and decreased margins on our products, and any such actions that we take in the future could have a similar effect. Any future underestimate or overestimate of supply requirements, and any actions we may take in the future to navigate supply chain disruptions, could have a material adverse effect on our business and results of operations. +We depend on key personnel, the loss of whom could have a material adverse impact on our business. +Our future success may depend in significant part upon the continued service of certain key management and other personnel. There can be no assurance that we will be able to recruit and retain such personnel. The loss of either Bart C. Shuldman, the Company’s Chief Executive Officer, or Steven A. DeMartino, the Company’s President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, could have a material adverse effect on our business and results of operations. +Our ability to recruit, retain, and develop qualified personnel is critical to our success and growth. +To successfully compete and grow our business, we must recruit, develop and retain highly qualified managerial, technical and sales and marketing personnel. In addition, we must develop, maintain and, as necessary, implement appropriate succession plans to ensure we have the necessary human resources capable of maintaining continuity in our business. +The market for qualified personnel is competitive, and we may not succeed in recruiting additional personnel or may fail to effectively replace current personnel who depart with qualified or effective successors. Our effort to retain and develop personnel may also result in significant additional expenses, which could adversely affect our profitability. We are also substantially dependent on our sales force to obtain new customers and increase sales to existing customers. There is significant competition for sales personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, training, and retaining a sufficient number of sales personnel to support our growth. If we are unable to hire, train, and retain a sufficient number of qualified and successful sales personnel, our business, financial condition, and results of operations may be harmed. +Our food service technology business depends substantially on our customers renewing their subscriptions with the Company. Any decline in our customer renewals could harm our food service technology business, results of operations and financial condition. +Our subscription offerings are term-based, and in order for us to maintain or improve our results of operations, it is important that our customers renew their subscriptions with us when the existing subscription term expires and renew on the same terms or terms more favorable to the Company. Our customers have no obligation to renew their applications and subscriptions, and they may not renew one or more of their applications as they are purchased separately and individually. We also may not be able to accurately predict customer renewal rates. Customers may elect not to renew their subscriptions with us for a variety of reasons, including as a result of changes in their strategic priorities, budgets and costs and, in some instances, due to competing solutions. Our retention rate may also decline or fluctuate as a result of a number of other factors, including our customers’ satisfaction or dissatisfaction with our solutions, the increase in the contract value of subscription and support contracts from new customers, the effectiveness of our customer support services, our pricing, the prices of competing products or services, global economic conditions and the other risk factors described herein. As a result, there can be no assurance that our food service technology customers will renew any or all of their individually purchased application subscriptions. If our customers do not renew their subscriptions or renew on less favorable terms, our business, results of operations and financial condition may be adversely affected. +9 +Because we rely in part on revenue from subscription contracts and recognize revenue from subscription contracts over the term of the relevant subscription period, downturns or upturns in sales are not immediately reflected in full in our results of operations. +Subscription services revenue accounts for a growing portion of our food service technology revenue. Sales of new or renewal subscription contracts may decline or fluctuate as a result of a number of factors, including customers’ level of satisfaction with our solutions, the prices of our subscriptions, the prices and features of products or subscriptions offered by our competitors, reductions in our customers’ spending levels, or other changes in consumer behavior. If our sales of new or renewal subscription contracts decline, our revenue and revenue growth may decline. We recognize subscription revenue ratably over the term of the relevant subscription period, which is generally 12 months in duration. As a result, much of the subscription revenue we report each quarter is derived from subscription contracts that we sold in prior quarters. +Consequently, a decline in new or renewed subscription contracts in any one quarter will not be fully reflected in revenue in that quarter but will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in new or renewal sales of our subscriptions is not reflected in full in our results of operations in a given period. Also, it is difficult for us to rapidly increase our subscription revenue through additional sales in any period, as revenue from new and renewal subscription contracts must be recognized ratably over the applicable subscription period. Furthermore, any increases in the average term of subscription contracts would result in revenue for those subscription contracts being recognized over longer periods of time. +If we fail to offer high quality support, our business and reputation could suffer. +Our customers rely on us and our third party service providers for support of our software and services included in our food service technology subscription packages. High-quality support is important for the renewal and expansion of our agreements with existing customers. The importance of high-quality support will increase as we expand our business and pursue new customers. If we or our third party service providers do not help our customers quickly resolve issues and provide effective ongoing support, our ability to sell new food service technology products to existing and new customers could suffer and our reputation and relationships with existing or potential customers could be harmed. +We experience elements of seasonal fluctuations in the food service technology and POS markets which could cause our stock price to fluctuate. +Our food service technology business is highly dependent on the behavior patterns of our customers and their guests. Restaurants typically reduce purchases of equipment in the fourth calendar quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our food service technology products or POS printers during that period. As a result, seasonality may cause fluctuations in our financial results, and other trends that develop may similarly impact our results of operations. +Risks Related to Intellectual Property and Data Security +Cyber-security and privacy breaches, cyber-attacks, or other disruptions could expose us to liability, affect our business, and damage our reputation. +We are increasingly dependent on our information technology systems and infrastructure for our business. We collect, store, and transmit sensitive information including intellectual property, proprietary business information and personal information of employees and, to a lesser extent, customers in connection with business operations. The secure maintenance of this information is critical to our operations and business strategy. Some of this information could be an attractive target of criminal attack by third parties with a wide range of motives and expertise, including organized criminal groups, disgruntled current or former employees, and others. Cyber-attacks are of ever-increasing levels of sophistication, and despite our extensive security measures, our information technology and infrastructure may be vulnerable to such attacks or may be breached, including due to employee error or malfeasance. Further, our BOHA! applications are hosted within cloud platforms that are managed by third parties. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen, and our business operations may be interrupted. If our systems become compromised, we may not promptly discover the intrusion. Like other companies in our industry, we have experienced attacks to our data and systems, including malware and computer viruses that we have been able to detect and eliminate. However, as disclosed on November 16, 2022, a criminal cybersecurity incident impacted our operational and information technology systems. The Company worked with a team of forensic experts to fully understand the extent and implications of this incident and we fully restored operations within a remediated environment. If our systems fail or are breached or disrupted by other future attacks, we could lose product sales, and suffer reputational damage and loss of customer confidence. Such incidents could require notification to affected individuals and may result in legal claims or proceedings and liability under federal and state laws that protect the privacy and security of personal information. If third parties use a cyber-attack to gain access to our proprietary information, they may sell it or use it to duplicate our products, which could put us at a competitive disadvantage. Any one of these events could cause our business to be materially harmed and our results of operations to be adversely impacted, and there can be no assurance that the insurance that we maintain to address certain aspects of cyber-security risks will be sufficient to cover all losses or all types of claims that may arise. +These risks may be exacerbated by global political unrest. For example, the Russia–Ukraine conflict and related sanctions imposed by the U.S. government may expose government entities and public and private U.S. companies to attempted or actual cyber-security attacks launched in retaliation, and these attacks could materially disrupt our supply chain or our systems and operations or those of our customers and suppliers. +10 +The inability to protect our intellectual property rights could harm our reputation, damage our business or interfere with our competitive position. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trademarks, service marks, trade secrets, technology licensing agreements, nondisclosure agreements and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without authorization, to obtain and use information that we regard as trade secrets. Our pending patents may be denied, and our patents may be circumvented by our competitors. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar technologies. Our failure to adequately protect our proprietary rights could have a material adverse effect on our competitive position and our business. +Prosecuting or defending against intellectual property litigation could be time consuming and costly, and an claims that we have infringed upon the intellectual property rights of others could impede our business and put us at a competitive disadvantage. +Prosecuting and defending against intellectual property litigation is generally complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. We are committed to aggressively asserting and defending our technology and related intellectual property rights, which we have spent a significant amount of money to develop. Similarly, third parties have claimed and may claim, from time to time in the future, that we have violated their intellectual property rights. In the event that a court rules that we have violated a third party’s patent or other intellectual property rights, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish our objectives. Any such claims could result in costly litigation and, if successful, could result in costly judgments or settlements, and there can be no assurance that a license or a substitute technology will be available on favorable terms, or at all. Any such outcome could have a material adverse effect on our business, financial condition and results of operations. +Risks Related to Product Development +Our revenue and profitability depend on our ability to continue to develop or license, on a timely basis, new products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated, and customer acceptance of such products. +Our success depends upon our and our development partners’ ability to timely adapt our capabilities and processes to meet the demands of producing new and innovative products. Because our newer products contain software and generally are more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product innovation. If we cannot efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +Developers, on our behalf, successfully develop such products, there is no assurance that our innovations will be accepted by our customers. Developing and marketing new products, such as our line of BOHA! products, is costly, and our business could be materially adversely affected if we are unable to generate sales of such products or if our existing or new customers do not quickly accept such products. Customer acceptance is crucial because new products typically have little competition and market penetration due to their novelty. Customer acceptance of new products is never assured and may take time to materialize, even with respect to products developed with customer input. Further, technological innovation often results in unintended consequences such as bugs, vulnerabilities, and other system failures. Any such bug, vulnerability, or failure, especially in connection with a significant technical implementation or change, could result in lost business, harm to our brand or reputation, consumer complaints, and other adverse consequences, any of which could materially adversely affect our business, results of operations, and financial condition. +Risks Related to Our Partners and Suppliers +We rely on an unrelated third party to develop, maintain and host certain portions of our food service technology software, and any disruption in the relationship with that third party, or any defects in the software provided by that third party, could have a material adverse effect on our reputation, business, financial condition and results of operations. +We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer our unique BOHA! branded solution to support back-of-house operations in the food service industry. Certain web-based food service application software and selected components of our downloadable software applications are licensed from a third party developer on a non-exclusive basis through 2031 and are subject to a revenue sharing arrangement with the developer. We are reliant upon the third party developer to further develop and maintain its developed software, and the developer controls the software source code. Therefore, presently, we are highly dependent on this third party developer for continued service to our customers and the further development of our food service technology software products. If the software provider were to terminate operations or otherwise be unavailable to provide maintenance, hosting and development services to us and our customers, the availability or usage of our software products could be disrupted and our customers could be adversely affected. In any such case, we may need to seek comparable software and services from other third parties or develop it internally, which could require significant time and expense. There can be no assurance that such software or services would be available from other sources, or that if available, they would be of comparable quality and cost. Moreover, any efforts to develop new software, whether internal or by third-parties, would require significant lead time, and there could be an interruption in service during any period in which the software provider ceases to provide products and services and new products remain under development. Any such occurrence could materially and adversely impact our business, financial condition and results of operations. +Any errors or defects in, or failures of, third party software or applications could result in errors or defects in or failures of our food service technology products and services, which could be costly to correct and have a material adverse effect on our reputation, business, financial condition and results of operations. +11 +We are currently dependent upon a manufacturer located in Thailand for the manufacturing and assembly of a substantial portion of our printers and terminals, and any further or future disruption in the businesses or operations of this manufacturer, such as those caused by the COVID-19 pandemic, political, social or economic instability, war, trade restrictions or tariffs, severe weather, changes in climate, additional public health crises and other events out of our control could materially adversely affect our business, financial condition and results of operations. +In an effort to maximize cost savings and operation benefits, we have outsourced substantially all of the manufacturing and assembly of our printers and terminals to a contract manufacturer located in Thailand. As a result, we are dependent on them for the manufacturing of our products, and any disruption in such manufacturing or the export of products from this manufacturer to the U.S. may adversely affect our business, financial condition and results of operations. +Risks affecting the businesses and operations of our manufacturer in Thailand include: political and regional strife; war; labor shortages; severe weather and natural disasters such as earthquakes, hurricanes, fires, and floods, whether as a result of climate change or otherwise; lengthy power outages; increased pricing, financial instability and capacity constraints of shippers; government imposition of tariffs which may impact the cost or availability of products or components that we purchase; and concerns with or threats of public health crises, contagious diseases or health epidemics. Though we are seeking a second source, the risk to our business posed by any disruption in manufacturing is exacerbated by the concentration of substantially all of our manufacturing operations in one manufacturer located in Thailand. +If the contract manufacturer is unable to manufacture our products or continue operating their facilities, as occurred in connection with the COVID-19 pandemic, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing facility, which could be costly and time consuming and have a material adverse effect on our operating and financial results. +We may also incur increased business continuity and reputational risks to the extent that we continue to outsource the manufacturing and assembly of our products to foreign third party service providers. For example, outsourcing of manufacturing prevents us from exercising control over the assembly of certain of our products and related operations or processes, including the internal controls associated with operations and processes conducted and the quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially adversely affected. Outsourcing also exposes us to increased risk of infringement or misappropriation of our intellectual property, to which our manufacturers have access. Because our manufacturer is located in Asia, there is no guarantee that our intellectual property rights will be protected or enforced to the same extent as under U.S. federal and state laws. Consequently, we may not be able to prevent third parties from developing or selling products made using our technologies. +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and services. We may be adversely impacted by any conflicts that could arise between and among our various sales channels. +Our dependence upon distributors and resellers exposes us to numerous risks, including: +● +loss of channel and the ability to bring new products to market; +● +concentration of credit risk, including disruption in distribution should the distributors, and / or resellers’ financial condition deteriorate; +● +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +● +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +● +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon the business, consolidated results of operations and financial condition. +We currently rely on third party service providers to host our food service technology software and deliver certain services, and any interruptions or delays in services from these third parties could impair the delivery of our products and services, and our business, results of operations, and financial condition could be materially adversely affected. +We rely on a third party service provider to host our food service technology software. Third parties also provide services to key aspects of our operations, including Internet connections and networking, data storage and processing, trust and safety and security infrastructure. We do not control the operation, physical security, or data security of any of these third party providers. Our efforts to use commercially reasonable diligence in the selection and retention of such third party providers may be insufficient or inadequate to prevent or remediate such operational and security risks. Our third party providers may be subject to intrusions, computer viruses, denial-of-service attacks, sabotage, acts of vandalism, acts of terrorism or other misconduct. They are vulnerable to damage or interruption from power loss, telecommunications failures, fires, floods, earthquakes, hurricanes, tornadoes, and similar events, and they may be subject to financial, legal, regulatory, and labor issues, each of which may impose additional costs or requirements on us or prevent these third parties from providing services to us or our customers on our behalf. From time to time, our software maintained by these third parties has experienced brief interruptions in service which we have been able to resolve promptly by working with the third-party providers, and there may be future such interruptions that could have a material adverse effect on our customer relationships or be more costly or time-consuming to resolve. In addition, these third parties may breach their agreements with us, disagree with our interpretation of contract terms or applicable laws and regulations, refuse to continue or renew these agreements on commercially reasonable terms or at all, fail to or refuse to process transactions or provide other services adequately, take actions that degrade the functionality of our platform and services, increase prices, impose additional costs or requirements on us or our customers, or give preferential treatment to our competitors. If we are unable to procure alternatives in a timely and efficient manner and on acceptable terms, or at all, we may be subject to business disruptions, losses, or costs to remediate any of these deficiencies. The occurrence of any of the above events could result in reputational damage, legal or regulatory proceedings, loss of customers or other adverse consequences, any of which could materially adversely affect our business, results of operations, and financial condition. +12 +Risks Related to Competition, Sales and Marketing +We compete in highly competitive markets, which are likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, consumables and services. Our principal competitors have substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +● +technologically advanced products that satisfy user demands; +● +superior customer service; +● +high levels of quality and reliability; and +● +dependable and efficient distribution networks. +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in price reductions, lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. Some competitors may make strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products, which may include relationships with our software developer. Any of these factors could reduce our earnings. +Our food service technology market operates in an emerging and evolving industry, which makes it difficult to evaluate the future prospects of this market. +We launched our BOHA! offering in 2019 and have grown our food service technology significantly since then. This is still an emerging market that is continually evolving as technology develops to automate back-of-house tasks that were historically performed manually. This evolving nature of the food service technology market may make it difficult to evaluate our future prospects in this market and the risks and challenges we may encounter. These risks and challenges include, but are not limited to, our ability to: +● +accurately forecast our revenue and plan our operating expenses; +● +increase the number of customers (and retain existing customers and their guests) using our platform; +● +successfully compete with current and future competitors; +● +successfully expand our market presence business in existing markets and enter new markets and geographies; +● +maintain and enhance the value of our reputation and brand; +● +adapt to rapidly evolving trends in the ways our customers interact with technology; +● +timely respond to customer needs with technology developments that enable our products to evolve to meet the changing demands of the marketplace; +● +avoid interruptions or disruptions in our service; +● +manage the risk of loss relating to food safety issues if there is a failure of our offerings designed to help in part to help assure perishable goods are safely preserved; +Risks Related to Our Customers +We are dependent on sales to one large customer; the loss of this customer or reduction in orders from this customer could materially affect our sales. +Casino and gaming sales and lottery printer spare parts sales to IGT represent a material percentage of our net sales. A reduction, delay or cancellation in orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Risks Related to Growth and Strategic Transactions +Our success will depend on our ability to sustain and manage growth. +As part of our business strategy, we intend to pursue a growth strategy. Assuming this growth occurs, it will require the expansion of customer relationships in domestic and international markets, the successful development and marketing of new products for our existing and new markets, expanded internal sales and marketing, customer service and support, and the continued implementation and improvement of our operational, financial and management information systems. +To the extent that we seek growth through acquisitions, our ability to manage our growth will also depend on our ability to integrate businesses that have previously operated independently. We may not be able to achieve this integration without encountering difficulties or experiencing the loss of key employees, customers or suppliers. It may be difficult to design and implement effective financial controls for combined operations and differences in existing controls for each business may result in weaknesses that require remediation when the financial controls and reporting functions are combined. If we pursue acquisitions, we may incur legal, accounting and other transaction-related expenses for unsuccessful acquisition attempts that could adversely affect our results of operations in the period in which they are incurred. There is no guarantee that any acquisitions will be accretive, or that future acquisitions will not result in additional impairments or write-downs. The existence of one or more material liabilities of an acquired company that are unknown to us at the time of acquisition could result in our incurring those liabilities. +13 +There can be no assurance that we will be able to successfully implement a growth strategy, or that we can successfully manage expanded operations, if they occur. If we expand, we may from time-to-time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our results of operations and financial condition. +We may not be able to successfully identify and execute future acquisitions, dispositions or other strategic transactions or to successfully manage the impacts of such transactions on our operations. +Acquisitions, dispositions and other strategic transactions involve a number of risks, including: (i) the potential disruption of our ongoing business; (ii) the distraction of management away from the ongoing oversight of our existing business activities; (iii) incurring additional indebtedness or issuing equity that may be dilutive to existing stockholders; (iv) the anticipated benefits and cost savings of those transactions not being realized fully, or at all, or taking longer to realize than anticipated; (v) an increase in the scope and complexity of our operations; (vi) the loss or reduction of control over certain of our assets; and (vii) the depletion of cash to pay for an acquisition. There can be no assurance that we will find suitable opportunities for strategic transactions at acceptable prices, have sufficient capital resources to pursue such transactions, be successful in negotiating required agreements, or successfully close transactions after signing such agreements. A strategic transaction may result in a significant change in the nature of our business, operations and strategy, and we may encounter unforeseen obstacles or costs in implementing a strategic transaction or integrating any acquired business into our operations. We cannot predict the number, timing or size of future strategic transactions, if any, or the effect that any such transactions might have on our operating results. +Risks Related to Our International Operations +In addition to maintaining offices in the UK and Macau, we sell and ship a significant portion of our products internationally and rely on third parties that make up part of our global salesforce. The international nature of our operations may expose us to certain risks associated with doing business outside of the U.S., including risks posed by tariffs and changes in trade relations. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. In addition, our manufacturer and suppliers are largely located in Asia. As a result, our products are largely exported to one of our facilities in the United States, which makes our operations vulnerable to disruptions in trade that could adversely affect our business results. +Our international operations, including our reliance on manufacturers and suppliers located in Asia, our worldwide sales team, and our sales to customers located outside the United States, expose us to disruptions in trade and other associated risks such as: +● +the imposition of additional duties, tariffs, quotas, taxes, trade barriers, capital flow restrictions and other charges on imports and exports by the United States or the governments of the countries in which we or our manufacturers and suppliers operate; +● +delays in the delivery of cargo due to port security considerations, labor disputes such as dock strikes, and our reliance on a limited number of shipping and air carriers, which may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; +● +fluctuations in the value of the U.S. Dollar against foreign currencies, which could restrict sales, or increase costs of purchasing, in foreign countries; +● +economic or political instability in any of the countries in which we or our manufacturers or suppliers operate, which could result in a reduction in demand for our products due to political and economic instability or impair our foreign assets; +● +a reduced ability or inability to sell in or purchase from certain markets as a result of export or import restrictions; +● +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from selling in certain geographic territories; +● +reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; and +● +economic uncertainties and adverse economic conditions (including inflation and recession). +Although we carry business interruption insurance to cover lost revenue and profits in an amount we consider adequate, this insurance does not cover all possible situations. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing customers resulting from our inability to produce products for them. +Risks Related to Regulations, Taxation, Governance and the Environment +If market conditions deteriorate or future results of operations are less than expected, a valuation allowance may be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred tax assets on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions deteriorate or future results of operations are less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are not realizable. As a result, we may need to establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +14 +Changes in tax rates or tax liabilities could affect results. +We are subject to taxation in the United States and certain state and foreign jurisdictions. Significant judgment is required to determine and estimate our tax liabilities. Our future annual and quarterly tax rates could be affected by numerous factors, including changes in the (1) applicable tax laws; (2) composition of earnings in countries with differing tax rates; or (3) recoverability of our deferred tax assets and liabilities. Beginning in 2022, the U.S. Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated the existing option to deduct research and development expenditures and requires taxpayers to amortize them over five years pursuant to IRC Section 174. The requirement is not expected to materially impact our cash flows. In August 2022, the United States enacted the Inflation Reduction Act of 2022 (“IRA”) which includes a new 15% corporate minimum tax as well as a 1% excise tax on fair value of corporate stock repurchases made after December 31, 2022. The IRA is not expected to impact our tax position. Any of these developments or any future changes in federal, state, or international tax laws or tax rulings could adversely affect our effective tax rate and our results of operations. +Risks Related to our Indebtedness +The agreement governing our credit facility contains restrictions and limitations that could significantly affect our ability to operate our business, as well as significantly affect our liquidity. +The loan and security agreement (the “Loan Agreement”) governing the Siena Credit Facility contains a number of significant covenants that could adversely affect our ability to operate our business, our liquidity, and our results of operations. These covenants restrict, among other things, our ability, and the ability of any future domestic subsidiary, to: +● +merge, consolidate, form subsidiaries or dispose of assets; +● +acquire assets outside the ordinary course of business; +● +enter into other transactions outside the ordinary course of business; +● +sell, transfer, return or dispose of collateral; +● +make loans to or investments in, or enter into transactions with, affiliates; +● +incur or guarantee indebtedness, incur liens; +● +redeem equity interests while borrowings are outstanding under the credit facility; +● +change our capital structure; or +● +dissolve, divide, change our line of business or cease or suffer a disruption to all or a material portion of our business. +Additionally, the Loan Agreement requires us to comply with a minimum excess availability covenant, which requires excess borrowing availability of at least $750 thousand and the Loan Agreement requires us to maintain outstanding borrowings of at least $2,250,000 in principal amount. The breach of any covenants or obligations in the Loan Agreement, if not otherwise waived or amended, could result in a default under the Loan Agreement and could trigger acceleration of our obligations thereunder and permit the lender to foreclose on the collateral securing our obligations under the Loan Agreement and exercise other rights of secured creditors. +Availability under the Siena Credit Facility is subject to a borrowing base, which is based on eligible accounts receivable and inventory. To the extent that our eligible accounts receivable and inventory decline in value, our borrowing base will decrease, and the availability under the Siena Credit Facility currently is and may continue to be less than its stated amount and may decrease. In addition, if at any time the amount of outstanding borrowings and letters of credit under that facility exceeds the borrowing base, we are required to prepay borrowings and/or cash collateralize letters of credit sufficient to eliminate the excess. +Our ability to comply with the covenants under the Loan Agreement or to maintain our borrowing base may be affected by events beyond our control, including deteriorating economic conditions. For example, reductions in the value of accounts receivable and inventory may occur in the future due to decreases in sales and production resulting from the impact of future economic uncertainties. Further, certain slow-moving inventory and accounts receivable that remain unpaid for a specified period of time are excluded from the borrowing base calculation. Thus, a decline in economic conditions and/or a decline in the financial condition of customers in the industries we serve may negatively impact the borrowing base both by decreasing the value of existing accounts and reducing the number and amount of new accounts. If we overestimate our inventory needs due to the uncertainty surrounding future economic conditions, we may have inventory that is considered slow-moving and thus excluded from the borrowing base calculation, and any reduction in production in response to decreased demand would also result in a lower inventory value and thus a lower borrowing base. +Any of these events could require us to seek waivers or amendments of covenants or alternative sources of financing or to reduce expenditures. We cannot assure you that such waivers, amendments or alternative financing could be obtained, or if obtained, would be on terms acceptable to us, or that we would be able to reduce expenditures enough to offset any decrease in the borrowing base, or that we could make such reductions without a material negative impact on our business. +General Risk Factors +General economic conditions could have a material adverse effect on our business, operating results and financial condition. +Our business is subject to general economic conditions. Uncertainty or negative trends in U.S. or international economic and investment climates, including the impact of developments in U.S.-China trade relations, as well as economic impacts from the Russia-Ukraine conflict and the current inflation surge attributable in part to supply chain disruptions, could adversely affect our business. For example, customers or potential customers could reduce or delay orders, key suppliers could become insolvent, which could result in production delays, and our customers may become insolvent or be unable to obtain credit. Any of these possible effects could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including write-downs of assets. +15 +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as: +● +prevailing domestic and international market and economic conditions, and conditions in the industries we serve, including current market volatility, inflation and rising interest rates and the ongoing economic impact of the COVID-19 pandemic; +● +adverse business conditions faced by customers, or bankruptcies or store closures of our customers resulting from adverse economic conditions due to inflation, resurgences or new variants of COVID-19 or otherwise; +● +changes in our business, operations or prospects; +● +developments in our relationships with our customers or strategic partners; +● +announcements of new products or services by us or by our competitors; +● +announcement or completion of acquisitions by us or by our competitors; +● +changes in existing, or adoption of additional, government regulations; and +● +unfavorable or reduced analyst coverage. +In addition, the stock market may experience significant price fluctuations year-to-year. Broad market fluctuations, general economic conditions and specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Unfavorable analyst coverage or a reduction in analyst coverage of our common stock may adversely affect the price of our common stock. +The trading market for our common stock relies in part on the research and reports that industry or financial analysts may publish about us, our business, our markets and our competitors. We currently have limited analyst coverage, and many investment banks no longer find it profitable to provide securities research on micro-cap and small-cap companies. If securities analysts do not cover our common stock in the future, the lack of research coverage may adversely affect the market price of our common stock. Furthermore, if one or more of the analysts who cover us downgrade our stock, or if those analysts issue other unfavorable commentary about us or our business, our stock price may decline. +Our common stock is traded on the Nasdaq Global Market. During the year ended December 31, 2022, the average daily trading volume for our common stock as reported by the Nasdaq Global Market was approximately 38,000 shares. We are uncertain whether a more active trading market in our common stock will develop. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the volatility and depress the price of our common stock. +Our common stock is thinly traded, and investors may be unable to sell their shares at their desired prices, or at all, and sales of large blocks of shares may adversely affect the price of our common stock. +Our common stock has historically been sporadically or “thinly” traded, meaning that the number of persons interested in purchasing shares of our common stock at prevailing prices at any given time may be relatively small. This could lead to wide fluctuations in our share price. Investors may be unable to sell their common stock at or above their purchase price, which may result in substantial losses. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of shares of our common stock in either direction. The price of shares of our common stock could, for example, decline precipitously in the event a large number of shares of our common stock are sold on the market without commensurate demand, while an issuer with a more robust daily trading volume for its common stock might better absorb those sales without an adverse impact on its share price. +If we raise additional capital in the future, existing shareholder ownership interest in the Company could be diluted or otherwise adversely impacted, and future sales of our common stock or other financing arrangements may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, or we may obtain funds through a credit facility or by issuing debt or preferred securities. We may also issue additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future issuance and sale pursuant to stock options and other equity awards that we have granted to our employees, and in the future, we may grant additional stock options, restricted stock units and other forms of equity compensation to our employees. Any issuance of equity we may undertake in the future to raise additional capital could cause the price of our common stock to decline, or require us to issue shares at a price that is lower than that paid by holders of our common stock in the past, which would result in those newly issued shares being dilutive. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. The lender under our existing debt agreement has rights that are senior to your rights as a common stockholder, and if we obtain funds in the future through a credit facility or through the issuance of debt or preferred securities, the lenders of such facility or the holders of such securities would likely also have rights senior to the rights of our common stockholders, which could impair the value of our common stock. +We do not intend to pay dividends for the foreseeable future, so investors must rely on price appreciation to realize a gain on their investment. +In January 2020, we announced the cessation of our quarterly cash dividend to accelerate our investment in BOHA!. We have not declared or paid cash dividends on our capital stock since November 2019 and do not intend to pay any cash dividends in the foreseeable future. We currently intend to retain any future earnings to finance the operation and expansion of our food service technology business, and we do not anticipate declaring or paying any dividends to holders of our common stock in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize future gains on their investments. +16 +We cannot provide any assurance that current laws, or any laws enacted in the future, will not have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements in a variety of jurisdictions, including those which we conduct business. Changes in such laws, rules, regulations, policies or requirements could result in the need to modify our products and could affect the demand for our products, which may have an adverse impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +We take advantage of specified scaled disclosure requirements applicable to a “smaller reporting company” under Regulation S-K, and the information that we provide to stockholders may therefore be different than they might receive from other public companies. If some investors find our shares of common stock less attractive as a result of this scaled disclosure, there may be a less active trading market for our shares of common stock, which may increase the volatility of the market price of our common stock. +We are a “smaller reporting company,” as defined in Item 10(f)(1) of Regulation S-K. As a smaller reporting company, we take advantage of specified scaled disclosure and other requirements that are otherwise applicable generally to public companies. +We intend to continue to take advantage of certain of the scaled disclosure requirements of smaller reporting companies and may continue to do so until we are no longer a smaller reporting company. We will cease to be a smaller reporting company if we have (i) equal or greater than $250 million in market value of our shares held by non-affiliates as of the last business day of our second fiscal quarter and (ii) if the market value of our shares held by non-affiliates does not exceed $700 million as of the last business day of our second fiscal quarter, equal or greater than $100 million of annual revenues in our most recent fiscal year. We choose to take advantage of some but not all of these scaled disclosure requirements; therefore, the information that we provide stockholders may be different than one might get from other public companies. If some investors find our shares of common stock less attractive as a result, there may be a less active trading market for our shares of common stock and the market price of such shares of common stock may be more volatile. +Our Amended and Restated By-Laws designate certain Delaware courts as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or stockholders. +Our Amended and Restated By-Laws (the “By-Laws”) provide that, unless we consent in writing to the selection of an alternative forum, to the fullest extent permitted by law, all Internal Corporate Claims must be brought solely and exclusively in the Court of Chancery of the State of Delaware (or, if such court declines to accept jurisdiction, the Superior Court of the State of Delaware, or, if such other court declines to accept jurisdiction, the United States District Court for the District of Delaware). The By-Laws define “Internal Corporate Claims” to mean claims, including claims in the right of the Company, brought by a current or former stockholder (including a current or former beneficial owner) (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity or (ii) as to which the General Corporation Law of the State of Delaware confers jurisdiction upon the Court of Chancery of the State of Delaware. +This choice of forum provision may increase costs to bring a claim, discourage claims or limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other stockholders, which may discourage such lawsuits against us and our directors, officers and stockholders. Alternatively, if a court were to find this choice of forum provision inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or results of operations. The choice of forum provision in the By-Laws will not preclude or contract the scope of exclusive federal or concurrent jurisdiction for actions brought under the federal securities laws including the Exchange Act or the Securities Act or the respective rules and regulations promulgated thereunder. +17 +Item 1B. Unresolved Staff Comments. +Not applicable. +Item 2. Properties. +Our principal facilities as of December 31, 2022 are listed below. We believe that all facilities generally are in good condition, adequately maintained and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. Ft.) +Owned +or Leased +Lease Expiration +Date +Hamden, Connecticut +Executive offices and sales office +11,100 +Leased +October 31, 2025 +Ithaca, New York +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2025 +Las Vegas, Nevada +Software design and development and casino and gaming sales office +19,600 +Leased +November 30, 2025 +Doncaster, UK +Sales office and service center +6,000 +Leased +August 26, 2026 +Macau, China +Sales office +180 +Leased +June 30, 2023 +110,780 +Item 3. Legal Proceedings. +The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. As of December 31, 2022, we are unaware of any material legal proceedings pending or threatened against us, or any material legal proceedings contemplated by governmental authorities. +Item 4. Mine Safety Disclosures. +Not applicable. +18 +PART II +Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +Our common stock is traded on the Nasdaq Global Market under the symbol TACT. As of February 28, 2023, there were 211 holders of record of the common stock. +Issuer Purchases of Equity Securities +During the fourth quarter of 2022, we did not repurchase any shares of our common stock. +Dividend Policy +The Company does not currently pay cash dividends and does not intend to do so in the foreseeable future. +Sales of Unregistered Securities +None. +Item 6. [Reserved] +Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Overview +During the year ended December 31, 2022, we continued to experience recovery from the negative impacts COVID-19 had on our business during 2021 and 2020. While we have experienced recovery in most of our markets, there are still uncertainties on how any future variants of COVID-19 and global supply chain disruptions may continue to impact our business, operations, supply chain, customers and vendors. During 2022, we continued to focus our efforts on sales execution, operating and engineering adjustments to react to global supply chain disruptions and expansion of our market share. We successfully navigated the supply chain disruptions, and thanks to a significant market share gain in our casino and gaming market, we returned to bottom line profitability in the third and fourth quarters of 2022. +During the year ended December 31, 2022, our total net sales increased 48% to approximately $58.1 million compared to the year ended December 31, 2021. See the table below for a breakdown of our sales by market: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Food service technology (“FST”) +$ +12,364 +21.3 +% +$ +12,625 +32.1 +% +$ +($261 +) +(2.1 +%) +POS automation +10,659 +18.3 +% +4,825 +12.2 +% +$ +5,834 +120.9 +% +Casino and gaming +30,029 +51.7 +% +15,302 +38.9 +% +$ +14,727 +96.2 +% +Printrex +– +– +631 +1.6 +% +$ +(631 +) +(100.0 +%) +TSG +5,087 +8.7 +% +6,003 +15.2 +% +$ +(916 +) +(15.3 +%) +$ +58,139 +100.0 +% +$ +39,386 +100.0 +% +$ +$18,753 +47.6 +% +Sales of our food service technology products remained relatively flat (decreasing 2%) in the year ended December 31, 2022 compared to the year ended December 31, 2021. In the food service technology market, we focus on providing hardware products, which include terminals/WorkStations, temperature probes, temperature sensors and gateways in addition to cloud-based software applications, labels and other recurring revenue items. Food service technology sales decreased in 2022 primarily due to a 30% decrease in FST hardware sales to one of our largest customers. Our total installed base increased by 2,362 terminals and WorkStations during 2022 resulting in a total installed base of 12,180 terminals at the end of 2022. This was partially offset by record sales and an 18% increase in BOHA! recurring revenue. Recurring revenue increased 18% primarily due to higher label sales, as well as record sales of BOHA! software (largely from our labeling software application) recognized on a SaaS subscription basis due principally to the continued growth of the installed base of our BOHA! Terminals and WorkStations. +Sales of our POS automation products increased 121% in the year ended December 31, 2022 compared to the year ended December 31, 2021. In the POS automation market, we focus primarily on supplying printers that print receipts or linerless labels to customers in the restaurant and quick serve markets. During the year ended December 31, 2022, sales of our Ithaca 9000 printer benefitted from market share gain resulting from a competitor’s supply chain issues, as well as a special project for our largest customer. Sales in 2021 were unusually low due to the significant negative impact of the COVID-19 pandemic on the POS automation market. +Sales of our casino and gaming products increased 96% in 2022 compared to 2021. In our casino and gaming market, our focus lies primarily in supplying printers worldwide for use in slot machines at casinos and racetracks, as well as in other electronic gaming devices that print tickets or receipts. Additionally, we supplement these printer sales with revenue from EPICENTRAL which is our promotional printing system that enables casino operators to create promotional coupons and marketing messages and print them in real time at the slot machine. The increase of casino and gaming printers was due to the recovery of the domestic and international casino and gaming market during 2022 as well as our expanding market share, as our largest competitor experienced supply chain issues and casinos continued to reopen compared to 2021 when the market was severely impacted by the COVID-19 pandemic and the related closures of casinos. +19 +Sales of our Printrex branded printers included wide format, rack-mounted and vehicle-mounted thermal printers used by customers to log and plot oil field and down hole well drilling data in the oil and gas exploration industry. There were no Printrex sales in 2022 as we fulfilled last buy orders to legacy customers during the fourth quarter of 2021 and exited this market as of December 31, 2021 to focus towards our higher value, technology-enabled food service technology terminals and casino and gaming products. +TSG, which sells service, replacement parts and consumable products, including receipt paper, ribbons and other printing supplies for our non-FST products, continues to offer a recurring revenue stream from mostly our legacy products. TSG sales decreased 15% in 2022 compared to 2021, primarily due to declining service revenue from a legacy banking customer whose service contract ended during 2022, as well as lower replacement part and consumable product sales. +Operationally, our gross margin rose to 42.0% in 2022, an increase of 290 basis points from 39.1% in 2021, due largely to higher volume of sales overall of our gaming and casino printers which have a higher margin, partially offset by higher material and shipping costs resulting from worldwide supply disruptions. +During 2022, our operating margin improved to (13.2%) compared to (23.8%) in 2021 as the 48% increase in sales helped increase gross margin by 290 basis points, offset by an increase of $7.3 million of operating expenses. Operating expenses increased by 30% as we gradually returned to more normalized pre-COVID-19 spending levels. +We reported a net loss of $5.9 million and a net loss per diluted share of $0.60 for 2022, compared to a net loss of $4.0 million and net loss per diluted share of $0.43 for 2021. In terms of cash flow, for 2022 we used $12.2 million of cash in operating activities. We ended the year with cash and cash equivalents of $7.9 million and we had $2.3 million of outstanding borrowings under the Siena Credit Facility on our Consolidated Balance Sheet at December 31, 2022. +Critical Accounting Estimates +The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make use of estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Operations categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances; however, due to the inherent uncertainties in developing estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods. +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These items utilize assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial Statements for a complete listing of our significant accounting policies. +Revenue Recognition – Application of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, the determination of whether revenues related to our revenue contracts should be recognized over time or at a point in time. Other significant judgments include contracts that contain multiple performance obligations (most commonly when contracts include a hardware product, software, financing and extended warranties) which require a contract’s transaction price to be allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Both of these determinations impact the timing and amount of our reported revenues and net income and loss. +Accounts Receivable – We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on available credit information; and adjustments to credit limits based upon payment history and the customer’s current creditworthiness. We also provide an estimate of doubtful accounts based on historical experience and specific customer collection issues. Our allowance for doubtful accounts as of December 31, 2022 was $351 thousand, or 2.5% of outstanding accounts receivable, which we believe is appropriate considering the overall quality of our accounts receivable. Although credit losses have historically been within expectations and the reserves established, there is no assurance that our credit loss experience will continue to be consistent with historical experience. +Inventories – Our inventories are stated at the lower of average cost or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completion, disposal and transportation, historical usage and estimates of future demand. Assumptions are reviewed at least quarterly and adjustments are made, as necessary, to reflect changing market conditions. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net realizable value. Should circumstances change and we determine that additional inventory is subject to obsolescence, additional write-downs of inventory could result in a charge to income. +Effective April 1, 2022, TransAct changed its method of inventory valuation from standard costing which approximated the “first-in, first-out” (“FIFO”) costing methodology to the average costing methodology. We believe this methodology is preferable because it reflects a better estimate of inventory cost as we do not typically perform intensive manufacturing of our finished products, which are therefore better measured under average cost. In addition, our business is projected to include an increasing sales volume of software going forward, which better aligns with average costing. See Note 16 for further details. +20 +Goodwill and Intangible Assets – We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 “Goodwill,” acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change that indicate it is more likely than not an impairment exists. We perform a fair value-based impairment test to the carrying value of goodwill and indefinite-lived intangible assets on an annual basis and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. The Company utilizes the option to first assess qualitative factors to determine whether it is necessary to perform the Step 1 quantitative goodwill impairment test in accordance with the applicable accounting standards. Under the qualitative assessment, management considers relevant events and circumstances including, but not limited to, macroeconomic conditions, industry and market considerations, Company performance, and events directly affecting the Company. If the Company determines that the Step 1 quantitative impairment test is required, management estimates the fair value of the reporting unit primarily using the income approach, which reflects management’s cash flow projections, and also evaluates the fair value using the market approach. Factors considered that may trigger an interim period impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. +As of December 31, 2022, upon the completion of our annual assessment for impairment, we have determined that no goodwill or intangible asset impairment has occurred and the fair value of the Company was substantially higher than our carrying value. +We have evaluated the recoverability of the assets on our Consolidated Balance Sheet as of December 31, 2022 in accordance with relevant authoritative accounting literature. We have considered the effects caused by the COVID-19 pandemic, the global supply chain disruptions, inflation and macroeconomic factors potentially impacting accounts receivable, inventory, investments, intangible assets, goodwill and other assets and liabilities. Where forward-looking estimates are required, we made a good-faith estimate based on information available as of the balance sheet date. We have continued to monitor for indicators of impairment through the date of this Annual Report on Form 10-K and reflected accordingly in the accompanying consolidated financial statements. +Income Taxes – In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing temporary differences between the tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, which are reflected in our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax reserves with respect to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this forecast against the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. Although we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future deferred tax assets in excess of its net recorded amount, an adjustment to the valuation allowance would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”). Among other things this provision prescribes a minimum recognition threshold that an income tax position must meet before it is recorded in the reporting entity’s financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet reporting date, it is “more likely than not” (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing authority will examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between the amount claimed, or expected to be claimed, on a company’s income tax returns and the benefits recognized in the financial statements. +Share-Based Compensation – We calculate share-based compensation expense in accordance with ASC 718, “Compensation – Stock Compensation” using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, and dividend yield. We account for forfeitures as they occur. +21 +Results of Operations: Year Ended December 31, 2022 Compared to Year Ended December 31, 2021 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2022 and 2021 are detailed in the below table. +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Food service technology +$ +12,364 +21.3 +% +$ +12,625 +32.1 +% +$ +($261 +) +(2.1 +%) +POS automation +10,659 +18.3 +% +4,825 +12.2 +% +$ +5,834 +120.9 +% +Casino and gaming +30,029 +51.7 +% +15,302 +38.9 +% +$ +14,727 +96.2 +% +Printrex +– +– +631 +1.6 +% +$ +(631 +) +(100.0 +%) +TSG +5,087 +8.7 +% +6,003 +15.2 +% +$ +(916 +) +(15.3 +%) +$ +58,139 +100.0 +% +$ +39,386 +100.0 +% +$ +$18,753 +47.6 +% +International* +$ +14,105 +24.3 +% +$ +6,986 +17.7 +% +$ +$7,119 +101.9 +% +* +International sales do not include sales of products to domestic distributors or other customers who in turn ship those products to international destinations. +Net sales for 2022 increased $18.8 million, or 48%, from 2021. Printer, terminal and other hardware sales volume increased by 63% to approximately 134,000 units for 2022, driven by large unit volume increases in all casino and gaming and POS automation, partially offset by unit volume declines in FST and Printrex (the oil and gas market which we exited in 2021). The primary volume increases were an 80% increase in unit volume from the casino and gaming market, as the casino market continued to rebound from the impact of COVID-19 shutdowns and our market share increased due to our efforts to navigate supply chain restraints that prevented certain other suppliers from fully meeting customer demand and, to a lesser extent, a 60% unit volume increase in our POS automation market. We experienced a 32% decrease in hardware unit volume from the FST market, driven by a year-over-year reduction in sales from a large convenience store. The average selling price of our printers, terminals and other hardware increased 4% during 2022 compared to 2021, mainly due to price increases instituted during 2022 in response to product cost increases related to supply chain issues. Additionally, sales of our software, labels and other recurring revenue from our FST market increased $1.3 million, or 18%, during 2022 compared to 2021. International sales for 2022 increased $7.1 million, or 102%, compared to 2022, primarily due to a 141% increase in international casino and gaming sales due to unit volume increases noted above, partially offset by increased materials and shipping costs in the face of global supply chain disruptions. +Food service technology . Our primary offering in the food service technology market is our line of BOHA! products, which can combine our latest generation terminal and workstation which includes one or two printers and our BOHA! Labeling, timers, and media software. In addition, customers may individually purchase cloud-based software applications that connect to a separate application on a separate mobile device into a solution to automate back-of-house operations in restaurants, convenience stores and food service operations. The additional software offering of BOHA! consists of a variety of individually purchased software-as-a-service (“SaaS”)-based applications for both Android and iOS operating systems, including applications for, temperature monitoring, temperature taking and checklists and task lists. These applications are sold separately, and customers purchase the applications they need for their back-of-house operations. Customers may also purchase associated hardware, such as handheld devices, tablets, temperature probes and temperature sensors and gateways. The BOHA! Terminal combines an operating system and hardware components in a device that includes a touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, and nutritional labels for prepared foods, and “enjoy by” date labels. The BOHA! WorkStation uses an iPad or Android tablet instead of an integrated touchscreen. The BOHA! Terminal and the BOHA! WorkStation are equipped with the TransAct Enterprise Management System to ensure that only approved touchscreen functions are available on the touchscreen device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, casual dining, fast casual and quick-service restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service contracts, and technical support services. Sales of our worldwide food service technology products for the years ended December 31, 2022 and 2021 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Domestic +$ +11,602 +93.8 +% +$ +11,738 +93.0 +% +$ +(136 +) +(1.2 +%) +International +762 +6.2 +% +887 +7.0 +% +(125 +) +(14.1 +%) +$ +12,364 +100.0 +% +$ +12,625 +100.0 +% +$ +(261 +) +(2.1 +%) +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Hardware +$ +3,653 +29.5 +% +$ +5,226 +41.4 +% +$ +(1,573 +) +(30.1 +%) +Software, labels and other recurring revenue +8,711 +70.5 +% +7,399 +58.6 +% +1,312 +17.7 +% +$ +12,364 +100.0 +% +$ +12,625 +100.0 +% +$ +(261 +) +2.1 +% +22 +Sales in food service technology decreased 2.1% in 2022 compared to 2021. This was driven by a decrease in sales of hardware, partially offset by an increase in BOHA! software, labels and other recurring revenue. Hardware sales decreased 30% during 2022 compared to 2021 due largely to a reduction in sales to a large retail customer. Recurring revenue increased 18% primarily due to higher label sales, as well as record sales Of BOHA! software (largely from our labeling software application) recognized on a SaaS subscription basis due principally to the continued growth of the installed base of our BOHA! Terminals and WorkStations. +We expect FST revenue to be higher in 2023 than in 2022 as we continue to grow our installed base of paid terminals and the related recurring revenue (primarily the sale of labels and subscription software revenue from our labeling software application). +POS automation . Revenue from the POS automation market includes sales of our Ithaca 9000 thermal printer used primarily by McDonald’s and other quick-service restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print liner-less labels. Sales of our worldwide POS automation products for the years ended December 31, 2022 and 2021 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Domestic +$ +10,657 +100.0 +% +$ +4,817 +99.8 +% +$ +5,840 +121.2 +% +International +2 +– +8 +0.2 +% +(6 +) +(75.0 +%) +$ +10,659 +100.0 +% +$ +4,825 +100.0 +% +$ +5,834 +120.9 +% +The increase in POS automation product revenue during 2022 compared to 2021 was driven by a 121% increase in sales of our Ithaca® 9000 printer, primarily to McDonald’s, as we benefited from market share gains resulting from a competitor’s supply chain issues as well as a special project for McDonald’s that utilized our printer. Sales for 2021 were unusually low due to the significant negative impact from the COVID-19 pandemic on POS automation sales during 2021. Due to the completion of the special project in 2022, we expect POS automation sales to be lower in 2023 compared to 2022. +Casino and gaming . Revenue from the casino and gaming market includes sales of thermal ticket printers used in slot machines, video lottery terminals, and other gaming machines that print tickets or receipts instead of issuing coins at casinos, racetracks and other gaming venues worldwide. Revenue from this market also includes sales of thermal roll-fed printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes, Skills with Prizes and Fixed Odds Betting Terminals and kiosks for sports betting at non-casino gaming and sports betting establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of the EPICENTRAL print system, our software solution (including annual software maintenance), that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. Sales of our worldwide casino and gaming products for the years ended December 31, 2022 and 2021 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Domestic +$ +17,686 +58.9 +% +$ +10,173 +66.5 +% +$ +7,513 +73.9 +% +International +12,343 +41.1 +% +5,129 +33.5 +% +7,214 +140.7 +% +$ +30,029 +100.0 +% +$ +15,302 +100.0 +% +$ +14,727 +96.2 +% +The increase in domestic sales of our casino and gaming products during 2022 compared to 2021 was primarily due to a 74% increase in domestic sales of our thermal casino printers, as our business experienced a strong recovery from the COVID-19 pandemic during 2022 compared to 2021 and we increased our overall market share due largely to our largest competitor’s inability to supply product due to supply chain issues. The overall increase in casino and gaming domestic sales was also driven by a 410% increase in domestic EPICENTRAL sales during 2022 as we completed several EPICENTRAL installations/expansions during 2022. EPICENTRAL sales are project based, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year. +International sales of our casino and gaming products increased during 2022 compared to 2021, primarily due to a 155% increase in sales of our thermal casino printers. Similar to the domestic market, we experienced significant recovery during 2022 from the COVID-19 pandemic in the international gaming markets and increased our market share due largely to our competitor’s inability to supply product due to supply chain issues. The substantial increase in international gaming sales was predominantly driven by the European and Australian markets while the Asian market still remained negatively impacted from the COVID-19 pandemic. +We expect both domestic and international sales of our casino printers to continue to be strong and higher in 2023 as compared to 2022 as we work to fulfil our large backlog of orders and continue to capitalize on our increasing market share in the industry. +23 +Printrex: Printrex branded printers were sold into markets that include wide format, desktop and rack-mounted and vehicle-mounted black/white thermal printers used by customers to log and plot oil field, seismic and down hole well drilling data in the oil and gas exploration industry. Sales of our worldwide Printrex printers for the years ended December 31, 2022 and 2021 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Domestic +$ +– +0.0 +% +$ +171 +27.1 +% +$ +(171 +) +100.0 +% +International +– +0.0 +% +460 +72.9 +% +(460 +) +100.0 +% +$ +– +0.0 +% +$ +631 +100.0 +% +$ +(631 +) +100.0 +% +We made a strategic decision to exit the Printrex market as of December 31, 2021 and have had no sales, and expect to have no future sales in this market beyond 2021. +TSG: Revenue generated by TSG includes sales of consumable products (POS receipt paper, inkjet cartridges, ribbons and other printing supplies for non-FST legacy products), replacement parts and accessories, maintenance and repair services, refurbished printers, and shipping and handling charges. Sales in our worldwide TSG market for the years ended December 31, 2022 and 2021 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2022 +December 31, 2021 +$ Change +% Change +Domestic +$ +4,089 +80.4 +% +$ +5,501 +91.6 +% +$ +(1,412 +) +(25.7 +%) +International +998 +19.6 +% +502 +8.4 +% +496 +98.8 +% +$ +5,087 +100.0 +% +$ +6,003 +100.0 +% +$ +(916 +) +(15.3 +%) +The decrease in domestic revenue from TSG during 2022 as compared to 2021 on significantly lower legacy lottery printer part sales was due primarily to lower sales of replacement parts. Replacement part sales decreased 34%. Service revenue and consumable sales also declined 8% and 19%, respectively. +Internationally, TSG revenue increased during 2022 compared to 2021, due primarily to a 136% increase in sales of replacement parts and accessories to international casino and gaming customers. +We expect TSG sales for 2023 to be higher than 2022. +Gross Profit. Gross profit information for the years ended December 31, 2022 and 2021 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2022 +2021 +Change +Total Sales - 2022 +Total Sales - 2021 +$ +24,412 +$ +15,382 +58.7 +% +42.0 +% +39.1 +% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, direct labor, manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers, expenses associated with installations and support of our EPICENTRAL print system and our line of BOHA! products and royalty payments to third-parties, including to the third party licensor of our food service technology software products. Gross profit increased $9.0 million, or 59%, in 2022 compared to 2021, primarily due to the 48% sales increase in 2022 compared to 2021. Gross margin increased to 42.0% in 2022 compared to 39.1% in 2021 due largely to a favorable change in product sales mix and the effect from two rounds of price increases we instituted during 2022 to mitigate higher product and shipping costs related to the worldwide supply chain disruptions. +Operating Expenses - Engineering, Design and Product Development. Engineering, design and product development information for the years ended December 31, 2022 and 2021 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2022 +2021 +Change +Total Sales - 2022 +Total Sales - 2021 +$ +8,570 +$ +7,475 +14.6 +% +14.7 +% +19.0 +% +Engineering, design and product development expenses primarily include salary and payroll-related expenses for our hardware and software engineering staff, depreciation and design expenses (including prototype printer expenses, outside design, development and testing services, supplies and contract software development expenses including those to the third party licensor of our food service technology software products). Engineering, design and product development expenses increased $1.1 million, or 15%, in 2022 compared to 2021 resulting from an increase in expenses related to reconfiguring unavailable parts and qualifying new parts, as well as a gradual return to more normalized pre-COVID-19 spending levels and from the full effect (in 2022) of hiring additional software developers in late 2021 to continue development of our food service technology products. +24 +Operating Expenses - Selling and Marketing . Selling and marketing information for the years ended December 31, 2022 and 2021 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2022 +2021 +Change +Total Sales - 2022 +Total Sales - 2021 +$ +11,326 +$ +7,658 +47.9 +% +19.5 +% +19.4 +% +Selling and marketing expenses primarily include salaries and payroll-related expenses for our sales, marketing and customer success staff, sales commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, public relations, e-commerce and other promotional marketing expenses. Selling and marketing expenses increased $3.7 million, or 48%, during 2022 compared to 2021 primarily due to higher trade show expenses, expanded marketing expenses as we returned to more normalized pre-COVID-19 levels of sales and marketing expense during 2022 compared to lower costs during 2021 due to cost saving measures implemented during 2020 that carried into 2021, payroll expenses for the expanded sales and marketing staff and increased commissions on higher sales in the casino and gaming market. +Operating Expenses - General and Administrative. General and administrative information for the years ended December 31, 2022 and 2021 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2022 +2021 +Change +Total Sales - 2022 +Total Sales - 2021 +$ +12,193 +$ +9,626 +26.7 +% +21.0 +% +24.4 +% +General and administrative expenses primarily include salaries, incentive compensation, and other payroll-related expenses for our executive, accounting, human resources, business development and information technology staff, expenses for our corporate headquarters, professional and legal expenses, information technology expenses, and other expenses related to being a publicly traded company. General and administrative expenses increased $2.6 million, or 27%, during 2022 compared to 2021 due to higher recruiting fees and employee compensation, as well as higher consulting fees and depreciation related to the implementation of a new ERP system that we completed in early 2022. Legal fees also increased year-over-year related to a shareholder matter that was resolved on March 30, 2022 when we entered into a Cooperation Agreement with two shareholders. +Operating Loss. Operating loss information for the years ended December 31, 2022 and 2021 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2022 +2021 +Change +Total Sales – 2022 +Total Sales – 2021 +$ +(7,677 +) +$ +(9,377 +) +(18.1 +%) +(13.2 +%) +(23.8 +%) +Our operating loss decreased $1.7 million, or 18%, during 2022 compared to 2021 as a $9.0 million, or 59% increase in gross profit on 48% higher sales was largely offset by a $7.3 million or 30% increase in operating expenses during 2022 compared to 2021.. +Interest, net. We recorded net interest expense of $208 thousand in 2022 compared to $96 thousand in 2021. The increase in net interest expense was primarily due to lower interest income earned from the note receivable to a third party software developer that was collected in March 2021. Interest expense also increased during 2022 and we expect will continue to increase during 2023 due to required minimum borrowings pursuant to the terms of the July 2022 Siena Credit Facility Amendment No. 2 along with expected interest rate increases in the broader financial markets. +Other, net . We recorded other expense of $16 thousand in 2022 compared to other expense of $283 thousand in 2021 primarily due to higher foreign exchange losses recorded by our UK subsidiary during 2021. Going forward, we may continue to experience more foreign exchange gains or losses depending on the level of sales to European customers through our UK subsidiary and the fluctuation in exchange rates of the Euro and Pound Sterling against the U.S. Dollar, which may be impacted by volatility in global economic conditions and political instability such as the Russia-Ukraine conflict. +Gain from Employee Retention Credit. We recorded a $1.5 million gain during 2021 resulting from the recognition of the employee retention credit pursuant to the CARES Act upon meeting the conditions required to claim the credit. +Gain on Forgiveness of Long-Term Debt. We recorded a $2.2 million gain in 2021 resulting from the forgiveness of the PPP Loan in July 2021. +Income Taxes . We recorded an income tax benefit during 2022 of $2.0 million at an effective tax rate of 24.9%, compared to an income tax benefit during 2021 of $2.0 million at an effective tax rate of 33.6%. The tax benefit recorded for 2021 was higher as it included the recognition of the gain on the forgiveness of the PPP Loan which was not taxable. +Net Loss. We reported a net loss for the year ended December 31, 2022 of $5.9 million, or $0.60 per basic and diluted share, compared to a net loss of $4.0 million, or $0.43 per basic and diluted share, in 2021. +25 +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors affecting the management of liquidity are cash flows from operating activities, capital expenditures, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to access credit lines at market-competitive rates, if needed, are expected to be sufficient to fund operations, capital expenditures, and any increase in working capital that would be required to accommodate a higher level of business activity for the 2023 fiscal year and beyond. +Cash Flow +During 2022, our cash balance decreased $11.5 million (versus an increase of $9.1 million in 2021) due primarily to operating activities, including an increase in inventories of $4.4 million to support the growing demand of our products and an increase of $6.4 million in receivables, reflecting stronger sales in 2022. We had $7.9 million in cash and cash equivalents as of December 31, 2022, of which $219 thousand was held by our UK subsidiary. +Operating activities : The following significant factors primarily affected our cash used in operating activities of $12.2 million in 2022 as compared to cash used in operating activities of $2.5 million in 2021. +During 2022: +● +We reported a net loss of $5.9 million. +● We recorded depreciation and amortization of $1.3 million and share-based compensation expense of $1.2 million. +● We recorded an increase in our deferred tax assets of $2.2 million due to our net loss in 2022. +● +Accounts receivable increased $6.4 million primarily due to increased sales volume during the fourth quarter of 2022. +● Inventories increased $4.4 million primarily due to strategic purchases of electronic and other parts to support our sales growth. +● Accounts payable provided $3.2 million in cash due to increased inventory purchases and the timing of cash disbursements. +During 2021: +● +We reported a net loss of $4.0 million. +● +We recorded depreciation and amortization of $1.0 million and share-based compensation expense of $1.2 million. +● +We recorded a gain of $2.2 million from the forgiveness of the PPP loan. +● +Accounts receivable increased $4.2 million, or 125%, primarily due to increased sales volume during the fourth quarter of 2021. +● +We recorded a receivable of $1.5 million for the employee retention credit. +● +Inventories decreased $3.4 million primarily due to the utilization of inventory on hand to fulfill sales and significantly reduced inventory purchases resulting from the supply chain disruptions caused by the COVID-19 pandemic. +● +Prepaid income taxes decreased $2.2 million due to receiving an income tax refund in 2021 related to the net operating loss reported for 2020 that was carried back to prior years as permitted by the CARES Act. +● +Accounts payable increased $2.5 million, or 150%, d ue to inventory purchases made towards the end of the fourth quarter of 2021 to support expected 2022 sales . +● +Accrued liabilities and other liabilities increased $0.6 million, or 7%, due primarily to increased deferred revenue. +Investing activities : Our capital expenditures were $1.3 million and $1.4 million in 2022 and 2021, respectively. Expenditures in both 2022 and 2021 were primarily related to the implementation of a new ERP system which was completed in early 2022, new product tooling and computer and networking equipment. Investing activities also provided $1.6 million in 2021 upon the collection of the remaining $1.6 million note receivable balance during the first quarter of 2021 from an unaffiliated third party software developer from whom we license our food service technology software. +Financing activities: Financing activities provided $2.1 million of cash during 2022 due primarily to required minimum borrowing on our Siena Credit Facility. During 2021, financing activities provided $11.5 million of cash primarily from the completion of an underwritten public offering which raised net proceeds of $11.2 million, after deducting u nderwriting discounts, commissions and offering expenses and, to a lesser extent, proceeds of $0.4 million from stock option exercises. +Resource Sufficiency +Since early 2020, the COVID-19 pandemic has continued to cause uncertainty and disruption in the global economy and financial markets. We have also been impacted by global supply chain issues, increased shipping costs and inflationary pressures. Given the unprecedented uncertainty related to the impact of these external factors on the food service and casino industries, the Company continues to monitor its cash generation, usage and preservation including the management of working capital to generate cash. +We believe that our cash and cash equivalents on hand, our expected cash flows generated from operating activities, and borrowings available under our Siena Credit Facility will provide sufficient resources to meet our working capital needs, finance our capital expenditures and meet our liquidity requirements through at least the next twelve months. Notwithstanding this belief, the duration and extent of these global economic pressures and the future of pandemic variants remain uncertain and the ultimate impact of these global pressures is unknown. +26 +Credit Facility and Borrowings +On March 13, 2020, we entered into the Loan and Security Agreement (the “Siena Credit Facility”) with Siena Lending Group LLC (the “Lender”) and terminated our credit facility with TD Bank N.A. The Siena Credit Facility provides for a revolving credit line of up to $10.0 million and was originally scheduled to expire on March 13, 2023. Borrowings under the Siena Credit Facility bear a floating rate of interest equal to the greatest of (i) the prime rate plus 1.75%, (ii) the federal funds rate plus 2.25%, and (iii) 6.50%. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility were $245 thousand. We also pay a fee of 0.50% on unused borrowings under the Siena Credit Facility. Borrowings under the Siena Credit Facility are secured by a lien on substantially all the assets of the Company. Borrowings under the Siena Credit Facility are subject to a borrowing base based on (i) 85% of eligible accounts receivable plus the lesser of (a) $5.0 million and (b) 50% of eligible raw material and 60% of finished goods inventory. +The Siena Credit Facility imposes a financial covenant on the Company and restricts, among other things, our ability to incur additional indebtedness and the creation of other liens. The three-month period from April 1, 2020 to June 30, 2020 was the first period we were subject to the original financial covenant, which required the Company to maintain a minimum EBITDA and continued through the 12-month period from April 1, 2020 to March 31, 2021. On July 21, 2021, the Company entered into an amendment (“Siena Credit Facility Amendment No. 1”) to the Siena Credit Facility. Siena Credit Facility Amendment No. 1 changed the financial covenant under the Siena Credit Facility from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at least $750 thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning with the calendar month ended July 31, 2021. From July 31, 2021 through December 31, 2022, we have been in compliance with our excess availability covenant. As of December 31, 2022, we had $2.3 million in outstanding borrowings under the Siena Credit Facility and $3.9 million of net available borrowing capacity under the Siena Credit Facility. +On July 19, 2022, the Company and the Lender entered into Amendment No. 2 (“Siena Credit Facility Amendment No. 2”) to the Siena Credit Facility as amended by Siena Credit Facility Amendment No. 1. Also on July 19, 2022, the Company and the Lender entered into an Amended and Restated Fee Letter (the “Amended Fee Letter”) in connection with Siena Credit Facility Amendment No. 2. Siena Credit Facility Amendment No. 2 did not modify the aggregate amount of the revolving commitment or the interest rate applicable to the loans. +The changes to Siena Credit Facility provided for in Siena Credit Facility Amendment No. 2 included, among other things, the following: +(i) +The extension of the maturity date from March 13, 2023 to March 13, 2025; and +(ii) +The termination of the existing blocked account control agreement and entry into a new “springing” deposit account control agreement, permitting the Company to direct the use of funds in its deposit account until such time as (a) the sum of excess availability under the Siena Credit Facility and unrestricted cash is less than $5 million for 3 consecutive business days or (b) an event of default occurs and is continuing. +In addition, the Amended Fee Letter requires the Company, while it retains the ability to direct the use of funds in the deposit account, to maintain outstanding borrowings of at least $2,250,000 in principal amount. If the Company does not have the ability to direct the use of funds in the deposit account, then the Amended Fee Letter requires the Company to pay interest on at least $2,250,000 principal amount of loans, whether or not such amount of loans is actually outstanding. +On May 1, 2020 (the “Loan Date”), the Company was granted the PPP Loan from Berkshire Bank in the aggregate amount of $2.2 million, pursuant to the PPP which is administered by the SBA and was established under Division A, Title I of the CARES Act, enacted March 27, 2020. Under the terms of the PPP, the PPP Loan would be forgiven to the extent that funds from the PPP Loan were used for payroll costs and costs to continue group health care benefits, as well as for interest on mortgage obligations incurred before February 15, 2020, rent payments under lease agreements in effect before February15, 2020, utilities for which service began before February 15, 2020 and interest on debt obligations incurred before February 15, 2020, subject to conditions and limitations provided in the CARES Act. At least 60% (under the PPP terms, as amended) of the proceeds of the PPP Loan needed to have been used for eligible payroll costs for the PPP Loan to be forgiven. +On July 8, 2021, the Company received notifications from Berkshire Bank and the SBA that its PPP Loan (including all interest accrued thereon) of $2.2 million had been fully forgiven by the SBA and that the forgiveness payment date was July 1, 2021. The forgiveness of the PPP Loan was reported as “Gain on forgiveness of long-term debt” in the Consolidated Statement of Operations during the year ended December 31, 2021. +Stock Repurchase Program +During 2022 and 2021, we did not repurchase any shares of our common stock. +Shareholders’ Equity +Shareholders’ equity decreased $5.1 million, or 13%, to $33.9 million at December 31, 2022 from $39.0 million at December 31, 2021. The decrease was primarily due to the net loss of $5.9 million in 2022. This was partially offset by share-based compensation expense related to stock awards of $1.0 million (net of withholding taxes paid by relinquishment of shares) in 2022. +Item 7A. Quantitative and Qualitative Disclosures about Market Risk. +TransAct is a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, and is not required to provide information under this item. +27 +Item 8. Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this Form 10-K as pages F-4 through F-22. The “Report of Independent Registered Public Accounting Firm” is annexed to this Form 10-K as of page F-2. An index to such materials appears on page F-1. +Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +Not applicable. +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of December 31, 2022. Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles, and that they can be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2022. Our management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). In the opinion of management, TransAct maintained effective internal control over financial reporting as of December 31, 2022. +Changes in Internal Control over Financial Reporting +No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended December 31, 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. Other Information. +Not applicable. +Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspection. +Not applicable. +28 +PART III +Item 10. Directors, Executive Officers and Corporate Governance. +Set forth in Item 1 of this Form 10-K under the heading “Information about our Executive Officers” is certain information regarding our executive officers, and information regarding our code of ethics is set forth below. The remaining information in response to this item is incorporated herein by reference to the disclosure that will be contained, as applicable, under the headings, “Delinquent Section 16(a) Reports,” “Corporate Governance,” “Proposal 1: Election of Directors,” “Audit Committee Report,” “Executive Compensation – Compensation Committee Report,” and “Procedures for Submitting Director Nominations and Recommendations” in our Proxy Statement for our 2023 Annual Meeting of Stockholders (the “Proxy Statement”), which will be filed within 120 days after the end of the year covered by this Form 10-K. +Code of Ethics +We maintain a Standards of Business Conduct and Code of Ethics (“Standards of Business Conduct”) that includes our code of ethics that is applicable to all employees, including our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Controller. Our Standards of Business Conduct, which require continued observance of high ethical standards, such as honesty, integrity and compliance with the law in the conduct of our business, are available for public access on our Internet website at https://transacttech.gcs-web.com/corporate-governance. Any person may request a copy of our Standards of Business Conduct free of charge by calling (203) 859-6800. We will disclose on our website at https://transacttech.gcs-web.com/corporate-governance any amendment to or waiver of a provision of the Standards of Business Conduct as may be required and within the time period specified under the applicable Securities and Exchange Commission and Nasdaq rules. +Item 11. Executive Compensation. +The information in response to this item will be contained in the Proxy Statement under the heading “Executive Compensation,” and is incorporated herein by reference. +Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item will be contained in the Proxy Statement under the heading, “Security Ownership of Certain Beneficial Owners and Management,” and is incorporated herein by reference. +Equity Compensation Plan Information +Information regarding our equity compensation plans as of December 31, 2022 is as follows: +Plan category +(a) +Number of securities +to be issued upon +exercise of outstanding +options, warrants and rights +(b) +Weighted-average +exercise price +of outstanding +options, warrants and rights +(c) +Number of securities +remaining available for future +issuance under equity compensation plans +(excluding securities reflected in column (a)) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +156,000 +$ +10.09 +– +2014 Equity Incentive Plan +1,414,241 +7.60 +347,652 +Total +1,570,241 +$ +7.84 +347,652 +In May 2014, our stockholders approved the adoption of the 2014 Equity Incentive Plan. In May 2020, our stockholders approved an amendment to the 2014 Equity Incentive Plan to increase the number of shares of common stock which may be subject to awards granted under the plan from 1,400,000 to its current level of 2,200,000. The Company also maintains the 2005 Equity Incentive Plan; however no new awards will be available for future issuance under this plan. Both plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. The Company does not have any equity plans that have not been approved by its stockholders. +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related Transactions” and “Corporate Governance-Board Leadership Structure and Independence” and is incorporated herein by reference. +Item 14. Principal Accounting Fees and Services. +The information in response to this item will be contained in the Proxy Statement under the headings, “Policy Regarding Pre-Approval of Services Provided by the Independent Registered Public Accounting Firm” and “Independent Registered Public Accounting Firm’s Services and Fees” and is incorporated herein by reference. +29 +PART IV +Item 15. Exhibits and Financial Statement Schedules. +(a) +The following documents are filed as part of this Form 10-K: +1. +Financial Statements. +Report of Independent Registered Public Accounting Firm +Consolidated Balance Sheets as of December 31, 2022 and 2021 +Consolidated Statements of Operations for the years ended December 31, 2022 and 2021 +Consolidated Statements of Comprehensive Loss for the years ended December 31, 2022 and 2021 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2022 and 2021 +Consolidated Statements of Cash Flows for the years ended December 31, 2022 and 2021 +Notes to Consolidated Financial Statements +2. +Schedules. +All schedules are omitted because they are either inapplicable or not required, or because the information required therein is included in the Consolidated Financial Statements and Notes thereto. +3. +Exhibits +Exhibit Index +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated (conformed copy) (incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 18, 2022). +3.1(b) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December 2, 1997 (incorporated by reference to Exhibit C of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on February 18, 1999). +3.1(c) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000 (incorporated by reference to Exhibit 3.1(c) of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 8, 2000). +3.2 * +Amended and Restated By-Laws of TransAct Technologies Incorporated. +4.1 +Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-1/A (No. 333-06895) filed with the SEC on August 1, 1996). +4.2 +Description of Securities (incorporated by reference to Exhibit 4.2 of the Company’s Annual Report on Form 10-K (SEC File No. +000-21121) filed with the SEC on March 16, 2020). +10.1 (x) +2005 Equity Incentive Plan (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on June 1, 2005). +10.2 (x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan, as Amended and Restated (incorporated by reference to Exhibit I to the Definitive Proxy Statement on Schedule 14A filed with the Commission on April 23, 2020, File No. 000-21121). +10.3 (x) +2014 Equity Incentive Plan Time-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 6, 2016). +10.4 (x) +2014 Equity Incentive Plan Performance-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-211121) filed with the SEC on August 8, 2016). +10.5 (x) +2014 Equity Incentive Plan Non-statutory Stock Option Agreement (incorporated by reference to Exhibit 10.2 of the Company’s current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on May 19, 2014). +10.6 (x) +Employment Agreement, dated July 31, 1996, by and between TransAct and Bart C. Shuldman (incorporated by reference to Exhibit 10.20 of the Company’s Registration Statement on Form S-1/A (No. 333-06895) filed with the SEC on August 1, 1996). +10.7 (x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004 (incorporated by reference to Exhibit 10.8 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2005). +10.8 (x) +Amendment to Employment Agreement, effective January 1, 2008, by and between TransAct and Bart C. Shuldman (incorporated by reference to Exhibit 10.10 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2009). +10.9 (x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008 (incorporated by reference to Exhibit 10.12 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2009). +10.10 (x) +Severance Agreement by and between TransAct and Andrew J. Hoffman (as amended), effective December 23, 2008 (incorporated by reference to Exhibit 10.10 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 24, 2022). +10.11 (x) +Second Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective April 29, 2021 (incorporated by reference to Exhibit 10.11 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 24, 2022). +10.12(x) +Amended and Restated Employment Agreement, dated as of December 14, 2022, by and between TransAct Technologies Incorporated and Bart C. Shuldman (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on December 27, 2022). +30 +10.13 +Lease Agreement by and between Bomax Properties and Ithaca, dated as of March 23, 1992 (incorporated by reference to Exhibit 10.14 of the Company’s Registration Statement on Form S-1 (No. 333-06895) filed with the SEC on June 26, 1996). +10.14 +Second Amendment to Lease Agreement by and between Bomax Properties and Ithaca, dated December 2, 1996 ( incorporated by reference to Exhibit 10.27 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 31, 1998). +10.15 +Agreement regarding the Continuation and Renewal of Lease by and between Bomax Properties, LLC and TransAct, dated July 18, 2001 (incorporated by reference to Exhibit 10.8 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 29, 2002). +10.16 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct (incorporated by reference to Exhibit 10.16 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 10, 2012). +10.17 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016 (incorporated by reference to Exhibit 10.13 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 11, 2016). +10.18 +Amendment No. 3 to Lease Agreement between Bomax Properties, LLC and TransAct, dated February 28, 2020 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on March 4, 2020). +10.19 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004 (incorporated by reference to Exhibit 10.13 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2005). +10.20 +First Amendment to Lease Agreement by and between CIP Hughes Center LLC and TransAct dated August 24, 2009 (incorporated by reference to Exhibit 10.19 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2010). +10.21 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, 2015 (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 7, 2015). +10.22 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006 (incorporated by reference to Exhibit 10.14 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 15, 2007). +10.23 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 3, 2017 (incorporated by reference to Exhibit 10.20 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2017). +10.24 +Second Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct Technologies dated April 30, 2021 (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 13, 2021). +10.25 +Loan and Security Agreement, dated as of March 13, 2020, among Siena Lending Group LLC, TransAct Technologies Incorporated and the other Loan Parties from time to time party thereto (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 22, 2020). +10.26 +Amendment No. 1 To Loan and Security Agreement, dated as of July 21, 2021, among Siena Lending Group and TransAct Technologies Incorporated (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 26, 2021) +10.27 +Amendment No. 2 To Loan and Security Agreement, dated as of July 19, 2022, between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 25, 2022). +10.28 +Amended and Restated Fee Letter, dated as of July 19, 2022, between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 25, 2022). +10.29 † +Master License Agreement dated February 22, 2019 and amendments thereto (incorporated by reference to Exhibit 10.24 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021). +10.30 † +Master Development and License Agreement dated July 20, 2018 (incorporated by reference to Exhibit 10.25 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021). +31 +10.31 +Cooperation Agreement, dated as of March 30, 2022, by and among TransAct Technologies Incorporated, 325 Capital Master Fund LP and Harbert Discovery Fund, L.P. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on March 31, 2022). +21 +Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021) +23.1 * +Consent of Marcum LLP +31.1 * +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 * +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +32 ‡ +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +101.INS +Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document). +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +(x) +Management contract or compensatory plan or arrangement. +* +These exhibits are filed herewith. +† +Certain portions of this exhibit (indicated by “[***]”) have been omitted pursuant to Item (601)(b)(10) of Regulation S-K. +‡ +These exhibits are furnished herewith. +(b) +Exhibits. +The Exhibits required by Item 601 of Regulation S-K under the Exchange Act are included in the Exhibit Index above under a(3) of this Item 15. +(c) +Financial Statement Schedules. +See the Notes to the Consolidated Financial Statements included in this Form 10-K. +Item 16. Form 10-K Summary. +Not applicable. +32 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ Bart C. Shuldman +Name: +Bart C. Shuldman +Title: +Chief Executive Officer +Date: March 27, 2023 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ Bart C. Shuldman +Chief Executive Officer and Director +March 27, 2023 +Bart C. Shuldman +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, Treasurer and Secretary +March 27, 2023 +Steven A. DeMartino +(Principal Financial Officer) +/s/ William J. DeFrances +Vice President and Chief Accounting Officer +March 27, 2023 +William J. DeFrances +(Principal Accounting Officer) +/s/ Haydee Ortiz Olinger +Chair of the Board +March 27, 2023 +Haydee Ortiz Olinger +/s/ John M. Dillon +Director +March 27, 2023 +John M. Dillon +/s/ Audrey P. Dunning +Director +March 27, 2023 +Audrey P. Dunning +/s/ Daniel M. Friedberg +Director +March 27, 2023 +Daniel M. Friedberg +/s/ Randall S. Friedman +Director +March 27, 2023 +Randall S. Friedman +/ s/ Emanuel P. N. Hilario +Director +March 27, 2023 +Emanuel P.N. Hilario +33 +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 688 ) +F-2 +Consolidated Balance Sheets as of December 31, 2022 and 2021 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2022 and 2021 +F-5 +Consolidated Statements of Comprehensive Loss for the years ended December 31, 2022 and 2021 +F-6 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2022 and 2021 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2022 and 2021 +F-8 +Notes to Consolidated Financial Statements +F-9 +F-1 +Report of Independent Registered Publi c Accounting Firm +To the Shareholders and Board of Directors of +TransAct Technologies Incorporated +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of TransAct Technologies Incorporated (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of operations, comprehensive loss, changes in shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America. +Explanatory Paragraph – Change in Accounting Principle +As described in Note 16 to the consolidated financial statements, effective April 1, 2022, the Company changed its method of inventory valuation from standard cost (which approximated actual cost on a “first-in, first-out” basis) to the average cost method of inventory accounting. Comparative financial statements of prior periods have been adjusted to apply the new method retrospectively. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +F-2 +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Valuation of Inventories - Change in Accounting Principle +As described in Note 16 to the consolidated financial statements, effective April 1, 2022, the Company changed its method of inventory valuation from standard costing (which approximated the “first-in, first-out” costing methodology) to the average costing methodology, and comparative financial statements of prior periods were adjusted to apply the new method retrospectively. Management determined that this change in accounting principle was preferable because it reflects a better estimate of inventory cost. At December 31, 2022, the Company’s inventory balance was approximately $12.0 million. As discussed in Note 2 to the consolidated financial statements, inventories are stated at the lower of average cost or net realizable value. +The principal considerations for our determination that the Company’s change in accounting principle related to inventory valuation was a critical audit matter included the following: (1) management identifies inventories as a critical accounting estimate, and this change in accounting principle was considered to be a significant transaction during the year; (2) there were significant judgments made by management with respect to the change, including the explanation of why the change in accounting principle was preferable and the estimation of the retrospective adjustment to apply the new method of inventory valuation; and (3) management’s calculation to estimate the adjustment was intricate, due to the complexities of the manual calculations involved and the magnitude of transactions flowing through the analysis. This complexity led to a high degree of auditor effort in performing our audit procedures, which were designed to evaluate the reasonableness of management’s calculation and application of the retrospective inventory valuation adjustment. +Addressing the critical audit matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included, among others, (i) obtaining an understanding of why the Company changed its accounting principle to the average costing methodology; (ii) evaluating management’s methodology and process for estimating the retrospective average costing adjustment; (iii) testing management’s calculation of the retrospective adjustment, which included evaluating the completeness and accuracy of management’s input data used in the manual calculation, principally inputs such as historical purchases and sales transactions; (iv) and evaluating the reasonableness of significant judgments used by management, principally management’s determination that one year of historical costing data was sufficient to adjust the opening balance for the retrospective adjustment. +/s/ Marcum LLP +We have served as the Company’s auditor since 2020. +Hartford, Connecticut +March 27, 2023 +F-3 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(As adjusted, in thousands, except share data) +December 31, +2022 +December 31, +2021 +Assets: +Current assets: +Cash and cash equivalents +$ +7,946 +$ +19,457 +Accounts receivable, net +13,927 +7,593 +Employee retention credit receivable +1,500 +1,500 +Inventories +12,028 +7,711 +Prepaid income taxes +– +137 +Other current assets +724 +738 +Total current assets +36,125 +37,136 +Fixed assets, net +2,781 +2,684 +Right-of-use asset +2,488 +2,553 +Goodwill +2,621 +2,621 +Deferred tax assets +7,327 +5,143 +Intangible assets, net +242 +397 +Other assets +248 +400 +15,707 +13,798 +Total assets +$ +51,832 +$ +50,934 +Liabilities and Shareholders’ Equity: +Current liabilities: +Current portion of revolving loan payable +$ +2,250 +$ +– +Accounts payable +7,395 +4,308 +Accrued liabilities +4,077 +3,894 +Lease liability +875 +789 +Deferred revenue +1,329 +805 +Total current liabilities +15,926 +9,796 +Deferred revenue, net of current portion +143 +186 +Lease liability, net of current portion +1,683 +1,781 +Other liabilities +218 +187 +2,044 +2,154 +Total liabilities +17,970 +11,950 +Commitments and contingencies (see Notes 9 and 14) +Shareholders’ equity: +Preferred stock, $ 0.01 value, 4,800,000 authorized, none issued and outstanding +– +– +Preferred stock, Series A, $ 0.01 par value, 200,000 authorized, none issued and outstanding +– +– +Common stock, $ 0.01 par value, 20,000,000 authorized at December 31, 2022 and 2021 ; 13,956,725 and 13,917,731 shares issued; 9,911,883 and 9,872,889 shares outstanding, at December 31, 2022 and 2021 , respectively +139 +139 +Additional paid-in capital +56,282 +55,246 +Retained earnings +9,630 +15,566 +Accumulated other comprehensive (loss) income, net of tax +( 79 +) +143 +Treasury stock, 4,044,842 shares, at cost +( 32,110 +) +( 32,110 +) +Total shareholders’ equity +33,862 +38,984 +Total liabilities and shareholders’ equity +$ +51,832 +$ +50,934 +See accompanying notes to Consolidated Financial Statements. +F-4 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF OPERATIONS +(As adjusted, in thousands, except per share data) +Years Ended December 31, +2022 +2021 +Net sales +$ +58,139 +$ +39,386 +Cost of sales +33,727 +24,004 +Gross profit +24,412 +15,382 +Operating expenses: +Engineering, design and product development +8,570 +7,475 +Selling and marketing +11,326 +7,658 +General and administrative +12,193 +9,626 +32,089 +24,759 +Operating loss +( 7,677 +) +( 9,377 +) +Interest and other income (expense): +Interest expense +( 208 +) +( 157 +) +Interest income +– +61 +Other, net +( 16 +) +( 283 +) +Gain from employee retention credit +– +1,500 +Gain on forgiveness of long-term debt +– +2,173 +( 224 +) +3,294 +Loss before income taxes +( 7,901 +) +( 6,083 +) +Income tax benefit +1,965 +2,042 +Net loss +$ +( 5,936 +) +$ +( 4,041 +) +Net loss per common share: +Basic +$ +( 0.60 +) +$ +( 0.43 +) +Diluted +$ +( 0.60 +) +$ +( 0.43 +) +Shares used in per-share calculation: +Basic +9,905 +9,298 +Diluted +9,905 +9,298 +See accompanying notes to Consolidated Financial Statements. +F-5 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS +(As adjusted, in thousands) +Years Ended December 31, +2022 +2021 +Net loss +$ +( 5,936 +) +$ +( 4,041 +) +Foreign currency translation adjustment, net of tax +( 222 +) +181 +Comprehensive loss +$ +( 6,158 +) +$ +( 3,860 +) +See accompanying notes to Consolidated Financial Statements. +F-6 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY +(As adjusted, in thousands, except share data) +Common Stock +Additional +Paid-in +Retained +Treasury +Accumulated +Other +Comprehensive +Total +Shares +Amount +Capital +Earnings +Stock +(Loss) Income +Equity +Balance, January 1, 2021 +8,931,385 +$ +130 +$ +42,536 +$ +19,607 +$ +( 32,110 +) +$ +( 38 +) +$ +30,125 +Issuance of common stock from exercise of stock options +97,000 +– +436 +– +– +– +436 +Issuance of common stock on restricted stock units +50,525 +– +– +– +– +– +– +Issuance of common stock, net of issuance cost +842,375 +9 +11,201 +– +– +– +11,210 +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 48,396 +) +– +( 133 +) +– +– +– +( 133 +) +Share-based compensation expense +– +– +1,206 +– +– +– +1,206 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +181 +181 +Net loss +– +– +– +( 4,041 +) +– +– +( 4,041 +) +Balance, December 31, 2021 +9,872,889 +139 +55,246 +15,566 +( 32,110 +) +143 +38,984 +Issuance of common stock from exercise of stock options +17,500 +– +– +– +– +– +– +Issuance of common stock on restricted stock units +47,931 +– +– +– +– +– +– +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 26,437 +) +– +( 119 +) +– +– +– +( 119 +) +Share-based compensation expense +– +– +1,155 +– +– +– +1,155 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +( 222 +) +( 222 +) +Net loss +– +– +– +( 5,936 +) +– +– +( 5,936 +) +Balance, December 31, 2022 +9,911,883 +$ +139 +$ +56,282 +$ +9,630 +$ +( 32,110 +) +$ +( 79 +) +$ +33,862 +See accompanying notes to Consolidated Financial Statements. +F-7 +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(As adjusted, in thousands) +Years Ended December 31, +2022 +2021 +Cash flows from operating activities: +Net loss +$ +( 5,936 +) +$ +( 4,041 +) +Adjustments to reconcile net loss to net cash used in operating activities: +Share-based compensation expense +1,155 +1,206 +Depreciation and amortization +1,332 +957 +Deferred income tax benefit +( 2,141 +) +( 2,121 +) +Loss on the disposal of fixed assets +2 +9 +Foreign currency transaction losses +6 +272 +Gain on forgiveness of long-term debt +– +( 2,173 +) +Changes in operating assets and liabilities: +Accounts receivable +( 6,421 +) +( 4,217 +) +Employee retention credit receivable +– +( 1,500 +) +Inventories +( 4,378 +) +3,440 +Prepaid income taxes +137 +2,210 +Other current and long-term assets +167 +322 +Accounts payable +3,103 +2,534 +Accrued liabilities and other liabilities +754 +592 +Net cash used in operating activities +( 12,220 +) +( 2,510 +) +Cash flows from investing activities: +Capital expenditures +( 1,299 +) +( 1,384 +) +Proceeds from the sale of fixed assets +– +8 +Collection of note receivable +– +1,598 +Net cash (used in) provided by investing activities +( 1,299 +) +222 +Cash flows from financing activities: +Proceeds from bank borrowings +2,250 +– +Proceeds from stock option exercises +– +436 +Proceeds from the issuance of common stock +– +12,214 +Payment of common stock issuance costs +– +( 1,014 +) +Withholding taxes paid on stock issuance +( 119 +) +( 133 +) +Payment of bank financing costs +( 69 +) +( 31 +) +Net cash provided by financing activities +2,062 +11,472 +Effect of exchange rate changes on cash and cash equivalents +( 54 +) +( 86 +) +(Decrease) increase in cash and cash equivalents +( 11,511 +) +9,098 +Cash and cash equivalents, beginning of period +19,457 +10,359 +Cash and cash equivalents, end of period +$ +7,946 +$ +19,457 +Supplemental cash flow information: +Interest paid +$ +129 +$ +76 +Income taxes paid +62 +57 +Non-cash capital expenditure items +54 +82 +See accompanying notes to Consolidated Financial Statements. +F-8 +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated (together with its subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”), which has its headquarters in Hamden, Connecticut and its primary operating facility in Ithaca, New York, operates in one operating segment: software-driven technology and printing solutions for high growth markets including food service technology, casino and gaming and “point of sale” (“POS”) automation markets. Our solutions are designed from the ground up based on market and customer requirements and are sold under the BOHA! TM , AccuDate™, Epic, Ithaca®, and EPICENTRAL product brands. We sell our products to original equipment manufacturers, value-added resellers, select distributors, and directly to end-users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its growing worldwide installed base of products. We also generate revenue from the after-market side of the business, providing printer and terminal service, consumables and spare parts in addition to revenue from our two software solutions; (i) our line of BOHA! software applications used to automate the back-of-house operations of restaurants, convenience stores and food service operators and (ii) the EPICENTRAL Print System (“EPICENTRAL”), that enables casino operators to create promotional coupons and marketing messages and print them in real time at the slot machine. +Impact of the COVID-19 Pandemic and Global Supply Chain Disruptions +Since early 2020, the COVID-19 pandemic has continued to cause uncertainty and disruption in the global economy and financial markets. We have also been impacted by global supply chain issues, increased shipping costs and inflationary pressures, which have increased our costs and, in some instances, slowed our ability to deliver products to our customers. During 2021, our inventory levels decreased significantly as a result of these supply chain disruptions, and we experienced significantly lower sales levels. However, during 2022 we were able to increase our inventory levels and minimize the impact to our customers by successfully modifying our products that were affected by supply chain disruptions, as well as sourcing component parts from alternate suppliers. Although we were able to increase inventory levels during 2022 and expect to continue to do so in 2023, there can be no assurance that new or continuing supply chain disruptions will not affect our products or that we will be able to make timely modifications to address any future supply chain issues that arise. Further, while we have offset most of our cost increases by increasing prices of our products, there can be no guarantee that we will be able to offset any future cost increases should they arise. After a slowdown in the first quarter of 2022 resulting from the Omicron and other variants of COVID-19, we continued to experience demand recovery during the remainder of 2022. Based on our strong backlog position and continued market expansion, we expect this recovery to continue into 2023, though the exact timing and pace of recovery may be impacted by global economic conditions. +Balance Sheet, Cash Flow and Liquidity. We have taken the following actions to increase liquidity and strengthen our financial position in an effort to mitigate the negative impacts from the COVID-19 pandemic, supply chain disruptions and inflationary pressures: +● +Public Offering – On August 16, 2021, the Company raised net proceeds of $ 11.2 million (including the exercise of the underwriters overallotment option on August 20, 2021), after deducting underwriting discounts, commissions and offering expenses, through an underwritten public offering and sold an aggregate of 842,375 shares of common stock. +● +PPP Loan – On May 1, 2020, the Company was granted a $ 2.2 million loan (the “PPP Loan”) under the Paycheck Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”) established under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which enabled us to return employees we furloughed earlier in 2020 to full time employment and to restore employees to full pay following certain pay cuts. On July 8, 2021, we received notice that the PPP Loan had been forgiven as of July 1, 2021. See Note 8 for further details regarding the PPP Loan. +● +Employee Retention Credit – Under the provisions of the CARES Act, the Company is eligible for a refundable employee retention credit subject to certain criteria. In connection with the CARES Act, the Company recognized the employee retention credit during the fourth quarter of 2021 and recorded $ 1.5 million as “Gain from employee retention credit” in the Consolidated Statement of Operations for the year ended December 31, 2021 and the related receivable as “Employee retention credit receivable” in the Consolidated Balance Sheet as of December 31, 2021 and 2022. We received these funds in the first quarter of 2023. +● +On March 13, 2020, we entered into a Credit Facility with Siena Lending Group LLC that provides a revolving credit line of up to $ 10.0 million, subject to a borrowing base and on July 19, 2022, we entered into an amendment to extend the maturity of the facility to March 13, 2025. See Note 8 for further details regarding this facility. +● +Reduced Capital Expenditures – We limited capital expenditures during 2020 and 2021 and gradually increased these expenditures during 2022 as sales improved. +F-9 +After reviewing whether conditions and/or events raise substantial doubt about our ability to meet future financial obligations over the 12 months following the date on which the Consolidated Financial Statements included in this “Form 10-K” were issued, including consideration of the actions taken to manage expenses and liquidity, we believe that our net cash to be provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility will provide sufficient liquidity to fund our current obligations, capital spending, and working capital requirements and to comply with the financial covenants of our credit facility over at least 12 months following such issuance date. +Use of Assumptions and Estimates +Management’s belief that the Company will be able to fund its planned operations over the 12 months following the date on which the Consolidated Financial Statements were issued is based on assumptions which involve significant judgment and estimates of future revenues, inflation, rising interest rates, capital expenditures and other operating costs. Our current assumptions are that casinos and restaurants will remain open and consumer traffic will continue to increase during the balance of 2023. Though demand for our products at casinos has increased substantially in 2022, and we expect this trend to continue, we cannot predict the ultimate impact of the current economic environment, including inflation, rising interest rates and supply chain disruptions on our customers, which may impact sales. We believe that we are positioned to withstand the impact of any potential economic downturn or slower than anticipated economic recovery. However, despite our significant backlog of orders as of December 31, 2022 and increasing market share during 2022, should such conditions arise, we believe we will be able to take additional financial and operational actions to cut costs and/or increase liquidity. +In addition, the presentation of the accompanying audited Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities. Our estimates include those related to revenue recognition, accounts receivable, inventory obsolescence, goodwill and intangible assets, the valuation of deferred tax assets and liabilities, depreciable lives of equipment, share-based compensation and contingent liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates used. +Smaller Reporting Company +As a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, we may choose to prepare our disclosures relying on certain scaled disclosure requirements for smaller reporting companies in Regulation S-K and in Article 8 of Regulation S-X. +The scaled disclosure requirements for smaller reporting companies permit us (i) to include less extensive narrative disclosure than required of other reporting companies, particularly in the description of executive compensation in our proxy statement and (ii) to provide audited financial statements for two fiscal years in our Form 10-K, in contrast to other reporting companies, which must provide audited financial statements for three years. +We may lose our status as a smaller reporting company on the last day of the fiscal year in which we have (i) public float of at least $250 million as of the last day of the second fiscal quarter and (ii) if we have a public float that does not exceed $700 million as of the last day of the second fiscal quarter and at least $100 million in annual revenues. +2. Summary of significant accounting policies +Principles of consolidation: The accompanying Consolidated Financial Statements include the audited Consolidated Financial Statements of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized profit. +Use of estimates : The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting.” We view our operations and manage our business as one segment: the design, development and marketing of software-driven technology and printing solutions and providing printer and terminal related software, services, supplies and spare parts. Factors used to identify TransAct’s single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief operating decision-maker in making decisions about how to allocate resources and assess performance. +Cash and cash equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Allowance for doubtful accounts : We establish an allowance for doubtful accounts to ensure trade receivables are valued appropriately. We maintain an allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events and historical experience. We record a specific allowance for individual accounts when we become aware of a customer’s inability to meet its financial obligations, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. If circumstances related to customers change, we further adjust estimates of the recoverability of receivables. +F-10 +The following table summarizes the activity recorded in the valuation account for accounts receivable: +Years Ended December 31 , +(In thousands) +2022 +2021 +Balance, beginning of period +$ +219 +$ +220 +Additions charged to costs and expenses +140 +– +Deductions +( 8 +) +( 1 +) +Balance, end of period +$ +351 +$ +219 +Inventories: Inventories are stated at the lower of average cost or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completions, disposal and transportation, historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net realizable value. +Effective April 1, 2022, TransAct changed its method of inventory valuation from standard costing which approximated the “first-in, first-out” (“FIFO”) costing methodology to the average costing methodology. Comparative financial statements of prior periods have been adjusted to apply the new method retrospectively. See Note 16 for a discussion of the change in accounting principle during the second quarter of 2022. +Fixed assets: Fixed assets are stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years ; machinery and equipment is ten years ; furniture and office equipment is five years to ten years ; and computer software and equipment is three years to seven years . Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $ 1.1 million and $ 0.7 million in 2022 and 2021, respectively. +Leases: We account for leases in accordance with ASC 842, “Leases” (“ASC 842”), which requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determines whether lease expense is recognized based on an effective interest method for finance leases or on a straight-line basis over the term of the lease for operating leases. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less are accounted for based on existing guidance for operating leases. If risks and rewards are conveyed without the transfer of control, the lease is treated as financing. If the lessor does not convey risks and rewards or control, the lease is treated as operating. +We have elected certain practical expedients available under ASC 842 upon adoption. We have applied the practical expedient for short-term leases. We have lease agreements that include lease and non-lease components, and we have not elected the practical expedients to combine these components for any of our leases. +We enter into lease agreements for the use of real estate space and certain equipment under operating leases and we have no financing leases. We determine if an arrangement contains a lease at inception. Our leases are included in “Right-of-use asset” and “Lease liability” in our Consolidated Balance Sheets. +Right of use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Lease right of use assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term. +On April 26, 2022, we entered into an amendment to modify the expiration date of our lease on our Las Vegas, Nevada facility. The lease was set to expire on November 1, 2022 and the amendment extended the lease term to November 30, 2025. The lease amendment resulted in an increase to the right-of-use-asset and lease liability of $ 0.8 million. The lease amendment modified the base rent. On April 30, 2021, we entered into an amendment to modify the expiration date of our lease on our Hamden, CT facility. The lease, which was last amended on January 3, 2017, was scheduled to expire on April 30, 2027. The lease amendment modified the expiration date to October 31, 2025. The modification resulted in reducing the right-of-use-asset and lease liability by $ 0.3 million. +Lease expense is recognized on a straight-line basis over the lease term. As most of our leases do not provide an implicit rate, the Company determines its incremental borrowing rate by using the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. Our lease right of use asset excludes lease incentives. Our leases have remaining lease terms of one year to four years , some of which include options to extend. The exercise of lease renewal options is at our sole discretion and our lease right of use assets and liabilities reflect only the options we are reasonably certain that we will exercise. Lease expense is recognized on a straight-line basis over the lease term. +F-11 +Goodwill and intangible assets : We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 “Goodwill,” acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change that indicate it is more likely than not an impairment exists. We perform a fair value-based impairment test to the carrying value of goodwill and indefinite-lived intangible assets on an annual basis and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. The Company utilizes the option to first assess qualitative factors to determine whether it is necessary to perform the Step 1 quantitative goodwill impairment test in accordance with the applicable accounting standards. Under the qualitative assessment, management considers relevant events and circumstances including but not limited to macroeconomic conditions, industry and market considerations, Company performance and events directly affecting the Company. If the Company determines that the Step 1 quantitative impairment test is required, management estimates the fair value of the reporting unit primarily using the income approach, which reflects management’s cash flow projections, and also evaluates the fair value using the market approach. Factors considered that may trigger an interim period impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. +As of December 31, 2022, we have determined that no goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2022 when our annual review for impairment was performed. +Revenue recognition: We account for revenue in accordance with ASC Topic 606: Revenue from Contracts with Customers. In accordance with ASC 606, a performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Some of our contracts with customers contain a single performance obligation, while other contracts contain multiple performance obligations (most commonly when contracts include a hardware product, software and extended warranties). A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. +The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring services to the customer. To the extent the transaction price includes variable consideration, such as price protection, reserves for returns and other allowances, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the “expected value” method or the “most likely amount” method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. +For a majority of our revenue, which consists of printers, terminals, consumables, and replacement parts, the Company recognizes revenue as of a point of time. The transaction price is recognized upon shipment of the order when control of the goods is transferred to the customer and at the time the performance obligation is fulfilled. We also sell a software solution in our casino and gaming market, EPICENTRAL, that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. EPICENTRAL is primarily comprised of both a software component, which is licensed to the customer, and a hardware component. EPICENTRAL software and hardware are integrated to deliver the system’s full functionality. The transaction prices from EPICENTRAL software license and hardware are recognized upon installation and formal acceptance by the customer when control of the license is transferred to the customer. For out-of-warranty repairs, the transaction price is recognized after the repair work is completed and the printer or terminal is returned to the customer, as control of the product is transferred to the customer and our performance obligation is completed. +Performance obligations are satisfied over time if the customer receives the benefits as we perform work, if the customer controls the asset as it is being produced, or if the product being produced for the customer has no alternative use and we have a contractual right to payment. For our separately priced extended warranty, BOHA! cloud-based software applications, technical support for our food service technology terminals and maintenance agreements (including free one-year maintenance received by customers upon completion of EPICENTRAL installation) revenue is recognized over time as the customer receives the benefit. The transaction price from the maintenance services is recognized ratably over time, using output methods, as control of the services is transferred to the customer. Our cloud-based BOHA! software allows customers to use hosted software over the contract period on a subscription basis without taking possession of the software and the subscription price is recognized ratably over the contract period. For extended warranties, the transaction price is recognized ratably over the warranty period, using output methods, as control of the services is transferred to the customer. +When there is more than one performance obligation in a customer arrangement, the Company typically uses the “standalone selling price” method to determine the transaction price to allocate to each performance obligation. The Company sells the performance obligations separately and has established standalone selling prices for its products and services. In the case of an overall price discount, the discount is applied to each performance obligation proportionately based on standalone selling price. To determine the standalone selling price for initial EPICENTRAL installations, the Company uses the adjusted market assessment approach. +For contracts with terms of less than 12 months, the Company expenses sales commissions as they are incurred, since the expected amortization period of the cost to obtain a contract is less than 12 months. +F-12 +Disaggregation of revenue +The following table disaggregates our revenue by market type, as we believe it best depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors. Sales and usage-based taxes are excluded from revenues. +Year Ended December 31, 2022 +(In thousands) +United States +International +Total +Food service technology +$ +11,602 +$ +762 +$ +12,364 +POS automation +10,657 +2 +10,659 +Casino and gaming +17,686 +12,343 +30,029 +TransAct Services Group +4,089 +998 +5,087 +Total net sales +$ +44,034 +$ +14,105 +$ +58,139 +Year Ended December 31, 2021 +(In thousands) +United States +International +Total +Food service technology +$ +11,738 +$ +887 +$ +12,625 +POS automation +4,817 +8 +4,825 +Casino and gaming +10,173 +5,129 +15,302 +Printrex +171 +460 +631 +TransAct Services Group +5,501 +502 +6,003 +Total net sales +$ +32,400 +$ +6,986 +$ +39,386 +Contract balances +Contract assets consist of unbilled receivables. Pursuant to the over-time revenue recognition model, revenue may be recognized prior to the customer being invoiced. An unbilled receivable is recorded to reflect revenue that is recognized when such revenue exceeds the amount invoiced to the customer. Unbilled receivables are separated into current and non-current assets and included within “Accounts Receivable, net” and “Other Assets” on the Consolidated Balance Sheets. We first recorded contract assets during 2020 upon the start of a long-term BOHA! contract. +Contract liabilities consist of customer prepayments and deferred revenue. Customer prepayments are reported as “Accrued Liabilities” in current liabilities in the Consolidated Balance Sheets and represent customer payments made in advance of performance obligations in instances where credit has not been extended and is recognized as revenue when the performance obligation is complete. Deferred revenue is reported separately in current liabilities and non-current liabilities and consists of our extended warranty contracts, technical support for our food service technology terminals, EPICENTRAL maintenance contracts and prepaid software subscriptions for our BOHA! software applications, and is recognized as revenue as (or when) we perform under the contract. During the year ended December 31, 2022, we recognized revenue of $ 1.1 million related to our contract liabilities as of December 31, 2021. +Net contract (liabilities) assets consist of the following: +December 31, +(In thousands) +2022 +2021 +Unbilled receivables, current +$ +392 +$ +314 +Unbilled receivables, non-current +163 +308 +Customer pre-payments +( 101 +) +( 99 +) +Deferred revenue, current +( 1,329 +) +( 805 +) +Deferred revenue, non-current +( 143 +) +( 186 +) +Net contract (liabilities) assets +$ +( 1,018 +) +$ +( 468 +) +Remaining performance obligations +Remaining performance obligations represent the transaction price of firm orders for which a good or service has not been delivered to our customer. As of December 31, 2022, the aggregate amount of the transaction price allocated to remaining performance obligations was $ 29.0 million. The Company expects to recognize revenue on $ 28.7 million of its remaining performance obligations within the next 12 months following December 31, 2022, $ 0.2 million within the next 24 months following December 31, 2022 and the balance of these remaining performance obligations within the next 36 months following December 31, 2022. +F-13 +Concentration of credit risk: Financial instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable, net were as follows: +December 31, +2022 +2021 +Chain Link Services +– +10 +% +International Gaming Technology (“IGT”) +12 +% +3 +% +NCR Corporation +3 +% +11 +% +The Bright Group +11 +% +– +Sales to customers representing 10% or more of total net sales were as follows: +December 31, +2022 +2021 +IGT +10 +% +9 +% +Engineering, design and product development: Engineering, design and product development expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as a component of operating expenses as incurred. We recorded $ 8.6 million and $ 7.5 million of research and development expenses in 2022 and 2021, respectively. +Costs incurred in the engineering, design and product development of a computer software product are charged to expense until technological feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs has been included in cost of sales over the estimated life of the product. During 2019, we contracted several third-parties to develop software for our food service technology products, the cost for which we capitalized. Unamortized development costs for such software was $ 242 thousand and $ 396 thousand as of December 31, 2022 and 2021, respectively. The total amount charged to cost of sales for capitalized software development costs was $ 154 thousand in both 2022 and 2021. +Advertising: Advertising costs are expensed as incurred. Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Operations for 2022 and 2021 totaled $ 3.1 million and $ 1.8 million, respectively. These expenses include items such as consulting, professional services, tradeshows, and print advertising. +Income taxes: The income tax amounts reflected in the accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, “Income Taxes” (“ASC 740”). Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. +Foreign currency translation: The financial position and results of operations of our foreign subsidiary in the UK are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars at the year-end exchange rate, related sales and expenses have been translated at the weighted average rate for the period, and shareholders’ equity has been translated at historical exchange rates. The resulting translation gains or losses, net of tax, are recorded in shareholders’ equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income and loss. Foreign currency transaction gains and losses, including those related to intercompany balances, are recognized in Other, net on the Consolidated Statements of Operations. +F-14 +Share-based payments: At December 31, 2022, we have share-based employee compensation plans, which are described more fully in Note 9 - Stock incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, “Compensation – Stock Compensation.” Share-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee’s requisite service period. +We use the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions require judgment and are highly sensitive in the determination of compensation expense. Forfeitures are recognized as they occur. +Net loss per share: We report net income or loss per share in accordance with ASC 260, “Earnings per Share (EPS).” Under this guidance, basic EPS, which excludes dilution, is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these instruments are excluded from the computation of diluted EPS. See Note 11 - Earnings per share. +Change in accounting principle: See Note 16 for a discussion of a change in accounting principle which occurred in the second quarter of 2022. TransAct changed its method of inventory valuation from standard costing which approximates first-in first-out (“FIFO”) to the average costing methodology. All prior periods presented have been retrospectively adjusted to apply the new method of accounting. Certain prior period amounts have been adjusted to conform with the current year presentation . +Reclassifications: Certain reclassifications have been made to prior year financial statements to conform to classifications used in the current year. +3. Inventories +The components of inventories are: +December 31, +(In thousands) +2022 +2021 +* +Raw materials and purchased component parts +$ +8,884 +$ +5,499 +Work-in-process +– +11 +Finished goods +3,144 +2,201 +$ +12,028 +$ +7,711 +* +see Note 16, Change in Accounting Principle +4. Fixed assets, net +The components of fixed assets, net are: +December 31, +(In thousands) +2022 +2021 +Tooling, machinery and equipment +$ +6,859 +$ +6,694 +Furniture and office equipment +1,882 +1,660 +Computer software and equipment +8,348 +6,973 +Leasehold improvements +2,883 +2,872 +19,972 +18,199 +Less: Accumulated depreciation and amortization +( 17,656 +) +( 16,736 +) +2,316 +1,463 +Construction in-process +465 +1,221 +$ +2,781 +$ +2,684 +F-15 +5. Intangible assets, net +Identifiable intangible assets are recorded in Intangible assets, net in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2022 +2021 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,591 +$ +( 1,349 +) +$ +1,591 +$ +( 1,195 +) +Patents +15 +( 15 +) +15 +( 14 +) +Total +$ +1,606 +$ +( 1,364 +) +$ +1,606 +$ +( 1,209 +) +Amortization expense was $ 155 thousand and $ 186 thousand in 2022 and 2021, respectively. Amortization expense for each of the next five years ending December 31 is expected to be as follows: $ 154 thousand in 2023 and $ 88 thousand in 2024; and none thereafter. +6. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2022 +2021 +Salaries and compensation related +$ +2,744 +$ +2,854 +Taxes +530 +79 +Professional and consulting +371 +285 +Other +432 +676 +$ +4,077 +$ +3,894 +7. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of the month immediately following their date of hire. We match employees’ contributions at a rate of 50 % of employees’ contributions up to the first 6 % of the employees’ compensation contributed to the 401(k) plan. Our matching contributions were $ 355 thousand and $ 312 thousand in 2022 and 2021, respectively. +8. Borrowings +Credit Facility +On March 13, 2020, we entered into a credit facility (the “Siena Credit Facility”) with Siena Lending Group LLC (the “Lender”) and terminated our credit facility with TD Bank, N.A. The Siena Credit Facility provides for a revolving credit line of up to $ 10.0 million and was originally scheduled to expire on March 13, 2023. Borrowings under the Siena Credit Facility bear a floating rate of interest equal to the greatest of (i) the prime rate plus 1.75 %, (ii) the federal funds rate plus 2.25 %, and (iii) 6.50 %. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility was $ 245 thousand, which were reported as “Other current assets” in current assets and “Other assets” in non-current assets in the Consolidated Balance Sheets. We also pay a fee of 0.50 % on unused borrowings under the Siena Credit Facility. Borrowings under the Siena Credit Facility are secured by a lien on substantially all the assets of the Company. +The Siena Credit Facility imposes a financial covenant on the Company and borrowings are subject to a borrowing base based on (i) 85 % of eligible accounts receivable plus the lesser of (a) $ 5.0 million and (b) 50 % of eligible raw material and 60 % of finished goods inventory and restricts, among other things, our ability to incur additional indebtedness and create other liens. The three-month period from April 1, 2020 to June 30, 2020 was the first period we were subject to the original financial covenant, which required the Company to maintain a minimum EBITDA and continued through the 12-month period from April 1, 2020 to March 31, 2021. On July 21, 2021, the Company entered into an amendment (“Siena Credit Facility Amendment No. 1”) to the Siena Credit Facility. Siena Credit Facility Amendment No. 1 changed the financial covenant under the Siena Credit Facility from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at least $ 750 thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning with the calendar month ending July 31, 2021. From July 31, 2021 through December 31, 2022, we remained in compliance with our excess availability covenant. As of December 31, 2022, we had $ 2.3 million of outstanding borrowings under the Siena Credit Facility and $ 3.9 million of net borrowing capacity available under the Siena Credit Facility. +On July 19, 2022, the Company and the Lender entered into Amendment No. 2 (“Siena Credit Facility Amendment No. 2”) to the Siena Credit Facility, as amended by Siena Credit Facility Amendment No. 1. Also on July 19, 2022, the Company and the Lender entered into an Amended and Restated Fee Letter (the “Amended Fee Letter”) in connection with the Siena Credit Facility Amendment No. 2. The Siena Credit Facility Amendment No. 2 did not modify the aggregate amount of the revolving commitment or the interest rate applicable to the loans. +F-16 +The changes to the Siena Credit Facility provided for in Siena Credit Facility Amendment No. 2 include, among other things, the following: +(i) +The extension of the maturity date from March 13, 2023 to March 13, 2025; and +(ii) +The termination of the existing blocked account control agreement and entry into a new “springing” deposit account control agreement, permitting the Company to direct the use of funds in its deposit account until such time as (a) the sum of excess availability under Siena Credit Facility (as amended) and unrestricted cash is less than $ 5 million for 3 consecutive business days or (b) an event of default occurs and is continuing. +In addition, the Amended Fee Letter requires the Company, while it retains the ability to direct the use of funds in the deposit account, to maintain outstanding borrowings of at least $ 2,250,000 in principal amount. If the Company does not have the ability to direct the use of funds in the deposit account, then the Amended Fee Letter requires the Company to pay interest on at least $ 2,250,000 principal amount of loans, whether or not such amount of loans is actually outstanding. +PPP Loan +On May 1, 2020, the Company was granted the PPP Loan from Berkshire Bank in the aggregate amount of $ 2.2 million, pursuant to the PPP. Under the terms of the PPP, the PPP Loan would be forgiven to the extent that funds from the PPP Loan were used for payroll costs and costs to continue group health care benefits, as well as for interest on mortgage obligations incurred before February 15, 2020, rent under lease agreements in effect before February 15, 2020, utilities for which service began before February 15, 2020, and interest on debt obligations incurred before February 15, 2020, subject to conditions and limitations provided in the CARES Act. At least 60% (under the PPP terms, as amended) of the proceeds from the PPP Loan were required to be used for eligible payroll costs for the PPP Loan to be forgiven. +On July 8, 2021, the Company received notifications from Berkshire Bank and the SBA that the PPP Loan (including all interest accrued thereon) of $ 2.2 million had been fully forgiven by the SBA and that the forgiveness payment date was July 1, 2021. The forgiveness of the PPP Loan was reported as “Gain on forgiveness of long-term debt” in the Consolidated Statement of Operations during the year ended December 31, 2021. +9. Stock incentive plans +Stock incentive plans . We currently have two stock incentive plans: the 2005 Equity Incentive Plan and the 2014 Equity Incentive Plan, which provide for awards to executives, key employees, directors and consultants. The plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. Awards granted under these plans have exercise prices equal to 100 % of the fair market value of the common stock at the date of grant. Awards granted have a ten-year term and generally vest over a two-year to four-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards may be made under the 2005 Equity Incentive Plan. Under our 2014 Equity Incentive Plan, as amended in May 2020, we are authorized to grant awards of up to 2,200,000 shares of TransAct common stock. At December 31, 2022, 347,652 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average per share fair value of stock option grants for 2022 and 2021 was $ 4.39 and $ 5.41 , respectively. We also issued restricted stock units for certain executives and directors that vest over a specified period of time, and in some instances require achieving certain performance metrics. The weighted-average per share fair value of these restricted stock units was $ 8.43 and $ 10.27 in 2022 and 2021, respectively. +The table below indicates the key assumptions (on a weighted-average basis) used in the option valuation calculations for options granted in 2022 and 2021 and a discussion of our methodology for developing each of the assumptions used in the valuation model: +Year Ended December 31, +2022 +2021 +Expected option term (in years) +7.1 +6.9 +Expected volatility +51.3 +% +50.5 +% +Risk-free interest rate +2.2 +% +1.2 +% +Dividend yield +0.0 +% +0.0 +% +Expected Option Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility – The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An increase in the expected volatility factor will increase compensation expense. +Risk-Free Interest Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +F-17 +Dividend Yield –The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation expense. +For both 2022 and 2021, we recorded $ 1.2 million of share-based compensation expense included primarily in general and administrative expense in our Consolidated Statements of Operations. We also recorded income tax benefits of $ 0.3 million in both 2022 and 2021, related to such share-based compensation. At December 31, 2022, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Equity award activity in the 2005 Equity Incentive Plan and the 2014 Equity Incentive Plan is summarized below: +Stock Options +Restricted Stock Units +Number of Shares +Average Price* +Number of Units +Average Price** +Outstanding at December 31, 2021 +1,269,355 +$ +9.18 +155,225 +$ +10.28 +Granted +181,100 +8.16 +129,700 +8.78 +Exercised +( 17,500 +) +6.70 +( 47,931 +) +10.22 +Forfeited +( 49,250 +) +9.38 +( 22,708 +) +10.27 +Expired +( 27,750 +) +8.51 +– +– +Outstanding at December 31, 2022 +1,355,955 +$ +9.08 +214,286 +$ +9.28 +* +weighted average exercise price per share +** +weighted average grant stock price per share +The following summarizes information about equity awards outstanding that are vested and expect to vest and equity awards that are exercisable at December 31, 2022: +Equity Awards Vested and Expected to Vest +Equity Awards That Are Exercisable +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Stock Options +1,355,955 +$ +9.08 +$ +224 +5.0 +971,865 +$ +9.23 +$ +93 +3.7 +Restricted stock units +145,687 +– +921 +2.1 +– +– +– +– +* +weighted average exercise price per share +** +weighted-average contractual remaining term in years +Shares that are issued upon exercise of employee stock awards are newly issued shares and not issued from treasury stock. As of December 31, 2022, unrecognized compensation cost related to non-vested equity awards granted under our stock incentive plans is approximately $ 2.1 million, which is expected to be recognized over a weighted average period of 2.6 years. +The total fair value of awards vested was $ 1.6 million and $ 1.7 million during the years ended December 31, 2022 and 2021, respectively. The total intrinsic value (which is the amount by which the stock price exceeded the exercise price on the date of exercise) of stock options exercised during the years ended December 31, 2022 and 2021 was $ 40 thousand and $ 268 thousand, respectively, and cash received from option exercises was zero and $ 436 thousand in 2022 and 2021, respectively. 17,500 and 97,000 stock options were exercised during the year ended December 31, 2022 and 2021, respectively. We recorded a realized tax provision in 2022 and 2021 from equity-based awards of $ 13 thousand and $ 35 thousand, respectively, related to options exercised. +10. Income taxes +The components of the income tax benefit are as follows: +December 31, +(In thousands) +2022 +2021 +Current: +Federal +$ +149 +$ +26 +State +110 +51 +Foreign +( 83 +) +2 +176 +79 +Deferred: +Federal +( 1,924 +) +( 2,057 +) +State +( 217 +) +( 62 +) +Foreign +– +( 2 +) +( 2,141 +) +( 2,121 +) +Income tax benefit +$ +( 1,965 +) +$ +( 2,042 +) +F-18 +Our effective tax rates were ( 24.9 % ) and ( 33.6 % ) for 2022 and 2021 , respectively. The tax benefit recorded for 2022 includes the recognition of stock option cancellations for which no benefit was realized and the benefit recorded for 2021 included the recognition of the gain on the forgiveness of the PPP Loan which was not taxable . +At December 31, 2022, we have $ 10.9 million of federal net operating loss carryforwards (with an unlimited carryforward), $ 0.2 million of tax-effected state net operating loss carryforwards (which have varying lives), $ 1.2 million in R&D credit carryforwards (which generally have a twenty year life), and no state tax credit carryforwards. Foreign income (loss) before taxes was $ 24 thousand and ($ 404 ) thousand in 2022 and 2021, respectively. +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Our deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2022 +2021 +Deferred tax assets: +Federal net operating losses +$ +2,297 +$ +1,978 +Foreign net operating losses +676 +624 +State net operating losses +149 +– +Depreciation +– +306 +Capitalized R&D expenses +1,708 +– +Inventory reserves +648 +710 +Deferred revenue +41 +24 +Warranty reserve +17 +22 +Stock compensation expense +769 +796 +Other accrued compensation +222 +308 +R&D credit carryforward +1,238 +901 +Other liabilities and reserves +463 +250 +Gross deferred tax assets +8,228 +5,919 +Valuation allowance +( 656 +) +( 733 +) +Net deferred tax assets +7,572 +5,186 +Deferred tax liabilities: +Depreciation +196 +– +Other +49 +43 +Net deferred tax liabilities +245 +43 +Total net deferred tax assets +$ +7,327 +$ +5,143 +As of December 31, 2022 and 2021, we had a $ 656 thousand and $ 733 thousand, respectively, of valuation allowances on our net operating loss carryforwards. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year Ended December 31, +(In thousands) +2022 +2021 +Balance, beginning of period +$ +733 +$ +659 +Subtractions released to income tax provisions +( 77 +) +– +Additions charged to income tax provision +– +74 +Balance, end of period +$ +656 +$ +733 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2022 +2021 +Federal statutory rate +21.0 +% +21.0 +% +PPP loan forgiveness +– +7.4 +R&D credit +4.3 +7.1 +Stock award excess tax benefit +– +0.3 +State income taxes, net of federal income taxes +1.1 +0.1 +Business meals and entertainment +– +( 0.2 +) +Miscellaneous permanent items +– +( 0.3 +) +Uncertain tax positions +( 0.5 +) +( 0.4 +) +Stock option cancellations +( 1.9 +) +( 0.6 +) +Valuation allowance and tax accruals +1.0 +( 1.2 +) +Other +( 0.1 +) +0.4 +Effective tax rate +24.9 +% +33.6 +% +F-19 +We had $ 142 thousand and $ 144 thousand of total gross unrecognized tax benefits at December 31, 2022 and 2021, respectively that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the gross amounts of unrecognized tax benefits at the beginning and end of the year is as follows: +December 31, +(In thousands) +2022 +2021 +Balance, beginning of period +$ +144 +$ +121 +Tax positions taken during the current period +26 +47 +Lapse of statute of limitations +( 28 +) +( 24 +) +Balance, end of period +$ +142 +$ +144 +We expect $ 28 thousand of the $ 142 thousand of unrecognized tax benefits will reverse in 2023 upon the expiration of the statute of limitations. +We recognize interest and penalties related to uncertain tax positions in the income tax provision. We have accrued interest and penalties related to uncertain tax positions of $ 34 thousand and $ 20 thousand as of December 31, 2022 and 2021, respectively. +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially concluded all U.S. federal income tax, state and local, and foreign tax matters through 2018. However, our federal tax returns for the years 2019 through 2022 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +11. Earnings per share +Earnings per share was computed as follows (in thousands, except per share amounts): +Years Ended December 31, +2022 +2021 +Net loss +$ +( 5,936 +) +$ +( 4,041 +) +Shares: +Basic: Weighted average common shares outstanding +9,905 +9,298 +Add: Dilutive effect of outstanding equity awards as determined by the treasury stock method +– +– +Diluted: Weighted average common and common equivalent shares outstanding +9,905 +9,298 +Net loss per common share: +Basic +$ +( 0.60 +) +$ +( 0.43 +) +Diluted +( 0.60 +) +( 0.43 +) +The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options, restricted stock units and performance stock awards, when the average market price of the common stock is lower than the exercise price of the related stock award during the period. These outstanding stock awards are not included in the computation of diluted earnings per share because the effect would be anti-dilutive. Furthermore, in periods when a net loss is reported, such as 2022 and 2021, basic and diluted net loss per common share are calculated using the same method. Anti-dilutive stock awards excluded from the computation of earnings per dilutive share were 1,463,000 and 391,000 at December 31, 2022 and 2021, respectively. +12. Stock repurchase program +We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. Repurchases of our common stock are accounted for as of the settlement date. During 2022 and 2021, we did no t repurchase any shares of our common stock. From January 1, 2005 through December 31, 2019, we repurchased a total of 4,044,842 shares of common stock for $ 32.1 million, at an average price of $ 7.94 per share. +F-20 +13. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are based on the location of the customer and asset. +Years Ended December 31, +(In thousands) +2022 +2021 +Net sales: +United States +$ +44,034 +$ +32,400 +International +14,105 +6,986 +Total +$ +58,139 +$ +39,386 +Fixed assets, net: +United States +$ +2,252 +$ +1,770 +International +529 +914 +Total +$ +2,781 +$ +2,684 +Sales to international customers were 24 % and 18 % of total sales in 2022 and 2021, respectively. Sales to Europe represented 68 % and 53 %, sales to the Pacific Rim (which includes Australia and Asia) represented 28 % and 35 %, and sales to Canada represented 4 % and 11 % of total international sales in 2022 and 2021, respectively. International long-lived assets consist of net fixed assets located at our foreign subsidiary in the UK, as well as our contract manufacturer in Thailand. +14. Leases +Operating lease expense was $ 1.0 million for both years ended December 31, 2022 and 2021 and is reported as “Cost of sales,” “Engineering, design and product development expense,” “Selling and marketing expense,” and “General and administrative expense” in the Consolidated Statements of Operations. Operating costs include short-term lease costs, which were immaterial during the period. +The following information represents supplemental disclosure for the statement of cash flows related to operating leases (in thousands): +Years Ended December 31, +2022 +2021 +Operating cash outflows from leases +$ +967 +$ +982 +The following summarizes additional information related to our leases: +Years Ended December 31, +2022 +2021 +Weighted average remaining lease term (in years) +2.7 +3.5 +Weighted average discount rate +4.5 +% +4.4 +% +The maturity of the Company’s operating lease liabilities are as follows (in thousands): +December 31, 2022 +2023 +$ +972 +2024 +1,022 +2025 +710 +2026 +20 +Total undiscounted lease payments +2,724 +Less imputed interest +166 +Total lease liabilities +$ +2,558 +F-21 +15. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2022 and 2021 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2022: +Net sales +$ +9,702 +$ +12,623 +$ +17,856 +$ +17,958 +Gross profit +2,566 +5,434 +8,193 +8,219 +Net (loss) income +( 4,348 +) +( 2,376 +) +528 +260 +Net (loss) income per common share: +Basic +( 0.44 +) +( 0.24 +) +0.05 +0.03 +Diluted +( 0.44 +) +( 0.24 +) +0.05 +0.03 +2021: +Net sales +$ +8,301 +$ +9,325 +$ +10,637 +$ +11,123 +Gross profit +3,339 +3,432 +4,305 +4,306 +Net (loss) income +( 2,089 +) +( 2,030 +) +901 +( 823 +) +Net (loss) income per common share: +Basic +( 0.23 +) +( 0.23 +) +0.10 +( 0.08 +) +Diluted +( 0.23 +) +( 0.23 +) +0.09 +( 0.08 +) +16. Change in accounting principle +Effective April 1, 2022, TransAct changed its method of inventory valuation from standard costing which approximated the FIFO costing methodology to the average costing methodology. We believe this methodology is preferable because it reflects a better estimate of inventory cost as we do not typically perform intensive manufacturing of our finished products, which are therefore better measured under average cost. In addition, our business is projected to include an increasing sales volume of software going forward, which better aligns with average costing. Comparative financial statements of prior periods have been adjusted to apply the new method retrospectively. Tax effects are calculated at the Company’s marginal tax rate, or the tax impact of incremental income changes rather than the average tax rate applied to our total net loss before income taxes. The following financial statement line items for the periods presented were impacted by the change in accounting principle. +The effect of the changes made to the Company’s Consolidated Balance Sheets for the periods presented are as follows: +December 31, 2021 +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Inventories +$ +7,720 +$ +7,711 +$ +( 9 +) +Deferred tax assets +5,141 +5,143 +2 +Retained earnings +15,573 +15,566 +( 7 +) +The ending balance in retained earnings as of December 31, 2020 was adjusted from $ 19,718 to $ 19,607 . +The effect of the changes made to the Company’s Consolidated Statements of Operations for the periods presented are as follows: +Three months ended December 31, 2021 +Year ended December 31, 2021 +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Cost of sales +$ +6,705 +$ +6,817 +$ +112 +$ +24,137 +$ +24,004 +$ +( 133 +) +Gross profit +4,418 +4,306 +( 112 +) +15,249 +15,382 +133 +Operating loss +( 2,485 +) +( 2,597 +) +( 112 +) +( 9,510 +) +( 9,377 +) +133 +Loss before income taxes +( 1,124 +) +( 1,236 +) +( 112 +) +( 6,216 +) +( 6,083 +) +133 +Income tax benefit +389 +413 +24 +2,071 +2,042 +( 29 +) +Net loss +( 735 +) +( 823 +) +( 88 +) +( 4,145 +) +( 4,041 +) +104 +Net loss per common share: +Basic +$ +( 0.07 +) +$ +( 0.08 +) +$ +( 0.01 +) +$ +( 0.45 +) +$ +( 0.43 +) +$ +0.02 +Diluted +$ +( 0.07 +) +$ +( 0.08 +) +$ +( 0.01 +) +$ +( 0.45 +) +$ +( 0.43 +) +$ +0.02 +Shares used in per-share calculation: +Basic +9,848 +9,848 +9,298 +9,298 +Diluted +9,848 +9,848 +9,298 +9,298 +F-22 +The effect of the changes made to the Company’s Consolidated Statements of Comprehensive Loss for the periods presented are as follows: +Three months ended December 31, 2021 +Year ended December 31, 2021 +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Net loss +$ +( 735 +) +$ +( 823 +) +$ +( 88 +) +$ +( 4,145 +) +$ +( 4,041 +) +$ +104 +Comprehensive loss +( 662 +) +( 750 +) +( 88 +) +( 3,964 +) +( 3,860 +) +104 +The effect of the changes made to the Company’s Consolidated Statements of Cash Flows for the periods presented are as follows: +Year ended December 31, 2021 +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Net loss +$ +( 4,145 +) +$ +( 4,041 +) +$ +104 +Deferred income tax benefit +( 2,150 +) +( 2,121 +) +29 +Inventories +3,573 +3,440 +( 133 +) +The effect of the changes made to the Company’s Consolidated Statements of Changes in Shareholders’ Equity for the periods presented are as follows: +Three months ended December 31, 2021 +Year ended December 31, 2021 +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Under +FIFO Cost +Under +Average Cost +Effect +of Change +Equity beginning balance +$ +39,280 +$ +39,361 +$ +81 +$ +30,236 +$ +30,125 +$ +( 111 +) +Retained earnings - beginning of period +16,308 +16,389 +81 +19,718 +19,607 +( 111 +) +Net loss +( 735 +) +( 823 +) +( 88 +) +( 4,145 +) +( 4,041 +) +104 +Retained earnings - end of period +15,573 +15,566 +( 7 +) +15,573 +15,566 +( 7 +) +Equity ending balance +38,991 +38,984 +( 7 +) +38,991 +38,984 +( 7 +) +17. Subsequent events +In the first quarter of 2023, we collected the $ 1.5 million employee retention credit receivable from the U.S. Government. The Company has evaluated all other events or transactions that occurred up to the date the consolidated financial statements were available to issue. Based upon this review, the Company did not identify any other subsequent events that would have required adjustment or disclosure in the consolidated financial statements. +F-23 \ No newline at end of file diff --git a/raw/filings/0001017303/2022/0001140361-23-014061/filing_metadata.csv b/raw/filings/0001017303/2022/0001140361-23-014061/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..d99f51fbf8ce8b7f419a55b2f4b01557479a7f51 --- /dev/null +++ b/raw/filings/0001017303/2022/0001140361-23-014061/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2023-03-28,2022-12-31,2023-03-27T23:00:48.000Z,0001140361-23-014061,form10k2022.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2022",10275611,1,1,https://www.sec.gov/Archives/edgar/data/1017303/000114036123014061/form10k2022.htm,https://www.sec.gov/Archives/edgar/data/1017303/000114036123014061/,2022,2022,1 diff --git a/raw/filings/0001017303/2022/0001140361-23-014061/item1.txt b/raw/filings/0001017303/2022/0001140361-23-014061/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..2f8a123e0d4df53433f33a0a08b5fed3f5c2ce1e --- /dev/null +++ b/raw/filings/0001017303/2022/0001140361-23-014061/item1.txt @@ -0,0 +1,89 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was incorporated in June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high-growth markets including food service technology, point of sale (“POS”) automation and casino and gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL®, and Ithaca®, brand names. During 2019, we launched a new line of products for the food service technology market, the BOHA! branded suite of cloud-based applications and companion hardware solutions. The BOHA! software and hardware products help restaurants, convenience stores and food service operators of all sizes automate the food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and terminals generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents. We sell our technology to original equipment manufacturers (“OEMs”), value-added resellers, and select distributors, as well as directly to end users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class service, support, labels, spare parts, accessories and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables used in the printing activities of customers in the restaurant and hospitality, retail, casino and gaming, and government markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the demand for these products. We operate in one reportable segment: the design, development, and marketing of software-driven technology and printing solutions for high growth markets, and provide related services, supplies and spare parts. Our primary operating, hardware research and development, and U.S. service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters and software research and development center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, 06518, with a telephone number of (203) 859-6800. +1 +Impact of the COVID-19 Pandemic and Global Supply Chain Disruptions +Since early 2020, the COVID-19 pandemic has continued to cause uncertainty and disruption in the global economy and financial markets. We have also been impacted by global supply chain issues, increased shipping costs and inflationary pressures, which have increased our costs and, in some instances, slowed our ability to deliver products to our customers. During 2021, our inventory levels decreased significantly as a result of these supply chain disruptions, and we experienced significantly lower sales levels. However, during 2022 we were able to increase our inventory levels and minimize the impact to our customers by successfully modifying our products that were affected by supply chain disruptions, as well as sourcing component parts from alternate suppliers. Although we were able to increase inventory levels during 2022 and expect to continue to do so in 2023, there can be no assurance that new or continuing supply chain disruptions will not affect our products or that we will be able to make timely modifications to address any future supply chain issues that arise. Further, while we have offset most of our cost increases by increasing prices of our products, there can be no guarantee that we will be able to offset any future cost increases should they arise. After a slowdown in the first quarter of 2022 resulting from the Omicron and other variants of COVID-19, we continued to experience demand recovery during the remainder of 2022. Based on our strong backlog position and continued market share expansion, we expect this recovery to continue into 2023, though the exact timing and pace of recovery may be impacted by global economic conditions. +During 2020 and 2021, our gross margin was negatively impacted by significantly lower sales levels from the economic effects of the COVID-19 pandemic, as well as increased material and shipping costs resulting from worldwide supply chain disruptions continuing into 2022. However, we saw significant improvement in the last nine months of 2022 resulting from significantly higher sales levels and price increases instituted on our products to mitigate higher material and shipping costs. Though we expect this trend to continue into 2023, our gross margin may be negatively impacted by the economic effects of any future cost increases that cannot be predicted, supply chain disruptions, inflationary pressures and potential new COVID-19 variants on the markets we serve. +Although in 2022 we continued to gradually return to more normalized pre-COVID-19 spending levels after implementing a number of cost saving measures in 2020 through 2022, we expect to continue to closely monitor our spending levels as circumstances warrant. +Since the onset of the COVID-19 pandemic, our top priority has been to ensure the health and safety of our employees while continuing to provide our customers with high-quality, personalized service. After instituting work-from-home practices in 2020, we transitioned in 2022 to a more flexible hybrid model to accommodate both our employees and the needs of the business. In addition, even with the transition to a hybrid model, our internal control structure remains operational and unchanged. +Balance Sheet, Cash Flow and Liquidity +We have taken the following actions to increase liquidity and strengthen our financial position in an effort to mitigate the negative impacts from the COVID-19 pandemic, supply chain disruptions and inflationary pressures: +● +Public Offerings – On August 16, 2021, the Company raised net proceeds of $11.2 million (including the exercise of the underwriters’ overallotment option on August 20, 2021), after deducting underwriting discounts, commissions and offering expenses, through an underwritten public offering and sold an aggregate of 842,375 shares of common stock. +● +PPP Loan – On May 1, 2020, the Company was granted a $2.2 million loan (the “PPP Loan”) under the Paycheck Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”) established under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which enabled us to return employees we furloughed earlier in 2020 to full time employment and to restore employees to full pay following certain pay cuts. On July 8, 2021, we received notice that the PPP Loan had been forgiven as of July 1, 2021. See Note 8 for further details regarding the PPP Loan. +● +Employee Retention Credit – Under the provisions of the CARES Act, the Company was eligible for a refundable employee retention credit subject to certain criteria. In connection with the CARES Act, the Company recognized the employee retention credit during the fourth quarter of 2021 as a $1.5 million “Gain from employee retention credit” in the Consolidated Statement of Operations for the year ended December 31, 2021 and recorded a $1.5 million “Employee retention credit receivable” in the Consolidated Balance Sheets as of December 31, 2022 and December 31, 2021. We received these funds in the first quarter of 2023. +● +Credit Facility – On March 13, 2020, we entered into a new credit facility with Siena Lending Group LLC that provides a revolving credit line of up to $10.0 million, subject to a borrowing base and on July 19, 2022, we entered into an amendment to extend the maturity of the facility to March 13, 2025. See Note 8 for further details regarding this facility. +● +Reduced Capital Expenditures – We limited capital expenditures during 2020 and 2021 and gradually increased expenses during 2022 as our sales improved. +Notwithstanding the foregoing, there is no assurance that the actions we have taken in response to the pandemic, global supply chain disruptions and inflation are sufficient or adequate, and we may be required to take additional preventive or responsive measures, as the ultimate extent of the effects of these risks on the Company, our financial condition, results of operations, liquidity, and cash flows are uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, Item 1A, Risk Factors, of this Form 10-K for further discussion of risks related to COVID-19, global supply chain disruptions and inflation. +2 +Products, Services and Distribution Methods +Printers, terminals and other hardware: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal printing technology for applications, primarily in the food service technology, POS automation, casino and gaming, and prior to exiting the market on December 31, 2021, the oil and gas printing markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices, paper handling capacities and cabinetry color. Our food service technology terminals also offer software configurable menu options and our food service technology market includes sales of optional hardware products including temperature probes, temperature sensors and gateways. +Food Service Technology (“FST”): Our primary offering in the food service technology market is our line of BOHA! products, which can combine our latest generation terminal and workstation which includes one or two printers and our BOHA! Labeling, timers, and media software. In addition, customers may individually purchase cloud-based software applications that connect to a separate application on a separate mobile device into a solution to automate back-of-house operations in restaurants, convenience stores and food service operations. The additional software offering of BOHA! consists of a variety of individually purchased software-as-a-service (“SaaS”)-based applications for both Android and iOS operating systems, including applications for, temperature monitoring, temperature taking and checklists and task lists. These applications are sold separately, and customers purchase the applications they need for their back-of-house operations. Customers may also purchase associated hardware, such as handheld devices, tablets, temperature probes and temperature sensors and gateways. The BOHA! Terminal combines an operating system and hardware components in a device that includes a touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, and nutritional labels for prepared foods, and “enjoy by” date labels. The BOHA! WorkStation uses an iPad or Android tablet instead of an integrated touchscreen. The BOHA! Terminal and the BOHA! WorkStation are equipped with the TransAct Enterprise Management System to ensure that only approved touchscreen functions are available on the touchscreen device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, casual dining, fast casual and quick-service restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service contracts, and technical support services. In the food service technology market, we use an internal sales force to solicit sales directly from end users. +POS automation: In the POS market, we sell a printer utilizing thermal printing technology. Our POS printer is used primarily by McDonald’s, and to a lesser extent, other quick-service restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. +Casino and gaming: We sell several models of printers used in slot machines and video lottery terminals (“VLTs”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in monochrome and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in international non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals, sports betting establishments and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through distributors. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales through our distributors. +We also offer a software solution, the EPICENTRAL Print System, including annual software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. With EPICENTRAL, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the casinos. +TSG : Through TSG, we proactively market the sale of consumable products (including POS receipt paper, ribbons and other printing supplies), replacement parts, maintenance and repair services, and shipping and handling charges. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, a 24-hour guaranteed replacement product service called TransAct Xpress™ and other repair services for our non-FST products. Within the United States, we provide repair services through our service center in Ithaca, New York. Internationally, we provide repair services through our European service center located in Doncaster, UK, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive training on all our products and services. In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our webstore, www.transactsupplies.com. +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. Almost all of our printers and terminals are currently produced by a third party manufacturer located in Thailand. A small portion of our products are assembled in our Ithaca, New York facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +3 +We procure component parts and subassemblies for use in the assembly of a small portion of our hardware products in Ithaca, New York. Critical component parts and subassemblies include thermal print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices, subject to availability. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist of fully assembled printers and terminals produced by our contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or unavailability. However, we have experienced and could continue to experience some disruption due to certain suppliers being unable to source specific components and we could experience temporary disruption in the availability of components. In addition, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy a majority of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for substantially all of our printer and food service technology terminal models, from a foreign contract manufacturer in Thailand. We believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms. We do not have supply agreements with foreign contract manufacturers, and we believe that our supply of thermal print mechanisms and fully assembled printers will be adequate in 2023 and the foreseeable future. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. As of January 31, 2023, we hold 34 United States and 34 foreign patents and have two foreign patent applications pending pertaining to our products. The remaining duration of these patents ranges from one to 17 years. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +Trademarks, Service Marks Trade Names and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, BOHA! TM , AccuDate™, EPICENTRAL®, Ithaca® and Printrex®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our food service technology products or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See also Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K. +Certain Significant Customers +IGT is our most significant customer, although to a lesser extent than in previous years, and has been since 1995. We sell casino and gaming printers and, prior to 2021, online lottery printers to IGT. On May 29, 2015, we signed an agreement with IGT to sell online lottery and casino printers to IGT on a non-exclusive basis through December 31, 2019. We decided not to renew the agreement upon its expiration and to exit the online lottery market. Although we no longer have an agreement with IGT, we expect to continue selling casino and gaming printers to IGT, as well as spare parts for our remaining, but declining, installed base of lottery printers, in the future. +Sales to IGT represented 10% and 9% of our total net sales for the years ended December 31, 2022 and 2021, respectively. +Backlog +Our backlog of firm orders was approximately $27.5 million as of February 28, 2023, compared to $14.2 million as of February 28, 2022. The increase in firm orders as of February 28, 2023 compared to February 28, 2022 is due primarily to advance orders placed by our casino and gaming customers due to increased production lead time, resulting from worldwide supply chain shortages caused by the pandemic. Based on customers’ current delivery requirements, we expect to fill and recognize as revenue $26.9 million of our current backlog during 2023, $0.5 million during 2024 and the remaining balance of the amount during 2025. +Competition +The market for transaction-based and specialty printers and food service technology terminals is extremely competitive, and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +4 +In the food service technology market, we primarily compete with Zenput, Squadle Inc., Jolt Software, Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, CMC Daymark, Integrated Control Corp, Digi International, and Toast. We compete in this market based largely on our ability to provide highly specialized purpose-built hardware products, different software applications that can be chosen by a customer and ongoing technical support. We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer a unique BOHA! branded solution to support back-of-house operations in the food service industry. Our competitors or others may develop, or may establish relationships with developers with the capability to develop, software and services that are similar to or competitive with ours, which may be disadvantageous to our competitive position. Certain portions of our food service technology software are licensed from a third party developer on a non-exclusive basis through 2031 and are subject to a revenue sharing arrangement with the developer. We are reliant upon the third party developer to further develop and maintain its developed software, and the developer controls the software source code. The license agreement does not preclude the developer from working with others on similar products. Also, the third party developer hosts the web-based applications. Therefore, presently, we are highly dependent upon this third party developer for continued service to our customers and the further development of our food service technology software products. +In the POS automation market, we primarily compete with Epson America, Inc., which holds a dominant market position. We also compete, to a much lesser extent, with Star Micronics America, Inc. and Citizen -- CBM America Corporation. Certain competitors of ours have greater financial resources and lower costs attributable to higher volume production which enables them to occasionally offer lower prices than us. +In the casino and gaming market (consisting principally of slot machine printing, VLT transaction printing and promotional coupon printing), we compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA, Eurocoin and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing technical support. In 2022, we increased our overall market share due largely to our largest competitor’s inability to supply product due to supply chain issues. +In the oil and gas market, our Printrex products competed primarily with the products of Imaging Systems Group, Inc. and Neuralog Inc. However, we exited the oil and gas market at the end of 2021 in order to shift our focus toward our higher-value, technology enabled food service technology and gaming products. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers and paper converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop and/or license new products (hardware and software), such as launching BOHA! in 2019, and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our market penetration, to take advantage of strategic relationships, and to lower the cost of our products by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, our printer products utilize certain thermal printing technologies and licensed software. If new technologies are introduced, or existing technologies evolve, we may be required to incorporate these technologies into our products. Alternatively, if such technologies were to become available to our competitors, our printer products could become obsolete, which could have a significant negative impact on our business. +Environmental Compliance +Our compliance with federal, state and local laws and regulations relating to environmental protection and discharge of hazardous materials has not had a material impact on our capital expenditures, earnings or competitive position, and we do not anticipate any material impact from such compliance in the future. +Available Information +We make available free of charge through the “Investor Relations” tab on our Internet website, www.transact-tech.com, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and all amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The content on any website referred to in this Form 10-K is not incorporated by reference in this Form 10-K unless expressly noted. +Employees +As of December 31, 2022, TransAct and our subsidiaries employed 128 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be good. +5 +Information about our Executive Officers +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +Bart C. Shuldman +65 +Chief Executive Officer +Steven A. DeMartino +53 +President, Chief Financial Officer, Treasurer and Secretary +Tracey S. Winslow +63 +Chief Revenue Officer +Brent Richtsmeier +58 +Chief Technology Officer +Bart C. Shuldman has been Chief Executive Officer and a Director of the Company since its formation in June 1996. Mr. Shuldman served as President of the Company from its formation until June 2010, when he relinquished the President title to focus on new products and markets, international expansion and potential acquisitions. Mr. Shuldman also served as Chairman of the Board from February 2001 through March 2022. +Steven A. DeMartino was named as TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +Tracey S. Winslow was appointed Chief Revenue Officer of the Company in March 2023 with responsibility for worldwide sales in all of the Company’s markets. Prior to this appointment, Ms. Winslow served as Senior Vice President, Casino and Gaming Sales from June 2010 to February 2023, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Winslow served as Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking with the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Winslow was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Brent Richtsmeier was named as Chief Technology Officer in September 2021. Previously, Mr. Richtsmeier served as Senior Vice President, Software Engineering since joining TransAct in December 2019 and was appointed as an officer of the Company in January 2021. Prior to joining TransAct, Mr. Richtsmeier was employed with Samsung, an electronics corporation, from May 2004 until November 2017 as the VP of Development where he was responsible for software strategy, software development at scale and business development. In November 2017, Samsung Electronics sold their business products division to HP Inc, and Mr. Richtsmeier transferred to HP Inc to become the Global Head of Cloud and Mobile Software Solutions until joining TransAct in 2019. +There are no family relationships between any of our executive officers and there is no arrangement or understanding between any of such officers and any other person pursuant to which he or she was selected as an officer. Each of our executive officers was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her earlier resignation or removal. +6 \ No newline at end of file diff --git a/raw/filings/0001017303/2022/0001140361-23-014061/item13.txt b/raw/filings/0001017303/2022/0001140361-23-014061/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..3cad6144fbbcd17dc133de5cdeea90cde741d63b --- /dev/null +++ b/raw/filings/0001017303/2022/0001140361-23-014061/item13.txt @@ -0,0 +1,2 @@ +Item 13. Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related Transactions” and “Corporate Governance-Board Leadership Structure and Independence” and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2022/0001140361-23-014061/item9a.txt b/raw/filings/0001017303/2022/0001140361-23-014061/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..fdcf6e7a7ed4de14356ca2e43205e30bc5a27343 --- /dev/null +++ b/raw/filings/0001017303/2022/0001140361-23-014061/item9a.txt @@ -0,0 +1,8 @@ +Item 9A. Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of December 31, 2022. Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles, and that they can be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2022. Our management based its assessment on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO”). In the opinion of management, TransAct maintained effective internal control over financial reporting as of December 31, 2022. +Changes in Internal Control over Financial Reporting +No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended December 31, 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001017303/2022/0001140361-23-014061/rp_note.txt b/raw/filings/0001017303/2022/0001140361-23-014061/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001017303/2022/0001140361-23-014061/rpt_disclosure.txt b/raw/filings/0001017303/2022/0001140361-23-014061/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..052655a6b44a7dd40e8aba6347cdee1858f2d5ea --- /dev/null +++ b/raw/filings/0001017303/2022/0001140361-23-014061/rpt_disclosure.txt @@ -0,0 +1,7 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains a Related Party Transactions Policy relating to the identification, review and approval of related party transactions, consistent with the requirements of The Nasdaq Global Market (“Nasdaq”) and the SEC. The Related Party Transactions Policy, which is administered by our Audit Committee, is set forth in our Standards of Business Conduct and Code of Ethics (the “Standards”) available on our website at www. transact -tech .com by clicking on “Investor Relations” under the “Company” dropdown menu and then selecting “Corporate Governance.” +In particular, the Standards require all directors, officers and employees to avoid any situation that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company, including engaging in “Related Party Transactions” unless approved or ratified by the Audit Committee. The term “Related Party Transaction” means any transaction, arrangement or relationship, or any series of similar transactions, arrangements or relationships, in which (i) the Company or any of its subsidiaries or Controlled Affiliates (as such term is defined in the policy) is or will be a participant, the aggregate amount involved will or may be expected to exceed $120,000 in any fiscal year, and (iii) any Related Party has or will have a direct or indirect interest. A “Related Party” is defined as any person who is or was (since the beginning of the last fiscal year for which the Company has filed an Annual Report on Form 10 -K and proxy statement, even if such person does not presently serve in that role) an executive officer, director or nominee for director of the Company, any stockholder owning more than 5% of any class of the Company’s voting securities, or an immediate family member of any such person. +The Chair of the Audit Committee must be notified before a Related Party engages in a Related Party Transaction. The Audit Committee is then responsible for reviewing the transaction. No transaction determined to be a Related Party Transaction will be approved or ratified if the transaction is contrary to the best interests of the Company and its stockholders. In determining whether to approve or ratify a Related Party Transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the transaction. +Emanuel P.N. Hilario, one of the Company’s directors, serves as President and Chief Executive Officer of The One Group Hospitality, Inc. (“The One Group”), and Haydee Ortiz Olinger, another Company director, serves on the Board of Directors of The One Group. From time to time, the Company sells food service technology products to The One Group. In 2023 and 2022, the Company’s sales of such products to The One Group totaled $246 thousand and $37 thousand, respectively. The transactions were made in the ordinary course of business and were conducted on an arm’s -length basis on terms substantially equal to those offered to persons who are not Related Parties and were approved and ratified by the Audit Committee. The Company expects to make additional sales to The One Group going forward in accordance with the Related Party Transactions Policy. +10 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001017303/2023/0001140361-24-013040/filing.txt b/raw/filings/0001017303/2023/0001140361-24-013040/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..a20120c851402d5f8603ebca91b9ad15ba941708 --- /dev/null +++ b/raw/filings/0001017303/2023/0001140361-24-013040/filing.txt @@ -0,0 +1,3777 @@ +false 12-31 2023 FY 0001017303 P12M P12M 688 0001017303 2023-01-01 2023-12-31 0001017303 2023-06-30 0001017303 2024-02-29 0001017303 2022-12-31 0001017303 2023-12-31 0001017303 us-gaap:SeriesAPreferredStockMember 2022-12-31 0001017303 us-gaap:SeriesAPreferredStockMember 2023-12-31 0001017303 2022-01-01 2022-12-31 0001017303 us-gaap:AccumulatedOtherComprehensiveIncomeMember 2021-12-31 0001017303 2021-12-31 0001017303 us-gaap:TreasuryStockCommonMember 2021-12-31 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2023 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from __________ to __________ +Commission file number: 0-21121 +TRANSACT TECHNOLOGIES INC +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center , +2319 Whitney Avenue, Suite 3B , Hamden , +CT +06518 +(Address of principal executive offices) +(Zip Code) +( 203 ) 859-6800 +(Registrant’s Telephone Number, Including Area Code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common stock, par value $0.01 per share +TACT +NASDAQ Global Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 +during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of +Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or +an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☒ +Smaller reporting company ☒ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new +or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its +management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark +whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received +by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $ 78,500,000 based on the last sale price on June 30, 2023. +As of February 29, 2024, the number of +shares outstanding of the registrant’s common stock, par value $0.01 per share, was 9,964,674 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement related to its 2024 Annual Meeting of Stockholders (the “Proxy Statement”) to be filed with the Securities and Exchange Commission within 120 days after the Registrant’s fiscal year end of December 31, 2023 are incorporated by reference into Part III of this Annual Report on Form 10-K. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +1 +Item 1A. +Risk Factors +6 +Item 1B. +Unresolved Staff Comments +19 +Item 1C. +Cybersecurity +19 +Item 2. +Properties +20 +Item 3. +Legal Proceedings +20 +Item 4. +Mine Safety Disclosures +20 +PART II. +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +21 +Item 6. +[Reserved] +21 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +21 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +29 +Item 8. +Financial Statements and Supplementary Data +29 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +29 +Item 9A. +Controls and Procedures +30 +Item 9B. +Other Information +30 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +30 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +31 +Item 11. +Executive Compensation +31 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +31 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +31 +Item 14. +Principal Accountant Fees and Services +31 +PART IV. +Item 15. +Exhibits and Financial Statement Schedules +32 +Item 16. +Form 10-K Summary +34 +SIGNATURES +35 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +Index +Smaller Reporting Company—Scaled Disclosure +Pursuant to Item 10(f) of Regulation S-K promulgated under the Securities Act of 1933, as amended (the “Securities Act”), as indicated herein, we have +elected to comply with certain scaled disclosure requirements applicable to “smaller reporting companies” in this Annual Report on Form 10-K for the year ended December 31, 2023 (this “Form 10-K”). +PART I +Forward-Looking Statements +Certain statements included in this Form 10-K may include “forward-looking statements” within the meaning of the U.S. federal +securities laws, including the Private Securities Litigation Reform Act of 1995. Forward-looking statements are any statements other than statements of historical fact. Forward-looking statements represent current views about possible future events +and are often identified by the use of forward-looking terminology, such as “may,” “will,” “could,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” “plan,” “predict,” “design” or “continue” or the negative thereof or other +similar words. Forward-looking statements are subject to certain risks, uncertainties and assumptions. In the event that one or more of such risks or uncertainties materialize, or one or more underlying assumptions prove incorrect, actual results +may differ materially from those expressed or implied by the forward-looking statements. +Important factors and uncertainties that could cause actual results to differ materially from those expressed or implied by the +forward-looking statements include, but are not limited to, the following: the adverse effects of current economic conditions on our business, operations, financial condition, results of operations and capital resources, difficulties or delays in +manufacturing or delivery of inventory or other supply chain disruptions, inflation and the Russia/Ukraine and Middle East conflicts, an inability of our customers to make payments on time or at all, diversion of management attention, a possible +future reduction in the value of goodwill or other intangible assets, inadequate manufacturing capacity or a shortfall or excess of inventory as a result of difficulty in predicting manufacturing requirements due to volatile economic conditions, +price increases or decreased availability of component parts or raw materials, exchange rate fluctuations, volatility of, and decreases in, trading prices of our common stock and the availability of needed financing on acceptable terms or at all; +our ability to successfully develop new products that garner customer acceptance and generate sales, both domestically and internationally, in the face of substantial competition; our reliance on an unrelated third party to develop, maintain and +host certain web-based food service application software and develop and maintain selected components of our downloadable software applications pursuant to a non-exclusive license agreement, and the risk that interruptions in our relationship with +that third party could materially impair our ability to provide services to our food service technology customers on a timely basis or at all and could require substantial expenditures to find or develop alternative software products; our ability to successfully grow our business in the food service technology market; risks associated with the pursuit of strategic initiatives and +business growth; general economic conditions; our dependence on contract manufacturers for the assembly of a large portion of our products in Asia; our dependence on significant suppliers; our ability to recruit and retain quality employees; our +dependence on third parties for sales outside the United States; marketplace acceptance of new products; risks associated with foreign operations; the availability of third party components at reasonable prices; price wars, supply chain disruptions +or other significant pricing pressures affecting the Company’s products in the United States or abroad; increased product costs or reduced customer demand for our products due to changes in U.S. policy that may result in trade wars or tariffs; our +ability to protect intellectual property; and other risk factors identified and discussed in Part I, Item 1A, Risk Factors, and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Form +10-K and that may be detailed from time to time in the Company’s other reports filed with the Securities and Exchange Commission (the “SEC”). +We caution readers not to place undue reliance on forward-looking statements, which speak only as of the date of this Form 10-K. We +undertake no obligation to publicly or otherwise revise any forward-looking statements, whether as a result of new information, future events or other factors, except where we are expressly required to do so by applicable law. +Item 1. Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was incorporated in +June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high-growth markets including food service +technology, point of sale (“POS”) automation and casino and gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL®, and Ithaca® brand +names. During 2019, we launched a new line of products for the food service technology market, the BOHA! hardware solutions and companion branded suite of cloud-based applications. The BOHA! software and hardware products help restaurants, +convenience stores and food service operators of all sizes automate the food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and terminals +generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents. We sell our technology to original equipment manufacturers (“OEMs”), value-added resellers, and select distributors, as well as directly to +end users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class service, support, labels, spare parts, accessories +and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables used in the printing activities of customers in +the restaurant and hospitality, retail, casino and gaming, and government markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the demand for these products. We operate in one reportable segment: the +design, development, and marketing of software-driven technology and printing solutions for high growth markets, and provide related services, supplies and spare parts. Our primary operating, hardware research and development, and U.S. service +center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters and software research and development center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom +(“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, 06518, and our telephone number is (203) 859-6800. +1 +Index +Recent Developments +In the fourth quarter of 2023, we completed an asset sale of our Printrex product line (essentially inventory +on-hand) and recorded a resulting non-operating gain of approximately $0.4 million in the fourth quarter of 2023. Prior to this sale, the last TransAct sales of Printrex products occurred in 2021. +Current Business Trends +After strong demand during the year due in part to our primary competitor’s struggle to deliver products in the +face of supply chain constraints, in late 2023, we began to see indications of a temporary slowdown in demand in the casino and gaming market, as customers that had built up excess inventory due to supply chain concerns advised us that they would +temporarily reduce orders until their stock normalized. This slowdown impacted our results in the fourth quarter of 2023, and we expect this trend to continue to impact results in 2024. Further, our primary competitor in the casino and gaming +market has resumed supplying product with increasing volume in 2024, which has begun to result in downward pricing pressure in that market and could exacerbate the demand slowdown, either of which could negatively impact our worldwide casino and +gaming sales. In addition, we have experienced cost increases as a result of current economic conditions, most of which we have been able to offset by increasing the prices of our products. However, there can be no guarantee that we will be able +to increase prices sufficiently to offset any future such cost increases that cannot be predicted, and we may be impacted by supply chain disruptions, inflationary pressures and other global economic conditions that may affect the markets we serve +and from which we source our supplies and parts. +Balance Sheet, Cash Flow and Liquidity +During the third quarter of 2023, we began a cost reduction initiative to reduce our overall level of operating expenses that includes reducing employee +headcount, trade show, advertising and other promotional marketing expenses, certain third party engineering resources and other expenses, and to a lesser extent, certain general and administrative expenses. We expect these actions will result in +approximately $3 million of annualized savings beginning in 2024, partially offset by typical annual inflationary and cost of living increases in operating expenses. Notwithstanding the foregoing, there is no assurance that the cost-cutting efforts +we have taken to bring expenses in line with our revenue and mitigate the impact of global economic conditions such as supply chain disruptions and inflation are sufficient or adequate, and we may be required to take additional measures, as the +ultimate extent of the effects of these risks on the Company, our financial condition, results of operations, liquidity, and cash flows are uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, +Item 1A, Risk Factors, of this Form 10-K for further discussion of risks related to global economic conditions, supply chain disruptions and inflation. +Products, Services, Markets and Distribution Methods +Printers, terminals and other +hardware: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals utilizing thermal printing technology for applications, primarily in the food service technology, POS automation, and +casino and gaming markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety of features and functions. Options typically include interface configuration, mounting configuration, paper cutting +devices and paper handling capacities. Our food service technology terminals also offer software configurable menu options and our food service technology market includes sales of optional hardware products including tablets, temperature sensors +and gateways (i.e. access points needed to enable wireless communications). +Food Service Technology (“FST”): +Our primary offering in the food service technology market is our line of BOHA! products, which can combine our latest generation terminal and workstation which includes one or two printers and our BOHA! labeling, timers, and media software. In +addition, customers may individually purchase cloud-based software applications that connect to a separate application on a separate mobile device into a solution to automate back-of-house operations in restaurants, convenience stores and food +service operations. The additional software offering of BOHA! consists of a variety of individually purchased software-as-a-service (“SaaS”)-based applications for both Android and iOS operating systems, including applications for, temperature +monitoring, temperature taking and creating checklists and task lists. These applications are sold separately, and customers purchase the applications they need for their back-of-house operations. Customers may also purchase associated hardware, +such as tablets, temperature sensors and gateways. The BOHA! Terminal and newly-launched Terminal 2 combine an operating system and hardware components in a device +that includes a touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, and nutritional labels for prepared foods, and “enjoy by” date labels. The BOHA! WorkStation uses an iPad or +Android tablet instead of an integrated touchscreen. The BOHA! Terminal, Terminal 2 and WorkStation are equipped with the TransAct Enterprise Management System to ensure that only approved touchscreen functions are available on the touchscreen +device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, casual dining, fast casual and quick-service restaurants, convenience stores, hospitality +establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is generated by software sales, including software +subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service contracts, and technical support services. In the food service technology market, we use an +internal sales force to solicit sales directly from end users. In May 2023, we launched our new BOHA! Terminal 2 (the “T2”). The T2 is designed to be a high-end product intended for enterprise customers with increased speed, print resolution and +wide-label capability. We started receiving orders for the T2 in the latter part of 2023 from both our international and domestic markets. +POS automation: In the POS market, we sell a printer utilizing thermal printing technology. Our POS printer is used primarily by McDonald’s, and to a lesser +extent, other quick-service restaurants and are located either at the checkout counter or within self-service kiosks, to print receipts for consumers or print on linerless labels. In the POS market, we primarily sell our products through a network +of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from end-users. +2 +Index +Casino and gaming: We sell +several models of printers used in slot machines and video lottery terminals (“VLTs”) and other gaming machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks and other gaming +venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in monochrome and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and +promotions. In addition, we sell printers using thermal roll-fed printing technology for use in international non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals, sports +betting establishments and other off-premise gaming type machines around the world. We sell our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed +slot machines directly to casinos and other gaming establishments and (2) through distributors. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales through our +distributors. In the fourth quarter of 2023, we launched the Epic TR80, our newest casino and gaming printer, which we believe will help us retain and expand our customer base in the casino and gaming markets. +We also offer a software solution, the EPICENTRAL Print System, including annual software maintenance, that enables casino operators to create +promotional coupons and marketing messages and to print them in real time at the slot machine. With EPICENTRAL, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor +or encourage additional visits to generate more revenue to the casinos. +TSG : Through TSG, we proactively market the sale of consumable products (including POS receipt paper, ribbons and other printing supplies), replacement parts, +maintenance and repair services, and shipping and handling charges. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, a 24-hour guaranteed replacement product service called TransAct Xpress™ and +other repair services for our non-FST products. Within the United States, we provide repair services through our service center in Ithaca, New York. Internationally, we provide repair services through our European service center located in +Doncaster, UK, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general +information. Technical and sales support personnel receive training on all our products and services. In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via +our webstore, www.transactsupplies.com. +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing +and assembly methods with high standards of workmanship. Almost all of our printers and terminals are currently produced by a third party manufacturer located in Thailand. A small portion of our products are assembled in our Ithaca, New York +facility largely on a configure-to-order basis using components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +Critical component parts and subassemblies include thermal print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic +parts, LCD screens, tablets, circuit boards and electronic components, which are obtained from domestic and foreign suppliers at competitive prices, subject to availability. As a result of the majority of our production being performed by our +contract manufacturers, the majority of our purchases consist of fully assembled printers and terminals produced by our contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for +our component parts, subassemblies and fully assembled printers and terminals to reduce the risk of parts shortages or unavailability. However, we have experienced and could continue to experience some disruption due to certain suppliers being +unable to source specific components and we could experience temporary disruption in the availability of components. In addition, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy a majority of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for +substantially all of our printer and food service technology terminal models, from a foreign contract manufacturer in Thailand. We believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers +and terminals, on comparable terms. We do not have supply agreements with foreign contract manufacturers, and we believe that our supply of thermal print mechanisms and fully assembled printers and terminals will be adequate in 2024 and the +foreseeable future. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to +establish and protect its proprietary rights in its products. As of January 31, 2024, we hold 26 active United States patents and 29 active foreign patents and have +seven foreign patent applications and two US patent applications pertaining to our products. The remaining duration of these patents ranges from one to 25 years. During the year ended December 31, 2023, no US patents were issued and two foreign +patents were issued. During the year ended December 31, 2023, one United States patent expired and one foreign patent expired. The expiration of this foreign patent has not had a material negative impact on our business. The expiration of any individual patent would not have a significant negative impact on our +business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them through employee and third party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy +certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary +rights as do the laws of the United States. There can be no assurance that legal protections we rely upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are +substantially equivalent or superior to our technologies. +3 +Index +Trademarks, Service Marks Trade Names and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including +our corporate names, logos and website names. Other trademarks, service marks and trade names appearing in this Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, BOHA! TM , AccuDate™, +EPICENTRAL® and Ithaca®. Solely for convenience, some of the trademarks, service marks, trade names and copyrights referred to in this Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable +law, our rights to our trademarks, service marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the holiday period, which +may negatively impact sales of our food service technology products or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general +practices of the industry and standard business procedures. See also Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K. +Certain Significant Customers +IGT is our most significant customer. We sell casino and gaming printers and, prior to 2021, online lottery printers to IGT. Although we no longer have +an agreement to sell lottery printers to IGT, we expect to continue selling casino and gaming printers to IGT, as well as spare parts for our remaining, but declining, installed base of lottery printers, in the future. +Sales to IGT represented 15% and 10% of our total net sales for the years ended December 31, 2023 and 2022, respectively. +Backlog +Our backlog of firm orders was approximately $10.7 million as of February 29, 2024, compared to $27.5 million as of February 28, 2023. The decrease in +firm orders as of February 29, 2024 compared to February 28, 2023 is due primarily to casino and gaming customers placing a large number of advance orders in 2023 due to pandemic-related supply chain shortages that have now begun to cease. Based +on customers’ current delivery requirements, we expect to fill and recognize as revenue $10.3 million of our current backlog during 2024, $0.3 million during 2025 and the remaining balance of the amount during 2026. +Competition +The market for transaction-based and specialty printers, food service technology terminals and related software applications is extremely competitive, +and we expect such competition to continue in the future. However, we experience less competition for EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater +financial, technical and marketing resources than TransAct. We believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product +customization, price, customer support, success in developing new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our +competitors, general market, economic and political conditions and, in some cases, the uniqueness of our products. +In the food service technology market, we primarily compete with CrunchTime! Information Systems, Inc. (including its Zenput and Squadle brands), Jolt +Software, Avery Dennison Corporation, Ecolab Inc., ITD Food Safety, CMC Daymark, Integrated Control Corp, Digi International, and Toast. We compete in this market based largely on our ability to provide highly specialized purpose-built hardware +products, different software applications that can be chosen by a customer and ongoing technical support. We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer a unique +BOHA! branded solution to support back-of-house operations in the food service industry. Our competitors or others may develop, or may establish relationships with developers with the capability to develop, software and services that are similar to +or competitive with ours, which may be disadvantageous to our competitive position. Certain portions of our food service technology software are licensed from a third party developer on a non-exclusive basis through 2031 and are subject to a +revenue sharing arrangement with the developer. We are reliant upon the third party developer to further develop and maintain its developed software, and the developer controls the software source code. The license agreement does not preclude the +developer or the Company from working with others on similar products. Also, the third party developer hosts the web-based applications. Therefore, presently, we are highly dependent upon this third party developer for continued service to our +customers and the further development of our food service technology software products. +In the POS automation market, we primarily compete with Epson America, Inc., which holds a dominant market position. We also compete, to a much lesser +extent, with BIXOLON America, Inc., Star Micronics America, Inc. and Citizen - CBM America Corporation. Certain competitors of ours have greater financial resources and lower costs attributable to higher volume production which enables them to +occasionally offer lower prices than us. +In the casino and gaming market (consisting principally of slot machine printing, VLT and sports betting transaction and promotional coupon printing), we +compete with several companies including JCM Global, Nanoptix, Inc., Custom Engineering SPA, Eurocoin and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized +products, custom engineering and ongoing technical support. We believe we have increased our market share in casino and gaming during 2022 and 2023 compared to prior years primarily as a result of our largest competitor’s inability to supply +product due to supply chain issues, but we that competitor has recently begun to supply product to the market, resulting in a more competitive environment in the casino and gaming market going forward in 2024. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers +and paper converters depending on the geographic area. +4 +Index +Our strategy for competing in our markets is to continually develop and/or license new products (hardware and software), such as launching the BOHA! +Terminal in 2019 and the BOHA! Terminal 2 in 2023, and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our market penetration, to take advantage of strategic relationships, +and to lower the cost of our products by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the +future. In addition, our printer products utilize certain thermal printing technologies and licensed software. If new technologies are introduced, or existing technologies evolve, we may be required to incorporate these technologies into our +products. Alternatively, if such technologies were to become available to our competitors, our printer products could become obsolete, which could have a significant negative impact on our business. +Governmental Regulation +The casino and gaming industries are generally subject to extensive and evolving regulation that in many jurisdictions includes licensing or regulatory +screening of suppliers, manufacturers and distributors and their applicable affiliates, their major shareholders, officers, directors and key employees. In addition, certain of our casino and gaming products and technologies must be certified or +approved in each of the jurisdictions in which we operate. Regulators review many facets of an applicant or holder of a license, including its financial stability, integrity and business experience. Any failure to receive a license or the loss of a +license that we currently hold could have a material adverse effect on us or on our results of operations, cash flow or financial condition. +While we believe that we are in compliance with all material casino and gaming laws and regulatory requirements applicable to us, we cannot assure that +our activities or the activities of our customers will not become the subject of any regulatory or law enforcement proceeding or that any such proceeding would not have a material adverse impact on us or our results of operations, cash flows or +financial condition. +Environmental Compliance +Our compliance with federal, state and local laws and regulations relating to environmental protection and discharge of hazardous materials has not had a +material impact on our capital expenditures, earnings or competitive position, and we do not anticipate any material impact from such compliance in the future. +Available Information +We make available free of charge through the “Investor Relations” tab on our website, www.transact-tech.com, our Annual Report on Form 10-K, Quarterly +Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and all amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC pursuant to Sections +13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the +SEC at http://www.sec.gov. The content on any website referred to in this Form 10-K is not incorporated by reference in this Form 10-K unless expressly noted. +Employees +As of December 31, 2023, TransAct and our subsidiaries employed 117 persons, all of whom were full-time employees. None of our employees are unionized, +and we consider our relationships with our employees to be good. +Information about our Executive Officers +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held +by each such person and each person’s principal occupations and employment during at least the past five years. +Name +Age +Position +John M. Dillon +74 +Chief Executive Officer +Steven A. DeMartino +54 +President, Chief Financial Officer, Treasurer and Secretary +Tracey S. Winslow +64 +Chief Revenue Officer +Brent Richtsmeier +59 +Chief Technology Officer +William J. DeFrances +59 +Vice President & Chief Accounting Officer +John M. Dillon was appointed Chief Executive Officer of TransAct on April 4, 2023 and has been a member of the Board of Directors of the Company since +2011. Mr. Dillon has been the Chairman of the Board of Directors of Aerospike, the world’s first flash-optimized database and the fastest database at scale, since January 2022 and served as CEO of Aerospike from January 2015 to January 2022. Prior +to joining Aerospike, Mr. Dillon served as CEO of Engine Yard, Inc., the leading cloud platform for automating and developing Ruby on Rails and PHP applications, from 2009 to 2014. He served as CEO for Navis, Inc., a private company specializing in +software systems for operating large marine container terminals and distribution centers, from 2002 to 2008. Before Navis, he also served as CEO for Salesforce, Inc. (formerly Salesforce.com) and President and CEO of Hyperion Solutions. He began +his career as a Systems Engineer for EDS (Electronic Data Systems) and then moved into a variety of sales management positions for various high-tech companies, including Oracle Corporation. Mr. Dillon holds a Bachelor’s degree in Engineering from +the United States Naval Academy and an MBA from Golden Gate University. +Steven A. DeMartino was named TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served +as Executive Vice President, Chief Financial Officer, Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January +1998 to October 2001, and Corporate Controller from August 1996 to December 1997. Mr. DeMartino is a certified public accountant. +5 +Index +Tracey S. Winslow was named Chief Revenue Officer of the Company in March 2023 with responsibility for worldwide sales in all of the Company’s markets. +Prior to this appointment, Ms. Winslow served as Senior Vice President, Casino and Gaming Sales from June 2010 to February 2023, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Winslow served as +Senior Vice President, Sales and Marketing from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking with the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, +Marketing. Prior to joining TransAct, Ms. Winslow was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing since 2003, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Brent Richtsmeier was named Chief Technology Officer in September 2021. Previously, Mr. Richtsmeier served as Senior Vice President, Software +Engineering since joining TransAct in December 2019 and was appointed as an officer of the Company in January 2021. Prior to joining TransAct, Mr. Richtsmeier was employed with Samsung Electronics Co., Ltd., an electronics corporation, from May +2004 until November 2017 as the VP of Development where he was responsible for software strategy, software development at scale and business development. In November 2017, Samsung Electronics sold their business products division to HP Inc, and +Mr. Richtsmeier transferred to HP Inc to become the Global Head of Cloud and Mobile Software Solutions until joining TransAct in 2019. +William J. DeFrances joined TransAct as Vice President & Chief Accounting Officer in July 2022. Mr. DeFrances previously served as Corporate +Controller at Omega Engineering, Inc., an electronics and instrumentation company that was, during Mr. DeFrances’ tenure, a subsidiary of Spectris plc, a UK public company listed on the London Stock Exchange, from September 2020 to July 2022. +From August 2019 to August 2020, Mr. DeFrances worked as an independent financial consultant. Prior to this, Mr. DeFrances held various positions with United Technologies Corporation (now RTX Corporation, formerly Raytheon Technologies +Corporation) (“UTC”) and Sikorsky Aircraft (owned by Lockheed Martin Corporation). Mr. DeFrances previously served as an Associate Director of Military Finance for Pratt & Whitney, a subsidiary of UTC, from October 2018 to August 2019, and +the Business Unit Controller, USG/Military and International Military for Sikorsky Aircraft from October 2015 to October 2018. Prior to this, Mr. DeFrances also served as the Assistant Controller, Financial Reporting for Sikorsky Aircraft from +2009 to 2013. In addition, Mr. DeFrances held various accounting and financial roles (VP Treasurer and VP Controller) from 2005 to 2009 at ATMI, Inc. (acquired by Entegris, Inc.), an advanced manufacturing company in the semiconductor industry. +Mr. DeFrances is a certified public accountant. +There are no family relationships between any of our executive officers and there is no arrangement or understanding between any of such officers and any +other person pursuant to which he or she was selected as an officer. Each of our executive officers was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her earlier resignation or +removal. +Item 1A . Risk Factors. +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Part II, Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are +not the only ones facing our Company. Additional risks and uncertainties not presently known to us, or that we currently believe to be immaterial, may also impair our business operations. In the event that such risks or uncertainties +materialize, our business, financial condition, cash flows and results of operations could be materially adversely affected. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking statements contained in +this Form 10-K to reflect actual results, changes in assumptions or other factors affecting such forward-looking statements, except as required by law. +Risks Related to our Financial Condition and Future Operating Results +We have a history of net losses, we anticipate making further investments in product development and we may not be +able to achieve, maintain or increase profitability in future periods. +While we generated $4.7 million of net income in 2023, we incurred a net loss of $5.9 million, $4.0 million and +$5.6 million in 2022, 2021 and 2020, respectively. We may not be able to achieve or maintain profitability in the future. In addition, we anticipate making further investments in product development and may increase expenses in future periods +which may affect our ability to maintain or increase profitability. We have expended, and expect to continue to expend, financial and other resources on developing our food service technology business, including expanding our offerings, developing +or acquiring new products and services and increasing our sales and marketing efforts. These efforts may be more costly than we expect and may not result in increased revenue or growth in our food service technology business. Any failure to +increase our revenue sufficiently to keep pace with our investments and other expenses could prevent us from maintaining or increasing profitability or positive cash flow on a consistent basis. This risk may be exacerbated by current economic +conditions, which have resulted and may continue to result in increased costs and, despite the demand recovery we experienced in 2022 and 2023, have recently resulted, and may continue to result, in decreased demand for our products as customers +who placed advance orders due to supply chain disruptions in 2022 and into 2023 pause orders while they sell accumulated inventory. If we are unable to successfully address these risks and challenges as we encounter them, our business, financial +condition, and results of operations could be adversely affected. +6 +Index +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are +likely to continue to vary due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data +from recent historical operating results, the market price of our common stock will likely decline. Fluctuations in our operating results and financial condition may occur due to a number of factors, including, but not limited to, those identified +below and throughout this “Risk Factors” section: +• +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +• +the geographic distribution of our sales and our supply chain; +• +market acceptance of our products, both domestically and internationally; +• +development of new competitive products by others; +• +increased levels of competition, including due to the return to market of our largest casino and gaming competitor; +• +our responses to price competition; +• +our level of research and development activities; +• +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +• +changes in the amount we spend to promote our products and services; +• +changes in the cost of satisfying our warranty obligations and servicing our installed base of products; +• +availability of third party components at reasonable prices or at all; +• +general economic and industry conditions, including inflation and changes in interest rates affecting returns on cash balances and investments, that affect customer +demand; +• +changes in customer demand as supply chain constraints ease; +• +the dependence of our supply chain on a few, foreign third party manufacturers and suppliers and the impact on our supply chain of product or component shortages and +cost increases due to events beyond our control, including inflation and political or social instability such as the ongoing Russia-Ukraine conflict and conflict in the Middle East and possible expansion of such conflicts; +• +severe weather events, public health crises, military actions and other external events out of our control that can disrupt our operations or the operations of our +customers’ or suppliers’ facilities; and +• +changes in accounting rules and regulations. +Due to all of the foregoing factors, and the other risks discussed in this Form 10-K, quarter-to-quarter comparisons of our operating results may not be +an indicator of future performance. +7 +Index +Risks Relating to Global Political and Economic Conditions +We purchase component parts and consumable products from third party and sole source suppliers, and any +interference with this supply chain may impact our ability to manufacture and sell our products. +We rely on third party or sole source suppliers to provide certain key components for our products. We do not have guaranteed supply contracts with any +of our component suppliers, and our suppliers could delay shipments, increase prices or cease manufacturing or selling such components to us at any time, such as the shortages in global microchip availability we experienced during much of 2022 and +2023. Such disruptions resulted in delays in delivery of products to customers and could in the future result in additional delays, even if we are able to source components from alternate suppliers. Supply chain disruptions have, in the past, +impacted our ability to maintain sufficient inventory on hand. As a result, we have paid, and if future disruptions occur we may have to pay in the future, increased shipping charges to expedite our receipt of components and inventory and the +delivery of finished products to our customers. In addition, we have incurred increased costs to obtain certain products and components from alternate suppliers when our usual suppliers did not have products available for us, and we may incur such +costs in the future if we need to seek alternate suppliers for any of our components. Cost increases and component shortages may be exacerbated by events beyond our control, such as changing economic conditions, inflation, currency and commodity +price fluctuations, tariffs, resource availability, transportation costs, weather conditions and natural disasters, political unrest and instability, war (such as the ongoing military conflict between Russia and Ukraine and the conflict in the +Middle East) and other factors impacting supply and demand pressures. Recurring or worsening disruptions in the supply chain of such component parts and consumable products could delay our production or release of our new products, cause us to +incur additional freight costs and hinder our ability to meet our commitments to customers. If we are unable to obtain sufficient quantity of these components on commercially reasonable terms or in a timely manner, or if we are unable to obtain +alternative sources for the components, sales of our products could be delayed or halted entirely or we may have to redesign our products, as we did with certain products in the recent past, to help meet market demand. In addition, supply chain +constraints and the resulting delays affected customer ordering habits and customer demand by leading to a temporary increase in advance orders in 2022 and into 2023, which has recently resulted in a decrease in customer demand as customers sell +accumulated inventory. It is our expectation that orders will continue to decrease, especially during the first half of 2024, as customers seek to balance inventory levels. Further, there can be no assurance that any cost increases attributable +to future supply chain disruptions can be fully offset by price increases, or that we will continue to be able to fulfill orders on time, and continued or prolonged impacts on our supply chain may result in lost sales, reduced gross margins or +damage to our end-customer relationships, which would have a material adverse effect on our financial results. +Catastrophic events, political unrest or a downturn in economic conditions may disrupt our business. +Geopolitical events, social unrest, war or the threat of war, including repercussions of the recent military conflict between Russia and Ukraine and the +conflict in the Middle East, terrorism, political instability, acts of public violence, boycotts, labor discord or disruptions, hostilities, pandemics or other public health crises, natural disasters or other catastrophic events may cause damage or +disruption to our operations or the operations of our customers, international commerce, and the global economy, and thus could harm our business. In particular, the reactions of governments, markets, and the general public to such events, many of +which are beyond our control, may result in a number of adverse consequences for our customers, business, operations, and results of operations. +For example, the continuing military conflict between Ukraine and Russia, as +well as the financial and trade-related restrictions associated with Russia and Belarus and economic sanctions on certain individuals and entities in Russia and Belarus, have impacted international trade relations, and resulted in +sustained increases in the cost of materials and components. If the conflict continues to persist or escalates, this may further disrupt global supply chains and could +result in shortages of key materials or components that our suppliers require to satisfy our needs. Any increases in the cost, or shortages, of raw materials, components or energy may continue to create supply issues that could constrain +manufacturing levels for our products. +In addition, based on the complex relationships among China, Hong Kong, Taiwan, and the United States, there is risk that political, diplomatic, and +national security influences might lead to trade, technology, or capital disputes, or disruptions that may affect our business or suppliers in Asia. These tensions may be exacerbated by continuing or new sanctions imposed in connection with the +Russia–Ukraine conflict, as there continues to be unwillingness on the part of China to support ongoing or expanded sanctions, which could distance China from its existing trade partners. More recently, both the United States and the European Union +have considered imposing sanctions directly on Chinese companies believed to be assisting Russia. Any increase in geopolitical tensions or expansion of sanctions either in Russia or Belarus or against Chinese companies may have a significant +negative impact on our business or on the regional or global economy. +In the event of a major earthquake, hurricane or catastrophic event such as fire, power loss, telecommunications failure, cyber-attack, war or terrorist +attack, we may be unable to continue our operations and may endure system interruptions, reputational harm, breaches of data security, and loss of critical data, all of which would harm our business, results of operations, and financial condition. +In addition, the insurance we maintain would likely not be adequate to cover our losses resulting from disasters or other business interruptions. Any downturn in the economy in general, including any lingering economic impacts of the COVID-19 +pandemic (including inflation and supply chain disruptions) and the impact of the Russia–Ukraine conflict and the Middle East conflict, or in the food service or casino and gaming industries in particular could result in reduced demand for our +products and could adversely affect our business and results of operations. In addition, heightened security measures or responses to hostilities may cause certain governments to restrict the import or export of goods, as has occurred with respect +to the export of oil from Russia, which may have an adverse effect on our ability to buy and sell goods or on the cost to obtain components. +8 +Index +Risks Related to Our Operations +Our food service technology business depends substantially on our customers renewing their subscriptions with the +Company. Any decline in our customer renewals could harm our food service technology business, results of operations and financial condition. +Our subscription offerings are term-based, and in order for us to maintain or improve our results of operations, it is important that our customers renew +their subscriptions with us when the existing subscription term expires and renew on the same terms or terms more favorable to the Company. Our customers have no obligation to renew their applications and subscriptions, and they may not renew one +or more of their applications as they are purchased separately and individually. We also may not be able to accurately predict customer renewal rates. Customers may elect not to renew their subscriptions with us for a variety of reasons, including +as a result of changes in their strategic priorities, budgets and costs and, in some instances, due to competing solutions. Our retention rate may also decline or fluctuate as a result of a number of other factors, including our customers’ +satisfaction or dissatisfaction with our solutions, the increase in the contract value of subscription and support contracts from new customers, the effectiveness of our customer support services, our pricing, the prices of competing products or +services, global economic conditions and the other risk factors described herein. As a result, there can be no assurance that our food service technology customers will renew any or all of their individually purchased application subscriptions. If +our customers do not renew their subscriptions or renew on less favorable terms, our business, results of operations and financial condition may be adversely affected. +Because we rely in part on revenue from subscription contracts and recognize revenue from subscription contracts +over the term of the relevant subscription period, downturns or upturns in sales are not immediately reflected in full in our results of operations. +Subscription services revenue accounts for a growing portion of our food service technology revenue. Sales of new or renewal subscription contracts may +decline or fluctuate as a result of a number of factors, including customers’ level of satisfaction with our solutions, the prices of our subscriptions, the prices and features of products or subscriptions offered by our competitors, reductions in +our customers’ spending levels, or other changes in consumer behavior. If our sales of new or renewal subscription contracts decline, our revenue and revenue growth may decline. We recognize subscription revenue ratably over the term of the +relevant subscription period, which is generally 12 months in duration. As a result, much of the subscription revenue we report each quarter is derived from subscription contracts that we sold in prior quarters. +Consequently, a decline in new or renewed subscription contracts in any one quarter will not be fully reflected in revenue in that quarter but will +negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in new or renewal sales of our subscriptions is not reflected in full in our results of operations in a given period. Also, it is difficult for us to +rapidly increase our subscription revenue through additional sales in any period, as revenue from new and renewal subscription contracts must be recognized ratably over the applicable subscription period. Furthermore, any increases in the average +term of subscription contracts would result in revenue for those subscription contracts being recognized over longer periods of time. +Our calculation of recurring revenue and average revenue per user (“ARPU”) may differ from how other SaaS-based +companies calculate such metrics; our definitions include sales of our consumable labels, which generally fluctuate from period to period. +We use recurring revenue and ARPU as performance indicators in connection with our food service technology market, and we include consumable label sales, +in addition to subscription software, extended warranty and service contracts, in our calculation of these metrics. Consumable labels are not sold on a subscription basis or subject to any minimum purchase requirements. In addition, our label sales +typically fluctuate and are dependent upon the current demand from food service and restaurant customers, which may be affected by factors such as general economic downturns and seasonality. As a result, our use and definitions of recurring revenue +and ARPU may not be comparable with, and may be subject to increased fluctuation relative to, those of other SaaS-based companies that do not include non-subscription components such as label sales in their definitions of recurring revenue or ARPU. +Overestimates or underestimates in our manufacturing forecasts could cause us to hold insufficient or excess +inventory or result in delays in the manufacturing and delivery of our products, which could interfere with our ability to retain orders or provide services to our customers. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays. We currently use a +rolling 12-month forecast based primarily on our anticipated product orders and our product order history to help determine our requirements for components and materials. It is important that we accurately predict both the demand for our products +and the lead-time required to obtain the necessary components and raw materials. We have also modified our products in the past to substitute available components in the place of those that have become scarce or difficult to obtain, and in some +instances have identified alternate sources for certain components. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size of the order, +contract terms, and demand for each component at a given time, as well as supply shortages with respect to raw materials needed to produce the components. If we underestimate our requirements, or if we are unable to obtain components on time due to +supply shortages, as has occurred in the wake of the COVID-19 pandemic and global supply chain disruptions, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and interfere with our +ability to timely deliver products to our customers and adversely impact our sales. If we overestimate our requirements, we could have excess inventory of parts and finished products. Some of the actions we have taken to meet customer demand in the +face of supply chain disruptions have raised our costs and decreased margins on our products, and any such actions that we take in the future could have a similar effect. Any future underestimate or overestimate of supply requirements, and any +actions we may take in the future to navigate supply chain disruptions, could have a material adverse effect on our business and results of operations. +9 +Index +We depend on key personnel, the loss of whom could have a material adverse impact on our business. +Our future success may depend in significant part upon the continued service of certain key management and other personnel. There can be no assurance +that we will be able to recruit and retain such personnel. The loss of either John M. Dillon, the Company’s Chief Executive Officer, or Steven A. DeMartino, the Company’s President, Chief Financial Officer, Treasurer and Secretary, or the loss of +certain groups of key employees, such as our or sales and engineering teams, could have a material adverse effect on our business and results of operations. +Our ability to recruit, retain, and develop qualified personnel is critical to our success and growth. +To successfully compete and grow our business, we must recruit, develop and retain highly qualified managerial, technical and sales and marketing +personnel. In addition, we must develop, maintain and, as necessary, implement appropriate succession plans to ensure we have the necessary human resources capable of maintaining continuity in our business. +The market for qualified personnel is competitive, and we may not succeed in recruiting additional personnel or may fail to effectively replace current +personnel who depart with qualified or effective successors. Our effort to retain and develop personnel may also result in significant additional expenses, which could adversely affect our profitability. We are also substantially dependent on our +sales force to obtain new customers and increase sales to existing customers. There is significant competition for sales personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will +depend, in large part, on our success in recruiting, training, and retaining a sufficient number of sales personnel to support our growth. If we are unable to hire, train, and retain a sufficient number of qualified and successful sales personnel, +our business, financial condition, and results of operations may be harmed. +If we fail to offer high quality support, our business and reputation could suffer. +Our customers rely on us and our third party service providers for support of our software and services included in our food service technology +subscription packages. High-quality support is important for the renewal and expansion of our agreements with existing customers. The importance of high-quality support will increase as we expand our business and pursue new customers. If we or our +third party service providers do not help our customers quickly resolve issues and provide effective ongoing support, our ability to sell new food service technology products to existing and new customers could suffer and our reputation and +relationships with existing or potential customers could be harmed. +We experience elements of seasonal fluctuations in the food service technology and POS markets which could cause +our stock price to fluctuate. +Our food service technology business is highly dependent on the behavior patterns of our customers and their guests. Restaurants typically reduce +purchases of equipment in the fourth calendar quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our food service technology products or POS printers during that period. As a result, +seasonality may cause fluctuations in our financial results, and other trends that develop may similarly impact our results of operations. +Risks Related to Product Development +Our revenue and profitability depend on our ability to continue to develop or license, on a timely basis, new +products and technologies which are free from hardware or software anomalies and cannot be fraudulently manipulated, and customer acceptance of such products. +Our success depends upon our, and our development partners’, ability to timely adapt our capabilities and processes to meet the demands of producing new +and innovative products. Because our newer products contain software and generally are more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product +innovation. In addition, the food service technology industry continues to experience technological developments and innovations (such as the use of artificial intelligence and machine learning), and if we are unable to provide enhancements and new +features and integrations for our existing platform, or if we are unable to efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +In addition, even if we, or developers on our behalf, successfully develop such products, there is no assurance that our innovations will be accepted by +our customers. Developing and marketing new products, such as our line of BOHA! products, is costly, and our business could be materially adversely affected if we are unable to generate sales of such products or if our existing or new customers do +not quickly accept such products. Customer acceptance is crucial because new products typically have little competition and market penetration due to their novelty. Customer acceptance of new products is never assured and may take time to +materialize, even with respect to products developed with customer input. In addition, we may not be able to obtain necessary registrations, licenses, permits or regulatory approvals for new products in the casino and gaming market on a timely +basis or at all, which may adversely affect our ability to develop such products. Further, technological innovation often results in unintended consequences such as bugs, vulnerabilities, and other system failures. Any such bug, vulnerability, or +failure, especially in connection with a significant technical implementation or change, could result in lost business, harm to our brand or reputation, consumer complaints, and other adverse consequences, any of which could materially adversely +affect our business, results of operations, and financial condition. +10 +Index +Risks Related to Intellectual Property and Data Security +Cybersecurity and privacy breaches, cyber-attacks, or other disruptions could expose us to liability, affect our +business, and damage our reputation. +We are increasingly dependent on our information technology systems and infrastructure for our business. We collect, store, and transmit sensitive +information including intellectual property, proprietary business information and personal information of employees and, to a lesser extent, customers in connection with business operations. The secure maintenance of this information is critical to +our operations and business strategy. Some of this information could be an attractive target of criminal attack by third parties with a wide range of motives and expertise, including organized criminal groups, disgruntled current or former +employees, and others. Cyber-attacks are of ever-increasing levels of sophistication, and despite our extensive security measures, our information technology and infrastructure may be vulnerable to such attacks or may be breached, including due to +employee error or malfeasance. Further, our BOHA! applications are hosted within cloud platforms that are managed by third parties. Any such breach could compromise our networks and the information stored there could be accessed, publicly +disclosed, lost or stolen, and our business operations may be interrupted. If our systems become compromised, we may not promptly discover the intrusion. In addition, the techniques used to obtain unauthorized access to networks, or to sabotage IT +systems, change frequently, including through the use of artificial intelligence and generally are not recognized until launched against a target. We may be unable to anticipate these techniques or to implement adequate preventative measures. Like other companies in our industry, we have experienced attacks to our data and systems, including malware and computer viruses that we have been able to detect +and eliminate. In addition, as disclosed on November 16, 2022, a criminal cybersecurity incident temporarily impacted our operational and information technology systems. If our systems fail or are breached or disrupted by other future attacks, we +could lose product sales, and suffer reputational damage and loss of customer confidence. Such incidents could require notification to affected individuals and may result in legal claims or proceedings and liability under federal and state laws +that protect the privacy and security of personal information. If third parties use a cyber-attack to gain access to our proprietary information, they may sell it or use it to duplicate our products, which could put us at a competitive +disadvantage. Any one of these events could cause our business to be materially harmed and our results of operations to be adversely impacted, and there can be no assurance that the insurance that we maintain to address certain aspects of +cybersecurity risks will be sufficient to cover all losses or all types of claims that may arise. +These risks may be exacerbated by global political unrest. For example, the Russia–Ukraine conflict and related sanctions imposed by the U.S. government +may expose government entities and public and private U.S. companies to attempted or actual cyber-security attacks launched in retaliation, and these attacks could materially disrupt our supply chain or our systems and operations or those of our +customers and suppliers. See Part I, Item 1C. Cybersecurity, of this Form 10-K discussed below for information regarding our cybersecurity risk management practices. +The inability to protect our intellectual property rights could harm our reputation, damage our business or +interfere with our competitive position. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trademarks, service marks, trade +secrets, technology licensing agreements, nondisclosure agreements and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without +authorization, to obtain and use information that we regard as trade secrets. Our pending patents may be denied, and our patents may be circumvented by our competitors. In addition, the laws of some foreign countries do not protect our proprietary +rights as fully as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar +technologies. Our failure to adequately protect our proprietary rights could have a material adverse effect on our competitive position and our business. +Prosecuting or defending against intellectual property litigation could be time consuming and costly, and claims +that we have infringed upon the intellectual property rights of others could impede our business and put us at a competitive disadvantage. +Prosecuting and defending against intellectual property litigation is generally complex, costly, protracted, and highly disruptive to business operations +by diverting the attention and energies of management and key technical personnel. We are committed to aggressively asserting and defending our technology and related intellectual property rights, which we have spent a significant amount of money +to develop. Similarly, third parties have claimed and may claim, from time to time in the future, that we have violated their intellectual property rights. In the event that a court rules that we have violated a third party’s patent or other +intellectual property rights, we may be prevented from operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish our objectives. Litigation +relating to any such claims could be costly and, if successful, could result in costly judgments or settlements, and there can be no assurance that a license or a substitute technology will be available on favorable terms, or at all. Any such +outcome could have a material adverse effect on our business, financial condition and results of operations. +11 +Index +Risks Related to Our Partners and Suppliers +We rely on an unrelated third party to develop, maintain and host certain portions of our food service technology +software, and any disruption in the relationship with that third party, or any defects in the software provided by that third party, could have a material adverse effect on our reputation, business, financial condition and results of operations. +We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer our unique BOHA! +branded solution to support back-of-house operations in the food service industry. Certain web-based food service application software and selected components of our downloadable software applications are licensed from a third party developer on a +non-exclusive basis through 2031 and are subject to a revenue sharing arrangement with the developer. We are reliant upon the third party developer to further develop and maintain its developed software, and the developer controls the software +source code. Therefore, presently, we are highly dependent on this third party developer for continued service to our customers and the further development of our food service technology software products. If the software provider were to +terminate operations or otherwise be unavailable to provide maintenance, hosting and development services to us and our customers, the availability or usage of our software products could be disrupted and our customers could be adversely affected. +In any such case, we may need to seek comparable software and services from other third parties or develop it internally, which could require significant time and expense. There can be no assurance that such software or services would be available +from other sources, or that if available, they would be of comparable quality and cost. Moreover, any efforts to develop new software, whether internal or by third parties, would require significant lead time, and there could be an interruption in +service during any period in which the software provider ceases to provide products and services and new products remain under development. Any such occurrence could materially and adversely impact our business, financial condition and results of +operations. +Any errors or defects in, or failures of, third party software or applications could result in errors or defects in or failures of our food service +technology products and services, which could be costly to correct and have a material adverse effect on our reputation, business, financial condition and results of operations. +We are currently dependent upon a manufacturer located in Thailand for the manufacturing and assembly of +substantially all of our printers and terminals, and any further or future disruption in the businesses or operations of this manufacturer, such as those caused by the COVID-19 pandemic, political, social or economic instability, war, trade +restrictions or tariffs, severe weather, changes in climate, additional public health crises and other events out of our control could materially adversely affect our business, financial condition and results of operations. +In an effort to maximize cost savings and operational benefits, we have outsourced substantially all of the manufacturing and assembly of our printers +and terminals to a contract manufacturer located in Thailand. As a result, we are dependent on them for the manufacturing of our products, and any disruption in such manufacturing or the export of products from this manufacturer to the U.S. may +adversely affect our business, financial condition and results of operations. +Risks affecting the businesses and operations of our manufacturer in Thailand include: political and regional strife; war; labor shortages; severe +weather and natural disasters such as earthquakes, hurricanes, fires, and floods, whether as a result of climate change or otherwise; lengthy power outages; increased pricing, financial instability and capacity constraints of shippers; government +imposition of tariffs which may impact the cost or availability of products or components that we purchase; and concerns with or threats of public health crises, contagious diseases or health epidemics. Though we are seeking a second source, the +risk to our business posed by any disruption in manufacturing is exacerbated by the concentration of substantially all of our manufacturing operations in one manufacturer located in Thailand. +If the contract manufacturer is unable to manufacture our products or continue operating its facilities, as occurred in connection with the COVID-19 +pandemic, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop an alternative manufacturing facility, which could be costly and time +consuming and have a material adverse effect on our operating and financial results. +We may also incur increased business continuity and reputational risks to the extent that we continue to outsource the manufacturing and assembly of our +products to foreign third party service providers. For example, outsourcing of manufacturing prevents us from exercising control over the assembly of certain of our products and related operations or processes, including the internal controls +associated with operations and processes conducted and the quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure efficiencies and +our operating and financial results could be materially adversely affected. Outsourcing also exposes us to increased risk of infringement or misappropriation of our intellectual property, to which our manufacturers have access. Because our +manufacturer is located in Asia, there is no guarantee that our intellectual property rights will be protected or enforced to the same extent as under U.S. federal and state laws. Consequently, we may not be able to prevent third parties from +developing or selling products made using our technologies. +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and services. We may be adversely impacted +by any conflicts that could arise between and among our various sales channels. +12 +Index +Our dependence upon distributors and resellers exposes us to numerous risks, including: +• +loss of channel and the ability to bring new products to market; +• +concentration of credit risk, including disruption in distribution should the distributors, and / or resellers’ financial condition deteriorate; +• +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +• +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +• +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon the business, +consolidated results of operations and financial condition. +We currently rely on third party service providers to host our food service technology software and deliver +certain services, and any interruptions or delays in services from these third parties could impair the delivery of our products and services, and our business, results of operations, and financial condition could be materially adversely affected. +We rely on a third party service provider to host our food service technology software. Third parties also provide services to key aspects of our +operations, including Internet connections and networking, data storage and processing, trust and safety and security infrastructure. We do not control the operation, physical security, or data security of any of these third party providers. Our +efforts to use commercially reasonable diligence in the selection and retention of such third party providers may be insufficient or inadequate to prevent or remediate such operational and security risks. Our third party providers may be subject to +intrusions, computer viruses, denial-of-service attacks, sabotage, acts of vandalism, acts of terrorism or other misconduct. They are vulnerable to damage or interruption from power loss, telecommunications failures, fires, floods, earthquakes, +hurricanes, tornadoes, and similar events, and they may be subject to financial, legal, regulatory, and labor issues, each of which may impose additional costs or requirements on us or prevent these third parties from providing services to us or +our customers on our behalf. From time to time, our software maintained by these third parties has experienced brief interruptions in service which we have been able to resolve promptly by working with the third party providers, and there may be +future such interruptions that could have a material adverse effect on our customer relationships or be more costly or time-consuming to resolve. In addition, these third parties may breach their agreements with us, disagree with our +interpretation of contract terms or applicable laws and regulations, refuse to continue or renew these agreements on commercially reasonable terms or at all, fail to or refuse to process transactions or provide other services adequately, take +actions that degrade the functionality of our platform and services, increase prices, impose additional costs or requirements on us or our customers, or give preferential treatment to our competitors. If we are unable to procure alternatives in a +timely and efficient manner and on acceptable terms, or at all, we may be subject to business disruptions, losses, or costs to remediate any of these deficiencies. The occurrence of any of the above events could result in reputational damage, legal +or regulatory proceedings, loss of customers or other adverse consequences, any of which could materially adversely affect our business, results of operations, and financial condition. +Risks Related to Competition, Sales and Marketing +We compete in highly competitive markets, which are likely to become more competitive. Competitors may be able to +respond more quickly to new or emerging technology and changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, consumables and services. Our principal competitors have +substantial marketing, financial, development and personnel resources. To remain competitive, we believe we must continue to provide: +• +technologically advanced products that satisfy user demands; +• +superior customer service; +• +high levels of quality and reliability; and +• +dependable and efficient distribution networks. +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in price reductions, +lower gross profit margins and loss of market share, and could require increased spending on research and development, sales and marketing and customer support. For example, we believe our largest competitor in the casino and gaming market has +begun to resume supplying product and will likely continue to do so at an increasing rate throughout 2024, which we anticipate will result in a more competitive environment in the casino and gaming market going forward and may cause downward +pricing pressure or a loss of market share that we believe we have gained while the competitor was unable to supply product. Any such occurrence could negatively impact our worldwide casino and gaming sales. In addition, some competitors may make +strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products, which may include relationships with our software developer. Any of these factors could reduce our earnings. +13 +Index +Our food service technology market operates in an emerging and evolving industry, which makes it difficult to +evaluate the future prospects of this market. +We launched our BOHA! offering in 2019 and have grown our food service technology significantly since then. This is still an emerging market that is +continually evolving as technology develops to automate back-of-house tasks that were historically performed manually. This evolving nature of the food service technology market may make it difficult to evaluate our future prospects in this market +and the risks and challenges we may encounter. These risks and challenges include, but are not limited to, our ability to: +• +accurately forecast our revenue and plan our operating expenses; +• +increase the number of customers (and retain existing customers and their guests) using our platform; +• +successfully compete with current and future competitors; +• +successfully expand our market presence in existing markets and enter new markets and geographies; +• +maintain and enhance the value of our reputation and brand; +• +develop and maintain strategic relationships with other market participants that provide complementary products; +• +adapt to rapidly evolving trends in the ways our customers interact with technology, including through the use of emerging artificial intelligence and machine +learning technologies; +• +timely respond to customer needs with technology developments that enable our products to evolve to meet the changing demands of the marketplace; +• +avoid interruptions or disruptions in our service; +• +manage the risk of loss relating to food safety issues if there is a failure of our offerings designed to help in part to assure perishable goods are safely +preserved; +Risks Related to Our Customers +We are dependent on sales to one large customer; the loss of this customer or reduction in orders from this +customer could materially affect our sales. +Casino and gaming sales and lottery printer spare parts sales to IGT represent a material percentage of our net sales. A reduction, delay or +cancellation in orders from this customer, including reductions or delays due to market, economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Risks Associated with Determining and Pursuing Strategic Initiatives and Business Growth +Our success may depend in part on our ability to identify and pursue the best long-term strategy for our business. +We have engaged a strategic advisor to assist in determining the best long-term strategy for the business. Accordingly, we may seek to pursue any number +of alternative strategies, which may include acquisitions, dispositions, financings and/or the development and implementation of new strategies designed to grow our business. Regardless of what strategy we ultimately determine to pursue, we +continue to seek to grow our business. Assuming growth occurs, it will require the expansion of customer relationships in domestic and international markets, the successful development and marketing of new products for our existing and new +customers, expanded internal sales and marketing, customer service and support, the continued implementation and improvement of our operational, financial and management information systems and the dedication of a significant amount of additional +resources and increased expenditures to support such additional resources. +No timetable has been established for our review of the best long-term strategy for our business, and we do not intend to disclose developments or +provide updates on the progress or status of our ongoing review until our Board of Directors deems such disclosure is appropriate or required. During the course of this review, perceived uncertainties related to our future may result in the loss of +potential business opportunities and volatility in our stock price and may make it more difficult for us to attract and retain qualified personnel and business partners. +Acquisitions, dispositions and other strategic transactions involve a number of risks, including: (i) the potential disruption of our ongoing business; +(ii) the distraction of management away from the ongoing oversight of our existing business activities; (iii) if we determined to pursue a disposition strategy, we may not be able to identify, pursue and close a transaction that provides adequate +value to the Company and its stockholders; (iv) the potential departure of key personnel during the negotiation or pendency of a transaction; (v) the loss or reduction of control over certain of our assets; (vi) the anticipated benefits and cost +savings of those transactions not being realized fully, or at all, or taking longer to realize than anticipated; (vii) an increase in the scope and complexity of our operations or the management of our business subsequent to a transaction; (viii) +incurring additional indebtedness or the potential sale of additional shares of our common stock in public or private offerings to finance acquisitions or strategic transactions, which may be dilutive to existing stockholders or cause the price of +our common stock to decline; and (ix) the depletion of cash to pay for an acquisition. +14 +Index +There can be no assurance that we will be able to successfully implement a growth strategy, or that we can successfully manage expanded operations, if they occur. If we expand, we may from time-to-time experience constraints that will adversely +affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our results of operations and financial condition. +Further, there can be no assurance that we will find suitable opportunities for strategic transactions at acceptable prices or on acceptable terms, be +successful in negotiating required agreements, obtain sufficient financing on acceptable terms or at all if necessary, successfully close transactions after signing such agreements, or that any resulting transaction will have a positive effect on +stockholder value. A strategic transaction may result in a significant change in the nature of our business, operations and strategy, and we may encounter unforeseen obstacles or costs in implementing a strategic transaction. +Risks Related to Our International Operations +In addition to maintaining offices in the UK, Macau and Thailand, we sell and ship a significant portion of our +products internationally and rely on third parties that make up part of our global salesforce. The international nature of our operations may expose us to certain risks associated with doing business outside of the U.S., including risks posed by +tariffs and changes in trade relations. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected to continue to +account for a material portion of net sales. In addition, our manufacturer and suppliers are largely located in Asia. As a result, our products are largely exported to one of our facilities in the United States, which makes our operations +vulnerable to disruptions in trade that could adversely affect our business results. +Our international operations, including our reliance on manufacturers and suppliers located in Asia, our worldwide sales team, and our sales to customers +located outside the United States, expose us to disruptions in trade and other associated risks such as: +• +the imposition of additional duties, tariffs, quotas, taxes, trade barriers, capital flow restrictions and other charges on imports and exports by the United States +or the governments of the countries in which we or our manufacturers and suppliers operate; +• +delays in the delivery of cargo due to port security considerations, labor disputes such as dock strikes, and our reliance on a limited number of shipping and air +carriers, which may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost; +• +fluctuations in the value of the U.S. dollar against foreign currencies, which could restrict sales, or increase costs of purchasing, in foreign countries; +• +economic or political instability in any of the countries in which we or our manufacturers or suppliers operate, which could result in a reduction in demand for our +products due to political and economic instability or impair our foreign assets; +• +a reduced ability or inability to sell in or purchase from certain markets as a result of export or import restrictions; +• +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from +selling in certain geographic territories; +• +difficulties staffing and managing foreign operations; and +• +economic uncertainties and adverse economic conditions (including inflation and recession). +Our business interruption insurance does not cover all possible situations, and there can be no assurance that the coverage would be adequate to +compensate us for all losses that may occur in the event of a disruption. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on +relations with our existing customers resulting from our inability to produce products for them. +Risks Related to Regulations, Taxation, Governance and the Environment +If market conditions deteriorate or future results of operations are less than expected, a valuation allowance may +be required for all or a portion of our deferred tax assets. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred tax assets +on a quarterly basis, and if we determine that it is more likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. If market conditions deteriorate or future results of operations are +less than expected, or there is a change to applicable tax rules, future assessments may result in a determination that it is more likely than not that some or all of our net deferred tax assets are not realizable. As a result, we may need to +establish a valuation allowance for all or a portion of our net deferred tax assets, which may have a material adverse effect on our business, results of operations and financial condition. +15 +Index +Changes in tax rates or tax liabilities could affect results. +We are subject to taxation in the United States and certain state and foreign jurisdictions. Significant judgment is required to determine and estimate +our tax liabilities. Our future annual and quarterly tax rates could be affected by numerous factors, including changes in the (1) applicable tax laws; (2) composition of earnings in countries with differing tax rates; or (3) recoverability of our +deferred tax assets and liabilities. Beginning in 2022, the U.S. Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated the existing option to deduct research and development expenditures and requires taxpayers to amortize them over five years pursuant +to IRC Section 174. The requirement is not expected to materially impact our cash flows. Any of these developments or any future changes in federal, state, or international tax laws or tax rulings could adversely affect our effective tax rate and +our results of operations. +Risks Related to our Indebtedness +The agreement governing our credit facility contains restrictions and limitations that could significantly affect +our ability to operate our business, as well as significantly affect our liquidity. +The loan and security agreement (the “Loan and Security Agreement”) governing the Siena Credit Facility contains a number of significant covenants that +could adversely affect our ability to operate our business, our liquidity, and our results of operations. These covenants restrict, among other things, our ability, and the ability of any future domestic subsidiary, to: +• +merge, consolidate, form subsidiaries or dispose of assets; +• +acquire assets outside the ordinary course of business; +• +enter into other transactions outside the ordinary course of business; +• +sell, transfer, return or dispose of collateral; +• +make loans to or investments in, or enter into transactions with, affiliates; +• +incur or guarantee indebtedness, incur liens; +• +redeem equity interests while borrowings are outstanding under the credit facility; +• +change our capital structure; or +• +dissolve, divide, change our line of business or cease or suffer a disruption to all or a material portion of our business. +Additionally, the Loan Agreement requires us to comply with a minimum excess availability covenant, which requires excess borrowing availability of at +least $750 thousand and the Loan Agreement requires us to maintain outstanding borrowings of at least $2,250,000 in principal amount. The breach of any covenants or obligations in the Loan Agreement, if not otherwise waived or amended, could result +in a default under the Loan Agreement and could trigger acceleration of our obligations thereunder and permit the lender to foreclose on the collateral securing our obligations under the Loan Agreement and exercise other rights of secured +creditors. +Availability under the Siena Credit Facility is subject to a borrowing base, which is based on eligible accounts receivable and inventory. To the extent +that our eligible accounts receivable and inventory decline in value, our borrowing base will decrease, and the availability under the Siena Credit Facility currently is and may continue to be less than its stated amount and may decrease. In +addition, if at any time the amount of outstanding borrowings and letters of credit under that facility exceeds the borrowing base, we are required to prepay borrowings and/or cash collateralize letters of credit sufficient to eliminate the excess. +Our ability to comply with the covenants under the Loan Agreement or to maintain our borrowing base may be affected by events beyond our control, +including deteriorating economic conditions. For example, reductions in the value of accounts receivable and inventory may occur in the future due to decreases in sales and production resulting from the impact of future economic uncertainties. +Further, certain slow-moving inventory and accounts receivable that remain unpaid for a specified period of time are excluded from the borrowing base calculation. Thus, a decline in economic conditions and/or a decline in the financial condition of +customers in the industries we serve may negatively impact the borrowing base both by decreasing the value of existing accounts and reducing the number and amount of new accounts. If we overestimate our inventory needs due to the uncertainty +surrounding future economic conditions, we may have inventory that is considered slow-moving and thus excluded from the borrowing base calculation, and any reduction in production in response to decreased demand would also result in a lower +inventory value and thus a lower borrowing base. +Any of these events could require us to seek waivers or amendments of covenants or alternative sources of financing or to reduce expenditures. We cannot +assure you that such waivers, amendments or alternative financing could be obtained, or if obtained, would be on terms acceptable to us, or that we would be able to reduce expenditures enough to offset any decrease in the borrowing base, or that we +could make such reductions without a material negative impact on our business. +16 +Index +General Risk Factors +General economic conditions could have a material adverse effect on our business, operating results and financial +condition. +Our business is subject to general economic conditions. Uncertainty or negative trends in U.S. or international economic and investment climates, +including the impact of developments in U.S.-China trade relations, as well as economic impacts from the Russia-Ukraine conflict and the Middle East conflict, and the current inflation surge attributable in part to supply chain disruptions, could +adversely affect our business. For example, customers or potential customers could reduce or delay orders, key suppliers could become insolvent, which could result in production delays, and our customers may become insolvent or be unable to obtain +credit. Any of these possible effects could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including +write-downs of assets. +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as: +• +prevailing domestic and international market and economic conditions, and conditions in the industries we serve, including current market volatility, inflation and +rising interest rates and any lingering economic impacts of the COVID-19 pandemic; +• +adverse business conditions faced by customers, or bankruptcies or store closures of our customers resulting from adverse economic conditions due to inflation or +otherwise; +• +changes in our business, operations or prospects; +• +developments in our relationships with our customers or strategic partners; +• +announcements of new products or services by us or by our competitors; +• +announcement or completion of acquisitions by us or by our competitors; +• +changes in existing, or adoption of additional, government regulations; and +• +unfavorable or reduced analyst coverage. +In addition, the stock market may experience significant price fluctuations year-to-year. Broad market fluctuations, general economic conditions and +specific conditions in the industries in which we operate may adversely affect the market price of our common stock. +Unfavorable analyst coverage or a reduction in analyst coverage of our common stock may adversely affect the price +of our common stock. +The trading market for our common stock relies in part on the research and reports that industry or financial analysts may publish about us, our +business, our markets and our competitors. We currently have limited analyst coverage, and many investment banks no longer find it profitable to provide securities research on micro-cap and small-cap companies. If securities analysts do not cover +our common stock in the future, the lack of research coverage may adversely affect the market price of our common stock. Furthermore, if one or more of the analysts who cover us downgrade our stock, or if those analysts issue other unfavorable +commentary about us or our business, our stock price may decline. +Our common stock is traded on the Nasdaq Global Market. During the year ended December 31, 2023, the average daily trading volume for our common stock +as reported by the Nasdaq Global Market was approximately 22,000 shares. We are uncertain whether a more active trading market in our common stock will develop. As a result, relatively small trades may have a significant impact on the market +price of our common stock, which could increase the volatility and depress the price of our common stock. +Our common stock is thinly traded, and investors may be unable to sell their shares at their desired prices, or at +all, and sales of large blocks of shares may adversely affect the price of our common stock. +Our common stock has historically been sporadically or “thinly” traded, meaning that the number of persons interested in purchasing shares of our common +stock at prevailing prices at any given time may be relatively small. This could lead to wide fluctuations in our share price. Investors may be unable to sell their common stock at or above their purchase price, which may result in substantial +losses. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of shares of our common stock in either direction. The price of shares of our +common stock could, for example, decline precipitously in the event a large number of shares of our common stock are sold on the market without commensurate demand, while an issuer with a more robust daily trading volume for its common stock might +better absorb those sales without an adverse impact on its share price. +17 +Index +If we raise additional capital in the future, existing stockholder ownership interest in the Company could be +diluted or otherwise adversely impacted, and future sales of our common stock or other financing arrangements may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, or we may obtain funds through a credit facility or by +issuing debt or preferred securities. We may also issue additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future issuance and sale pursuant to stock options and other equity +awards that we have granted to our employees, and in the future, we may grant additional stock options, restricted stock units and other forms of equity compensation to our employees. Any issuance of equity we may undertake in the future to raise +additional capital could cause the price of our common stock to decline, or require us to issue shares at a price that is lower than that paid by holders of our common stock in the past, which would result in those newly issued shares being +dilutive. Sales of our common stock or the perception that such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. The lender under +our existing debt agreement has rights that are senior to your rights as a common stockholder, and if we obtain funds in the future through a credit facility or through the issuance of debt or preferred securities, the lenders of such facility or +the holders of such securities would likely also have rights senior to the rights of our common stockholders, which could impair the value of our common stock. +We do not intend to pay dividends for the foreseeable future, so investors must rely on price appreciation to +realize a gain on their investment. +We have not declared or paid cash dividends on our capital stock since November 2019. We currently intend to retain any future earnings to finance our +operations and the expansion of our food service technology business, and we do not anticipate declaring or paying any dividends to holders of our common stock in the foreseeable future. Any determination to pay dividends in the future will be at +the discretion of our Board of Directors. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize future gains on their investments. +We cannot provide any assurance that current laws, or any laws enacted in the future, will not have a material +adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements in a variety of +jurisdictions, including those in which we conduct business. Changes in such laws, rules, regulations, policies or requirements could result in the need to modify our products, could delay the development of new products and could affect the +demand for our products, which may have an adverse impact on our future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +We take advantage of specified scaled disclosure requirements applicable to a “smaller reporting company” under +Regulation S-K, and the information that we provide to stockholders may therefore be different than they might receive from other public companies. If some investors find our shares of common stock less attractive as a result of this scaled +disclosure, there may be a less active trading market for our shares of common stock, which may increase the volatility of the market price of our common stock. +We are a “smaller reporting company,” as defined in Item 10(f)(1) of Regulation S-K. As a smaller reporting company, we take advantage of specified +scaled disclosure and other requirements that are otherwise applicable generally to public companies. +We intend to continue to take advantage of certain of the scaled disclosure requirements of smaller reporting companies and may continue to do so until +we are no longer a smaller reporting company. We will cease to be a smaller reporting company if we have (i) equal to or greater than $250 million in market value of our shares held by non-affiliates as of the last business day of our second fiscal +quarter and (ii) if the market value of our shares held by non-affiliates does not exceed $700 million as of the last business day of our second fiscal quarter, equal to or greater than $100 million of annual revenues in our most recent fiscal +year. We choose to take advantage of some but not all of these scaled disclosure requirements; therefore, the information that we provide stockholders may be different than one might get from other public companies. If some investors find our +shares of common stock less attractive as a result, there may be a less active trading market for our shares of common stock and the market price of such shares of common stock may be more volatile. +Our Amended and Restated By-Laws designate certain Delaware courts as the sole and exclusive forum for certain +types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or stockholders. +Our Amended and Restated By-Laws (the “By-Laws”) provide that, unless we consent in writing to the selection of an alternative forum, to the fullest +extent permitted by law, all Internal Corporate Claims must be brought solely and exclusively in the Court of Chancery of the State of Delaware (or, if such court declines to accept jurisdiction, the Superior Court of the State of Delaware, or, if +such other court declines to accept jurisdiction, the United States District Court for the District of Delaware). The By-Laws define “Internal Corporate Claims” to mean claims, including claims in the right of the Company, brought by a current or +former stockholder (including a current or former beneficial owner) (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity or (ii) as to which the General Corporation Law of the +State of Delaware confers jurisdiction upon the Court of Chancery of the State of Delaware. +This choice of forum provision may increase costs to bring a claim, discourage claims or limit a stockholder’s ability to bring a claim in a judicial +forum that it finds favorable for disputes with us or our directors, officers or other stockholders, which may discourage such lawsuits against us and our directors, officers and stockholders. Alternatively, if a court were to find this choice of +forum provision inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect +our business, financial condition or results of operations. The choice of forum provision in the By-Laws will not preclude or contract the scope of exclusive federal or concurrent jurisdiction for actions brought under the federal securities laws +including the Exchange Act or the Securities Act or the respective rules and regulations promulgated thereunder. +18 +Index +Item 1B . Unresolved Staff Comments. +Not applicable. +Item 1C . Cybersecurity +Risk Management and Strategy +The Company’s Board of Directors recognizes the critical importance of maintaining the trust and confidence of our customers, clients, business partners +and employees. The Board of Directors is actively involved in oversight of the Company’s risk management program, and cybersecurity represents an important component of the Company’s overall approach to enterprise risk management (“ERM”). The +Company’s cybersecurity policies, standards, processes and practices are fully integrated into the Company’s ERM program and are based on recognized frameworks established by the National Institute of Standards and Technology, the International +Organization for Standardization and other applicable industry standards. In general, the Company seeks to address cybersecurity risks through a comprehensive, cross-functional approach that is focused on preserving the confidentiality, security +and availability of the information that the Company collects and stores by identifying, preventing and mitigating cybersecurity threats and effectively responding to cybersecurity incidents when they occur. As one of the critical elements of the +Company’s overall ERM approach, the Company’s cybersecurity program is focused on the following key areas: +• +Governance: As discussed in more detail under the heading +“Governance,” the Board of Directors’ oversight of cybersecurity risk management is supported by the Audit Committee of the Board of Directors (the “Audit Committee”), which regularly interacts with the Company’s ERM function, the Company’s +Vice President of Information Technology, other members of management and relevant management committees and councils, including management’s Sarbanes-Oxley & Cybersecurity Steering Committee. +• +Collaborative Approach: The Company has implemented a +comprehensive, cross-functional approach to identifying, preventing and mitigating cybersecurity threats and incidents, while also implementing controls and procedures that are designed to provide for the prompt and appropriate internal +reporting of certain cybersecurity incidents, either in the form of a single unauthorized occurrence or a series of unauthorized occurrences, so that decisions regarding the public disclosure and reporting of such incidents can be made by +management in a timely manner. +• +Technical Safeguards: The Company deploys technical safeguards +that are designed to protect the Company’s information systems from cybersecurity threats, including firewalls, intrusion prevention and detection systems, anti-malware functionality and access controls, which are evaluated and improved +through vulnerability assessments and cybersecurity threat intelligence. +• +Incidence Response and Recovery Planning: The Company has +established and maintains comprehensive incident response and recovery plans intended to fully and timely address the Company’s response to a cybersecurity incident, and such plans are tested and evaluated on a regular basis. +• +Third-Party Risk Management: The Company maintains a +comprehensive, risk-based approach to identifying and overseeing cybersecurity risks presented by third parties, including vendors, service providers and other external users of the Company’s systems, as well as the systems of third parties +that could adversely impact our business in the event of a cybersecurity incident affecting those third-party systems. +• +Education and Awareness: The Company provides regular, +mandatory training for personnel regarding cybersecurity threats as a means to equip the Company’s personnel with effective tools to proactively address cybersecurity threats and prevent incursions and to communicate the Company’s evolving +information security policies, standards, processes and practices. Our awareness program includes assessment of our personnel’s preparedness through regular phishing e-mail alerts, highlighted banners that warn about external senders, and +tests administered to help the Company’s personnel interrogate, navigate around, and avoid clicking suspicious and unfamiliar links from unknown senders. +The Company engages in the periodic assessment and testing of the Company’s policies, standards, processes and practices that are designed to address +cybersecurity threats and incidents. These efforts include a wide range of activities, including audits, assessments, tabletop exercises, threat modeling, vulnerability testing and other exercises focused on evaluating the effectiveness of our +cybersecurity measures and planning. The Company engages third parties to perform assessments on our cybersecurity measures, including information security maturity assessments, audits and independent reviews of our information security control +environment and operating effectiveness. The results of such assessments, audits and reviews are periodically reported to the Audit Committee and the Board of Directors, and the Company adjusts its cybersecurity policies, standards, processes and +practices as appropriate based on the information provided by these assessments, audits and reviews. +19 +Index +Governance +The Board of Directors, in coordination with the Audit Committee, oversees the Company’s ERM process, including the management of risks arising from +cybersecurity threats. The Board of Directors and the Audit Committee each receive presentations and reports on cybersecurity risks, which address a wide range of topics including recent developments, evolving standards, vulnerability assessments, +third-party and independent reviews, the threat environment, technological trends and information security considerations arising with respect to the Company’s peers and third parties. The Board of Directors and the Audit Committee also receive +prompt and timely information regarding any cybersecurity incident that meets established reporting thresholds or that management otherwise deems to be significant, as well as ongoing updates regarding any such incident until it has been addressed. +On an annual basis, the Board of Directors and Audit Committee discuss the Company’s approach to cybersecurity risk management with the members of management’s Sarbanes-Oxley & Cybersecurity Steering Committee, which includes the Company’s +President and Chief Financial Officer (“CFO”) and Vice President of Information Technology. +The Sarbanes-Oxley & Cybersecurity Steering Committee, in coordination with the Company’s outside legal counsel, works collaboratively across the +Company and with various consultants to implement a program designed to protect the Company’s information systems from cybersecurity threats and to promptly respond to any cybersecurity incidents in accordance with the Company’s incident response +and recovery plans. The Vice President of Information Technology has served in various roles in information technology and information security for over 25 years and holds undergraduate and graduate degrees in computer science. As described in +more detail above under the heading “Information about our Executive Officers,” the Company’s Chief Executive Officer and the President and CFO each hold undergraduate and graduate degrees in their respective fields, and each has over 30 years of +experience managing risks at the Company and at similar companies, including risks arising from cybersecurity threats. +Cybersecurity threats, including as a result of previous cybersecurity incidents, have not materially affected, and are not reasonably likely to +materially affect, the Company, including its business strategy, results of operations or financial condition. +Item 2 . Properties. +Our principal facilities as of December 31, 2023 are listed below. We believe that all facilities generally are in good condition, adequately maintained +and suitable for their present and currently contemplated uses. +Location +Operations Conducted +Size +(Approx. Sq. Ft.) +Owned +or Leased +Lease Expiration +Date +Hamden, Connecticut +Executive offices and sales office +11,100 +Leased +October 31, 2025 +Ithaca, New York +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2025 +Las Vegas, Nevada +Software design and development and casino and gaming sales office +19,600 +Leased +November 30, 2025 +Doncaster, UK +Sales office and service center +6,000 +Leased +August 24, 2026 +Macau, China +Sales office +180 +Leased +April 30, 2024 +110,780 +Item 3 . Legal Proceedings. +The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal +proceedings relating to the conduct of its business. As of December 31, 2023, we are not involved in any pending or, to our knowledge, threatened legal proceedings, including legal proceedings contemplated by governmental authorities, the outcome +of which we believe would be material to our financial condition or results of operations. +Item 4 . Mine Safety Disclosures. +Not applicable. +20 +Index +PART II +Item 5 . Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity +Securities. +Our common stock is traded on the Nasdaq Global Market under the symbol TACT. As of February 29, 2024, there were 200 holders of record of the common +stock. +Issuer Purchases of Equity Securities +During the fourth quarter of 2023, we did not repurchase any shares of our common stock. +Dividend Policy +The Company does not currently pay cash dividends and does not intend to do so in the foreseeable future. +Sales of Unregistered Securities +None. +Item 6 . [Reserved] +Item 7 . Management’s Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Recent Developments +The Company engaged an advisor in the fourth quarter of 2023 to assist in determining the best long-term +strategy for its business and ensure the Company is maximizing the value of its operations for all shareholders and stakeholders. For information regarding the risks related to our engagement with an advisor, please see Part I, Item 1A, Risk +Factors under the sub-caption “Our success may depend in part on our ability to identify and pursue the best long-term strategy for our businesses.” +Current Trends +After strong demand during the year due in part to our primary competitor’s struggle to deliver products in the face of supply chain constraints, in late +2023, we began to see indications of a temporary slowdown in demand in the casino and gaming market, as customers that had built up excess inventory due to supply chain concerns advised us that they would temporarily reduce orders until their stock +normalized. This slowdown impacted our results in the fourth quarter of 2023, and we expect this trend to continue to impact results in 2024. Further, our primary competitor in the casino and gaming market has resumed supplying product with +increasing volume in 2024, which has begun to result in downward pricing pressure in that market and could exacerbate the demand slowdown, either of which could negatively impact our worldwide casino and gaming sales. In addition, we have +experienced cost increases as a result of current economic conditions, most of which we have been able to offset by increasing prices of our products. However, there can be no guarantee that we will be able to increase prices sufficiently to +offset any future such cost increases that cannot be predicted, and we may be impacted by supply chain disruptions, inflationary pressures and other global economic conditions that may affect the markets we serve and from which we source our +supplies and parts. +For additional discussion of our business, refer to Part I, Item 1. Business, of this Form 10-K. +Critical Accounting Estimates +The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America (“GAAP”) requires +management to make use of estimates, judgments and assumptions that affect both Balance Sheet items and Statement of Operations categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed +to be reasonable in the particular circumstances; however, due to the inherent uncertainties in developing estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods. +We base our estimates on historical experience, forecasts and on various other assumptions that are believed to be reasonable under the circumstances; +however actual results may differ from those estimates under different assumptions or conditions. The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial +statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These items utilize +assumptions and estimates about the effect of future events that are inherently uncertain and are therefore based on our judgment. Refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial Statements +for a complete listing of our significant accounting policies. We also have other policies that we consider key accounting policies; however, these policies typically +do not require us to make estimates or judgments that are difficult or subjective. +21 +Index +Revenue Recognition – Our net sales are derived from the sale of products and services and are adjusted for estimated returns and allowances, which historically have been insignificant. Application +of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, the determination of whether revenues related to our revenue contracts should be recognized over time or at a point in time. We recognize revenue when the obligations under the terms of a contract with our customers are satisfied; generally, this occurs with the transfer of control of our printers, +terminals, consumables and replacement parts. For our warranty, software applications and maintenance agreements, revenue is generally recognized ratably over the contract period. Other significant judgments include contracts that +contain multiple performance obligations (most commonly when contracts include a hardware product, software, financing and extended warranties) which require a contract’s transaction price to be allocated to each distinct performance obligation and +recognized as revenue when, or as, the performance obligation is satisfied. For arrangements containing multiple performance obligations, the revenue relating to the +undelivered performance obligation is deferred using the relative standalone selling price method utilizing estimated sales prices until satisfaction of the deferred performance obligation. Both of these determinations impact the timing +and amount of our reported revenues and net income and loss. +Accounts Receivable – We have +standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on available +credit information; and adjustments to credit limits based upon payment history and the customer’s current creditworthiness. We also provide an estimate for expected credit losses based on an expected loss methodology which considers a broad range of information to estimate expected credit losses, including historical information, current economic conditions and a reasonable forecast period . Our +reserve for expected credit losses as of December 31, 2023 was $0.8 million, or 7.0% of outstanding trade accounts receivable, which we believe is appropriate considering the overall quality of our accounts receivable. Although credit losses have +historically been within expectations and the reserves established, there is no assurance that our credit loss experience will continue to be consistent with historical experience. While we believe that our allowance for credit losses is adequate and represents our best estimate of future losses, we will continue to monitor customer liquidity and other economic conditions, which may result in changes to our +estimates. +Inventories – The valuation of inventory requires us to estimate obsolete or excess inventory as well as inventory that is not of saleable quality. The determination of obsolete or excess +inventory requires us to estimate the future demand for our products. We record valuation reserves on our inventory for estimated excess and obsolete inventory and lower of cost or net realizable value concerns equal to the difference between +the cost of inventory and the estimated realizable value based upon assumptions about future product demand, market conditions and product selling prices. If future product demand, market conditions or product selling prices are less than those +projected by management or if continued modifications to products are required to meet specifications or other customer requirements, increases to inventory reserves may be required which would have a negative impact on our gross margin. +Effective April 1, 2022, TransAct changed its method of inventory valuation from standard costing which approximated the “first-in, first-out” (“FIFO”) +costing methodology to the average costing methodology. We believe this methodology is preferable because it reflects a better estimate of inventory cost as we do not typically perform intensive manufacturing of our finished products, which are +therefore better measured under average cost. +Goodwill and Intangible Assets +– We evaluate goodwill and other indefinite-lived intangible assets for impairment annually and when an event occurs or circumstances change that indicate that the +carrying value may not be recoverable. The Company utilizes the option to first assess qualitative factors to determine whether it is necessary to perform the Step 1 quantitative goodwill impairment test in accordance with the applicable +accounting standards. Under the qualitative assessment, management considers relevant events and circumstances including, but not limited to, macroeconomic conditions, industry and market considerations, Company performance, and events directly +affecting the Company. If the Company determines that the Step 1 quantitative impairment test is required, management estimates the fair value of the reporting unit primarily using the income approach. Under the income approach, we use a discounted cash flow methodology to derive an indication of value, which requires management to make significant estimates and assumptions related to forecasted revenues, gross +profit margins, operating income margins, working capital cash flow, perpetual growth rates, and long-term discount rates, among others. Factors considered that may trigger an interim period impairment review of either acquired goodwill +or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative +industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. +As of December 31, 2023, upon the completion of our annual assessment for impairment, we have determined that no goodwill or intangible asset impairment +has occurred and the fair value of the Company was substantially higher than our carrying value. +We have evaluated the recoverability of the assets on our Consolidated Balance Sheet as of December 31, 2023 in accordance with relevant authoritative +accounting literature. We have considered the effects caused by the global supply chain disruptions, inflation and macroeconomic factors potentially impacting accounts receivable, inventory, investments, intangible assets, goodwill and other assets +and liabilities. Where forward-looking estimates are required, we made a good-faith estimate based on information available as of the balance sheet date. We have continued to monitor for indicators of impairment through the date of this Annual +Report on Form 10-K and reflected accordingly in the accompanying consolidated financial statements. +Income Taxes – In preparing +our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This involves estimating the actual current tax exposure together with assessing temporary differences between the +tax basis of certain assets and liabilities and their reported amounts in the financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, which are +reflected in our Consolidated Balance Sheets. We then assess the likelihood that the deferred tax assets will be realized from future taxable income, and to the extent that we believe that realization is not likely, we establish a valuation +allowance. +22 +Index +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax reserves with respect +to our deferred tax assets and uncertain tax positions. On a quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this forecast against +the basis differences, deductions available in future years and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. Although we have +considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our deferred tax assets +in the future, an adjustment to the valuation allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future deferred tax assets +in excess of its net recorded amount, an adjustment to the valuation allowance would increase net income in the period such determination was made. +We account for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”). Among other things this provision prescribes a minimum recognition +threshold that an income tax position must meet before it is recorded in the reporting entity’s financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet reporting date, it +is “more likely than not” (i.e., more than a 50% likelihood) that the income tax position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing authority will +examine the income tax position and have full knowledge of all relevant facts and other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between the amount +claimed, or expected to be claimed, on a company’s income tax returns and the benefits recognized in the financial statements. +Share-Based Compensation – We +calculate share-based compensation expense in accordance with ASC 718, “Compensation – Stock Compensation” using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation +method include the expected term of an option grant, stock price volatility, risk-free interest rate, and dividend yield. We account for forfeitures as they occur. +Results of Operations: Year Ended December 31, 2023 Compared to Year Ended December 31, 2022 +2023 Financial Highlights +• Net sales were $72.6 million in the current year compared to $58.1 million in the prior year. +• Operating income was $5.7 million in the current year compared to an operating loss of $7.7 million in the +prior year. +• Net income was $4.7 million, or $0.47 per diluted share in the current year, compared to a net loss of $5.9 +million, or a $0.60 loss per share in the prior year. +• Operating cash inflow was $5.5 million in the current year compared to an outflow of $12.2 million in the prior +year. +Net Sales. Net sales, which +include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair services, by market for the years ended December 31, 2023 and 2022 are detailed in the below table. +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2023 +December 31, 2022 +$ Change +% Change +Food service technology +$ +16,308 +22.5 +% +$ +12,364 +21.3 +% +$ +3,944 +31.9 +% +POS automation +6,922 +9.5 +% +10,659 +18.3 +% +$ +(3,737 +) +(35.1 +%) +Casino and gaming +41,192 +56.7 +% +30,029 +51.7 +% +$ +11,163 +37.2 +% +TSG +8,209 +11.3 +% +5,087 +8.7 +% +$ +3,122 +61.4 +% +$ +72,631 +100.0 +% +$ +58,139 +100.0 +% +$ +14,492 +24.9 +% +International* +$ +14,571 +20.1 +% +$ +14,105 +24.3 +% +$ +$466 +3.3 +% +* +International sales do not include sales of products to domestic distributors or other customers who in turn ship those products to international destinations. +Net sales for 2023 increased $14.5 million, or 25%, from 2022. Printer, terminal and other hardware sales volume increased by 10% to approximately +148,000 units for 2023, driven by large unit volume increases in FST and all casino and gaming, partially offset by a unit volume decline in POS automation. The primary volume increase came from a 27% increase in unit volume from the casino and +gaming market, supplemented by a 73% hardware unit volume increase in our FST market. We believe that the 2023 increase in our casino and gaming market share increased was principally due to our successful efforts in navigating the supply chain +constraints that prevented certain other suppliers from fully meeting customer demand. Partially offsetting these increases, we experienced a 36% decrease in unit volume from the POS automation market. The average selling price of our printers, +terminals and other hardware increased approximately 9% during 2023 compared to 2022, mainly due to price increases instituted during 2022 in response to product cost increases that we were able to largely maintain throughout 2023. Additionally, +sales of our software, labels and other recurring revenue from our FST market increased $2.4 million, or 28%, during 2023 compared to 2022. International sales for 2023 remained relatively flat (increasing $0.5 million, or 3%, compared to 2022). +23 +Index +Food service technology . Our primary offering in the food service technology market is our line of BOHA! products, which can combine our latest generation terminal and workstation, which include one or two +printers, with our BOHA! labeling, timers, and media software. In addition, customers may individually purchase cloud-based software applications that connect to an application on a separate mobile device into a solution to automate back-of-house +operations in restaurants, convenience stores and food service operations. The additional software offering of BOHA! consists of a variety of individually purchased software-as-a-service (“SaaS”)-based applications for both Android and iOS +operating systems, including applications for temperature monitoring, temperature taking and checklists and task lists. These applications are sold separately, and customers purchase the applications they need for their back-of-house operations. +Customers may also purchase associated hardware, such as tablets, temperature sensors and gateways. The BOHA! Terminal and newly-launched Terminal 2 combine an +operating system and hardware components in a device that includes a touchscreen and one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, and nutritional labels for prepared foods, and “enjoy by” +date labels. The BOHA! WorkStation uses an iPad or Android tablet instead of an integrated touchscreen. The BOHA! Terminal, Terminal 2 and WorkStation are equipped with the TransAct Enterprise Management System to ensure that only approved +touchscreen functions are available on the touchscreen device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, casual dining, fast casual and quick-service +restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house operations. Recurring revenue from BOHA! is +generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service contracts, and technical support services. Sales of +our worldwide food service technology products for the years ended December 31, 2023 and 2022 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2023 +December 31, 2022 +$ Change +% Change +Domestic +$ +15,159 +93.0 +% +$ +11,602 +93.8 +% +$ +3,557 +30.7 +% +International +1,149 +7.0 +% +762 +6.2 +% +387 +50.8 +% +$ +16,308 +100.0 +% +$ +12,364 +100.0 +% +$ +3,944 +31.9 +% +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2023 +December 31, 2022 +$ Change +% Change +Hardware +$ +5,170 +31.7 +% +$ +3,653 +29.5 +% +$ +1,517 +41.5 +% +Software, labels and other recurring revenue +11,138 +68.3 +% +8,711 +70.5 +% +2,427 +27.9 +% +$ +16,308 +100.0 +% +$ +12,364 +100.0 +% +$ +3,944 +31.9 +% +Sales in food service technology increased 32% in 2023 compared to 2022 driven by increases in both sales of hardware and sales of BOHA! Software and +labels. Hardware sales increased 42% compared to 2022 due largely to increased sales of our BOHA! Terminal, as well as the first volume sales in the fourth quarter of 2023 of our newly-launched BOHA! Terminal 2. In addition, we experienced an +increase in sales of our BOHA! sensors and gateways due to shipments to a new senior assisted living customer in the fourth quarter of 2023. FST software, labels +and other recurring revenue sales increased 28% in 2023 compared to 2022. Recurring revenue increased 24% primarily due to higher label sales, as well as record sales of BOHA! software (largely from our labeling software application) recognized on +a SaaS subscription basis due principally to the continued growth of the installed base of our BOHA! Terminals and WorkStations. +We expect FST revenue to be higher in 2024 than in 2023 as we continue to focus on growing our installed base of terminals and the related recurring +revenue (primarily the sale of labels and subscription software revenue from our labeling software application). +POS automation . Revenue from the POS automation +market includes sales of our Ithaca 9000 thermal printer used primarily by McDonald’s, and to a much lesser extent, other quick-service restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers +or print liner-less labels. Sales of our worldwide POS automation products for the years ended December 31, 2023 and 2022 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2023 +December 31, 2022 +$ Change +% Change +Domestic +$ +6,805 +98.3 +% +$ +10,657 +100.0 +% +$ +(3,852 +) +(36.1 +%) +International +117 +1.7 +% +2 +-- +115 +-- +$ +6,922 +100.0 +% +$ +10,659 +100.0 +% +$ +(3,737 +) +(35.1 +%) +The decrease in POS automation product revenue during 2023 compared to 2022 was driven by lower sales of our Ithaca® 9000 printer. During the latter half +of 2022, we successfully managed through supply chain issues, significantly increased production and began to fulfill our large backlog of sales orders from the first half of 2022 (due to our competitor’s inability to supply product) which +resulted in unusually high sales during 2022. During 2023, we shipped closer to our normal run-rate of POS automation printers and we began to lower our average selling price in the latter portion of the year in response to our competitors +beginning to resume supplying product. +We expect POS automation sales to be lower in 2024 compared to 2023 as our competitors resume volume shipments and we therefore anticipate our sales +volume and average selling price to return to more normalized levels. +24 +Index +Casino and gaming . Revenue from the casino and +gaming market includes sales of thermal ticket printers used in slot machines, video lottery terminals, and other gaming machines that print tickets or receipts instead of issuing coins at casinos, racetracks and other gaming venues worldwide. +Revenue from this market also includes sales of thermal roll-fed printers used in the international off-premise gaming market in gaming machines such as Amusement with Prizes, Skills with Prizes and Fixed Odds Betting Terminals and kiosks for +sports betting at non-casino gaming and sports betting establishments. Revenue from this market also includes royalties related to our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of the +EPICENTRAL print system, our software solution (including annual software maintenance), that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. Sales of our worldwide +casino and gaming products for the years ended December 31, 2023 and 2022 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2023 +December 31, 2022 +$ Change +% Change +Domestic +$ +28,715 +69.7 +% +$ +17,686 +58.9 +% +$ +11,029 +62.4 +% +International +12,477 +30.3 +% +12,343 +41.1 +% +134 +1.1 +% +$ +41,192 +100.0 +% +$ +30,029 +100.0 +% +$ +11,163 +37.2 +% +The increase in domestic sales of our casino and gaming products during 2023 compared to 2022 was primarily due to a 62% increase in sales volume as well +as price increases instituted during 2023 and largely maintained throughout the year. We believe that the 2023 increase in our casino and gaming market share increased was principally due to our successful efforts in navigating the supply chain +constraints that prevented certain other suppliers from fully meeting customer demand. However, we anticipate a more competitive environment in the casino and gaming market during 2024. The overall increase in casino and gaming domestic sales was +partially offset by a 48% decrease in domestic EPICENTRAL sales during 2023 compared to 2022. EPICENTRAL sales are project based, and as a result, may fluctuate significantly quarter-to-quarter and year-to-year. +We expect domestic sales for 2024 to be lower than 2023 as many of our customers have built up higher than normal levels of inventory of our product +(accumulated as a hedge by our customers during the worldwide supply chain crisis during 2022 and 2023) and we therefore have started to see a slowdown in their order and shipment rates that we expect to continue (especially during the first half +of 2024) until they are able to sell through their on-hand inventory. In addition, we expect an overall more competitive environment in 2024 as we anticipate our +largest competitor will likely resume volume shipments again. +International sales of our casino and gaming products remained flat during 2023 compared to 2022. Similar to our domestic customers, our international +customers also began to slow their order and shipment rates in the third and fourth quarters of 2023 due to higher than normal inventory levels and we expect this trend to continue for 2024, especially during the first half of the year. +TSG: Revenue generated by TSG includes sales of +consumable products (POS receipt paper, inkjet cartridges, ribbons and other printing supplies for non-FST legacy products), replacement parts and accessories, maintenance and repair services and shipping and handling charges. Sales in our +worldwide TSG market for the years ended December 31, 2023 and 2022 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2023 +December 31, 2022 +$ Change +% Change +Domestic +$ +7,381 +89.9 +% +$ +4,089 +80.4 +% +$ +3,292 +80.5 +% +International +828 +10.1 +% +998 +19.6 +% +(170 +) +(17.0 +%) +$ +8,209 +100.0 +% +$ +5,087 +100.0 +% +$ +3,122 +61.4 +% +The increase in domestic revenue from TSG during 2023 as compared to 2022 was due primarily to a 137% increase in sales of replacement parts and +accessories primarily due to a large order by IGT for our installed base of legacy lottery printers that we do not expect to recur, and to a lesser extent, a 12% increase in service revenue. This increase was partially offset by a decline in +consumable sales of 11%, as we are no longer focused on these legacy sales and expect them to continue to decline over time. +Internationally, TSG revenue decreased 17% during 2023 compared to 2022, due primarily to a decline in sales of replacement parts and accessories to +international casino and gaming customers. +We expect TSG sales to be lower in 2024 compared to 2023 as we experienced an unusually high level of sales of legacy lottery printer replacement parts +in 2023 that we do not expect to repeat at the same level in 2024 as the installed base of these printers continues to decline. +25 +Index +Gross Profit. Gross profit +information for the years ended December 31, 2023 and 2022 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2023 +2022 +Change +Total Sales - 2023 +Total Sales - 2022 +$ +38,400 +$ +24,412 +57.3 +% +52.9 +% +42.0 +% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, direct labor, +manufacturing overhead expenses, cost of finished products purchased directly from our contract manufacturers, expenses associated with installations and support of our EPICENTRAL print system and our line of BOHA! products and royalty payments to +third-parties, including to the third party licensor of our food service technology software products. Gross profit increased $14.0 million, or 57%, in 2023 compared to 2022, primarily due to the 25% sales increase in 2023 compared to 2022. Gross +margin also increased 1,090 basis points to 53% in 2023 compared to 42% in 2022. The large increase in both gross profit and gross margin is due to a 25% sales increase, increased market share in the casino and gaming market, increased sales of +higher margin products and price increases instituted in 2022 and largely maintained throughout 2023 to mitigate higher product and shipping costs. However, we expect gross margin in 2024 to be lower than in 2023 due to a return to a more +normalized competitive environment in both the casino and gaming and POS automation markets. +Operating Expenses - Engineering, +Design and Product Development. Engineering, design and product development information for the years ended December 31, 2023 and 2022 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2023 +2022 +Change +Total Sales - 2023 +Total Sales - 2022 +$ +9,442 +$ +8,570 +10.2 +% +13.0 +% +14.7 +% +Engineering, design and product development expenses primarily include salary and payroll-related expenses for our hardware and software engineering +staff, depreciation and design expenses (including prototype printer expenses, outside design, development and testing services, supplies and contracted software development expenses including those to the third party licensor of our food service +technology software products). Engineering, design and product development expenses increased $0.9 million, or 10%, in 2023 compared to 2022 due to the hiring of +additional engineering staff as well as investments in additional software staff resources and product testing primarily for the completed launch of the new BOHA! Terminal 2 and Epic TR80 gaming printer in the fourth quarter of 2023. These +increases were partially offset by cost reduction initiatives taken during the latter part of 2023, including a reduction of contracted software development expenses. We expect engineering, design and product development expenses to be lower in +2024 compared to 2023 as we expect to benefit from the full effect of the 2023 cost reduction efforts. +Operating Expenses - Selling and +Marketing . Selling and marketing information for the years ended December 31, 2023 and 2022 is summarized below (in thousands, except +percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2023 +2022 +Change +Total Sales - 2023 +Total Sales - 2022 +$ +9,934 +$ +11,326 +(12.3 +%) +13.7 +% +19.5 +% +Selling and marketing expenses primarily include salaries and payroll-related expenses for our sales, marketing and customer success staff, sales +commissions, travel expenses, expenses associated with the lease of sales offices, advertising, trade show expenses, public relations, e-commerce and other promotional marketing expenses. Selling and marketing expenses decreased $1.4 million, or +12%, during 2023 compared to 2022 primarily due to BOHA! market studies conducted in 2022 which were not repeated in 2023, as well as cost reduction initiatives put into place during 2023, including reduced headcount and a reduction in trade show +and other marketing expenses. +Operating Expenses - General and +Administrative. General and administrative information for the years ended December 31, 2023 and 2022 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2023 +2022 +Change +Total Sales - 2023 +Total Sales - 2022 +$ +13,318 +$ +12,193 +9.2 +% +18.3 +% +21.0 +% +General and administrative expenses primarily include salaries, incentive compensation, and other payroll-related expenses for our Chief Executive +Officer, Chief Financial Officer, accounting, human resources, corporate development and information technology staff, expenses for our corporate headquarters, professional and legal expenses, information technology expenses, and other expenses +related to being a publicly traded company. General and administrative expenses increased $1.1 million, or 9%, during 2023 compared to 2022 due in large part to a +$1.5 million severance charge related to the resignation of the Company’s former Chief Executive Officer in April 2023, partially offset by expense reduction initiatives we commenced in the third quarter of 2023. Excluding the $1.5 million +severance charge, we expect general and administrative expenses for 2024 to be slightly lower compared to 2023. +26 +Index +Operating Income (Loss). +Operating income (loss) information for the years ended December 31, 2023 and 2022 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2023 +2022 +Change +Total Sales – 2023 +Total Sales – 2022 +$ +5,706 +$ +(7,677 +) +174.3 +% +7.9 +% +(13.2 +%) +Our operating income increased $13.4 million, or 174%, during 2023 compared to 2022 as a $14.0 million or 57% increase in gross profit on 25% higher +sales, was partially offset by a $0.6 million or 2% increase in operating expenses (including the $1.5 million severance charge discussed above in “General and Administrative”) in 2023 compared to 2022. +Interest, net. We recorded net interest expense of $255 thousand in 2023 compared to $208 thousand in 2022. This increase in interest expense is related to the Siena Credit +Facility. Following the July 2022 amendment of the Siena Credit Facility, we were required to maintain outstanding borrowings of at least $2,250,000 in principal amount. See Note 8 – Borrowings to the accompanying condensed consolidated financial +statements. Interest expense increased due to the initiation of the minimum borrowing requirement in July 2022 and a higher interest rate environment during 2023 compared to 2022. +Other, net . We recorded other income of $452 thousand in 2023 compared to other expense of $16 thousand in 2022. During the fourth quarter of 2023, we +completed an asset sale of our Printrex product line (essentially inventory on-hand) and recorded a non-operating gain of approximately $426 thousand. Prior to this sale, the last TransAct sales of Printrex products occurred in 2021. +Income Taxes . We recorded income tax expense during 2023 of $1.2 million at +an effective tax rate of 19.6%, compared to an income tax benefit during 2022 of $2.0 million at an effective tax rate of 24.9%. The effective tax rate for 2022 was unusually high due to the reversal of a valuation allowance on deferred tax assets +in our UK subsidiary. +Net Income (Loss). As a +result of the above, we reported net income for the year ended December 31, 2023 of $4.7 million, or $0.47 per diluted share, compared to a net loss of ($5.9 million), or $0.60 per basic and diluted share, in 2022. +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors +affecting the management of liquidity are cash flows from operating activities, capital expenditures, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to access credit +lines at market-competitive rates, if needed, are expected to be sufficient to fund operations, capital expenditures, and any increase in working capital that would be required to accommodate our anticipated level of business activity for the 2024 +fiscal year and beyond. +During the third quarter of 2023, we began a cost reduction initiative to reduce our overall level of operating expenses that included reducing employee +headcount, trade show, advertising and other promotional marketing expenses, certain third party engineering resources and other expenses, and to a lesser extent, certain general and administrative expenses. We expect these actions will result in +approximately $3 million of annualized savings beginning in 2024, partially offset by typical annual inflationary and cost of living increases in operating expenses. Notwithstanding the foregoing, there is no assurance that the cost-cutting efforts +we have taken to bring expenses in line with our revenue and mitigate the impact of global economic conditions such as supply chain disruptions and inflation are sufficient or adequate, and we may be required to take additional measures, as the +ultimate extent of the effects of these risks on the Company, our financial condition, results of operations, liquidity, and cash flows are uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, +Item 1A, Risk Factors, of this Form 10-K for further discussion of risks related to global economic conditions, supply chain disruptions and inflation. +27 +Index +Cash Flow +During 2023, our cash balance increased $4.4 million, or 55%, (versus a decrease of $11.5 million in 2022) due primarily to operating activities, +including a reduction in accounts receivable of $4.2 million and net income of $4.7 million (depreciation, amortization and share based compensation totaled $2.3 million). We had $12.3 million in cash and cash equivalents as of December 31, +2023, of which $116 thousand was held by our UK subsidiary. +Operating activities : The following significant +factors primarily affected our cash provided by operating activities of $5.5 million in 2023 as compared to cash used in operating activities of $12.2 million in 2022. +For 2023: +• +We reported net income of $4.7 million. +• +We recorded depreciation and amortization of $1.5 million and share-based compensation expense of $0.9 million. +• +We recorded a decrease in our deferred tax assets of $1.0 million due to our net income in 2023. +• +Accounts receivable decreased $4.2 million primarily due to decreased sales volume during the fourth quarter of 2023. +• +Inventories increased $5.7 million primarily due to strategic purchases, including initial stocking orders related to the launch of our new BOHA! Terminal 2 and +Epic TR80 in the fourth quarter of 2023, and declining sales during the four quarters in 2023. We expect our inventories to gradually decline as we sell through our existing stock during 2024. +• +Accounts payable used $3.0 million in cash due to increased inventory purchases and the timing of cash disbursements. +For 2022: +• +We reported a net loss of $5.9 million. +• +We recorded depreciation and amortization of $1.3 million and share-based compensation expense of $1.2 +million. +• +We recorded an increase in our deferred tax assets of $2.2 million due to our net loss in 2022. +• +Accounts receivable increased $6.4 million primarily due to increased sales volume during the fourth quarter of 2022. +• +Inventories increased $4.4 million primarily due to strategic purchases of electronic and other parts to +support our sales growth. +• +Accounts payable provided $3.2 million in cash due to increased inventory purchases and the timing of cash disbursements. +Investing activities : Our capital expenditures were $0.9 million and $1.3 million in 2023 and 2022, respectively. Expenditures in 2023 were related to new product tooling and computer and networking equipment +while in 2022 they were primarily related to the implementation of a new ERP system which was completed in early 2022, new product tooling and computer and networking equipment. +Financing activities: Financing activities used +$0.1 million of cash during 2023 due primarily to withholding taxes paid on stock issuances. During 2022, financing activities provided $2.1 million of cash primarily due to proceeds received from the required minimum borrowings on our Siena +Credit Facility. +Resource Sufficiency +Since early 2020, we have been impacted in varying degrees by the lingering effects from the COVID-19 pandemic. In addition, and more recently, we have +been impacted by global supply chain issues, increased shipping costs, increased interest rates and inflationary pressures. However, we believe that our operating results and operating cash flow improved significantly during 2023 due largely to +certain competitors’ inability to supply products in both the POS automation and casino and gaming markets. Nevertheless, given the continued uncertainty related to the impact of external factors on the food service and casino industries, we +continue to monitor our cash generation, usage and preservation including the management of working capital to generate cash. +We believe that our cash and cash equivalents on hand, our expected cash flows generated from operating activities, and borrowings available under our +Siena Credit Facility will provide sufficient resources to meet our working capital needs, finance our capital expenditures and meet our liquidity requirements through at least the next twelve months. Notwithstanding this belief, the duration and +extent of these global economic pressures and the future of pandemic variants remain uncertain and the ultimate impact of these global pressures is unknown. +28 +Index +Credit Facility and Borrowings +On March 13, 2020, we entered into the Loan and Security Agreement governing the Siena Credit Facility with Siena Lending Group LLC (the “Lender”). The +Siena Credit Facility provides for a revolving credit line of up to $10.0 million and was originally scheduled to expire on March 13, 2023, prior to being extended, as discussed below. Borrowings under the Siena Credit Facility bear a floating rate +of interest equal to the greatest of (i) the prime rate plus 1.75%, (ii) the federal funds rate plus 2.25%, and (iii) 6.50%. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility were $245 thousand. +We also pay a fee of 0.50% on unused borrowings under the Siena Credit Facility. Borrowings under the Siena Credit Facility are secured by a lien on substantially all the assets of the Company. Borrowings under the Siena Credit Facility are subject +to a borrowing base based on 85% of eligible accounts receivable plus the lesser of (a) $5.0 million and (b) 50% of eligible raw material and 60% of finished goods inventory. +The Siena Credit Facility imposes a financial covenant on the Company and restricts, among other things, our ability to incur additional indebtedness and +the creation of other liens. On July 21, 2021, the Company entered into an amendment (“Siena Credit Facility Amendment No. 1”) to the Siena Credit Facility. Siena Credit Facility Amendment No. 1 changed the financial covenant under the Siena Credit +Facility from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at least $750 thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning +with the calendar month ended July 31, 2021. From July 31, 2021 through December 31, 2023, we remained in compliance with our excess availability covenant. +On July 19, 2022, the Company and the Lender entered into Amendment No. 2 (“Siena Credit Facility Amendment No. 2”) to the Siena Credit Facility as +amended by Siena Credit Facility Amendment No. 1. Also on July 19, 2022, the Company and the Lender entered into an Amended and Restated Fee Letter (the “Amended Fee Letter”) in connection with Siena Credit Facility Amendment No. 2. Siena Credit +Facility Amendment No. 2 did not modify the aggregate amount of the revolving commitment or the interest rate applicable to the loans. +The changes to Siena Credit Facility provided for in Siena Credit Facility Amendment No. 2 included, among other things, the following: +(i) +The extension of the maturity date from March 13, 2023 to March 13, 2025; and +(ii) +The termination of the existing blocked account control agreement and entry into a new “springing” deposit account control agreement, permitting the Company to direct +the use of funds in its deposit account until such time as (a) the sum of excess availability under the Siena Credit Facility and unrestricted cash is less than $5 million for 3 consecutive business days or (b) an event of default occurs +and is continuing. +In addition, the Amended Fee Letter requires the Company, while it retains the ability to direct the use of funds in the deposit account, to maintain +outstanding borrowings of at least $2,250,000 in principal amount. If the Company does not have the ability to direct the use of funds in the deposit account, then the Amended Fee Letter requires the Company to pay interest on at least $2,250,000 +principal amount of loans, whether or not such amount of loans is actually outstanding. As stated above, we continue to monitor our cash generation, usage and preservation including the management of working capital to generate cash and continue to +evaluate any alternative sources of funding as necessary, including the possible extension of our line of credit under the Siena Credit Facility. +On May 1, 2023, the Company and the Lender agreed to a letter amendment to the Loan and Security Agreement governing the Siena Credit Facility. Prior to +this amendment, section 7.1(m) of the Loan and Security Agreement governing the Siena Credit Facility required that any successor to the Company’s former Chief Executive Officer be reasonably acceptable to the Lender, and the amendment confirmed +that Mr. Dillon, the Company’s current Chief Executive Officer, is an acceptable successor and applied the same requirement to any future successor to Mr. Dillon. +As of December 31, 2023, we had $2.3 million of outstanding borrowings under the Siena Credit Facility and $5.9 million of net borrowing capacity +available under the Siena Credit Facility. +Stock Repurchase Program +During 2023 and 2022, we did not repurchase any shares of our common stock. +Shareholders’ Equity +Shareholders’ equity increased $5.6 million, or 16%, to $39.4 million at December 31, 2023 from $33.9 million at December 31, 2022. The increase was +primarily due to net income of $4.7 million in 2023 and share-based compensation expense related to stock awards of $0.8 million (net of withholding taxes paid by relinquishment of shares) in 2023. +Item 7A . Quantitative and Qualitative Disclosures about Market Risk. +TransAct is a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, and is not required to provide information under this item. +Item 8 . Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this Form 10-K as pages F-4 through F-22. The “Report of Independent Registered Public Accounting +Firm” is annexed to this Form 10-K as of page F-2. An index to such materials appears on page F-1. +Item 9 . Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +29 +Index +Item 9A . Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our +disclosure controls and procedures, as defined in Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of +December 31, 2023. Based on this evaluation of our disclosure controls and procedures as of December 31, 2023, our CEO and CFO concluded that, as of +December 31, 2023, our disclosure controls and procedures were effective at the reasonable assurance level. +Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly present, in all +material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with GAAP, and that they can be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the +Exchange Act, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those +policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are +recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2023. Our management based its assessment on criteria +established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. In the opinion of management, TransAct maintained effective internal control over financial reporting as of +December 31, 2023. +Changes in Internal Control over Financial Reporting +No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three +months ended December 31, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +Item 9B . Other Information. +(a) +None +(b) +During the fourth quarter of 2023, no director or officer of the Company adopted or terminated a “Rule 10b5-1trading arrangement” or “non-Rule 10b5-1trading +arrangement,” as each term is defined in Item 408(a) of Regulation S-K. +Item 9C . Disclosure Regarding Foreign Jurisdictions that Prevent Inspection. +Not applicable. +30 +Index +PART III +Item 10 . Directors, Executive Officers and Corporate Governance. +Set forth in Part I, Item 1. Business of this Form 10-K, under the heading “Information about our Executive Officers,” is certain information regarding +our executive officers, and information regarding our code of ethics is set forth below. The remaining information in response to this item is incorporated herein by reference to the disclosure, if any; that will be contained, as applicable, under +the headings “Proposal 1: Election of Directors,” “Delinquent Section 16(a) Reports,” “Corporate Governance – Director Nomination Process” and “Corporate Governance – Committees of the Board” in our Proxy Statement for our 2024 Annual Meeting of +Stockholders (the “Proxy Statement”), which will be filed within 120 days after the end of the year covered by this Form 10-K. +Code of Ethics +We maintain a Standards of Business Conduct and Code of Ethics (“Standards of Business Conduct”) that includes our code of ethics that is applicable to +all employees, including our Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Controller. Our Standards of Business Conduct, which require continued observance of high ethical standards, such as honesty, integrity and +compliance with the law in the conduct of our business, are available for public access on our website at https://transacttech.gcs-web.com/corporate-governance. Any person may request a copy of our Standards of Business Conduct free of charge by +calling (203) 859-6800. We will disclose on our website at https://transacttech.gcs-web.com/corporate-governance any amendment to or waiver of a provision of the Standards of Business Conduct as may be required and within the time period specified +under the applicable SEC and Nasdaq rules. +Item 11 . Executive Compensation. +The information in response to this item will be contained in the Proxy Statement under the headings “Executive Compensation,” “Summary Compensation +Table,” “Outstanding Equity Awards at 2023 Fiscal Year-End,” “Potential Payments Upon Termination or Change in Control” and “Pay Versus Performance,” and is incorporated herein by reference. +Item 12 . Security Ownership of Certain Beneficial Owners and Management and Related Stockholder +Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item will be contained in +the Proxy Statement under the heading, “Security Ownership of Certain Beneficial Owners and Management,” and is incorporated herein by reference. +Equity Compensation Plan Information +Information regarding our equity compensation plans as of December 31, 2023 is as follows: +Plan category +(a) +Number of +securities to be +issued upon exercise +of outstanding +options, warrants +and rights +(b) +Weighted- +average +exercise price +of outstanding +options, warrants +and rights +(c) +Number of securities +remaining available for +future issuance under +equity compensation plans +(excluding securities +reflected in column (a) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +76,000 +$ +11.61 +– +2014 Equity Incentive Plan +1,423,011 +7.53 +981,769 +Total +1,499,011 +$ +7.73 +981,769 +In May 2014, our stockholders approved the adoption of the 2014 Equity Incentive Plan. In May 2020, our stockholders approved an amendment and +restatement of the 2014 Equity Incentive Plan to increase the number of shares of common stock which may be subject to awards granted under the plan from 1,400,000 to 2,200,000 shares. In June 2023, our stockholders approved an amendment and +restatement of the 2014 Equity Incentive Plan to increase the number of shares of common stock which may be subject to awards granted under the plan from 2,200,000 to its current level of 2,900,000 and to change the date of adoption of the 2014 +Equity Incentive Plan to April 17, 2023 (thereby extending its expiration date to April 17, 2033). The Company also maintains the 2005 Equity Incentive Plan; however no new awards are be available for future issuance under this plan. Both plans +generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) +limited stock appreciation rights. The Company does not have any equity plans that have not been approved by its stockholders. +Item 13 . Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related Transactions” and +“Corporate Governance-Board Leadership Structure and Independence” and is incorporated herein by reference. +Item 14 . Principal Accountant Fees and Services. +The information in response to this item will be contained in the Proxy Statement under the headings, “Policy Regarding Pre-Approval of Services Provided +by the Independent Registered Public Accounting Firm” and “Independent Registered Public Accounting Firm’s Services and Fees” and is incorporated herein by reference. +31 +Index +PART IV +Item 15 . Exhibits and Financial Statement Schedules. +(a) +The following documents are filed as part of this Form 10-K: +1. +Financial Statements. +Report of Independent Registered Public Accounting Firm +Consolidated Balance Sheets as of December 31, 2023 and 2022 +Consolidated Statements of Operations for the years ended December 31, 2023 and 2022 +Consolidated Statements of Comprehensive Loss for the years ended December 31, 2023 and 2022 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2023 and 2022 +Consolidated Statements of Cash Flows for the years ended December 31, 2023 and 2022 +Notes to Consolidated Financial Statements +2. +Schedules. +All schedules are omitted because they are either inapplicable or not required, or because the information required therein is included in the Consolidated +Financial Statements and Notes thereto. +3. +Exhibits +Exhibit Index +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated (conformed copy) (incorporated by reference to Exhibit 3.2 of the Company’s +Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 18, 2022). +3.1(b) +Certificate of Designation, Series A Preferred Stock, filed with the +Secretary of State of Delaware on December 2, 1997 (incorporated by reference to Exhibit C of the Form of Amended and Restated Rights Agreement, dated as of February 16, 1999, between TransAct Technologies Incorporated and +American Stock Transfer & Trust Company filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on February 18, 1999.” +3.1(c) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000 (incorporated by reference +to Exhibit 3.1(c) of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 8, 2000). +3.2 +Amended and Restated By-Laws of TransAct Technologies Incorporated (incorporated by reference to Exhibit 3.2 of the Company’s Annual Report on +Form 10-K (SEC File No. 000-21121) filed with the SEC on March 28, 2023). +4.1 +Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-1/A (No. 333-06895) +filed with the SEC on August 1, 1996). +4.2 * +Description of Securities. +10.1 (x) +2005 Equity Incentive Plan (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed +with the SEC on June 1, 2005). +10.2 (x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form +8-K (SEC File No. 000-21121) filed with the SEC on May 19, 2014). +10.3 (x) +Amendment to 2014 Equity Incentive Plan approved by Shareholders on May 22, 2017 (incorporated by reference to Exhibit 10.1 of the Company’s +Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 9, 2017). +10.4 (x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan, as Amended and Restated in 2020 (incorporated by reference to Exhibit I to the +Definitive Proxy Statement on Schedule 14A filed with the Commission on April 23, 2020, File No. 000-21121). +10.5 (x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan, as Amended and Restated in 2023 (incorporated by reference to Exhibit I to the +Definitive Proxy Statement on Schedule 14A filed with the Commission on April 21, 2023, File No. 000-21121). +10.6 (x) +2014 Equity Incentive Plan Time-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly +Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 6, 2016). +10.7 (x) +2014 Equity Incentive Plan Performance-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 of the Company’s +Quarterly Report on Form 10-Q (SEC File No. 000-211121) filed with the SEC on August 8, 2016). +10.8 (x) +2014 Equity Incentive Plan Non-statutory Stock Option Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on +Form 8-K (SEC File No. 000-21121) filed with the SEC on May 19, 2014). +10.9 (x) +Severance Agreement by and between TransAct and Steven A. DeMartino, dated June 1, 2004 (incorporated by reference to Exhibit 10.8 of the +Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2005). +10.10 (x) +Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective January 1, 2008 (incorporated by reference to Exhibit +10.12 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2009). +10.11 (x) +Severance Agreement by and between TransAct and Andrew J. Hoffman (as amended), effective December 23, 2008 (incorporated by reference to Exhibit +10.10 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 24, 2022). +32 +Index +10.12 (x) +Second Amendment to Severance Agreement by and between TransAct and Steven A. DeMartino, effective April 29, 2021 (incorporated by reference to +Exhibit 10.11 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 24, 2022). +10.13 (x) +Amended and Restated Employment Agreement, dated as of December 14, 2022, by and between TransAct Technologies Incorporated and Bart C. Shuldman +(incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on December 27, 2022). +10.14 (x) +Separation Agreement and General Release, dated April 20, 2023, between the Company and Bart C. Shuldman (incorporated by reference to Exhibit +10.1 of Amendment No. 1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on April 26, 2023). +10.15 (x) +Letter Agreement, dated April 24, 2023, between the Company and John M. Dillon (incorporated by reference to Exhibit 10.2 of Amendment No. 1 to +the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on April 26, 2023). +10.16 * +Lease Agreement between Bomax Properties, LLC and TransAct, dated July 18, 2001.* +10.17 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct, dated May 8, 2012 (incorporated by reference to Exhibit 10.16 of +the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 10, 2012). +10.18 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016 (incorporated by reference to Exhibit 10.13 +of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 11, 2016). +10.19 +Amendment No. 3 to Lease Agreement between Bomax Properties, LLC and TransAct, dated February 29, 2020 (incorporated by reference to Exhibit 10.1 +to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on March 4, 2020). +10.20 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004 (incorporated by reference to Exhibit 10.13 +of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2005). +10.21 +First Amendment to Lease Agreement by and between CIP Hughes Center LLC and TransAct dated August 24, 2009 (incorporated by reference to Exhibit +10.19 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2010). +10.22 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, 2015 (incorporated by reference +to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 7, 2015). +10.23 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006 (incorporated by reference to Exhibit 10.14 of +the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 15, 2007). +10.24 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 3, 2017 (incorporated by reference to Exhibit +10.20 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2017). +10.25 +Second Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct Technologies dated April 30, 2021 (incorporated by reference +to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 13, 2021). +10.26 +Loan and Security Agreement, dated as of March 13, 2020, among Siena Lending Group LLC, TransAct Technologies Incorporated and the other Loan +Parties from time to time party thereto (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 22, 2020). +10.27 +Amendment No. 1 To Loan and Security Agreement, dated as of July 21, 2021, among Siena Lending Group and TransAct Technologies Incorporated +(incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 26, 2021) +10.28 +Amendment No. 2 To Loan and Security Agreement, dated as of July 19, 2022, between Siena Lending Group LLC and TransAct Technologies Incorporated +(incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 25, 2022). +10.29 +Amended and Restated Fee Letter, dated as of July 19, 2022, between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated +by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 25, 2022). +10.30 +Letter Amendment, dated May 1, 2023, to Loan and Security Agreement between Siena Lending Group LLC and TransAct Technologies Incorporated +(incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on May 4, 2023). +10.31 † +Master License Agreement dated February 22, 2019 and amendments thereto (incorporated by reference to Exhibit 10.24 to the Company’s Annual +Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021). +10.32 † +Master Development and License Agreement dated July 20, 2018 (incorporated by reference to Exhibit 10.25 to the Company’s Annual Report on Form 10-K +(SEC File No. 000-21121) filed with the SEC on March 12, 2021). +33 +Index +21 +Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with +the SEC on March 12, 2021) +23.1 * +Consent of Marcum LLP +31.1 * +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 * +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +32 ‡ +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the +Sarbanes-Oxley Act of 2002. +97 * +TransAct Technologies Incorporated Clawback Policy in the Event of a Financial Restatement +101.INS +Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the +Inline XBRL document). +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +(x) +Management contract or compensatory plan or arrangement. +* +These exhibits are filed herewith. +† +Certain portions of this exhibit (indicated by “[***]”) have been omitted pursuant to Item (601)(b)(10) of Regulation S-K. +‡ +These exhibits are furnished herewith. +(b) +Exhibits. +The Exhibits required by Item 601 of Regulation S-K under the Exchange Act are included in the Exhibit Index above under a(3) of this Item 15. +(c) +Financial Statement Schedules. +See the Notes to the Consolidated Financial Statements included in this Form 10-K. +Item 16 . Form 10-K Summary. +None. +34 +Index +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its +behalf by the undersigned, thereunto duly authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ John M. Dillon +Name: +John M. Dillon +Title: +Chief Executive Officer +Date: March 13, 2024 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant +and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ John M. Dillon +Chief Executive Officer and Director +March 13, 2024 +John M. Dillon +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, Treasurer and Secretary +March 13, 2024 +Steven A. DeMartino +(Principal Financial Officer) +/s/ William J. DeFrances +Vice President and Chief Accounting Officer +March 13, 2024 +William J. DeFrances +(Principal Accounting Officer) +/s/ Haydee Ortiz Olinger +Chair of the Board +March 13, 2024 +Haydee Ortiz Olinger +/s/ Audrey P. Dunning +Director +March 13, 2024 +Audrey P. Dunning +/s/ Daniel M. Friedberg +Director +March 13, 2024 +Daniel M. Friedberg +/s/ Randall S. Friedman +Director +March 13, 2024 +Randall S. Friedman +/s/ Emanuel P. N. Hilario +Director +March 13, 2024 +Emanuel P. N. Hilario +35 +Index +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 688 ) +F-2 +Consolidated Balance Sheets as of December 31, 2023 and 2022 +F-4 +Consolidated Statements of Operations for the years ended December 31, 2023 and 2022 +F-5 +Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2023 and 2022 +F-6 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2023 and 2022 +F-7 +Consolidated Statements of Cash Flows for the years ended December 31, 2023 and 2022 +F-8 +Notes to Consolidated Financial Statements +F-9 +F-1 +Index +REPORT OF INDEPENDENT REGISTERED PUBLIC +ACCOUNTING FIRM +To the Shareholders and Board of Directors of +TransAct Technologies Incorporated +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of TransAct Technologies +Incorporated and its subsidiaries(the “Company”) as of December 31, 2023 and 2022, the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2023, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated +financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the two years in the period ended December 31, +2023, in conformity with accounting principles generally accepted in the United States of America. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated +financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the +U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about +whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of +our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we +express no such opinion. +Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and +performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting +principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required +to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of +critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on +the accounts or disclosures to which it relates. +Valuation of Inventories - Excess and Obsolete Inventory Reserve +As described in Note 2 to +the consolidated financial statements, inventories are stated at the lower of average cost or net realizable value. The Company reviews net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of +completions, disposal and transportation, historical usage and estimates of future demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities, and net realizable value. +A majority of the Company’s excess and obsolete inventory reserve relates to excess quantities of products, based on the Company’s inventory levels and future product purchase commitments compared to assumptions +relating to future demand and market conditions. As of December 31, 2023, the Company’s consolidated inventories balance was $17.759 million . +The principal +considerations for our determination that the Company’s valuation of inventories, specifically the excess and obsolete inventory reserve, was a critical audit matter included the following: (1) +management identifies inventories as a critical accounting estimate, and (2) there were significant judgments made by management in estimating the excess and obsolete inventory reserve, including developing assumptions related to future product +demand based on historical usage and current market conditions. This in turn led to a high degree of auditor judgment in performing our audit procedures, which were designed to evaluate the reasonableness of audit evidence related to management’s +assumptions of future product demand . +F-2 +Index +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included, among others, (i) obtaining an +understanding of the Company’s accounting policy related to inventory, specifically as it relates to the excess and obsolete inventory reserve; (ii) evaluating management’s methodology and process for developing the excess and obsolete inventory +reserve, including estimating assumptions related to future product demand based on historical usage and current market conditions; and (iii) testing management’s calculation of the excess and obsolete inventory reserve, which included evaluating +the completeness and accuracy of underlying data used by management in the calculation, principally inputs such as actual historical usage and management’s determination of future estimated consumption of inventory . +Marcum LLP +We have served as the Company’s auditor since 2020. +Hartford, Connecticut +March 13, 2024 +F-3 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2023 +December 31, +2022 +Assets: +Current assets: +Cash and cash equivalents +$ +12,321 +$ +7,946 +Accounts receivable (net of allowance for expected credit losses of $ 768 and $ 351 ) +9,824 +13,927 +Employee retention credit receivable +– +1,500 +Inventories +17,759 +12,028 +Prepaid income taxes +322 +– +Other current assets +773 +724 +Total current assets +40,999 +36,125 +Fixed assets, net +2,421 +2,781 +Right-of-use assets +1,602 +2,488 +Goodwill +2,621 +2,621 +Deferred tax assets +6,304 +7,327 +Intangible assets, net +88 +242 +Other assets +163 +248 +13,199 +15,707 +Total assets +$ +54,198 +$ +51,832 +Liabilities and Shareholders’ Equity: +Current liabilities: +Revolving loan payable +$ +2,250 +$ +2,250 +Accounts payable +4,431 +7,395 +Accrued liabilities +4,947 +4,077 +Lease liabilities +929 +875 +Deferred revenue +1,079 +1,329 +Total current liabilities +13,636 +15,926 +Deferred revenue, net of current portion +209 +143 +Lease liabilities, net of current portion +720 +1,683 +Other liabilities +219 +218 +1,148 +2,044 +Total liabilities +14,784 +17,970 +Commitments and contingencies (see Notes 8 and 14) +Shareholders’ equity: +Preferred stock, $ 0.01 value, 4,800,000 authorized, none issued and outstanding +– +– +Preferred stock, Series A, $ 0.01 par value, 200,000 authorized, none issued and outstanding +– +– +Common stock, $ 0.01 par value, 20,000,000 authorized at December 31, 2023 and 2022 ; 14,003,653 and 13,956,725 shares +issued; 9,958,811 and 9,911,883 +shares outstanding, at December 31, 2023 and 2022 , respectively +140 +139 +Additional paid-in capital +57,055 +56,282 +Retained earnings +14,378 +9,630 +Accumulated other comprehensive loss, net of tax +( 49 +) +( 79 +) +Treasury stock, 4,044,842 shares, at cost +( 32,110 +) +( 32,110 +) +Total shareholders’ equity +39,414 +33,862 +Total liabilities and shareholders’ equity +$ +54,198 +$ +51,832 +See accompanying notes to Consolidated Financial Statements. +F-4 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Years Ended December 31, +2023 +2022 +Net sales +$ +72,631 +$ +58,139 +Cost of sales +34,231 +33,727 +Gross profit +38,400 +24,412 +Operating expenses: +Engineering, design and product development +9,442 +8,570 +Selling and marketing +9,934 +11,326 +General and administrative +13,318 +12,193 +32,694 +32,089 +Operating income (loss) +5,706 +( 7,677 +) +Interest and other income (expense): +Interest expense +( 310 +) +( 208 +) +Interest income +55 +– +Other, net +452 +( 16 +) +197 +( 224 +) +Income (loss) before income taxes +5,903 +( 7,901 +) +Income tax (expense) benefit +( 1,155 +) +1,965 +Net income (loss) +$ +4,748 +$ +( 5,936 +) +Net income (loss) per common share: +Basic +$ +0.48 +$ +( 0.60 +) +Diluted +$ +0.47 +$ +( 0.60 +) +Shares used in per-share calculation: +Basic +9,951 +9,905 +Diluted +10,021 +9,905 +See accompanying notes to Consolidated Financial Statements. +F-5 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +Years Ended December 31, +2023 +2022 +Net income (loss) +$ +4,748 +$ +( 5,936 +) +Foreign currency translation adjustment, net of tax +30 +( 222 +) +Comprehensive income (loss) +$ +4,778 +$ +( 6,158 +) +See accompanying notes to Consolidated Financial Statements. +F-6 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY +(in thousands, except share data) +Common Stock +Additional +Paid-in +Retained +Treasury +Accumulated +Other +Comprehensive +Total +Shares +Amount +Capital +Earnings +Stock +Income (Loss) +Equity +Balance, December 31, 2021 +9,872,889 +$ +139 +$ +55,246 +$ +15,566 +$ +( 32,110 +) +$ +143 +$ +38,984 +Issuance of common stock from exercise of stock options +17,500 +– +– +– +– +– +– +Issuance of common stock on restricted stock units +47,931 +– +– +– +– +– +– +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 26,437 +) +– +( 119 +) +– +– +– +( 119 +) +Share-based compensation expense +– +– +1,155 +– +– +– +1,155 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +( 222 +) +( 222 +) +Net loss +– +– +– +( 5,936 +) +– +– +( 5,936 +) +Balance, December 31, 2022 +9,911,883 +139 +56,282 +9,630 +( 32,110 +) +( 79 +) +33,862 +Issuance of common stock from exercise of stock options +1,875 +– +– +– +– +– +– +Issuance of common stock on restricted stock units +58,705 +1 +– +– +– +– +1 +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 13,652 +) +– +( 87 +) +– +– +– +( 87 +) +Share-based compensation expense +– +– +860 +– +– +– +860 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +30 +30 +Net income +– +– +– +4,748 +– +– +4,748 +Balance, December 31, 2023 +9,958,811 +$ +140 +$ +57,055 +$ +14,378 +$ +( 32,110 +) +$ +( 49 +) +$ +39,414 +See accompanying notes to Consolidated Financial Statements. +F-7 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Years Ended December 31, +2023 +2022 +Cash flows from operating activities: +Net income (loss) +$ +4,748 +$ +( 5,936 +) +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: +Share-based compensation expense +860 +1,155 +Depreciation and amortization +1,489 +1,332 +Deferred income tax benefit +1,020 +( 2,141 +) +Loss on the disposal of fixed assets +– +2 +Foreign currency transaction losses +( 30 +) +6 +Changes in operating assets and liabilities: +Accounts receivable +4,248 +( 6,421 +) +Employee retention credit receivable +1,500 +– +Inventories +( 5,658 +) +( 4,378 +) +Prepaid income taxes +( 322 +) +137 +Other current and long-term assets +( 10 +) +167 +Accounts payable +( 2,988 +) +3,103 +Accrued liabilities and other liabilities +650 +754 +Net cash provided by (used in) operating activities +5,507 +( 12,220 +) +Cash flows from investing activities: +Capital expenditures +( 901 +) +( 1,299 +) +Net cash used in investing activities +( 901 +) +( 1,299 +) +Cash flows from financing activities: +Proceeds from bank borrowings +– +2,250 +Withholding taxes paid on stock issuance +( 87 +) +( 119 +) +Payment of bank financing costs +– +( 69 +) +Net cash (used in) provided by financing activities +( 87 +) +2,062 +Effect of exchange rate changes on cash and cash equivalents +( 144 +) +( 54 +) +Increase (decrease) in cash and cash equivalents +4,375 +( 11,511 +) +Cash and cash equivalents, beginning of period +7,946 +19,457 +Cash and cash equivalents, end of period +$ +12,321 +$ +7,946 +Supplemental cash flow information: +Interest paid +$ +268 +$ +129 +Income taxes paid +160 +62 +Non-cash capital expenditures +23 +54 +See accompanying notes to Consolidated Financial Statements. +F-8 +Index +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated (together with its subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”), which has its headquarters in +Hamden, Connecticut and its primary operating facility in Ithaca, New York, operates in one operating segment: software-driven technology +and printing solutions for high growth markets including food service technology, casino and gaming and “point of sale” (“POS”) automation markets. Our solutions are designed from the ground up based on market and customer requirements and are sold +under the BOHA! TM , AccuDate™, Epic, Ithaca®, and EPICENTRAL ® product brands. We sell our products to original equipment manufacturers, value-added resellers, select distributors, and directly to end-users. Our product +distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its +growing worldwide installed base of products. We also generate revenue from the after-market side of the business, providing printer and terminal service, consumables and spare parts in addition to revenue from our two software solutions; (i) our line of BOHA! software applications used to automate the back-of-house operations of restaurants, convenience stores and +food service operators and (ii) the EPICENTRAL Print System (“EPICENTRAL”), that enables casino operators to create promotional coupons and marketing messages and print them in real time at the slot machine. +Current Business Trends +After strong demand during the year due in part to our primary competitor’s +struggle to deliver products in the face of supply chain constraints, in late 2023, we began to see indications of a temporary slowdown in demand in the casino and gaming market, as customers that had built up excess inventory due to supply chain +concerns advised us that they would temporarily reduce orders until their stock normalized. This slowdown impacted our results in the fourth quarter of 2023, and we expect this trend to continue to impact results in 2024. Further, our primary +competitor in the casino and gaming market has resumed supplying product with increasing volume in 2024, which has begun to result in downward pricing pressure in that market and could exacerbate the demand slowdown, either of which could +negatively impact our worldwide casino and gaming sales. In addition, we have experienced cost increases as a result of current economic conditions, most of which we have been able to offset by increasing prices of our products. However, there can +be no guarantee that we will be able to increase prices sufficiently to offset any future such cost increases that cannot be predicted, and we may be impacted by supply chain disruptions, inflationary pressures and other global economic conditions +that may affect the markets we serve and from which we source our supplies and parts. +Balance Sheet, Cash Flow and Liquidity. During the third quarter of 2023, we began a cost reduction +initiative to reduce our overall level of operating expenses that includes reducing employee headcount, trade show, advertising and other promotional marketing expenses, certain third party engineering resources and other expenses, and to a +lesser extent, certain general and administrative expenses. We expect these actions will result in approximately $ 3 million of +annualized savings beginning in 2024, partially offset by typical annual inflationary and cost of living increases in operating expenses. Notwithstanding the foregoing, there is no assurance that the cost-cutting efforts we have taken to bring +expenses in line with our revenue and mitigate the impact of global economic conditions such as supply chain disruptions and inflation are sufficient or adequate, and we may be required to take additional measures, as the ultimate extent of the +effects of these risks on the Company, our financial condition, results of operations, liquidity, and cash flows are uncertain and are dependent on evolving developments which cannot be predicted at this time. +After reviewing whether conditions and/or events raise substantial doubt about our ability to meet future financial +obligations over the 12 months following the date on which the Consolidated Financial Statements included in this Annual Report on Form 10-K (this “Form 10-K”) were issued, including consideration of the actions taken to manage expenses and +liquidity, we believe that our net cash to be provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility will provide sufficient liquidity to fund our current obligations, +capital spending, and working capital requirements and to comply with the financial covenants of our credit facility over at least 12 months following such issuance date. +Use of Assumptions and Estimates +Management’s belief that the Company will +be able to fund its planned operations over the 12 months following the date on which the Consolidated Financial Statements were issued is based on assumptions which involve significant judgment and estimates of future revenues, inflation, +rising interest rates, capital expenditures and other operating costs. Our current assumptions are that casinos and restaurants will remain open and consumer traffic will continue to remain strong during 2024. Though demand for our products at +casinos has increased substantially post-COVID, we cannot predict the ultimate impact of the current economic environment, including inflation, rising interest rates and supply chain disruptions on our customers, which may impact sales. We +believe that we are positioned to withstand the impact of any potential economic downturn or slower than anticipated economic recovery and we would be able to take additional financial and operational actions to cut costs and/or increase +liquidity. +In addition, the presentation of the accompanying audited Consolidated Financial Statements requires us to make estimates +and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities. Our estimates include those related to revenue recognition, accounts receivable, inventory +obsolescence, goodwill and intangible assets, the valuation of deferred tax assets and liabilities, depreciable lives of equipment, share-based compensation and contingent liabilities. We base our estimates on historical experience and on various +other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates used. +F-9 +Smaller Reporting Company +As a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, we may choose to prepare our disclosures relying on certain scaled +disclosure requirements for smaller reporting companies in Regulation S-K and in Article 8 of Regulation S-X. +The scaled disclosure requirements for smaller reporting companies permit us (i) to include less extensive narrative disclosure than required of other +reporting companies, particularly in the description of executive compensation in our proxy statement and (ii) to provide audited financial statements for two fiscal years in our Form 10-K, in contrast to other reporting companies, which must provide +audited financial statements for three years. +We will cease to be a smaller reporting company if we have (i) equal to or greater than $250 million in market value of our shares held by non-affiliates as of the last +business day of our second fiscal quarter and (ii) if the market value of our shares held by non-affiliates does not exceed $700 million as of the last business day of our second fiscal quarter, equal to or greater than $100 million in annual +revenues for the most recent fiscal year. +Index +2. Summary of significant accounting policies +Principles of consolidation: The +accompanying Consolidated Financial Statements include the audited Consolidated Financial Statements of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and +unrealized profit. +Use of estimates : The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make +estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and the reported amounts of sales and +expenses during the reporting period. Actual results could differ from those estimates. +Segment reporting : We apply the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting.” We view our operations and manage our +business as one segment: the design, development and marketing of software-driven technology and printing solutions and providing printer +and terminal related software, services, supplies and spare parts. Factors used to identify TransAct’s single operating segment include the organizational structure of the Company and the financial information available for evaluation by the chief +operating decision-maker in making decisions about how to allocate resources and assess performance. +Cash and cash equivalents : We consider all highly liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Accounts +receivable and credit losses : The +Company records accounts receivable when the right to consideration becomes unconditional. We establish an allowance for expected credit losses to ensure trade receivables are valued appropriately. +We are exposed to credit losses primarily through our net sales of products and services to our customers which are +recorded as Accounts Receivable, net on the Consolidated Balance Sheets. We evaluate each customer’s ability to pay through assessing customer creditworthiness, historical experience and current economic conditions through a reasonable forecast +period. Factors considered in our evaluation of assessing collectability and risk include: underlying value of any collateral or security interests, significant past due balances, historical losses and existing economic conditions including country +and political risk. There can be no assurance that actual results will not differ from estimates or that consideration of these factors in the future will not result in an increase or decrease to the allowance for credit losses. We may require +collateral or prepayment to mitigate credit risk. +We estimate expected credit losses of financial assets with +similar risk characteristics. We determine an asset is impaired when our assessment identifies there is a risk that we will be unable to collect amounts due according to the contractual terms of the agreement. We monitor our ongoing credit +exposure through reviews of customer balances against contract terms and due dates, current economic conditions and dispute resolution. Estimated credit losses are written off in the period in which the financial asset is no longer collectible. +The +following table summarizes the activity recorded in the allowance for expected credit losses related to accounts receivable: +Years Ended December 31 , +(In thousands) +2023 +2022 +Balance, beginning of period +$ +351 +$ +219 +Additions charged to costs and expenses +606 +140 +Deductions +( 189 +) +( 8 +) +Balance, end of period +$ +768 +$ +351 +Inventories: Inventories are stated at the lower of average cost +or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completions, disposal and transportation, historical usage and estimates of future demand. Based on +these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net realizable value. +Effective April 1, 2022, TransAct changed its method of inventory valuation from standard costing which approximated the “first-in, first-out” (“FIFO”) costing +methodology to the average costing methodology. +F-10 +Index +Fixed assets: Fixed assets are stated at cost. +Depreciation is recorded using the straight-line method over the estimated useful lives. The estimated useful life of tooling is five years ; +machinery and equipment is ten years ; furniture and office equipment is five years to ten years ; and computer software and equipment is three years to seven years . Leasehold +improvements are amortized over the shorter of the term of the lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and +accumulated depreciation accounts and any gain or loss is recognized. Depreciation expense was $ 1.3 and $ 1.1 million in 2023 and 2022, respectively. +Leases: We account for leases in accordance with ASC 842, “Leases” +(“ASC 842”), which requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determines +whether lease expense is recognized based on an effective interest method for finance leases or on a straight-line basis over the term of the lease for operating leases. A lessee is also required to record a right-of-use asset and a lease liability +for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less are accounted for based on existing guidance for operating leases. If risks and rewards are conveyed without the +transfer of control, the lease is treated as financing. If the lessor does not convey risks and rewards or control, the lease is treated as operating. +We have elected certain practical expedients available under ASC 842 upon adoption. We have applied the practical expedient for short-term leases. We +have lease agreements that include lease and non-lease components, and we have not elected the practical expedients to combine these components for any of our leases. +We enter into lease agreements for the use of real estate space and certain equipment under operating leases and we have no financing leases. We +determine if an arrangement contains a lease at inception. Our leases are included in “Right-of-use assets” and “Lease liabilities” in our Consolidated Balance Sheets. +Right of use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease +payments arising from the lease. Lease right of use assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term. +On April 26, 2022, we entered into an amendment to modify the expiration date of our lease on our Las Vegas, Nevada facility. The lease was set to expire +on November 1, 2022 and the amendment extended the lease term to November 30, 2025. The lease amendment resulted in an increase to the right-of-use-asset and lease liability of $ 0.8 million. The lease amendment modified the base rent. +Lease expense is recognized on a straight-line basis over the lease term. As most of our leases do not provide an implicit rate, the Company determines +its incremental borrowing rate by using the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. Our lease right of use +asset excludes lease incentives. Our leases have remaining lease terms of one year to four years , some of which include options to extend. The exercise of lease renewal options is at our sole discretion and our lease right of use assets and liabilities reflect +only the options we are reasonably certain that we will exercise. +Goodwill and intangible assets : We acquire businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible +assets requires management to make estimates and assumptions. In accordance with ASC 350-20 “Goodwill,” acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change that +indicate it is more likely than not an impairment exists. We perform a fair value-based impairment test to the carrying value of goodwill and indefinite-lived intangible assets on an annual basis and, if certain events or circumstances indicate that +an impairment loss may have been incurred, on an interim basis. The Company utilizes the option to first assess qualitative factors to determine whether it is necessary to perform the Step 1 quantitative goodwill impairment test in accordance with +the applicable accounting standards. Under the qualitative assessment, management considers relevant events and circumstances including but not limited to macroeconomic conditions, industry and market considerations, Company performance and events +directly affecting the Company. If the Company determines that the Step 1 quantitative impairment test is required, management estimates the fair value of the reporting unit primarily using the income approach, which reflects management’s cash flow +projections, and also evaluates the fair value using the market approach. Factors considered that may trigger an interim period impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected +historical or projected future operating results; significant changes in the manner of use of acquired assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization +relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when appropriate. +As of December 31, 2023, we have determined that no +goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2023 when our annual review for impairment was performed. +Revenue recognition: We account for revenue in +accordance with ASC Topic 606: Revenue from Contracts with Customers. In accordance with ASC 606, a performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Some of our contracts with +customers contain a single performance obligation, while other contracts contain multiple performance obligations (most commonly when contracts include a hardware product, software and extended warranties). A contract’s transaction price is +allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. +The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring services to the +customer. To the extent the transaction price includes variable consideration, such as price protection, reserves for returns and other allowances, the Company estimates the amount of variable consideration that should be included in the transaction +price utilizing either the “expected value” method or the “most likely amount” method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable +that a significant future reversal of cumulative revenue under the contract will not occur. +F-11 +Index +For a majority of our revenue, which consists of printers, terminals, consumables, and replacement parts, the Company recognizes revenue as of a point of +time. The transaction price is recognized upon shipment of the order when control of the goods is transferred to the customer and at the time the performance obligation is fulfilled. We also sell a software solution in our casino and gaming market, +EPICENTRAL, that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. EPICENTRAL is primarily comprised of both a software component, which is licensed to the customer, and +a hardware component. EPICENTRAL software and hardware are integrated to deliver the system’s full functionality. The transaction prices from EPICENTRAL software license and hardware are recognized upon installation and formal acceptance by the +customer when control of the license is transferred to the customer. For out-of-warranty repairs, the transaction price is recognized after the repair work is completed and the printer or terminal is returned to the customer, as control of the +product is transferred to the customer and our performance obligation is completed. +Performance obligations are satisfied over time if the customer receives the benefits as we perform work, if the customer controls the asset as it is +being produced, or if the product being produced for the customer has no alternative use and we have a contractual right to payment. For our separately priced extended warranty, BOHA! cloud-based software applications, technical support for our food +service technology terminals and maintenance agreements (including free one-year maintenance received by customers upon completion of +EPICENTRAL installation) revenue is recognized over time as the customer receives the benefit. The transaction price from the maintenance services is recognized ratably over time, using output methods, as control of the services is transferred to +the customer. Our cloud-based BOHA! software allows customers to use hosted software over the contract period on a subscription basis without taking possession of the software and the subscription price is recognized ratably over the contract +period. For extended warranties, the transaction price is recognized ratably over the warranty period, using output methods, as control of the services is transferred to the customer. +When there is more than one performance obligation in a customer arrangement, the Company typically uses the “standalone selling price” method to +determine the transaction price to allocate to each performance obligation. The Company sells the performance obligations separately and has established standalone selling prices for its products and services. In the case of an overall price +discount, the discount is applied to each performance obligation proportionately based on standalone selling price. To determine the standalone selling price for initial EPICENTRAL installations, the Company uses the adjusted market assessment +approach. +For contracts with terms of less than 12 months, the Company expenses sales commissions as they are incurred, since the expected amortization period of +the cost to obtain a contract is less than 12 months. +Disaggregation of revenue +The following table disaggregates our revenue by market type, as we believe it best depicts how the nature, amount, timing and uncertainty of our revenue +and cash flows are affected by economic factors. Sales and usage-based taxes are excluded from revenues. +Year Ended December 31, 2023 +(In thousands) +United States +International +Total +Food service technology +$ +15,159 +$ +1,149 +$ +16,308 +POS automation +6,805 +117 +6,922 +Casino and gaming +28,715 +12,477 +41,192 +TransAct Services Group +7,381 +828 +8,209 +Total net sales +$ +58,060 +$ +14,571 +$ +72,631 +Year Ended December 31, 2022 +(In thousands) +United States +International +Total +Food service technology +$ +11,602 +$ +762 +$ +12,364 +POS automation +10,657 +2 +10,659 +Casino and gaming +17,686 +12,343 +30,029 +TransAct Services Group +4,089 +998 +5,087 +Total net sales +$ +44,034 +$ +14,105 +$ +58,139 +Contract balances +Contract assets consist of unbilled receivables. Pursuant to the over-time revenue recognition model, revenue may be recognized prior to the customer +being invoiced. An unbilled receivable is recorded to reflect revenue that is recognized when such revenue exceeds the amount invoiced to the customer. Unbilled receivables are separated into current and non-current assets and included within +“Accounts Receivable, net” and “Other Assets” on the Consolidated Balance Sheets. We first recorded contract assets during 2020 upon the start of a long-term BOHA! contract. +Contract liabilities consist of customer prepayments and deferred revenue. Customer prepayments are reported as “Accrued Liabilities” in current +liabilities in the Consolidated Balance Sheets and represent customer payments made in advance of performance obligations in instances where credit has not been extended and is recognized as revenue when the performance obligation is complete. +Deferred revenue is reported separately in current liabilities and non-current liabilities and consists of our extended warranty contracts, technical support for our food service technology terminals, EPICENTRAL maintenance contracts and prepaid +software subscriptions for our BOHA! software applications, and is recognized as revenue as (or when) we perform under the contract. During the year ended December 31, 2023, we recognized revenue of $ 1.4 million related to our contract liabilities as of December 31, 2022. +F-12 +Index +Net contract (liabilities) assets consist of the following: +December 31, +(In thousands) +2023 +2022 +Unbilled receivables, current +$ +145 +$ +392 +Unbilled receivables, non-current +120 +163 +Customer pre-payments +( 155 +) +( 101 +) +Deferred revenue, current +( 1,079 +) +( 1,329 +) +Deferred revenue, non-current +( 209 +) +( 143 +) +Net contract (liabilities) assets +$ +( 1,178 +) +$ +( 1,018 +) +Remaining performance obligations +Remaining performance obligations represent the transaction price of firm orders for which a good or service has not been delivered to our customer. As +of December 31, 2023, the aggregate amount of the transaction price allocated to remaining performance obligations was $ 8.2 million. The Company expects to recognize revenue on $ 7.9 +million of its remaining performance obligations within the next 12 months following December 31, 2023, $ 0.2 million within the next 24 months +following December 31, 2023 and the balance of these remaining performance obligations within the next 36 months following December 31, 2023. +Concentration of credit risk: Financial +instruments that potentially expose us to concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable, net were as follows: +December 31, +2023 +2022 +International Gaming Technology (“IGT”) +28 +% +12 +% +The Bright Group +9 +% +11 +% +Sales to customers representing 10% or more of total net sales were as follows: +December 31, +2023 +2022 +IGT +15 +% +10 +% +Engineering, design and product +development: Engineering, design and product development expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as a component +of operating expenses as incurred. We recorded $ 9.4 million and $ 8.6 million of research and development expenses in 2023 and 2022, respectively. +Costs incurred in the engineering, design and product development of a computer software product are charged to expense until technological feasibility +has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in determining +when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs has been included in cost +of sales over the estimated life of the product. +Advertising: Advertising costs are expensed as incurred. +Advertising expenses, which are included in selling and marketing expense on the accompanying Consolidated Statements of Operations for 2023 +and 2022 totaled $ 1.7 +million and $ 3.1 million, respectively. These expenses include items such as consulting, professional services, tradeshows, and print +advertising. +Income taxes: The income tax amounts reflected in the +accompanying Consolidated Financial Statements are accounted for under the liability method in accordance with ASC 740, “Income Taxes” (“ASC 740”). Deferred tax assets and liabilities are recognized for the estimated future tax consequences +attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using +enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We assess the likelihood that net deferred tax assets will be realized from future taxable income, and to the extent that we +believe that realization is not likely, we establish a valuation allowance. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. +Foreign currency translation: The financial +position and results of operations of our foreign subsidiary in the UK are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars at the year-end exchange rate, +related sales and expenses have been translated at the weighted average rate for the period, and shareholders’ equity has been translated at historical exchange rates. The resulting translation gains or losses, net of tax, are recorded in +shareholders’ equity as a cumulative translation adjustment, which is a component of accumulated other comprehensive income and loss. Foreign currency transaction gains and losses, including those related to intercompany balances, are recognized in +Other, net on the Consolidated Statements of Operations. +F-13 +Index +Share-based payments: At December 31, 2023, we have share-based employee compensation plans, +which are described more fully in Note 9 - Stock incentive plans. We account for those plans under the recognition and measurement principles of ASC 718, “Compensation – Stock Compensation.” Share-based compensation expense is measured at the grant +date, based on the estimated fair value of the award, and is recognized as expense over the employee’s requisite service period. +We use the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include +the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions require judgment and are highly sensitive in the determination of +compensation expense. Forfeitures are recognized as they occur. +Net income (loss) per share : We report net income or loss per share in accordance with ASC 260, “Earnings per Share (EPS).” Under this guidance, basic EPS, which excludes dilution, is computed by dividing +income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were +exercised or converted into common stock. Diluted EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, these +instruments are excluded from the computation of diluted EPS. See Note 11 - Earnings per share. +Recently issued accounting pronouncements : +In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses +(Topic 326): Measurement of Credit Losses on Financial Instruments . This ASU and its related amendments (collectively, the “Credit Loss Standard”) modifies the impairment model to utilize an expected loss methodology in place of the +incurred loss methodology for financial instruments, including trade receivables, contract assets and off-balance sheet credit exposures. The Credit Loss Standard requires consideration of a broader range of information to estimate expected +credit losses, including historical information, current economic conditions and a reasonable forecast period. This Credit Loss Standard requires that the statement of operations reflect estimates of expected credit losses for newly recognized +financial assets as well as changes in the estimate of expected credit losses that have taken place during the period, which may result in earlier recognition of certain losses. We adopted this standard effective January 1, 2023, and this +standard did not have a material impact on the Company’s Consolidated Financial Statements. +On November 27, 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280) . +The amendments improve reportable segment disclosures requirements and clarify circumstances in which an entity can disclose multiple segment measures of profit or loss, provide new segment disclosure requirements for entities with a single +reportable segment and contain other disclosure requirements. These amendments are effective for fiscal years beginning after December 15, 2023 and for interim periods beginning after December 15, 2024. These segment disclosure requirements +must be applied retrospectively to all periods presented in the financial statements. We are currently evaluating the impact of adopting this standard; however, we do not expect it to have a material impact on our Consolidated Financial +Statements. +On December 14, 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740) . This ASU requires the use of consistent categories and greater +disaggregation in tax rate reconciliations and income taxes paid disclosures. These amendments are effective for fiscal years beginning after December 15, 2024. These income tax disclosure requirements can be applied either prospectively or +retrospectively to all periods presented in the financial statements. We are currently evaluating the impact of adopting this standard; however, we do not expect it to have a material impact on our Consolidated Financial Statements. +3. Inventories +The components of inventories are: +December 31, +(In thousands) +2023 +2022 +Raw materials and purchased component parts +$ +9,382 +$ +8,884 +Finished goods +8,377 +3,144 +$ +17,759 +$ +12,028 +4. Fixed assets, net +The components of fixed assets, net are: +December 31, +(In thousands) +2023 +2022 +Tooling, machinery and equipment +$ +7,562 +$ +6,859 +Furniture and office equipment +2,078 +1,882 +Computer software and equipment +8,190 +8,348 +Leasehold improvements +2,895 +2,883 +20,725 +19,972 +Less: Accumulated depreciation and amortization +( 18,646 +) +( 17,656 +) +2,079 +2,316 +Construction in-process +342 +465 +$ +2,421 +$ +2,781 +F-14 +Index +5. Intangible assets, net +Identifiable intangible assets are recorded in Intangible assets, net in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2023 +2022 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,591 +$ +( 1,503 +) +$ +1,591 +$ +( 1,349 +) +Patents +15 +( 15 +) +15 +( 15 +) +Total +$ +1,606 +$ +( 1,518 +) +$ +1,606 +$ +( 1,364 +) +Amortization expense was $ 154 thousand and +$ 155 thousand in 2023 and +2022, respectively. Amortization expense for each of the next five years ending December 31 is expected to be as follows: $ 88 thousand in 2024; and none thereafter. +6. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2023 +2022 +Salaries and compensation related +$ +3,455 +$ +2,744 +Taxes +870 +530 +Professional and consulting +161 +371 +Other +461 +432 +$ +4,947 +$ +4,077 +7. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of the month immediately following their date +of hire. We match employees’ contributions at a rate of 50 % of employees’ contributions up to the first 6 % of the employees’ compensation contributed to the 401(k) plan. Our matching contributions, net of applied forfeitures, were $ 230 thousand and $ 355 thousand in 2023 and 2022, respectively. +8. Borrowings +Credit Facility +On March 13, 2020, we entered into the Loan and Security Agreement governing the Siena Credit Facility with Siena Lending Group LLC (the “Lender”). The +Siena Credit Facility provides for a revolving credit line of up to $ 10.0 million and was originally scheduled to expire on March 13, 2023. Borrowings under the Siena Credit Facility bear a floating rate of interest equal to the greatest of (i) the prime rate plus 1.75 %, (ii) the federal funds rate plus 2.25 %, +and (iii) 6.50 %. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility were $ 245 thousand. We also pay a fee of 0.50 % +on unused borrowings under the Siena Credit Facility. Borrowings under the Siena Credit Facility are secured by a lien on substantially all the assets of the Company. Borrowings under the Siena Credit Facility are subject to a borrowing base based on +85 % of eligible accounts receivable plus the lesser of (a) $ 5.0 million and (b) 50 % of eligible raw material and 60 % of finished goods inventory. +The Siena Credit Facility imposes a financial covenant on the Company and restricts, among other things, our ability to incur additional indebtedness +and create other liens. On July 21, 2021, the Company entered into an amendment (“Siena Credit Facility Amendment No. 1”) to the Siena Credit Facility. Siena Credit Facility Amendment No. 1 changed the financial covenant under the Siena Credit +Facility from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at least $ 750 +thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning with the calendar month ended July 31, 2021. From July 31, 2021 through December 31, 2023, we remained in compliance with our excess availability +covenant. +On July 19, 2022, the Company and the Lender entered into Amendment No. 2 (“Siena Credit Facility Amendment No. 2”) to the Siena Credit Facility as +amended by Siena Credit Facility Amendment No. 1. Also on July 19, 2022, the Company and the Lender entered into an Amended and Restated Fee Letter (the “Amended Fee Letter”) in connection with Siena Credit Facility Amendment No. 2. Siena Credit +Facility Amendment No. 2 did not modify the aggregate amount of the revolving commitment or the interest rate applicable to the loans. +The changes to the Siena Credit Facility provided for in Siena Credit Facility Amendment No. 2 include, among other things, the following: +(i) +The extension of the maturity date from March 13, 2023 to March 13, 2025; and +(ii) +The termination of the existing blocked account control agreement and entry into a new “springing” deposit account control agreement, +permitting the Company to direct the use of funds in its deposit account until such time as (a) the sum of excess availability under the Siena Credit Facility and unrestricted cash is less than $ 5 million for 3 consecutive business days or (b) an +event of default occurs and is continuing. +F-15 +Index +In addition, the Amended Fee Letter requires the Company, while it retains the ability to direct the use of funds in the deposit account, to maintain +outstanding borrowings of at least $ 2,250,000 in principal amount. If the Company does not have the ability to direct the use of funds in +the deposit account, then the Amended Fee Letter requires the Company to pay interest on at least $ 2,250,000 principal amount of loans, +whether or not such amount of loans is actually outstanding. +On May 1, 2023, the Company and the Lender agreed to a letter amendment to the Loan and Security Agreement governing the Siena Credit Facility. Prior to such amendment, +Section 7.1(m) of the Loan and Security Agreement governing the Siena Credit Facility required that any successor to the Company’s former Chief Executive Officer be reasonably acceptable to the Lender. This amendment confirmed that Mr. Dillon, the +Company’s current Chief Executive Officer, is an acceptable successor, and applied the same requirement to any future successor to Mr. Dillon as Chief Executive Officer. +As of December 31, 2023, we had $ 2.3 +million of outstanding borrowings under the Siena Credit Facility and $ 5.9 million of net borrowing capacity available under the Siena +Credit Facility. +9. Stock incentive plans +Stock incentive plans . We currently have two stock incentive plans: the 2005 Equity +Incentive Plan and the 2014 Equity Incentive Plan, which provide for awards to executives, key employees, directors and consultants. The plans generally provide for awards in the form of: (i) incentive stock options, (ii) non-qualified stock +options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. Awards granted under these plans have exercise prices equal to 100 % of the fair market value of the common stock at the date of grant. Awards granted have a ten-year term and generally vest over a two-year to four-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards may be made under the 2005 Equity Incentive +Plan. Under our 2014 Equity Incentive Plan, as amended in May 2023, we are authorized to grant awards of up to 2,900,000 shares of +TransAct common stock. At December 31, 2023, 981,769 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average per share fair value of stock option grants for 2023 and 2022 was $ 4.16 and $ 4.39 , respectively. We also issued restricted stock +units for certain executives and directors that vest over a specified period of time, and in some instances require achieving certain performance metrics. The weighted-average per share fair value of these restricted stock units was $ 7.21 and $ 8.43 in 2023 and 2022, respectively. +The table below indicates the key assumptions (on a weighted-average basis) used in the option valuation calculations for options granted in 2023 and 2022 and a discussion of our +methodology for developing each of the assumptions used in the valuation model: +Years ended December 31, +2023 +2022 +Expected option term (in years) +7.0 +7.1 +Expected volatility +55.6 +% +51.3 +% +Risk-free interest rate +4.2 +% +2.2 +% +Dividend yield +0.0 +% +0.0 +% +Expected Option Term - This is the weighted +average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility – The stock volatility +for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of the grant. An increase in the expected volatility factor will +increase compensation expense. +Risk-Free Interest Rate - This is the U.S. +Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense. +Dividend Yield –The dividend yield is +calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will decrease compensation expense. +We recorded $ 0.9 and $ 1.2 million of share-based compensation expense for 2023 +and 2022, respectively, included primarily in general and administrative expense in our Consolidated Statements of Operations. We also +recorded income tax benefits of $ 0.2 million in 2023 and $ 0.3 million in 2022, related to such share-based compensation. At December 31, +2023, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +F-16 +Index +Equity award activity in the 2005 Equity Incentive Plan and the 2014 Equity Incentive Plan, as amended, is summarized below: +Stock Options +Restricted Stock Units +Number of Shares +Average Price* +Number of Units +Average Price** +Outstanding at December 31, 2022 +1,355,955 +$ +9.08 +214,286 +$ +9.28 +Granted +309,800 +6.91 +210,100 +7.21 +Exercised +( 1,875 +) +4.25 +( 58,705 +) +9.55 +Forfeited +( 271,655 +) +7.72 +( 181,145 +) +8.34 +Expired +( 77,750 +) +8.90 +– +– +Outstanding at December 31, 2023 +1,314,475 +$ +8.82 +184,536 +$ +7.76 +* +weighted average exercise price per share +** +weighted average grant stock price per share +The following summarizes information about equity awards outstanding that are vested and expect to vest and equity awards that are exercisable at December 31, 2023: +Equity Awards Vested and Expected to Vest +Equity Awards That Are Exercisable +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Awards +Average Price* +Aggregate Intrinsic Value +Remaining Term** +Stock Options +1,314,475 +$ +8.82 +$ +316 +4.0 +968,972 +$ +9.31 +$ +167 +2.2 +Restricted stock units +184,536 +– +1,288 +2.7 +– +– +– +– +* +weighted average exercise price per share +** +weighted-average contractual remaining term in years +Shares that are issued upon exercise of employee stock awards are newly issued shares and not issued from treasury stock. As of December 31, 2023, unrecognized compensation cost related to non-vested equity awards granted under our stock incentive plans is approximately $ 4.1 million, which is expected to be recognized over a weighted average period of 3.3 years. +The total fair value of awards vested was $ 1.3 +million and $ 1.6 million during the years ended December 31, 2023 and 2022, respectively. The total intrinsic value (which +is the amount by which the stock price exceeded the exercise price on the date of exercise) of stock options exercised during the years ended December 31, 2023 +and 2022 was $ 3 thousand +and $ 40 thousand, respectively, and cash received from option exercises was zero in both 2023 and 2022. 1,875 and 17,500 stock options were exercised during the year ended December 31, 2023 and 2022, respectively. We recorded a realized tax provision in 2023 and 2022 from equity-based awards +of zero and $ 13 thousand, +respectively, related to options exercised. +10. Income taxes +The components of the income tax expense (benefit) are as follows: +December 31, +(In thousands) +2023 +2022 +Current: +Federal +$ +( 1 +) +$ +149 +State +51 +110 +Foreign +85 +( 83 +) +135 +176 +Deferred: +Federal +825 +( 1,924 +) +State +132 +( 217 +) +Foreign +63 +– +1,020 +( 2,141 +) +Income tax expense (benefit) +$ +1,155 +$ +( 1,965 +) +Our effective tax rates were 19.6 % and ( 24.9 % ) for 2023 and 2022 , respectively. The tax benefit recorded for 2022 includes the recognition of stock option +cancellations for which no benefit was realized . +At December 31, 2023, we have no federal net operating loss carryforwards, $ 0.1 +million of tax-effected state net operating loss carryforwards, $ 0.7 million in R&D credit carryforwards, and no state tax credit carryforwards. Foreign income before taxes were $ 322 thousand and $ 24 thousand in 2023 and 2022, respectively. +F-17 +Index +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Our +deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2023 +2022 +Deferred tax assets: +Federal net operating losses +$ +– +$ +2,297 +Foreign net operating losses +733 +676 +State net operating losses +84 +149 +Accrued severance +165 +– +Capitalized R&D expenses +3,127 +1,708 +Inventory reserves +896 +648 +Deferred revenue +31 +41 +Warranty reserve +24 +17 +Stock compensation expense +790 +769 +Other accrued compensation +404 +222 +R&D credit carryforward +695 +1,238 +Other Assets +360 +– +Other liabilities and reserves +– +463 +Gross deferred tax assets +7,309 +8,228 +Valuation allowance +( 719 +) +( 656 +) +Net deferred tax assets +6,590 +7,572 +Deferred tax liabilities: +Depreciation and amortization +237 +196 +Other +49 +49 +Net deferred tax liabilities +286 +245 +Total net deferred tax assets +$ +6,304 +$ +7,327 +As of December 31, 2023 and 2022, we had a $ 719 thousand and $ 656 thousand, +respectively, of valuation allowances on our net operating loss carryforwards. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year Ended December 31, +(In thousands) +2023 +2022 +Balance, beginning of period +$ +656 +$ +733 +Subtractions released to income tax provisions +– +( 77 +) +Additions charged to income tax provision +63 +– +Balance, end of period +$ +719 +$ +656 +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2023 +2022 +Federal statutory rate +21.0 +% +21.0 +% +R&D credit +( 5.9 +) +4.3 +Foreign-derived intangible income deduction +( 1.7 +) +– +Stock award excess tax benefit +0.4 +– +State income taxes, net of federal income taxes +2.5 +1.1 +Business meals and entertainment +0.3 +– +Executive compensation limitation +0.6 +– +Uncertain tax positions +0.5 +( 0.5 +) +Stock option cancellations +0.6 +( 1.9 +) +Valuation allowance and tax accruals +1.0 +1.0 +Other +0.3 +( 0.1 +) +Effective tax rate +19.6 +% +24.9 +% +F-18 +We had $ 197 thousand and $ 142 thousand of total gross unrecognized tax benefits at December 31, 2023 +and 2022, respectively that, if recognized, would favorably affect the effective income tax rate in any future periods. We are not +aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the gross amounts of unrecognized tax benefits at the beginning +and end of the year is as follows: +December 31, +(In thousands) +2023 +2022 +Balance, beginning of period +$ +142 +$ +144 +Tax positions taken during the current period +83 +26 +Lapse of statute of limitations +( 28 +) +( 28 +) +Balance, end of period +$ +197 +$ +142 +We expect $ 40 thousand of the $ 197 thousand of unrecognized tax benefits will reverse in 2024 +upon the expiration of the statute of limitations. +We recognize interest and penalties related to uncertain tax positions in the income tax provision. We have accrued interest and penalties related to +uncertain tax positions of $ 25 thousand and $ 34 +thousand as of December 31, 2023 and 2022, +respectively. +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially concluded all U.S. +federal income tax, state and local, and foreign tax matters through 2019. However, our federal tax returns for the years 2020 through 2023 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination +as well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +Index +11. Earnings per share +Earnings per share was computed as follows (in thousands, except per share amounts): +Years Ended December 31, +2023 +2022 +Net income (loss) +$ +4,748 +$ +( 5,936 +) +Shares: +Basic: Weighted average common shares outstanding +9,951 +9,905 +Add: Dilutive effect of outstanding equity awards as determined by the treasury stock method +70 +– +Diluted: Weighted average common and common equivalent shares outstanding +10,021 +9,905 +Net income (loss) per common share: +Basic +$ +0.48 +$ +( 0.60 +) +Diluted +0.47 +( 0.60 +) +The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options, restricted stock +units and performance stock awards, when the average market price of the common stock is lower than the exercise price of the related stock award during the period. These outstanding stock awards are not included in the computation of diluted +earnings per share because the effect would be anti-dilutive. Furthermore, in periods when a net loss is reported, such as in 2022, basic and diluted net loss per common share are calculated using the same method. Anti-dilutive stock awards +excluded from the computation of earnings per dilutive share were 1.1 million and 1.5 million at December 31, 2023 and 2022, respectively. +12. Stock repurchase program +We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. +Repurchases of our common stock are accounted for as of the settlement date. During 2023 and 2022, we did no t repurchase any shares of our common stock. +From January 1, 2005 through December 31, 2019, we repurchased a total of 4,044,842 shares of common stock for $ 32.1 million, at an average price of $ 7.94 +per share. +F-19 +13. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are based on the +location of the customer and asset. +Years Ended December 31, +(In thousands) +2023 +2022 +Net sales: +United States +$ +58,060 +$ +44,034 +International +14,571 +14,105 +Total +$ +72,631 +$ +58,139 +Fixed assets, net: +United States +$ +945 +$ +2,252 +International +1,476 +529 +Total +$ +2,421 +$ +2,781 +Sales to international customers were 20 % +and 24 % of total sales in 2023 +and 2022, respectively. Sales to Europe represented 64 % and 68 %, sales to the Pacific Rim (which includes Australia and Asia) represented 29 % and 28 %, and sales to Canada +represented 4 % of total international sales in both 2023 and 2022, respectively. International long-lived assets consist of net fixed assets located at +our foreign subsidiary in the UK, as well as our contract manufacturer in Thailand. +Index +14. Leases +Operating lease expense was $ 1.1 million and $ 1.0 million for the years ended December 31, 2023 and 2022 , +respectively, and is reported as “Cost of sales,” “Engineering, design and product development expense,” “Selling and marketing expense,” and “General and administrative expense” in the Consolidated Statements of Operations. Operating costs include short-term lease costs. +The following information represents supplemental disclosure for the statement of cash flows related to operating leases (in thousands): +Years Ended December 31, +2023 +2022 +Operating cash outflows from leases +$ +1,013 +$ +967 +The following summarizes additional information related to our leases: +Years Ended December 31, +2023 +2022 +Weighted average remaining lease term (in years) +1.7 +2.7 +Weighted average discount rate +4.4 +% +4.5 +% +The maturity of the Company’s operating lease liabilities are as follows (in thousands): +December 31, 2023 +2024 +$ +985 +2025 +713 +2026 +22 +Total undiscounted lease payments +1,720 +Less imputed interest +71 +Total lease liabilities +$ +1,649 +F-20 +15. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2023 +and 2022 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2023: +Net sales +$ +22,270 +$ +19,906 +$ +17,190 +$ +13,265 +Gross profit +12,255 +10,858 +8,916 +6,371 +Net income (loss) +3,139 +765 +906 +( 62 +) +Net income (loss) per common share: +Basic +0.32 +0.08 +0.09 +( 0.01 +) +Diluted +0.31 +0.08 +0.09 +( 0.01 +) +2022: +Net sales +$ +9,702 +$ +12,623 +$ +17,856 +$ +17,958 +Gross profit +2,566 +5,434 +8,193 +8,219 +Net (loss) income +( 4,348 +) +( 2,376 +) +528 +260 +Net (loss) income per common share: +Basic +( 0.44 +) +( 0.24 +) +0.05 +0.03 +Diluted +( 0.44 +) +( 0.24 +) +0.05 +0.03 +16. Related party transactions +One of the Company’s directors serves as President and Chief Executive Officer of The One Group Hospitality, Inc. The +Company sold various food service technology products to The One Group Hospitality, Inc. on an arms’ length basis totaling $ 246 thousand +and $ 37 thousand in 2023 and 2022, respectively. The Company’s accounts receivable from The One Group Hospitality, Inc. amounted to $ 34 thousand and $ 4 thousand in 2023 and +2022, respectively. +Index +17. Subsequent events +The Company has evaluated all events or transactions that occurred up to the date the consolidated financial statements were available to issue. Based upon this review, +the Company did not identify any subsequent events that would have required adjustment or disclosure in the consolidated financial statements. +F-21 \ No newline at end of file diff --git a/raw/filings/0001017303/2023/0001140361-24-013040/filing_metadata.csv b/raw/filings/0001017303/2023/0001140361-24-013040/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..dd9c84c982766294f68de3ec0d3ce0a6c9f216a0 --- /dev/null +++ b/raw/filings/0001017303/2023/0001140361-24-013040/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2024-03-13,2023-12-31,2024-03-13T21:05:25.000Z,0001140361-24-013040,ef20015290_10k.htm,"FORM 10K FOR THE YEAR ENDED DECEMBER 31, 2023",9708952,1,1,https://www.sec.gov/Archives/edgar/data/1017303/000114036124013040/ef20015290_10k.htm,https://www.sec.gov/Archives/edgar/data/1017303/000114036124013040/,2023,2023,1 diff --git a/raw/filings/0001017303/2023/0001140361-24-013040/item1.txt b/raw/filings/0001017303/2023/0001140361-24-013040/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..292d06c8818be3853e73662b17d37932df20f6a0 --- /dev/null +++ b/raw/filings/0001017303/2023/0001140361-24-013040/item1.txt @@ -0,0 +1,34 @@ +Item 1. Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was incorporated in +June 1996 and began operating as a stand-alone business in August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high-growth markets including food service +technology, point of sale (“POS”) automation and casino and gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL®, and Ithaca® brand +names. During 2019, we launched a new line of products for the food service technology market, the BOHA! hardware solutions and companion branded suite of cloud-based applications. The BOHA! software and hardware products help restaurants, +convenience stores and food service operators of all sizes automate the food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and terminals +generate top-quality labels, coupons and transaction records such as receipts, tickets and other documents. We sell our technology to original equipment manufacturers (“OEMs”), value-added resellers, and select distributors, as well as directly to +end users. Our product distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class service, support, labels, spare parts, accessories +and printing supplies to our growing worldwide base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables used in the printing activities of customers in +the restaurant and hospitality, retail, casino and gaming, and government markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the demand for these products. We operate in one reportable segment: the +design, development, and marketing of software-driven technology and printing solutions for high growth markets, and provide related services, supplies and spare parts. Our primary operating, hardware research and development, and U.S. service +center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters and software research and development center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom +(“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, 06518, and our telephone number is (203) 859-6800. +1 +Index +Recent Developments +In the fourth quarter of 2023, we completed an asset sale of our Printrex product line (essentially inventory +on-hand) and recorded a resulting non-operating gain of approximately $0.4 million in the fourth quarter of 2023. Prior to this sale, the last TransAct sales of Printrex products occurred in 2021. +Current Business Trends +After strong demand during the year due in part to our primary competitor’s struggle to deliver products in the +face of supply chain constraints, in late 2023, we began to see indications of a temporary slowdown in demand in the casino and gaming market, as customers that had built up excess inventory due to supply chain concerns advised us that they would +temporarily reduce orders until their stock normalized. This slowdown impacted our results in the fourth quarter of 2023, and we expect this trend to continue to impact results in 2024. Further, our primary competitor in the casino and gaming +market has resumed supplying product with increasing volume in 2024, which has begun to result in downward pricing pressure in that market and could exacerbate the demand slowdown, either of which could negatively impact our worldwide casino and +gaming sales. In addition, we have experienced cost increases as a result of current economic conditions, most of which we have been able to offset by increasing the prices of our products. However, there can be no guarantee that we will be able +to increase prices sufficiently to offset any future such cost increases that cannot be predicted, and we may be impacted by supply chain disruptions, inflationary pressures and other global economic conditions that may affect the markets we serve +and from which we source our supplies and parts. +Balance Sheet, Cash Flow and Liquidity +During the third quarter of 2023, we began a cost reduction initiative to reduce our overall level of operating expenses that includes reducing employee +headcount, trade show, advertising and other promotional marketing expenses, certain third party engineering resources and other expenses, and to a lesser extent, certain general and administrative expenses. We expect these actions will result in +approximately $3 million of annualized savings beginning in 2024, partially offset by typical annual inflationary and cost of living increases in operating expenses. Notwithstanding the foregoing, there is no assurance that the cost-cutting efforts +we have taken to bring expenses in line with our revenue and mitigate the impact of global economic conditions such as supply chain disruptions and inflation are sufficient or adequate, and we may be required to take additional measures, as the +ultimate extent of the effects of these risks on the Company, our financial condition, results of operations, liquidity, and cash flows are uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, \ No newline at end of file diff --git a/raw/filings/0001017303/2023/0001140361-24-013040/item13.txt b/raw/filings/0001017303/2023/0001140361-24-013040/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..bd72849cb08902a8ecdd8203104ff58f881aadc0 --- /dev/null +++ b/raw/filings/0001017303/2023/0001140361-24-013040/item13.txt @@ -0,0 +1,3 @@ +Item 13 . Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related Transactions” and +“Corporate Governance-Board Leadership Structure and Independence” and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2023/0001140361-24-013040/item9a.txt b/raw/filings/0001017303/2023/0001140361-24-013040/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..34528a4b073928eae555d675758888c97aa103bf --- /dev/null +++ b/raw/filings/0001017303/2023/0001140361-24-013040/item9a.txt @@ -0,0 +1,20 @@ +Item 9A . Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our +disclosure controls and procedures, as defined in Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of +December 31, 2023. Based on this evaluation of our disclosure controls and procedures as of December 31, 2023, our CEO and CFO concluded that, as of +December 31, 2023, our disclosure controls and procedures were effective at the reasonable assurance level. +Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly present, in all +material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with GAAP, and that they can be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the +Exchange Act, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those +policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are +recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2023. Our management based its assessment on criteria +established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. In the opinion of management, TransAct maintained effective internal control over financial reporting as of +December 31, 2023. +Changes in Internal Control over Financial Reporting +No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three +months ended December 31, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001017303/2023/0001140361-24-013040/rp_note.txt b/raw/filings/0001017303/2023/0001140361-24-013040/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..b0a82ca979e14737ed0af714d8e532033ea5d050 --- /dev/null +++ b/raw/filings/0001017303/2023/0001140361-24-013040/rp_note.txt @@ -0,0 +1,6 @@ +16. Related party transactions +One of the Company’s directors serves as President and Chief Executive Officer of The One Group Hospitality, Inc. The +Company sold various food service technology products to The One Group Hospitality, Inc. on an arms’ length basis totaling $ 246 thousand +and $ 37 thousand in 2023 and 2022, respectively. The Company’s accounts receivable from The One Group Hospitality, Inc. amounted to $ 34 thousand and $ 4 thousand in 2023 and +2022, respectively. +Index \ No newline at end of file diff --git a/raw/filings/0001017303/2023/0001140361-24-013040/rpt_disclosure.txt b/raw/filings/0001017303/2023/0001140361-24-013040/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..81c12eb92e0650c0fd8dcc44203836f016acd0eb --- /dev/null +++ b/raw/filings/0001017303/2023/0001140361-24-013040/rpt_disclosure.txt @@ -0,0 +1,7 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains a Related Party Transactions Policy relating to the identification, review and approval of related party transactions, consistent with the requirements of The Nasdaq Global Market (“Nasdaq”) and the SEC. The Related Party Transactions Policy, which is administered by our Audit Committee, is set forth in our Standards of Business Conduct and Code of Ethics (the “Code of Ethics”) available on our website at www.transact -tech .com by clicking on “Investor Relations” under the “Company” dropdown menu and then clicking on “Documents & Charters” under the “Governance” dropdown menu. +In particular, the Code of Ethics requires all directors, officers and employees to avoid any situation that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company, including engaging in “Related Party Transactions” unless approved or ratified by the Audit Committee. The term “Related Party Transaction” means any transaction, arrangement or relationship, or any series of similar transactions, arrangements or relationships, in which (i) the Company or any of its subsidiaries or Controlled Affiliates (as such term is defined in the policy) is or will be a participant, (ii) the aggregate amount involved will or may be expected to exceed $120,000 in any fiscal year, and (iii) any Related Party has or will have a direct or indirect interest. A “Related Party” is defined as any person who is or was (since the beginning of the last fiscal year for which the Company has filed an Annual Report on Form 10 -K and proxy statement, even if such person does not presently serve in that role) an executive officer, director or nominee for director of the Company, any stockholder owning more than 5% of any class of the Company’s voting securities, or an immediate family member of any such person. +The Chair of the Audit Committee must be notified before a Related Party engages in a Related Party Transaction. The Audit Committee is then responsible for reviewing the transaction. No transaction determined to be a Related Party Transaction will be approved or ratified if the transaction is contrary to the best interests of the Company and its stockholders. In determining whether to approve or ratify a Related Party Transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the transaction. +Emanuel P.N. Hilario, one of the Company’s directors, serves as President and Chief Executive Officer of The ONE Group Hospitality, Inc. (“The ONE Group”), and Haydee Ortiz Olinger, another Company director, serves on the Board of Directors of The ONE Group. From time to time, the Company sells food service technology products to The ONE Group. In 2024 and 2023, the Company’s sales of such products to The ONE Group totaled $117 thousand and $246 thousand, respectively. The transactions were made in the ordinary course of business and were conducted on an arm’s -length basis on terms substantially equal to those offered to persons who are not Related Parties and were approved and ratified by the Audit Committee. The Company expects to make additional sales to The ONE Group going forward in accordance with the Related Party Transactions Policy. +10 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001017303/2024/0001140361-25-010065/filing.txt b/raw/filings/0001017303/2024/0001140361-25-010065/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..1d5ebc69ad2ea359c7402e798af47957b3b1e9cd --- /dev/null +++ b/raw/filings/0001017303/2024/0001140361-25-010065/filing.txt @@ -0,0 +1,3956 @@ +false 12-31 2024 FY 0001017303 P12M P12M 688 0001017303 2024-01-01 2024-12-31 0001017303 2024-06-30 0001017303 2025-03-14 0001017303 2024-12-31 0001017303 2023-12-31 0001017303 us-gaap:SeriesAPreferredStockMember 2024-12-31 0001017303 us-gaap:SeriesAPreferredStockMember 2023-12-31 0001017303 2023-01-01 2023-12-31 0001017303 us-gaap:TreasuryStockCommonMember 2022-12-31 0001017303 us-gaap:CommonStockMember 2022-12-31 0001017303 2022-12-31 0001017303 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THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2024 +or +☐ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from __________ to __________ +Commission file number: 0-21121 +TRANSACT TECHNOLOGIES INC +(Exact name of registrant as specified in its charter) +Delaware +06-1456680 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +One Hamden Center , +2319 Whitney Avenue, Suite 3B , Hamden , +CT +06518 +(Address of principal executive offices) +(Zip Code) +( 203 ) 859-6800 +(Registrant’s Telephone Number, Including Area Code) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Trading Symbol(s) +Name of each exchange on which registered +Common stock, par value $0.01 per share +TACT +NASDAQ Global Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 +during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of +Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or +an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ☐ +Accelerated filer ☐ +Non-accelerated filer ☒ +Smaller reporting company ☒ +Emerging growth company ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new +or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its +management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark +whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received +by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $ 33,000,000 based on the last sale price on June 30, 2024. +As of March 14, 2025, the number of +shares outstanding of the registrant’s common stock, par value $0.01 per share, was 10,080,717 . +DOCUMENTS INCORPORATED BY REFERENCE +Portions of the registrant’s Definitive Proxy Statement related to its 2025 Annual Meeting of Stockholders (the “Proxy Statement”) to be filed with the Securities and Exchange Commission within 120 days after the Registrant’s fiscal year end of December 31, 2024 are incorporated by reference into Part III of this Annual Report on Form 10-K. +TRANSACT TECHNOLOGIES INCORPORATED +INDEX +PART I. +Item 1. +Business +2 +Item 1A. +Risk Factors +6 +Item 1B. +Unresolved Staff Comments +20 +Item 1C. +Cybersecurity +21 +Item 2. +Properties +22 +Item 3. +Legal Proceedings +22 +Item 4. +Mine Safety Disclosures +22 +PART II. +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +23 +Item 6. +[Reserved] +23 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +23 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +32 +Item 8. +Financial Statements and Supplementary Data +32 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +32 +Item 9A. +Controls and Procedures +32 +Item 9B. +Other Information +32 +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspections +32 +PART III. +Item 10. +Directors, Executive Officers and Corporate Governance +33 +Item 11. +Executive Compensation +33 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +33 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +33 +Item 14. +Principal Accountant Fees and Services +33 +PART IV. +Item 15. +Exhibits and Financial Statement Schedules +34 +Item 16. +Form 10-K Summary +36 +SIGNATURES +37 +CONSOLIDATED FINANCIAL STATEMENTS +Index to Consolidated Financial Statements +F-1 +Index +Smaller Reporting Company—Scaled Disclosure +Pursuant to Item 10(f) of Regulation S-K promulgated under the Securities Act of 1933, as amended (the “Securities Act”), as indicated herein, we have elected to comply with certain scaled disclosure requirements +applicable to “smaller reporting companies” in this Annual Report on Form 10-K for the year ended December 31, 2024 (this “Form 10-K”). +PART I +Forward-Looking Statements +Certain statements included in this Form 10-K include “forward-looking statements” within the meaning of the U.S. federal securities laws, including the Private Securities Litigation Reform Act +of 1995. Forward-looking statements are any statements other than statements of historical fact. Forward-looking statements represent current views about possible future events and are often identified by the use of forward-looking terminology, +such as “may,” “will,” “could,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “project,” “plan,” “predict,” “design” or “continue” or the negative thereof or other similar words. Forward-looking statements are subject to certain +risks, uncertainties and assumptions. In the event that one or more of such risks or uncertainties materialize, or one or more underlying assumptions prove incorrect, actual results may differ materially from those expressed or implied by the +forward-looking statements. +Important factors and uncertainties that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include, but are not limited to, the +following: +• +the adverse effects of current economic conditions on our business, operations, financial condition, results of operations and capital resources; +• +difficulties or delays in manufacturing or delivery of inventory or other supply chain disruptions; +• +inflation; +• +the Russia/Ukraine and Middle East conflicts; +• +inadequate manufacturing capacity or a shortfall or excess of inventory as a result of difficulty in predicting manufacturing requirements due to volatile economic conditions; +• +price increases, decreased availability of third-party component parts or raw materials at reasonable prices, price wars or other significant pricing pressures affecting the Company’s products in the United +States or abroad; +• +increased product costs or reduced customer demand for our products in the United States or abroad, including as a result of trade wars or tariffs; +• +our ability to successfully develop new products that garner customer acceptance and generate sales, both domestically and internationally, in the face of substantial competition; +• +our reliance on an unrelated third party to develop, maintain and host certain web-based food service application software and develop and maintain selected components of our downloadable software +applications pursuant to a non-exclusive license agreement, and the risk that interruptions in our relationship with that third party could materially impair our ability to provide services to our food service technology customers on a +timely basis or at all and could require substantial expenditures to find or develop alternative software products; +• +any system outages, interruptions or other disruptions to our software applications, including as a result of unexpected errors or mistakes in connection with over-the-air updates; +• +our ability to successfully grow our business in the food service technology market; +• +renewal rates for our subscription-based products; +• +risks associated with the pursuit of strategic initiatives and business growth; +• +our dependence on contract manufacturers for the assembly of a large portion of our products in Asia; +• +our dependence on significant suppliers; +• +our ability to recruit and retain quality employees; +• +our dependence on third parties for sales outside the United States; +• +marketplace acceptance of new products; +• +risks associated with foreign operations; +• +political and policy uncertainties in connection with the U.S. presidential election and change in administration; +• +our ability to protect intellectual property; +• +exchange rate fluctuations; +• +the availability of needed financing on acceptable terms or at all; +• +volatility of, and decreases in, trading prices of our common stock; and +• +other risk factors identified and discussed in Part I, Item 1A, Risk Factors, and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Form 10-K and +that may be detailed from time to time in the Company’s other reports filed with the Securities and Exchange Commission (the “SEC”). +We caution readers not to place undue reliance on forward-looking statements, which speak only as of the date of this Form 10-K. We undertake no obligation to publicly or otherwise revise any +forward-looking statements, whether as a result of new information, future events or other factors, except where we are expressly required to do so by applicable law. +1 +Index +Item 1. +Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was incorporated in June 1996 and began operating as a stand-alone business in +August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high-growth markets including food service technology, point of sale (“POS”) automation and casino and +gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL®, and Ithaca® brand names. During 2019, we launched a new line of products for +the food service technology market, the BOHA! hardware solutions and companion branded suite of cloud-based applications. The BOHA! software and hardware products help restaurants, convenience stores and food service operators of all sizes +automate the food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and terminals generate top-quality labels, coupons and transaction +records such as receipts, tickets and other documents. We sell our technology to original equipment manufacturers (“OEMs”), value-added resellers, and select distributors, as well as directly to end users. Our product distribution spans across +the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class service, support, labels, spare parts, accessories and printing supplies to our growing worldwide +base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables used in the printing activities of customers in the restaurant and hospitality, retail, +casino and gaming, and government markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the demand for these products. We operate in one reportable segment: the design, development, and marketing of +software-driven technology and printing solutions for high growth markets, and related services, supplies and spare parts. The Company’s chief operating decision maker, who is the Company’s chief executive officer, in consultation with the +Company’s chief financial officer, utilizes a consolidated approach to assess the performance of and allocate resources to the business. Accordingly, management has concluded that the Company consists of a single operating segment and single +reportable segment for accounting and financial reporting purposes. Our primary operating, hardware research and development, and U.S. service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters +and software research and development center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden +Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, 06518, and our telephone number is (203) 859-6800. +Recent Developments +The Company’s previously announced strategic review process remains active. Management and the Company’s Board of Directors are focused on the process. The Company is +determined to consider any and all options that increase and/or deliver stockholder value. The Company will provide further updates on this process when it determines that additional disclosure is appropriate or required. This process is subject +to unknown variables, including costs, structure, terms and timing, and may not result in any transaction or other particular outcome. For information regarding the risks related to the strategic review process, please see Part I, Item 1A, Risk +Factors under the sub-caption “Our success may depend in part on our ability to identify and pursue the best long-term strategy for our businesses” in this Form 10-K. +Products, Services, Markets and Distribution Methods +Printers, terminals and other hardware: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals +utilizing thermal printing technology for applications, primarily in the food service technology, POS automation, and casino and gaming markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety +of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices and paper handling capacities. Our food service technology terminals also offer software configurable menu options and +our food service technology market includes sales of optional hardware products including tablets, temperature sensors and gateways (i.e. access points needed to enable wireless communications). +Food Service Technology (“FST”): Our primary offering in the food service technology market is our line of BOHA! products. The BOHA! product suite +combines our latest generation terminal or workstation which includes one or two printers, with our BOHA! labeling, timers, and media software. In addition, customers may individually purchase cloud-based software applications that connect to a +separate application on a separate mobile device into a solution to automate back-of-house operations in restaurants, convenience stores and food service operations. The additional software offering of BOHA! consists of a variety of individually +purchased software-as-a-service (“SaaS”) based applications for both Android and iOS operating systems, including applications for, temperature monitoring, temperature taking and creating checklists and task lists. These applications are sold +separately, and customers purchase the applications they need for their back-of-house operations. Customers may also purchase associated hardware, such as tablets, temperature sensors and gateways. The BOHA! Terminal and the more recently +launched Terminal 2 combine an operating system and hardware components in a single touchscreen device with one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, +and nutritional labels for prepared foods, and “enjoy by” date labels. The BOHA! WorkStation uses an iPad or Android tablet instead of an integrated touchscreen. The BOHA! Terminal, Terminal 2 and WorkStation are equipped with the TransAct +Enterprise Management System to ensure that only approved functions are available on the touchscreen device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, +casual dining, fast casual and quick-service restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house +operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service +contracts, and technical support services. In the food service technology market, we use an internal sales force to solicit sales directly from end users. In May 2023, we launched our new BOHA! Terminal 2. The Terminal 2 is designed to be a +high-end product intended for enterprise customers with increased speed, print resolution and wide-label capability. We started receiving orders for the Terminal 2 in the latter part of 2023 from both our international and domestic markets. +2 +Index +POS automation: In the POS market, we sell a printer utilizing thermal printing technology. Our POS printer is +used primarily by McDonald’s, and to a lesser extent, other quick-service restaurants and are located either at the checkout counter or within self-service kiosks, to print receipts for consumers or print on linerless labels. In the POS market, +we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from +end-users. +Casino and gaming: We sell several models of printers used in slot machines, video lottery terminals (“VLTs”), sports betting kiosks and other gaming +machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in +monochrome and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in +international non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals, sports betting establishments and other off-premise gaming type machines around the world. We sell +our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through +distributors. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales through our distributors. In the fourth quarter of 2023, we launched the Epic TR80, our newest +casino and gaming printer, which we believe will help us retain and expand our customer base in the casino and gaming markets. +We also offer a software solution, the EPICENTRAL Print System, including annual software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real +time at the slot machine. With EPICENTRAL, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the +casinos. We sell EPICENTRAL directly to casinos or through partners who incorporate EPICENTRAL into their casino management system software offerings, largely sold on a SaaS basis. +TSG : Through TSG, we proactively market the sale of consumable products (including POS receipt paper, ribbons +and other printing supplies), replacement parts, maintenance and repair services, and shipping and handling charges. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, a 24-hour guaranteed +replacement product service called TransAct Xpress™ and other repair services for our non-FST products. Within the United States, we provide repair services through our service center in Ithaca, New York. Internationally, we provide repair +services through our European service center located in Doncaster, UK, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive +training on all our products and services. In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our webstore, www.transactsupplies.com. +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. +Almost all of our printers and terminals are currently produced by a third party manufacturer located in Thailand. A small portion of our products are assembled in our Ithaca, New York facility largely on a configure-to-order basis using +components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +Critical component parts and subassemblies include thermal print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, tablets, circuit boards and electronic +components, which are obtained from domestic and foreign suppliers at competitive prices, subject to availability. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist +of fully assembled printers and terminals produced by our contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled +printers and terminals to reduce the risk of parts shortages or unavailability. However, we have experienced and could continue to experience some disruption due to certain suppliers being unable to source specific components and we could +experience temporary disruption in the availability of components. In addition, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy a majority of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for substantially all of our printer and food service technology terminal +models, from a foreign contract manufacturer in Thailand. We believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms. We do not have supply +agreements with foreign contract manufacturers, and we believe that our supply of thermal print mechanisms and fully assembled printers and terminals will be adequate in 2025 and the foreseeable future. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. +As of December 31, 2024, we held 23 active United States patents and 39 active foreign patents and have three pending United States patent applications and eight pending foreign patent applications pertaining +to our products. The remaining duration of these patents ranges from one to 25 years. During the year ended December 31, 2024, no United States patents were issued and 12 foreign patents were issued. During the year ended December 31, 2024, no +United States or foreign patents expired. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them +through employee and third party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, +information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely +upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +3 +Index +Trademarks, Service Marks Trade Names and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, +service marks and trade names appearing in this Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, BOHA! ®, AccuDate®, EPICENTRAL®, Epic TR80™, Ithaca® and TransAct Express™. Solely for convenience, +some of the trademarks, service marks, trade names and copyrights referred to in this Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service +marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our food service technology +products or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See +also Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K. +Certain Significant Customers +Light & Wonder Gaming, Inc. (Light & Wonder”) is our most significant customer. We primarily sell casino and gaming printers to Light & Wonder. +Sales to Light & Wonder represented 11% and 6% of our total net sales for the years ended December 31, 2024 and 2023, respectively. +Competition +The market for transaction-based and specialty printers, food service technology terminals and related software applications is extremely competitive, and we expect such competition to continue in the future. +However, we experience less competition for EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than TransAct. We +believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing +new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political +conditions and, in some cases, the uniqueness of our products. +In the food service technology market, we primarily compete with CrunchTime! Information Systems, Inc. (including its Zenput and Squadle brands), Jolt Software, Avery Dennison Corporation, Ecolab Inc., ITD Food +Safety, Daymark Safety Systems (part of CMC Group, Inc.), Integrated Control Corp, Digi International, and Toast. We compete in this market based largely on our ability to provide highly specialized purpose-built hardware products, different +software applications that can be chosen by a customer and ongoing technical support. We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer a unique BOHA! branded +solution to support back-of-house operations in the food service industry. Our competitors or others may develop, or may establish relationships with developers with the capability to develop, software and services that are similar to or +competitive with ours, which may be disadvantageous to our competitive position. Certain portions of our food service technology software are licensed from a third party developer on a non-exclusive basis through 2031 and are subject to a +revenue sharing arrangement with the developer. We are reliant upon the third party developer to further develop and maintain its developed software, and the developer controls the software source code. The license agreement does not preclude the +developer or the Company from working with others on similar products. Also, the third party developer hosts the web-based applications. Therefore, presently, we are highly dependent upon this third party developer for continued service to our +customers and the further development of our food service technology software products. +In the POS automation market, we primarily compete with Epson America, Inc., which holds a dominant market position. We also compete with BIXOLON America, Inc., and, to a much extent with Star Micronics America, +Inc. and Citizen - CBM America Corporation. We believe certain competitors of ours have greater financial resources and lower costs attributable to higher volume production and lower gross profit margin expectations which enable them to offer +lower prices than us. +In the casino and gaming market (consisting principally of slot machine printing, VLT and sports betting transaction and promotional coupon printing), we compete with several companies including JCM Global, +Nanoptix, Inc., Custom Engineering SPA, Eurocoin Components and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing +technical support. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers and paper converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop and/or license new products (hardware and software), such as launching the BOHA! Terminal in 2019, the BOHA! Terminal 2 in 2023, the Epic TR80 +which was launched in 2023 and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our market penetration, to take advantage of strategic relationships, and to lower the cost of +our products by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, +our printer products utilize certain thermal printing technologies and licensed software. If new technologies are introduced, or existing technologies evolve, we may be required to incorporate these technologies into our products. +Alternatively, if such technologies were to become available to our competitors, our printer products could become obsolete, which could have a significant negative impact on our business. +4 +Index +Governmental Regulation +The casino and gaming industries are generally subject to extensive and evolving regulation that in many jurisdictions includes licensing or regulatory screening of suppliers, manufacturers and distributors and +their applicable affiliates, their major shareholders, officers, directors and key employees. In addition, certain of our casino and gaming products and technologies must be certified or approved in each of the jurisdictions in which we operate. +Regulators review many facets of an applicant or holder of a license, including its financial stability, integrity and business experience. Any failure to receive a license or the loss of a license that we currently hold could have a material +adverse effect on us or on our results of operations, cash flow or financial condition. +While we believe that we are in compliance with all material casino and gaming laws and regulatory requirements applicable to us, we cannot assure that our activities or the activities of our customers will not +become the subject of any regulatory or law enforcement proceeding or that any such proceeding would not have a material adverse impact on us or our results of operations, cash flows or financial condition. +Environmental Compliance +Our compliance with federal, state and local laws and regulations relating to environmental protection and discharge of hazardous materials has not had a material impact on our capital expenditures, earnings or +competitive position, and we do not anticipate any material impact from such compliance in the future. +Available Information +We make available free of charge through the “Investor Relations” page on our website, www.transact-tech.com (which can be accessed by selecting the “Company” tab and then clicking on “Investor Relations”), +our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and all amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or +furnished to the SEC pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains a website that contains reports, proxy and information statements, and other information +regarding issuers that file electronically with the SEC at http://www.sec.gov. The content on any website referred to in this Form 10-K is not incorporated by reference in this Form 10-K unless expressly noted. +Employees +As of December 31, 2024, TransAct and our subsidiaries employed 108 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be +good. +Information about our Executive Officers +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person’s principal occupations +and employment during at least the past five years. +Name +Age +Position +John M. Dillon +75 +Chief Executive Officer +Steven A. DeMartino +55 +President, Chief Financial Officer, Treasurer and Secretary +Tracey S. Winslow +65 +Chief Revenue Officer +Brent Richtsmeier +60 +Chief Technology Officer +William J. DeFrances +60 +Vice President & Chief Accounting Officer +John M. Dillon was appointed Chief Executive Officer of TransAct on April 4, 2023 and has been a member of the Board of Directors of the Company since 2011. Mr. Dillon served as the Chairman of the Board of +Directors of Aerospike, the world’s first flash-optimized database and the fastest database at scale, from January 2022 to February 2024 and served as CEO of Aerospike from January 2015 to January 2022. Prior to joining Aerospike, Mr. Dillon +served as CEO of Engine Yard, Inc., the leading cloud platform for automating and developing Ruby on Rails and PHP applications, from 2009 to 2014. He served as CEO for Navis, Inc., a private company specializing in software systems for operating +large marine container terminals and distribution centers, from 2002 to 2008. Before Navis, he also served as CEO for Salesforce, Inc. (formerly Salesforce.com) and President and CEO of Hyperion Solutions. He began his career as a Systems +Engineer for EDS (Electronic Data Systems) and then moved into a variety of sales management positions for various high-tech companies, including Oracle Corporation. Mr. Dillon holds a Bachelor’s degree in Engineering from the United States Naval +Academy and an MBA from Golden Gate University. +Steven A. DeMartino was named TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, +Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from +August 1996 to December 1997. Mr. DeMartino holds a Bachelor’s degree in Accounting and Economics from the College of the Holy Cross and an MBA from the University of Connecticut. He also is a certified public accountant. +5 +Index +Tracey S. Winslow was named Chief Revenue Officer of the Company in March 2023 with responsibility for worldwide sales in all of the Company’s markets. Prior to this appointment, Ms. Winslow served as Senior Vice +President, Casino and Gaming Sales from June 2010 to February 2023, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Winslow served as Senior Vice President, Sales and Marketing of the Company +from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking of the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Winslow +was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing from 2003 to 2005, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Brent Richtsmeier was named Chief Technology Officer in September 2021. Previously, Mr. Richtsmeier served as Senior Vice President, Software Engineering since joining TransAct in December 2019 and was appointed +as an officer of the Company in January 2021. Prior to joining TransAct, Mr. Richtsmeier was employed with Samsung Electronics Co., Ltd., an electronics corporation, from May 2004 until November 2017 as the VP of Development where he was +responsible for software strategy, software development at scale and business development. In November 2017, Samsung Electronics sold their business products division to HP Inc, and Mr. Richtsmeier transferred to HP Inc to become the Global Head +of Cloud and Mobile Software Solutions until joining TransAct in 2019. +William J. DeFrances joined TransAct as Vice President & Chief Accounting Officer in July 2022. Mr. DeFrances previously served as Corporate Controller at Omega Engineering, Inc., an electronics and +instrumentation company that was, during Mr. DeFrances’ tenure, a subsidiary of Spectris plc, a UK public company listed on the London Stock Exchange, from September 2020 to July 2022. From August 2019 to August 2020, Mr. DeFrances worked as an +independent financial consultant. Prior to this, Mr. DeFrances held various positions with United Technologies Corporation (now RTX Corporation, formerly Raytheon Technologies Corporation) (“UTC”) and Sikorsky Aircraft (owned by Lockheed Martin +Corporation). Mr. DeFrances previously served as an Associate Director of Military Finance for Pratt & Whitney, a subsidiary of UTC, from October 2018 to August 2019, and the Business Unit Controller, USG/Military and International Military +for Sikorsky Aircraft from October 2015 to October 2018. Prior to this, Mr. DeFrances also served as the Assistant Controller, Financial Reporting for Sikorsky Aircraft from 2009 to 2013. In addition, Mr. DeFrances held various accounting and +financial roles (VP Treasurer and VP Controller) from 2005 to 2009 at ATMI, Inc. (acquired by Entegris, Inc.), an advanced manufacturing company in the semiconductor industry. Mr. DeFrances has an MBA from the University of Connecticut and is +a certified public accountant. +There are no family relationships between any of our executive officers and there is no arrangement or understanding between any of such officers and any other person pursuant to which he or she was selected as an +officer. Each of our executive officers was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her earlier resignation or removal. +Item 1A. +Risk Factors. +Investors should carefully consider the risks, uncertainties and other factors described below, as well as other disclosures in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and +Results of Operations, because they could have a material adverse effect on our business, financial condition, operating results, and growth prospects. The risks described below are the currently known risks facing our Company that management +deems to be material to the Company. Additional risks and uncertainties not presently known to us, or that we currently believe to be immaterial, may also impair our business operations. In the event that such risks or uncertainties materialize, +our business, financial condition, cash flows and results of operations could be materially adversely affected. +We assume no obligation (and specifically disclaim any such obligation) to update these Risk Factors or any other forward-looking statements contained in this Form 10-K to reflect actual results, changes in +assumptions or other factors affecting such forward-looking statements, except as required by law. +Risks Related to our Financial Condition and Future Operating Results +We have a history of net losses, we anticipate making further investments in product development and we may not be able to achieve, maintain or increase profitability in +future periods. +In 2024, we incurred a net loss of $9.9 million. While we generated $4.7 million of net income in 2023, we incurred a net loss of $5.9 million, $4.0 million and $5.6 +million in 2022, 2021 and 2020, respectively. We may not be able to achieve or maintain profitability in the future. In addition, we may make further investments in product development and may increase expenses in future periods which may +affect our ability to maintain or increase profitability. We have expended, and expect to continue to expend, financial and other resources on developing our food service technology business, including expanding our offerings, developing or +acquiring new products and services and increasing our sales and marketing efforts. These efforts may be more costly than we expect and may not result in increased revenue or growth in our food service technology business. Any failure to increase +our revenue sufficiently to keep pace with our investments and other expenses could prevent us from maintaining or increasing profitability or positive cash flow on a consistent basis. This risk may be exacerbated by current economic conditions, +which have resulted, and may continue to result in increased costs and decreased demand for our products. Customers that placed advance orders due to supply chain disruptions in 2022 and into 2023 paused orders in 2024 while they sold +accumulated inventory. We believe all domestic customers have resumed ordering with the exception of one significant international casino and gaming customer. Though we expect overall casino and gaming sales to improve in 2025 compared to 2024, +we expect such sales to be somewhat impacted in 2025 until this customer has sold through its inventory on hand. If we are unable to successfully address these risks and challenges as we encounter them, our business, financial condition, and +results of operations could be adversely affected. +6 +Index +Our operating results and financial condition may fluctuate. +Our operating results and financial condition may fluctuate from quarter to quarter and year to year and are likely to continue to vary due to a number of factors, many of +which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical operating results, the market price of +our common stock will likely decline. Fluctuations in our operating results and financial condition may occur due to a number of factors, including, but not limited to, those identified below and throughout this “Risk Factors” section: +• +delays between our expenditures to develop and market new or enhanced products and consumables and the generation of sales from those products; +• +the geographic distribution of our sales and our supply chain; +• +market acceptance of our products, both domestically and internationally; +• +development of new competitive products by others; +• +increased levels of competition, including due to the return to market of our largest casino and gaming competitor; +• +our responses to price competition; +• +our level of research and development activities; +• +changes in the amount that we spend to develop, acquire or license new products, consumables, technologies or businesses; +• +changes in the amount we spend to promote our products and services; +• +changes in the cost of satisfying our warranty obligations and servicing our installed base of products; +• +availability of third party components at reasonable prices or at all; +• +general economic and industry conditions, including inflation and changes in interest rates affecting returns on cash balances, investments and debt, that affect customer demand; +• +changes in customer demand due to supply chain constraints; +• +the dependence of our supply chain on a few, foreign third party manufacturers and suppliers and the impact on our supply chain of product or component shortages and cost increases due to events beyond our control, including tariffs +and other trade policies, inflation and political or social instability such as the ongoing Russia/Ukraine war , the war in the Middle East, and the conflict between China and Taiwan and possible expansion of such conflicts; +• +severe weather events, public health crises, military actions, the cost of insurance and other external events out of our control that can disrupt our operations or the operations of our customers’ or suppliers’ facilities; and +• +changes in accounting rules and regulations. +Due to all of the foregoing factors, and the other risks discussed in this Form 10-K, quarter-to-quarter comparisons of our operating results may not be an indicator of future performance. +Risks Associated with Determining and Pursuing Strategic Initiatives and Business Growth +Our success may depend in part on our ability to identify and pursue the best long-term strategy for our business. +The Company engaged an advisor, Roth Capital Partners, LLC (“Roth”), in the fourth quarter of 2023 to assist in determining the best long-term strategy for its business and ensure the Company is maximizing the +value of its operations for all shareholders and stakeholders. The Company continues to actively assess strategic alternatives with the assistance of Roth while continuing to pursue its business growth and development initiatives on a parallel +track. The Company has engaged with a number of outside parties and is in various stages of discussion with such outside parties. The Company is committed to pursuing an optimal outcome for all its stakeholders and maximizing shareholder value. +7 +Index +No timetable has been established for our review of the best long-term strategy for our business, and we do not intend to disclose developments or provide updates on the progress or status of our ongoing review +until our Board of Directors deems such disclosure is appropriate or required. During the course of this review, perceived uncertainties related to our future may result in the loss of potential business opportunities and volatility in our stock +price and may make it more difficult for us to attract and retain qualified personnel and business partners. +Acquisitions, dispositions and other strategic alternatives involve a number of risks, including: (i) the potential disruption of our ongoing business; (ii) the distraction of management away from the ongoing +oversight of our existing business activities; (iii) if we determined to pursue a disposition strategy, we may not be able to identify, pursue and close a transaction that provides adequate value to the Company and its stockholders; (iv) the +potential departure of key personnel during the negotiation or pendency of a transaction; (v) the loss or reduction of control over certain of our assets; (vi) the anticipated benefits and cost savings of those transactions not being realized +fully, or at all, or taking longer to realize than anticipated; (vii) an increase in the scope and complexity of our operations or the management of our business subsequent to a transaction; (viii) incurring additional indebtedness or the +potential sale of additional shares of our common stock in public or private offerings to finance acquisitions or transactions, which may be dilutive to existing stockholders or cause the price of our common stock to decline; and (ix) the +depletion of cash to pay for an acquisition. +There can be no assurance that we will be able to successfully implement a growth strategy, or that we can successfully manage expanded operations, if they occur. If we expand, we may from time-to-time experience +constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect our results of operations and financial condition. +Further, there can be no assurance that we will find suitable opportunities for strategic transactions at acceptable prices or on acceptable terms, successfully negotiate required agreements, obtain sufficient +financing on acceptable terms or at all if necessary, successfully close transactions after signing such agreements, or that any resulting transaction will have a positive effect on stockholder value. A strategic transaction may result in a +significant change in the nature of our business, operations and strategy, and we may encounter unforeseen obstacles or costs in implementing a strategic transaction. +Risks Related to Our Operations +Our food service technology business depends substantially on our customers renewing their subscriptions with the Company. Any decline in our customer renewals could harm our +food service technology business, results of operations and financial condition. +Our subscription offerings are term-based, and in order for us to maintain or improve our results of operations, it is important that our customers renew their subscriptions with us when the existing subscription +term expires and renew on the same terms or terms more favorable to the Company. Our customers have no obligation to renew their applications and subscriptions, and they may not renew one or more of their applications as they are purchased +separately and individually. We also may not be able to accurately predict customer renewal rates. Customers may elect not to renew their subscriptions with us for a variety of reasons, including as a result of changes in their strategic +priorities, budgets and costs and, in some instances, due to competing solutions. Our retention rate may also decline or fluctuate as a result of a number of other factors, including our customers’ satisfaction or dissatisfaction with our +solutions, the increase in the contract value of subscription and support contracts from new customers, the effectiveness of our customer support services, our pricing, the prices of competing products or services, global economic conditions and +the other risk factors described herein. As a result, there can be no assurance that our food service technology customers will renew any or all of their individually purchased application subscriptions. If our customers do not renew their +subscriptions or renew on less favorable terms, our business, results of operations and financial condition may be adversely affected. +Because we rely in part on revenue from subscription contracts and recognize revenue from subscription contracts over the term of the relevant subscription period, downturns +or upturns in sales are not immediately reflected in full in our results of operations. +Subscription services revenue accounts for a growing portion of our food service technology revenue. Sales of new or renewal subscription contracts may decline or fluctuate as a result of a number of factors, +including customers’ level of satisfaction with our solutions, the prices of our subscriptions, the prices and features of products or subscriptions offered by our competitors, reductions in our customers’ spending levels, or other changes in +consumer behavior. If our sales of new or renewal subscription contracts decline, our revenue and revenue growth may decline. We recognize subscription revenue ratably over the term of the relevant subscription period, which is generally 12 +months in duration. As a result, much of the subscription revenue we report each quarter is derived from subscription contracts that we sold in prior quarters. +Consequently, a decline in new or renewed subscription contracts in any one quarter will not be fully reflected in revenue in that quarter but will negatively affect our revenue in future quarters. Accordingly, the +effect of significant downturns in new or renewal sales of our subscriptions is not reflected in full in our results of operations in a given period. Also, it is difficult for us to rapidly increase our subscription revenue through additional +sales in any period, as revenue from new and renewal subscription contracts must be recognized ratably over the applicable subscription period. Furthermore, any increases in the average term of subscription contracts would result in revenue for +those subscription contracts being recognized over longer periods of time. +8 +Index +Our calculation of recurring revenue and average revenue per unit (“ARPU”) may differ from how other SaaS-based companies calculate such metrics; our definitions include sales +of our consumable labels, which generally fluctuate from period to period. +We use recurring revenue and ARPU as performance indicators in connection with our food service technology market, and we include consumable label sales, in addition to subscription software, extended warranty and +service contracts, in our calculation of these metrics. Consumable labels are not sold on a subscription basis or subject to any minimum purchase requirements. In addition, our label sales typically fluctuate and are dependent upon the current +demand from food service and restaurant customers, which may be affected by factors such as general economic downturns and seasonality. As a result, our use and definitions of recurring revenue and ARPU may not be comparable with, and may be +subject to, increased fluctuation relative to those of other SaaS-based companies that do not include non-subscription components such as label sales in their definitions of recurring revenue or ARPU. +Overestimates or underestimates in our manufacturing forecasts could cause us to hold insufficient or excess inventory or result in delays in the manufacturing and delivery of +our products, which could interfere with our ability to retain orders or provide services to our customers. +If we fail to predict our manufacturing requirements accurately, we could incur additional costs or experience manufacturing delays. We currently use a rolling 12-month forecast based primarily on our anticipated +product orders and our product order history to help determine our requirements for purchasing components, raw materials and finished products. It is important that we accurately predict both the demand for our products and the lead-time required +to obtain the necessary components, raw materials and finished products. We have also modified our products in the past to substitute available components in the place of those that have become scarce or difficult to obtain, and in some +instances have identified alternate sources for certain components. +Lead times for materials and components that we order vary significantly and depend on factors such as the specific supplier, the size of the order, contract terms, and demand for each component at a given time, as +well as supply shortages with respect to raw materials needed to produce the components. If we underestimate our requirements, or if we are unable to obtain components on time due to supply shortages, as occurred during the COVID-19 pandemic and +resulting global supply chain disruptions, we may have inadequate manufacturing capacity or inventory, which could interrupt manufacturing of our products and interfere with our ability to timely deliver products to our customers and adversely +impact our sales. Alternatively, if we overestimate our requirements, we could have excess inventory of parts and finished products. Some of the actions we have taken to meet customer demand in the face of recent supply chain disruptions have +raised our costs and decreased margins on our products, and any such actions that we take in the future could have a similar effect. Any future underestimate or overestimate of supply requirements, and any actions we may take in the future to +navigate supply chain disruptions, could have a material adverse effect on our business and results of operations. +We depend on key personnel, the loss of whom could have a material adverse impact on our business. +Our future success may depend in significant part upon the continued service of certain key management and other personnel. There can be no assurance that we will be able to recruit and retain such personnel. The +loss of either John M. Dillon, the Company’s Chief Executive Officer, or Steven A. DeMartino, the Company’s President, Chief Financial Officer, Treasurer and Secretary, or the loss of certain groups of key employees, such as our or sales, +operations and engineering teams, could have a material adverse effect on our business and results of operations. +Our ability to recruit, retain, and develop qualified personnel is critical to our success and growth. +To successfully compete and grow our business, we must recruit, develop and retain highly qualified managerial, technical and sales and marketing personnel. In addition, we must develop, maintain and, as necessary, +implement appropriate succession plans to ensure we have the necessary human resources capable of maintaining continuity in our business. +The market for qualified personnel is competitive, and we may not succeed in recruiting additional personnel or may fail to effectively replace current personnel who depart with qualified or effective successors. +Our effort to retain and develop personnel may also result in significant additional expenses, which could adversely affect our profitability. We are also substantially dependent on our sales force to obtain new customers and increase sales to +existing customers. There is significant competition for sales personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, +training, and retaining a sufficient number of sales personnel to support our growth. If we are unable to hire, train, and retain a sufficient number of qualified and successful sales personnel, our business, financial condition, and results of +operations may be harmed. +If we fail to offer high quality support, our business and reputation could suffer. +Our customers rely on us and our third-party service providers for support of our software and services included in our food service technology subscription packages. High-quality support is important for the +renewal and expansion of our agreements with existing customers. The importance of high-quality support will increase as we expand our business and pursue new customers. If we or our third party service providers do not help our customers quickly +resolve issues and provide effective ongoing support, our ability to sell new food service technology products to existing and new customers could suffer and our reputation and relationships with existing or potential customers could be harmed. +9 +Index +We experience elements of seasonal fluctuations in the food service technology and POS markets which could cause our stock price to fluctuate. +Our food service technology business is highly dependent on the behavior patterns of our customers and their guests. Restaurants typically reduce purchases of equipment in the fourth calendar quarter due to the +increased volume of transactions during the holiday period, which may negatively impact sales of our food service technology products or POS printers during that period. As a result, seasonality may cause fluctuations in our financial results, +and other trends that develop may similarly impact our results of operations. +Risks Related to Product Development +Our revenue and profitability depend on our ability to continue to develop or license, on a timely basis, new products and technologies which are free from hardware or +software anomalies and cannot be fraudulently manipulated, and customer acceptance of such products. +Our success depends upon our, and our development partners’, ability to timely adapt our capabilities and processes to meet the demands of producing new and innovative products. Because our newer products contain +software and generally are more technologically sophisticated than those we have produced in the past, we must continually refine our capabilities to meet the needs of our product innovation. In addition, the food service technology industry +continues to experience technological developments and innovations (such as the use of artificial intelligence and machine learning), and if we are unable to provide enhancements, new features and integrations for our existing platform (due to a +lack of investment or otherwise), or if we are unable to efficiently adapt our infrastructure to meet the needs of our product innovations in a timely manner, our business could be negatively impacted. +In addition, even if we, or developers on our behalf, successfully develop such products, there is no assurance that our innovations will be accepted by our customers. Developing and marketing new products, such +as our line of BOHA! products, is costly, and our business could be materially adversely affected if we are unable to generate sufficient sales of such products or if our existing or new customers do not quickly accept such products. Customer +acceptance is crucial because new products typically have little competition and market penetration due to their novelty. Customer acceptance of new products is never assured and may take time to materialize, even with respect to products +developed with customer input. In addition, we may not be able to obtain necessary registrations, licenses, permits or regulatory approvals for new products in the casino and gaming market on a timely basis or at all, which may adversely affect +our ability to develop such products. Further, technological innovation often results in unintended consequences such as bugs, vulnerabilities, and other system failures. Any such bug, vulnerability, or failure, especially in connection with a +significant technical implementation or change, could result in lost business, harm to our brand or reputation, consumer complaints, and other adverse consequences, any of which could materially adversely affect our business, results of +operations, and financial condition. +Risks Related to Intellectual Property and Data Security +Cybersecurity and privacy breaches, cyber-attacks, or other disruptions could expose us to liability, affect our business, and damage our reputation. +We are increasingly dependent on information technology systems and infrastructure for our business. We collect, store, and transmit sensitive information including intellectual property, proprietary business +information and personal information of employees and, to a lesser extent, customers in connection with business operations. Further, our BOHA! Applications are hosted within cloud platforms that are managed by third parties. The secure +maintenance of the information stored on our systems and such third-party systems is critical to our operations and business strategy. Any system outages, and any interruptions or other disruptions to our software applications, including as a +result of unexpected errors or mistakes in connection with over-the-air updates, could materially adversely affect our business, results of operations, and financial condition. +In addition, some of the information that we and third-party service providers collect, store and transmit could be an attractive target of criminal attack by third parties with a wide range of motives and +expertise, including organized criminal groups, disgruntled current or former employees, and others. Cyber-attacks are of ever-increasing levels of sophistication, and despite our extensive security measures, our information technology and +infrastructure may be vulnerable to such attacks or may be breached, including due to employee error or malfeasance. We have experienced such breaches in the past, but they have not had a material effect on our business, financial condition or +results of operations. Any such breach that occurs in the future could compromise our networks or the networks of third-party service providers, and the information stored there could be accessed, publicly disclosed, lost or stolen, and our +business operations may be interrupted. If our systems become compromised, we may not promptly discover the intrusion. In addition, the techniques used to obtain unauthorized access to networks, or to sabotage IT systems, change and evolve +frequently, including through the use of artificial intelligence and quantum computing and generally are not recognized until launched against a target. We may be unable to anticipate these techniques or to implement adequate preventative +measures. Like other companies in our industry, we have experienced attacks to our data and systems, including malware and computer viruses that we have been able to detect and eliminate and incidents +resulting in immaterial disruptions to our business that were remediated. . If our systems fail or are breached or disrupted by future attacks, we could lose product sales, and suffer reputational damage and loss of customer confidence. Such +incidents could require notification to affected individuals and may result in legal claims or proceedings and liability under federal and state laws that protect the privacy and security of personal information. If third parties use a +cyber-attack to gain access to our proprietary information, they may sell it or use it to duplicate our products, which could put us at a competitive disadvantage. Any one of these events could cause our business to be materially harmed and our +results of operations to be adversely impacted, and there can be no assurance that the insurance that we maintain to address certain aspects of cybersecurity risks will be sufficient to cover all losses or all types of claims that may arise. +10 +Index +These risks may be exacerbated by global political unrest. For example, the Russia–Ukraine war and other international hostilities, and related sanctions imposed by the U.S. government may expose government +entities and public and private U.S. companies to attempted or actual cyber-security attacks launched for geopolitical reasons or in conjunction with, or to finance, military conflicts and defense activities. These attacks could materially +disrupt our supply chain or our systems and operations or those of our customers and suppliers and may lead to loss of data and income, reputational harm and diversion of funds. See Part I, Item 1C. Cybersecurity, of this Form 10-K for +information regarding our cybersecurity risk management practices. +The inability to protect our intellectual property rights could harm our reputation, damage our business or interfere with our competitive position. +Our intellectual property is valuable and provides us with certain competitive advantages. Copyrights, patents, trademarks, service marks, trade secrets, technology licensing agreements, nondisclosure agreements +and contracts are used to protect these proprietary rights. Despite these precautions, it may be possible for third parties to copy aspects of our products or, without authorization, to obtain and use information that we regard as trade secrets. +Our pending patents may be denied, and our patents may be circumvented by our competitors. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. There can be no +assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar technologies. Our failure to adequately protect our proprietary +rights could have a material adverse effect on our competitive position and our business. +Prosecuting or defending against intellectual property litigation could be time consuming and costly, and claims that we have infringed upon the intellectual property rights +of others could impede our business and put us at a competitive disadvantage. +Prosecuting and defending against intellectual property litigation is generally complex, costly, protracted, and highly disruptive to business operations by diverting the attention and energies of management and +key technical personnel. We are committed to aggressively asserting and defending our technology and related intellectual property rights, which we have spent a significant amount of money to develop. Similarly, third parties have claimed and +may claim, from time to time in the future, that we have violated their intellectual property rights. In the event that a court rules that we have violated a third party’s patent or other intellectual property rights, we may be prevented from +operating our business as planned and may be required to pay damages, to obtain a license, if available, or to use a non-infringing method, if possible, to accomplish our objectives. Litigation relating to any such claims could be costly and, if +successful, could result in costly judgments or settlements, and there can be no assurance that a license or a substitute technology will be available on favorable terms, or at all. Any such outcome could have a material adverse effect on our +business, financial condition and results of operations. +We may face difficulty keeping up with market developments in artificial intelligence and machine learning, and any such developments may be subject to rapidly evolving and extensive regulation +Our industry is marked by rapid technological developments and innovations (such as the use of artificial intelligence and machine learning) and evolving industry standards. If we are unable to provide enhancements +and new features and integrations for our existing platform, develop new products that achieve market acceptance, or innovate quickly enough to keep pace with these rapid technological developments, our business could be harmed. +In addition, laws and regulations regarding artificial intelligence and machine learning are evolving rapidly. The technologies underlying artificial intelligence and machine learning, and the use of such +technologies, are subject to a variety of laws and regulations, including intellectual property, data privacy and cybersecurity, consumer protection and competition laws, and are expected to be subject to increased regulation and new laws or new +applications of existing laws and regulations, which may vary by jurisdiction. Further, because these technologies are highly complex and rapidly developing, it is not possible to predict all of the legal, operational or technological risks that +may arise relating to the use of artificial intelligence and machine learning. +Risks Related to Our Partners and Suppliers +We rely on an unrelated third party to develop, maintain and host certain portions of our food service technology software, and any disruption in the relationship with that +third party, or any defects in the software provided by that third party, could have a material adverse effect on our reputation, business, financial condition and results of operations. +We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer our unique BOHA! branded solution to support back-of-house operations in the food +service industry. Certain web-based food service application software and selected components of our downloadable software applications are licensed from a third-party developer on a non-exclusive basis through 2031 and are subject to a revenue +sharing arrangement with the developer. We are reliant upon the third-party developer to further develop and maintain its developed software, and the developer controls the software source code. Therefore, presently, we are highly dependent on +this third-party developer for continued service to our customers and the further development of our food service technology software products. If the software provider were to terminate operations or otherwise be unavailable to provide +maintenance, hosting and development services to us and our customers, the availability or usage of our software products could be disrupted and our customers could be adversely affected. In any such case, we may need to seek comparable software +and services from other third parties or develop it internally, which could require significant time and expense. There can be no assurance that such software or services would be available from other sources, or that if available, they would be +of comparable quality and cost. Moreover, any efforts to develop new software, whether internal or by third parties, would require significant lead time, and there could be an interruption in service during any period in which the software +provider ceases to provide products and services and new products remain under development. Any such occurrence could materially and adversely impact our business, financial condition and results of operations. +11 +Index +Any errors or defects in, or failures of, third party software or applications could result in errors or defects in or failures of our food service technology products and services, which could be costly to correct +and have a material adverse effect on our reputation, business, financial condition and results of operations. +We are currently dependent upon a manufacturer located in Thailand for the manufacturing and assembly of substantially all of our printers and terminals, and any further or +future disruption in the businesses or operations of this manufacturer, political, social or economic instability, war, trade restrictions or tariffs, severe weather, changes in climate, additional public health crises and other events out of our +control could materially adversely affect our business, financial condition and results of operations. +In an effort to maximize cost savings and operational benefits, we have outsourced substantially all of the manufacturing and assembly of our printers and terminals to a contract manufacturer located in Thailand. +As a result, we are dependent on them for the manufacturing of our products, and any disruption in such manufacturing or the export of products from this manufacturer to the U.S. may adversely affect our business, financial condition and results +of operations. +Risks affecting the businesses and operations of our manufacturer in Thailand include: political and regional strife; war; labor shortages; severe weather and natural disasters such as earthquakes, hurricanes, +fires, and floods, whether as a result of climate change or otherwise; lengthy power outages; increased pricing, financial instability and capacity constraints of shippers; government imposition of tariffs which may impact the cost or +availability of products or components that we purchase; and concerns with or threats of public health crises, contagious diseases or health epidemics. Tthe risk to our business posed by any disruption in manufacturing is exacerbated by the +concentration of substantially all of our manufacturing operations in one manufacturer located in Thailand. +If the contract manufacturer is unable to manufacture our products or continue operating its facilities, as occurred in connection with the COVID-19 pandemic, or if cost increases (as a result of tariffs or +otherwise) make continued reliance on the contract manufacturer impractical, we will have limited means for the final assembly of a majority of our products until we are able to secure the manufacturing capability at another facility or develop +an alternative manufacturing facility, which could be costly and time consuming and have a material adverse effect on our operating and financial results. +We may also incur increased business continuity and reputational risks to the extent that we continue to outsource the manufacturing and assembly of our products to foreign third party service providers. For +example, outsourcing of manufacturing prevents us from exercising control over the assembly of certain of our products and related operations or processes, including the internal controls associated with operations and processes conducted and the +quality of our products assembled by contract manufacturers. If we are unable to effectively manage and oversee our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially +adversely affected. Outsourcing also exposes us to increased risk of infringement or misappropriation of our intellectual property, to which our manufacturers have access. Because our manufacturer is located in Asia, there is no guarantee that +our intellectual property rights will be protected or enforced to the same extent as under U.S. federal and state laws. Consequently, we may not be able to prevent third parties from developing or selling products made using our technologies. +We rely on distributors and resellers to sell our products and services. +We use a variety of distribution channels, including OEMs and distributors, to market and sell our products and services. We may be adversely impacted by any conflicts that could arise between and among our +various sales channels. +Our dependence upon distributors and resellers exposes us to numerous risks, including: +• +loss of channel and the ability to bring new products to market; +• +concentration of credit risk, including disruption in distribution should the distributors, and / or resellers’ financial condition deteriorate; +• +reduced visibility to end user demand and pricing issues which makes forecasting more difficult; +• +distributors or resellers leveraging their buying power to change the terms of pricing, payment and product delivery schedules; and +• +direct competition should a distributor or reseller decide to manufacture printers internally or source printers from a competitor. +We cannot guarantee that resellers will not reduce, delay or eliminate purchases from us, which could have a material adverse effect upon the business, consolidated results of operations and financial condition. +12 +Index +We currently rely on third party service providers to host our food service technology software and deliver certain services, and any interruptions or delays in services from +these third parties could impair the delivery of our products and services, and our business, results of operations, and financial condition could be materially adversely affected. +We rely on a third-party service provider to host our food service technology software. Third parties also provide services to key aspects of our operations, including Internet connections and networking, data +storage and processing, trust and safety and security infrastructure. We do not control the operation, physical security, or data security of any of these third-party providers. Our efforts to use commercially reasonable diligence in the +selection and retention of such third-party providers may be insufficient or inadequate to prevent or remediate such operational and security risks. Our third-party providers may be subject to intrusions, computer viruses, denial-of-service +attacks, sabotage, acts of vandalism, acts of terrorism or other misconduct. They are vulnerable to damage or interruption from power loss, telecommunications failures, fires, floods, earthquakes, hurricanes, tornadoes, and similar events, and +they may be subject to financial, legal, regulatory, and labor issues, each of which may impose additional costs or requirements on us or prevent these third parties from providing services to us or our customers on our behalf. From time to time, +our software maintained by these third parties has experienced brief interruptions in service which we have been able to resolve promptly by working with the third-party providers, and there may be future such interruptions that could have a +material adverse effect on our customer relationships or be more costly or time-consuming to resolve. In addition, these third parties may breach their agreements with us, disagree with our interpretation of contract terms or applicable laws and +regulations, refuse to continue or renew these agreements on commercially reasonable terms or at all, fail to or refuse to process transactions or provide other services adequately, take actions that degrade the functionality of our platform and +services, increase prices, impose additional costs or requirements on us or our customers, or give preferential treatment to our competitors. If we are unable to procure alternatives in a timely and efficient manner and on acceptable terms, or at +all, we may be subject to business disruptions, losses, or costs to remediate any of these deficiencies. The occurrence of any of the above events could result in reputational damage, legal or regulatory proceedings, loss of customers or other +adverse consequences, any of which could materially adversely affect our business, results of operations, and financial condition. +Risks Related to Competition, Sales and Marketing +We compete in highly competitive markets, which are likely to become more competitive. Competitors may be able to respond more quickly to new or emerging technology and +changes in customer requirements. +We face significant competition in developing and selling our printers, terminals, software, consumables and services. Our principal competitors have substantial marketing, financial, development and personnel +resources. To remain competitive, we believe we must continue to provide: +• +technologically advanced products that satisfy user demands; +• +superior customer service; +• +high levels of quality and reliability; and +• +dependable and efficient distribution networks. +We cannot ensure we will be able to compete successfully against current or future competitors. Increased competition may result in price reductions, lower gross profit margins and loss of market share, and could +require increased spending on research and development, sales and marketing and customer support. For example, we believe our largest competitor in the casino and gaming market has resumed supplying product at full capacity which has resulted in +a more competitive environment in the casino and gaming market going forward and may cause future downward pricing pressure and a loss of market share that we had gained while the competitor was unable to supply product. Any such occurrence +could negatively impact our worldwide casino and gaming sales. In addition, some competitors may make strategic acquisitions or establish cooperative relationships with suppliers or companies that produce complementary products, which may +include relationships with our software developer. Any of these factors could reduce our earnings. +13 +Index +Our food service technology market operates in an emerging and evolving industry, which makes it difficult to evaluate the future prospects of this market. +We launched our BOHA! offering in 2019 and have grown our food service technology significantly since then. This is still an emerging market that is continually evolving as technology develops to automate +back-of-house tasks that were historically performed manually. This evolving nature of the food service technology market may make it difficult to evaluate our future prospects in this market and the risks and challenges we may encounter. These +risks and challenges include, but are not limited to, our ability to: +• +accurately forecast our revenue and plan our operating expenses; +• +increase the number of customers (and retain existing customers and their guests) using our platform; +• +successfully compete with current and future competitors; +• +successfully expand our market presence in existing markets and enter new markets and geographies; +• +maintain and enhance the value of our reputation and brand; +• +develop and maintain strategic relationships with other market participants that provide complementary products; +• +adapt to rapidly evolving trends in the ways our customers interact with technology, including through the use of emerging artificial intelligence and machine learning technologies; +• +timely respond to customer needs with technology developments that enable our products to evolve to meet the changing demands of the marketplace; +• +avoid interruptions or disruptions in our service; and +• +manage the risk of loss relating to food safety issues if there is a failure of our offerings designed to help in part to assure perishable goods are safely preserved; +Risks Related to Our Customers +We are dependent on sales to one large customer; the loss of this customer or reduction in orders from this customer could materially affect our sales. +Casino and gaming sales to Light & Wonder represent a material percentage of our net sales. A reduction, delay or cancellation in orders from this customer, including reductions or delays due to market, +economic, or competitive conditions in the industries in which we serve, could have a material adverse effect upon our results of operations. +Risks Related to Our International Operations +In addition to maintaining offices in the UK and Macau, we sell and ship a significant portion of our products internationally and rely on third parties that make up part of +our global salesforce. The international nature of our operations may expose us to certain risks associated with doing business outside of the U.S., including risks posed by tariffs and changes in trade relations. +We sell a significant amount of our products to customers outside the United States. Shipments to international customers are expected to continue to account for a material portion of net sales. In addition, our +manufacturer and suppliers are largely located in Thailand. As a result, our products are largely exported to one of our facilities in the United States, which makes our operations vulnerable to disruptions in trade that could adversely affect +our business results. +14 +Index +Our international operations, including our reliance on manufacturers and suppliers located in Thailand, our worldwide sales team, and our sales to customers located outside the United States, expose us to +disruptions in trade and other associated risks such as: +• +the imposition of additional duties, tariffs including those imposed by the new U.S. presidential administration), quotas, taxes, trade barriers, capital flow restrictions and other charges on imports and exports by the United States +or the governments of the countries in which we or our manufacturers and suppliers operate; +• +delays in the delivery of cargo due to port security considerations, labor disputes such as dock strikes, and our reliance on a limited number of shipping and air carriers, which may experience capacity issues that adversely affect our +ability to ship inventory in a timely manner or for an acceptable cost; +• +fluctuations in the value of the U.S. dollar against foreign currencies, which could restrict sales, or increase costs of purchasing, in foreign countries; +• +economic or political instability in any of the countries in which we or our manufacturers or suppliers operate, which could result in a reduction in demand for our products or impair our foreign assets; +• +a reduced ability or inability to sell in or purchase from certain markets as a result of export or import restrictions; +• +potentially limited intellectual property protection in certain countries, such as China, may limit recourse against infringing products or cause us to refrain from selling in certain geographic territories; +• +difficulties staffing and managing foreign operations; and +• +economic uncertainties and adverse economic conditions (including inflation and recession). +Our business interruption insurance does not cover all possible situations, and there can be no assurance that the coverage would be adequate to compensate us for all losses that may occur in the event of a +disruption. In addition, the business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact, both short-term and long-term, on relations with our existing customers resulting from our inability +to produce products for them. +Risks Relating to Global Political and Economic Conditions +We purchase component parts and consumable products from third-party and sole-source suppliers, and any interference with this supply chain may impact our ability to +manufacture and sell our products. +We rely on third-party or sole-source suppliers to provide certain key components for our products. We do not have guaranteed supply contracts with any of our component suppliers, and our suppliers could delay +shipments, increase prices or cease manufacturing or selling such components to us at any time, as occurred as a result of such as the shortages in global microchip availability we experienced during much of 2022 and 2023. These disruptions +resulted in delays in delivery of products to customers and similar disruptions in the future could result in additional delays, even if we are able to source components from alternate suppliers. Supply chain disruptions have, in the past, +impacted our ability to maintain sufficient inventory on hand. As a result, we have paid, and if future disruptions occur we may have to pay in the future, increased shipping charges to expedite our receipt of components and inventory and the +delivery of finished products to our customers. In addition, we have incurred increased costs to obtain certain products and components from alternate suppliers when our usual suppliers did not have products available for us, and we may incur +such costs in the future if we need to seek alternate suppliers for any of our components. Cost increases and component shortages may be exacerbated by events beyond our control, such as changing economic conditions, inflation, currency and +commodity price fluctuations, tariffs (including those imposed by the new U.S. presidential administration) trade wars, resource availability, transportation costs, weather conditions and natural disasters, political unrest and instability, war +(such as the ongoing military conflict between Russia and Ukraine and the conflict in the Middle East) and other factors impacting supply and demand pressures. Recurring or worsening disruptions in the supply chain of such component parts and +consumable products could delay our production or release of our new products, cause us to incur additional freight costs and hinder our ability to meet our commitments to customers. If we are unable to obtain sufficient quantity of these +components on commercially reasonable terms or in a timely manner, or if we are unable to obtain alternative sources for the components, sales of our products could be delayed or halted entirely or we may have to redesign our products, as we did +with certain products in the recent past, to help meet market demand. In addition, supply chain constraints and the resulting delays affected customer ordering habits and customer demand by leading to a temporary increase in advance orders in +2022 and into 2023. This resulted in a significant slowdown in customer order and shipment rates in 2024 as customers struggled to sell their on-hand inventory that has continued into 2025 with respect to one significant international casino and +gaming customer that has not yet resumed ordering. Further, there can be no assurance that any cost increases attributable to future supply chain disruptions can be fully offset by price increases, or that we will continue to be able to fulfill +orders on time, and continued or prolonged impacts on our supply chain may result in lost sales, reduced gross margins or damage to our end-customer relationships, which would have a material adverse effect on our financial results. +15 +Index +Catastrophic events, political unrest or a downturn in economic conditions may disrupt our business. +Geopolitical events, social unrest, war or the threat of war, including repercussions of the war between Russia and Ukraine, the war in the Middle East, conflict between China and Taiwan, terrorism, political +instability, acts of public violence, boycotts, labor discord or disruptions, hostilities, pandemics or other public health crises, natural disasters or other catastrophic events may cause damage or disruption to our operations or the operations +of our customers, international commerce, and the global economy, and thus could harm our business. In particular, the reactions of governments, markets, and the general public to such events, many of which are beyond our control, may result in a +number of adverse consequences for our customers, business, operations, and results of operations. +For example, the continuing war between Ukraine and Russia, as well as the financial and trade-related restrictions associated with Russia and Belarus and economic sanctions on certain individuals and entities in +Russia and Belarus, have impacted international trade relations, and resulted in sustained increases in the cost of materials and components. If this war continues to persist or escalates, this may further disrupt global supply chains and could +result in shortages of key materials or components that our suppliers require to satisfy our needs. Any increases in the cost, or shortages, of raw materials, components or energy may continue to create supply issues that could constrain +manufacturing levels for our products. +In addition, based on the complex relationships among China, Hong Kong, Taiwan, and the United States, there is risk that political, diplomatic, and national security influences might lead to trade, technology, or +capital disputes, or disruptions that may affect our business or suppliers in Asia. These tensions may be exacerbated by continuing or new sanctions imposed in connection with the Russia–Ukraine war, as there continues to be unwillingness on the +part of China to support ongoing or expanded sanctions, which could distance China from its existing trade partners. More recently, both the United States and the European Union have considered imposing sanctions directly on Chinese companies +believed to be assisting Russia. Any increase in geopolitical tensions or expansion of sanctions either in Russia or Belarus or against Chinese companies may have a significant negative impact on our business or on the regional or global economy. +In the event of a major earthquake, hurricane or catastrophic event such as fire, power loss, telecommunications failure, cyber-attack, war or terrorist attack, we may be unable to continue our operations and may +endure system interruptions, reputational harm, breaches of data security, and loss of critical data, all of which would harm our business, results of operations, and financial condition. In addition, the insurance we maintain would likely not be +adequate to cover our losses resulting from disasters or other business interruptions. Any downturn in the economy in general, including the impact of the Russia–Ukraine war and the Middle East war, or in the food service or casino and gaming +industries in particular could result in reduced demand for our products and could adversely affect our business and results of operations. In addition, heightened security measures or responses to hostilities may cause certain governments to +restrict the import or export of goods, as has occurred with respect to the export of oil from Russia, which may have an adverse effect on our ability to buy and sell goods or on the cost to obtain components. +Risks Related to Regulations, Taxation, Governance and the Environment +We recorded a full valuation allowance on the value of our net deferred tax assets in the United States, and we expect to maintain that full valuation allowance on such assets +until we are able to demonstrate a consistent pattern of profitability. +We currently have deferred tax assets, which may be used to reduce taxable income in the future. We assess the realization of these deferred tax assets on a quarterly basis, and if we determine that it is more +likely than not that some portion of these assets will not be realized, an income tax valuation allowance is recorded. During the fourth quarter 2024, while undertaking our quarterly assessment, the Company recorded a $7.3 million valuation +allowance on the full value of the net deferred tax assets in the United States. We expect to continue to maintain a full tax valuation allowance on such assets until we are able to demonstrate a consistent pattern of profitability. As a result, +we expect to record no income tax expense or benefit during 2025. We currently have no net deferred tax assets on our consolidated financial statements. +Changes in tax rates or tax liabilities could affect results. +We are subject to taxation in the United States and certain state and foreign jurisdictions. Significant judgment is required to determine and estimate our tax liabilities. Our future annual and quarterly tax rates +could be affected by numerous factors, including changes in the (1) applicable tax laws; (2) composition of earnings in countries with differing tax rates; or (3) recoverability of our deferred tax assets and liabilities. Any of these +developments or any future changes in federal, state, or international tax laws or tax rulings could adversely affect our effective tax rate and our results of operations. +16 +Index +Risks Related to our Indebtedness +The agreement governing our credit facility contains restrictions and limitations that could significantly affect our ability to operate our business, as well as significantly +affect our liquidity. +On March 3, 2020, we entered into a Loan and Security Agreement (the “Loan Agreement”) governing a credit facility (the “Siena Credit Facility”) with Siena Lending Group LLC (the “Lendor”). The Loan Agreement +contains a number of significant covenants that could adversely affect our ability to operate our business, our liquidity, and our results of operations. These covenants restrict, among other things, our ability, and the ability of any future +domestic subsidiary, to: +• +merge, consolidate, form subsidiaries or dispose of assets; +• +acquire assets outside the ordinary course of business; +• +enter into other transactions outside the ordinary course of business; +• +sell, transfer, return or dispose of collateral; +• +make loans to or investments in, or enter into transactions with, affiliates; +• +incur or guarantee indebtedness, incur liens; +• +redeem equity interests while borrowings are outstanding under the credit facility; +• +change our capital structure; or +• +dissolve, divide, change our line of business or cease or suffer a disruption to all or a material portion of our business. +Additionally, the Loan Agreement requires us to comply with a minimum excess availability covenant, which requires excess borrowing availability of at least $750 thousand and the Loan Agreement requires us to +maintain outstanding borrowings of at least $3 million in principal amount. The breach of any covenants or obligations in the Loan Agreement, if not otherwise waived or amended, could result in a default under the Loan Agreement and could trigger +acceleration of our obligations thereunder and permit the lender to foreclose on the collateral securing our obligations under the Loan Agreement and exercise other rights of secured creditors. +Availability under the Siena Credit Facility is subject to a borrowing base, which is based on eligible accounts receivable and inventory. To the extent that our eligible accounts receivable and inventory decline +in value, our borrowing base will decrease, and the availability under the Siena Credit Facility currently is and may continue to be less than its stated amount and may decrease. In addition, if at any time the amount of outstanding borrowings +and letters of credit under that facility exceeds the borrowing base, we are required to prepay borrowings and/or cash collateralize letters of credit sufficient to eliminate the excess. +Our ability to comply with the covenants under the Loan Agreement or to maintain our borrowing base may be affected by events beyond our control, including deteriorating economic conditions. For example, +reductions in the value of accounts receivable and inventory may occur in the future due to decreases in sales and production resulting from the impact of future economic uncertainties. Further, certain slow-moving inventory and accounts +receivable that remain unpaid for a specified period of time are excluded from the borrowing base calculation. Thus, a decline in economic conditions and/or a decline in the financial condition of customers in the industries we serve may +negatively impact the borrowing base both by decreasing the value of existing accounts and reducing the number and amount of new accounts. If we overestimate our inventory needs due to the uncertainty surrounding future economic conditions, we +may have inventory that is considered slow-moving and thus excluded from the borrowing base calculation, and any reduction in production in response to decreased demand would also result in a lower inventory value and thus a lower borrowing base. +Any of these events could require us to seek waivers or amendments of covenants or alternative sources of financing or to reduce expenditures. We cannot assure you that such waivers, amendments or alternative +financing could be obtained, or if obtained, would be on terms acceptable to us, or that we would be able to reduce expenditures enough to offset any decrease in the borrowing base, or that we could make such reductions without a material +negative impact on our business. +17 +Index +General Risk Factors +General economic conditions could have a material adverse effect on our business, operating results and financial condition. +Our business is subject to general economic conditions. Uncertainty or negative trends in U.S. or international economic and investment climates, including the impact of developments in U.S.-China trade relations, +as well as economic impacts from the Russia-Ukraine war and the Middle East war, and any continued inflation attributable in part to supply chain disruptions or any other economic factors, could adversely affect our business. For example, +customers or potential customers could reduce or delay orders, key suppliers could become insolvent, which could result in production delays, and our customers may become insolvent or be unable to obtain credit. Any of these possible effects +could impact our ability to effectively manage inventory levels and collect receivables, create unabsorbed costs due to lower net sales, and ultimately decrease our net sales and profitability including write-downs of assets. +Our stock price may fluctuate significantly. +The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as: +• +prevailing domestic and international market and economic conditions, and conditions in the industries we serve, including current market volatility, inflation and rising interest rates; +• +adverse business conditions faced by customers, or bankruptcies or store closures of our customers resulting from adverse economic conditions due to inflation or otherwise; +• +changes in our business, operations or prospects; +• +developments in our relationships with our customers or strategic partners; +• +announcements of new products or services by us or by our competitors; +• +announcement or completion of acquisitions by us or by our competitors; +• +changes in existing, or adoption of additional, government regulations; +• +developments or announcements with respect to our strategic review process and the pace of progress with respect to that process, and +• +unfavorable or reduced analyst coverage. +In addition, the stock market may experience significant price fluctuations year-to-year. Broad market fluctuations, general economic conditions and specific conditions in the industries in which we operate may +adversely affect the market price of our common stock. +Unfavorable analyst coverage or a reduction in analyst coverage of our common stock may adversely affect the price of our common stock. +The trading market for our common stock relies in part on the research and reports that industry or financial analysts may publish about us, our business, our markets and our competitors. We currently have limited +analyst coverage, and many investment banks no longer find it profitable to provide securities research on micro-cap and small-cap companies. If securities analysts do not cover our common stock in the future, the lack of research coverage may +adversely affect the market price of our common stock. Furthermore, if one or more of the analysts who cover us downgrade our stock, or if those analysts issue other unfavorable commentary about us or our business, our stock price may decline. +Our common stock is traded on the Nasdaq Global Market. During the year ended December 31, 2024, the average daily trading volume for our common stock as reported by the Nasdaq Global Market was approximately +22,000 shares. We are uncertain whether a more active trading market in our common stock will develop. As a result, relatively small trades may have a significant impact on the market price of our common stock, which could increase the +volatility and depress the price of our common stock. +18 +Index +Our common stock is thinly traded, and investors may be unable to sell their shares at their desired prices, or at all, and sales of large blocks of shares may adversely +affect the price of our common stock. +Our common stock has historically been sporadically or “thinly” traded, meaning that the number of persons interested in purchasing shares of our common stock at prevailing prices at any given time may be +relatively small. This could lead to wide fluctuations in our share price. Investors may be unable to sell their common stock at or above their purchase price, which may result in substantial losses. As a consequence of this lack of liquidity, +the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of shares of our common stock in either direction. The price of shares of our common stock could, for example, decline +precipitously in the event a large number of shares of our common stock are sold on the market without commensurate demand, while an issuer with a more robust daily trading volume for its common stock might better absorb those sales without an +adverse impact on its share price. +If we raise additional capital in the future, existing stockholder ownership interest in the Company could be diluted or otherwise adversely impacted, and future sales of our +common stock or other financing arrangements may cause our stock price to decline. +In the future, we may sell additional shares of our common stock in public or private offerings, or we may obtain funds through a credit facility or by issuing debt or preferred securities. We may also issue +additional shares of our common stock to finance future acquisitions. Shares of our common stock are also available for future issuance and sale pursuant to stock options and other equity awards that we have granted to our employees, and in the +future, we may grant additional stock options, restricted stock units and other forms of equity compensation to our employees. Any issuance of equity we may undertake in the future to raise additional capital could cause the price of our common +stock to decline, or require us to issue shares at a price that is lower than that paid by holders of our common stock in the past, which would result in those newly issued shares being dilutive. Sales of our common stock or the perception that +such sales could occur may adversely affect prevailing market prices for shares of our common stock and could impair our ability to raise capital through future offerings. The lender under our existing debt agreement has rights that are senior to +your rights as a common stockholder, and if we obtain funds in the future through a credit facility or through the issuance of debt or preferred securities, the lenders of such facility or the holders of such securities would likely also have +rights senior to the rights of our common stockholders, which could impair the value of our common stock. +We do not intend to pay dividends for the foreseeable future, so investors must rely on price appreciation to realize a gain on their investment. +We have not declared or paid cash dividends on our capital stock since November 2019. We currently intend to retain any future earnings to finance our operations and the expansion of our food service technology +business, and we do not anticipate declaring or paying any dividends to holders of our common stock in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors. Accordingly, +investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize future gains on their investments. +The Company’s goodwill may become impaired, which could require a significant charge to earnings be recognized. +In accordance with GAAP, we review goodwill at least annually and when an event occurs or circumstances change that indicate that the carrying value may not be recoverable, including as a result of declines in +stock price, market capitalization, reduced future cash flow estimates or slower growth rates in our industry. Future operating results used in the assumptions underlying such as sales or profit forecasts, may not materialize, and the Company may +be required to record a significant charge to earnings in the financial statements for the period in which any impairment is determined, resulting in a decrease in our earnings or an increase in our losses in such period and an unfavorable impact +on our results of operations. +We cannot provide any assurance that current laws, or any laws enacted in the future, will not have a material adverse effect on our business. +Our operations are subject to laws, rules, regulations, including environmental regulations, government policies and other requirements in a variety of jurisdictions, including those in which we conduct business. +Changes in such laws, rules, regulations, policies or requirements could result in the need to modify our products, could delay the development of new products and could affect the demand for our products, which may have an adverse impact on our +future operating results. If we do not comply with applicable laws, rules and regulations we could be subject to costs and liabilities and our business may be adversely impacted. +19 +Index +We take advantage of specified scaled disclosure requirements applicable to a “smaller reporting company” under Regulation S-K, and the information that we provide to +stockholders may therefore be different than they might receive from other public companies. If some investors find our shares of common stock less attractive as a result of this scaled disclosure, there may be a less active trading market for +our shares of common stock, which may increase the volatility of the market price of our common stock. +We are a “smaller reporting company,” as defined in Item 10(f)(1) of Regulation S-K. As a smaller reporting company, we take advantage of specified scaled disclosure and other requirements that are otherwise +applicable generally to public companies. +We intend to continue to take advantage of certain of the scaled disclosure requirements of smaller reporting companies and may continue to do so until we are no longer a smaller reporting company. We will cease to +be a smaller reporting company if we have (i) equal to or greater than $250 million in market value of our shares held by non-affiliates as of the last business day of our second fiscal quarter, (ii) equal to or greater than $100 million in +annual revenue for the most recent fiscal year or (iii) less than $100 million in annual revenue for the most recent fiscal year and the market value of our shares held by non-affiliates exceeds $700 million as of the last business day of our +second fiscal quarter. We choose to take advantage of some but not all of these scaled disclosure requirements; therefore, the information that we provide stockholders may be different than one might get from other public companies. +We are also a “non-accelerated filer” within the meaning of Rule 12b-2 promulgated under the Exchange Act, and we are not required to comply with the auditor attestation requirements of Section 404 of the +Sarbanes-Oxley Act of 2002, as amended, with respect to management’s assessment of our internal control over financial reporting. Therefore, our internal control over financial reporting will not receive the level of review provided by the +process relating to the auditor attestation included in annual reports of issuers that are subject to the auditor attestation requirements. +We cannot predict if investors will find our securities less attractive because we rely on these available exemptions. If some investors find our shares of common stock less attractive as a result, there may be a +less active trading market for our shares of common stock and the market price of such shares of common stock may be more volatile. +Our Amended and Restated By-Laws designate certain Delaware courts as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our +stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or stockholders. +Our Amended and Restated By-Laws (the “By-Laws”) provide that, unless we consent in writing to the selection of an alternative forum, to the fullest extent permitted by law, all Internal Corporate Claims must be +brought solely and exclusively in the Court of Chancery of the State of Delaware (or, if such court declines to accept jurisdiction, the Superior Court of the State of Delaware, or, if such other court declines to accept jurisdiction, the United +States District Court for the District of Delaware). The By-Laws define “Internal Corporate Claims” to mean claims, including claims in the right of the Company, brought by a current or former stockholder (including a current or former beneficial +owner) (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity or (ii) as to which the General Corporation Law of the State of Delaware confers jurisdiction upon the Court of +Chancery of the State of Delaware. +This choice of forum provision may increase costs to bring a claim, discourage claims or limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our +directors, officers or other stockholders, which may discourage such lawsuits against us and our directors, officers and stockholders. Alternatively, if a court were to find this choice of forum provision inapplicable to, or unenforceable in +respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or results of +operations. The choice of forum provision in the By-Laws will not preclude or contract the scope of exclusive federal or concurrent jurisdiction for actions brought under the federal securities laws including the Exchange Act or the Securities +Act or the respective rules and regulations promulgated thereunder. +Item 1B. +Unresolved Staff Comments. +Not applicable. +20 +Index +Item 1C. Cybersecurity +Risk Management and Strategy +The Company’s Board of Directors recognizes the critical importance of maintaining the trust and confidence of our customers, clients, business +partners and employees. The Board of Directors is actively involved in oversight of the Company’s risk management program, and cybersecurity represents an important component of the Company’s overall approach to enterprise risk management (“ERM”). +The Company’s cybersecurity policies, standards, processes and practices are fully integrated into the Company’s ERM program and are based on recognized frameworks established by the National Institute of Standards and Technology, the International Organization for Standardization and other applicable industry standards. In general, the +Company seeks to address cybersecurity risks through a comprehensive, cross-functional approach that is focused on preserving the confidentiality, security and availability of the information that the Company collects and stores by identifying, +preventing and mitigating cybersecurity threats and effectively responding to cybersecurity incidents when they occur. As one of the critical elements of the Company’s overall ERM approach, the Company’s cybersecurity +program is focused on the following key areas: +• +Governance: As discussed in more detail under the heading “Governance,” the Board of Directors’ oversight of cybersecurity risk management is supported by the Audit Committee of the Board of +Directors (the “Audit Committee”), which regularly interacts with the Company’s ERM function, the Company’s Vice President of Information Technology, other members of management and relevant management committees and councils, including +management’s Sarbanes-Oxley & Cybersecurity Steering Committee. +• +Collaborative Approach: The Company has implemented a comprehensive, cross-functional approach to identifying, preventing and mitigating cybersecurity threats and incidents, while also +implementing controls and procedures that are designed to provide for the prompt and appropriate internal reporting of certain cybersecurity incidents, either in the form of a single unauthorized occurrence or a series of unauthorized +occurrences, so that decisions regarding the public disclosure and reporting of such incidents can be made by management in a timely manner. +• +Technical Safeguards: The Company deploys technical safeguards that are designed to protect the Company’s information systems from cybersecurity threats, including firewalls, intrusion +prevention and detection systems, anti-malware functionality and access controls, which are evaluated and improved through vulnerability assessments and cybersecurity threat intelligence. +• +Incidence Response and Recovery Planning: The Company has established and maintains comprehensive incident response and recovery plans intended to fully and timely address the Company’s +response to a cybersecurity incident, and such plans are tested and evaluated on a regular basis. +• +Third-Party Risk Management : The Company maintains a comprehensive, risk-based +approach to identifying and overseeing cybersecurity risks presented by third parties, including vendors, service providers and other external users of the Company’s systems, as well as the systems of third parties that could adversely +impact our business in the event of a cybersecurity incident affecting those third-party systems. +• +Education and Awareness: The Company provides regular, mandatory training for personnel regarding cybersecurity threats as a means to equip the Company’s personnel with effective tools to +proactively address cybersecurity threats and prevent incursions and to communicate the Company’s evolving information security policies, standards, processes and practices. Our awareness program includes assessment of our personnel’s +preparedness through regular phishing e-mail alerts, highlighted banners that warn about external senders, and tests administered to help the Company’s personnel interrogate, navigate around, and avoid clicking suspicious and unfamiliar +links from unknown senders. +The Company engages in the periodic assessment and testing of the Company’s policies, standards, processes and practices that are designed to +address cybersecurity threats and incidents. These efforts include a wide range of activities, including audits, assessments, tabletop exercises, threat modeling, vulnerability testing and other exercises focused on evaluating the effectiveness of +our cybersecurity measures and planning. The Company engages third parties to perform assessments on our cybersecurity measures , +including information security maturity assessments, audits and independent reviews of our information security control environment and operating effectiveness. The results of such assessments, audits and reviews are periodically reported to the +Audit Committee and the Board of Directors, and the Company adjusts its cybersecurity policies, standards, processes and practices as appropriate based on the information provided by these assessments, audits and reviews. +Governance +The Board of Directors, in coordination with the Audit Committee, oversees the Company’s ERM process, including the management of risks arising +from cybersecurity threats. The Board of Directors and the Audit Committee each receive presentations and +reports on cybersecurity risks, which address a wide range of topics including recent developments, evolving standards, vulnerability assessments, third-party and independent reviews, the threat environment, technological trends and information +security considerations arising with respect to the Company’s peers and third parties. The Board of Directors and the Audit Committee also receive prompt and timely information regarding any cybersecurity incident that meets established reporting +thresholds or that management otherwise deems to be significant, as well as ongoing updates regarding any such incident until it has been addressed. On an annual basis, the Board of Directors and Audit Committee discuss the Company’s approach to cybersecurity risk management with the members of management’s Sarbanes-Oxley & Cybersecurity Steering Committee, which includes the Company’s President and Chief Financial Officer (“CFO”) and Vice President of Information Technology. +21 +Index +The Sarbanes-Oxley & Cybersecurity Steering Committee , in coordination with the Company’s outside legal counsel, works collaboratively across the Company and with various consultants to implement a program designed to protect the Company’s information systems from +cybersecurity threats and to promptly respond to any cybersecurity incidents in accordance with the Company’s incident response and recovery plans. +The Vice President of Information Technology has served in various roles in information technology and information security for over 25 years and holds undergraduate and graduate degrees in +computer science. As described in more detail above under the heading “Information about our Executive Officers,” the Company’s Chief Executive Officer and the President and CFO each hold undergraduate and graduate degrees in their respective +fields, and each has over 30 years of experience managing risks at the Company and at similar companies, including risks arising from cybersecurity threats. +Cybersecurity threats, including as a result of previous cybersecurity incidents, have not materially affected, and are not reasonably likely to materially affect, the Company, including its business strategy, results of operations or financial condition. +Item 2. +Properties. +Our principal facilities as of December 31, 2024 are listed below. We believe that all facilities generally are in good condition, adequately maintained and suitable for their present and currently contemplated +uses. +Location +Operations Conducted +Size +(Approx. Sq. Ft.) +Owned +or Leased +Lease +Expiration Date +Hamden, Connecticut +Executive offices and sales office +11,100 +Leased +October 31, 2025 +Ithaca, New York +Hardware design and development, assembly and service facility +73,900 +Leased +May 31, 2026 +Las Vegas, Nevada +Software design and development and casino and gaming sales office +19,600 +Leased +November 30, 2025 +Doncaster, UK +Sales office and service center +6,000 +Leased +August 24, 2026 +Macau, China +Sales office +180 +Leased +April 30, 2025 +110,780 +Item 3. +Legal Proceedings. +The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. As of December +31, 2024, we are not involved in any pending or, to our knowledge, threatened legal proceedings, including legal proceedings contemplated by governmental authorities, the outcome of which we believe would be material to our financial condition or +results of operations. +Item 4. +Mine Safety Disclosures. +Not applicable. +22 +Index +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. +Our common stock is traded on the Nasdaq Global Market under the symbol TACT. As of February 28, 2025, there were 191 holders of record of the common stock. +Issuer Purchases of Equity Securities +During the fourth quarter of 2024, we did not repurchase any shares of our common stock. +Dividend Policy +The Company does not currently pay cash dividends and does not intend to do so in the foreseeable future. +Sales of Unregistered Securities +None. +Item 6. +[Reserved] +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations. +This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto. +Recent Developments +The Company’s previously announced strategic review process remains active. Management and the Company’s Board of Directors are focused on the process. The Company is +determined to consider any and all options that increase and/or deliver stockholder value. The Company will provide further updates on this process when it determines that additional disclosure is appropriate or required. For information +regarding the risks related to the strategic review process, please see Part I, Item 1A, Risk Factors under the sub-caption “Our success may depend in part on our ability to identify and pursue the best long-term strategy for our businesses.” +Current Trends +After strong demand during most of 2023 due in part to our primary competitor’s struggle to deliver products in the face of supply chain constraints, in late 2023, we began to see indications of a +temporary slowdown in demand in the casino and gaming market, as customers that had built up excess inventory due to supply chain concerns advised us that they would temporarily reduce orders until their stock normalized. This slowdown impacted +our results in the fourth quarter of 2023 and the first nine months of 2024. We currently believe all major customers, with the exception of one large international casino and gaming customer, were able to sell through their on-hand inventory and +resumed ordering. Though we expect our overall casino and gaming sales to improve in 2025 compared to 2024, we expect such sales to be somewhat impacted in 2025 until this customer has sold through its inventory on hand. Further, our primary +competitor in the casino and gaming market has resumed supplying product at what we believe is their full capacity. The return of this competitor has resulted in some downward pricing pressure in certain geographies of that market which may +continue and may negatively impact our worldwide casino and gaming sales. In addition, during 2022 and 2023, we experienced cost increases as a result of supply chain constraints, most of which we have been able to offset by increasing prices of +our products. However, pricing pressure has subsequently caused us to lower prices again and there can be no guarantee that we will be able to increase prices sufficiently to offset any future similar cost increases, which generally cannot be +predicted, and we may be further impacted by supply chain disruptions, inflation and other global economic conditions that may affect the markets we serve and from which we source our supplies and parts. +In February and March 2025, the U.S. presidential administration began implementing certain orders imposing new tariffs on foreign imports impacting multiple commodities and industries and multiple +countries, including Canada and Mexico. In addition, the Canadian and Mexican governments have indicated they may retaliate with tariffs on U.S. goods. While at this time we do not expect any potential tariffs imposed by Canada and Mexico to have +a material impact on our business, we are currently monitoring the ongoing trade dispute among the United States, Canada and Mexico and any future potential impact of these tariffs, and any additional tariffs that may be imposed or retaliatory +actions that may be taken, and their impact to our business and financial condition. +For additional discussion of our business, refer to Part I, Item 1. Business, of this Form 10-K. +Critical Accounting Estimates +The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America (“GAAP”) requires management to make use of estimates, judgments and assumptions +that affect both Balance Sheet items and Statement of Operations categories. Such estimates and judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances; however, +due to the inherent uncertainties in developing estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods. +We base our estimates on historical experience, forecasts and on various other assumptions that are believed to be reasonable under the circumstances; however actual results may differ from those +estimates under different assumptions or conditions. The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies +require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. +23 +Index +The following accounting policies are those that we believe to be most critical in the preparation of our financial statements. These items utilize assumptions and estimates about the effect of future events +that are inherently uncertain and are therefore based on our judgment. Refer to Note 2 – Summary of significant accounting policies in the accompanying Consolidated Financial Statements for a complete listing of our significant accounting +policies. We also have other policies that we consider key accounting policies; however, these policies typically do not require us to make estimates or judgments that are difficult or subjective. +Revenue Recognition – Our net sales are derived from the sale of products and services and are adjusted for estimated +returns and allowances, which historically have been insignificant. The a pplication of GAAP to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, the determination of whether revenues +related to our revenue contracts should be recognized over time or at a point in time. We recognize revenue when the obligations under the terms of a contract with our customers are satisfied; generally, this +occurs with the transfer of control of our printers, terminals, consumables and replacement parts. For our warranty, software applications and maintenance agreements, revenue is generally recognized ratably over the contract period. Other +significant judgments include contracts that contain multiple performance obligations (most commonly when contracts include a hardware product, software, financing and extended warranties) which require a contract’s transaction price to be +allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. For arrangements containing multiple performance obligations, the revenue relating +to the undelivered performance obligation is deferred using the relative standalone selling price method utilizing estimated sales prices until satisfaction of the deferred performance obligation. Both of these determinations impact +the timing and amount of our reported revenues and net income and loss. +Accounts Receivable – We have standardized credit granting and review policies and procedures for all customer accounts, including: credit reviews of all +new customer accounts; ongoing credit evaluations of current customers; credit limits and payment terms based on available credit information; and adjustments to credit limits based upon payment history and the customer’s current +creditworthiness. We also provide an estimate for expected credit losses based on an expected loss methodology which considers a broad range of information to estimate expected credit losses, including historical +information, current economic conditions and a reasonable forecast period . Our reserve for expected credit losses as of December 31, 2024 was $0.5 million, or 7.0% of outstanding trade accounts receivable, which we believe is +appropriate considering the overall quality of our accounts receivable. Although credit losses have historically been within expectations and the reserves established, there is no assurance that our credit loss experience will continue to be +consistent with historical experience. While we believe that our allowance for credit losses is adequate and represents our best estimate of future losses, we will continue to monitor customer liquidity and other +economic conditions, which may result in changes to our estimates. +Inventories – The valuation of inventory requires us to estimate obsolete or excess inventory as well as inventory that +is not of saleable quality. The determination of obsolete or excess inventory requires us to estimate the future demand for our products. We record valuation reserves on our inventory for estimated excess and obsolete inventory and lower of +cost or net realizable value concerns equal to the difference between the cost of inventory and the estimated realizable value based upon assumptions about future product demand, market conditions and product selling prices. If future product +demand, market conditions or product selling prices are less than those projected by management or if continued modifications to products are required to meet specifications or other customer requirements, increases to inventory reserves may +be required which would have a negative impact on our gross margin. +Goodwill and Intangible Assets – We evaluate goodwill and other indefinite-lived intangible assets for impairment annually +and when an event occurs or circumstances change that indicate that the carrying value may not be recoverable. The Company utilizes the option to first assess qualitative factors to determine whether it is necessary to perform the Step +1 quantitative goodwill impairment test in accordance with the applicable accounting standards. Under the qualitative assessment, management considers relevant events and circumstances including, but not limited to, macroeconomic conditions, +industry and market considerations, Company performance, and events directly affecting the Company. If the Company determines that the Step 1 quantitative impairment test is required, management estimates the fair value of the reporting unit +primarily using the income approach. Under the income approach, we use a discounted cash flow methodology to derive an indication of value, which requires management to make significant estimates and assumptions +related to forecasted revenues, gross profit margins, operating income margins, working capital cash flow, perpetual growth rates, and long-term discount rates, among others. Factors considered that may trigger an interim period +impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired assets or the +strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment when +appropriate. +As of December 31, 2024, upon the completion of our annual assessment for impairment, we have determined that no goodwill or intangible asset impairment has occurred and the fair value of the Company was +substantially higher than our carrying value. +We have evaluated the recoverability of the assets on our Consolidated Balance Sheet as of December 31, 2024 in accordance with relevant authoritative accounting literature. We have considered the effects caused by +the global supply chain disruptions, inflation and macroeconomic factors potentially impacting accounts receivable, inventory, investments, intangible assets, goodwill and other assets and liabilities. Where forward-looking estimates are +required, we made a good-faith estimate based on information available as of the balance sheet date. We have continued to monitor for indicators of impairment through the date of this Form 10-K and reflected accordingly in the accompanying +consolidated financial statements. +24 +Index +Income Taxes – We account for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”). In preparing our Consolidated Financial Statements, we +are required to estimate income taxes in each of the jurisdictions in which we operate. Among other things, this provision prescribes a minimum recognition threshold that an income tax position must meet before it is recorded in the reporting +entity’s financial statements. It also requires that the effects of such income tax positions be recognized only if, as of the balance sheet reporting date, it is “more likely than not” (i.e., more than a 50% likelihood) that the income tax +position will be sustained based solely on its technical merits. When making this assessment, management must assume that the responsible taxing authority will examine the income tax position and have full knowledge of all relevant facts and +other pertinent information. The accounting guidance also clarifies the method of accruing for interest and penalties when there is a difference between the amount claimed, or expected to be claimed, on a company’s income tax returns and the +benefits recognized in the financial statements. This involves estimating the actual current tax exposure together with assessing temporary differences between the tax basis of certain assets and liabilities and their reported amounts in the +financial statements, as well as net operating losses, tax credits and other carryforwards. These differences result in deferred tax assets and liabilities, which are reflected in our Consolidated Balance Sheets. We then assess the likelihood +that the deferred tax assets will be realized from future taxable income. +Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not (greater than 50%) that a tax benefit will not be realized. In evaluating the need for a valuation +allowance, management considers all potential sources of taxable income, including income available in carryback periods, future reversals of taxable temporary differences, projections of taxable income, and income from tax planning strategies, +as well as all available positive and negative evidence. Positive evidence includes factors such as a history of profitable operations and, projections of future profitability within the carryforward period, including any potential tax planning +strategies. Negative evidence includes items such as cumulative losses and projections of future losses. Upon changes in facts and circumstances, management may conclude that deferred tax assets for which no valuation allowance is currently +recorded may not be realized, resulting in a charge to establish a valuation allowance. Existing valuation allowances are re-examined under the same standards of positive and negative evidence. If it is determined that it is more likely than not +that a deferred tax asset will be realized, the appropriate amount of the valuation allowance, if any, is released. Deferred tax assets and liabilities are also re-measured to reflect changes in underlying tax rates due to law changes and the +granting and lapse of tax holidays. +In 2024, TransAct recognized a $7.3 million discrete income tax charge for a valuation allowance on the full value of the net deferred tax assets in the United States. After weighing all available +positive and negative evidence, as described above, management determined that it was no longer more likely than not that TransAct will realize the tax benefit of these deferred tax assets. This was mainly driven by a cumulative taxable loss over +the previous three fiscal years (2022 through 2024) combined with a near term outlook of future taxable losses. The need for this valuation allowance will be assessed on a quarterly basis in future periods and, as a result, a portion, or all of +the allowance, may be reversed based on changes in facts and circumstances. +Significant judgment is required in determining the provision for income taxes and, in particular, any valuation allowance or tax reserves with respect to our deferred tax assets and uncertain tax positions. On a +quarterly basis, we evaluate the recoverability of our deferred tax assets based upon historical results and forecasted taxable income over future years, and match this forecast against the basis differences, deductions available in future years +and the limitations allowed for net operating loss and tax credit carryforwards to ensure that there is adequate support for the realization of the deferred tax assets. Although we have considered future taxable income and ongoing prudent and +feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the valuation +allowance or tax reserves would be charged as a reduction to income in the period such determination was made. Likewise, should we determine that we would be able to realize future deferred tax assets in excess of its net recorded amount, an +adjustment to the valuation allowance would increase net income in the period such determination was made. +Share-Based Compensation – We calculate share-based compensation expense in accordance with ASC 718, “Compensation – Stock Compensation” using the +Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate, and dividend +yield. We account for forfeitures as they occur. +25 +Index +Results of Operations: Year Ended December 31, 2024 Compared to Year Ended December 31, 2023 +Net Sales. Net sales, which include printer, terminal and software sales as well as sales of replacement parts, consumables and maintenance and repair +services, by market for the years ended December 31, 2024 and 2023 are detailed in the below table. +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2024 +December 31, 2023 +$ Change +% Change +Food service technology +$ +16,101 +37.1 +% +$ +16,308 +22.5 +% +$ +(207 +) +(1.3 +%) +POS automation +3,361 +7.8 +% +6,922 +9.5 +% +(3,561 +) +(51.4 +%) +Casino and gaming +20,348 +46.9 +% +41,192 +56.7 +% +(20,844 +) +(50.6 +%) +TSG +3,574 +8.2 +% +8,209 +11.3 +% +(4,635 +) +(56.5 +%) +$ +43,384 +100.0 +% +$ +72,631 +100.0 +% +$ +(29,247 +) +(40.3 +%) +International* +$ +9,899 +22.8 +% +$ +14,571 +20.1 +% +$ +(4,672 +) +(32.1 +%) +* +International sales do not include sales of products to domestic distributors or other customers who in turn ship those products to international destinations. +Net sales for 2024 decreased $29.2 million, or 40%, from 2023. Printer, terminal and other hardware sales volume decreased by 47% to approximately 79,000 units for 2024, driven by large unit volume decreases +across all markets, including a 50% decrease in unit volume from the casino and gaming market, a 42% decrease in unit volume in the POS automation market and a 20% hardware unit volume decrease in our FST market. For more information about the +sales volume changes described above, please refer to the results of operations for each of our markets discussed further below. The average selling price of our printers, terminals and other hardware increased approximately 1% during 2024 +compared to 2023 due to general inflationary pressures. +International sales for 2024 decreased $4.7 million, or 32%, compared to 2023 predominantly due to lower sales in our casino and gaming market. +Food service technology (“FST”) . Our primary offering in the food service technology market is our line of BOHA! products, the BOHA! product suite combines our latest +generation terminal or workstation, which include one or two printers, with our BOHA! labeling, timers, and media software. In addition, customers may individually purchase cloud-based software applications that connect to an application on a +separate mobile device into a solution to automate back-of-house operations in restaurants, convenience stores and food service operations. The additional software offering of BOHA! consists of a variety of individually purchased +software-as-a-service (“SaaS”)-based applications for both Android and iOS operating systems, including applications for temperature monitoring, temperature taking and checklists and task lists. These applications are sold separately, and +customers purchase the applications they need for their back-of-house operations. Customers may also purchase associated hardware, such as tablets, temperature sensors and gateways. The BOHA! Terminal and the more recently launched Terminal 2 +combine an operating system and hardware components in a single touchscreen device with one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, and nutritional +labels for prepared foods, and “enjoy by” date labels. The BOHA! WorkStation uses an iPad or Android tablet instead of an integrated touchscreen. The BOHA! Terminal, Terminal 2 and WorkStation are equipped with the TransAct Enterprise Management +System to ensure that only approved touchscreen functions are available on the device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, casual dining, fast +casual and quick-service restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house operations. +Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service contracts, and +technical support services. Sales of our worldwide food service technology products for the years ended December 31, 2024 and 2023 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2024 +December 31, 2023 +$ Change +% Change +Domestic +$ +14,719 +91.4 +% +$ +15,159 +93.0 +% +$ +(440 +) +(2.9 +%) +International +1,382 +8.6 +% +1,149 +7.0 +% +233 +20.3 +% +$ +16,101 +100.0 +% +$ +16,308 +100.0 +% +$ +(207 +) +(1.3 +%) +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2024 +December 31, 2023 +$ Change +% Change +Hardware +$ +5,319 +33.0 +% +$ +5,170 +31.7 +% +$ +149 +2.9 +% +Software, labels and other recurring revenue +10,782 +67.0 +% +11,138 +68.3 +% +(356 +) +(3.2 +%) +$ +16,101 +100.0 +% +$ +16,308 +100.0 +% +$ +(207 +) +(1.3 +%) +26 +Index +Sales in food service technology decreased 1% in 2024 compared to 2023 driven by a 3% decrease in sales of BOHA! software, labels and other recurring revenue, partially offset by a 3% increase in hardware sales. +Despite the loss of a significant customer (as further explained below) FST software, labels and recurring revenue experienced only a slight decline of 3% due to the growth of the installed base of BOHA! Terminal 2. Hardware sales increased +largely due to increased sales of our BOHA! Terminal 2. Hardware sales were also impacted by a 94% decrease in sales of our AccuDate 9700 terminals which we discontinued at the end of 2023 and 77% lower sales of our legacy BOHA! Terminal +(including those of the lost customer explained further below). These decreases were more than offset by strong sales of our BOHA! Terminal 2 (that replaced the original BOHA! Terminal) to a large international QSR customer as well as increased +sales of Workstations. +During the second quarter of 2024, a significant customer notified us that it would be terminating service, including its BOHA! software subscriptions and label sales, for its existing installed base of BOHA! +Terminals by the middle of July 2024. Total sales to this customer (including hardware, software, labels and other recurring revenue) were approximately $4.0 million in 2023 and $0.9 million in 2024. We did not have any hardware sales, and +minimal label and software sales, to this customer in the third and fourth quarters of 2024, but we expect to continue to service a small percentage of ongoing units and may have some additional sales to this customer in the future. +We expect FST revenue to be higher in 2025 than in 2024 as we continue to focus on growing our installed base of terminals and the related recurring revenue (primarily the sale of labels and subscription software +revenue from our labeling software application). +POS automation . Revenue from the POS automation market includes sales of our Ithaca 9000 thermal printer used primarily by McDonald’s, and to a much lesser extent, other +quick-service restaurants located either at the checkout counter or within self-service kiosks to print receipts for consumers or print liner-less labels. Sales of our worldwide POS automation products for the years ended December 31, 2024 and +2023 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2024 +December 31, 2023 +$ Change +% Change +Domestic +$ +3,361 +100.0 +% +$ +6,805 +98.3 +% +$ +(3,444 +) +(50.6 +%) +International +-- +-- +117 +1.7 +% +(117 +) +(100.0 +%) +$ +3,361 +100.0 +% +$ +6,922 +100.0 +% +$ +(3,561 +) +(51.4 +%) +The decrease in POS automation revenue in 2024 compared to 2023 was driven by a 51% decrease in domestic sales largely due to unusually high sales during 2023, as we increased production and began to fulfill our +large backlog of sales orders following supply chain slowdowns in 2022. During 2024, we experienced renewed competitive pressure that has resulted in a return to a more normalized level of sales as well as a reduction in our average selling +prices +We expect POS automation sales to be lower in 2025 compared to 2024 as we expect to continue to face competitive pressure in this market. +Casino and gaming . Revenue from the casino and gaming market includes sales of thermal printers used in slot machines, video lottery terminals, and other gaming machines +that print tickets or receipts instead of issuing coins at casinos, racetracks and other gaming venues worldwide. Revenue from this market also includes sales of thermal roll-fed printers used in the international off-premise gaming market in +gaming machines such as Amusement with Prizes, Skills with Prizes and Fixed Odds Betting Terminals and kiosks for sports betting at non-casino gaming and sports betting establishments. Revenue from this market also includes royalties related to +our patented casino and gaming technology. In addition, casino and gaming market revenue includes sales of the EPICENTRAL print system, our software solution (including annual software maintenance), that enables casino operators to create +promotional coupons and marketing messages and to print them in real time at the slot machine. Sales of our worldwide casino and gaming products for the years ended December 31, 2024 and 2023 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2024 +December 31, 2023 +$ Change +% Change +Domestic +$ +12,522 +61.5 +% +$ +28,715 +69.7 +% +$ +(16,193 +) +(56.4 +%) +International +7,826 +38.5 +% +12,477 +30.3 +% +(4,651 +) +(37.3 +%) +$ +20,348 +100.0 +% +$ +41,192 +100.0 +% +$ +(20,844 +) +(50.6 +%) +The 56% decrease in domestic sales of our casino and gaming products during 2024 compared to 2023 was primarily due to a 50% decrease in sales unit volume. Sales during 2023 were unusually high due to our largest +competitor’s inability to supply product to customers as a result of supply chain issues. In addition, entering 2024, many of our customers had accumulated higher-than-normal levels of inventory of our product as a hedge during the worldwide +supply chain crisis during 2022 and 2023. As a result, during 2024, we experienced a significant slowdown in their order and shipment rates as they worked through this excess inventory. In addition, we believe our sales in the second half of +2024 were impacted by softness in overall demand in the industry. +27 +Index +International sales of our casino and gaming products decreased 37% during 2024 compared to 2023. Similar to our domestic customers, our international customers also began to slow their order rates in late 2023 +and continuing through 2024 due to higher-than-normal inventory levels and in response to softness in overall demand in the industry. +As of the end of 2024, we believe all our major casino and gaming customers have worked through the majority of their on-hand inventory and have begun to order again, with the exception of one large international +customer. In addition, we expect the demand softness we experienced in the worldwide casino and gaming market in late 2024 to begin to improve in 2025. As a result, we expect our casino and gaming sales to be higher in 2025 compared to 2024. +TSG: Revenue generated by TSG includes sales of consumable products (POS receipt paper and ribbons for non-FST legacy products), replacement parts and accessories, +maintenance and repair services and shipping and handling charges. Sales in our worldwide TSG market for the years ended December 31, 2024 and 2023 were as follows: +Year Ended +Year Ended +(In thousands, except percentages) +December 31, 2024 +December 31, 2023 +$ Change +% Change +Domestic +$ +2,883 +80.7 +% +$ +7,381 +89.9 +% +$ +(4,498 +) +(60.9 +%) +International +691 +19.3 +% +828 +10.1 +% +(137 +) +(16.5 +%) +$ +3,574 +100.0 +% +$ +8,209 +100.0 +% +$ +(4,635 +) +(56.5 +%) +The large decrease in domestic revenue from TSG during 2024 as compared to 2023 resulted primarily from a 75% decrease in sales of replacement parts and accessories. During 2023, we experienced unusually high +sales of approximately $4.1 million from the final purchases of spare parts for our legacy lottery printer that did not repeat in 2024. We do not expect any future sales of these spare parts. Also contributing to the decline was a 57% decrease +in consumable sales as we are no longer focused on these legacy products (POS paper and ribbons) and expect to cease selling these products by the end of 2025. +Internationally, TSG revenue decreased 17% during 2024 compared to 2023, due primarily to a decline in sales of replacement parts and accessories to international casino and gaming customers. +We expect TSG sales to be somewhat lower in 2025 compared to 2024 as we expect to cease selling our legacy consumable products by the end of 2025. +Gross Profit. Gross profit information for the years ended December 31, 2024 and 2023 is summarized below (in thousands, except +percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2024 +2023 +Change +Total Sales - 2024 +Total Sales - 2023 +$ +21,482 +$ +38,400 +(44.1 +%) +49.5 +% +52.9 +% +Gross profit is measured as revenue less cost of sales, which includes primarily the cost of all raw materials and component parts, direct labor, manufacturing overhead expenses, cost of finished products purchased +directly from our contract manufacturers, expenses associated with installations and support of our EPICENTRAL print system and our line of BOHA! products and royalty payments to third-parties, including to the third party licensor of our food +service technology software products. Gross profit decreased $16.9 million, or 44%. Gross margin also decreased 340 basis points to 49.5% in 2024 compared to 52.9% in 2023. Both gross profit and gross margin declined primarily due to a 40% +decline in overall sales including a 51% decline in sales of higher margin casino and gaming printers. Gross margin for 2024 was also impacted by competitive price adjustments. +We expect gross margin for 2025 to be in the mid 40% to high 40% range. +Operating Expenses - Engineering, Design and Product Development. Engineering, design and product development information for the years +ended December 31, 2024 and 2023 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2024 +2023 +Change +Total Sales - 2024 +Total Sales - 2023 +$ +6,977 +$ +9,442 +(26.1 +%) +16.1 +% +13.0 +% +Engineering, design and product development expenses primarily include salary and payroll-related expenses for our hardware and software engineering staff, depreciation and design expenses (including prototype +printer expenses, outside design, development and testing services, supplies and contracted software development expenses including those to the third party licensor of our food service technology software products). Engineering, design and +product development expenses decreased $2.5 million, or 26%, in 2024 compared to 2023 due to cost reduction initiatives taken during the latter part of 2023, and in the second quarter of 2024, including a reduction of contracted software +development expenses. We expect engineering, design and product development expenses to be higher in 2025 compared to 2024 due to typical inflationary and cost of living increases in such expenses. +28 +Index +Operating Expenses - Selling and Marketing . Selling and marketing information for the years ended +December 31, 2024 and 2023 is summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2024 +2023 +Change +Total Sales - 2024 +Total Sales - 2023 +$ +8,195 +$ +9,934 +(17.5 +%) +18.9 +% +13.7 +% +Selling and marketing expenses primarily include salaries and payroll-related expenses for our sales, marketing and customer success staff, sales commissions, travel expenses, expenses associated with the lease of +sales offices, advertising, trade show expenses, public relations, e-commerce and other promotional marketing expenses. Selling and marketing expenses decreased $1.7 million, or 18%, during 2024 compared to 2023 primarily due to cost reduction +initiatives, including reduced headcount, trade show and other marketing expenses. We expect selling and marketing expenses for 2025 to increase compared to 2024 due to typical inflationary and cost of living increases as well incremental costs +we expect to incur related to programs to further improve and refine our go-to-market strategy. +Operating Expenses - General and Administrative. General and administrative information for the years ended December 31, 2024 and 2023 is +summarized below (in thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2024 +2023 +Change +Total Sales - 2024 +Total Sales - 2023 +$ +9,936 +$ +13,318 +(25.4 +%) +22.9 +% +18.3 +% +General and administrative expenses primarily include salaries, incentive compensation, and other payroll-related expenses for our Chief Executive Officer, Chief Financial Officer, accounting, human resources, +corporate development and information technology staff, expenses for our corporate headquarters, professional and legal expenses, information technology expenses, and other expenses related to being a publicly traded company. General and +administrative expenses decreased $3.4 million, or 25%, during 2024 compared to 2023 due in large part to a $1.5 million severance charge incurred in 2023 related to the resignation of the Company’s former Chief Executive Officer in April 2023, +as well as expense reduction initiatives we commenced in the third quarter of 2023 and in the second quarter of 2024. We expect general and administrative expenses to increase in 2025 compared to 2024 due to typical inflationary and cost or +living increases combined with higher expected incentive and share-based compensation expense (both largely performance-based). +Operating (Loss) Income. Operating (loss) income information for the years ended December 31, 2024 and 2023 is summarized below (in +thousands, except percentages): +Year Ended December 31, +Percent +Percent of +Percent of +2024 +2023 +Change +Total Sales – 2024 +Total Sales – 2023 +$ +(3,626 +) +$ +5,706 +(163.5 +%) +(8.4 +%) +7.9 +% +Our operating income decreased $9.3 million, or 164%, during 2024 compared to 2023 as a $16.9 million or 44% decrease in gross profit on 40% lower sales, was partially offset by a $7.6 million or 23% decrease in +operating expenses (including the $1.5 million severance charge in 2023 discussed above in “General and Administrative”) in 2024 compared to 2023. +Interest, net. We recorded net interest income of $147 thousand in 2024 compared to net interest expense of +$255 thousand in 2023. During 2023 and 2024, we incurred interest expense related to minimum borrowings required pursuant to the Siena Credit Facility. Following the November 2024 amendment of the Siena Credit Facility, we were required +to maintain outstanding borrowings of at least $3 million in principal amount, an increase from $2.25 million prior to the amendment. See Note 9 – Borrowings to the accompanying consolidated financial statements. In addition, during 2024 we +earned more interest income than in 2023 due to higher levels of invested cash on hand. +Other, net . We recorded other expense of $89 thousand in 2024 compared to other income of $452 +thousand in 2023. The other expense for 2024 is related to higher foreign exchange losses recorded by our UK subsidiary during 2024. During the fourth quarter of 2023, we completed an asset sale of our Printrex product line (essentially +inventory on-hand) and recorded a non-operating gain of approximately $426 thousand. Prior to this sale, the last TransAct sales of Printrex products occurred in 2021. +Income Taxes . We recorded income tax +expense in 2024 of $6.3 million at an effective tax rate of (176.4%), compared to income tax expense in 2023 of $1.2 million at an effective tax rate of 19.6%. The effective tax rate for 2024 was unusually high due to an income tax charge of +$7.3 million related to the write down of our U.S. net deferred income tax asset as more fully described below (See Note 11 – Income taxes in the Consolidated Financial Statements). +Net (Loss) Income. As a result of the above, we reported a net loss for the year ended December 31, 2024 of $9.9 million, or ($0.99) per +diluted share, compared to net income of $4.7 million, or $0.47 per diluted share in 2023. +29 +Index +Liquidity and Capital Resources +We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Significant factors affecting the management of liquidity are cash flows from operating +activities, capital expenditures, access to bank lines of credit and our ability to attract long-term capital with satisfactory terms. +Internal cash generation together with currently available cash and cash equivalents, available borrowing facilities and an ability to access credit lines at market-competitive rates, if needed, are expected to be +sufficient to fund operations, capital expenditures, and any increase in working capital that would be required to accommodate our anticipated level of business activity for the 2025 fiscal year and beyond. +During the third quarter of 2023, we began a cost reduction initiative to reduce our overall level of operating expenses that included reducing employee headcount, trade show, advertising and other promotional +marketing expenses, certain third-party engineering resources and other expenses, and to a lesser extent, certain general and administrative expenses. We estimated annual cost savings from these initiatives to be approximately $3.0 million and we +realized the full savings from these actions in 2024.. We also began an additional cost reduction initiative in the second quarter of 2024 focused largely on further reducing employee headcount and other external third-party resources. Savings +from this initiative were realized beginning in the third quarter of 2024 and are expected to be approximately $2.0 million on an annualized basis. Notwithstanding the foregoing, there is no assurance that the cost-cutting efforts we have taken +to bring expenses in line with our revenue and mitigate the impact of global economic conditions such as supply chain disruptions and inflation are sufficient or adequate, and we may be required to take additional measures, as the ultimate extent +of the effects of these risks on the Company, our financial condition, results of operations, liquidity, and cash flows are uncertain and are dependent on evolving developments which cannot be predicted at this time. See Part I, Item 1A, Risk +Factors, of this Form 10-K for further discussion of risks related to global economic conditions, supply chain disruptions and inflation. +Cash Flow +During 2024, our cash balance increased $2.1 million, or 16% (versus an increase of $4.4 million in 2023) due primarily to operating activities, including a reduction in accounts +receivable of $3.3 million and a reduction of inventory of $1.6 million. Financing activities also provided a net increase in cash of $0.6 million due to the increase in bank borrowings required by Amendment No. 4 to the Siena Loan and +Credit Facility Agreement signed on November 20, 2024 (see further detail in “ Credit Facility and Borrowings ” section below). We had $14.4 million in cash and cash equivalents as of December 31, 2024, of which $168 thousand was held by our UK subsidiary. +Operating activities : The following significant factors primarily affected our cash provided by operating activities of $1.8 million in 2024 as compared to +cash provided by operating activities of $5.5 million in 2023. +For 2024: +• +We reported a net loss of $9.9 million. +• +We recorded depreciation and amortization of $1.0 million and share-based compensation expense of $1.2 million. +• +We recorded a decrease in our net deferred tax assets of $6.3 million due to an income tax charge of $7.3 million related to the write down of our U.S. net deferred income tax asset +• +Accounts receivable decreased $3.3 million primarily due to lower sales volume in 2024. +• +Inventories decreased $1.6 million primarily due to lower sales volume in 2024. We expect inventories to continue to decline in 2025 due to an inventory reduction program we put into place in the latter part +of 2024. +• +Accrued liabilities and other liabilities decreased $1.8 million due to lower employee bonus and payroll accruals in 2024 compared to 2023. +For 2023: +• +We reported net income of $4.7 million. +• +We recorded depreciation and amortization of $1.5 million and share-based compensation expense of $0.9 million. +• +We recorded a decrease in our deferred tax assets of $1.0 million due to our net income in 2023. +• +Accounts receivable decreased $4.2 million primarily due to decreased sales volume during the fourth quarter of 2023. +• +Inventories increased $5.7 million primarily due to strategic purchases, including initial stocking orders related to the launch of BOHA! Terminal 2 and Epic TR80 in the fourth quarter of 2023, and declining +sales during the four quarters in 2023. +• +Accounts payable used $3.0 million in cash due to increased inventory purchases and the timing of cash disbursements. +Investing activities : Our capital expenditures were $0.3 million and $0.9 million in 2024 and 2023, respectively. +Expenditures for both years were related to new product tooling and computer and networking equipment. +Financing activities: Financing activities provided $0.6 million of cash in 2024 due primarily to proceeds received from the increase in the required minimum borrowings on +our Siena Credit Facility while the use of cash of $0.1 million in 2023 related to withholding taxes paid on stock issuances. +30 +Index +Resource Sufficiency +Over the past two years, we have been impacted by global supply chain issues, increased shipping costs, increased interest rates and inflationary pressures. After experiencing lingering effects of the COVID-19 +pandemic through 2022, our operating results and operating cash flow improved significantly during 2023 due largely to certain competitors’ inability to supply products in both the POS automation and casino and gaming markets. In late 2023, we +began to see indications of a temporary slowdown in demand in the casino and gaming market, as customers that had built up excess inventory due to supply chain concerns advised us that they would temporarily reduce orders until their stock +normalized. This slowdown impacted our results in the fourth quarter of 2023 and during the year ended December 31, 2024. Given the continued uncertainty related to the impact of external factors on the food service and casino industries, we +continue to monitor our cash generation, usage and preservation including the management of working capital to generate cash. +We believe that our cash and cash equivalents on hand, our expected cash flows generated from operating activities, and borrowings available under our Siena Credit Facility will provide sufficient resources to meet +our working capital needs, finance our capital expenditures and meet our liquidity requirements through at least the next twelve months. Notwithstanding this belief, the ultimate impact of current global economic pressures and uncertainty +relating to tariffs, inflationary pressures and market instability is unknown. +Credit Facility and Borrowings +On March 13, 2020, we entered into the Loan and Security Agreement (the “Loan Agreement”) governing a credit facility (the “Siena Credit Facility”) with Siena Lending Group LLC (the “Lender”). The Siena Credit +Facility provides for a revolving credit line of up to $10.0 million and was originally scheduled to expire on March 13, 2023, prior to being extended, as discussed below. Borrowings under the Siena Credit Facility bear a floating rate of +interest equal to the greatest of (i) the prime rate plus 1.75%, (ii) the federal funds rate plus 2.25%, and (iii) 6.50%. We also pay a fee of 0.50% on unused borrowings under the Siena Credit Facility. Borrowings under the Siena Credit Facility +are secured by a lien on substantially all the assets of the Company. Borrowings under the Siena Credit Facility are subject to a borrowing base based on 85% of eligible accounts receivable plus the lesser of (a) $5.0 million and (b) 50% of +eligible raw material and 60% of finished goods inventory. +The Siena Credit Facility imposes a financial covenant on the Company and restricts, among other things, our ability to incur additional indebtedness and create other liens. On July 21, 2021, the Company entered +into an amendment (“Siena Credit Facility Amendment No. 1”) to the Loan Agreement. Siena Credit Facility Amendment No. 1 changed the financial covenant under the Siena Credit Facility from a minimum EBITDA covenant to an excess availability +covenant requiring that the Company maintain excess availability of at least $750 thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning with the calendar month ended July 31, 2021. From July 31, 2021 +through December 31, 2024, we remained in compliance with our excess availability covenant. +On July 19, 2022, the Company and the Lender entered into Amendment No. 2 (“Siena Credit Facility Amendment No. 2”) to the Loan Agreement as amended by Siena Credit Facility Amendment No. 1. Also on July 19, 2022, +the Company and the Lender entered into an Amended and Restated Fee Letter (the “Amended Fee Letter”) in connection with Siena Credit Facility Amendment No. 2. Siena Credit Facility Amendment No. 2 did not modify the aggregate amount of the +revolving commitment or the interest rate applicable to the loans. Among other changes, Siena Credit Facility Amendment No. 2 extended the maturity date from March 13, 2023 to March 13, 2025. In addition, the Amended Fee Letter required the +Company to maintain outstanding borrowings of at least $2.25 million in principal amount or, during any period during which the Lender had control of the Company’s deposit account in accordance with the Loan Agreement, as amended by Siena Credit +Facility Amendment No. 2, to pay interest on at least $2,250,000 in principal amount of outstanding borrowings, whether or not such amount of loans was actually outstanding. +On May 1, 2023, the Company and the Lender agreed to a letter amendment (Amendment No. 3) to the Loan Agreement. Prior to such amendment, Section 7.1(m) of the Loan Agreement required that any successor to the +Company’s former Chief Executive Officer be reasonably acceptable to the Lender. This amendment confirmed that Mr. John Dillon, the Company’s current Chief Executive Officer, is an acceptable successor, and applied the same requirement to any +future successor to Mr. Dillon as Chief Executive Officer. +On November 30, 2024, the Company and the Lender entered into Amendment No. 4 (“Siena Credit Facility Amendment No. 4”) to the Loan Agreement. The changes to the Loan Agreement provided for in Siena Credit +Facility Amendment No. 4 include, among other things, the extension of the maturity date from March 13, 2025 to March 31, 2027. Also on November 20, 2024, the Company and the Lender entered into a Second Amended and Restated Fee Letter (the +“Second Amended Fee Letter”) in connection with Siena Credit Facility Amendment No. 4. The Second Amended Fee Letter increases the minimum borrowing amount from $2.25 million to $3.0 million, such that the Company is required to either maintain +outstanding borrowings of at least $3,000,000 in principal amount, or during any period during which the Lender has control of the Company’s deposit account in accordance with the Loan Agreement, as amended through Siena Credit Facility Amendment +No. 4, to pay interest on at least $3,000,000 principal amount of loans, whether or not such amount of loans is actually outstanding. The Second Amended Fee Letter also extends the dates before which a prepayment and termination of the Loan +Agreement requires the Company to pay to the Lender an early payment/termination premium, providing for (i) a two percent premium for prepayment on or prior to March 31, 2025, (ii) a one percent premium for prepayment from April 1, 2025 through +March 31, 2026, and no premium for prepayment thereafter. +As of December 31, 2024, we had $3.0 million of outstanding borrowings under the Siena Credit Facility and $3.2 million of net borrowing capacity available under the Siena Credit Facility. +As stated above, we continue to monitor our cash generation, usage and preservation including the management of working capital to generate cash and continue to evaluate alternative sources of funding as necessary. +31 +Index +Stock Repurchase Program +During 2024 and 2023, we did not repurchase any shares of our common stock. +Shareholders’ Equity +Shareholders’ equity decreased $8.8 million, or 22%, to $30.6 million at December 31, 2024 from $39.4 million at December 31, 2023. The decrease was primarily due to a net loss of $9.9 million in 2024, including a +$7.3 million write down of the deferred income tax asset, partially offset by share-based compensation expense related to stock awards of $1.2 million (net of withholding taxes paid by relinquishment of shares) in 2024. +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk. +TransAct is a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, and is not required to provide information under this item. +Item 8. +Financial Statements and Supplementary Data. +The financial statements of the Company are annexed to this Form 10-K as pages F-4 through F-22. The “Report of Independent Registered Public Accounting Firm” is annexed to this Form 10-K as of page F-2. An index +to such materials appears on page F-1. +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. +None. +Item 9A. +Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15 +under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of +December 31, 2024. Based on this evaluation of our disclosure controls and procedures as of December 31, 2024, our CEO and CFO concluded that, as of December 31, 2024, our disclosure controls and procedures were +effective at the reasonable assurance level. +Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly present, in all material respects, our financial condition, results of +operations and cash flows for the periods presented in conformity with GAAP, and that they can be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act, to provide reasonable assurance regarding the +reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance +of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial +statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or +timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2024. Our management based its assessment on criteria established in Internal Control–Integrated Framework issued by the +Committee of Sponsoring Organizations of the Treadway Commission. In the opinion of management, TransAct maintained effective internal control over financial reporting as of December 31, 2024. +Changes in Internal Control over Financial Reporting +No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended December 31, 2024 that has materially affected, +or is reasonably likely to materially affect, our internal control over financial reporting. +Item 9B. +Other Information. +(a) +None +(b) +During the fourth quarter of 2024, no director or officer of the Company adopted or terminated a “Rule 10b5-1trading arrangement” or “non-Rule 10b5-1trading arrangement,” as each term is defined in Item 408(a) of +Regulation S-K. +Item 9C. +Disclosure Regarding Foreign Jurisdictions that Prevent Inspection. +Not applicable. +32 +Index +PART III +Item 10. +Directors, Executive Officers and Corporate Governance. +Set forth in Part I, Item 1. Business of this Form 10-K, under the heading “Information about our Executive Officers,” is certain information regarding our executive officers, and information regarding our code of +ethics is set forth below. The remaining information in response to this item is incorporated herein by reference to the disclosure, if any; that will be contained, as applicable, under the headings “Proposal 1: Election of Directors,” +“Delinquent Section 16(a) Reports,” “Corporate Governance – Director Nomination Process,” “Corporate Governance – Committees of the Board” and “Executive Compensation – Insider Trading Policy” in our Proxy Statement for our 2025 Annual Meeting of +Stockholders (the “Proxy Statement”), which will be filed within 120 days after the end of the year covered by this Form 10-K. +Code of Ethics +We maintain a Standards of Business Conduct and Code of Ethics (“Standards of Business Conduct”) that includes our code of ethics that is applicable to all employees, including our Chief Executive Officer, Chief +Financial Officer, Chief Accounting Officer and Controller. Our Standards of Business Conduct, which require continued observance of high ethical standards, such as honesty, integrity and compliance with the law in the conduct of our business, +are available for public access on our website at https://transacttech.gcs-web.com/governance/documents-charters. Any person may request a copy of our Standards of Business Conduct free of charge by calling (203) 859-6800. We will disclose on +our website at https://transacttech.gcs-web.com/governance/documents-charters any amendment to or waiver of a provision of the Standards of Business Conduct as may be required and within the time period specified under the applicable SEC and +Nasdaq rules. +Item 11. +Executive Compensation. +The information in response to this item will be contained in the Proxy Statement under the headings “Executive Compensation,” “Summary Compensation Table,” “Outstanding Equity Awards at 2024 Fiscal Year-End,” +“Potential Payments Upon Termination or Change in Control,” “Pay Versus Performance,” and “Director Compensation for Fiscal Year 2024” and is incorporated herein by reference. +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. +Set forth below is certain information regarding our equity compensation plans. The remaining information in response to this item will be contained in the Proxy Statement under the heading, “Security Ownership of +Certain Beneficial Owners and Management,” and is incorporated herein by reference. +Equity Compensation Plan Information +Information regarding our equity compensation plans as of December 31, 2024 is as follows: +Plan category +(a) +Number of +securities to be +issued upon exercise +of outstanding +options, warrants +and rights +(b) +Weighted- +average +exercise price +of outstanding +options, warrants +and rights +(c) +Number of securities +remaining available for +future issuance under +equity compensation plans +(excluding securities +reflected in column (a) +Equity compensation plans approved by security holders: +2005 Equity Incentive Plan +– +$ +– +– +2014 Equity Incentive Plan +1,753,678 +8.41 +655,672 +Total +1,753,678 +$ +8.41 +655,672 +In May 2014, our stockholders approved the adoption of the 2014 Equity Incentive Plan. In May 2020, our stockholders approved an amendment and restatement of the 2014 Equity Incentive Plan to +increase the number of shares of common stock which may be subject to awards granted under the plan from 1,400,000 to 2,200,000 shares. In June 2023, our stockholders approved an amendment and restatement of the 2014 Equity Incentive Plan to +increase the number of shares of common stock which may be subject to awards granted under the plan from 2,200,000 to its current level of 2,900,000 and to change the date of adoption of the 2014 Equity Incentive Plan to April 17, 2023 (thereby +extending its expiration date to April 17, 2033). The Company also maintains the 2005 Equity Incentive Plan; however no new awards are be available for future issuance under this plan. Both plans generally provide for awards in the form of: (i) +incentive stock options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. The Company +does not have any equity plans that have not been approved by its stockholders. +Item 13. +Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related Transactions” and “Corporate Governance-Board Leadership Structure and +Independence” and is incorporated herein by reference. +Item 14. +Principal Accountant Fees and Services. +The information in response to this item will be contained in the Proxy Statement under the headings, “Policy Regarding Pre-Approval of Services Provided by the Independent Registered Public Accounting Firm” and +“Independent Registered Public Accounting Firm’s Services and Fees” and is incorporated herein by reference. +33 +Index +PART IV +Item 15. +Exhibits and Financial Statement Schedules. +(a) +The following documents are filed as part of this Form 10-K: +1. +Financial Statements. +Report of Independent Registered Public Accounting Firm +Consolidated Balance Sheets as of December 31, 2024 and 2023 +Consolidated Statements of Operations for the years ended December 31, 2024 and 2023 +Consolidated Statements of Comprehensive (Loss) Income for the years ended December 31, 2024 and 2023 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2024 and 2023 +Consolidated Statements of Cash Flows for the years ended December 31, 2024 and 2023 +Notes to Consolidated Financial Statements +2. +Schedules. +All schedules are omitted because they are either inapplicable or not required, or because the information required therein is included in the Consolidated Financial Statements and Notes thereto. +3. +Exhibits +Exhibit Index +3.1(a) +Certificate of Incorporation of TransAct Technologies Incorporated (conformed copy) (incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. +000-21121) filed with the SEC on August 18, 2022). +3.1(b) +Certificate of Designation, Series A Preferred Stock, filed with the Secretary of State of Delaware on December 2, 1997 (incorporated by reference to Exhibit C of the Form of +Amended and Restated Rights Agreement, dated as of February 16, 1999, between TransAct Technologies Incorporated and American Stock Transfer & Trust Company filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K +(SEC File No. 000-21121) filed with the SEC on February 18, 1999. +3.1(c) +Certificate of Designation, Series B Preferred Stock, filed with the Secretary of State of Delaware on April 6, 2000 (incorporated by reference to Exhibit 3.1(c) of the Company’s Quarterly +Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 8, 2000). +3.2 +Amended and Restated By-Laws of TransAct Technologies Incorporated (incorporated by reference to Exhibit 3.2 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with +the SEC on March 28, 2023). +4.1 +Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-1/A (No. 333-06895) filed with the SEC on August 1, 1996). +4.2 +Description of Securities (incorporated by reference to Exhibit 4.2 of the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 13, 2024). +10.1(x) +2005 Equity Incentive Plan (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on June 1, 2005). +10.2(x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the +SEC on May 19, 2014). +10.3(x) +Amendment to 2014 Equity Incentive Plan approved by Shareholders on May 22, 2017 (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q (SEC File No. +000-21121) filed with the SEC on August 9, 2017). +10.4 (x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan, as Amended and Restated in 2020 (incorporated by reference to Exhibit I to the Definitive Proxy Statement on Schedule 14A filed +with the Commission on April 23, 2020, File No. 000-21121). +10.5 (x) +TransAct Technologies Incorporated 2014 Equity Incentive Plan, as Amended and Restated in 2023 (incorporated by reference to Exhibit I to the Definitive Proxy Statement on Schedule 14A filed +with the Commission on April 21, 2023, File No. 000-21121). +10.6 (x) +2014 Equity Incentive Plan Time-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed +with the SEC on May 6, 2016). +10.7(x) +2014 Equity Incentive Plan Performance-based Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q (SEC File No. +000-211121) filed with the SEC on August 8, 2016). +10.8(x) +2014 Equity Incentive Plan Non-statutory Stock Option Agreement (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the +SEC on May 19, 2014). +10.1 0 (x) +Severance Agreement by and between TransAct Technologies Incorporated and Brent Richtsmeier, dated as of January 1, 2021 (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly +Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 15, 2023). +10.11(x)* +Severance Agreement by and between TransAct and Tracey S. Winslow, dated as of December 22, 2023. +10.12(x)* +Severance Agreement by and between TransAct and William J. DeFrances, dated as of August 3, 2022. +34 +Index +10.13(x) +Executive Employment Agreement by and between TransAct Technologies Incorporated and John M. Dillon, dated as of September 4, 2024 (incorporated by reference to Exhibit 10.1 to the Company’s +Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on September 6, 2024). +10.14(x) +Executive Employment Agreement by and between TransAct Technologies Incorporated and Steven A. DeMartino, dated as of September 4, 2024 (incorporated by reference to Exhibit 10.2 to the +Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on September 6, 2024). +10.15 +Lease Agreement between Bomax Properties, LLC and TransAct, dated July 18, 2001 (incorporated by reference to Exhibit 10.16 to the Company’s Annual Report on Form 10-K (SEC File No. +000-21121) filed with the SEC on March 13, 2024). +10.16 +Amendment No. 1 to Lease Agreement between Bomax Properties, LLC and TransAct, dated May 8, 2012 (incorporated by reference to Exhibit 10.16 of the Company’s Quarterly Report on Form 10-Q +(SEC File No. 000-21121) filed with the SEC on May 10, 2012). +10.17 +Amendment No. 2 to Lease Agreement between Bomax Properties, LLC and TransAct, dated January 14, 2016 (incorporated by reference to Exhibit 10.13 of the Company’s Annual Report on Form 10-K +(SEC File No. 000-21121) filed with the SEC on March 11, 2016). +10.18 +Amendment No. 3 to Lease Agreement between Bomax Properties, LLC and TransAct, dated February 29, 2020 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K +(SEC File No. 000-21121) filed with the SEC on March 4, 2020). +10.19* +Amendment No. 4 to Lease Agreement between Bomax Properties, LLC and TransAct, dated July 15, 2022. +10.2 0 +Amendment No. 5 to Lease Agreement between Bomax Properties, LLC and TransAct, dated May 31, 2024 (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q +(SEC File No. 000-21121) filed with the SEC on August 9, 2024). +10.2 1 +Lease Agreement by and between Las Vegas Airport Properties LLC and TransAct dated December 2, 2004 (incorporated by reference to Exhibit 10.13 of the Company’s Annual Report on Form 10-K +(SEC File No. 000-21121) filed with the SEC on March 16, 2005). +10.22 +First Amendment to Lease Agreement by and between CIP Hughes Center LLC and TransAct dated August 24, 2009 (incorporated by reference to Exhibit 10.19 of the Company’s Annual Report on Form +10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2010). +10.23 +Second Amendment to Lease Agreement by and between The Realty Associates Fund IX LP and TransAct dated June 30, 2015 (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly +Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on August 7, 2015). +10.24 +Lease Agreement by and between 2319 Hamden Center I, L.L.C. and TransAct dated November 27, 2006 (incorporated by reference to Exhibit 10.14 of the Company’s Annual Report on Form 10-K (SEC +File No. 000-21121) filed with the SEC on March 15, 2007). +10.25 +First Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct dated January 3, 2017 (incorporated by reference to Exhibit 10.20 of the Company’s Annual Report on Form +10-K (SEC File No. 000-21121) filed with the SEC on March 16, 2017). +10.26 +Second Amendment to Lease by and between 2319 Hamden Center I, L.L.C. and TransAct Technologies dated April 30, 2021 (incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q +(SEC File No. 000-21121) filed with the SEC on May 13, 2021). +10.27 +Loan and Security Agreement, dated as of March 13, 2020, among Siena Lending Group LLC, TransAct Technologies Incorporated and the other Loan Parties from time to time party thereto +(incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q (SEC File No. 000-21121) filed with the SEC on May 22, 2020). +10.28 +Amendment No. 1 To Loan and Security Agreement, dated as of July 21, 2021, among Siena Lending Group and TransAct Technologies Incorporated (incorporated by reference to Exhibit 99.1 to the Company's +Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 26, 2021) +10.29 +Amendment No. 2 To Loan and Security Agreement, dated as of July 19, 2022, between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated by reference to Exhibit 10.1 to the Company’s +Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 25, 2022). +10.3 0 +Amended and Restated Fee Letter, dated as of July 19, 2022, between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated by reference to Exhibit 10.2 to the Company’s +Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on July 25, 2022). +10.3 1 +Letter Amendment, dated May 1, 2023, to Loan and Security Agreement between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated by reference to Exhibit 10.1 to the +Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on May 4, 2023). +35 +Index +10.32 +Amendment No. 4 To Loan and Security Agreement, dated as of November 20, 2024, between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated by reference to Exhibit +10.1 to the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on November 21,2024). +10.33 +Second Amended and Restated Fee Letter, dated as of November 20, 2024, between Siena Lending Group LLC and TransAct Technologies Incorporated (incorporated by reference to Exhibit 10.2 to +the Company’s Current Report on Form 8-K (SEC File No. 000-21121) filed with the SEC on November 21, 2024). +10.34† +Master License Agreement dated February 22, 2019 and amendments thereto (incorporated by reference to Exhibit 10.24 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed +with the SEC on March 12, 2021). +10.35† +Master Development and License Agreement dated July 20, 2018 (incorporated by reference to Exhibit 10.25 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021). +19* +TransAct Technologies Incorporated Insider Trading Policy. +21 +Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed with the SEC on March 12, 2021). +23.1* +Consent of Marcum LLP. +31.1* +Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +31.2* +Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. +32‡ +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +97 +TransAct Technologies Incorporated Clawback Policy in the Event of a Financial Restatement (incorporated by reference to Exhibit 97 to the Company’s Annual Report on Form 10-K (SEC File No. 000-21121) filed +with the SEC on March 13, 2024). +101.INS +Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document). +101.SCH +Inline XBRL Taxonomy Extension Schema Document. +101.CAL +Inline XBRL Taxonomy Extension Calculation Linkbase Document. +101.DEF +Inline XBRL Taxonomy Extension Definition Linkbase Document. +101.LAB +Inline XBRL Taxonomy Extension Label Linkbase Document. +101.PRE +Inline XBRL Taxonomy Extension Presentation Linkbase Document. +104 +Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). +(x) +Management contract or compensatory plan or arrangement. +* +These exhibits are filed herewith. +† +Certain portions of this exhibit (indicated by “[***]”) have been omitted pursuant to Item (601)(b)(10) of Regulation S-K. +‡ +These exhibits are furnished herewith. +(b) +Exhibits. +The Exhibits required by Item 601 of Regulation S-K under the Exchange Act are included in the Exhibit Index above under a(3) of this Item 15. +(c) +Financial Statement Schedules. +See the Notes to the Consolidated Financial Statements included in this Form 10-K. +Item 16. +Form 10-K Summary. +None. +36 +Index +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly +authorized. +TRANSACT TECHNOLOGIES INCORPORATED +By: +/s/ John M. Dillon +Name: +John M. Dillon +Title: +Chief Executive Officer +Date: March 24, 2024 +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ John M. Dillon +Chief Executive Officer and Director +March 24, 2024 +John M. Dillon +(Principal Executive Officer) +/s/ Steven A. DeMartino +President, Chief Financial Officer, Treasurer and Secretary +March 24, 2024 +Steven A. DeMartino +(Principal Financial Officer) +/s/ William J. DeFrances +Vice President and Chief Accounting Officer +March 24, 2024 +William J. DeFrances +(Principal Accounting Officer) +/s/ Haydee Ortiz Olinger +Chair of the Board +March 24, 2024 +Haydee Ortiz Olinger +/s/ Audrey P. Dunning +Director +March 24, 2024 +Audrey P. Dunning +/s/ Daniel M. Friedberg +Director +March 24, 2024 +Daniel M. Friedberg +/s/ Randall S. Friedman +Director +March 24, 2024 +Randall S. Friedman +/s/ Emanuel P. N. Hilario +Director +March 24, 2024 +Emanuel P. N. Hilario +37 +Index +TRANSACT TECHNOLOGIES INCORPORATED +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Consolidated Financial Statements +Report of Independent Registered Public Accounting Firm (PCAOB ID 688 ) +F-2 +Consolidated Balance Sheets as of December 31, 2024 and 2023 +F-5 +Consolidated Statements of Operations for the years ended December 31, 2024 and 2023 +F-6 +Consolidated Statements of Comprehensive (Loss) Income for the years ended December 31, 2024 and 2023 +F-7 +Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2024 and 2023 +F-8 +Consolidated Statements of Cash Flows for the years ended December 31, 2024 and 2023 +F-9 +Notes to Consolidated Financial Statements +F-10 +F-1 +Index +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Shareholders and Board of Directors of +TransAct Technologies Incorporated +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of TransAct +Technologies Incorporated (the “Company”) as of December 31, 2024 and 2023, the related consolidated statements of operations, comprehensive (loss) income , +changes in shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2024, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present +fairly, in all material respects, the financial position of the Company as of December 31, 2024 and 2023, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2024, in conformity with +accounting principles generally accepted in the United States of America. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial +statements based on our audit s . We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) +("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit s in accordance with the +standards of the PCAOB . Those standards require that we plan and perform the audit s to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an +audit of its internal control over financial reporting. As part of our audit s we are required to obtain an understanding of internal control over +financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. +Our audit s included performing procedures to assess +the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in +the financial statements. Our audit s also included evaluating the accounting principles used and significant estimates made by management, as well as +evaluating the overall presentation of the financial statements. We believe that our audit s provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or +required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of +critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the +accounts or disclosures to which they relate. +Valuation of Inventories - Excess and Obsolete Inventory Reserve +As described in Note 2 to the consolidated financial statements, inventories are stated at the lower of average cost or net realizable value. The Company +reviews net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completions, disposal and transportation, historical usage and estimates of future demand. Based on these reviews, inventory +write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities, and net realizable value. +F-2 +Index +A majority of the Company’s excess and obsolete inventory reserve relates to excess quantities of products, based on the Company’s inventory levels and +future product purchase commitments compared to assumptions relating to future demand and market conditions. As of December 31, 2024, the Company’s consolidated inventories balance was $16.161 million. +The principal considerations for our determination that the Company’s valuation of inventories, specifically the excess and obsolete inventory reserve, was a +critical audit matter included the following: (1) management identifies inventories as a critical accounting estimate, and (2) there were significant judgments made by management in estimating the excess and obsolete inventory reserve, including +developing assumptions related to future product demand based on historical usage and current market conditions. This in turn led to a high degree of auditor judgment in performing our audit procedures, which were designed to evaluate the +reasonableness of audit evidence related to management’s assumptions of future product demand. +Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated +financial statements. These procedures included, among others, +• +Obtained an understanding of the Company’s accounting policy related to inventory, specifically as it relates to the excess and obsolete inventory reserve and ensure it +is relevant to the accounting standards and consistent applied to prior periods; +• +Recalculated the inventory reserve based on the Company's policy and our knowledge obtained above. Ensure mathematical accuracy and test the computations for a sample of +inventory items; +• +Evaluated management’s methodology and process for developing the excess and obsolete inventory reserve, including estimating assumptions related to future product +demand based on historical usage and current market conditions; +• +Tested management’s calculation of the excess and obsolete inventory reserve, which included evaluating the completeness and accuracy of underlying data used by +management in the calculation, principally inputs such as actual usage and management’s determination of future estimated consumption of inventory and comparing them to historical amounts; +• +Performed observation of inventory at various Company locations to ensure the quantities are in working order and identify damaged or poor conditioned +inventory. +Evaluation of the Realizability of Deferred Tax Assets +As described in Note 2 to the consolidated financial statements, the income tax amounts are accounted for under the liability method in accordance with ASC +740, “Income Taxes” (“ASC 740”). Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their +respective tax bases and operating loss and tax carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. +As described in Note 11 to the consolidated financial statements, at December 31, 2024, the Company had deferred tax assets of $8.3 million. These deferred +tax assets consist primarily deductible temporary differences related to $3.7 million of capitalized R&D expenses, $0.9 million of R&D credit carryforward, $0.85 million of stock compensation expense, $1 million for inventory reserves and $1.2 +million in net operating losses. The Company recognizes deferred tax assets to the extent it is more likely than not that the assets will be realized. The Company considered positive and negative evidence, including future reversals of existing taxable +temporary differences, projected future taxable income, tax planning strategies, and recent results of operations. To the extent that the Company believes realization is not likely, the Company has established a valuation allowance. +F-3 +Index +We identified the evaluation of the realizability of deferred tax assets as a critical audit matter. The evaluation of the realizability of deferred tax +assets required subjective auditor judgment to assess the projections of future taxable income, specifically projected revenue growth rates, over the periods in which those temporary differences become deductible. +The following are the primary procedures we performed to address this critical audit matter. +• +Reviewed the Company’s overall tax position by reviewing its income tax returns and related provision and deferred tax analysis. This allowed us to understand the +nature and timing that has led to the recognition of these deferred tax assets; +• +Evaluated the Company’s process to assess the “more likely than not” scenario and review the Company’s position paper on its deferred tax position including our +evaluation of their negative factors and positive factors related to the assessment; +• +Reviewed and recalculated the company’s analysis of the deferred tax calculation to ensure accuracy in the schedule and ensure that the Company has reflected the +current tax laws and regulations; +• +Evaluated the timing and impact of the reversal of the deferred tax liabilities and how they impact or utilized the deferred tax assets. We considered the +Company’s historical profitability trends and cumulative profits over a reasonable period of time; +• +Evaluated the Company’s projected revenue and net income (loss) growth rates used to project future taxable income by comparing them to +(1) historical and projected growth rates of peer entities and (2) historical growth rates of the Company. +• +Performed a sensitivity analysis to assess the impact of reasonably possible changes in the projected future taxable income, including +changes to projected revenue growth rates, on the Company’s determination of the realizability of deferred tax assets. +/s/ Marcum LLP +Marcum LLP +We have served as the Company’s auditor since 2020. +Hartford, Connecticut +March 24, 2025 +F-4 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED BALANCE SHEETS +(in thousands, except share data) +December 31, +2024 +December 31, +2023 +Assets: +Current assets: +Cash and cash equivalents +$ +14,394 +$ +12,321 +Accounts receivable, net of allowance for expected credit losses of $ 474 and $ 768 +6,507 +9,824 +Inventories +16,161 +17,759 +Prepaid income taxes +401 +322 +Other current assets +899 +773 +Total current assets +38,362 +40,999 +Fixed assets, net of accumulated depreciation of $ 19,468 +and $ 18,646 +1,818 +2,421 +Right-of-use assets, net +1,141 +1,602 +Goodwill +2,621 +2,621 +Deferred tax assets +– +6,304 +Intangible assets, net of accumulated amortization of $ 1,606 and $ 1,518 +– +88 +Other assets +92 +163 +5,672 +13,199 +Total assets +$ +44,034 +$ +54,198 +Liabilities and Shareholders’ Equity: +Current liabilities: +Revolving loan payable +$ +3,000 +$ +2,250 +Accounts payable +4,569 +4,431 +Accrued liabilities +3,253 +4,947 +Lease liabilities +955 +929 +Deferred revenue +1,107 +1,079 +Total current liabilities +12,884 +13,636 +Deferred revenue, net of current portion +246 +209 +Lease liabilities, net of current portion +231 +720 +Other liabilities +40 +219 +517 +1,148 +Total liabilities +13,401 +14,784 +Commitments and contingencies (see Notes 9 and 15) +Shareholders’ equity: +Preferred stock, $ 0.01 value, 4,800,000 authorized, none issued and outstanding +– +– +Preferred stock, Series A, $ 0.01 par value, 200,000 authorized, none issued and outstanding +– +– +Common stock, $ 0.01 par value, 20,000,000 authorized at December 31, 2024 and 2023 ; 14,068,049 and 14,003,653 shares +issued; 10,023,207 and 9,958,811 +shares outstanding, at December 31, 2024 and 2023 , respectively +141 +140 +Additional paid-in capital +58,141 +57,055 +Retained earnings +4,515 +14,378 +Accumulated other comprehensive loss, net of tax +( 54 +) +( 49 +) +Treasury stock, 4,044,842 shares, at cost +( 32,110 +) +( 32,110 +) +Total shareholders’ equity +30,633 +39,414 +Total liabilities and shareholders’ equity +$ +44,034 +$ +54,198 +See accompanying notes to Consolidated Financial Statements. +F-5 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Years Ended December 31, +2024 +2023 +Net sales +$ +43,384 +$ +72,631 +Cost of sales +21,902 +34,231 +Gross profit +21,482 +38,400 +Operating expenses: +Engineering, design and product development +6,977 +9,442 +Selling and marketing +8,195 +9,934 +General and administrative +9,936 +13,318 +25,108 +32,694 +Operating (loss) income +( 3,626 +) +5,706 +Interest and other income (expense): +Interest expense +( 322 +) +( 310 +) +Interest income +469 +55 +Other, net +( 89 +) +452 +58 +197 +(Loss) income before income taxes +( 3,568 +) +5,903 +Income tax expense +( 6,295 +) +( 1,155 +) +Net (loss) income +$ +( 9,863 +) +$ +4,748 +Net (loss) income per common share: +Basic +$ +( 0.99 +) +$ +0.48 +Diluted +$ +( 0.99 +) +$ +0.47 +Shares used in per-share calculation: +Basic +9,997 +9,951 +Diluted +9,997 +10,021 +See accompanying notes to Consolidated Financial Statements. +F-6 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME +(in thousands) +Years Ended December 31, +2024 +2023 +Net (loss) income +$ +( 9,863 +) +$ +4,748 +Foreign currency translation adjustment, net of tax +( 5 +) +30 +Comprehensive (loss) income +$ +( 9,868 +) +$ +4,778 +See accompanying notes to Consolidated Financial Statements. +F-7 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY +(in thousands, except share data) +Common Stock +Additional +Paid-in +Retained +Treasury +Accumulated +Other +Comprehensive +Total +Shares +Amount +Capital +Earnings +Stock +Income (Loss) +Equity +Balance, December 31, 2022 +9,911,883 +$ +139 +$ +56,282 +$ +9,630 +$ +( 32,110 +) +$ +( 79 +) +$ +33,862 +Issuance of common stock from exercise of stock options +1,875 +– +– +– +– +– +– +Issuance of common stock on restricted stock units +58,705 +1 +– +– +– +– +1 +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 13,652 +) +– +( 87 +) +– +– +– +( 87 +) +Share-based compensation expense +– +– +860 +– +– +– +860 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +30 +30 +Net income +– +– +– +4,748 +– +– +4,748 +Balance, December 31, 2023 +9,958,811 +140 +57,055 +14,378 +( 32,110 +) +( 49 +) +39,414 +Issuance of common stock on restricted stock units +74,995 +1 +– +– +– +– +1 +Relinquishment of stock awards and deferred stock units to pay withholding taxes +( 10,599 +) +– +( 71 +) +– +– +– +( 71 +) +Share-based compensation expense +– +– +1,157 +– +– +– +1,157 +Foreign currency translation adjustment, net of tax +– +– +– +– +– +( 5 +) +( 5 +) +Net loss +– +– +– +( 9,863 +) +– +– +( 9,863 +) +Balance, December 31, 2024 +10,023,207 +$ +141 +$ +58,141 +$ +4,515 +$ +( 32,110 +) +$ +( 54 +) +$ +30,633 +See accompanying notes to Consolidated Financial Statements. +F-8 +Index +TRANSACT TECHNOLOGIES INCORPORATED +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Years Ended December 31, +2024 +2023 +Cash flows from operating activities: +Net (loss) income +$ +( 9,863 +) +$ +4,748 +Adjustments to reconcile net (loss) income to net cash provided by operating activities: +Share-based compensation expense +1,157 +860 +Depreciation and amortization +1,037 +1,489 +Deferred income taxes +6,304 +1,020 +Foreign currency transaction losses (gains) +89 +( 30 +) +Changes in operating assets and liabilities: +Accounts receivable +3,315 +4,248 +Employee retention credit receivable +– +1,500 +Inventories +1,607 +( 5,658 +) +Prepaid income taxes +( 80 +) +( 322 +) +Other current and long-term assets +( 43 +) +( 10 +) +Accounts payable +149 +( 2,988 +) +Accrued liabilities and other liabilities +( 1,811 +) +650 +Net cash provided by operating activities +1,861 +5,507 +Cash flows from investing activities: +Capital expenditures +( 322 +) +( 901 +) +Net cash used in investing activities +( 322 +) +( 901 +) +Cash flows from financing activities: +Proceeds from bank borrowings +750 +– +Withholding taxes paid on stock issuance +( 71 +) +( 87 +) +Payment of bank financing costs +( 45 +) +– +Net cash provided by (used in) financing activities +634 +( 87 +) +Effect of exchange rate changes on cash and cash equivalents +( 100 +) +( 144 +) +Increase in cash and cash equivalents +2,073 +4,375 +Cash and cash equivalents, beginning of period +12,321 +7,946 +Cash and cash equivalents, end of period +$ +14,394 +$ +12,321 +Supplemental cash flow information: +Interest paid +$ +272 +$ +268 +Income taxes paid +499 +160 +Non-cash capital expenditures +9 +23 +See accompanying notes to Consolidated Financial Statements. +F-9 +Index +TRANSACT TECHNOLOGIES INCORPORATED +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. Description of business +TransAct Technologies Incorporated (together with its subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”), which has its headquarters in +Hamden, Connecticut and its primary operating facility in Ithaca, New York, operates in one operating segment: software-driven technology +and printing solutions for high growth markets including food service technology, casino and gaming and “point of sale” (“POS”) automation markets. Our solutions are designed from the ground up based on market and customer requirements and are sold +under the BOHA! TM , AccuDate™, Epic, Ithaca®, and EPICENTRAL ® product brands. We sell our products to original equipment manufacturers, value-added resellers, select distributors, and directly to end-users. Our product +distribution spans across the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. TransAct also provides world-class service, spare parts, accessories and printing supplies to its +growing worldwide installed base of products. We also generate revenue from the after-market side of the business, providing printer and terminal service, consumables and spare parts in addition to revenue from our two software solutions; (i) our line of BOHA! software applications used to automate the back-of-house operations of restaurants, convenience stores and +food service operators and (ii) the EPICENTRAL Print System (“EPICENTRAL”), that enables casino operators to create promotional coupons and marketing messages and print them in real time at the slot machine. +After strong demand during most of 2023 due in part to our primary competitor’s struggle to deliver products in the face +of supply chain constraints, in late 2023, we began to see indications of a temporary slowdown in demand in the casino and gaming market, as customers that had built up excess inventory due to supply chain concerns advised us that they would +temporarily reduce orders until their stock normalized. This slowdown impacted our results in the fourth quarter of 2023 and during the year ended December 31, 2024. After reviewing whether conditions and/or events raise substantial doubt about our +ability to meet future financial obligations over the 12 months following the date on which the Consolidated Financial Statements included in this Annual Report on Form 10-K (this “Form 10-K”) were issued, including consideration of the actions +taken to manage expenses and liquidity, we believe that our net cash to be provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility will provide sufficient liquidity to fund +our current obligations, capital spending, and working capital requirements and to comply with the financial covenants of our credit facility over at least 12 months following such issuance date. +Use of Assumptions and Estimates +Management’s belief that the Company will +be able to fund its planned operations over the 12 months following the date on which the Consolidated Financial Statements were issued is based on assumptions which involve significant judgment and estimates of future revenues, inflation, +interest rates, capital expenditures and other operating costs. Our current assumption is that consumer traffic will continue to remain strong ay casinos and restaurants during 2025. We cannot predict the ultimate impact of the current economic +environment, including inflation, interest rates and supply chain disruptions on our customers, which may impact sales. We believe that we are positioned to withstand the impact of any potential economic downturn and we would be able to take +additional financial and operational actions to cut costs and/or increase liquidity. +In addition, the presentation of the accompanying audited Consolidated Financial Statements requires us to make estimates +and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities. Our estimates include those related to revenue recognition, accounts receivable, inventory +obsolescence, goodwill and intangible assets, the valuation of deferred tax assets and liabilities, depreciable lives of equipment, share-based compensation and contingent liabilities. We base our estimates on historical experience and on various +other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates used. +Smaller Reporting Company +As a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K, we may choose to prepare our disclosures relying on certain scaled +disclosure requirements for smaller reporting companies in Regulation S-K and in Article 8 of Regulation S-X. +The scaled disclosure requirements for smaller reporting companies permit us (i) to include less extensive narrative disclosure than required of other +reporting companies, particularly in the description of executive compensation in our proxy statement and (ii) to provide audited financial statements for two fiscal years in our Form 10-K, in contrast to other reporting companies, which must provide +audited financial statements for three years. +We will cease to be a smaller reporting company if we have (i) equal to or greater than $250 million in market value of our shares held by non-affiliates as of the last +business day of our second fiscal quarter, (ii) equal to or greater than $100 million in annual revenue for the most recent fiscal year or (iii) less than $100 million in annual revenue for the most recent fiscal year and the market value of our +shares held by non-affiliates exceeds $700 million as of the last business day of our second fiscal quarter. +F-10 +Index +2. Summary of significant accounting policies +Principles of consolidation: The accompanying Consolidated Financial Statements include the +audited Consolidated Financial Statements of TransAct and its wholly-owned subsidiaries, which require consolidation, after the elimination of intercompany accounts, transactions and unrealized profit. +Certain amounts for prior years have been reclassified to conform to the current year presentation. +Use of estimates : The preparation of Consolidated Financial +Statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and +disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. +Cash and cash equivalents : We consider all highly +liquid investments with a maturity date of three months or less at date of purchase to be cash equivalents. +Accounts receivable and credit losses : The Company records accounts receivable when the right to consideration becomes +unconditional. We establish an allowance for expected credit losses to ensure trade receivables are valued appropriately. +We are exposed to credit losses primarily through our net sales of products and services to our customers which are recorded as Accounts Receivable, net on the +Consolidated Balance Sheets. We evaluate each customer’s ability to pay through assessing customer creditworthiness, historical experience and current economic conditions through a reasonable forecast period. Factors considered in our evaluation of +assessing collectability and risk include: underlying value of any collateral or security interests, significant past due balances, historical losses and existing economic conditions including country and political risk. There can be no assurance +that actual results will not differ from estimates or that consideration of these factors in the future will not result in an increase or decrease to the allowance for credit losses. We may require collateral or prepayment to mitigate credit risk. +We estimate expected credit losses of financial assets with similar risk characteristics. We determine an asset is impaired when our assessment identifies there is a +risk that we will be unable to collect amounts due according to the contractual terms of the agreement. We monitor our ongoing credit exposure through reviews of customer balances against contract terms and due dates, current economic conditions +and dispute resolution. Estimated credit losses are written off in the period in which the financial asset is no longer collectible. +The following table summarizes the activity +recorded in the allowance for expected credit losses related to accounts receivable: +Years Ended December 31, +(In thousands) +2024 +2023 +Balance, beginning of period +$ +768 +$ +351 +Additions charged to costs and expenses +– +606 +Deductions +( 294 +) +( 189 +) +Balance, end of period +$ +474 +$ +768 +Inventories: Inventories are stated at the lower +of average cost or net realizable value. We review net realizable value based on estimated selling prices in the ordinary course of business less estimated costs of completion, disposal and transportation, historical usage and estimates of future +demand. Based on these reviews, inventory write-downs are recorded, as necessary, to reflect estimated obsolescence, excess quantities and net realizable value. +Fixed assets: Fixed assets are stated at cost. Depreciation is recorded using the +straight-line method over the estimated useful lives. The estimated useful life of tooling is five years ; machinery and equipment is ten years ; furniture and office equipment is five years +to ten years ; and computer software and equipment is three years to seven years . Leasehold improvements are amortized over the shorter of the term of the +lease or the useful life of the asset. Costs related to repairs and maintenance are expensed as incurred. The costs of sold or retired assets are removed from the related asset and accumulated depreciation accounts and any gain or loss is +recognized. Depreciation expense was $ 0.9 and $ 1.3 million in 2024 and 2023, respectively. +F-11 +Index +Leases: We account for leases in accordance with ASC 842, “Leases” (“ASC 842”), which requires lessees to apply a +dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determines whether lease expense is recognized based on +an effective interest method for finance leases or on a straight-line basis over the term of the lease for operating leases. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 +months regardless of their classification. Leases with a term of 12 months or less are accounted for based on existing guidance for operating leases. If risks and rewards are conveyed without the transfer of control, the lease is treated as +financing. If the lessor does not convey risks and rewards or control, the lease is treated as operating. +We elected certain practical expedients available under ASC 842 upon adoption. We applied the practical expedient for short-term leases. We have +lease agreements that include lease and non-lease components, and we did not elect the practical expedients to combine these components for any of our leases. +We enter into lease agreements for the use of real estate space and certain equipment under operating leases and we have no financing or sales-type +leases. We determine if an arrangement contains a lease at inception. Our leases are included in “Right-of-use assets, net” and “Lease liabilities” in our Consolidated Balance Sheets. +Right of use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease +payments arising from the lease. Lease right of use assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term. +Lease expense is recognized on a straight-line basis over the lease term. As most of our leases do not provide an implicit rate, the Company +determines its incremental borrowing rate by using the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. Our lease +right of use asset excludes lease incentives. Our leases have remaining lease terms of one year to three years , some of which include options to extend. The exercise of lease renewal options is at our sole discretion and our lease right of use assets +and liabilities reflect only the options we are reasonably certain that we will exercise. +Goodwill and Intangible assets : We acquire +businesses in purchase transactions that result in the recognition of goodwill and intangible assets. The determination of the value of intangible assets requires management to make estimates and assumptions. In accordance with ASC 350-20 “Goodwill,” +acquired goodwill is not amortized but is subject to impairment testing at least annually and when an event occurs or circumstances change that indicate it is more likely than not an impairment exists. We perform a fair value-based impairment test +to the carrying value of goodwill and indefinite-lived intangible assets on an annual basis and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. The Company utilizes the option to +first assess qualitative factors to determine whether it is necessary to perform the Step 1 quantitative goodwill impairment test in accordance with the applicable accounting standards. Under the qualitative assessment, management considers relevant +events and circumstances including but not limited to macroeconomic conditions, industry and market considerations, Company performance and events directly affecting the Company. If the Company determines that the Step 1 quantitative impairment test +is required, management estimates the fair value of the reporting unit primarily using the income approach, which reflects management’s cash flow projections, and also evaluates the fair value using the market approach. Factors considered that may +trigger an interim period impairment review of either acquired goodwill or intangible assets are: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of use of acquired +assets or the strategy for the overall business; significant negative industry or economic trends; and significant decline in market capitalization relative to net book value. Finite lived intangible assets are amortized and are tested for impairment +when appropriate. All of our finite lived intangible assets are fully amortized as of December 31, 2024. +As of December 31, 2024, we have determined that no +goodwill or intangible asset impairment has occurred and the fair value of goodwill was substantially higher than our carrying value based on our assessment as of December 31, 2024 when our annual review for impairment was performed. +F-12 +Index +Revenue recognition: We account for revenue in accordance with ASC Topic 606: Revenue +from Contracts with Customers. In accordance with ASC 606, a performance obligation is a promise in a contract with a customer to transfer a distinct good or service to the customer. Some of our contracts with customers contain a single performance +obligation, while other contracts contain multiple performance obligations (most commonly when contracts include a hardware product, software and extended warranties). A contract’s transaction price is allocated to each distinct performance +obligation and recognized as revenue when, or as, the performance obligation is satisfied. +The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring services to the +customer. To the extent the transaction price includes variable consideration, such as price protection, reserves for returns and other allowances, the Company estimates the amount of variable consideration that should be included in the transaction +price utilizing either the “expected value” method or the “most likely amount” method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable +that a significant future reversal of cumulative revenue under the contract will not occur. +For a majority of our revenue, which consists of printers, terminals, consumables, and replacement parts, the Company recognizes revenue as of a +point of time. The transaction price is recognized upon shipment of the order when control of the goods is transferred to the customer and at the time the performance obligation is fulfilled. We also sell a software solution in our casino and +gaming market, EPICENTRAL, that enables casino operators to create promotional coupons and marketing messages and to print them in real time at the slot machine. EPICENTRAL is primarily comprised of both a software component, which is licensed to +the customer, and a hardware component. EPICENTRAL software and hardware are integrated to deliver the system’s full functionality. The transaction prices from EPICENTRAL software license and hardware are recognized upon installation and formal +acceptance by the customer when control of the license is transferred to the customer. For out-of-warranty repairs, the transaction price is recognized after the repair work is completed and the printer or terminal is returned to the customer, as +control of the product is transferred to the customer and our performance obligation is completed. +Performance obligations are satisfied over time if the customer receives the benefits as we perform work, if the customer controls the asset as it +is being produced, or if the product being produced for the customer has no alternative use and we have a contractual right to payment. For our separately priced extended warranty, BOHA! cloud-based software applications, technical support for our +food service technology terminals and maintenance agreements (including free one-year maintenance received by customers upon completion of +EPICENTRAL installation) revenue is recognized over time as the customer receives the benefit. The transaction price from the maintenance services is recognized ratably over time, using output methods, as control of the services is transferred to +the customer. Our cloud-based BOHA! software allows customers to use hosted software over the contract period on a subscription basis without taking possession of the software and the subscription price is recognized ratably over the contract +period. For extended warranties, the transaction price is recognized ratably over the warranty period, using output methods, as control of the services is transferred to the customer. +When there is more than one performance obligation in a customer arrangement, the Company typically uses the “standalone selling price” method to +determine the transaction price to allocate to each performance obligation. The Company sells the performance obligations separately and has established standalone selling prices for its products and services. In the case of an overall price +discount, the discount is applied to each performance obligation proportionately based on standalone selling price. To determine the standalone selling price for initial EPICENTRAL installations, the Company uses the adjusted market assessment +approach. +For contracts with terms of less than 12 months, the Company expenses sales commissions as they are incurred, since the expected amortization period +of the cost to obtain a contract is less than 12 months. +F-13 +Index +Disaggregation of revenue +The following table disaggregates our revenue by market type, as we believe it best depicts how the nature, amount, timing and uncertainty of our +revenue and cash flows are affected by economic factors. Sales and usage-based taxes are excluded from revenues. +Year Ended December 31, 2024 +(In thousands) +United States +International +Total +Food service technology +$ +14,719 +$ +1,382 +$ +16,101 +POS automation +3,361 +– +3,361 +Casino and gaming +12,522 +7,826 +20,348 +TransAct Services Group +2,883 +691 +3,574 +Total net sales +$ +33,485 +$ +9,899 +$ +43,384 +Year Ended December 31, 2023 +(In thousands) +United States +International +Total +Food service technology +$ +15,159 +$ +1,149 +$ +16,308 +POS automation +6,805 +117 +6,922 +Casino and gaming +28,715 +12,477 +41,192 +TransAct Services Group +7,381 +828 +8,209 +Total net sales +$ +58,060 +$ +14,571 +$ +72,631 +Contract balances +Contract assets consist of unbilled receivables. Pursuant to the over-time revenue recognition model, revenue may be recognized prior to the +customer being invoiced. An unbilled receivable is recorded to reflect revenue that is recognized when such revenue exceeds the amount invoiced to the customer. Unbilled receivables are separated into current and non-current assets and included +within “Accounts Receivable, net” and “Other Assets” on the Consolidated Balance Sheets. We first recorded contract assets during 2020 upon the start of a long-term BOHA! contract. +Contract liabilities consist of customer prepayments and deferred revenue. Customer prepayments are reported as “Accrued Liabilities” in current +liabilities in the Consolidated Balance Sheets and represent customer payments made in advance of performance obligations in instances where credit has not been extended and is recognized as revenue when the performance obligation is complete. +Deferred revenue is reported separately in current liabilities and non-current liabilities and consists of our extended warranty contracts, technical support for our food service technology terminals, EPICENTRAL maintenance contracts and prepaid +software subscriptions for our BOHA! software applications, and is recognized as revenue as (or when) we perform under the contract. During the year ended December 31, 2024, we recognized revenue of $ 1.1 million related to our contract liabilities as of December 31, 2023. +Net contract (liabilities) assets consist of the following: +December 31, +(In thousands) +2024 +2023 +Unbilled receivables, current +$ +106 +$ +145 +Unbilled receivables, non-current +32 +120 +Customer pre-payments +( 164 +) +( 155 +) +Deferred revenue, current +( 1,107 +) +( 1,079 +) +Deferred revenue, non-current +( 246 +) +( 209 +) +Net contract (liabilities) assets +$ +( 1,379 +) +$ +( 1,178 +) +Remaining performance obligations +Remaining performance obligations represent the transaction price of firm orders for which a good or service has not been delivered to our +customer. As of December 31, 2024, the aggregate amount of the transaction price allocated to remaining performance obligations was $ 6.3 million. The Company expects to recognize revenue on $ 6.0 +million of its remaining performance obligations within the next 12 months following December 31, 2024, $ 0.2 million within the next 24 months +following December 31, 2024 and the balance of these remaining performance obligations within the next 36 months following December 31, 2024. +F-14 +Index +Concentration of credit risk: Financial instruments that potentially expose us to +concentrations of credit risk are limited to cash and cash equivalents held by our banks in excess of insured limits and accounts receivable. +Accounts receivable from customers representing 10% or more of total accounts receivable, net during the years ended December 31, 2024 and 2023 were as +follows: +December 31, +2024 +2023 +Light & Wonder Gaming, Inc. +15 +% +3 +% +International Gaming Technology (“IGT”) +6 +% +28 +% +Sales to customers representing 10% or more of total net sales during the years ended December 31, 2024 and 2023 were as follows: +December 31, +2024 +2023 +Light & Wonder Gaming, Inc. +11 +% +6 +% +IGT +6 +% +15 +% +Engineering, design and product development: Engineering, design and product +development expenses include expenses incurred in connection with specialized engineering and design to introduce new products and to customize existing products, and are expensed as a component of operating expenses as incurred. We recorded $ 7.0 million and $ 9.4 million of research +and development expenses in 2024 and 2023, +respectively. +Costs incurred in the engineering, design and product development of a computer software product are charged to expense until technological +feasibility has been established, at which point all material software costs are capitalized within Intangible assets in our Consolidated Balance Sheet until the product is available for general release to customers. While judgment is required in +determining when technological feasibility of a product is established, we have determined that it is reached after all high-risk development issues have been documented in a formal detailed plan design. The amortization of these costs has been +included in cost of sales over the estimated life of the product. +Advertising: Advertising costs are expensed as incurred. Advertising expenses, which are included in +selling and marketing expense on the accompanying Consolidated Statements of Operations for 2024 and 2023 totaled $ 1.2 million and $ 1.7 million, respectively. These expenses include items such as consulting, professional services, tradeshows, and print advertising. +Income taxes: The income tax amounts reflected in the accompanying Consolidated Financial Statements +are accounted for under the liability method in accordance with ASC 740, “Income Taxes” (“ASC 740”). Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial +statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which +those temporary differences are expected to be recovered or settled. A valuation allowance is provided for certain deferred tax assets if it is more likely than not that the Company will not realize some portion of the deferred tax assets through +future operations. In accordance with ASC 740, we identified, evaluated and measured the amount of benefits to be recognized for our tax return positions. See Note 11 – Income Taxes. +Foreign currency translation: The financial position and results of operations of our +foreign subsidiary in the UK are measured using local currency as the functional currency. Assets and liabilities of such subsidiary have been translated into U.S. dollars at the year-end exchange rate, related sales and expenses have been +translated at the weighted average rate for the period, and shareholders’ equity has been translated at historical exchange rates. The resulting translation gains or losses, net of tax, are recorded in shareholders’ equity as a cumulative +translation adjustment, which is a component of accumulated other comprehensive income and loss. Foreign currency transaction gains and losses, including those related to intercompany balances, are recognized in Other, net on the Consolidated +Statements of Operations. +F-15 +Index +Share-based payments: At December 31, 2024, we have share-based employee compensation plans, which are described more fully in Note 10 - Stock incentive plans. We account for those plans +under the recognition and measurement principles of ASC 718, “Compensation – Stock Compensation.” Share-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the +employee’s requisite service period. +We use the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method +include the expected term of the option, our stock price volatility, risk-free interest rate, dividend yield, market price of our underlying stock and exercise price. Many of these assumptions require judgment and are highly sensitive in the +determination of compensation expense. Forfeitures are recognized as they occur. +Net income (loss) per share : We report net income or loss per share in accordance with ASC 260, “Earnings per Share (EPS).” Under this guidance, basic EPS, which excludes dilution, is computed by +dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock +were exercised or converted into common stock. Diluted EPS includes in-the-money stock options using the treasury stock method. During a loss period, the assumed exercise of in-the-money stock options has an anti-dilutive effect, and therefore, +these instruments are excluded from the computation of diluted EPS. See Note 12 - Earnings per share. +Recently issued accounting pronouncements : +On November 27, 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280) . The +amendments improve reportable segment disclosures requirements and clarify circumstances in which an entity can disclose multiple segment measures of profit or loss, provide new segment disclosure requirements for entities with a single +reportable segment and contain other disclosure requirements. These amendments are effective for fiscal years beginning after December 15, 2023 and for interim periods beginning after December 15, 2024. These segment disclosure requirements +must be applied retrospectively to all periods presented in the financial statements. We adopted this standard effective January 1, 2024, and this standard did not have a material impact on the Company’s Consolidated Financial Statements. We +have adopted this standard for our fiscal year 2024 annual financial statements and interim financial statements thereafter and have applied this standard retrospectively for all prior periods presented in the financial statements. See Note 7 +– Segment Reporting for further information. +On December 14, 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740) . This ASU requires the use of consistent categories and greater disaggregation in tax rate reconciliations and income taxes +paid disclosures. These amendments are effective for fiscal years beginning after December 15, 2024. These income tax disclosure requirements can be applied either prospectively or retrospectively to all periods presented in the financial +statements. We are currently evaluating the impact of adopting this standard; however, we do not expect it to have a material impact on our Consolidated Financial Statements. +In November 2024, the FASB issued ASU 2024-03, Income Statement—Reporting Comprehensive Income—Expense Disaggregation Disclosures (Subtopic 220-40): +Disaggregation of Income Statement Expenses. The amendments in this update require footnote disclosures on disaggregated information about specific categories underlying certain income statement expense line items that are considered +relevant. This includes items such as the purchase of inventory, employee compensation, depreciation, and intangible asset amortization. The amendments in ASU 2024-03 are effective for fiscal years beginning after December 15, 2026. Early +adoption is permitted. Adoption of this ASU will result in additional disclosure, but will not impact our consolidated financial position, results of operations, or cash flows. +3. Inventories +The components of inventories are: +December 31, +(In thousands) +2024 +2023 +Raw materials and purchased component parts +$ +8,413 +$ +8,432 +Finished goods +7,748 +9,327 +$ +16,161 +$ +17,759 +F-16 +Index +4. Fixed assets, net +The components of fixed assets, net are: +December 31, +(In thousands) +2024 +2023 +Tooling, machinery and equipment +$ +7,828 +$ +7,562 +Furniture and office equipment +2,078 +2,078 +Computer software and equipment +8,412 +8,190 +Leasehold improvements +2,895 +2,895 +21,213 +20,725 +Less: Accumulated depreciation and amortization +( 19,468 +) +( 18,646 +) +1,745 +2,079 +Construction in-process +73 +342 +$ +1,818 +$ +2,421 +5. Intangible assets, net +Identifiable intangible assets are recorded in Intangible assets, net in the accompanying Consolidated Balance Sheets and are comprised of the following: +December 31, +2024 +2023 +(In thousands) +Gross Amount +Accumulated Amortization +Gross Amount +Accumulated Amortization +Purchased technology +$ +1,591 +$ +( 1,591 +) +$ +1,591 +$ +( 1,503 +) +Patents +15 +( 15 +) +15 +( 15 +) +Total +$ +1,606 +$ +( 1,606 +) +$ +1,606 +$ +( 1,518 +) +Amortization expense was $ 88 thousand and +$ 154 thousand in 2024 and +2023, respectively. We currently do not anticipate any amortization expense for each of the next five years ending December 31. +6. Accrued liabilities +The components of accrued liabilities are: +December 31, +(In thousands) +2024 +2023 +Salaries and compensation related +$ +1,786 +$ +3,455 +Taxes +725 +870 +Professional and consulting +200 +161 +Other +542 +461 +$ +3,253 +$ +4,947 +F-17 +Index +7. Segment reporting +We apply the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting.” We +view our operations and manage our business as one segment: the design, development and marketing of software-driven technology and +printing solutions and the sale of printer and terminal related software, services, supplies and spare parts. Factors used to identify TransAct’s single operating segment include the similar design, construction and functionality of our products +and services, the combined research & development team that supports the entire company, a combined assembly, production and supply chain logistics process used to construct our products and services and a similar class of customers within our +core markets (distributors, resellers, original equipment manufacturers (“OEMs”) and end users). Other factors used to identify TransAct’s single operating segment include the organizational structure of the Company and the financial information +available for evaluation by the chief operating decision-maker (“CODM”) in making decisions about how to allocate resources and assess performance. The Company’s chief operating decision makers, who are the Company’s chief executive officer and the +Company’s chief financial officer, utilize a consolidated approach to assess the performance of and allocate resources to the business. +We generally use measures of sales, gross margin percentage, net income, earnings before interest, taxes, depreciation and amortization (“EBITDA”) and +adjusted EBITDA to make operational and strategic decisions. These financial measures are compared to budgeted and forecasted amounts by the CODMs on a regular basis to measure our progress towards our strategic plans, pursue product enhancements, +conduct research and development initiatives and make any other necessary overall strategic changes to the business. +The following table provides the operating financial results of our segment: +December 31, +(In thousands) +2024 +2023 +Revenues +$ +43,384 +$ +72,631 +Cost of materials sold +15,268 +25,990 +Compensation costs +18,323 +20,004 +Professional services +3,493 +4,965 +Occupancy costs +1,477 +1,485 +Marketing expenses +1,109 +1,715 +IT expenses +1,255 +1,203 +Severance expense +75 +1,785 +Depreciation and amortization +1,037 +1,489 +Other segment expenses (1) +4,973 +8,289 +( 3,626 +) +5,706 +Interest income +469 +55 +Interest expense +( 322 +) +( 310 +) +Other (expense) income +( 89 +) +452 +Income tax benefit (expense) +( 6,295 +) +( 1,155 +) +Net (loss) income +$ +( 9,863 +) +$ +4,748 +(1) +Other Segment expenses included in Segment net income primarily include other cost of goods sold, other administrative costs and engineering costs. +F-18 +Index +A reconciliation of net (loss) income to EBITDA and adjusted EBITDA follows: +Years Ended December 31, +(In thousands) +2024 +2023 +Net (loss) income +$ +( 9,863 +) +$ +4,748 +Interest (income) expense, net +( 147 +) +255 +Income tax expense +6,295 +1,155 +Depreciation and amortization +1,037 +1,489 +EBITDA +( 2,678 +) +7,647 +Share-based compensation +1,157 +860 +Adjusted EBITDA (1) +$ +( 1,521 +) +$ +8,507 +(1) +Adjusted EBITDA in 2023 includes a $ 1.5 million severance charge related to the +resignation of the Company’s former Chief Executive Officer. +Please see Note 14 for net sales and long-lived assets by geographic area. +8. Retirement savings plan +We maintain a 401(k) plan under which all full-time employees are eligible to participate at the beginning of the month immediately following their date +of hire. We match employees’ contributions at a rate of 50 % of employees’ contributions up to the first 6 % of the employees’ compensation contributed to the 401(k) plan. Our matching contributions, net of applied forfeitures, were $ 364 thousand and $ 230 thousand in 2024 and 2023, respectively. +9. Borrowings +Credit Facility +On March 13, 2020, we entered into the +Loan and Security Agreement (the “Loan Agreement”) governing a credit facility (the “Siena Credit Facility”) with Siena Lending Group LLC (the “Lender”). The Siena Credit Facility provides for a revolving credit line of up to $ 10.0 million and was originally scheduled to expire on March 13, 2023, prior to being extended, as discussed below. Borrowings under the Siena Credit Facility bear a floating rate of interest equal to the greatest of (i) the prime rate plus 1.75 %, (ii) the federal funds rate plus 2.25 %, and (iii) 6.50 %. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility were $ 245 thousand which were reported as “Other current assets” in current assets and “Other assets” in non-current assets in the Consolidated Balance +Sheets. We also pay a fee of 0.50 % on unused borrowings under the Siena Credit Facility. Borrowings under the Siena Credit Facility +are secured by a lien on substantially all the assets of the Company. Borrowings under the Siena Credit Facility are subject to a borrowing base based on 85 % of eligible accounts receivable plus the lesser of (a) $ 5.0 million and +(b) 50 % of eligible raw material and 60 % +of finished goods inventory. +The Siena Credit Facility imposes a +financial covenant on the Company and restricts, among other things, our ability to incur additional indebtedness and create other liens. On July 21, 2021, the Company entered into an amendment (“Siena Credit Facility Amendment No. 1”) to the +Loan Agreement. Siena Credit Facility Amendment No. 1 changed the financial covenant under the Siena Credit Facility from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at +least $ 750 thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning with the calendar month +ended July 31, 2021. From July 31, 2021 through December 31, 2024, we remained in compliance with our excess availability covenant. +On July 19, 2022, the Company and the Lender entered into Amendment No. 2 (“Siena Credit Facility Amendment No. 2”) to the Loan Agreement as amended +by Siena Credit Facility Amendment No. 1. Also on July 19, 2022, the Company and the Lender entered into an Amended and Restated Fee Letter (the “Amended Fee Letter”) in connection with Siena Credit Facility Amendment No. 2. Siena Credit Facility +Amendment No. 2 did not modify the aggregate amount of the revolving commitment or the interest rate applicable to the loans. Among other changes, Siena Credit Facility Amendment No. 2 extended the maturity date from March 13, 2023 to March 13, 2025. +In addition, the Amended Fee Letter required the Company to maintain outstanding borrowings of at least $ 2.25 million in principal amount +or, during any period during which the Lender had control of the Company’s deposit account in accordance with the Loan Agreement, as amended by Siena Credit Facility Amendment No. 2, to pay interest on at least $ 2.25 million in principal amount of outstanding borrowings, whether or not such amount of loans was actually outstanding. +F-19 +Index +On May 1, 2023, the Company and the Lender agreed to a letter amendment (Amendment No. 3) to the Loan Agreement. Prior to such amendment, Section 7.1(m) +of the Loan Agreement required that any successor to the Company’s former Chief Executive Officer be reasonably acceptable to the Lender. This amendment confirmed that Mr. John Dillon, the Company’s current Chief Executive Officer, is an acceptable +successor, and applied the same requirement to any future successor to Mr. Dillon as Chief Executive Officer. +On November 20, 2024, the Company and the Lender entered into Amendment No. 4 (“Siena Credit Facility Amendment No. 4”) to the Loan Agreement. The +changes to the Loan Agreement provided for in Siena Credit Facility Amendment No. 4 include, among other things, the extension of the maturity date from March 13, 2025 to March 31, 2027. Also on November 20, 2024, the Company and the Lender entered +into a Second Amended and Restated Fee Letter (the “Second Amended Fee Letter”) in connection with Siena Credit Facility Amendment No. 4. The Second Amended Fee Letter increases the minimum borrowing amount from $ 2.25 million to $ 3.0 million, such that the +Company is required to either maintain outstanding borrowings of at least $ 3.0 million in principal amount, or during any period during +which the Lender has control of the Company’s deposit account in accordance with the Loan Agreement, as amended by Siena Credit Facility Amendment No. 4, to pay interest on at least $ 3.0 million principal amount of loans, whether or not such amount of loans is actually outstanding. The Second Amended Fee Letter also extends the dates before which a prepayment and +termination of the Loan Agreement requires the Company to pay to the Lender an early payment/termination premium, providing for (i) a two percent +premium for prepayment on or prior to March 31, 2025, (ii) a one percent premium for prepayment from April 1, 2025 through March 31, 2026, +and no premium for prepayment thereafter. +As of December 31, 2024 and 2023, we had $ 3.0 million and $ 2.3 million, respectively, of outstanding borrowings under the Siena Credit Facility at interest rates of 9.25 % and 10.25 %, respectively. We had $ 3.2 million of net borrowing capacity available under the Siena Credit Facility at December 31, 2024. +10. Stock incentive plans +Stock incentive plans . We currently have two +stock incentive plans: the 2005 Equity Incentive Plan and the 2014 Equity Incentive Plan, which provide for awards to executives, key employees, directors and consultants. The plans generally provide for awards in the form of: (i) incentive stock +options, (ii) non-qualified stock options, (iii) restricted stock, (iv) restricted stock units (which may include performance-based vesting), (v) stock appreciation rights or (vi) limited stock appreciation rights. Awards granted under these plans +have exercise prices equal to 100 % of the fair market value of the common stock at the date of grant. Awards granted have a ten-year term and generally vest over a two-year +to four-year period, unless automatically accelerated for certain defined events. As of May 2014, no new awards may be made under the +2005 Equity Incentive Plan. Under our 2014 Equity Incentive Plan, as amended in May 2023, we are authorized to grant awards of up to 2.9 +million shares of TransAct common stock. At December 31, 2024, 655,672 shares of common stock remained available for issuance under the 2014 Equity Incentive Plan. +Under the assumptions indicated below, the weighted-average per share fair value of stock option grants for 2024 and 2023 was $ 3.98 and $ 4.16 , respectively. We also +issued restricted stock units for certain executives and directors that vest over a specified period of time, and in some instances require achieving certain performance metrics. The weighted-average per share fair value of these restricted stock +units was $ 5.81 and $ 7.21 in +2024 and 2023, +respectively. The per share fair value of restricted stock units is the trading value of the stock on the date of the grant. +The table below indicates the key assumptions (on a weighted-average basis) used in the option valuation calculations for options granted in 2024 and 2023 and a discussion of our +methodology for developing each of the assumptions used in the valuation model: +Years ended December 31, +2024 +2023 +Expected option term (in years) +6.1 +7.0 +Expected volatility +57.7 +% +55.6 +% +Risk-free interest rate +4.3 +% +4.2 +% +Dividend yield +0.0 +% +0.0 +% +Expected Option Term - This is the weighted average period of time over which the options granted are expected to remain outstanding giving consideration to our historical exercise patterns. Options granted +have a maximum term of ten years and an increase in the expected term will increase compensation expense. +Expected Volatility – The stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period approximately equal to the expected option term of +the grant. An increase in the expected volatility factor will increase compensation expense. +F-20 +Index +Risk-Free Interest Rate - This is the U.S. Treasury rate in effect at the time of grant having a term approximately equal to the expected term of the option. An increase in the risk-free interest rate will +increase compensation expense. +Dividend Yield –The dividend yield is calculated by dividing the annual dividend declared per common share by the weighted average market value of our common stock on the date of grant. An increase in the dividend yield will +decrease compensation expense. +We recorded $ 1.2 and $ 0.9 million of share-based compensation expense for 2024 +and 2023, respectively, included primarily in general and administrative expense in our Consolidated Statements of Operations. We also +recorded income tax benefits of $ 0.3 million in 2024 and $ 0.2 million in 2023, related to such share-based compensation. At December 31, +2024, these benefits are recorded as a deferred tax asset in the Consolidated Balance Sheets. +Equity award activity in the 2005 Equity Incentive Plan and the 2014 Equity Incentive Plan, as amended, is summarized below: +Stock Options +Restricted Stock Units +Number of Shares +Average Price* +Number of Units +Average Price** +Outstanding at December 31, 2023 +1,314,475 +$ +8.82 +184,536 +$ +7.76 +Granted +179,700 +6.80 +267,024 +5.81 +Exercised +– +– +( 74,995 +) +7.41 +Forfeited +( 7,750 +) +7.11 +– +– +Expired +( 109,312 +) +10.71 +– +– +Outstanding at December 31, 2024 +1,377,113 +$ +8.41 +376,565 +$ +6.44 +* +weighted average exercise price per share +** +weighted average grant stock price per share +The following summarizes information about equity awards outstanding that are vested and expect to vest and equity awards that are exercisable at December 31, 2024: +Equity Awards Vested and Expected to Vest +Equity Awards That Are Exercisable +Awards +Average Price* +Aggregate +Intrinsic +Value +Remaining Term** +Awards +Average Price* +Aggregate +Intrinsic +Value +Remaining Term** +Stock Options +1,377,113 +$ +8.41 +$ +– +4.1 +973,963 +$ +8.96 +$ +– +2.2 +Restricted stock units +376,565 +– +1,540 +2.1 +– +– +– +– +* +weighted average exercise price per share +** +weighted-average contractual remaining term in +years +Shares that are issued upon exercise of employee stock awards are newly issued shares and not issued from treasury stock. As of December 31, 2024, unrecognized compensation cost related to non-vested equity awards granted under our stock incentive plans is approximately $ 2.7 million, which is expected to be recognized over a weighted average period of 2.7 years. +The total fair value of awards vested was $ 0.9 +million and $ 1.3 million during the years ended December 31, 2024 and 2023, respectively. The total intrinsic value (which +is the amount by which the stock price exceeded the exercise price on the date of exercise) of stock options exercised during the years ended December 31, 2024 +and 2023 was zero and $ 3 thousand, respectively, and cash received from option exercises was zero in both 2024 and 2023. Zero and 1,875 stock options were exercised during the year ended December 31, 2024 +and 2023, respectively. We recorded zero +realized tax provision in 2024 and 2023 +from equity-based awards, related to options exercised. +F-21 +Index +11. Income taxes +The components of the income tax expense are as follows: +December 31, +(In thousands) +2024 +2023 +Current: +Federal +$ +( 154 +) +$ +( 1 +) +State +37 +51 +Foreign +108 +85 +( 9 +) +135 +Deferred: +Federal +5,991 +825 +State +293 +132 +Foreign +20 +63 +6,304 +1,020 +Income tax expense +$ +6,295 +$ +1,155 +Our effective tax rates were ( 176.4 %) and 19.6 % for 2024 and 2023 , respectively. Our 2024 tax rate was impacted by an income tax charge of $ 7.3 million related to the write down of our U.S. net deferred income tax asset as more fully described below. +At December 31, 2024, we have $ 276 thousand of federal net operating loss carryforwards which can be carried over indefinitely, $ 135 thousand of state net operating loss carryforwards which expire in various years, $ 903 +thousand of R&D credit carryforwards which can be carried forward for 20 years, and no state tax credit carryforwards. All of these items have a full valuation allowance against them as of December 31, 2024. Foreign income before taxes was $ 79 thousand and $ 322 thousand in 2024 and 2023, respectively. +Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the Consolidated Financial Statements. Our +deferred tax assets and liabilities were comprised of the following: +December 31, +(In thousands) +2024 +2023 +Deferred tax assets: +Federal net operating losses +$ +276 +$ +– +Foreign net operating losses +802 +733 +State net operating losses +135 +84 +Accrued severance +20 +165 +Capitalized R&D expenses +3,708 +3,127 +Inventory reserves +1,047 +896 +Deferred revenue +7 +31 +Warranty reserve +29 +24 +Stock compensation expense +853 +790 +Other accrued compensation +165 +404 +R&D credit carryforward +903 +695 +Other Assets +379 +360 +Gross deferred tax assets +8,324 +7,309 +Valuation allowance +( 8,103 +) +( 719 +) +Net deferred tax assets +221 +6,590 +Deferred tax liabilities: +Depreciation and amortization +179 +237 +Other +42 +49 +Net deferred tax liabilities +221 +286 +Total net deferred tax assets +$ +– +$ +6,304 +F-22 +Index +As of December 31, 2024 and 2023, we had $ 8.1 million and $ 719 thousand, respectively, +of valuation allowance against our deferred income tax assets. The following table summarizes the activity recorded in the valuation allowance on the deferred tax assets: +Year Ended December 31, +(In thousands) +2024 +2023 +Balance, beginning of period +$ +719 +$ +656 +Additions charged to income tax provision +7,384 +63 +Balance, end of period +$ +8,103 +$ +719 +Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not (greater than 50%) that a tax benefit will not be realized. In +evaluating the need for a valuation allowance, management considers all potential sources of taxable income, including income available in carryback periods, future reversals of taxable temporary differences, projections of taxable income, income +from tax planning strategies, as well as all available positive and negative evidence. Positive evidence includes factors such as a history of profitable operations, projections of future profitability within the carryforward period, including any +potential tax planning strategies. Negative evidence includes items such as cumulative losses and projections of future losses. Upon changes in facts and circumstances, management may conclude that deferred tax assets for which no valuation +allowance is currently recorded may not be realized, resulting in a charge to establish a valuation allowance. Existing valuation allowances are re-examined under the same standards of positive and negative evidence. If it is determined that it is +more likely than not that a deferred tax asset will be realized, the appropriate amount of the valuation allowance, if any, is released. Deferred tax assets and liabilities are also re-measured to reflect changes in underlying tax rates due to law +changes and the granting and lapse of tax holidays. +In 2024, TransAct recognized a $ 7.3 million discrete +income tax charge for a valuation allowance on the full value of the net deferred tax assets in the United States. After weighing all available positive and negative evidence, as described above, management determined that it was no longer more +likely than not that TransAct will realize the tax benefit of these deferred tax assets. This was mainly driven by a cumulative taxable loss experienced over the previous three fiscal years (2022 through 2024) combined with a near term outlook of +future taxable losses. The need for this valuation allowance will be assessed on a continuous basis in future periods and, as a result, a portion, or all of the allowance, may be reversed based on changes in facts and circumstances. +Differences between the U.S. statutory federal income tax rate and our effective income tax rate are analyzed below: +Year Ended December 31, +2024 +2023 +Federal statutory rate +21.0 +% +21.0 +% +R&D credit +8.8 +( 5.9 +) +Foreign-derived intangible income deduction +– +( 1.7 +) +Stock award excess tax benefit +( 0.7 +) +0.4 +State income taxes, net of federal income taxes +1.0 +2.5 +Business meals and entertainment +( 0.4 +) +0.3 +Executive compensation limitation +– +0.6 +Uncertain tax positions +( 0.2 +) +0.5 +Stock option cancellations +( 2.0 +) +0.6 +Change in valuation allowance +( 206.9 +) +1.0 +Other +3.0 +0.3 +Effective tax rate +( 176.4 +%) +19.6 +% +F-23 +Index +We had $ 203 and $ 197 thousand of total gross unrecognized tax benefits at December 31, 2024 and 2023, respectively that, if recognized, would favorably affect the +effective income tax rate in any future periods. We are not aware of any events that could occur within the next twelve months that could cause a significant change in the total amount of unrecognized tax benefits. A tabular reconciliation of the +gross amounts of unrecognized tax benefits at the beginning and end of the year is as follows: +December 31, +(In thousands) +2024 +2023 +Balance, beginning of period +$ +197 +$ +142 +Tax positions taken during the current period +31 +83 +Reductions for tax positions in prior years +( 25 +) +– +Lapse of statute of limitations +– +( 28 +) +Balance, end of period +$ +203 +$ +197 +We recognize interest and penalties related to uncertain tax positions in the income tax provision. +We are subject to U.S. federal income tax as well as income tax of certain state and foreign jurisdictions. We have substantially concluded all U.S. +federal income tax, state and local, and foreign tax matters through 2019. However, our federal tax returns for the years 2021 through 2024 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination as +well, though we believe that any additional assessment would be immaterial to the Consolidated Financial Statements. +12. Earnings per share +Earnings per share was computed as follows (in thousands, except per share amounts): +Years Ended December 31, +2024 +2023 +Net (loss) income +$ +( 9,863 +) +$ +4,748 +Shares: +Basic: Weighted average common shares outstanding +9,997 +9,951 +Add: Dilutive effect of outstanding equity awards as determined by the treasury stock method +– +70 +Diluted: Weighted average common and common equivalent shares outstanding +9,997 +10,021 +Net (loss) income per common share: +Basic +$ +( 0.99 +) +$ +0.48 +Diluted +( 0.99 +) +0.47 +The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options, restricted +stock units and performance stock awards, when the average market price of the common stock is lower than the exercise price of the related stock award during the period. These outstanding stock awards are not included in the computation of diluted +earnings per share because the effect would be anti-dilutive. Furthermore, in periods when a net loss is reported, such as in 2024, basic and diluted net loss per common share are calculated using the same method. Anti-dilutive option awards +excluded from the computation of earnings per dilutive share were 1.4 million and 1.1 million at December 31, 2024 and 2023, respectively. Anti-dilutive restricted stock awards excluded from the computation of earnings per dilutive share were 0.3 million and zero at December 31, 2024 +and 2023, respectively. Anti-dilutive performance stock awards excluded from the computation of earnings per dilutive share were 0.1 +million and zero at December 31, 2024 and 2023, respectively. +F-24 +Index +13. Stock repurchase program +We use the cost method to account for treasury stock purchases, under which the price paid for the stock is charged to the treasury stock account. +Repurchases of our common stock are accounted for as of the settlement date. During 2024 and 2023, we did no t repurchase any shares of our common stock. +From January 1, 2005 through December 31, 2019, we repurchased a total of 4,044,842 shares of common stock for $ 32.1 million, at an average price of $ 7.94 +per share. +14. Geographic area information +Information regarding our operations by geographic area is contained in the following table. These amounts in the geographic area table are based on the +location of the customer and asset. +Years Ended December 31, +(In thousands) +2024 +2023 +Net sales: +United States +$ +33,485 +$ +58,060 +International +9,899 +14,571 +Total +$ +43,384 +$ +72,631 +Fixed assets, net: +United States +$ +831 +$ +945 +International +987 +1,476 +Total +$ +1,818 +$ +2,421 +Sales to international customers were 23 % +and 20 % of total sales in 2024 +and 2023, respectively. Sales to Europe represented 55 % and 64 %, sales to the Pacific Rim (which includes Australia and Asia) represented 34 % and 29 %, and sales to Canada +represented 10 % and 4 % of +total international sales in 2024 and 2023, +respectively. International long-lived assets consist of net fixed assets located at our foreign subsidiary in the UK, as well as our contract manufacturer in Thailand. +15. Leases +Operating lease expense was $ 1.0 million and $ 1.1 million for the years ended December 31, 2024 and 2023 , +respectively, and is reported as “Cost of sales,” “Engineering, design and product development expense,” “Selling and marketing expense,” and “General and administrative expense” in the Consolidated Statements of Operations. Operating costs include short-term lease costs. +The following information represents supplemental disclosure for the statement of cash flows related to operating leases (in thousands): +Years Ended December 31, +2024 +2023 +Operating cash outflows from leases +$ +1,022 +$ +1,013 +The following summarizes additional information related to our leases: +Years Ended December 31, +2024 +2023 +Weighted average remaining lease term (in years) +1.2 +1.7 +Weighted average discount rate +7.7 +% +4.4 +% +F-25 +Index +The maturity of the Company’s operating lease liabilities are as follows (in thousands): +December 31, 2024 +2025 +$ +1,014 +2026 +237 +Total undiscounted lease payments +1,251 +Less imputed interest +65 +Total lease liabilities +$ +1,186 +16. Quarterly results of operations (unaudited) +Our quarterly results of operations for 2024 +and 2023 are as follows: +Quarter Ended +(In thousands, except per share amounts) +March 31 +June 30 +September 30 +December 31 +2024: +Net sales +$ +10,687 +$ +11,599 +$ +10,867 +$ +10,231 +Gross profit +5,624 +6,110 +5,227 +4,521 +Net loss +( 1,036 +) +( 319 +) +( 551 +) +( 7,957 +) +Net loss per common share: +Basic +( 0.10 +) +( 0.03 +) +( 0.06 +) +( 0.79 +) +Diluted +( 0.10 +) +( 0.03 +) +( 0.06 +) +( 0.79 +) +2023: +Net sales +$ +22,270 +$ +19,906 +$ +17,190 +$ +13,265 +Gross profit +12,255 +10,858 +8,916 +6,371 +Net income (loss) +3,139 +765 +906 +( 62 +) +Net income (loss) per common share: +Basic +0.32 +0.08 +0.09 +( 0.01 +) +Diluted +0.31 +0.08 +0.09 +( 0.01 +) +17. Related party transactions +One of the Company’s directors serves as President and Chief Executive Officer of The One Group Hospitality, Inc. The +Company sold various food service technology products to The One Group Hospitality, Inc. on an arms’ length basis totaling $ 117 thousand +and $ 246 thousand in 2024 and 2023, respectively. The Company’s accounts receivable from The One Group Hospitality, Inc. amounted to $ 5 thousand and $ 34 thousand at December +31, 2024 and 2023, respectively. +18. Subsequent events +The Company has evaluated all events or transactions that occurred up to the date the consolidated financial statements were available to issue. Based upon this review, +the Company did not identify any subsequent events that would have required adjustment or disclosure in the consolidated financial statements. +F-26 \ No newline at end of file diff --git a/raw/filings/0001017303/2024/0001140361-25-010065/filing_metadata.csv b/raw/filings/0001017303/2024/0001140361-25-010065/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..6c60ad9d8a31b0471fd40cda7d9f6692354b0d66 --- /dev/null +++ b/raw/filings/0001017303/2024/0001140361-25-010065/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001017303,TACT,TRANSACT TECHNOLOGIES INC,10-K,2025-03-24,2024-12-31,2025-03-24T21:27:44.000Z,0001140361-25-010065,ef20039038_10k.htm,"FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2024",10082375,1,1,https://www.sec.gov/Archives/edgar/data/1017303/000114036125010065/ef20039038_10k.htm,https://www.sec.gov/Archives/edgar/data/1017303/000114036125010065/,2024,2024,1 diff --git a/raw/filings/0001017303/2024/0001140361-25-010065/item1.txt b/raw/filings/0001017303/2024/0001140361-25-010065/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..df3145b51db50674c0e794458c531b595e5650e9 --- /dev/null +++ b/raw/filings/0001017303/2024/0001140361-25-010065/item1.txt @@ -0,0 +1,193 @@ +Item 1. +Business. +The Company +TransAct Technologies Incorporated (together with its consolidated subsidiaries, “TransAct,” the “Company,” “we,” “us,” or “our”) was incorporated in June 1996 and began operating as a stand-alone business in +August 1996 as a spin-off of the printer business that was formerly conducted by certain subsidiaries of Tridex Corporation. We completed an initial public offering on August 22, 1996. +TransAct is a global leader in developing and selling software-driven technology and printing solutions for high-growth markets including food service technology, point of sale (“POS”) automation and casino and +gaming. Our world-class products are designed from the ground up based on market and customer requirements and are sold under the BOHA!™, AccuDate™, Epic, EPICENTRAL®, and Ithaca® brand names. During 2019, we launched a new line of products for +the food service technology market, the BOHA! hardware solutions and companion branded suite of cloud-based applications. The BOHA! software and hardware products help restaurants, convenience stores and food service operators of all sizes +automate the food production in the back-of-house operations. Known and respected worldwide for innovative designs and real-world service reliability, our thermal printers and terminals generate top-quality labels, coupons and transaction +records such as receipts, tickets and other documents. We sell our technology to original equipment manufacturers (“OEMs”), value-added resellers, and select distributors, as well as directly to end users. Our product distribution spans across +the Americas, Europe, the Middle East, Africa, Asia, Australia, New Zealand, the Caribbean Islands and the South Pacific. We also offer world-class service, support, labels, spare parts, accessories and printing supplies to our growing worldwide +base of products currently in use by our customers. Through our TransAct Services Group (“TSG”), we provide a complete range of supplies and consumables used in the printing activities of customers in the restaurant and hospitality, retail, +casino and gaming, and government markets. Through our webstore, www.transactsupplies.com, and our direct selling team, we address the demand for these products. We operate in one reportable segment: the design, development, and marketing of +software-driven technology and printing solutions for high growth markets, and related services, supplies and spare parts. The Company’s chief operating decision maker, who is the Company’s chief executive officer, in consultation with the +Company’s chief financial officer, utilizes a consolidated approach to assess the performance of and allocate resources to the business. Accordingly, management has concluded that the Company consists of a single operating segment and single +reportable segment for accounting and financial reporting purposes. Our primary operating, hardware research and development, and U.S. service center is located in Ithaca, New York. In addition, we have a casino and gaming sales headquarters +and software research and development center in Las Vegas, Nevada; a European sales and service center at our subsidiary in the United Kingdom (“UK”); and a sales office located in Macau, China. Our executive offices are located at One Hamden +Center, 2319 Whitney Avenue, Suite 3B, Hamden, Connecticut, 06518, and our telephone number is (203) 859-6800. +Recent Developments +The Company’s previously announced strategic review process remains active. Management and the Company’s Board of Directors are focused on the process. The Company is +determined to consider any and all options that increase and/or deliver stockholder value. The Company will provide further updates on this process when it determines that additional disclosure is appropriate or required. This process is subject +to unknown variables, including costs, structure, terms and timing, and may not result in any transaction or other particular outcome. For information regarding the risks related to the strategic review process, please see Part I, Item 1A, Risk +Factors under the sub-caption “Our success may depend in part on our ability to identify and pursue the best long-term strategy for our businesses” in this Form 10-K. +Products, Services, Markets and Distribution Methods +Printers, terminals and other hardware: TransAct designs, develops and markets a broad array of transaction-based and specialty printers and terminals +utilizing thermal printing technology for applications, primarily in the food service technology, POS automation, and casino and gaming markets. Our printers and terminals are configurable and offer customers the ability to choose from a variety +of features and functions. Options typically include interface configuration, mounting configuration, paper cutting devices and paper handling capacities. Our food service technology terminals also offer software configurable menu options and +our food service technology market includes sales of optional hardware products including tablets, temperature sensors and gateways (i.e. access points needed to enable wireless communications). +Food Service Technology (“FST”): Our primary offering in the food service technology market is our line of BOHA! products. The BOHA! product suite +combines our latest generation terminal or workstation which includes one or two printers, with our BOHA! labeling, timers, and media software. In addition, customers may individually purchase cloud-based software applications that connect to a +separate application on a separate mobile device into a solution to automate back-of-house operations in restaurants, convenience stores and food service operations. The additional software offering of BOHA! consists of a variety of individually +purchased software-as-a-service (“SaaS”) based applications for both Android and iOS operating systems, including applications for, temperature monitoring, temperature taking and creating checklists and task lists. These applications are sold +separately, and customers purchase the applications they need for their back-of-house operations. Customers may also purchase associated hardware, such as tablets, temperature sensors and gateways. The BOHA! Terminal and the more recently +launched Terminal 2 combine an operating system and hardware components in a single touchscreen device with one or two thermal print mechanisms that print easy-to-read food rotation labels, grab-and-go labels, +and nutritional labels for prepared foods, and “enjoy by” date labels. The BOHA! WorkStation uses an iPad or Android tablet instead of an integrated touchscreen. The BOHA! Terminal, Terminal 2 and WorkStation are equipped with the TransAct +Enterprise Management System to ensure that only approved functions are available on the touchscreen device and to allow over-the-air updates to the operating system. BOHA! helps food service establishments and restaurants (including fine dining, +casual dining, fast casual and quick-service restaurants, convenience stores, hospitality establishments and contract food service providers) effectively manage food safety and grab-and-go initiatives, as well as automate and manage back-of-house +operations. Recurring revenue from BOHA! is generated by software sales, including software subscriptions that are typically charged to customers annually on a per-application basis, as well as sales of labels, extended warranty and service +contracts, and technical support services. In the food service technology market, we use an internal sales force to solicit sales directly from end users. In May 2023, we launched our new BOHA! Terminal 2. The Terminal 2 is designed to be a +high-end product intended for enterprise customers with increased speed, print resolution and wide-label capability. We started receiving orders for the Terminal 2 in the latter part of 2023 from both our international and domestic markets. +2 +Index +POS automation: In the POS market, we sell a printer utilizing thermal printing technology. Our POS printer is +used primarily by McDonald’s, and to a lesser extent, other quick-service restaurants and are located either at the checkout counter or within self-service kiosks, to print receipts for consumers or print on linerless labels. In the POS market, +we primarily sell our products through a network of domestic and international distributors and resellers. We use an internal sales force to manage sales through our distributors and resellers, as well as to solicit sales directly from +end-users. +Casino and gaming: We sell several models of printers used in slot machines, video lottery terminals (“VLTs”), sports betting kiosks and other gaming +machines that print tickets or receipts instead of issuing coins (“ticket-in, ticket-out” or “TITO”) at casinos, racetracks and other gaming venues worldwide. These printers utilize thermal printing technology to print tickets and receipts in +monochrome and offer various other features such as jam resistant bezels and a dual port interface that enables casinos to print coupons and promotions. In addition, we sell printers using thermal roll-fed printing technology for use in +international non-casino establishments, including game types such as Amusements with Prizes, Skills with Prizes, Fixed Odds Betting Terminals, sports betting establishments and other off-premise gaming type machines around the world. We sell +our casino and gaming products primarily (1) to slot machine manufacturers, who incorporate our printers into slot machines and, in turn, sell completed slot machines directly to casinos and other gaming establishments and (2) through +distributors. We also maintain a dedicated internal sales force to solicit sales from slot machine manufacturers and casinos, and to manage sales through our distributors. In the fourth quarter of 2023, we launched the Epic TR80, our newest +casino and gaming printer, which we believe will help us retain and expand our customer base in the casino and gaming markets. +We also offer a software solution, the EPICENTRAL Print System, including annual software maintenance, that enables casino operators to create promotional coupons and marketing messages and to print them in real +time at the slot machine. With EPICENTRAL, casinos can utilize the system to create multiple promotions and incentives to either increase customer time spent on the casino floor or encourage additional visits to generate more revenue to the +casinos. We sell EPICENTRAL directly to casinos or through partners who incorporate EPICENTRAL into their casino management system software offerings, largely sold on a SaaS basis. +TSG : Through TSG, we proactively market the sale of consumable products (including POS receipt paper, ribbons +and other printing supplies), replacement parts, maintenance and repair services, and shipping and handling charges. Our maintenance services include the sale of extended warranties, multi-year maintenance contracts, a 24-hour guaranteed +replacement product service called TransAct Xpress™ and other repair services for our non-FST products. Within the United States, we provide repair services through our service center in Ithaca, New York. Internationally, we provide repair +services through our European service center located in Doncaster, UK, and through partners strategically located around the world. +We also provide customers with telephone sales and technical support, and a personal account representative to handle orders, shipping and general information. Technical and sales support personnel receive +training on all our products and services. In addition to personalized telephone and technical support, we also market and sell consumable products 24 hours a day, seven days a week, via our webstore, www.transactsupplies.com. +Sources and Availability of Raw Materials +We design our products to optimize product performance, quality, reliability and durability. These designs combine cost efficient materials, sourcing and assembly methods with high standards of workmanship. +Almost all of our printers and terminals are currently produced by a third party manufacturer located in Thailand. A small portion of our products are assembled in our Ithaca, New York facility largely on a configure-to-order basis using +components and subassemblies that have been sourced from vendors and contract manufacturers around the world. +Critical component parts and subassemblies include thermal print heads, printing/cutting mechanisms, power supplies, motors, injection molded plastic parts, LCD screens, tablets, circuit boards and electronic +components, which are obtained from domestic and foreign suppliers at competitive prices, subject to availability. As a result of the majority of our production being performed by our contract manufacturers, the majority of our purchases consist +of fully assembled printers and terminals produced by our contract manufacturers and, to a much lesser extent, component parts. We typically strive to maintain more than one source for our component parts, subassemblies and fully assembled +printers and terminals to reduce the risk of parts shortages or unavailability. However, we have experienced and could continue to experience some disruption due to certain suppliers being unable to source specific components and we could +experience temporary disruption in the availability of components. In addition, we could experience temporary disruption if certain suppliers ceased doing business with us, as described below. +We currently buy a majority of our thermal print mechanisms, an important component of our thermal printers, and fully assembled printers for substantially all of our printer and food service technology terminal +models, from a foreign contract manufacturer in Thailand. We believe that other contract manufacturers could provide similar thermal print mechanisms or fully assembled printers and terminals, on comparable terms. We do not have supply +agreements with foreign contract manufacturers, and we believe that our supply of thermal print mechanisms and fully assembled printers and terminals will be adequate in 2025 and the foreseeable future. +Patents and Proprietary Information +TransAct relies on a combination of trade secrets, patents, employee and third party nondisclosure agreements, copyright laws and contractual rights to establish and protect its proprietary rights in its products. +As of December 31, 2024, we held 23 active United States patents and 39 active foreign patents and have three pending United States patent applications and eight pending foreign patent applications pertaining +to our products. The remaining duration of these patents ranges from one to 25 years. During the year ended December 31, 2024, no United States patents were issued and 12 foreign patents were issued. During the year ended December 31, 2024, no +United States or foreign patents expired. The expiration of any individual patent would not have a significant negative impact on our business. We regard certain manufacturing processes and designs to be proprietary and attempt to protect them +through employee and third party nondisclosure agreements and similar means. It may be possible for unauthorized third parties to copy certain portions of our products or to reverse engineer or otherwise obtain and use, to our detriment, +information that we regard as proprietary. Moreover, the laws of some foreign countries do not afford the same protection to our proprietary rights as do the laws of the United States. There can be no assurance that legal protections we rely +upon to protect our proprietary position will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. +3 +Index +Trademarks, Service Marks Trade Names and Copyrights +We own or have rights to trademarks, service marks, trade names and copyrights that we use in connection with the operation of our business, including our corporate names, logos and website names. Other trademarks, +service marks and trade names appearing in this Form 10-K are the property of their respective owners. The trademarks we own include TransAct®, BOHA! ®, AccuDate®, EPICENTRAL®, Epic TR80™, Ithaca® and TransAct Express™. Solely for convenience, +some of the trademarks, service marks, trade names and copyrights referred to in this Form 10-K are listed without the ©, ® and ™ symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks, service +marks, trade names and copyrights. +Seasonality +Restaurants typically reduce purchases of equipment in the fourth quarter due to the increased volume of transactions during the holiday period, which may negatively impact sales of our food service technology +products or POS printers. +Working Capital +Inventory, accounts receivable, and accounts payable levels, payment terms, and where applicable, return policies are in accordance with the general practices of the industry and standard business procedures. See +also Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K. +Certain Significant Customers +Light & Wonder Gaming, Inc. (Light & Wonder”) is our most significant customer. We primarily sell casino and gaming printers to Light & Wonder. +Sales to Light & Wonder represented 11% and 6% of our total net sales for the years ended December 31, 2024 and 2023, respectively. +Competition +The market for transaction-based and specialty printers, food service technology terminals and related software applications is extremely competitive, and we expect such competition to continue in the future. +However, we experience less competition for EPICENTRAL software due to the highly customized nature of the product. We compete with a number of companies, many of which have greater financial, technical and marketing resources than TransAct. We +believe our ability to compete successfully depends on a number of factors both within and outside our control, including durability, reliability, quality, design capability, product customization, price, customer support, success in developing +new products, manufacturing expertise and capacity, supply of component parts and materials, strategic relationships with suppliers, the timing of new product introductions by us and our competitors, general market, economic and political +conditions and, in some cases, the uniqueness of our products. +In the food service technology market, we primarily compete with CrunchTime! Information Systems, Inc. (including its Zenput and Squadle brands), Jolt Software, Avery Dennison Corporation, Ecolab Inc., ITD Food +Safety, Daymark Safety Systems (part of CMC Group, Inc.), Integrated Control Corp, Digi International, and Toast. We compete in this market based largely on our ability to provide highly specialized purpose-built hardware products, different +software applications that can be chosen by a customer and ongoing technical support. We rely upon third party developed software and hosting services combined with our own proprietary hardware and software to offer a unique BOHA! branded +solution to support back-of-house operations in the food service industry. Our competitors or others may develop, or may establish relationships with developers with the capability to develop, software and services that are similar to or +competitive with ours, which may be disadvantageous to our competitive position. Certain portions of our food service technology software are licensed from a third party developer on a non-exclusive basis through 2031 and are subject to a +revenue sharing arrangement with the developer. We are reliant upon the third party developer to further develop and maintain its developed software, and the developer controls the software source code. The license agreement does not preclude the +developer or the Company from working with others on similar products. Also, the third party developer hosts the web-based applications. Therefore, presently, we are highly dependent upon this third party developer for continued service to our +customers and the further development of our food service technology software products. +In the POS automation market, we primarily compete with Epson America, Inc., which holds a dominant market position. We also compete with BIXOLON America, Inc., and, to a much extent with Star Micronics America, +Inc. and Citizen - CBM America Corporation. We believe certain competitors of ours have greater financial resources and lower costs attributable to higher volume production and lower gross profit margin expectations which enable them to offer +lower prices than us. +In the casino and gaming market (consisting principally of slot machine printing, VLT and sports betting transaction and promotional coupon printing), we compete with several companies including JCM Global, +Nanoptix, Inc., Custom Engineering SPA, Eurocoin Components and others. Certain of our products sold for casino and gaming applications compete based upon our ability to provide highly specialized products, custom engineering and ongoing +technical support. +The market in which TSG competes is highly fragmented, and we compete with numerous competitors of various sizes, including POS and internet resellers and paper converters depending on the geographic area. +Our strategy for competing in our markets is to continually develop and/or license new products (hardware and software), such as launching the BOHA! Terminal in 2019, the BOHA! Terminal 2 in 2023, the Epic TR80 +which was launched in 2023 and product line extensions that are technologically advanced and provide differentiated features and functions, to increase our market penetration, to take advantage of strategic relationships, and to lower the cost of +our products by sourcing certain products overseas. Although we believe that our products, operations and relationships provide a competitive foundation, there can be no assurance that we will compete successfully in the future. In addition, +our printer products utilize certain thermal printing technologies and licensed software. If new technologies are introduced, or existing technologies evolve, we may be required to incorporate these technologies into our products. +Alternatively, if such technologies were to become available to our competitors, our printer products could become obsolete, which could have a significant negative impact on our business. +4 +Index +Governmental Regulation +The casino and gaming industries are generally subject to extensive and evolving regulation that in many jurisdictions includes licensing or regulatory screening of suppliers, manufacturers and distributors and +their applicable affiliates, their major shareholders, officers, directors and key employees. In addition, certain of our casino and gaming products and technologies must be certified or approved in each of the jurisdictions in which we operate. +Regulators review many facets of an applicant or holder of a license, including its financial stability, integrity and business experience. Any failure to receive a license or the loss of a license that we currently hold could have a material +adverse effect on us or on our results of operations, cash flow or financial condition. +While we believe that we are in compliance with all material casino and gaming laws and regulatory requirements applicable to us, we cannot assure that our activities or the activities of our customers will not +become the subject of any regulatory or law enforcement proceeding or that any such proceeding would not have a material adverse impact on us or our results of operations, cash flows or financial condition. +Environmental Compliance +Our compliance with federal, state and local laws and regulations relating to environmental protection and discharge of hazardous materials has not had a material impact on our capital expenditures, earnings or +competitive position, and we do not anticipate any material impact from such compliance in the future. +Available Information +We make available free of charge through the “Investor Relations” page on our website, www.transact-tech.com (which can be accessed by selecting the “Company” tab and then clicking on “Investor Relations”), +our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and all amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or +furnished to the SEC pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains a website that contains reports, proxy and information statements, and other information +regarding issuers that file electronically with the SEC at http://www.sec.gov. The content on any website referred to in this Form 10-K is not incorporated by reference in this Form 10-K unless expressly noted. +Employees +As of December 31, 2024, TransAct and our subsidiaries employed 108 persons, all of whom were full-time employees. None of our employees are unionized, and we consider our relationships with our employees to be +good. +Information about our Executive Officers +The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person’s principal occupations +and employment during at least the past five years. +Name +Age +Position +John M. Dillon +75 +Chief Executive Officer +Steven A. DeMartino +55 +President, Chief Financial Officer, Treasurer and Secretary +Tracey S. Winslow +65 +Chief Revenue Officer +Brent Richtsmeier +60 +Chief Technology Officer +William J. DeFrances +60 +Vice President & Chief Accounting Officer +John M. Dillon was appointed Chief Executive Officer of TransAct on April 4, 2023 and has been a member of the Board of Directors of the Company since 2011. Mr. Dillon served as the Chairman of the Board of +Directors of Aerospike, the world’s first flash-optimized database and the fastest database at scale, from January 2022 to February 2024 and served as CEO of Aerospike from January 2015 to January 2022. Prior to joining Aerospike, Mr. Dillon +served as CEO of Engine Yard, Inc., the leading cloud platform for automating and developing Ruby on Rails and PHP applications, from 2009 to 2014. He served as CEO for Navis, Inc., a private company specializing in software systems for operating +large marine container terminals and distribution centers, from 2002 to 2008. Before Navis, he also served as CEO for Salesforce, Inc. (formerly Salesforce.com) and President and CEO of Hyperion Solutions. He began his career as a Systems +Engineer for EDS (Electronic Data Systems) and then moved into a variety of sales management positions for various high-tech companies, including Oracle Corporation. Mr. Dillon holds a Bachelor’s degree in Engineering from the United States Naval +Academy and an MBA from Golden Gate University. +Steven A. DeMartino was named TransAct’s President, Chief Financial Officer, Treasurer and Secretary on June 1, 2010. Previously, Mr. DeMartino served as Executive Vice President, Chief Financial Officer, +Treasurer and Secretary from June 2004 to May 2010, Senior Vice President, Finance and Information Technology from October 2001 to May 2004, Vice President and Corporate Controller from January 1998 to October 2001, and Corporate Controller from +August 1996 to December 1997. Mr. DeMartino holds a Bachelor’s degree in Accounting and Economics from the College of the Holy Cross and an MBA from the University of Connecticut. He also is a certified public accountant. +5 +Index +Tracey S. Winslow was named Chief Revenue Officer of the Company in March 2023 with responsibility for worldwide sales in all of the Company’s markets. Prior to this appointment, Ms. Winslow served as Senior Vice +President, Casino and Gaming Sales from June 2010 to February 2023, with responsibility for the sales and marketing of all casino and gaming products. Previously, Ms. Winslow served as Senior Vice President, Sales and Marketing of the Company +from June 2007 to May 2010, Senior Vice President, Marketing and Sales, POS and Banking of the Company from July 2006 to June 2007, and joined TransAct in May of 2005 as Senior Vice President, Marketing. Prior to joining TransAct, Ms. Winslow +was employed with Xerox Corporation where she held the role of Manager, Worldwide Marketing from 2003 to 2005, and Manager, Sales Operations from 2000 to 2002. She joined Xerox Corporation in 1983. +Brent Richtsmeier was named Chief Technology Officer in September 2021. Previously, Mr. Richtsmeier served as Senior Vice President, Software Engineering since joining TransAct in December 2019 and was appointed +as an officer of the Company in January 2021. Prior to joining TransAct, Mr. Richtsmeier was employed with Samsung Electronics Co., Ltd., an electronics corporation, from May 2004 until November 2017 as the VP of Development where he was +responsible for software strategy, software development at scale and business development. In November 2017, Samsung Electronics sold their business products division to HP Inc, and Mr. Richtsmeier transferred to HP Inc to become the Global Head +of Cloud and Mobile Software Solutions until joining TransAct in 2019. +William J. DeFrances joined TransAct as Vice President & Chief Accounting Officer in July 2022. Mr. DeFrances previously served as Corporate Controller at Omega Engineering, Inc., an electronics and +instrumentation company that was, during Mr. DeFrances’ tenure, a subsidiary of Spectris plc, a UK public company listed on the London Stock Exchange, from September 2020 to July 2022. From August 2019 to August 2020, Mr. DeFrances worked as an +independent financial consultant. Prior to this, Mr. DeFrances held various positions with United Technologies Corporation (now RTX Corporation, formerly Raytheon Technologies Corporation) (“UTC”) and Sikorsky Aircraft (owned by Lockheed Martin +Corporation). Mr. DeFrances previously served as an Associate Director of Military Finance for Pratt & Whitney, a subsidiary of UTC, from October 2018 to August 2019, and the Business Unit Controller, USG/Military and International Military +for Sikorsky Aircraft from October 2015 to October 2018. Prior to this, Mr. DeFrances also served as the Assistant Controller, Financial Reporting for Sikorsky Aircraft from 2009 to 2013. In addition, Mr. DeFrances held various accounting and +financial roles (VP Treasurer and VP Controller) from 2005 to 2009 at ATMI, Inc. (acquired by Entegris, Inc.), an advanced manufacturing company in the semiconductor industry. Mr. DeFrances has an MBA from the University of Connecticut and is +a certified public accountant. +There are no family relationships between any of our executive officers and there is no arrangement or understanding between any of such officers and any other person pursuant to which he or she was selected as an +officer. Each of our executive officers was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her earlier resignation or removal. \ No newline at end of file diff --git a/raw/filings/0001017303/2024/0001140361-25-010065/item13.txt b/raw/filings/0001017303/2024/0001140361-25-010065/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..5e3b897a4ff4f5229eccaa70e597f4c61e0e1c3e --- /dev/null +++ b/raw/filings/0001017303/2024/0001140361-25-010065/item13.txt @@ -0,0 +1,4 @@ +Item 13. +Certain Relationships and Related Transactions, and Director Independence. +The information in response to this item will be contained in the Proxy Statement under the headings “Certain Relationships and Related Transactions” and “Corporate Governance-Board Leadership Structure and +Independence” and is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0001017303/2024/0001140361-25-010065/item9a.txt b/raw/filings/0001017303/2024/0001140361-25-010065/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..031f234ea44de4e0fe17bd5dbcce5bf7595420dc --- /dev/null +++ b/raw/filings/0001017303/2024/0001140361-25-010065/item9a.txt @@ -0,0 +1,20 @@ +Item 9A. +Controls and Procedures. +Evaluation of Disclosure Controls and Procedures +Our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15 +under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of +December 31, 2024. Based on this evaluation of our disclosure controls and procedures as of December 31, 2024, our CEO and CFO concluded that, as of December 31, 2024, our disclosure controls and procedures were +effective at the reasonable assurance level. +Our management, including our CEO and CFO, has concluded that our consolidated financial statements, included in this Form 10-K, fairly present, in all material respects, our financial condition, results of +operations and cash flows for the periods presented in conformity with GAAP, and that they can be relied upon. +Management’s Annual Report on Internal Control Over Financial Reporting +Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act, to provide reasonable assurance regarding the +reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance +of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial +statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or +timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. +Our management assessed our internal control over financial reporting as of December 31, 2024. Our management based its assessment on criteria established in Internal Control–Integrated Framework issued by the +Committee of Sponsoring Organizations of the Treadway Commission. In the opinion of management, TransAct maintained effective internal control over financial reporting as of December 31, 2024. +Changes in Internal Control over Financial Reporting +No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended December 31, 2024 that has materially affected, +or is reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001017303/2024/0001140361-25-010065/rp_note.txt b/raw/filings/0001017303/2024/0001140361-25-010065/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..20391e924a62e65fee10bb9f6a8a98d73f6b9ddf --- /dev/null +++ b/raw/filings/0001017303/2024/0001140361-25-010065/rp_note.txt @@ -0,0 +1,5 @@ +17. Related party transactions +One of the Company’s directors serves as President and Chief Executive Officer of The One Group Hospitality, Inc. The +Company sold various food service technology products to The One Group Hospitality, Inc. on an arms’ length basis totaling $ 117 thousand +and $ 246 thousand in 2024 and 2023, respectively. The Company’s accounts receivable from The One Group Hospitality, Inc. amounted to $ 5 thousand and $ 34 thousand at December +31, 2024 and 2023, respectively. \ No newline at end of file diff --git a/raw/filings/0001017303/2024/0001140361-25-010065/rpt_disclosure.txt b/raw/filings/0001017303/2024/0001140361-25-010065/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..6364763ecf71aa2773ee39fd2512b1dc3a4ea6a3 --- /dev/null +++ b/raw/filings/0001017303/2024/0001140361-25-010065/rpt_disclosure.txt @@ -0,0 +1,7 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +The Company maintains a Related Party Transactions Policy relating to the identification, review and approval of related party transactions, consistent with the requirements of The Nasdaq Global Market (“Nasdaq”) and the SEC. The Related Party Transactions Policy, which is administered by our Audit Committee, is set forth in our Standards of Business Conduct and Code of Ethics (the “Code of Ethics”) available on our website at www. transact -tech .com by clicking on “Investor Relations” under the “About Us” dropdown menu and then clicking on “Documents & Charters” under the “Governance” dropdown menu. +In particular, the Code of Ethics requires all directors, officers and employees to avoid any situation that involves an actual or apparent conflict of interest in personal and professional relationships or with their duty to, or with any interest of, the Company, including engaging in “Related Party Transactions” unless approved or ratified by the Audit Committee. The term “Related Party Transaction” means any transaction, arrangement or relationship, or any series of similar transactions, arrangements or relationships, in which (i) the Company or any of its subsidiaries or Controlled Affiliates (as such term is defined in the policy) is or will be a participant, (ii) the aggregate amount involved will or may be expected to exceed $120,000 in any fiscal year, and (iii) any Related Party has or will have a direct or indirect interest. A “Related Party” is defined as any person who is or was (since the beginning of the last fiscal year for which the Company has filed an Annual Report on Form 10 -K and proxy statement, even if such person does not presently serve in that role) an executive officer, director or nominee for director of the Company, any stockholder owning more than 5% of any class of the Company’s voting securities, or an immediate family member of any such person. +The Chair of the Audit Committee must be notified before a Related Party engages in a Related Party Transaction. The Audit Committee is then responsible for reviewing the transaction. No transaction determined to be a Related Party Transaction will be approved or ratified if the transaction is contrary to the best interests of the Company and its stockholders. In determining whether to approve or ratify a Related Party Transaction, the Audit Committee takes into account such factors as it deems appropriate, which may include whether the interested transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the transaction. +Emanuel P.N. Hilario, one of the Company’s directors, serves as President and Chief Executive Officer of The ONE Group Hospitality, Inc. (“The ONE Group”), and Haydee Ortiz Olinger, another Company director, serves on the Board of Directors of The ONE Group. From time to time, the Company sells food service technology products to The ONE Group. In 2025 and 2024, the Company’s sales of such products to The ONE Group totaled $161 thousand and $117 thousand, respectively. The transactions were made in the ordinary course of business and were conducted on an arm’s -length basis on terms substantially equal to those offered to persons who are not Related Parties and were approved and ratified by the Audit Committee. The Company expects to make additional sales to The ONE Group going forward in accordance with the Related Party Transactions Policy. +9 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2014/0001047469-15-001519/filing.txt b/raw/filings/0001334036/2014/0001047469-15-001519/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..b6e2b653feab2e01d35d8150ea89b4da9934af3c --- /dev/null +++ b/raw/filings/0001334036/2014/0001047469-15-001519/filing.txt @@ -0,0 +1,8307 @@ +10-K +1 +a2223339z10-k.htm +10-K +Use these links to rapidly review the document +TABLE OF CONTENTS +TABLE OF CONTENTS 2 +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2014 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer +Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's principal executive offices) +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities +registered pursuant to Section 12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes ý No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act +of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the +past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to +be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the +registrant was required to submit and post such files). Yes ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and +will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to +the Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the +definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +(do not check if a +smaller reporting company) +Smaller reporting company o +Indicate +by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the +Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2014 was $1.3 billion. For the purpose +of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant's common stock are assumed to be affiliates of the registrant. +This determination of affiliate status is not necessarily conclusive for any other purpose. +The +number of shares of the registrant's common stock outstanding as of January 30, 2015 was 77,834,494. +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant's proxy statement for the 2015 annual meeting of stockholders to be filed no +later than 120 days after the end of the registrant's fiscal year ended December 31, 2014. +Table of Contents +Special Note Regarding Forward-Looking Statements +Statements in this Form 10-K and in documents incorporated by reference herein (or otherwise made by us or on our behalf) may +contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that +contain such statements. Forward-looking statements include statements as to industry trends, our future expectations and other matters that do not relate strictly to historical facts and are based on +certain assumptions of our management. These statements, which express management's current views concerning future events or results, use words like "anticipate," "assume," "believe," "continue," +"estimate," "expect," "future," "intend," "plan," "project," "strive," and future or conditional tense verbs like "could," "may," "might," "should," "will," "would" and similar expressions or +variations. Forward-looking statements are subject to risks, uncertainties and other factors which may cause actual results to differ materially from future results expressed or implied by such +forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in the section +titled "Risk Factors" (Item 1A. of this annual report on Form 10-K). Moreover, such forward-looking statements speak only as of the date of this report. We undertake no obligation to +update any forward-looking statements to reflect events or circumstances after the date of such statements. +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2014 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +13 +Item 1B. +Unresolved Staff Comments +26 +Item 2. +Properties +27 +Item 3. +Legal Proceedings +27 +Item 4. +Mine Safety Disclosures +28 +PART II +Item 5. +Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of +Equity Securities +29 +Item 6. +Selected Financial Data +32 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of +Operations +33 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +63 +Item 8. +Financial Statements and Supplementary Data +65 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial +Disclosure +65 +Item 9A. +Controls and Procedures +65 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +69 +Item 11. +Executive Compensation +69 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder +Matters +69 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +70 +Item 14. +Principal Accountant Fees and Services +70 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +70 +Signatures +75 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our" or "us") are engaged in the design, +development, manufacturing, worldwide marketing and distribution of casual lifestyle footwear, apparel and accessories for men, women and children. We strive to be the global leader in the sale of +molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite. The use of this unique +material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international +retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, webstores and kiosks. +In +2002, we launched the marketing and distribution of our original clog style footwear in the United States. The unique characteristics of Croslite enabled us to offer consumers a shoe +unlike any other footwear model then available. Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new +styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). Going +forward, we intend to focus our footwear product lines on our core molded footwear heritage, as well as develop new innovative casual lifestyle footwear collections. We intend to streamline our +product portfolio, eliminate non-core product development and explore strategic alternatives for non-core programs such as our golf line and our Ocean Minded brand, as well as our apparel and +accessories business. +The +broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including family footwear stores, department stores and traditional +footwear retailers as well as a variety of specialty and independent retail channels and the internet. We intend to drive cohesive global brand positioning from region-to-region and year-to-year in +order to establish more powerful consumer connections and deliver more consistent product designs. This strategy will be accomplished through developing powerful product stories supported with +effective and consistent global marketing campaigns. Finally, we intend to increase our working market spend, which we define as funds that put marketing messages in front of consumers. +As +a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. Sales in international markets in foreign currencies are expected to +continue to represent a substantial portion of our revenues. Likewise, we expect our subsidiaries with functional currencies other than the U.S. Dollar will continue to represent a substantial portion +of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs from +period to period as a result of the impact of foreign currency translation adjustments into our reporting currency. +Products +Footwear +Our footwear product offerings have grown significantly since we first introduced the single-style clog in six colors, in 2002. We +currently offer a wide variety of footwear products, some of which includes sandals, sneakers, mules, flats and boots, which are made of materials like leather and textile fabrics as well as Croslite. +Footwear sales made up 97.6%, 96.9% and 95.8% of total revenues for the years ended December 31, 2014, 2013 and 2012, respectively. During the years ended December 31, 2014, 2013 and +2012, approximately 73.5%, 71.1% and 75.3%, respectively, of unit sales consisted of +2 +Table of Contents +products +geared toward adults compared to 26.5%, 28.9% and 24.7%, respectively, of unit sales of products geared toward children. +A +key differentiating feature of our footwear products is the "Croslite" material, which is uniquely suited for comfort and functionality. Croslite is carefully formulated to be of a +density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increases comfort. Croslite is a closed-cell resin material which is water +resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such as +textile fabric and leather into many new styles; however, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +We +strive to provide our global consumer with a year-round product assortment featuring comfort, fun, casual styling, color and innovation. Our collections are designed to meet the needs +of the family by focusing on their key wearing occasions. Our goal is to deliver world-class product assortments for the family with all of the comfort features and benefits Crocs is known for. We +have been discontinuing non-core programs in order to focus on growing our core-molded heritage category while developing more compelling casual footwear platforms. Our products are divided into three +product offerings: Core, Casual Lifestyle and Active. +Core Products +At +the heart of our brand resides the Classic, our first and most iconic style for adults and kids that embodies our innovation in molding and design, delivers all-day comfort, and has established a +new category in the footwear marketplace. The unique look and feel of the Classic can be experienced throughout our entire product line due to the design and application of our proprietary material +Croslite. We have expanded our core molded product line, introduced in 2002, with the addition of dual density technology, warm lined styles, seasonal flips and slides. Licensed style partnerships +from Disney, Marvel, Sanrio, Nickelodeon and Warner Bros., among others, provide popularity to our kids' core line along with our kids-only product innovations including lights, color-change materials +and interactive elements. +In +addition, we have extended our licensing partnerships to brand partnerships artists such as Jon Burgerman, as well as stylist Patricia Field. Invigorating our core product assortment is a key focus +for growth and we will expand our reach with new styling, 'built just for her' silhouettes and lots of great color and graphic treatments. New Citilane and Bump It programs merge "retro" sports +styling with classic Crocs looks for a fresh and fun look for men, women, boys and girls. Our core molded products are available to all channels of distribution and span both stylish and active +wearing occasions for the entire family. +Casual Lifestyle Products +Our +Casual Lifestyle Category showcases collections designed for the family around casual and stylish wearing occasions with a relaxed and fun point of view. This category is primarily designed for +our consumers shopping in footwear, specialty/independent retailers, department stores and our own direct-to-consumer channel. +Active Products +Our +Active Category showcases collections designed with an active-casual point of view, catering to on-the-go families with busy lifestyles. These collections are primarily found in sport, footwear, +specialty/independent retailers and our own direct-to-consumer channel. +3 +Table of Contents +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically +suited for Crocs shoes. We acquired Jibbitz in December 2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports +gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of +Disney, Nickelodeon and Sanrio, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. Sales from Jibbitz designs made up 1.5%, +2.8% and 3.5% of total revenues for the years ended December 31, 2014, 2013 and 2012, respectively. +Sales and Marketing +Each season, we focus on presenting a compelling "brand story and experience" for our new product collections and our broader casual +lifestyle assortment. Our marketing efforts center on multi-level story-telling across diverse wearing occasions and product silhouettes. +As +we are a global brand, our marketing model is based on global relevance while still allowing for regional flexibility in execution. At the regional or market level, campaigns are +initiated using a mix of digital, social, and traditional media outlets that align with local marketplaces and target consumer dynamics. This strategy allows for relevant cross-channel input +coordinated through our global brand objectives to drive an aligned global marketing and brand strategy. +We +have three primary sales channels: wholesale, retail and internet (discussed at a more detailed level below). Our marketing efforts are aimed toward driving business to both our +wholesale partners and our company-operated retail and internet stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key +stories, activation materials and creative materials. Retail stores provide a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store +experience a meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product launches. Our marketing, merchandising, and visual merchandising departments +work closely together to ensure the store environment and merchandise are aligned to support key seasonal product offerings while promoting the larger product lines and iconic product collections. +Wholesale Channel +During the years ended December 31, 2014, 2013 and 2012, approximately 55.7%, 56.5% and 57.5% of net revenues, respectively, +were derived from sales through the wholesale channel which consists of sales to distributors and third-party retailers. Wholesale customers include national and regional retail chains, department +stores, sporting goods stores, independent footwear retailers and family footwear retailers, such as Academy, Rack Room Shoes, Famous Footwear, Kohl's, DSW, Shoe Carnival, Dick's Sporting Goods, +Nordstrom, Xebio and Murasaki Sports, as well as on-line retailers such as Amazon and Zappos. No single customer accounted for 10% or more of our revenues for any of the years ended +December 31, 2014, 2013 and 2012. +We +use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price +list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable upon 30 days prior notice and have minimum sales requirements. Many of our agreements allow us to accept returns from wholesale customers at our discretion for defective +products, quality issues and shipment errors on an exception basis or, for certain wholesale customers, and to extend pricing discounts in lieu of defective product returns. We also may accept returns +from our wholesale +4 +Table of Contents +customers, +on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide markdown allowances to key +wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our +product and brand awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct +channels to be complementary to our wholesale channel. +Retail Channel +• During the years ended December 31, 2014, 2013 and 2012, approximately 35.5%, 35.0% and 33.4%, respectively, of our net +revenues were derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full-service retail locations, outlet locations, and kiosk/store-in-store +locations. Our three types of store platforms enable us to organically promote the breadth of our product in high-traffic, highly visible locations. Our strategy for expanding our global retail +business is to increase our market share in a disciplined manner, by selectively opening additional stores in new and existing markets, as well as increasing sales in existing stores, to support our +long-term strategic growth objective to further build Crocs into the leading casual lifestyle footwear brand in the world. We will continue to moderate the pace of our retail expansion in 2015 with a +focus on outlet and kiosk locations and consolidating and enhancing the profitability of existing locations. We halted the expansion of our retail channel and have begun to focus on the long-term +profitability of current locations. We opened 70 company-operated stores during the year ended December 31, 2014, half of which were outlet or low investment kiosk/store-in-store locations, and +closed 104 company-operated stores, 20 of which were identified in the initial restructuring plan. As store growth will vary in new and existing markets due to many factors, including maturity of the +market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +• Full Retail Locations +Our +company-operated retail locations allow us to effectively showcase the full extent of our new and existing products to customers at retail pricing. In addition, our full retail locations enable us +to interact with our customers on a personal level in order to guarantee a satisfying shopping experience as well as to obtain key retail metrics to better fulfill customer demands. On average, the +optimal space for our retail locations is between approximately 1,500 and 1,800 square feet, depending on the geographical vicinity of the property, and typically located in high-traffic shopping +malls or districts. During the year ended December 31, 2014, we closed 56 stores and opened 40 new stores, including a three-story flagship location with approximately 4,500 square feet of +selling space in a 13,600 square foot building located on 34 th Street in New York. As of December 31, 2014, 2013, and 2012, we operated 311, 327 and 287 global full retail +stores, respectively. +• Outlet Locations +Our +company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We additionally sell full priced products in certain of our +outlet stores. Outlet locations follow a similar size model as our full retail stores; however, they are generally located within outlet shopping locations. During the year ended December 31, +5 +Table of Contents +2014, +we closed 18 locations and opened 22 new locations. As of December 31, 2014, 2013 and 2012, we operated 174, 170 and 129 global outlet stores, respectively. +• Kiosk / Store-in-Store Locations +Our +company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other +high foot traffic areas. With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks can be an effective outlet for marketing our +products. As part of our overall retail strategy, we continue to close certain kiosks/store-in-store locations, as we believe our full retail and outlet locations allow us to better merchandise the +full extent and depth of our product line. During the year ended December 31, 2014, we closed 30 locations and opened eight new locations. As of December 31, 2014, 2013 and 2012, we +operated 100, 122 and 121 global kiosks and store-in-stores, respectively. +6 +Table of Contents +The +following table illustrates the net growth in 2014 with respect to the number of our company-operated retail locations by reportable operating segment and country: +Company-operated retail locations: +December 31, +2013 +Opened +Closed +December 31, +2014 +Americas +U.S. +186 +16 +(17 +) +185 +Canada +13 +— +— +13 +Brazil +8 +— +(4 +) +4 +Puerto Rico +7 +— +— +7 +Argentina +2 +— +(1 +) +1 +Total Americas +216 +16 +(22 +) +210 +Asia Pacific +Korea +76 +10 +(3 +) +83 +Taiwan +58 +5 +(58 +) +5 +China +38 +8 +(3 +) +43 +Hong Kong +21 +6 +(4 +) +23 +Singapore +15 +3 +18 +Australia +11 +3 +(1 +) +13 +United Arab Emirates (UAE) +9 +2 +(1 +) +10 +South Africa +8 +1 +— +9 +Total Asia Pacific +236 +38 +(70 +) +204 +Japan +49 +6 +(1 +) +54 +Europe +Russia +36 +6 +(3 +) +39 +Germany +20 +1 +(1 +) +20 +Great Britain +17 +— +(2 +) +15 +France +14 +2 +(2 +) +14 +Netherlands +9 +— +(2 +) +7 +Finland +7 +— +(1 +) +6 +Spain +6 +— +— +6 +Belgium +3 +— +— +3 +Italy +2 +1 +— +3 +Sweden +2 +— +— +2 +Ireland +1 +— +— +1 +Portugal +1 +— +— +1 +Total Europe +118 +10 +(11 +) +117 +Total company-operated retail locations +619 +70 +(104 +) +585 +Internet Channel +As of December 31, 2014, we offered our products through 12 company-operated internet webstores worldwide. During the years +ended December 31, 2014, 2013 and 2012, approximately 8.8%, 8.5% and 9.1%, respectively, of our net revenues were derived from sales through our internet channel. Our internet presence enables +us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. During the year ended December 31, 2014, we decreased our global +company-operated e-commerce sites to 12 in order to focus our internet strategy in our principal geographical locations. We continue to expand our web-based marketing +7 +Table of Contents +efforts +to increase consumer awareness of our full product range and have begun expanding the implementation of locally executed internet web stores at the regional level. +Business Segments and Geographic Information +For 2014 and 2013, we had four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, +Japan and Europe. We also have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represents manufacturing +operations located in Mexico, Italy and Asia. The composition of our reportable operating segments is consistent with that used by our Chief Operating Decision Maker ("CODM") to evaluate performance +and allocate resources. See additional +discussion of our segments including results of operations and assets by segment in Note 16 in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in the North and South America geographic +regions. Regional wholesale channel customers consist of a broad range of family footwear, sporting goods and department stores as well as specialty retailers and distributors. The regional retail +channel sells directly to the consumer through 210 company-operated store locations as well as through webstores. During the years ended December 31, 2014, 2013 and 2012, revenues from the +Americas segment constituted approximately 40.9%, 41.9% and 44.1% of our consolidated revenues, respectively. Specifically, revenues from the United States constituted approximately 36.3%, 33.7% and +35.3% of our consolidated revenues, respectively, for the years ended December 31, 2014, 2013 and 2012. +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia (excluding Japan), +Australia, New Zealand, the Middle East and South Africa. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the +Americas segment. We also sell products directly to the consumer through 204 company-operated stores as well as through our webstores. During the years ended December 31, 2014, 2013 and 2012, +revenues from the Asia segment constituted 29.3%, 28.7% and 26.1% of our consolidated revenues, respectively. +Japan +The Japan segment consists of revenues and expenses related to product sales in Japan. The Japan wholesale channel consists of sales to +a broad range of retailers similar to the wholesale channel we have established in the Americas segment. The regional retail channel sells directly to the consumer through 54 company-operated store +locations as well as through webstores. During the years ended December 31, 2014, 2013 and 2012, revenues from the Japan segment constituted approximately 10.3%, 11.3% and 14.7% of our +consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Europe and Russia. The Europe +segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment. We also sell our products directly to the +consumer through 117 company-operated stores as well as through our webstores. During the years ended December 31, 2014, 2013 and 2012, revenues from the Europe segment constituted 19.5%, 18.1% +and 15.1% of our consolidated revenues, respectively. +8 +Table of Contents +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase +our speed to market and lower operating costs. During the year ended December 31, 2014, we stored our raw material and finished goods inventories in company-operated warehouse and distribution +facilities located in the United States, Mexico, the Netherlands, Japan, Finland, South Africa, Russia and Italy. We also utilize distribution centers which are operated by third parties located in +the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico and Italy. Throughout 2014, we continued +to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2014, our company-operated warehouse and distribution +facilities provided us with approximately 1.0 million square feet and our third-party operated distribution facilities provided us with approximately 0.4 million square feet. We also +ship a portion of our products directly to our customers from our internal and third-party manufacturers. We are actively pursuing initiatives aimed at shipping more of our product directly to our +customers in an effort to lower future cost of sales. +Raw Materials +"Croslite", our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our +accessories. Croslite is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our +materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins, that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other +production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may, however, in the future identify and +utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to +produce the Croslite products are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +non-Croslite materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. We also outsource the +compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We continue to dedicate significant resources to product design and development as we develop footwear styles based on opportunities we +identify in the marketplace. Our design and development process is highly collaborative, as members of the regional design teams, including our EXO Italia ("EXO") location, which specializes in EVA +(Ethylene Vinyl Acetate) based finish products for the footwear industry, frequently meet with sales and marketing staff, production and supply managers and certain of our retail customers to further +refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while +maintaining product quality. We spent $16.7 million, $15.4 million and $12.0 million in research, design and development activities for the years ended December 31, 2014, +2013 and 2012, respectively. +9 +Table of Contents +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated +production facilities in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or provide support to our internal production processes. We believe +that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors +throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our +production costs, increase overall operating efficiencies and shorten production and development times. +In +the years ended December 31, 2014, 2013 and 2012, we manufactured approximately 13.9%, 15.1% and 21.1%, respectively, of our footwear products internally. We sourced the +remaining footwear production from multiple third-party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2014, 2013 and 2012, our +largest third-party manufacturer in China produced approximately 27.5%, 28.0% and 31.7%, respectively, of our footwear unit volume. We do not have written supply agreements with our primary +third-party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our +intellectual property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or +manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada +among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, +YOU by Crocs Logo, Ocean Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, "Croslite" and the Croslite logo, as well as other marks in various countries around the world. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. +are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful +marketing and sale of our products. We will continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the +future. We will also continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We +consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a +process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the +formula by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors and by requiring our employees to execute confidentiality agreements +concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort +and utility of our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously +protect this trade secret. +10 +Table of Contents +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers, as well as outside +investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and +distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of +certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for +our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during +our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our +product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily +indicative of results to be expected for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at +that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only +relates to wholesale and distributor orders for the next season and current season fill-in orders and excludes potential sales in our retail and internet channels. Backlog as of a particular date is +affected by a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly +period over period. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and our recent system conversion and business model changes around the +globe, we believe that backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Foreign Currency Fluctuations on Revenues and Operating Income (Loss) +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other +than the U.S. Dollar. Accordingly, any amounts recorded in foreign currencies are translated into U.S. Dollars for consolidated financial reporting and are impacted by foreign currency fluctuations. +While we enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is +dependent on many factors that cannot be forecasted with reliable accuracy and our forward contracts may not prove effective in reducing our exposures. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly +with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business compete with companies such as, but not limited to, Deckers Outdoor Corp., +Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear +11 +Table of Contents +retailers +such as Genesco, Inc., Macy's, Dillard's, Dick's Sporting Goods Inc., The Finish Line Inc. and Footlocker, Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices, expanded product line and our distribution network continue to position us well in the marketplace. However, some companies in the +casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating +histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the +market with imitation products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2014, we had approximately 4,900 full-time, part-time and seasonal employees, of which approximately 3,000 +were engaged in retail-related functions. Less than 1% of our employees were represented by a union. +Available Information +We were organized in 1999 as a limited liability company. In January 2005, we converted to a Colorado corporation and subsequently +re-incorporated as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our common stock on NASDAQ commenced. +Our +internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to +the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports +filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Copies of any of these documents will be provided in print to any +stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +12 +Table of Contents +ITEM 1A. Risk Factors +Described below are certain risks that our management believes are applicable to our business and the industry in which we operate. +These risks have the potential to materially adversely affect our business, results of operations, cash flows, financial condition, liquidity or access to sources of financing. The risks included here +are not exhaustive and there may be additional risks that are not presently material or known. You should carefully consider each of the following risks described below in conjunction with all other +information presented in this report. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to +predict all such risk factors, nor can it assess the impact of all such risk factors on our business. +Uncertainty about current and future global economic conditions may adversely affect consumer +spending and the financial health of our customers and others with whom we do business which may adversely affect our financial condition, results of operations and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase +orders for our products in response to tighter credit, decreased cash availability and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both +globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest borrowing rates, higher fuel and other energy costs, +inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws or other economic factors. For example, in 2014, we +experienced difficulty in our Asia Pacific segment primarily due to decreased performance in our China business which resulted in delayed payments of receivables. In 2014 and 2013, we also experienced +volatility in sales in our Japan segment due to the continued adverse macroeconomic conditions in that country. In addition, in 2013, our Americas segment experienced volatility in sales due to +adverse macroeconomic conditions and overall weakness in consumer confidence. If global economic and financial market conditions deteriorate or remain weak for an extended period of time, the +following factors could have a material adverse effect on our business, operating results, cash flows and financial condition: +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, reduced orders +or order cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, increased difficulty regarding inventory management, higher discounting efforts and +lower gross margins. +• We may be unable to open and operate new retail stores, or continue to operate existing stores, due to the high fixed cost nature of +the retail segment. +• We conduct operations in several different countries and therefore, are exposed to fluctuations in foreign currency exchange rates +relative to the U.S. Dollar. Transactional and translational foreign currency risk exposure could have a material impact on our reported financial results and condition. +• Any decrease in available credit caused by a weakened global economy may result in financial difficulties for our wholesale and retail +customers, product suppliers and other service providers, as well as the financial institutions that are counterparties to our credit facility and derivative transactions. If credit pressures or other +financial difficulties result in insolvency for these parties, it could adversely impact our estimated reserves, our ability to obtain future financing and our financial results. +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer +order cancellations and/or the need to extend customer +13 +Table of Contents +payment +terms which could lead to higher accounts receivable balances, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense. +• If our manufacturers or other parties in our supply chain experience diminished liquidity, they may not meet their obligations to us, +and we may experience the inability to meet customer product demands in a timely manner. +Foreign currency fluctuations could have a material adverse effect on our results of operations and +financial condition. +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other +than the U.S. Dollar. We pay the majority of expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of +our overseas third-party manufacturers in U.S. Dollars. Our ability to sell our products in foreign markets and the U.S. Dollar value of the sales made in foreign currencies can be significantly +influenced by foreign currency fluctuations. A decrease in the +value of foreign currencies relative to the U.S. Dollar could result in lower revenues, product price pressures and increased losses from currency exchange rates. Price increases caused by currency +exchange rate fluctuations could make our products less competitive or have an adverse effect on our profitability as most of our purchases from third-party suppliers are denominated in U.S. Dollars. +Currency exchange rate fluctuations could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more +difficult to finance. +In +addition to the operational effects of foreign currency fluctuations, any amounts recorded in foreign currencies and translated into U.S. Dollars for consolidated financial reporting +are affected by foreign currency fluctuations. For example, in general, only approximately 35% of our revenues are generated in the U.S. Dollar, compared to approximately 70% of our expense structure +that is incurred in the U.S. Dollar, which can negatively impact gross margins. Additionally in 2014, we experienced a decrease of $8.6 million in revenue in our Japan segment related to +foreign currency translation losses as a result of decreases in the value of the Japanese Yen compared to the U.S. Dollar. +While +we enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency +exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and our forward contracts may not prove effective in reducing our exposures. +We face significant competition. +The footwear industry is highly competitive. Continued growth in the market for casual footwear has encouraged the entry of new +competitors into the marketplace and has increased competition from established companies. Our competitors include most major athletic and non-athletic footwear companies, branded apparel companies +and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market +presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition and spend substantially more than we do on product +marketing. Our competitors' greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, +compete more effectively on the basis of price and production and more quickly develop new products. Additionally, some of our competitors are offering products that are substantially similar, in +design and materials, to Crocs branded footwear. In addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. If we fail to +compete successfully in the future, our sales and profits may decline, we may lose market +14 +Table of Contents +share, +our financial condition may deteriorate and the market price of our common stock is likely to fall. +Our business relies significantly on the use of information technology, and any material disruption +to operational technology or failure to protect the integrity and security of customer and employee information could harm our reputation and/or our ability to effectively operate our business. +We rely heavily on the use of information technology systems and networks in our operations and supporting departments such as +marketing, accounting, finance, and human resources. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, +internet activity and other network processes. Despite our current security measures, our systems, and those of our third-party service providers, may be vulnerable to information security breaches, +acts of vandalism, computer viruses and interruption or loss of valuable business data. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being +unable to perform duties or communicate throughout the organization, loss of retail and internet sales, significant costs for data restoration and other adverse impacts on our business and reputation. +Over +the last several years, we have implemented numerous information systems designed to support various areas of our business, including warehouse management, order management, retail +point-of-sale and internet point-of-sale as well as various interfaces between these systems and supporting back office systems. In addition, we are currently in the process of implementing a +customized and fully-integrated global accounting, operations and finance enterprise resource planning system, or ERP system, which is expected to launch in early 2015. Delays or issues in introducing +the new ERP system to our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems +could cause delays in product fulfillment and reduced efficiency of our operations, could require significant additional capital investments, including to remediate problems, and may have an adverse +effect on our results of operations and financial condition. +We +routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks. Any +breach of our network may result in the loss of valuable business data, misappropriation of our consumers' or employees' personal information, or a disruption of our business. Despite our existing +security procedures and controls, if our network was compromised, it could give rise to unwanted media attention, materially damage our customer relationships, harm our business, reputation, results +of operations, cash flows and financial condition, result in fines or lawsuits, and may increase the costs we incur to protect against such information security breaches, such as increased investment +in technology, the costs of compliance with consumer protection laws and costs resulting from consumer fraud. +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current +revenue and profit levels or accurately forecast geographic demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of +our efforts to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, and our ability to expand within our current distribution channels and +increase sales of our products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, +including: +• the global strengthening of the Crocs brand into a leading casual lifestyle footwear provider; +• our ability to focus on relevant product innovation and profitable new growth platforms while maintaining demand for our current +offerings; +15 +Table of Contents +• our ability to effectively manage our retail stores (including closures of existing stores) while meeting operational and financial +targets at the retail store level; +• accurately forecasting the global demand for our products and the timely execution of supply chain strategies to deliver product +around the globe efficiently based on that demand; +• our ability to use and protect the Crocs brand and our other intellectual property in new markets and territories; +• achieving and maintaining a strong competitive position in new and existing markets; +• our ability to attract and retain qualified distributors or agents or to continue to develop direct sales channels; +• our ability to successfully execute our current restructuring plans and changes in strategy; +• our ability to consolidate our network to leverage resources and simplify our fulfillment process; and +• executing a multi-channel advertising and marketing campaign to effectively communicate our message directly to our consumers and +employees. +If +we are unable to successfully implement any of the above mentioned strategies and many other factors mentioned throughout this section, our business may fail to grow, our brand may +suffer and our results of operations and cash flows may be adversely impacted. +There can be no assurance that the strategic plans we have begun to implement will be successful. +In July 2014, we announced strategic plans for long-term improvement and growth of our business, which is comprised of four key +initiatives: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient +organizational structure including reducing duplicative and excess overhead which will also enhance the decision making process, and (4) closing or converting approximately 75 to 100 retail +locations around the world. The initial charges for the strategic plan were incurred in the first quarter of 2014 and are expected to continue through 2015. During 2014, we closed 20 retail locations +which were identified in the initial restructuring plan, and closed 84 other retail locations, offset by 70 new retail locations opened. Such plans may take more time or more expenditures to execute +than initially envisioned; specifically there may be delays in identifying and closing under-performing retail locations due to lease termination negotiations, etc. In addition, in December 2014, we +announced the appointment of our new Chief Executive Officer effective January 28, 2015, which could change or delay our plans. We also have an evolving retail strategy to increase the +profitability of our business. +While +these strategic plans, along with other steps to be taken by our new Chief Executive Officer, are intended to improve and grow our business, there can be no assurance that this +will be the case, or that additional steps or material accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or +will be successful. The implementation of our new strategy may take a significant amount of time and resources to implement, and may not impact our financial condition, results of operations and cash +flows in the short term, or at all. +We conduct significant business activity outside the U.S. which exposes us to risks of international +commerce. +A significant portion of our revenues is from foreign sales. Our ability to maintain the current level of operations in our existing +international markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. In addition to foreign +manufacturing, we operate retail stores and sell our products to retailers outside of +16 +Table of Contents +the +U.S. Foreign manufacturing and sales activities are subject to numerous risks, including tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and +local content rules; delays associated with the manufacture, transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the +transportation and delivery of goods due to increased security concerns; restrictions on the transfer of funds; restrictions, due to privacy laws, on the handling and transfer of consumer and other +personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; potential violations of U.S. and +foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; expropriation and +nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; difficulties in understanding and complying with local laws, regulations and customs in foreign +jurisdictions; longer accounts receivable patterns and difficulties in collecting foreign accounts receivables; difficulties in enforcing contractual and intellectual property rights; and increased +accounting and internal control expenses. In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal +jurisdictions in which we operate. We cannot assure that there will be no control failure around customs enforcement despite the precautions we take. We are currently subject to audits by various +customs authorities including the U.S. and Mexico. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities +may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our financial position and results of operations. +Our success depends substantially on the value of our brands and failure to strengthen and preserve +their value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strengthening of the Crocs global brand. To be successful in the future, +particularly outside of the U.S., where the Crocs brand is less well-known and perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the +value of our brands across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be outdated +and one-dimensional prior to purchasing our products. Brand value is based in part on consumer perceptions on a variety of subjective qualities. In the past, several footwear companies including ours +have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses. Our business has been and may be similarly affected in the future. Business +incidents, such as perceived product safety issues, whether isolated or recurring, that erode consumer trust, particularly if the incidents receive considerable publicity or result in litigation, can +significantly reduce brand value and have a negative impact on our financial results. Consumer demand for our products and our brand equity could diminish significantly if we fail to preserve the +quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations or fail to deliver a consistently positive consumer experience +in each of our markets. Additionally, counterfeit +reproductions of our products or other infringement of our intellectual property rights, including from unauthorized uses of our trademarks by third parties could harm our brand and adversely impact +our business. +Opening and operating additional retail locations, which require substantial financial commitments +and fixed costs, are subject to numerous risks, and declines in revenue of such retail locations could adversely affect our profitability. +Although we have halted the expansion of our retail sales channel during 2014, we intend to continue to open outlet or low-investment +kiosk/store-in-store locations. Our ability to open new +17 +Table of Contents +locations +successfully depends on our ability to identify suitable store locations, negotiate acceptable lease terms, hire, train and retain store personnel and satisfy the fashion preferences in new +geographic areas. Many of our retail locations are located in shopping malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We +cannot control the success of individual malls and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Reduced customer traffic could reduce sales of +existing retail stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results and cash flows. In addition, some of our retail stores and kiosks +occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military +events or otherwise, is likely to adversely affect sales in our existing stores and kiosks, particularly those with street locations. +Opening +retail stores globally involves substantial investment, including the construction of leasehold improvements, furniture and fixtures, equipment, information systems, inventory +and personnel. Operating global retail stores incurs fixed costs; if we have insufficient sales, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +We may be required to record impairments of long-lived assets relating to our retail operations. +The testing of our retail stores' long-lived assets for impairment requires us to make significant estimates about our future +performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive +conditions in the industry. Due to the high fixed cost structure associated with our retail operations, negative cash flows or the closure of a store could result in write downs of inventory, +impairment of leasehold improvements, impairment losses on other long-lived assets, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact +our financial position, results of operations or cash flows. For example, during 2014, we recorded impairments relating to retail stores of $8.8 million, and these impairment charges may +increase as we evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our financial results. +We depend on key personnel across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives +and senior management can adversely impact our stock price, our results of operations and our client relationships and may make recruiting for future management positions more difficult or may require +us to offer more generous executive compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of +operations as new management becomes familiar with our business. In recent years, we have experienced management turnover. Our future success depends on our ability to identify, attract and retain +qualified personnel on a timely basis. In addition, we must successfully integrate any newly hired management personnel within our organization in order to achieve our operating objectives. In late +2013, our President and CEO, John McCarvel, announced his resignation from the Company effective in April 2014. In May 2014, Andrew Rees was appointed as President of the Company and interim CEO with +principal responsibilities for the Crocs brand, and effective in January 2015, Gregg Ribatt was appointed as our Chief Executive Officer. The key initiatives directed by these executives may take time +to implement and yield positive results, if at all. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays in our long-term +growth strategy. +As +a global company, we also rely on a limited number of key international personnel to perform their functions at a high level in many of our geographic regions. In certain instances, +one or two +18 +Table of Contents +personnel +may be the primary knowledge base for business operations in a geographic region. The loss of key international personnel can adversely impact our operations and our client relationships. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have +greater difficulty filling our customers' orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid +changes in consumer preferences, the effects of weather, general economic conditions and other factors affecting demand and possibly impairing our brand image. In addition, sales to our wholesale +customers are generally subject to rights of cancellation and rescheduling by the customer. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we +may be forced to liquidate excess inventories at discounted prices resulting in lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages which can result +in lower sales, delays in shipments to customers, strains on our relationships with customers and diminished brand loyalty. A decline in demand for our products, or any failure on our part to satisfy +increased demand for our products, could adversely affect our business and results of operations. In addition, an inability to accurately forecast consumer demand could cause our revenue and earnings +guidance to differ materially from our financial results. +Expanding our footwear product line may be difficult and expensive. If we are unable to successfully +continue such expansion, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully expand our footwear product line, we must anticipate, understand and react to the rapidly changing tastes of consumers +and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to +anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline and we may not be able to +execute our growth plans. +In +producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. Our development schedules for new products are difficult +to predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently manufacture new products in quantities sufficient to support retail +and wholesale +distribution, we may not be able to recover our investment in the development of new styles and product lines and we would continue to be subject to the risks inherent to having a limited product +line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We have a limited history of introducing +new products in certain target markets; as such, we may set the prices of new styles too high for the market to bear or we may not provide the appropriate level of marketing in order to educate the +market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material +increase in our selling, general and administrative expenses and there can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be +successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brands, erode our +competitive position and result in long-term harm to our business. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of +factors, including seasonal variations, which could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. As a significant portion of our +revenues are attributable to footwear styles that are more suitable for fair +19 +Table of Contents +weather +and are derived from sales in the northern hemisphere, we typically experience our highest sales activity during the second and third quarters of the calendar year, when there is fair weather +in the northern hemisphere. While we continue to create new footwear styles that are more suitable for cold weather, the effects of favorable or unfavorable weather on sales can be significant enough +to affect our quarterly results which could adversely affect our common stock price. Quarterly results may also fluctuate as a result of other factors, including new style introductions, general +economic conditions or changes in consumer preferences. Results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and revenues for any +particular period may fluctuate. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +We depend heavily on third-party manufacturers located outside the U.S. +Third-party manufacturers located in China and Vietnam produced the majority of our footwear products in 2014. We depend on the ability +of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity +of our third-party manufacturers, and we do not exert direct control over the manufacturers' operations. As such, we have experienced at times, delays or inabilities to fulfill customer demand and +orders, particularly in China. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines or meet our quality standards. +In +addition, we do not have supply contracts with these third-party manufacturers and any of them may unilaterally terminate their relationship with us at any time or seek to increase +the prices they charge us. As a result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third-party manufacturers. Foreign manufacturing is +subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic +conditions, changes in governmental policies and the imposition of tariffs, import and export controls and other non-tariff barriers. We may not be able to offset any interruption or decrease in +supply of our products by increasing production in our internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third-party +manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an +increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more +expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of +petroleum products can adversely affect our profit margins. +In +addition, because a large portion of our footwear products is manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations between the U.S. +and these countries, political instability in China, increases in labor costs, or adverse weather conditions could significantly interfere with the production and shipment of our products, which would +have a material adverse effect on our operations and financial results. +We manufacture a portion of our products which causes us to incur greater fixed costs. Any +difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of operations. +We produce a portion of our footwear products at our internal manufacturing facilities in Mexico and Italy. Ownership of these +facilities adds fixed costs to our cost structure which are not as easily scalable as variable costs. In addition, the manufacture of our products +from the Croslite material requires the use of a complex process and we may experience difficulty in producing footwear that +20 +Table of Contents +meets +our high quality control standards. We will be required to absorb the costs of manufacturing and disposing of products that do not meet our quality standards. Any increases in our manufacturing +costs could adversely impact our profit margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges faced by our third-party manufacturers, including our +ability to scale our production capabilities to meet the needs of our customers. Our manufacturing may also be disrupted for reasons beyond our control, including work stoppages, fires, earthquakes, +floods or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in a timely manner and could have a material and adverse +effect on our business, results of operations and cash flows. +Our third-party manufacturing operations must comply with labor, trade and other laws; failure to do +so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions +and other matters, including compliance with applicable labor, environmental and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by +any of our third-party manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our products, generate negative publicity, +damage our reputation and the value of our brand and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by +any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall which could result in critical media coverage and harm our business and reputation and +could cause us to incur additional costs. +In +addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and +the forfeiture of the products we are attempting to import or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of +our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas or labor violations. The effects of +these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or +foreign customs quotas, duties, taxes or other changes or restrictions will be imposed upon the importation of foreign produced +products in the future or what effect such actions could have on our business, financial condition or results of operations. +Our revolving credit facility contains financial covenants that require us to maintain certain +financial metrics and ratios and restrictive covenants that limit our flexibility. A breach of those covenants may cause us to be in default under the facility, and our lenders could foreclose on our +assets. +The credit agreement for our revolving credit facility requires us to maintain a certain leverage ratio, a certain level of +unrestricted cash at all times, and a minimum fixed charge coverage ratio on a quarterly basis. A failure to maintain current revenue levels or an inability to control costs or capital expenditures +could negatively impact our ability to meet these financial covenants. If we breach such covenants or any of the restrictive covenants described below, the lenders could either refuse to lend funds to +us or accelerate the repayment of any outstanding borrowings under the revolving credit facility. We may not have sufficient assets to repay such indebtedness upon a default. If we are unable to repay +the indebtedness, the lenders could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the revolving credit facility. +The +credit agreement also contains certain restrictive covenants that limit and in some circumstances prohibit, our ability to, among other things incur additional debt, sell, lease or +transfer our assets, pay dividends on our common stock, make capital expenditures and investments, guarantee +21 +Table of Contents +debt +or obligations, create liens, repurchase our common stock, enter into transactions with our affiliates and enter into certain merger, consolidation or other reorganizations transactions. These +restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, +conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +Our financial success may be limited to the strength of our relationships with our wholesale +customers and to the success of such wholesale customers. +Our financial success is related to the willingness of our current and prospective wholesale customers to carry our products. We do not +have long term contracts with any of our wholesale customers. Sales to our wholesale customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by +the customer. If we cannot fill our customers' orders in a timely manner, the sales of our products and our relationships with those customers may suffer. Alternatively, if our customers experience +diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in customer order cancellations and/or the need to extend customer payment terms which +could lead to higher accounts receivable balances, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense. Specifically, we recorded a reserve for +doubtful accounts of approximately $11.5 million in our Asia Pacific segment for the year ended December 31, 2014 primarily as a result of delayed payments from our partner stores in +China and Southeast Asia. Additional problems with our wholesale customers, including continued payment delays in the Asia Pacific segment or other segments from regional wholesale partners may have a +material adverse effect on our product sales, financial condition, results of operations and our ability to grow our product line. +We depend on a limited number of suppliers for key production materials, and any disruption in the +supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that +constitute the primary raw materials used in compounding our Croslite products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for +elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production cycle. We are also subject to +market issues related to supply and demand for our raw materials. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would +increase our production costs and could have a significantly adverse impact on our profit margins and results of operations. If we are unable to obtain suitable elastomer resins or if we are unable to +procure sufficient quantities of the Croslite material, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics resulting in less +favorable market acceptance which could result in lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and +counterfeiting of our brands could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress and designs on nearly all of +our products. We believe that having distinctive marks that are readily identifiable is important to our brand, our success and our competitive position. The laws of some countries, for example, +China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on +our intellectual property rights. If we are unsuccessful in challenging another +22 +Table of Contents +party's +products on the basis of trademark or design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, continued +sales of such competing products by third parties could harm our brand and adversely impact our business, financial condition, revenues and results of operations by resulting in the shift of consumer +preference away from our products. If our brands are associated with inferior counterfeit reproductions, the integrity and reputation of our brands could be adversely affected. Furthermore, our +efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face +significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts +with others, our business or financial condition could be adversely affected. +We +also rely on trade secrets, confidential information and other unpatented proprietary rights and information related to, among other things, the Croslite material and product +development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation +of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information and other +unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the +agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information and other unpatented proprietary rights and information may become known to +others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +We have substantial cash requirements in the U.S.; however, a majority of our cash is generated and +held outside of the U.S. The consequential risks of holding cash abroad could adversely affect our financial condition and results of operations. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider +unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily +used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be +subject to U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax +consequences if we were to move the cash to another country. Certain countries, including China, may have monetary laws which may limit our ability to utilize cash resources in those countries for +operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. Since +repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able to repatriate such cash on favorable terms or in a timely +manner. If we incur operating losses on a continued basis and require cash that is held in international accounts for use in our U.S. operations, a failure to repatriate such cash in a timely and +cost-effective manner could adversely affect our business, financial condition and results of operations. +We are subject to periodic litigation, which could result in unexpected expense of time and +resources. +From time to time, we are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties +of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. We are currently involved in several, potentially adverse legal proceedings. For a detailed discussion of our +current legal proceedings, see Item 3 . Legal Proceedings in +23 +Table of Contents +Part I +of this Form 10-K. An unfavorable outcome in any of these proceedings or any future legal proceedings could have an adverse impact on our business, financial condition and results +of operations. In addition, any significant litigation in the future, regardless of its merits, could divert management's attention from our operations and result in substantial legal fees. In the +past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in +substantial costs and a diversion of management's attention and resources that are needed to successfully run our business. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us +which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from +management's estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. +Changes in tax laws and unanticipated tax liabilities and the results of tax audits or litigation +could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective income tax rate in the future +could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and +liabilities, changes in tax laws, the outcome of income tax audits in various jurisdictions around the world and any repatriation of non-U.S. earnings for which we have not previously provided for +U.S. taxes. We regularly assess all of these matters to determine the adequacy of our tax provision, which is subject to significant discretion and we could face significant adverse impact if our +assumptions are incorrect and/or face significant cost to defend our practices from international and U.S. tax authorities. We are regularly subject to, and are currently undergoing, audits by tax +authorities in the United States and foreign jurisdictions for prior tax years. Please refer to Item 3. Legal Proceedings in Part I of +this Form 10-K as well as Note 15—Commitments and Contingencies in the accompanying notes to the consolidated financial statements for additional details regarding current +tax audits. Although we believe our tax estimates are reasonable and we intend to defend our positions through litigation if necessary, the final outcome of tax audits and related litigation is +inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional +taxes and/or fines or penalties relating to ongoing or future audits. The adverse resolution of any audits or litigation could have an adverse effect on our financial position and results of +operations. +We are required to pay regular dividends on the Series A Convertible Preferred Stock, par +value $0.001 per share ("Series A Preferred Stock") issued to Blackstone Capital Partners VI L.P. ("Blackstone") in 2014, which ranks senior to our common stock, and we may be required +under certain circumstances to repurchase the outstanding shares of Series A Preferred Stock; such obligations could adversely affect our liquidity and financial condition. +The Series A Preferred Stock ranks senior to our common stock with respect to dividend rights, and holders of Series A +Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value of $1,000 per share. These regular cash dividends on our Series A +Preferred Stock are payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year. If we fail to make timely dividend payments, the dividend rate +will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in full. In addition, the holders of our Series A Preferred Stock have certain redemption +rights, including upon certain change +24 +Table of Contents +in +control events involving us, which, if exercised, could require us to repurchase all of the outstanding shares of Series A Preferred Stock at 100% or more of the stated value of the shares, +plus all accrued but unpaid dividends. Our obligations to pay regular dividends to the holders of our Series A Preferred Stock or any required repurchase of the outstanding shares of +Series A Preferred Stock could impact our liquidity and reduce the amount of cash flows available for working capital, capital expenditures, growth opportunities, acquisitions, and other +general corporate purposes. Our obligations to the holders of Series A Preferred Stock could also limit our ability to obtain additional financing or increase our borrowing costs, which could +have an adverse effect on our financial condition. +Our financial results may be adversely affected if substantial investments in businesses and +operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses and expansion of existing businesses, such +as our retail operations, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, +significant investments are subject to typical risks and uncertainties inherent in acquiring or expanding a business. The failure of any significant investment to provide the returns or profitability +we expect or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Natural disasters could negatively impact our operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis or other adverse weather and climate conditions, whether occurring in the +U.S. or abroad, and the consequences and effects thereof, including energy shortages and public health issues, could disrupt our operations or the operations of our vendors and other suppliers, or +result in economic instability that may negatively impact our operating results and financial condition. +The issuance of 200,000 shares of our Series A Preferred Stock to Blackstone in 2014 and +certain of its permitted transferees reduces the relative voting power of holders of our common stock, may dilute the ownership of such holders, and may adversely affect the market price of our common +stock. +On January 27, 2014, we issued 200,000 shares of Series A Preferred Stock to Blackstone and certain of its permitted +transferees (collectively, the "Blackstone Purchasers") pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, the "Investment Agreement"). The +Blackstone Purchasers currently own all of the outstanding shares of Series A Preferred Stock, and based on the number of shares of our common stock outstanding as of December 31, 2014, +the Blackstone Purchasers collectively own Series A Preferred Stock convertible into approximately 14.9% of our common stock. As holders of our Series A Preferred Stock are entitled to +vote, on an as-converted basis, together with holders of our common stock as a single class on all matters submitted to a vote of our common stock holders, the issuance of the Series A +Preferred Stock to the Blackstone Purchasers has effectively reduced the relative voting power of the holders of our common stock. +In +addition, conversion of the Series A Preferred Stock to common stock will dilute the ownership interest of existing holders of our common stock, and any sales in the public +market of the common stock issuable upon conversion of the Series A Preferred Stock could adversely affect prevailing market prices of our common stock. We have granted the Blackstone +Purchasers registration rights in respect of the shares of Series A Preferred Stock and any shares of common stock issued upon conversion of the Series A Preferred Stock. These +registration rights would facilitate the resale of such securities into the public market, and any such resale would increase the number of shares of our common stock available for public trading. +Sales by the Blackstone Purchasers of a substantial number of shares of +25 +Table of Contents +our +common stock in the public market, or the perception that such sales might occur, could have a material adverse effect on the price of our common stock. +Blackstone may exercise significant influence over us, including through its ability to elect up to +two members of our Board of Directors. +As of December 31, 2014, the shares of Series A Preferred Stock owned by the Blackstone Purchasers represent +approximately 14.9% of the voting rights of our common stock, on an as-converted basis, so the Blackstone Purchasers will have the ability to significantly influence the outcome of any matter +submitted for the vote of our stockholders. In addition, the Certificate of Designations of the Series A Preferred Stock grants certain consent rights to the holders of Series A +Preferred Stock in respect of certain actions by the Company, including the issuance of pari passu or senior equity securities of the Company, certain +amendments to our certificate of incorporation or bylaws, any increase in the size of our Board of Directors (the "Board") above eight members, the payment of certain distributions to our +stockholders, and the incurrence or refinancing of a certain level of indebtedness. The Blackstone Purchasers may have interests that diverge from, or even conflict with, those of our other +stockholders. For example, Blackstone and its affiliates may have an interest in directly or indirectly pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, +could enhance their other equity investments, even though such transactions might involve risks to us. Blackstone and its affiliates are in the business of making or advising on investments in +companies, including businesses that may directly or indirectly compete with certain portions of our business. They may also pursue acquisition opportunities that may be complementary to our business, +and, as a result, those acquisition opportunities may not be available to us. +In +addition, the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as Blackstone and its permitted transferees +(i) beneficially own at least 95% of the Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement or (ii) maintain beneficial +ownership of at least 12.5% of our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors to our Board. For so long as +Blackstone and its permitted transferees beneficially own shares of Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement that represent less +than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate +for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules, and one of such +directors, Gregg Ribatt, has been recently appointed to be our new Chief Executive Officer. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain +provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could +delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and +take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General +Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be +favorable could cause the market price of our common stock to decline. +ITEM 1B. Unresolved Staff Comments +None. +26 +Table of Contents +ITEM 2. Properties +Our principal executive and administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado. We lease, rather than +own, all of our domestic and international facilities. We currently enter into short-term and long-term leases for kiosk, manufacturing, office, outlet, retail, and warehouse space. The terms of our +leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, +use and approximate size of our principal properties are given below. +Location +Reportable Operating Segment(s) +that Use this Property +Use +Approximate +Square Feet +Leon, Mexico +Americas, Asia Pacific, Japan, Europe +Manufacturing/warehouse/offices +421,000 +Ontario, California +Americas +Warehouse +399,000 +Rotterdam, the Netherlands +Europe +Warehouse +174,000 +Niwot, Colorado +Americas +Corporate headquarters and regional offices +160,000 +Narita, Japan(1) +Asia Pacific, Japan +Warehouse +156,000 +Padova, Italy +Americas, Asia Pacific, Japan, Europe +Manufacturing/warehouse/offices +45,000 +Hoopddorf, the Netherlands +Europe +Regional offices +31,000 +Shenzen, China +Asia Pacific +Regional offices +28,000 +Gordon's Bay, South Africa +Asia Pacific +Warehouse/offices +28,000 +Singapore +Asia Pacific +Regional offices +23,000 +Shanghai, China +Asia Pacific +Regional offices +19,000 +Boston, Massachusetts +Americas +Global Commercial Center +16,000 +Tokyo, Japan +Japan +Regional offices +13,000 +(1) The +warehouse facilities in this location are fully or partially subleased. +In +addition to the principal properties listed above, we maintain small branch sales offices in the United States, Canada, South America, Taiwan, Hong Kong, Australia, Korea, China, the +United Arab Emirates, India and Europe. We also lease more than 580 retail, outlet and kiosk/store in store +locations worldwide. See Item 1 of this Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +We and certain current and former officers and directors were named as defendants in complaints filed by investors in the United States +District Court for the District of Colorado. The first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in +September 2008, the district court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purported to state claims under +Sections 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the "Class +Period"). The amended complaint also added our independent auditor as a defendant. The amended complaint alleged that, during the Class Period, the defendants made false and misleading public +statements about us and our business and prospects and, as a result, the market price of our common stock was artificially inflated. The amended complaint also claimed that certain current and former +officers and directors traded in our common stock on the basis of material non-public information. The amended complaint sought compensatory damages on behalf of the alleged class in an unspecified +amount, including interest, and also sought attorneys' fees and costs of litigation. On February 28, 2011, the District Court granted motions to dismiss filed by the defendants and dismissed +all claims. A final +27 +Table of Contents +judgment +was thereafter entered. Plaintiffs subsequently appealed to the United States Court of Appeals for the Tenth Circuit. We and those current and former officers and directors named as +defendants entered into a Stipulation of Settlement with the plaintiffs to resolve all claims asserted against us by the plaintiffs on behalf of the putative class. Our independent auditor was not a +party to the Stipulation of Settlement. The Stipulation of Settlement received preliminary approval from the District Court on August 28, 2013. On September 18, 2014, the District Court +entered an order of final approval of the settlement and, on September 19, 2014, the District Court entered final judgment dismissing the action against us and those current and former officers +and directors named as defendants in its entirety with prejudice. The full settlement amount has been paid by our insurers. Since no notice of appeal was filed during the appeal period, this action is +now terminated as to Crocs and its affiliated individuals. Crocs considers this matter closed. +We +are currently subject to an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In October 2013, CBP issued the final audit report. In +that report CBP projects that unpaid duties totaling approximately $12.4 million are due for the period under review and +recommends collection of the duties due. We responded that these projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less +than the projection. Additionally, on December 12, 2014, we made an offer to settle CBP's potential claims and tendered $3.5 million. At this time, it is not possible to determine how +long it will take CBP to evaluate our offer or to predict whether our offer will be accepted. Likewise, if a settlement cannot be reached, it is not possible to predict with any certainty whether CBP +will seek to assert a claim for penalties in addition to any unpaid duties, but such an assertion is a possibility. +Mexico's +Federal Tax Authority ("SAT") has audited the company's records regarding imports and exports during the period from January 2006 to July 2011. There were two phases to the +audit, the first for capital equipment and finished goods and the second for raw materials. The first phase was completed and no major discrepancies were noted by the SAT. On January 9, 2013, +Crocs received a notice for the second phase in which the SAT issued a tax assessment (taxes and penalties) of roughly 280.0 million pesos (approximately $22.0 million) based on the +value of all of Crocs' imported raw materials during the audit period. We believe that the proposed penalty amount is unfounded and without merit. With the help of local counsel we filed an appeal by +the deadline of March 15, 2013. We have argued that the amount due in connection with the matter, if any, is substantially less than that proposed by the SAT. In connection with the appeal, the +SAT required us to post an appeal surety bond in the amount of roughly 321.0 million pesos (approximately $26.0 million), which amount reflects estimated additional penalties and +interest if we are not successful on our appeal. This amount will be adjusted on an annual basis. On November 27, 2014, the Superior Chamber of the Federal Tax Court ruled in favor of Crocs and +annulled the tax assessment and the corresponding penalty. Crocs anticipates that the SAT will appeal this ruling. It is not possible at this time to predict the outcome of this matter or reasonably +estimate any potential loss. +Crocs +is currently subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010-2014. On January 13, 2015 Crocs was notified +about the issuance of assessments totaling roughly $5.25 million for the period January 2010 through May 2011. Crocs has disputed these assessments and asserted defenses to the claims. On +February 25, 2015 Crocs received additional assessments totaling roughly $11.54 million related to the remainder of the audit period. Crocs is in the process of reviewing these +assessments, however, it expects to contest and file defenses to these claims as well. It is not possible at this time to predict the outcome of this matter. +Although +we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not +party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business, financial position, results of operations or cash flows. +ITEM 4. Mine Safety Disclosures +None. +28 +Table of Contents +PART II +ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol "CROX". The +following table shows the high and low sales prices of our common stock for the periods indicated. +Fiscal Year 2014 Three Months Ended +High +Low +March 31, 2014 +$ +16.88 +$ +14.41 +June 30, 2014 +$ +15.78 +$ +14.15 +September 30, 2014 +$ +16.83 +$ +12.25 +December 31, 2014 +$ +13.47 +$ +11.33 +Fiscal Year 2013 Three Months Ended +High +Low +March 31, 2013 +$ +16.36 +$ +14.13 +June 30, 2013 +$ +17.95 +$ +14.19 +September 30, 2013 +$ +17.62 +$ +12.65 +December 31, 2013 +$ +16.27 +$ +11.96 +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite +Index and the Dow Jones U.S. Footwear Index from December 31, 2009 through December 31, 2014. The graph assumes an investment of $100 on December 31, 2009 and assumes the +reinvestment of all dividends and other distributions. +29 +Table of Contents +Comparison of Cumulative Total Return on Investment +12/31/2009 +12/31/2010 +12/31/2011 +12/31/2012 +12/31/2013 +12/31/2014 +Crocs, Inc. +$ +100.00 +$ +297.74 +$ +256.87 +$ +250.26 +$ +276.87 +$ +217.22 +Dow Jones US Footwear Index +100.00 +130.93 +145.60 +152.57 +234.13 +272.40 +Nasdaq Composite Index +100.00 +116.91 +114.81 +133.07 +184.06 +208.71 +The +Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all +of our product categories and lines of business. The Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corp., Iconix Brand Group, Inc., Skechers +U.S.A., Inc. Steven Madden Ltd. and Wolverine World Wide, Inc., among other companies. As Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of +our stock have an effect on this index. The Nasdaq Composite +Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not +necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 90 as of January 30, 2015. +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common +stock in the foreseeable future. Our financing arrangements contain certain restrictions on our ability to pay cash dividends on our common stock. In addition, the Certificate of Designations +governing the Series A Convertible Preferred Stock that we issued in January 2014 restricts us from declaring and paying certain dividends on our common stock if we fail to pay all accumulated +and unpaid regular dividends and/or declared and unpaid participating dividends to which the preferred holders are entitled. Any future determination to declare cash dividends on our common stock will +be made at the discretion of our Board of Directors (the "Board"), subject to +30 +Table of Contents +compliance +with covenants under any then-existing financing agreements and the terms of the Certificate of Designations. +Purchases of Equity Securities by the Issuer +Period +Total Number +of Shares +(or Units) +Purchased +Average +Price Paid +per Share +(or Unit) +Total Number of +Shares (or Units) +Purchased as Part of +Publicly Announced +Plans or +Programs(1) +Approximate Dollar +Value of Shares that +May Yet Be +Purchased Under the Plan +Programs (in thousands) +October 1, 2014 - October 31, 2014 +669,988 +$ +11.99 +669,988 +$ +249,710 +November 1, 2014 - November 30, 2014 +2,324,788 +12.36 +2,324,788 +220,972 +December 1, 2014 - December 31, 2014 +1,501,411 +12.58 +1,501,411 +202,089 +Total +4,496,187 +$ +12.38 +4,496,187 +$ +202,089 +(1) On +December 26, 2013, the board of directors approved the repurchase of up to $350.0 million of our common stock, which was announced on +December 30, 2013. This authorization replaced our previous stock repurchase authorizations. During the three months ended December 31, 2014, we repurchased approximately +4.5 million shares at a weighted-average price of $12.38 for an aggregate price of approximately $55.7 million excluding related commission charges, under our publicly-announced +repurchase plan. During the year ended December 31, 2014, we repurchased approximately 10.6 million shares at a weighted-average price of $13.75 for an aggregate price of approximately +$145.6 million excluding related commission charges, under our publicly-announced repurchase plan. As of December 31, 2014, approximately $202.1 million of shares remained +available for repurchase under our share repurchase authorization. The number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be +evaluated by us depending on market conditions, liquidity needs and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase +authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The board of directors may suspend, modify or terminate the repurchase +program at any time without prior notice. +31 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five fiscal years. The information in this table +should be read in conjunction with the consolidated financial statements and accompanying notes and with Management's Discussion and Analysis of Financial Conditions and Results of Operations included +in Item 7 of this Form 10-K. +Financial History +($ thousands, except share and per share data) +2014 +2013 +2012 +2011 +2010 +Year Ended December 31, +Revenues +$ +1,198,223 +$ +1,192,680 +$ +1,123,301 +$ +1,000,903 +$ +789,695 +Cost of sales +603,893 +569,482 +515,324 +464,493 +364,631 +Restructuring charges +3,985 +— +— +— +1,300 +Gross profit +590,345 +623,198 +607,977 +536,410 +423,764 +Gross margin % +49.3 +% +52.3 +% +54.1 +% +53.6 +% +53.7 +% +Selling, general and administrative expenses +565,712 +549,154 +460,393 +404,803 +342,961 +Selling, general and administrative expenses as a % of revenues +47.2 +% +46.0 +% +41.0 +% +40.4 +% +43.4 +% +Restructuring charges +20,532 +— +— +— +2,539 +Asset impairment charges +8,827 +10,949 +1,410 +528 +141 +Income (loss) from operations +(4,726 +) +63,095 +146,174 +131,079 +78,123 +Income (loss) before income taxes +(8,549 +) +59,959 +145,548 +136,690 +80,792 +Income tax (benefit) expense +(3,623 +) +49,539 +14,205 +23,902 +13,066 +Net income (loss) +(4,926 +) +10,420 +131,343 +112,788 +67,726 +Dividends on Series A convertible preferred shares +11,301 +— +— +— +— +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +2,735 +— +— +— +— +Net income (loss) attributable to common stockholders +$ +(18,962 +) +$ +10,420 +$ +131,343 +$ +112,788 +$ +67,726 +Income (loss) per common share: +Basic +$ +(0.22 +) +$ +0.12 +$ +1.46 +$ +1.27 +$ +0.78 +Diluted +$ +(0.22 +) +$ +0.12 +$ +1.44 +$ +1.24 +$ +0.76 +Weighted average common shares: +Basic +85,140,181 +87,988,798 +89,571,105 +88,317,898 +85,482,055 +Diluted +85,140,181 +89,089,473 +90,588,416 +89,981,382 +87,595,618 +Cash (used in) provided by operating activities +$ +(11,651 +) +$ +83,464 +$ +128,356 +$ +142,376 +$ +104,274 +Cash used in investing activities +$ +(57,992 +) +$ +(69,758 +) +$ +(65,943 +) +$ +(41,664 +) +$ +(42,078 +) +Cash provided by (used in) financing activities +$ +23,431 +$ +(1,161 +) +$ +(16,625 +) +$ +8,917 +$ +5,245 +Financial History +($ thousands) +2014 +2013 +2012 +2011 +2010 +As of December 31, +Cash and cash equivalents +$ +267,512 +$ +317,144 +$ +294,348 +$ +257,587 +$ +145,583 +Inventories +$ +171,012 +$ +162,341 +$ +164,804 +$ +129,627 +$ +121,155 +Working capital +$ +441,523 +$ +453,149 +$ +455,177 +$ +370,040 +$ +243,252 +Total assets +$ +806,931 +$ +875,159 +$ +829,638 +$ +695,453 +$ +549,481 +Long term obligations +$ +27,849 +$ +63,487 +$ +54,300 +$ +48,370 +$ +35,613 +Total stockholders' equity +$ +452,518 +$ +624,744 +$ +617,400 +$ +491,780 +$ +376,106 +32 +Table of Contents +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +We are a designer, developer, manufacturer, worldwide marketer and distributor of casual lifestyle footwear, apparel and accessories +for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that +utilize our proprietary closed cell-resin, called Croslite. The use of this unique material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell +our products in more than 90 countries through domestic and international retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, webstores +and kiosks. +Since +the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new styles and products and have +further extended our product reach through the acquisition of brand platforms. Going forward, we intend to focus our footwear product lines on our core molded footwear heritage, as well as develop new +innovative casual +lifestyle footwear collections. We intend to streamline our product portfolio, eliminate non-core product development and explore strategic alternatives for non-core programs such as our golf line and +our Ocean Minded brand, as well as our apparel and accessories business. +The +broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including family footwear stores, department stores, sporting goods and +traditional footwear retailers as well as a variety of specialty and independent retail channels and the internet. We intend to drive cohesive global brand positioning from region-to-region and +year-to-year to create a more clear and consistent product portfolio and message, resulting in a more powerful consumer connections to the brand. This strategy will be accomplished through developing +powerful product stories supported with effective and consistent global marketing campaigns. Finally, we intend to increase our working market spend, which we define as funds that put marketing +messages in front of consumers. +As +a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. Sales in international markets in foreign currencies are expected to +continue to represent a substantial portion of our revenues. Likewise, we expect that our subsidiaries with functional currencies other than the U.S. Dollar will continue to represent a substantial +portion of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs +from period to period as a result of the impact of foreign currency translation adjustments into our reporting currency. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America +("U.S. GAAP"), we present current period "adjusted selling, general and administrative expenses", which is a non-GAAP financial measure, within this Management's Discussion and Analysis. +Adjusted results exclude the impact of items that management believes affect the comparability or underlying business trends in our consolidated financial statements in the periods presented. +We +also present certain information related to our current period results of operations in this Item 7 through "constant currency", which is a non-GAAP financial measure and +should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been +restated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate +fluctuations. +33 +Table of Contents +Management +uses adjusted results to assist in comparing business trends from period to period on a consistent basis without regard to the impact of non-GAAP adjustments in communications +with the Board, stockholders, analysts and investors concerning our financial performance. We believe that these non-GAAP measures are used by, and are useful to, investors and other users of our +financial statements in evaluating operating performance by providing better comparability between reporting periods because they provide an additional tool to evaluate our performance without regard +to non-GAAP adjustments that may not be indicative of overall business trends. We believe they also provide a better baseline for analyzing trends in our operations. We do not suggest that investors +should consider these non-GAAP measures in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. Please refer to our 'Results of Operations' +within this section for a reconciliation of adjusted selling, general and administrative expenses to GAAP selling, general and administrative expenses. +Recent Events +Gregg Ribatt was appointed the Company's Chief Executive Officer, effective January 28, 2015. In connection with his appointment +as Chief Executive Officer, he will also serve as the Company's principal executive officer, succeeding the Company's acting principal executive officer, Andrew Rees. Mr. Rees will continue in +his role as President of the Company. +2014 Financial Highlights +During the year ended December 31, 2014, we experienced relatively flat revenue growth of 0.5%. Unfavorable exchange rates +driven by a stronger U.S. Dollar reduced revenue by $15.6 million on a constant-currency basis. We experienced a $7.8 million, or 1.9%, increase in retail channel revenues despite net +store closures of 34 worldwide since December 31, 2013, but an overall decrease of 3.7% in comparable store sales compared to prior year. Additionally, sales from the internet channel increased +3.9% in 2014 compared to 2013. This was offset by a 0.9% aggregate decline in wholesale sales during 2014. +Specifically, +we experienced strong revenue results in our Europe wholesale channel and retail channels and our Asia Pacific retail and internet channels. We experienced lower than +expected growth in our Asia Pacific segment primarily due to decreased performance in our China business as a result of increased distributor inventory levels and lower replenishment orders. On a +constant-currency basis, our Japan segment experienced lower revenues of $2.8 million and an operating loss of $9.4 million as a result of continuing macroeconomic turmoil related to the +lingering decline of the Japanese Yen. +The +following are significant developments in our businesses during the year ended December 31, 2014: +• Revenues increased $5.5 million, or 0.5%, to $1.2 billion compared to the same period in 2013. Revenue growth was +predominately driven by a 2.5% increase in global footwear unit sales partially offset by a 1.7% decrease in global average footwear unit selling price which was primarily a result of foreign currency +translation adjustments and liquidation of discontinued products. +• Gross profit decreased $32.9 million, or 5.3%, to $590.3 million and gross margin percentage decreased 298 basis points +to 49.3% compared to 2013. The decline in gross margin percentage is primarily driven by the evolution of our product assortment and foreign currency translation adjustments, as only approximately 35% +of our revenues were earned in the U.S. Dollar, compared to approximately 80% of costs of sales that were incurred in the U.S. Dollar. In addition, we experienced unit sales volume difficulty in our +Americas market, lower than expected unit sales in our China market leading to decreased gross margins as average margins in China are typically higher than the global average, increased shipping +costs globally and a +34 +Table of Contents +$11.5 million +write-down and/or disposals of obsolete inventory, $4.0 million of which was reported in 'Restructuring charges' in cost of sales related to the elimination of our golf +product line. +• Selling, general and administrative expenses increased $16.6 million, or 3.0%, to $565.7 million compared to the same +period in 2013. Selling, general and administrative expenses increased predominately due to an increase of $10.2 million in bad debt expense associated with delayed payments from distributors +in China and Southeast Asia. In addition, we experienced an increase of $24.8 million in expenses that we believe to be non-indicative of our underlying business trends including +reorganizational charges as a result of transition activities, additional operating expenses related to our ERP implementation and charges related to litigation settlements. +• We incurred $24.5 million in restructuring charges as a result of our strategic plans for long-term improvement and growth of +the business. These charges included severance costs related to executive management and employees, retail store closure costs and a write-down of obsolete inventory related to an exited business +lines. +• We incurred $8.8 million in retail asset impairment charges related to certain underperforming retail locations in our +Americas, Europe and Asia Pacific segments that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. +• Net income (loss) attributable to common stockholders decreased $29.4 million, or 282.0%, to a net loss of $19.0 million +compared to net income of $10.4 million for 2013. Net loss per share was $0.22 during the year ended December 31, 2014 compared to net income per share of $0.12 during the year ended +December 31, 2013. These decreases are primarily the result of certain special charges such as restructuring and asset impairment charges as well as dividends declared on our Series A +Preferred Stock and dividend equivalents as a result of the investment from Blackstone Capital Partners VI L.P. ("Blackstone"), which contributed a decrease of $14.0 million in net +income attributable to common stockholders. +• We slowed the expansion of our retail channel and have begun to focus on the long-term profitability of current locations. We opened +70 company-operated stores during the year ended December 31, 2014, half of which were outlet or low investment kiosk/store-in-store locations, and closed 104 company-operated stores, 20 of +which were identified in the initial restructuring plan. +• We continue to fund the implementation of our customized and fully integrated operations, accounting, and finance ERP system. During +2014, we successfully launched the ERP in Australia, New Zealand and Japan, and in early 2015, we continued the implementation globally. We believe the introduction of the new ERP system to our +current environment will allow for seamless and high-quality data across the Company. As of December 31, 2014, total costs to date related to the ERP implementation were $88.3 million, +of which $70.7 million has been capitalized and $17.6 million has been expensed. As of December 31, 2014, we had $11.6 million in outstanding borrowings related to the ERP +system under a Master Installment Payment Agreement ("Master IPA") with PNC Equipment Finance, LLC ("PNC Equipment"). +• We repurchased approximately 10.6 million shares at an average price of $13.75 per share for a total value of +$145.6 million, excluding related commission charges. +Future Outlook +During 2014, we announced strategic plans for long-term improvement and growth of the business. These plans comprised four key +initiatives including: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient +35 +Table of Contents +organizational +structure including reducing duplicative and excess overhead which will also enhance the decision making process, and (4) closing or converting approximately 75 to 100 Crocs +branded retail stores around the world. During 2014, we executed several initiatives to accomplish our strategic plans, such as a reduction in workforce and the closure of 104 stores (20 of which were +identified in the initial restructuring plan) and will continue to execute our strategy during 2015. +First, +we intend to focus on our core molded footwear heritage, as well as develop innovative new casual lifestyle footwear platforms. We intend to streamline the product portfolio, +eliminate non-core product development and will explore strategic alternatives for the non-core products and brands. We expect more centralized product line control will also result in a reduction of +the SKU proliferation +that has occurred over the past few years, a more simplified and efficient supply chain and a reduction in overall product line costs and inventory levels. +Further, +we intend to drive cohesive global brand positioning from region-to-region and year-to-year to create a clearer and consistent product portfolio and message, resulting in a more +powerful consumer connection to the brand. We intend to accomplish this strategy through developing powerful product stories supported with effective consistent and clear marketing. Finally, during +2015 we intend to increase our working market spend, which we define as funds that put marketing messages in front of consumers. +We +have been discontinuing non-core programs in order to focus on growing our core-molded heritage categories while developing more compelling casual footwear platforms. We have +discontinued our Crocs Golf products as well as gear and apparel, and closed Ocean Minded as an independent brand. We are currently focusing on products and product stories for Fall/Holiday 2015. +Second, +we are refining our business model around the world, prioritizing direct investment in larger-scale geographies to focus our resources on the biggest opportunities, moving away +from direct investment in the retail and wholesale businesses in smaller markets and transferring significant commercial responsibilities to distributors and third-party agents. These re-alignments +are already underway in Brazil, Taiwan and other markets around the globe. Further, we intend to expand engagement with leading wholesale accounts in select markets to drive sales growth, optimize +product placement and enhance brand reputation. +Third, +we have reorganized key business functions to improve efficiency and have eliminated approximately185 global positions of which the majority occurred on July 21, 2014, +reducing structural complexity, size and cost. In addition, we opened our Global Commercial Center in the Boston area in late 2014, housing key merchandising, marketing and retail executives. The +Boston location was selected in order to attract experienced senior footwear and business development management talent. The Global Commercial Center in Boston will join the Product Creation and +Global Shared Services Center in Niwot, Colorado, the cornerstone of support for Crocs' global business. We intend to strengthen our Regional Commercial Centers in the Netherlands, Singapore and Japan +with responsibility for managing Crocs' global business. +We +have made multiple organizational changes including the appointment of Andrew Rees as President of the Company and interim CEO during 2014, and the subsequent appointment of Gregg +Ribatt as Chief Executive Officer effective in early 2015, the hiring of Michelle Poole, as Senior Vice President of Global Product Creation and Merchandising, and Bob Munroe, as the new General +Manager of our Americas segment. Additionally, we hired David Thomson as SVP, General Manager of Asia/Africa and Middle East, commencing May 1, 2015. We are excited to enrich our team as we +focus on the future and potential growth opportunities of the Crocs brand. +Fourth, +we plan to rationalize under-performing business units, in order to re-align cost structure and place greater focus on assets and operations with higher profit potential. During +the year ended December 31, 2014, we closed 104 company-operated stores (20 of which were identified in the initial +36 +Table of Contents +restructuring +plan). We plan to continue to close approximately 65 stores during 2015. The impact of these closures and conversions is expected to reduce annual revenue by approximately +$8 million, with an insignificant impact on future operating income during 2015. +Overall, +we undertook a comprehensive strategic review of the business and its operations globally, and identified four key areas of opportunity in the business: products, geographies, +organization and channels. These plans prioritize earnings growth and our focus on becoming the leading brand in casual lifestyle footwear. +Results of Operations +Comparison of the Years Ended December 31, 2014 to 2013 +Year Ended December 31, +($ thousands, except per share data and +average footwear selling price) +2014 +2013 +$ +% +Revenues +$ +1,198,223 +$ +1,192,680 +$ +5,543 +0.5 +% +Cost of sales +603,893 +569,482 +34,411 +6.0 +Restructuring charges +3,985 +— +3,985 +* +Gross profit +590,345 +623,198 +(32,853 +) +(5.3 +) +Selling, general and administrative expenses +565,712 +549,154 +16,558 +3.0 +Restructuring charges +20,532 +— +20,532 +* +Asset impairment charges +8,827 +10,949 +(2,122 +) +(19.4 +) +Income (loss) from operations +(4,726 +) +63,095 +(67,821 +) +(107.5 +) +Foreign currency transaction losses, net +4,885 +4,678 +207 +4.4 +Interest income +(1,664 +) +(2,432 +) +768 +(31.6 +) +Interest expense +806 +1,016 +(210 +) +(20.7 +) +Other income, net +(204 +) +(126 +) +(78 +) +61.9 +Income (loss) before income taxes +(8,549 +) +59,959 +(68,508 +) +(114.3 +) +Income tax expense (benefit) +(3,623 +) +49,539 +(53,162 +) +(107.3 +) +Net income (loss) +$ +(4,926 +) +$ +10,420 +$ +(15,346 +) +(147.3 +)% +Dividends on Series A convertible preferred shares +11,301 +— +11,301 +* +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +2,735 +— +2,735 +* +Net income (loss) attributable to common stockholders +$ +(18,962 +) +$ +10,420 +$ +(29,382 +) +(282.0 +)% +Net income (loss) per common share: +Basic +$ +(0.22 +) +$ +0.12 +$ +(0.34 +) +(283.3 +)% +Diluted +$ +(0.22 +) +$ +0.12 +$ +(0.34 +) +(283.3 +)% +Gross margin +49.3 +% +52.3 +% +(298)bps +(5.7 +)% +Operating margin +(0.4 +)% +5.3 +% +(568)bps +(107.5 +)% +Footwear unit sales +55,700 +54,326 +1,374 +2.5 +% +Average footwear selling price +$ +20.92 +$ +21.27 +$ +(0.35 +) +(1.7 +)% +Revenues. During the year ended December 31, 2014, revenues remained relatively flat, increasing $5.5 million, or 0.5%, +compared to +2013 primarily due to an increase of 1.4 million, or 2.5%, in global footwear unit sales primarily driven by improved year-over-year performance in our wholesale and internet channels. This +increase was partially offset by a decrease of $0.35 per unit, or 1.7%, in average footwear selling price. +37 +Table of Contents +For +the year ended December 31, 2014, revenues from our wholesale channel decreased $6.2 million, or 0.9%, compared to 2013, which was primarily driven by lower unit sales +in our Americas and Japan segments, decreased performance in our China business as a result of increased distributor inventory levels and lower replenishment orders and lower average selling price in +Europe and Japan. These decreases were partially offset by a 19.2% increase in unit sales in Europe primarily driven by product volume expansion through new wholesale doors and continued support from +existing customers. +For +the year ended December 31, 2014, revenues from our retail channel increased $7.8 million, or 1.9%, compared to 2013, which was primarily driven by a 3.8% increase in +footwear unit sales, primarily attributable to the Americas and Japan segments. This increase was partially offset by lower average selling prices in those segments. Additionally, we experienced an +overall decrease of 3.7% in comparable store sales compared to the prior year. During the year ended December 31, 2014, we opened 70 and closed 104 company-operated stores. We plan to continue +to moderate the pace of our retail expansion in 2015 with a focus on outlet and kiosk locations and consolidating and enhancing the profitability of existing locations. +For +the year ended December 31, 2014, revenues from our internet channel increased $3.9 million, or 3.9%, compared to 2013, which was primarily driven by increased internet +sales in our Asia Pacific segment partially offset by a decrease in internet sales in our Europe segment and lower average selling prices in all segments except Europe. Our internet sales totaled +approximately 8.8% and 8.5% of our consolidated net sales during the years ended December 31, 2014 and 2013, respectively. We continue to benefit from our online presence through webstores +worldwide enabling us to have increased access to our customers in a low cost, attractive manner and providing us with an opportunity to educate them about our products and brand. During the year +ended December 31, 2014, we decreased our global company-operated e-commerce sites 12 in order to focus our internet strategy in our principal geographical locations. +38 +Table of Contents +The +following table summarizes our total revenue by channel for the years ended December 31, 2014 and 2013: +Year Ended +December 31, +Change +Constant +Currency +Change(1) +($ thousands) +2014 +2013 +$ +% +$ +% +Channel revenues: +Wholesale: +Americas +$ +228,615 +$ +239,104 +$ +(10,489 +) +(4.4 +)% +$ +(7,286 +) +(3.0 +)% +Asia Pacific +210,924 +212,761 +(1,837 +) +(0.9 +) +(449 +) +(0.2 +) +Japan +79,686 +90,426 +(10,740 +) +(11.9 +) +(5,176 +) +(5.7 +) +Europe +147,561 +131,215 +16,346 +12.5 +16,189 +12.3 +Other businesses +794 +254 +540 +212.6 +533 +209.8 +Total Wholesale +667,580 +673,760 +(6,180 +) +(0.9 +) +3,811 +0.6 +Consumer-direct: +Retail: +Americas +206,053 +202,925 +3,128 +1.5 +4,552 +2.2 +Asia Pacific +123,597 +120,020 +3,577 +3.0 +2,768 +2.3 +Japan +35,867 +36,566 +(699 +) +(1.9 +) +1,745 +4.8 +Europe +60,309 +58,507 +1,802 +3.1 +3,240 +5.5 +Total Retail +425,826 +418,018 +7,808 +1.9 +12,305 +2.9 +Internet: +Americas +55,247 +56,523 +(1,276 +) +(2.3 +) +(960 +) +(1.7 +) +Asia Pacific +15,928 +9,971 +5,957 +59.7 +6,208 +62.3 +Japan +7,908 +7,871 +37 +0.5 +659 +8.4 +Europe +25,734 +26,537 +(803 +) +(3.0 +) +(868 +) +(3.3 +) +Total Internet +104,817 +100,902 +3,915 +3.9 +5,039 +5.0 +Total revenues: +$ +1,198,223 +$ +1,192,680 +$ +5,543 +0.5 +% +$ +21,155 +1.8 +% +(1) Reflects +year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP +Financial Measures" above for more information. +The +table below illustrates the overall growth in the number of our company-operated retail locations by type of store and reportable operating segment as of December 31, 2014 and +2013: +Company-operated retail locations: +December 31, +2013 +Opened +Closed +December 31, +2014 +Type: +Kiosk/Store in Store +122 +8 +(30 +) +100 +Retail Stores +327 +40 +(56 +) +311 +Outlet Stores +170 +22 +(18 +) +174 +Total +619 +70 +(104 +) +585 +Operating segment: +Americas +216 +16 +(22 +) +210 +Asia Pacific +236 +38 +(70 +) +204 +Japan +49 +6 +(1 +) +54 +Europe +118 +10 +(11 +) +117 +Total +619 +70 +(104 +) +585 +39 +Table of Contents +The +table below sets forth our comparable store sales by reportable operating segment for the year ended December 31, 2014 as compared to the same period in 2013: +Comparable store sales(1) +Constant Currency +Year Ended +December 31, 2014(2) +Constant Currency +Year Ended +December 31, 2013(2) +Americas +(4.4 +)% +(5.8 +)% +Asia Pacific +(4.6 +) +6.9 +Japan +(4.8 +) +(15.0 +) +Europe +0.7 +2.4 +Global +(3.7 +)% +(2.7 +)% +(1) Comparable +store status is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which +selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily +closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. +Comparable store sales exclude the impact of our internet channel revenues and are calculated on a currency neutral basis using historical annual average currency rates. +(2) Reflects +quarter over quarter change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of +Non-GAAP Financial Measures" above for more information. +Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate revenues from our +functional currencies to our reporting currency during the year ended December 31, 2014 decreased our revenues by $15.6 million compared to 2013. +Gross profit. During the year ended December 31, 2014, gross profit decreased $32.9 million, or 5.3%, compared to 2013, +which was +primarily attributable to a $34.4 million, or 6.0%, increase in cost of sales, excluding restructuring, partially offset by a 0.5% increase in revenue. Gross margin percentage decreased 298 +basis points compared to the same period in 2013. The decline in gross margin percentage is primarily driven by an increase in obsolete inventory of $8.1 million for the year ended +December 31, 2014 compared to 2013 primarily driven by inventory obsolescence in China, $4.0 million of costs related to restructuring and the evolution of our product assortment and is +consistent with our product strategy. In addition, we experienced unit sales volume difficulty in our Americas market, lower than expected unit sales in our China market leading to decreased gross +margins, as average margins in China are typically higher than the global average, and increased shipping costs globally. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate revenues and +costs of sales from our functional currencies to our reporting currency during the year ended December 31, 2014 decreased our gross profit by $9.2 million compared to 2013. +Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $16.6 million, or 3.0%, +during the year +ended December 31, 2014 compared to the same period in 2013. As a percentage of revenue, selling, general and administrative expenses increased 117 basis points to 47.2% from 46.0% during the +year ended December 31, 2014 compared to 2013. This increase was predominately due to year over year increases of $16.7 million in professional fees and other outside services, +$10.2 million increases in bad debt expense, primarily related to delayed payments from distributors in China and Southeast Asia, and an increase of $7.2 million related to +40 +Table of Contents +rising +rental rates and repairs and maintenance for retail locations. We have slowed the expansion of our retail channel in order to focus on the long-term profitability of existing locations and we +have closed 104 company-operated locations between December 31, 2013 and December 31, 2014. These increases were partially offset by a decrease of approximately $5.4 million +related to the reduction in headcount, $2.7 million related to travel reductions and other cost saving and mitigation initiatives. +In +addition to these fluctuations, we have identified certain selling, general and administrative expenses that affect the comparability or underlying business trends in our consolidated +financial statements. The following table summarizes these expenses as well as details the additional drivers of the increase above by reconciling our GAAP selling, general and administrative expenses +to non-GAAP selling, general and administrative expenses: +Year Ended +December 31, +Selling, general and administrative expenses reconciliation: +2014 +2013 +GAAP selling, general and administrative expenses +$ +565,712 +$ +549,154 +New ERP implementation(1) +(13,268 +) +(8,893 +) +Reorganization charges(2) +(8,872 +) +(466 +) +Legal settlement(3) +(2,646 +) +(5,714 +) +Brazil tax credits(4) +— +(6,094 +) +Non-GAAP selling, general and administrative expenses +$ +540,926 +$ +527,987 +(1) This +represents operating expenses related to the implementation of our new ERP system and the add-back of accelerated depreciation and amortization on +tangible and intangible items related to our current ERP system and supporting platforms that will no longer be utilized once the implementation of a new ERP is complete. +(2) This +relates to bonuses, consulting fees and other expenses related to recent restructuring activities and our investment agreement with Blackstone. +(3) This +represents legal settlement expenses. +(4) This +represents a net expense related to the resolution of a statutory tax audit in Brazil. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign +currency exchange rates +used to translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2014, negatively impacted, or increased, selling, general and +administrative expenses by approximately $6.0 million compared to 2013. +Restructuring Charges. We recorded $24.5 million in restructuring charges during the year ended December 31, 2014. +These restructuring +charges arose primarily as a result of our strategic plans for long-term improvement and growth of the business. Restructuring charges for the year ended December 31, 2014 consisted +of: +• $12.5 million in severance costs, of which $3.7 million was related to the termination of executive management and +$3.6 million was related to the reductions in workforce announced on July 21, 2014; +• $7.8 million in other restructuring costs primarily related to the write-off of long-lived assets associated with the exiting +of retail locations and obsolete inventory; and +• $4.2 million in contract termination costs primarily related to the early termination of operating leases and sponsorship +agreements. +41 +Table of Contents +Asset Impairment Charges. We recorded $8.8 million in asset impairment charges during the year ended December 31, 2014, +a decrease of +$2.1 million compared to 2013, related to certain underperforming retail locations in our Americas, Europe and Asia Pacific segments that were unlikely to generate sufficient cash flows to +fully recover the carrying value of the stores' assets over their remaining economic life. +Foreign Currency Transaction Losses. The line item entitled foreign currency transaction losses, net is comprised of foreign +currency gains and +losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the +year ended December 31, 2014, losses on foreign currency transactions increased $0.2 million, or 4.4%, as compared to 2013. +Income tax expense. During the year ended December 31, 2014, we recognized a benefit from income tax of $3.6 million +compared to an +expense of $49.5 million in 2013. Our effective tax rate decreased primarily due to the release of certain unrecognized tax benefits as the result of settling the Company's audits with the +Canada Revenue Agency and the Internal Revenue Service. Our effective tax rate for the year ended December 31, 2014 differs from the federal U.S. statutory rate primarily because of the release +of certain unrecognized tax benefits as well as differences between income tax rates between U.S. and foreign jurisdictions. +Comparison of the Years Ended December 31, 2013 and 2012 +Year Ended December 31, +Change +($ thousands, except per share data and average footwear selling price) +2013 +2012 +$ +% +Revenues +$ +1,192,680 +$ +1,123,301 +$ +69,379 +6.2 +% +Cost of sales +569,482 +515,324 +54,158 +10.5 +Gross profit +623,198 +607,977 +15,221 +2.5 +Selling, general and administrative expenses +549,154 +460,393 +88,761 +19.3 +Asset impairment charges +10,949 +1,410 +9,539 +676.5 +Income from operations +63,095 +146,174 +(83,079 +) +(56.8 +) +Foreign currency transaction losses, net +4,678 +2,500 +2,178 +87.1 +Interest income +(2,432 +) +(1,697 +) +(735 +) +43.3 +Interest expense +1,016 +837 +179 +21.4 +Other income, net +(126 +) +(1,014 +) +888 +(87.6 +) +Income before income taxes +59,959 +145,548 +(85,589 +) +(58.8 +) +Income tax expense +49,539 +14,205 +35,334 +248.7 +Net income +$ +10,420 +$ +131,343 +$ +(120,923 +) +(92.1 +)% +Net income per common share: +Basic +$ +0.12 +$ +1.46 +$ +(1.34 +) +(91.9 +)% +Diluted +$ +0.12 +$ +1.44 +$ +(1.32 +) +(91.9 +)% +Gross margin +52.3 +% +54.1 +% +(180)bps +(3.3 +)% +Operating margin +5.3 +% +13.0 +% +(770)bps +(59.2 +)% +Footwear unit sales +54,326 +49,947 +4,379 +8.8 +% +Average footwear selling price +$ +21.27 +$ +21.55 +$ +(0.28 +) +(1.3 +)% +Revenues. During the year ended December 31, 2013, revenues increased $69.4 million, or 6.2%, compared to the same +period in 2012, +primarily due to an increase of 4.4 million, or 8.8%, in global footwear unit sales. This increase was partially offset by a decrease of $0.28 per unit, or 1.3%, in average footwear selling +price. +42 +Table of Contents +For +the year ended December 31, 2013, revenues from our wholesale channel increased $27.9 million, or 4.3%, compared to 2012, which was primarily driven by increased +wholesale demand in our Asia Pacific, Europe and Americas segments partially offset by decreased wholesale sales in our Japan segment. These increases were driven by strong commitments from current +wholesale customers and global distributors in emerging markets specifically in our Asia Pacific and Europe regions. We faced challenges in our Americas segment due to lower than anticipated at-once +sales as a result of accounts +remaining lean on inventory and in our Japan segment due to continued macroeconomic pressure on consumer spending and unfavorable exchange rates between the Japanese Yen and U.S. Dollar. +For +the year ended December 31, 2013, revenues from our retail channel increased $43.2 million, or 11.5%, compared to 2012, primarily driven by the disciplined expansion of +our global retail presence, which included the opening of 82 company-operated stores (net of store closures) during the year. This increase was driven by a global balance as we realized retail revenue +growth in all four segments on a constant currency basis. Partially offsetting this increase was a global decrease in comparable store sales of 2.7% on a constant currency basis which is primarily the +result of global weakness in consumer confidence, particularly in the Americas and Japan, as lingering effects of recessionary traffic and spending continued to impact retail markets. +For +the year ended December 31, 2013, revenues from our internet channel decreased $1.7 million, or 1.7%, compared to 2012, which was primarily driven by decreased internet +sales in Americas and Japan partially offset by increased internet sales in Europe and Asia Pacific. Our internet sales totaled approximately 8.5% and 9.1% of our consolidated net sales in 2013 and +2012, respectively. +Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate revenues from our +functional currencies to our reporting currency during the year ended December 31, 2013 decreased our revenues by $29.1 million compared to 2012. The majority of this decrease was +related to the decrease in value of the Japanese Yen compared to the U.S. Dollar due to the political and macroeconomic environment in Japan. +43 +Table of Contents +The following table summarizes our total revenue by channel for the years ended December 31, 2013 and 2012: +Year Ended December 31, +Change +Constant +Currency +Change(1) +($ thousands) +2013 +2012 +$ +% +$ +% +Channel revenues: +Wholesale: +Americas +$ +239,104 +$ +235,988 +$ +3,116 +1.3 +% +$ +5,589 +2.4 +% +Asia Pacific +212,761 +180,970 +31,791 +17.6 +31,199 +17.2 +Japan +90,426 +117,380 +(26,954 +) +(23.0 +) +(6,940 +) +(5.9 +) +Europe +131,215 +110,947 +20,268 +18.3 +17,585 +15.8 +Other businesses +254 +574 +(320 +) +(55.7 +) +(325 +) +(56.6 +) +Total Wholesale +673,760 +645,859 +27,901 +4.3 +47,108 +7.3 +Consumer-direct: +Retail: +Americas +202,925 +196,711 +6,214 +3.2 +7,303 +3.7 +Asia Pacific +120,020 +104,632 +15,388 +14.7 +15,380 +14.7 +Japan +36,566 +38,430 +(1,864 +) +(4.9 +) +6,526 +17.0 +Europe +58,507 +35,052 +23,455 +66.9 +22,728 +64.8 +Total Retail +418,018 +374,825 +43,193 +11.5 +51,937 +13.9 +Internet: +Americas +56,523 +63,153 +(6,630 +) +(10.5 +) +(6,404 +) +(10.1 +) +Asia Pacific +9,971 +7,244 +2,727 +37.6 +2,749 +37.9 +Japan +7,871 +8,755 +(884 +) +(10.1 +) +867 +9.9 +Europe +26,537 +23,465 +3,072 +13.1 +2,231 +9.5 +Total Internet +100,902 +102,617 +(1,715 +) +(1.7 +) +(557 +) +(0.5 +) +Total revenues: +$ +1,192,680 +$ +1,123,301 +$ +69,379 +6.2 +% +$ +98,488 +8.8 +% +(1) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" above for more information. +The +table below illustrates the overall growth in the number of our company-operated retail locations by type of store and reportable operating segment as of December 31, 2013 and +2012: +Company-operated retail locations: +December 31, +2012 +Opened +Closed +December 31, +2013 +Type: +Kiosk/Store in Store +121 +23 +(22 +) +122 +Retail Stores +287 +66 +(26 +) +327 +Outlet Stores +129 +43 +(2 +) +170 +Total +537 +132 +(50 +) +619 +Operating segment: +Americas +199 +34 +(17 +) +216 +Asia Pacific +201 +61 +(26 +) +236 +Japan +40 +11 +(2 +) +49 +Europe +97 +26 +(5 +) +118 +Total +537 +132 +(50 +) +619 +44 +Table of Contents +The +table below sets forth our comparable store sales by reportable operating segment for the year ended December 31, 2013 as compared to 2012: +Comparable store sales(1) +Constant Currency +Year Ended +December 31, 2013(2) +Constant Currency +Year Ended +December 31, 2012(2) +Americas +(5.8 +)% +2.6 +% +Asia Pacific +6.9 +3.3 +Japan +(15.0 +) +(13.0 +) +Europe +2.4 +5.4 +Global +(2.7 +)% +1.5 +% +(1) Comparable +store sales is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which +selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily +closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. +Comparable store sales growth is calculated on a currency neutral basis using historical annual average currency rates. +(2) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" below for more information. +Gross profit. During the year ended December 31, 2013, gross profit increased $15.2 million, or 2.5%, compared to 2012, +which was +primarily attributable to the 6.2% increase in revenues as a result of higher footwear unit sales partially offset by lower footwear selling prices and a $54.2 million, or 10.5%, increase in +cost of sales. Gross margin percentage decreased 180 basis points compared to 2012. The decline in gross margin percentage is primarily driven by the evolution of our product assortment and is +consistent with our product strategy. Product cost inflation also contributed to the decline in gross margin percentage, but was mostly offset by internal cost savings initiatives. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency +exchange rates used to translate revenues and costs of sales from our functional currencies to our reporting currency during the year ended December 31, 2013 decreased our gross profit by +$15.9 million compared to 2012. The majority of this decrease was related to the decrease in value of the Japanese Yen compared to the U.S. Dollar due to the political and macroeconomic +environment in Japan. +Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $88.8 million, or +19.3%, during the year +ended December 31, 2013 compared to 2012. We continue to focus our operating expense increases around the long-term growth of the Company and are currently undergoing several long-term +strategic projects including global retail expansion and the implementation of our ERP system, which resulted in selling, general and administrative charges as well as capitalized expenditures. The +increase in selling, general and administrative expenses is primarily due to: +(i) an +increase of $39.6 million, or 19.3%, related to the global expansion of our retail channel, in which we opened 82 company-operated stores (net of +store closures) during the year. This increase includes $23.5 million of additional building expenses such as rent and maintenance fees, $11.4 million in additional labor expenses and +$3.2 million in depreciation and amortization; +45 +Table of Contents +(ii) an +increase of $14.9 million, or 13.9%, related to non-retail labor charges including variable and stock compensation as well as the normalization +of 2012 headcount increases; +(iii) an +increase of $9.9 million, or 44.8%, related to other non-retail expenses which includes a $6.1 million non-recurring expense related to +the resolution of a statutory tax audit in Brazil during the second quarter of 2013; +(iv) an +increase of $9.8 million, or 25.3%, related to non-retail professional expenses related to various litigation services, consulting fees, contract +labor and other outside services. This increase includes $3.5 million of additional non-recurring charges related to on-going litigation and $1.1 million of additional non-recurring fees +related to our recent investment agreement with Blackstone, which includes professional service fees associated with the transaction and our cash repatriation activities; +(v) an +increase of $7.1 million in non-retail marketing expenses, which was part of a company-wide initiative to increase advertising and agency services +in order to help drive demand; and +(vi) an +increase of $5.0 million in operating expenses related to the implementation of our ERP system. +As +a percentage of revenue, selling, general and administrative expenses increased 12.2%, or 500 basis points, to 46.0% during the year ended December 31, 2013 compared to +2012 as we continued to increase our global retail presence, utilize state-of-the-art marketing techniques to expand our global brand and update our information technology for a streamlined business +approach. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign +currency exchange rates +used to translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2013, decreased selling, general and administrative expenses by +approximately $8.6 million compared to 2012. The majority of this decrease was related to the decrease in value of the Japanese Yen compared to the U.S. Dollar due to the political and +macroeconomic environment in Japan. +Asset Impairments. We periodically evaluate all of our long-lived assets for impairment when events or circumstances would +indicate the carrying +value of a long-lived asset may not be fully recoverable. In addition, we assess goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and circumstances +indicate impairment may have occurred. Asset impairments increased $9.5 million during the year ended December 31, 2013 compared to 2012 primarily due to $10.6 million of +long-lived asset impairment charges during the year ended December 31, 2013 related to 60 underperforming retail locations in the Americas, Asia Pacific and Europe segments that we concluded +were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. In addition, we recorded $0.3 million of goodwill +impairment during the year ended December 31, 2013 related to our Crocs Benelux B.V. business, which we purchased in July 2012. +Foreign Currency Transaction Losses. The line item entitled 'Foreign currency transaction losses, net' is comprised of foreign +currency gains and +losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the +year ended December 31, 2013, losses on foreign currency transactions increased $2.2 million, or 87.1%, compared to 2012. This increase is primarily related to an $8.0 million +increase in net losses associated with exposure from day-to-day business transactions in various foreign currencies compared to 2012. This difference was partially offset by a $5.8 million +increase in net gains associated with our derivative instruments and our ability to hedge foreign currency fluctuations through undesignated forward instruments compared to 2012. +46 +Table of Contents +Income tax expense. During the year ended December 31, 2013, income tax expense increased $35.3 million resulting in a +72.9% increase +in effective tax rate compared to 2012, which was primarily the result of valuation allowances being recorded on net deferred tax assets in tax jurisdictions where we believe it is not more likely +than not that those benefits will be realized and tax associated with our cash repatriation activities. Our effective tax rate of 82.6% for the year ended December 31, 2013 differs from the +federal U.S. statutory rate primarily because the result of valuation allowances being recorded on net deferred tax assets in tax jurisdictions where we believe it is not more likely than not that +those benefits will be realized and tax associated with our cash repatriation activities. +Presentation of Reportable Segments +For 2014, 2013 and 2012, we had four reportable operating segments based on the geographic nature of our operations: Americas, Asia +Pacific, Japan and Europe. We also have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing +operations located in Mexico, Italy and Asia. The composition of our reportable operating segments is consistent with that used by our Chief Operating Decision Maker ("CODM") to evaluate performance +and allocate resources. +During +the first quarter of 2013, we adjusted our operating segment structure for internal reports reviewed by the CODM by presenting Japan separate from the Asia Pacific segment. This +change was +made due to the volatility of the Japanese yen and the macroeconomic environment within Japan as well as negative sales growth compared to the rest of the Asia Pacific segment, which resulted in the +need for a regular review of the operating results of Japan by management and the CODM in order to better evaluate performance and allocate resources for the consolidated business. Results from +operations for the year ended December 31, 2012 was restated for this change. +Subsequent +to December 31, 2014, we have determined that for fiscal 2015, our internal reports reviewed by the CODM will revert back to include Japan in the Asia Pacific segment. +This change is to align reporting to our new strategic model and management structure, as Japan and Asia Pacific will be managed and analyzed as one operating segment by management and the CODM, to +better allocate resources. Therefore, there will be three reportable operating segments for 2015. +Each +of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers as well as intersegment sales. Revenues of the +"Other businesses" category are primarily made up of intersegment sales. The remaining revenues for the "Other businesses" represent non-footwear product sales to external customers. Intersegment +sales are not included in the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. +The +primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on +segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to +eliminate intersegment profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment +eliminations. Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these balances are regularly reviewed by the CODM. +47 +Table of Contents +Comparison of the Years Ended December 31, 2014 and 2013 by Segment +The following table sets forth information related to our reportable operating business segments for the years ended +December 31, 2014 and 2013: +Year Ended December 31, +Change +Constant Currency +Change(4) +($ thousands) +2014 +2013 +$ +% +$ +% +Revenues: +Americas +$ +489,915 +$ +498,552 +$ +(8,637 +) +(1.7 +)% +$ +(3,694 +) +(0.7 +)% +Asia Pacific +350,449 +342,752 +7,697 +2.2 +8,527 +2.5 +Japan +123,461 +134,863 +(11,402 +) +(8.5 +) +(2,772 +) +(2.1 +) +Europe +233,604 +216,259 +17,345 +8.0 +18,561 +8.6 +Total segment revenues +1,197,429 +1,192,426 +5,003 +0.4 +20,622 +1.7 +Other businesses +794 +254 +540 +212.6 +533 +209.8 +Total consolidated revenues +$ +1,198,223 +$ +1,192,680 +$ +5,543 +0.5 +% +$ +21,155 +1.8 +% +Operating income (loss): +Americas +$ +48,347 +$ +61,894 +$ +(13,547 +) +(21.9 +)% +$ +(13,944 +) +(22.5 +)% +Asia Pacific +47,753 +80,693 +(32,940 +) +(40.8 +) +(29,446 +) +(36.5 +) +Japan +27,382 +37,560 +(10,178 +) +(27.1 +) +(9,409 +) +(25.1 +) +Europe +24,517 +16,192 +8,325 +51.4 +7,021 +43.4 +Total segment operating income +147,999 +196,339 +(48,340 +) +(24.6 +) +(45,778 +) +(23.3 +) +Other businesses(1) +(19,400 +) +(20,811 +) +1,411 +(6.8 +) +1,504 +(7.2 +) +Intersegment eliminations +(1,498 +) +61 +(1,559 +) +(2555.7 +) +(1,559 +) +(2,555.7 +) +Unallocated corporate and other(2) +(131,827 +) +(112,494 +) +(19,332 +) +17.2 +(13,500 +) +12.0 +Total consolidated operating income (loss)(3) +$ +(4,726 +) +$ +63,095 +$ +(67,821 +) +(107.5 +)% +$ +(59,333 +) +(94.0 +)% +Foreign currency transaction losses, net +4,885 +4,678 +207 +4.4 +Interest income +(1,664 +) +(2,432 +) +768 +(31.6 +) +Interest expense +806 +1,016 +(210 +) +(20.7 +) +Other income, net +(204 +) +(126 +) +(78 +) +61.9 +Income before income taxes +$ +(8,549 +) +$ +59,959 +$ +(68,508 +) +(114.3 +)% +(1) During +the year ended December 31, 2014, operating losses of Other businesses decreased $1.4 million compared to 2013, primarily due to a +$1.5 million increase in gross margin offset by a $0.1 million increase in selling, general and administrative expenses. +(2) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. +For the year ended December 31, 2014, Unallocated corporate and other operating losses increased $19.3 million compared to the same period in 2013, primarily due to $8.9 million +restructuring charges related to the termination of certain employees and executives and a write-off of obsolete inventory related to an exited business line and an $8.1 million increase in +selling, general and administrative expenses primarily related to the implementation of our ERP system and our investment agreement with Blackstone partially offset by cost savings in variable +compensation. +48 +Table of Contents +(3) Please +refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect on +values below total consolidated operating income. +(4) Reflects +year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP +Financial Measures" above for more information. +Americas Operating Segment. During the year ended December 31, 2014, revenues from our Americas segment decreased +$8.6 million, or +1.7%, compared to 2013 primarily due to a 3.2% decrease in footwear units sold and a $4.9 million unfavorable impact from foreign currency fluctuations driven by weakening of the Brazilian Real +against the U.S. Dollar. This decrease was partially offset by a 2.2% increase in average footwear unit selling price. During the year ended December 31, 2014, revenue declines for the region +were realized primarily in the wholesale channel which decreased $10.5 million, or 4.4%, and in the internet channel which decreased $1.3 million, or 2.3%, compared to 2013. The decrease +in wholesale channel revenue was predominately driven by a mix of lower than anticipated at-once orders as a result of accounts remaining lean on inventory in the first half of the year and a decline +in activity in our Latin and South American markets partially offset by an increase in activity in the United States. The decrease in internet channel revenue was predominately driven by a decrease in +average footwear selling price partially offset by an increase in footwear unit sales and increased conversion and traffic. Partially offsetting this decrease was a $3.1 million, or 1.5%, +increase in retail channel revenues, which is primarily the result of higher unit sales. Comparable store sales decreased 4.4% due to the impact of foreign currency translation adjustments into our +reporting currency. +During +the year ended December 31, 2014, segment operating income decreased $13.5 million, or 21.9%, compared to 2013 primarily related to: +(i) a +decrease in segment gross margins of $13.2 million, or 5.3%, primarily related to higher material costs and an increase of $1.2 million of +inventory written off related to obsolete inventory including raw materials, footwear and other accessories; +(ii) $4.3 million +in restructuring charges related to the reorganization of our business in Brazil, severance costs in the United States and an inventory +write-down related to an exited business line; and +(iii) Partially +offsetting these negative impacts to operating income was a decrease of $2.8 million, or 1.6%, in selling, general and administrative +expenses as a result of lower marketing expenses partially offset by higher rent and maintenance fees. +Asia Pacific Operating Segment. During the year ended December 31, 2014, revenues from our Asia Pacific segment increased +$7.7 million, +or 2.2%, compared to 2013 primarily due to a 1.2% increase in footwear units sold and a 1.5% increase in average footwear selling price. This increase was partially offset by a $0.8 million +unfavorable impact from foreign currency fluctuations. During the year ended December 31, 2014, we realized revenue growth of 59.7% in the region in the internet channels compared to 2013. +Partially offsetting these increases was a decrease of $1.9 million, or 0.9%, in the wholesale channel revenues, primarily due to a decrease in third and fourth quarter performance in our China +business as a result of increased distributor inventory levels and lower replenishment orders. Our direct-to-consumer channel revenues increased $3.6 million, or 3.0%, primarily due to +increased traffic during the year and the addition of 38 company-operated stores since December 31, 2013 as we focus on high-traffic, outlet locations partially offset by a 4.6% decrease in +comparable store sales. The closure of 70 underperforming company-operated stores and temporary locations since December 31, 2013 did not have an unfavorable impact on revenues. +49 +Table of Contents +During the year ended December 31, 2014, segment operating income decreased $32.9 million, or 40.8%, compared to 2013 primarily related +to: +(i) an +increase of $15.7 million, or 12.6%, in selling, general and administrative expenses due to an increase in reserves for doubtful accounts as a +result of delayed payments from distributors in China and Southeast Asia and an increase in sales expenses, that was partially offset by a reduction of employee expenses related to the reduction of +retail locations; +(ii) a +decrease in segment gross margins of $10.1 million, or 4.9%, primarily related to an increase of $4.0 million of inventory written off +related to obsolete inventory including raw materials, footwear and other accessories; +(iii) $6.8 million +in restructuring charges related to severance and store closure costs; +(iv) a +$3.5 million unfavorable impact from foreign currency fluctuations primarily related to costs of sales; and +(v) a +$2.6 million increase in retail asset impairment charges related to the long-lived assets. +Japan Operating Segment. During the year ended December 31, 2014, revenues from our Japan segment decreased +$11.4 million, or 8.5%, +compared to 2013 primarily due to a 11.7% decrease in average footwear selling price and a $8.6 million unfavorable impact from foreign currency fluctuations that was partially offset by a 1.1% +increase in footwear units sold. During the year ended December 31, 2014, we realized revenue declines primarily in the wholesale channel which decreased $10.7 million, or 11.9%, +compared to 2013. This decrease was mainly due to a soft wholesale market and slow sell-through of inventory as a result of macroeconomic declines leading to lower average footwear selling prices. In +addition, our direct-to-consumer channel revenues slightly decreased $0.7 million, or 1.9%, compared to 2013 primarily due to a 4.8% decrease in comparable stores sales which was partially +offset by the addition of five retail locations (net of store closures) since December 31, 2013. During the year ended December 31, 2014, segment operating income decreased +$10.2 million, or 27.1%, compared to the same period in 2013 primarily related to: +(i) a +decrease in segment gross margins of $11.7 million, or 15.6%, primarily related to higher material costs as a result of product costs being tied to +the U.S. Dollar; +(ii) a +$0.8 million unfavorable impact from foreign currency fluctuations primarily related to revenue; and +(iii) Partially +offsetting these negative impacts to operating income was a decrease of $1.7 million, or 4.5%, in selling, general and administrative +expenses. +Europe Operating Segment. During the year ended December 31, 2014, revenues from our Europe +segment increased $17.3 million, or 8.0%, compared to 2013 primarily due to a 15.1% increase in footwear units sold, which was partially offset by a 8.8% decrease in average footwear unit +selling price. This contrasting increase in average footwear units sold and decrease in average footwear unit selling price is primarily related to discounting on certain products during the first +half of the year in our wholesale channel. In addition to sales metrics, our Europe segment realized a $1.2 million unfavorable impact from foreign currency fluctuations driven by the weakening +of the Russian Ruble against the U.S. Dollar. During the year ended December 31, 2014, we realized revenue growth in the region in the wholesale and retail channels compared to 2013. Our +wholesale channel revenue increased $16.3 million, or 12.5%, primarily due to the expansion in our number of wholesale doors and strong sales performance throughout the region. Our +direct-to-consumer channel revenues increased $1.8 million, or 3.1%, primarily due to the 0.7% increase in comparable store sales and a 4.3% increase +50 +Table of Contents +in +the average footwear unit selling price. During the year ended December 31, 2014, segment operating income increased $8.3 million, or 51.4%, compared to 2013 primarily related +to: +(i) a +decrease to asset impairments of $4.9 million; +(ii) a +decrease of 4.4 million, or 4.8%, in selling, general and administrative expenses; +(iii) an +increase in gross margin of $3.0 million, or 2.6%; and +(iv) a +$3.9 million restructuring charge related to severance and store closures, which partially offset the above increases. +Comparison of the Years Ended December 31, 2013 and 2012 by Segment +The following tables set forth information related to our reportable operating business segments for the years ended +December 31, 2013 and 2012: +Year Ended December 31, +Change +Constant Currency +Change(4) +($ thousands) +2013 +2012 +$ +% +$ +% +Revenues: +Americas +$ +498,552 +$ +495,852 +$ +2,700 +0.5 +% +$ +6,488 +1.3 +% +Asia Pacific +342,752 +292,846 +49,906 +17.0 +49,328 +16.8 +Japan +134,863 +164,565 +(29,702 +) +(18.0 +) +453 +0.3 +Europe +216,259 +169,464 +46,795 +27.6 +42,544 +25.1 +Total segment revenues +1,192,426 +1,122,727 +69,699 +6.2 +98,813 +8.8 +Other businesses +254 +574 +(320 +) +(55.7 +) +(325 +) +(56.6 +) +Total consolidated revenues +$ +1,192,680 +$ +1,123,301 +$ +69,379 +6.2 +% +$ +98,488 +8.8 +% +Operating income (loss): +Americas +$ +61,894 +$ +85,538 +$ +(23,644 +) +(27.6 +)% +$ +(24,364 +) +(28.5 +)% +Asia Pacific +80,693 +74,535 +6,158 +8.3 +5,419 +7.3 +Japan +37,560 +66,293 +(28,733 +) +(43.3 +) +(20,324 +) +(30.7 +) +Europe +16,192 +21,678 +(5,486 +) +(25.3 +) +(5,359 +) +(24.7 +) +Total segment operating income +196,339 +248,044 +(51,705 +) +(20.8 +) +(44,628 +) +(18.0 +) +Other businesses(1) +(20,811 +) +(10,805 +) +(10,006 +) +92.6 +(9,756 +) +90.3 +Intersegment eliminations +61 +60 +1 +1.7 +1 +0.9 +Unallocated corporate and other(2) +(112,494 +) +(91,125 +) +(21,369 +) +23.5 +(21,242 +) +23.3 +Total consolidated operating income(3) +$ +63,095 +$ +146,174 +$ +(83,079 +) +(56.8 +)% +$ +(75,625 +) +(51.7 +)% +Foreign currency transaction losses, net +4,678 +2,500 +2,178 +87.1 +Interest income +(2,432 +) +(1,697 +) +(735 +) +43.3 +Interest expense +1,016 +837 +179 +21.4 +Other income, net +(126 +) +(1,014 +) +888 +(87.6 +) +Income before income taxes +$ +59,959 +$ +145,548 +$ +(85,589 +) +(58.8 +)% +(1) During +the year ended December 31, 2013, operating losses of Other businesses increased $10.0 million compared to 2012, primarily due to a +$9.7 million decrease in gross margin as a result of increased cost of sales and a $0.3 million increase in selling, general and administrative expenses. +(2) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand +51 +Table of Contents +marketing, +legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. For the year ended +December 31, 2013, operating losses of Unallocated corporate and other expenses increased $21.4 million compared to 2012, primarily due to a $23.0 million increase in selling, +general and administrative costs as a result of increased labor charges including variable and stock compensation as well as the normalization of 2012 headcount increases and increased professional +services expenses related to the implementation of our ERP system. This increase of selling, general and administrative expenses was partially offset by a $1.6 million decrease in cost of sales +primarily related to decreases in variable overhead and freight expenses. +(3) Please +refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect on +values below total consolidated operating income. +(4) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" above for more information. +Americas Operating Segment. During the year ended December 31, 2013, revenues from our Americas segment increased +$2.7 million, or +0.5%, compared to 2012 primarily due to a 5.0% increase in average footwear selling price. This increase was partially offset by a 2.6% decrease in footwear units sold and $3.8 million +unfavorable impact from foreign currency fluctuations driven by weakening of the Brazilian Real against the U.S. Dollar. During the year ended December 31, 2013, revenue growth for the region +was realized primarily in the retail channel which increased $6.2 million, or 3.2%, and in the wholesale channel which increased $3.1 million, or 1.3% compared to 2012. The increase in +retail channel revenue is predominately driven by the disciplined expansion of our retail presence, which included the opening of 17 company-operated stores (net of closures) during the year. Despite +the advancement of our retail presence in the Americas segment and increased retail channel revenues, we experienced a decrease in comparable store sales of 5.8% on a constant currency basis. This +decrease was primarily the result of weakness in consumer confidence in the region as lingering effects of recessionary traffic and spending continue to impact retail markets. Despite the slight +increase in wholesale channel revenues on a year-over-year basis, we faced challenges in the region due to lower than anticipated at-once sales as a result of wholesale accounts remaining lean on +inventory. In addition, we were impacted by economic and market conditions in Latin America as our revenue was constrained due to import restrictions and lower market demand. These increases in retail +and wholesale channel revenues during the year ended December 31, 2013 were partially offset by our internet channel which decreased $6.6 million, or 10.5%, compared to 2012. This +decrease was attributable to decreased internet traffic and conversion rates throughout the year. During the year ended December 31, 2013, segment operating income decreased +$23.6 million, or 27.6%, compared to 2012 driven predominately by: +(i) a +$18.4 million, or 11.3%, increase in selling, general and administrative expenses as a result of the continued expansion of our retail channel, +increased marketing efforts and a non-recurring net expense of $6.1 million related to the resolution of a statutory tax audit in Brazil; +(ii) retail +asset impairment charges of $3.9 million related to certain underperforming locations; +(iii) a +non-recurring write-off of $3.4 million related to obsolete inventory including raw materials, footwear and other accessories; and +(iv) a +decrease in segment gross margins of 1.6%, or 80 basis points. +Partially +offsetting this decrease were the revenue increases noted above and a $0.7 million favorable impact from foreign currency fluctuations. +52 +Table of Contents +Asia Pacific Operating Segment. During the year ended December 31, 2013, revenues from our Asia Pacific segment increased +$49.9 million, or 17.0%, compared to 2012 primarily due to a 14.1% increase in footwear units sold, a 3.0% increase in average footwear selling price and a $0.6 million favorable impact +from foreign currency fluctuations. Although our leading footwear model in terms of sales in the Asia Pacific region continues to be our traditional clog, the increase in footwear units sold and +average footwear selling price was driven mainly through other footwear styles such as our mary-jane, flip-flop and loafer. During the year ended December 31, 2013, we realized revenue growth +for the region in all three channels compared to 2012. Our wholesale channel revenue increased $31.8 million, or 17.6%, primarily due to the expansion of our wholesale doors and the continued +support from existing customers. Our direct-to-consumer channel revenues increased $18.1 million, or 16.2%, primarily due to our continued focus on and the disciplined expansion of our retail +channel as we opened 35 company-operated stores (net of store closures) during the year combined with an increase in comparable store sales of 6.9% on a constant currency basis. During the year ended +December 31, 2013, segment operating income increased $6.2 million, or 8.3%, compared to 2012 driven +predominately by the revenue increases noted above and a $0.7 million favorable impact from foreign currency fluctuations. Partially offsetting this increase were the +following: +(i) a +$21.2 million, or 20.5%, increase in selling, general and administrative expenses as a result of the continued expansion of our retail channel, +increased salaries and wages as we added approximately 40 full-time employees to our growing Asia Pacific business and increased marketing efforts; +(ii) retail +asset impairment charges of $0.2 million related to certain underperforming locations; and +(iii) a +decrease in segment gross margins of 1.3%, or 80 basis points. +Japan Operating Segment. During the year ended December 31, 2013, revenues from our Japan segment decreased +$29.7 million, or 18.0%, +compared to 2012 primarily due to $30.2 million unfavorable impact from foreign currency fluctuations as a result of recent decreases in the value of the Japanese Yen to the U.S. Dollar +stemming from political and macroeconomic challenges in the region, which led to a 21.0% decrease in footwear selling price. This decrease was partially offset by a 4.8% increase in footwear units +sold. During the year ended December 31, 2013, revenue underperformance was realized primarily in the wholesale channel which decreased $27.0 million, or 23.0%, compared to 2012. This +decrease was mainly due to a soft wholesale market and slow sell-through of inventory as a result of macroeconomic declines. Our direct-to-consumer channel revenues decreased $2.7 million, or +5.8%, primarily due to a decrease in comparable store sales growth of 15.0% on a constant currency basis. Despite current macroeconomic conditions in Japan, we continue to expand our retail channel in +the region as we opened nine company-operated stores (net of store closures) during the year in anticipation of an economic recovery. During the year ended December 31, 2013, segment operating +income decreased $28.7 million, or 43.3%, compared to 2012 driven predominately by a the revenue decreases noted above, a $8.4 million unfavorable impact from foreign currency +fluctuations and a decrease in segment gross margins of 12.6%, or 800 basis points. Partially offsetting this decrease was a $0.9 million, or 2.3%, decrease in selling, general and +administrative expenses. +Europe Operating Segment. During the year ended December 31, 2013, revenues from our Europe segment increased +$46.8 million, or 27.6%, +compared to 2012 primarily due to a 41.9% increase in footwear units sold and a $4.3 million favorable impact from foreign currency fluctuations driven by strengthening of the Euro against the +U.S. Dollar. This increase was partially offset by a 9.9% decrease in average footwear selling price. Our traditional clog continues to generate the majority of our +footwear sales in Europe, making up approximately 70.3% of total footwear unit sales during the year; however, we did experience marked improvement in the sales of other footwear models during the +year including boots and flip-flops. During the year ended December 31, 2013, we realized revenue growth +53 +Table of Contents +for +the region in all three channels compared to 2012 as we experienced noticeable improvement in the macroeconomic environment in Europe. Our retail channel revenue increased $23.5 million, or +66.9%, primarily due to our continued focus on and the disciplined expansion of our retail channel as we opened 21 company-operated stores (net of store closures) during the year combined with an +increase in comparable store sales growth of 2.4% on a constant currency basis. Our wholesale channel revenue increased $20.3 million, or 18.3%, primarily due to the expansion in our number of +wholesale doors leading to improved backlog sales and at-once orders. Our internet channel revenue increased $3.1 million, or 13.1%, primarily due to increased internet traffic and our +promotional focus. During the year ended December 31, 2013, segment operating income decreased $5.5 million, or 25.3%, compared to 2012 driven predominately +by: +(i) a +$26.8 million, or 41.5%, increase in selling, general and administrative expenses as a result of the continued expansion of our retail channel and +a non-recurring legal contingency accrual of $5.7 million related to on-going litigation; +(ii) retail +asset impairment charges of $6.9 million related to certain underperforming locations; +(iii) a +goodwill impairment charge of $0.3 million related to our acquisition of Benelux in 2012; and +(iv) a +$0.1 million unfavorable impact from foreign currency fluctuations. +Partially +offsetting this decrease were the revenue increases noted above and an increase in segment gross margins of 3.9%, or 200 basis points. +Liquidity and Capital Resources +Cash Flows and Working Capital +During the year ended December 31, 2014, cash and cash equivalents decreased $49.6 million, or 15.6%, to +$267.5 million compared to $317.1 million at December 31, 2013. The primary driver of this decrease is the repurchase of $145.9 million of our common stock associated with +Board authorized repurchases including related commission charges under our publicly-announced repurchase plan, strategic reinvestments into the business including $46.9 million in capital +spend primarily related to our ERP system implementation, dividend payments of $11.3 million on our Series A Preferred Stock, of which $3.1 million was recorded as dividends +payable and prepaid dividends as of December 31, 2014, and debt payments, including principal and interest, of $5.5 million related to long-term bank borrowings. Partially offsetting +these decreases was the $182.2 million in net cash proceeds from our sale of our Series A Preferred Stock. +Cash +used by operations was $11.7 million for the year ended December 31, 2014 compared to cash provided by operations of $83.5 million for the year ended +December 31, 2013. This decrease was primarily driven by the change in working capital accounts year over year which accounted for $66.4 million of our cash used by operating activities. +During the year ended December 31, 2014, we paid $33.7 million in cash related to taxes that were accrued for as of December 31, 2013, which accounted for half of this change. +Working Capital +As of December 31, 2014, accounts receivable decreased $3.2 million compared to December 31, 2013. During the year +ended December 31, 2014, we recorded a reserve for doubtful accounts of $11.5 million in our Asia Pacific segment primarily as a result of delayed payments from our partner stores in +China and Southeast Asia. Inventory increased $8.7 million primarily due to increased finished goods, offset by the write-off of obsolete inventory and a decrease in raw materials. As of +December 31, 2014, other long-term assets decreased by approximately $27.7 million primarily due to +54 +Table of Contents +the +decrease in derivative instruments recorded on our balance sheet, as no such instruments were outstanding as of December 31, 2014. +As +of December 31, 2014, accounts payable decreased $14.5 million compared to December 31, 2013. As a result of the January 2015 implementation of our new ERP +system, we accelerated payments of our outstanding payables in late 2014 to accommodate the transition. Accrued liabilities decreased $16.9 million compared to December 31, 2013 +primarily due to lower accrued legal fees, customer deposits and sales taxes payable. These decreases were offset by the accrual of $3.1 million of dividends payable related to the +Series A preferred stock. +We +anticipate our cash flows from operations will be sufficient to meet the ongoing needs of our business for the next twelve months. In order to provide additional liquidity in the +future and to help support our strategic goals, we have a revolving credit facility with a syndicate of lenders, including PNC Bank, National Association ("PNC") as lead lender, which currently +provides us with up to $100.0 million in borrowing capacity and matures in December 2017 (see Revolving Credit Facility below). Additional future +financing may be necessary and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. +Sale of Preferred Stock +On December 28, 2013, we entered into, and on January 27, 2014, we closed on an investment agreement with Blackstone, +whereby we sold them 200,000 shares of the Company's Series A Preferred Stock for $182.2 million of net proceeds. The Series A Preferred Stock has a par value $0.001 per share, +with an aggregate stated value of $200.0 million, or $1,000 per share, and an aggregate purchase price of $198.0 million, or $990 per share. +The +Series A Preferred Stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and dissolution. Holders of Series A +Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum as well as any dividends declared or paid on our common stock and are entitled to vote together +with the holders of common stock on an as-converted basis. As of December 31, 2014, accrued dividends were $3.1 million, which were paid to Blackstone on January 2, 2015. +The +Series A Preferred Stock has several conversion features as well as redemption rights. The conversion rate is subject to customary anti-dilution and other adjustments subject +to certain share caps and other restrictions. As of December 31, 2014, the Blackstone investment, on an as converted to common stock basis, represented approximately 14.9% of our outstanding +common stock. We intend to continue to use the net proceeds, as well as excess cash, to fund the repurchase of our common stock pursuant to the $350.0 million stock repurchase authorization +approved by the Board discussed further below. We believe this investment provides an opportunity to drive shareholder value and refine the strategic direction of the business. +Stock Repurchase Plan Authorizations +We continue to evaluate options to maximize the returns on our cash and to maintain an appropriate capital structure, including, among +other alternatives, repurchases of our common stock. +On +December 26, 2013, the Board approved the repurchase of up to $350.0 million of our common stock, subject to certain restrictions on repurchases under our revolving +credit facility. This replaced all of our existing stock repurchase authorizations. The number, price, structure and timing of the repurchases will be at our sole discretion and future repurchases +will be evaluated by us depending on market conditions, liquidity needs and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase +authorization does not have an +55 +Table of Contents +expiration +date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify or terminate the repurchase program at any time without prior notice. +During +the year ended December 31, 2014, we repurchased approximately 10.6 million shares at an average price of $13.75 for an aggregate price of approximately +$145.6 million excluding related commission charges, under a publicly-announced repurchase plan. +As +of December 31, 2014, subject to certain restrictions on repurchases under our revolving credit facility, we had $202.1 million of our common shares available for +repurchase under the repurchase authorizations. +Revolving Credit Facility +On September 25, 2009, we entered into a Revolving Credit and Security Agreement, as amended, with the lenders named therein and +PNC Bank, National Association ("PNC"), as a lender and administrative agent for the lenders. On December 16, 2011, we entered into an Amended and Restated Credit Agreement (as amended, the +"Credit Agreement"), and on December 27, 2013, we entered into the Third Amendment to Amended and Restated Credit Agreement (the "Third Amendment"). The Third Amendment, among other things, +(i) allowed for the payment of dividends on the Series A Convertible Preferred Stock ("Series A Preferred Stock"), (ii) permitted the Company to have greater flexibility to +repurchase its Common Stock, (iii) decreased the maximum leverage ratio from 3.50 to 1.00 to 3.25 to 1.00, and (iv) amended certain definitions of the financial covenants to become more +favorable to the Company. See Note 14—Series A Preferred Stock for further details regarding the payment of dividends on the Series A Preferred Stock. On +March 27, 2014, we entered into the Fourth Amendment to Amended and Restated Credit Agreement (the "Fourth Amendment"). The Fourth Amendment primarily (i) altered the minimum fixed +charge coverage ratio from 1.25 to 1.00 to a scaled quarterly ratio of 1.15 to 1.00 in the first and second quarters of 2014, 1.20 to 1.00 in the third quarter of 2014, and (ii) amended certain +definitions of the financial covenants to become more favorable to us. +On +September 26, 2014, we entered into the Fifth Amendment to Amended and Restated Credit Agreement (the "Fifth Amendment"), pursuant to which certain terms of the Credit +Agreement were amended. The Fifth Amendment primarily (i) extended the minimum fixed charge coverage ratio of 1.15 to 1.00 through the second quarter of 2015 and will return to 1.25 to 1.00 for +each quarter thereafter, and (ii) amended certain definitions of the financial covenants to become more favorable to us. +The +Credit Agreement enables us to borrow up to $100.0 million, with the ability to increase commitments to up to $125.0 million subject to certain conditions, and is +currently set to mature on December 16, 2017. The Credit Agreement is available for working capital, capital expenditures, permitted acquisitions, reimbursement of drawings under letters of +credit, and permitted dividends, distributions, purchases, redemptions and retirements of equity interests. Borrowings under the Credit Agreement are secured by all of our assets including all +receivables, equipment, general intangibles, inventory, investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For +domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and +(iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate loans, the interest rate is equal to a +LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each +interest period with respect to LIBOR rate loans. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $20.0 million. The Credit +56 +Table of Contents +Agreement +contains provisions requiring us to maintain compliance with certain restrictive and financial covenants. +As +of December 31, 2014 and 2013, we had no outstanding borrowings under the Credit Agreement. As of December 31, 2014 and 2013, we had issued and outstanding letters of +credit of $1.8 million and $7.2 million, respectively, which were reserved against the borrowing base under the terms of the Credit Agreement. During the years ended December 31, +2014, 2013 and 2012, we capitalized $0.1 million, $0.1 million and $0.5 million, respectively, in fees and third party costs which were incurred in connection with the Credit +Agreement, as deferred financing costs. As of December 31, 2014, we were in compliance with all restrictive financial and other covenants under the Credit Agreement. +Long-term Bank Borrowings +On December 10, 2012, we entered into a Master Installment Payment Agreement ("Master IPA") with PNC Bank National Association +("PNC") in which PNC will finance the Company's purchase of software and services, which may include but are not limited to third-party costs to design, install and implement software systems, and +associated hardware described in the schedules defined within the Master IPA. This agreement was entered into to finance the recent implementation of a new enterprise resource planning ("ERP") system +which began in October 2012 and is estimated to continue through early 2015. The terms of the agreement consist of variable interest rates and payment terms based on amounts borrowed and timing of +activity throughout the implementation of the ERP system. +As +of December 31, 2014 and 2013, we had $11.6 million and $16.8 million, respectively, of long-term debt outstanding under five separate notes payable, of which +$5.3 million and $5.1 million, respectively, represent current installments. As of December 31, 2014, the notes bear interest rates ranging from 2.45% to 2.79% and maturities +ranging from September 2016 to September 2017. As this debt arrangement relates solely to the construction and implementation of an ERP system for our use, all interest expense incurred under the +arrangement has been capitalized to the consolidated balance sheets until the assets are ready for their intended use and will be amortized over the useful life of the software starting on that date. +During the year ended December 31, 2014 and 2013, we capitalized $0.4 million and $0.3 million, respectively, in interest expense related to this debt arrangement to the +consolidated balance sheets. Interest rates and payment terms are subject to changes as further financing occurs under the Master IPA. +Capital Assets +During the year ended December 31, 2014, net capital assets acquired, inclusive of intangible assets, were $57.0 million +compared to $68.8 million during the same period in 2013. The increase is primarily due to decreased capital spend in our retail channel as we begin to close or convert locations partially +offset by a large increase in the capitalization of our ERP implementation costs. +We +have entered into various operating leases that require cash payments on a specified schedule. Over the next five years we are committed to make payments of approximately +$241.6 million related to our operating leases. We plan to continue to enter into operating leases related to our retail stores; however, we plan to reduce our overall retail footprint in 2015. +We also continuously evaluate cost reduction opportunities. Our evaluation of cost reduction opportunities includes assessments of sponsorship contracts, operating lease contracts and other contracts +that require future minimum payments resulting in fixed operating costs. Any changes to these contracts may require early termination fees or other charges that could result in significant cash +expenditures. +57 +Table of Contents +Repatriation of Cash +As we are a global business, we have cash balances which are located in various countries and are denominated in various currencies. +Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital +resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and +transfer cash balances between entities. +We +generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested; however, our Board has approved a foreign cash repatriation +strategy. As part of this strategy, we repatriated approximately $106.0 million during the year ended December 31, 2014 for which income taxes have already been accrued or paid. Further +cash repatriation will depend on future cash requirements in the U.S. We maintain approximately $65.8 million of foreign earnings for which tax has previously been provided, and which has not +been repatriated at this time. +Most +of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable +foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. +Certain countries have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully +utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2014, we held $247.6 million of our total +$267.5 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the +$247.6 million, $10.8 million could potentially be restricted, as described above. If the remaining $236.8 million were to be immediately repatriated to the U.S., we would be +required to incur approximately $39.0 million in taxes that were not previously provided for in our consolidated statement of operations. +Contractual Obligations +In December 2011, we renewed and amended our supply agreement with Finproject S.p.A. (formerly known as +Finproject s.r.l.), which provides us the exclusive right to purchase certain raw materials used to manufacture our products. The agreement also provides that we meet minimum purchase +requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2016. Historically, the minimum purchase requirements have not been onerous and we do not +expect them to become onerous in the future. Depending on the material purchased, pricing was either based on contracted price or was subject to quarterly reviews and fluctuates based on order volume, +currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain third-party manufacturer purchases of these raw materials up to a maximum potential +amount of €3.5 million (approximately $4.3 million as of December 31, 2014), through a letter of credit that was issued to Finproject S.p.A. +During +2015, we currently estimate additional restructuring costs related to store closures and changes in organizational structure of approximately $5 million to +$20 million, but can make no assurance that actual costs will not differ, as our restructuring plans are not yet complete. +58 +Table of Contents +The +following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2014: +Payments due by period +($ thousands) +Total +Less than +1 year +1 - 3 +years +3 - 5 +years +More than +5 years +Operating lease obligations(1) +$ +356,693 +$ +78,724 +$ +99,133 +$ +63,770 +$ +115,066 +Inventory purchase obligations with third-party manufacturers(2) +202,289 +202,289 +— +— +— +Dividends payable(3) +87,766 +11,900 +24,000 +24,000 +27,866 +Other contracts(4) +37,176 +13,620 +21,494 +2,062 +— +Debt obligations(5)(9) +12,034 +5,739 +6,295 +— +— +Minimum licensing royalties(6) +5,346 +2,748 +1,755 +843 +— +Estimated liability for uncertain tax positions(7) +813 +— +813 +— +— +Capital lease obligations(8)(9) +33 +27 +5 +1 +— +Total +$ +702,150 +$ +315,047 +$ +153,495 +$ +90,676 +$ +142,932 +(1) Our +operating lease obligations consist of leases for retail stores, offices, warehouses, vehicles, and equipment expiring at various dates through 2033. +This balance represents the minimum cash commitment under contract to various third parties for operating lease obligations including the effect of rent escalation clauses and deferred rent and +minimum sublease rentals due in the future under non-cancelable subleases. This balance does not include certain contingent rent clauses that may require additional rental amounts based on sales +volume, inventories, etc. as these amounts are not determinable for future periods. +(2) Our +inventory purchase obligations with third party manufacturers consist of open purchase orders for footwear products and include an immaterial amount of +purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third party manufacturers are +expected to be paid within one year. +(3) Dividends +payable are associated with our Series A Preferred Stock at a rate of 6.0% of the stated value of the stock. The amounts represent expected +dividend payments over the eight year redemption accretion period. +(4) Other +contracts consist of various agreements with third-party providers. +(5) We +have entered into an agreement with PNC to finance the purchase of software and services related to the implementation of our new ERP system, which began +in October 2012 and is expected to continue into early 2015. Our current debt obligations consist of five separate notes issued under the agreement, which bear interest rates ranging from 2.45% to +2.79% and maturities ranging from September 2016 to September 2017. We will continue to finance the ERP implementation on an as needed basis through this agreement. Interest rates and payment terms +are subject to change as further financing occurs. +(6) Our +minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our +footwear, apparel and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not +determinable for future periods. +(7) Our +estimated liability for uncertain tax positions are unrecognized tax benefits taken in our income tax return that would reduce our effective tax rate, +if recognized. As of December 31, 2014, we had gross unrecognized tax benefits recorded in non-current liabilities of $8.4 million and +59 +Table of Contents +an +additional $0.8 million in gross interest and penalties. We released $4.9 million of interest due to settlements of prior year positions, lapse of statute of limitations and change in +uncertainty. Of the $8.4 million, we expect approximately $0.8 million to be paid within less than a year. Of the remaining $7.6 million uncertain tax liabilities, we are unable +to make a reasonable estimate of the timing of payments in individual years and therefore, such amounts are not included in the contractual obligation table above. +(8) Our +capital lease obligations consist of leases for office equipment expiring at various dates through 2016. This balance represents the minimum cash +commitment under contract to various third-parties for capital lease obligations. +(9) Amounts +include anticipated interest payments. +Off-Balance Sheet Arrangements +We had no material off-balance sheet arrangements as of December 31, 2014. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and +non-GAAP financial measures, is based on the consolidated financial statements which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make +estimates and judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during +the reporting periods. We evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable +under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results +may differ from these estimates under different assumptions or conditions. The following discussion pertains to accounting policies management believes are most critical to the portrayal of our +financial condition and results of operations as well as the accounting policies that management considers subjective. +Reserves for Uncollectible Accounts Receivable. We make ongoing estimates related to the collectability of our accounts +receivable and maintain a +reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including the +length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events and historical write-off experience. Specific provisions are +recorded for individual receivables when we become aware of a customer's inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial +stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable +that we deem uncollectible. If the financial condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we +determine that a smaller or larger reserve is appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a determination. +Sales Returns, Allowances and Discounts. We record reductions to revenue for estimated customer returns, allowances and +discounts. Our estimated +sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Provisions for customer specific discounts based on contractual obligations with +certain major customers are recorded as reductions to +60 +Table of Contents +net +sales. We may accept returns from our wholesale and distributor customers on an exception basis at the sole discretion of management for the purpose of stock re-balancing, to ensure that our +products are merchandised in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances to key wholesale and distributor customers to facilitate the +"in-channel" markdown of products where we have experienced less than anticipated sell-through. We also record reductions to revenue for estimated customer credits as a result of price mark-downs in +certain markets. Fluctuations in our estimates for sales returns, allowances and discounts may be caused by many factors, including, but not limited to, fluctuations in our sales revenue and changes +in demand for our products. Our judgment in determining these estimates is impacted by various factors including customer acceptance of our new styles, customer inventory levels, shipping delays or +errors, known or suspected product defects, the seasonal nature of our products and macroeconomic factors affecting our customers. Because we cannot predict or control certain of these factors, the +actual amounts of customer returns and allowances may differ from our estimates. +Inventory Valuation. Inventories are valued at the lower of cost or market. Inventory cost is determined using the moving +average cost method. At +least annually, or more frequently if events and circumstances indicate fair value is less than carrying value, we evaluate our inventory for possible impairment using standard categories to classify +inventory based on the degree to which we believe that the products may need to be discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective and +unobservable assumptions including estimated future demand and market conditions and other observable factors such as current sell-through of our products, recent changes in demand for our product, +shifting demand between the products we offer, +global and regional economic conditions, historical experience selling through liquidation and "off-price" channels and the amount of inventory on hand. If the estimated inventory fair value is less +than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of operations. The ultimate +results achieved in selling excess and discontinued products in future periods may differ significantly from management's fair value estimates. See Note 2—Inventories in the +accompanying notes to the consolidated financial statements for additional information regarding inventory. +Impairment of Long-Lived Assets. We test long-lived assets to be held and used for impairment when events or circumstances +indicate the carrying +value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include: (i) a significant decrease in +its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or +business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected +for its acquisition or construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate +continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously +estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by determining if its carrying value exceeds the sum of its +projected undiscounted cash flows expected from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount of +impairment is measured as the difference between its carrying value and its fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Fair +value is determined by independent third-party appraisals, the net present value of expected cash flows, or other valuation techniques as appropriate. Assets to be abandoned or from which no further +benefit is expected are written down to zero at the time that the determination is made and the assets are removed entirely from service. +61 +Table of Contents +An +asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets +involved in our retail business, our asset group is at the retail store level. Our estimates of future cash flows over the remaining useful life of the asset group are based on management's operating +budgets and forecasts. These budgets and forecasts take into consideration inputs from our regional management related to growth rates, pricing, new markets and other factors expected to affect the +business, as well as management's forecasts for inventory, receivables, capital spending, and other cash needs. These considerations and expectations are inherently uncertain, and estimates included +in our operating forecasts beyond a three to six month future period are extremely subjective. Accordingly, actual cash flows may differ significantly from our estimated future cash flows. +Impairment +charges are driven by, among other things, changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and +other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets and result in impairment charges in future periods. Significant +impairment charges recognized during a reporting period could have an adverse effect on our reported financial results. +Share-based Compensation. We estimate the fair value of our stock option awards using a Black Scholes valuation model, the inputs +of which require +various assumptions including the expected volatility of our stock price and the expected life of the option. The expected volatility assumptions are derived using our historical stock price +volatility and the historical volatilities of competitors whose shares are traded in the public markets. These assumptions reflect our best estimates, however; they involve inherent uncertainties +based on market conditions generally outside of our control. If factors change and we use a different methodology for deriving the Black Scholes assumptions, our share- based compensation expense may +differ materially in the future from that recorded in the current period. Additionally, we make certain estimates about the number of awards which will be made under performance based incentive plans. +As a result, if other assumptions or estimates had been used, share-based compensation expense could have been materially impacted. Furthermore, if we use different assumptions in future periods, +share-based compensation expense could be materially impacted in future periods. See Note 10—Equity in the accompanying notes to the consolidated financial statements for additional +information regarding our share-based compensation. +Provisions for Contingencies and Legal Proceedings. We estimate our provision for general contingencies, including potential +losses in relation to +tax and customs matters and legal proceedings, based on an assessment of the probability of the contingency and accrue if information available indicates that it is probable that a liability has been +incurred. When it has been determined that a liability has been incurred, and information available indicates that the estimated amount of loss can be reasonably estimated and/or is within a range of +amounts, that amount is accrued for in the consolidated financial statements. +Income Taxes. We account for income taxes using the asset and liability method which requires the recognition of deferred tax +assets and liabilities +for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future +enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures +regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be +recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being +sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a +62 +Table of Contents +matter +of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. +Our +annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is +required in determining our annual tax expense and in evaluating our tax positions. Tax laws require items to be included in our tax returns at different times than when these items are reflected in +the consolidated financial statements. As a result, the annual tax rate reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). Some +of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create +deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. The tax +rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on an evaluation of all available +information, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. +We +evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating +results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to +be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. Undistributed earnings of a subsidiary +are accounted for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign subsidiary that are deemed to be indefinitely reinvested in +the foreign jurisdiction. We have operated under a specific plan for reinvestment of undistributed earnings of our foreign subsidiaries which demonstrates that such earnings will be indefinitely +reinvested in the applicable tax jurisdictions. Should we change our plans, we would be required to record a significant amount of deferred tax liabilities. We recognize interest and penalties related +to unrecognized tax benefits within the "Income tax expense" line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability +line in the consolidated balance sheets. See Note 12—Income Taxes in the accompanying notes to the consolidated financial statements for additional information regarding our income +taxes. +Recent Accounting Pronouncements. See Note 1—Organization and Summary of Significant Accounting Policies in the +accompanying notes +to the consolidated financial statements for recently adopted and issued accounting pronouncements. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall +financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility and certain financial instruments. In addition to the revolving +credit facility, we have incurred short- and long-term indebtedness related to the implementation of our ERP system. Borrowings under these debt instruments bear fixed interest rates and therefore, do +not have the potential for market risk. +Borrowings +under the revolving credit facility bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds +open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from +0.25% to 1.00% based on certain conditions. For +63 +Table of Contents +LIBOR +rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. Borrowings under the revolving credit facility are therefore subject +to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and +political considerations and other factors that are beyond our control. As of December 31, 2014, there were no borrowings under the revolving credit facility. During the year ended +December 31, 2013, the maximum daily amount borrowed under the revolving credit facility was $5.0 million and the average daily amount of borrowings outstanding was $0.1 million. +If the prevailing market interest rates relative to these borrowings increased by 10% during the year ended December 31, 2013, our interest expense would not have increased materially. +We +additionally hold cash equivalents including certificate of deposits, time deposits and money market funds. Interest income generated from these cash equivalents will fluctuate with +the general level of interest rates. As of December, 2014, we held $23.3 million in cash equivalents subject to variable interest rates. If the prevailing market interest rates relative to +these investments increased or decreased by10% during the year ended December 31, 2014, interest income would have increased or decreased by approximately $0.1 million. +Foreign Currency Exchange Risk +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We pay the majority +of expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of our overseas third-party manufacturers in +U.S. Dollars. Our ability to sell our products in foreign markets and the U.S. Dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. +Fluctuations in the value of foreign currencies relative to the U.S. Dollar could result in downward price pressure for our products and increase losses from currency exchange rates. An increase or +decrease of 1% in value of the U.S. Dollar relative to foreign currencies would have increased or decreased loss before taxes during the year ended December 31, 2014 by approximately +$2.1 million. The volatility of the applicable exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. In the event our foreign sales and purchases +increase and are denominated in currencies other than the U.S. Dollar, our operating results may be affected by fluctuations in the exchange rate of currencies we receive for such sales. See +Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a discussion of the impact of foreign exchange rate variances experienced during the years +ended December 31, 2014 and 2013. +We +transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk inherent in revenues, costs, and monetary assets and liabilities +denominated in non-functional currencies. We have entered into foreign currency exchange forward contracts and currency swap derivative instruments to selectively protect against volatility in the +value of non-functional currency denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. +The +following table summarizes the notional amounts of the outstanding foreign currency exchange contracts at December 31, 2014 and 2013. The notional amounts of the derivative +financial instruments shown below are denominated in their U.S. Dollar equivalents and represent the amount of all contracts of the foreign currency specified. These notional values do not necessarily +represent amounts +64 +Table of Contents +exchanged +by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2014 +2013 +Foreign currency exchange forward contracts by currency: +Euro +$ +134,755 +$ +38,577 +Singapore Dollar +61,887 +28,225 +Japanese Yen +44,533 +68,707 +British Pound Sterling +17,230 +15,487 +South Korean Won +14,590 +12,100 +Mexican Peso +13,180 +18,350 +Australian Dollar +7,913 +4,941 +Chinese Yuan Renminbi +5,376 +— +South African Rand +4,355 +3,076 +Indian Rupee +3,356 +2,150 +New Taiwan Dollar +3,229 +3,463 +Canadian Dollar +3,005 +3,428 +Swedish Krona +1,918 +1,615 +Russian Ruble +1,838 +17,588 +Norwegian Krone +917 +— +Hong Kong Dollar +814 +1,844 +New Zealand Dollar +743 +943 +Total notional value, net +$ +319,639 +$ +220,494 +Latest maturity date +January 2015 +December 2015 +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on +page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange +Act, as of December 31, 2014 (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure +controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission ("SEC") +reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, +including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +65 +Table of Contents +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange +Act Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014, using the criteria set forth in the Internal +Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on +this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2014. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonably likely to materially affect, our internal control over financial reporting. +66 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the Company) as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management's Annual Report on +Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended +67 +Table of Contents +December 31, +2014 of the Company and our report dated March 2, 2015 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +March 2, 2015 +68 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2015 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2014. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal +financial officer, principal accounting officer and controller. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose certain +changes to, or waivers from, our code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct +and ethics policy as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2015 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2014. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2015 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2014, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 3.7 million shares of common stock for future issuance pursuant to exercise of +outstanding awards under equity compensation plans as of December 31, 2014. +Plan Category +Number of +Securities to be Issued +on Exercise of +Outstanding +Options and Rights +Weighted-average +Exercise Price of +Outstanding +Options(2) +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders(1) +3,701,089 +$ +13.52 +3,721,112 +Equity compensation plans not approved by stockholders +— +— +— +Total +3,701,089 +$ +13.52 +3,721,112 +(1) On +July 9, 2007, at the annual stockholders' meeting, our stockholders approved the 2007 Equity Incentive Plan (the "2007 Plan"), which previously +had been approved by our Board of Directors (the "Board") and which became effective as of July 19, 2007. On June 28, 2011, our stockholders approved an amendment to the 2007 Plan to +increase the number of shares of our common stock available for issuance from 9.0 million shares to 15.3 million shares, subject to adjustment for future stock splits, stock dividends +and similar changes in our capitalization. On April 27, 2005, our Board adopted the 2005 Equity Incentive Plan (the "2005 Plan"). On January 10, 2006, our Board +69 +Table of Contents +amended +the 2005 Plan to increase the number of shares of our common stock available for issuance under the 2005 Plan from 11.7 million shares to 14.0 million shares. Following the +adoption of the 2007 Plan, no additional grants were made under the 2005 Plan. +(2) The +weighted-average exercise price of outstanding options pertains only to 1.7 million shares issuable on the exercise of outstanding options and +rights. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2015 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2014. +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2015 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2014. +PART IV +ITEM 15. Exhibits and Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the consolidated financial +statements or notes thereto. +70 +Table of Contents +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, +2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.1 +* +Form of Indemnification Agreement between Crocs, Inc. and each of its directors and executive officers (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.2 +* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.3 +* +Amendment No. 1 to the 2005 Plan (incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.4 +* +Form of Notice of Grant of Stock Option under the 2005 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.5 +* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on +August 15, 2005 (File No. 333-127526)). +10.6 +* +Form of Stock Purchase Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.7 +* +Form of Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.8 +* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +71 +Table of Contents +Exhibit +Number +Description +10.9 +* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.10 +* +Form of Non Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 +(File No. 333-127526)). +10.11 +* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.'s Annual Report on Form 10-K, filed on +March 17, 2009). +10.12 +* +2008 Cash Incentive Plan (As Amended and Restated Effective June 4, 2012) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on June 7, +2012). +10.13 +* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the "2007 Plan") (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +July 1, 2011). +10.14 +* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, +2007). +10.15 +* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, +2007). +10.16 +* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +November 14, 2007). +10.17 +* +Form of Restricted Stock Unit Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 1, 2011). +10.18 +* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +August 5, 2010). +10.19 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, +National Association, as a lender and administrative agent for the lenders (the "Amended and Restated Credit Agreement") (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 19, +2011). +10.20 +First Amendment to the Amended and Restated Credit Agreement, dated December 10, 2012, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders +named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 11, 2012). +72 +Table of Contents +Exhibit +Number +Description +10.21 +Second Amendment to Amended and Restated Credit Agreement, dated June 12, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein +and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on July 30, 2013). +10.22 +Third Amendment to Amended and Restated Credit Agreement, dated December 27, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named +therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 30, 2013). +10.23 +Fourth Amendment to Amended and Restated Credit Agreement, dated March 27, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named +therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.24 +Fifth Amendment to Amended and Restated Credit Agreement, dated September 26, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named +therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on October 29, 2014). +10.25 +Master Installment Payment Agreement, dated December 10, 2012, among Crocs, Inc. the lender named therein and PNC Bank National Association, as a lender and administrative agent (incorporated herein by +reference to Exhibit 10.24 to Crocs, Inc.'s Annual Report on Form 10-K, filed on February 25, 2013). +10.26 +* +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on May 1, +2014). +10.27 +Investment Agreement, dated December 28, 2013, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on +Form 8-K, filed on December 30, 2013). +10.28 +First Amendment to Investment Agreement, dated January 27, 2014, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s +Current Report on Form 8-K, filed on January 27, 2014). +10.29 +* +Separation Agreement, dated December 27, 2013, between Crocs, Inc. and John P. McCarvel (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Current Report on Form 8-K, filed on +December 30, 2013). +10.30 +* +Form Severance Agreement (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 30, 2013). +10.31 +* +Form of Severance Agreement (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on July 30, 2014). +10.32 +* +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +May 14, 2014). +73 +Table of Contents +Exhibit +Number +Description +10.33 +Registration Rights Agreement, dated January 27, 2014 (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on January 27, 2014). +10.34 +* +Employment Offer Letter, dated December 15, 2014, between Crocs, Inc. and Gregg Ribatt (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +December 15, 2014). +21 +† +Subsidiaries of the registrant. +23.1 +† +Consent of Deloitte & Touche LLP. +31.1 +† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 +† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley +Act. +32 +† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS +† +XBRL Instance Document +101.SCH +† +XBRL Taxonomy Extension Schema Document +101.CAL +† +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF +† +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB +† +XBRL Taxonomy Extension Label Linkbase Document +101.PRE +† +XBRL Taxonomy Extension Presentation Linkbase Document +* Compensatory +plan or arrangement +† Filed +herewith. +74 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this +report to be signed on its behalf by the undersigned, thereunto duly authorized, as of March 2, 2015. +CROCS, INC. +a Delaware Corporation +By: +/s/ GREGG RIBATT +Name: +Gregg Ribatt +Title: +Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on +the dates indicated. +Signature +Title +Date +/s/ GREGG RIBATT +Gregg Ribatt +Chief Executive Officer and Director +March 2, 2015 +/s/ JEFFREY J. LASHER +Jeffrey J. Lasher +Senior Vice President—Finance, Chief Financial Officer +March 2, 2015 +/s/ RAYMOND D. CROGHAN +Raymond D. Croghan +Director +March 2, 2015 +/s/ RONALD L. FRASCH +Ronald L. Frasch +Director +March 2, 2015 +/s/ JASON GIORDANO +Jason Giordano +Director +March 2, 2015 +/s/ PETER A. JACOBI +Peter A. Jacobi +Director +March 2, 2015 +/s/ PRAKASH A. MELWANI +Prakash A. Melwani +Director +March 2, 2015 +75 +Table of Contents +Signature +Title +Date +/s/ THOMAS J. SMACH +Thomas J. Smach +Chairman of the Board +March 2, 2015 +/s/ DOREEN A. WRIGHT +Doreen A. Wright +Director +March 2, 2015 +76 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Statements of Operations for the Years Ended December 31, 2014, 2013 and 2012 +F-3 +Consolidated Statements of Comprehensive Income (Loss) as of December 31, 2014, 2013 and 2012 +F-4 +Consolidated Balance Sheets as of December 31, 2014 and 2013 +F-5 +Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2014, 2013 and 2012 +F-6 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2014 and 2013 and the related consolidated +statements of operations, comprehensive income (loss), stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the +responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in +the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement +presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, +2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally +accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over +financial reporting as of December 31, 2014, based on the criteria established in Internal Control—Integrated Framework (2013) issued +by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2015 expressed an unqualified opinion on the Company's internal control over financial +reporting. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +March 2, 2015 +F-2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +($ thousands, except per share data) +2014 +2013 +2012 +Revenues +$ +1,198,223 +$ +1,192,680 +$ +1,123,301 +Cost of sales +603,893 +569,482 +515,324 +Restructuring charges (Note 6) +3,985 +— +— +Gross profit +590,345 +623,198 +607,977 +Selling, general and administrative expenses +565,712 +549,154 +460,393 +Restructuring charges (Note 6) +20,532 +— +— +Asset impairment charges (Note 3) +8,827 +10,949 +1,410 +Income (loss) from operations +(4,726 +) +63,095 +146,174 +Foreign currency transaction losses, net +4,885 +4,678 +2,500 +Interest income +(1,664 +) +(2,432 +) +(1,697 +) +Interest expense +806 +1,016 +837 +Other income, net +(204 +) +(126 +) +(1,014 +) +Income (loss) before income taxes +(8,549 +) +59,959 +145,548 +Income tax (benefit) expense +(3,623 +) +49,539 +14,205 +Net income (loss) +$ +(4,926 +) +$ +10,420 +$ +131,343 +Dividends on Series A convertible preferred stock (Note 14) +11,301 +— +— +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature (Note 14) +2,735 +— +— +Net income (loss) attributable to common stockholders +$ +(18,962 +) +$ +10,420 +$ +131,343 +Net income (loss) per common share (Note 13): +Basic +$ +(0.22 +) +$ +0.12 +$ +1.46 +Diluted +$ +(0.22 +) +$ +0.12 +$ +1.44 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +Year Ended December 31, +($ thousands) +2014 +2013 +2012 +Net income (loss) +$ +(4,926 +) +$ +10,420 +$ +131,343 +Other comprehensive income (loss): +Foreign currency translation +(33,004 +) +(5,335 +) +5,525 +Reclassification of cumulative foreign exchange translation adjustments to net income, net of tax of $0, $(3) and $7, respectively +— +299 +(658 +) +Total comprehensive income (loss) +$ +(37,930 +) +$ +5,384 +$ +136,210 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +($ thousands, except number of shares) +2014 +2013 +ASSETS +Current assets: +Cash and cash equivalents +$ +267,512 +$ +317,144 +Accounts receivable, net of allowances of $32,392 and $10,513, respectively +101,217 +104,405 +Inventories +171,012 +162,341 +Deferred tax assets, net +4,190 +4,440 +Income tax receivable +9,332 +10,630 +Other receivables +11,989 +11,942 +Prepaid expenses and other current assets +30,156 +29,175 +Total current assets +595,408 +640,077 +Property and equipment, net +68,288 +86,971 +Intangible assets, net +97,337 +72,314 +Goodwill +2,044 +2,508 +Deferred tax assets, net +17,886 +19,628 +Other assets +25,968 +53,661 +Total assets +$ +806,931 +$ +875,159 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +42,923 +$ +57,450 +Accrued expenses and other current liabilities +80,216 +97,111 +Deferred tax liabilities, net +11,869 +11,199 +Accrued restructuring +4,511 +— +Income taxes payable +9,078 +15,992 +Current portion of long-term borrowings and capital lease obligations +5,288 +5,176 +Total current liabilities +153,885 +186,928 +Long-term income tax payable +8,843 +36,616 +Long-term borrowings and capital lease obligations +6,381 +11,670 +Long-term accrued restructuring +348 +— +Other liabilities +12,277 +15,201 +Total liabilities +181,734 +250,415 +Commitments and contingencies (Note 15) +Series A convertible preferred stock, par value $0.001 per share, 1,000,000 shares authorized, 200,000 shares issued and outstanding, redemption +amount and liquidation preference of $203,067 and $0 as of December 31, 2014 and 2013, respectively (Note 14) +172,679 +— +Stockholders' equity: +Preferred stock, par value $0.001 per share, 4,000,000 shares authorized, none outstanding +— +— +Common stock, par value $0.001 per share, 250,000,000 shares authorized, 92,325,201 and 78,516,566 shares issued and outstanding, +respectively, as of December 31, 2014 and 91,662,656 and 88,450,203 shares issued and outstanding, respectively, as of December 31, 2013 +92 +92 +Treasury stock, at cost, 13,808,635 and 3,212,453 shares as of December 31, 2014 and 2013, respectively +(200,424 +) +(55,964 +) +Additional paid-in capital +345,732 +321,532 +Retained earnings +325,470 +344,432 +Accumulated other comprehensive income (loss) +(18,352 +) +14,652 +Total stockholders' equity +452,518 +624,744 +Total liabilities, commitments and contingencies and stockholders' equity +$ +806,931 +$ +875,159 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY +Common Stock +Treasury Stock +Accumulated +Other +Comprehensive +Income +Total +Stock +Holders' +Equity +Additional +Paid in +Capital +Retained +Earnings +($ and shares in thousands) +Shares +Amount +Shares +Amount +BALANCE—January 1, 2012 +89,807 +$ +90 +499 +$ +(19,759 +) +$ +293,959 +$ +202,669 +$ +14,821 +$ +491,780 +Amortization of stock compensation +— +— +— +— +11,764 +— +— +11,764 +Forfeitures +(43 +) +— +— +— +(493 +) +— +— +(493 +) +Exercises of stock options and issuance of restricted stock awards +783 +1 +(29 +) +1,112 +2,593 +— +— +3,706 +Repurchase of common stock for tax withholding +— +— +30 +(493 +) +— +— +— +(493 +) +Purchase of treasury stock +(1,884 +) +— +1,884 +(25,074 +) +— +— +— +(25,074 +) +Net income +— +— +— +— +— +131,343 +— +131,343 +Foreign currency translation +— +— +— +— +— +— +5,525 +5,525 +Reclassification of cumulative foreign exchange translation adjustments to net income +— +— +— +— +— +— +(658 +) +(658 +) +BALANCE—December 31, 2012 +88,663 +$ +91 +2,384 +$ +(44,214 +) +$ +307,823 +$ +334,012 +$ +19,688 +$ +617,400 +Amortization of stock compensation +— +— +— +— +14,483 +— +— +14,483 +Forfeitures +(78 +) +— +— +— +(2,014 +) +— +— +(2,014 +) +Exercises of stock options and issuance of restricted stock awards +715 +1 +(22 +) +1,039 +1,240 +— +— +2,280 +Repurchase of common stock for tax withholding +(16 +) +— +16 +(256 +) +— +— +— +(256 +) +Purchase of treasury stock +(834 +) +— +834 +(12,533 +) +— +— +— +(12,533 +) +Net income +— +— +— +— +— +10,420 +— +10,420 +Foreign currency translation +— +— +— +— +— +— +(5,335 +) +(5,335 +) +Reclassification of cumulative foreign exchange translation adjustments to net income +— +— +— +— +— +— +299 +299 +BALANCE—December 31, 2013 +88,450 +$ +92 +3,212 +$ +(55,964 +) +$ +321,532 +$ +344,432 +$ +14,652 +$ +624,744 +Amortization of stock compensation +— +— +— +— +14,896 +— +— +14,896 +Forfeitures +(144 +) +— +— +— +(2,129 +) +— +— +(2,129 +) +Exercises of stock options and issuance of restricted stock awards +853 +— +(46 +) +2,185 +(843 +) +— +— +1,342 +Repurchase of common stock for tax withholding +(53 +) +— +53 +(787 +) +— +— +— +(787 +) +Purchase of treasury stock +(10,590 +) +— +10,590 +(145,858 +) +— +— +— +(145,858 +) +Dividends—Series A preferred stock +— +— +— +— +— +(11,301 +) +— +(11,301 +) +Accretion—Series A preferred stock +— +— +— +— +— +(2,735 +) +— +(2,735 +) +Adjustment for beneficial conversion feature of Series A preferred stock +— +— +— +— +12,276 +— +— +12,276 +Net loss +— +— +— +— +— +(4,926 +) +— +(4,926 +) +Foreign currency translation +— +— +— +— +— +— +(33,004 +) +(33,004 +) +BALANCE—December 31, 2014 +78,516 +$ +92 +13,809 +$ +(200,424 +) +$ +345,732 +$ +325,470 +$ +(18,352 +) +$ +452,518 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +($ thousands) +2014 +2013 +2012 +Cash flows from operating activities: +Net income (loss) +$ +(4,926 +) +$ +10,420 +$ +131,343 +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depreciation and amortization +37,413 +41,506 +36,694 +Unrealized (gain) loss on foreign exchange, net +(11,100 +) +(6,420 +) +13,928 +Deferred income taxes +829 +23,536 +(2,981 +) +Asset impairment charges +8,827 +10,949 +1,410 +Provision for doubtful accounts, net +12,087 +1,930 +2,166 +Share-based compensation +12,503 +11,871 +11,321 +Inventory write-down charges +7,490 +3,419 +— +Non-cash restructuring charges +6,413 +— +— +Other non-cash items +534 +1,193 +1,725 +Changes in operating assets and liabilities: +Accounts receivable +(15,288 +) +(17,166 +) +(9,475 +) +Inventories +(31,251 +) +(5,274 +) +(35,493 +) +Prepaid expenses and other assets +21,698 +(4,225 +) +(25,490 +) +Accounts payable +(12,106 +) +(5,740 +) +99 +Accrued expenses and other liabilities +(15,824 +) +14,256 +8,016 +Accrued restructuring +4,859 +— +— +Income taxes +(33,809 +) +3,209 +(4,907 +) +Cash provided by (used in) operating activities +(11,651 +) +83,464 +128,356 +Cash flows from investing activities: +Cash paid for purchases of property and equipment +(15,991 +) +(40,424 +) +(39,762 +) +Proceeds from disposal of property and equipment +236 +250 +2,216 +Cash paid for intangible assets +(41,035 +) +(28,404 +) +(21,074 +) +Business acquisitions, net of cash +— +— +(5,169 +) +Restricted cash +(1,202 +) +(1,180 +) +(2,154 +) +Cash used in investing activities +(57,992 +) +(69,758 +) +(65,943 +) +Cash flows from financing activities: +Proceeds from preferred stock offering, net of issuance costs of $15.8 million and $0.0 million, respectively +182,220 +— +— +Dividends—Series A preferred stock +(8,234 +) +— +— +Proceeds from bank borrowings +— +23,375 +96,086 +Repayment of bank borrowings and capital lease obligations +(5,177 +) +(13,160 +) +(90,625 +) +Deferred debt issuance costs +(75 +) +(100 +) +(225 +) +Deferred offering costs +— +(767 +) +— +Issuances of common stock +1,342 +2,280 +3,706 +Purchase of treasury stock +(145,858 +) +(12,533 +) +(25,074 +) +Repurchase of common stock for tax withholding +(787 +) +(256 +) +(493 +) +Cash provided by (used in) financing activities +23,431 +(1,161 +) +(16,625 +) +Effect of exchange rate changes on cash +(3,420 +) +10,251 +(9,027 +) +Net increase in cash and cash equivalents +(49,632 +) +22,796 +36,761 +Cash and cash equivalents—beginning of period +317,144 +294,348 +257,587 +Cash and cash equivalents—end of period +$ +267,512 +$ +317,144 +$ +294,348 +Supplemental disclosure of cash flow information—cash paid during the period for: +Interest, net of capitalized interest +$ +616 +$ +693 +$ +619 +Income taxes +$ +33,655 +$ +20,274 +$ +29,385 +Supplemental disclosure of non-cash investing and financing activities: +Assets acquired under capitalized leases +$ +— +$ +61 +$ +34 +Accrued purchases of property and equipment +$ +771 +$ +2,165 +$ +2,368 +Accrued purchases of intangibles +$ +2,988 +$ +4,742 +$ +768 +Intrinsic value of beneficial conversion feature—Series A preferred stock +$ +12,276 +$ +— +$ +— +Accrued dividends +$ +3,067 +$ +— +$ +— +Accretion of dividend equivalents +$ +2,735 +$ +— +$ +— +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Organization —Crocs, Inc. and its subsidiaries (collectively the "Company," "we," "our" or "us") are engaged in the design, development, +manufacturing, marketing and distribution of footwear, apparel and accessories for men, women and children. +Basis of Consolidation —The consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles +generally accepted in the United States of America ("U.S. GAAP"). The consolidated financial statements include the accounts of our wholly-owned subsidiaries as well as variable interest +entities ("VIE") for which we are the primary beneficiary after the elimination of intercompany accounts and transactions. The primary beneficiary of a VIE is the entity that has (i) the power +to direct the activities of the VIE that most significantly impact the VIE's economic performance and (ii) the obligation to absorb losses of the VIE that could potentially be significant to +the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. +In +April 2011, we and an unrelated third party formed Crocs Gulf, LLC ("Crocs Gulf") for the purpose of selling our products in the United Arab Emirates. We have determined that +Crocs Gulf is a VIE for +which we are the primary beneficiary due to our variable interest in Crocs Gulf's equity and because we currently control all of the VIE's business activities and will absorb all of its expected +residual returns and expected losses. All voting and dividend rights have been assigned to us. As of December 31, 2014 and 2013, the consolidated financial statements included +$3.3 million and $2.4 million in total assets of Crocs Gulf, respectively, which primarily consisted of cash and cash equivalents, inventory, property and equipment. The total assets as +of December 31, 2014 and 2013 were partially offset by $0.4 million and $0.2 million in total liabilities, respectively, which primarily consisted of accounts payable and accrued +expenses, excluding liabilities related to the support provided by us. +Noncontrolling Interests —As of December 31, 2014, all of our subsidiaries were, in substance, wholly owned. +Concentrations of Risk —We are exposed to concentrations of risks in the following categories: +Cash and cash equivalents —Our cash and cash equivalents are maintained in several different financial institutions in amounts that typically exceed +U.S. federally insured limits or in financial institutions in international jurisdictions where insurance is not provided and restrictions may exist. +As +we are a global business, we have cash and cash equivalent balances which are located in various countries and are denominated in various currencies. Most of the cash balances held +outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable foreign tax credits. In some countries, +repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, including China, have +monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash and cash +equivalent resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2014, we held $247.6 million of our total $267.5 million +in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the +F-8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +$247.6 million +held in international locations, $10.8 million could potentially be restricted, as described above. +On +January 27, 2014, we issued to Blackstone Capital Partners VI L.P. ("Blackstone"), and certain of its permitted transferees (together with Blackstone, the "Blackstone +Purchasers"), 200,000 shares of our Series A Preferred Stock. In return, we received approximately $182.2 million in cash proceeds (net of related expenses) all of which is held in the +U.S. See Note 14—Series A Preferred Stock for further detail regarding the investment agreement. +Accounts receivable —We have not experienced significant losses in such accounts in prior years, however, as of December 31, 2014, we recorded a +reserve for doubtful accounts of $11.5 million in our Asia Pacific segment primarily as a result of delayed payments from our partner stores in China and Southeast Asia and a reserve for +rebates on a consolidated basis of $11.6 million primarily related to our Asia Pacific region. As of December 31, 2013, our reserve for doubtful accounts was $3.7 million and the +rebates reserve was $1.4 million. Generally, we consider any concentration of credit risk related to accounts receivable to be mitigated by our credit policy, the insignificance of outstanding +balances owed by each individual customer at any point in time and the geographic dispersion of our customers. See Note 11—Allowances for further detail. +Manufacturing sources —We rely on a limited source of internal and external manufacturers. Establishing a replacement source could require significant +additional time and expense. +Suppliers of certain raw materials —We source the elastomer resins that constitute the primary raw materials used in compounding Croslite, which we use +to produce our footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable +substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the elastomer resins or any substitute +materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +Management Estimates —The preparation of financial statements in conformity with +U.S. GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported +amounts of revenue and expenses during the reporting period. Management believes that the estimates, judgments and assumptions made when accounting for items and matters such as, but not limited to, +the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, share-based +compensation expense, the assessment of lower of cost or market on inventory, useful lives assigned to long-lived assets, depreciation and provisions for contingencies are reasonable based on +information available at the time they are made. Management also makes estimates in the assessments of potential losses in relation to tax and customs matters and threatened or pending legal +proceedings (see Note 15—Commitments & Contingencies and Note 17—Legal Proceedings). Actual results could materially differ from these estimates. For +matters not related to income taxes, if a loss is considered probable and the amount can be reasonably estimated, we recognize an expense for the estimated loss. If there is the potential to recover a +portion of the estimated loss from a third party, we make a separate assessment of recoverability and reduce the estimated loss if recovery is deemed probable. +F-9 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Accumulated Other Comprehensive Income —Activity within our accumulated other comprehensive income ("AOCI") balance consists solely of gains and +losses +resulting from the translation of foreign subsidiary financial statements to our reporting currency. Foreign currency translation resulting in changes to other comprehensive income and related +reclassification adjustments are presented net of tax effects on the consolidated statements of other comprehensive income. Foreign currency reclassification adjustments are included within the line +item entitled 'Foreign currency transaction gains (losses), net' on the consolidated statements of operations. +Fair Value —Fair value is the price that would be received from the sale of an asset or transfer of a liability in an orderly transaction between +market participants at the measurement date. When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal or most +advantageous market in which a hypothetical sale or transfer would take place and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, +transfer restrictions, and risk of non-performance. +The +fair value hierarchy is made up of three levels of inputs which may be used to measure fair value: +Level 1—observable +inputs such as quoted prices for identical instruments in active markets; +Level 2—observable +inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not +active and model derived valuations in which all significant inputs are observable in active markets; and +Level 3—unobservable +inputs for which there is little or no market data and which require us to develop our own assumptions. We categorize fair value measurements +within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine such fair value measurement. +Cash +equivalents primarily include time deposits and certificates of deposit with original maturities of three months or less. Time deposits and certificates of deposit included in cash +equivalents are valued at amortized cost, which approximates fair value. These investments have been classified as a Level 1 measurement. +Derivative +financial instruments are required to be recorded at their fair value, on a recurring basis. The fair values of any derivative instruments, should we enter into them, would be +determined using a discounted cash flow valuation model. The significant inputs used in the model are readily available in public markets or can be derived from observable market transactions, and +therefore, have been classified as Level 2. These inputs include the applicable exchange rates and forward rates, and discount rates based on the prevailing LIBOR deposit rates. +Our +other financial instruments are not required to be carried at fair value on a recurring basis. The carrying value of these financial instruments, including cash equivalents, accounts +receivable, accounts payable and accrued liabilities, approximates fair value due to their short maturities. Based on borrowing rates currently available to us, with similar terms, the carrying values +of capital lease obligations and the line of credit approximate their fair values. +Inventories +and long-lived assets such as property and equipment and intangible assets are also not required to be carried at fair value on a recurring basis. For a discussion of +inventory estimated fair +F-10 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +value +see "Inventory Valuation" below. However, when determining impairment losses, the fair values of property and equipment and intangibles must be determined. For such determination, we generally +use either an income approach with inputs that are mainly unobservable, such as expected future cash flows, or a market approach using observable inputs such as replacement cost or third-party +appraisals, as appropriate. Estimated future cash flows are based on management's operating budgets and forecasts which take into consideration both observable and unobservable inputs including growth +rates, pricing, new markets and other factors expected to affect the business, as well as management's forecasts for inventory, receivables, capital spending, and other cash needs. We consider this +type of estimate to be classified as a Level 3 measurement. See Note 7—Fair Value Measurements for further discussion related to fair value measurements. +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three months or +less +at the date of purchase. We consider receivables from credit card companies to be cash equivalents, if expected to be received within five days. +Accounts Receivable —Accounts receivable represent amounts due from customers. Accounts receivable are recorded at invoiced amounts, net of +reserves +and allowances, are not collateralized and do not bear interest. We use our best estimate to determine the required allowance for doubtful accounts based on a variety of factors, including the length +of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events and historical non-collection experience. Specific provisions are +recorded for individual receivables when we become aware of a customer's inability to meet its financial obligations. See Note 11—Allowances for further discussion related to +provisions for doubtful accounts and sale returns and allowances. +Inventory Valuation —Inventories are valued at the lower of cost or market. Inventory cost is determined using the moving average cost method. At +least +annually, or more frequently if events and circumstances indicate fair value is less than carrying value, we evaluate our inventory for possible impairment using standard categories to classify +inventory based on the degree to which we believe that the products may need to be discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective +assumptions including estimated future demand and market conditions, as well as other observable factors such as current sell-through of our products, recent changes in demand for our products, global +and regional economic conditions, historical experience selling through liquidation and price discounted channels and the amount of inventory on hand. If the estimated inventory fair value is less +than its carrying value, the carrying value is adjusted to market +value and the resulting impairment charge is recorded in 'Cost of sales' on the consolidated statements of operations. See Note 2—Inventories for further discussion related to +inventories. +Property and Equipment —Property, equipment, furniture and fixtures are stated at cost and depreciation is computed using the straight-line method +based on the estimated useful lives ranging from two to five years. Leasehold improvements are stated at cost and amortized on the straight-line basis over their estimated economic useful lives or the +lease term, whichever is shorter. Depreciation of manufacturing assets is included in cost of sales on the consolidated statements of operations. Depreciation related to corporate, non-product and +non-manufacturing assets is included in 'Selling, general and administrative expenses' on the consolidated statements of operations. +Impairment of Long-Lived Assets —Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the +carrying +value of a long-lived asset may not be +F-11 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +fully +recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include (i) a significant decrease in its market price, (ii) a +significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or business climate that could +affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for its acquisition or +construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses +associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously estimated useful +life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by determining if its carrying value exceeds the sum of its projected +undiscounted cash flows from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is measured +as the difference between its carrying value and its estimated fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Assets to be +abandoned or from which no further benefit is expected are written down to zero at the time that the determination is made and the assets are removed entirely from service. +An +asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets +involved in our retail business, our asset group is at the retail store level. See Note 3—Property and Equipment for a discussion of impairment losses recorded during the periods +presented. +Intangible Assets —Intangible assets that are determined to have finite lives are amortized over their useful lives on a straight-line basis. +Customer +relationships are amortized on a straight-line basis or an accelerated basis. Indefinite lived intangible assets, such as trade names, are not amortized and are evaluated for impairment at least +annually and when circumstances imply possible impairment. +Amortization +of manufacturing intangible assets is included in cost of sales on the consolidated statements of operations. Amortization related to corporate, non-product and +non-manufacturing assets such as our global information systems is included in selling, general and administrative expenses on the consolidated statements of operations. The following table sets forth +our definite lived intangible assets and the periods over which they are amortized. +Intangible Asset Class +Weighted-average Amortization Period +Patents +10 years +Customer relationships +Estimated customer life +Core technology +5 years +Non-competition agreement +Contractual term +Capitalized software +Shorter of 7 years or useful life +Capitalized Software —We capitalize certain internal and external software acquisition and development costs, including the costs of employees and +contractors devoting time to the software development projects and external direct costs for materials and services. Initial costs associated with internally-developed-and-used software are expensed +until it is determined that the project has reached the application development stage. Once in its development stage, subsequent additions, modifications or upgrades to an internal-use software +project are capitalized to the extent that they add functionality. +F-12 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Software +maintenance and training costs are expensed in the period in which they are incurred. Capitalized software primarily consists of our enterprise resource system software, warehouse management +software and point of sale software. At least annually, we consider the potential impairment of capitalized software by assessing the substantive service potential of the software, changes, if any, in +the extent or manner in which the software is used or is expected to be used, and the actual cost of software development or modification compared to expected cost. See +Note 4—Goodwill and Intangible Assets for further discussion. +Impairment of Intangible Assets —Intangible assets with indefinite lives are evaluated for impairment when events or changes in circumstances indicate +that the carrying value may not be fully recoverable and at least annually. Intangible assets that are determined to have definite lives are amortized over their useful lives and are evaluated for +impairment only when events or circumstances indicate a carrying value may not be fully recoverable. Recoverability is based on the estimated future undiscounted cash flows of the asset. If the asset +is not supported on an undiscounted cash flow basis, the amount of impairment is measured as the difference between its carrying value and its estimated fair value. +Goodwill —Goodwill represents the excess purchase price paid over the fair value of assets acquired and liabilities assumed in acquisitions. +Goodwill +is considered an indefinite lived asset and therefore is not amortized. The Company assesses goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and +circumstances indicate impairment may have occurred. If the carrying value of goodwill exceeds its implied fair value, the Company records an impairment loss equal to the difference. See +Note 4—Goodwill and Intangible Assets for discussion of goodwill balances and discussion of impairment losses recorded during the periods presented. +Earnings per Share —Basic and diluted earnings per common share ("EPS") is presented using the two-class method, which is an earnings allocation +formula that determines earnings per share for common stock and any participating securities according to dividend rights and participation rights in undistributed earnings. Under the two-class +method, EPS is computed by dividing the sum of distributed and undistributed earnings attributable to common stockholders by the weighted-average number of shares of common stock outstanding during +the period. A participating security is a security that may participate in undistributed earnings with common stock had those earnings been distributed in any form. Our recently issued Series A +convertible preferred stock ("Series A Preferred Stock") represents participating securities as holders of the Series A Preferred Stock are entitled to receive any and all dividends +declared or paid on common stock on an as-converted basis. In addition, shares of our non-vested restricted stock awards are considered participating securities as they represent unvested share-based +payment awards containing non-forfeitable rights to dividends. As such, these participating securities must be included in the computation of EPS pursuant to the two-class method on a pro-rata, +as-converted basis. Diluted EPS reflects the potential dilution from securities that could share in our earnings. In addition, the dilutive effect of each participating security is calculated using +the more dilutive of the two-class method described above, which assumes that the securities remain in their current form, or the if-converted method, which assumes conversion to common stock as of +the beginning of the reporting date. Anti-dilutive securities are excluded from diluted EPS. See Note 13—Earnings Per Share for further discussion. +F-13 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Beneficial conversion feature —The issuance of our Series A Preferred Stock generated a beneficial conversion feature, which arises when a +debt +or equity security is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the conversion option has an effective strike price that is less +than the market price of the underlying stock at the commitment date. We recognized the beneficial conversion feature by allocating the intrinsic value of the conversion option, which is the number of +shares of common stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of common stock per share on the commitment date, to +additional paid-in capital, resulting in a discount +on the Series A Preferred Stock. We are accreting the discount over eight years from the date of issuance through the redemption date. Accretion expense will be recognized as dividend +equivalents over the eight year period utilizing the effective interest method. +Recognition of Revenues —Revenues are recognized when the customer takes title and assumes risk of loss, collection of related receivables is +probable, +persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country in which the sale occurs and +the agreement terms with the customer. Allowances for estimated returns and discounts are recognized when the related revenue is earned. +Shipping and Handling Costs and Fees —Shipping and handling costs are expensed as incurred and included in cost of sales. Shipping and handling +fees +billed to customers are included in revenues. +Share-based Compensation —We have share-based compensation plans in which certain officers, employees and members of the Company's Board of +Directors +(the "Board") are participants and may be granted stock options, restricted stock and stock performance awards. Awards granted under these plans are fair valued and amortized, net of estimated +forfeitures, over the vesting period using the straight-line method. The fair value of stock options is calculated by using the Black Scholes option pricing model that requires estimates for expected +volatility, expected dividends, the risk-free interest rate and the term of the option. If any of the assumptions used in the Black Scholes model or the anticipated number of shares to be awarded +change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period. Share-based compensation expense associated with our manufacturing +and retail employees is included in 'Cost of sales' in the consolidated statements of operations. Share-based compensation expense associated with selling, marketing and administrative employees is +included 'Selling, general and administrative expenses' on the consolidated statements of operations. Share-based compensation directly associated with the construction or implementation of certain +long-term projects for internal use are capitalized to the consolidated balance sheets until assets are ready for intended use and will be amortized over the useful life of the assets upon that date. +See Note 10—Equity for additional information related to share-based compensation. +Defined contribution plans —We have a 401(k) plan known as the Crocs, Inc. 401(k) Plan (the "Plan"). The Plan is available to employees on our +U.S. payroll and provides employees with tax deferred salary deductions and alternative investment options. The Plan does not provide employees with the option to invest in our common stock. Employees +may contribute up to 75.0% of their salary, +subject to certain limitations. We match employees' contributions to the Plan up to a maximum of 4.0% of eligible compensation. Our expense related to the matching contributions to the Plan was +F-14 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +$7.1 million, +$6.8 million and $5.8 million for the years ended December 31, 2014, 2013 and 2012, respectively. +Advertising —Advertising costs are expensed as incurred and production costs are expensed when the advertising is first run. Total advertising, +marketing and promotional costs reflected in 'Selling, general, and administrative expenses' on the consolidated statement of operations were $44.7 million, $47.6 million and +$39.8 million for the years ended December 31, 2014, 2013 and 2012, respectively. +Research and Development —Research and development costs are expensed as incurred. Research and development expenses amounted to $16.7 million, +$15.4 million and $12.0 million for the years ended December 31, 2014, 2013 and 2012, respectively, and are included in 'Selling, general, and administrative expenses' in the +consolidated statement of operations. +Foreign Currency Translation and Foreign Currency Transactions —Our reporting currency is the U.S. Dollar. Assets and liabilities of foreign +operations +denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted-average rate of exchange during the applicable +period. Adjustments resulting from translating foreign functional currency financial statements into U.S. Dollars are included in the foreign currency translation adjustment, a component of +accumulated other comprehensive income in stockholders' equity. +Gains +and losses generated by transactions denominated in currencies other than the local functional currencies are reflected in the consolidated statement of operations in the period in +which they occur and are primarily associated with payables and receivables arising from intercompany transactions. +Derivative Foreign Currency Contracts —We are directly and indirectly affected by fluctuations in foreign currency rates which may adversely impact +our +financial performance. To mitigate the potential impact of foreign currency exchange rate risk, we may employ derivative financial instruments including forward contracts and option contracts. Forward +contracts are agreements to buy or sell a quantity of a currency at a predetermined future date and at a predetermined rate. An option contract is an agreement that conveys the purchaser the right, +but not the obligation, to buy or sell a quantity of a currency at a predetermined rate during a period or at a time in the future. These derivative financial instruments are viewed as risk management +tools and are not used for trading or speculative purposes. We recognize derivative financial instruments as either assets or liabilities in the consolidated balance sheets and measure those +instruments at fair value. Changes in the fair value of derivatives not designated or effective as hedges are recorded in 'Foreign currency transaction (gains)/losses, net" in the consolidated +statements of operations. We had no derivative instruments that qualified for hedge accounting during any of the periods presented. See Note 7—Fair Value Measurements and Financial +Instruments for further discussion. +Income Taxes —Income taxes are accounted for using the asset and liability method which requires the recognition of deferred tax assets and +liabilities +for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future +enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures +regarding uncertainties in income tax positions. We +F-15 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +recognize +interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See Note 12—Income Taxes for further discussion. +Taxes Assessed by Governmental Authorities —Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, +including +value added tax, are recorded on a net basis and are therefore excluded from sales. +Application of Recent Accounting Pronouncements +Recently Adopted Accounting Pronouncements +Discontinued Operations +In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-08: Presentation of Financial Statements +(Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of +an Entity , which amends the definition of a discontinued operation in ASC 205-20 and requires entities to provide additional disclosures about discontinued operations as well +as disposal transactions that do not meet the discontinued operations criteria. The FASB issued the ASU to provide more decision-useful information and to make it more difficult for a disposal +transaction to qualify as a discontinued operation. Under the previous guidance, the results of operations of a component of an entity were classified as a discontinued operation if all of the +following conditions were met: +• The component has been disposed of or is classified as held for sale. +• The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result +of the disposal transaction. +• The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. +The +new guidance eliminates the second and third criteria above and instead requires discontinued operations treatment for disposals of a component or group of components that represents +a strategic shift that has or will have a major impact on an entity's operations or financial results. The ASU also expands the scope of ASC 205-20 to disposals of equity method investments and +businesses that, upon initial acquisition, qualify as held for sale. In addition, the ASU requires entities to reclassify assets and liabilities of a discontinued operation for all comparative periods +presented in the statement of financial position. Before these amendments, ASC 205-20 neither required nor prohibited such presentation. Regarding the statement of cash flows, an entity must disclose, +in all periods presented, either (1) operating and investing cash flows or (2) depreciation and amortization, capital expenditures, and significant operating and investing noncash items +related to the discontinued operation. This presentation requirement represents a significant change from previous guidance. This ASU is effective prospectively for all disposals or components +initially classified as held for sale in periods beginning on or after December 15, 2014. Early adoption is permitted. The adoption of this pronouncement did not have a material impact to the +Company's consolidated financial statements. +F-16 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Income Taxes +In July 2013, the FASB issued ASU No. 2013-11 Income Taxes (Topic 740): Presentation of an Unrecognized +Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU No. 2013-11"). This pronouncement provides guidance on +financial statement presentation of an unrecognized tax benefit ("UTB") when a net operating loss ("NOL") carryforward, a similar tax loss or a tax credit carryforward exists. Under the +pronouncement, an entity must present a UTB, or a portion of the UTB, in the financial statements as a reduction to a deferred tax asset ("DTA") for an NOL carryforward, a similar tax loss or a tax +credit carryforward except when: +1) An +NOL carryforward, a similar tax loss or a tax credit carryforward is not available as of the reporting date under the governing tax law to settle that +would result from the disallowance of the tax position. +2) The +entity does not intend to use the DTA for this purpose (provided that the tax law permits a choice). +If +either of these conditions exists, an entity should present a UTB in the financial statements as a liability and should not net the UTB with a DTA. This amendment does not affect the +amounts disclosed in the tabular reconciliation of the total amounts of UTBs because the tabular reconciliation presents gross amounts of UTBs. This pronouncement is effective for fiscal years and +interim periods within those fiscal years beginning after December 15, 2013. The Company adopted this pronouncement on January 1, 2014. The adoption of this pronouncement did not have a +material impact to the Company's consolidated financial position or results of operations. +Recently Issued Accounting Pronouncements +Going Concern +On August 27, 2014, the FASB issued ASU 2014-15, which provides guidance on determining when and how reporting entities must +disclose going concern uncertainties in their financial statements. The new standard requires management to perform interim and annual assessments of an entity's ability to continue as a going concern +within one year of the date of issuance of the entity's financial statements (or within one year after the date on which the financial statements are available to be issued, when applicable). Further, +an entity must provide certain disclosures if there is "substantial doubt about the entity's ability to continue as a going concern." +The +FASB believes that requiring management to perform the assessment will enhance the timeliness, clarity and consistency of related disclosures and improve convergence with IFRSs +(which emphasize management's responsibility for performing the going concern assessment). However, the time horizon for the assessment (look-forward period) and the disclosure thresholds under +U.S. GAAP and IFRSs +will continue to differ. This ASU is effective for annual periods ending after December 16, 2016, and interim periods thereafter; early adoption is permitted. The Company does not believe that +this pronouncement will have a material impact on our financial statement disclosures. +Share-Based Payment +On June 19, 2014, the FASB issued ASU 2014-12 in response to the EITF consensus on Issue 13-D. The ASU clarifies that +entities should treat performance targets that can be met after the +F-17 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +requisite +service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense related to an award for which transfer +to the employee is contingent on the entity's satisfaction of a performance target until it becomes probable that the performance target will be met. The ASU does not contain any new disclosure +requirements. This ASU is effective for all entities for reporting periods (including interim periods) beginning after December 15, 2015. The Company does not believe that this pronouncement +will have a material impact to the Company's consolidated financial statements. +Revenue Recognition +In May 2014, the FASB issued their final standard on revenue from contracts with customers. The standard, issued as ASU +No. 2014-09: Revenue from Contracts with Customers (Topic 606) by the FASB, outlines a single comprehensive model for entities to use in +accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is +that "an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange +for those goods or services." In applying the revenue model to contracts within its scope, an entity: +• Identifies the contract(s) with a customer (Step 1) +• Identifies the performance obligations in the contract (Step 2) +• Determines the transaction price (Step 3) +• Allocates the transaction price to the performance obligations in the contract (Step 4) +• Recognizes revenue when (or as) the entity satisfies a performance obligation (Step 5) +The +ASU applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. Certain of the ASU's provisions also +apply to transfers of nonfinancial assets, including in-substance nonfinancial assets that are not an output of an entity's ordinary activities (e.g., sales of property, plant, and equipment, +real estate or intangible assets). Existing accounting guidance applicable to these transfers has been amended or superseded. Compared with current U.S. GAAP, the ASU also requires +significantly expanded disclosures about revenue recognition. +The +ASU is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early application is not permitted. +The Company is currently evaluating the impact that this pronouncement will have on the Company's consolidated financial statements. +F-18 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. INVENTORIES +The following table summarizes inventories by major classification as of December 31, 2014 and 2013: +($ thousands) +2014 +2013 +Finished goods +$ +167,515 +$ +154,272 +Work-in-progress +703 +685 +Raw materials +2,794 +7,384 +Inventories +$ +171,012 +$ +162,341 +Inventory Write-down +During the year ended December 31, 2014, we recorded approximately $11.5 million of inventory write-down charges related +to obsolete inventory with a market value lower than cost, of which $4.0 million was reported in the 'Restructuring charges' included in gross margin with the remaining amounts reported in +'Cost of sales' in the consolidated statements of operations. During the year ended December 31, 2013, we recorded approximately $3.4 million of inventory write-down charges related to +obsolete inventory with a market value lower than cost. These charges were related to certain obsolete raw materials, footwear and accessories in the Americas segment and are reported in 'Cost of +sales' in the consolidated statement of operations. We recorded no inventory write-down charges for the year ended December 31, 2012. +Charitable Contributions +During the years ended December 31, 2014, 2013 and 2012, we donated certain inventory items to charitable organizations +consisting primarily of end of life units. The contributions made were expensed at their fair value of $0.6 million, $0.6 million and $1.7 million, respectively. Also during the +years ended December 31, 2014, 2013 and 2012, we recognized a gain of $0.2 million, $0.1 million and $0.6 million, respectively, and a net reduction of inventory of +$0.4 million, $0.5 million and $1.1 million, respectively, as the fair value of the inventory contributed exceeded its carrying amount. +F-19 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. PROPERTY AND EQUIPMENT +The following table summarizes property and equipment by major classification as of December 31, 2014 and 2013: +December 31, +($ thousands) +2014 +2013 +Machinery and equipment +$ +48,989 +$ +52,003 +Leasehold improvements +91,962 +93,235 +Furniture, fixtures and other +23,818 +23,653 +Construction-in-progress +3,318 +16,231 +Property and equipment, gross(1) +168,087 +185,122 +Less: Accumulated depreciation(2) +(99,799 +) +(98,151 +) +Property and equipment, net +$ +68,288 +$ +86,971 +(1) Includes +$0.2 million and $0.2 million of certain equipment held under capital leases and classified as equipment as of each of +December 31, 2014 and 2013, respectively. +(2) Includes +$0.1 million of accumulated depreciation related to certain equipment held under capital leases, as of each of December 31, 2014 and +2013, which are depreciated using the straight-line method over the lease term. During the year ended December 31, 2014, approximately $17.5 million of accumulated depreciation was +related to assets that were written off or disposed. +During +the years ended December 31, 2014, 2013 and 2012, we recorded $23.2 million, $24.3 million and $23.1 million and, respectively, in depreciation expense +of which $1.7 million, $2.9 million and $4.6 million, +respectively, was recorded in 'Cost of sales', with the remaining amounts recorded in 'Selling, general and administrative expenses' on the consolidated statements of operations. +We +retired approximately $28.5 million of long-lived assets during the year ended December 31, 2014 primarily related to assets no longer in service or impaired due to the +closure of stores. During the years ended December 31, 2014 and 2013, we retired $1.6 million and $19.5 million of fully depreciated assets. The fully depreciated assets retired +in 2013 were fully depreciated shoe molds related to styles that we no longer intend on manufacturing. As such, we did not record a gain or loss associated with the disposal and the cost and +accumulated depreciation previously classified as machinery and equipment were removed from the consolidated balance sheets. +Asset Impairments +We periodically evaluate all of our long-lived assets for impairment when events or circumstances would indicate the carrying value of +a long-lived asset may not be fully recoverable. During the years ended December 31, 2014, 2013 and 2012, we recorded $8.8 million, $10.6 million and $1.4 million, +respectively, in impairment charges related to underperforming retail locations, respectively, that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' +assets over +F-20 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. PROPERTY AND EQUIPMENT (Continued) +their +remaining economic life. The following table summarizes asset impairment charges by reportable operating segment for the years ended December 31, 2014, 2013 and 2012: +December 31, +2014 +2013 +2012 +($ thousands, except store count data) +Impairment +charge +Number of +stores +Impairment +charge +Number of +stores +Impairment +charge +Number of +stores +Americas +$ +4,001 +36 +$ +3,861 +23 +$ +1,410 +4 +Asia Pacific +2,807 +14 +185 +2 +— +— +Japan +— +— +— +— +— +— +Europe +2,019 +27 +6,565 +35 +— +— +Asset impairment charges +$ +8,827 +77 +$ +10,611 +60 +$ +1,410 +4 +4. GOODWILL & INTANGIBLE ASSETS +The following table summarizes the goodwill and identifiable intangible assets as of December 31, 2014 and 2013: +December 31, 2014 +December 31, 2013 +($ thousands) +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Capitalized software +$ +157,615 +(1) +$ +(62,591 +)(2) +$ +95,024 +$ +118,940 +(1) +$ +(49,665 +)(2) +$ +69,275 +Customer relationships +5,945 +(5,798 +) +147 +6,878 +(6,439 +) +439 +Patents, copyrights, and trademarks +6,702 +(4,931 +) +1,771 +6,501 +(4,272 +) +2,229 +Core technology +4,170 +(4,170 +) +— +4,548 +(4,548 +) +— +Other +698 +(636 +) +62 +983 +(709 +) +274 +Total finite lived intangible assets +175,130 +(78,126 +) +97,004 +137,850 +(65,633 +) +72,217 +Indefinite lived intangible assets +333 +— +333 +97 +— +97 +Goodwill(3) +2,044 +— +2,044 +2,508 +— +2,508 +Goodwill and intangible assets +$ +177,507 +$ +(78,126 +) +$ +99,381 +$ +140,455 +$ +(65,633 +) +$ +74,822 +(1) Includes +$4.1 million of software held under a capital lease classified as capitalized software as of each of December 31, 2014 and 2013. +During 2013, we began an implementation of a new enterprise resource planning, ("ERP") system, and in 2014, we continued this implementation. Certain costs associated with the new ERP system were +capitalized in both periods. The majority of the ERP system was placed into service during 2015. +(2) Includes +$2.5 million and $1.9 million of accumulated amortization of software held under a capital lease as of December 31, 2014 and +2013, respectively, which is amortized using the straight-line method over the useful life. +(3) Change +in goodwill relates entirely to foreign currency translation. +F-21 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. GOODWILL & INTANGIBLE ASSETS (Continued) +During the years ended December 31, 2014, 2013 and 2012, amortization expense recorded for intangible assets with finite lives was $14.2 million, $17.2 million and +$13.6 million, respectively, of which $4.9 million, $6.0 million and $4.3 million, respectively, was recorded in 'Cost of sales', with the remaining amounts recorded in +'Selling, general and administrative expenses' on the consolidated statements of operations. +The +following table summarizes estimated future annual amortization of intangible assets as of December 31, 2014: +Fiscal years ending December 31, +Amortization +($ thousands) +2015 +$ +20,198 +2016 +19,376 +2017 +13,825 +2018 +12,334 +2019 +10,844 +Thereafter +20,427 +Total +$ +97,004 +Goodwill Impairment +We assess goodwill for impairment on an annual basis on the last day of the fourth quarter, or more frequently if events and +circumstances indicate impairment may have occurred, at the reporting unit level. If the carrying value of the goodwill exceeds its implied fair value, we record an impairment loss equal to the +difference. During the year ended December 31, 2013, we recorded $0.3 million of goodwill impairment related to the retail channel of our Crocs Benelux B.V. business purchased by +our Crocs Stores B.V. subsidiary in July 2012. Goodwill and associated impairments are part of our Europe operating segment. During the years ended December 31, 2014 and 2012, we did not +record any impairments related to goodwill. +F-22 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +The following table summarizes accrued expenses and other current liabilities as of December 31, 2014 and 2013: +December 31, +($ thousands) +2014 +2013 +Accrued compensation and benefits +$ +23,824 +$ +26,903 +Professional services +16,212 +14,128 +Fulfillment, freight and duties +12,110 +12,565 +Sales/use and VAT tax payable +5,897 +9,142 +Accrued rent and occupancy +9,675 +12,198 +Customer deposits +3,075 +6,940 +Dividend payable +3,067 +— +Accrued legal liabilities +2,150 +8,722 +Other(1) +4,206 +6,513 +Total accrued expenses and other current liabilities +$ +80,216 +$ +97,111 +(1) The +amounts in Other consist of various accrued expenses and no individual item accounted for more than 5% of the total balance as of December 31, +2014 or 2013. +Asset Retirement Obligations +We record a liability equal to the fair value of the estimated future cost to retire an asset, if the liability's fair value can be +reasonably estimated. Our asset retirement obligation ("ARO") liabilities are primarily associated with the disposal of property and equipment which we are contractually obligated to remove at the end +of certain retail and office leases in order to restore the facilities back original condition as specified in the related lease agreements. We estimate the fair value of these liabilities based on +current store closing costs and discount the costs back as if they were to be performed at the inception of the lease. At the inception of such leases, we record the ARO as a liability and also record +a related asset in an amount equal to the estimated fair value of the obligation. The capitalized asset is then depreciated on a straight-line basis over the useful life of the asset. Upon retirement +of the ARO liability, any difference between the actual retirement costs incurred and the previously recorded estimated ARO liability is recognized as a gain or loss in the consolidated statements of +operations. Our ARO liability as of December 31, 2014 and 2013 was $2.2 million and $2.0 million, respectively. +6. RESTRUCTURING ACTIVITIES +Restructuring +On July 21, 2014, we announced strategic plans for long-term improvement and growth of the business. These plans comprise four +key initiatives including: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient +organizational structure including reducing duplicative and excess overhead +which will also enhance the decision making process, and (4) closing or converting approximately 75 to 100 retail locations around the world. The initial effects of these plans were incurred in +2014 and are expected to continue through 2015. The Company recorded restructuring charges of $24.5 million during the year ended December 31, 2014, and closed 20 retail locations which +were identified in the initial +F-23 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. RESTRUCTURING ACTIVITIES (Continued) +restructuring +plan. During 2015, we currently estimate additional restructuring costs related to store closures and changes in organizational structure of approximately $5 million to +$20 million, but can make no assurance that actual costs will not differ, as our restructuring plans are not yet complete. +The +following table summarizes our restructuring activity during the years ended December 31, 2014 and 2013: +Year Ended +December 31, +($ thousands) +2014 +2013 +Severance costs +$ +12,500 +$ +— +Lease / contract exit and related costs +4,251 +— +Other(1) +7,766 +— +Total restructuring charges +$ +24,517 +$ +— +(1) The +amounts in 'Other' consist of various asset and inventory impairment charges prompted by the aforementioned restructuring plan, legal fees and facility +maintenance fees. +The +following table summarizes our total restructuring charges incurred during the years ended December 31, 2014 and 2013 as well as charges incurred to date by reportable +segment: +Year Ended +December 31, +($ thousands) +2014 +2013 +Americas +$ +4,259 +$ +— +Asia Pacific +6,816 +— +Japan +606 +Europe +3,934 +— +Corporate +8,902 +— +Total restructuring charges +$ +24,517 +$ +— +F-24 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. RESTRUCTURING ACTIVITIES (Continued) +The +following table summarizes our accrued restructuring balance and associated activity from December 31, 2013 through December 31, 2014: +($ thousands) +Accrued +Restructuring as of +December 31, 2013 +Additions +Cash payments +Adjustments(1) +Accrued +Restructuring as of +December 31, 2014 +Severance +$ +— +$ +13,287 +$ +(9,329 +) +$ +(804 +) +$ +3,154 +Lease / contract exit and related costs +— +4,252 +(2,756 +) +(95 +) +1,401 +Other +— +1,352 +(1,028 +) +(20 +) +304 +Total accrued restructuring +$ +— +$ +18,891 +$ +(13,113 +) +$ +(919 +) +$ +4,859 +(1) Adjustments +relate to a reversal of accrued expenses, differences resulting from the translation of the liability balance as of the balance sheet rate and +restructuring expense translated at the weighted-average rate of exchange for the applicable period. +Retail Store Closings +As mentioned above, the Company plans to close additional retail locations around the globe. As such, we expect to incur certain exit +costs specific to store closures including operating lease termination costs, rent obligations for leased facilities, net of expected sublease income, and other expenses in association with this plan, +such as severance for retail and non-retail related positions. During the year ended December 31, 2014, we closed 20 company-operated retail locations which were identified in the initial +restructuring plan, and were selected for closure by management based on historical and projected profitability levels, relocation plans, and other factors. As of December 31, 2014, we had a +liability of approximately $4.9 million related to locations to be closed and other reductions in workforce in accrued restructuring on the consolidated balance sheet. No such accrual was made +as of December 31, 2013. The calculation of accrued store closing reserves primarily includes future minimum lease payments from the date of closure to the end of the remaining lease term, net +of contractual or estimated sublease income. We record the liability at fair value in the period in which the store is closed. +7. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The following tables summarize the financial instruments required to be measured at fair value on a recurring basis as of +December 31, 2014 and 2013. See Note 1—Organization & Summary of +F-25 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +7. FAIR VALUE MEASUREMENTS (Continued) +Significant +Accounting Policies for additional detail regarding our fair value measurement determinations. +Fair Value as of December 31, 2014 +($ thousands) +Quoted prices in +active markets +for identical +assets or liabilities +(Level 1) +Significant +other +observable +inputs +(Level 2) +Significant +unobservable +inputs +(Level 3) +Total +Balance Sheet Classification +Cash equivalents +$ +23,326 +$ +— +$ +— +$ +23,326 +Cash and cash equivalents and other current assets +Derivative assets: +Foreign currency contracts +$ +— +$ +— +$ +— +$ +— +Prepaid expenses and other current assets +Derivative liabilities: +Foreign currency contracts +$ +— +$ +— +$ +— +$ +— +Accrued expense and other current liabilities +Fair Value as of December 31, 2013 +($ thousands) +Quoted prices in +active markets +for identical +assets or liabilities +(Level 1) +Significant +other +observable +inputs +(Level 2) +Significant +unobservable +inputs +(Level 3) +Total +Balance Sheet Classification +Cash equivalents +$ +37,870 +$ +— +$ +— +$ +37,870 +Cash and cash equivalents and other current assets +Derivative assets: +Foreign currency contracts +— +13,501 +— +13,501 +Prepaid expenses and other current assets and other assets +Derivative liabilities: +Foreign currency contracts +$ +— +$ +984 +$ +— +$ +984 +Accrued expense and other current liabilities +Non-Recurring Fair Value Measurements +The majority of our non-financial instruments, which include inventories, property and equipment and intangible assets, are not +required to be carried at fair value on a recurring basis. However, if certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment and the carrying +value is not recoverable, the carrying value would be adjusted to the lower of its cost or fair value and an impairment charge would be recorded. See Note 2—Inventories, +Note 3—Property and Equipment and Note 4—Goodwill & Intangible Assets for discussions on impairment charges recorded during the periods presented. +F-26 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. DERIVATIVE FINANCIAL INSTRUMENTS +We transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk inherent in revenues, costs, and monetary assets and liabilities +denominated in non-functional currencies. We have entered into foreign currency exchange forward contract and currency swap derivative instruments to selectively protect against volatility in the +value of non-functional currency denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. We do not designate these derivative +instruments as hedging instruments under the accounting standards for derivatives and hedging. Accordingly, these +instruments are recorded at fair value as a derivative asset or liability on the balance sheet with their corresponding change in fair value recognized in 'Foreign currency transaction losses, net' in +our consolidated statements of operations. For purposes of the cash flow statement, we classify the cash flows at settlement from undesignated instruments in the same category as the cash flows from +the related hedged items, generally within 'Cash provided by operating activities.' See Note 7—Fair Value Measurements for further details regarding the fair values of the +corresponding derivative assets and liabilities. +The +following table summarizes the notional amounts of the outstanding foreign currency exchange contracts at December 31, 2014 and 2013. The notional amounts of the derivative +financial instruments shown below are denominated in their U.S. Dollar equivalents and represent the amount of all contracts of the foreign currency specified. These notional values do not necessarily +represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2014 +2013 +Foreign currency exchange forward contracts by currency: +Euro +$ +134,755 +$ +38,577 +Singapore Dollar +61,887 +28,225 +Japanese Yen +44,533 +68,707 +British Pound Sterling +17,230 +15,487 +South Korean Won +14,590 +12,100 +Mexican Peso +13,180 +18,350 +Australian Dollar +7,913 +4,941 +Chinese Yuan Renminbi +5,376 +— +South African Rand +4,355 +3,076 +Indian Rupee +3,356 +2,150 +New Taiwan Dollar +3,229 +3,463 +Canadian Dollar +3,005 +3,428 +Swedish Krona +1,918 +1,615 +Russian Ruble +1,838 +17,588 +Norwegian Krone +917 +— +Hong Kong Dollar +814 +1,844 +New Zealand Dollar +743 +943 +Total notional value, net +$ +319,639 +$ +220,494 +Latest maturity date +January 2015 +December 2015 +F-27 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. DERIVATIVE FINANCIAL INSTRUMENTS (Continued) +The +following table presents the amounts affecting the consolidated statements of operations from derivative instruments for the years ended December 31, 2014, 2013 and 2012: +Year Ended December 31, +Location of Gain (Loss) +Recognized in Income on Derivatives +($ thousands) +2014 +2013 +2012 +Derivatives not designated as hedging instruments: +Foreign currency exchange forwards +$ +3,788 +$ +(13,002 +) +$ +(7,200 +) +Foreign currency transaction (gains) losses, net +The +account 'Foreign currency transaction losses, net' on the consolidated statements of operations includes both realized and unrealized gains/losses from underlying foreign currency +activity and derivative contracts. These gains and losses are reported on a net basis. For the year ended December 31, 2014, the net loss recognized of $4.9 million recorded on the +consolidated statements of operations is comprised of $3.8 million net loss associated with our derivative instruments and $1.1 million net loss associated with exposure from day-to-day +business transactions in various foreign currencies. For the year ended December 31, 2013, the net loss recognized of $4.7 million recorded on the consolidated statements of operations +is comprised of a $17.7 million net loss associated with exposure from day-to-day business transactions in various foreign currencies partially offset by a $13.0 million net gain +associated with our derivative instruments. For the year ended December 31, 2012, the net loss recognized of $2.5 million recorded on the consolidated statements of operations is +comprised of a $9.7 million net loss associated with exposure from day-to-day business transactions in various foreign currencies partially offset by a $7.2 million net gain associated +with our derivative instruments. +9. REVOLVING CREDIT FACILITY & BANK BORROWINGS +Revolving Credit Facility +On September 25, 2009, we entered into a Revolving Credit and Security Agreement, as amended, with the lenders named therein and +PNC Bank, National Association ("PNC"), as a lender and administrative agent for the lenders. On December 16, 2011, we entered into an Amended and Restated Credit Agreement (as amended, the +"Credit Agreement"), and on December 27, 2013, we entered into the Third Amendment to Amended and Restated Credit Agreement (the "Third Amendment"). The Third Amendment, among other things, +(i) allowed for the payment of dividends on the Series A Convertible Preferred Stock ("Series A Preferred Stock"), (ii) permitted the Company to have greater flexibility to +repurchase its Common Stock, (iii) decreased the maximum leverage ratio from 3.50 to 1.00 to 3.25 to 1.00, and (iv) amended certain definitions of the financial covenants to become more +favorable to the Company. See Note 14—Series A Preferred Stock for further details regarding the payment of dividends on the Series A Preferred Stock. On +March 27, 2014, we entered into the Fourth Amendment to Amended and Restated Credit Agreement (the "Fourth Amendment"). The Fourth Amendment primarily (i) altered the minimum fixed +charge coverage ratio from 1.25 to 1.00 to a scaled quarterly ratio of 1.15 to 1.00 in the first and second quarters of 2014, 1.20 to 1.00 in the third quarter of 2014, and (ii) amended certain +definitions of the financial covenants to become more favorable to us. +F-28 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. REVOLVING CREDIT FACILITY & BANK BORROWINGS (Continued) +On +September 26, 2014, we entered into the Fifth Amendment to Amended and Restated Credit Agreement (the "Fifth Amendment"), pursuant to which certain terms of the Credit +Agreement were amended. The Fifth Amendment primarily (i) extended the minimum fixed charge coverage ratio of 1.15 to 1.00 through the second quarter of 2015 and will return to 1.25 to 1.00 for +each quarter thereafter, and (ii) amended certain definitions of the financial covenants to become more favorable to us. +The +Credit Agreement enables us to borrow up to $100.0 million, with the ability to increase commitments to up to $125.0 million subject to certain conditions, and is +currently set to mature on December 16, 2017. The Credit Agreement is available for working capital, capital expenditures, permitted acquisitions, reimbursement of drawings under letters of +credit, and permitted dividends, distributions, purchases, redemptions and retirements of equity interests. Borrowings under the Credit Agreement are secured by all of our assets including all +receivables, equipment, general intangibles, inventory, investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For +domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and +(iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate loans, the interest rate is equal to a +LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each +interest period with respect to LIBOR rate loans. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $20.0 million. The Credit Agreement +contains provisions requiring us to maintain compliance with certain restrictive and financial covenants. +As +of December 31, 2014 and 2013, we had no outstanding borrowings under the Credit Agreement. As of December 31, 2014 and 2013, we had issued and outstanding letters of +credit of $1.8 million and $7.2 million, respectively, which were reserved against the borrowing base under the terms of the Credit Agreement. During the years ended December 31, +2014, 2013 and 2012, we capitalized $0.1 million, $0.1 million and $0.5 million, respectively, in fees and third party costs which were incurred in connection with the Credit +Agreement, as deferred financing costs. As of December 31, 2014, we were in compliance with all restrictive financial and other covenants under the Credit Agreement. +Long-term Bank Borrowings +On December 10, 2012, we entered into a Master Installment Payment Agreement ("Master IPA") with PNC in which PNC finances our +purchase of software and services, which may include but are not limited to third party costs to design, install and implement software systems, and associated hardware described in the schedules +defined within the Master IPA. The Master IPA was entered into to finance our implementation of a new enterprise resource planning ("ERP") system, which began in October 2012 and is estimated to +continue through early 2015. The terms of each note payable under the Master IPA consist of variable interest rates and payment terms based on amounts borrowed and timing of activity throughout the +implementation of the ERP system. +As +of December 31, 2014 and 2013, we had $11.6 million and $16.8 million, respectively, of long-term debt outstanding under five separate notes payable, of which +$5.3 million and $5.1 million, +F-29 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. REVOLVING CREDIT FACILITY & BANK BORROWINGS (Continued) +respectively, +represent current installments. As of December 31, 2014, the notes bear interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 to September 2017. As +this debt arrangement relates solely to the construction and implementation of an ERP system for use by the entity, all interest expense incurred under the arrangement has been capitalized to the +consolidated balance sheets until the assets are ready for intended use and will be amortized over the useful life of the software upon that date. During the years ended December 31, 2014 and +2013, we capitalized $0.4 million and $0.3 million, respectively, in interest expense related to this debt arrangement to the consolidated balance sheets. Interest rates and payment +terms are subject to changes as further financing occurs under the Master IPA. +The +aggregate maturities of long-term bank borrowings at December 31, 2014 are as follows (in thousands): +Fiscal years ending December 31, +2015 +$ +5,271 +2016 +4,765 +2017 +1,610 +2018 +— +2019 +— +Thereafter +— +Total principal debt maturities +$ +11,646 +10. EQUITY +Equity Incentive Plans +On August 15, 2005, we adopted the 2005 Equity Incentive Plan (the "2005 Plan"), which permitted the issuance of up to +14.0 million common shares in connection with the grant of non-qualified stock options, incentive stock options, and restricted stock to eligible employees, consultants and members of our +Board. As of December 31, 2014 and 2013, 0.6 million and 0.7 million stock options, respectively, were outstanding under the 2005 Plan. Following the adoption of the 2007 Equity +Incentive Plan (the "2007 Plan"), described below, no additional grants were made under the 2005 Plan. +On +July 9, 2007, we adopted and on June 28, 2011 we amended, the 2007 Plan which increased the allowable number of shares of our common stock reserved for issuance under +the 2007 Plan from 9.0 million to 15.3 million (subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization) in connection with the grant of +non-qualified stock options, incentive stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, common stock or any other share-based award to eligible +employees, consultants and members of our Board. As of December 31, 2014 and 2013, 3.1 million and 3.6 million shares of common stock, respectively, were issuable under the 2007 +Plan pursuant to outstanding stock options and RSUs. As of December 31, 2014, 3.7 million shares were available for future issuance under the 2007 Plan. +Restricted +stock awards and units generally vest annually on a straight-line basis over three or four years depending on the terms of the award agreement. +F-30 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +Stock Option Activity +The following table summarizes stock option activity for the years ended December 31, 2014, 2013 and 2012: +Shares +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +(Years) +Aggregate +Intrinsic +Value +($ thousands) +Outstanding at December 31, 2011 +3,331,031 +$ +11.91 +6.35 +$ +18,468 +Granted +208,400 +16.84 +Exercised +(613,691 +) +6.04 +Forfeited or expired +(304,054 +) +17.55 +Outstanding at December 31, 2012 +2,621,686 +13.03 +5.55 +11,373 +Granted +177,000 +15.62 +Exercised +(333,395 +) +6.84 +Forfeited or expired +(360,139 +) +18.18 +Outstanding at December 31, 2013 +2,105,152 +13.34 +4.86 +10,790 +Granted +119,000 +14.22 +Exercised +(265,675 +) +5.05 +Forfeited or expired +(262,347 +) +21.02 +Outstanding at December 31, 2014 +1,696,130 +$ +13.52 +3.88 +$ +4,435 +Exercisable at December 31, 2014 +1,439,175 +$ +13.15 +3.15 +$ +4,422 +Vested and expected to vest at December 31, 2014 +1,629,270 +$ +13.47 +3.69 +$ +4,429 +During +the years ended December 31, 2014, 2013 and 2012, options issued were valued using the Black Scholes option pricing model using the following assumptions: +Year Ended December 31, +2014 +2013 +2012 +Expected volatility +44% - 50% +50% - 64% +50% - 70% +Dividend yield +— +— +— +Risk-free interest rate +1.41% - 1.71% +0.81% - 1.62% +0.62% - 1.20% +Expected life (in years) +4.00 +4.00 +4.00 - 4.27 +The +weighted-average fair value of options granted during the years ended December 31, 2014, 2013, and 2012 was approximately $5.35, $7.33 and $7.76, respectively. The aggregate +intrinsic value of options exercised during the years ended December 31, 2014, 2013 and 2012 was $2.7 million, $2.8 million and $6.9 million, respectively. During the years +ended December 31, 2014 and 2013, we received $1.3 million and $2.3 million in cash in connection with the exercise of stock options with no income tax benefit due to our use of +Accounting Standard Codification 740—'Income Taxes' (with-and-without approach) ("ASC 740") ordering for purposes of determining when excess benefits have been realized (see +Note 12—Income Taxes). The total grant date fair value of stock options vested +F-31 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +during +the years ended December 31, 2014, 2013 and 2012 was $0.8 million, $1.2 million, $2.8 million, respectively. +As +of December 31, 2014, we had $1.5 million of total unrecognized share-based compensation expense related to unvested options, net of expected forfeitures, which is +expected to be amortized over the remaining weighted-average period of 2.5 years. +Stock +options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first year vesting on a "cliff" basis followed by monthly vesting for the +remaining three years. +Restricted Stock Awards and Units +From time to time, we grant restricted stock awards (RSAs) and restricted stock units (RSUs) to our employees. RSAs and RSUs generally +vest over three or four years, depending on the terms of the grant. Unvested RSAs have the same rights as those of common shares including voting rights and non-forfeitable dividend rights. However, +ownership of unvested RSAs cannot be transferred until they are vested. An unvested RSU is a contractual right to receive a share of common stock only upon its vesting. RSUs have dividend equivalent +rights which accrue over the term of the award and are paid if and when the RSUs vest, but they have no voting rights. +We +typically grant time-based RSUs and performance-based RSUs. Time-based RSUs are typically granted on an annual basis to certain non-executive employees and vest in three annual +installments on a straight-line basis beginning one year after the grant date. During the years ended December 31, 2014, 2013 and 2012, the Board approved grants of 0.3 million, +0.4 million and 0.4 million RSUs to certain non-executives. Performance-based RSUs are typically granted on an annual basis to certain executive employees and consist of a time-based and +performance-based component. The following represents the vesting schedule of performance-based RSUs granted during the years ended December 31, 2014: +Performance Vested RSUs (50% of Award) +Time Vested RSUs (50% of Award) +Performance Goals—each +weighted 50% +Potential Award +Further Time Vesting +Vest in 3 annual installments beginning one year after the date of grant +Achievement of at least 70% of a one-year cumulative earnings per share performance goal +Executive may earn from 50% to 200% of the target number of RSUs based on the level of achievement of the performance goal +Earned RSUs vest 50% upon satisfaction of performance goal and 50% on the one-year anniversary of the end of the Performance Period. +Achievement of at least 90% of a one-year revenue performance goal +Executive may earn from 50% to 200% of the target number of RSUs based on the level of achievement of the performance goal +Earned RSUs vest 50% upon satisfaction of performance goal and 50% on the one-year anniversary of the end of the Performance Period. +F-32 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +The +following represents the vesting schedule of performance-based RSUs granted during the years ended December 31, 2013 and 2012: +Performance Vested RSUs (50% of Award) +Time Vested RSUs (50% of Award) +Performance Goal +Potential Award +Further Time Vesting +Vest in 3 annual installments beginning one year after the date of grant +Achievement of at least 70% of a two-year cumulative earnings per share performance goal +Executive may earn from 50% to 200% of the target number of RSUs based on the level of achievement of the performance goal +Earned RSUs vest 50% upon satisfaction of performance goal and 50% one year later +During +the years ended December 31, 2014, 2013 and 2012, the Board approved the grant of 0.9 million, 0.9 million and 0.4 million, respectively, RSUs or RSAs +to certain executives as part of a performance incentive program. +The +following table summarizes RSA and RSU activity during the years ended December 31, 2014, 2013 and 2012: +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted +Average +Grant Date +Fair Value +Units +Weighted +Average +Grant Date +Fair Value +Unvested at December 31, 2011 +571,175 +$ +11.87 +711,980 +$ +23.43 +Granted +18,813 +16.48 +1,010,559 +18.92 +Vested +(191,779 +)(1) +9.22 +(133,555 +)(1) +23.25 +Forfeited +(42,700 +) +13.25 +(174,323 +) +20.64 +Unvested at December 31, 2012 +355,509 +13.37 +1,414,661 +20.61 +Granted +21,590 +16.56 +1,637,114 +14.96 +Vested +(89,006 +)(1) +14.81 +(329,542 +)(1) +21.52 +Forfeited +(77,603 +) +12.46 +(756,566 +) +14.71 +Unvested at December 31, 2013 +210,490 +13.43 +1,965,667 +16.50 +Granted +9,973 +15.04 +1,749,993 +16.05 +Vested +(68,420 +)(1) +15.03 +(541,888 +)(1) +17.64 +Forfeited +(144,555 +) +12.67 +(1,176,301 +) +16.51 +Unvested at December 31, 2014 +7,488 +$ +15.61 +1,997,471 +$ +15.78 +(1) The +RSAs vested during the years ended December 31, 2014, 2013 and 2012 consisted entirely of time-based awards. The RSUs vested during the year +ended December 31, 2014 consisted of 30,946 performance-based awards and 510,942 time-based awards. The RSUs vested during the year ended December 31, 2013 consisted of 52,288 +performance-based awards and 277,254 time-based awards. The RSUs vested during the year ended December 31, 2012 consisted entirely of time-based awards. +F-33 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +The +total grant date fair value of RSAs vested during the years ended December 31, 2014, 2013 and 2012 was $1.0 million, $1.3 million and $1.8 million, +respectively. As of December 31, 2014, we had $0.1 million of total unrecognized share-based compensation expense related to non-vested restricted stock awards, net of expected +forfeitures, all of which was related to time-based awards. The unvested RSAs are expected to be amortized over the remaining weighted-average period of 0.36 years. +The +total grant date fair value of RSUs vested during the years ended December 31, 2014, 2013 and 2012 was $9.6 million, $7.1 million and $3.1 million, +respectively. As of December 31, 2014, we had $13.0 million of total unrecognized share-based compensation expense related to unvested restricted stock units, net of expected +forfeitures, of which $6.2 million is related to performance-based awards and $6.8 million is time-based awards. The unvested RSUs are expected to be amortized over the +remaining weighted-average period of 1.49 years, which consists of a remaining weighted-average period of 1.15 years related to performance-based awards and a remaining weighted-average +period of 1.78 years related to time-based awards. +Share-based Compensation +During the years ended December 31, 2014, 2013 and 2012, we recorded $12.7 million, $12.5 million and +$11.3 million, respectively, of pre-tax share-based compensation expense of which $0.2 million, $0.7 million and $0.0 million, respectively, related solely to the +construction and implementation of our ERP system for use by the entity was capitalized to the consolidated balance sheets until assets are ready for intended use and will be amortized over the useful +life of the software upon that date. +Separation Agreements +On December 27, 2013, John McCarvel resigned from his position as President, Chief Executive Officer (CEO) and director of the +Company effective April 30, 2014. Also on December 27, 2013, the Company and Mr. McCarvel entered into a separation agreement providing that the Company will pay +Mr. McCarvel (i) a $1.1 million separation payment on the first regularly scheduled payroll date after the effectiveness of his resignation and (ii) a $1.0 million +separation payment on the first anniversary of the effectiveness of his resignation. In accordance with ASC 420—Exit or Disposal Cost +Obligations , the Company recognized the first and second installment payments of $1.1 million and $1.0 million ratably from December 27, 2013 through +April 30, 2014. Mr. McCarvel was also entitled to receive any amount earned pursuant to the Company's 2013 annual incentive program, in such form and at such time as is provided under +the terms of such program. +Pursuant +to the separation agreement, unvested share awards that vested through April 30, 2014 amounted to 58,840 shares. Additionally, pursuant to the terms of the separation +agreement, Mr. McCarvel forfeited 388,745 share awards which did not vest through April 30, 2014. The separation payments are conditioned upon the effectiveness of Mr. McCarvel's +release of claims in favor of the Company and his compliance with the non-competition, non-solicitation and confidentiality covenants contained in the separation agreement. +F-34 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +Appointment of President and Interim CEO +On May 13, 2014, the Board appointed Andrew Rees as President of the Company with principal responsibilities for the Crocs +brand, effective June 9, 2014. In addition, the Board appointed Mr. Rees as principal executive officer to serve until such time as the Board appoints a Chief Executive Officer of the +Company, which it did effective January 28, 2015. Upon commencement of his employment, Mr. Rees was granted an RSU award representing to right to receive shares of our common stock equal +to $197,534, based on the closing price of our common stock on the date immediately prior to his start date, which vests in three annual installments beginning on the first anniversary of his start +date, subject to his continued employment with us as of each vesting date. In addition, Mr. Rees was granted an RSU award representing the right to receive shares of our common stock equal to +$3,500,000, based on a 30 day weighted-average stock price as of May 13, 2014, and such RSU award shall vest based on achievement of certain share price levels before the fourth +anniversary of his start date, subject to his continued employment with us. For calendar years after 2014, Mr. Rees is also eligible to participate in the Company's long-term incentive plan, +with a target grant value of no less than $700,000, except that the target grant value in 2015 shall be $897,534. +Appointment of CEO +On December 12, 2014, Gregg Ribatt was appointed our Chief Executive Officer, effective January 28, 2015. In connection +with his appointment as Chief Executive Officer, Mr. Ribatt was granted a sign-on time-vesting RSU award representing the right to receive shares of our common stock equal to $2,000,000, based +on a 30-day weighted-average stock price as of December 15, 2014. This time-vesting RSU award will vest in three annual installments beginning on the first anniversary of his start date, +subject to his continued employment with us as of each vesting date. In addition, Mr. Ribatt was granted a sign-on performance-vesting RSU award, subject to various vesting criteria, +representing the right to receive shares of our common stock equal to $6,000,000, based on a 30-day weighted-average stock price as of December 15, 2014. Based on a Monte-Carlo valuation model, +the fair value of the RSU was determined to be $2.4 million, or 46.0% of the grant price, which will be expensed on a straight-line basis over a derived service period of 2.5 years, +beginning in 2015. +11. ALLOWANCES +The changes in the allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, 2014, 2013 and 2012, are as follows: +($ thousands) +Balance at +Beginning of Year +Charged to costs +and expenses +Reversals and +Write-offs +Balance at End +of Year +Year ended December 31, 2014: +Allowance for doubtful accounts +$ +3,656 +$ +12,087 +$ +(2,134 +) +$ +13,609 +Reserve for sales returns and allowances +6,857 +23,099 +(11,173 +) +18,783 +Year ended December 31, 2013: +Allowance for doubtful accounts +3,441 +1,930 +(1,715 +) +3,656 +Reserve for sales returns and allowances +9,874 +13,888 +(16,905 +) +6,857 +Year ended December 31, 2012: +Allowance for doubtful accounts +3,680 +$ +2,166 +$ +(2,405 +) +$ +3,441 +Reserve for sales returns and allowances +11,828 +5,111 +(7,065 +) +9,874 +F-35 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES +The following table sets forth income before taxes and the expense for income taxes for the years ended December 31, 2014, 2013 and 2012: +December 31, +($ thousands) +2014 +2013 +2012 +Income (loss) before taxes: +U.S. +$ +(34,622 +) +$ +(7,818 +) +$ +12,060 +Foreign +26,073 +67,777 +133,488 +Total income (loss) before taxes +(8,549 +) +59,959 +145,548 +Income tax expense: +Current income taxes +U.S. federal +(12,049 +) +3,311 +(6,364 +) +U.S. state +(23 +) +355 +597 +Foreign +7,620 +22,337 +22,953 +Total current income taxes +(4,452 +) +26,003 +17,186 +Deferred income taxes: +U.S. federal +400 +14,968 +(3,981 +) +U.S. state +236 +3,639 +(4,016 +) +Foreign +193 +4,929 +5,016 +Total deferred income taxes +829 +23,536 +(2,981 +) +Total income tax expense (benefit) +$ +(3,623 +) +$ +49,539 +$ +14,205 +The +following table sets forth income reconciliations of the statutory federal income tax rate to our actual rates based on income or loss before income taxes for the years ended +December 31, 2014, 2013 and 2012: +December 31, +($ thousands) +2014 +2013 +2012 +Federal income tax rate +35.0 +% +35.0 +% +35.0 +% +State income tax rate, net of federal benefit +(30.4 +) +(0.6 +) +(2.7 +) +Effects of rates different than statutory & rate change +(62.2 +) +(47.9 +) +(25.0 +) +Non-deductible / Non-taxable items +115.8 +3.4 +4.6 +Change in valuation allowance +(62.8 +) +35.6 +(8.4 +) +U.S. tax on foreign earnings +(77.4 +) +38.2 +2.0 +Uncertain tax positions +294.4 +6.8 +3.5 +Audit settlements +(157.3 +) +5.1 +— +Non-deductible write-off of intercompany debt +— +1.9 +— +Non-deductible impairment +— +3.5 +— +Write-off of income tax receivable +(18.4 +) +— +— +Other +5.7 +1.6 +0.8 +Effective income tax rate +42.4 +% +82.6 +% +9.8 +% +F-36 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +The +following table sets forth deferred income tax assets and liabilities as of December 31, 2014 and 2013: +December 31, +($ thousands) +2014 +2013 +Current deferred tax assets: +Accrued expenses +$ +13,217 +$ +13,108 +Unrealized loss on foreign currency +342 +10 +Other +— +1,364 +Valuation allowance +(7,008 +) +(5,139 +) +Total current deferred tax assets +$ +6,551 +$ +9,343 +Current deferred tax liabilities: +Unremitted earnings of foreign subsidiary +$ +(14,186 +) +$ +(16,102 +) +Other +(44 +) +— +Total current deferred tax liabilities. +$ +(14,230 +) +$ +(16,102 +) +Non-current deferred tax assets: +Stock compensation expense +$ +9,760 +$ +9,652 +Long-term accrued expenses +6,773 +3,811 +Net operating loss +20,047 +24,517 +Intangible assets +1,517 +895 +Property and equipment +12,097 +8,527 +Future uncertain tax position offset +445 +1,804 +Unrealized loss on foreign currency +— +639 +Foreign tax credit +6,259 +8,524 +Other +1,207 +1,755 +Valuation allowance +(40,273 +) +(41,745 +) +Total non-current deferred tax assets +$ +17,832 +$ +18,379 +Non-current deferred tax liabilities: +Intangible assets +$ +— +$ +— +Total non-current deferred tax liabilities +$ +— +$ +— +We +do not provide for deferred taxes on the excess of the financial reporting basis over the tax basis in our investments in foreign subsidiaries that are essentially permanent in +duration. In general, it is our practice and intention to reinvest the earnings of our foreign subsidiaries in those operations. Generally, the earnings of our foreign subsidiaries become subject to +U.S. taxation upon the remittance of dividends and under certain other circumstances. Exceptions may be made on a year-by-year basis to repatriate current year earnings of certain foreign subsidiaries +based on cash needs in the U.S. As of December 31, 2014, we have provided for deferred U.S. income tax of $14.2 million on $65.8 million of foreign subsidiary earnings. No +withholding tax is due with respect to the repatriation of these earnings to the U.S. and none has been provided for. +As +of December 31, 2014, U.S. income and foreign withholding taxes have not been provided on for approximately $450.4 million of unremitted earnings of subsidiaries +operating outside of the U.S. +F-37 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +These +earnings are estimated to represent the excess of the financial reporting over the tax basis in our investments in those subsidiaries. These earnings, which are considered to be indefinitely +reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. income tax liability on the unremitted earnings has not been determined +because the hypothetical calculation is not practicable. +We +have deferred tax assets related to certain deductible temporary differences in various tax jurisdictions for which we have recorded a valuation allowance of $47.3 million +against these deferred tax assets because we do not believe that it is more likely than not that we will be able to realize these deferred tax assets. The significant components of the deferred tax +assets for which a valuation allowance has been applied consist of net operating losses in certain tax jurisdictions for which management believes there is not sufficient positive evidence that such +net operating losses will be realized against future income and book expenses not deductible for tax purposes in the current year such as inventory impairment reserves, equity compensation and +unrealized foreign exchange loss that would increase such net operating losses in the same jurisdictions. These temporary differences are amounts which arose in jurisdictions where (i) current +losses exist, (ii) such losses are in excess of any loss carryback potential, (iii) any tax planning strategies exist with which to overcome such losses are cost prohibitive and +(iv) no profits are projected for the following year. For these reasons it is determined that it is more likely than not that these deferred tax assets will not be realized and a valuation +allowance has been provided with respect to these deferred tax assets. +As +of December 31, 2014, we had U.S. federal net operating loss carryforwards of $1.3 million, state net operating loss carryforwards of $109.5 million and foreign +tax credits of $1.1 million which will expire at various dates between 2025 and 2035. We do not believe that it is more likely than not that the benefit from certain federal and state net +operating losses and foreign tax credits will be realized. +Consequently, we have a valuation allowance of $6.8 million on the deferred tax assets relating to these tax attributes. +As +of December 31, 2014, we have a foreign deferred tax asset of $19.5 million reflecting the benefit of $54.2 million in foreign net operating loss carryforwards, +some of which have an indefinite life. We do not believe it is more likely than not that the benefit from certain foreign net operating loss carryforwards will be realized. Consequently, we have +provided a valuation allowance of $19.5 million on the deferred tax assets relating to these foreign net operating loss carryforwards. +We +had approximately $10.2 million in net deferred tax assets as of December 31, 2014. Approximately $8.2 million of the net deferred tax assets were located in +foreign jurisdictions for which a sufficient history and expected future profits indicated that it is more likely than not that such deferred tax assets will be realized. Pre-tax profit of +approximately $35.5 million is required to realize the net deferred tax assets. +As +of December 31, 2014, approximately $0.4 million of net deferred tax assets consists of deferred tax assets related to estimated liabilities for uncertain tax positions +that would be realized if such liabilities are actually incurred. The deferred tax assets represent primarily the reduction in tax expense that would occur upon an increase of intercompany royalty +expense by various taxing authorities. Approximately $2.2 million of taxable income would have to be recognized to realize these deferred tax assets. +F-38 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +As +a result of certain accounting realization requirements, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets as of +December 31, 2014 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by +$16.8 million if and when such deferred tax assets are ultimately realized. We use ASC 740 with-and-without ordering for purposes of determining when excess tax benefits have been realized. +The +following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits during the years ended December 31, 2014, 2013 and 2012: +($ thousands) +2014 +2013 +2012 +Unrecognized tax benefit—January 1 +$ +31,616 +$ +31,900 +$ +44,537 +Gross increases—tax positions in prior period +7 +572 +— +Gross decreases—tax positions in prior period +(3,711 +) +(2,086 +) +(425 +) +Gross increases—tax positions in current period +904 +3,743 +4,310 +Settlements +(20,210 +) +(2,291 +) +(16,260 +) +Lapse of statute of limitations +(162 +) +(222 +) +(262 +) +Unrecognized tax benefit—December 31 +$ +8,444 +$ +31,616 +$ +31,900 +Unrecognized +tax benefits of $8.4 million, $31.6 million and $31.9 million as of December 31, 2014, 2013 and 2012, respectively, if recognized, would reduce +our annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +Interest +and penalties related to income tax liabilities are included in income tax expense in the consolidated statement of operations. For the years ended December 31, 2014, +2013 and 2012, we recorded approximately $0.8 million, $0.6 million and $0.6 million, respectively, of penalties and interest. We released $4.9 million of interest from +settlements, lapse of statutes and change in certainty. The +cumulative accrued balance of penalties and interest was $0.9 million, $5.0 million and $4.4 million, as of December 31, 2014, 2013 and 2012, respectively. +Unrecognized +tax benefits consist primarily of tax positions related to intercompany transfer pricing in multiple international jurisdictions. The gross increase for tax positions in +current and prior periods in 2014 of $0.9 million primarily includes specific transfer pricing exposures in various jurisdictions. The gross decrease for tax positions for prior periods in 2014 +of $24.1 million are mostly the result of audits in several major jurisdictions including the US and Canada which are effectively settled. Although the timing of the resolution, settlement, and +closure of any audits is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. However, given the +number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. The total amount of +unrecognized tax benefits that, if recognized, would affect the effective tax rate is $8.4 million. +F-39 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +The +following table sets forth the remaining tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2014: +Netherlands +2007 to 2014 +Canada +2007 to 2014 +Japan +2008 to 2014 +China +2007 to 2014 +Singapore +2009 to 2014 +United States +2011 to 2014 +State +income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains +subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. +13. EARNINGS PER SHARE +The following table illustrates the basic and diluted earnings (loss) per share ("EPS") computations for the years ended December 31, 2014, 2013 and 2012. See +Note 1—Organization & Summary of Significant Accounting Policies for additional detail regarding our EPS calculations. +Year Ended December 31, +($ thousands, except per share data) +2014 +2013 +2012 +Numerator +Net income (loss) attributable to common stockholders +$ +(18,962 +) +$ +10,420 +$ +131,343 +Less: adjustment for income allocated to participating securities +— +(36 +) +(645 +) +Net income (loss) attributable to common stockholders—basic and diluted +$ +(18,962 +) +$ +10,384 +$ +130,698 +Denominator +Weighted average common shares outstanding—basic +85,140 +87,989 +89,571 +Plus: dilutive effect of stock options and unvested restricted stock units +— +1,100 +1,017 +Weighted average common shares outstanding—diluted +85,140 +89,089 +90,588 +Net income (loss) attributable per common share: +Basic +$ +(0.22 +) +$ +0.12 +$ +1.46 +Diluted +$ +(0.22 +) +$ +0.12 +$ +1.44 +For +the years ended December 31, 2014, 2013 and 2012, 2.0 million, 1.0 million and 1.4 million options and RSUs, respectively, were not included in the +calculation of diluted EPS as their effect would have been anti-dilutive. +F-40 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. EARNINGS PER SHARE (Continued) +Stock Repurchase Plan Authorizations +We continue to evaluate options to maximize the returns on our cash and maintain an appropriate capital structure, including, among +other alternatives, repurchases of our common stock. +On +December 26, 2013, our Board approved the repurchase of up to $350.0 million of our common stock. This authorization effectively replaced our previous stock repurchase +authorizations. The number, price, structure and timing of the repurchases will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs +and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to +acquire any particular amount of our common stock. Our Board may suspend, modify or terminate the repurchase program at any time without prior notice. +During +the year ended December 31, 2014, we repurchased approximately 10.6 million shares at a weighted-average price of $13.75 per share for an aggregate price of +approximately $145.6 million excluding related commission charges under our publicly-announced repurchase plan. During the year ended December 31, 2013, we repurchased approximately +0.8 million shares at an average price of $14.99 for an aggregate price of approximately $12.5 million excluding related commission charges, under our publicly-announced repurchase plan. +As +of December 31, 2014, subject to certain restrictions on repurchases under our revolving credit facility, we had $202.1 million of our common shares available for +repurchase under previously announced repurchase authorizations. +14. SERIES A PREFERRED STOCK +On January 27, 2014, we issued to Blackstone, together with the Blackstone Purchasers, 200,000 shares of our Series A Preferred Stock for an aggregate purchase price of +$198.0 million, or $990 per share, pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, the "Investment Agreement"). In connection with the +issuance of the Series A Preferred Stock (the "Closing"), we received proceeds of $182.2 million after deducting the issuance discount of $2.0 million and direct and incremental +expenses of $15.8 million including financial advisory fees, closing costs, legal expenses and other offering-related expenses. +Participation Rights and Dividends +The Series A Preferred Stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, +winding-up and dissolution. The Series A Preferred Stock has a stated value of $1,000 per share, and holders of Series A Preferred Stock are entitled to cumulative dividends payable +quarterly in cash at a rate of 6% per annum. If we fail to make timely dividend payments, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been +paid in full. Holders of Series A Preferred Stock are entitled to receive dividends declared or paid on our common stock and are entitled to vote together with the holders of our common stock +as a single class, in each case, on an as-converted basis. As of December 31, 2014, we have accrued dividends of $3.1 million on the consolidated balance sheets, which were paid in cash +to holders of the Series A Preferred Stock on January 2, 2015. Holders of Series A Preferred Stock have certain limited +F-41 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. SERIES A PREFERRED STOCK (Continued) +special +approval rights, including with respect to the issuance of pari passu or senior equity securities of the Company. +Conversion Features +The Series A Preferred Stock is convertible at the option of the holders at any time after the Closing into shares of common +stock at an implied conversion price of $14.50 per share, subject to adjustment. At our election, all or a portion of the Series A Preferred Stock will be convertible into the relevant number +of shares of common stock on or after the third anniversary of the Closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days. The Series A +Preferred Stock is convertible into 13,793,100 shares of our common stock based on the conversion rate in place as of December 31, 2014. The conversion rate is subject to the following +customary anti-dilution and other adjustments: +1) The +occurrence of common stock dividends or distributions, stock splits or combinations, and equity reclassifications. +2) The +distribution of rights, options, or warrants to all holders of common stock entitling them to purchase shares of common stock at a price per share that +is less than the closing price of the Company's common stock. +3) Pursuant +to a tender offer or exchange offer to purchase outstanding shares of common stock for consideration valued at an amount greater than the closing +price of the Company's common stock. +4) If +the Company distributes evidences of its indebtedness, assets, other property or securities or rights, options or warrants to acquire its Capital Stock. +5) If +the Company has any stockholder rights plan in effect with respect to the common stock on the date of conversion, upon conversion of the Series A +Preferred Stock, the holder will also receive (in addition to the common stock pursuant to the conversion) the rights under such rights plan, unless those rights (a) become exercisable before +the conversion of the Series A Preferred Stock, or (b) are separated from the common stock (each a "Trigger Event"). Upon the occurrence of a Trigger Event, the Series A Preferred +Stock conversion rate will be adjusted in accordance with 1) or 2) described above. +6) If +the Company issues shares of common stock (or other instruments convertible into common stock) for valuable consideration, the conversion price is +adjusted if (a) the offering price is less than the conversion price and (b) if the offering is at a price less than the fair market value of the Company's common stock on the date of +issuance. +Redemption Features +At any time after the eighth anniversary of the Closing, we will have the right to redeem and the holders of the Series A +Preferred Stock will have the right to require us to repurchase, all or any portion of the Series A Preferred Stock at 100% of the stated value thereof plus all accrued but unpaid dividends. +Upon certain change of control events involving us, the holders can require us to repurchase the Series A Preferred Stock at 101% of the stated value thereof plus all accrued but unpaid +dividends. +F-42 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. SERIES A PREFERRED STOCK (Continued) +In +accordance with FASB ASC Topic 480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities , +redemption features which are not solely within the control of the issuer are required to be presented outside of permanent equity on the consolidated balance sheets. Under the Investment Agreement +and as noted above, the holder has the option to redeem the Series A Preferred Stock any time after January 27, 2022 or upon a change in control. As such, the Series A Preferred +Stock is presented in temporary or mezzanine equity on the consolidated balance sheets and will be accreted up to the stated redemption value of $203.1 million using an appropriate accretion +method over a redemption period of eight years, as this represents the earliest probable date at which the Series A Preferred Stock will become redeemable. +15. COMMITMENTS AND CONTINGENCIES +Rental Commitments and Contingencies +We rent space for our retail stores, offices, warehouses, vehicles, and equipment under operating leases expiring at various dates +through 2033. Certain leases contain rent escalation clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents or rent +holidays is recognized on a straight-line basis over the lease term beginning on the lease inception date. Deferred rent is included in the consolidated balance sheets in 'Accrued expenses and other +current liabilities.' +Future +minimum annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2014, are as follows (in thousands): +Fiscal years ending December 31, +2015 +$ +79,087 +2016 +56,688 +2017 +42,911 +2018 +34,473 +2019 +29,481 +Thereafter +115,071 +Total minimum lease payments(1) +$ +357,711 +(1) Minimum +lease payments have not been reduced by minimum sublease rentals of $1.0 million due in the future under non-cancelable subleases. They also +do not include contingent rentals which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts. +F-43 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. COMMITMENTS AND CONTINGENCIES (Continued) +The +following table summarizes the composition of rent expense under operating leases for the years ended December 31, 2014, 2013 and 2012 (in thousands): +Year Ended December 31, +2014 +2013 +2012 +Minimum rentals(1) +$ +108,466 +$ +101,721 +$ +84,671 +Contingent rentals +16,875 +18,178 +16,519 +Less: Sublease rentals +(868 +) +(646 +) +(619 +) +Total rent expense +$ +124,473 +$ +119,253 +$ +100,571 +(1) Minimum +rentals include all lease payments as well as fixed and variable common area maintenance ("CAM"), parking and storage fees, which were approximately +$9.6 million, $9.7 million and $8.5 million during the years ended December 31, 2014, 2013 and 2012, respectively. +Purchase Commitments +As of December 31, 2014 and 2013, we had firm purchase commitments with certain third-party manufacturers of +$202.3 million and $172.3 million, respectively. +In +December 2011, we renewed and amended our supply agreement with Finproject S.p.A. (formerly known as Finproject s.r.l.), which provides us the exclusive right to +purchase certain raw materials used to manufacture our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, +which expires December 31, 2016. Historically, the minimum purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material +purchased, pricing was either based on contracted price or was subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. Pursuant to the +agreement, we guarantee the payment for certain +third-party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.3 million as of December 31, 2014), +through a letter of credit that was issued to Finproject S.p.A. +Government Tax Audits +We are regularly subject to, and are currently undergoing, audits by tax authorities in the United States and several foreign +jurisdictions for prior tax years. +In +April 2013, Brazil's State of Sao Paulo, Brazil government ("Brazil") assessed sales taxes, interest and penalties for the period April 2009 to May 2011. We had previously tendered +these taxes using Brazil obligations purchased at a discount from third parties. On May 22, 2013, we applied for amnesty in order to receive a significant reduction in penalties and interest, +agreed to amend our 2009 through 2012 tax returns to remove the Brazil obligations, and agreed to settle the assessment in cash to Brazil. In June 2013, cash payment was made to Brazil, in full +satisfaction of the Brazil assessment and amended tax returns. Brazil is making court-ordered payments to holders of the Brazil obligations along with accrued interest. We anticipate that the Brazil +obligations (plus accrued interest) will be paid by Brazil in accordance with the court-orders, however, during the year ended December 31, 2014, we reserved the entire carrying balance of the +Brazil obligation. The net impact of the above is a +F-44 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. COMMITMENTS AND CONTINGENCIES (Continued) +$3.5 million +charge to operating income recorded during the year ended December 31, 2014. As of December 31, 2013, the carrying balance of the Brazil obligations was +$3.5 million, which was recorded in 'Other assets' on the consolidated balance sheets. The net impact of the above is a $6.1 million charge to operating income recorded during the year +ended December 31, 2013. +In +April 2014, we received a final notice of assessment on transfer pricing items from the Canadian tax authorities, which closed the ongoing audit of our Canada operations through 2011. +The assessment, along with the estimated impact on certain Canadian provinces, was less than the amount of the uncertain tax benefits recorded, and therefore, resulted in a net tax benefit of +approximately $2.3 million in the quarter ended June 30, 2014. We have paid the assessment, which included tax and interest for the tax periods through December 31, 2011. +See +Note 17—Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +For 2014, 2013 and 2012, we had four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, Japan and Europe. We also have an "Other +businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represent manufacturing operations located in Mexico, Italy and Asia. The +composition of our reportable operating segments is consistent with that used by our chief operating decision maker, ("CODM") to evaluate performance and allocate resources. +During +the first quarter of 2013, we adjusted our operating segment structure for internal reports reviewed by the CODM by presenting Japan separate from the Asia Pacific segment. This +change was made due to the volatility of the Japanese yen and the macroeconomic environment within Japan as well as negative sales growth compared to the rest of the Asia Pacific segment, which +resulted in the need for a regular review of the operating results of Japan by management and the CODM in order to better evaluate performance and allocate resources for the consolidated business. +Results from operations for the year ended December 31, 2012 was restated for this change. +Subsequent +to December 31, 2014, we have determined that for fiscal 2015, our internal reports reviewed by the CODM will revert back to include Japan in the Asia Pacific segment. +This change is to align reporting to our new strategic model and management structure, as Japan and Asia Pacific will be managed and analyzed as one operating segment by management and the CODM, to +better allocate resources. Therefore, there will be three reportable operating segments for 2015. +Each +of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers as well as intersegment sales. Revenues of the +"Other businesses" category are primarily made up of intersegment sales. The remaining revenues for the "Other +businesses" represent non-footwear product sales to external customers. Intersegment sales are not included in the measurement of segment operating income or regularly reviewed by the CODM and are +eliminated when deriving total consolidated revenues. +The +primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on +segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to +eliminate intersegment profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment +eliminations. Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these balances are regularly reviewed by the CODM. +F-45 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +The +following tables set forth information related to our reportable operating business segments as of and for the years ended December 31, 2014, 2013 and 2012: +Year Ended December 31, +($ thousands) +2014 +2013 +2012 +Revenues: +Americas +$ +489,915 +$ +498,552 +$ +495,852 +Asia Pacific +350,449 +342,752 +292,846 +Japan +123,461 +134,863 +164,565 +Europe +233,604 +216,259 +169,464 +Total segment revenues +1,197,429 +1,192,426 +1,122,727 +Other businesses +794 +254 +574 +Total consolidated revenues +$ +1,198,223 +$ +1,192,680 +$ +1,123,301 +Operating income: +Americas +$ +48,347 +(1) +$ +61,894 +(1) +$ +85,538 +(1) +Asia Pacific +47,753 +(2) +80,693 +(2) +74,535 +Japan +27,382 +(3) +37,560 +(3) +66,293 +Europe +24,517 +(4) +16,192 +21,678 +Total segment operating income +147,999 +196,339 +248,044 +Reconciliation of total segment operating income to income before income taxes: +Other businesses +(19,400 +) +(20,811 +) +(10,805 +) +Intersegment eliminations +(1,498 +) +61 +60 +Unallocated corporate and other(5) +(131,827 +) +(112,494 +) +(91,125 +) +Total consolidated operating income (loss) +(4,726 +) +63,095 +146,174 +Foreign currency transaction gains, net +4,885 +4,678 +2,500 +Interest income +(1,664 +) +(2,432 +) +(1,697 +) +Interest expense +806 +1,016 +837 +Other income, net +(204 +) +(126 +) +(1,014 +) +Income (loss) before income taxes +$ +(8,549 +) +$ +59,959 +$ +145,548 +Depreciation and amortization: +Americas +$ +11,670 +$ +10,384 +$ +9,849 +Asia Pacific +5,186 +5,032 +4,869 +Japan +1,538 +1,454 +2,053 +Europe +3,761 +5,108 +3,116 +Total segment depreciation and amortization +22,155 +21,978 +19,887 +Other businesses +5,900 +8,002 +7,003 +Unallocated corporate and other(5) +9,358 +11,526 +9,804 +Total consolidated depreciation and amortization +$ +37,413 +$ +41,506 +$ +36,694 +(1) Includes +$4.0 million, $3.9 million and $1.4 million for the years ended December 31, 2014, 2013 and 2012, respectively, of +asset impairment charges related to 36, 23 and four underperforming retail locations, respectively. +(2) Includes +$2.8 million and $0.2 million for the year ended December 31, 2014 and 2013, respectively, of asset impairment charges related +to 14 and two underperforming retail locations, respectively. +F-46 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +(3) Includes +$6.6 million for the year ended December 31, 2013 of asset impairment charges related to 35 underperforming retail locations. +(4) Includes +$2.0 million for the year ended December 31, 2014 of asset impairment charges related to 27 underperforming retail locations. +(5) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, restructuring, depreciation and amortization of corporate and other assets not allocated to operating segments and costs of the same nature related to +certain corporate holding companies. See Note 6—Restructuring for additional details. +The +following table sets forth asset information related to our reportable operating business segments as of December 31, 2014 and December 31, 2013: +December 31, +($ thousands) +2014 +2013 +Assets: +Americas +$ +127,077 +$ +139,855 +Asia Pacific +166,878 +177,343 +Japan +34,032 +51,155 +Europe +166,285 +137,701 +Total segment current assets +494,272 +506,054 +Other businesses +18,132 +14,093 +Unallocated corporate and other(1) +27,337 +63,743 +Deferred tax assets, net +4,190 +4,440 +Income tax receivable +9,332 +10,630 +Other receivables +11,989 +11,942 +Prepaid expenses and other current assets +30,156 +29,175 +Total current assets +595,408 +640,077 +Property and equipment, net +68,288 +86,971 +Intangible assets, net +97,337 +72,314 +Goodwill +2,044 +2,508 +Deferred tax assets, net +17,886 +19,628 +Other assets +25,968 +53,661 +Total consolidated assets +$ +806,931 +$ +875,159 +(1) Corporate +assets primarily consist of cash and equivalents. +F-47 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +There +were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2014, 2013 and 2012. The following table sets forth certain +geographical and other information regarding our revenues during the years ended December 31, 2014, 2013 and 2012: +Year Ended December 31, +($ thousands) +2014 +2013 +2012 +Product: +Footwear +$ +1,169,247 +$ +1,155,377 +$ +1,076,210 +Other +28,976 +37,303 +47,091 +Total revenues +$ +1,198,223 +$ +1,192,680 +$ +1,123,301 +Location: +United States +$ +435,154 +$ +401,948 +$ +396,121 +International +763,069 +790,732 +727,180 +Total revenues +$ +1,198,223 +$ +1,192,680 +$ +1,123,301 +Foreign country revenues in excess of 10% of total revenues: +Japan +$ +123,461 +$ +134,863 +$ +164,565 +The +following table sets forth geographical information regarding our property and equipment assets as of December 31, 2014 and 2013: +December 31, +($ thousands) +2014 +2013 +Location: +United States +$ +45,046 +$ +56,262 +International +23,242 +30,709 +Total long-lived assets(1) +$ +68,288 +$ +86,971 +(1) Not +more than 10% of our long-lived assets resided in any individual foreign country in 2014 or 2013. +17. LEGAL PROCEEDINGS +We and certain current and former officers and directors were named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The +first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purported to state claims under Sections 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint also added our independent auditor as +a defendant. The amended complaint alleged that, during the Class Period, the defendants made false and misleading public statements about us and our business and prospects and, as a result, the +market price of our common +F-48 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. LEGAL PROCEEDINGS (Continued) +stock +was artificially inflated. The amended complaint also claimed that certain current and former officers and directors traded in our common stock on the basis of material non-public information. +The amended complaint sought compensatory damages on behalf of the alleged class in an unspecified amount, including interest, and also sought attorneys' fees and costs of litigation. On +February 28, 2011, the District Court granted motions to dismiss filed by the defendants and dismissed all claims. A final judgment was thereafter entered. Plaintiffs subsequently appealed to +the United States Court of Appeals for the Tenth Circuit. We and those current and former officers and directors named as defendants entered into a Stipulation of Settlement with the plaintiffs to +resolve all claims asserted against us by the plaintiffs on behalf of the putative class. Our independent auditor was not a party to the Stipulation of Settlement. The Stipulation of Settlement +received preliminary approval from the District Court on August 28, 2013. On September 18, 2014, the District Court entered an order of final approval of the settlement and, on +September 19, 2014, the District Court entered final judgment dismissing the action against us and those current and former officers and directors named as defendants in its entirety with +prejudice. The full settlement amount has been paid by our insurers. Since no notice of appeal was filed during the appeal period, this action is now terminated as to Crocs and its affiliated +individuals. Crocs considers this matter closed. +We +are currently subject to an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In October 2013, CBP issued the final audit report. In +that report CBP projects that unpaid duties totaling approximately $12.4 million are due for the period under review and recommends collection of the duties due. We responded that these +projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the projection. Additionally, on December 12, 2014, we +made an offer to settle CBP's potential claims and tendered $3.5 million. At this time, it is not possible to determine how long it will take CBP to evaluate our offer or to predict whether our +offer will be accepted. Likewise, if a settlement cannot be reached, it is not possible to predict with any certainty whether CBP will seek to assert a claim for penalties in addition to any unpaid +duties, but such an assertion is a possibility. +Mexico's +Federal Tax Authority ("SAT") has audited the company's records regarding imports and exports during the period from January 2006 to July 2011. There were two phases to the +audit, the first for capital equipment and finished goods and the second for raw materials. The first phase was completed and no major discrepancies were noted by the SAT. On January 9, 2013, +Crocs received a notice for the second phase in which the SAT issued a tax assessment (taxes and penalties) of roughly 280.0 million pesos (approximately $22.0 million) based on the +value of all of Crocs' imported raw materials during the audit period. We believe that the proposed penalty amount is unfounded and without merit. With the help of local counsel we filed an appeal by +the deadline of March 15, 2013. We have argued that the amount due in connection with the matter, if any, is substantially less than that proposed by the SAT. In connection with the appeal, the +SAT required us to post an appeal surety bond in the amount of roughly 321.0 million pesos (approximately $26.0 million), which amount reflects estimated additional penalties and +interest if we are not successful on our appeal. This amount will be adjusted on an annual basis. On November 27, 2014, the Superior Chamber of the Federal Tax Court ruled in favor of Crocs and +annulled the tax assessment and the corresponding penalty. Crocs anticipates that the SAT will appeal this ruling. It is not possible at this time to predict the outcome of this matter or reasonably +estimate any potential loss. +Crocs +is currently subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010-2014. On January 13, 2015 Crocs was notified +about the issuance of +F-49 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. LEGAL PROCEEDINGS (Continued) +assessments +totaling roughly $5.25 million for the period January 2010 through May 2011. Crocs has disputed these assessments and asserted defenses to the claims. On February 25, 2015, +Crocs received additional assessments totaling roughly $11.54 million related to the remainder of the audit period. Crocs is in the process of reviewing these assessments, however, it expects +to contest and file defenses to these claims as well. It is not possible at this time to predict the outcome of this matter. +As +of December 31, 2014, we have accrued a total of $5.1 million relating to these litigation matters and other disputes. We estimate that the ultimate resolution of these +litigation matters and other disputes could result in a loss that is reasonably possible between $0.0 million and $9.1 million in the aggregate, in excess of the amount accrued. +Although +we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not +party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business, financial position, results of operations or cash flows. +18. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +($ thousands, except per share data) +March 31, 2014 +June 30, 2014 +September 30, 2014 +December 31, 2014 +Revenues +$ +312,429 +$ +376,920 +$ +302,401 +$ +206,473 +Gross profit +$ +156,227 +$ +202,571 +$ +155,017 +$ +76,530 +Restructuring +$ +2,250 +$ +4,060 +$ +7,585 +$ +6,637 +Asset impairment charges +$ +— +$ +3,230 +$ +2,600 +$ +2,997 +Income (loss) from operations +$ +16,822 +$ +41,911 +$ +1,113 +$ +(64,572 +) +Net income (loss) +$ +9,124 +$ +23,277 +$ +15,767 +$ +(53,094 +) +Net income (loss) attributable to common stockholders +$ +6,373 +$ +19,523 +$ +12,009 +$ +(56,867 +) +Basic income (loss) per common share +$ +0.06 +$ +0.19 +$ +0.12 +$ +(0.70 +) +Diluted income (loss) per common share +$ +0.06 +$ +0.19 +$ +0.12 +$ +(0.70 +) +For the Quarter Ended +($ thousands, except per share data) +March 31, 2013 +June 30, 2013 +September 30, 2013 +December 31, 2013 +Revenues +$ +311,656 +$ +363,827 +$ +288,524 +$ +228,673 +Gross profit +$ +165,849 +$ +200,867 +$ +153,581 +$ +102,901 +Asset impairment charges +$ +— +$ +202 +$ +— +$ +10,747 +Income (loss) from operations +$ +37,650 +$ +50,419 +$ +17,907 +$ +(42,881 +) +Net income (loss) +$ +28,961 +$ +35,356 +$ +13,036 +$ +(66,933 +) +Basic income (loss) per common share +$ +0.33 +$ +0.40 +$ +0.15 +$ +(0.76 +) +Diluted income (loss) per common share +$ +0.33 +$ +0.40 +$ +0.15 +$ +(0.76 +) +F-50 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (Continued) +During +the three months ended December 31, 2014, we recorded the following charges that affect the comparability of information between +periods: +• Inventory write-down charges of $10.0 million related to obsolete inventory including raw materials, footwear and accessories. +See Note 2—Inventories for further discussions regarding these charges. +During +the three months ended December 31, 2013, we recorded the following charges that affect the comparability of information between +periods: +• Tax expenses of $26.8 million related to our cash repatriation activities as well as a valuation allowance adjustment. See +Note 12—Income Taxes for further discussions regarding these charges. +• Retail asset impairment charges of $10.4 million for certain underperforming locations in our Americas, Asia Pacific and Europe +segments as well as $0.3 million in goodwill impairment charges. See Note 3—Property & Equipment and Note 4—Goodwill & Intangible Assets for +further discussions regarding these charges. +• Legal contingency accruals of $5.7 million recorded in selling, general and administrative expenses. See +Note 17—Legal Proceedings for further discussions regarding these charges. +• Inventory write-down charges of $3.4 million related to obsolete inventory including raw materials, footwear and accessories. +See Note 2—Inventories for further discussions regarding these charges. +• Professional services fees of $1.1 million associated with our recent investment agreement with Blackstone and cash +repatriation activities. See Note 19—Subsequent Events for further discussions regarding these charges. +19. SUBSEQUENT EVENTS +Accounting Standards Update No. 2010-09 to ASC Topic 855, Subsequent Events , requires the Company to disclose the date through +which subsequent events have been evaluated. The Company has evaluated subsequent events through the date the financial statements were issued, and has determined there are no other subsequent events +to be reported. +F-51 \ No newline at end of file diff --git a/raw/filings/0001334036/2014/0001047469-15-001519/filing_metadata.csv b/raw/filings/0001334036/2014/0001047469-15-001519/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..f238649083cf52fdf9cf8974c958559df34b4e26 --- /dev/null +++ b/raw/filings/0001334036/2014/0001047469-15-001519/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2015-03-02,2014-12-31,2015-03-02T22:25:35.000Z,0001047469-15-001519,a2223339z10-k.htm,10-K,20082342,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746915001519/a2223339z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746915001519/,2014,2014,1 diff --git a/raw/filings/0001334036/2014/0001047469-15-001519/item1.txt b/raw/filings/0001334036/2014/0001047469-15-001519/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..1cc3ae732e1916430bee01baead0fcfa65a3cce8 --- /dev/null +++ b/raw/filings/0001334036/2014/0001047469-15-001519/item1.txt @@ -0,0 +1,474 @@ +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our" or "us") are engaged in the design, +development, manufacturing, worldwide marketing and distribution of casual lifestyle footwear, apparel and accessories for men, women and children. We strive to be the global leader in the sale of +molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite. The use of this unique +material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international +retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, webstores and kiosks. +In +2002, we launched the marketing and distribution of our original clog style footwear in the United States. The unique characteristics of Croslite enabled us to offer consumers a shoe +unlike any other footwear model then available. Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new +styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). Going +forward, we intend to focus our footwear product lines on our core molded footwear heritage, as well as develop new innovative casual lifestyle footwear collections. We intend to streamline our +product portfolio, eliminate non-core product development and explore strategic alternatives for non-core programs such as our golf line and our Ocean Minded brand, as well as our apparel and +accessories business. +The +broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including family footwear stores, department stores and traditional +footwear retailers as well as a variety of specialty and independent retail channels and the internet. We intend to drive cohesive global brand positioning from region-to-region and year-to-year in +order to establish more powerful consumer connections and deliver more consistent product designs. This strategy will be accomplished through developing powerful product stories supported with +effective and consistent global marketing campaigns. Finally, we intend to increase our working market spend, which we define as funds that put marketing messages in front of consumers. +As +a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. Sales in international markets in foreign currencies are expected to +continue to represent a substantial portion of our revenues. Likewise, we expect our subsidiaries with functional currencies other than the U.S. Dollar will continue to represent a substantial portion +of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs from +period to period as a result of the impact of foreign currency translation adjustments into our reporting currency. +Products +Footwear +Our footwear product offerings have grown significantly since we first introduced the single-style clog in six colors, in 2002. We +currently offer a wide variety of footwear products, some of which includes sandals, sneakers, mules, flats and boots, which are made of materials like leather and textile fabrics as well as Croslite. +Footwear sales made up 97.6%, 96.9% and 95.8% of total revenues for the years ended December 31, 2014, 2013 and 2012, respectively. During the years ended December 31, 2014, 2013 and +2012, approximately 73.5%, 71.1% and 75.3%, respectively, of unit sales consisted of +2 +Table of Contents +products +geared toward adults compared to 26.5%, 28.9% and 24.7%, respectively, of unit sales of products geared toward children. +A +key differentiating feature of our footwear products is the "Croslite" material, which is uniquely suited for comfort and functionality. Croslite is carefully formulated to be of a +density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increases comfort. Croslite is a closed-cell resin material which is water +resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such as +textile fabric and leather into many new styles; however, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +We +strive to provide our global consumer with a year-round product assortment featuring comfort, fun, casual styling, color and innovation. Our collections are designed to meet the needs +of the family by focusing on their key wearing occasions. Our goal is to deliver world-class product assortments for the family with all of the comfort features and benefits Crocs is known for. We +have been discontinuing non-core programs in order to focus on growing our core-molded heritage category while developing more compelling casual footwear platforms. Our products are divided into three +product offerings: Core, Casual Lifestyle and Active. +Core Products +At +the heart of our brand resides the Classic, our first and most iconic style for adults and kids that embodies our innovation in molding and design, delivers all-day comfort, and has established a +new category in the footwear marketplace. The unique look and feel of the Classic can be experienced throughout our entire product line due to the design and application of our proprietary material +Croslite. We have expanded our core molded product line, introduced in 2002, with the addition of dual density technology, warm lined styles, seasonal flips and slides. Licensed style partnerships +from Disney, Marvel, Sanrio, Nickelodeon and Warner Bros., among others, provide popularity to our kids' core line along with our kids-only product innovations including lights, color-change materials +and interactive elements. +In +addition, we have extended our licensing partnerships to brand partnerships artists such as Jon Burgerman, as well as stylist Patricia Field. Invigorating our core product assortment is a key focus +for growth and we will expand our reach with new styling, 'built just for her' silhouettes and lots of great color and graphic treatments. New Citilane and Bump It programs merge "retro" sports +styling with classic Crocs looks for a fresh and fun look for men, women, boys and girls. Our core molded products are available to all channels of distribution and span both stylish and active +wearing occasions for the entire family. +Casual Lifestyle Products +Our +Casual Lifestyle Category showcases collections designed for the family around casual and stylish wearing occasions with a relaxed and fun point of view. This category is primarily designed for +our consumers shopping in footwear, specialty/independent retailers, department stores and our own direct-to-consumer channel. +Active Products +Our +Active Category showcases collections designed with an active-casual point of view, catering to on-the-go families with busy lifestyles. These collections are primarily found in sport, footwear, +specialty/independent retailers and our own direct-to-consumer channel. +3 +Table of Contents +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically +suited for Crocs shoes. We acquired Jibbitz in December 2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports +gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of +Disney, Nickelodeon and Sanrio, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. Sales from Jibbitz designs made up 1.5%, +2.8% and 3.5% of total revenues for the years ended December 31, 2014, 2013 and 2012, respectively. +Sales and Marketing +Each season, we focus on presenting a compelling "brand story and experience" for our new product collections and our broader casual +lifestyle assortment. Our marketing efforts center on multi-level story-telling across diverse wearing occasions and product silhouettes. +As +we are a global brand, our marketing model is based on global relevance while still allowing for regional flexibility in execution. At the regional or market level, campaigns are +initiated using a mix of digital, social, and traditional media outlets that align with local marketplaces and target consumer dynamics. This strategy allows for relevant cross-channel input +coordinated through our global brand objectives to drive an aligned global marketing and brand strategy. +We +have three primary sales channels: wholesale, retail and internet (discussed at a more detailed level below). Our marketing efforts are aimed toward driving business to both our +wholesale partners and our company-operated retail and internet stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key +stories, activation materials and creative materials. Retail stores provide a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store +experience a meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product launches. Our marketing, merchandising, and visual merchandising departments +work closely together to ensure the store environment and merchandise are aligned to support key seasonal product offerings while promoting the larger product lines and iconic product collections. +Wholesale Channel +During the years ended December 31, 2014, 2013 and 2012, approximately 55.7%, 56.5% and 57.5% of net revenues, respectively, +were derived from sales through the wholesale channel which consists of sales to distributors and third-party retailers. Wholesale customers include national and regional retail chains, department +stores, sporting goods stores, independent footwear retailers and family footwear retailers, such as Academy, Rack Room Shoes, Famous Footwear, Kohl's, DSW, Shoe Carnival, Dick's Sporting Goods, +Nordstrom, Xebio and Murasaki Sports, as well as on-line retailers such as Amazon and Zappos. No single customer accounted for 10% or more of our revenues for any of the years ended +December 31, 2014, 2013 and 2012. +We +use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price +list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable upon 30 days prior notice and have minimum sales requirements. Many of our agreements allow us to accept returns from wholesale customers at our discretion for defective +products, quality issues and shipment errors on an exception basis or, for certain wholesale customers, and to extend pricing discounts in lieu of defective product returns. We also may accept returns +from our wholesale +4 +Table of Contents +customers, +on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide markdown allowances to key +wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our +product and brand awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct +channels to be complementary to our wholesale channel. +Retail Channel +• During the years ended December 31, 2014, 2013 and 2012, approximately 35.5%, 35.0% and 33.4%, respectively, of our net +revenues were derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full-service retail locations, outlet locations, and kiosk/store-in-store +locations. Our three types of store platforms enable us to organically promote the breadth of our product in high-traffic, highly visible locations. Our strategy for expanding our global retail +business is to increase our market share in a disciplined manner, by selectively opening additional stores in new and existing markets, as well as increasing sales in existing stores, to support our +long-term strategic growth objective to further build Crocs into the leading casual lifestyle footwear brand in the world. We will continue to moderate the pace of our retail expansion in 2015 with a +focus on outlet and kiosk locations and consolidating and enhancing the profitability of existing locations. We halted the expansion of our retail channel and have begun to focus on the long-term +profitability of current locations. We opened 70 company-operated stores during the year ended December 31, 2014, half of which were outlet or low investment kiosk/store-in-store locations, and +closed 104 company-operated stores, 20 of which were identified in the initial restructuring plan. As store growth will vary in new and existing markets due to many factors, including maturity of the +market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +• Full Retail Locations +Our +company-operated retail locations allow us to effectively showcase the full extent of our new and existing products to customers at retail pricing. In addition, our full retail locations enable us +to interact with our customers on a personal level in order to guarantee a satisfying shopping experience as well as to obtain key retail metrics to better fulfill customer demands. On average, the +optimal space for our retail locations is between approximately 1,500 and 1,800 square feet, depending on the geographical vicinity of the property, and typically located in high-traffic shopping +malls or districts. During the year ended December 31, 2014, we closed 56 stores and opened 40 new stores, including a three-story flagship location with approximately 4,500 square feet of +selling space in a 13,600 square foot building located on 34 th Street in New York. As of December 31, 2014, 2013, and 2012, we operated 311, 327 and 287 global full retail +stores, respectively. +• Outlet Locations +Our +company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We additionally sell full priced products in certain of our +outlet stores. Outlet locations follow a similar size model as our full retail stores; however, they are generally located within outlet shopping locations. During the year ended December 31, +5 +Table of Contents +2014, +we closed 18 locations and opened 22 new locations. As of December 31, 2014, 2013 and 2012, we operated 174, 170 and 129 global outlet stores, respectively. +• Kiosk / Store-in-Store Locations +Our +company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other +high foot traffic areas. With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks can be an effective outlet for marketing our +products. As part of our overall retail strategy, we continue to close certain kiosks/store-in-store locations, as we believe our full retail and outlet locations allow us to better merchandise the +full extent and depth of our product line. During the year ended December 31, 2014, we closed 30 locations and opened eight new locations. As of December 31, 2014, 2013 and 2012, we +operated 100, 122 and 121 global kiosks and store-in-stores, respectively. +6 +Table of Contents +The +following table illustrates the net growth in 2014 with respect to the number of our company-operated retail locations by reportable operating segment and country: +Company-operated retail locations: +December 31, +2013 +Opened +Closed +December 31, +2014 +Americas +U.S. +186 +16 +(17 +) +185 +Canada +13 +— +— +13 +Brazil +8 +— +(4 +) +4 +Puerto Rico +7 +— +— +7 +Argentina +2 +— +(1 +) +1 +Total Americas +216 +16 +(22 +) +210 +Asia Pacific +Korea +76 +10 +(3 +) +83 +Taiwan +58 +5 +(58 +) +5 +China +38 +8 +(3 +) +43 +Hong Kong +21 +6 +(4 +) +23 +Singapore +15 +3 +18 +Australia +11 +3 +(1 +) +13 +United Arab Emirates (UAE) +9 +2 +(1 +) +10 +South Africa +8 +1 +— +9 +Total Asia Pacific +236 +38 +(70 +) +204 +Japan +49 +6 +(1 +) +54 +Europe +Russia +36 +6 +(3 +) +39 +Germany +20 +1 +(1 +) +20 +Great Britain +17 +— +(2 +) +15 +France +14 +2 +(2 +) +14 +Netherlands +9 +— +(2 +) +7 +Finland +7 +— +(1 +) +6 +Spain +6 +— +— +6 +Belgium +3 +— +— +3 +Italy +2 +1 +— +3 +Sweden +2 +— +— +2 +Ireland +1 +— +— +1 +Portugal +1 +— +— +1 +Total Europe +118 +10 +(11 +) +117 +Total company-operated retail locations +619 +70 +(104 +) +585 +Internet Channel +As of December 31, 2014, we offered our products through 12 company-operated internet webstores worldwide. During the years +ended December 31, 2014, 2013 and 2012, approximately 8.8%, 8.5% and 9.1%, respectively, of our net revenues were derived from sales through our internet channel. Our internet presence enables +us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. During the year ended December 31, 2014, we decreased our global +company-operated e-commerce sites to 12 in order to focus our internet strategy in our principal geographical locations. We continue to expand our web-based marketing +7 +Table of Contents +efforts +to increase consumer awareness of our full product range and have begun expanding the implementation of locally executed internet web stores at the regional level. +Business Segments and Geographic Information +For 2014 and 2013, we had four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, +Japan and Europe. We also have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represents manufacturing +operations located in Mexico, Italy and Asia. The composition of our reportable operating segments is consistent with that used by our Chief Operating Decision Maker ("CODM") to evaluate performance +and allocate resources. See additional +discussion of our segments including results of operations and assets by segment in Note 16 in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in the North and South America geographic +regions. Regional wholesale channel customers consist of a broad range of family footwear, sporting goods and department stores as well as specialty retailers and distributors. The regional retail +channel sells directly to the consumer through 210 company-operated store locations as well as through webstores. During the years ended December 31, 2014, 2013 and 2012, revenues from the +Americas segment constituted approximately 40.9%, 41.9% and 44.1% of our consolidated revenues, respectively. Specifically, revenues from the United States constituted approximately 36.3%, 33.7% and +35.3% of our consolidated revenues, respectively, for the years ended December 31, 2014, 2013 and 2012. +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia (excluding Japan), +Australia, New Zealand, the Middle East and South Africa. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the +Americas segment. We also sell products directly to the consumer through 204 company-operated stores as well as through our webstores. During the years ended December 31, 2014, 2013 and 2012, +revenues from the Asia segment constituted 29.3%, 28.7% and 26.1% of our consolidated revenues, respectively. +Japan +The Japan segment consists of revenues and expenses related to product sales in Japan. The Japan wholesale channel consists of sales to +a broad range of retailers similar to the wholesale channel we have established in the Americas segment. The regional retail channel sells directly to the consumer through 54 company-operated store +locations as well as through webstores. During the years ended December 31, 2014, 2013 and 2012, revenues from the Japan segment constituted approximately 10.3%, 11.3% and 14.7% of our +consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Europe and Russia. The Europe +segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment. We also sell our products directly to the +consumer through 117 company-operated stores as well as through our webstores. During the years ended December 31, 2014, 2013 and 2012, revenues from the Europe segment constituted 19.5%, 18.1% +and 15.1% of our consolidated revenues, respectively. +8 +Table of Contents +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase +our speed to market and lower operating costs. During the year ended December 31, 2014, we stored our raw material and finished goods inventories in company-operated warehouse and distribution +facilities located in the United States, Mexico, the Netherlands, Japan, Finland, South Africa, Russia and Italy. We also utilize distribution centers which are operated by third parties located in +the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico and Italy. Throughout 2014, we continued +to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2014, our company-operated warehouse and distribution +facilities provided us with approximately 1.0 million square feet and our third-party operated distribution facilities provided us with approximately 0.4 million square feet. We also +ship a portion of our products directly to our customers from our internal and third-party manufacturers. We are actively pursuing initiatives aimed at shipping more of our product directly to our +customers in an effort to lower future cost of sales. +Raw Materials +"Croslite", our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our +accessories. Croslite is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our +materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins, that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other +production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may, however, in the future identify and +utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to +produce the Croslite products are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +non-Croslite materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. We also outsource the +compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We continue to dedicate significant resources to product design and development as we develop footwear styles based on opportunities we +identify in the marketplace. Our design and development process is highly collaborative, as members of the regional design teams, including our EXO Italia ("EXO") location, which specializes in EVA +(Ethylene Vinyl Acetate) based finish products for the footwear industry, frequently meet with sales and marketing staff, production and supply managers and certain of our retail customers to further +refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while +maintaining product quality. We spent $16.7 million, $15.4 million and $12.0 million in research, design and development activities for the years ended December 31, 2014, +2013 and 2012, respectively. +9 +Table of Contents +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated +production facilities in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or provide support to our internal production processes. We believe +that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors +throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our +production costs, increase overall operating efficiencies and shorten production and development times. +In +the years ended December 31, 2014, 2013 and 2012, we manufactured approximately 13.9%, 15.1% and 21.1%, respectively, of our footwear products internally. We sourced the +remaining footwear production from multiple third-party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2014, 2013 and 2012, our +largest third-party manufacturer in China produced approximately 27.5%, 28.0% and 31.7%, respectively, of our footwear unit volume. We do not have written supply agreements with our primary +third-party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our +intellectual property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or +manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada +among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, +YOU by Crocs Logo, Ocean Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, "Croslite" and the Croslite logo, as well as other marks in various countries around the world. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. +are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful +marketing and sale of our products. We will continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the +future. We will also continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We +consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a +process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the +formula by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors and by requiring our employees to execute confidentiality agreements +concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort +and utility of our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously +protect this trade secret. +10 +Table of Contents +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers, as well as outside +investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and +distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of +certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for +our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during +our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our +product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily +indicative of results to be expected for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at +that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only +relates to wholesale and distributor orders for the next season and current season fill-in orders and excludes potential sales in our retail and internet channels. Backlog as of a particular date is +affected by a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly +period over period. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and our recent system conversion and business model changes around the +globe, we believe that backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Foreign Currency Fluctuations on Revenues and Operating Income (Loss) +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other +than the U.S. Dollar. Accordingly, any amounts recorded in foreign currencies are translated into U.S. Dollars for consolidated financial reporting and are impacted by foreign currency fluctuations. +While we enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is +dependent on many factors that cannot be forecasted with reliable accuracy and our forward contracts may not prove effective in reducing our exposures. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly +with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business compete with companies such as, but not limited to, Deckers Outdoor Corp., +Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear +11 +Table of Contents +retailers +such as Genesco, Inc., Macy's, Dillard's, Dick's Sporting Goods Inc., The Finish Line Inc. and Footlocker, Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices, expanded product line and our distribution network continue to position us well in the marketplace. However, some companies in the +casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating +histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the +market with imitation products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2014, we had approximately 4,900 full-time, part-time and seasonal employees, of which approximately 3,000 +were engaged in retail-related functions. Less than 1% of our employees were represented by a union. +Available Information +We were organized in 1999 as a limited liability company. In January 2005, we converted to a Colorado corporation and subsequently +re-incorporated as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our common stock on NASDAQ commenced. +Our +internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to +the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports +filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Copies of any of these documents will be provided in print to any +stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +12 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2014/0001047469-15-001519/item13.txt b/raw/filings/0001334036/2014/0001047469-15-001519/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..b2702fc788613b36204c64570af36cec85ba4502 --- /dev/null +++ b/raw/filings/0001334036/2014/0001047469-15-001519/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2015 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2014. \ No newline at end of file diff --git a/raw/filings/0001334036/2014/0001047469-15-001519/item9a.txt b/raw/filings/0001334036/2014/0001047469-15-001519/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..8b2979a117afa784c0f5920862078cfe6e21dbd1 --- /dev/null +++ b/raw/filings/0001334036/2014/0001047469-15-001519/item9a.txt @@ -0,0 +1,68 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange +Act, as of December 31, 2014 (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure +controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission ("SEC") +reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, +including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +65 +Table of Contents +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange +Act Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014, using the criteria set forth in the Internal +Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on +this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2014. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonably likely to materially affect, our internal control over financial reporting. +66 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the Company) as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management's Annual Report on +Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control—Integrated Framework +(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended +67 +Table of Contents +December 31, +2014 of the Company and our report dated March 2, 2015 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +March 2, 2015 +68 +Table of Contents +PART III \ No newline at end of file diff --git a/raw/filings/0001334036/2014/0001047469-15-001519/rp_note.txt b/raw/filings/0001334036/2014/0001047469-15-001519/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2014/0001047469-15-001519/rpt_disclosure.txt b/raw/filings/0001334036/2014/0001047469-15-001519/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..5f5c31357256d1a7a2687650e2d2ffe40dcfe691 --- /dev/null +++ b/raw/filings/0001334036/2014/0001047469-15-001519/rpt_disclosure.txt @@ -0,0 +1,67 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Investment Agreement with Blackstone +On January 27, 2014, we issued to Blackstone and certain of its permitted transferees (together with Blackstone, the "Blackstone Purchasers"), +200,000 shares of our Series A Convertible Preferred Stock for an aggregate purchase price of $198 million, or $990 per share, pursuant to the Investment Agreement. In connection with +the issuance of the convertible preferred stock (the "Closing") and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2 million and reimbursed Blackstone's transaction +fees and expenses of approximately $4 million. As of March 31, 2015, the Blackstone Purchasers collectively owned all of our outstanding shares of convertible preferred stock and, on an +as-converted basis, approximately 15.2% of our outstanding common stock. Mr. Ribatt was a permitted transferee of Blackstone and purchased 1,000 shares of our Series A Convertible +Preferred Stock. +As +discussed above under "Proposal 1—Election of Directors," the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as +the Blackstone Purchasers (i) beneficially own at least 95% of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement or +(ii) maintain beneficial ownership of at least 12.5% of the our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors +to our Board. For so long as the Blackstone Purchasers beneficially own shares of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement that +represent less than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right +to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. Blackstone +designated Messrs. Melwani and Giordano for nomination to our Board and had previously nominated Mr. Ribatt. +19 +Table of Contents +Pursuant to the Investment Agreement, Blackstone is subject to certain standstill restrictions which restrict Blackstone from acquiring more than 25% of our outstanding common +stock until the date on which Blackstone is no longer entitled to designate any directors to our Board. In addition, subject to certain customary exceptions, Blackstone is restricted from transferring +any shares of the convertible preferred stock until the second anniversary of the Closing and, for so long as any convertible preferred stock is outstanding, may not transfer any shares of convertible +preferred stock to certain of our competitors (as defined in the Investment Agreement) or holders of 25% or more of our common stock. Blackstone also has certain preemptive rights and information +rights under the Investment Agreement, which are subject to certain conditions. +Certificate of Designations +Pursuant to the Certificate of Designations of Series A Convertible Preferred Stock filed with the Delaware Secretary of State on +January 24, 2014, which establishes the +designations, preferences, and other rights of the convertible preferred stock: +• The convertible preferred stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up +and dissolution; +• The Blackstone Purchasers are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value +of $1,000 per share; +• If we fail to make timely dividend payments to the holders of our convertible preferred stock, the dividend rate will increase to 8% +per annum until such time as all accrued but unpaid dividends have been paid in full; +• The Blackstone Purchasers are entitled to receive any dividends declared or paid on our common stock and are entitled to vote together +with the holders of our common stock as a single class, in each case, on an as-converted basis; +• The Blackstone Purchasers have certain limited special approval rights, including with respect to the issuance by us of pari passu or senior equity securities; +• The Blackstone Purchasers may, at any time, require us to convert their shares of convertible preferred stock into shares of common +stock at an implied conversion price of $14.50 per share, subject to certain adjustments; +• At our election, all or a portion of the convertible preferred stock will be convertible into the relevant number of shares of common +stock on or after the third anniversary of the Closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days; +• The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share caps and other restrictions; +• At any time after the eighth anniversary of the Closing, we will have the right to redeem, and the Blackstone Purchasers will have the +right to require us to repurchase, all or any portion of the convertible preferred stock at 100% of the stated value, plus all accrued but unpaid dividends; and +• Upon certain change in control events involving us, the Blackstone Purchasers can require us to repurchase their shares of convertible +preferred stock at 101% of the stated value plus all accrued but unpaid dividends. +Registration Rights Agreement +In connection with the Closing, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the "Registration Rights Agreement"), +pursuant to which we have agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of the shares of convertible preferred stock and any +shares of common stock issued upon conversion of the +20 +Table of Contents +convertible +preferred stock. The Registration Rights Agreement contains customary terms and conditions, including certain customary indemnification obligations. +Policy on Transactions with Related Persons +Our Code of Business Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive +officers, or greater than five percent stockholders, or one of the aforementioned's immediate family members (each, a "related person"), have a material interest be approved or ratified by the Audit +Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course +of business transactions in which directors have an interest as part of the Board's annual director independence review, and our Code of Business Conduct and Ethics permits the full Board to waive any +conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems +appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. The full Board approved each of the transactions disclosed above. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our +certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' fees), +judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person's services as a director or +executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary +to attract and retain qualified persons as directors and executive officers. \ No newline at end of file diff --git a/raw/filings/0001334036/2015/0001047469-16-010591/filing.txt b/raw/filings/0001334036/2015/0001047469-16-010591/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..7528af759caabc8a1d55ef33ffe1e9018788fd7b --- /dev/null +++ b/raw/filings/0001334036/2015/0001047469-16-010591/filing.txt @@ -0,0 +1,8837 @@ +10-K +1 +a2227543z10-k.htm +10-K +Use these links to rapidly review the document +Crocs, Inc. Table of Contents to the Annual Report on Form 10-K For the Year Ended December 31, 2015 +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2015 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer +Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's principal executive offices) +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities +registered pursuant to Section 12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during +the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past +90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and +posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to +submit and post such files). Yes ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, +and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any +amendment to the Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of +"large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +(do not check if a +smaller reporting company) +Smaller reporting company o +Indicate +by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the +Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2015 was $1.1 billion. For the purpose of the +foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant's common stock are assumed to be affiliates of the registrant. This +determination of affiliate status is not necessarily conclusive for any other purpose. +The +number of shares of the registrant's common stock outstanding as of February 22, 2016 was 73,010,000. +DOCUMENTS INCORPORATED BY REFERENCE +Part III +incorporates certain information by reference from the registrant's proxy statement for the 2016 annual meeting of stockholders to be filed no later than 120 days after the end +of the registrant's fiscal year ended December 31, 2015. +Table of Contents +Special Note Regarding Forward-Looking Statements +Statements in this Form 10-K and in documents incorporated by reference herein (or otherwise made by us or on our behalf) may contain +"forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain +such statements. Forward-looking statements include statements as to industry trends, our future expectations and other matters that do not relate strictly to historical facts and are based on certain +assumptions of our management. These statements, which express management's current views concerning future events or results, use words like "anticipate," "assume," "believe," "continue," "estimate," +"expect," "future," "intend," "plan," "project," "strive," and future or conditional tense verbs like "could," "may," "might," "should," "will," "would," and similar expressions or variations. +Forward-looking statements are subject to risks, uncertainties, and other factors which may cause actual results to differ materially from future results expressed or implied by such forward-looking +statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in the section titled "Risk Factors" +(Item 1A. of this annual report on Form 10-K). Moreover, +such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such +statements. +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2015 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +11 +Item 1B. +Unresolved Staff Comments +25 +Item 2. +Properties +25 +Item 3. +Legal Proceedings +26 +Item 4. +Mine Safety Disclosures +27 +PART II +Item 5. +Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +28 +Item 6. +Selected Financial Data +31 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +33 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +65 +Item 8. +Financial Statements and Supplementary Data +67 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +67 +Item 9A. +Controls and Procedures +67 +Item 9B. +Other Information +69 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +72 +Item 11. +Executive Compensation +72 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +72 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +73 +Item 14. +Principal Accountant Fees and Services +73 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +73 +Signatures +79 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our," or "us") are engaged in the design, development, +manufacturing, worldwide marketing and distribution of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear +featuring fun, comfort, color, and functionality. The Company, a Delaware corporation, is the successor of a Colorado corporation of the same name, and was originally organized in 1999 as a limited +liability company. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite, as well as casual lifestyle footwear that use a range of materials. +Our Croslite material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 65 countries through domestic and +international retailers and distributors, and directly to consumers through our company-operated retail stores, outlets, webstores, and kiosks. +Since +the initial introduction of our popular Beach and Crocs Classic designs in 2002, we have expanded our classic products to include a variety of new styles and products. Going forward, we are +focusing on our core molded footwear heritage, as well as developing innovative casual lifestyle footwear. The broad appeal of our footwear has allowed us to market our products to a wide range of +distribution channels, including family footwear stores, department stores, sporting goods stores and traditional footwear retailers, as well as a variety of specialty and independent retail channels, +and via the internet. +Products +Our product offerings have grown significantly since we first introduced the single-style clog in six colors in 2002. We currently offer a wide +variety of footwear products including clogs, sandals, wedges, flats, sneakers, and boots. During the years ended December 31, 2015, 2014, and 2013, approximately 76.2%, 73.5%, and 71.1%, +respectively, of unit sales consisted of products geared toward adults compared to 23.8%, 26.5%, and 28.9%, respectively, of unit sales of products geared toward children. +A +key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and functionality. Croslite is carefully formulated to create extremely +lightweight, comfortable, and non-marking footwear that conforms to the shape of the foot and increase comfort. Croslite is a closed-cell resin material which is water resistant, virtually odor free +and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials, such as textile fabric and leather, into +many of our styles; however, we continue to utilize the Croslite material for the foot bed, sole, and other key structural components for many of these styles. +We +strive to provide our global consumer with a year-round product assortment featuring fun, comfortable, casual, colorful, and innovative styles. Our collections are designed to meet the needs of the +family by focusing on key wearing occasions. Our goal is to deliver world-class product assortments for the family with all of the comfort features and benefits Crocs is known for. We have +discontinued our non-core products in order to focus on growing our core-molded heritage category while developing more compelling casual footwear platforms. +At +the heart of our brand resides the Classic, our first and most iconic style for adults and kids that embodies our innovation in molding and design, delivers all-day comfort, and has established a +new category in the footwear marketplace. The unique look and feel of the Classic can be experienced throughout our entire product line due to the use and design of our proprietary material Croslite. +We have expanded our core molded product line, introduced in 2002, with the addition of dual density technology, warm lined styles, seasonal flips and slides. Licensed style partnerships from Disney, +Marvel, Sanrio, +2 +Table of Contents +Nickelodeon, +and Warner Bros., among others, provide popularity to our kids' core line along with our kids-only product innovations, including lights, color-change materials, and interactive elements. +In +addition, we have extended our core product assortment with new styling including 'built for her' and 'built for him' silhouettes, which are offered in multiple color and graphic treatments. Our +core products are available across a range of channels of distribution and span both stylish and active wearing occasions for the entire family. +Sales and Marketing +Each season we focus on presenting a compelling "brand story and experience" for our new product collections and our broader casual lifestyle +assortment. Our marketing efforts center on story-telling across diverse wearing occasions and product silhouettes. For the years ended December 31, 2015, 2014, and 2013, total advertising +costs were $58.2 million, $44.7 million, and $47.6 million, respectively. +We +run our business across three major regions: the Americas, Asia Pacific and Europe. In developing our market growth and expansion strategy, we prioritize six core markets including: (i) the +United States, (ii) Japan, (iii) China, (iv) South Korea, (v) Germany, and (vi) the United Kingdom. These countries have been identified as large-scale geographies +where we believe the greatest opportunities for growth exist. Accordingly, our product development efforts for our 2016 product line are largely focused on expanding our market share in these +locations. We are also focusing our marketing efforts on these regions in an effort to increase customer awareness of both our brand and our full product range. +We +have three primary sales channels: wholesale, retail, and e-commerce (discussed in more detail below). Our marketing efforts are aimed at driving business to both our wholesale partners and our +company-operated retail and e-commerce stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key stories, activation +materials, and creative materials. Retail stores provide a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store experience a +meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product launches. +Wholesale Channel +During the years ended December 31, 2015, 2014, and 2013, approximately 54.2%, 55.7%, and 56.5% of net revenues, respectively, were derived +from sales through the wholesale channel which consists of sales to distributors and third-party retailers. Wholesale customers include family footwear retailers, national and regional retail chains, +department stores, sporting goods stores, and independent footwear retailers. No single customer accounted for 10% or more of our revenues for any of the years ended December 31, 2015, 2014, +and 2013. +Many +of our agreements allow us to accept returns from wholesale customers for defective products and quality issues, on an exception basis, and to extend pricing discounts in lieu of defective +product returns. We also may accept returns from our wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper +assortments. +We +use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price list and are +granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are generally terminable +upon 30 days prior notice, and have minimum sales requirements that allow us to terminate or renegotiate the contract if minimum requirements are not met. +3 +Table of Contents +Retail Channel +During the years ended December 31, 2015, 2014, and 2013, approximately 34.7%, 35.5%, and 35.0%, respectively, of our net revenues were +derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full-service retail locations, outlet locations, and kiosk/store-in-store locations. +Our three types of store platforms enable us to organically promote the breadth of our product offering in high-traffic, highly visible locations. Our strategy for expanding our global retail business +is to increase our market share in a disciplined manner by selectively opening additional stores in new and existing markets, as well as increasing sales in existing stores. We will continue to +moderate the pace of our retail expansion in 2016 with a focus on outlet locations as well as enhancing the profitability of existing locations. We opened 42 company-operated stores during the year +ended December 31, 2015 and closed 68 company-operated stores. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand +recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +• Full-Service Retail Locations +Our +company-operated retail locations allow us to effectively showcase the full extent of our new and existing products to customers at retail pricing. In addition, our full-service retail locations +enable us to interact with our customers on a personal level in order to ensure a satisfying shopping experience. On average, the optimal space for our retail locations is between approximately 1,500 +and 1,800 square feet, depending on the geographic vicinity of the property, and is typically located in high-traffic shopping malls or districts. During the year ended December 31, 2015, we +closed 51 stores and opened 15 new stores. As of December 31, 2015, 2014, and 2013, we operated 275, 311, and 327 global full-service retail stores, respectively. +• Outlet Locations +Our +company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We also sell full priced products in certain of our outlet +stores. Outlet locations follow a similar size model as our full-service retail stores; however, they are generally located within outlet shopping locations. During the year ended December 31, +2015, we closed four outlet locations and opened 16 new outlet locations. As of December 31, 2015, 2014, and 2013, we operated 186, 174, and 170 global outlet stores, respectively. +• Kiosk / Store-in-Store Locations +Our +company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other +high foot traffic areas. With bright and colorful displays, efficient use of retail space, and limited capital investment, we believe that kiosks and shop in shops locations can be an effective outlet +for marketing our products where this business model is applicable. During the year ended December 31, 2015, we closed 13 kiosk and store-in-store locations and opened 11 new kiosk and +store-in-store locations. As of December 31, 2015, 2014, and 2013, we operated 98, 100, and 122 global kiosks and store-in-stores, respectively. +4 +Table of Contents +The +following table illustrates the net change in 2015 with respect to the number of our company-operated retail locations by reportable operating segment and country: +December 31, +2014 +Opened +Closed +December 31, +2015 +Company-operated retail locations +Americas +United States +185 +4 +10 +179 +Canada +13 +— +3 +10 +Puerto Rico +7 +— +— +7 +Other +5 +— +5 +— +Total Americas +210 +4 +18 +196 +Asia Pacific +Korea +83 +5 +4 +84 +Japan +54 +4 +6 +52 +China +43 +19 +7 +55 +Hong Kong +23 +1 +3 +21 +Singapore +18 +1 +4 +15 +Australia +13 +1 +3 +11 +United Arab Emirates (UAE) +10 +5 +1 +14 +South Africa(1) +9 +— +— +9 +Taiwan +5 +— +5 +— +Total Asia Pacific +258 +36 +33 +261 +Europe +Russia +39 +2 +4 +37 +Germany +20 +— +2 +18 +Great Britain +15 +— +5 +10 +France +14 +— +2 +12 +Netherlands +7 +— +1 +6 +Finland +6 +— +1 +5 +Spain +6 +— +— +6 +Other +10 +— +2 +8 +Total Europe +117 +2 +17 +102 +Total +585 +42 +68 +559 +(1) Our +South Africa operations were designated as held for sale as of December 31, 2015. These locations were subsequently sold on January 19, +2016. See Note 5—Property and Equipment and Note 21—Subsequent Events to the consolidated financial statements for additional information. +E-commerce Channel +As of December 31, 2015, we offered our products through 12 company-operated e-commerce webstores worldwide. During the years ended +December 31, 2015, 2014, and 2013, approximately 11.1%, 8.8%, and 8.5%, respectively, of our net revenues were derived from sales through our e-commerce channel. Our e-commerce presence enables +us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. Improving our e-commerce capabilities is one of our key strategies in +positioning Crocs for sustained growth. Going forward, we will continue to improve our consumer's online experience and look for new ways to leverage digital technologies to connect with them. +5 +Table of Contents +Business Segments and Geographic Information +For 2015, we had three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and Europe. We also +have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represents manufacturing operations located in Mexico, Italy +and Asia. For 2014 and 2013, we had four reportable operating segments: Americas, Asia Pacific, Japan and Europe. Subsequent to December 31, 2014, Crocs' internal reports reviewed by the Chief +Operating Decision Maker ("CODM") began consolidating Japan into the Asia Pacific segment. This change aligned the Company's internal reporting to its new strategic model and management structure, as +Japan and Asia Pacific are now managed and analyzed as one operating segment by management and the CODM. Accordingly, prior period segment results have been reclassified to reflect this change. The +composition of our reportable operating segments is consistent with that used by our CODM to evaluate performance and allocate resources. See additional discussion of our segments including results of +operations and assets by segment in Note 18 in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in the North and South America geographic regions. Regional +wholesale channel customers consist of a broad range of family footwear, sporting goods and department stores as well as specialty retailers and distributors. The regional retail channel sells +directly to consumers through 196 company-operated store locations in the Americas as well as through webstores. During the years ended December 31, 2015, 2014, and 2013, revenues from the +Americas segment constituted approximately 43.7%, 40.9%, and 41.9% of our consolidated revenues, respectively. Specifically, revenues from the United States of America constituted approximately 35.8%, +36.3%, and 33.7% of our consolidated revenues, respectively, for the years ended December 31, 2015, 2014, and 2013. +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, the Middle +East and South Africa. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the Americas segment. We also sell +products directly to the consumer through 261 company-operated stores located in Asia as well as through our webstores. +During the years ended December 31, 2015, 2014, and 2013, revenues from the Asia segment constituted 39.0%, 39.6%, and 40.0%, of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Europe and Russia. The Europe segment wholesale +channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment. We also sell our products directly to the consumer through 102 +company-operated stores located in Europe as well as through our webstores. During the years ended December 31, 2015, 2014, and 2013, revenues from the Europe segment constituted 17.3%, 19.5%, +and 18.1% of our consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, +and lower operating costs. During the year ended December 31, 2015, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located +in the United States, Mexico, the Netherlands, Japan, +6 +Table of Contents +Finland, +South Africa, Russia, and Italy. We also utilize distribution centers which are operated by third parties located in the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, +India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico, and Italy. Throughout 2015, we continued to engage in efforts to consolidate our global warehouse and +distribution facilities to facilitate a lean cost structure. As of December 31, 2015, our company-operated warehouse and distribution facilities provided us with approximately +1.0 million square feet and our third-party operated distribution facilities provided us with approximately 0.4 million square feet. We also ship a portion of our products directly to +our customers from our internal and third-party manufacturers. +Raw Materials +"Croslite", our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our accessories. +Croslite is soft, durable, and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our materials to +enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other production inputs +such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may, however, in the future identify and utilize materials +produced by other suppliers as an alternative to, or in addition to, the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to +produce the Croslite products are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products we offer. Many of these new products are constructed using leather, textile fabrics, or other non-Croslite +materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. We also outsource the compounding of +the Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We continue to dedicate significant resources to product design and development as we expand the footwear styles we offer based on opportunities we +identify in the marketplace. Our design and development process is highly collaborative and we continually strive to improve our development function so we can bring products to market quickly and at +reduced costs, while maintaining product quality. We spent $14.0 million, $16.7 million, and $15.4 million in research, design, and development activities for the years ended +December 31, 2015, 2014, and 2013, respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities +in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or to provide support to our internal production processes. Our internal manufacturing +capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors throughout the year, while outsourcing +allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our production costs, increase overall +operating efficiencies, and shorten production and development times. +In +the years ended December 31, 2015, 2014, and 2013, we manufactured approximately 11.3%, 13.9%, and 15.1%, respectively, of our footwear products internally. We sourced the remaining footwear +production from multiple third-party manufacturers primarily in China, Vietnam, Eastern Europe and +7 +Table of Contents +South +America. During the years ended December 31, 2015, 2014, and 2013, our largest third-party manufacturer in China produced approximately 26.6%, 27.5%, and 28.0%, respectively, of our +footwear unit volume. We do not have written supply agreements with our primary third-party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress and patent protections to establish, protect and enforce our +intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold +or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and +Canada among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, +YOU by Crocs Logo, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone, and Crocs Littles, "Croslite" and the Croslite logo, as well as other marks in various countries around the world. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. are generally +valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful marketing and sale +of our products. We will continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also +continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We +consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a process that +combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formula by using +exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the +protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort and utility of +our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade +secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators and +attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also +educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not +protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual +property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth +quarter is typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. We continue to +8 +Table of Contents +expand +our product line to include more winter oriented styles to reduce the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions, or general economic, or consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not +necessarily indicative of expected results for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at that point, +represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to +wholesale and distributor orders for the next season and current season fill-in orders and excludes potential sales in our retail and internet channels. Backlog as of a particular date is affected by +a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly period over +period. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model changes around the globe, we believe backlog is an imprecise +indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Foreign Currency Fluctuations on Revenues and Operating Income (Loss) +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other than the U.S. +Dollar. Accordingly, any amounts recorded in foreign currencies are translated into U.S. Dollars for consolidated financial reporting and are impacted by foreign currency fluctuations. While we enter +into foreign currency exchange forward contracts as economic hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is dependent on many factors +that cannot be forecasted with reliable accuracy and our forward contracts may not prove effective in reducing our exposures. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single +company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and ecommerce businesses compete with companies including, but not limited to, Deckers +Outdoor Corp., Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers +such as Genesco, Inc., Macy's, Dillard's, Dick's Sporting Goods Inc., The Finish Line Inc., and Footlocker, Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, and marketing and distribution. We believe that our +unique footwear designs, the Croslite material, our prices, our expanded product line, and our distribution network continue to position us well in the marketplace. However, a number of companies in +the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, +greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the market with +products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2015, we had approximately 5,400 full-time, part-time, and seasonal employees, of which approximately 3,600 were engaged in +retail-related functions. +9 +Table of Contents +Available Information +Our internet address is www.crocs.com where we post the following filings, free of charge, as soon as reasonably practicable after they are +electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on +Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Copies of any +of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +10 +Table of Contents +ITEM 1A. Risk Factors +Described below are certain risks that our management believes are applicable to our business and the industry in which we operate. These risks have +the potential to materially adversely affect our business, results of operations, cash flows, financial condition, liquidity, or access to sources of financing. The risks included here are not +exhaustive and there may be additional risks that are not presently material or known. You should carefully consider each of the following risks described below in conjunction with all other +information presented in this report. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time +to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on our business. +Uncertainty about current and future global economic conditions may adversely affect consumer +spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for +our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally +and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest borrowing rates, higher fuel and other energy costs, inflation, +increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, or other economic factors. For example, in 2015 and 2014, we +experienced difficulty in our Asia Pacific segment primarily due to decreased performance in our China business which resulted in delayed payments of receivables and increased reserves for +uncollectable accounts receivable. In 2015 and 2014, we also experienced volatility in sales in our Asia Pacific segment due to the continued adverse macroeconomic conditions in China. If global +economic and financial market conditions deteriorate or remain weak for an extended period of time, the following factors could have a material adverse effect on our business, operating results, cash +flows and financial condition: +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, causing reduced +orders or order cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, which may reduce in increased difficulty in managing inventory, higher +discounting efforts, and lower product margins. +• If consumer demand for our products declines, we may be unable to open and operate new retail stores, or continue to operate existing +stores, due to the high fixed cost nature of the retail segment. +• Fluctuations in foreign currency exchange rates relative to the U.S. Dollar could have a material impact on our reported financial +results and condition. +• Any decrease in available credit caused by a weakened global economy may result in financial difficulties for our wholesale and retail +customers, product suppliers and other service providers, as well as the financial institutions that are counterparties to our credit facility and derivative transactions. If credit pressures or other +financial difficulties result in insolvency for these parties, it could adversely impact our estimated reserves, our ability to obtain future financing, and our financial results. +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer +order cancellations, and/or the need to extend customer payment terms which could lead to higher accounts receivable balances, reduced cash flows, greater expense associated with collection efforts, +and increased bad debt expense. +11 +Table of Contents +• If our manufacturers or other parties in our supply chain experience diminished liquidity, they may not meet their obligations to us, +and we may experience the inability to meet customer product demands in a timely manner. +China's deteriorating macro-economic environment could adversely affect sales in our Asia Pacific +segment which may adversely affect our financial condition and results of operations. +Current and future global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom +we do business which may adversely affect our financial condition, results of operations, and cash resources. Macro-economic conditions in China have deteriorated over the past several quarters +resulting in softening consumer demand and payment delays from our China distributors which have negatively impacted the sales volumes and cash collections for our China operations. During 2015, we +increased our allowance for doubtful accounts by an additional $23.2 million related to receivables in China as a +result of distributors defaulting on their payment obligations. As a result of this adjustment, our remaining net receivable balance in China is $5.1 million as of December 31, 2015. If +the economic conditions in China continue to decline, we may experience further reductions in consumer demand in the China market resulting in additional losses. As our China operations represent +approximately 8% of our total revenue, the impact of declining sales volumes in China could have a material adverse impact on our financial results in future periods. +We are currently in negotiations with multiple China distributors regarding our terms of payment and +there can be no assurance that these negotiations will be successful. If we are not able to agree on acceptable terms with our China distributors, we may need to establish new distributor +relationships and we cannot guarantee if we will be able to do so within a reasonable time frame, if at all. +In the third quarter of 2015, multiple China distributors failed to comply with the terms of their payment obligations. As a result, we have ceased +all shipments to these distributors until we are able to develop mutually beneficial terms of payment for both current sales and aged receivables. There are no assurances our efforts to obtain payment +will be successful. In the event we are not able to reach an agreement with these distributors we may terminate our relationship and look for new partners in the region. At this time we do not know +how long it will take to establish new distributor relationships on acceptable terms to us or if we will be able to establish such relationships at all. If we are unable to establish new partnerships +within a reasonable time frame, we could experience a significant decline in sales volumes within China in future periods which could have a material adverse effect on our business including our +financial results, cash flows, and financial condition. +Foreign currency fluctuations could have a material adverse effect on our results of operations and +financial condition. +As a global company, we have significant revenues, costs, assets, liabilities, and intercompany balances denominated in currencies other than the +U.S. Dollar. We pay the majority of expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of our +overseas third-party manufacturers in U.S. Dollars. Our ability to sell our products in foreign markets and the U.S. Dollar value of the sales made in foreign currencies can be significantly +influenced by foreign currency fluctuations. In 2015, we experienced a decrease of $31.9 million in revenue in our Asia Pacific segment related to foreign currency translation losses as a +result of decreases in the value of the Japanese Yen and Chinese Yuan compared to the U.S. Dollar and a decrease of $43.3 million in our Europe segment related to foreign currency translation +losses as a result of decreases in the value of the Euro and Ruble compared to the U.S. Dollar. A decrease in the value of foreign currencies relative to the U.S. Dollar could result in lower +revenues, product price pressures, and increased losses from currency exchange rates. Price increases caused by currency exchange rate fluctuations could make our products less competitive or have an +adverse effect on our profitability as most of our purchases from third-party +12 +Table of Contents +suppliers +are denominated in U.S. Dollars. Currency exchange rate fluctuations could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of +raw materials more expensive and more difficult to finance. +While +we enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is +dependent on many factors that cannot be forecasted with reliable accuracy and our forward contracts may not prove effective in reducing our exposures. +We face significant competition. +The footwear industry is highly competitive. Continued growth in the market for casual footwear has encouraged the entry of new competitors into the +marketplace and has increased competition from established companies. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label +footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer standing relationships with +wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, and spend substantially more than we do on product marketing. Our competitors' greater financial +resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of +price and production, and more quickly develop new products. Some of our competitors are offering products that are substantially similar, in design and materials, to Crocs branded footwear. In +addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. If we fail to compete successfully in the future, our sales and profits +may decline, we may lose market share, our financial condition may deteriorate, and the market price of our common stock would likely fall. +Our business relies significantly on the use of information technology and any material disruption +to operational technology or failure to protect the integrity and security of customer and employee information could harm our reputation and/or our ability to effectively operate our business. +We rely heavily on the use of information technology systems and networks in our operations and supporting departments including marketing, +accounting, finance, and human resources. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet +activity, and other network processes. Despite our current security measures, our systems, and those of our third-party service providers, may be vulnerable to information security breaches, acts of +vandalism, computer viruses, credit card fraud, phishing, and interruption or loss of valuable business data. Any disruption to these systems or networks could result in product fulfillment delays, +key personnel being unable to perform duties or communicate throughout the organization, loss of retail and internet sales, significant costs for data restoration, and other adverse impacts on our +business and reputation. +Over +the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance +enterprise resource planning (ERP) system, and warehouse management, order management, retail point-of-sale, and internet point-of-sale systems, as well as various interfaces between these systems and +supporting back office systems. Issues in implementing or integrating new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded +or replacement systems, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations. This could require significant additional capital +investments, including to remediate problems, and may have an adverse effect on our results of operations and financial condition. +13 +Table of Contents +We +routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks. Any breach of our +network may result in the loss of valuable business data, misappropriation of our consumers' or employees' personal information, or a disruption of our business. Despite our existing security +procedures and controls, if our network becomes compromised, it could give rise to unwanted media attention, materially damage our customer relationships, harm our business, reputation, results of +operations, cash flows, and financial condition which could result in fines or lawsuits, and may increase the costs we incur to protect against such information security breaches, such as increased +investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current +revenue and profit levels, or accurately forecast geographic demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts +to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, and our ability to expand within our current distribution channels and increase sales of +our products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, +including: +• Our ability to strengthen the Crocs brand globally into a leading casual lifestyle footwear provider; +• Our ability to focus on relevant geographies and markets, product innovation and profitable new growth platforms while maintaining +demand for our current offerings; +• Our ability to effectively manage our retail stores (including closures of existing stores) while meeting operational and financial +targets at the retail store level; +• Our ability to accurately forecast the global demand for our products and the timely execution of supply chain strategies to deliver +product around the globe efficiently based on that demand; +• Our ability to use and protect the Crocs brand and our other intellectual property in new markets and territories; +• Our ability to Achieve and maintain a strong competitive position in new and existing markets; +• Our ability to attract and retain qualified distributors or agents or to continue to develop direct sales channels; +• Our ability to consolidate our network to leverage resources and simplify our fulfillment process; and +• Our ability to execute a multi-channel advertising and marketing campaign to effectively communicate our message directly to our +consumers and employees. +If +we are unable to successfully implement any of the above mentioned strategies and many other factors mentioned throughout this section, our business may fail to grow, our brand may suffer, and our +results of operations and cash flows may be adversely impacted. +There can be no assurance that the strategic plans we have begun to implement will be successful. +In July 2014, we announced strategic plans for long-term improvement and growth of our business, which is comprised of four key initiatives: +(1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient organizational structure +including reducing duplicative and excess overhead which will also enhance the decision making process, and (4) closing or converting retail locations around the world. The initial charges for +the strategic plan were incurred in the first quarter of 2014 and continued through 2015. During 2014 and 2015, we closed 172 retail locations, offset by 112 new retail locations opened. +14 +Table of Contents +While +these strategic plans, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance that this will be the case, or that additional steps or +material accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. The implementation of our +new strategy may take a significant amount of time and resources to implement, and may not impact our financial condition, results of operations and cash flows in the short term, or at all. +We conduct significant business activity outside the U.S. which exposes us to risks of international +commerce. +A significant portion of our revenues is from foreign sales. Our ability to maintain the current level of operations in our existing international +markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. In addition to foreign manufacturing, +we operate retail stores and sell our products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks including: tariffs, anti-dumping fines, import +and export controls, and other non-tariff barriers such as quotas and local content rules; delays associated with the manufacture, transportation and delivery of products; increased transportation +costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to increased security concerns; restrictions on the transfer of funds; restrictions, due +to privacy laws, on the handling and transfer of consumer and other personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, any of +which can interrupt commerce; potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating +to compliance with these laws; expropriation and nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; difficulties in understanding and complying +with local laws, regulations and customs in foreign jurisdictions; longer accounts receivable patterns and difficulties in collecting foreign accounts receivables; difficulties in enforcing +contractual and intellectual property rights; greater risk that our business partners do not comply with our policies and procedures relating to labor, health and safety; and increased accounting and +internal control expenses. In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we +operate. We cannot assure that there will be no control failure around customs enforcement despite the precautions we take. We are currently subject to audits by various customs authorities including +the U.S. and Mexico. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff +treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our financial position and results of operations. +Our success depends substantially on the value of our brand and failure to strengthen and preserve +this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strengthening of the Crocs global brand. To be successful in the future, particularly +outside of the U.S., where the Crocs brand is less well-known and perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our +brand across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be outdated and +one-dimensional prior to purchasing our products. Brand value is based in part on consumer perceptions on a variety of subjective qualities. In the past, several footwear companies including ours have +experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, our business may be similarly affected in the future. Business incidents, such as +perceived product safety issues, whether isolated or recurring, that erode consumer trust, particularly if the incidents receive considerable publicity or result in litigation, can significantly +reduce brand value and have a negative impact on our financial results. Consumer demand for our products and our brand equity could diminish significantly if we fail to preserve the quality of our +products, are perceived to act in an unethical or socially +15 +Table of Contents +irresponsible +manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. Additionally, counterfeit reproductions of our +products or other infringement of our intellectual property rights, including from unauthorized uses of our trademarks by third parties, could harm our brand and adversely impact our business. +If our online sales platform does not function effectively, our operating results could be +materially adversely affected. +Many of our customers buy our products on our e-commerce webstores as well as third-party webstores. Any failure on our part to provide effective, +reliable, user-friendly e-commerce platforms, that offer a wide assortment of our merchandise, could place us at a competitive disadvantage, result in the loss of sales, and could have a material +adverse impact on our business and results of operations. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Opening and operating additional retail locations, which require substantial financial commitments +and fixed costs, are subject to numerous risks and declines in revenue of such retail locations could adversely affect our profitability. +Although we have slowed the expansion of our retail sales channel, we intend to continue to open outlet locations. Our ability to open new locations +successfully depends on our ability to identify suitable store locations, negotiate acceptable lease terms, hire, train, and retain store personnel and satisfy the fashion preferences in new +geographic areas. Many of our retail locations are located in shopping malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We +cannot control the success of individual malls and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Reduced customer traffic could reduce sales of +existing retail stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results and cash flows. In addition, some of our retail stores and kiosks +occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, social or military +events or otherwise, is likely to adversely affect sales in our existing stores and kiosks, particularly those with street locations. +Opening +retail stores globally involves substantial investment, including the construction of leasehold improvements, furniture and fixtures, equipment, information systems, inventory and personnel. +Operating global retail stores incurs fixed costs; if we have insufficient sales, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +We may be required to record impairments of long-lived assets relating to our retail operations. +The testing of our retail stores' long-lived assets for impairment requires us to make significant estimates about our future performance and cash +flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the +industry. Due to the high fixed cost structure associated with our retail operations, negative cash flows or the closure of a store could result in write downs of inventory, impairment of leasehold +improvements, impairment losses on other long-lived assets, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our financial position, +results of operations or cash flows. For example, during 2015, 2014, and 2013, we recorded impairments $15.3 million, $8.8 million and $10.9 million, respectively, of which +$9.6 million, $8.8 million and $10.6 million, respectively, related to our retail stores. These impairment charges may increase as we evaluate our retail operations. The recording +of additional impairments in the future may have a material adverse impact on our financial results. +16 +Table of Contents +We depend on key personnel across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior +management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to +offer more generous executive compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as +new management becomes familiar with our business. In recent years, we have experienced management turnover. Our future success depends on our ability to identify, attract and retain qualified +personnel on a timely basis. In addition, we must successfully integrate any newly hired management personnel within our organization in order to achieve our operating objectives. Effective in January +2015, Gregg Ribatt was appointed as our Chief Executive Officer and effective in December 2015, Carrie Teffner was appointed as Executive Vice President and Chief Financial Officer. Ms. Teffner +resigned as a member of the Board prior to her start date with the Company. The key initiatives directed by these executives may take time to implement and yield positive results, if at all. If our +new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays in our long-term growth strategy. +As +a global company, we also rely on a limited number of key international personnel to perform their functions at a high level in many of our geographic regions. In certain instances, one or two +personnel may be the primary knowledge base for business operations in a geographic region. The loss of key international personnel could adversely impact our operations and our client relationships. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have +greater difficulty filling our customers' orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in +consumer preferences, the effects of weather, general economic conditions and other factors affecting demand and possibly impairing our brand image. In addition, sales to our wholesale customers are +generally subject to rights of cancellation and rescheduling by the customer. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced +to liquidate excess inventories at discounted prices resulting in lower gross margins. Conversely, if we underestimate consumer +demand, we could have inventory shortages which can result in lower sales, delays in shipments to customers, strains on our relationships with customers and diminished brand loyalty. A decline in +demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and results of operations. In addition, an inability to accurately +forecast consumer demand could cause our revenue and earnings guidance to differ materially from our financial results. +Expanding our footwear product line may be difficult and expensive. If we are unable to successfully +continue such expansion, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully expand our footwear product line, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide +appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, +identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline, and we may not be able to execute our +growth plans. +In +producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. Our development schedules for new products are difficult to predict and +are subject to change in response to consumer preferences and competing products. If we are not able to +17 +Table of Contents +efficiently +manufacture new products in quantities sufficient to support retail and wholesale distribution, we may not be able to recover our investment in the development of new styles and product +lines and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate +success of a new style may depend on our pricing. We have a limited history of introducing new products in certain target markets; as such, we may set the prices of new styles too high for the market +to bear or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert +substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses and there can be no assurance that we will have the +resources necessary to undertake such efforts effectively or that such efforts will be successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow +current revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position and result in long-term harm to our business. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of +factors, including seasonal variations, which could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. As a significant portion of our revenues are +attributable to footwear styles that are more suitable for fair weather and are derived from sales in the northern hemisphere, we typically experience our highest sales activity during the second and +third quarters of the calendar year, when there is fair weather in the northern hemisphere. While we continue to create new footwear styles that are more suitable for cold weather, the effects of +favorable or unfavorable weather on sales can be significant enough to affect our quarterly results which could adversely affect our common stock price. Quarterly results may also fluctuate as a +result of other factors, including new style introductions, general economic conditions or changes in consumer preferences. Results for any one quarter are not necessarily indicative of results to be +expected for any other quarter or for any year and revenues for any particular period may fluctuate. This could lead to results outside of analyst and investor expectations, which could increase +volatility of our stock price. +We depend heavily on third-party manufacturers located outside the U.S. +Third-party manufacturers located in China and Vietnam produced the majority of our footwear products in 2015 and are expected to do so in 2016. We +depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for +the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers' operations. As such, we have experienced at times, delays or inabilities to fulfill +customer demand and orders, particularly in China. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines or meet our quality +standards. +In +addition, we do not have supply contracts with many of these third-party manufacturers and any of them may unilaterally terminate their relationship with us at any time or seek to increase the +prices they charge us. As a result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third-party manufacturers. Foreign manufacturing is subject to +additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, +changes in governmental policies and the imposition of tariffs, import and export controls, and other barriers. We may not be able to offset any interruption or decrease in supply of our products by +increasing production in our internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at +acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which +would adversely affect our results of operations. In addition, manufacturing delays +18 +Table of Contents +or +unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a +significant component in transportation costs. Increases in the price of petroleum products can adversely affect our profit margins. +In +addition, because a large portion of our footwear products is manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations between the U.S. and these +countries, political instability in China, increases in labor costs, or adverse weather conditions could significantly interfere with the production and shipment of our products, which would have a +material adverse effect on our operations and financial results. +We manufacture a portion of our products which causes us to incur greater fixed costs. Any +difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of operations. +We produce a portion of our footwear products at our internal manufacturing facilities in Mexico and Italy. Ownership of these facilities adds fixed +costs to our cost structure which are not as easily scalable as variable costs. In addition, the manufacture of our products from the Croslite material requires the use of a complex process and we may +experience difficulty in producing footwear that meets our high quality control standards. We will be required to absorb the costs of manufacturing and disposing of products that do not meet our +quality standards. Any increases in our manufacturing costs could adversely impact our profit margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges +faced by our third-party manufacturers, including our ability to scale our production capabilities to meet the needs of our customers. Our manufacturing may also be disrupted for reasons beyond our +control, including work stoppages, fires, earthquakes, floods or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in +a timely manner and could have a material and adverse effect on our business, results of operations and cash flows. +Our third-party manufacturing operations must comply with labor, trade and other laws; failure to do +so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other +matters, including +compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party +manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and +the value of our brand, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party +manufacturers to adhere to such product safety standards could lead to a product recall which could result in critical media coverage and harm our business and reputation and could cause us to incur +additional costs. +In +addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture +of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported +products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas or labor violations. The effects of these factors +could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign +customs quotas, duties, taxes or other charges, or if restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our +business, financial condition, or results of operations. +19 +Table of Contents +Our revolving credit facility contains financial covenants that require us to maintain certain +financial metrics and ratios and restrictive covenants that limit our flexibility. A breach of those covenants may cause us to be in default under the facility, and our lenders could foreclose on our +assets. +The credit agreement for our revolving credit facility requires us to maintain certain financial covenants. A failure to maintain current revenue +levels or an inability to control costs or capital expenditures could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders +could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the revolving credit facility. We may not have sufficient assets to repay such indebtedness upon +a default or receive a waiver of the default from the lender. If we are unable to repay the indebtedness, the lender could initiate a +bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the revolving credit facility. +The +credit agreement also contains certain restrictive covenants that limit and in some circumstances prohibit, our ability to, among other things incur additional debt, sell, lease or transfer our +assets, pay dividends on our common stock, make capital expenditures and investments, guarantee debt or obligations, create liens, repurchase our common stock, enter into transactions with our +affiliates and enter into certain merger, consolidation or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or needed +capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any +of which could place us at a competitive disadvantage relative to our competitors. +Our financial success may be limited to the strength of our relationships with our wholesale +customers and to the success of such wholesale customers. +Our financial success is related to the willingness of our current and prospective wholesale customers to carry our products. We do not have long +term contracts with any of our wholesale customers. Sales to our wholesale customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by the +customer. If we cannot fill our customers' orders in a timely manner, the sales of our products and our relationships with those customers may suffer. Alternatively, if our customers experience +diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in customer order cancellations and/or the need to extend customer payment terms which +could lead to higher accounts receivable balances, reduced cash flows, greater expense associated with collection efforts, and increased bad debt expense. Specifically, we recorded a reserve for +doubtful accounts of approximately $23.2 million in China for the year ended December 31, 2015, primarily as a result of delayed payments from our partner stores in China. Additional +problems with our wholesale customers, including continued payment delays in the Asia Pacific segment or other segments from regional wholesale partners may have a material adverse effect on our +product sales, financial condition, results of operations and our ability to grow our product line. +We depend on a limited number of suppliers for key production materials, and any disruption in the +supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the +primary raw materials used in compounding our Croslite products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were +to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of +our production cycle. We are also subject to market issues related to supply and demand for our raw materials. We may have to pay substantially higher prices in the future for the elastomer resins or +any substitute materials we use, which would increase our production costs and could have a significantly adverse impact on our profit margins and results of operations. If we are unable to obtain +suitable elastomer resins or if we are unable to procure sufficient +20 +Table of Contents +quantities +of the Croslite material, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics resulting in less favorable market +acceptance which could result in lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and +counterfeiting of our brands could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress and designs on nearly all of our products. +We believe that having distinctive marks that are readily identifiable is important to our brand, our success and our competitive position. The laws of some countries, for example, China, do not +protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our +intellectual property rights. If we are unsuccessful in challenging another party's products on the basis of trademark or design or utility patent infringement, particularly in some foreign countries, +or if we are required to change our name or use a different logo, continued sales of such competing products by third parties could harm our brand and adversely impact our business, financial +condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, the +integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the +validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to +successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We +also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite material and product development, +particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade +secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information, and other unpatented +proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement +and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, +including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +We have substantial cash requirements in the U.S.; however, a majority of our cash is generated and +held outside of the U.S. The consequential risks of holding cash abroad could adversely affect our financial condition and results of operations. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider unremitted +earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the +ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to +U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax +consequences if we were to move the cash to another country. Certain countries, including China, may have monetary laws which may limit our ability to utilize cash resources in those countries for +operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or +21 +Table of Contents +other +countries and may adversely affect our liquidity. Since repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able +to repatriate such cash on favorable terms or in a timely manner. If we incur operating losses on a continued basis and require cash that is held in international accounts for use in our U.S. +operations, a failure to repatriate such cash in a timely and cost-effective manner could adversely affect our business, financial condition and results of operations. +We are subject to periodic litigation, which could result in unexpected expense of time and +resources. +From time to time, we are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, +we cannot accurately +predict the ultimate outcome of any such proceedings. We are currently involved in several, potentially adverse legal proceedings. For a detailed discussion of our current material legal proceedings, +see Item 3 . Legal Proceedings in Part I of this Form 10-K. An unfavorable outcome in any of these proceedings or any future legal +proceedings could have an adverse impact on our business, financial condition and results of operations. In addition, any significant litigation in the future, regardless of its merits, could divert +management's attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may +become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management's attention and resources that are needed to successfully run +our business. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include +information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management's +estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. +Changes in tax laws and unanticipated tax liabilities and the results of tax audits or litigation +could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective income tax rate in the future could be +adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, +changes in tax laws, the outcome of income tax audits in various jurisdictions around the world and any repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes. We +regularly assess all of these matters to determine the adequacy of our tax provision, which is subject to significant discretion and we could face significant adverse impact if our assumptions are +incorrect and/or face significant cost to defend our practices from international and U.S. tax authorities. We are regularly subject to, and are currently undergoing, audits by tax authorities in the +United States and foreign jurisdictions for prior tax years. Please refer to Item 3. Legal Proceedings in Part I of this Form 10-K +as well as Note 17—Commitments and Contingencies in the accompanying notes to the consolidated financial statements for additional details regarding current tax audits. Although we +believe our tax estimates are reasonable and we intend to defend our positions through litigation if necessary, the final outcome of tax audits and related litigation is inherently uncertain and could +be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties +relating to ongoing or future audits. The adverse resolution of any audits or litigation could have an adverse effect on our financial position and results of operations. Future changes in domestic or +international tax laws and regulations +could also adversely affect our income tax liabilities. Recent developments, including the European Commission's investigations of local country tax authority rulings and whether those rulings comply +with European +22 +Table of Contents +Union +rules on state aid, as well as the Organization for Economic Co-operation and Development's project on Base Erosion and Profit Shifting, may result in changes to long-standing tax principles. +Any such changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +We are required to pay regular dividends on the Series A Convertible Preferred Stock, par +value $0.001 per share ("Series A Preferred Stock") issued to Blackstone Capital Partners VI L.P. ("Blackstone") in 2014, which ranks senior to our common stock, and we may be required +under certain circumstances to repurchase the outstanding shares of Series A Preferred Stock; such obligations could adversely affect our liquidity and financial condition. +The Series A Preferred Stock ranks senior to our common stock with respect to dividend rights, and holders of Series A Preferred Stock +are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value of $1,000 per share. These regular cash dividends on our Series A Preferred Stock +are payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year. If we fail to make timely dividend payments, the dividend rate will increase to +8% per annum until such time as all accrued but unpaid dividends have been paid in full. In addition, the holders of our Series A Preferred Stock have certain redemption rights, including upon +certain change in control events involving us, which, if exercised, could require us to repurchase all of the outstanding shares of Series A Preferred Stock at 100% or more of the stated value +of the shares, plus all accrued but unpaid dividends. Our obligations to pay regular dividends to the holders of our Series A Preferred Stock or any required repurchase of the outstanding +shares of Series A Preferred Stock could impact our liquidity and reduce the amount of cash flows available for working capital, capital expenditures, growth opportunities, acquisitions, and +other general corporate purposes. Our obligations to the holders of Series A Preferred Stock could also limit our ability to obtain additional financing or increase our borrowing costs, which +could have an adverse effect on our financial condition. +Our financial results may be adversely affected if substantial investments in businesses and +operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses, and expansion of existing businesses, such as our retail +operations, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant +investments are subject to typical risks and uncertainties inherent in acquiring or expanding a business. The failure of any significant investment to provide the returns or profitability we expect or +the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +If our internal controls are ineffective, our operating results and market confidence in our +reported financial information could be adversely affected. +Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility +of human error, the circumvention or overriding of controls or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of +financial statements. If we fail to maintain the adequacy of our internal controls or if we experience difficulties in their implementation, our business and operating results and market confidence in +our reported financial information could be harmed and we could fail to meet our financial reporting obligations. +As +of December 31, 2015, we identified material weaknesses in our internal control over financial reporting, which led us to conclude that our internal control over financial reporting as of +such date was not effective. The material weaknesses identified related to controls over the period end closing procedures and inventory monitoring. These material weaknesses are more fully explained +below in Part II Item 9A of this Form 10-K. +23 +Table of Contents +The +existence of such material weaknesses preclude management from concluding that our internal control over financial reporting is effective and precludes our independent auditors from issuing an +unqualified opinion that our internal controls are effective. In addition, these material weaknesses could cause investors to lose confidence in our financial reporting and may negatively affect the +price +of our common stock. We also can make no assurances that we will be able to timely and cost effectively remediate these internal control deficiencies. Moreover, effective internal controls are +necessary to produce reliable financial reports and to prevent fraud. If we are unable to satisfactorily remediate these deficiencies or if we discover other deficiencies in our internal control over +financial reporting, such deficiencies may lead to misstatements in our financial statements or otherwise negatively impact our financial statements, business, results of operations, and reputation. +Natural disasters could negatively impact our operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis or other adverse weather and climate conditions, whether occurring in the U.S. or abroad, +and the consequences and effects thereof, including damage to our supply chain, manufacturing or distribution centers, energy shortages, and public health issues, could disrupt our operations or the +operations of our vendors and other suppliers, or result in economic instability that may negatively impact our operating results and financial condition. +The issuance of 200,000 shares of our Series A Preferred Stock to Blackstone in 2014 and +certain of its permitted transferees reduces the relative voting power of holders of our common stock, may dilute the ownership of such holders, and may adversely affect the market price of our common +stock. +On January 27, 2014, we issued 200,000 shares of Series A Preferred Stock to Blackstone and certain of its permitted transferees +(collectively, the "Blackstone Purchasers") pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, the "Investment Agreement"). The Blackstone +Purchasers currently own all of the outstanding shares of Series A Preferred Stock, and based on the number of shares of our common stock outstanding as of December 31, 2015, the +Blackstone Purchasers collectively own Series A Preferred Stock convertible into approximately 15.9% of our common stock. As holders of our Series A Preferred Stock are entitled to vote, +on an as-converted basis, together with holders of our common stock as a single class on all matters submitted to a vote of our common stock holders, the issuance of the Series A Preferred +Stock to the Blackstone Purchasers has effectively reduced the relative voting power of the holders of our common stock. +In +addition, conversion of the Series A Preferred Stock to common stock will dilute the ownership interest of existing holders of our common stock, and any sales in the public market of the +common stock issuable upon conversion of the Series A Preferred Stock could adversely affect prevailing market prices of our common stock. We have granted the Blackstone Purchasers registration +rights in respect of the shares of Series A Preferred Stock and any shares of common stock issued upon conversion of the Series A Preferred Stock. These registration rights would +facilitate the resale of such securities into the public market, and any such resale would increase the number of shares of our common stock available for public trading. Sales by the Blackstone +Purchasers of a substantial number of shares of +our common stock in the public market, or the perception that such sales might occur, could have a material adverse effect on the price of our common stock. +Blackstone may exercise significant influence over us, including through its ability to elect up to +two members of our Board of Directors. +As of December 31, 2015, the shares of Series A Preferred Stock owned by the Blackstone Purchasers represent approximately 15.9% of the +voting rights of our common stock, on an as-converted basis, so the Blackstone Purchasers will have the ability to significantly influence the outcome of any matter submitted for the vote of our +stockholders. In addition, the Certificate of Designations of the Series A Preferred Stock grants certain consent rights to the holders of Series A Preferred Stock in respect of certain +actions +24 +Table of Contents +by +the Company, including the issuance of pari passu or senior equity securities of the Company, certain amendments to our certificate of incorporation +or bylaws, any increase in the size of our Board of Directors (the "Board") above eight members, the payment of certain distributions to our stockholders, and the incurrence or refinancing of a +certain level of indebtedness. The Blackstone Purchasers may have interests that diverge from, or even conflict with, those of our other stockholders. For example, Blackstone and its affiliates may +have an interest in directly or indirectly pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their other equity investments, even though such +transactions might involve risks to us. Blackstone and its affiliates are in the business of making or advising on investments in companies, including businesses that may directly or indirectly +compete with certain portions of our business. They may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be +available to us. +In +addition, the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as the Blackstone purchasers (i) beneficially own at least 95% +of the Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement or (ii) maintain beneficial ownership of at least 12.5% of our outstanding +common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors to our Board. For so long as the Blackstone purchasers beneficially own shares of +Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement that represent less than the Two-Director Threshold but more than 25% of the number of +shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate for nomination one director to our Board. The directors designated +by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain +provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, +or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other +corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation +Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could +cause the market price of our common stock to decline. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado 80503. We lease, rather than own, all +of our domestic and international facilities. We currently enter into short-term and long-term leases for kiosk, manufacturing, office, outlet, retail, and warehouse space. The terms of our leases +include fixed monthly rents and/or contingent rents based on percentage of +25 +Table of Contents +revenues +for certain of our retail locations, and expire at various dates through the year 2033. The general location, use and approximate size of our principal properties are given below. +Location +Reportable Operating Segment(s) +that Use this Property +Use +Approximate +Square Feet +Ontario, California +Americas +Warehouse +399,000 +Leon, Mexico +Americas, Asia Pacific, Europe +Manufacturing/warehouse/offices +392,000 +Shenzen, China +Asia Pacific +Warehouse/offices +263,000 +Rotterdam, the Netherlands +Europe +Warehouse +174,000 +Niwot, Colorado +Americas +Corporate headquarters and regional offices +158,000 +Narita, Japan(1) +Asia Pacific +Warehouse +156,000 +Padova, Italy +Americas, Asia Pacific, Europe +Manufacturing/warehouse/offices +45,000 +Singapore +Asia Pacific +Regional offices +37,000 +Hoofddorf, the Netherlands +Europe +Regional offices +31,000 +Bhiwandi, India +Asia +Warehouse +29,000 +Gordon's Bay, South Africa +Asia Pacific +Warehouse/offices +28,000 +Boston, Massachusetts +Americas +Global Commercial Center +16,000 +Tokyo, Japan +Asia Pacific +Regional offices +14,000 +Shanghai, China +Asia Pacific +Regional offices +13,000 +(1) The +warehouse facilities in this location are fully or partially subleased. +In +addition to the principal properties listed above, we maintain small branch sales offices in the United States, Canada, South America, Taiwan, Hong Kong, Australia, Korea, China, the United Arab +Emirates, India and Europe. We also lease more than 550 retail, outlet and kiosk/store in store locations worldwide. See Item 1 of this Form 10-K for further discussion regarding global +company-operated stores. +ITEM 3. Legal Proceedings +We are currently subject to an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In October 2013, +CBP issued the final audit report. In that report CBP projects that unpaid duties totaling approximately $12.4 million are due for the period under review and recommends collection of the +duties due. We responded that these projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the projection. +Additionally, on December 12, 2014, we made an offer to settle CBP's potential claims and tendered $3.5 million. At this time, it is not possible to determine how long it will take CBP +to evaluate our offer or to predict whether our offer will be accepted. Likewise, if a settlement cannot be reached, it is not possible to predict with any certainty whether CBP will seek to assert a +claim for penalties in addition to any unpaid duties, but such an assertion is a possibility. +We +are currently subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, we were notified about the +issuance of assessments totaling approximately $3.7 million for the period January 2010 through May 2011. We have disputed these assessments and asserted defenses to the claims. On +February 25, 2015, we received additional assessments totaling approximately $8.4 million related to the remainder of the audit period. We have also disputed these assessments and +asserted defenses and filed an appeal to these claims. It is anticipated that this matter will take up to several years to be resolved. It is not possible at this time to predict the outcome of this +matter. +On +August 8, 2014, a purported class action lawsuit was filed in California State Court against a Crocs subsidiary, Crocs Retail, LLC (Zaydenberg v. Crocs Retail, LLC, Case No. +BC554214). The lawsuit alleged various employment law violations related to overtime, meal and break periods, minimum wage, timely payment of wages, wage statements, payroll records and business +expenses. We filed an answer on February 6, 2015, denying the allegations and asserting several defenses. On June 3, 2015, a second purported class action lawsuit was filed in California +State Court against Crocs Retail, LLC (Christopher S. Duree and Richard Morely v. Crocs, Inc., Case No. BC583875), making substantially the same allegations +26 +Table of Contents +as +in the Zaydenberg lawsuit. The parties attended a mediation on June 26, 2015, and reached a settlement for $1.5 million, which will release the claims in both lawsuits. On +September 4, 2015, the California State Court granted preliminary approval of the settlement and set the final approval +hearing for December 14, 2015. At the final approval hearing, the California State Court entered its final order approving the settlement and final judgement. We consider this matter closed. +Although +we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not party to any +other pending legal proceedings that we believe would reasonably have a material adverse impact on its business, financial position, results of operations or cash flows. +ITEM 4. Mine Safety Disclosures +None. +27 +Table of Contents +PART II +ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol "CROX". The following table shows +the high and low sales prices of our common stock for the periods indicated. +Fiscal Year 2015—Three Months Ended +High +Low +March 31, 2015 +$ +12.78 +$ +10.25 +June 30, 2015 +$ +16.05 +$ +11.55 +September 30, 2015 +$ +15.86 +$ +12.52 +December 31, 2015 +$ +12.30 +$ +9.26 +Fiscal Year 2014—Three Months Ended +High +Low +March 31, 2014 +$ +16.88 +$ +14.41 +June 30, 2014 +$ +15.78 +$ +14.15 +September 30, 2014 +$ +16.83 +$ +12.25 +December 31, 2014 +$ +13.47 +$ +11.33 +28 +Table of Contents +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite Index and the +Dow Jones U.S. Footwear Index from December 31, 2010 through December 31, 2015. The graph assumes an investment of $100 on December 31, 2010 and assumes the reinvestment of all +dividends and other distributions. +Comparison of Cumulative Total Return on Investment +12/31/2011 +12/31/2012 +12/31/2013 +12/31/2014 +12/31/2015 +Crocs, Inc. +$ +86.27 +$ +84.05 +$ +92.99 +$ +72.96 +$ +59.81 +Dow Jones US Footwear Index +$ +111.21 +$ +116.53 +$ +178.83 +$ +208.06 +$ +254.36 +Nasdaq Composite Index +$ +98.2 +$ +113.82 +$ +157.44 +$ +178.53 +$ +188.75 +The +Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product +categories and lines of business. The Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corp., Iconix Brand Group, Inc., Skechers +U.S.A., Inc. Steven Madden Ltd. and Wolverine World Wide, Inc., among other companies. As Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of +our stock have an effect on this index. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock +performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 90 as of February 22, 2016. +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the +foreseeable future. Our financing arrangements contain certain restrictions on our ability to pay cash dividends on our common stock. In addition, the Certificate of Designations governing the +Series A Convertible Preferred Stock that we issued in January 2014 restricts +29 +Table of Contents +us +from declaring and paying certain dividends on our common stock if we fail to pay all accumulated and unpaid regular dividends and/or declared and unpaid participating dividends to which the +preferred holders are entitled. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board of Directors (the "Board"), subject to compliance +with covenants under any then-existing financing agreements and the terms of the Certificate of Designations. +Purchases of Equity Securities by the Issuer +Period +Total +Number of +Shares +(or Units) +Purchased +Average +Price Paid +per Share +(or Unit) +Total Number of +Shares (or Units) +Purchased as +Part of Publicly +Announced Plans +or Programs(1) +Approximate Dollar +Value of Shares or Units +That May Yet Be +Purchased Under the +Plans or Programs +(in thousands) +October 1, 2015 to October 31, 2015 +— +$ +— +— +$ +128,647 +November 1, 2015 to November 30, 2015 +— +$ +— +— +$ +128,647 +December 1, 2015 to December 31, 2015 +917,971 +$ +10.86 +917,971 +$ +118,676 +Total +917,971 +$ +10.86 +917,971 +$ +118,676 +(1) On +December 26, 2013, our board approved the repurchase of up to $350.0 million of our common stock, which was announced on +December 30, 2013. This authorization replaced our previous stock repurchase authorizations. During the three months ended December 31, 2015, we repurchased approximately +918 thousand shares at a weighted average price of $10.86 per share for an aggregate price of approximately $10.0 million excluding related commission charges, under our +publicly-announced repurchase plan. As of December 31, 2015, approximately $118.7 million of shares remained available for repurchase under our share repurchase authorization. The +number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs and other +factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any +particular amount of our common stock. The Board of Directors may suspend, modify or terminate the repurchase program at any time without prior notice. +30 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five fiscal years. The information in this table should be read +in conjunction with the consolidated financial statements and accompanying notes and with Management's Discussion and Analysis of Financial Conditions and Results of Operations included in +Item 7 of this Form 10-K. +Year Ended December 31, +2015 +2014 +2013 +2012 +2011 +(in thousands, except per share data) +Revenues +$ +1,090,630 +$ +1,198,223 +$ +1,192,680 +$ +1,123,301 +$ +1,000,903 +Cost of sales +579,825 +603,893 +569,482 +515,324 +464,493 +Restructuring charges +— +3,985 +— +— +— +Gross profit +510,805 +590,345 +623,198 +607,977 +536,410 +Gross margin % +46.8 +% +49.3 +% +52.3 +% +54.1 +% +53.6 +% +Selling, general and administrative expenses +559,095 +565,712 +549,154 +460,393 +404,803 +Selling, general and administrative expenses as a % of revenue +51.3 +% +47.2 +% +46.0 +% +41.0 +% +40.4 +% +Restructuring charges +8,728 +20,532 +— +— +— +Asset impairment charges +15,306 +8,827 +10,949 +1,410 +528 +Income (loss) from operations +$ +(72,324 +) +$ +(4,726 +) +$ +63,095 +$ +146,174 +$ +131,079 +Income (loss) before income taxes +$ +(74,744 +) +$ +(8,549 +) +$ +59,959 +$ +145,548 +$ +136,690 +Income tax benefit (expense) +(8,452 +) +3,623 +(49,539 +) +(14,205 +) +(23,902 +) +Net income (loss) +$ +(83,196 +) +$ +(4,926 +) +$ +10,420 +$ +131,343 +$ +112,788 +Dividends on Series A convertible preferred stock: +(11,833 +) +(11,301 +) +— +— +— +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(2,978 +) +(2,735 +) +— +— +— +Net income (loss) attributable to common stockholders +$ +(98,007 +) +$ +(18,962 +) +$ +10,420 +$ +131,343 +$ +112,788 +Basic +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +$ +1.46 +$ +1.27 +Diluted +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +$ +1.44 +$ +1.24 +Weighted average common shares +Basic +75,604 +85,140 +87,989 +89,571 +88,318 +Diluted +75,604 +85,140 +89,089 +90,588 +89,981 +Cash provided by (used in) operating activities +$ +9,698 +$ +(11,651 +) +$ +83,464 +$ +128,356 +$ +142,376 +Cash used in investing activities +$ +(18,627 +) +$ +(57,992 +) +$ +(69,758 +) +$ +(65,943 +) +$ +(41,664 +) +Cash provided by (used in) financing activities +$ +(101,260 +) +$ +23,431 +$ +(1,161 +) +$ +(16,625 +) +$ +8,917 +31 +Table of Contents +As of December 31, +2015 +2014 +2013 +2012 +2011 +(in thousands) +Cash and cash equivalents +$ +143,341 +$ +267,512 +$ +317,144 +$ +294,348 +$ +257,587 +Inventories +$ +168,192 +$ +171,012 +$ +162,341 +$ +164,804 +$ +129,627 +Working capital +$ +278,852 +$ +441,523 +$ +453,149 +$ +455,177 +$ +370,040 +Total assets +$ +608,020 +$ +806,931 +$ +875,159 +$ +829,638 +$ +695,453 +Long term liabilities +$ +19,294 +$ +27,849 +$ +63,487 +$ +54,300 +$ +48,370 +Total stockholders' equity +$ +245,972 +$ +452,518 +$ +624,744 +$ +617,400 +$ +491,780 +32 +Table of Contents +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +We are a designer, developer, manufacturer, worldwide marketer, and distributor of casual lifestyle footwear, and accessories for men, women, and +children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color, and functionality. Our products include footwear and accessories that utilize our proprietary +closed-cell resin, called Croslite, +as well as casual lifestyle footwear that use a range of materials. Our Croslite material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our +products in more than 65 countries through domestic and international retailers and distributors, and directly to end-user consumers through our company-operated retail stores, outlets, webstores, and +kiosks. +Since +the initial introduction of our popular Beach and Crocs Classic designs, we have expanded our classic products to include a variety of new styles. Going forward, we are focusing on our core +molded footwear heritage, as well as developing innovative new casual lifestyle footwear. By streamlining the product portfolio and reducing non-core product development, we believe that we can +realize our strategy of generating a more powerful consumer connection to our brand and products. +The +broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including family footwear stores, department stores, sporting goods stores, and +traditional footwear retailers, as well as a variety of specialty and independent retail channels and via the internet. We intend to continue to drive cohesive global brand positioning from region to +region and year to year to create a clearer and more consistent product portfolio and message. We attempt to implement this strategy through developing powerful product stories supported by effective +and consistent global marketing campaigns. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America +("U.S. GAAP"), we present current period "adjusted selling, general and administrative expenses", which is a non-GAAP financial measure, within this Management's Discussion and Analysis. +Adjusted results exclude the impact of items that management believes affect the comparability or underlying business trends in our consolidated financial statements in the periods presented. +We +also present certain information related to our current period results of operations in this Item 7 through "constant currency", which is a non-GAAP financial measure and should be viewed as +a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been restated using prior year +average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations. +Management +uses adjusted results to assist in comparing business trends from period to period on a consistent non-GAAP basis in communications with the Board, stockholders, analysts, and investors +concerning our financial performance. We believe that these non-GAAP measures are useful to +investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance. We believe they also provide a useful baseline for analyzing trends in our +operations. Investors should not consider these non-GAAP measures in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. Please refer to our +'Results of Operations' within this section for a reconciliation of adjusted selling, general and administrative expenses to GAAP selling, general and administrative expenses. +33 +Table of Contents +2015 Financial Highlights +During the year ended December 31, 2015, we experienced a revenue decline of 9.0% compared to the year ended December 31, 2014 +primarily due to unfavorable exchange rates driven by a stronger U.S. Dollar which reduced revenue by $85.3 million or 7.1%. Sales volume increased revenue by $37.8 million, or +3.1%, which was offset by a $34.4 million, or 2.9%, decrease associated with store closures, and a $25.7 million, or 2.1%, decrease in lower average sales price. +The +following are significant developments in our businesses during the year ended December 31, 2015: +• We sold 57.8 million pairs of shoes worldwide, an increase of 3.7% compared to 2014. +• Gross profit decreased $79.5 million, or 13.5%, to $510.8 million and gross margin percentage decreased 243 basis points +to 46.8% compared to 2014. The revenue from higher unit sales during 2015 was offset by a lower price per unit and higher cost per unit compared to prior year. The impact of foreign currency on gross +margin was $41.7 million, or 7.1%, and the impact of store closures was $34.4 million, or 2.9%. +• Selling, general and administrative ("SG&A") expenses decreased $6.6 million, or 1.2%, to $559.1 million compared to the +same period in 2014. This change was primarily driven by increased marketing and bad debt expense, as well as the impact of foreign exchange currency loss, which was more than offset by decreases in +professional services, wages and salaries and building expenses. +• We incurred $8.7 million in restructuring charges as a result of our strategic plans for long-term improvement and growth of +the business. These charges primarily related to severance costs and contract termination costs principally associated with the early termination of operating leases. +• We incurred $15.3 million in asset impairment charges during 2015. Of this amount, $5.7 million related to an impairment +of our South Africa asset group, currently, held for sale, and $9.6 million related to certain underperforming retail locations in our Americas, Europe, and Asia Pacific segments that were +unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. +• Net income (loss) attributable to common stockholders decreased $79.0 million to a net loss of $98.0 million compared to +net loss of $19.0 million for 2014. Net loss per share was $1.30 during the year ended December 31, 2015 compared to net loss per share of $0.22 during the year ended December 31, +2014. These decreases are primarily the result of decreased gross profit and increased asset impairment charges offset by decreased restructuring charges and SG&A expense. +• We continued to slow the expansion of our retail channel and focus on the long-term profitability of current locations. We opened 42 +company-operated stores during the year ended December 31, 2015, a quarter of which were outlet or low investment kiosk/store-in-store locations, and closed 68 company-operated stores. +• During 2015, we repurchased approximately 6.5 million shares at an average price of $13.24 per share for a total value of +$85.9 million, including related commission charges. As of December 31, 2015, we have remaining repurchase authorizations of $118.7 million. +Future Outlook +During 2016, we will continue our strategic plans for long-term improvement and growth of the business. Our plans comprise four key initiatives +including (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient organizational +structure by reducing excess overhead costs and enhancing the decision making process, and (4) closing or converting Crocs branded retail stores around the world. +34 +Table of Contents +These +changes will better position Crocs to adapt to changing customer demands and global economic developments. We are focusing on our core molded footwear heritage, as well as developing innovative +new casual lifestyle footwear platforms. By streamlining the product portfolio and reducing non-core product development, we will create a more powerful consumer connection to the brand. +We +are refining our business model around the world, prioritizing direct investment in larger-scale geographies to focus our resources on the demographics with the largest growth prospects, moving +away from direct investment in the retail and wholesale businesses in smaller markets and transferring significant commercial responsibilities to distributors and third-party agents. Further, we +intend to expand our engagement with leading wholesale accounts in select markets to drive sales growth, optimize product placement and enhance brand reputation. +We +believe declining collections from our China operations is associated with deteriorating macro-economic conditions in China resulting in declining customer demand and deteriorating working capital +position of our distributors. We are unable to predict future economic conditions in China, but if economic conditions in China continue to decline, we may experience further reductions in consumer +demand in our China markets. As our China operations represent approximately 8% of our total revenue, the net impact of declining sales volumes in China could have a material adverse impact on our +financial results in future periods. +35 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2015 to 2014 +Year Ended December 31, +2015 +2014 +$ Change +% Change +(in thousands, except per share data and +average selling price) +Revenues +$ +1,090,630 +$ +1,198,223 +$ +(107,593 +) +(9.0 +)% +Cost of sales +579,825 +603,893 +(24,068 +) +(4.0 +) +Restructuring charges +— +3,985 +(3,985 +) +(100.0 +) +Gross profit +510,805 +590,345 +(79,540 +) +(13.5 +) +Selling, general and administrative expenses +559,095 +565,712 +(6,617 +) +(1.2 +) +Restructuring charges +8,728 +20,532 +(11,804 +) +(57.5 +) +Asset impairment charges +15,306 +8,827 +6,479 +73.4 +Loss from operations +(72,324 +) +(4,726 +) +(67,598 +) +1,430.3 +Foreign currency transaction loss, net +(3,332 +) +(4,885 +) +1,553 +(31.8 +) +Interest income +967 +1,664 +(697 +) +(41.9 +) +Interest expense +(969 +) +(806 +) +(163 +) +20.2 +Other income, net +914 +204 +710 +348.0 +Loss before income taxes +(74,744 +) +(8,549 +) +(66,195 +) +774.3 +Income tax benefit (expense) +(8,452 +) +3,623 +(12,075 +) +(333.3 +) +Net loss +$ +(83,196 +) +$ +(4,926 +) +$ +(78,270 +) +1,588.9 +% +Dividends on Series A convertible preferred stock +(11,833 +) +(11,301 +) +(532 +) +4.7 +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(2,978 +) +(2,735 +) +(243 +) +8.9 +Net loss attributable to common stockholders +$ +(98,007 +) +$ +(18,962 +) +$ +(79,045 +) +416.9 +% +Net income (loss) per common share: +Basic +$ +(1.30 +) +$ +(0.22 +) +$ +(1.08 +) +490.9 +% +Diluted +$ +(1.30 +) +$ +(0.22 +) +$ +(1.08 +) +490.9 +% +Gross margin +46.8 +% +49.3 +% +(250 +)bps +(5.1 +)% +Operating margin +(6.6 +)% +(0.4 +)% +(620 +)bps +1,550.0 +% +Footwear unit sales +57,763 +55,700 +2,063 +3.7 +% +Average footwear selling price +$ +18.53 +$ +20.92 +$ +(2.39 +) +(11.4 +)% +Revenues. During the year ended December 31, 2015, revenue declined 9.0% compared to the same period in 2014. The decrease in revenue is due to the net +impact of (i) a $85.3 million, or 7.1%, decrease associated with foreign currency exchange rate adjustments associated with a strong U.S. Dollar, (ii) a $37.8 million, or +3.1%, increase associated with higher sales volumes, and (iii) a $34.4 million, or 2.9%, decrease associated with store closures, partially offset by (iv) a $25.7 million, +or 2.1%, decrease associated with a lower average selling price due to changes in product mix. +During +the year ended December 31, 2015, revenues from our wholesale channel decreased $76.6 million, or 11.5%, compared to the same period in 2014. The decrease in wholesale channel +revenue is driven primarily by a $52.1 million unfavorable impact related to foreign currency translation, primarily in our Europe segment, a $30.5 million unfavorable impact due to +lower average sales prices related to a lower priced product style mix, primarily in our Americas segment, partially offset by higher sales volume in our Americas and Europe segments. +36 +Table of Contents +During +the year ended December 31, 2015, revenues from our retail channel decreased $47.3 million, or 11.1%, compared to the same period in 2014, primarily driven by the Asia Pacific +segment, which decreased $23.1 million primarily as a result of a lower average selling price related to a lower priced product mix, the unfavorable impact of foreign currency translation, and +store closures. Additionally we experienced a $15.4 million decrease in the Europe segment largely associated with the impact of store closures. +During +the year ended December 31, 2015, revenues from our e-commerce channel increased $16.3 million, or 15.6%, compared to the same period in 2014, primarily driven by increased sales +volumes in all segments, partially offset by the unfavorable impact of foreign currency translation and lower average sales prices, also in all segments. Our e-commerce sales totaled approximately +11.1% and 8.7% of our consolidated net sales during the year ended December 31, 2015 and 2014, respectively. We continue to benefit from our online presence through web stores worldwide +enabling us to have increased access to our customers in a low cost, attractive manner and providing us with an opportunity to educate them about our products and brand. +The +following table summarizes our total revenue by channel for the years ended December 31, 2015 and 2014: +Year Ended +December 31, +Change +Constant +Currency +Change(1) +2015 +2014 +$ +% +$ +% +(in thousands) +Wholesale: +Americas +$ +210,887 +$ +228,615 +$ +(17,728 +) +(7.8 +)% +$ +(10,241 +) +(4.5 +)% +Asia Pacific +255,897 +290,610 +(34,713 +) +(11.9 +) +(16,194 +) +(5.6 +) +Europe +123,131 +147,561 +(24,430 +) +(16.6 +) +1,886 +1.3 +Other businesses +1,096 +794 +302 +38.0 +194 +24.4 +Total wholesale +591,011 +667,580 +(76,569 +) +(11.5 +) +(24,355 +) +(3.6 +) +Retail: +Americas +197,306 +206,053 +(8,747 +) +(4.2 +) +(6,652 +) +(3.2 +) +Asia Pacific +136,320 +159,464 +(23,144 +) +(14.5 +) +(11,552 +) +(7.2 +) +Europe +44,873 +60,309 +(15,436 +) +(25.6 +) +(3,012 +) +(5.0 +) +Total retail +378,499 +425,826 +(47,327 +) +(11.1 +) +(21,216 +) +(5.0 +) +E-commerce: +Americas +68,017 +55,247 +12,770 +23.1 +13,434 +24.3 +Asia Pacific +32,274 +23,836 +8,438 +35.4 +10,256 +43.0 +Europe +20,829 +25,734 +(4,905 +) +(19.1 +) +(380 +) +(1.5 +) +Total e-commerce +121,120 +104,817 +16,303 +15.6 +23,310 +22.2 +Total revenues +$ +1,090,630 +$ +1,198,223 +$ +(107,593 +) +(9.0 +)% +$ +(22,261 +) +(1.9 +)% +(1) Reflects +year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP +Financial Measures" above for more information. +37 +Table of Contents +The table below illustrates the overall change in the number of our company-operated retail locations by type of store and reportable operating segment as of +December 31, 2015 and 2014: +December 31, +2014 +Opened +Closed +December 31, +2015 +Company-operated retail locations +Type +Kiosk/store in store +100 +11 +13 +98 +Retail stores +311 +15 +51 +275 +Outlet stores +174 +16 +4 +186 +Total +585 +42 +68 +559 +Operating segment +Americas +210 +4 +18 +196 +Asia Pacific +258 +36 +33 +261 +Europe +117 +2 +17 +102 +Total +585 +42 +68 +559 +The +table below sets forth our comparable store sales by reportable operating segment for the year ended December 31, 2015 as compared to the same period in 2014: +Constant Currency(2) +Year Ended +December 31, 2015 +Constant Currency(2) +Year Ended +December 31, 2014 +Comparable store sales (retail only)(1) +Americas +(3.2 +)% +(4.4 +)% +Asia Pacific +(4.5 +)% +(4.7 +)% +Europe +3.0 +% +0.7 +% +Global +(2.8 +)% +(3.7 +)% +The +table below sets forth Direct to Consumer ("DTC") comparable stores sales, which includes our e-commerce and retail operating segments, for the year ended December 31, 2015 as compared to +the same period in 2014: +Constant Currency(2) +Year Ended +December 31, 2015 +Constant Currency(2) +Year Ended +December 31, 2014 +DTC comparable store sales (includes retail and e-commerce)(1) +Americas +3.3 +% +(3.8 +)% +Asia Pacific +3.0 +% +0.6 +% +Europe +7.8 +% +(0.6 +)% +Global +3.9 +% +(1.9 +)% +(1) Comparable +store status is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which +selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily +closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. +Comparable store sales exclude the impact of our internet channel revenues and are calculated on a currency neutral basis using historical annual average currency rates. Ecommerce revenue is based on +same site sales period over period. +38 +Table of Contents +(2) Reflects +quarter over quarter change on a "constant currency" basis, which is a non-GAAP financial measure that restates current period results using prior +year foreign exchange rates for the comparative period to enhance visibility of the underlying business trends, excluding the impact of foreign currency. +Comparable +store sales decreased 2.8% on a global basis for the year ended December 31, 2015, compared to a decrease of 3.7% for the year ended December 31, 2014. Comparable store sales +for our direct to consumer customers, which includes retail and ecommerce, increased 3.9% on a global basis for the year ended December 31, 2015, compared to a decrease of 1.9% for the year +ended December 31, 2014. +The +metric "revenue adjusted for business model changes" is used by management to assess period-over-period change in the performance of our continuing operations as compared to the same quarter of +the previous year. This metric is calculated on a constant currency basis and removes the impact of store closures and eliminated product lines from prior period results. We believe this metric is +useful in analyzing business trends related to our ongoing operations by excluding products and locations that have been eliminated and by removing foreign currency translation adjustments which can +mask the underlying performance of the business. +The +table below sets forth revenues for the year ended December 31, 2015 adjusted for the prior year impact of business model changes: +Year Ended +December 31, +(in thousands) +GAAP revenues, for the period ended December 31, 2014 +$ +1,198,223 +Less: constant currency adjustment(1) +(87,661 +) +Less: decrease associated with store closures +(34,894 +) +Less: decrease associated with eliminated product lines +(11,921 +) +Non-GAAP revenues, adjusted for business model changes +$ +1,063,747 +GAAP revenues, for the period ended December 31, 2015 +$ +1,090,630 +Percentage change +2.5 +% +Year Ended +December 31, +(in thousands) +GAAP revenues, for the period ended December 31, 2013 +$ +1,192,680 +Less: constant currency adjustment(1) +(15,612 +) +Less: decrease associated with store closures +(22,027 +) +Less: decrease associated with eliminated product lines +(15,483 +) +Non-GAAP revenues, adjusted for business model changes +$ +1,139,558 +GAAP revenues, for the period ended December 31, 2014 +$ +1,198,223 +Percentage change +5.1 +% +(1) Constant +currency in a non-GAAP measure that restates current period results using prior year average foreign exchange rates for the comparative period to +enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations. +Revenue +adjusted for business model changes increased 2.5% for the year ended December 31, 2015 compared to 5.1% for the year ended December 31, 2014. +39 +Table of Contents +Impact on revenues due to foreign exchange rate fluctuations. Changes in average foreign currency exchange rates used to translate revenue from our functional +currencies to our reporting currency during the year ended December 31, 2015 resulted in a $85.3 million decrease in revenue compared to the same period in 2014. +Gross profit. During the year ended December 31, 2015, gross profit decreased $79.5 million, or 13.5%, compared to the same period in 2014, and was +primarily attributable to the 9.0% decrease in revenue partially offset by a decrease of $24.1 million, or 4.0% to cost of sales compared to the same period in 2014 primarily due to foreign +currency translation. Gross margin percentage decreased 250 basis points compared to the same period in 2014. +Impact on gross profit due to foreign exchange rate fluctuations. Changes in average foreign currency exchange rates used to translate revenue and costs of sales +from our functional currencies to our reporting currency during the year ended December 31, 2015 decreased our gross profit by $41.7 million, or 7.1%, compared to the same period in +2014. +Selling, general and administrative expenses. SG&A expenses decreased $6.6 million, or 1.2%, during the year ended December 31, 2015 compared to the +same period in 2014. This change was primarily driven by wage and salary decreases of $22.1 million, and a $17.0 million decrease in building expenses partially offset by a +$13.6 million increase in marketing expenses, and a $13.6 million increase in bad debt expense, largely associated with our Asia Pacific operations relating to China. During the year +ended December 31, 2015, our bad debt expense was $25.7 million compared to $12.1 million in the same period in the prior year. Substantially all of this increase in bad debt +expense is due to lower collections from our China operations, which is included in our Asia Pacific segment. +We +believe declining collections from our China operations is associated with deteriorating macro-economic conditions in China resulting in declining customer demand and the deteriorating working +capital position of our distributors. We are unable to predict future economic conditions in China, but if economic conditions in China continue to decline, we may experience further reductions in +consumer demand in our China markets. As our China operations represent approximately 8% of +our total revenue in 2015, the net impact of declining sales volumes in China could have a material adverse impact on our financial results in future periods. +In +addition to these fluctuations, we have identified certain selling, general and administrative expenses that affect the comparability or underlying business trends in our condensed consolidated +financial statements. The following table summarizes these expenses and describes the additional drivers of the +40 +Table of Contents +increase +above by reconciling our GAAP selling, general and administrative expenses to non-GAAP selling, general and administrative expenses: +Year Ended +December 31, +2015 +2014 +(in thousands) +Selling, general and administrative expenses reconciliation: +GAAP selling, general and administrative expenses +$ +559,095 +$ +565,712 +ERP implementation and other contract termination fees(1) +(12,569 +) +(13,268 +) +Reorganization charges(2) +(8,391 +) +(8,872 +) +Legal settlements and disbursement(3) +(7,895 +) +(2,646 +) +Bad debt expense related to South Africa(4) +(613 +) +— +Non-GAAP selling, general and administrative expenses +$ +529,627 +$ +540,926 +(1) This +represents operating expenses related to the implementation of our new enterprise resource planning ("ERP") system and the termination of certain IT +contracts for better alignment with strategic initiatives as well as fees associated with the termination of certain royalty and other contracts. +(2) This +relates to severance expenses, bonuses, store closure costs, consulting fees and other expenses related to recent restructuring and reorganization +activities and our investment agreement with Blackstone. +(3) Expenses +in 2015 relate primarily to legal expenses for matters surrounding disbursements to invalid vendors and California wage settlements. Expenses in +2014 relate primarily to other legal settlements. +(4) Certain +bad debt and impairment expenses were incurred in 2015 relating to the planned sale of operations in South Africa. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2015, negatively impacted, or increased, selling, general and administrative +expenses by approximately $35.6 million compared to 2014. +Restructuring charges. During the years ended December 31, 2015 and 2014, we recorded $8.7 million and $24.5 million, respectively, in +restructuring charges. These restructuring charges arose primarily as a result of our strategic plans for long-term improvement and growth of the business. Restructuring charges for the years ended +December 31, 2015 and 2014 consisted of: +• $5.5 million and $12.5 million in severance costs during the years ended December 31, 2015 and 2014, +respectively; +• $2.6 million and $4.2 million in contract termination costs primarily related to the early termination of operating +leases during the years ended December 31, 2015 and 2014, respectively; and +• $0.6 million and $7.8 million in other restructuring charges primarily related to expenses to exiting stores and legal +fees during the years ended December 31, 2015 and included the write-off of obsolete inventory and store exiting and legal fees for the year ended December 31, 2014. +41 +Table of Contents +Asset impairment charges. During the year ended December 31, 2015 and 2014, we incurred $15.3 million and $8.8 million, respectively, in asset +impairment charges. For the year ended December 31, 2015, $9.6 million of this amount related to certain underperforming retail locations, primarily in our Americas and Europe segments, +which were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life and $5.7 million related to the impairment of +our South Africa asset group that is currently held for sale. +Foreign currency transaction loss, net. The line item entitled foreign currency transaction loss, net is comprised of foreign currency gains and losses from the +re-measurement and settlement of monetary +assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the year ended December 31, 2015 and 2014, the effect +of foreign currency transactions was a net loss of $3.3 million and $4.9 million, respectively. +Income tax expense. During the year ended December 31, 2015, we recognized income tax expense of $8.5 million on pre-tax book loss of +$74.7 million, representing an effective tax rate of (11.3)%, compared to an income tax benefit of $3.6 million on pre-tax book loss of $8.5 million in 2014, which represented an +effective tax rate of 42.4%. Generally, our effective tax rate varies primarily based on our profitability level and the relative earnings of operations across multiple jurisdictions. Beyond operating +results, the most significant rate drivers relate to U.S. tax accrued on foreign unremitted earnings and continued varying need for valuation allowances. +The +following are key jurisdictions impacting our tax rate for 2015 and 2014, respectively: +For the Year Ended December 31, 2015 +United States +Netherlands +Japan +Canada +China +Korea +(in thousands) +Book income (loss) +$ +(83,537 +) +$ +25,988 +$ +(69 +) +$ +(850 +) +$ +(21,572 +) +$ +4,141 +Income tax expense +$ +(3,345 +) +$ +4,262 +$ +2,345 +$ +(391 +) +$ +4,433 +$ +1,081 +Effective tax rate +4.0 +% +16.4 +% +(3,398.6 +)% +46.0 +% +(20.5 +)% +26.1 +% +For the Year Ended December 31, 2014 +United States +Netherlands +Japan +Canada(1) +China +Korea +(in thousands) +Book income (loss) +$ +(34,027 +) +$ +8,606 +$ +9,571 +$ +913 +$ +(9,144 +) +$ +4,434 +Income tax expense +$ +(9,692 +) +$ +4,955 +$ +3,928 +$ +(2,623 +) +$ +(623 +) +$ +642 +Effective tax rate +28.5 +% +57.6 +% +41.0 +% +(287.3 +)% +6.8 +% +14.5 +% +(1) Primarily +driven by a $2.9 million net benefit related to a tax settlement with the Canada Revenue Agency. +The +principal drivers impacting the rate other than the overall profitability or loss of the Company disclosed in our rate reconciliation table in Note 14—Income Taxes +includes: +• The tax effect of non-deductible/non-taxable items changes from a $9.9 million tax benefit in 2014 (resulting in a favorable +rate impact of 115.8%) to a $2.2 million tax benefit in 2015 (resulting in a favorable rate impact of 2.9%). The incremental benefit recognized in 2014 primarily related to the non-taxable +nature of both foreign exchange gains and dividends in foreign jurisdictions. These benefits did not occur in the current year and are not anticipated to recur on an ongoing basis. +• The change in the 'Effect of rate differences' line of the rate reconciliation table is principally driven by differences in pre-tax +book income between the periods compared, and the source of this income, which is subject to different jurisdiction tax rates. We employ a tax planning strategy that directly impacts the total tax +expense directly attributable to the level of foreign earnings in the specific jurisdictions. However, we note that the impact on the effective rate is different due to book earnings +42 +Table of Contents +recorded +in the equivalent period. The relative impact of this has existed in the recent past; however, there is no assurance that this item will be recurring beyond 2019. Through at least 2019, we +will continue to have an equivalent favorable impact on the tax provision and effective tax rate based on +the specific foreign earnings. We currently do not anticipate significant near-term changes to its overall tax strategies, meaning that relative income tax benefits provided from the expected U.S. +federal tax rate are anticipated to recur in the foreseeable future. The amount of this tax benefit, if any, is subject to continued profitability in various foreign jurisdictions. The other notable +difference between the two periods relates to the 2014 impact of restructuring related to our Brazilian operations that is not anticipated to recur in the future. +• The impact of the 'U.S. tax on foreign earnings' line of the rate reconciliation table includes the impact of foreign inclusions, +including tax expense accrued on undistributed foreign earnings, and related foreign tax credits. During 2014, inclusions for these items resulted in $6.6 million of tax expense, reflecting an +unfavorable impact of 77.4% on the total provision. During 2015, inclusions for these items resulted in $32.9 million of tax expense, reflecting an unfavorable impact of 43.9% on the total +provision. While foreign inclusions are primarily related to business results during a specific period, we note the primary difference between the two periods relates to the $24.6 million tax +charge recognized for the accrual of unremitted foreign earnings during 2015. We anticipate the continuation of foreign earnings repatriation to the extent of the currently-accrued amount of +$128.0 million. After such time, we will assess various cash needs in the U.S. and may repatriate future current year earnings up to the extent of future current foreign earnings on an annual +basis. +• Prior to fiscal year 2014, we asserted that undistributed earnings of our foreign subsidiaries were permanently reinvested. Primarily +due to the increase in our U.S. operating obligations during the current fiscal year and continued share repurchases of $86.0 million in 2015, management concluded that the ability to access +certain amounts of foreign earnings would provide greater flexibility to meet domestic cash flow needs without constraining foreign objectives. Accordingly, in the fourth quarter of 2015, we withdrew +the permanent reinvestment assertion on $79.0 million of earnings generated by certain of our foreign subsidiaries through fiscal year 2013. We provided for U.S. income taxes on +$128.0 million of undistributed foreign earnings, resulting in a recognition of a deferred tax liability of approximately $24.6 million. Exceptions may be made on a year-by-year basis to +repatriate current year earnings of certain foreign subsidiaries based on cash needs in the U.S. No withholding tax is due with respect to the repatriation of these earnings to the U.S. and none has +been provided for. +• We continue to evaluate the realizability of its deferred tax assets. As such, additional valuation allowances of $10.9 million +on deferred tax assets are not anticipated to be realized. This is in addition to the $5.4 million accrued on deferred tax assets during 2014. Furthermore, the change in the valuation allowance +reflected on the cumulative schedule of deferred tax assets includes $2.8 million, which does not impact the tax provision. This amount reflects the impact on equity based on changes in +cumulative translation adjustment. The specific circumstances regarding management's assertion of the realizability of certain deferred tax assets is discussed as part of the disclosures in +Note 14—Income Taxes. We maintain total valuation allowances of approximately $56.6 million as of December 31, 2015, which may be reduced in the future depending upon +the achieved or sustained profitability of certain entities. +• During both 2014 and 2015, we recorded tax expense for audits settled during the year of $13.5 million and $1.2 million, +respectively. The amount included in settlements during 2015 is net against total uncertain tax position releases during the same period relating to the same positions. Furthermore, the uncertain tax +benefits line item in 2015 includes net accruals related to current year positions recorded, and is consistent with amounts accrued during prior years. We have released a significant portion of +historical uncertain tax benefits based on effective and actual settlements. As such, there is not currently an expectation that uncertain tax positions will significantly impact our tax expense on an +ongoing basis. +43 +Table of Contents +• We recognized state tax benefits during the period due to net operating loss recorded in the U.S., as well as applicable state +modifications related to the taxability of foreign dividends. +Comparison of the Years Ended December 31, 2014 to 2013 +Year Ended December 31, +2014 +2013 +$ Change +% Change +(in thousands, except per share data and average +selling price) +Revenues +$ +1,198,223 +$ +1,192,680 +$ +5,543 +0.5 +% +Cost of sales +603,893 +569,482 +34,411 +6.0 +Restructuring charges +3,985 +— +3,985 +100.0 +Gross profit +590,345 +623,198 +(32,853 +) +(5.3 +) +Selling, general and administrative expenses +565,712 +549,154 +16,558 +3.0 +Restructuring charges +20,532 +— +20,532 +100.0 +Asset impairment charges +8,827 +10,949 +(2,122 +) +(19.4 +) +Income (loss) from operations +(4,726 +) +63,095 +(67,821 +) +(107.5 +) +Foreign currency transaction loss, net +(4,885 +) +(4,678 +) +(207 +) +4.4 +Interest income +1,664 +2,432 +(768 +) +(31.6 +) +Interest expense +(806 +) +(1,016 +) +210 +(20.7 +) +Other income, net +204 +126 +78 +61.9 +Income (loss) before income taxes +(8,549 +) +59,959 +(68,508 +) +(114.3 +) +Income tax benefit (expense) +3,623 +(49,539 +) +53,162 +(107.3 +) +Net income (loss) +$ +(4,926 +) +$ +10,420 +$ +(15,346 +) +(147.3 +)% +Dividends on Series A convertible preferred stock +(11,301 +) +— +(11,301 +) +(100.0 +) +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(2,735 +) +— +(2,735 +) +(100.0 +) +Net income (loss) attributable to common stockholders +$ +(18,962 +) +$ +10,420 +$ +(29,382 +) +(282.0 +)% +Net income (loss) per common share: +Basic +$ +(0.22 +) +$ +0.12 +$ +(0.34 +) +(283.3 +)% +Diluted +$ +(0.22 +) +$ +0.12 +$ +(0.34 +) +(283.3 +)% +Gross margin +49.3 +% +52.3 +% +(300 +)bps +(5.7 +)% +Operating margin +(0.4 +)% +5.3 +% +(570 +)bps +(107.5 +)% +Footwear unit sales +55,700 +54,326 +1,374 +2.5 +% +Average footwear selling price +$ +20.92 +$ +21.27 +$ +(0.35 +) +(1.6 +)% +Revenues. During the year ended December 31, 2014, revenues remained relatively flat, increasing $5.5 million, or 0.5%, compared to 2013 primarily +due to an increase of 1.4 million, or 2.5%, in global footwear unit sales primarily driven by improved year-over-year performance in our wholesale and internet channels. This increase was +partially offset by a decrease of $0.35 per unit, or 1.6%, in average footwear selling price. +For +the year ended December 31, 2014, revenues from our wholesale channel decreased $6.2 million, or 0.9%, compared to 2013, which was primarily driven by lower unit sales in our +Americas and Asia Pacific segments including decreased performance in China as a result of increased distributor inventory levels and lower replenishment orders and lower average selling price in +Europe and our Asia Pacific segment. +44 +Table of Contents +These +decreases were partially offset by a 19.2% increase in unit sales in Europe primarily driven by product volume expansion through new wholesale doors and continued support from existing +customers. +For +the year ended December 31, 2014, revenues from our retail channel increased $7.8 million, or 1.9%, compared to 2013, which was primarily driven by a 3.8% increase in footwear unit +sales, primarily +attributable to the Americas and Asia Pacific segments. This increase was partially offset by lower average selling prices in those segments. Additionally, we experienced an overall decrease of 3.7% +in comparable store sales compared to the prior year. During the year ended December 31, 2014, we opened 70 and closed 104 company-operated stores. +For +the year ended December 31, 2014, revenues from our internet channel increased $3.9 million, or 3.9%, compared to 2013, which was primarily driven by increased internet sales in our +Asia Pacific segment partially offset by a decrease in internet sales in our Americas and Europe segments and lower average selling prices in all segments except Europe. Our internet sales totaled +approximately 8.8% and 8.5% of our consolidated net sales during the years ended December 31, 2014 and 2013, respectively. We continued to benefit from our online presence through webstores +worldwide enabling us to have increased access to our customers in a low cost, attractive manner and providing us with an opportunity to educate them about our products and brand. During the year +ended December 31, 2014, we decreased our global company-operated e-commerce sites to 12 in order to focus our internet strategy in our principal geographical locations. +The +following table summarizes our total revenue by channel for the years ended December 31, 2014 and 2013: +Year Ended December 31, +Change +Constant Currency +Change(1) +2014 +2013 +$ +% +$ +% +(in thousands) +Wholesale: +Americas +$ +228,615 +$ +239,104 +$ +(10,489 +) +(4.4 +)% +$ +(7,286 +) +(3.0 +)% +Asia Pacific +290,610 +303,187 +(12,577 +) +(4.1 +) +(5,625 +) +(1.9 +) +Europe +147,561 +131,215 +16,346 +12.5 +16,189 +12.3 +Other businesses +794 +254 +540 +212.6 +533 +209.8 +Total wholesale +667,580 +673,760 +(6,180 +) +(0.9 +) +3,811 +0.6 +Retail: +Americas +206,053 +202,925 +3,128 +1.5 +4,552 +2.2 +Asia Pacific +159,464 +156,586 +2,878 +1.8 +4,513 +2.9 +Europe +60,309 +58,507 +1,802 +3.1 +3,240 +5.5 +Total retail +425,826 +418,018 +7,808 +1.9 +12,305 +2.9 +E-commerce: +Americas +55,247 +56,523 +(1,276 +) +(2.3 +) +(960 +) +(1.7 +) +Asia Pacific +23,836 +17,842 +5,994 +33.6 +6,867 +38.5 +Europe +25,734 +26,537 +(803 +) +(3.0 +) +(868 +) +(3.3 +) +Total e-commerce +104,817 +100,902 +3,915 +3.9 +5,039 +5.0 +Total revenues +$ +1,198,223 +$ +1,192,680 +$ +5,543 +0.5 +% +$ +21,155 +1.8 +% +(1) Reflects +year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP +Financial Measures" above for more information. +45 +Table of Contents +The table below illustrates the overall change in the number of our company-operated retail locations by type of store and reportable operating segment as of +December 31, 2014 and 2013: +December 31, +2013 +Opened +Closed +December 31, +2014 +Company-operated retail locations +Type +Kiosk/store in store +122 +8 +30 +100 +Retail stores +327 +40 +56 +311 +Outlet stores +170 +22 +18 +174 +Total +619 +70 +104 +585 +Operating segment +Americas +216 +16 +22 +210 +Asia Pacific +285 +44 +71 +258 +Europe +118 +10 +11 +117 +Total +619 +70 +104 +585 +The +table below sets forth our comparable store sales by reportable operating segment for the year ended December 31, 2014 as compared to the same period in 2013: +Constant Currency(2) +Year Ended +December 31, 2014 +Constant Currency(2) +Year Ended +December 31, 2013 +Comparable store sales (retail only)(1) +Americas +(4.4 +)% +(5.8 +)% +Asia Pacific +(4.7 +)% +0.7 +% +Europe +0.7 +% +2.4 +% +Global +(3.7 +)% +(2.7 +)% +The +table below sets forth our DTC comparable stores sales, which includes our e-commerce and retail operating segments, for the year ended December 31, 2014 as compared to the same period in +2013: +Constant Currency(2) +Year Ended +December 31, 2014 +Constant Currency(2) +Year Ended +December 31, 2013 +DTC comparable store sales (includes retail and e-commerce)(1) +Americas +(3.8 +)% +(7.3 +)% +Asia Pacific +0.6 +% +3.3 +% +Europe +(0.6 +)% +4.3 +% +Global +(1.9 +)% +(2.6 +)% +(1) Comparable +store status is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which +selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily +closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. +Comparable store sales exclude the impact of our internet channel revenues and are calculated on a currency neutral basis using historical annual average currency rates. Ecommerce revenue is based on +same site sales period over period. +46 +Table of Contents +(2) Reflects +quarter over quarter change that restates current period results using prior year foreign exchange rates for the comparative period to enhance +visibility of the underlying business trends, excluding the impact of foreign currency. +Comparable +store sales decreased 3.7% on a global basis for the year ended December 31, 2015, compared to a decrease of 2.7% for the year ended December 31, 2014. Comparable store sales +for our direct to consumer customers, which includes retail and ecommerce, decreased 1.9% on a global basis for the year ended December 31, 2015, compared to a decrease of 2.6% for the year +ended December 31, 2014. +The +metric "revenue adjusted for business model changes" is used by management to assess period-over-period change in the performance of our continuing operations as compared to the same quarter of +the previous year. This metric is calculated on a constant currency basis and removes the impact of store closures and eliminated product lines from prior period results. We believe this metric is +useful in analyzing business trends related to our ongoing operations by excluding products and locations that have been eliminated and by removing foreign currency translation adjustments which can +mask the underlying performance of the business. +The +table below sets forth revenues for the year ended December 31, 2014 adjusted for the prior year impact of business model changes: +Year Ended +December 31, +(in thousands) +GAAP revenues, for the period ended December 31, 2013 +$ +1,192,680 +Less: constant currency adjustment(1) +(15,612 +) +Less: decrease associated with store closures +(22,027 +) +Less: decrease associated with eliminated product lines +(15,483 +) +Non-GAAP revenues, adjusted for business model changes +$ +1,139,558 +GAAP revenues, for the period ended December 31, 2014 +$ +1,198,223 +Percentage change +5.1 +% +Year Ended +December 31, +(in thousands) +GAAP revenues, for the period ended December 31, 2012 +$ +1,123,301 +Less: constant currency adjustment(1) +(29,109 +) +Less: decrease associated with store closures +(27,812 +) +Less: decrease associated with eliminated product lines +(13,731 +) +Non-GAAP revenues, adjusted for business model changes +$ +1,052,649 +GAAP revenues, for the period ended December 31, 2013 +$ +1,192,680 +Percentage change +13.3 +% +(1) Constant +currency in a non-GAAP measure that restates current period results using prior year average foreign exchange rates for the comparative period to +enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations. +Revenue +adjusted for business model changes increased 5.1% for the year ended December 31, 2014 compared to 13.3% for the year ended December 31, 2013. +47 +Table of Contents +Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate revenues from our functional +currencies to our reporting currency during the year ended December 31, 2014 decreased our revenues by $15.6 million compared to 2013. +Gross profit. During the year ended December 31, 2014, gross profit decreased $32.9 million, or 5.3%, compared to 2013, which was primarily +attributable to a $34.4 million, or 6.0%, increase in cost of sales, excluding restructuring, partially offset by a 0.5% increase in revenue. Gross margin percentage decreased 298 basis points +compared to the same period in 2013. The decline in gross margin percentage was primarily driven by an increase in obsolete inventory of $8.1 million for the year ended December 31, 2014 +compared to 2013 primarily driven by inventory obsolescence in China, $4.0 million of costs related to restructuring and the evolution of our product assortment and is consistent with our +product strategy. In addition, we experienced unit sales volume difficulty in our Americas market, lower than expected unit sales in China leading to decreased gross margins, as average margins in +China are typically higher than the global average, and increased shipping costs globally. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate revenues and costs of sales +from our functional currencies to our reporting currency during the year ended December 31, 2014 decreased our gross profit by $9.2 million compared to 2013. +Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $16.6 million, or 3.0%, during the year ended +December 31, 2014 compared to the same period in 2013. As a percentage of revenue, selling, general and administrative expenses increased 117 basis points to 47.2% from 46.0% during the year +ended December 31, 2014 compared to 2013. This increase was predominately due to year over year increases of $16.7 million in professional fees and other outside services, +$10.2 million increases in bad debt expense, primarily related to delayed payments from distributors in China and Southeast Asia, and an increase of $7.2 million related to rising rental +rates and repairs and maintenance for retail locations. We slowed the expansion of our retail channel and closed 104 company-operated locations between December 31, 2013 and December 31, +2014. These increases were partially offset by a decrease of approximately $5.4 million related to the reduction in headcount, $2.7 million related to travel reductions and other cost +saving and mitigation initiatives. +In +addition to these fluctuations, we have identified certain selling, general and administrative expenses that affect the comparability or underlying business trends in our consolidated financial +statements. The following table summarizes these expenses as well as details the additional drivers of the increase above by reconciling our GAAP selling, general and administrative expenses to +non-GAAP selling, general and administrative expenses: +Year Ended +December 31, +2014 +2013 +(in thousands) +Selling, general and administrative expenses reconciliation: +GAAP selling, general and administrative expenses +$ +565,712 +$ +549,154 +ERP implementation(1) +(13,268 +) +(8,893 +) +Reorganization charges(2) +(8,872 +) +(466 +) +Legal settlements(3) +(2,646 +) +(5,714 +) +Brazil tax credits(4) +— +(6,094 +) +Non-GAAP selling, general and administrative expenses +$ +540,926 +$ +527,987 +(1) This +represents operating expenses related to the implementation of our new ERP system and the add-back of accelerated depreciation and amortization on +tangible and intangible +48 +Table of Contents +items +related to our current ERP system and supporting platforms that will no longer be utilized once the implementation of a new ERP is complete. +(2) This +relates to bonuses, consulting fees and other expenses related to recent restructuring activities and our investment agreement with Blackstone. +(3) This +represents legal settlement expenses. +(4) This +represents a net expense related to the resolution of a statutory tax audit in Brazil. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2014, negatively impacted, or increased, selling, general and administrative +expenses by approximately $6.0 million compared to 2013. +Restructuring Charges. We recorded $24.5 million in restructuring charges during the year ended December 31, 2014. These restructuring charges arose +primarily as a result of our strategic plans for long-term improvement and growth of the business. Restructuring charges for the year ended December 31, 2014 consisted +of: +(i) $12.5 million +in severance costs, of which $3.7 million was related to the termination of executive management and $3.6 million was +related to the reductions in workforce announced on July 21, 2014; +(ii) $7.8 million +in other restructuring costs primarily related to the write-off of long-lived assets associated with the exiting of retail locations +and obsolete inventory; and +(iii) $4.2 million +in contract termination costs primarily related to the early termination of operating leases and sponsorship agreements. +Asset Impairment Charges. We recorded $8.8 million in asset impairment charges during the year ended December 31, 2014, a decrease of +$2.1 million compared to 2013, related to certain underperforming retail locations in our Americas, Europe, and Asia Pacific segments that were unlikely to generate sufficient cash flows to +fully recover the carrying value of the stores' assets over their remaining economic life. +Foreign Currency Transaction Losses. The line item entitled foreign currency transaction losses, net is comprised of foreign currency gains and losses from the +re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the year ended +December 31, 2014, losses on foreign currency transactions increased $0.2 million, or 4.4%, as compared to 2013. +Income tax expense. During the year ended December 31, 2014, we recognized a benefit from income tax of $3.6 million compared to an expense of +$49.5 million in 2013. Our effective tax rate decreased primarily due to the release of certain unrecognized tax benefits as the result of settling the Company's audits with the Canada Revenue +Agency and the Internal Revenue Service. Our effective tax rate for +the year ended December 31, 2014 differs from the federal U.S. statutory rate primarily because of the release of certain unrecognized tax benefits as well as differences between income tax +rates between U.S. and foreign jurisdictions. +Presentation of Reportable Segments +For 2015, we had three reportable operating segments based on the geographic nature of our operations: America, Asia Pacific, and Europe. We also +have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represents manufacturing operations located in Mexico, Italy +and Asia. +For +2014 and 2013, we had four reportable operating segments: Americas, Asia Pacific, Japan and Europe. Subsequent to December 31, 2014, our internal reports reviewed by the Chief Operating +Decision Maker +49 +Table of Contents +("CODM") +began consolidating Japan into the Asia Pacific segment. This aligned our internal reporting to our new strategic model and management structure, as Japan and Asia Pacific were managed and +analyzed as one operating segment in 2015 by management and the CODM. Accordingly, prior period segment results have been reclassified to reflect this change. The composition of our reportable +operating segments is consistent with that used by our CODM to evaluate performance and allocate resources. +Each +of our reportable operating segments derives its revenues from the sale of footwear and accessories to external customers as well as intersegment sales. Revenues of the "Other businesses" +category are primarily made up of intersegment sales. The remaining revenues for the "Other businesses" represent non-footwear product sales to external customers. Intersegment sales are not included +in the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. +The +primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on segment results +without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to eliminate +intersegment +profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment eliminations. Segment assets +consist of cash and cash equivalents, accounts receivable, and inventory as these balances are regularly reviewed by the CODM. +50 +Table of Contents +Comparison of the Years Ended December 31, 2015 and 2014 by Segment +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2015 and +2014: +Year Ended December 31, +Change +Constant Currency +Change(3) +2015 +2014 +$ +% +$ +% +(in thousands, except % data) +Revenues: +Americas +$ +476,210 +$ +489,915 +$ +(13,705 +) +(2.8 +)% +$ +(3,459 +) +(0.7 +)% +Asia Pacific +424,491 +473,910 +(49,419 +) +(10.4 +) +(17,490 +) +(3.7 +) +Europe +188,833 +233,604 +(44,771 +) +(19.2 +) +(1,506 +) +(0.6 +) +Total segment revenues +1,089,534 +1,197,429 +(107,895 +) +(9.0 +) +(22,455 +) +(1.9 +) +Other businesses +1,096 +794 +302 +38.0 +194 +24.4 +Total consolidated revenues +$ +1,090,630 +$ +1,198,223 +$ +(107,593 +) +(9.0 +)% +$ +(22,261 +) +(1.9 +)% +Operating income: +Americas +$ +49,422 +$ +48,347 +$ +1,075 +2.2 +% +$ +1,251 +2.6 +% +Asia Pacific +48,447 +75,135 +(26,688 +) +(35.5 +) +(20,730 +) +(27.6 +) +Europe +15,629 +24,517 +(8,888 +) +(36.3 +) +(2,507 +) +(10.2 +) +Total segment operating income +113,498 +147,999 +(34,501 +) +(23.3 +) +(21,986 +) +(14.9 +) +Reconciliation of total segment operating income to income before income taxes: +Other businesses(1) +(30,092 +) +(19,400 +) +(10,692 +) +55.1 +(13,410 +) +69.1 +Intersegment eliminations +— +(1,498 +) +1,498 +(100.0 +) +— +— +Unallocated corporate and other(2) +(155,730 +) +(131,827 +) +(23,903 +) +18.1 +(36,917 +) +28.0 +Total consolidated operating income (loss) +(72,324 +) +(4,726 +) +(67,598 +) +1,430.3 +$ +(72,313 +) +1,530.1 +% +Foreign currency transaction gain (loss), net +(3,332 +) +(4,885 +) +1,553 +(31.8 +) +Interest income +967 +1,664 +(697 +) +(41.9 +) +Interest expense +(969 +) +(806 +) +(163 +) +20.2 +Other income (expense), net +914 +204 +710 +348.0 +Income (loss) before income taxes +$ +(74,744 +) +$ +(8,549 +) +$ +(66,195 +) +774.3 +% +(1) During +the year ended December 31, 2015, operating losses of Other businesses increased $10.7 million compared to 2014, primarily due to a +$12.0 million decrease in gross margin. +(2) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and other corporate costs. For the year ended December 31, 2015, +'Unallocated corporate and other' operating losses increased $23.9 million compared to the same period in 2014, primarily due to an increase in administrative expenses. +(3) Reflects +year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP +Financial Measures" above for more information. +Americas Operating Segment. During the year ended December 31, 2015, revenues from our Americas segment decreased $13.7 million, or 2.8%, compared to +the same period in 2014 primarily due to +51 +Table of Contents +unfavorable +foreign currency fluctuations, a negative impact of store closures, and decreased average selling prices, partially offset by increased sales volume,. +During +the year ended December 31, 2015, segment operating income increased $1.1 million, or 2.2%, compared to the same period in 2014 primarily related to the net effect +of: +(i) a +decrease in revenue of $13.7 million, or 2.8%, slightly offset by a decrease in cost of sales of $3.9 million, or 1.5%; +(ii) a +decrease of $12.3 million, or 6.9%, in selling, general and administrative expenses related to lower employee compensation expense, lower building +expense, and lower depreciation and amortization expense, partially offset by higher marketing expense; +(iii) a +decrease in restructuring expense of $1.8 million related to severance and store closure costs; and +(iv) an +increase in retail asset impairment of $3.2 million. +Asia Pacific Operating Segment. During the year ended December 31, 2015, revenues from our Asia Pacific segment decreased $49.4 million, or 10.4%, +compared to the same period in 2014 primarily due a decrease associated with unfavorable foreign currency fluctuations, lower average selling prices, the negative impact of store closures, partially +offset by a slightly higher sales volume. +Our +Asia Pacific operating segment continues to perform poorly primarily due to adverse macro-economic conditions and overall weakness in China's economy. The macro-economic environment in China has +deteriorated over the past several quarters which has decreased revenue from our China operations by 53.0%, for the year ended December 31, 2015 as compared to the same period in 2014. +We have also experienced significant declines in collection rates from our China operations due to the adverse macro-economic environment and the deteriorating working capital position of our +distributors. The impact of these declines became apparent in September 2015, when multiple China distributors defaulted on their payment obligations. As a result, we have reassessed the +collectability of our accounts receivable balances, for our China operations, and we concluded a significant increase in reserves is required. Accordingly, we have increased our China allowance for +doubtful accounts by an additional $23.2 million, resulting in total allowances for our China operations of $30.3 million as of December 31, 2015. Our net accounts receivable +balance for our China operations as of December 31, 2015 is $5.1 million. +If +the economic conditions in China continue to decline, we may experience further reductions in consumer demand in our China markets which could result in additional declines. As our China operations +represent approximately 8% of our total revenue, declining sales volumes in China could have a material adverse impact on our financial results in future periods. +During +the year ended December 31, 2015, segment operating income decreased $26.7 million, or 35.5%, compared to the same period in 2014 primarily related to the net effect +of: +(i) a +decrease in revenue of $49.4 million, or 10.4% due to unfavorable foreign currency fluctuations, and a decrease in footwear units sold, partially +offset by a decrease in cost of sales of $21.7 million, or 10.1%; +(ii) a +decrease of $3.6 million, or 2.0%, in selling, general and administrative expenses primarily as a result of bad debt expense relating to China, +partially offset by lower employee compensation related expenses and lower rent and occupancy related expenses; +(iii) a +decrease in restructuring expense of $1.1 million related to severance and store closure costs; and +(iv) an +increase in retail asset impairment of $3.7 million. +Europe Operating Segment. During the year ended December 31, 2015, revenues from our Europe segment decreased $44.8 million, or 19.2%, compared to +the same period in 2014, primarily due to unfavorable +52 +Table of Contents +foreign +currency fluctuations, and the negative impact of store closures, partially offset an increase in sales volume. +During +the year ended December 31, 2015, segment operating income decreased $8.9 million, or 36.3%, compared to the same period in 2014 primarily related to the net effect +of: +(i) a +decrease in revenue of $44.8 million, or 19.2%, and a decrease in cost of sales by $16.4 million, or 14.1%; +(ii) a +decrease of $17.9 million, or 20.6% , in selling, general and administrative expenses related to lower employee compensation related expenses, +lower professional services expense, partially offset by an increase in marketing and sales expenses; +(iii) a +decrease in restructuring charges of $1.1 million related to severance and store closure costs; and +(iv) a +decrease in asset impairment of $0.4 million. +53 +Table of Contents +Comparison of the Years Ended December 31, 2014 and 2013 by Segment +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2014 and +2013: +Year Ended December 31, +Change +Constant Currency Change(3) +2014 +2013 +$ +% +$ +% +(in thousands, except % data) +Revenues: +Americas +$ +489,915 +$ +498,552 +$ +(8,637 +) +(1.7 +)% +$ +(3,694 +) +(0.7 +)% +Asia Pacific +473,910 +477,615 +(3,705 +) +(0.8 +) +5,755 +1.2 +Europe +233,604 +216,259 +17,345 +8.0 +18,561 +8.6 +Total segment revenues +1,197,429 +1,192,426 +5,003 +0.4 +20,622 +1.7 +Other businesses +794 +254 +540 +212.6 +533 +209.8 +Total consolidated revenues +$ +1,198,223 +$ +1,192,680 +$ +5,543 +0.5 +% +$ +21,155 +1.8 +% +Operating income: +Americas +$ +48,347 +$ +61,894 +$ +(13,547 +) +(21.9 +)% +$ +(13,944 +) +(22.5 +)% +Asia Pacific +75,135 +118,253 +(43,118 +) +(36.5 +) +(38,855 +) +(32.9 +) +Europe +24,517 +16,192 +8,325 +51.4 +7,021 +43.4 +Total segment operating income +147,999 +196,339 +(48,340 +) +(24.6 +) +(45,778 +) +(23.3 +) +Reconciliation of total segment operating income to income before income taxes: +Other businesses(1) +(19,400 +) +(20,811 +) +1,411 +(6.8 +) +1,504 +(7.2 +) +Intersegment eliminations +(1,498 +) +61 +(1,559 +) +(2,555.7 +) +(1,559 +) +(2,555.7 +) +Unallocated corporate and other(2) +(131,827 +) +(112,494 +) +(19,333 +) +17.2 +(13,500 +) +12.0 +Total consolidated operating income (loss) +(4,726 +) +63,095 +(67,821 +) +(107.5 +) +$ +(59,333 +) +(94.0 +)% +Foreign currency transaction gain (loss), net +(4,885 +) +(4,678 +) +(207 +) +4.4 +Interest income +1,664 +2,432 +(768 +) +(31.6 +) +Interest expense +(806 +) +(1,016 +) +210 +(20.7 +) +Other income (expense), net +204 +126 +78 +61.9 +Income (loss) before income taxes +$ +(8,549 +) +$ +59,959 +$ +(68,508 +) +(114.3 +)% +(1) During +the year ended December 31, 2014, operating losses of Other businesses decreased $1.4 million compared to 2013, primarily due to a +$1.5 million increase in gross margin offset by a $0.1 million increase in selling, general and administrative expenses. +(2) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. +For the year ended December 31, 2014, Unallocated corporate and other operating losses increased $19.3 million compared to the same period in 2013, primarily due to $8.9 million +restructuring charges related to the termination of certain employees and executives and a write-off of obsolete inventory related to an exited business line and an $8.1 million increase in +selling, general and administrative expenses primarily related to the implementation of our ERP system and our investment agreement with Blackstone partially offset by cost savings in variable +compensation. +(3) Reflects +year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP +Financial Measures" above for more information. +54 +Table of Contents +Americas Operating Segment. During the year ended December 31, 2014, revenues from our Americas segment decreased $8.6 million, or 1.7%, compared to +2013 primarily due to a 3.2% decrease in footwear units sold and a $4.9 million unfavorable impact from foreign currency fluctuations driven by weakening of the Brazilian Real against the U.S. +Dollar. This decrease was partially offset by a 2.2% increase in average footwear unit selling price. During the year ended December 31, 2014, revenue declines for the region were realized +primarily in the wholesale channel which decreased $10.5 million, or 4.4%, and in the internet channel which decreased $1.3 million, or 2.3%, compared to 2013. The decrease in wholesale +channel revenue was predominately driven by a mix of lower than anticipated at-once orders as a result of accounts remaining lean on inventory in the first half of the year and a decline in activity +in our Latin and South American markets partially offset by an increase in activity in the United States. The decrease in internet channel revenue was predominately driven by a decrease in average +footwear selling price partially offset by an increase in footwear unit sales and increased conversion and traffic. Partially offsetting this decrease was a $3.1 million, or 1.5%, increase in +retail channel revenues, which is primarily the result of higher unit sales. Comparable store sales decreased 4.4% due to the impact of foreign currency translation adjustments into our reporting +currency. +During +the year ended December 31, 2014, segment operating income decreased $13.5 million, or 21.9%, compared to 2013 primarily related to: +(i) a +decrease in segment gross margins of $13.2 million, or 5.3%, primarily related to higher material costs and an increase of $1.2 million of +inventory written off related to obsolete inventory including raw materials, footwear and other accessories; +(ii) $4.3 million +in restructuring charges related to the reorganization of our business in Brazil, severance costs in the United States and an inventory +write-down related to an exited business line; and +(iii) Partially +offsetting these negative impacts to operating income was a decrease of $2.8 million, or 1.6%, in selling, general and administrative +expenses as a result of lower marketing expenses partially offset by higher rent and maintenance fees. +Asia Pacific Operating Segment. During the year ended December 31, 2014, revenues from our Asia Pacific segment decreased $3.7 million, or 0.8%, +compared to 2013 primarily due to a 12.5% decrease in average footwear selling price and a $9.4 million unfavorable impact from foreign currency fluctuations partially offset by a 1.2% increase +in footwear units sold. During the year ended December 31, 2014, we realized revenue growth of 33.6% in the region in the internet channel compared to 2013. Partially offsetting this increase +was a decrease of $11.6 million, or 4.0%, in the wholesale channel revenues, primarily due to a decrease in third and fourth quarter performance in our China business as a result of increased +distributor inventory levels and lower replenishment orders. Our retail channel revenues increased $7.8 million, or 1.9%, primarily due to increased traffic during the year and the +addition of 44 company-operated stores since December 31, 2013 as we focused on high-traffic, outlet locations partially offset by a 4.7% decrease in comparable store sales. The closure of 71 +underperforming company-operated stores and temporary locations since December 31, 2013 did not have an unfavorable impact on revenues. +During +the year ended December 31, 2014, segment operating income decreased $43.1 million, or 36.5%, compared to 2013 primarily related to: +(i) an +increase of $14.0 million, or 8.6%, in selling, general and administrative expenses due to an increase in reserves for doubtful accounts as a +result of delayed payments from distributors in China and Southeast Asia and an increase in sales expenses, that was partially offset by a reduction of employee expenses related to the reduction of +retail locations; +(ii) a +decrease in segment gross margins of $21.8 million, or 7.8%, primarily related to an increase of $4.0 million of inventory written off +related to obsolete inventory including raw materials, footwear and other accessories; +55 +Table of Contents +(iii) $4.6 million +in restructuring charges related to severance and store closure costs; and +(iv) a +$2.6 million increase in retail asset impairment charges related to the long-lived assets. +Europe Operating Segment. During the year ended December 31, 2014, revenues from our Europe segment increased $17.3 million, or 8.0%, compared to +2013 primarily due to a 15.1% increase in footwear units sold, which was partially offset by a 8.8% decrease in average footwear unit selling price. This contrasting increase in average footwear units +sold and decrease in average footwear unit selling price is primarily related to discounting on certain products during the first half of the year in our wholesale channel. In addition to sales +metrics, our Europe segment realized a $1.2 million unfavorable impact from foreign currency fluctuations driven by the weakening of the Russian Ruble against the U.S. Dollar. During the year +ended December 31, 2014, we realized revenue growth in the region in the wholesale and retail channels compared to 2013. Our wholesale channel revenue increased $16.3 million, or 12.5%, +primarily due to the expansion in our number of wholesale doors and strong sales performance throughout the region. Our direct-to-consumer channel revenues increased $1.8 million, or 3.1%, +primarily due to the 0.7% increase in comparable store sales and a 4.3% increase in the average footwear unit selling price. +During +the year ended December 31, 2014, segment operating income increased $8.3 million, or 51.4%, compared to 2013 primarily related to: +(i) a +decrease to asset impairments of $4.9 million; +(ii) a +decrease of 4.4 million, or 4.8%, in selling, general and administrative expenses; +(iii) an +increase in gross margin of $3.0 million, or 2.6%; and +(iv) a +$3.9 million restructuring charge related to severance and store closures, which partially offset the above increases. +Liquidity and Capital Resources +Cash Flows +2015 +2014 +2013 +(in thousands) +Cash provided by (used in) operating activities +$ +9,698 +$ +(11,651 +) +$ +83,464 +Cash used in investing activities +(18,627 +) +(57,992 +) +(69,758 +) +Cash provided by (used in) financing activities +(101,260 +) +23,431 +(1,161 +) +Effect of exchange rate changes on cash +(13,982 +) +(3,420 +) +10,251 +Net increase (decrease) in cash and cash equivalents +$ +(124,171 +) +$ +(49,632 +) +$ +22,796 +During +the year ended December 31, 2015, cash and cash equivalents decreased $124.2 million, or 46.5%, to $143.3 million compared to $267.5 million at December 31, +2014. The primary driver of this decrease is the repurchase of $85.9 million of our common stock associated with repurchases including related commission charges under our publicly-announced +repurchase plan, strategic reinvestments into the business including $5.8 million in capital spend primarily related to our ERP system implementation, dividend payments of $11.9 million +on our Series A Preferred Stock, of which $3.0 million was recorded as dividends payable and prepaid dividends as of December 31, 2015, and debt payments, including principal and +interest, of $3.0 million related to long-term bank borrowings. +Cash +provided by operations was $9.7 million for the year ended December 31, 2015 compared to cash used in operations of $11.7 million for the year ended December 31, 2014. +This increase was primarily driven by the change in working capital accounts year over year which accounted for $36.4 million of our cash provided by operating activities. During the year ended +December 31, 2015, we paid $19.9 million in +56 +Table of Contents +cash +related to taxes that were accrued for as of December 31, 2014, which accounted for half of this change. +In +2015, we completed the implementation and customization of our fully-integrated global operational and financial accounting and resource planning system, or ERP system. This ERP system was placed +into service in the first quarter of 2015. The total cost of the ERP system implementation was $102.3 million of which $74.6 million was capitalized and $27.7 million was +expensed. This amount represents a 309.2% increase over the projected initial pre-blueprinting cost estimate disclosed in our Form 10-K for the year ended December 31, 2012. The cost +increase, as compared to the original pre-blueprinting estimate, is primarily a result of the following: (i) project scope changes including: expanding the number of locations where the new +system was implemented and enhancements in the security, reporting and governance tools; (ii) increased costs to develop data conversion software to convert data from the previous ERP system to +the new ERP system, and (iii) increased consulting costs primarily associated with system enhancements. The ERP system is being amortized using the straight-line method over an estimated +economic useful life of seven years. +Working Capital +As of December 31, 2015, accounts receivable, net decreased $17.6 million compared to December 31, 2014. During the year ended +December 31, 2015, we recorded a reserve for doubtful accounts of $23.2 million in our Asia Pacific segment primarily as a result of delayed payments from our partner stores in China. As +of December 31, 2015, other long-term assets decreased by approximately $4.3 million primarily due to the decrease in derivative instruments recorded on our balance sheet, as no such +instruments were outstanding as of December 31, 2015. As of December 31, 2015, accounts payable increased $20.4 million compared to December 31, 2014. As a result of the +January 2015 implementation of our new ERP system, we accelerated payments of our outstanding payables in late 2014 to accommodate the transition. Accrued expenses and other liabilities increased +$11.6 million compared to December 31, 2014 primarily due to an accrued loss on our South Africa operations held for sale as of December 31, 2015. +We +anticipate our cash flows from operations will be sufficient to meet the ongoing needs of our business for the next twelve months. In order to provide additional liquidity in the future and to help +support our strategic goals, we have a revolving credit facility with a syndicate of lenders, including PNC Bank, National Association ("PNC") as lead lender, which was amended on February 18, +2016, and as amended, provides us with up to $75.0 million in borrowing capacity and matures in February 2021 (see Revolving Credit Facility +below). Additional future financing may be necessary and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. +Sale of Preferred Stock +On December 28, 2013, we entered into, and on January 27, 2014, we closed on an investment agreement with Blackstone, whereby we sold +them 200,000 shares of the Company's Series A Preferred Stock for $182.2 million of net proceeds. The Series A Preferred Stock has a par value $0.001 per share, with an aggregate +stated value of $200.0 million, or $1,000 per share, and an aggregate purchase price of $198.0 million, or $990.00 per share. +The +Series A Preferred Stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and dissolution. Holders of Series A Preferred Stock +are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum as well as any dividends declared or paid on our common stock and are entitled to vote together with the +holders of common stock on an as-converted basis. As of December 31, 2015, accrued dividends were $3.0 million, which were paid to Blackstone on January 4, 2016. +57 +Table of Contents +The +Series A Preferred Stock has several conversion features as well as redemption rights. The conversion rate is subject to customary anti-dilution and other adjustments subject to certain +share caps and other restrictions. As of December 31, 2015, the Blackstone investment, on an as converted to common stock basis, represented approximately 15.9% of our outstanding common stock. +We intend to continue to use the net proceeds, as well as excess cash, to fund the repurchase of our common stock pursuant to the $350.0 million stock repurchase authorization approved by the +Board discussed further below. We believe this investment provides an opportunity to drive shareholder value and refine the strategic direction of the business. +Stock Repurchase Plan Authorizations +We continue to evaluate options to maximize the returns on our cash and to maintain an appropriate capital structure, including, among other +alternatives, repurchases of our common stock. +On +December 26, 2013, the Board approved the repurchase of up to $350.0 million of our common stock, subject to certain restrictions on repurchases under our revolving credit facility. +This replaced all of our existing stock repurchase authorizations. The number, price, structure and timing of the repurchases will be at our sole discretion and future repurchases will be evaluated by +us depending on market conditions, liquidity needs and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not +have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify or terminate the repurchase program at any time without prior notice. +During +the year ended December 31, 2015, we repurchased approximately 6.5 million shares at an average price of $13.24 for an aggregate price of approximately $85.9 million +including related commission charges, under a publicly-announced repurchase plan. +During +the year ended December 31, 2014, we repurchased approximately 10.6 million shares at an average price of $13.75 for an aggregate price of approximately $145.6 million +excluding related commission charges, under a publicly-announced repurchase plan. +As +of December 31, 2015, subject to certain restrictions on repurchases under our revolving credit facility, we had $118.7 million of our common shares available for repurchase under the +repurchase authorizations. +On +February 18, 2016, we entered into the Eleventh Amendment to the Credit Agreement (as defined below) which limits the amount that the we can repurchase to $50.0 million per year, +subject to certain conditions. +Revolving Credit Facility +On December 16, 2011, we entered into an Amended and Restated Credit Agreement (as amended, the "Credit Agreement"), with the lenders named +therein and PNC Bank, National Association ("PNC"), as a lender and administrative agent for the lenders. On December 27, 2013, we entered into the Third Amendment of the Credit Agreement which +allowed for the payment of dividends on the Series A preferred stock and permitted the Company to have greater flexibility to repurchase its Common Stock. On April 2, 2015, we entered +into the Sixth Amendment to the Credit Agreement which amended certain definitions of the financial covenants and certain covenant ratios to be more favorable. On September 1, 2015, we entered +into the Eighth Amendment to the Credit Agreement which further amended certain definitions of the financial covenants and certain covenant ratios to become more favorable to us. On +December 24, 2015, we entered into the Tenth Amendment +to the Credit Agreement which further amended certain definitions of the financial covenants to become more favorable to us. +On +February 18, 2016, the Company entered into the Eleventh Amendment to the Credit Agreement. The Eleventh amendment primarily: (i) extended the maturity date to February 18, +2021, (ii) resized the borrowing capacity of the facility to $75.0 million, (iii) amended certain definitions of the financial +58 +Table of Contents +covenants +to become more favorable to the Company, (iv) allows up to $50 million in stock repurchases per year, and (v) limited certain capital expenditures and commitments to an +aggregate of $50 million per year. The Company anticipates it will be in compliance with its covenants as of March 31, 2016, however, there can be no assurance that the Company will be +in compliance at that date. See Note 11—Revolving Credit Facility & Bank Borrowing, for further details regarding applicable covenant terms and interest rates associated the +Credit Agreement. +As +of December 31, 2015 and December 31, 2014, the Company had no outstanding borrowings under the Credit Agreement. As of December 31, 2015 and December 31, 2014, the +Company had outstanding letters of credit of $1.3 million and $1.8 million, respectively, which were reserved against the borrowing base under the terms of the Credit Agreement. During +the years ended December 31, 2015, 2014, and 2013, Crocs capitalized $0.2 million, $0.1 million, and $0.1 million, respectively, in fees and third party costs which were +incurred in connection with the Credit Agreement, as deferred financing costs. As of December 31, 2015, the Company was not in compliance with the fixed charge coverage ratio and the leverage +ratio under the Credit Agreement. On February 18, 2016, we received a waiver of our December 31, 2015 financial covenant obligations from the lenders. +Asia Pacific Revolving Credit Facility +On August 28, 2015, a Crocs subsidiary entered into a revolving credit facility agreement with HSBC Bank (China) Company Limited, Shanghai +Branch ("HSBC") as the lender. The revolving credit facility enables Crocs to borrow uncommitted dual currency revolving loan facilities up to RMB 40.0 million, or the USD equivalent, and +import facilities up to RMB 60.0 million, or the USD equivalent, with a combined facility limit of RMB 60.0 million. This revolving credit facility supports possible future net working +capital needs in China. For loans denominated in USD, the interest rate is 2.1% per annum plus LIBOR for three months or any other period as may be determined by HSBC at the end of each interest +period. For loans denominated in RMB, interest equals the one year benchmark lending rate effective on the loan drawdown date set forth by the +People's Bank of China with a 10% mark-up and is payable on the maturity date of the related loan. The revolving credit facility is guaranteed by Crocs, Inc. and certain accounts receivables in +China are pledged as security under the revolving credit facility. The revolving credit facility can be canceled or suspended at any time at the lenders discretion and contains provisions requiring +Crocs to maintain compliance with certain restrictive covenants. As of December 31, 2015, we received notification from the lender that the facility has been temporarily suspended. +Long-term Bank Borrowings +On December 10, 2012, Crocs entered into a Master Installment Payment Agreement ("Master IPA") with PNC in which PNC financed the Company's +recent implementation of a new ERP system, which began in October 2012 and was substantially completed in early 2015. The terms of each note payable, under the Master IPA, consist of a fixed interest +rate and payment terms based on the amount borrowed and the timing of activity throughout the implementation of the ERP system. The Master IPA is subject to cross-default, cross-termination, and is +coterminous with the Credit Agreement. +As +of December 31, 2015 and 2014, Crocs had $6.4 million and $11.6 million, respectively, of debt outstanding under five separate notes payable, of which $4.8 million and +$5.3 million, respectively, represents current installments. As of December 31, 2015, the notes bear interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 +to September 2017. As this debt arrangement relates solely to the construction and implementation of an ERP system for use by the entity, interest expense was capitalized to the consolidated balance +sheets and amortized over the life of the assets, starting on the January 1, 2015 in-service date. During the years ended December 31, 2015 and 2014, Crocs capitalized +$0.0 million and $0.4 million, respectively, in interest expense related to this debt arrangement to the consolidated balance sheets. Interest rates and payment terms are subject to +changes as further financing occurs under the Master IPA. +59 +Table of Contents +Capital Assets +During the year ended December 31, 2015, net capital assets acquired, inclusive of intangible assets, were $16.9 million compared to +$57.0 million during the same period in 2014. The decrease is primarily due to lower capital spend in our ERP system, which was placed into service in January 2015. +Repatriation of Cash +As we are a global business, we have cash balances which are located in various countries and are denominated in various currencies. Fluctuations in +foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash +balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash +balances between entities. +We +generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested; however, our Board has approved a foreign cash repatriation strategy. As part of +this strategy, we repatriated approximately $127.3 million during the year ended December 31, 2015 for which income taxes have already been accrued or paid. Further cash repatriation +will depend on future cash requirements in the U.S. We maintain approximately $128 million of foreign earnings for which tax has previously been provided, and which has not been repatriated at +this time. +Most +of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable foreign tax credits. +In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries have +monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources +for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2015, we held $111.9 million of our total $143.3 million in cash in +international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $111.9 million, $1.4 million could +potentially be restricted, as described above. If the remaining $110.5 million were to be immediately repatriated to the U.S., no additional tax expense would be incurred as all amounts are +currently provided for in the our statement of operations. +Contractual Obligations +In December 2011, Crocs renewed and amended its supply agreement with Finproject S.p.A. (formerly known as Finproject s.r.l.), which +provides Crocs the exclusive right to purchase certain raw materials used to manufacture our products. The agreement also provides that Crocs meets minimum purchase requirements to maintain +exclusivity throughout the term of the agreement, which expires December 31, 2016. Historically, the minimum purchase requirements have not been onerous and Crocs does not expect them to become +onerous in the future. Depending on the material purchased, pricing was based either on contracted price or was subject to quarterly reviews +and fluctuates based on order volume, currency fluctuations, and raw material prices. Pursuant to the agreement, Crocs guarantees the payment for certain third-party manufacturer purchases of these +raw materials up to a maximum potential amount of €3.5 million (approximately $3.8 million as of December 31, 2015). +60 +Table of Contents +The +following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2015: +Total +Less than +1 Year +1 - 3 Years +3 - 5 Years +More than +5 Years +(in thousands) +Operating lease obligations(1) +$ +357,831 +$ +77,127 +$ +104,186 +$ +71,208 +$ +105,310 +Inventory purchase obligations with third-party manufacturers(2) +158,152 +158,152 +— +— +— +Dividends payable(3) +72,866 +12,000 +24,000 +24,000 +12,866 +Other contracts(4) +13,642 +1,685 +11,466 +486 +5 +Debt obligations(5)(8) +6,399 +4,772 +1,620 +7 +— +Minimum licensing royalties(6) +2,853 +2,723 +130 +— +— +Capital lease obligations(7) +28,464 +10,042 +10,750 +7,672 +— +Total +$ +640,207 +$ +266,501 +$ +152,152 +$ +103,373 +$ +118,181 +(1) Our +operating lease obligations consist of leases for retail stores, offices, warehouses, vehicles, and equipment expiring at various dates through 2033. +This balance represents the minimum cash commitment under contract to various third parties for operating lease obligations including the effect of rent escalation clauses and deferred rent and +minimum sublease rentals due in the future under non-cancelable subleases. This balance does not include certain contingent rent clauses that may require additional rental amounts based on sales +volume, inventories, etc. as these amounts are not determinable for future periods. +(2) Our +inventory purchase obligations with third party manufacturers consist of open purchase orders for footwear products and include an immaterial amount of +purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third party manufacturers are +expected to be paid within one year. +(3) Dividends +payable are associated with our Series A Preferred Stock at a rate of 6.0% of the stated value of the stock. The amounts represent expected +dividend payments over the eight year redemption accretion period. +(4) Other +contracts consist of various agreements with third-party providers. +(5) Our +current debt obligations consist of five separate notes issued under our agreement with PNC to finance the purchase and implementation of our new ERP +system, which bear interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 to September 2017. We will continue to finance the ERP implementation on an as needed basis +through this agreement. Interest rates and payment terms are subject to change as further financing occurs. +(6) Our +minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our +footwear and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for +future periods. +(7) Our +capital lease obligations consist of leases for office equipment expiring at various dates through 2016. This balance represents the minimum cash +commitment under contract to various third-parties for capital lease obligations. +(8) Amounts +include anticipated interest payments. +(9) We +do not expect to settle any uncertain tax positions within one year. Therefore, we have not included any amounts in the contractual obligations table +above. +61 +Table of Contents +Off-Balance Sheet Arrangements +We had no material off-balance sheet arrangements as of December 31, 2015. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and non-GAAP +financial measures, is based on the consolidated financial statements which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and +judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting +periods. We evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the +circumstances, the results of +which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under +different assumptions or conditions. The following discussion pertains to accounting policies management believes are most critical to the portrayal of our financial condition and results of +operations as well as the accounting policies that management considers subjective. +Reserves for Uncollectible Accounts Receivable. We make ongoing estimates related to the collectability of our accounts receivable and maintain a reserve for +estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, +economic trends and conditions affecting our customer base, significant non-recurring events and historical write-off experience. Specific provisions are recorded for individual receivables when we +become aware of a customer's inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses +from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial +condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is +appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a determination. +Sales Returns, Allowances and Discounts. We record reductions to revenue for estimated customer returns, allowances and discounts. Our estimated sales returns and +allowances are based on customer return history and actual outstanding returns yet to be received. Provisions for customer specific discounts based on contractual obligations with certain major +customers are recorded as reductions to net sales. We may accept returns from our wholesale and distributor customers on an exception basis at the sole discretion of management for the purpose of +stock re-balancing, to ensure that our products are merchandised in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances to key wholesale and +distributor customers to facilitate the "in-channel" markdown of products where we have experienced less than anticipated sell-through. We also record reductions to revenue for estimated customer +credits as a result of price mark-downs in certain markets. Fluctuations in our estimates for sales returns, allowances and discounts may be caused by many factors, including, but not limited to, +fluctuations in our sales revenue and changes in demand for our products. Our judgment in determining these estimates is impacted by various factors including customer acceptance of our new styles, +customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products and macroeconomic factors affecting our customers. Because we cannot +predict or control certain of these factors, the actual amounts of customer returns and allowances may differ from our estimates. +62 +Table of Contents +Inventory Valuation. Inventories are valued at the lower of cost or market. Inventory cost is determined using the moving average cost method. At least annually, +or more frequently if events and circumstances indicate fair value is less than carrying value, we evaluate our inventory for possible impairment using standard categories to classify inventory based +on the degree to which we believe that the products may need to be discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective and unobservable +assumptions including estimated future demand and market conditions and other observable factors such as current sell-through of our products, recent changes in demand for our product, shifting demand +between the products we offer, global and regional economic conditions, historical experience selling through liquidation and "off-price" channels and the amount of inventory on hand. If the estimated +inventory fair value is less than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of +operations. The ultimate results achieved in selling excess and discontinued products in future periods may differ significantly from management's fair value estimates. See +Note 2—Inventories in the accompanying notes to the consolidated financial statements for additional information regarding inventory. +Impairment of Long-Lived Assets. We test long-lived assets to be held and used for impairment when events or circumstances indicate the carrying value of a +long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include: (i) a significant decrease in its market +price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or business +climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for its +acquisition or construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing +losses associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously estimated +useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by determining if its carrying value exceeds the sum of its projected +undiscounted cash flows expected from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is +measured as the difference between its carrying value and its fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Fair value is +determined by independent third-party appraisals, the net present value of expected cash flows, or other valuation techniques as appropriate. Assets to be abandoned or from which no further benefit is +expected are written down to zero at the time that the determination is made and the assets are removed entirely from service. +An +asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets involved in our +retail business, our asset group is at the retail store level. Our estimates of future cash flows over the remaining useful life of the asset group are based on management's operating budgets and +forecasts. These budgets and forecasts take into consideration inputs from our regional management related to growth rates, pricing, new markets and other factors expected to affect the business, as +well as management's forecasts for inventory, receivables, capital spending, and other cash needs. These considerations and expectations are inherently uncertain, and estimates included in our +operating forecasts beyond a three to six month +future period are extremely subjective. Accordingly, actual cash flows may differ significantly from our estimated future cash flows. +Impairment +charges are driven by, among other things, changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate +initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets and result in impairment charges in future periods. Significant impairment +charges recognized during a reporting period could have an adverse effect on our reported financial results. +63 +Table of Contents +Assets and Liabilities Held for Sale. The Company classifies a disposal group to be sold as held for sale when management approves and commits to a formal plan to +actively market a disposal group and expects the sale to close within twelve months. Upon classifying a disposal group as held for sale, the disposal group is recorded at the lower of its carrying +amount or its estimated fair value, reduced for selling costs. In determining the fair value of a disposal group, the Company considers both the net book value of the disposal group as a whole and the +impact of any related foreign currency translation adjustments recorded within stockholders' equity. Any losses are recognized as asset impairment charges in the Consolidated Statement of Operations. +Depreciation expense is no longer recorded for any assets within a disposal group that is classified as held for sale. +The +fair value of a disposal group less any costs to sell is assessed each reporting period it remains classified as held for sale and any subsequent changes are reported as an adjustment to the +carrying value of the disposal group, as long as the new carrying value does not exceed the carrying value of the disposal group at the time it was initially classified as held for sale. +Share-based Compensation. We estimate the fair value of our stock option awards using a Black Scholes valuation model, the inputs of which require various +assumptions including the expected volatility of our stock price and the expected life of the option. The expected volatility assumptions are derived using our historical stock price volatility and +the historical volatilities of competitors whose shares are traded in the public markets. These assumptions reflect our best estimates, however; they involve inherent uncertainties based on market +conditions generally outside of our control. If factors change and we use a different methodology for deriving the Black Scholes assumptions, our share- based compensation expense may differ +materially in the future from that recorded in the current period. Additionally, we make certain estimates about the number of awards which will be made under performance based incentive plans. As a +result, if other assumptions or estimates had been used, +share-based compensation expense could have been materially impacted. Furthermore, if we use different assumptions in future periods, share-based compensation expense could be materially impacted in +future periods. See Note 10—Equity in the accompanying notes to the consolidated financial statements for additional information regarding our share-based compensation. +Provisions for Contingencies and Legal Proceedings. We estimate our provision for general contingencies, including potential losses in relation to tax and customs +matters and legal proceedings, based on an assessment of the probability of the contingency and accrue if information available indicates that it is probable that a liability has been incurred. When +it has been determined that a liability has been incurred, and information available indicates that the estimated amount of loss can be reasonably estimated and/or is within a range of amounts, that +amount is accrued for in the consolidated financial statements. +Income Taxes. We account for income taxes using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the +expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted +tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding +uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be recognized at +the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest +expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and +interpretive guidance on the application of the law is complex and often ambiguous. +Our +annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in +determining our annual tax expense and in evaluating our tax positions. Tax laws require items to be included in our tax +64 +Table of Contents +returns +at different times than when these items are reflected in the consolidated financial statements. As a result, the annual tax rate reflected in our consolidated financial statements is +different than that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse +over time, such as +depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial +reporting and tax basis of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are +expected to reverse. Based on an evaluation of all available information, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is +considered more likely than not. +We +evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the +reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established +unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. Undistributed earnings of a subsidiary are accounted +for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign subsidiary that are deemed to be indefinitely reinvested in the foreign +jurisdiction. We have operated under a specific plan for reinvestment of undistributed earnings of our foreign subsidiaries which demonstrates that such earnings will be indefinitely reinvested in the +applicable tax jurisdictions. Should we change our plans, we would be required to record a significant amount of deferred tax liabilities. We recognize interest and penalties related to unrecognized +tax benefits within the "Income tax expense" line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the +consolidated balance sheets. See Note 14—Income Taxes in the accompanying notes to the consolidated financial statements for additional information regarding our income taxes. +Recent Accounting Pronouncements. See Note 1—Organization and Summary of Significant Accounting Policies in the accompanying notes to the +consolidated financial statements for recently adopted and issued accounting pronouncements. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing +strategies. Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility and certain financial instruments. In addition to the revolving credit +facility, we have incurred short- and long-term indebtedness related to the implementation of our ERP system. Borrowings under these debt instruments bear fixed interest rates and therefore, do not +have the potential for market risk. +Borrowings +under the revolving credit facility bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate as +quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% +based on certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. Borrowings under the revolving +credit facility are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, +domestic and international economic and political considerations and other factors that are beyond our control. As of December 31, 2015 and 2014, there were no borrowings under the revolving +credit facility. +65 +Table of Contents +We +additionally hold cash equivalents including certificate of deposits, time deposits and money market funds. Interest income generated from these cash equivalents will fluctuate with the general +level of interest rates. As of December, 2015, we held $7.5 million in cash equivalents subject to variable interest rates. If the prevailing market interest rates relative to these investments +increased or decreased by10% during the year ended December 31, 2015, interest income would have increased or decreased by approximately $0.1 million. +Foreign Currency Exchange Risk +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We pay the majority of expenses +attributable to our foreign +operations in the functional currency of the country in which such operations are conducted and pay the majority of our overseas third-party manufacturers in U.S. Dollars. Our ability to sell our +products in foreign markets and the U.S. Dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. Fluctuations in the value of foreign +currencies relative to the U.S. Dollar could result in downward price pressure for our products and increase losses from currency exchange rates. An increase or decrease of 1% in value of the U.S. +Dollar relative to foreign currencies would have increased or decreased loss before taxes during the year ended December 31, 2015 by approximately $1.0 million. The volatility of the +applicable exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. In the event our foreign sales and purchases increase and are denominated in currencies other +than the U.S. Dollar, our operating results may be affected by fluctuations in the exchange rate of currencies we receive for such sales. See Item 7, "Management's Discussion and Analysis of +Financial Condition and Results of Operations," for a discussion of the impact of foreign exchange rate variances experienced during the years ended December 31, 2015 and 2014. +We +transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk inherent in revenues, costs, and monetary assets and liabilities denominated in +non-functional currencies. We have entered into foreign currency exchange forward contracts and currency swap derivative instruments to selectively protect against volatility in the value of +non-functional currency denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. +The +following table summarizes the notional amounts of the outstanding foreign currency exchange contracts at December 31, 2015 and 2014. The notional amounts of the derivative financial +instruments shown below are denominated in their U.S. Dollar equivalents and represent the amount of all contracts of +66 +Table of Contents +the +foreign currency specified. These notional values do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the foreign currency +exchange risks. +December 31, +2015 +2014 +(in thousands) +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ +98,390 +$ +44,533 +Euro +34,219 +134,755 +British Pound Sterling +21,859 +17,230 +South Korean Won +7,981 +14,590 +Mexican Peso +7,277 +13,180 +Australian Dollar +6,459 +7,913 +South African Rand +6,402 +4,355 +Indian Rupee +5,036 +3,356 +Canadian Dollar +1,980 +3,005 +New Taiwan Dollar +1,798 +3,229 +Swedish Krona +1,655 +1,918 +Hong Kong Dollar +668 +814 +Russian Ruble +667 +1,838 +Singapore Dollar +— +61,887 +Chinese Yuan Renminbi +— +5,376 +Norwegian Krone +— +917 +New Zealand Dollar +— +743 +Brazilian Real +— +— +Total notional value, net +$ +194,391 +$ +319,639 +Latest maturity date +January 2016 +January 2015 +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we +conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of +December 31, 2015 (the "Evaluation Date"). Based on the evaluation of our disclosure controls and procedures as of December 31, 2015, our Chief Executive Officer and Chief Financial +Officer concluded that, as a result of the material weaknesses in internal control over financial reporting described below in Management's Report on Internal Control Over Financial Reporting, our +disclosure controls and procedures were not effective, as of that date. +Notwithstanding +such material weaknesses, which are described below in Management's Report on Internal Control over Financial Reporting, our management has concluded that the consolidated financial +67 +Table of Contents +statements +included in this Form 10-K present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with +accounting principles generally accepted in the U.S. +Management's Report on Internal Control over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act +Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2015, using the criteria set forth in the Internal Control—Integrated +Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to +provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with U.S. generally +accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, +accurately and fairly reflect the transactions and dispositions of the assets of the Company, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation +of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of +management and directors of the Company, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets +that could have a material effect on the financial statements. +Management +has concluded our internal control over financial reporting is ineffective as of December 31, 2015 as management identified material weaknesses as further described below. A material +weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual +or interim financial statements will not be prevented or detected on a timely basis. +Management +identified the following control deficiencies that constitute individually, or in the aggregate, material weaknesses in our internal control over financial reporting as of +December 31, 2015: +Financial Close Process. We identified deficiencies related to the operating effectiveness of controls over the completeness and accuracy of our review and +approval of certain journal entries and period end adjusting entries. In addition, we did not consistently maintain or perform on a timely basis our control procedures over certain account analyses, +data integrity, documentation, review and approval of year-end accounting entries to ensure the accuracy and completeness of the entries recorded. We also identified deficiencies regarding the review +and approval of our income tax entries related to our deferred income tax accounts and the related impacts on income tax expense or benefit. +We +also lacked a sufficient balance of personnel commensurate with our financial close reporting requirements. If not corrected, these controls could impact the accuracy and completeness of our +financial statements. +Inventory Accounting Controls. We identified deficiencies related to the operating effectiveness of our controls to ensure the existence, valuation, accuracy, and +completeness of inventory on hand. Specifically, our physical inventory procedures were not performed with sufficient consistency to ensure the underlying quantities were accurate. Additionally, our +cost absorption control procedures were not consistently maintained or performed on a timely basis in accordance with Company's policy, to ensure inventory was properly valued. If not corrected, these +ineffective controls could impact the accuracy and completeness of our cost of sales and inventory balances. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +68 +Table of Contents +Changes in Internal Control over Financial Reporting +Other than the material weaknesses noted above, there has been no change in our internal control over financial reporting during the three months +ended December 31, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +Remediation Efforts to Address Identified Material Weaknesses +Management is dedicated to remediate the control deficiencies that gave rise to the material weaknesses in our internal control over financial +reporting. If not remediated, the material weaknesses in our internal controls may result in material misstatements in our financial statements. +The +following steps are among the measures that have been implemented or that we intend to implement after the date of this filing to address our material weaknesses as of December 31, 2015: +Financial Close Process. We are performing a review to identify opportunities to improve the operation of our financial close control activities. We intend to +engage a third party service provider to assist with our review and remediation efforts and to make recommendations related to our staffing levels and structure. Furthermore, we are undertaking +additional training of the personnel recording and reviewing journal entries to ensure consistent compliance with our policies and controls over the account analysis, documentation, review, and +approval of manual journal entries as well as data integrity procedures. We will also direct our internal auditors to perform additional testing around these processes to ensure the sufficiency of our +remediation efforts. +Inventory Accounting Controls. We are performing a review to identify opportunities to improve the operation of our inventory accounting control activities. We +intend to engage a third party service provider to assist with our review and remediation efforts. Furthermore, we are undertaking additional training of our supply chain personnel to ensure inventory +control procedures are adequate, performed timely, and are properly recorded in accordance with our policies. We will also provide enhanced training on cost absorption analysis procedures to ensure +inventory values are properly maintained. We will also direct our internal auditors to perform additional testing of our inventory procedures to assess the sufficiency of our remediation efforts. +We +are committed to maintaining a strong internal control environment. The Audit Committee has directed management to develop a detailed plan and timetable for the completion of the implementation of +the remedial measures outlined above and will continue to monitor such implementation. In addition, under the direction of the Audit Committee, management will continue to review and make necessary +changes to the overall design of our internal control environment, as well as to our policies and procedures in order to improve the overall effectiveness of our internal control over financial +reporting. +As +we implement these remediation efforts, we may determine that additional steps may be necessary to remediate the material weaknesses. We cannot assure you that these remediation efforts will be +successful or that our internal control over financial reporting will be effective in accomplishing all control objectives all of the time. We will continue to assess the effectiveness of our +remediation efforts in connection with our evaluations of internal control over financial reporting. +ITEM 9B. Other Information +None. +69 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited Crocs, Inc. and subsidiaries' (the "Company") internal control over financial reporting as of December 31, 2015, based on criteria established in Internal +Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). The Company's management is responsible for maintaining +effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying "Management's Report on +Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain +reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over +financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on that risk, and performing such other +procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing +similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the +preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and +procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to +error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are +subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +A +material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the +company's annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management's assessment: +the Company did not maintain effective internal controls related to the financial close process and +inventory accounting. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements as of and for +the year ended December 31, 2015, of the Company and this report does not affect our report on such financial statements. +In +our opinion, because of the effect of the material weaknesses identified above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal +control over financial +70 +Table of Contents +reporting +as of December 31, 2015, based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the +Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended +December 31, 2015, of the Company and our report dated February 29, 2016 expressed an unqualified opinion on those financial statements and includes an explanatory paragraph relating to +a change in the method of accounting for income taxes as of December 31, 2015 due to the adoption of Accounting Standards Update (ASU) 2015-17, Balance Sheet +Classification of Deferred Taxes. +/s/ +DELOITTE & TOUCHE LLP +Denver, +CO +February 29, 2016 +71 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2016 Annual Meeting of +Stockholders to be filed with the SEC within 120 days after December 31, 2015. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal financial officer, +principal accounting officer and controller. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose certain changes to, or +waivers from, our code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct and ethics +policy as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2016 Annual Meeting of +Stockholders to be filed with the SEC within 120 days after December 31, 2015. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2016 Annual Meeting of +Stockholders to be filed with the SEC within 120 days after December 31, 2015, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 4.4 million shares of common stock for future issuance pursuant to exercise of outstanding awards +under equity compensation plans as of December 31, 2015. +Plan Category +Number of +Securities to be Issued +on Exercise of +Outstanding +Options and Rights +Weighted Average +Exercise Price of +Outstanding +Options(2) +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders(1) +4,384,129 +$ +14.09 +8,218,218 +Equity compensation plans not approved by stockholders +— +— +— +Total +4,384,129 +$ +14.09 +8,218,218 +(1) On +June 8, 2015, the Company's stockholders approved the Crocs, Inc. 2015 Equity Incentive Plan (the "Plan"). The number of shares available +for issuance under the Plan (subject to changes in capitalization) consist of (i) 7.0 million newly available shares; (ii) 1.2 million shares available for issuance under +the 2007 Plan as of June 8, 2015; and (iii) 2007 Plan shares associated with outstanding options or awards that are cancelled or forfeited after June 8, 2015. The Plan provides +for the grant of incentive and non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, and other stock-based awards. The Plan replaces the +Company's 2007 Equity +72 +Table of Contents +Incentive +Plan (As Amended and Restated), and no further awards will be made under the 2007 Plan. The Plan became effective immediately upon stockholder approval. +(2) The +weighted-average exercise price of outstanding options pertains only to 1.3 million shares issuable on the exercise of outstanding options and +rights. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2016 Annual Meeting of +Stockholders to be filed with the SEC within 120 days after December 31, 2015. +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2016 Annual Meeting of +Stockholders to be filed with the SEC within 120 days after December 31, 2015. +PART IV +ITEM 15. Exhibits and Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the +consolidated financial statements or notes thereto. +73 +Table of Contents +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.1 +* +Form of Indemnification Agreement between Crocs, Inc. and each of its directors and executive officers (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, +2005 (File No. 333-127526)). +10.2 +* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) +). +10.3 +* +Amendment No. 1 to the 2005 Plan (incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.4 +* +Form of Notice of Grant of Stock Option under the 2005 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.5 +* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.6 +* +Form of Stock Purchase Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.7 +* +Form of Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.8 +* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) +). +74 +Table of Contents +Exhibit +Number +Description +10.9 +* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.10 +* +Form of Non Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) +). +10.11 +* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.'s Annual Report on Form 10-K, filed on March 17, 2009). +10.12 +* +2008 Cash Incentive Plan (As Amended and Restated Effective June 4, 2012) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on June 7, 2012). +10.13 +* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the "2007 Plan") (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 1, 2011). +10.14 +* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.15 +* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.16 +* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, +2007). +10.17 +* +Form of Restricted Stock Unit Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 1, 2011). +10.18 +* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.19 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a +lender and administrative agent for the lenders (the "Amended and Restated Credit Agreement") (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 19, 2011). +10.20 +First Amendment to the Amended and Restated Credit Agreement, dated December 10, 2012, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, +National Association, as a lender and administrative agent (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 11, 2012). +75 +Table of Contents +Exhibit +Number +Description +10.21 +Second Amendment to Amended and Restated Credit Agreement, dated June 12, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on July 30, 2013). +10.22 +Third Amendment to Amended and Restated Credit Agreement, dated December 27, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 30, 2013). +10.23 +Fourth Amendment to Amended and Restated Credit Agreement, dated March 27, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.24 +Fifth Amendment to Amended and Restated Credit Agreement, dated September 26, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on October 29, 2014) +10.25 +Sixth Amendment to Amended and Restated Credit Agreement, dated April 2, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 7, 2015). +10.26 +Seventh Amendment to Amended and Restated Credit Agreement, dated April 21, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 7, 2015). +10.27 +Eighth Amendment to Amended and Restated Credit Agreement, dated September 1, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.28 +Ninth Amendment to Amended and Restated Credit Agreement, dated November 3, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National +Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.29 +† +Tenth Amendment to Amended and Restated Credit Agreement, dated December 24, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National +Association, as a lender and administrative agent. +76 +Table of Contents +Exhibit +Number +Description +10.30 +† +Eleventh Amendment to Amended and Restated Credit Agreement, dated February 18, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., and PNC Bank, National Association, as a lender +and administrative agent. +10.31 +* +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.32 +Investment Agreement, dated December 28, 2013, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +December 30, 2013). +10.33 +First Amendment to Investment Agreement, dated January 27, 2014, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, +filed on January 27, 2014). +10.34 +* +Form of Severance Agreement (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on July 30, 2014). +10.35 +* +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on May 14, 2014). +10.36 +Registration Rights Agreement, dated January 27, 2014 (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on January 27, 2014). +10.37 +* +Employment Offer Letter, dated December 15, 2014, between Crocs, Inc. and Gregg Ribatt (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 15, +2014). +10.38 +* +Crocs, Inc. 2015 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on June 9, 2015). +10.39 +* +Employment Offer Letter, dated November 4, 2015, between Crocs, Inc. and Carrie Teffner (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on November 5, +2015). +21 +† +Subsidiaries of the registrant. +23.1 +† +Consent of Deloitte & Touche LLP. +31.1 +† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 +† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 +† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS +† +XBRL Instance Document +101.SCH +† +XBRL Taxonomy Extension Schema Document +101.CAL +† +XBRL Taxonomy Extension Calculation Linkbase Document +77 +Table of Contents +Exhibit +Number +Description +101.DEF +† +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB +† +XBRL Taxonomy Extension Label Linkbase Document +101.PRE +† +XBRL Taxonomy Extension Presentation Linkbase Document +* Compensatory +plan or arrangement +† Filed +herewith. +78 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be +signed on its behalf by the undersigned, thereunto duly authorized, as of February 29, 2016. +CROCS, INC. +a Delaware Corporation +By: +/s/ GREGG S. RIBATT +Name: +Gregg S. Ribatt +Title: +Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates +indicated. +Signature +Title +Date +/s/ GREGG S. RIBATT +Gregg S. Ribatt +Chief Executive Officer and Director +February 29, 2016 +/s/ CARRIE W. TEFFNER +Carrie W. Teffner +Executive Vice President and Chief Financial Officer +February 29, 2016 +/s/ IAN M. BICKLEY +Ian M. Bickley +Director +February 29, 2016 +/s/ RONALD L. FRASCH +Ronald L. Frasch +Director +February 29, 2016 +/s/ JASON K. GIORDANO +Jason K. Giordano +Director +February 29, 2016 +/s/ PRAKASH A. MELWANI +Prakash A. Melwani +Director +February 29, 2016 +/s/ THOMAS J. SMACH +Thomas J. Smach +Chairman of the Board +February 29, 2016 +/s/ DOREEN A. WRIGHT +Doreen A. Wright +Director +February 29, 2016 +79 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Statements of Operations for the Years Ended December 31, 2015, 2014, and 2013 +F-3 +Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2015, 2014, and 2013 +F-4 +Consolidated Balance Sheets as of December 31, 2015 and 2014 +F-5 +Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2015, 2014, and 2013 +F-6 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2015, 2014, and 2013 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2015 and 2014, and the related consolidated statements of +operations, comprehensive income (loss), stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the +responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain +reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the +financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. +We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2015 and 2014, and the results of its +operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. +As +discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for the classification of income tax balances as of December 31, 2015 +due to the adoption of Accounting Standards Update (ASU) 2015-17, Balance Sheet Classification of Deferred Taxes . +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of +December 31, 2015, based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of +Sponsoring Organizations of the Treadway Commission and our report dated February 29, 2016 expressed an adverse opinion on the Company's internal control over financial reporting. +/s/ +DELOITTE & TOUCHE LLP +Denver, +Colorado +February 29, 2016 +F-2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +($ thousands, except per share data) +Year Ended December 31, +2015 +2014 +2013 +Revenues +$ +1,090,630 +$ +1,198,223 +$ +1,192,680 +Cost of sales +579,825 +603,893 +569,482 +Restructuring charges +— +3,985 +— +Gross profit +510,805 +590,345 +623,198 +Selling, general and administrative expenses +559,095 +565,712 +549,154 +Restructuring charges +8,728 +20,532 +— +Asset impairment charges +15,306 +8,827 +10,949 +Income (loss) from operations +(72,324 +) +(4,726 +) +63,095 +Foreign currency transaction loss, net +(3,332 +) +(4,885 +) +(4,678 +) +Interest income +967 +1,664 +2,432 +Interest expense +(969 +) +(806 +) +(1,016 +) +Other income, net +914 +204 +126 +Income (loss) before income taxes +(74,744 +) +(8,549 +) +59,959 +Income tax benefit (expense) +(8,452 +) +3,623 +(49,539 +) +Net income (loss) +$ +(83,196 +) +$ +(4,926 +) +$ +10,420 +Dividends on Series A convertible preferred stock +(11,833 +) +(11,301 +) +— +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion +feature +(2,978 +) +(2,735 +) +— +Net income (loss) attributable to common stockholders +$ +(98,007 +) +$ +(18,962 +) +$ +10,420 +Net income (loss) per common share: +Basic +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +Diluted +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +($ thousands) +Year Ended December 31, +2015 +2014 +2013 +Net income (loss) +$ +(83,196 +) +$ +(4,926 +) +$ +10,420 +Other comprehensive income (loss): +Foreign currency translation gain (loss), net +(32,561 +) +(33,004 +) +(5,335 +) +Reclassification of cumulative foreign exchange translation adjustments to net income (loss), net of tax of $0, $0, and $(3), respectively +— +— +299 +Total comprehensive income (loss) +$ +(115,757 +) +$ +(37,930 +) +$ +5,384 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +($ thousands, except number of shares) +December 31, +2015 +2014 +ASSETS +Current assets: +Cash and cash equivalents +$ +143,341 +$ +267,512 +Accounts receivable, net of allowances of $49,364 and $32,392, respectively +83,616 +101,217 +Inventories +168,192 +171,012 +Deferred tax assets, net +— +4,190 +Income tax receivable +10,233 +9,332 +Other receivables +14,233 +11,989 +Prepaid expenses and other assets +26,334 +30,156 +Total current assets +445,949 +595,408 +Property and equipment, net +49,490 +68,288 +Intangible assets, net +82,297 +97,337 +Goodwill +1,973 +2,044 +Deferred tax assets, net +6,608 +17,886 +Other assets +21,703 +25,968 +Total assets +$ +608,020 +$ +806,931 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +63,336 +$ +42,923 +Accrued expenses and other liabilities +91,835 +80,216 +Deferred tax liabilities, net +— +11,869 +Accrued restructuring +738 +4,511 +Income taxes payable +6,416 +9,078 +Current portion of long-term borrowings and capital lease obligations +4,772 +5,288 +Total current liabilities +167,097 +153,885 +Long-term income tax payable +4,547 +8,843 +Long-term borrowings and capital lease obligations +1,627 +6,381 +Long-term accrued restructuring +230 +348 +Other liabilities +12,890 +12,277 +Total liabilities +186,391 +181,734 +Commitments and contingencies +Series A convertible preferred stock, par value $0.001 per share, 1,000,000 shares authorized, 200,000 shares issued and outstanding, redemption +amount and liquidation preference of $203,000 and $203,067 as of December 31, 2015 and December 31, 2014, respectively +175,657 +172,679 +Stockholders' equity: +Preferred stock, par value $0.001 per share, 4,000,000 shares authorized, none outstanding +— +— +Common stock, par value $0.001 per share, 250,000,000 shares authorized, 93,101,007 and 72,851,418 shares issued and outstanding, respectively, as of +December 31, 2015 and 92,325,201 and 78,516,566 shares issued and outstanding, respectively, as of December 31, 2014 +94 +92 +Treasury stock, at cost, 20,249,589 and 13,808,635 shares as of December 31, 2015 and December 31, 2014, respectively +(283,913 +) +(200,424 +) +Additional paid-in capital +353,241 +345,732 +Retained earnings +227,463 +325,470 +Accumulated other comprehensive loss +(50,913 +) +(18,352 +) +Total stockholders' equity +245,972 +452,518 +Total liabilities, commitments and contingencies and stockholders' equity +$ +608,020 +$ +806,931 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY +($ thousands) +Common Stock +Treasury Stock +Accumulated +Other +Comprehensive +Income +Total +Stock +Holders' +Equity +Additional +Paid in +Capital +Retained +Earnings +Shares +Amount +Shares +Amount +Balance—December 31, 2012 +88,663 +$ +91 +2,384 +$ +(44,214 +) +$ +307,823 +$ +334,012 +$ +19,688 +$ +617,400 +Amortization of stock compensation +— +— +— +— +14,483 +— +— +14,483 +Forfeitures +(78 +) +— +— +— +(2,014 +) +— +— +(2,014 +) +Exercises of stock options and issuance of restricted stock awards +715 +1 +(22 +) +1,039 +1,240 +— +— +2,280 +Repurchase of common stock for tax +withholding +(16 +) +— +16 +(256 +) +— +— +— +(256 +) +Purchase of treasury stock +(834 +) +— +834 +(12,533 +) +— +— +— +(12,533 +) +Net income +— +— +— +— +— +10,420 +— +10,420 +Foreign currency translation, net of tax +— +— +— +— +— +— +(5,335 +) +(5,335 +) +Reclassification of cumulative foreign exchange translation adjustments to net income +— +— +— +— +— +— +299 +299 +Balance—December 31, 2013 +88,450 +$ +92 +3,212 +$ +(55,964 +) +$ +321,532 +$ +344,432 +$ +14,652 +$ +624,744 +Amortization of stock compensation +— +— +— +— +14,896 +— +— +14,896 +Forfeitures +(144 +) +— +— +— +(2,129 +) +— +— +(2,129 +) +Exercises of stock options and issuance of restricted stock awards +853 +— +(46 +) +2,185 +(843 +) +— +— +1,342 +Repurchase of common stock for tax +withholding +(53 +) +— +53 +(787 +) +— +— +— +(787 +) +Purchase of treasury stock +(10,590 +) +— +10,590 +(145,858 +) +— +— +— +(145,858 +) +Dividends—Series A preferred stock +— +— +— +— +— +(11,301 +) +— +(11,301 +) +Accretion—Series A preferred stock +— +— +— +— +— +(2,735 +) +— +(2,735 +) +Adjustment for beneficial conversion feature of Series A preferred stock +— +— +— +— +12,276 +— +— +12,276 +Net loss +— +— +— +— +— +(4,926 +) +— +(4,926 +) +Foreign currency translation, net of tax +— +— +— +— +— +— +(33,004 +) +(33,004 +) +Balance—December 31, 2014 +78,516 +$ +92 +13,809 +$ +(200,424 +) +$ +345,732 +$ +325,470 +$ +(18,352 +) +$ +452,518 +Amortization of stock compensation +— +— +— +— +13,094 +— +— +13,094 +Forfeitures +— +— +— +— +(1,908 +) +— +— +(1,908 +) +Tax shortfall from share-based plans +(2,841 +) +(2,841 +) +Exercises of stock options and issuance of restricted stock awards +832 +2 +(56 +) +2,698 +(836 +) +— +— +1,864 +Repurchase of common stock for tax +withholding +(22 +) +— +22 +(261 +) +— +— +— +(261 +) +Purchase of treasury stock +(6,475 +) +— +6,475 +(85,926 +) +— +— +— +(85,926 +) +Dividends—Series A preferred stock +— +— +— +— +— +(11,833 +) +— +(11,833 +) +Accretion—Series A preferred stock +— +— +— +— +— +(2,978 +) +— +(2,978 +) +Net loss +— +— +— +— +— +(83,196 +) +— +(83,196 +) +Foreign currency translation, net of tax +— +— +— +— +— +(32,561 +) +(32,561 +) +Balance—December 31, 2015 +72,851 +$ +94 +20,250 +$ +(283,913 +) +$ +353,241 +$ +227,463 +$ +(50,913 +) +$ +245,972 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +($ thousands) +Year Ended December 31, +2015 +2014 +2013 +Cash flows from operating activities: +Net income (loss) +$ +(83,196 +) +$ +(4,926 +) +$ +10,420 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +35,993 +37,413 +41,506 +Unrealized (gain) loss on foreign exchange, net +(814 +) +(11,100 +) +(6,420 +) +Deferred income taxes +289 +829 +23,536 +Asset impairment charges +15,306 +8,827 +10,949 +Provision for doubtful accounts, net +25,997 +12,087 +1,930 +Share-based compensation +11,236 +12,503 +11,871 +Inventory write-down charges +3,108 +7,490 +3,419 +Non-cash restructuring charges +— +6,413 +— +Other non-cash items +4,029 +534 +1,193 +Changes in operating assets and liabilities: +Accounts receivable, net of allowances +(15,604 +) +(15,288 +) +(17,166 +) +Inventories +(8,586 +) +(31,251 +) +(5,274 +) +Prepaid expenses and other assets +1,755 +21,698 +(4,225 +) +Accounts payable +23,260 +(12,106 +) +(5,740 +) +Accrued expenses and other liabilities +8,765 +(15,824 +) +14,256 +Accrued restructuring +(3,677 +) +4,859 +— +Income taxes +(8,163 +) +(33,809 +) +3,209 +Cash provided by (used in) operating activities +9,698 +(11,651 +) +83,464 +Cash flows from investing activities: +Cash paid for purchases of property and equipment +(12,826 +) +(15,991 +) +(40,424 +) +Proceeds from disposal of property and equipment +(2 +) +236 +250 +Cash paid for intangible assets +(5,660 +) +(41,035 +) +(28,404 +) +Change in restricted cash +(139 +) +(1,202 +) +(1,180 +) +Cash used in investing activities +(18,627 +) +(57,992 +) +(69,758 +) +Cash flows from financing activities: +Proceeds from preferred stock offering, net of issuance costs of $0.0 million and $15.8 million, respectively +— +182,220 +— +Dividends—Series A preferred stock +(11,900 +) +(8,234 +) +— +Proceeds from bank borrowings +— +— +23,375 +Repayment of bank borrowings and capital lease obligations +(5,290 +) +(5,177 +) +(13,160 +) +Deferred debt issuance costs +191 +(75 +) +(100 +) +Deferred offering costs +— +— +(767 +) +Issuances of common stock +1,864 +1,342 +2,280 +Purchase of treasury stock, net of issuances +(85,926 +) +(145,858 +) +(12,533 +) +Repurchase of common stock for tax withholding +(261 +) +(787 +) +(256 +) +Excess tax benefit from share-based compensation +62 +— +— +Cash provided by (used in) financing activities +(101,260 +) +23,431 +(1,161 +) +Effect of exchange rate changes on cash +(13,982 +) +(3,420 +) +10,251 +Net increase (decrease) in cash and cash equivalents +(124,171 +) +(49,632 +) +22,796 +Cash and cash equivalents—beginning of period +267,512 +317,144 +294,348 +Cash and cash equivalents—end of period +$ +143,341 +$ +267,512 +$ +317,144 +Supplemental disclosure of cash flow information—cash paid during the period for: +Interest, net of capitalized interest +$ +917 +$ +616 +$ +693 +Income taxes +$ +19,923 +$ +33,655 +$ +20,274 +Supplemental disclosure of non-cash investing and financing activities: +Assets acquired under capitalized leases +$ +20 +$ +— +$ +61 +Accrued purchases of property and equipment +$ +851 +$ +771 +$ +2,165 +Accrued purchases of intangibles +$ +— +$ +2,988 +$ +4,742 +Intrinsic value of beneficial conversion feature—Series A preferred stock +$ +— +$ +12,276 +$ +— +Accrued dividends +$ +3,000 +$ +3,067 +$ +— +Accretion of dividend equivalents +$ +2,978 +$ +2,735 +$ +— +Change in assets held for sale +$ +1,595 +$ +— +$ +— +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Organization +Crocs, Inc. and its subsidiaries (collectively the "Company," "Crocs," "we," "our" or "us") are engaged in the design, development, +manufacturing, marketing, and distribution of footwear and accessories for men, women, and children. +Basis of Presentation +The consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the +United States of America ("U.S. GAAP"). The consolidated financial statements include the accounts of the Company's wholly owned subsidiaries. +In +April 2011, Crocs and an unrelated third party formed Crocs Gulf, LLC ("Crocs Gulf") for the purpose of selling the Company's products in the United Arab Emirates. Crocs has acquired all +voting and dividend rights associated with Crocs Gulf and has therefore determined that Crocs Gulf is a wholly owned subsidiary. +Noncontrolling Interests +As of December 31, 2015, all of the Company's subsidiaries were, in substance, wholly owned. +Transactions with Affiliates +The Company receives inventory count services from RGIS, a wholly owned subsidiary of Blackstone which currently owns all of the outstanding shares +of Company's +Series A convertible preferred stock ("Series A preferred stock"), which is convertible into approximately 15.9% of the Company's common stock. Crocs paid a total of $0.5 million +to RGIS for services received during 2015. +2. RECENT ACCOUNTING PRONOUNCEMENTS +Financial Instruments +In +January 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-01: Financial +Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The pronouncement requires equity investments (except those +accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires +public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial +liabilities by measurement category and form of financial asset, and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the +fair value that is required to be disclosed for financial instruments measured at amortized cost. These changes become effective for fiscal years beginning after December 15, 2017. The expected +adoption method of ASU 2016-01 is being evaluated by the Company and the adoption is not expected to have a significant impact on the Company's consolidated financial statements. +F-8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. RECENT ACCOUNTING PRONOUNCEMENTS (Continued) +Classification of Deferred Taxes +In +November 2015, the FASB issued ASU 2015-17: Financial Instruments—Overall: Recognition and Measurement of Financial Assets and +Financial Liabilities, which provides guidance to simplify the financial statement presentation of deferred income taxes. The new guidance requires an entity to present +deferred tax assets and liabilities as non-current in a classified balance sheet. Prior to the issuance of this guidance, deferred tax liabilities and assets were required to be separately classified +into a current amount and a non-current amount in the balance sheet. The new guidance represents a change in accounting principle and is effective for annual reporting periods beginning after +December 15, 2016, with early adoption permitted. The Company elected to early adopt this guidance as of December 31, 2015 and to apply it prospectively. Prior period information was not +adjusted. Because the application of this guidance affects the balance sheet classification only, adoption of this guidance did not have a material impact on our consolidated financial statements. As +a result, 2015 current deferred tax assets and liabilities have been adjusted by approximately $15.9 million and are now reflected as noncurrent under the new standard. +Inventory +In +July 2015, the FASB issued ASU 2015-11: Simplifying the Measurement of Inventory , which modifies existing requirements +regarding measuring inventory at the lower of cost or market. Specifically, this standard eliminates the need to determine and consider replacement cost or net realizable value less an approximately +normal profit margin when measuring inventory. This standard is effective prospectively after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact +that this pronouncement will have on its consolidated financial statements. +Debt Issuance Costs +In +April 2015, the FASB issued ASU 2015-03: Simplifying the Presentation of Debt Issuance Costs, which requires that debt +issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, +consistent with debt discounts. ASU 2015-03 requires retrospective adoption and will be effective for fiscal years beginning after December 15, 2015. Early adoption is permitted. Crocs +does not expect this pronouncement will have a material impact on the consolidated financial statements. +Share-Based Payments +In +June 2014, the FASB issued ASU 2014-12 in response to the EITF consensus on Issue 13-D. The ASU clarifies that entities should treat performance targets that can be met +after the requisite service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense related to an award for +which transfer to the employee is contingent on the entity's satisfaction of a performance target until it becomes probable that the performance target will be met. The ASU does not contain any new +disclosure requirements. This ASU is effective for all entities for reporting periods (including interim periods) beginning after December 15, 2015. Crocs does not expect this pronouncement +will have a material impact on the consolidated financial statements. +Revenue Recognition +In +May 2014, the FASB issued their final standard on revenue from contracts with customers. The standard, issued as ASU 2014-09: Revenue from +Contracts with Customers (Topic 606) by the FASB, outlines +F-9 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. RECENT ACCOUNTING PRONOUNCEMENTS (Continued) +a +single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific +guidance. The core principle of the revenue model is that "an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration +to which the entity expects to be entitled in exchange for those goods or services." ASU 2014-09 becomes effective for reporting periods (including interim periods) beginning after December 15, +2017. Early application is permitted for reporting periods (including interim periods) beginning after December 15, 2016. This new standard permits the use of either the retrospective or +cumulative effect transition method. Crocs is currently evaluating the impact that this pronouncement will have on the condensed consolidated financial statements. Crocs has not yet selected a +transition method or determined the effect of the standard on financial reporting once the standard is effective. +Other +new pronouncements issued but not effective until after December 31, 2015 are not expected to have a material impact on the Company's financial position, results of operations or cash +flows. +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Management Estimates +The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates, judgments, and assumptions that +affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Management believes that the +estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment +assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, share-based compensation expense, the assessment of lower of cost or market on inventory, +useful lives assigned to long-lived assets, depreciation, and provisions for contingencies are reasonable based on information available at the time they are made. Management also makes estimates in +the assessments of potential losses in relation to tax and customs matters and threatened or pending legal proceedings (see Note 17—Commitments & Contingencies and +Note 19—Legal Proceedings). Actual results could materially differ from these estimates. For matters not related to income taxes, if a loss is considered probable and the amount can +be reasonably estimated, Crocs recognizes an expense for the estimated loss. If there is the potential to recover a portion of the estimated loss from a third party, Crocs makes a separate assessment +of recoverability and reduces the estimated loss if recovery is deemed probable. +Accumulated Other Comprehensive Income +Activity within the accumulated other comprehensive income ("AOCI") balance consists solely of gains and losses resulting from the translation of +foreign subsidiary financial statements to the Company's reporting currency. Foreign currency translation resulting in changes to other comprehensive income and related reclassification adjustments +are presented net of tax effects on the consolidated statements of other comprehensive income. Foreign currency reclassification adjustments are included within the line item entitled 'Foreign +currency transaction loss, net' on the consolidated statements of operations. +F-10 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Fair Value +Fair value is the price that would be received from the sale of an asset or transfer of a liability in an orderly transaction between market +participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, Crocs considers the principal or most +advantageous market in which a hypothetical sale or transfer would take place and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, +transfer restrictions, and risk of non-performance. +The +fair value hierarchy is made up of three levels of inputs, which may be used to measure fair value: +Level 1—observable +inputs such as quoted prices for identical instruments in active markets; +Level 2—observable +inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and +model derived valuations in which all significant inputs are observable in active markets; and +Level 3—unobservable +inputs for which there is little or no market data, which require Crocs to develop its own assumptions. Crocs categorizes fair value measurements within the +fair value hierarchy based upon the lowest level of the most significant inputs used to determine such fair value measurement. +Cash +equivalents primarily include time deposits and certificates of deposit with original maturities of three months or less. Time deposits and certificates of deposit included in cash equivalents +are valued at amortized cost, which approximates fair value. These investments have been classified as a Level 1 measurement. +Derivative +financial instruments are required to be recorded at their fair value, on a recurring basis. The fair values of any derivative instruments, should Crocs enter into them, would be determined +using a discounted cash flow valuation model. The significant inputs used in the model are readily available in public markets or can be derived from observable market transactions, and therefore, +have been classified as Level 2. These inputs are based on the prevailing LIBOR deposit rates and include the applicable exchange rates, forward rates, and discount rates. +The +Company's other financial instruments are not required to be carried at fair value on a recurring basis. The carrying value of these financial instruments, including cash equivalents, accounts +receivable, accounts payable and accrued liabilities, approximates fair value due to their short maturities. The carrying values of capital lease obligations and the line of credit approximate their +fair values based on borrowing rates currently available to Crocs, with similar terms. +Inventories +and long-lived assets such as property and equipment and intangible assets are also not required to be carried at fair value on a recurring basis. For a discussion of inventory values, see +"Inventory Valuation" below. Crocs reviews the carrying amounts of property and equipment and intangible assets when events and circumstances indicate the carrying value of the asset may not be +recoverable. For such determination, Crocs generally uses either an income approach with inputs that are mainly unobservable, such as expected future cash flows, or a market approach using observable +inputs such as replacement cost or third party appraisals, as appropriate. Estimated future cash flows are based on management's operating budgets and forecasts which take into consideration both +observable and unobservable inputs including growth rates, pricing, new markets and other factors expected to affect the business, as well as management's forecasts for inventory, receivables, capital +spending, and other cash needs. Crocs considers +F-11 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +this +type of estimate to be classified as a Level 3 measurement. See Note 9—Fair Value Measurements for further discussion related to fair value measurements. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three months or less at the date of purchase. +Crocs considers receivables from credit card companies to be cash equivalents, if expected to be received within five days. +Accounts Receivable +Accounts receivable represent amounts due from customers. Accounts receivable are recorded at invoiced amounts, net of reserves and allowances, and +do not bear interest. Crocs uses its best estimate to determine the required allowance for doubtful accounts based on a variety of factors including the length of time receivables are past due, +economic trends and conditions affecting the Company's customer base and historical collection experience. Specific provisions are recorded for individual receivables when the Company becomes aware of +a customer's inability to meet its financial obligations. See Note 13—Allowances for further discussion related to provisions for doubtful accounts, sale returns and allowances, and +reserve for unapplied rebates. +Inventory Valuation +Inventories are valued at the lower of cost or market. Inventory cost is determined using the moving average cost method. At least annually, or more +frequently if events and circumstances indicate fair value is less than carrying value, Crocs evaluates its inventory for possible impairment. Crocs estimates inventory fair value based on several +subjective assumptions including estimated future demand and market conditions, as well as other observable factors such as current sell-through of the Company's products, recent changes in demand for +Crocs products, global and regional economic conditions, historical experience selling through liquidation and price discounted channels, and the amount of inventory on hand. If the estimated +inventory fair value is less than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in 'Cost of sales' on the consolidated statements +of operations. See Note 4—Inventories for further discussion related to inventories. +Property and Equipment +Property, equipment, furniture, and fixtures are stated at cost and depreciation is computed using the straight-line method based on the assets +estimated useful life, which typically ranges from two to five years. Leasehold improvements are stated at cost and amortized on the straight-line basis over their estimated economic useful lives or +the lease term, whichever is shorter. Depreciation of manufacturing assets is included in cost of sales on the consolidated statements of operations. Depreciation related to corporate, non-product and +non-manufacturing assets is included in 'Selling, general and administrative expenses' on the consolidated statements of operations. +Assets and Liabilities Held for Sale +The Company classifies a disposal group to be sold as held for sale when management approves and commits to a formal plan to actively market a +disposal group and expects the sale to close within twelve months. Upon classifying a disposal group as held for sale, the disposal group is recorded at the lower of its +F-12 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +carrying +amount or its estimated fair value, reduced for selling costs. In determining the fair value of a disposal group, the Company considers both the net book value of the disposal group as a +whole and the impact of any related foreign currency translation adjustments recorded within stockholders' equity. Any losses are recognized as asset impairment charges in the Consolidated Statement +of Operations. Depreciation expense is no longer recorded for any assets within a disposal group that is classified as held for sale. +The +fair value of a disposal group less any selling costs is assessed each reporting period it remains classified as held for sale and any subsequent changes are reported as an adjustment to the +carrying value of the disposal group, as long as the new carrying value does not exceed the carrying value of the disposal group at the time it was initially classified as held for sale. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset may +not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include (i) a significant decrease in its market price, (ii) a +significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or business climate that could +affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for its acquisition or +construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses +associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously estimated useful +life. If such facts indicate a potential impairment of a long-lived asset (or asset group), Crocs assesses the recoverability by determining if its carrying value exceeds the sum of its projected +undiscounted cash flows from its use and eventual disposition over its remaining economic life. If the asset's carrying value is not supported, on an undiscounted cash flow basis, the amount of +impairment is measured as the difference between the asset's carrying value and its estimated fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs +to sell. Assets, or groups of assets, to be abandoned or from which no future benefit is expected, are written down to zero in the period it is determined the asset or asset groups will no longer be +used, and the assets, or asset groups, are removed entirely from service. An asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the +cash flows of other assets and liabilities. For assets involved in Crocs' retail business, the asset group is at the retail store level. See Note 5—Property and Equipment for a +discussion of impairment losses recorded during the periods presented. +Intangible Assets +Intangible assets that are determined to have finite lives are amortized over their estimated useful lives on a straight-line basis and are evaluated +for impairment when events or circumstances indicate a carrying value may not be fully recoverable. Customer relationships are amortized on a straight-line basis. Intangible assets that are determined +to have indefinite lives, such as trade names, are not amortized and are evaluated for impairment at least annually, or more frequently when circumstances imply possible impairment. Recoverability is +based on the estimated future undiscounted cash flows of the asset. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is measured as the difference between its +carrying value and its estimated fair value. +F-13 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Amortization +of manufacturing intangible assets is included in cost of sales on the consolidated statements of operations. Amortization related to corporate, non-product, and non-manufacturing assets, +such as the Company's global information systems, is included in selling, general, and administrative expenses on the consolidated statements of operations. The following table sets forth Crocs' +definite lived intangible assets and the periods over which they are amortized. +Intangible Asset Class +Weighted Average Amortization Period +Patents +10 years +Customer relationships +Estimated customer life +Core technology +5 years +Non-competition agreement +Contractual term +Capitalized software +Shorter of 7 years or useful life +Capitalized Software +Crocs capitalizes certain internal and external software acquisition and development costs, including the costs of employees and contractors devoting +time to software development projects and external direct costs for materials and services. Initial costs associated with internally-developed-and-used software are expensed until it is determined +that the project has reached the application development stage. Once in its development stage, subsequent additions, modifications or upgrades to an internal-use software project are capitalized to +the extent that they add functionality. Software maintenance and training costs are expensed in the period in which they are incurred. Capitalized software primarily consists of Crocs' enterprise +resource system software, warehouse management software, and point of sale software. At least annually, Crocs considers the potential impairment of capitalized software by assessing the substantive +service potential of the software, as well as changes, if any, in the extent or manner in which the software is used or is expected to be used, and +the actual cost of software development or modification compared to expected cost. See Note 6—Goodwill and Intangible Assets for further discussion. +Goodwill +Goodwill represents the excess purchase price paid over the fair value of assets acquired and liabilities assumed in acquisitions. Goodwill is +considered an indefinite lived asset and therefore is not amortized. The Company assesses goodwill for impairment annually on the last day of the year, or more frequently if events and circumstances +indicate impairment may have occurred. If the carrying value of goodwill exceeds its implied fair value, the Company records an impairment loss equal to the difference. See +Note 6—Goodwill and Intangible Assets for discussion of goodwill balances and discussion of impairment losses recorded during the periods presented. +Earnings per Share +Basic and diluted earnings per common share ("EPS") is presented using the two-class method, which is an earnings allocation formula that determines +earnings per share for common stock and any participating securities according to dividend rights and participation rights in undistributed earnings. Under the two-class method, EPS is computed by +dividing the sum of distributed and undistributed earnings attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. A participating +security is a security that may participate in undistributed +F-14 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +earnings +with common stock had those earnings been distributed in any form. The Company's Series A convertible preferred stock issued in 2014 represents participating securities as holders of +the Series A preferred stock are entitled to receive any and all dividends declared or paid on common stock on an as-converted basis. In addition, shares of the Company's non-vested restricted +stock and restricted stock unit awards are considered participating securities as they represent unvested share-based payment awards containing non-forfeitable rights to dividends. As such, these +participating securities must be included in the computation of EPS pursuant to the two-class method on a pro-rata, as-converted basis. Diluted EPS reflects the potential dilution from securities that +could share in the Company's earnings. In addition, the dilutive effect of each participating security, if any, is calculated using the more dilutive of the two-class method described above. This +method assumes the if-converted method, which assumes +conversion to common stock as of the beginning of the reporting date for any security that is more dilutive upon conversion. Anti-dilutive securities are excluded from diluted EPS. See +Note 15—Earnings Per Share for further discussion. +Beneficial Conversion Feature +The issuance of the Company's Series A preferred stock generated a beneficial conversion feature, which arises when a debt or equity security +is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the conversion option has an effective strike price that is less than the market +price of the underlying stock at the commitment date. Crocs recognized the beneficial conversion feature by allocating the intrinsic value of the conversion option, which is the number of shares of +common stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of common stock per share on the commitment date, to additional +paid-in capital, resulting in a discount on the Series A preferred stock. Crocs is accreting the discount over eight years from the date of issuance through the redemption date. Accretion +expense is recognized as dividend equivalents over the eight-year period utilizing the effective interest method. +Recognition of Revenues +Revenues are recognized when the customer takes title and assumes risk of loss, collection of related receivables is probable, persuasive evidence of +an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country in which the sale occurs and the agreement terms +with the customer. Allowances for estimated returns and discounts are recognized when the related revenue is recognized. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in 'Cost of sales' in the consolidated statements of operation. Shipping and +handling fees billed to customers are included in revenues. +Share-based Compensation +Crocs share-based compensation plans allows stock options, restricted stock, and stock performance awards to be granted to plan participants, which +includes certain officers, employees and members of the Company's Board of Directors (the "Board"). Awards granted under these plans are fair valued, and are amortized, net of estimated forfeitures, +over the vesting period using the straight-line method. The fair +F-15 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +value +of stock options is calculated by using the Monte Carlo simulation model and the Black Scholes option pricing model, both of which require estimates for expected volatility, expected dividends, +the risk-free interest rate, and the term of the option. If any of the assumptions used in these models or the anticipated number of shares to be awarded change significantly, share-based compensation +expense may differ materially in the future from that recorded in the current period. Share-based compensation expense associated with Crocs' manufacturing and retail employees is included in 'Cost of +sales' in the consolidated statements of operations. Share-based compensation expense associated with selling, marketing and administrative employees is included 'Selling, general and administrative +expenses' on the consolidated statements of operations. Share-based compensation directly associated with the construction or implementation of certain long-term projects for internal use are +capitalized to the consolidated balance sheets and will be amortized over the useful life of the assets beginning on the date the asset is placed in service. See Note 12—Equity for +additional information related to share-based compensation. +Defined Contribution Plans +Crocs has a 401(k) plan known as the Crocs, Inc. 401(k) Plan (the "Plan"). The Plan is available to Crocs U.S. employees and provides +employees with tax deferred salary deductions and alternative investment options. The Plan does not provide employees with the option to invest in the Company's common stock. Employees may contribute +up to 75.0% of their salary, subject to certain limitations. The Company matches employees' contributions to the Plan up to a maximum of 4.0% of eligible compensation. The Company's expense related to +the matching contributions to the Plan was $6.0 million, $7.1 million and $6.8 million for the years ended December 31, 2015, 2014, and 2013, respectively. +Advertising +Advertising costs are expensed as incurred and production costs are expensed when the advertising is first run. Total advertising costs reflected in +'Selling, general, and administrative expenses' on the consolidated statement of operations were $58.2 million, $44.7 million and $47.6 million for the years ended +December 31, 2015, 2014, and 2013, respectively. +Research and Development +Research and development costs are expensed as incurred. Research and development expenses were $14.0 million, $16.7 million and +$15.4 million for the years ended December 31, 2015, 2014, and 2013, respectively, and are included in 'Selling, general, and administrative expenses' in the consolidated statement of +operations. +Foreign Currency Translation and Foreign Currency Transactions +Crocs' reporting currency is the U.S. Dollar. Assets and liabilities of foreign operations denominated in local currencies are translated at the rate +of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the applicable period. Adjustments resulting from translating foreign +functional currency financial statements into U.S. Dollars are included in the foreign currency translation adjustment, a component of accumulated other comprehensive income in stockholders' equity. +F-16 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Gains +and losses generated by transactions denominated in currencies other than the local functional currencies are reflected in the consolidated statement of operations in the period in which they +occur and are primarily associated with payables and receivables arising from intercompany transactions. +Derivative Foreign Currency Contracts +Crocs is directly and indirectly affected by fluctuations in foreign currency rates, which may adversely impact its financial performance. To +mitigate the potential impact of foreign currency exchange rate risk, Crocs may employ derivative financial instruments including forward contracts and option contracts. Forward contracts are +agreements to buy or sell a quantity of a currency at a predetermined future date and at a predetermined rate. An option contract is an agreement that conveys the purchaser the right, but not the +obligation, to buy or sell a quantity of a currency at a predetermined rate during a period or at a time in the future. These derivative financial instruments are viewed as risk management tools and +are not used for trading or speculative purposes. Crocs recognizes derivative financial instruments as either assets or liabilities in the consolidated balance sheets and measure those instruments at +fair value. Changes in the fair value of derivatives not designated or effective as hedges are recorded in 'Foreign currency transaction loss, net' in the consolidated statements of operations. Crocs +had no derivative instruments that qualified for hedge accounting during any of the periods presented. See Note 9—Fair Value Measurements and Financial Instruments for further +discussion. +Income Taxes +Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the +expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. Crocs provides for income taxes at the current and future +enacted tax rates and laws applicable in each taxing jurisdiction. Crocs uses a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and +disclosures regarding uncertainties in income tax positions. Crocs recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. +See Note 14—Income Taxes for further discussion. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis +and are therefore excluded from sales. +F-17 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. INVENTORIES +The following table summarizes inventories by major classification as of December 31, 2015 and 2014: +December 31, +2015 +2014 +(in thousands) +Finished goods +$ +162,341 +$ +167,515 +Work-in-progress +918 +703 +Raw materials +4,933 +2,794 +Total inventories, net +$ +168,192 +$ +171,012 +Inventory Write-down +During the year ended December 31, 2015, Crocs recorded approximately $3.1 million of inventory write-down charges related to inventory +with a market value lower than cost, which are reported in 'Cost of sales' in the consolidated statement of operations. During the year ended December 31, 2014, Crocs recorded approximately +$11.5 million of inventory write-down charges related to obsolete inventory with a market value lower than cost, of which $4.0 million was reported in the 'Restructuring charges' +included in gross margin with the remaining amounts reported in 'Cost of sales' in the consolidated statements of operations. During the year ended December 31, 2013, Crocs recorded +approximately $3.4 million of inventory write-down charges related to obsolete inventory with a market value lower than cost. These charges were related to certain obsolete raw materials, +footwear, and accessories and are reported in 'Cost of sales' in the consolidated statement of operations. +5. PROPERTY AND EQUIPMENT +The following table summarizes property and equipment by major classification as of December 31, 2015 and 2014: +December 31, +2015 +2014 +(in thousands) +Machinery and equipment +$ +36,864 +$ +48,989 +Leasehold improvements +81,593 +91,962 +Furniture, fixtures and other +23,576 +23,818 +Assets held for sale(1) +1,595 +— +Construction-in-progress +3,512 +3,318 +Property and equipment, gross(2) +147,140 +168,087 +Less: Accumulated depreciation(3) +(97,650 +) +(99,799 +) +Property and equipment, net +$ +49,490 +$ +68,288 +(1) This +amount represents the South Africa disposal group assets held for sale. +(2) Includes +$0.1 million and $0.2 million of certain equipment held under capital leases and classified as equipment as of December 31, +2015 and 2014, respectively. +F-18 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. PROPERTY AND EQUIPMENT (Continued) +(3) Includes +$0.0 million and $0.1 million of accumulated depreciation related to certain equipment held under capital leases as of +December 31, 2015 and 2014, which are depreciated using the straight-line method over the lease term. During the year ended December 31, 2015, approximately $11.0 million of +accumulated depreciation was related to assets that were written off or disposed. +During +the years ended December 31, 2015, 2014, and 2013, Crocs recorded $16.3 million, $23.2 million, and $24.3 million, respectively, of depreciation expense of which +$1.8 million, $1.7 million, and $2.9 million, respectively, was recorded in 'Cost of sales', with the remaining amounts recorded in 'Selling, general and administrative expenses' +on the consolidated statements of operations. +The +Company recognized a loss on disposals of property and equipment of $1.4 million for the year ended December 31, 2015, and $0.0 million for both years ended +December 31, 2014 and 2013, which is included in the 'other income, net' line on the consolidated statement of operations. +Property and Equipment Asset Impairments +Crocs evaluates its long-lived assets for impairment when events or circumstances indicate the carrying value of a long-lived asset may not be fully +recoverable. During the years ended December 31, 2015, 2014, and 2013, Crocs recorded $9.6 million, $8.8 million, and $10.6 million, respectively, in impairment charges +related to underperforming retail locations that were unlikely to generate sufficient cash flows to fully recover the assets' carrying value over the remaining economic life. During the year ended +December 31, 2015, Crocs recorded an additional $5.7 million of impairment charges associated with assets held for sale in South Africa. The following table summarizes these asset +impairment charges, by reportable operating segment, for the years ended December 31, 2015, 2014, and 2013: +Year Ended December 31, +2015 +2014 +2013 +Impairment +Charge +Number of +Stores(1) +Impairment +Charge +Number of +Stores(1) +Impairment +Charge +Number of +Stores(1) +(in thousands, except store count data) +Americas +$ +7,237 +27 +$ +4,001 +36 +$ +3,861 +23 +Asia Pacific +6,450 +(2) +36 +(2) +2,807 +14 +185 +2 +Europe +1,584 +21 +2,019 +27 +6,565 +35 +Total asset impairment +$ +15,271 +84 +$ +8,827 +77 +$ +10,611 +60 +(1) Represents +stores with partially and fully depreciated assets. +(2) Includes +$5.7 million of impairment related to assets held for sale in nine South Africa retail locations. +Long-Lived Assets Held for Sale +As of December 31, 2015, the Company reclassified its operations in South Africa as held for sale as management approved and committed to a +formal plan to actively market the disposal group and expects the sale to close within the next twelve months. Upon classifying the South Africa disposal group as held for sale, the Company measured +the disposal group at the lower of its carrying value or fair value less any costs to sell, resulting in an impairment loss of $5.7 million during the three months ended December 31, +2015. +F-19 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. GOODWILL & INTANGIBLE ASSETS +The following table summarizes the goodwill and identifiable intangible assets as of December 31, 2015 and 2014: +December 31, 2015 +December 31, 2014 +Gross +Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +(in thousands) +Capitalized software +$ +162,700 +(1) +$ +(82,596 +)(2) +$ +80,104 +$ +157,615 +(1) +$ +(62,591) +(2) +$ +95,024 +Customer relationships +4,016 +(4,016 +) +— +5,945 +(5,798 +) +147 +Patents, copyrights, and trademarks +6,892 +(5,135 +) +1,757 +6,702 +(4,931 +) +1,771 +Core technology(3) +3,498 +(3,498 +) +— +4,170 +(4,170 +) +— +Other +776 +(637 +) +139 +698 +(636 +) +62 +Total finite lived intangible assets +177,882 +(95,882 +) +82,000 +175,130 +(78,126 +) +97,004 +Indefinite lived intangible assets(3) +297 +— +297 +333 +— +333 +Goodwill(3) +1,973 +— +1,973 +2,044 +— +2,044 +Goodwill and intangible assets +$ +180,152 +$ +(95,882 +) +$ +84,270 +$ +177,507 +$ +(78,126 +) +$ +99,381 +(1) Includes +$4.1 million of software held under a capital lease classified as capitalized software as of each of December 31, 2015 and 2014. +During 2013, Crocs began an implementation of a new enterprise resource planning, ("ERP") system, which was placed into service in 2015. As of December 31, 2015 and 2014, Crocs capitalized +$4.1 million and $36.1 million, respectively, for costs associated with the development of and added functionality to the ERP system. +(2) Includes +$3.1 million and $2.5 million of accumulated amortization of software held under a capital lease as of December 31, 2015 and +2014, respectively, which is amortized using the straight-line method over the useful life. +(3) Changes +in core technology, goodwill, and indefinite lived intangible assets relate entirely to the impact of foreign currency translation. +During +the years ended December 31, 2015, 2014, and 2013, amortization expense recorded for intangible assets with finite lives was $19.7 million, $14.2 million and +$17.2 million, respectively, of which $5.8 million, $4.9 million and $6.0 million, respectively, was recorded in 'Cost of sales', with the remaining amounts recorded in +'Selling, general and administrative expenses' on the consolidated statements of operations. +F-20 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. GOODWILL & INTANGIBLE ASSETS (Continued) +The +following table summarizes estimated future annual amortization of intangible assets as of December 31, 2015: +Fiscal years ending December 31, +Amortization +(in thousands) +2016 +$ +18,100 +2017 +16,397 +2018 +14,513 +2019 +12,983 +2020 +10,483 +Thereafter +9,524 +Total +$ +82,000 +Goodwill Impairment +Crocs assesses goodwill for impairment at the reporting unit level on an annual basis on the last day of the year, or more frequently if events and +circumstances indicate impairment may have occurred. If the carrying value of the goodwill exceeds its implied fair value, Crocs records an impairment loss equal to the difference. During the years +ended December 31, 2015 and 2014, Crocs did not record any impairments related to goodwill. During the year ended December 31, 2013, Crocs recorded $0.3 million of goodwill +impairment related to the retail channel of the Crocs Benelux B.V. business purchased by Crocs Stores B.V. subsidiary in July 2012. Goodwill and associated impairments are part of the +Europe segment. +F-21 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +The following table summarizes accrued expenses and other current liabilities as of December 31, 2015 and 2014: +December 31, +2015 +2014 +(in thousands) +Accrued compensation and benefits +$ +20,973 +$ +23,824 +Professional services +15,019 +16,212 +Fulfillment, freight and duties +14,776 +12,110 +Accrued rent and occupancy +7,639 +9,675 +Sales/use and VAT tax payable +7,018 +5,897 +Accrued loss on disposal group(1) +6,743 +— +Customer deposits +3,236 +3,075 +Dividend payable +3,000 +3,067 +Travel and entertainment liabilities +2,150 +199 +Accrued legal liabilities +1,971 +2,150 +Deferred revenue and royalties payable +1,430 +2,005 +Other(2) +7,880 +2,002 +Total accrued expenses and other current liabilities +$ +91,835 +$ +80,216 +(1) This +amount represents accrued losses related to the South Africa disposal group held for sale and is inclusive of $6.7 million in foreign currency +translation adjustments recorded within stockholders' equity. +(2) The +amounts in 'Other' consist of various accrued expenses, of which no individual item accounted for more than 5% of the total balance as of +December 31, 2015 or 2014. +Asset Retirement Obligations +Crocs records a liability equal to the fair value of the estimated future cost to retire an asset, if the liability's fair value can be reasonably +estimated. Crocs' asset retirement obligation ("ARO") liabilities are primarily associated with the disposal of property and equipment that the Company is contractually obligated to remove at the end +of certain retail and office leases in order to restore the facilities back to original condition as specified in the related lease agreements. Crocs estimates the fair value of these liabilities +based on current store closing costs and discounts the costs back as if they were to be performed at the inception of the lease. At the inception of such leases, Crocs records the ARO as a liability +and also records a related asset in an amount equal to the estimated fair value of the obligation. The capitalized asset is then depreciated on a straight-line basis over the useful life of the asset. +Upon retirement of the ARO liability, any difference between the actual retirement costs incurred and the previously recorded estimated ARO liability is recognized as a gain or loss in the +consolidated statements of operations. Crocs' ARO liability as of December 31, 2015 and 2014 was $2.0 million and $2.2 million, respectively. +F-22 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. RESTRUCTURING ACTIVITIES +Restructuring +On July 21, 2014, Crocs announced strategic plans for long-term improvement and growth of the business. These plans comprise four key +initiatives including: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient +organizational structure by reducing excess overhead and enhancing the decision making process, and (4) closing retail locations around the world. The initial effects of these plans were +incurred in 2014 and were continued throughout 2015. During the years ended December 31, 2015 and 2014, the Company recorded restructuring charges of $8.7 million and +$24.5 million, respectively. As of December 31, 2015, Crocs concluded its restructuring efforts. +The +following table summarizes restructuring activity during the years ended December 31, 2015 and 2014: +Year Ended +December 31, +2015 +2014 +(in thousands) +Severance costs +$ +5,472 +$ +12,500 +Lease / contract exit and related costs +2,623 +4,251 +Other(1) +633 +7,766 +Total restructuring charges +$ +8,728 +$ +24,517 +(1) The +amounts in 'Other' consist of various asset and inventory impairment charges prompted by the aforementioned restructuring plan, legal fees and facility +maintenance fees. +The +following table summarizes the Company's total restructuring charges incurred during the years ended December 31, 2015 and 2014 by reportable segment: +Year Ended +December 31, +2015 +2014 +(in thousands) +Americas +$ +890 +$ +4,259 +Asia Pacific +3,542 +7,422 +Europe +2,824 +3,934 +Corporate +1,472 +8,902 +Total restructuring charges +$ +8,728 +$ +24,517 +F-23 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. RESTRUCTURING ACTIVITIES (Continued) +The +following table summarizes the Company's accrued restructuring balance and associated activity from December 31, 2014 through December 31, 2015: +December 31, +2014 +Additions +Cash +Payments +Adjustments(2) +December 31, +2015 +(in thousands) +Severance costs +$ +3,154 +$ +5,472 +$ +(8,000 +) +$ +$ +626 +Lease/ contract exit and related costs +1,401 +2,623 +(3,807 +) +(217 +) +— +Other(1) +304 +633 +(595 +) +342 +Total accrued restructuring +$ +4,859 +$ +8,728 +$ +(12,402 +) +$ +(217 +) +$ +968 +(1) Includes +expenses related to exiting stores and legal fees. +(2) Represents +reversal of prior year accrual as a result of subleasing an exited facility at a better than anticipated rate. +As +of December 31, 2015 and 2014, Crocs had a liability of approximately $1.0 million and $4.9 million, respectively, related to locations already closed and reductions in +workforce in accrued restructuring on the consolidated balance sheet. +9. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +GAAP provides for a fair value hierarchy that prioritizes the inputs to the valuation techniques used to measure fair value into three broad levels. +Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs +are inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs +for the asset or liability. See Note 3—Summary of Significant Accounting Policies for additional detail regarding Crocs' fair value measurement determinations. +As +of December 31, 2015 and 2014, Crocs' assets and liabilities subject to fair value measurements consisted of cash equivalents of $7.5 million and $23.3 million, respectively, +which are Level 1 assets, and foreign currency derivative liabilities of $0.1 million and $0.0 million, respectively, which are Level 2 assets. The Company's Level 1 +assets are classified in the consolidated balance sheets as 'Cash and cash equivalents' and 'Prepaid expenses and other assets' and the Level 2 assets are classified in the consolidated balance +sheets as 'Accrued expenses and other liabilities'. +Non-Recurring Fair Value Measurements +The majority of the Company's non-financial instruments, which include inventories, property and equipment, and intangible assets, are not required +to be carried at fair value on a recurring basis. However, if certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment and the carrying value is +not recoverable, the carrying value would be adjusted to the lower of its cost or fair value and an impairment charge would be recorded. See Note 5—Property and Equipment and +Note 6—Goodwill & Intangible Assets for discussions on impairment charges recorded during the periods presented. +F-24 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. DERIVATIVE FINANCIAL INSTRUMENTS +Crocs transacts business in various foreign countries and is therefore exposed to foreign currency exchange rate risk inherent in revenues, costs, and monetary assets and liabilities denominated in +non-functional currencies. In general, Crocs enters into foreign currency exchange forward contracts and currency swap derivative instruments to selectively protect against volatility in the value of +non-functional currency denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. As these derivative instruments do not qualify as +hedging instruments under the accounting standards for derivatives and hedging, they are recorded at fair value as a derivative asset or liability on the balance sheet with their corresponding change +in fair value recognized in 'Foreign currency transaction loss, net' in the consolidated statements of operations. For purposes of the cash flow statement, Crocs classifies the cash flows from +derivative instruments at +settlement from undesignated instruments in the same category as the cash flows from the related hedged items, generally within 'Cash provided by (used in) operating activities'. +The +following table summarizes the notional amounts of outstanding foreign currency exchange contracts as of December 31, 2015 and December 31, 2014. The notional amounts of the +derivative financial instruments shown below are denominated in their U.S. Dollar equivalents and represent the amount of all contracts of the foreign currency specified. These notional values do not +necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of the Company's exposure to the foreign currency exchange risks. +December 31, +2015 +2014 +(in thousands) +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ +98,390 +$ +44,533 +Euro +34,219 +134,755 +British Pound Sterling +21,859 +17,230 +South Korean Won +7,981 +14,590 +Mexican Peso +7,277 +13,180 +Australian Dollar +6,459 +7,913 +South African Rand +6,402 +4,355 +Indian Rupee +5,036 +3,356 +Canadian Dollar +1,980 +3,005 +New Taiwan Dollar +1,798 +3,229 +Swedish Krona +1,655 +1,918 +Hong Kong Dollar +668 +814 +Russian Ruble +667 +1,838 +Singapore Dollar +— +61,887 +Chinese Yuan Renminbi +— +5,376 +Norwegian Krone +— +917 +New Zealand Dollar +— +743 +Brazilian Real +— +— +Total notional value, net +$ +194,391 +$ +319,639 +Latest maturity date +January 2016 +January 2015 +F-25 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. DERIVATIVE FINANCIAL INSTRUMENTS (Continued) +The +following table presents the amounts affecting the condensed consolidated statements of operations from derivative instruments and exposure from day-to-day business transactions in various foreign +currencies for the years ended December 31, 2015, 2014, and 2013: +Year Ended December 31, +2015 +2014 +2013 +(in thousands) +Foreign currency gain (loss) +$ +3,980 +$ +(1,097 +) +$ +(17,680 +) +Derivatives not designated as hedging instruments: +Foreign currency exchange forwards gain (loss) +(7,312 +) +(3,788 +) +13,002 +Foreign currency transaction loss, net +$ +(3,332 +) +$ +(4,885 +) +$ +(4,678 +) +The +line 'Foreign currency transaction loss, net' on the consolidated statements of operations includes both realized and unrealized gains/losses from underlying foreign currency activity and +derivative contracts. These gains and losses are reported on a net basis. +11. REVOLVING CREDIT FACILITY & BANK BORROWINGS +Senior Revolving Credit Facility +On December 16, 2011, Crocs entered into an Amended and Restated Credit Agreement (as amended, the "Credit Agreement"), with the lenders named +therein and PNC Bank, National Association ("PNC"), as a lender and administrative agent for the lenders. On December 27, 2013, Crocs entered into the Third Amendment to Amended and Restated +Credit Agreement (the "Third Amendment"). The Third Amendment, among other things, allowed for the payment of dividends on the Series A preferred stock and permitted the Company to have greater +flexibility to repurchase its Common Stock. See Note 16—Series A Preferred Stock for further details regarding the payment of dividends on the Series A preferred +stock. +On +April 2, 2015, Crocs entered into the Sixth Amendment to Amended and Restated Credit Agreement (the "Sixth Amendment") pursuant to which certain terms of the Credit Agreement were amended. +The Sixth Amendment primarily amended certain definitions of the financial covenants to be more favorable to Crocs including (i) setting the minimum fixed charge coverage ratio to 1.00 to 1.00 +through December 31, 2015, 1.15 to 1.00 through March 31, 2016 and 1.25 to 1.00 for each quarter thereafter, (ii) setting the leverage ratio to 4.00 to 1.00 through +March 31, 2016 and 3.75 to 1.00 for each quarter thereafter, and (iii) reducing the Company's global cash requirement from $100.0 million to $50.0 million. +On +September 1, 2015, the Company entered into the Eighth Amendment to Amended and Restated Credit Agreement (the "Eighth Amendment") pursuant to which certain terms of the Credit Agreement +were amended. The Eighth Amendment primarily amended certain definitions of the financial covenants to become more favorable to the Company including (i) increasing the exclusion of cash and +non-cash charges from the EBITDAR calculation up to $85.0 million, not to exceed $65.0 million with respect to cash charges, (ii) setting the minimum fixed charge coverage ratio +to 0.95 to 1.00 for the period ended September 30, 2015, (iii) allowing up to $40.0 million in stock repurchases to be made during the quarter ended September 30, 2015, +(iv) suspending stock repurchases if the fixed charge coverage ratio is less than 1.00 to 1.00, and (v) eliminating the administrative agent basket through December 31, 2015. +F-26 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. REVOLVING CREDIT FACILITY & BANK BORROWINGS (Continued) +On +December 24, 2015, the Company entered into the Tenth Amendment to Amended and Restated Credit Agreement (the "Tenth Amendment"), pursuant to which certain terms of the Credit Agreement were +amended. The Tenth Amendment primarily: (i) permitted $18.9 million in bad debt write-downs to be added back to EBITDAR, and (ii) increased the other EBITDAR add-back limit from +$85.0 million (as permitted by Amendment Eight) to $100.0 million. +On +February 18, 2016, the Company entered into the Eleventh Amendment to the Amended and Restated Credit Agreement which primarily: (i) extended the maturity date to February, 2021, +(ii) resized the borrowing capacity of the facility to $75.0 million, (iii) amended certain definitions of the financial covenants to become more favorable to the Company, +(iv) set the minimum fixed charge coverage ratio to 1.00 to 1.00 for the period ended June 30, 2016 and 1.10 to 1.00 thereafter, (v) set the maximum leverage ratio to 2.50 to 1.00 +for the period ended June 30, 2016 and 2.00 to 1.00 thereafter, (vi) allows up to $50.0 million in stock repurchases to be made each fiscal year, subject to certain restrictions, +and (vii) limited certain capital expenditures and commitments to an aggregate of $50.0 million per year. The Eleventh Amendment also changed the variable lending rate. For domestic rate +loans, including swing loans, the interest rate is equal to a daily base rate plus a margin ranging from 0.50% to 0.75% based on certain conditions. For LIBOR rate loans, the interest rate is equal to +a LIBOR rate plus a margin ranging from 1.50% to 1.75% based on certain conditions. +As +of December 31, 2015, the Company was not in compliance with the fixed charge coverage ratio and the leverage ratio under the Credit Agreement. On February 18, 2016, the Company +received a waiver from the lenders of the financial covenants as of December 31, 2015 and the Company entered into the Eleventh Amendment to Amended and Restated Credit Agreement. The Company +anticipates it will be in compliance with its covenants as of March 31, 2016, however, there can be no assurance that the Company will be in compliance at that date. +As +of December 31, 2015 and December 31, 2014, the Company had no outstanding borrowings under the Credit Agreement. As of December 31, 2015 and December 31, 2014, the +Company had outstanding letters of credit of $1.3 million and $1.8 million, respectively, which were reserved against the borrowing base under the terms of the Credit Agreement. During +the years ended December 31, 2015, 2014, and 2013, Crocs capitalized $0.2 million, $0.1 million, and $0.1 million, respectively, in fees and third party costs which were +incurred in connection with the Credit Agreement, as deferred financing costs. +Asia Pacific Revolving Credit Facility +On August 28, 2015, a Crocs subsidiary entered into a revolving credit facility agreement with HSBC Bank (China) Company Limited, Shanghai +Branch ("HSBC") as the lender. The revolving credit facility enables Crocs to borrow uncommitted dual currency revolving loan facilities up to RMB 40.0 million, or the USD equivalent, and +import facilities up to RMB 60.0 million, or the USD equivalent, with a combined facility limit of RMB 60.0 million. This revolving credit facility supports possible future net working +capital needs in China. For loans denominated in USD, the interest rate is 2.1% per annum plus LIBOR for three months or any other period as may be determined by HSBC at the end of each interest +period. For loans denominated in RMB, interest equals the one year benchmark lending rate effective on the loan drawdown date set forth by the People's Bank of China with a 10% mark-up and is payable +on the maturity date of the related loan. The revolving credit facility is guaranteed by Crocs, Inc. and certain accounts receivables in China are +pledged as security under the revolving credit facility. The revolving credit facility can be canceled or suspended at any time at the discretion of the lender and contains provisions requiring Crocs +F-27 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. REVOLVING CREDIT FACILITY & BANK BORROWINGS (Continued) +to +maintain compliance with certain restrictive covenants. As of December 31, 2015, Crocs had no outstanding borrowings under the revolving credit facility. As of December 31, 2015, the +Company has received notification from the lender that the revolving credit facility has been temporarily suspended. +Long-term Bank Borrowings +On December 10, 2012, Crocs entered into a Master Installment Payment Agreement ("Master IPA") with PNC in which PNC financed the Company's +recent implementation of a new ERP system, which began in October 2012 and was substantially completed in early 2015. The terms of each note payable, under the Master IPA, consist of a fixed interest +rate and payment terms based on the amount borrowed and the timing of activity throughout the implementation of the ERP system. The Master IPA is subject to cross-default, cross-termination, and is +coterminous with the Credit Agreement. +As +of December 31, 2015 and 2014, Crocs had $6.4 million and $11.6 million, respectively, of debt outstanding under five separate notes payable, of which $4.8 million and +$5.3 million, respectively, represents current installments. As of December 31, 2015, the notes bear interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 +to September 2017. As this debt arrangement relates solely to the construction and implementation of an ERP system for use by the entity, interest expense was capitalized to the consolidated balance +sheets and amortized over the life of the assets, starting on the January 1, 2015 in-service date. During the years ended December 31, 2015 and 2014, Crocs capitalized +$0.0 million and $0.4 million, respectively, in interest expense related to this debt arrangement +F-28 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. REVOLVING CREDIT FACILITY & BANK BORROWINGS (Continued) +to +the consolidated balance sheets. Interest rates and payment terms are subject to changes as further financing occurs under the Master IPA. +December 31, 2015 +Unused Borrowing +Capacity(2) +Carrying Value(3) +Weighted Average +Interest Rate(1) +Borrowing +Currency +U.S.D. +Equivalent +December 31, +2015 +December 31, +2014 +(in thousands) +Debt obligations +Senior revolving credit facility +LIBOR plus 1.25% - 2.00% +$ +75,000 +(4) +$ +75,000 +(4) +$ +— +$ +— +Asia Pacific revolving credit facility +LIBOR plus 2.10% +RMB +— +(5) +— +(5) +— +— +Long-term bank borrowings +2.63% +6,375 +11,646 +Total +$ +75,000 +6,375 +11,646 +Capital lease obligations +24 +23 +Total debt and capital lease obligations +$ +6,399 +$ +11,669 +Current maturities +$ +4,772 +$ +5,288 +Long-term debt and capital lease obligations +$ +1,627 +$ +6,381 +(1) Carrying +value represents the weighted average interest rate in effect at December 31, 2015 for all borrowings outstanding pursuant to each debt +instrument, including any applicable margin. The interest rates presented represent stated rates and do not include the impact of the derivative instruments, deferred financing costs, original issue +premiums or discounts and commitment fees, all of which affect Crocs' overall cost of borrowing. +(2) Unused +borrowing capacity represents the maximum available under the applicable facility at December 31, 2015 without regard to covenant compliance +calculations or other conditions precedent to borrowing. +(3) As +the interest rate of each credit agreement is variable, typically based on the daily LIBOR rates plus an additional margin, the estimated fair value of +each debt instrument approximates its carrying value. +(4) On +February 18, 2016, the Company entered into the Eleventh Amendment to the Amended and Restated Credit Agreement, which extended the maturity date +to February 2021, resized the borrowing capacity of the facility to $75.0 million, and amended certain definitions of the financial covenants to become more favorable to the Company. +(5) As +of December 31, 2015, Crocs received notification that the Asia Pacific revolving credit facility had been temporarily suspended. +F-29 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. REVOLVING CREDIT FACILITY & BANK BORROWINGS (Continued) +The maturities of the Company's debt obligations as of December 31, 2015 are presented below: +December 31, +2015 +(in thousands) +Maturities of debt and capital lease obligations +2016 +$ +4,772 +2017 +1,616 +2018 +4 +Thereafter +7 +Total principal debt maturities +$ +6,399 +Current portion +$ +4,772 +Noncurrent portion +$ +1,627 +As +of December 31, 2015 and 2014, the fair value of the Company's debt instruments approximates their reported carrying amounts. +12. EQUITY +Equity Incentive Plans +On August 15, 2005, the Company adopted the 2005 Equity Incentive Plan (the "2005 Plan"), which permitted the issuance of up to +14.0 million common shares in connection with the grant of non-qualified stock options, incentive stock options, and restricted stock to eligible employees, consultants, and members of the +Board. As of December 31, 2015 and 2014, 0.5 million and 0.6 million stock options, respectively, were outstanding under the 2005 Plan. Following the adoption of the 2007 Equity +Incentive Plan (the "2007 Plan"), described below, no additional grants were made under the 2005 Plan. +On +July 9, 2007, the Company adopted and on June 28, 2011 the Company amended the 2007 Plan, which increased the allowable number of shares of common stock reserved for issuance under +the 2007 Plan from 9.0 million to 15.3 million (subject to adjustment for future stock splits, stock dividends, and similar changes in the Company's capitalization) in connection with +the grant of non-qualified stock options, incentive stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, common stock, or any other share-based award +to eligible employees, consultants, and members of the Board. As of December 31, 2015 and 2014, 3.5 million and 3.1 million shares of common stock, respectively, were issuable +under the 2007 Plan pursuant to outstanding stock options and RSUs. Following the adoption of the 2015 Equity Incentive Plan (the "2015 Plan"), described below, no additional grants will be made under +the 2007 Equity Incentive Plan. +On +June 8, 2015, the Company adopted the 2015 Plan. Shares reserved and authorized for issuance under the Plan consist of 7,000,000 shares, plus up to 1,192,777 shares available for issuance +under the Company's 2007 Plan as of June 8, 2015, plus up to 4,916,835 shares subject to outstanding awards under the 2007 Plan that are cancelled or forfeited after the effective date of the +2015 Plan. Shares in the 2015 Plan are subject to adjustment for future stock splits, stock dividends, and similar changes in Crocs' capitalization in connection with the grant of non-qualified stock +options, incentive stock options, +F-30 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. EQUITY (Continued) +restricted +stock, restricted stock units, stock appreciation rights, performance units, common stock, or any other share-based award to eligible employees, consultants, and members of the Board. +Restricted +stock awards and units generally vest annually on a straight-line basis over three or four years depending on the terms of the award agreement. +Stock Option Activity +The following table summarizes stock option activity for the years ended December 31, 2015, 2014, and 2013: +Shares +Weighted Average +Exercise Price +Weighted Average +Remaining +Contractual Life +(Years) +Aggregate +Intrinsic +Value +(in thousands) +Outstanding as of December 31, 2012 +2,621,686 +$ +13.03 +5.55 +$ +11,373 +Granted +177,000 +$ +15.62 +Exercised +(333,395 +) +$ +6.84 +Forfeited or expired +(360,139 +) +$ +18.18 +Outstanding as of December 31, 2013 +2,105,152 +$ +13.34 +4.86 +$ +10,790 +Granted +119,000 +$ +14.22 +Exercised +(265,675 +) +$ +5.05 +Forfeited or expired +(262,347 +) +$ +21.02 +Outstanding as of December 31, 2014 +1,696,130 +$ +13.52 +3.88 +$ +4,435 +Granted +35,000 +$ +13.52 +Exercised +(284,791 +) +$ +6.54 +Forfeited or expired +(150,590 +) +$ +21.82 +Outstanding as of December 31, 2015 +1,295,749 +$ +14.09 +2.83 +$ +1,261 +Exercisable at December 31, 2015 +1,159,445 +$ +14.06 +2.21 +$ +1,261 +Vested and expected to vest at December 31, 2015 +1,295,749 +$ +14.09 +2.78 +$ +1,261 +During +the years ended December 31, 2015, 2014, and 2013, options issued were valued using the Black Scholes option pricing model using the following assumptions: +Year Ended December 31, +2015 +2014 +2013 +Expected volatility +43% +44% - 50% +50 - 64% +Dividend yield +— +— +— +Risk-free interest rate +1.50% - 1.72% +1.41% - 1.71% +0.81% - 1.62% +Expected life (in years) +4.00 +4.00 +4.00 +The +weighted average computed value of options granted during the years ended December 31, 2015, 2014, and 2013 was approximately $4.74, $5.35, and $7.33, respectively. The aggregate intrinsic +value of options exercised during the years ended December 31, 2015, 2014, and 2013 was $1.7 million, $2.7 million, +F-31 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. EQUITY (Continued) +and +$2.8 million, respectively. During the years ended December 31, 2015 and 2014, Crocs received $1.9 million and $1.3 million in cash in connection with the exercise of +stock options with no income tax +benefit due to the Company's use of ASC 740—'Income Taxes' (with-and-without approach) ("ASC 740") ordering for purposes of determining when excess benefits have been realized (see +Note 14—Income Taxes). The total grant date fair value of stock options vested during the years ended December 31, 2015, 2014, and 2013 was $0.7 million, +$0.8 million, and $1.2 million, respectively. +As +of December 31, 2015, Crocs had $0.7 million of total unrecognized share-based compensation expense related to unvested options, net of expected forfeitures, which is expected to be +amortized over the remaining weighted average period of 2.52 years. +Stock +options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first year vesting at the end of the first year, followed by monthly vesting for the remaining +three years. +Restricted Stock Awards and Units +From time to time, Crocs grants restricted stock awards ("RSAs") and restricted stock units ("RSUs") to its employees. RSAs and RSUs generally vest +over three or four years, depending on the terms of the grant. Unvested RSAs have the same rights as those of common shares including voting rights and non-forfeitable dividend rights. However, +ownership of unvested RSAs cannot be transferred until they are vested. An unvested RSU is a contractual right to receive a share of common stock only upon its vesting. RSUs have dividend equivalent +rights which accrue over the term of the award and are paid if and when the RSUs vest, but they have no voting rights. +Crocs +typically grants time-based RSUs and performance-based RSUs. Time-based RSUs are typically granted on an annual basis to certain non-executive employees and vest in three annual installments on +a straight-line basis beginning one year after the grant date. During the years ended December 31, 2015, 2014, and 2013, the Board approved grants of 0.4 million, 0.3 million, and +0.4 million RSUs to certain non-executives. Performance-based RSUs are typically granted on an annual basis to certain executive +F-32 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. EQUITY (Continued) +employees +and consist of a time-based and performance-based component. The following represents the vesting schedule of performance-based RSUs granted during the year ended December 31, 2015: +Performance Vested RSUs +Time Vested RSUs +Performance Goals +By Weight +Potential Award +Further Time Vesting +Vest in 3 annual installments beginning one year after the date of grant +Weight 50% - +Achievement of at least 85% of a one-year Earnings Before Interest and Taxes ("EBIT") performance target +Executive may earn from 0% to 200% of the performance-based RSUs based on the level of achievement of the performance goal +1/3 of the earned RSUs vest upon certification of achievement by the Compensation Committee and 2/3 vest equally on the one- and two-year anniversary of the certification +date +Weight 30% - +Achievement of at least 85% of a one-year revenue performance target +Executive may earn from 0% to 200% of the performance-based RSUs based on the level of achievement of the performance goal +1/3 of the earned RSUs vest upon certification of achievement by the Compensation Committee and 2/3 vest equally on the one-and two-year anniversary of the certification date +Weight 20% - +Achievement of at least 80% of a one-year free cash flow performance target +Executive may earn from 0% to 200% of the performance-based RSUs based on the level of achievement of the performance goal +1/3 of the earned RSUs vest upon certification of achievement by the Compensation Committee and 2/3 vest equally on the one- and two-year anniversary of the certification date +F-33 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. EQUITY (Continued) +The +following represents the vesting schedule of performance-based RSUs granted during the year ended December 31, 2014: +Performance Vested RSUs (50% of Award) +Time Vested RSUs +(50% of Award) +Performance Goals—each +weighted 50% +Potential Award +Further Time Vesting +Vest in 3 annual installments beginning one year after the date of grant +Achievement of at least 70% of a one-year cumulative earnings per share performance goal +Executive may earn from 50% to 200% of the target number of RSUs based on the level of achievement of the performance goal +Earned RSUs vest 50% upon satisfaction of performance goal and 50% on the one-year anniversary of the end of the performance period +Achievement of at least 90% of a one-year revenue performance goal +Executive may earn from 50% to 200% of the target number of RSUs based on the level of achievement of the performance goal +Earned RSUs vest 50% upon satisfaction of performance goal and 50% on the one-year anniversary of the end of the performance period +The +following represents the vesting schedule of performance-based RSUs granted during the years ended December 31, 2013: +Performance Vested RSUs (50% of Award) +Time Vested RSUs +(50% of Award) +Performance Goal +Potential Award +Further Time Vesting +Vest in 3 annual installments beginning one year after the date of grant +Achievement of at least 70% of a two-year cumulative earnings per share performance goal +Executive may earn from 50% to 200% of the target number of RSUs based on the level of achievement of the performance goal +Earned RSUs vest 50% upon satisfaction of performance goal and 50% one year later +F-34 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. EQUITY (Continued) +During the years ended December 31, 2015, 2014, and 2013, the Board approved the grant of 1.5 million, 0.9 million, and 0.9 million, respectively, RSUs or RSAs to certain +executives as part of a performance incentive program. +The +following table summarizes RSA and RSU activity during the years ended December 31, 2015, 2014, and 2013: +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted +Average +Grant Date +Fair Value +Units +Weighted +Average +Grant Date +Fair Value +Unvested at December 31, 2012 +355,509 +$ +13.37 +1,414,661 +$ +20.61 +Granted +21,590 +$ +16.56 +1,637,114 +$ +14.96 +Vested +(89,006) +(1) +$ +14.81 +(329,542) +(1) +$ +21.52 +Forfeited +(77,603 +) +$ +12.46 +(756,566 +) +$ +14.71 +Unvested at December 31, 2013 +210,490 +$ +13.43 +1,965,667 +$ +16.50 +Granted +9,973 +$ +15.04 +1,749,993 +$ +16.05 +Vested +(68,420) +(1) +$ +15.03 +(541,888) +(1) +$ +17.64 +Forfeited +(144,555 +) +$ +12.67 +(1,176,301 +) +$ +16.51 +Unvested at December 31, 2014 +7,488 +$ +15.61 +1,997,471 +$ +15.78 +Granted +15,987 +$ +15.01 +2,866,562 +$ +10.14 +Vested +(15,480) +(1) +$ +15.30 +(505,025) +(1) +$ +16.20 +Forfeited +(1,328 +) +$ +15.00 +(1,270,630 +) +$ +14.14 +Unvested at December 31, 2015 +6,667 +$ +15.00 +3,088,378 +$ +10.75 +(1) The +RSAs vested during the years ended December 31, 2015, 2014, and 2013 consisted entirely of time-based awards. The RSUs vested during the year +ended December 31, 2015 consisted of 67,893 performance-based awards and 437,132 time-based awards. The RSUs vested during the year ended December 31, 2014 consisted of 30,946 +performance-based awards and 510,942 time-based awards. The RSUs vested during the year ended December 31, 2013 consisted of 52,288 performance-based awards and 277,254 time-based awards. +The +total grant date fair value of RSAs vested during the years ended December 31, 2015, 2014, and 2013 was $0.2 million, $1.0 million, and $1.3 million, respectively. As +of December 31, 2015, Crocs had $0.1 million of total unrecognized share-based compensation expense related to non-vested restricted stock awards, net of expected forfeitures, all of +which was related to time-based awards. As of +December 31, 2015, the unvested RSAs are expected to be amortized over the remaining weighted average period of 0.44 years. +The +total grant date fair value of RSUs vested during the years ended December 31, 2015, 2014, and 2013 was $8.2 million, $9.6 million and $7.1 million, respectively. As of +December 31, 2015, Crocs had $18.5 million of total unrecognized share-based compensation expense related to unvested restricted stock units, net of expected forfeitures, of which +$5.7 million is related to performance-based awards and $12.8 million is related to time-based awards. As of December 31, 2015, the unvested RSUs are expected to be amortized over +the remaining weighted average period of 1.84 years, which consists of a remaining +F-35 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. EQUITY (Continued) +weighted +average period of 1.73 years related to performance-based awards and a remaining weighted average period of 1.95 years related to time-based awards. +Share-based Compensation +During the years ended December 31, 2015, 2014, and 2013, Crocs recorded $11.2 million, $12.7 million, and $12.5 million, +respectively, of pre-tax share-based compensation expense of which $0.0 million, $0.2 million, and $0.7 million, respectively, related solely to the construction and +implementation of the Company's ERP, which was capitalized to the consolidated balance sheets and amortized over the useful life of the software beginning on the January 1, 2015 in-service +date. +Appointment of CFO +On November 4, 2015, the Board appointed Carrie Teffner as Executive Vice President and Chief Financial Officer, effective December 16, +2015. In connection with her appointment, Ms. Teffner resigned as a member of the Board and now serves as the Company's principal financial officer and principal accounting officer. +Upon +the commencement of her employment, Ms. Teffner was granted a time-vesting RSU award representing the right to receive shares of the Company's common stock equal to $1,000,000, based on a +30-day weighted-average stock price as of the date Ms. Teffner's appointment was publicly announced. RSUs will vest in three annual installments beginning on the first anniversary of her start +date, subject to her continued employment with the Company as of each vesting date. +In +addition, Ms. Teffner was granted a performance-vesting RSU award, representing the right to receive shares of the Company's common stock equal to $1,000,000, based on a 30-day +weighted-average stock price as of the date Ms. Teffner's appointment was publicly announced. The RSUs vest based on the achievement of certain share price levels on or before the fourth +anniversary of her start date, subject to continued employment with the Company. +F-36 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. ALLOWANCES +The changes in the allowance for doubtful accounts, inclusive of unapplied rebate reserves, and reserve for sales returns and allowances for the years ended December 31, 2015, 2014, and 2013, +are as follows: +Consolidated reserves and allowances +Allowance for +doubtful accounts +Reserve for sales +returns and +allowances +Reserve for +unapplied rebates +Total +(in thousands) +Beginning balance at December 31, 2012 +$ +(3,441 +) +$ +(7,086 +) +$ +(2,788 +) +$ +(13,315 +) +Reduction in revenue +— +(55,784 +) +(5,420 +) +(61,204 +) +Expense +(1,930 +) +— +— +(1,930 +) +Recoveries, applied amounts, and write-offs +1,715 +57,460 +6,761 +65,936 +Ending balance at December 31, 2013 +(3,656 +) +(5,410 +) +(1,447 +) +(10,513 +) +Reduction in revenue +— +(69,834 +) +(5,397 +) +(75,231 +) +Expense +(12,087 +) +— +— +(12,087 +) +Recoveries, applied amounts, and write-offs +2,134 +68,030 +(4,725 +) +65,439 +Ending balance at December 31, 2014 +(13,609 +) +(7,214 +) +(11,569 +) +(32,392 +) +Reduction in revenue +— +(71,649 +) +(11,106 +) +(82,755 +) +Expense +(26,225 +) +— +— +(26,225 +) +Recoveries, applied amounts, and write-offs +3,466 +74,224 +14,318 +92,008 +Ending balance at December 31, 2015 +$ +(36,368 +) +$ +(4,639 +) +$ +(8,357 +) +$ +(49,364 +) +During +the year ended December 31, 2015, Crocs had multiple China distributors default on their payment obligations. As a result, the Company reassessed the collectability of its accounts +receivable balances for its China operations and concluded that a significant increase in the allowance for doubtful accounts was required. Accordingly, Crocs has increased its China allowance for +doubtful accounts by $23.2 million, resulting in total allowances in China of $36.4 million and $21.1 million as of +December 31, 2015 and 2014, respectively. The Company's net accounts receivable balance for its China operations as of December 31, 2015 and 2014 was $5.1 million and +$17.5 million, respectively. +F-37 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. ALLOWANCES (Continued) +The +changes in the allowance for doubtful accounts, inclusive of unapplied rebate reserves, and reserves for sale returns and allowances related to China operations for the years ended +December 31, 2015, 2014, and 2013, are as follows: +China reserves and allowances +Allowance for +doubtful accounts +Reserve for sales +returns and +allowances +Reserve for +unapplied rebates +Total +(in thousands) +Beginning balance at December 31, 2012 +$ +(77 +) +$ +(87 +) +$ +(2,865 +) +$ +(3,029 +) +Reduction in revenue +— +(2,371 +) +— +(2,371 +) +Expense +37 +— +— +37 +Recoveries, applied amounts, and write-offs +16 +2,233 +1,814 +4,063 +Ending balance at December 31, 2013 +(24 +) +(225 +) +(1,051 +) +(1,300 +) +Reduction in revenue +— +(6,921 +) +— +(6,921 +) +Expense +(8,552 +) +— +— +(8,552 +) +Recoveries, applied amounts, and write-offs +136 +3,103 +(7,572 +) +(4,333 +) +Ending balance at December 31, 2014 +(8,440 +) +(4,043 +) +(8,623 +) +(21,106 +) +Reduction in revenue +— +(7,769 +) +(3,511 +) +(11,280 +) +Expense +(23,163 +) +— +— +(23,163 +) +Recoveries, applied amounts, and write-offs +1,315 +11,618 +6,172 +19,105 +Ending balance at December 31, 2015 +$ +(30,288 +) +$ +(194 +) +$ +(5,962 +) +$ +(36,444 +) +As +of December 31, 2015 and 2014, China operations accounted for $41.6 million and $38.6 million, respectively, of the Company's total gross accounts receivable balances, of which +$38.2 million and $36.9 million, respectively, were past due. As of December 31, 2015 and 2014, China operations had total accounts receivable reserves of $36.4 million and +$21.1 million, respectively, associated with these receivables. +F-38 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. INCOME TAXES +The following table sets forth income before taxes and the expense for income taxes for the years ended December 31, 2015, 2014, and 2013: +December 31, +2015 +2014 +2013 +(in thousands) +Income (loss) before taxes: +U.S. +$ +(83,537 +) +$ +(34,622 +) +$ +(7,818 +) +Foreign +8,793 +26,073 +67,777 +Total income (loss) before taxes +(74,744 +) +(8,549 +) +59,959 +Income tax expense: +Current income taxes +U.S. federal +480 +(12,049 +) +3,311 +U.S. state +195 +(23 +) +355 +Foreign +7,488 +7,620 +22,337 +Total current income taxes +8,163 +(4,452 +) +26,003 +Deferred income taxes: +U.S. federal +(3,902 +) +400 +14,968 +U.S. state +(118 +) +236 +3,639 +Foreign +4,309 +193 +4,929 +Total deferred income taxes +289 +829 +23,536 +Total income tax expense (benefit) +$ +8,452 +$ +(3,623 +) +$ +49,539 +The +following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes for the years ended December 2015, 2014, and +2013: +December 31, +2015 +2014 +2013 +(in thousands) +Federal income tax rate +$ +(26,160 +) +35.0 +% +$ +(2,992 +) +35.0 +% +$ +20,781 +35.0 +% +State income tax rate, net of federal benefit +(543 +) +0.7 +2,598 +(30.4 +) +(373 +) +(0.6 +) +Effect of rate differences +(3,678 +) +4.9 +5,317 +(62.2 +) +(28,671 +) +(47.9 +) +Non-deductible / Non-taxable items +(2,181 +) +2.9 +(9,904 +) +115.8 +2,231 +3.4 +Change in valuation allowance +10,892 +(14.5 +) +5,370 +(62.8 +) +21,370 +35.6 +U.S. tax on foreign earnings +32,879 +(43.9 +) +6,620 +(77.4 +) +22,877 +38.2 +Uncertain tax positions +(3,952 +) +5.3 +(25,172 +) +294.4 +4,091 +6.8 +Audit settlements +1,167 +(1.6 +) +13,448 +(157.3 +) +3,035 +5.1 +Non-deductible write-off of intercompany debt +— +— +— +— +1,114 +1.9 +Non-deductible impairment +— +— +— +— +2,118 +3.5 +Write-off of income tax receivable +— +— +1,577 +(18.4 +) +— +— +Other +28 +(0.1 +) +(485 +) +5.7 +966 +1.6 +Effective income tax rate +$ +8,452 +(11.3 +)% +$ +(3,623 +) +42.4 +% +$ +49,539 +82.6 +% +F-39 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. INCOME TAXES (Continued) +The following table sets forth deferred income tax assets and liabilities as of December 2015 and 2014: +December 31, +2015 +2014 +(in thousands) +Current deferred tax assets: +Accrued expenses +$ +— +$ +13,217 +Unrealized loss on foreign currency +— +342 +Other +— +— +Valuation allowance +— +(7,008 +) +Total current deferred tax assets(1) +$ +— +$ +6,551 +Current deferred tax liabilities: +Unremitted earnings of foreign subsidiary +$ +— +$ +(14,186 +) +Other +— +(44 +) +Total current deferred tax liabilities(1) +$ +— +$ +(14,230 +) +Non-current deferred tax assets: +Stock compensation expense +$ +7,142 +$ +9,760 +Long-term accrued expenses +26,114 +6,773 +Net operating loss and charitable contribution carryovers +22,518 +20,047 +Intangible assets +4,725 +1,517 +Property and equipment +— +12,097 +Future uncertain tax position offset +456 +445 +Unrealized loss on foreign currency +466 +— +Foreign tax credit +27,109 +6,259 +Other +5,548 +1,207 +Valuation allowance +(56,572 +) +(40,273 +) +Total non-current deferred tax assets +$ +37,506 +$ +17,832 +Non-current deferred tax liabilities: +Unremitted earnings of foreign subsidiary +$ +(24,572 +) +$ +— +Property and equipment +(6,432 +) +— +Total non-current deferred tax liabilities +$ +(31,004 +) +$ +— +(1) In +November 2015, the FASB issued guidance to simplify the financial statement presentation of deferred income taxes. The new guidance requires an entity to +present deferred tax assets and liabilities as non-current in a classified balance sheet. Prior to the issuance of this guidance, deferred tax liabilities and assets were required to be separately +classified into a current amount and a non-current amount in the balance sheet. The new guidance represents a change in accounting principle and is effective for annual reporting periods beginning +after December 15, 2016, with early adoption permitted. The Company elected to early adopt this guidance as of December 31, 2015 and to apply it prospectively. Prior period information +was not adjusted. Because the application of this guidance affects the balance sheet classification only, adoption of this guidance did not have a material impact on our consolidated financial +statements. +F-40 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. INCOME TAXES (Continued) +As +of December 31, 2015, U.S. income and foreign withholding taxes have not been provided on for approximately $249.3 million of unremitted earnings of subsidiaries operating outside of +the U.S. These earnings are estimated to represent the excess of the financial reporting over the tax basis in Crocs' investments in those subsidiaries. These earnings, which are considered to be +indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of +unrecognized deferred U.S. income tax liability on the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +Crocs +maintains a valuation allowance of $56.5 million on certain deferred tax assets in various tax jurisdictions for which the Company believes it is not more-likely-than-not to realize, and +relate primarily to state and foreign net operation losses and other tax attributes across all jurisdictions. +As +a result of certain accounting realization requirements, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets as of December 31, 2015 +that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity would be increased by $18.2 million if and when such +deferred tax assets are ultimately realized. Crocs applies ASC 740 with-and-without ordering for purposes of determining when excess tax benefits have been realized. +The +following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits during the years ended December 31, 2015, 2014, and 2013: +December 31, +2015 +2014 +2013 +(in thousands) +Unrecognized tax benefit—January 1 +$ +8,444 +$ +31,616 +$ +31,900 +Gross increases—tax positions in prior period +643 +7 +572 +Gross decreases—tax positions in prior period +(385 +) +(3,711 +) +(2,086 +) +Gross increases—tax positions in current period +549 +904 +3,743 +Settlements +(4,126 +) +(20,210 +) +(2,291 +) +Lapse of statute of limitations +(168 +) +(162 +) +(222 +) +Unrecognized tax benefit—December 31 +$ +4,957 +$ +8,444 +$ +31,616 +Unrecognized +tax benefits of $5.0 million, $8.4 million and $31.6 million as of December 31, 2015, 2014, and 2013, respectively, if recognized, would reduce the annual +effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The +Company also recorded a net benefit of $2.8 million related to increases in 2015 unrecognized tax benefits, net of amounts effectively settled under audit in several major jurisdictions +including Japan and Finland. Although the timing of the resolution, settlement, and closure of any audits is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax +benefits could significantly change in the next 12 months. However, given the number of years remaining that are subject to examination, Crocs is unable to estimate the full range of possible +adjustments to the balance of gross unrecognized tax benefits. +As +it relates to the impact of uncertain tax positions on the rate reconciliation, the primary impact includes audit settlements, net increases in position changes (both are noted as part of the tax +position tabular disclosure), and accrued interest expense. The gross impact of positions effectively settled are disclosed +F-41 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. INCOME TAXES (Continued) +separately +as audit settlements. The net benefit related to audit settlements is not expected to recur in future periods. Note that the interest component, while carried as a liability on the balance +sheet and recorded as a component of tax expense, is excluded from the tabular disclosure pursuant to the guidance under ASC 740-10-50. +Interest +and penalties related to income tax liabilities are included in income tax expense in the consolidated statement of operations. For the years ended December 31, 2015, 2014 and 2013, +Crocs recorded approximately $0.2 million, $0.8 million and $0.6 million, respectively, of penalties and interest. During the year ended December 31, 2015, Crocs released +$0.6 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $0.5 million, $0.9 million and +$5.0 million, as of December 31, 2015, 2014 and 2013, respectively. +The +following table sets forth the tax years subject to examination for the major jurisdictions where the Company conducts business as of December 31, 2015: +Netherlands +2008 to 2015 +Canada +2008 to 2015 +Japan +2009 to 2015 +China +2007 to 2015 +Singapore +2011 to 2015 +United States +2011 to 2015 +State +income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to +examination by various state jurisdictions for a period up to two years after formal notification to the states. +F-42 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. EARNINGS PER SHARE +The following table illustrates the basic and diluted earnings (loss) per share ("EPS") computations for the years ended December 31, 2015, 2014, and 2013. See Note 3—Summary +of Significant Accounting Policies for additional detail regarding the Company's EPS calculations. +Year Ended December 31, +2015 +2014 +2013 +(in thousands) +Numerator +Net income (loss) attributable to common stockholders +$ +(98,007 +) +$ +(18,962 +) +$ +10,420 +Less: adjustment for income allocated to participating securities +— +— +(36 +) +Net income (loss) attributable to common stockholders—basic and diluted +$ +(98,007 +) +$ +(18,962 +) +$ +10,384 +Denominator +Weighted average common shares outstanding—basic +75,604 +85,140 +87,989 +Plus: dilutive effect of stock options and unvested restricted stock units +— +— +1,100 +Weighted average common shares outstanding—diluted +75,604 +85,140 +89,089 +Net income (loss) attributable per common share: +Basic +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +Diluted +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +Diluted +EPS is calculated using the two-class method for options and RSUs and the if-converted method for Series A preferred stock. For the years ended December 31, 2015, 2014, and 2013, +2.1 million, 2.0 million, and 1.0 million options and RSUs, respectively, were excluded in the calculation of diluted EPS under the two-class method because the effect would be +anti-dilutive. The Series A preferred shares were excluded in the calculation of diluted EPS under the if-converted method because the effect would be anti-dilutive. If converted, +Series A preferred stock would represent approximately 15.9% of the Company's common stock outstanding or 13.8 million additional common shares, as of December 31, 2015. See +Note 16—Series A Preferred Stock for further details regarding the preferred share offering. +Stock Repurchase Plan Authorizations +Crocs continues to evaluate options to maximize the returns on its cash and maintain an appropriate capital structure, including, among other +alternatives, repurchases of common stock. On December 26, 2013, Crocs' Board approved the repurchase of up to $350.0 million of the Company's common stock. The number, price, structure, +and timing of the repurchases will be at the Company's sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs, and other factors. Share +repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate Crocs to acquire any particular +amount of its common stock. The Board may suspend, modify or terminate the repurchase program at any time without prior notice. +During +the year ended December 31, 2015, Crocs repurchased approximately 6.5 million shares at a weighted average price of $13.24 per share for an aggregate price of approximately +$85.9 million, including related commission charges, under the publicly announced repurchase plan. During the year ended +F-43 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. EARNINGS PER SHARE (Continued) +December 31, +2014, Crocs repurchased approximately 10.6 million shares at a weighted average price of $13.75 per share for an aggregate price of approximately $145.6 million, +excluding related commission charges. As of December 31, 2015, subject to certain restrictions on repurchases under the Company's revolving credit facility, Crocs had $118.7 million +remaining under the repurchase authorizations. +16. SERIES A PREFERRED STOCK +On January 27, 2014, Crocs issued 200,000 shares of Series A preferred stock to Blackstone Capital Partners VI L.P. ("Blackstone") and certain of its permitted transferees, for an +aggregate purchase price of $198.0 million, or $990.00 per share, pursuant to an Investment Agreement between Crocs and Blackstone, dated December 28, 2013 (as amended, the "Investment +Agreement"). In connection with the issuance of the Series A preferred stock, Crocs received proceeds of $182.2 million after deducting the issuance discount of $2.0 million and +direct and incremental expenses of $15.8 million including financial advisory fees, closing costs, legal expenses, and other offering-related expenses. +Participation Rights and Dividends +The Series A preferred stock ranks senior to the Company's common stock with respect to dividend rights and rights on liquidation, winding-up, +and dissolution. The Series A preferred stock has a stated value of $1,000 per share, and holders of Series A preferred stock are entitled to cumulative dividends payable quarterly in +cash at a rate of 6% per annum. If Crocs fails to make timely dividend payments, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in +full. Holders of Series A preferred stock are entitled to receive dividends declared or paid on the Company's common stock and are entitled to vote together with the holders of the Company's +common stock as a single class, in each case, on an as-converted basis. As of December 31, 2015 and 2014, Crocs had accrued dividends of $3.0 million and $3.1 million, +respectively on the consolidated balance sheets, which were paid in cash to holders of the Series A preferred stock on January 4, 2016 and January 2, 2015, respectively. Holders +of Series A preferred stock have certain limited special approval rights, including with respect to the issuance of pari passu or senior equity +securities of the Company. +Conversion Features +The Series A preferred stock is convertible at the option of the holders at any time after the closing into shares of common stock at an +implied conversion price of $14.50 per share, subject to adjustment. At the Company's election, all or a portion of the Series A preferred stock will be convertible into the relevant number of +shares of common stock on or after the third anniversary of the closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days. The Series A +preferred stock is convertible into 13,793,100 shares of common stock based on the conversion rate in place as of December 31, 2015. The conversion rate is subject to the following customary +anti-dilution and other adjustments: +(1) The +occurrence of common stock dividends or distributions, stock splits or combinations, and equity reclassifications. +(2) The +distribution of rights, options, or warrants to all holders of common stock entitling them to purchase shares of common stock at a price per share that +is less than the closing price of the Company's common stock. +F-44 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. SERIES A PREFERRED STOCK (Continued) +(3) Pursuant +to a tender offer or exchange offer to purchase outstanding shares of common stock for consideration valued at an amount greater than the closing +price of the Company's common stock. +(4) If +the Company distributes evidences of its indebtedness, assets, other property or securities or rights, options or warrants to acquire its capital stock. +(5) If +the Company has any stockholder rights plan in effect with respect to the common stock on the date of conversion, upon conversion of the Series A +preferred stock, the holder will also receive (in addition to the common stock pursuant to the conversion) the rights under such rights plan, unless those rights (a) become exercisable before +the conversion of the Series A preferred stock, or (b) are separated from the common stock (each a "Trigger Event"). Upon the occurrence of a Trigger Event, the Series A preferred +stock conversion rate will be adjusted in accordance with (1) or (2) described above. +(6) If +the Company issues shares of common stock (or other instruments convertible into common stock) for valuable consideration, the conversion price is +adjusted if (a) the offering price is less than the conversion price and (b) if the offering is at a price less than the fair market value of the Company's common stock on the date of +issuance. +Redemption Features +At any time after the eighth anniversary of the closing, Crocs will have the right to redeem and the holders of the Series A preferred stock +will have the right to require Crocs to repurchase all or any portion of the Series A preferred stock at 100% of the stated value thereof plus all accrued and unpaid dividends. Upon certain +change of control events involving the Company, the holders can require Crocs to repurchase the Series A preferred stock at 101% of the stated value thereof plus all accrued and unpaid +dividends. +In +accordance with FASB ASC Topic 480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities , redemption features, +which are not solely within the control of the issuer, are required to be presented outside of permanent equity on the consolidated balance sheets. Under the Investment Agreement and as noted above, +the holder has the option to redeem the Series A preferred stock any time after January 27, 2022 or upon a change in control. As such, the Series A preferred stock is presented in +temporary or mezzanine equity on the consolidated balance sheets and will be accreted up to the stated redemption value of $203.0 million using an appropriate accretion method over a redemption +period of eight years, as this represents the earliest probable date at which the Series A preferred stock will become redeemable. +17. COMMITMENTS AND CONTINGENCIES +Rental Commitments and Contingencies +Crocs rents space for its retail stores, offices, warehouses, vehicles, and equipment under operating leases expiring at various dates through 2033. +Certain leases contain rent escalation clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents or rent holidays is +recognized on a straight-line basis over the lease term beginning on the lease inception +F-45 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. COMMITMENTS AND CONTINGENCIES (Continued) +date. +Deferred rent is included in the consolidated balance sheets in 'Accrued expenses and other current liabilities.' +Fiscal years ending December 31, +2016 +$ +77,127 +2017 +57,258 +2018 +46,928 +2019 +37,621 +2020 +33,587 +Thereafter +105,310 +Total minimum lease payments(1) +$ +357,831 +(1) Minimum +lease payments have not been reduced by minimum sublease rentals of $0.2 million due in the future under non-cancelable subleases. They also +do not include contingent rentals, which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts. +The +following table summarizes the composition of rent expense under operating leases for the years ended December 31, 2015, 2014, and 2013: +Year Ended December 31, +2015 +2014 +2013 +(in thousands) +Minimum rentals(1) +$ +96,579 +$ +108,466 +$ +101,721 +Contingent rentals +14,929 +16,875 +18,178 +Less: Sublease rentals +(322 +) +(868 +) +(646 +) +Total rent expense +$ +111,186 +$ +124,473 +$ +119,253 +(1) Minimum +rentals include all lease payments as well as fixed and variable common area maintenance, parking and storage fees, which were approximately +$9.1 million, $9.6 million, and $9.7 million during the years ended December 31, 2015, 2014, and 2013, respectively. +Purchase Commitments +In December 2011, Crocs renewed and amended its supply agreement with Finproject S.p.A. (formerly known as Finproject s.r.l.), which +provides Crocs the exclusive right to purchase certain raw materials used to manufacture its products. The agreement also provides that +Crocs meets minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2016. Historically, the minimum purchase requirements have not +been onerous and Crocs does not expect them to become onerous in the future. Depending on the material purchased, pricing was based either on contracted price or was subject to quarterly reviews and +fluctuates based on order volume, currency fluctuations, and raw material prices. Pursuant to the agreement, Crocs guarantees the payment for certain third-party manufacturer purchases of these raw +materials up to a maximum potential amount of €3.5 million (approximately $3.8 million as of December 31, 2015). +F-46 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. COMMITMENTS AND CONTINGENCIES (Continued) +As +of December 31, 2015 and 2014, Crocs had firm purchase commitments with certain third-party manufacturers of $158.2 million and $202.3 million, respectively. +Government Tax Audits +Crocs is regularly subject to, and is currently undergoing, audits by tax authorities in the United States and several foreign jurisdictions for +prior tax years. +See +Note 19—Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +18. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +During 2013 and 2014, Crocs had four reportable operating segments based on the geographic nature of the Company's operations: Americas, Asia Pacific, Japan, and Europe. Crocs' 'Other businesses' +category aggregates insignificant operating segments that do not meet the reportable segment threshold and includes manufacturing operations located in Mexico, Italy and Asia. The composition of the +Company's reportable operating segments is consistent with that used by Crocs' chief operating decision maker, ("CODM") to evaluate performance and allocate resources. +Subsequent +to December 31, 2014, Crocs' internal reports reviewed by the CODM began consolidating Japan into the Asia Pacific segment. This change aligned the Company's internal reporting to +its new strategic model and management structure, as Japan and Asia Pacific are now managed and analyzed as one operating segment by management and the CODM. Accordingly, Crocs now has three +reportable segments for 2015 as well as the 'Other Businesses' category and prior period segment results have been reclassified to reflect this change. +Each +of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers as well as intersegment sales. Revenues of the 'Other businesses' +category are primarily made up of intersegment sales. The remaining revenues for 'Other businesses' represent non-footwear product sales to external customers. Intersegment sales are not included in +the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. +Segment +performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments +to +F-47 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +eliminate +intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment eliminations. +Year Ended December 31, +2015 +2014 +2013 +(in thousands) +Revenues: +Americas +$ +476,210 +$ +489,915 +$ +498,552 +Asia Pacific +424,491 +473,910 +477,615 +Europe +188,833 +233,604 +216,259 +Total segment revenues +1,089,534 +1,197,429 +1,192,426 +Other businesses +1,096 +794 +254 +Total consolidated revenues +$ +1,090,630 +$ +1,198,223 +$ +1,192,680 +Operating income: +Americas +$ +49,422 +(1) +$ +48,347 +(1) +$ +61,894 +(1) +Asia Pacific +48,447 +(2) +75,135 +(2) +118,253 +(2) +Europe +15,629 +(3) +24,517 +(3) +16,192 +(3) +Total segment operating income +113,498 +147,999 +196,339 +Reconciliation of total segment operating income to income before income taxes: +Other businesses +(30,092 +) +(19,400 +) +(20,811 +) +Intersegment eliminations +— +(1,498 +) +61 +Unallocated corporate and other(4) +(155,730 +) +(131,827 +) +(112,494 +) +Total consolidated operating income (loss) +(72,324 +) +(4,726 +) +63,095 +Foreign currency transaction loss, net +(3,332 +) +(4,885 +) +(4,678 +) +Interest income +967 +1,664 +2,432 +Interest expense +(969 +) +(806 +) +(1,016 +) +Other income (expense), net +914 +204 +126 +Income (loss) before income taxes +$ +(74,744 +) +$ +(8,549 +) +$ +59,959 +Depreciation and amortization: +Americas +$ +7,401 +$ +11,670 +$ +10,384 +Asia Pacific +3,913 +6,724 +6,486 +Europe +2,229 +3,761 +5,108 +Total segment depreciation and amortization +13,543 +22,155 +21,978 +Other businesses +7,634 +5,900 +8,002 +Unallocated corporate and other(4) +14,816 +9,358 +11,526 +Total consolidated depreciation and amortization +$ +35,993 +$ +37,413 +$ +41,506 +(1) Includes +$7.2 million, $4.0 million, and $3.9 million for the years ended December 31, 2015, 2014, and 2013, respectively, of +asset impairment charges related to 27, 36, and 23 underperforming retail locations, respectively. +F-48 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +(2) Includes +$0.7 million, $2.8 million, and $0.2 million for the years ended December 31, 2015, 2014, and 2013, respectively, of +asset impairment charges related to 27, 14, and two underperforming retail locations, respectively. Additionally in the year ended December 31, 2015, Crocs recorded $5.8 million in +impairment charges related to South Africa assets, pertaining to 9 retail locations, classified as available for sale. +(3) Includes +$1.6 million, $2.0 million, and $6.6 million for the years ended December 31, 2015, 2014, and 2013 of asset impairment +charges related to 21, 27, and 35 underperforming retail locations. +(4) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, restructuring, depreciation and amortization of corporate and other assets not allocated to operating segments and costs of the same nature related to +certain corporate holding companies. +The +following table sets forth asset information related to Crocs' reportable operating business segments as of December 31, 2015 and December 31, 2014: +December 31, +2015 +2014 +(in thousands) +Assets(1): +Americas +$ +148,104 +$ +127,077 +Asia Pacific +169,865 +200,910 +Europe +46,137 +166,285 +Total segment current assets +364,106 +494,272 +Supply Chain +14,778 +18,132 +Corporate(2) +16,265 +27,337 +Deferred tax assets, net +— +4,190 +Income tax receivable +10,233 +9,332 +Other receivables +14,233 +11,989 +Prepaid expenses and other current assets +26,334 +30,156 +Total current assets +445,949 +595,408 +Property and Equipment, net +49,490 +68,288 +Intangible assets, net +82,297 +97,337 +Goodwill +1,973 +2,044 +Deferred tax assets, net +6,608 +17,886 +Other assets +21,703 +25,968 +Total consolidated assets +$ +608,020 +$ +806,931 +(1) Assets +by segment include cash and equivalents, net accounts receivable, and inventory. +(2) Corporate +assets primarily consist of cash and equivalents and inventory. +F-49 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +There +were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2015, 2014, and 2013. The following table sets forth certain geographical +information regarding Crocs' revenues during the years ended December 31, 2015, 2014, and 2013: +Year Ended December 31, +2015 +2014 +2013 +(in thousands) +Location +United States +$ +392,463 +$ +435,154 +$ +401,948 +International(1) +698,167 +763,069 +790,732 +Total revenues +$ +1,090,630 +$ +1,198,223 +$ +1,192,680 +(1) Not +more than 10% of international revenue was derived in any individual international country. +The +following table sets forth geographical information regarding property and equipment assets as of December 31, 2015 and 2014: +December 31, +2015 +2014 +(in thousands) +Location +United States +$ +32,954 +$ +45,046 +International +16,536 +23,242 +Total long-lived assets(1) +$ +49,490 +$ +68,288 +(1) Not +more than 10% of long-lived assets resided in any individual foreign country in 2015 or 2014. +19. LEGAL PROCEEDINGS +The Company is currently subject to an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In October 2013, CBP issued the final audit report. In that +report CBP projects that unpaid duties totaling approximately $12.4 million are due for the period under review and recommends collection of the duties due. Crocs responded that these +projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the projection. Additionally, on December 12, 2014, +Crocs made an offer to settle CBP's potential claims and tendered $3.5 million. At this time, it is not possible to determine how long it will take CBP to evaluate Crocs' offer or to predict +whether Crocs' offer will be accepted. Likewise, if a settlement cannot be reached, it is not possible to predict with any certainty whether CBP will seek to assert a claim for penalties in addition +to any unpaid duties, but such an assertion is a possibility. +Crocs +is currently subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, Crocs was notified about +the issuance of assessments totaling approximately $3.7 million for the period January 2010 through May 2011. Crocs +F-50 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +19. LEGAL PROCEEDINGS (Continued) +has +disputed these assessments and asserted defenses to the claims. On February 25, 2015, Crocs received additional assessments totaling approximately $8.4 million related to the +remainder of the audit period. Crocs has also disputed these assessments and asserted defenses and filed an appeal to these claims. It is anticipated that this matter will take up to several years to +be resolved. It is not possible at this time to predict the outcome of this matter. +On +August 8, 2014, a purported class action lawsuit was filed in California State Court against a Crocs subsidiary, Crocs Retail, LLC (Zaydenberg v. Crocs Retail, LLC, Case No. +BC554214). The lawsuit alleged various employment law violations related to overtime, meal and break periods, minimum wage, timely payment of wages, wage statements, payroll records and business +expenses. Crocs filed an answer on February 6, 2015, denying the allegations and asserting several defenses. On June 3, 2015, a second purported class action lawsuit was filed in +California State Court against Crocs Retail, LLC (Christopher S. Duree and Richard Morely v. Crocs, Inc., Case No. BC583875), making substantially the same allegations as in the +Zaydenberg lawsuit. The parties attended a mediation on June 26, 2015, and reached a settlement for $1.5 million, which will release the claims in both lawsuits. On September 4, +2015, the California State Court granted preliminary approval of the settlement and set the final approval hearing for December 14, 2015. At the final approval hearing, the California State +Court entered its final order approving the settlement and final judgement. Crocs considers this matter closed. +As +of December 31, 2015, Crocs estimates that the resolution of these litigation matters and other disputes could result in a loss that is reasonably possible between $0.0 million and +$5.9 million in aggregate. The Company has accrued $5.6 million associated with our estimated obligation related to these legal claims, which is reported in the balance sheet in line +'Accrued expenses and other liabilities'. +Although +Crocs is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, Crocs is not party to any +other pending legal proceedings that Crocs believes would reasonably have a material adverse impact on its business, financial position, results of operations or cash flows. +20. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +March 31, +2015 +June 30, +2015 +September 30, +2015 +December 31, +2015 +(in thousands, except per share data) +Revenues +$ +262,193 +$ +345,671 +$ +274,088 +$ +208,678 +Gross profit +$ +127,370 +$ +189,870 +$ +120,821 +$ +72,744 +Restructuring +$ +3,663 +$ +2,810 +$ +981 +$ +1,274 +Asset impairment charges +$ +— +$ +2,075 +$ +5,460 +$ +7,771 +Income (loss) from operations +$ +(2,362 +) +$ +16,349 +$ +(20,730 +) +$ +(65,581 +) +Net income (loss) +$ +(2,425 +) +$ +13,426 +$ +(24,024 +) +$ +(70,173 +) +Net income (loss) attributable to common shareholders +$ +(5,979 +) +$ +9,690 +$ +(27,776 +) +$ +(73,942 +) +Basic income (loss) per common share +$ +(0.08 +) +$ +0.11 +$ +(0.37 +) +$ +(1.01 +) +Diluted income (loss) per common share +$ +(0.08 +) +$ +0.11 +$ +(0.37 +) +$ +(1.01 +) +F-51 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +20. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (Continued) +For the Quarter Ended +March 31, +2014 +June 30, +2014 +September 30, +2014 +December 31, +2014 +(in thousands, except per share data) +Revenues +$ +312,429 +$ +376,920 +$ +302,401 +$ +206,473 +Gross profit +$ +156,227 +$ +202,571 +$ +155,017 +$ +76,530 +Restructuring +$ +2,250 +$ +4,060 +$ +7,585 +$ +6,637 +Asset impairment charges +$ +— +$ +3,230 +$ +2,600 +$ +2,997 +Income (loss) from operations +$ +16,822 +$ +41,911 +$ +1,113 +$ +(64,572 +) +Net income (loss) +$ +9,124 +$ +23,277 +$ +15,767 +$ +(53,094 +) +Net income (loss) attributable to common shareholders +$ +6,373 +$ +19,523 +$ +12,009 +$ +(56,867 +) +Basic income (loss) per common share +$ +0.06 +$ +0.19 +$ +0.12 +$ +(0.70 +) +Diluted income (loss) per common share +$ +0.06 +$ +0.19 +$ +0.12 +$ +(0.70 +) +During +the three months ended December 31, 2014, Crocs recorded the following charges that affect the comparability of information between +periods: +• Inventory write-down charges of $10.0 million related to obsolete inventory including raw materials, footwear, and accessories. +See Note 4—Inventories for further discussions regarding these charges. +21. SUBSEQUENT EVENTS +ASU 2010-09 to ASC Topic 855, Subsequent Events , requires the Company to disclose the date through which subsequent events have been evaluated. The +Company has evaluated subsequent events through the date the financial statements were issued, and has determined there are no other subsequent events than those presented below. +On +January 19, 2016, the Company sold its operations in South Africa to and entered into a franchise agreement with the buyer. South Africa operations were presented as assets held for sale as +of December 31, 2015 and during the three month period ended December 31, 2015, the carrying value of the entire asset group was written down to its estimated fair value less costs to +sell. +On +February 18, 2016, the Company entered into the Eleventh Amendment to the Amended and Restated Credit Agreement. See Note 11—Revolving Credit Facility & Bank +Borrowings. +F-52 \ No newline at end of file diff --git a/raw/filings/0001334036/2015/0001047469-16-010591/filing_metadata.csv b/raw/filings/0001334036/2015/0001047469-16-010591/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..7ffe6eef9e0a3b47437408faadf796623221e207 --- /dev/null +++ b/raw/filings/0001334036/2015/0001047469-16-010591/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2016-02-29,2015-12-31,2016-02-29T22:51:52.000Z,0001047469-16-010591,a2227543z10-k.htm,10-K,18574874,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746916010591/a2227543z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746916010591/,2015,2015,1 diff --git a/raw/filings/0001334036/2015/0001047469-16-010591/item1.txt b/raw/filings/0001334036/2015/0001047469-16-010591/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..2b3d8fb1f888f3d693b521b2bae37371399acc5c --- /dev/null +++ b/raw/filings/0001334036/2015/0001047469-16-010591/item1.txt @@ -0,0 +1,378 @@ +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our," or "us") are engaged in the design, development, +manufacturing, worldwide marketing and distribution of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear +featuring fun, comfort, color, and functionality. The Company, a Delaware corporation, is the successor of a Colorado corporation of the same name, and was originally organized in 1999 as a limited +liability company. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite, as well as casual lifestyle footwear that use a range of materials. +Our Croslite material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 65 countries through domestic and +international retailers and distributors, and directly to consumers through our company-operated retail stores, outlets, webstores, and kiosks. +Since +the initial introduction of our popular Beach and Crocs Classic designs in 2002, we have expanded our classic products to include a variety of new styles and products. Going forward, we are +focusing on our core molded footwear heritage, as well as developing innovative casual lifestyle footwear. The broad appeal of our footwear has allowed us to market our products to a wide range of +distribution channels, including family footwear stores, department stores, sporting goods stores and traditional footwear retailers, as well as a variety of specialty and independent retail channels, +and via the internet. +Products +Our product offerings have grown significantly since we first introduced the single-style clog in six colors in 2002. We currently offer a wide +variety of footwear products including clogs, sandals, wedges, flats, sneakers, and boots. During the years ended December 31, 2015, 2014, and 2013, approximately 76.2%, 73.5%, and 71.1%, +respectively, of unit sales consisted of products geared toward adults compared to 23.8%, 26.5%, and 28.9%, respectively, of unit sales of products geared toward children. +A +key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and functionality. Croslite is carefully formulated to create extremely +lightweight, comfortable, and non-marking footwear that conforms to the shape of the foot and increase comfort. Croslite is a closed-cell resin material which is water resistant, virtually odor free +and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials, such as textile fabric and leather, into +many of our styles; however, we continue to utilize the Croslite material for the foot bed, sole, and other key structural components for many of these styles. +We +strive to provide our global consumer with a year-round product assortment featuring fun, comfortable, casual, colorful, and innovative styles. Our collections are designed to meet the needs of the +family by focusing on key wearing occasions. Our goal is to deliver world-class product assortments for the family with all of the comfort features and benefits Crocs is known for. We have +discontinued our non-core products in order to focus on growing our core-molded heritage category while developing more compelling casual footwear platforms. +At +the heart of our brand resides the Classic, our first and most iconic style for adults and kids that embodies our innovation in molding and design, delivers all-day comfort, and has established a +new category in the footwear marketplace. The unique look and feel of the Classic can be experienced throughout our entire product line due to the use and design of our proprietary material Croslite. +We have expanded our core molded product line, introduced in 2002, with the addition of dual density technology, warm lined styles, seasonal flips and slides. Licensed style partnerships from Disney, +Marvel, Sanrio, +2 +Table of Contents +Nickelodeon, +and Warner Bros., among others, provide popularity to our kids' core line along with our kids-only product innovations, including lights, color-change materials, and interactive elements. +In +addition, we have extended our core product assortment with new styling including 'built for her' and 'built for him' silhouettes, which are offered in multiple color and graphic treatments. Our +core products are available across a range of channels of distribution and span both stylish and active wearing occasions for the entire family. +Sales and Marketing +Each season we focus on presenting a compelling "brand story and experience" for our new product collections and our broader casual lifestyle +assortment. Our marketing efforts center on story-telling across diverse wearing occasions and product silhouettes. For the years ended December 31, 2015, 2014, and 2013, total advertising +costs were $58.2 million, $44.7 million, and $47.6 million, respectively. +We +run our business across three major regions: the Americas, Asia Pacific and Europe. In developing our market growth and expansion strategy, we prioritize six core markets including: (i) the +United States, (ii) Japan, (iii) China, (iv) South Korea, (v) Germany, and (vi) the United Kingdom. These countries have been identified as large-scale geographies +where we believe the greatest opportunities for growth exist. Accordingly, our product development efforts for our 2016 product line are largely focused on expanding our market share in these +locations. We are also focusing our marketing efforts on these regions in an effort to increase customer awareness of both our brand and our full product range. +We +have three primary sales channels: wholesale, retail, and e-commerce (discussed in more detail below). Our marketing efforts are aimed at driving business to both our wholesale partners and our +company-operated retail and e-commerce stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key stories, activation +materials, and creative materials. Retail stores provide a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store experience a +meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product launches. +Wholesale Channel +During the years ended December 31, 2015, 2014, and 2013, approximately 54.2%, 55.7%, and 56.5% of net revenues, respectively, were derived +from sales through the wholesale channel which consists of sales to distributors and third-party retailers. Wholesale customers include family footwear retailers, national and regional retail chains, +department stores, sporting goods stores, and independent footwear retailers. No single customer accounted for 10% or more of our revenues for any of the years ended December 31, 2015, 2014, +and 2013. +Many +of our agreements allow us to accept returns from wholesale customers for defective products and quality issues, on an exception basis, and to extend pricing discounts in lieu of defective +product returns. We also may accept returns from our wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper +assortments. +We +use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price list and are +granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are generally terminable +upon 30 days prior notice, and have minimum sales requirements that allow us to terminate or renegotiate the contract if minimum requirements are not met. +3 +Table of Contents +Retail Channel +During the years ended December 31, 2015, 2014, and 2013, approximately 34.7%, 35.5%, and 35.0%, respectively, of our net revenues were +derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full-service retail locations, outlet locations, and kiosk/store-in-store locations. +Our three types of store platforms enable us to organically promote the breadth of our product offering in high-traffic, highly visible locations. Our strategy for expanding our global retail business +is to increase our market share in a disciplined manner by selectively opening additional stores in new and existing markets, as well as increasing sales in existing stores. We will continue to +moderate the pace of our retail expansion in 2016 with a focus on outlet locations as well as enhancing the profitability of existing locations. We opened 42 company-operated stores during the year +ended December 31, 2015 and closed 68 company-operated stores. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand +recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +• Full-Service Retail Locations +Our +company-operated retail locations allow us to effectively showcase the full extent of our new and existing products to customers at retail pricing. In addition, our full-service retail locations +enable us to interact with our customers on a personal level in order to ensure a satisfying shopping experience. On average, the optimal space for our retail locations is between approximately 1,500 +and 1,800 square feet, depending on the geographic vicinity of the property, and is typically located in high-traffic shopping malls or districts. During the year ended December 31, 2015, we +closed 51 stores and opened 15 new stores. As of December 31, 2015, 2014, and 2013, we operated 275, 311, and 327 global full-service retail stores, respectively. +• Outlet Locations +Our +company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We also sell full priced products in certain of our outlet +stores. Outlet locations follow a similar size model as our full-service retail stores; however, they are generally located within outlet shopping locations. During the year ended December 31, +2015, we closed four outlet locations and opened 16 new outlet locations. As of December 31, 2015, 2014, and 2013, we operated 186, 174, and 170 global outlet stores, respectively. +• Kiosk / Store-in-Store Locations +Our +company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other +high foot traffic areas. With bright and colorful displays, efficient use of retail space, and limited capital investment, we believe that kiosks and shop in shops locations can be an effective outlet +for marketing our products where this business model is applicable. During the year ended December 31, 2015, we closed 13 kiosk and store-in-store locations and opened 11 new kiosk and +store-in-store locations. As of December 31, 2015, 2014, and 2013, we operated 98, 100, and 122 global kiosks and store-in-stores, respectively. +4 +Table of Contents +The +following table illustrates the net change in 2015 with respect to the number of our company-operated retail locations by reportable operating segment and country: +December 31, +2014 +Opened +Closed +December 31, +2015 +Company-operated retail locations +Americas +United States +185 +4 +10 +179 +Canada +13 +— +3 +10 +Puerto Rico +7 +— +— +7 +Other +5 +— +5 +— +Total Americas +210 +4 +18 +196 +Asia Pacific +Korea +83 +5 +4 +84 +Japan +54 +4 +6 +52 +China +43 +19 +7 +55 +Hong Kong +23 +1 +3 +21 +Singapore +18 +1 +4 +15 +Australia +13 +1 +3 +11 +United Arab Emirates (UAE) +10 +5 +1 +14 +South Africa(1) +9 +— +— +9 +Taiwan +5 +— +5 +— +Total Asia Pacific +258 +36 +33 +261 +Europe +Russia +39 +2 +4 +37 +Germany +20 +— +2 +18 +Great Britain +15 +— +5 +10 +France +14 +— +2 +12 +Netherlands +7 +— +1 +6 +Finland +6 +— +1 +5 +Spain +6 +— +— +6 +Other +10 +— +2 +8 +Total Europe +117 +2 +17 +102 +Total +585 +42 +68 +559 +(1) Our +South Africa operations were designated as held for sale as of December 31, 2015. These locations were subsequently sold on January 19, +2016. See Note 5—Property and Equipment and Note 21—Subsequent Events to the consolidated financial statements for additional information. +E-commerce Channel +As of December 31, 2015, we offered our products through 12 company-operated e-commerce webstores worldwide. During the years ended +December 31, 2015, 2014, and 2013, approximately 11.1%, 8.8%, and 8.5%, respectively, of our net revenues were derived from sales through our e-commerce channel. Our e-commerce presence enables +us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. Improving our e-commerce capabilities is one of our key strategies in +positioning Crocs for sustained growth. Going forward, we will continue to improve our consumer's online experience and look for new ways to leverage digital technologies to connect with them. +5 +Table of Contents +Business Segments and Geographic Information +For 2015, we had three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and Europe. We also +have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represents manufacturing operations located in Mexico, Italy +and Asia. For 2014 and 2013, we had four reportable operating segments: Americas, Asia Pacific, Japan and Europe. Subsequent to December 31, 2014, Crocs' internal reports reviewed by the Chief +Operating Decision Maker ("CODM") began consolidating Japan into the Asia Pacific segment. This change aligned the Company's internal reporting to its new strategic model and management structure, as +Japan and Asia Pacific are now managed and analyzed as one operating segment by management and the CODM. Accordingly, prior period segment results have been reclassified to reflect this change. The +composition of our reportable operating segments is consistent with that used by our CODM to evaluate performance and allocate resources. See additional discussion of our segments including results of +operations and assets by segment in Note 18 in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in the North and South America geographic regions. Regional +wholesale channel customers consist of a broad range of family footwear, sporting goods and department stores as well as specialty retailers and distributors. The regional retail channel sells +directly to consumers through 196 company-operated store locations in the Americas as well as through webstores. During the years ended December 31, 2015, 2014, and 2013, revenues from the +Americas segment constituted approximately 43.7%, 40.9%, and 41.9% of our consolidated revenues, respectively. Specifically, revenues from the United States of America constituted approximately 35.8%, +36.3%, and 33.7% of our consolidated revenues, respectively, for the years ended December 31, 2015, 2014, and 2013. +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, the Middle +East and South Africa. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the Americas segment. We also sell +products directly to the consumer through 261 company-operated stores located in Asia as well as through our webstores. +During the years ended December 31, 2015, 2014, and 2013, revenues from the Asia segment constituted 39.0%, 39.6%, and 40.0%, of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Europe and Russia. The Europe segment wholesale +channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment. We also sell our products directly to the consumer through 102 +company-operated stores located in Europe as well as through our webstores. During the years ended December 31, 2015, 2014, and 2013, revenues from the Europe segment constituted 17.3%, 19.5%, +and 18.1% of our consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, +and lower operating costs. During the year ended December 31, 2015, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located +in the United States, Mexico, the Netherlands, Japan, +6 +Table of Contents +Finland, +South Africa, Russia, and Italy. We also utilize distribution centers which are operated by third parties located in the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, +India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico, and Italy. Throughout 2015, we continued to engage in efforts to consolidate our global warehouse and +distribution facilities to facilitate a lean cost structure. As of December 31, 2015, our company-operated warehouse and distribution facilities provided us with approximately +1.0 million square feet and our third-party operated distribution facilities provided us with approximately 0.4 million square feet. We also ship a portion of our products directly to +our customers from our internal and third-party manufacturers. +Raw Materials +"Croslite", our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our accessories. +Croslite is soft, durable, and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our materials to +enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other production inputs +such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may, however, in the future identify and utilize materials +produced by other suppliers as an alternative to, or in addition to, the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to +produce the Croslite products are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products we offer. Many of these new products are constructed using leather, textile fabrics, or other non-Croslite +materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. We also outsource the compounding of +the Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We continue to dedicate significant resources to product design and development as we expand the footwear styles we offer based on opportunities we +identify in the marketplace. Our design and development process is highly collaborative and we continually strive to improve our development function so we can bring products to market quickly and at +reduced costs, while maintaining product quality. We spent $14.0 million, $16.7 million, and $15.4 million in research, design, and development activities for the years ended +December 31, 2015, 2014, and 2013, respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities +in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or to provide support to our internal production processes. Our internal manufacturing +capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors throughout the year, while outsourcing +allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our production costs, increase overall +operating efficiencies, and shorten production and development times. +In +the years ended December 31, 2015, 2014, and 2013, we manufactured approximately 11.3%, 13.9%, and 15.1%, respectively, of our footwear products internally. We sourced the remaining footwear +production from multiple third-party manufacturers primarily in China, Vietnam, Eastern Europe and +7 +Table of Contents +South +America. During the years ended December 31, 2015, 2014, and 2013, our largest third-party manufacturer in China produced approximately 26.6%, 27.5%, and 28.0%, respectively, of our +footwear unit volume. We do not have written supply agreements with our primary third-party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress and patent protections to establish, protect and enforce our +intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold +or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and +Canada among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, +YOU by Crocs Logo, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone, and Crocs Littles, "Croslite" and the Croslite logo, as well as other marks in various countries around the world. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. are generally +valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful marketing and sale +of our products. We will continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also +continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We +consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a process that +combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formula by using +exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the +protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort and utility of +our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade +secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators and +attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also +educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not +protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual +property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth +quarter is typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. We continue to +8 +Table of Contents +expand +our product line to include more winter oriented styles to reduce the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions, or general economic, or consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not +necessarily indicative of expected results for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at that point, +represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to +wholesale and distributor orders for the next season and current season fill-in orders and excludes potential sales in our retail and internet channels. Backlog as of a particular date is affected by +a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly period over +period. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model changes around the globe, we believe backlog is an imprecise +indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Foreign Currency Fluctuations on Revenues and Operating Income (Loss) +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other than the U.S. +Dollar. Accordingly, any amounts recorded in foreign currencies are translated into U.S. Dollars for consolidated financial reporting and are impacted by foreign currency fluctuations. While we enter +into foreign currency exchange forward contracts as economic hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is dependent on many factors +that cannot be forecasted with reliable accuracy and our forward contracts may not prove effective in reducing our exposures. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single +company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and ecommerce businesses compete with companies including, but not limited to, Deckers +Outdoor Corp., Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers +such as Genesco, Inc., Macy's, Dillard's, Dick's Sporting Goods Inc., The Finish Line Inc., and Footlocker, Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, and marketing and distribution. We believe that our +unique footwear designs, the Croslite material, our prices, our expanded product line, and our distribution network continue to position us well in the marketplace. However, a number of companies in +the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, +greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the market with +products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2015, we had approximately 5,400 full-time, part-time, and seasonal employees, of which approximately 3,600 were engaged in +retail-related functions. +9 +Table of Contents +Available Information +Our internet address is www.crocs.com where we post the following filings, free of charge, as soon as reasonably practicable after they are +electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on +Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Copies of any +of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +10 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2015/0001047469-16-010591/item13.txt b/raw/filings/0001334036/2015/0001047469-16-010591/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..1f4c207b0af652c501d07b680aa3d0d17b28adeb --- /dev/null +++ b/raw/filings/0001334036/2015/0001047469-16-010591/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2016 Annual Meeting of +Stockholders to be filed with the SEC within 120 days after December 31, 2015. \ No newline at end of file diff --git a/raw/filings/0001334036/2015/0001047469-16-010591/item9a.txt b/raw/filings/0001334036/2015/0001047469-16-010591/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..5cdcb63c69ec69b8157d2b5171d9e953394ecd1d --- /dev/null +++ b/raw/filings/0001334036/2015/0001047469-16-010591/item9a.txt @@ -0,0 +1,72 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we +conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of +December 31, 2015 (the "Evaluation Date"). Based on the evaluation of our disclosure controls and procedures as of December 31, 2015, our Chief Executive Officer and Chief Financial +Officer concluded that, as a result of the material weaknesses in internal control over financial reporting described below in Management's Report on Internal Control Over Financial Reporting, our +disclosure controls and procedures were not effective, as of that date. +Notwithstanding +such material weaknesses, which are described below in Management's Report on Internal Control over Financial Reporting, our management has concluded that the consolidated financial +67 +Table of Contents +statements +included in this Form 10-K present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with +accounting principles generally accepted in the U.S. +Management's Report on Internal Control over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act +Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2015, using the criteria set forth in the Internal Control—Integrated +Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to +provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with U.S. generally +accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, +accurately and fairly reflect the transactions and dispositions of the assets of the Company, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation +of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of +management and directors of the Company, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets +that could have a material effect on the financial statements. +Management +has concluded our internal control over financial reporting is ineffective as of December 31, 2015 as management identified material weaknesses as further described below. A material +weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual +or interim financial statements will not be prevented or detected on a timely basis. +Management +identified the following control deficiencies that constitute individually, or in the aggregate, material weaknesses in our internal control over financial reporting as of +December 31, 2015: +Financial Close Process. We identified deficiencies related to the operating effectiveness of controls over the completeness and accuracy of our review and +approval of certain journal entries and period end adjusting entries. In addition, we did not consistently maintain or perform on a timely basis our control procedures over certain account analyses, +data integrity, documentation, review and approval of year-end accounting entries to ensure the accuracy and completeness of the entries recorded. We also identified deficiencies regarding the review +and approval of our income tax entries related to our deferred income tax accounts and the related impacts on income tax expense or benefit. +We +also lacked a sufficient balance of personnel commensurate with our financial close reporting requirements. If not corrected, these controls could impact the accuracy and completeness of our +financial statements. +Inventory Accounting Controls. We identified deficiencies related to the operating effectiveness of our controls to ensure the existence, valuation, accuracy, and +completeness of inventory on hand. Specifically, our physical inventory procedures were not performed with sufficient consistency to ensure the underlying quantities were accurate. Additionally, our +cost absorption control procedures were not consistently maintained or performed on a timely basis in accordance with Company's policy, to ensure inventory was properly valued. If not corrected, these +ineffective controls could impact the accuracy and completeness of our cost of sales and inventory balances. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +68 +Table of Contents +Changes in Internal Control over Financial Reporting +Other than the material weaknesses noted above, there has been no change in our internal control over financial reporting during the three months +ended December 31, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +Remediation Efforts to Address Identified Material Weaknesses +Management is dedicated to remediate the control deficiencies that gave rise to the material weaknesses in our internal control over financial +reporting. If not remediated, the material weaknesses in our internal controls may result in material misstatements in our financial statements. +The +following steps are among the measures that have been implemented or that we intend to implement after the date of this filing to address our material weaknesses as of December 31, 2015: +Financial Close Process. We are performing a review to identify opportunities to improve the operation of our financial close control activities. We intend to +engage a third party service provider to assist with our review and remediation efforts and to make recommendations related to our staffing levels and structure. Furthermore, we are undertaking +additional training of the personnel recording and reviewing journal entries to ensure consistent compliance with our policies and controls over the account analysis, documentation, review, and +approval of manual journal entries as well as data integrity procedures. We will also direct our internal auditors to perform additional testing around these processes to ensure the sufficiency of our +remediation efforts. +Inventory Accounting Controls. We are performing a review to identify opportunities to improve the operation of our inventory accounting control activities. We +intend to engage a third party service provider to assist with our review and remediation efforts. Furthermore, we are undertaking additional training of our supply chain personnel to ensure inventory +control procedures are adequate, performed timely, and are properly recorded in accordance with our policies. We will also provide enhanced training on cost absorption analysis procedures to ensure +inventory values are properly maintained. We will also direct our internal auditors to perform additional testing of our inventory procedures to assess the sufficiency of our remediation efforts. +We +are committed to maintaining a strong internal control environment. The Audit Committee has directed management to develop a detailed plan and timetable for the completion of the implementation of +the remedial measures outlined above and will continue to monitor such implementation. In addition, under the direction of the Audit Committee, management will continue to review and make necessary +changes to the overall design of our internal control environment, as well as to our policies and procedures in order to improve the overall effectiveness of our internal control over financial +reporting. +As +we implement these remediation efforts, we may determine that additional steps may be necessary to remediate the material weaknesses. We cannot assure you that these remediation efforts will be +successful or that our internal control over financial reporting will be effective in accomplishing all control objectives all of the time. We will continue to assess the effectiveness of our +remediation efforts in connection with our evaluations of internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001334036/2015/0001047469-16-010591/rp_note.txt b/raw/filings/0001334036/2015/0001047469-16-010591/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2015/0001047469-16-010591/rpt_disclosure.txt b/raw/filings/0001334036/2015/0001047469-16-010591/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..9da90c2dc47d14eea23e7635e89359ff8761ae3a --- /dev/null +++ b/raw/filings/0001334036/2015/0001047469-16-010591/rpt_disclosure.txt @@ -0,0 +1,69 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Investment Agreement with Blackstone +On January 27, 2014, we issued to Blackstone and certain of its permitted transferees (together with Blackstone, the "Blackstone Purchasers"), +200,000 shares of our Series A convertible preferred stock for an aggregate purchase price of $198 million, or $990 per share, pursuant to the Investment Agreement. In connection with +the issuance of the convertible preferred stock (the "Closing") and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2 million and reimbursed Blackstone's transaction +fees and expenses of approximately $4 million. As of March 31, 2016, the Blackstone Purchasers collectively owned all of our outstanding shares of convertible preferred stock and, on an +as-converted basis, approximately 15.8% of our outstanding common stock. Mr. Ribatt was a permitted transferee of Blackstone and purchased 1,000 shares of our Series A convertible +preferred stock. +As +discussed above under "Proposal 1 - Election of Directors," the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as the +Blackstone Purchasers (i) beneficially own at least 95% of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement or +(ii) maintain beneficial ownership of at least 12.5% of the our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors +to our Board. For so long as the Blackstone Purchasers beneficially own shares of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement that +represent less than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right +to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject +to applicable law and stock exchange rules. Blackstone's ownership currently exceeds the Two-Director Threshold. Blackstone designated Messrs. Melwani and Giordano for nomination to our Board +and had previously nominated Mr. Ribatt. +Pursuant +to the Investment Agreement, Blackstone is subject to certain standstill restrictions which generally restrict Blackstone from acquiring more than 25% of our outstanding common stock until +the date on which Blackstone is no longer entitled to designate any directors to our Board. In addition, subject to certain customary exceptions, Blackstone was restricted from transferring any shares +of the convertible preferred stock until the second anniversary of the Closing and, for so long as any convertible preferred stock is outstanding, may not transfer any shares of convertible preferred +stock to certain of our competitors (as defined in the Investment Agreement) or holders of 25% or more of our common stock. Blackstone also has certain preemptive rights and information rights under +the Investment Agreement, which are subject to certain conditions. +Certificate of Designations +Pursuant to the Certificate of Designations of Series A Convertible Preferred Stock filed with the Delaware Secretary of State on +January 24, 2014, which establishes the designations, preferences, and other rights of the convertible preferred stock: +• The convertible preferred stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up +and dissolution; +• The Blackstone Purchasers are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value +of $1,000 per share; +21 +Table of Contents +• If we fail to make timely dividend payments to the holders of our convertible preferred stock, the dividend rate will increase to 8% +per annum until such time as all accrued but unpaid dividends have been paid in full; +• The Blackstone Purchasers are entitled to receive any dividends declared or paid on our common stock and are entitled to vote together +with the holders of our common stock as a single class, in each case, on an as-converted basis; +• The Blackstone Purchasers have certain limited special approval rights, including with respect to the issuance by us of pari passu or senior equity securities; +• The Blackstone Purchasers may, at any time, require us to convert their shares of convertible preferred stock into shares of common +stock at an implied conversion price of $14.50 per share, subject to certain adjustments; +• At our election, all or a portion of the convertible preferred stock will be convertible into the relevant number of shares of common +stock on or after the third anniversary of the Closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days; +• The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share caps and other restrictions; +• At any time after the eighth anniversary of the Closing, we will have the right to redeem, and the Blackstone Purchasers will have the +right to require us to repurchase, all or any portion of the convertible preferred stock at 100% of the stated value, plus all accrued but unpaid dividends; and +• Upon certain change in control events involving us, the Blackstone Purchasers can require us to repurchase their shares of convertible +preferred stock at 101% of the stated value plus all accrued but unpaid dividends. +Registration Rights Agreement +In connection with the Closing, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the "Registration Rights Agreement"), +pursuant to which we have agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of the shares of convertible preferred stock and any +shares of common stock issued upon conversion of the convertible preferred stock. The Registration Rights Agreement contains customary terms and conditions, including certain customary indemnification +obligations. +Policy on Transactions with Related Persons +Our Code of Business Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive +officers, or greater than five percent stockholders, or one of the aforementioned's immediate family members (each, a "related person"), have a material interest be approved or ratified by the Audit +Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course +of business transactions in which directors have an interest as part of the Board's annual director independence review, and our Code of Business Conduct and Ethics permits the full Board to waive any +conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems +appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. The full Board approved each of the transactions disclosed above. +22 +Table of Contents +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our +certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' fees), +judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person's services as a director or +executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary +to attract and retain qualified persons as directors and executive officers. +23 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2016/0001628280-17-002068/filing.txt b/raw/filings/0001334036/2016/0001628280-17-002068/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..e79ebce22cc90318c8a8ba96945ef20053294d71 --- /dev/null +++ b/raw/filings/0001334036/2016/0001628280-17-002068/filing.txt @@ -0,0 +1,6701 @@ +10-K +1 +crox-20161231x10k.htm +10-K +Document +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +____________________________________________________________________________ +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2016 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +____________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer +Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +(do not check if a +smaller reporting company) +Smaller reporting company o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2016 was $650.6 million. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant's common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant's common stock outstanding as of February 22, 2017 was 73,690,901 +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant's proxy statement for the 2017 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant's fiscal year ended December 31, 2016 . +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding: +• +our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• +our expectations regarding our level of capital expenditures in 2017; and +• +our expectations regarding future trends, expectations and performance of our business. +Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially (both favorably and unfavorably) from future results expressed or implied by such forward-looking statements. These risks and uncertainties include, but are not limited to those described in Part I — Item 1A. Risk Factors of this Annual Report , elsewhere throughout this report, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the "SEC"). Caution should be taken not to place undue reliance on any such forward-looking statements. Forward-looking statements speak only as of the date when made and we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2016 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +9 +Item 1B. +Unresolved Staff Comments +21 +Item 2. +Properties +21 +Item 3. +Legal Proceedings +22 +Item 4. +Mine Safety Disclosures +23 +PART II +Item 5. +Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +24 +Item 6. +Selected Financial Data +26 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +28 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +57 +Item 8. +Financial Statements and Supplementary Data +59 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +60 +Item 9A. +Controls and Procedures +61 +Item 9B. +Other Information +64 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +65 +Item 11. +Executive Compensation +65 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +65 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +66 +Item 14. +Principal Accountant Fees and Services +66 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +66 +Item 16. +Form 10-K Summary +71 +Signatures +72 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our," or "us") are engaged in the design, development, manufacturing, worldwide marketing, distribution and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear featuring comfort, color, and functionality. The Company, a Delaware corporation, is the successor to a Colorado corporation of the same name, and was originally organized in 1999 as a limited liability company. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite, as well as casual lifestyle footwear that use a range of materials. Our Croslite TM material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international retailers and distributors, and directly to consumers through our company-operated retail stores, outlets, e-commerce store sites, and kiosks. +Since the initial introduction of our original Classic clog designs in 2002, we have expanded our product ranges to include a variety of styles and products. Going forward, we are focusing on our core molded styles, clogs, sandals, flips and slides as well as developing select casual styles. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels, our own Crocs single-branded stores including both full price and outlet stores, our own e-commerce sites, traditional multi-branded stores including family footwear stores, sporting goods stores and a variety of specialty and independent retail channels, and third-party e-commerce sites. In select markets we also sell to distributors that are typically granted the rights to distribute our products in a given geographical area. +Products +Our product offerings have grown significantly since we first introduced the single-style clog in six colors in 2002. Recognized across the world for our iconic clog silhouette, we have taken the successful formula of a simple design aesthetic paired with modern comfort and expanded into a wide variety of casual footwear products including sandals, flips and slides, shoes, and boots that meet the needs of the whole family. +At the heart of our brand reside the Classic and Crocband clogs, our most iconic styles for adults and kids - product that embodies our innovation in molding, simplicity of design and all-day comfort. A key differentiating feature of our footwear products is our proprietary closed-cell resin Croslite material, which is uniquely suited for comfort and functionality. For further information on Croslite, see Raw Materials below. +We strive to provide our global consumer with a year-round product assortment featuring fun, comfortable, casual, colorful, and innovative styles. Our collections are designed to meet the needs of the family by focusing on key wearing occasions. Our goal is to deliver product assortments for the family with all of the comfort, features and benefits Crocs is known for. +The unique look and feel of the Classic clog can be experienced throughout our entire product line due to the use and design of Croslite. We have expanded our core molded product line, with the addition of dual density technology, warm lined styles, sandals, flips and slides, shoes and boots. We enjoy highly successful licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allows us to bring popular global franchises and characters to life on our product in a fun, exciting way. +We continue to leverage our expertise and innovation in injection molding to create a fresh, distinctive point of view in the casual footwear market and to deliver a winning combination of comfort, style and versatility to our consumer year round. +Sales and Marketing +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. Our marketing efforts center on story-telling across diverse wearing occasions and product silhouettes. For the years ended December 31, 2016 , 2015 , and 2014 , total advertising costs were approximately $56.0 million, $58.2 million, and $44.7 million, respectively. +We run our business across three major geographic regions: the Americas, Asia Pacific, and Europe, which are discussed in more detail in Business Segments and Geographic Information below. In developing our market growth and expansion strategies, we prioritize five core markets including: (i) the United States, (ii) Japan, (iii) China, (iv) South Korea and (v) Germany. These countries have been identified as large-scale geographies where we believe the greatest opportunities for growth exist. We are also focusing our marketing efforts on these countries in an effort to increase customer awareness of both our brand and our full product range. +2 +Table of Contents +We have three primary sales channels: wholesale, which includes distributors, Crocs owned retail, and Crocs e-commerce (discussed in more detail below). Our marketing efforts are aimed at driving business to both our wholesale partners and our company-operated Crocs retail stores and e-commerce sites. Our marketing efforts in the wholesale and retail channels are focused on social and digital outreach to consumers to shop and visual merchandising. Company operated retail stores provide a unique opportunity to engage with consumers at a deeper level by showcasing our full assortment of molded and casual footwear. No single wholesale customer accounted for 10% or more of our revenues for any of the years ended December 31, 2016 , 2015 , and 2014 . +Wholesale Channel +During the years ended December 31, 2016 , 2015 , and 2014 , approximately 52.7%, 54.2% and 55.7% of revenues, respectively, were derived through the wholesale channel which consists of distributors and third-party retailers. Wholesale customers include family footwear retailers, national and regional retail chains, sporting goods stores, independent footwear retailers as well as e-tailers. +Many of our agreements allow us to accept returns from wholesale customers for defective products, on an exception basis, and to extend pricing discounts in lieu of such returns. We also may accept returns from our wholesale customers, on an exception basis, for the purpose of stock re-balancing, to ensure that our products are merchandised in the proper assortments. +Outside the United States, in addition to wholesale customers, we use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years, are generally terminable upon 30 days prior notice, and have minimum sales requirements that allow us to terminate or renegotiate the contract if minimum requirements are not met. +Retail Channel +During the years ended December 31, 2016 , 2015 , and 2014 , approximately 34.7%, 34.7%, and 35.5%, respectively, of our revenues were derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full-price retail locations, outlet locations, kiosk and store-in-store locations. Our three types of store platforms enable us to promote the breadth of our product offering in high-traffic, highly visible locations. With the worldwide consumer shift in shopping patterns out of traditional retail to e-commerce, we are focused on carefully managing and reducing our physical retail portfolio. We intend to continue to moderate the pace of our retail expansion in 2017 with a focus on outlet locations as well as enhancing the profitability of existing locations. We opened 83 company-operated stores during the year ended December 31, 2016 and closed 84 company-operated stores. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +Full-Price Retail Locations +Our company-operated full-price retail locations allow us to effectively showcase the full extent of our product ranges to consumers. In addition, our full-price retail locations provide us with the opportunity to interact with our consumers directly. The optimal space for our retail locations is between approximately 1,500 and 1,800 square feet, and is located in high-traffic shopping malls or districts. During the year ended December 31, 2016, we closed 66 stores and opened 19 new full-price retail stores. As of December 31, 2016 , 2015 , and 2014 , we operated 228 , 275, and 311 full-price retail stores, respectively. +Outlet Locations +Our company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built for outlet products in certain locations. Outlet locations are similar in size to our full-price retail stores; however, they are generally located within outlet shopping centers. During the year ended December 31, 2016, we closed four outlet locations and opened 50 outlet locations. As of December 31, 2016 , 2015 , and 2014 , we operated 232 , 186, and 174 outlet stores, respectively. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other high foot traffic areas. With efficient use of retail space, and limited capital investment, we believe that kiosks and store-in-store locations can be an effective vehicle for marketing our products where this business model is applicable. During the year ended December 31, 2016 , we closed 14 kiosk and store-in-store locations and opened 14 new kiosk and store-in-store locations. As of December 31, 2016 , 2015 , and 2014 , we operated 98 , 98, and 100 kiosks and store-in-stores, respectively. +3 +Table of Contents +The following table illustrates the net change in 2016 with respect to the number of our company-operated retail locations by reportable operating segment and country: +Company-Operated Retail Locations +December 31, 2015 +Opened +Closed +December 31, 2016 +Americas +United States +179 +7 +12 +174 +Canada +10 +— +— +10 +Puerto Rico +7 +— +1 +6 +Total Americas +196 +7 +13 +190 +Asia Pacific +Korea +84 +9 +6 +87 +Japan +52 +1 +4 +49 +China +55 +43 +19 +79 +Hong Kong +21 +5 +9 +17 +Singapore +15 +3 +— +18 +Australia +11 +5 +8 +8 +United Arab Emirates +14 +1 +3 +12 +South Africa +9 +— +9 +— +Total Asia Pacific +261 +67 +58 +270 +Europe +Russia +37 +2 +3 +36 +Germany +18 +— +— +18 +Great Britain +10 +— +3 +7 +France +12 +— +2 +10 +Netherlands +6 +— +1 +5 +Finland +5 +— +1 +4 +Spain +6 +— +1 +5 +Austria +— +7 +1 +6 +Other +8 +— +1 +7 +Total Europe +102 +9 +13 +98 +Total +559 +83 +84 +558 +_______________________________________________________________________________ +E-commerce Channel +As of December 31, 2016 , we offered our products through 12 company-operated e-commerce sites worldwide. We also offer our products through third-party e-commerce sites. Revenues from third-party e-commerce sites are reported in our wholesale channel. During the years ended December 31, 2016 , 2015 , and 2014 , approximately 12.6% , 11.1% and 8.8%, respectively, of our revenues were derived from sales through our e-commerce channel. Our e-commerce presence enables us to have increased access to our consumers and provides us with an opportunity to educate them about our products and brand. Improving our e-commerce capabilities is one of our key growth strategies. We will continue to improve our consumer's online experience, and our in stock reliability and will look for new ways to leverage digital technologies to connect with consumers, including mobile optimization of our sites. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and Europe. We also have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable operating segment threshold, including manufacturing operations located in Mexico and Italy, and corporate operations. See additional discussion of our segments and geographic information, including results of operations and assets by segment and geography in Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II — Item 8. Financial Statements and Supplementary Data of this Annual Report. +4 +Table of Contents +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in North and South America. Regional wholesale channel customers consist of a broad range of family footwear, sporting goods and e-tailers as well as independent retailers and distributors. The Americas retail channel sells directly to consumers through 190 company-operated retail store locations in the Americas as well as through e-commerce sites. During the years ended December 31, 2016 , 2015 , and 2014 , revenues from the Americas segment were approximately 45.1%, 43.7%, and 40.9% of our consolidated revenues, respectively. Specifically, revenues from the United States were approximately 37.1%, 35.8%, and 36.3% of our consolidated revenues, respectively, for the years ended December 31, 2016 , 2015 , and 2014 . +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, Africa and the Middle East. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell products directly to consumers through 270 company-operated retail stores located in Asia as well as through our e-commerce sites. During the years ended December 31, 2016 , 2015 , and 2014 , revenues from our Asia Pacific segment were 38.1%, 39.0%, and 39.6%, of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Western Europe, Eastern Europe and Russia. The Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell our products directly to consumers through 98 company-operated retail stores located in Europe as well as through our e-commerce sites. During the years ended December 31, 2016 , 2015 , and 2014 , revenues from the Europe segment were 16.7 %, 17.3%, and 19.5% of our consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. During the year ended December 31, 2016, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Russia, and Italy. We also utilize third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico, and Italy. As of December 31, 2016, our company-operated warehouse and distribution facilities provided us with approximately 0.9 million square feet and our third-party operated distribution facilities provided us with approximately 0.5 million square feet. We also ship a portion of our products directly to our wholesale customers from our internal and third-party manufacturers. +Raw Materials +Croslite, our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our accessories. Croslite is soft, durable, and allows our products to be non-marking and extremely lightweight. Croslite is carefully formulated to create extremely lightweight, odor-resistant, water-resistant and non-marking footwear that conforms to the shape of the foot and increases comfort. +We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. +Croslite material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other production inputs such as color dyes. We have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may also in the future identify and utilize materials produced by other suppliers as an alternative to, or in addition to, the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to produce the Croslite products are readily available for purchase from multiple suppliers. +Since our inception in 2002, we have substantially increased the number of footwear products we offer. Many of these new products are constructed using leather, textile fabrics, or other non-Croslite materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. We also outsource the compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third-party in Europe. +5 +Table of Contents +Research, Design and Development +We continue to dedicate significant resources to product design and development as we expand the footwear styles we offer based on opportunities we identify in the marketplace. Our design and development process is highly collaborative and we continually strive to improve our development function so we can bring products to market quickly and at reduced costs, while maintaining product quality. We spent $11.9 million, $14.0 million, and $16.7 million in research, design, and development activities for the years ended December 31, 2016 , 2015 , and 2014 , respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or to provide support to our internal production processes. +In the years ended December 31, 2016 , 2015 , and 2014 , we manufactured approximately 14.6%, 11.3%, and 13.9%, respectively, of our footwear products internally. We sourced the remaining footwear production from multiple third-party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2016 , 2015 , and 2014 , our largest third-party manufacturer in China produced approximately 23.4%, 26.6%, and 27.5%, respectively, of our third-party footwear unit volume. We do not have written supply agreements with our primary third-party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress and patent protections to establish, protect and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks and copyrights are crucial to the successful marketing and sale of our products. We will continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We also intend to continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formula by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter are typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our product line to include more winter oriented styles to reduce the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions, or general economic conditions, or consumer confidence. Accordingly, +6 +Table of Contents +results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders, and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules and the timing of product shipments. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model differences around the globe, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to, Nike Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as Genesco, Inc., Macy's Inc., Dillard's, Inc., Dick's Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, pricing, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite material, our prices, our expanded product line, and our distribution network continue to position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new companies who have been attracted to the market with products similar to ours as the result of the unique design and success of our footwear products. +Foreign Currency Fluctuations on Revenues and Net Income (Loss) +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiary’s functional currency. Likewise, our U.S. companies are also exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar. +We have experienced, and will continue to experience, changes in international currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings. +Changes in exchange rates have a direct effect on our reported U.S. Dollar consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the U.S. Dollar reporting currency using average exchange rates each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly by differences in the exchange rates used to translate the operating results of our international subsidiaries. +For example, in our European segment, when the U.S. Dollar strengthens relative to the Euro, our reported U.S. Dollar results are less than if there had been no change in the exchange rate, because more Euros are required to generate the same U.S. Dollar translated amount. Conversely, when the U.S. Dollar weakens relative to the Euro, the reported U.S. Dollar results of our Europe segment are higher compared to a period with a stronger U.S. Dollar relative to the Euro. Similarly, the reported U.S. Dollar results of our Asia Pacific segment, where the functional currencies are primarily the Japanese Yen, Chinese Yuan, Korean Won and the Singapore Dollar, are comparatively lower or higher when the U.S. Dollar strengthens or weakens, respectively, relative to these currencies. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Form 10-K for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar consolidated statements of operations for the years ended December 31, 2016 and 2015. +7 +Table of Contents +Employees +As of December 31, 2016 , we had approximately 5,068 full-time, part-time, and seasonal employees, of which approximately 3,390 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended . These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained at www.sec.gov or at the SEC's public reference room at 100 F Street, N.E., Washington, D.C. 20549. Copies of any of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +8 +Table of Contents +ITEM 1A. Risk Factors +The reader should carefully consider the following risk factors and all other information presented within this report. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, or access to sources of financing. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. You should carefully consider each of the following risks described below in conjunction with all other information presented in this report. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to predict all risk factors, nor can it assess the impact of all such risk factors on our business. +Risks Specific to Our Company +Uncertainty about current and future global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, or other economic factors. For example, in 2015 and 2014, we experienced difficulty in our Asia Pacific segment primarily due to decreased performance in our China business which resulted in delayed collections of receivables and increased the risk of customer nonpayment. Due to the continued adverse macroeconomic conditions in China during 2016 and 2015 , we also experienced volatility in revenues in our Asia Pacific segment. If global economic and financial market conditions deteriorate further or remain weak for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• +Changes in foreign currency exchange rates relative to the U.S. Dollar could have a material impact on our reported financial results. +• +Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, cause reduced product orders or product order cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• +If consumer demand for our products declines, we may not be able to profitably establish new retail stores, or continue to operate existing stores, due to higher fixed costs of the retail business. +• +A decrease in credit available to our wholesale or retail customers, product suppliers and other service providers, or financial institutions that are counterparties to our credit facility or derivative instruments may result in credit pressures other financial difficulties or insolvency for these parties, with a potential adverse impact on our ability to obtain future financing, our business and our financial results. +• +If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment by our wholesalers. +• +If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +China's deteriorating macro-economic environment could adversely affect sales in our Asia Pacific segment which may adversely affect our business financial results. +Current and future global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. Macro-economic conditions in China have deteriorated over the past several quarters resulting in softening consumer demand and payment delays from our China distributors which have negatively impacted the sales volumes and cash collections for our China operations. During 2015 we discontinued relationships with several distributors and also changed terms to require cash payment at delivery. During 2015, we increased our allowance for doubtful accounts receivable in China by $23.2 million as a result of a +9 +Table of Contents +default by several distributors that were unable to make payments to us. If the economic conditions in China continue to decline, we may experience further reductions in consumer demand in the China market resulting in additional losses. As our China operations represent approximately 7% of our total revenues, the impact of declining sales volumes in China could have a material adverse impact on our business and financial results in future periods. +Changes in foreign exchange rates, most significantly but not limited to the Singapore Dollar, Chinese Yuan, Japanese Yen, Korean Won, the Euro and British Pound, could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar (“USD”). We pay the majority of our overseas third-party manufacturers, located primarily in China and Vietnam, in USD. Our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, product price pressures, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance, as we generally pay our overseas third-party manufacturers in U.S. Dollars. In 2016, we experienced an increase of approximately $3.3 million in our Asia Pacific segment revenues as a result of increases in the value of Asian currencies relative to the U.S. Dollar, and a decrease of approximately $3.2 million in our Europe revenues as a result of decreases in the Euro and Russian Ruble relative to the U.S. Dollar. Strengthening of the USD against Asian and European currencies, and various other global currencies would adversely impact our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and as a result our forward contracts may not prove effective in reducing our exposures. +We face significant competition. +The footwear industry is highly competitive. Continued growth in the market for casual footwear has encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, and spend substantially more than we do on product marketing. Our competitors' greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, and more quickly develop new products. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. In addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or failure to protect the integrity and security of customer and employee information could harm our reputation and/or our ability to effectively operate our business. +We rely heavily on the use of information technology systems and networks in our operations and supporting departments including marketing, accounting, finance, and human resources. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We rely exclusively on information services providers worldwide for our information technology functions including network, help desk, hardware and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments. We use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal and tax requirements. We also have outsourced a significant portion of work associated with our finance and accounting, human resources and other information technology functions to third-party service providers. Despite our current security measures, our systems, and those of our third-party service providers, we may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, and interruption or loss of valuable business data. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of retail and internet sales, significant costs for data restoration, and other adverse impacts on our business and reputation. +Over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse +10 +Table of Contents +management, order management, retail point-of-sale, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back office systems. Issues in implementing or integrating new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations and require significant additional capital investments, to remediate, and may have an adverse effect on our business and financial results. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers' or employees' personal information, or a disruption of our business. Despite our existing security procedures and controls, if our network becomes compromised, it could give rise to unwanted media attention, materially damage our customer relationships, harm our business, our reputation, and our financial results, which could result in fines or lawsuits, and may increase the costs we incur to protect against such information security breaches, such as increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast geographic demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, including: +• +Our ability to strengthen our brand globally into a leading casual lifestyle footwear provider; +• +Our ability to focus on relevant geographies and markets, product innovation and profitable new growth platforms while maintaining demand for our current offerings; +• +Our ability to effectively manage our retail stores (including closures of existing stores) while meeting operational and financial targets at the retail store level; +• +Our ability to accurately forecast the global demand for our products and the timely execution of supply chain strategies to deliver product around the globe efficiently based on that demand; +• +Our ability to use and protect the Crocs brand and our other intellectual property in new markets and territories; +• +Our ability to achieve and maintain a strong competitive position in new and existing markets; +• +Our ability to attract and retain qualified distributors, agents, and to continue to develop direct sales channels; +• +Our ability to consolidate our distribution and supply chain network to leverage resources and simplify our fulfillment process; and +• +Our ability to execute a multi-channel advertising and marketing campaign to effectively communicate our message directly to our consumers and employees. +If we are unable to successfully implement any of the above mentioned strategies and the many other factors mentioned throughout these risk factors, our business may fail to grow, our brand may suffer, and our business and financial results may be adversely impacted. +There can be no assurance that the strategic plans we have begun to implement will be successful. +In July 2014, we announced strategic plans for long-term improvement and growth of our business, which is comprised of four key initiatives: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient organizational structure including reducing duplicative and excess overhead which will also enhance the decision making process, and (4) optimizing our retail locations around the world. +While these strategic plans, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance that this will be the case, or that additional steps or accrual of additional material accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. The initial charges for the strategic plan were incurred in the first quarter of 2014 and continued through 2015. During 2014 and 2015, we closed 172 retail locations, offset in part by 112 new retail locations opened. We completed our restructuring plan in 2015. +We conduct significant business activity outside the U.S. which exposes us to risks of international commerce. +11 +Table of Contents +A significant portion of our revenues is from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. In addition to foreign manufacturing, we operate retail stores and sell our products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks including: tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; delays associated with the manufacture, transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to increased security concerns; restrictions on the transfer of funds; restrictions, due to privacy laws, on the handling and transfer of consumer and other personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; expropriation and nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions; longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; difficulties in enforcing contractual and intellectual property rights; greater risk that our business partners do not comply with our policies and procedures relating to labor, health and safety; and increased accounting and internal control costs. In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we operate. We cannot assure that there will be not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by various customs authorities including the U.S. and Mexico. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. +In addition, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries and a materially negative effect on our brands and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners or agents will not violate our policies. +Our success depends substantially on the value of our brand and failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strengthening of the Crocs global brand. To be successful in the future, particularly outside of the U.S., where the Crocs global brand is less well-known and perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brand across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be out of style, outdated, one-dimensional or otherwise undesirable. Brand value is based in part on consumer perceptions on a variety of subjective qualities. In the past, several footwear companies including ours have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Consumer demand for our products and our brand equity could diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brand and adversely impact our business. +If our online e-commerce store sites do not function effectively, our business and financial results could be materially adversely affected. +Many of our customers buy our products on our e-commerce store sites as well as third-party e-commerce store sites. Any failure on our part or third-party platform providers to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our merchandise could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Opening retail stores globally involves substantial investment, including the construction costs of leasehold improvements, furniture and fixtures, equipment, information systems, inventory and personnel. Operating global retail stores incurs fixed +12 +Table of Contents +costs. If we are unable to generate sales, operate our retail stores profitably or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating additional retail locations requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location and other factors that we do not control. Declines in revenue and operating performance of our retail locations could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2016, we opened, closed and operated 19 , 66 and 228 retail locations, respectively. +Although we have slowed the expansion of our retail sales channel, we intend to continue to open new retail locations globally. Our ability to open new locations successfully depends on our ability to identify suitable store locations, negotiate acceptable lease terms, hire, train, and retain store personnel and satisfy the fashion preferences in new geographic areas. Many of our retail locations are located in shopping malls and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot traffic. Reduced customer foot traffic could reduce sales at our retail stores or hinder our ability to open retail stores in new markets, which could in turn negatively affect our business and financial results. In addition, some of our retail stores and kiosks occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, terrorism, social or military events or otherwise, is likely to adversely affect sales in our existing stores and kiosks. For example, in 2016 we closed our retail locations in Belgium in part as a result of the terrorist attacks in Europe. +We may be required to record impairments of long-lived assets relating to our retail operations. +Impairment testing of our retail stores' long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows or the closure of a store could result in write-downs of inventory, impairment of leasehold improvements, impairment of other long-lived assets, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. For example, during 2016, 2015, and 2014, we recorded impairments of which $2.7 million, $9.6 million and $8.8 million, respectively, related to our retail stores. These impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +We depend on key personnel across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous executive compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. In recent years, we have experienced management turnover. Our future success depends on our ability to identify, attract and retain qualified personnel on a timely basis. In addition, we must successfully integrate any newly hired management personnel within our organization in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, if at all. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays in our long-term growth strategy. +As a global company, we also rely on the expertise and knowledge of a limited number of key international personnel in many of our geographic regions. In certain instances, one or two personnel may be the primary knowledge base for business operations in a geographic region. The loss of key international personnel could adversely impact our operations and our client relationships. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers' orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions and other factors affecting consumer demand. In addition, sales to our wholesale customers are generally subject to rights of cancellation and rescheduling by the customer. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages which can result in lower sales, delays in shipments to customers, expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. A decline in demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +13 +Table of Contents +Refining our footwear product line may be difficult and expensive. If we are unable to do so successfully, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully refine our footwear product line, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. Our development schedules for new products are difficult to predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently manufacture new products in quantities sufficient to support retail and wholesale distribution, we may not be able to recover our investment in the development of new styles and product lines and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We have a limited history of introducing new products in certain target markets; as such, we may set the prices of new styles too high for the market to bear or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses and there can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position and result in long-term harm to our business and financial results. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. A significant portion of our revenues are attributable to footwear styles that are more suitable for fair weather and are derived from sales in the northern hemisphere. We typically experience our highest sales activity during the second and third quarters of the calendar year, when there is warmer weather in the northern hemisphere. While we continue to create new footwear styles that are more suitable for cold weather, the effects of favorable or unfavorable weather on sales can be significant enough to affect our quarterly results which could adversely affect our common stock price. Quarterly results may also fluctuate as a result of other factors, including new style introductions, general economic conditions or changes in consumer preferences. Results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +We depend heavily on third-party manufacturers located outside the U.S. +Third-party manufacturers located in China and Vietnam produced the majority of our footwear products in 2016 and are expected to do so in 2017. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers' operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders, particularly in China and Vietnam. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines or meet our quality standards. +In addition, we do not have supply contracts with many of these third-party manufacturers and any of them may unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. As a result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third-party manufacturers. Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, changes in governmental policies and the imposition of tariffs, import and export controls, and other barriers. We may not be able to offset any interruption or decrease in supply of our products by increasing production in our internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can adversely affect our product margins. +14 +Table of Contents +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, increases in labor costs, changes in international trade agreements and tariffs, or adverse weather conditions could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. For example, the Trump Administration has suggested modifying existing trade agreements and/or imposing tariffs on foreign products. Changes in existing trade agreements, including the North American Free Trade Agreement ("NAFTA"), or the imposition of tariffs on our products could have a material adverse effect on our operations and financial results. +We manufacture a portion of our products which causes us to incur greater fixed costs. Any difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of operations. +We produce a portion of our footwear products at our company-owned internal manufacturing facilities in Mexico and Italy. There are significant fixed costs associated with the ownership and operations of these facilities and, as a result, efficient production of a sufficient volume of products is necessary to enable recovery of these costs. In addition, the manufacture of our products from the Croslite material requires the use of a complex process and we may experience difficulty in producing footwear that meets our high quality control standards. We absorb the manufacturing and disposal costs of products that do not meet our quality standards. Further, significant excess capacity at any of our manufacturing facilities as a result of increased efficiencies in our supply chain process or continued volume declines, could result in under-utilization of our facilities, which could lead to excess fixed overhead costs per unit and reduced product margins. Any increases in our manufacturing costs, lack of operating efficiency or product quality could adversely impact our product margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges faced by our third-party manufacturers, including our ability to scale our production capabilities to meet the needs of our customers. Our manufacturing may also be disrupted for reasons beyond our control, including work stoppages, fires, earthquakes, floods or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in a timely manner and could have a material and adverse effect on our business and financial results. +Our third-party manufacturing operations must comply with labor, trade and other laws; failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall which could result in critical media coverage and harm our business, brand and reputation and cause us to incur additional costs. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business, or results. +Our senior revolving credit facility agreement (the "Credit Agreement") contains financial covenants that require us to maintain certain financial measures, ratios and includes restrictive covenants that limit our ability to take certain actions. A breach of restrictive covenants may cause us to be in default under the facility, and our lenders could foreclose on our assets. +Our Credit Agreement requires us to maintain certain financial covenants. A failure to maintain current revenue levels or an inability to control costs or capital expenditures could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or and accelerate the repayment of any outstanding borrowings under the Credit Agreement. In February 2016, we obtained a waiver to remedy noncompliance with certain coverage ratios in December 2015 and amended our Credit Agreement with more favorable terms. We may not have sufficient assets to repay such indebtedness upon a default or receive a waiver of the default from the lender. If we are unable to repay the indebtedness, the lender could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Credit Agreement. +15 +Table of Contents +The Credit Agreement also contains certain restrictive covenants that limit and in some circumstances prohibit, our ability to, among other things incur additional debt, sell, lease or transfer our assets, pay dividends on our common stock, make capital expenditures and investments, guarantee debt or obligations, create liens, repurchase our common stock, enter into transactions with our affiliates and enter into certain merger, consolidation or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +Our financial success may be limited to the strength of our relationships with our wholesale and distribution customers and the success of our wholesalers and distributors. +Our financial success is related to the willingness of our current and prospective wholesale and distributors customers to carry our products. We do not have long-term contracts and sales to our wholesalers and distributors are generally on an order-by-order basis and subject to cancellation and rescheduling. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses and reduced cash flows if our collection efforts are unsuccessful. For example, we recorded an increase in bad debts expense of approximately $23.2 million in China in 2015, primarily as a result of delayed payments and payment defaults from certain distribution partners in China. Additional problems with our distribution customers, including continued payment delays in the Asia Pacific segment or other segments, may have a material adverse effect on our product sales, financial condition, results of operations and our ability to grow our product line. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market issues related to supply and demand for our raw materials. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of the Croslite material, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and designs on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brand, our success and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party's products on the basis of trademark or design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others intellectual property rights, continued sales of such competing products by third parties could harm our brand or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, the integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite material and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our +16 +Table of Contents +intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +We have substantial cash requirements in the U.S. However, a majority of our cash is generated and held outside of the U.S. The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S. business and financial results. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, including China, may have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. Since repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able to repatriate such cash on favorable terms or in a timely manner. If we incur operating losses on a continued basis and require cash that is held in international accounts for use in our U.S. operations, a failure to repatriate such cash in a timely and cost-effective manner could adversely affect our business and financial results. Further, U.S. legislative initiatives to reform U.S. tax law could have a material impact on our future tax rate and our repatriation plans. +We are subject to periodic litigation, which could result in unexpected expense of time and resources. +From time to time, we are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. We are currently involved in several, potentially adverse legal proceedings. For a detailed discussion of our current material legal proceedings, see Item 3 . Legal Proceedings in Part I of this Form 10-K. An unfavorable outcome in any of these proceedings or any future legal proceedings could have an adverse impact on our business, and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management's attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management's attention and resources that are needed to successfully run our business. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management's estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. +Changes in tax laws and unanticipated tax liabilities and the results of tax audits or litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, the outcome of income tax audits in various jurisdictions around the world and any repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes. We regularly assess all of these matters to determine the adequacy of our tax provision, which is subject to significant discretion and we could face significant adverse impact if our assumptions are incorrect and/or face significant cost to defend our practices from international and U.S. tax authorities. We are regularly subject to, and are currently undergoing, audits by tax authorities in the United States and foreign jurisdictions for prior tax years. Please refer to Item 3. Legal Proceedings in Part I of this Form 10-K as well as Note 15 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements for additional details regarding current tax audits. Although we believe our tax estimates are reasonable and we intend to defend our positions through litigation if necessary, the final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be +17 +Table of Contents +subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits. The unfavorable resolution of any audits or litigation could have an adverse effect on our financial position and results of operations. Future changes in domestic or international tax laws and regulations could also adversely affect our income tax liabilities. Recent developments, including the European Commission's investigations of local country tax authority rulings and whether those rulings comply with European Union rules on state aid, as well as the Organization for Economic Co-operation and Development's project on Base Erosion and Profit Shifting, may result in changes to long-standing tax principles. Any such changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses, and expansion of existing businesses, such as our retail operations, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties inherent in acquiring or expanding a business. The failure of any significant investment to provide the returns or profitability we expect or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +If our internal controls are ineffective, our operating results and market confidence in our reported financial information could be adversely affected. +Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal controls or if we experience difficulties in their implementation, our business and operating results and market confidence in our reported financial information could be harmed, we could incur significant costs to evaluate and remediate weaknesses, and we could fail to meet our financial reporting obligations. +As of December 31, 2015, we identified material weaknesses in our internal control over financial reporting, which led us to conclude that our internal control over financial reporting as of such date was not effective. The material weaknesses identified were related to controls over the period end closing procedures and inventory monitoring, which we believe have been remediated as of December 31, 2016 as further explained in Item 9A. Controls and Procedures in Part II of this Form 10-K. +The existence of a material weakness precludes management from concluding that our internal control over financial reporting is effective and precludes our independent auditors from issuing an unqualified opinion that our internal controls are effective. In addition, a material weakness could cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock. We also can make no assurances that we will be able to remediate any future internal control deficiencies timely and in a cost effective manner. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we are unable to satisfactorily remediate future deficiencies or if we discover other deficiencies in our internal control over financial reporting, such deficiencies may lead to misstatements in our financial statements or otherwise negatively impact our business, financial results and reputation. +Natural disasters could negatively impact our operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis or other adverse weather and climate conditions, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including damage to our supply chain, manufacturing or distribution centers, retail locations, energy shortages, and public health issues, could disrupt our operations or the operations of our vendors other suppliers, or customers, or result in economic instability that may negatively impact our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +18 +Table of Contents +Risks Specific to Our Capital Stock +The issuance of 200,000 shares of our Series A Convertible Preferred Stock ("Series A") to Blackstone Capital Partners VI L.P. ("Blackstone") in 2014 and certain of its permitted transferees reduces the relative voting power of holders of our common stock, may dilute the ownership of such holders, and may adversely affect the market price of our common stock. +On January 27, 2014, we issued 200,000 shares of Series A Preferred Stock to Blackstone and certain of its permitted transferees (collectively, the "Blackstone Purchasers") pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, the "Investment Agreement"). The Blackstone Purchasers currently own all of the outstanding shares of Series A Preferred Stock, and based on the number of shares of our common stock outstanding as of December 31, 2016 , the Blackstone Purchasers collectively own Series A Preferred Stock convertible into approximately 15.8% of our common stock. As holders of our Series A Preferred Stock are entitled to vote, on an as-converted basis, together with holders of our common stock as a single class on all matters submitted to a vote of our common stockholders, the issuance of the Series A Preferred Stock to the Blackstone Purchasers has effectively reduced the relative voting power of the holders of our common stock. +In addition, conversion of the Series A Preferred Stock to common stock will dilute the ownership interest of existing holders of our common stock, and any sales in the public market of the common stock issuable upon conversion of the Series A Preferred Stock could adversely affect prevailing market prices of our common stock. We have granted the Blackstone Purchasers registration rights in respect of the shares of Series A Preferred Stock and any shares of common stock issued upon conversion of the Series A Preferred Stock. These registration rights would facilitate the resale of such securities into the public market, and any such resale would increase the number of shares of our common stock available for public trading. Sales by the Blackstone Purchasers of a substantial number of shares of our common stock in the public market, or the perception that such sales might occur, could have a material adverse effect on the price of our common stock. +We are required to pay regular dividends on the Series A issued to Blackstone in 2014, which ranks senior to our common stock, and we may be required under certain circumstances to repurchase the outstanding shares of Series A Preferred Stock; such obligations could adversely affect our liquidity and financial condition. +The Series A Preferred Stock ranks senior to our common stock with respect to dividend rights, and holders of Series A Preferred Stock are entitled to quarterly cumulative cash dividends at a rate of 6% per annum of the stated value of $1,000 per share. If we fail to make timely dividend payments, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in full. In addition, the holders of our Series A Preferred Stock have certain redemption rights, including upon certain change in control events involving us, which, if exercised, could require us to repurchase all of the outstanding shares of Series A Preferred Stock at 100% or more of the stated value of the shares, plus all accrued but unpaid dividends. Our obligations to pay regular dividends to the holders of our Series A Preferred Stock or any required repurchase of the outstanding shares of Series A Preferred Stock could impact our liquidity and reduce the amount of cash flows available for working capital, capital expenditures, growth opportunities, acquisitions, and other general corporate purposes. Our obligations to the holders of Series A Preferred Stock could also limit our ability to obtain additional financing or increase our borrowing costs, which could have an adverse effect on our business and financial results. +Blackstone may exercise significant influence over us, including through its ability to elect up to two members of our Board of Directors. +As of December 31, 2016 , the shares of Series A Preferred Stock owned by the Blackstone Purchasers represent approximately 15.8% of the voting rights of our common stock, on an as-converted basis, so the Blackstone Purchasers will have the ability to significantly influence the outcome of any matter submitted for the vote of our stockholders. In addition, the Certificate of Designations of the Series A Preferred Stock grants certain consent rights to the holders of Series A Preferred Stock in respect of certain actions by the Company, including the issuance of pari passu or senior equity securities of the Company, certain amendments to our certificate of incorporation or bylaws, any increase in the size of our Board of Directors (the "Board") above eight members, the payment of certain distributions to our stockholders, and the origination or refinancing of a certain level of indebtedness. The Blackstone Purchasers may have interests that diverge from, or even conflict with, those of our other stockholders. For example, Blackstone and its affiliates may have an interest in directly or indirectly pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their other equity investments, even though such transactions might involve risks to us. Blackstone and its affiliates are in the business of making or advising on investments in companies, including businesses that may directly or indirectly compete with certain portions of our business. They may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us. +In addition, the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as the Blackstone Purchasers (i) beneficially own at least 95% of the Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement or (ii) maintain beneficial ownership of at least 12.5% of our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors to our Board. For +19 +Table of Contents +so long as the Blackstone Purchasers beneficially own shares of Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement that represent less than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. +20 +Table of Contents +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado 80503. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for kiosk, manufacturing, office, retail, and warehouse space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, use and approximate size of our principal properties, and the reportable operating segment are given below. +Location +Reportable Operating Segment +Use +Approximate +Square Feet +Expiration (1) +Ontario, California +Americas +Warehouse +339,000 +Mar 2019 +Shenzen, China +Asia Pacific +Warehouse/offices +266,000 +Jun 2017 +Rotterdam, the Netherlands +Europe +Warehouse +174,000 +Dec 2021 +Leon, Mexico +Americas, Other Businesses +Manufacturing/warehouse/offices +166,000 +Mar 2019 +Narita, Japan +Asia Pacific +Warehouse +156,000 +Apr 2019 +Niwot, Colorado +Americas +Corporate headquarters and regional offices +98,000 +Jun 2021 +Padova, Italy +Americas, Other Businesses +Manufacturing/warehouse/offices +45,000 +Sep 2018 +Hoofddorf, the Netherlands +Europe +Regional offices +31,000 +May 2020 +Singapore +Asia Pacific +Regional offices +17,000 +Dec 2018 +Westwood, Massachusetts +Americas +Global Commercial Center +16,000 +Sep 2021 +Tokyo, Japan +Asia Pacific +Regional offices +14,000 +Oct 2018 +Shanghai, China +Asia Pacific +Regional offices +13,000 +Jul 2018 +Bhiwandi, India +Asia Pacific +Warehouse +11,000 +Oct 2017 +Moscow, Russia (2) +Europe +Warehouse/offices +11,000 +Dec 2016 +_______________________________________________________________________________ +(1) Expiration of the initial or existing lease term, excluding optional renewals. +(2) On month-to-month renewal after December 2016. +In addition to the principal properties listed above, we maintain sales offices in the United States, Canada, South America, Hong Kong, Australia, Korea, China, the United Arab Emirates, India and Europe. We also lease more than 550 retail, outlet and kiosk/store in store locations worldwide. See Item 1. Business of this Form 10-K for further discussion regarding global company-operated stores. +21 +Table of Contents +ITEM 3. Legal Proceedings +The Company is currently subject to an audit by U.S. Customs & Border Protection (“CBP”) in respect of the period from 2006 to 2010. In October 2013, CBP issued the final audit report. In that report CBP projects that unpaid duties totaling approximately $12.4 million are due for the period under review and recommends collection of the duties due. The Company responded that these projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the projection. Additionally, on December 12, 2014, we made an offer to settle CBP’s potential claims and paid $3.5 million. In 2016, after discussions with CBP's local counsel, we increased our settlement offer to $7.0 million and paid an additional $3.5 million in the quarterly period ended December 31, 2016. The revised offer is subject to formal acceptance by the CBP . At this time, it is not possible to determine how long this process will take or to predict whether a negotiated settlement can be reached. Likewise, if a settlement cannot be reached, it is not possible to predict with any certainty whether CBP will seek to assert a claim for penalties in addition to any unpaid duties, but such an assertion is a possibility. +We are currently subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, we were notified about the issuance of assessments totaling approximately $4.5 million for the period January 2010 through May 2011. The Company has disputed these assessments and asserted defenses to the claims. On February 25, 2015, we received additional assessments totaling approximately $10.2 million related to the remainder of the audit period. We have also disputed these assessments and asserted defenses and filed appeals to these claims. On May 11, 2016, we were notified of a decision rejecting the defense filed against the first assessment covering the period of January 2010 through May 2011. We filed an appeal against that decision on June 8, 2016. It is anticipated that this matter will take up to two or more years to be resolved. It is not possible at this time to predict the outcome of this matter. +For all other claims and other disputes, where we are able to estimate possible losses or a range of possible losses, we estimate that as of December 31, 2016, it is reasonably possible that losses associated with these claims and other disputes could potentially exceed amounts accrued by us by up to $0.4 million. +In the aggregate, the Company has accrued $7.4 million associated with our estimated obligations related to legal claims, which is reported in the consolidated balance sheet in 'Accrued expenses and other liabilities'. +Although the Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, the Company is not party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business and financial results. +22 +Table of Contents +ITEM 4. Mine Safety Disclosures +Not applicable. +23 +Table of Contents +PART II +ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the NASDAQ Global Select Market and trades under the stock symbol "CROX". The following table shows the high and low sales prices of our common stock for the periods indicated. +2016 +High +Low +First quarter +$ +10.16 +$ +8.09 +Second quarter +11.50 +7.63 +Third quarter +12.54 +8.02 +Fourth quarter +8.99 +6.70 +2015 +High +Low +First quarter +$ +12.78 +$ +10.25 +Second quarter +16.05 +11.55 +Third quarter +15.86 +12.52 +Fourth quarter +12.30 +9.26 +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite Index and the Dow Jones U.S. Footwear Index from December 31, 2011 through December 31, 2016. The graph assumes an investment of $100.00 on December 31, 2011 and assumes the reinvestment of all dividends and other distributions. +24 +Table of Contents +12/31/2012 +12/31/2013 +12/31/2014 +12/31/2015 +12/31/2016 +Crocs, Inc. +$ +97.43 +$ +107.79 +$ +84.56 +$ +69.33 +$ +46.45 +Dow Jones U.S. Footwear Index +104.78 +160.80 +187.09 +228.72 +190.92 +Nasdaq Composite Index +115.91 +160.32 +181.80 +192.21 +206.63 +The Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corporation., Iconix Brand Group, Inc., Skechers U.S.A., Inc., Steven Madden Ltd. and Wolverine World Wide, Inc., among other companies. As Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of our stock have an effect on this index. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 84 as of February 22, 2017. +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements contain certain restrictions on our ability to pay cash dividends on our common stock. In addition, the Certificate of Designations governing the Series A Convertible Preferred Stock that we issued in January 2014 restricts us from declaring and paying certain dividends on our common stock if we fail to pay all accumulated and unpaid regular dividends and/or declared and unpaid participating dividends to which the preferred holders are entitled. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to compliance with covenants under any then-existing financing agreements and the terms of the Certificate of Designations. +Purchases of Equity Securities by the Issuer +On December 26, 2013, our Board approved the repurchase of up to $350 million of our common stock, which was announced on December 30, 2013. We did not purchase any shares of our common stock during the twelve months ended December 31, 2016. As of December 31, 2016, authorization to repurchase up to approximately $118.7 million of our shares remained available. The number, price, structure and timing of repurchases, if any, may be made at our sole discretion, subject to limitations in our Credit Agreement. We may transact repurchases on the open market or in privately negotiated transactions. The repurchase authorization does not expire and we have no obligation to repurchase any additional common shares. The Board may suspend, modify, or terminate the repurchase authorization at any time without prior notice. +25 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five years. The information in this table should be read in conjunction with our consolidated financial statements and accompanying notes presented in Item 8. Financial Statements and Supplementary Data , and Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations in Part II of this Form 10-K. +Year Ended December 31, +2016 +2015 +2014 +2013 +2012 +(in thousands, except per share data) +Revenues +$ +1,036,273 +$ +1,090,630 +$ +1,198,223 +$ +1,192,680 +$ +1,123,301 +Cost of sales +536,109 +579,825 +603,893 +569,482 +515,324 +Restructuring charges +— +— +3,985 +— +— +Gross profit +500,164 +510,805 +590,345 +623,198 +607,977 +Gross margin % +48.3 +% +46.8 +% +49.3 +% +52.3 +% +54.1 +% +Selling, general and administrative expenses +503,174 +559,095 +565,712 +549,154 +460,393 +Selling, general and administrative expenses as a % of revenues +48.6 +% +51.3 +% +47.2 +% +46.0 +% +41.0 +% +Restructuring charges +— +8,728 +20,532 +— +— +Asset impairments (1) +3,144 +15,306 +8,827 +10,949 +1,410 +Income (loss) from operations +(6,154 +) +(72,324 +) +(4,726 +) +63,095 +146,174 +Income (loss) before income taxes +(7,213 +) +(74,744 +) +(8,549 +) +59,959 +145,548 +Income tax (expense) benefit +(9,281 +) +(8,452 +) +3,623 +(49,539 +) +(14,205 +) +Net income (loss) +(16,494 +) +(83,196 +) +(4,926 +) +10,420 +131,343 +Dividends on Series A convertible preferred stock +(12,000 +) +(11,833 +) +(11,301 +) +— +— +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(3,244 +) +(2,978 +) +(2,735 +) +— +— +Net income (loss) attributable to common stockholders +$ +(31,738 +) +$ +(98,007 +) +$ +(18,962 +) +$ +10,420 +$ +131,343 +Net income (loss) per share +Basic income (loss) per share +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +$ +1.46 +Diluted income (loss) per share +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +$ +1.44 +Weighted average common shares +Basic shares +73,371 +75,604 +85,140 +87,989 +89,571 +Diluted shares +73,371 +75,604 +85,140 +89,089 +90,588 +Cash provided by (used in) operating activities +$ +39,754 +$ +9,698 +$ +(11,651 +) +$ +83,464 +$ +128,356 +Cash used in investing activities +18,657 +(18,627 +) +(57,992 +) +(69,758 +) +(65,943 +) +Cash provided by (used in) financing activities (2) +(16,443 +) +(101,260 +) +23,431 +(1,161 +) +(16,625 +) +(1) Asset impairments consist primarily of long-lived assets of closed retail locations in all years, and $0.4 million of goodwill in 2016. +(2) Cash used in financing activities includes approximately $85.9 million and $145.9 million including commissions used to repurchase the Company's common shares during 2015 and 2014, respectively. +26 +Table of Contents +As of December 31, +2016 +2015 +2014 +2013 +2012 +(in thousands) +Cash and cash equivalents +$ +147,565 +$ +143,341 +$ +267,512 +$ +317,144 +$ +294,348 +Inventories +147,029 +168,192 +171,012 +162,341 +164,804 +Working capital +276,335 +278,852 +441,523 +453,149 +455,177 +Total assets +566,390 +608,020 +806,931 +875,159 +829,638 +Long-term liabilities +17,966 +19,294 +27,849 +63,487 +54,300 +Total stockholders' equity +220,383 +245,972 +452,518 +624,744 +617,400 +27 +Table of Contents +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, manufacturing, worldwide marketing, distribution and sale of casual lifestyle footwear and accessories for men, women, and children. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels, our own Crocs single-branded stores including both full price and outlet stores, our own e-commerce sites, traditional multi-branded stores including family footwear stores, sporting goods stores and a variety of specialty and independent retail channels, and third-party e-commerce sites. In select markets we also sell to distributors that are typically granted the rights to distribute our products in a given geographical area. +Known or Anticipated Trends +Based on our recent operating results and current perspectives on our operating environment, we anticipate certain trends to impact our operating results: +• +Softening of the global economy and a cautious retail environment may continue to negatively affect customer purchasing trends. +• +Foreign exchange rates may continue to unfavorably impact revenues from our foreign operations for the foreseeable future. +• +Consumers spending preferences continue to shift toward e-commerce and away from brick and mortar stores. This has resulted in continued sales growth in our e-commerce channel, which has been largely offset by declining foot traffic in our retail locations. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“ U.S. GAAP ”), we present “non-GAAP selling, general, and administrative expenses”, which is a non-GAAP financial measure, within this Management's Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”). Adjusted results exclude the impact of items that management believes affect the comparability or underlying business trends in our consolidated financial statements in the periods presented. +We also present certain information related to our current period results of operations in this MD&A through “constant currency”, which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable operating segments under U.S. GAAP . Constant currency represents current period results that have been recast using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations. +Management uses adjusted results to assist in comparing business trends from period to period on a consistent non-GAAP basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe that these non-GAAP measures are useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance. We believe they also provide a useful baseline for analyzing trends in our operations. Investors should not consider these non-GAAP measures in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP . Please refer to our ‘Results of Operations’ within this section for a reconciliation of adjusted selling, general and administrative expenses to U.S. GAAP selling, general and administrative expenses. +2016 Financial Highlights +During the year ended December 31, 2016 , we experienced a decrease in our revenues of 5.0% compared to the year ended December 31, 2015 . The decrease in 2016 revenues as compared to 2015 revenues was due to: (i) lower sales volumes, including store closures, which reduced revenues by $46.3 million, or 4.2%; (ii) lower average selling prices which decreased revenues by $4.7 million, or 0.5%; and (iii) unfavorable changes in exchange rates which reduced revenues by $3.4 million or 0.3%. +The following are significant developments in our business during the year ended December 31, 2016 : +28 +Table of Contents +• +We sold 56.1 million pairs of shoes worldwide, a decrease of 4.2% from 58.6 million compared to 2015 . +• +Gross profit decreased $10.6 million, or 2.1%, to $500.2 million. However, our gross profit percentage increased 150 basis points to 48.3% compared to 46.8% in 2015 , in spite of unfavorable exchange rates which reduced our gross profit by $2.2 million, or 1.5%. +• +Selling, general and administrative ("SG&A") expenses decreased $55.9 million, or 10.0%, to $503.2 million compared to the same period in 2015 . This change was primarily driven by decreased sales, building and bad debt expense. +• +We incurred $3.1 million in asset impairments during 2016 , which included $2.7 million related to certain underperforming retail locations in our Americas, Europe, and Asia Pacific segments, and $0.4 million of goodwill in a retail business within our Europe segment. +• +Net loss attributable to common stockholders decreased $66.3 million to a net loss of $31.7 million compared to a net loss of $98.0 million for 2015 . Net loss per share was $0.43 during the year ended December 31, 2016 compared to net loss per share of $1.30 during the year ended December 31, 2015 . The decrease in our net loss is primarily the result of decreased asset impairment charges, restructuring charges and SG&A expenses. +• +We continued to focus on improving the efficiency and effectiveness of our operations, including continuing to shift the mix of our retail business from full-price retail to outlet stores. During the year ended December 31, 2016 , we opened 50 outlet stores and closed 66 full-price stores. In total, during the year ended December 31, 2016 we opened 83 stores and closed 84 stores. +• +We continued to focus on simplifying our product line and disciplined inventory management and reduced our inventory by $21.2 million or 12.6% from $168.2 million to $147.0 million. +• +During 2016, we did not repurchase any shares. +Future Outlook +We intend to continue our strategic plans for long-term improvement and growth of the business, which comprise these key initiatives: +(1) developing powerful product stories supported with effective marketing, +(2) driving global cohesive brand positioning , +(3) increasing working marketing spend , +(4) enhancing engagement with key wholesale accounts , +(5) gaining greater strategic and economic leverage from our direct-to-consumer assets, +(6) prioritizing investment in larger-scale geographies , +(7) streamlining the cost structure by reducing duplication & complexity across regional offices & the corporate center, and +(8) investing to drive supply chain effectiveness and reliability . +We believe these changes will better position Crocs to adapt to changing consumer demands and global economic developments. We are focusing on our core molded footwear heritage by narrowing our product line with an emphasis on higher margin units, as well as developing innovative new casual lifestyle footwear platforms. By streamlining the product portfolio and reducing non-core product development, we believe we will create a more powerful consumer connection to the brand. +We are refining our business model around the world, prioritizing direct investment in larger-scale geographies to focus our resources on the markets with the largest growth prospects, moving away from direct investment in the retail and wholesale businesses in smaller markets and transferring significant commercial responsibilities to distributors and third party agents. Further, we intend to expand our engagement with leading wholesale accounts in select markets to drive sales growth, optimize product placement and enhance brand reputation. +29 +Table of Contents +Additionally, we addressed the declining collection rates we experienced in 2015 from our China operations by limiting or terminating our relationship with distributors who we have identified as being a significant credit risk. In 2015, we recorded bad debts expense of $23.2 million associated with our China operations. As of December 31, 2016, we have terminated our relationship with multiple distributors in China and we expanded our relationship with existing business partners who are in a stronger financial position and who have a proven track record. We have also implemented a more restrictive credit policy for several China distributors to reduce our exposure in that market. For the year ended December 31 , 2016, our bad debt expense related to our China operations was lower by $22.1 million compared to the year ended December 31, 2015 . We are unable to predict future economic conditions in China, but if economic conditions in China continue to decline, we may experience further declines in consumer demand in our China markets. As our China operations represents 7% of our total revenues, the net impact of declining sales volumes in China could have a material adverse impact on our financial results in future periods. +30 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2016 to 2015 +Year Ended December 31, +Change +2016 +2015 +$ +% +(in thousands, except per share data and +average selling price) +Revenues +$ +1,036,273 +$ +1,090,630 +$ +(54,357 +) +(5.0 +)% +Cost of sales +536,109 +579,825 +(43,716 +) +(7.5 +)% +Gross profit +500,164 +510,805 +(10,641 +) +(2.1 +)% +Selling, general and administrative expenses +503,174 +559,095 +(55,921 +) +(10.0 +)% +Restructuring charges +— +8,728 +(8,728 +) +(100.0 +)% +Asset impairments +3,144 +15,306 +(12,162 +) +(79.5 +)% +Loss from operations +(6,154 +) +(72,324 +) +66,170 +(91.5 +)% +Foreign currency loss, net +(2,454 +) +(3,332 +) +878 +(26.4 +)% +Interest income +692 +967 +(275 +) +(28.4 +)% +Interest expense +(836 +) +(969 +) +133 +(13.7 +)% +Other income, net +1,539 +914 +625 +68.4 +% +Income (loss) before income taxes +(7,213 +) +(74,744 +) +67,531 +(90.3 +)% +Income tax expense +(9,281 +) +(8,452 +) +(829 +) +9.8 +% +Net loss +$ +(16,494 +) +$ +(83,196 +) +$ +66,702 +(80.2 +)% +Dividends on Series A convertible preferred stock +(12,000 +) +(11,833 +) +(167 +) +1.4 +% +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(3,244 +) +(2,978 +) +$ +(266 +) +8.9 +% +Net loss attributable to common stockholders +$ +(31,738 +) +$ +(98,007 +) +$ +66,269 +(67.6 +)% +Net loss per common share: +Basic +$ +(0.43 +) +$ +(1.30 +) +$ +0.87 +(66.9 +)% +Diluted +$ +(0.43 +) +$ +(1.30 +) +$ +0.87 +(66.9 +)% +Gross profit +48.3 +% +46.8 +% +143 +bps +3.1 +% +Operating loss +(0.6 +)% +(6.6 +)% +600 +bps +6.1 +% +Footwear unit sales +56,097 +57,763 +(1,666 +) +(3.7 +)% +Average footwear selling price +$ +18.21 +$ +18.53 +$ +(0.32 +) +(1.7 +)% +Revenues. During the year ended December 31, 2016 , revenue decreased 5.0% compared to the same period in 2015 . The decrease in revenue is due to the net impact of (i) a $46.3 million , or 4.2% , decrease associated with lower sales volumes, (ii) a $4.7 million or 0.5% decrease associated with lower average selling prices per pair, and (iii) a $3.4 million or 0.3% decrease associated with unfavorable changes in foreign currency rates. +During the year ended December 31, 2016 , revenues from our wholesale channel decreased $45.0 million , or 7.6% , compared to the same period in 2015 . The decrease in wholesale channel revenue is driven primarily by a $23.4 million decrease in our Asia Pacific segment due to lower average selling prices related to a lower priced product mix, the unfavorable impact of foreign currency translation, and store closures. +During the year ended December 31, 2016 , revenues from our retail channel decreased $18.9 million , or 5.0% , compared to the same period in 2015 , primarily driven by the Asia Pacific segment, which decreased $11.3 million primarily as a result of a lower average selling prices related to a lower priced product mix and the unfavorable impact of foreign currency translation. +During the year ended December 31, 2016 , revenues from our e-commerce channel increased $9.5 million , or 7.9% , compared to the same period in 2015 , primarily driven by increased sales volumes in all segments, partially offset by the unfavorable impact of foreign currency translation and lower average selling prices, also in all segments. Our e-commerce sales totaled approximately 12.6% and 11.1% of our consolidated net sales during the year ended December 31, 2016 and 2015 , respectively. We continue to +31 +Table of Contents +benefit from our online presence through e-commerce sites worldwide enabling us to have increased access to our consumers in a low cost, attractive manner and providing us with an opportunity to educate them about our products and brand. +Cost of sales. During the year ended December 31, 2016 , cost of sales decreased $43.7 million , or 7.5% , compared to the same period in 2015 . The decrease in cost of sales was primarily due to the net impact of: (i) a $24.6 million , or 4.2% decrease , due to lower sales volumes, (ii) an $18.6 million , or 3.2% , decrease due to a lower average cost per unit sold, and (iii) a $0.5 million , or 0.1% , decrease due to the impact of foreign currency translation. The impact of sales volumes on cost of sales was reduced by approximately $1.6 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +Gross profit. During the year ended December 31, 2016 , gross profit decreased $10.6 million , or 2.1% , and gross margin increased 143 basis points to 48.3% compared to the same period in 2015 . The decrease in gross profit is primarily due to the net impact of: (i) a $21.6 million , or 4.2% , decrease due to lower sales volumes, (ii) a $14.0 million , or 2.7% , increase due to the combined impact of a lower average cost of sales per unit partially offset by a lower average selling price, and (iii) a $3.0 million , or 0.6% , decrease due to the unfavorable impact of foreign currency translation. Gross profit declined by approximately $1.0 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +SG&A . SG&A decreased $55.9 million, or 10.0%, during the year ended December 31, 2016 compared to the same period in 2015. This change was primarily driven by (i) bad debt expense decrease of $22.8 million, (ii) an $8.7 million decrease in rent expenses associated with contingent rents and closed retail stores partially offset by (iii) $4.3 million increase in outside services expense. During the year ended December 31, 2016, our bad debt expense was $3.2 million compared to $26.0 million in the same period in the prior year. Substantially all of this decrease in bad debt expense is due to stricter credit collection policies from our China operations, which is included in our Asia Pacific segment. +During the year ended December 31, 2016 and 2015 , our bad debt expense was $3.2 million and $26.0 million, respectively. Of the $3.2 million expense recorded during the year ended December 31, 2016 , immaterial amounts related to our China operations. The decrease in bad debt expense associated with our China operations is primarily due to the implementation of a more restrictive credit policy for several China distributors in 2016 , to reduce our exposure in that market. +In addition to these fluctuations, we have identified certain SG&A expenses that affect the comparability or underlying business trends in our consolidated financial statements. The following table summarizes these expenses and describes the additional drivers of the decrease above by reconciling our U.S. GAAP SG&A to non-GAAP SG&A . +Year Ended December 31, +2016 +2015 +(in thousands) +Selling general and administrative expenses reconciliation: +U.S. GAAP SG&A expenses +$ +503,174 +$ +559,095 +Reorganization charges (1) +(458 +) +(8,391 +) +Customs audit settlements (2) +(354 +) +— +ERP implementation and other contract termination fees (3) +(1,361 +) +(12,569 +) +Improper disbursements and related legal fees (4) +— +(7,895 +) +Bad debt expense related to South Africa (5) +— +(613 +) +Total adjustments +(2,173 +) +(29,468 +) +Non-GAAP Selling, general and administrative expenses +$ +501,001 +$ +529,627 +_________________________________________________________________ +( 1) Relates to severance expenses, bonuses, store closure costs, consulting fees, and other expenses related to restructuring and reorganization activities and our investment agreement with Blackstone. +(2) Amount paid in partial settlement of a customs audit. +(3) Represents operating expenses incurred in 2015 related to the implementation of our enterprise resource planning system ("ERP") and the termination of certain information technology, royalty and other contracts. Expense in 2016 relates to early lease termination costs. +(4) Represents legal expenses related to invalid disbursements that occurred in 2015 and California wage settlements. +(5) Represents certain bad debt and impairment expenses in 2015 related to the sales of operations in South Africa. +Restructuring charges. During 2015, we incurred $8.7 million of restructuring charges related to the 2014 plan to create efficiencies and close global retail locations. The Company concluded its restructuring efforts on December 31, 2015. +32 +Table of Contents +Asset impairment charges. During the years ended December 31, 2016 and 2015 , we incurred $2.7 million and $15.3 million, respectively, in retail asset impairment charges related to certain underperforming retail locations, primarily in our Americas segment, that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores’ assets over their remaining economic life. In addition, we incurred $0.4 million in goodwill impairment charges. +Foreign currency loss, net. ‘Foreign currency loss, net’ consists of foreign currency gains and losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and foreign currency derivative instruments. During the year December 31, 2016 , we recognized a net loss of $2.5 million compared to a net loss of $3.3 million on foreign currency transactions during the year ended December 31, 2015 . +Income tax expense. During the year ended December 31, 2016, we recognized income tax expense of $9.3 million on pre-tax book loss of $7.2 million, representing an effective tax rate of (128.7)%, compared to income tax expense of $8.5 million on pre-tax book loss of $74.7 million in 2015, which represented an effective tax rate of (11.3)%. Generally, our effective tax rate has varied dramatically during 2016 and in recent years due to differences in our profitability level and relative operating earnings across multiple jurisdictions, and is most notably impacted by the significant amount of operating losses that cannot be benefitted for tax purposes. +The following are some of our key jurisdictions and the income tax expense for each in 2016 and 2015, respectively: +For the Year Ended December 31, 2016 +United States +Netherlands +Japan +Canada +China +Korea +Other +Total +(in thousands) +Book income (loss) +$ +(55,617 +) +$ +39,184 +$ +(5,229 +) +$ +740 +$ +821 +$ +2,529 +$ +10,359 +$ +(7,213 +) +Income tax expense (benefit) +437 +4,711 +— +361 +(473 +) +511 +3,734 +9,281 +Effective tax rate +(0.8 +)% +12.0 +% +— +% +48.8 +% +(57.6 +)% +20.2 +% +36.0 +% +(128.7 +)% +For the Year Ended December 31, 2015 +United States +Netherlands +Japan +Canada +China +Korea +Other +Total +(in thousands) +Book income (loss) +$ +(83,537 +) +$ +25,988 +$ +(69 +) +$ +(850 +) +$ +(21,572 +) +$ +4,141 +$ +1,155 +$ +(74,744 +) +Income tax expense (benefit) +(3,345 +) +4,262 +2,345 +(391 +) +4,433 +1,081 +67 +8,452 +Effective tax rate +4.0 +% +16.4 +% +(3,398.6 +)% +46.0 +% +(20.5 +)% +26.1 +% +5.8 +% +(11.3 +)% +The differences in total tax expense and effective rate variances in the table above resulted primarily from the following factors. We incurred significant changes in many of the key jurisdictions in book income/loss (U.S. losses of $55.6 million in 2016 versus $83.5 million in 2015, Netherlands income of $39.2 million in 2016 versus $26.0 million in 2015, Japanese losses of $5.2 million in 2016 versus $0.1 million in 2015, Chinese income of $0.8 million in 2016 versus losses of $21.6 million in 2015). Additionally, differences in the Netherlands income tax rate relates to consistent withholding tax expense year over year, compared with increased operating income in that jurisdiction during the same period. In 2016, the Company recorded a taxable loss position in Japan with no corresponding tax benefit realized as a result of a valuation allowance. In 2015, the total tax provision in Japan was impacted by the settlement of uncertain tax positions which resulted in a benefit of approximately $3.6 million which was more than offset by the accrual of expense for an increased valuation allowance of $4.8 million. While there are effective tax rate differences in China related to differences in operating losses, we also incurred additional tax expense in 2015 of approximately $9.5 million due to increased valuation allowances established during 2015 which are unlikely to recur. +The tax effect of non-deductible/non-taxable items changed from a $2.2 million tax benefit in 2015, which is a favorable rate impact of 2.9%, to a $2.7 million tax expense in 2016, which is an unfavorable rate impact of 37.4%. The expense recognized in 2016 primarily relates to non-deductible executive and foreign share-based compensation. We anticipate that these expenses will recur in the foreseeable future. +33 +Table of Contents +The change in the 'Effect of rate differences' line of the rate reconciliation table in Note 13 — Income Taxes is principally driven by differences in pre-tax book income between the periods compared, and the source of this income, which is subject to different jurisdictional tax rates. During 2016, the effect of rate differences resulted in a $12.6 million tax benefit compared to a $3.7 million tax benefit in 2015. The primary reason for this incremental benefit results from increased foreign book earnings included in consolidated results. During 2016, foreign book income before taxes was $48.4 million as compared with $8.8 million in 2015, all of which is subject to tax at rates lower than the U.S. statutory rate. Further, we employ a tax planning strategy that directly impacts the total tax expense directly attributable to the level of foreign earnings in the specific jurisdictions. However, we note that the impact on the effective tax rate is different due to higher book earnings recorded in 2016 compared to 2015. The relative impact of this has existed in the recent past; however, there is no assurance that this circumstance will be recurring beyond 2019. Through at least 2019, we will continue to have an equivalent favorable impact on the tax provision and effective tax rate based on the specific foreign earnings. We currently do not anticipate significant near-term changes to our overall tax strategies, meaning that relative income tax benefits provided from the expected U.S. federal tax rate are anticipated to recur in the foreseeable future. The amount of this tax benefit, if any, is subject to continued profitability in various foreign jurisdictions. +The impact of the 'U.S. tax on foreign earnings' line of the rate reconciliation table includes the impact of foreign inclusions and the tax expense accrued on undistributed foreign earnings net of the related foreign tax credits. During 2016, inclusions for these items resulted in $23.1 million of tax expense, reflecting an unfavorable impact of 320.6 % on the total provision. During 2015, inclusions for these items resulted in $82.3 million of tax expense, reflecting an unfavorable impact of 110.0 % on the total provision. Foreign inclusions are primarily related to business results and cash repatriations during a specific period as well as the accrual on foreign earnings. During 2016, we provided for U.S. income taxes on an additional $50 million of current year undistributed foreign earnings, for a combined total of $178 million of undistributed foreign earnings for which U.S. tax has been accrued, representing a total deferred tax liability of approximately $32.4 million. We further note that actual cash repatriations decreased from approximately $127.3 million in 2015 to approximately $37 million in 2016 (and note that no withholding tax is due with respect to the repatriation of these earnings to the U.S. and none has been provided for). Furthermore during 2015, there was a $24.6 million tax charge recognized for the accrual of unremitted foreign earnings as compared to a $7.9 million tax charge in 2016 for unremitted foreign earnings. As of 2016, we anticipate continued repatriation of foreign earnings to the extent of the $178 million currently accrued. We will also continue to assess various cash needs in the U.S. and abroad, which could result in the prospective accrual and repatriation of some or all future current year earnings on an annual basis. +We continue to evaluate the realizability of our deferred tax assets. As such, additional valuation allowances of $34.3 million were recorded on deferred tax assets are not anticipated to be realized. This is in addition to the $56.6 million accrued on deferred tax assets during 2015. Furthermore, the change in the valuation allowance reflected on the cumulative schedule of deferred tax assets includes $18.3 million, which does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to the adoption in 2016 of new US GAAP guidance related to income tax effect of share-based compensation and changes in cumulative translation adjustment. The specific circumstances regarding management's assertion of the realizability of certain deferred tax assets is discussed as part of the disclosures in Note 13 — Income Taxes. We maintain total valuation allowances of approximately $90.9 million as of December 31, 2016, which may be reduced in the future depending upon the achieved or sustained profitability of certain entities. +During both 2015 and 2016, we recorded tax expense for audits settled during the year of $1.2 million and $0.3 million, respectively. The amount included in settlements during 2016 is net against total uncertain tax position releases during the same period relating to the same positions. Furthermore, the uncertain tax benefits line item in 2016 includes net accruals related to current year positions recorded, and is consistent with amounts accrued during prior years. We have released a significant portion of historical uncertain tax benefits based on effective and actual settlements. As such, there is not currently an expectation that uncertain tax positions will significantly impact our tax expense on an ongoing basis. +We incur state income tax losses during the period due to net operating losses recorded in the U.S., as well as applicable state modifications related to the taxability of foreign dividends. The tax provision benefit of these losses are offset by a valuation allowance. We are subject to certain minimal state income taxes. +34 +Table of Contents +Revenues by Channel +Year Ended December 31, +Change +Constant Currency Change (1) +2016 +2015 +$ +% +$ +% +(in thousands) +Wholesale: +Americas +$ +202,211 +$ +210,887 +$ +(8,676 +) +(4.1 +)% +$ +(5,555 +) +(2.6 +)% +Asia Pacific +232,541 +255,897 +(23,356 +) +(9.1 +)% +(26,408 +) +(10.3 +)% +Europe +110,511 +123,131 +(12,620 +) +(10.2 +)% +(11,441 +) +(9.3 +)% +Other businesses +745 +1,096 +(351 +) +(32.0 +)% +(352 +) +(32.1 +)% +Total wholesale +546,008 +591,011 +(45,003 +) +(7.6 +)% +(43,756 +) +(7.3 +)% +Retail: +Americas +191,855 +197,306 +(5,451 +) +(2.8 +)% +(5,168 +) +(2.6 +)% +Asia Pacific +125,037 +136,320 +(11,283 +) +(8.3 +)% +(12,077 +) +(8.9 +)% +Europe +42,712 +44,873 +(2,161 +) +(4.8 +)% +(189 +) +(0.4 +)% +Total retail +359,604 +378,499 +(18,895 +) +(5.0 +)% +(17,434 +) +(4.6 +)% +E-commerce: +Americas +72,940 +68,017 +4,923 +7.2 +% +5,088 +7.5 +% +Asia Pacific +37,500 +32,274 +5,226 +16.2 +% +5,741 +17.8 +% +Europe +20,221 +20,829 +(608 +) +(2.9 +)% +(578 +) +(2.8 +)% +Total e-commerce +130,661 +121,120 +9,541 +7.9 +% +10,251 +8.5 +% +Total revenues +$ +1,036,273 +$ +1,090,630 +$ +(54,357 +) +(5.0 +)% +$ +(50,939 +) +(4.7 +)% +_________________________________________________________________ +(1) +Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” above for more information. +Wholesale channel revenues. During the year ended December 31, 2016 , revenues from our wholesale channel decreased $45.0 million , or 7.6% , compared to the same period in 2015 . The decrease in wholesale channel revenues was due to the net impact of: (i) a $42.0 million , or 7.1% , decrease in sales volumes, (ii) a $3.6 million , or 1.0% , decrease due to a lower average selling price, and (iii) a $1.5 million , or 0.4% , decrease due to the unfavorable impact of foreign currency translation. Sales volumes for the year ended December 31, 2016 were negatively impacted by approximately $ 8.4 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +Retail channel revenues. During the year ended December 31, 2016 , revenues from our retail channel decreased $18.9 million , or 5.0% , compared to the same period in 2015 . The decrease in retail channel revenues was due to the net impact of: (i) a $13.8 million , or 3.7% , decrease in sales volumes, (ii) a $3.6 million , or 1.0% , decrease due to a lower average selling price, and (iii) a $1.5 million , or 0.4% , decrease due to the unfavorable impact of foreign currency translation. +E-commerce channel revenues. During the year ended December 31, 2016 , revenues from our e-commerce channel increased $9.5 million , or 7.9% , compared to the same period in 2015 . The increase in e-commerce revenues was due to the net impact of: (i) a $30.2 million , or 24.9% , increase in sales volumes (primarily due to increased sales volumes in the Americas and Asia Pacific segments), (ii) a $20.0 million , or 16.4% , decrease due to a lower average selling price, and (iii) a $0.7 million , or 0.6% , decrease due to the unfavorable impact of foreign currency translation. +Future change in the average selling price per unit will be impacted by: (i) the mix of products sold, (ii) the sales channel (as we generally realize higher sales prices from our retail and e-commerce channels as compared to our wholesale channel), and (iii) the level of sales discounts and incentives we offer our customers. +35 +Table of Contents +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2016 and 2015 : +Year Ended December 31, +Change +Constant Currency +Change (3) +2016 +2015 +$ +% +$ +% +(in thousands, except % data) +Revenues: +Americas +$ +467,006 +$ +476,210 +$ +(9,204 +) +(1.9 +)% +$ +(3,569 +) +(0.7 +)% +Asia Pacific +395,078 +424,491 +(29,413 +) +(6.9 +) +3,331 +0.8 +Europe +173,444 +188,833 +(15,389 +) +(8.1 +) +(3,181 +) +(1.7 +) +Total segment revenues +1,035,528 +1,089,534 +(54,006 +) +(5.0 +) +(3,419 +) +(0.3 +) +Other businesses +745 +1,096 +(351 +) +(32.0 +) +1 +0.1 +Total consolidated revenues +$ +1,036,273 +$ +1,090,630 +$ +(54,357 +) +(5.0 +)% +$ +(3,418 +) +(0.3 +)% +Operating income: +Americas +$ +58,844 +$ +49,422 +$ +9,422 +19.1 +% +$ +(1,372 +) +(2.8 +) +Asia Pacific +78,907 +48,447 +30,460 +62.9 +1,378 +2.8 +Europe +17,757 +15,629 +2,128 +13.6 +(249 +) +(1.6 +) +Total segment operating income +155,508 +113,498 +42,010 +37.0 +(243 +) +(0.2 +) +Reconciliation of total segment operating income to income before income taxes: +Other businesses +(26,935 +) +(30,092 +) +3,157 +(10.5 +) +3,006 +(10.0 +) +Unallocated corporate and other (1) +(134,727 +) +(155,730 +) +21,003 +(13.5 +) +23,341 +(15.0 +) +Total consolidated operating income (loss) +$ +(6,154 +) +$ +(72,324 +) +$ +66,170 +(91.5 +) +$ +26,104 +(36.1 +) +Foreign currency transaction gain (loss), net +(2,454 +) +(3,332 +) +878 +(26.4 +) +Interest income +692 +967 +(275 +) +(28.4 +) +Interest expense +(836 +) +(969 +) +133 +(13.7 +) +Other income (expense), net +1,539 +914 +625 +68.4 +Income (loss) before income taxes +$ +(7,213 +) +$ +(74,744 +) +$ +67,531 +(90.3 +)% +_________________________________________________________________ +(1) +Revenues for the year ended December 31, 2016 were negatively impacted by approximately $8.4 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +36 +Table of Contents +Americas Operating Segment +Revenues. During the year ended December 31, 2016 , revenues for our Americas segment decreased $9.2 million , or 1.9% , compared to the same period in 2015 . The decrease in the Americas segment revenues was due to the net impact of: (i) a $13.6 million , or 2.9% , decrease related to lower sales volumes, (ii) an $8.0 million , or 1.7% , increase related to an increase in the average sales price, and (iii) a $3.6 million , or 0.7% , decrease due to the unfavorable impact of foreign currency translation. +Future changes in the average sales price per unit in any of our operating segments will be impacted by: (i) the mix of products sold, (ii) the sales channel (as we generally realize higher sales prices from our retail and e-commerce channels as compared to our wholesale channel), and (iii) the level of sales discounts and incentives we offer our customers. +Cost of Sales. During the year ended December 31, 2016 , cost of sales for our Americas segment decreased $10.2 million , or 4.0% , compared to the same period in 2015 . The decrease in the Americas segment cost of sales was due to the net impact of: (i) a $7.2 million , or 2.9% , decrease due to lower sales volumes, (ii) a $1.3 million , or 0.5% , decrease due to lower average costs per unit sold, and (iii) a $1.6 million , or 0.6% , decrease due to the impact of foreign currency translation. +Gross Profit. During the year ended December 31, 2016 , gross profit for the Americas segment increased $1.0 million , or 0.4% , and gross margin increased 115 basis points to 48.3% compared to the same period in 2015 . The increase in the Americas segment gross profit is due to the net impact of: (i) an $6.4 million , or 2.9% , decrease due to lower sales volumes, (ii) an $9.3 million , or 4.2% , increase due to the combined impact of a higher average sales price and a lower average cost of sales per unit, and (iii) a $2.0 million , or 0.9% , decrease due to the impact of foreign currency translation. +SG&A. During the year ended December 31, 2016, SG&A for our Americas segment decreased $1.7 million, or 1.0%, compared to the same period in 2015. +Asia Pacific Operating Segment +Revenues. During the year ended December 31, 2016 , revenues for our Asia Pacific segment decreased $29.4 million , or 6.9% , compared to the same period in 2015 . The decrease in the Asia Pacific segment revenues was due to the net impact of: (i) a $2.4 million , or 0.6% , decrease due to lower sales volumes, (ii) a $30.3 million , or 7.1% , decrease in the average sales price and (iii) +a $3.3 million , or 0.8% , increase due to the favorable impact of foreign currency translation. Sales volumes for the year ended December 31, 2016 were negatively impacted by approximately $8.4 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +Cost of Sales. During the year ended December 31, 2016 , cost of sales for our Asia Pacific segment decreased $20.9 million , or 10.8% , compared to the same period in 2015 . The decrease in the Asia Pacific segment cost of sales was due to the net impact of: (i) a $1.1 million , or 0.6% , decrease due to lower sales volumes, (ii) a $21.6 million , or 11.2% , decrease due to lower average costs per unit sold, and (iii) a $1.5 million , or 1.5% , increase due to the impact of foreign currency translation. The impact of sales volumes on cost of sales includes approximately $8.5 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +Gross Profit. During the year ended December 31, 2016 , gross profit for the Asia Pacific segment decreased $8.5 million , or 3.7% , and gross margin increase 190 basis points to 56.3% compared to the same period in 2015 . The decrease in the Asia Pacific segment gross profit is due to the net impact of: (i) a $1.3 million , or 0.6% , decrease due to lower sales volumes, (ii) a $8.8 million , or 3.7% , decrease due to a lower average sales prices in excess of a lower average cost per unit, and (iii) a $1.5 million , or 0.6% , increase due to the impact of foreign currency translation. Gross profit declined by approximately $0.1 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +SG&A . During the year ended December 31, 2016 , SG&A for our Asia Pacific segment decreased $29.6 million, or 17.2%, compared to the same period in 2015 . The decrease in SG&A was primarily due to the net impact of: (i) a $25.4 million decrease associated with bad debt expense, (ii) a $5.5 million increase associated with services, (iii) a $6.3 million decrease in sales expense, (iv) a $5.0 million decrease in rent expense, and (v) other items that are individually insignificant. +37 +Table of Contents +Europe Operating Segment +Revenues. During the year ended December 31, 2016 , revenues for our Europe segment decreased $15.4 million , or 8.1% , compared to the same period in 2015 . The decrease in the Europe segment revenues was due to the net impact of: (i) a $22.8 million , or 12.1% , decrease due to lower sales volumes, (ii) a $10.6 million , or 5.7% , increase due to a higher average sales price, and (iii) a $3.2 million , or 1.7% , decrease due to the impact of foreign currency translation. +Cost of Sales. During the year ended December 31, 2016 , cost of sales for our Europe segment decreased $11.2 million , or 11.3% , compared to the same period in 2015 . The decrease in the Europe segment cost of sales was mainly due to the net impact of: (i) a $12.0 million , or 12.1% , decrease due to lower sales volumes, (ii) a $ 2.3 million or 2.3% , increase due to higher average cost per unit sold and (iii) a $1.5 million , or 1.5% , decrease due to the impact of foreign currency translation. +Gross Profit. During the year ended December 31, 2016 , gross profit for the Europe segment decreased $4.2 million , or 4.7% , and gross margin increased 180 basis points to 48.9% compared to the same period in 2015 . The decrease in the Europe segment gross profit is due to the net impact of: (i) a $10.8 million , or 12.1% , decrease due to lower sales volumes, (ii) a $8.3 million , or 9.3% , increase due to a higher average sales price in excess of higher costs per unit, and (iii) a $1.7 million , or 1.9% , decrease due to the impact of foreign currency translation. +SG&A . During the year ended December 31, 2016 , SG&A for our Europe segment decreased $2.6 million, or 3.8%, compared to the same period in 2015 . The decrease in SG&A was primarily due to the net impact of: (i) a $2.0 increase in bad debt expense, (ii) a $0.9 million decrease in rent expense, and (iv) other items that are individually insignificant. +The changes in the number of our company-operated retail locations by reportable operating segment and type of store were: +December 31, 2015 +Opened +Closed +December 31, 2016 +Company-operated retail locations +Type +Kiosk/store in store +98 +14 +14 +98 +Retail stores +275 +19 +66 +228 +Outlet stores +186 +50 +4 +232 +Total +559 +83 +84 +558 +Operating segment +Americas +196 +7 +13 +190 +Asia Pacific +261 +67 +58 +270 +Europe +102 +9 +13 +98 +Total +559 +83 +84 +558 +Comparable retail store sales and Direct to Consumer store sales by reportable operating segment are as follows: +Constant Currency (2) +Year Ended +December 31, 2016 +Year Ended +December 31, 2015 +Comparable store sales (retail only) (1) +Americas +(2.3 +)% +(3.2 +)% +Asia Pacific +(5.9 +)% +(4.5 +)% +Europe +1.9 +% +3.0 +% +Global +(3.0 +)% +(2.8 +)% +38 +Table of Contents +Constant Currency (2) +Year Ended +December 31, 2016 +Year Ended +December 31, 2015 +DTC comparable store sales (includes retail and e-commerce) (1) +Americas +0.3 +% +3.3 +% +Asia Pacific +(0.4 +)% +3.0 +% +Europe +0.2 +% +7.8 +% +Global +0.1 +% +3.9 +% +_______________________________________________________________________________ +(1) +Comparable store status is determined on a monthly basis. Comparable store sales includes revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year revenues. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period. +(2) +Reflects quarter over quarter change on a “constant currency” basis, which is a non-GAAP financial measure that restates current period results using prior year foreign exchange rates for the comparative period to enhance visibility of the underlying business trends, excluding the impact of foreign currency. +Comparable store sales (retail only) decreased 3.0% on a global basis for the year ended December 31, 2016, compared to a decrease of 2.8% for the year ended December 31, 2015. Direct to Consumer (DTC) comparable store sales, which includes retail and e-commerce, increased 0.1% on a global basis for the year ended December 31, 2016, compared to an increase of 3.9% for the year ended December 31, 2015. +Impact on revenues due to foreign exchange rate fluctuations. Changes in average foreign currency exchange rates used to translate revenue from our functional currencies to our reporting currency during the year ended December 31, 2016 resulted in a $3.4 million decrease in revenue compared to the same period in 2015. +Gross profit. During the year ended December 31, 2016, gross profit decreased $10.6 million, or 2.1%, compared to the same period in 2015. The decrease in gross profit was primarily attributable to the 5.0% decrease in revenue partially offset by the gross margin increase of 150 basis points compared to the same period in 2015 due to a lower selling price. +Impact on gross profit due to foreign exchange rate fluctuations. Changes in average foreign currency exchange rates used to translate revenue and costs of sales from our functional currencies to our reporting currency during the year ended December 31, 2016 decreased our gross profit by $2.1 million, or 0.4%, compared to the same period in 2015. +39 +Table of Contents +Comparison of the Years Ended December 31, 2015 to 2014 +Year Ended December 31, +Change +2015 +2014 +$ +% +(in thousands, except per share data and +average selling price) +Revenues +$ +1,090,630 +$ +1,198,223 +$ +(107,593 +) +(9.0 +)% +Cost of sales +579,825 +603,893 +(24,068 +) +(4.0 +) +Restructuring charges +— +3,985 +(3,985 +) +(100.0 +) +Gross profit +510,805 +590,345 +(79,540 +) +(13.5 +) +Selling, general and administrative expenses +559,095 +565,712 +(6,617 +) +(1.2 +) +Restructuring charges +8,728 +20,532 +(11,804 +) +(57.5 +) +Asset impairments +15,306 +8,827 +6,479 +73.4 +Loss from operations +(72,324 +) +(4,726 +) +(67,598 +) +1,430.3 +Foreign currency loss, net +(3,332 +) +(4,885 +) +1,553 +(31.8 +) +Interest income +967 +1,664 +(697 +) +(41.9 +) +Interest expense +(969 +) +(806 +) +(163 +) +20.2 +Other income, net +914 +204 +710 +348.0 +Loss before income taxes +(74,744 +) +(8,549 +) +(66,195 +) +774.3 +Income tax (expense) benefit +(8,452 +) +3,623 +(12,075 +) +(333.3 +) +Net loss +$ +(83,196 +) +$ +(4,926 +) +$ +(78,270 +) +1,588.9 +% +Dividends on Series A convertible preferred stock +(11,833 +) +(11,301 +) +(532 +) +4.7 +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(2,978 +) +(2,735 +) +(243 +) +8.9 +Net loss attributable to common stockholders +$ +(98,007 +) +$ +(18,962 +) +$ +(79,045 +) +416.9 +% +Net income (loss) per common share: +Basic +$ +(1.30 +) +$ +(0.22 +) +$ +(1.08 +) +490.9 +% +Diluted +$ +(1.30 +) +$ +(0.22 +) +$ +(1.08 +) +490.9 +% +Gross margin +46.8 +% +49.3 +% +(250 +) +(5.1 +)% +Operating margin +(6.6 +)% +(0.4 +)% +(620 +) +1,550.0 +% +Footwear unit sales +57,763 +55,700 +2,063 +3.7 +% +Average footwear selling price +$ +18.53 +$ +20.92 +$ +(2.39 +) +(11.4 +)% +Revenues. During the year ended December 31, 2015, revenues declined $107.6 million, or 9.0%, compared to the same period in 2014. The decrease in revenues is due to the net impact of (i) a $85.3 million, or 7.1%, decrease associated with foreign currency exchange rate adjustments associated with a strong U.S. Dollar, (ii) a $37.8 million, or 3.1%, increase associated with higher sales volumes, and (iii) a $34.4 million, or 2.9%, decrease associated with store closures, partially offset by (iv) a $25.7 million, or 2.1%, decrease associated with a lower average selling price due to changes in product mix. +During the year ended December 31, 2015, revenues from our wholesale channel decreased $76.6 million, or 11.5%, compared to the same period in 2014. The decrease in wholesale channel revenue is driven primarily by a $52.1 million unfavorable impact related to foreign currency translation, primarily in our Europe segment, a $30.5 million unfavorable impact due to lower average sales prices related to a lower priced product style mix, primarily in our Americas segment, partially offset by higher sales volume in our Americas and Europe segments. +During the year ended December 31, 2015, revenues from our retail channel decreased $47.3 million, or 11.1%, compared to the same period in 2014, primarily driven by the Asia Pacific segment, which decreased $23.1 million primarily as a result of a lower average selling price related to a lower priced product mix, the unfavorable impact of foreign currency translation, and store closures. Additionally we experienced a $15.4 million decrease in the Europe segment largely associated with the impact of store closures. +During the year ended December 31, 2015, revenues from our e-commerce channel increased $16.3 million, or 15.6%, compared to the same period in 2014, primarily driven by increased sales volumes in all segments, partially offset by the unfavorable impact +40 +Table of Contents +of foreign currency translation and lower average sales prices, also in all segments. Our e-commerce sales totaled approximately 11.1% and 8.7% of our consolidated net sales during the year ended December 31, 2015 and 2014, respectively. We continue to benefit from our online presence through web stores worldwide enabling us to have increased access to our customers in a low cost, attractive manner and providing us with an opportunity to educate them about our products and brand. +Cost of sales. Cost of sales, including restructuring charges, decreased $28.1 million, or 4.8%, for the year ended December 31, 2015, as compared to the prior year. The net decrease in cost of sales is due to: (i) a $44.4 million, or 7.4%, decrease due to the impact of foreign currency translation, (ii) a $24.0 million, or 3.9%, increase due to a higher average costs, (iii) a $22.8 million, or 3.8%, decrease associated with store closures, (iv) a $19.1 million, or 3.2%, increase due to higher sales volumes, and (v) a $4.0 million, or 0.7%, decrease associated with lower restructuring charges in cost of sales (these restructuring efforts were completed as of December 31, 2015). +Gross Profit. Gross profit decreased $79.5 million, or 13.5%, for the year ended December 31, 2015, as compared to the prior year. The net decrease in gross profit is primarily due to the impact of: (i) a $49.7 million, or 8.4%, decrease associated with lower average selling price and higher costs of sales, (ii) a $40.9 million, or 6.9%, decrease associated with the unfavorable impact of foreign currency translation, (iii) a $18.7 million, or 3.2%, increase associated with higher sales volumes (iv) an $11.6 million, or 2.0%, decrease associated with store closures, and (v) a $4.0 million, or 0.6%, increase associated with lower restructuring charges in cost of sales (these restructuring efforts were completed as of December 31, 2015). For the year ended December 31, 2015 we realized a gross profit margin of 46.8%. +SG&A. SG&A expenses decreased $6.6 million, or 1.2%, during the year ended December 31, 2015 compared to the same period in 2014. This change was primarily driven by wage and salary decreases of $22.1 million, and a $17.0 million decrease in building expenses partially offset by a $13.6 million increase in marketing expenses, and a $13.6 million increase in bad debt expense, largely associated with our Asia Pacific operations relating to China. During the year ended December 31, 2015, our bad debt expense was $25.7 million compared to $12.1 million in the same period in the prior year. Substantially all of this increase in bad debt expense is due to lower collections from our China operations, which is included in our Asia Pacific segment. +We believe declining collections from our China operations is associated with deteriorating macro-economic conditions in China resulting in declining customer demand and the deteriorating working capital position of our distributors. We are unable to predict future economic conditions in China, but if economic conditions in China continue to decline, we may experience further reductions in consumer demand in our China markets. As our China operations represent approximately 8% of our total revenue in 2015, the net impact of declining sales volumes in China could have a material adverse impact on our financial results in future periods. +In addition to these fluctuations, we have identified certain selling, general and administrative expenses that affect the comparability or underlying business trends in our consolidated financial statements. The following table summarizes these expenses and describes the additional drivers of the increase above by reconciling our GAAP selling, general and administrative expenses to non-GAAP selling, general and administrative expenses: +Year Ended +December 31, +2015 +2014 +(in thousands) +Selling, general and administrative expenses reconciliation: +GAAP selling, general and administrative expenses +$ +559,095 +$ +565,712 +ERP implementation and other contract termination fees (1) +(12,569 +) +(13,268 +) +Reorganization charges (2) +(8,391 +) +(8,872 +) +Legal settlements and disbursement (3) +(7,895 +) +(2,646 +) +Bad debt expense related to South Africa (4) +(613 +) +— +Non-GAAP selling, general and administrative expenses +$ +529,627 +$ +540,926 +_______________________________________________________________________________ +(1) +This represents operating expenses related to the implementation of our new enterprise resource planning ("ERP") system and the termination of certain IT contracts for better alignment with strategic initiatives as well as fees associated with the termination of certain royalty and other contracts. +(2) +This relates to severance expenses, bonuses, store closure costs, consulting fees and other expenses related to recent restructuring and reorganization activities and our investment agreement with Blackstone. +41 +Table of Contents +(3) +Expenses in 2015 relate primarily to legal expenses for matters surrounding disbursements to invalid vendors and California wage settlements. Expenses in 2014 relate primarily to other legal settlements. +(4) +Bad debt and impairment expenses were incurred in 2015 relating to the planned sale of operations in South Africa. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2015, negatively impacted, or increased, selling, general and administrative expenses by approximately $35.6 million compared to 2014. +Restructuring charges. During the years ended December 31, 2015 and 2014, we recorded $8.7 million and $24.5 million, respectively, in restructuring charges. These restructuring charges arose primarily as a result of our strategic plans for long-term improvement and growth of the business. Restructuring charges for the years ended December 31, 2015 and 2014 consisted of: +• +$5.5 million and $12.5 million in severance costs during the years ended December 31, 2015 and 2014, respectively; +• +$2.6 million and $4.2 million in contract termination costs primarily related to the early termination of operating leases during the years ended December 31, 2015 and 2014, respectively; and +• +$0.6 million and $7.8 million in other restructuring charges primarily related to expenses to exiting stores and legal fees during the years ended December 31, 2015 and included the write-off of obsolete inventory and store exiting and legal fees for the year ended December 31, 2014. +Asset impairments. During the year ended December 31, 2015 and 2014, we incurred $15.3 million and $8.8 million, respectively, in asset impairment charges. For the year ended December 31, 2015, $9.6 million of this amount related to certain underperforming retail locations, primarily in our Americas and Europe segments, which were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life and $5.7 million related to the impairment of our South Africa asset group that is currently held for sale. +Foreign currency loss, net. Foreign currency loss, net is comprised of foreign currency gains and losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the year ended December 31, 2015 and 2014, the effect of foreign currency transactions was a net loss of $3.3 million and $4.9 million, respectively. +Income Taxes: The following are some of our key jurisdictions and the income tax expense for each in 2015, +For the Year Ended December 31, 2015 +United States +Netherlands +Japan +Canada (1) +China +Korea +Other +Total +(in thousands) +Book income (loss) +$ +(83,537 +) +$ +25,988 +$ +(69 +) +$ +(850 +) +$ +(21,572 +) +$ +4,141 +$ +1,155 +$ +(74,744 +) +Income tax expense (benefit) +(3,345 +) +4,262 +2,345 +(391 +) +4,433 +1,081 +67 +8,452 +Effective tax rate +4.0 +% +16.4 +% +(3,398.6 +)% +46.0 +% +(20.5 +)% +26.1 +% +5.8 +% +(11.3 +)% +(1) +Primarily driven by a $2.9 million net benefit related to a tax settlement with the Canada Revenue Agency. The principal drivers impacting the rate other than the overall profitability or loss of the Company disclosed in our rate reconciliation table in Note 13 — Income Taxes includes: +The differences in total tax expense and effective rate difference in the table above resulted primarily from the following factors. In the U.S. and Japan, the Company incurred significant changes in book income/loss (U.S. losses of $84 million in 2015 versus $34 million in 2014, and Japanese losses of $69 thousand in 2015 versus income of $9.6 million in 2014). In addition, in the U.S. in 2014, the Company received a net benefit of $10.7 million related the settlement of a tax audit and the release of related uncertain tax positions. While the operating losses in the U.S. can differ in future years based upon the Company’s performance and risk factors for the business, the benefits associated with the audit settlement and release of uncertain tax positions are not likely to recur in the future. Tax expense in Canada was also impacted materially by the net impact of $9.8 million related to the settlement of a tax audit and release of related uncertain tax positions, which is not likely to recur in the future. While there are effective rate differences in China related to differences in operating losses, the Company also incurred additional tax expense of approximately +42 +Table of Contents +$9.5 million due to increased valuation allowances established during 2015. The increase in valuation allowances or potential release of such allowances will depend upon the increase in future taxable income of the Company’s China operations. The total tax expense, and associated effective tax rate, for Japan was also impacted in 2015 by the settlement of uncertain tax positions which resulted in a benefit of approximately $3.6 million which is not likely to recur in the future, and the accrual of expense for an increased valuation allowance of $4.8 million due to the ongoing operating losses in that jurisdiction. Lastly, the difference in the Netherlands effective tax rate relates to consistent withholding tax expense year over year, compared with decreased operating income in that jurisdiction in 2015. +43 +Table of Contents +Revenues by Channel +The following table summarizes our total revenue by channel for the years ended December 31, 2015 and 2014: +Years Ended +December 31, +Change +Constant +Currency +Change (1) +2015 +2014 +$ +% +$ +% +(in thousands) +Wholesale: +Americas +$ +210,887 +$ +228,615 +$ +(17,728 +) +(7.8 +)% +$ +(10,241 +) +(4.5 +)% +Asia Pacific +255,897 +290,610 +(34,713 +) +(11.9 +) +(16,194 +) +(5.6 +) +Europe +123,131 +147,561 +(24,430 +) +(16.6 +) +1,886 +1.3 +Other businesses +1,096 +794 +302 +38.0 +194 +24.4 +Total wholesale +591,011 +667,580 +(76,569 +) +(11.5 +) +(24,355 +) +(3.6 +) +Retail: +Americas +197,306 +206,053 +(8,747 +) +(4.2 +) +(6,652 +) +(3.2 +) +Asia Pacific +136,320 +159,464 +(23,144 +) +(14.5 +) +(11,552 +) +(7.2 +) +Europe +44,873 +60,309 +(15,436 +) +(25.6 +) +(3,012 +) +(5.0 +) +Total retail +378,499 +425,826 +(47,327 +) +(11.1 +) +(21,216 +) +(5.0 +) +E-commerce: +Americas +68,017 +55,247 +12,770 +23.1 +13,434 +24.3 +Asia Pacific +32,274 +23,836 +8,438 +35.4 +10,256 +43.0 +Europe +20,829 +25,734 +(4,905 +) +(19.1 +) +(380 +) +(1.5 +) +Total e-commerce +121,120 +104,817 +16,303 +15.6 +23,310 +22.2 +Total revenues +$ +1,090,630 +$ +1,198,223 +$ +(107,593 +) +(9.0 +)% +$ +(22,261 +) +(1.9 +)% +_______________________________________________________________________________ +(1) +Reflects year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. +Wholesale channel revenues. During the year ended December 31, 2015 , revenues from our wholesale channel decreased $76.6 million , or 11.5% , compared to the same period in 2014 . The decrease in wholesale channel revenues was due to the net impact of: (i) an $8.7 million , or 1.3% , increase in sales volumes, (ii) a $33.0 million , or 5.0% , decrease due to a lower average sales price, and (iii) a $52.2 million , or 7.8% , decrease due to the unfavorable impact of foreign currency translation. +Retail channel revenues. During the year ended December 31, 2015 , revenues from our retail channel decreased $47.3 million , or 11.1% , compared to the same period in 2014 . The decrease in retail channel revenues was due to the net impact of: (i) a $7.0 million , or 1.6% , decrease in sales volumes, (ii) a $14.2 million , or 3.4% , decrease due to a lower average sales price, and (iii) a $26.1 million , or 6.1% , decrease due to the favorable impact of foreign currency translation. +E-commerce channel revenues. During the year ended December 31, 2015 , revenues from our e-commerce channel increased $16.3 million , or 15.6% , compared to the same period in 2014 . The increase in e-commerce revenues was due to the net impact of: (i) a $47.4 million , or 45.2% , increase in sales volumes (primarily due to increased sales volumes in the Americas and Asia Pacific segments), (ii) a $24.1 million , or 22.9% , decrease due to a lower average sales price, and (iii) a $7.0 million , or 6.7% , decrease associated with the unfavorable impact of foreign currency translation. +44 +Table of Contents +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2015 and 2014 : +Year Ended December 31, +Change +Constant Currency +Change (3) +2015 +2014 +$ +% +$ +% +(in thousands, except % data) +Revenues: +Americas +$ +476,210 +$ +489,915 +$ +(13,705 +) +(2.8 +)% +$ +(3,459 +) +(0.7 +)% +Asia Pacific +424,491 +473,910 +(49,419 +) +(10.4 +) +(17,490 +) +(3.7 +) +Europe +188,833 +233,604 +(44,771 +) +(19.2 +) +(1,506 +) +(0.6 +) +Total segment revenues +1,089,534 +1,197,429 +(107,895 +) +(9.0 +) +(22,455 +) +(1.9 +) +Other businesses +1,096 +794 +302 +38.0 +194 +24.4 +Total consolidated revenues +$ +1,090,630 +$ +1,198,223 +$ +(107,593 +) +(9.0 +)% +$ +(22,261 +) +(1.9 +)% +Operating income: +Americas +$ +49,422 +$ +48,347 +$ +1,075 +2.2 +% +$ +1,251 +2.6 +% +Asia Pacific +48,447 +75,135 +(26,688 +) +(35.5 +) +(20,730 +) +(27.6 +) +Europe +15,629 +24,517 +(8,888 +) +(36.3 +) +(2,507 +) +(10.2 +) +Total segment operating income +113,498 +147,999 +(34,501 +) +(23.3 +) +(21,986 +) +(14.9 +) +Reconciliation of total segment operating income to income before income taxes: +Other businesses (1) +(30,092 +) +(19,400 +) +(10,692 +) +55.1 +(13,410 +) +69.1 +Intersegment eliminations +— +(1,498 +) +1,498 +(100.0 +) +— +— +Unallocated corporate and other (2) +(155,730 +) +(131,827 +) +(23,903 +) +18.1 +(36,917 +) +28.0 +Total consolidated operating income (loss) +$ +(72,324 +) +$ +(4,726 +) +$ +(67,598 +) +$ +1,430.3 +$ +(72,313 +) +1,530.1 +% +Foreign currency loss, net +(3,332 +) +(4,885 +) +1,553 +(31.8 +) +Interest income +967 +1,664 +(697 +) +(41.9 +) +Interest expense +(969 +) +(806 +) +(163 +) +20.2 +Other income (expense), net +914 +204 +710 +348.0 +Income (loss) before income taxes +$ +(74,744 +) +$ +(8,549 +) +$ +(66,195 +) +774.3 +% +_______________________________________________________________________________ +(1) +During the year ended December 31, 2015, operating losses of Other businesses increased $10.7 million compared to 2014, primarily due to a $12.0 million decrease in gross margin. +(2) +Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and other corporate costs. For the year ended December 31, 2015, 'Unallocated corporate and other' operating losses increased $23.9 million compared to the same period in 2014, primarily due to an increase in administrative expenses. +(3) +Reflects year over year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Use of Non-GAAP Financial Measures" above for more information. +45 +Table of Contents +Americas Operating Segment +Revenues. During the year ended December 31, 2015 , revenues for our Americas segment decreased $13.7 million , or 2.8% , compared to the same period in 2014 . The decrease in the Americas segment revenues was due to the net impact of: (i) a $17.8 million , or 3.6% , increase related to higher sales volumes, (ii) a $21.3 million , or 4.3% , decrease related to a lower average sales price, and (iii) a $10.2 million , or 2.1% , decrease due to the unfavorable impact of foreign currency translation. +Future changes in the average sales price per unit in any of our operating segments will be impacted by: (i) the mix of products sold, (ii) the sales channel (as we generally realize higher sales prices from our retail and e-commerce channels as compared to our wholesale channel), and (iii) the level of sales discounts and incentives we offer our customers. +Cost of Sales (including restructuring charge). During the year ended December 31, 2015 , cost of sales for our Americas segment decreased $4.0 million, or 1.6%, compared to the same period in 2014 . The net decrease in cost of sales was due to: (i) a $9.2 million , or 3.6% , increase due to higher sales volumes, (ii) a $6.2 million , or 2.4% , decrease due to lower average costs per unit sold, (iii) a $5.8 million , or 2.3% , decrease due to the impact of foreign currency translation, and (iv) a $1.2 million, or 0.4%, decrease associated with lower restructuring charges recorded in cost of sales (these restructuring efforts were completed as of December 31, 2015). +Gross Profit. The combined impact of the decrease in the Americas segment revenues and cost of sales resulted in a $9.7 million, or 4.2%, decrease in gross profit during the year ended December 31, 2015 compared to the same period in 2014. The net decrease in the Americas segment gross profit was due to: (i) a $15.1 million, or 6.4%, decrease due to the combined impact of a lower average sale price partially offset by a lower average cost per unit sold, (ii) an $8.6 million, or 3.7%, increase due to higher sales volumes, (iii) a $4.4 million, or 1.9%, decrease due to the impact of foreign currency translation, and (iv) a $1.2 million, or 0.4%, increase due to lower restructuring costs recorded in cost of sales. +SG&A . During the year ended December 31, 2015, SG&A for the Americas segment decreased $12.3 million, or 6.9%, compared to the same period in 2014. This net decrease is primarily due to: (i) a $7.3 million, or 4.1%, decrease in compensation expense, (ii) a $4.2 million, or 2.3%, decrease in rent expense, (iii) a $1.2 million, or 0.7%, decrease in contract labor, and (iv) and other items that are individually insignificant. +Restructuring Charges. Restructuring charges for the Americas segment decreased $1.7 million as compared to the prior year as the majority of our restructure efforts were completed in 2014. +Asset Impairment Charges. Asset impairment charges for the Americas segment increased $3.2 million for the year ended December 31, 2015 as compared to the same period in 2014. This increase is largely due to the impairment of certain retail locations that experienced declining sales volumes. +Income from Operations. T he $1.1 million, or 2.2%, increase in income from operations for the Americas segment is due to the net impact of: (i) a $9.7 million decrease in gross profit, as discussed above, (ii) a $12.3 million decrease in SG&A, as discussed above, (iii) a $1.7 million decrease in restructure charges, as discussed above, and (iv) a $3.2 million increase in asset impairment charges, as discussed above. +Asia Pacific Operating Segment +Revenues. During the year ended December 31, 2015 , revenues for our Asia Pacific segment decreased $49.4 million , or 10.4% , compared to the same period in 2014 . The decrease in the Asia Pacific segment revenues was due to the net impact of: (i) an $11.0 million , or 2.3% , increase due to higher sales volumes, (ii) a $28.5 million , or 6.0% , decrease in the average sales price and (iii) a $31.9 million , or 6.7% , decrease due to the unfavorable impact of foreign currency translation. +Cost of Sales. During the year ended December 31, 2015 , cost of sales for our Asia Pacific segment decreased $21.7 million, or 8.9% , compared to the same period in 2014 . The decrease in the Asia Pacific segment cost of sales was due to the net impact of: (i) a $4.9 million , or 2.3% , increase due to higher sales volumes, (ii) a $9.6 million , or 4.5% , decrease due to lower average costs per unit sold, (iii) a $14.2 million , or 6.7% , decrease due to the impact of foreign currency translation, and (iv) a $2.8 million, or 1.3%, decrease associated with lower restructuring charges recorded in cost of sales (these restructuring efforts were completed as of December 31, 2015). +Gross Profit. During the year ended December 31, 2015 , gross profit for the Asia Pacific segment decreased $27.7 million , or 10.7% , and gross margin decreased 18 basis points compared to the same period in 2014 to 54.4% . The decrease in the Asia Pacific +46 +Table of Contents +segment gross profit is due to the net impact of: (i) a $6.1 million , or 2.4% , increase due to higher sales volumes, (ii) a $16.1 million , or 6.3% , decrease due to a lower average sales prices in excess of a lower average cost per unit, and (iii) a $17.7 million , or 6.8% , decrease due to the impact of foreign currency translation. +SG&A . During the year ended December 31, 2015 , SG&A for our Asia Pacific segment decreased $3.6 million, or 2.0%, compared to the same period in 2014. The decrease in SG&A was primarily due to the net impact of: (i) a $10.0 million decrease associated with salaries and wages, (ii) a $14.3 million increase associated with bad debt expense. +Restructuring Charges. Restructuring charges for the Asia Pacific segment were $3.5 million for the year ended December 31, 2015 compared to $3.5 million in the same period of 2014. +Asset Impairment Charges. Asset impairment charges for the Asia Pacific segment were $6.5 million for the year ended December 31, 2015, compared to $2.8 million in the same period of 2014, primarily due the impairments associated with the sale of the South Africa operations. +Our Asia Pacific operating segment continues to perform poorly primarily due to adverse macro-economic conditions and overall weakness in China's economy. The macro-economic environment in China has deteriorated over the past several quarters which has decreased revenue from our China operations by 53.0%, for the year ended December 31, 2015 as compared to the same period in 2014. We have also experienced significant declines in collection rates from our China operations due to the adverse macro-economic environment and the deteriorating working capital position of our distributors. The impact of these declines became apparent in September 2015, when multiple China distributors defaulted on their payment obligations. As a result, we have reassessed the collectability of our accounts receivable balances, for our China operations, and we concluded a significant increase in reserves is required. Accordingly, we have increased our China allowance for doubtful accounts by an additional $23.2 million, resulting in total allowances for our China operations of $30.3 million as of December 31, 2015. Our net accounts receivable balance for our China operations as of December 31, 2015 is $5.1 million. +If the economic conditions in China continue to decline, we may experience further reductions in consumer demand in our China markets which could result in additional declines. As our China operations represent approximately 8% of our total revenue, declining sales volumes in China could have a material adverse impact on our financial results in future periods. +Europe Operating Segment +Revenues. During the year ended December 31, 2015 , revenues for our Europe segment decreased $44.8 million , or 19.2% , compared to the same period in 2015 . The decrease in the Europe segment revenues was due to the net impact of: (i) an $8.2 million , or 3.5% , increase due to higher sales volumes, (ii) a $9.7 million , or 4.2% , decrease due to a lower average sales price, and (iii) a $43.3 million , or 18.5% , decrease due to the impact of foreign currency translation. +Cost of Sales. During the year ended December 31, 2015 , cost of sales for our Europe segment decreased $16.4 million , or 14.1% , compared to the same period in 2015 . The decrease in the Europe segment cost of sales was due to the net impact of: (i) a $4.1 million , or 3.5% , increase due to higher sales volumes, (ii) a $2.7 million or 2.3% , decrease due to lower average cost per unit sold and (iii) a $17.9 million, or 15.4% decrease due to the impact of foreign currency translation. +Gross Profit. During the year ended December 31, 2015 , gross profit for our Europe segment decreased $28.4 million , or 24.2% , and gross margin decreased 311 basis points compared to the same period in 2015 , to 47.2% . The decrease in the Europe segment gross profit is due to the net impact of: (i) a $4.1 million , or 3.5% , increase due to higher sales volumes, (ii) a $7.1 million , or 6.1% , decrease due to a lower average sales price in excess of the decrease in costs per unit, and (iii) a $25.4 million , or 21.6% , decrease due to the impact of foreign currency translation. +SG&A . During the year ended December 31, 2015 , SG&A for our Europe segment decreased $17.9 million, or 20.6%, compared to the same period in 2014. The decrease in SG&A was primarily due to the net impact of: (i) a $9.5 million decrease associated with salaries and wages, (ii) a $6.7 million decrease associated with building expenses, and (iii) a $2.2 million decrease in services expense. +Restructuring Charges. Restructuring charges for our Europe segment were $2.8 million for the year ended December 31, 2015, compared to $4.0 million in the same period of 2014. +Asset Impairment Charges. Asset impairment charges for our Europe segment were $1.6 million for the year ended December 31, 2015, compared to $2.0 million in the same period of 2014. +47 +Table of Contents +The changes in the number of our company-operated retail locations by reportable operating segment and type of store were: +December 31, +2014 +Opened +Closed +December 31, +2015 +Company-operated retail locations +Type +Kiosk/store in store +100 +11 +13 +98 +Retail stores +311 +15 +51 +275 +Outlet stores +174 +16 +4 +186 +Total +585 +42 +68 +559 +Operating segment +Americas +210 +4 +18 +196 +Asia Pacific +258 +36 +33 +261 +Europe +117 +2 +17 +102 +Total +585 +42 +68 +559 +Comparable retail store sales and Direct to Consumer store sales by reportable operating segment are as follows: +Constant Currency (2) +Year Ended +December 31, 2015 +Constant Currency (2) +Year Ended +December 31, 2014 +Comparable store sales (retail only) (1) +Americas +(3.2 +)% +(4.4 +)% +Asia Pacific +(4.5 +)% +(4.7 +)% +Europe +3.0 +% +0.7 +% +Global +(2.8 +)% +(3.7 +)% +Constant Currency (2) +Year Ended +December 31, 2015 +Constant Currency (2) +Year Ended +December 31, 2014 +DTC comparable store sales (includes retail and e-commerce) (1) +Americas +3.3 +% +(3.8 +)% +Asia Pacific +3.0 +% +0.6 +% +Europe +7.8 +% +(0.6 +)% +Global +3.9 +% +(1.9 +)% +_______________________________________________________________________________ +(1) +Comparable store status is determined on a monthly basis. Comparable store sales includes the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period. +(2) +Reflects quarter over quarter change on a “constant currency” basis, which is a non-GAAP financial measure that restates current period results using prior year foreign exchange rates for the comparative period to enhance visibility of the underlying business trends, excluding the impact of foreign currency. +Comparable store sales decreased 2.8% on a global basis for the year ended December 31, 2015, compared to a decrease of 3.7% for the year ended December 31, 2014. Comparable store sales for our direct to consumer customers, which includes retail and ecommerce, increased 3.9% on a global basis for the year ended December 31, 2015, compared to a decrease of 1.9% for the year ended December 31, 2014. +48 +Table of Contents +Impact on revenues due to foreign exchange rate fluctuations. Changes in average foreign currency exchange rates used to translate revenue from our functional currencies to our reporting currency during the year ended December 31, 2015 resulted in an $85.3 million decrease in revenue compared to the same period in 2014. +Gross profit. During the year ended December 31, 2015, gross profit decreased $79.5 million, or 13.5%, compared to the same period in 2014, and was primarily attributable to the 9.0% decrease in revenue partially offset by a decrease of $24.1 million, or 4.0% to cost of sales compared to the same period in 2014 primarily due to foreign currency translation. Gross margin percentage decreased 250 basis points compared to the same period in 2014. +Impact on gross profit due to foreign exchange rate fluctuations. Changes in average foreign currency exchange rates used to translate revenue and costs of sales from our functional currencies to our reporting currency during the year ended December 31, 2015 decreased our gross profit by $41.7 million, or 7.1%, compared to the same period in 2014. +Liquidity and Capital Resources +Cash and cash equivalents were $147.6 million at December 31, 2016, compared to $143.3 million at December 31, 2015. Cash and cash equivalents increased during 2016 by $4.2 million compared to a decrease of $ 124.2 million during 2015 . We did not make any repurchases of our common stock during 2016 compared to repurchases of $85.9 million during 2015 . The remaining increase in cash and cash equivalents in 2016 primarily resulted from increases of $30.1 million in net loss adjusted for non-cash items and working capital items, $13.5 million from the effects of exchange rates and $1.1 million of other financing activities. +Year Ended December 31, 2016 Compared to Year Ended December 31, 2015 +Cash Flows +Years Ended December 31, +2016 +2015 +Change +(in thousands) +Cash provided by (used in) operating activities +$ +39,754 +$ +9,698 +$ +30,056 +Cash used in investing activities +(18,657 +) +(18,627 +) +(30 +) +Cash used in financing activities +(16,443 +) +(101,260 +) +84,817 +Effect of exchange rate changes on cash +(430 +) +(13,982 +) +13,552 +Net increase (decrease) in cash and cash equivalents +$ +4,224 +$ +(124,171 +) +$ +128,395 +Net Cash Provided by Operating Activities. Cash provided by operating activities increased to $39.8 million during 2016 compared to $9.7 million during 2015 . The $30.1 million net increase in cash provided by operating activities resulted from the net effects of a $13.8 million increase in cash from net loss adjusted for non-cash items, and improved cash from operating assets of $16.3 million, primarily in working capital. The $13.8 million increase in cash from net loss adjusted for non-cash items include a $66.7 million improvement in net loss, partially offset by a $52.9 million decrease in non-cash items, which consist of: (i) a $22.8 million decrease from the prior year in non-cash expense associated with doubtful accounts, primarily in Asia; (ii) a $15.3 million decrease from the prior year in asset impairments related to closed retail locations and inventory reserves; (iii) an $8.2 million increase in net unrealized foreign currency gains; and (iv) a $6.7 million decrease from other non-cash items. +Improvements in cash from operating acitivites of $16.3 million include: (i) reductions in accounts receivable of $18.0 million; (ii) reductions in inventories of $29.0 million due to increased inventory management efforts; offset in part by decreases in accounts payable and accrued expenses of $29.6 million; and (iv) other working capital items that decreased cash from operations by $1.1 million. +Net Cash Used in Investing Activities. Net cash used in investing activities was $18.7 million during 2016 compared to $18.6 million during 2015 . The $3.7 million increase in capital expenditures, primarily associated with enhancements to our information technology infrastructure, was offset by proceeds received of approximately $2.4 million on the sale of our South Africa business and $1.2 million of other investing activities. +Net Cash Used in Financing Activities. Net cash used in financing activities decreased to $16.4 million during 2016 compared to $101.3 million during 2015. The decrease of $84.9 million was primarily attributable to the net impact of: (i) we made no repurchases of our common shares during 2016 as compared to repurchases of $85.9 million during 2015; (ii) a $1.4 million decrease in cash received in 2016 from issuances of common stock associated with our stock compensation plans compared to 2015; and (iii) other cash used in financing activities related to net borrowings and repayments associated with our Senior Revolving Credit Facility. +49 +Table of Contents +Year Ended December 31, 2015 Compared to Year Ended December 31, 2014 +Years Ended December 31, +2015 +2014 +Change +(in thousands) +Cash provided by (used in) operating activities +$ +9,698 +$ +(11,651 +) +$ +21,349 +Cash used in investing activities +(18,627 +) +(57,992 +) +39,365 +Cash provided by (used in) financing activities +(101,260 +) +23,431 +(124,691 +) +Effect of exchange rate changes on cash +(13,982 +) +(3,420 +) +(10,562 +) +Net increase (decrease) in cash and cash equivalents +$ +(124,171 +) +$ +(49,632 +) +$ +(74,539 +) +During the year ended December 31, 2015 , cash and cash equivalents decreased $124.2 million to $143.3 million , compared to a decrease of $49.6 million during December 31, 2014 . The primary drivers of this decrease were the repurchase of $85.9 million of our common stock including related commissions under our publicly-announced repurchase plan, strategic reinvestments into the business including $5.8 million in capital spend primarily related to our ERP system implementation, dividend payments of $11.9 million on our Series A Preferred Stock, of which $3.0 million was recorded as dividends payable and prepaid dividends as of December 31, 2016 , and debt payments, including principal and interest, of $3.0 million related to long-term bank borrowings. +Cash provided by operations was $9.7 million for the year ended December 31, 2015 compared to cash used in operations of $11.7 million for the year ended December 31, 2014 . This increase was primarily driven by the change in working capital accounts year over year which accounted for $36.4 million of our cash provided by operating activities. During the year ended December 31, 2016 , we paid $19.9 million in cash related to taxes that were accrued for as of December 31, 2014 , which accounted for half of this change. +As of December 31, 2015 , accounts receivable, net decreased $17.6 million compared to December 31, 2014 . During the year ended December 31, 2015 , we recorded a reserve for doubtful accounts of $23.2 million in our Asia Pacific segment primarily as a result of delayed payments from our partner stores in China. As of December 31, 2015 , other long-term assets decreased by approximately $4.3 million primarily due to the decrease in derivative instruments recorded on our balance sheet, as no such instruments were outstanding as of December 31, 2015 . As of December 31, 2015 , accounts payable increased $20.4 million compared to December 31, 2014 . As a result of the January 2015 implementation of our new ERP system, we accelerated payments of our outstanding payables in late 2014 to accommodate the transition. Accrued expenses and other liabilities increased $11.6 million compared to December 31, 2014 primarily due to an accrued loss on our South Africa operations held for sale as of December 31, 2015 . +Sources of Liquidity +Our primary sources of liquidity are cash flows generated from our operations, our cash and cash equivalents and available borrowing capacity under our Senior Revolving Credit Facility. +The following table presents the total availability under our credit facilities as of December 31 2016: +December 31, 2016 +Borrowing +Borrowings +Remaining +Description +Capacity +Outstanding +Availability +(in thousands) +Senior Revolving Credit Facility (1) +$ +80,000 +$ +1,253 +$ +78,747 +Asia Revolving Credit Facility (2) +8,625 +— +— +_________________________________________________________________ +(1) +Borrowing capacity is subject to certain financial covenants as further described in Note 9 — Revolving Credit Facility and Bank Borrowings. Outstanding amount represents letters of credit. The term of this facility expires in February 2021. +(2) +Borrowing capacity is the U.S. Dollar equivalent of 60 million Chinese Renminbi and has been suspended as more fully described in Note 9 — Revolving Credit Facility and Bank Borrowings. The term of this facility expires in February 2021. +50 +Table of Contents +The Senior Revolving Credit Facility is with a single lender, PNC Bank. We have no reason to believe that the lender would be unable to fulfill its obligation to provide financing in accordance with the terms of the Senior Revolving Credit Facility in the event of our election to borrow funds. +We also have notes payable obligations totaling $2.4 million as of December 31, 2016, which represent funds borrowed to finance the purchase and implementation of our ERP system under a Master IPA agreement that expires in February 2021, and certain insurance coverage premiums. +Repatriation of Cash +As we are a global business, we have cash balances which are located in various countries and are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +We generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested; however, our Board has approved a foreign cash repatriation strategy. As part of this strategy, we repatriated approximately $37 million during the year ended December 31, 2016 for which income taxes have already been accrued or paid. Further cash repatriation will depend on future cash requirements in the U.S. We maintain approximately $178 million of foreign earnings for which tax has previously been provided, and which has not been repatriated at this time. +Most of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2016, we held $121.9 million of our total $147.6 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $121.9 million, $.3 million could potentially be restricted, as described above. If the remaining $121.6 million were to be immediately repatriated to the U.S., no additional tax expense would be incurred as all amounts are currently provided for in the statement of operations. +Sale of Preferred Stock +On January 27, 2014, we sold 200,000 shares of the Company's Series A Convertible Preferred Stock ("Series A Preferred") for $182.2 million of net proceeds. The Series A Preferred has a par value of $0.001 per share, with a liquidation value of $200.0 million, or $1,000 per share, and an aggregate purchase price of $198.0 million, or $990.00 per share. We are obligated to pay cash dividends of $3 million each quarter to the Holders of Series A Preferred in cash as well as any dividends declared or paid on our common stock. More information regarding the Series A Preferred is included in Note10 — Equity. +Our sources of liquidity are used to fund our ongoing cash requirements, including our working capital, global retail, distribution and e-commerce development and construction, investments in our infrastructure including technology, payments of dividends, repayments of debt and borrowings, settlements of contingent liabilities (including uncertain tax positions), and other ongoing corporate activities. We believe that our existing sources of liquidity, including cash on hand, accounts receivable and borrowing capacity under our Senior Revolving Credit Facility will be sufficient to meet our liquidity needs over the next year as well as the foreseeable future. +Contractual Obligations +In December 2011, the Company renewed and amended its supply agreement with Finproject S.p.A. (formerly known as Finproject s.r.l.), which provides the Company the right to purchase certain raw materials used to manufacture its products. The supply agreement requires that the Company meet minimum purchase requirements throughout the term of the agreement, which renews annually on January 1st unless terminated by either party. Historically, the minimum purchase requirements have not been onerous and the Company does not expect them to become onerous in the future. Depending on the material purchased, pricing is based either on contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations, and raw material prices. Pursuant to the agreement, the Company guarantees the payment for certain third-party manufacturer purchases of these raw materials up to a maximum potential amount of € 3.5 million (approximately $3.7 million as of December 31, 2016 ). +The following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2016 : +51 +Table of Contents +Total +Less than +1 Year +1 - 3 Years +3 - 5 Years +More than +5 Years +(in thousands) +Operating lease obligations (1) +$ +310,555 +68,241 +134,519 +29,230 +78,565 +Inventory purchase obligations with third-party manufacturers (2) +125,987 +125,987 +— +— +— +Dividends payable (3) +60,866 +12,000 +24,000 +24,000 +866 +Other contracts (4) +39,872 +27,442 +10,083 +2,347 +— +Debt obligations (5)(8) +2,329 +2,329 +— +— +— +Minimum licensing royalties (6) +6,403 +4,023 +2,374 +6 +— +Capital lease obligations (7) +49 +9 +29 +11 +— +Total +$ +546,061 +$ +240,031 +$ +171,005 +$ +55,594 +$ +79,431 +_______________________________________________________________________________ +(1) +Our operating lease obligations consist of leases for retail stores, offices, warehouses, vehicles, and equipment expiring at various dates through 2033. This balance represents the minimum cash commitment under contract to various third parties for operating lease obligations including the effect of rent escalation clauses and deferred rent and minimum sublease rentals due in the future under non-cancelable subleases. This balance does not include certain contingent rent clauses that may require additional rental amounts based on sales volume, inventories, etc. as these amounts are not determinable for future periods. +(2) +Our inventory purchase obligations with third-party manufacturers consist of open purchase orders for footwear products and include an immaterial amount of purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third-party manufacturers are expected to be paid within one year. +(3) +Dividends payable are associated with our Series A Preferred Stock at a rate of 6.0% of the stated value of the stock. The amounts represent expected dividend payments over the eight year redemption accretion period. +(4) +Other contracts consist of various agreements with third-party providers, primarily for IT and financial services, distribution and logistics service providers, and other agreements. +(5) +Our current debt obligations consist of five separate notes issued under our agreement with PNC to finance the purchase and implementation of our new ERP system, which bear interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 to September 2017. We will continue to finance the ERP implementation on an as needed basis through this agreement. Interest rates and payment terms are subject to change as further financing occurs. +(6) +Our minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our footwear and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for future periods. +(7) +Our capital lease obligations consist of leases for office equipment expiring at various dates through 2020. This balance represents the minimum cash commitment under contract to various third-parties for capital lease obligations. +(8) +Amounts include anticipated interest payments. +Excluded from the table above is a $4.8 million liability for unrecognized tax benefits as of December 31, 2016, as we cannot make a reliable estimate of the period in which the liability will be settled, if ever. +Off-Balance Sheet Arrangements +In accordance with generally accepted accounting principles, our operating leases are not reflected in our consolidated balance sheets. See Part II—Item 8, Financial Statements and Supplementary Data , Note 15 — Commitments and Contingencies for further discussion of these off-balance sheet arrangements (as defined in Item 303(a)(4)(ii) of Regulation S-K). As of December 31, 2016 , we did not have any other material off-balance sheet arrangements other than certain operating leases and other commitments. +52 +Table of Contents +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and non-GAAP financial measures, is based on the consolidated financial statements which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Significant Accounting Policies to the accompanying consolidated financial statements. +Reserves for Uncollectible Accounts Receivable +We make ongoing estimates related to the collectibility of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer's inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge, respectively, to 'Selling, general and administrative expenses' in our consolidated statement of operations in the period in which we made such a determination. +See Note 12 — Allowances to the accompanying consolidated financial statements for an analysis of the activity in our allowance for doubtful accounts. +Sales Returns, Allowances and Discounts +A significant area of judgment affecting reported revenues and net income involves estimating reserves for sales returns, allowances and discounts, which represent the portion of revenues not expected to be realized. Wholesale revenues are reduced by estimates of returns, allowance, discounts and contractual discounts to major customers. We also accept returns at our sole discretion from our wholesalers and distributors to rebalance stock and to ensure that our products are merchandised in the proper assortments, and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. We also record reductions to revenues for estimated customer credits as a result of price markdowns in certain markets. Retail revenues, including e-commerce store sales, are also reduced by an estimate of returns. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns, allowances and discounts may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances and discounts have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns, allowances and discounts as of December 31, 2016 would have decreased our 2016 revenues by approximately $7.2 million. +See Note 12 — Allowances to the accompanying consolidated financial statements for an analysis of the activity in our sales returns, allowances and discounts. +Inventory Valuation +Our products are sold through wholesale distribution channels department stores, sporting goods stores, distributors, national, regional and independent retailers. We also sell directly to consumers through wholly-owned full-service retail stores, kiosks, outlet stores and e-commerce store sites. Substantially all of our inventories are finished goods, which are stated at the lower of cost or market, with cost determined using the moving average cost method. +53 +Table of Contents +We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end of life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value and the difference is recorded in 'Cost of sales' in our consolidated statements of operations. Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and recorded within 'Cost of sales' in our consolidated statements of operations. The ultimate results achieved in selling excess and discontinued products in future periods may differ significantly from our estimates. A hypothetical 1% increase in the level of our inventory reserves as of December 31, 2016 would have decreased our 2016 gross profit by approximately $0.1 million. +See Note 3 — Inventories to the accompanying consolidated financial statements for a discussion of our inventory reserves. +Impairment of Other Long-Lived Assets +Property and equipment along with other long-lived assets are evaluated for impairment periodically whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. Testing of long-lived assets for impairment is at the level of an asset group, which is the is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +During 2016, 2015, and 2014, we recorded non-cash impairment of $2.7 million, $15.3 million, and $8.8 million, respectively, to reduce the net carrying value of certain long-lived assets, primarily related to underperforming company owned retail stores, to their estimated fair values. See Note 4 — Property and Equipment to the accompanying consolidated financial statements for further information related to long-lived asset impairments. +Stock-Based Compensation +Stock Options +Stock options are granted to employees and non-employee directors with exercise prices equal to the fair market value of our common stock on the date of grant. We use the Black-Scholes option-pricing model to estimate the grant date fair value of stock options, which requires the use of assumptions, including the expected term of the option, expected volatility of our stock price, our expected dividend yield, and the risk-free interest rate, among others. These assumptions reflect our best estimates, however; they involve inherent uncertainties including market conditions and employee behavior that are generally outside of our control. Generally, once stock option values are determined, accounting practices do not permit them to be changed, even if the estimates used are different from actual results. We expense all stock-based compensation awarded to employees and non-employee directors based on the grant date fair value of the awards over the requisite service period, adjusted for forfeitures. +Restricted Stock Awards and Units ("RSUs") +We grant restricted shares of our common stock to our non-employee directors, and service-based RSUs to certain executives, as well as to certain non-executive employees. In addition, we grant performance-based RSUs to certain executives. The fair values of restricted stock shares and RSUs are based on the fair value of our unrestricted common stock, adjusted to reflect the absence of dividends for those restricted securities that are not entitled to dividend equivalents prior to vesting. Compensation expense for performance-based RSUs is recognized over the employees' requisite service period when attainment of the performance goals is deemed probable, which involves judgment as to achievement of certain performance metrics. +54 +Table of Contents +Our performance-based RSU awards vest based upon attainment of certain performance conditions, including earnings levels, revenue and cash flow targets, and certification by our Compensation Committee. The fair value of these awards is estimated using a Monte Carlo simulation valuation model prepared by an independent third party. This pricing model utilizes multiple input variables that determine the probability of satisfying each performance condition stipulated in the terms of the award to estimate its grant date fair value. Compensation expense, net of forfeitures, is updated for the Company's expected performance level against each related goal at the end of each reporting period. +Sensitivity +The assumptions used in calculating the grant date fair values of stock-based compensation awards represent our best estimates. In addition, judgment is required in estimating the number of stock-based awards that will vest upon achievement of performance conditions. If actual results differ significantly from our estimates and assumptions, if we change the assumptions used to estimate the grant date fair value for future stock-based award grants, or if there are changes in market conditions, stock-based compensation expense and, therefore, our results of operations could be materially impacted. A hypothetical 1% change in our stock-based compensation expense would have affected our 2016 net income by approximately $0.1 million. +See Note 11 — Stock Compensation to the accompanying consolidated financial statements for further information related to stock-based compensation. +Contingencies and Legal Proceedings +We are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. In addition, if it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. Management considers many factors in making these assessments. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management's judgment in developing the related estimates and assumptions. See Note 15 —Commitments and Contingencies in the accompanying notes to the audited consolidated financial statements for additional information regarding our contingencies and legal proceedings. +Income Taxes +We account for income taxes using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the “Income tax expense” line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +Our annual tax rate is based on our income, statutory tax rates, and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. Tax laws require items to be included in our tax returns at different times than when these items are reflected in the consolidated financial statements. As a result, the annual tax rate reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on an evaluation of all available information, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. +55 +Table of Contents +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. Undistributed earnings of a subsidiary are accounted for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign subsidiary that are deemed to be indefinitely reinvested in the foreign jurisdiction. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. U.S. income and foreign withholding taxes have not been provided on approximately $208.1 million of cumulative undistributed foreign earnings of the non-US subsidiaries as of December 31, 2016. These historical earnings are indefinitely reinvested outside of the United States. +Should we change our plans, we would be required to record a significant amount of deferred tax liabilities. The amount of unrecognized deferred U.S. income tax liability on the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +See Note 13 — Income Taxes in the accompanying notes to the consolidated financial statements for additional information regarding our income taxes. +Recent Accounting Pronouncements. See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements for recently adopted and issued accounting pronouncements. +56 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility and certain financial instruments. In addition to the revolving credit facility, we have incurred indebtedness related to the implementation of our enterprise resource planning software ("ERP") system. Borrowings under these debt instruments bear fixed interest rates and therefore, do not have the potential for market risk. +Borrowings under the revolving credit facility bear interest at a variable rate. For domestic rate loans, including swing loans, the interest rate is equal to a daily base rate plus a margin ranging from 0.50% to 0.75% based on certain conditions. For domestic London Interbank Borrowing Rate ("LIBOR") rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.50% to 1.75% based on certain conditions. +Borrowings under the revolving credit facility are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. As of December 31, 2016 and 2015 , there were no borrowings outstanding under the revolving credit facility. +We additionally hold cash equivalents including certificate of deposits, time deposits and money market funds. Interest income generated from these cash equivalents will fluctuate with the general level of interest rates. As of December 31, 2016 , we held $3.4 million in cash equivalents subject to variable interest rates. The effects of an increase or decrease of 10% in prevailing market interest rates earned on these investments on interest income during the year ended December 31, 2016 , is not significant to our consolidated results of operations, financial condition or cash flows. +Foreign Currency Exchange Risk +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiary’s functional currency. Likewise, our U.S. companies are also exposed to the risk of gains and losses resulting changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar. +We have experienced and will continue to experience changes in international currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings. As of December 31, 2016 , the U.S. Dollar notional value of our outstanding foreign currency forward exchange contracts was approximately $328.2 million . The net fair value of these contracts at December 31, 2016 was a liability $0.2 million. +We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our forward foreign currency exchange contracts. To perform the sensitivity analysis, we assess the risk of loss in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of December 31, 2016 , a 10% appreciation in the value of the U.S. Dollar would result in a net increase in the fair value of our derivative portfolio of approximately $5.5 million . +Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries +Changes in exchange rates have a direct effect on our reported U.S. dollar consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to U.S. dollars using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the U.S. dollar reporting currency using average exchange rates each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates used in translate the operating results of our international subsidiaries. +For example, in our European segment, when the U.S. Dollar strengthens relative to the Euro, our reported U.S. Dollar results are lower than if there had been no change in the exchange rate, because more Euros are required to generate the same U.S. Dollar translated amount. Conversely, when the U.S. Dollar weakens relative to the Euro, the reported U.S. Dollar results of our Europe segment are higher compared to a period with a stronger U.S. Dollar relative to the Euro. Similarly, the reported U.S. Dollar results of our Asia Pacific segment, where the functional currencies are primarily the Japanese Yen, Chinese Yuan, Korean Won and the +57 +Table of Contents +Singapore Dollar, are comparatively lower or higher when the U.S. Dollar strengthens or weakens, respectively, relative to these currencies. +An increase of 1% of the value of the U.S. Dollar relative to foreign currencies would have increased our loss before taxes during the year ended December 31, 2016 by approximately $0.8 million. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Form 10-K for a discussion of the impact of the change in foreign exchange rates on our U.S Dollar consolidated statement of operations for the years ended December 31, 2016 and 2015 . +58 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +59 +Table of Contents +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +60 +Table of Contents +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange Act"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2016, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management's control objectives. +Management's Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2016, based on the framework and criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2016. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2016, as stated in the report which appears herein. +Changes in Internal Controls over Financial Reporting +During 2016, the Company completed a number of initiatives designed to remediate certain material weaknesses with respect to internal controls over the Company's financial close process and inventory. Specifically, management completed the following with respect to its internal controls. +Financial Close Process. +The Company implemented internal control procedures over the financial close process, including: (i) added internal control review and documentation procedures that ensure that all manual journal entries, including deferred income tax and period end adjusting entries, are properly documented and reviewed by competent personnel; (ii) global account reconciliation procedures that ensure all key accounts are properly reconciled on a timely basis, documented and reviewed by competent personnel; (iii) hired personnel with the requisite skills in income taxes and accounting; (iv) improved the organizational structure of our tax and accounting departments; and (v) provided training to global accounting process owners on policies and controls over account analysis, documentation, review, and approval of manual journal entries, and data integrity procedures. +Inventory Accounting Controls . +The Company implemented internal control procedures over inventory accounting controls, including: (i) additional procedures to ensure all inventory physical observations and counts are performed timely, all resulting adjustments are recorded and appropriately documented in our inventory management system; (ii) additional inventory reconciliation procedures to ensure our inventory management system is appropriately reconciled to the general ledger on a regular basis; (iii) improvements to our analysis +61 +Table of Contents +of inventory cost absorption to ensure the proper valuation; (iv) provided training to our supply chain personnel to ensure appropriate understanding of our inventory policies and procedures including the importance of timely and accurate recording; and (v) hired additional personnel to our inventory management team to implement and maintain our inventory accounting controls. +As described above in “Management’s Annual Report on Internal Control Over Financial Reporting”, the Company concluded that its internal control over financial reporting was effective as of December 31, 2016 based, in part, on the effectiveness of the changed and new controls implemented during 2016 as described above. +Other than the changes described above, there have been no changes in our internal controls over financial reporting (as defined in Rule 13(a)-15(f) of the Exchange Act) during the year ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. +62 +Table of Contents +ITEM 9B. Other Information +None. +63 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management's Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in I nternal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2016 of the Company and our report dated March 1, 2017 expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding a change in the method of accounting for share-based payments due to the adoption of Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting . +/s/ DELOITTE & TOUCHE LLP +Denver, CO +March 1, 2017 +64 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2016 . +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal financial officer, principal accounting officer and controller. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, our code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct and ethics policy as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2016 . +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2016, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 3.8 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2016. +Plan Category +Number of +Securities to be Issued +on Exercise of +Outstanding +Options and Rights (3) +Weighted Average +Exercise Price of +Outstanding +Options (2) +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders (1) +3,750,449 +$ +16.90 +6,720,218 +Equity compensation plans not approved by stockholders +— +— +— +Total +3,750,449 +$ +16.90 +6,720,218 +_______________________________________________________________________________ +(1) +On June 8, 2015, the Company's stockholders approved the Crocs, Inc. 2015 Equity Incentive Plan (the "Plan"). The number of shares available for issuance under the Plan (subject to changes in capitalization) consist of (i) 7.0 million newly available shares; (ii) 1.2 million shares available for issuance under the 2007 Plan as of June 8, 2015; and (iii) 2007 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 8, 2015. The Plan provides for the grant of incentive and non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, and other stock-based awards. The Plan replaces the Company's 2007 Equity Incentive Plan (As Amended and Restated), and no further awards will be made under the 2007 Plan. The Plan became effective immediately upon stockholder approval. +(2) +The weighted-average exercise price of outstanding options pertains only to 0.5 million shares issuable on the exercise of outstanding options and rights. +(3) +At target performance. +65 +Table of Contents +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2016 . +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2016 . +PART IV +ITEM 15. Exhibits and Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the consolidated financial statements or notes thereto. +66 +Table of Contents +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.1 +* +Form of Indemnification Agreement between Crocs, Inc. and each of its directors and executive officers (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.2 +* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) ). +10.3 +* +Amendment No. 1 to the 2005 Plan (incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.4 +* +Form of Notice of Grant of Stock Option under the 2005 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.5 +* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.6 +* +Form of Stock Purchase Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.7 +* +Form of Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.8 +* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) ). +10.9 +* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.10 +* +Form of Non Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) ). +10.11 +* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.'s Annual Report on Form 10-K, filed on March 17, 2009). +67 +Table of Contents +Exhibit +Number +Description +10.12 +* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the "2007 Plan") (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 1, 2011). +10.13 +* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.14 +* +Form of Non-Statutory Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.15 +* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.16 +* +Form of Restricted Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.17 +* +2008 Cash Incentive Plan (As Amended and Restated Effective June 4, 2012) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on June 7, 2012). +10.18 +* +Crocs, Inc. 2015 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on June 9, 2015). +10.19 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders (the "Amended and Restated Credit Agreement") (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 19, 2011). +10.20 +First Amendment to the Amended and Restated Credit Agreement, dated December 10, 2012, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 11, 2012). +10.21 +Second Amendment to Amended and Restated Credit Agreement, dated June 12, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on July 30, 2013). +10.22 +Third Amendment to Amended and Restated Credit Agreement, dated December 27, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 30, 2013). +10.23 +Fourth Amendment to Amended and Restated Credit Agreement, dated March 27, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.24 +Fifth Amendment to Amended and Restated Credit Agreement, dated September 26, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on October 29, 2014) +10.25 +Sixth Amendment to Amended and Restated Credit Agreement, dated April 2, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 7, 2015). +68 +Table of Contents +Exhibit +Number +Description +10.26 +Seventh Amendment to Amended and Restated Credit Agreement, dated April 21, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 7, 2015). +10.27 +Eighth Amendment to Amended and Restated Credit Agreement, dated September 1, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.28 +Ninth Amendment to Amended and Restated Credit Agreement, dated November 3, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.29 +Tenth Amendment to Amended and Restated Credit Agreement, dated December 24, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.30 to Crocs, Inc.'s Annual Report on Form 10-K, filed February 29, 2016).. +10.30 +Eleventh Amendment to Amended and Restated Credit Agreement, dated February 18, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., and PNC Bank, National Association, as a lender and administrative agent. (incorporated herein by reference to Exhibit 10.1 to Crocs Inc.'s Quarterly Report on Form 10-Q, filed on August 5, 2016). +10.31 +Twelfth Amendment to Amended and Restated Credit Agreement, dated June 13, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 5, 2016). +10.32 +† +Thirteenth Amendment to Amended and Restated Credit Agreement, dated November 22, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent. +10.33 +* +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.34 +Investment Agreement, dated December 28, 2013, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 30, 2013). +10.35 +First Amendment to Investment Agreement, dated January 27, 2014, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on January 27, 2014). +10.36 +* +Form of Severance Agreement (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on July 30, 2014). +10.37 +Registration Rights Agreement, dated January 27, 2014 (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on January 27, 2014). +10.38 +* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 5, 2010). +69 +Table of Contents +Exhibit +Number +Description +10.39 +* +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on May 14, 2014). +10.40 +* +Employment Offer Letter, dated December 15, 2014, between Crocs, Inc. and Gregg Ribatt (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 15, 2014). +10.41 +* +Employment Offer Letter, dated November 4, 2015, between Crocs, Inc. and Carrie Teffner (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on November 5, 2015). +21 +† +Subsidiaries of the registrant. +23.1 +† +Consent of Deloitte & Touche LLP. +31.1 +† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 +† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 +† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS +† +XBRL Instance Document +101.SCH +† +XBRL Taxonomy Extension Schema Document +101.CAL +† +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF +† +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB +† +XBRL Taxonomy Extension Label Linkbase Document +101.PRE +† +XBRL Taxonomy Extension Presentation Linkbase Document +_______________________________________________________________________________ +* +Compensatory plan or arrangement. +† +Filed herewith. +70 +Table of Contents +Item 16. Form 10–K Summary. +None. +71 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of March 1, 2017. +CROCS, INC. +a Delaware Corporation +By: +/s/ GREGG S. RIBATT +Name: +Gregg S. Ribatt +Title: +Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ GREGG S. RIBATT +Chief Executive Officer and Director (Principal Executive Officer) +March 1, 2017 +Gregg S. Ribatt +/s/ CARRIE W. TEFFNER +Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) +March 1, 2017 +Carrie W. Teffner +/s/ IAN M. BICKLEY +Director +March 1, 2017 +Ian M. Bickley +/s/ RONALD L. FRASCH +Director +March 1, 2017 +Ronald L. Frasch +/s/ JASON K. GIORDANO +Director +March 1, 2017 +Jason K. Giordano +/s/ PRAKASH A. MELWANI +Director +March 1, 2017 +Prakash A. Melwani +/s/ THOMAS J. SMACH +Chairman of the Board +March 1, 2017 +Thomas J. Smach +/s/ DOUGLAS J TREFF +Director +March 1, 2017 +Douglas J. Treff +/s/ DOREEN A. WRIGHT +Director +March 1, 2017 +Doreen A. Wright +72 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015, and 2014 +F-3 +Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2016, 2015, and 2014 +F-4 +Consolidated Balance Sheets as of December 31, 2016 and 2015 +F-5 +Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2016, 2015, and 2014 +F-6 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015, and 2014 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive loss, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. +As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for share-based payments for the year ended December 31, 2016 due to the adoption of Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2017 expressed an unqualified opinion on the Company's internal control over financial reporting. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +March 1, 2017 +F-2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Year Ended December 31, +2016 +2015 +2014 +Revenues +$ +1,036,273 +$ +1,090,630 +$ +1,198,223 +Cost of sales +536,109 +579,825 +603,893 +Restructuring charges +— +— +3,985 +Gross profit +500,164 +510,805 +590,345 +Selling, general and administrative expenses +503,174 +559,095 +565,712 +Restructuring charges +— +8,728 +20,532 +Asset impairments +3,144 +15,306 +8,827 +Loss from operations +(6,154 +) +(72,324 +) +(4,726 +) +Foreign currency loss, net +(2,454 +) +(3,332 +) +(4,885 +) +Interest income +692 +967 +1,664 +Interest expense +(836 +) +(969 +) +(806 +) +Other income, net +1,539 +914 +204 +Loss before income taxes +(7,213 +) +(74,744 +) +(8,549 +) +Income tax (expense) benefit +(9,281 +) +(8,452 +) +3,623 +Net loss +(16,494 +) +(83,196 +) +(4,926 +) +Dividends on Series A convertible preferred stock +(12,000 +) +(11,833 +) +(11,301 +) +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(3,244 +) +(2,978 +) +(2,735 +) +Net loss attributable to common stockholders +$ +(31,738 +) +$ +(98,007 +) +$ +(18,962 +) +Net loss per common share +Basic +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +Diluted +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS +(in thousands) +Year Ended December 31, +2016 +2015 +2014 +Net loss +$ +(16,494 +) +$ +(83,196 +) +$ +(4,926 +) +Other comprehensive loss: +Foreign currency translation loss, net +(4,683 +) +(32,561 +) +(33,004 +) +Total comprehensive loss +$ +(21,177 +) +$ +(115,757 +) +$ +(37,930 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except par value) +December 31, +2016 +2015 +ASSETS +Current assets: +Cash and cash equivalents +$ +147,565 +$ +143,341 +Accounts receivable, net of allowances of $48,138 and $49,364, respectively +78,297 +83,616 +Inventories +147,029 +168,192 +Income tax receivable +2,995 +10,233 +Other receivables +14,642 +14,233 +Restricted cash - current +2,534 +2,554 +Prepaid expenses and other assets +32,413 +23,780 +Total current assets +425,475 +445,949 +Property and equipment, net +44,090 +49,490 +Intangible assets, net +72,700 +82,297 +Goodwill +1,480 +1,973 +Deferred taxes, net +6,825 +6,608 +Restricted cash +2,547 +3,551 +Other assets +13,273 +18,152 +Total assets +$ +566,390 +$ +608,020 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +61,927 +$ +63,336 +Accrued expenses and other liabilities +78,282 +92,573 +Income taxes payable +6,593 +6,416 +Current portion of long-term borrowings and capital lease obligations +2,338 +4,772 +Total current liabilities +149,140 +167,097 +Long-term income tax payable +4,464 +4,547 +Long-term borrowings and capital lease obligations +40 +1,627 +Other liabilities +13,462 +13,120 +Total liabilities +167,106 +186,391 +Commitments and contingencies +Series A convertible preferred stock, 1.0 million authorized, 0.2 million shares outstanding, liquidation preference $203 million +178,901 +175,657 +Stockholders' equity: +Preferred stock, par value $0.001 per share, 4.0 million shares authorized, none outstanding +Common stock, par value $0.001 per share, 93.9 million and 93.1 million issued, 73.6 million and 72.9 million shares outstanding, respectively +94 +94 +Treasury stock, at cost, 20.3 million and 20.2 million shares, respectively +(284,237 +) +(283,913 +) +Additional paid-in capital +364,397 +353,241 +Retained earnings +195,725 +227,463 +Accumulated other comprehensive loss +(55,596 +) +(50,913 +) +Total stockholders' equity +220,383 +245,972 +Total liabilities and stockholders' equity +$ +566,390 +$ +608,020 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY +(in thousands) +Common Stock +Treasury Stock +Additional +Paid in +Capital +Retained +Earnings +Accumulated +Other +Comprehensive +(Loss) +Total +Stock +Holders' +Equity +Shares +Amount +Shares +Amount +Balance—December 31, 2013 +88,450 +$ +92 +3,212 +$ +(55,964 +) +$ +321,532 +$ +344,432 +$ +14,652 +$ +624,744 +Share-based compensation +(144 +) +— +— +— +12,767 +— +— +12,767 +Exercises of stock options and issuance of restricted stock awards +800 +— +7 +1,398 +(843 +) +— +— +555 +Repurchases of common stock +(10,590 +) +— +10,590 +(145,858 +) +— +— +— +(145,858 +) +Series A preferred dividends +— +— +— +— +— +(11,301 +) +— +(11,301 +) +Series A preferred accretion +— +— +— +— +— +(2,735 +) +— +(2,735 +) +Series A preferred beneficial conversion +— +— +— +— +12,276 +— +— +12,276 +Net loss +— +— +— +— +— +(4,926 +) +— +(4,926 +) +Other comprehensive loss +— +— +— +— +— +— +(33,004 +) +(33,004 +) +Balance—December 31, 2014 +78,516 +$ +92 +13,809 +$ +(200,424 +) +$ +345,732 +$ +325,470 +$ +(18,352 +) +$ +452,518 +Share-based compensation +— +— +— +— +11,186 +— +— +11,186 +Tax shortfall from share-based plans +— +— +— +— +(2,841 +) +— +— +(2,841 +) +Exercises of stock options and issuance of restricted stock awards +810 +2 +(34 +) +2,437 +(836 +) +— +— +1,603 +Repurchases of common stock +(6,475 +) +— +6,475 +(85,926 +) +— +— +— +(85,926 +) +Series A preferred dividends +— +— +— +— +— +(11,833 +) +— +(11,833 +) +Series A preferred accretion +— +— +— +— +— +(2,978 +) +— +(2,978 +) +Net loss +— +— +— +— +— +(83,196 +) +— +(83,196 +) +Other comprehensive loss +— +— +— +— +— +— +(32,561 +) +(32,561 +) +Balance—December 31, 2015 +72,851 +$ +94 +20,250 +$ +(283,913 +) +$ +353,241 +$ +227,463 +$ +(50,913 +) +$ +245,972 +Share-based compensation +— +— +— +— +10,736 +— +— +10,736 +Exercises of stock options and issuance of restricted stock awards +749 +— +37 +(324 +) +420 +— +— +96 +Series A preferred dividends +— +— +— +— +— +(12,000 +) +— +(12,000 +) +Series A preferred accretion +— +— +— +— +— +(3,244 +) +— +(3,244 +) +Net loss +— +— +— +— +— +(16,494 +) +— +(16,494 +) +Other comprehensive loss +— +— +— +— +— +— +(4,683 +) +(4,683 +) +Balance—December 31, 2016 +73,600 +$ +94 +20,287 +$ +(284,237 +) +$ +364,397 +$ +195,725 +$ +(55,596 +) +$ +220,383 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +December 31, +2016 +2015 +2014 +Cash flows from operating activities: +Net income (loss) +$ +(16,494 +) +$ +(83,196 +) +$ +(4,926 +) +Adjustments to reconcile net income to net cash provided by (used in) operating activities: +Depreciation and amortization +34,043 +35,993 +37,413 +Unrealized (gain) loss on foreign exchange, net +(9,027 +) +(814 +) +(11,100 +) +Deferred income taxes +(388 +) +289 +829 +Asset impairment charges +3,144 +15,306 +8,827 +Provision for doubtful accounts, net +3,230 +25,997 +12,087 +Share-based compensation +10,736 +11,236 +12,503 +Inventory write-down charges +— +3,108 +7,490 +Non-cash restructuring charges +— +— +6,413 +Other non-cash items +503 +4,029 +534 +Changes in operating assets and liabilities: +Accounts receivable, net of allowances +2,408 +(15,604 +) +(15,288 +) +Inventories +20,371 +(8,586 +) +(31,251 +) +Prepaid expenses and other assets +(4,532 +) +1,755 +21,698 +Accounts payable +(1,354 +) +23,260 +(12,106 +) +Accrued expenses and other liabilities +3,836 +8,765 +(15,824 +) +Accrued restructuring +(952 +) +(3,677 +) +4,859 +Income taxes +(5,770 +) +(8,163 +) +(33,809 +) +Cash provided by (used in) operating activities +39,754 +9,698 +(11,651 +) +Cash flows from investing activities: +Cash paid for purchases of property and equipment +(13,233 +) +(12,826 +) +(15,991 +) +Proceeds from disposal of property and equipment +2,438 +(2 +) +236 +Cash paid for intangible assets +(8,961 +) +(5,660 +) +(41,035 +) +Change in restricted cash +1,199 +(139 +) +(1,202 +) +Other +(100 +) +— +— +Cash used in investing activities +(18,657 +) +(18,627 +) +(57,992 +) +Cash flows from financing activities: +Proceeds from preferred stock offering, net of issuance costs of $15.8 million +— +— +182,220 +Dividends—Series A preferred stock +(12,000 +) +(11,900 +) +(8,234 +) +Proceeds from bank borrowings +31,582 +— +— +Repayment of bank borrowings and capital lease obligations +(35,640 +) +(5,290 +) +(5,177 +) +Deferred debt issuance costs +(481 +) +191 +(75 +) +Issuances of common stock +420 +1,864 +1,342 +Purchase of treasury stock, net of issuances +— +(85,926 +) +(145,858 +) +Repurchase of common stock for tax withholding +(324 +) +(261 +) +(787 +) +Excess tax benefit from share-based compensation +— +62 +— +Cash provided by (used in) financing activities +(16,443 +) +(101,260 +) +23,431 +Effect of exchange rate changes on cash +(430 +) +(13,982 +) +(3,420 +) +Net increase (decrease) in cash and cash equivalents +4,224 +(124,171 +) +(49,632 +) +Cash and cash equivalents—beginning of period +143,341 +267,512 +317,144 +Cash and cash equivalents—end of period +$ +147,565 +$ +143,341 +$ +267,512 +Supplemental disclosure of cash flow information—cash paid during the period for: +Interest, net of capitalized interest +$ +653 +$ +917 +$ +616 +Income taxes +12,344 +19,923 +33,655 +Supplemental disclosure of non-cash investing and financing activities: +Assets acquired under capitalized leases +39 +20 +— +Accrued purchases of property and equipment +2,195 +851 +771 +Accrued purchases of intangibles +533 +— +2,988 +Intrinsic value of beneficial conversion feature—Series A preferred stock +— +— +12,276 +Accrued dividends +3,000 +3,000 +3,067 +Accretion of dividend equivalents +3,244 +2,978 +2,735 +Change in assets held for sale +2,428 +(1,595 +) +— +Vendor financed insurance premiums +2,082 +— +— +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. BASIS OF PRESENTATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of "we," "us" or "our" includes Crocs, Inc. ("Crocs" or the "Company,") and its wholly-owned subsidiaries within our reportable operating segments and Corporate. The Company is engaged in the design, development, manufacturing, worldwide marketing and distribution of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color, and functionality. Our reportable operating segments include: the Americas, operating in North and South America; Asia Pacific, operating throughout Asia, Australia, New Zealand, Africa and the Middle East; and Europe, operating throughout Europe and Russia. +Basis of Presentation and Consolidation +The Company's consolidated financial statements include its accounts and those of its wholly-owned subsidiaries. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany accounts and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, share-based compensation expense, the assessment of lower of cost or market on inventory, useful lives assigned to long-lived assets, depreciation, and provisions for contingencies are reasonable based on information available at the time they are made. Management also makes estimates in the assessments of potential losses in relation to tax matters and threatened or pending legal proceedings (see Note 15 — Commitments and Contingencies and Note 17 — Legal Proceedings).To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassification Adjustments +The Company has reclassified certain amounts on the consolidated balance sheets, statements of stockholders' equity, Note 5 — Goodwill and Intangible Assets, Net, Note 6 — Accrued Expenses and Other Current Liabilities, and Note 8 — Derivative Instruments to conform to current period presentation. +Transactions with Affiliates +The Company receives inventory count services from RGIS, LLC (“RGIS”), a wholly owned subsidiary of Blackstone Capital Partners VI L.P. (“Blackstone”). Blackstone and certain of its permitted transferees currently beneficially owns all the outstanding shares of the Company’s series A convertible preferred stock (“Series A Preferred Stock”), which is convertible into approximately 15.8% of the Company’s common stock as of December 31, 2016 . Two Blackstone representatives also serve on the Company’s board of directors (the “Board”). During 2016 and 2015 the Company paid $0.4 million and $0.5 million , respectively, to RGIS for services. Expenses related to these services provided are reported in ‘Selling, general and administrative expenses’ in the consolidated statement of operations. +The Company receives cyber security and consulting services from Optiv, Inc. ("Optiv"), a subsidiary of Blackstone. The Company also receives workforce management services from Kronos Incorporated ("Kronos"), a subsidiary of Blackstone. During 2016 and 2015, the Company paid $0.2 million in each year to Kronos, and $0.2 million in each year to Optiv for services. Expenses related to these services are reported in ‘Selling, general and administrative expenses’ in the consolidated statement of operations. +Revenue Recognition +Revenue is recognized when persuasive evidence of an arrangement exists, the significant risks and rewards of ownership, including title and risk of loss, are transferred to the customer or distributor, the collection of the related receivables is probable, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country in which the sale occurs and the agreement terms with the customer. Sales of products are for cash or otherwise agreed upon credit terms. The +F-8 +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. BASIS OF PRESENTATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +estimated costs of sales incentives, discounts, returns, price promotions, rebates, loyalty and coupon programs are reported as a reduction of revenues. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in 'Cost of sales' in our consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs we incur to make and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, depreciation, packaging, and other manufacturing overheads and costs. +Research, Design and Development +We continue to dedicate significant resources to product design and development as we expand the footwear styles we offer based on opportunities we identify in the marketplace. Our design and development process is highly collaborative and we continually strive to improve our development function so we can bring products to market quickly and at reduced costs, while maintaining product quality. We spent $11.9 million , $14.0 million , and $16.7 million in research, design, and development activities for the years ended December 31, 2016 , 2015 , and 2014 , respectively. Research and development costs are expensed as incurred and are included in 'Selling, general and administrative expenses' in our consolidated statements of operations. +Selling, General and Administrative Expenses +Our selling, general and administrative expenses include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Production costs of advertising and promotional materials are expensed when the advertising is first run. Advertising expense was $56.0 million , $58.2 million and $44.7 million for 2016, 2015 and 2014, respectively. Prepaid advertising costs of $4.5 million and $0.0 million , were included in other current assets in the consolidated balance sheets at December 31, 2016 and December 31, 2015, respectively. +Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources and information technology, which consist primarily of labor and outside services, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to non-production equipment and share-based compensation. +Interest Expense +Our interest expense is associated with borrowings to finance our operations. We capitalize interest cost as a part of the original cost of acquiring certain fixed assets if the cost of the capital expenditure and the expected time to complete the project are considered significant. No interest expense was capitalized in 2016 and 2015. Interest expense of $0.4 million was capitalized in 2014. +Other Income, net +Other income, net primarily includes gains and losses associated with activities not directly related to making and selling footwear, as well as certain gains or losses on sales of non-operating assets. +Foreign Currency Loss, net +Foreign currency loss, net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-denominated monetary assets and liabilities, and realized and unrealized gains and losses on forward foreign +F-9 +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. BASIS OF PRESENTATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +exchange derivative contracts. Realized foreign exchange gains and losses are reported in the operating segment in which they occur; however, foreign exchange gains and losses on intercompany balances are reported within the Corporate segment. The initial recording of foreign denominated transactions is based on the nature of the transaction, with the unrealized or realized foreign exchange gains or losses resulting from the subsequent remeasurement of the monetary asset or liability, and its ultimate settlement, classified in other income, net. +I ncome Taxes +Deferred income taxes are provided for the expected future tax consequences of temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. We provide for taxes that may be payable if undistributed earnings of overseas subsidiaries were to be remitted to the U.S., except for those earnings that we consider to be permanently reinvested. We record provisions for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. Interest, penalties and offsetting positions related to unrecognized tax benefits are recognized as a component of income tax expense. Our deferred tax valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions. These valuation allowances are primarily related to deferred tax assets generated from net operating losses. See Note 13 — Income Taxes for further discussion. +Accumulated Other Comprehensive Loss +Other comprehensive loss ("OCI") represents losses for the reporting period which are excluded from net loss and recognized directly within accumulated other comprehensive loss ("AOCI") as a component of equity. These amounts are expected to be reclassified out of AOCI in the future, at which point they will be recognized within the consolidated statement of operations as a component of net income (loss). Our AOCI consists solely of gains and losses resulting from translation of assets and liabilities of our foreign subsidiaries which are denominated in currencies other than the Company's US Dollar reporting currency. Foreign currency reclassification adjustments are reported within 'Foreign currency loss, net' on our consolidated statements of operations. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three months or less at the date of purchase. The Company reports receivables from credit card companies, if expected to be received within five days, in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail stores, certain customs requirements and other contractual arrangements. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. The Company reduces the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting the Company's customer base and historical collection experience. Specific provisions are recorded for individual receivables when the Company becomes aware of a customer's inability to meet its financial obligations. The Company write-off the accounts receivable to the reserves when it is deemed uncollectable or, in certain jurisdictions, when legally able to do so. See Note 12 — Allowances for further discussion related to provisions for doubtful accounts, sale returns and allowances, and reserve for unapplied rebates. +Inventory Valuation +Inventories are valued at the lower of cost or market. Inventory cost is determined primarily using the moving average cost method. We regularly evaluate inventory for possible impairment and estimate inventory market value based on several subjective assumptions including estimated future demand and market conditions, as well as other observable factors such as current sell-through of the Company's products, recent changes in product demand, global and regional economic conditions, historical experience selling through liquidation and price discounted channels, and the amount of inventory on hand. If the estimated inventory market value is less than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in 'Cost of sales' in the consolidated statements of operations. See Note 3 — Inventories for further discussion. +F-10 +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. BASIS OF PRESENTATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and have the following ranges: machinery and equipment: 2 - 5 years; furniture, fixtures and other: 2 - 10 years. Leasehold improvements are stated at cost and amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of manufacturing assets is included in cost of sales in our consolidated statements of operations. Depreciation related to corporate, non-product and non-manufacturing assets is included in 'Selling, general and administrative expenses' in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets and the resulting gain or loss, if any, is reflected in 'Loss from operations' on our consolidated statements of operations. +Properties held under capital lease are depreciated using the straight-line method over the estimated useful life or the lease term, whichever is shorter. +Assets and Liabilities Held for Sale +The Company classifies a disposal group to be sold as held for sale when management approves and commits to a formal plan to actively market a disposal group and expects the sale to close within twelve months. Upon classifying a disposal group as held for sale, the disposal group is recorded at the lower of its carrying amount or its estimated fair value, reduced for selling costs. In determining the fair value of a disposal group, the Company considers both the net book value of the disposal group as a whole and the impact of any related foreign currency translation adjustments recorded within stockholders' equity. Any losses are recognized as asset impairment charges in the consolidated statement of operations. Depreciation expense is no longer recorded for any assets within a disposal group that is classified as held for sale. +The fair value of a disposal group less any selling costs is assessed each reporting period it remains classified as held for sale and any subsequent changes are reported as an adjustment to the carrying value of the disposal group, as long as the new carrying value does not exceed the carrying value of the disposal group at the time it was initially classified as held for sale. +Goodwill and Other Intangible Assets, Net +Goodwill is allocated to the reporting unit in which the business that created the goodwill resides. A reporting unit is a reportable operating segment, or a business unit one level below a reportable operating segment, for which discrete financial information is prepared and regularly reviewed by segment management. The operations in each of the specific regions within our Americas, Asia Pacific and Europe reportable operating segments are considered components based on the availability of discrete financial information and the regular review by segment management and the Company's Chief Operating Decision Maker. We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event occurs that would indicate that impairment may have taken place. Our annual test is performed as of the last day of our fiscal fourth quarter. We continuously monitor the performance of our other definite-lived intangible assets and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +Direct costs of acquiring or developing internal-use computer software, including costs of employees, are capitalized and classified within properties. Software maintenance and training costs are expensed in the period incurred. Initial costs associated with internally-developed-and-used software are expensed until it is determined that the project has reached the application development stage, after which subsequent additions, modifications or upgrades are capitalized to the extent that they add functionality. The Company's capitalized software consists primarily of enterprise resource system software, warehouse management software, and point of sale software. Amortization is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 5 - 7 years. Amortization of capitalized software used in manufacturing activities is included in 'Cost of sales' in our consolidated statements of operations. Amortization related to corporate, non-product, and non-manufacturing assets, such as the Company's global information systems, is included in 'Selling, general, and administrative expenses' in our consolidated statements of operations. +F-11 +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. BASIS OF PRESENTATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. Indicators of potential impairment include: (i) a significant decrease in its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for its acquisition or construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. +The Company assesses recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and records a loss from impairment if the carrying value is less than its undiscounted cash flows. An asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets involved in Crocs' retail business, the asset group is at the retail store level. Assets or asset groups to be abandoned or from which no future benefit is expected, are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 4 — Property and Equipment for a discussion of impairment losses recorded during the periods presented. +Beneficial Conversion Feature +The Company's Series A Convertible Preferred Stock ("Series A Preferred") included a beneficial conversion feature, which is a conversion right with an effective strike price less than the market price of the underlying stock at the commitment date. The Company recognized the beneficial conversion feature by allocating the intrinsic value of the conversion option, which is the number of shares of common stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of common stock per share on the commitment date, to additional paid-in capital. Accretion expense is recorded over the eight years from the date of issuance through the redemption date utilizing the effective interest method. +Share-based Compensation +The Company's share-based compensation plans provides for stock options, restricted stock, and stock performance awards to be granted to plan participants, which includes certain officers, employees and members of the Company's Board of Directors (the "Board"). The grant date fair value of awards granted under these plans is amortized over the vesting period using the straight-line method. The grant date fair value of stock options is calculated using a Black Scholes option pricing model, which requires estimates for expected volatility, expected dividends, the risk-free interest rate, and the term of the option. The grant date fair value of RSU's and RSA's is based on the closing market price of our common stock on the grant date, adjusted for dividend rights during the vesting period. If any of the assumptions used in these models or the anticipated number of shares to be awarded change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period. Share-based compensation expense associated with manufacturing and retail employees is included in 'Cost of sales' in our consolidated statements of operations. Share-based compensation expense associated with selling, marketing and administrative employees is included 'Selling, general and administrative expenses' in our consolidated statements of operations. Share-based compensation directly associated with the construction or implementation of long-term projects is capitalized as part of the cost of the assets and amortized over their expected useful lives beginning on the asset in service date. +The Company changed its method of accounting for forfeitures of stock based compensation as further discussed in Note 2 — Recent Accounting Pronouncements. See also Note 11— Stock Compensation for additional information related to share-based compensation. +Earnings per Share +Basic and diluted earnings per common share ("EPS") is presented using the two-class method, which is an earnings allocation formula that determines earnings per share for common stock and any participating securities according to dividend rights and participation rights in undistributed earnings. Under the two-class method, EPS is computed by dividing the sum of distributed and undistributed earnings attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. A participating security is a security that may participate in undistributed earnings with common stock had those earnings been distributed in any form. The Company's Series A Preferred stock is a participating security because +F-12 +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. BASIS OF PRESENTATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +the holders are entitled to receive any and all dividends declared or paid on common stock on an as-converted basis. In addition, the Company's unvested restricted stock and restricted stock unit awards are participating securities because they include non-forfeitable rights to dividends. Participating securities are included in the computation of EPS pursuant to the two-class method on a pro-rata, if-converted basis. Diluted EPS reflects the potential dilution from securities that could share in the Company's earnings. In addition, the dilutive effect of each participating security, if any, is calculated using the more dilutive of the two-class method described above. This method assumes the if-converted method, which assumes conversion to common stock as of the beginning of the reporting date for any security that is more dilutive upon conversion. Anti-dilutive securities are excluded from diluted EPS. See Note 14 — Earnings Per Share for further discussion. +Derivative Foreign Currency Contracts +The Company enters into derivative financial instruments to mitigate the potential impact of foreign currency exchange rate risk, including foreign currency forward contracts and option contracts. The Company's derivative financial instruments are used to mitigate foreign currency risk and are not used for trading or speculative purposes. The fair value of the derivative financial instruments is reported either as assets or liabilities in our consolidated balance sheets. Changes in the fair value of our foreign currency derivatives not designated or effective as hedges are recorded in 'Foreign currency loss, net' in our consolidated statements of operations. The Company did not designate any derivative instruments for hedge accounting during any of the periods presented. See Note 8 — Derivative Financial Instruments for further discussion. +Foreign Currency Translation and Foreign Currency Transactions +The financial position and operating results of the Company's foreign operations are reported using their respective local currency as the functional currency. Local currency assets and liabilities are translated to U.S. Dollars at the rates of exchange in effect on the balance sheet date, and local currency revenues and expenses are translated to U.S. Dollars at average monthly rates of exchange in effect during the period. The resulting translation gains or losses are included in the consolidated statements of comprehensive income as a component of other comprehensive income (loss) and in the consolidated statements of equity within accumulated other comprehensive income (loss). +The Company also recognizes gains and losses on both third-party and intercompany transactions that are denominated in a currency other than the respective entity's functional currency. Foreign currency transaction gains and losses are recognized in earnings and reported in 'Foreign currency loss, net' in the consolidated statements of operations. +Fair Value +Fair value is the price that would be received from the sale of an asset or transfer of a liability in an orderly transaction between market participants, in the principal or most advantageous market in which a hypothetical sale or transfer would take place, and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of non-performance. +U.S. GAAP guidance for fair value includes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach and cost approach). Our financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. +The three levels of the fair value hierarchy are as follows: +Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities in active markets; +Level 2—Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar instruments in markets that are less active and inputs other than quoted market prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (market corroborated inputs); and +Level 3—Unobservable inputs for which there is little or no market data, that reflect the assumptions that we believe market participants would use in pricing the asset or liability. We develop these inputs based on the best information available, including our own data. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. See Note 7 — Fair Value Measurements for further discussion related to fair value measurements. +F-13 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncements Adopted +Stock Compensation +In March 2016, the Financial Accounting Standards Board ("FASB") issued authoritative guidance intended to simplify and improve several aspects of the accounting for share-based payment transactions. The guidance includes amendments that require excess tax benefits or deficiencies resulting from share-based payments be recognized in the income statement as a component of the provision for income taxes, whereas previously these were recognized within additional paid-in-capital. Further, the new guidance provides an accounting policy election to account for forfeitures as they occur. The new standard also amends the presentation of employee share-based payment-related items in the statement of cash flows by requiring that: (i) excess tax benefits be classified as cash inflows provided by operating activities, and (ii) cash paid to taxing authorities arising from the withholding of shares from employees be classified as cash outflows used in financing activities. We early adopted this guidance during the quarter ended December 31, 2016. The provisions of the new guidance have been adopted as of January 1, 2016, which is the beginning of the annual period that includes the interim period of adoption. +The adoption of this guidance had no effect on our income tax expense or additional paid-in-capital as a result of the change in accounting for excess tax benefits or deficiencies for the three months or the year ended December 31, 2016 because the Company did not recognize any excess tax benefits during 2016. As permitted by this standard, the Company has elected to account for forfeitures as they occur when calculating share-based compensation expense (previously the Company had estimated forfeitures). The effect of this election on share-based compensation expense reported in 2016 was not significant. The adoption of this guidance did not have an impact on either net cash provided by operating activities or on net cash provided by financing activities because the Company had no recognizable excess tax benefits during 2016, and cash paid to taxing authorities arising from the withholding of shares from employees was reported within cash from financing activities, consistent with the adopted guidance. +The adoption of this guidance resulted in an increase to retained earnings for cumulative foreign tax credit and state net operating loss carryforward deferred tax assets attributable to excess tax benefits, not previously recognized as they did not reduce income taxes payable. The cumulative adjustment was fully offset by a valuation allowance for the same amount; thus the net effect of both adjustments was zero. +Deferred Tax Assets and Liabilities +In November 2015, the Financial Accounting Standards Board ("FASB") issued authoritative guidance simplifying the presentation of deferred taxes by requiring all deferred tax assets and liabilities to be classified as non-current on the balance sheet. We have early adopted this guidance on a prospective basis, effective December 31, 2015. Adoption of this guidance resulted in the reclassification of our current deferred tax assets and liabilities to non-current in our consolidated balance sheet as of December 31, 2015. No prior periods were retrospectively adjusted. See Note 13 — Income Taxes for further information related to the early adoption of this guidance. +Debt Issuance Costs +In April 2015, the FASB issued authoritative guidance intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs be presented as a direct deduction from the carrying amount of the related debt liabilities, consistent with the presentation of debt discounts. This results in the elimination of debt issuance costs as an asset and reduces the carrying value of our debt liabilities. In August 2015, the FASB issued an announcement in stating that debt issuance costs related to line-of-credit arrangements may be reported as an asset and amortized pro rata over the term of the line-of-credit arrangement. We early adopted this guidance effective for our quarter ended March 2016, and have elected to continue to present our debt issuance costs associated with our line-of-credit arrangements as assets. The adoption of this guidance had no effect on our financial position. +New Accounting Pronouncements Not Yet Adopted +Inventory Measurement +In July 2015, FASB issued authoritative guidance intended to simplify the measurement of inventory. The amendment requires entities to measure in-scope inventory at the lower of cost or net realizable value, and replaces the current requirement to measure in-scope inventory at the lower of cost or market, which considers replacement cost, net realizable value, and net realizable value less an approximate normal profit margin. This guidance is effective for annual reporting periods, and interim periods within those +F-14 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. RECENT ACCOUNTING PRONOUNCEMENTS (Continued) +annual periods, beginning after December 15, 2016. The amendment should be applied prospectively with early adoption permitted. We do not expect this guidance to have a material effect on our financial position or results of operations upon adoption. +Statement of Cash Flows - Classification +In August 2016, the FASB issued authoritative guidance intended to clarify how entities should classify certain cash receipts and cash payments on the statement of cash flows. The amendment addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. These updates are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods, with early adoption permitted. The guidance should be applied retrospectively unless it is impractical to do so; in which case, the guidance should be applied prospectively as of the earliest date practicable. We do not anticipate that this guidance will have an impact on our consolidated financial statements. +Prepaid Stored-Value Products +In March 2016, the FASB issued guidance related to the recognition of breakage for certain prepaid stored-value products. This update aligns recognition of the financial liabilities related to prepaid stored-value products (for example, prepaid gift cards), with Topic 606, Revenue from Contracts with Customers, for non-financial liabilities. In general, certain of these liabilities may be extinguished proportionally in earnings as redemptions occur, or when redemption is remote if issuers are not entitled to the unredeemed stored value. This standard is effective for annual periods (including interim periods) beginning after December 15, 2017, with early adoption permitted. At adoption, this update will be applied either using a modified retrospective transition method by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the guidance is effective or retrospectively to each period presented. The Company is currently assessing the adoption method and the impact that adopting this new accounting standard will have on its consolidated financial statements. +Leases +In February 2016, the FASB issued authoritative guidance intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance, lessees will be required to recognize a right-of-use asset and a lease liability, measured on a discounted basis, at the commencement date for all leases with terms greater than twelve months. Additionally, this guidance will require disclosures to help investors and other financial statement users to better understand the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements. The guidance should be applied under a modified retrospective transition approach for leases existing at the beginning of the earliest comparative period presented in the adoption-period financial statements. Any leases that expire before the initial application date will not require any accounting adjustment. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. +The Company will adopt this guidance beginning with the quarterly reporting period ending March 31, 2019. The Company is evaluating the full impact this guidance will have on its consolidated financial statements, but expects that adoption will result in significant increases in lease related assets and liabilities on our consolidated balance sheet. +Revenue Recognition +In May 2014, the FASB issued authoritative guidance related to new accounting requirements for the recognition of revenue from contracts with customers. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for the goods or services. Subsequent to the release of this guidance, the FASB has issued additional updates intended to provide interpretive clarifications and to reduce the cost and complexity of applying the new revenue recognition standard both at transition and on an ongoing basis. The new standard and related amendments are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. Upon adoption of the new standard, the use of either a full retrospective or cumulative effect transition method is permitted. +In December 2016 the Company established an implementation team (“team”) and engaged external advisers to develop a multi-phase plan to assess the company’s business and contracts, as well as any changes to accounting policies, processes or systems necessary to adopt the requirements of the new standard. The team is in the process of reviewing its contracts and assessing how adoption of the new standard will affect its consolidated financial statements and disclosures upon adoption, as well as the adoption method. The Company expects to complete its evaluation of the impact of the accounting and disclosure changes on its business processes, controls and systems during the first half of 2017. The Company will provide additional information regarding expected effects on its consolidated financial statements and disclosures, and the transition method in its Quarterly Reports during 2017. +F-15 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. RECENT ACCOUNTING PRONOUNCEMENTS (Continued) +Other new pronouncements issued but not effective until after December 31, 2016 are not expected to have a material impact on the Company’s consolidated financial statements. +3. INVENTORIES +The following table summarizes inventories by major classification: +December 31, +2016 +2015 +(in thousands) +Finished goods +$ +142,333 +$ +162,341 +Work-in-progress +654 +918 +Raw materials +4,042 +4,933 +Total inventories +$ +147,029 +$ +168,192 +The Company recorded approximately $0.0 million , $3.1 million , and $11.5 million of inventory write-downs during the years ended December 31, 2016, 2015 and 2014, respectively, related to certain obsolete raw materials, footwear, and accessories. The write-downs for 2016 and 2015 are reported in 'Cost of sales' in the consolidated statement of operations. In 2014, write-downs of $7.5 million and $4.0 million are reported within 'Cost of sales' and 'Restructuring charges', respectively, in the consolidated statement of operations. +4. PROPERTY AND EQUIPMENT +Property and equipment, net consists of the following: +December 31, +2016 +2015 +(in thousands) +Machinery and equipment +$ +33,163 +$ +36,864 +Leasehold improvements +73,363 +81,593 +Furniture, fixtures and other +19,358 +23,576 +Other (1) +— +1,595 +Construction-in-progress +6,809 +3,512 +Property and equipment +132,693 +147,140 +Less: Accumulated depreciation +(88,603 +) +(97,650 +) +Property and equipment, net +$ +44,090 +$ +49,490 +____________________________________________________________________________ +(1) +Represents the South Africa disposal group, sold in April 2016. +During the years ended December 31, 2016 , 2015 , and 2014 , depreciation expense was $ 15.1 million , $ 16.3 million , and $ 23.2 million , respectively, of which $ 1.8 million , $ 1.8 million , and $ 1.7 million , respectively, was recorded in 'Cost of sales', with the remaining amounts recorded in 'Selling, general and administrative expenses' in the consolidated statements of operations. +The Company recognized a loss on disposals of property and equipment of $0.5 million , $1.4 million and $0.0 million for the year ended December 31, 2016, 2015, and 2014, which is included in 'Selling, general and administrative expenses' in the consolidated statement of operations. +F-16 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. PROPERTY AND EQUIPMENT (Continued) +The Company is contractually obligated to restore certain retail and office facilities back to their original condition as specified in the related lease agreements. The estimated fair value of these liabilities is recorded at lease inception along with a related asset at inception of the leases. At December 31, 2016 and 2015 liabilities for asset retirement obligations were $2.8 million and $2.0 million , respectively. Asset retirement obligations are reported in "Other liabilities' in the consolidated balance sheets. +Asset Impairments +During the years ended December 31, 2016 , 2015 , and 2014 , the Company recorded impairments of $ 2.7 million , $ 9.6 million , and $ 8.8 million , respectively, for underperforming retail stores. During the year ended December 31, 2015 , additional impairment of $ 5.7 million related to the South Africa disposal group was recorded. Long-lived asset impairments by reportable operating segment, were: +Year Ended December 31, +2016 +2015 +2014 +Asset Impairment +Number of +Stores +Asset Impairment +Number of +Stores +Asset Impairment +Number of +Stores +(in thousands, except store count data) +Americas +$ +1,703 +12 +$ +7,237 +27 +$ +4,001 +36 +Asia Pacific (1) +672 +21 +6,450 +36 +2,807 +14 +Europe +338 +9 +1,584 +21 +2,019 +27 +Total +$ +2,713 +42 +$ +15,271 +84 +$ +8,827 +77 +_______________________________________________________________________________ +(1) In 2015, the Company recorded impairment of nine retail stores in South Africa of $5.7 million . +5. GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +All goodwill is in the Europe segment. The changes in goodwill for the years ended December 31, 2016 and 2015 were: +Goodwill +(in thousands) +Gross goodwill at January 1, 2015 +$ +2,382 +Accumulated impairments +(338 +) +Net goodwill at January 1, 2015 +2,044 +Foreign currency translation +(71 +) +Net goodwill at December 31, 2015 +1,973 +Foreign currency translation +(62 +) +Impairment (1) +(431 +) +Net goodwill at December 31, 2016 (2) +$ +1,480 +_______________________________________________________________________________ +(1) +During the year ended we recognized impairment of goodwill in our Belgian retail business, due to declining business performance. +(2) +In December 2016, the Company completed its purchase accounting for the June 2016 acquisition of operations in Austria and concluded the acquisition did not result in goodwill. +For further information related to the goodwill impairment, see Note 7 — Fair Value Measurements. +F-17 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. GOODWILL & INTANGIBLE ASSETS (Continued) +Intangible Assets, Net +Other intangible assets consist of the following: +December 31, 2016 +December 31, 2015 +Useful Life +Gross +Accum. Amortiz. +Net +Gross +Accum. Amortiz. +Net +(Years) +(in thousands) +Intangible assets subject to amortization: +Capitalized software (1) +2 - 7 +$ +142,358 +$ +(74,530 +) +$ +67,828 +$ +162,700 +$ +(82,596 +) +$ +80,104 +Patents, copyrights and trademarks +6 - 25 +6,438 +(5,471 +) +967 +6,892 +(5,135 +) +1,757 +Other +* +2,855 +(2,855 +) +— +8,290 +(8,151 +) +139 +Intangibles not subject to amortization: +In progress (2) +3,616 +— +3,616 +— +— +— +Trademarks and other (3) +289 +— +289 +297 +— +297 +Total +$ +155,556 +$ +(82,856 +) +$ +72,700 +$ +178,179 +$ +(95,882 +) +$ +82,297 +______________________________________________________________________________ +(1) +Gross carrying amount at December 31, 2016 includes $ 0.8 million of software held under a capital lease classified as capitalized software as of December 31, 2016 , and $4.1 million as of December 31, 2015 . Accumulated amortization includes $ 0.8 million and $ 3.1 million for software held under a capital lease as of December 31, 2016 , and December 31, 2015 , respectively, and is amortized using the straight-line method over the useful life. +(2) Primarily capitalized software project costs under development. +(3) Change due to foreign currency translation. +As of December 31, 2016 , estimated future annual amortization expense of intangible assets is: +Amortization +(in thousands) +2017 +$ +17,812 +2018 +15,819 +2019 +13,452 +2020 +10,698 +2021 +10,366 +Thereafter +648 +Total +$ +68,795 +During the years ended December 31, 2016 , 2015 , and 2014 , total amortization expense was $19.0 million , $19.7 million and $14.2 million , of which $5.1 million , $5.8 million and $4.9 million , respectively, was reported in 'Cost of sales', with the remainder in 'Selling, general and administrative expenses' in the consolidated statements of operations. At December 31, 2016, the weighted average remaining useful life of intangibles subject to amortization was approximately 6.5 years. +F-18 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +Accrued expenses and other current liabilities consist of the following: +December 31, +2016 +2015 +(in thousands) +Accrued compensation and benefits +$ +20,898 +$ +20,973 +Fulfillment, freight and duties +14,572 +14,776 +Professional services +10,900 +15,019 +Accrued rent and occupancy +7,335 +7,639 +Deferred revenue and royalties +7,475 +1,430 +Sales/use and value-added taxes +4,978 +7,018 +Accrued loss on disposal group (1) +— +6,743 +Other (2) +12,124 +18,975 +Total accrued expenses and other current liabilities +$ +78,282 +$ +92,573 +_______________________________________________________________________________ +(1) +Accrued loss on the South Africa disposal group, primarily a reclassification of the cumulative translation adjustment. +(2) +Includes current liabilities related to derivatives, Series A preferred stock dividends, legal, other accrued expenses and, in 2015, restructuring. +7. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach and cost approach). The Company utilizes a combination of market and income approaches to value derivative instruments. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy are as follows: +Level 1 +Unadjusted quoted prices in active markets for identical assets and liabilities. +Level 2 +Unadjusted quoted prices in active markets for similar assets and liabilities; or +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +Level 3 +Unobservable inputs for the asset or liability. +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of the Company's derivative instruments. The Company's derivative instruments are forward foreign currency exchange contracts. The Company manages credit risk of its derivative instruments on the basis of its net exposure with its counterparty and has elected to measure the fair value in the same manner. All of the Company's derivative instruments are classified as Level 2 and are reported within 'Accrued expenses and other liabilities' in the consolidated balance sheets. There were no transfers between Level 1 or Level 2, nor were there any outstanding derivative instruments classified as Level 3 as of December 31, 2016 and 2015. The fair value of the Company's derivative instruments was $0.2 million and $0.1 million at December 31, 2016 and 2015, respectively. See Note 8 — Derivative Financial Instruments for more information. +The carrying amounts of the Company's cash and cash equivalents, accounts receivable, accounts payable and current accrued liabilities approximate their fair value as recorded due to the short-term maturity of these instruments, which approximates fair value. +The Company's borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. The fair values of the Company's notes payable outstanding approximate their carrying values at December, 31, 2016 based on interest rates currently available to the Company for similar borrowings. +F-19 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +7. FAIR VALUE MEASUREMENTS (Continued) +December 31, 2016 +December 31, 2015 +Carrying Value +Fair Value +Carrying Value +Fair Value +(in thousands) +Notes payable and capital lease obligations +$ +2,378 +$ +2,378 +$ +6,399 +$ +6,399 +Non-Financial Assets and Liabilities +The Company's non-financial assets, which primarily consist of property and equipment, goodwill and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value, +During 2016, 2015 and 2014 the Company recorded non-cash impairments to reduce the carrying values of certain retail store assets to their fair values. These impairments were recorded in 'Asset impairments' on the Company's consolidated statements of operations. In 2016, the Company recorded a non-cash impairment to the carrying value of goodwill in its European segment. The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management's plans. +December 31, +2016 +2015 +2014 +(in thousands) +Retail store asset impairment +$ +2,713 +$ +15,306 +$ +8,827 +Goodwill impairment +431 +— +— +The Company's remaining goodwill is reported within its European segment. The results of the Company's most recent quantitative impairment test for the remaining goodwill indicated that the fair value of the reporting unit exceeded its carrying value. See Note 4 — Property and Equipment, net and Note 5 — Goodwill and Intangible Assets, net for additional information. +8. DERIVATIVE FINANCIAL INSTRUMENTS +The Company transacts business in various foreign countries and is therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar amounts of revenues, costs, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in cash flows and earnings caused by fluctuations in foreign exchange rates, the Company enters into forward contracts to buy and sell foreign currency. By policy, the Company does not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts that the Company enters into are over-the-counter instruments transacted with highly-rated financial institutions. The Company was not required and did not post collateral as of December 31, 2016 and 2015. +The Company's derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets. The Company reports derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. Changes in fair value are recognized within 'Foreign currency loss, net' in the consolidated statements of operations. For purposes of the cash flow statement, the Company classifies cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items, generally within 'Cash provided by (used in) operating activities'. +Results of Derivative Activities +The fair values of derivative assets and liabilities, which are reported within 'Accrued expenses and other liabilities' in the consolidated balance sheets were: +F-20 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. DERIVATIVE FINANCIAL INSTRUMENTS (Continued) +December 31, 2016 +December 31, 2015 +Derivative Assets +Derivative Liabilities +Derivative Assets +Derivative Liabilities +(in thousands) +Forward foreign exchange contracts +Level 1 +$ +— +$ +— +$ +— +$ +— +Level 2 +6,541 +(6,698 +) +— +(55 +) +Level 3 +— +— +— +— +6,541 +(6,698 +) +— +(55 +) +Netting of counterparty contracts +(6,541 +) +6,541 +— +— +Foreign exchange derivative liabilities +$ +— +$ +(157 +) +$ +— +$ +(55 +) +The notional amounts of outstanding foreign currency forward exchange contracts shown below report the total U.S. Dollar equivalent position of all contracts for each foreign currency position. +December 31, 2016 +December 31, 2015 +Notional +Fair Value +Notional +Fair Value +Singapore Dollar +$ +94,763 +$ +(2,611 +) +$ +— +$ +— +Japanese Yen +87,171 +4,180 +98,390 +— +Euro +71,228 +(1,441 +) +34,219 +— +British Pound Sterling +14,332 +(660 +) +21,859 +— +Other currencies +60,727 +375 +39,923 +(55 +) +$ +328,221 +$ +(157 +) +$ +194,391 +$ +(55 +) +Latest maturity date +January 2017 +January 2016 +Amounts reported within 'Foreign currency loss, net' in the consolidated statements of operations include both realized and unrealized gains/losses from foreign currency transactions and derivative contracts, and are as follows: +Year Ended December 31, +2016 +2015 +2014 +(in thousands) +Foreign currency transaction gain (loss) +$ +10,814 +$ +3,980 +$ +(1,097 +) +Foreign currency loss on foreign currency forward contracts +(13,268 +) +(7,312 +) +(3,788 +) +Foreign currency loss, net +$ +(2,454 +) +$ +(3,332 +) +$ +(4,885 +) +9. REVOLVING CREDIT FACILITY AND BANK BORROWINGS +The Company's borrowings consist of: +December 31, +2016 +2015 +(in thousands) +Notes payable +$ +2,329 +$ +6,375 +Capital lease obligations +49 +24 +Total notes payable and capital lease obligations +2,378 +6,399 +Less: short term notes payable and capital lease obligations +2,338 +4,772 +Total long-term notes payable and capital lease obligations +$ +40 +$ +1,627 +F-21 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. REVOLVING CREDIT FACILITY AND BANK BORROWINGS (Continued) +Senior Revolving Credit Facility +The Company's Senior Revolving Credit Facility (the "Facility"), as amended, provides for borrowings of up to $80 million through February 2021. Borrowings under the Facility for domestic base rate loans, including swing loans, bear interest a daily base rate plus a margin ranging from 0.50% to 0.75% . Domestic London Interbank Borrowing Rate ("LIBOR") loans bear interest equal to a LIBOR rate plus a margin ranging from 1.50% to 1.75% . The Facility has financial covenants that restrict the amount available under the Facility, including limitations on: (i) stock repurchases to $50.0 million per year, subject to certain restrictions; and (ii) capital expenditures and commitments to $50.0 million per year. The Facility also requires the Company to meet certain financial covenant ratios, including a minimum fixed charge coverage ratio of 1.10 to 1.00, and a maximum leverage ratio to 2.00 to 1.00. +On November 22, 2016 the Company entered into the Thirteenth Amendment to the Facility, which slightly modified the definition of Consolidated EBITDA to be more favorable to the Company. +On June 13, 2016, the Company entered into the Twelfth Amendment to the Facility, which increased the borrowing capacity available from $75.0 million to $80.0 million . In addition, financial covenants were amended to become applicable when the average borrowings under the Facility exceed 25% of the total borrowing capacity, over a 30 -day period, commencing 15 days prior to the last day of each fiscal quarter. +As of December 31, 2016 , the Company had no borrowings under the Facility. The Company was in compliance with each of the covenants under the Facility as of December 31, 2016 as follows: (i) fixed charge coverage ratio (adjusted EBITDA plus fixed charges before tax for a rolling four quarters divided by fixed charges before tax plus interest for a rolling four quarters) was 1.98 to 1.00 (ii) leverage ratio (consolidated indebtedness divided by adjusted EBITDA for a rolling four quarters) was 0.26 to 1.00, (iii) stock repurchases were zero, and (iv) capital expenditures and commitments were $23.9 million . +At December 31, 2016 the Company had outstanding letters of credit of $1.3 million , which reduce the amounts available for borrowing under the terms of the Facility. As of December 31, 2016 and 2015 , the Company had $78.7 million and $73.7 million , respectively, of available borrowing capacity. +Asia Revolving Credit Facility +On August 28, 2015, a wholly-owned subsidiary of the Company entered into a revolving credit facility agreement (the "Asia Facility") with HSBC Bank (China) Company Limited, Shanghai Branch ("HSBC"). The Asia Facility enables the Company to borrow uncommitted dual currency revolving loan facilities up to 40.0 million Chinese Renminbi ("RMB"), or $5.8 million , with a combined facility limit of RMB 60.0 million or $8.6 million through February 2021. For loans denominated in U.S. dollars, the interest rate is 2.1% per annum plus LIBOR for three months or any other period as may be determined by HSBC at the end of each three month interest period. +For RMB loans, interest equals the one year benchmark lending rate effective on the loan draw-down date set forth by the People’s Bank of China plus 10% , payable on the maturity date of the related loan. The Asia Facility may be canceled or suspended at any time at the discretion of the lender and contains provisions requiring the Company to maintain compliance with certain restrictive covenants. As of December 31, 2016 and 2015 , the Asia Facility remained suspended at the discretion of HSBC and the Company had no outstanding borrowings or borrowings available. The Asia Revolving Credit Facility will mature on February 18, 2021. +F-22 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. REVOLVING CREDIT FACILITY AND BANK BORROWINGS (Continued) +Notes Payable +The Company financed the cost of its enterprise software system, which began in October 2012 and was substantially completed in early 2015 through a series of notes payable. In addition the Company financed certain insurance coverage premiums. The Company pays fixed interest at rates ranging from 1.85% to 2.79% . +The maturities of the Company's debt and capital lease obligations were: +December 31, 2016 +(in thousands) +2017 +$ +2,338 +2018 +13 +2019 +12 +2020 +15 +Total principal debt maturities +2,378 +Current portion +2,338 +Non-current portion +$ +40 +10. EQUITY +Common Stock +The Company has one class of common stock with a par value of $0.001 per share. There are 250 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share voting together as a single class on all matters presented to the stockholders for their approval, except with respect to the election and removal of directors or as otherwise required by applicable law. +Common Stock Repurchase Program +On December 26, 2013, the Board of Directors approved and authorized a program to repurchase up to $350 million of our common stock. The number, price and timing of the repurchases are at the Company’s sole discretion, subject to certain restrictions on repurchases under the Company's Revolving Credit Facility, and may be made depending on market conditions, liquidity needs or other factors. The Company’s Board of Directors may suspend, modify or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate the Company to acquire any amount of its common stock. Under Delaware state law, these shares are not retired, and the issuer has the right to resell any of the shares repurchased. +The Company did not repurchase any of its common stock during 2016. During 2015, the Company repurchased 6.5 million shares for $85.9 million including commissions. During 2014, the Company repurchased 10.6 million shares for $145.9 million including commissions. As of December 31, 2016, the Company had authorization to repurchase approximately $118.7 million of its common stock. +Preferred Stock +The Company has authorized and available for issuance 4 million shares of preferred stock. None of these preferred shares are issued or outstanding as of December 31, 2016 and 2015. +Series A Convertible Preferred Stock +The Company is authorized to issue up to 1.0 million shares of Series A convertible preferred stock ("Series A Preferred stock"), par value $0.001 per share, of which 0.2 million shares have been issued to the Blackstone Purchasers. The Series A Preferred stock has a stated value of $1,000 per share. Holders of Series A Preferred stock are entitled to receive dividends declared or paid +F-23 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (CONTINUED) +on the Company's common stock and are entitled to vote together with the holders of the Company's common stock as a single class, in each case, on an as-converted basis. Holders of Series A Preferred stock also have certain limited special approval rights, including with respect to the issuance of pari passu or senior equity securities of the Company. +Participation Rights and Dividends +The Series A preferred stock ranks senior to the Company's common stock with respect to rights to preferred dividends, liquidation, winding-up, and dissolution. Holders of Series A preferred stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum. If the Company fails to make timely dividend payments, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in full. As of December 31, 2016 and 2015, the Company had accrued preferred dividends of $3.0 million at each balance sheet date which are reported within "Accrued expenses and other liabilities' in the consolidated balance sheets. These accrued dividends were each paid in cash on January 3, 2017 and January 4, 2016. +Conversion Right +The Series A preferred stock is convertible at the option of the holders at any time into shares of common stock at a conversion price of $14.50 per share, subject to adjustment for customary anti-dilution provisions. Anytime on or after January 27, 2017, provided the closing price of the Company's common stock has been equal to or greater than $29.00 for 20 consecutive trading days, the Company may elect to convert all or a portion of the Series A preferred stock into an equivalent number of shares of common stock. At December 31, 2016, had the Company been entitled to exercise its conversion right, the Series A preferred stock would have been convertible into 13,793,100 shares of common stock. +Redemption Rights of the Company and Blackstone +The Company has the option to redeem the Series A preferred stock anytime on or after January 27, 2022 for 100% of the stated redemption value of $200 million plus all accrued and unpaid dividends. +Blackstone has the option to redeem the Series A preferred stock any time after January 27, 2022 or upon a change in control. Further, upon certain change of control events, Blackstone can require the Company to repurchase the Series A preferred stock at 101% of the redemption value plus all accrued and unpaid dividends. The Series A preferred stock is reported as temporary or mezzanine equity in the consolidated balance sheets. The carrying value of the Series A preferred stock is accreted up to its $200 million redemption value on a straight-line basis through the redemption date. +11. STOCK COMPENSATION +Equity Incentive Plans +The Company's 2015 Equity Incentive Plan (the "2015 Plan") provides for the issuance of common stock in connection with the grant of non-qualified stock options, incentive stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, common stock, or any other share-based award to eligible employees, consultants, and members of the Board. The Company also had two predecessor plans, the 2005 Equity Incentive Plan (the "2005 Plan") and the 2007 Equity Incentive Plan (the "2007 Plan"). Shares of common stock reserved and authorized for issuance at December 31, 2016 under all plans were 9,969,331 shares, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +F-24 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. STOCK COMPENSATION (Continued) +Stock Option Activity +Stock option activity for the years ended December 31, 2016, 2015, and 2014 was: +Shares +Weighted Average +Exercise Price +Weighted Average +Remaining +Contractual Life +(Years) +Aggregate +Intrinsic +Value +(in thousands, except exercise price and years) +Outstanding as of January 1, 2014 +2,105 +$ +13.34 +4.86 +$ +10,790 +Granted +119 +14.22 +Exercised +(266 +) +5.05 +Forfeited or expired +(262 +) +21.02 +Outstanding as of December 31, 2014 +1,696 +$ +13.52 +3.88 +$ +4,435 +Granted +35 +13.52 +Exercised +(285 +) +6.54 +Forfeited or expired +(150 +) +21.82 +Outstanding as of December 31, 2015 +1,296 +$ +14.09 +2.83 +$ +1,261 +Granted +— +— +Exercised +(104 +) +4.04 +Forfeited or expired +(674 +) +13.47 +Outstanding as of December 31, 2016 +518 +$ +16.90 +3.99 +$ +186,184 +Exercisable at December 31, 2016 +447 +$ +17.37 +3.48 +$ +186,184 +Vested and expected to vest at December 31, 2016 +518 +$ +16.90 +3.97 +$ +186,184 +No stock options were granted during 2016. During the years ended December 31, 2015 and 2014 stock options were valued using a Black Scholes option pricing model using the following assumptions: +Year Ended December 31, +2015 +2014 +Expected volatility +43% +44% - 50% +Dividend yield +— +— +Risk-free interest rate +1.50% - 1.72% +1.41% - 1.71% +Expected life (in years) +4.00 +4.00 +The weighted average grant date fair value of stock options granted during the years ended December 31, 2015 and 2014 was approximately $4.74 , and $5.35 , respectively. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2016, 2015, and 2014 was $0.5 million , $1.7 million , and $2.7 million , respectively. During the years ended December 31, 2016, 2015, and 2014 the Company received $0.4 million , $1.9 million and $1.3 million cash in connection with the exercise of stock options. The total grant date fair value of stock options vested during the years ended December 31, 2016, 2015, and 2014 was $0.3 million , $0.7 million , and $0.8 million , respectively. +As of December 31, 2016 , the Company had $0.3 million of total unrecognized share-based compensation expense related to unvested options, which is expected to be amortized over the remaining weighted average period of 1.81 years. +Stock options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years. +F-25 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. STOCK COMPENSATION (Continued) +Restricted Stock Awards and Units +From time to time, restricted stock awards ("RSAs") and restricted stock units ("RSUs") are granted to employees. RSAs and RSUs generally vest over three years, depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive a share of common stock upon vesting. RSUs have dividend equivalent rights which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. The Company grants time-based RSUs and performance-based RSUs. +Time-based RSUs are typically granted on an annual basis to certain executive and non-executive employees and vest on a straight-line basis in three annual installments, beginning one year after the grant date. During the years ended December 31, 2016, 2015, and 2014, the Board approved grants of 0.4 million , 0.4 million , and 0.3 million RSUs to certain non-executives. +During the years ended December 31, 2016, 2015, and 2014, the Board approved the grant of 1.2 million , 1.5 million , and 0.9 million , respectively, RSUs to certain executives as part of a performance incentive program. +Performance-based RSUs are granted on an annual basis to certain executive employees and consist of a time-based and performance-based component. Under the time-based component, RSUs vest at the end of each of the three years beginning one year from the grant date. The performance targets and vesting conditions for performance-based RSU's are based on achievement of multiple weighted performance goals, and vest upon certification of the compensation committee plus an additional service period. +RSA and RSU activity during the years ended December 31, 2016, 2015, and 2014 was: +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted +Average +Grant Date +Fair Value +Units +Weighted +Average +Grant Date +Fair Value +Unvested at January 1, 2014 +210,490 +$ +13.43 +1,965,667 +$ +16.50 +Granted +9,973 +15.04 +1,749,993 +16.05 +Vested +(68,420 +) +15.03 +(541,888 +) +17.64 +Forfeited +(144,555 +) +12.67 +(1,176,301 +) +16.51 +Unvested at December 31, 2014 +7,488 +$ +15.61 +1,997,471 +$ +15.78 +Granted +15,987 +15.01 +2,866,562 +10.14 +Vested +(15,480 +) +15.30 +(505,025 +) +16.20 +Forfeited +(1,328 +) +15.00 +(1,270,630 +) +14.14 +Unvested at December 31, 2015 +6,667 +$ +15.00 +3,088,378 +$ +10.75 +Granted +22,860 +10.28 +2,312,121 +9.16 +Vested +(18,097 +) +12.02 +(612,370 +) +13.05 +Forfeited +— +— +(932,761 +) +11.26 +Unvested at December 31, 2016 +11,430 +$ +10.28 +3,855,368 +$ +10.31 +RSAs vested during the years ended December 31, 2016, 2015, and 2014 consisted entirely of time-based awards. RSUs vested during the year ended December 31, 2016 consisted of 31,396 performance-based awards and 599,071 time-based awards. RSUs vested during the year ended December 31, 2015 consisted of 67,893 performance-based awards and 437,132 time-based awards. RSUs vested during the year ended December 31, 2014 consisted of 30,946 performance-based awards and 510,942 time-based awards. +The total grant date fair value of RSAs vested during the years ended December 31, 2016, 2015, and 2014 was $0.2 million , $0.2 million , and $1.0 million , respectively. As of December 31, 2016, there was $0.1 million of total unrecognized share-based compensation expense related to non-vested restricted stock awards, all of which was related to time-based awards. As of December 31, 2016, unvested RSAs are expected to amortize over a remaining weighted average period of 0.43 years. +F-26 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. STOCK COMPENSATION (Continued) +The total grant date fair value of RSUs vested during the years ended December 31, 2016, 2015, and 2014 was $8.0 million , $8.2 million and $9.6 million , respectively. As of December 31, 2016, there was $14.2 million of total unrecognized share-based compensation expense related to unvested restricted stock units, of which $2.6 million is related to performance-based awards and $11.6 million is related to time-based awards. As of December 31, 2016, unvested RSUs are expected to amortize over a remaining weighted average period of 1.63 years, which consists of a remaining weighted average period of 1.56 years related to performance-based awards and a remaining weighted average period of 1.71 years related to time-based awards. +Share-based Compensation Expense +During the years ended December 31, 2016, 2015, and 2014, the Company recorded $10.7 million , $11.2 million , and $12.7 million , respectively, of pre-tax share-based compensation expense, of which $0.5 million , $0.5 million and $0.8 million is reported within 'Cost of sales', and $10.2 million , $10.7 million and $11.8 million , respectively in 'Selling, general and administrative expense in the consolidated statements of operations. During 2014, $0.2 million of share compensation cost related to the Company's enterprise resource planning system was included in capitalized software cost. +12. ALLOWANCES +Changes in the allowance for doubtful accounts, the reserve for sales returns and allowances, and unapplied rebates were: +Allowance for +doubtful accounts +Reserve for sales +returns and +allowances +Reserve for +unapplied rebates +Total +(in thousands) +Beginning balance at January 1, 2014 +$ +3,656 +$ +5,410 +$ +1,447 +$ +10,513 +Reduction in revenues +— +69,834 +5,397 +75,231 +Expense +12,087 +— +— +12,087 +Recoveries, applied amounts, and write-offs +(2,134 +) +(68,030 +) +4,725 +(65,439 +) +Ending balance at December 31, 2014 +13,609 +7,214 +11,569 +32,392 +Reduction in revenues +— +71,649 +11,106 +82,755 +Expense +26,225 +— +— +26,225 +Recoveries, applied amounts, and write-offs +(3,466 +) +(74,224 +) +(14,318 +) +(92,008 +) +Ending balance at December 31, 2015 +36,368 +4,639 +8,357 +49,364 +Reduction in revenues +— +72,995 +9,036 +82,031 +Expense +6,079 +— +— +6,079 +Recoveries, applied amounts, and write-offs +(9,591 +) +(71,513 +) +(8,232 +) +(89,336 +) +Ending balance at December 31, 2016 +$ +32,856 +$ +6,121 +$ +9,161 +$ +48,138 +During the year ended December 31, 2015, multiple China distributors defaulted on their payment obligations and, as a result, the Company recorded a $23.2 million charge in 2015 to increase the China allowance for doubtful accounts to $30.3 million at December 31, 2015. In addition to the allowance for doubtful accounts of $30.3 million , the Company also maintained China reserves for sales returns and allowances and unapplied rebates, bringing the total China allowances to $36.4 million as of December 31, 2015. As of December 31, 2015, China operations accounted for $41.6 million of the Company's gross receivables, of which $38.2 million were past due. Our net accounts receivable balance for our China operations as of December 31, 2015 was $5.1 million . +The Company addressed the declining collection rates experienced in 2015 from our China operations by limiting or terminating its relationship with certain distributors. Beginning in late 2015, the Company implemented a more restrictive credit policy for several China distributors and also expanded its relationship with other, financially stronger existing business partners. +F-27 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. ALLOWANCES (Continued) +Changes in the China allowance for doubtful accounts, the reserve for sales returns and allowances, and unapplied rebates were: +Allowance for +doubtful accounts +Reserve for sales +returns and +allowances +Reserve for +unapplied rebates +Total +China Operations +(in thousands) +Beginning balance at January 1, 2014 +$ +24 +$ +225 +$ +1,051 +$ +1,300 +Reduction in revenue +— +6,921 +— +6,921 +Expense +8,552 +— +— +8,552 +Recoveries, applied amounts, and write-offs +(136 +) +(3,103 +) +7,572 +4,333 +Ending balance at December 31, 2014 +8,440 +4,043 +8,623 +21,106 +Reduction in revenue +— +7,769 +3,511 +11,280 +Expense +23,163 +— +— +23,163 +Recoveries, applied amounts, and write-offs +(1,315 +) +(11,618 +) +(6,172 +) +(19,105 +) +Ending balance at December 31, 2015 +30,288 +194 +5,962 +36,444 +Reduction in revenue +— +9,243 +1,380 +10,623 +Expense +1,097 +— +— +1,097 +Recoveries, applied amounts, and write-offs +(5,752 +) +(8,575 +) +(1,013 +) +(15,340 +) +Ending balance at December 31, 2016 +$ +25,633 +$ +862 +$ +6,329 +$ +32,824 +F-28 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES +The following table sets forth income before taxes and the expense for income taxes for the years ended December 31, 2016, 2015, and 2014: +Year Ended December 31, +2016 +2015 +2014 +(in thousands) +Income (loss) before taxes: +U.S. +$ +(55,617 +) +$ +(83,537 +) +$ +(34,622 +) +Foreign +48,404 +8,793 +26,073 +Total income (loss) before taxes +$ +(7,213 +) +$ +(74,744 +) +$ +(8,549 +) +Income tax expense: +Current income taxes +U.S. federal +$ +49 +$ +480 +$ +(12,049 +) +U.S. state +126 +195 +(23 +) +Foreign +9,494 +7,488 +7,620 +Total current income taxes +9,669 +8,163 +(4,452 +) +Deferred income taxes: +U.S. federal +263 +(3,902 +) +400 +U.S. state +— +(118 +) +236 +Foreign +(651 +) +4,309 +193 +Total deferred income taxes +(388 +) +289 +829 +Total income tax expense (benefit) +$ +9,281 +$ +8,452 +$ +(3,623 +) +The increase in tax expense for 2016 versus 2015 was driven by the income tax effects on the pretax results in countries where the Company records a provision. +F-29 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes for the years ended December 2016, 2015, and 2014: +December 31, +2016 +2015 +2014 +(in thousands) +Federal income tax rate +$ +(2,524 +) +35.0 +% +$ +(26,160 +) +35.0 +% +$ +(2,992 +) +35.0 +% +State income tax rate, net of federal benefit +(202 +) +2.8 +(543 +) +0.7 +2,598 +(30.4 +) +Effect of rate differences +(12,624 +) +175.0 +(3,678 +) +4.9 +(3,362 +) +39.3 +Non-deductible / Non-taxable items +2,694 +(37.4 +) +(2,181 +) +2.9 +(9,904 +) +115.8 +Change in valuation allowance +16,041 +(222.4 +) +10,892 +(14.5 +) +5,370 +(62.8 +) +U.S. tax on foreign earnings +23,130 +(320.6 +) +82,311 +(110.0 +) +17,196 +(201.2 +) +Foreign tax credits +(18,581 +) +257.6 +(49,432 +) +66.1 +(11,026 +) +129.0 +Uncertain tax positions +19 +(0.3 +) +(3,952 +) +5.3 +(25,172 +) +294.4 +Audit settlements +253 +(3.5 +) +1,167 +(1.6 +) +13,448 +(157.3 +) +Stock Compensation Windfall / Shortfall +2,120 +(29.4 +) +— +— +— +— +Deferred income tax account adjustments +(842 +) +11.7 +— +— +8,679 +(101.5 +) +Write-off of income tax receivable +— +— +— +— +1,577 +(18.4 +) +Other +(203 +) +2.8 +28 +(0.1 +) +(35 +) +0.5 +Effective income tax rate +$ +9,281 +(128.7 +)% +$ +8,452 +(11.3 +)% +$ +(3,623 +) +42.4 +% +The 2015 and 2014 amounts have been recast to reflect the pertinent amounts on the rows that were added this year. +The following table sets forth deferred income tax assets and liabilities as of December 2016 and 2015: +December 31, +2016 +2015 +(in thousands) +Non-current deferred tax assets: +Stock compensation expense +$ +4,597 +$ +7,142 +Long-term accrued expenses +26,127 +26,114 +Net operating loss and charitable contribution carryovers +36,424 +22,518 +Intangible assets +3,654 +4,725 +Future uncertain tax position offset +396 +456 +Unrealized loss on foreign currency +— +466 +Foreign tax credit +69,586 +27,109 +Other +5,481 +5,548 +Valuation allowance +(90,900 +) +(56,572 +) +Total non-current deferred tax assets +$ +55,365 +$ +37,506 +Non-current deferred tax liabilities: +Intangible assets +$ +(41 +) +$ +(24,572 +) +Unremitted earnings of foreign subsidiary +(32,427 +) +(6,432 +) +Property and equipment +(16,072 +) +— +Total non-current deferred tax liabilities +$ +(48,540 +) +$ +(31,004 +) +F-30 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +We annually receive cash from our foreign subsidiaries’ current year earnings. Separately, while we have accrued U.S. federal income tax on substantially all current year foreign earnings from 2010-2016, we treat all other accumulated foreign subsidiary earnings through December 31, 2016, as indefinitely reinvested under the accounting guidance, and accordingly have not provided for any U.S. or foreign tax thereon. In order to arrive at this conclusion, we considered factors including, but not limited to, past experience, domestic cash requirements, and cash requirements to satisfy the ongoing operations, capital expenditures and other financial obligations of our foreign subsidiaries. As of December 31, 2016, U.S. federal income tax expense on approximately $178 million of undistributed earnings and profits attributable to foreign subsidiaries have been accrued. Furthermore, as of December 31, 2016, U.S. income and foreign withholding taxes have not been provided on for approximately $208.1 million of unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. These earnings are estimated to represent the excess of the financial reporting over the tax basis in Crocs' investments in those subsidiaries. These earnings, which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. federal income tax liability on the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +The Company adopted ASU 2016-09 during the year, which caused an increase in tax attributes recorded for provision purposes. As the net impact of these difference was recorded to retained earnings as a cumulative change, and subsequently valued, there was no net impact to the Company’s financial statements. +During 2016, Crocs received a Private Letter Ruling from the IRS related to a request to claim bonus depreciation for tax years 2011-2013. As such, the Company filed amended tax returns for those periods and subsequently recorded additional deferred tax liabilities associated with our basis differences in fixed assets. This increase was offset against incremental deferred tax assets related to foreign tax credits. +During 2016, we recorded additional tax loss carryforwards in certain European, South American and Asian jurisdictions in the aggregate of $18.2 million , primarily driven by operational losses recognized based on local statutory accounting requirements. As the carryforwards were generated in jurisdictions where we have historically had book losses or do not have strong future projections related to those operations, we concluded that it was more likely than not that the net operating losses would not be realized, and thus recorded a full valuation allowance on the associated deferred tax assets. As such, as of December 31, 2016, Crocs maintains a valuation allowance of $90.9 million . The recognition of these deferred tax assets and fully offsetting valuation allowance resulted in a zero net impact to the consolidated statement of operations, balance sheet and statement of cash flows. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits during the years ended December 31, 2016, 2015 and 2014: +December 31, +2016 +2015 +2014 +(in thousands) +Unrecognized tax benefit—January 1 +$ +4,957 +$ +8,444 +$ +31,616 +Gross increases—tax positions in prior period +646 +643 +7 +Gross decreases—tax positions in prior period +(664 +) +(385 +) +(3,711 +) +Gross increases—tax positions in current period +245 +549 +904 +Settlements +(238 +) +(4,126 +) +(20,210 +) +Lapse of statute of limitations +(196 +) +(168 +) +(162 +) +Unrecognized tax benefit—December 31 +$ +4,750 +$ +4,957 +$ +8,444 +The Company recorded net expense of $0.3 million related to increases in 2016 unrecognized tax benefits combined with amounts effectively settled under audit. Unrecognized tax benefits as of December 31, 2016, relate to tax years that are currently open, and amounts may differ from those to be determined upon closing of the positions. Annual tax provisions include amounts considered sufficient to pay assessments that may result from examination of prior year tax returns; however, the amount ultimately paid upon resolution of issues may differ materially from the amount accrued. Given the uncertainty regarding the timing of the resolution, settlement, and closure of any audits, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. However, given the number of years remaining that are subject to examination, Crocs is unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. +F-31 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +As it relates to the impact of uncertain tax positions on the rate reconciliation, the primary impact includes audit settlements, net increases in position changes (both are noted as part of the tax position tabular disclosure), and accrued interest expense. The gross impact of positions effectively settled are disclosed separately as audit settlements. The net benefit related to 2014 audit settlements is not expected to recur in future periods. Note that the interest component, while carried as a liability on the balance sheet and recorded as a component of tax expense, is excluded from the tabular disclosure pursuant to the guidance under ASC 740-10-50. +Interest and penalties related to income tax liabilities are included in income tax expense in the consolidated statement of operations. For the years ended December 31, 2016, 2015 and 2014, Crocs recorded approximately $0.2 million , $0.2 million and $0.8 million , respectively, of penalties and interest. During the year ended December 31, 2016, Crocs released $0.1 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $0.6 million , $0.5 million and $0.9 million , as of December 31, 2016, 2015 and 2014, respectively. +Unrecognized tax benefits of $4.8 million , $5.0 million and $8.4 million as of December 31, 2016, 2015 and 2014, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2016: +Netherlands +2009 to 2016 +Canada +2009 to 2016 +Japan +2010 to 2016 +China +2008 to 2016 +Singapore +2012 to 2016 +United States +2010 to 2016 +State income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for the Company are generally subject to examination for the years 2011 to 2016. +The Company has recorded deferred tax assets related to U.S. federal tax carryforwards, including foreign tax credits and net operating losses, which expire at various dates between 2020 and 2036 of $57.3 million and $21.9 million at December 31, 2016, and December 31, 2015, respectively. The Company has recorded deferred tax assets related to U.S. state tax net operating loss carryforwards which expire at various dates between 2017 and 2036 of $9.4 million and $7.0 million at December 31, 2016, and December 31, 2015, respectively. The Company has recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2020 and some that do not expire of $39.3 million and $20.7 million as of December 31, 2016, and December 31, 2015, respectively. The significant increase in tax carryforwards is primarily driven by $17.7 million of U.S. tax carryforwards recorded during 2016 which were previously unrecorded stock compensation windfall attributes and from current year net operating losses and foreign tax credit generation. +F-32 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. EARNINGS PER SHARE +Basic and diluted earnings (loss) per share ("EPS") for the years ended December 31, 2016, 2015, and 2014 were: +Year Ended December 31, +2016 +2015 +2014 +(in thousands) +Numerator +Net loss attributable to common stockholders—basic and diluted +$ +(31,738 +) +$ +(98,007 +) +$ +(18,962 +) +Denominator +Weighted average common shares outstanding—basic and diluted +73,371 +75,604 +85,140 +Net loss attributable per common share: +Basic +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +Diluted +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +Diluted EPS is calculated using the two-class method for options and RSUs and the if-converted method for Series A preferred stock. For the years ended December 31, 2016 , 2015 , and 2014 , 2.2 million , 2.1 million , and 2.0 million options and RSUs, respectively, were excluded from the calculation of diluted EPS under the two-class method because the effect was anti-dilutive. The Series A preferred shares were excluded in the calculation of diluted EPS under the if-converted method because the effect on was anti-dilutive. If converted, Series A preferred stock would represent approximately 15.8% of the Company's common stock outstanding, or 13.8 million additional common shares as of December 31, 2016 . +15. COMMITMENTS AND CONTINGENCIES +Rental Commitments and Contingencies +The Company rents space for its retail stores, offices, warehouses, vehicles, and equipment under operating leases expiring at various dates through 2033. Certain leases contain rent escalation clauses. Rent expense for leases with escalations or rent holidays is recognized on a straight-line basis over the lease term beginning on the lease inception date. Certain leases also provide for contingent rents, which are generally determined as a percent of sales in excess of specified levels. A contingent rent liability is recognized together with the corresponding rent expense when specified levels have been achieved or when the Company determines that achieving the specified levels during the period is probable. +Deferred rent is included in the consolidated balance sheets in 'Accrued expenses and other current liabilities'. Future minimum lease payments under operating leases were as follows: +Year ending December 31, +December 31, 2016 +(in thousands) +2017 +$ +68,241 +2018 +56,125 +2019 +42,702 +2020 +35,692 +2021 +29,230 +Thereafter +78,565 +Total minimum lease payments +$ +310,555 +Minimum sublease rentals of $0.2 million under non-cancelable subleases and contingent rentals, which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts, are excluded from the commitment schedule. +F-33 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. LEGAL PROCEEDINGS (Continued) +Rent expense under operating leases was: +Year Ended December 31, +2016 +2015 +2014 +(in thousands) +Minimum rentals +$ +88,182 +$ +96,579 +$ +108,466 +Contingent rentals +14,596 +14,929 +16,875 +Less: Sublease rentals +(187 +) +(322 +) +(868 +) +Total rent expense +$ +102,591 +$ +111,186 +$ +124,473 +_______________________________________________________________________________ +Minimum rentals include all lease payments, fixed and variable common area maintenance, parking and storage fees, which were approximately $10.2 million , $9.1 million , and $9.6 million during the years ended December 31, 2016 , 2015 , and 2014 , respectively. +Purchase Commitments +In December 2011, the Company renewed and amended its supply agreement with Finproject S.p.A. (formerly known as Finproject s.r.l.), which provides the Company the right to purchase certain raw materials used to manufacture its products. The supply agreement requires that the Company meet minimum purchase requirements throughout the term of the agreement, which renews annually on January 1st unless terminated by either party. Historically, the minimum purchase requirements have not been onerous and the Company does not expect them to become onerous in the future. Depending on the material purchased, pricing is based either on contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations, and raw material prices. Pursuant to the agreement, the Company guarantees the payment for certain third-party manufacturer purchases of these raw materials up to a maximum potential amount of € 3.5 million (approximately $3.7 million as of December 31, 2016 ). +As of December 31, 2016 and 2015 , the Company had firm purchase commitments with other certain third-party manufacturers of $125.9 million and $158.2 million , respectively. +Government Tax Audits +The Company is regularly subject to, and is currently undergoing, audits by tax authorities in the United States and several foreign jurisdictions for prior tax years. +Other +During its normal course of business, the Company may make certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain matters. The Company cannot determine a range of estimated future payments and has not recorded any liability for indemnities, commitments and guarantees in the accompanying consolidated balance sheets. +See Note 17 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +The Company has three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and Europe. We also have an 'Other businesses' category which aggregates insignificant operating segments that do not meet the reportable segment threshold, including manufacturing operations located in Mexico and Italy, and corporate operations. +Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers as well as inter-segment sales. Revenues of the Other businesses category are primarily made up of inter-segment sales. The remaining revenues for 'Other businesses' represent non-footwear product sales to external customers. Inter-segment sales are not included in the measurement of segment operating income and are eliminated when reporting total consolidated revenues. +F-34 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +Segment performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as inter-segment eliminations. +Year Ended December 31, +2016 +2015 +2014 +(in thousands) +Revenues: +Americas +$ +467,006 +$ +476,210 +$ +489,915 +Asia Pacific +395,078 +424,491 +473,910 +Europe +173,444 +188,833 +233,604 +Total segment revenues +1,035,528 +1,089,534 +1,197,429 +Other businesses +745 +1,096 +794 +Total consolidated revenues +$ +1,036,273 +$ +1,090,630 +$ +1,198,223 +Operating income: +Americas (1) +$ +58,844 +$ +49,422 +$ +48,347 +Asia Pacific (2) +78,907 +48,447 +75,135 +Europe (3) +17,757 +15,629 +24,517 +Total segment operating income +155,508 +113,498 +147,999 +Reconciliation of total segment operating income to income before income taxes: +Other businesses +(26,935 +) +(30,092 +) +(19,400 +) +Intersegment eliminations +— +— +(1,498 +) +Unallocated corporate and other (4) +(134,727 +) +(155,730 +) +(131,827 +) +Total consolidated operating income (loss) +(6,154 +) +(72,324 +) +(4,726 +) +Foreign currency transaction loss, net +(2,454 +) +(3,332 +) +(4,885 +) +Interest income +692 +967 +1,664 +Interest expense +(836 +) +(969 +) +(806 +) +Other income (expense), net +1,539 +914 +204 +Income (loss) before income taxes +$ +(7,213 +) +$ +(74,744 +) +$ +(8,549 +) +Depreciation and amortization: +Americas +$ +5,787 +$ +7,401 +$ +11,670 +Asia Pacific +4,264 +3,913 +6,724 +Europe +2,133 +2,229 +3,761 +Total segment depreciation and amortization +12,184 +13,543 +22,155 +Other businesses +6,830 +7,634 +5,900 +Unallocated corporate and other (4) +15,029 +14,816 +9,358 +Total consolidated depreciation and amortization +$ +34,043 +$ +35,993 +$ +37,413 +Cash paid for Property Plant and Equipment +Americas +$ +6,851 +$ +6,611 +$ +6,807 +Europe +1,388 +1,510 +3,061 +Asia Pacific +4,994 +4,705 +6,123 +Total cash paid for Property Plant and Equipment +$ +13,233 +$ +12,826 +$ +15,991 +Cash paid for Intangible Assets +Americas +$ +8,961 +$ +5,459 +$ +40,532 +F-35 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +Europe +— +201 +208 +Asia +— +— +295 +Total cash paid for Intangible Assets +$ +8,961 +$ +5,660 +$ +41,035 +_______________________________________________________________________________ +(1) +Includes $1.7 million , $7.2 million , and $4.0 million for the years ended December 31, 2016 , 2015 , and 2014 respectively, of asset impairment charges related to 12 , 27 , and 36 underperforming retail locations, respectively. +(2) +Includes $0.7 million , $0.7 million , and $2.8 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively, of asset impairment charges related to 21 , 27 , and 14 underperforming retail locations, respectively. Additionally in the year ended December 31, 2015, the company recorded $5.7 million in impairment charges related to South Africa assets, pertaining to 9 retail locations, classified as available for sale. +(3) +Includes $0.3 million , $1.6 million , and $2.0 million for the years ended December 31, 2016 , 2015 , and 2014 of asset impairment charges related to 9 , 21 , and 27 underperforming retail locations. Additionally in the year ended December 31, 2016, the Company recorded $0.4 million in impairment charges related to goodwill in our European retail business. +(4) +Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, research and development, marketing, legal, restructuring, depreciation and amortization of corporate and other assets not allocated to operating segments, and similar costs of certain corporate holding companies. +The following table sets forth asset information related to reportable operating segments: +December 31, +2016 +2015 +(in thousands) +Assets (1) +Americas +$ +128,071 +$ +148,104 +Asia Pacific +144,037 +169,865 +Europe +69,306 +46,137 +Total segment current assets +341,414 +364,106 +Supply Chain +12,343 +14,778 +Corporate (2) +19,134 +16,265 +Income tax receivable +2,995 +10,233 +Other receivables +14,642 +14,233 +Restricted cash - current +2,534 +2,554 +Prepaid expenses and other current assets +32,413 +23,780 +Total current assets +425,475 +445,949 +Property and Equipment, net +44,090 +49,490 +Intangible assets, net +72,700 +82,297 +Goodwill +1,480 +1,973 +Deferred tax assets, net +6,825 +6,608 +Restricted cash +2,547 +3,551 +Other assets +13,273 +18,152 +Total consolidated assets +$ +566,390 +$ +608,020 +_______________________________________________________________________________ +(1) +Assets by segment include cash and equivalents, net accounts receivable, and inventory. +(2) +Corporate assets primarily consist of cash and equivalents and inventory. +F-36 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2016 , 2015 and 2014 . The following table sets forth certain geographical information regarding Crocs' revenues during the years ended December 31, 2016 , 2015 and 2014 : +Year Ended December 31, +2016 +2015 +2014 +(in thousands) +Location +United States +$ +384,939 +$ +392,463 +$ +435,154 +International (1) +651,334 +698,167 +763,069 +Total revenues +$ +1,036,273 +$ +1,090,630 +$ +1,198,223 +_______________________________________________________________________________ +(1) +For the years ended December 31, 2015 and 2014 , no individual country represented more than 10% of consolidated revenues. For the year ended December 31, 2016 , sales in Japan represented 10.6% of consolidated revenues. +The following table sets forth geographical information regarding property and equipment assets: +December 31, +2016 +2015 +(in thousands) +Location +United States +$ +29,420 +$ +32,954 +International +14,670 +16,536 +Total long-lived assets +$ +44,090 +$ +49,490 +Not more than 10% of long-lived assets resided in any individual foreign country in 2016 or 2015. +17. LEGAL PROCEEDINGS +The Company is currently undergoing an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In October 2013, CBP issued the final audit report. In that report CBP projects that unpaid duties totaling approximately $12.4 million are due for the period under review and recommends collection of the duties due. The Company responded that these projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the projection. Additionally, on December 12, 2014, The Company made an offer to settle CBP's potential claims and paid $3.5 million . In 2016, after discussions with CBP's local counsel, the Company increased its settlement offer to $7 million and paid an additional $3.5 million during the quarterly period ending December 31, 2016. The revised offer is still subject to formal acceptance by CBP. It is not possible to determine whether the Company and CBP will reach a negotiated settlement or when such a settlement might occur. If a settlement cannot be reached, it is not possible to predict with any certainty whether CBP will seek to assert a claim for penalties in addition to any unpaid duties, but such an assertion is a possibility. +The Company is currently subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, the Company was notified about the issuance of assessments totaling approximately $4.5 million for the period January 2010 through May 2011. The Company has disputed these assessments and asserted defenses to the claims. On February 25, 2015, the Company received additional assessments totaling approximately $10.2 million related to the remainder of the audit period. The Company has also disputed these assessments and asserted defenses and filed an appeal to these claims. On May 11, 2016, the Company was notified of a decision rejecting the defense filed against the first assessment covering the period of January 2010 through May 2011. The Company filed an appeal of that decision on June 8, 2016. It is anticipated that this matter will take up to two or more years to be resolved. It is not possible at this time to predict the outcome of this matter. +For all other claims and other disputes, where the Company is able to estimate possible losses or a range of possible losses, the Company estimates that as of December 31, 2016, it is reasonably possible that losses associated with these claims and other disputes could potentially exceed amounts accrued by the Company by up to $0.4 million . +F-37 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. LEGAL PROCEEDINGS (Continued) +In the aggregate, the Company has accrued $7.4 million associated with our estimated obligations related to legal claims, which is reported in the consolidated balance sheet in 'Accrued expenses and other liabilities'. +The Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims. The Company is not party to any other pending legal proceedings that it believes would reasonably have a material adverse impact on its business, financial position, results of operations or cash flows. +18. EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +The Company sponsors a qualified defined contribution benefit plan (the "Plan"), covering substantially all of its U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. The Company makes matching contributions to the plans equal to 100% of the first 3% , and up to 50% of the next 2% of salary contributed by an eligible employee. Participants are vested 100% in the Company's matching contributions when made. Contributions made by the Company under the Plan were $5.8 million , $6.0 million and $7.1 million for the years ended December 31, 2016 , 2015 , and 2014 , respectively, and are recorded in 'Selling, general and administrative expenses' in the consolidated statements of operations. +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +March 31, +2016 +June 30, +2016 +September 30, +2016 +December 31, 2016 +(in thousands, except per share data) +Revenues +$ +279,140 +$ +323,828 +$ +245,888 +$ +187,417 +Gross profit +129,366 +169,640 +122,434 +78,724 +Asset impairment charges +193 +572 +930 +1,449 +Income (loss) from operations +14,243 +20,605 +(1,215 +) +(39,787 +) +Net income (loss) +10,146 +15,537 +(1,533 +) +(40,644 +) +Net income (loss) attributable to common shareholders +6,361 +11,735 +(5,352 +) +(44,482 +) +Basic income (loss) per common share +$ +0.07 +$ +0.13 +$ +(0.07 +) +$ +(0.60 +) +Diluted income (loss) per common share +$ +0.07 +$ +0.13 +$ +(0.07 +) +$ +(0.60 +) +For the Quarter Ended +March 31, +2015 +June 30, +2015 +September 30, +2015 +December 31, 2015 +(in thousands, except per share data) +Revenues +$ +262,193 +$ +345,671 +$ +274,088 +$ +208,678 +Gross profit +127,370 +189,870 +120,821 +72,744 +Restructuring +3,663 +2,810 +981 +1,274 +Asset impairment charges +— +2,075 +5,460 +7,771 +Income (loss) from operations +(2,362 +) +16,349 +(20,730 +) +(65,581 +) +Net income (loss) +(2,425 +) +13,426 +(24,024 +) +(70,173 +) +Net income (loss) attributable to common shareholders +(5,979 +) +9,690 +(27,776 +) +(73,942 +) +Basic income (loss) per common share +$ +(0.08 +) +$ +0.11 +$ +(0.37 +) +$ +(1.01 +) +Diluted income (loss) per common share +$ +(0.08 +) +$ +0.11 +$ +(0.37 +) +$ +(1.01 +) +F-38 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (Continued) +During the three months ended December 31, 2016 we identified the following factors affecting the comparability of information between periods: +• +Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter of the year relative to the other quarters. For the quarter ended December 31, 2016 revenue decreased 10.2% as compared to the same quarter of the prior year which was primarily driven by a decrease in sales in the Wholesale and Retail segments. +• +Gross margin as a percent of revenue remained relatively constant across periods. For the three months ended December 31, 2016 gross margins decreased by 7.8% as compared to the three months ended September 30, 2016 which is typical in the fourth quarter as a result of product mix coupled with traditionally higher year end promotion activities related to the liquidation of current year product lines remaining in inventory. Of the 7.8% decrease in gross margin, 2.3% of the shortfall was due to an increase in royalty expense related to clarification of new and existing agreements, which resulted in a change in estimates for royalties. +• +Our Income from operations for the quarter ended June 30, 2016 was negatively impacted by an increase of $18.3 M in marketing expense related to the Spring/Summer line advertising campaigns. SG&A, otherwise, remained relatively constant across the quarters, with some fluctuation between periods in relation to contingent rent expense that is driven by sales. +During the three months ended December 31, 2015 we identified the following factors affecting the comparability of information between periods: +• +Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter of the year relative to the other quarters. For the quarter ended December 31, 2015 revenue increased 1.0% as compared to the same quarter of the prior year. +• +Revenue and gross profit are typically negatively impacted by an increase in sales returns and allowances in the quarter ended December 31, 2015 due to traditionally higher year end promotion activities related to the liquidation of current year product lines remaining in inventory. For the three months ended December 31, 2015 revenue and gross profit decreased by $8.7 million , relative to the first three quarters of 2015, due to an increase in sales discounts. +• +Revenue and gross profit for the three months ended December 31, 2015 decreased by an additional $6.0 million due to higher sales returns and allowances, as a percent of gross revenue, as compared to the first three quarters of 2015. This increase in sales returns and allowances is consistent with the fourth quarter of prior years. +• +Our Income from operations for the quarter ended December 31, 2015 was also negatively impacted by asset impairment charges of $7.8 million , of which $5.7 million related to the impairment of our South Africa asset group with the remaining impairment being related to certain underperforming retail locations. See Note 4 — Property and Equipment for additional information. +• +Our net income for the quarter ended December 31, 2015 was negatively impacted by a tax expense of $4.7 million primarily associated with an increase in valuation allowances on deferred tax assets which management determined were not likely to be realized in future periods. See Note 13 — Income taxes for additional information. +20. RESTRUCTURING ACTIVITIES +On July 21, 2014, Crocs announced strategic plans for long-term improvement and growth of the business. These plans comprise four key initiatives including: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient organizational structure by reducing excess overhead and enhancing the decision making process, and (4) closing retail locations around the world. The initial effects of these plans were incurred in 2014 and were continued throughout 2015. During the years ended December 31, 2015 and 2014, the Company recorded restructuring charges of $8.7 million and $24.5 million , respectively. As of December 31, 2015, Crocs concluded its restructuring efforts. +F-39 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +20. RESTRUCTURING ACTIVITIES (Continued) +The following table summarizes restructuring activity during the years ended December 31, 2015 and 2014: +Year Ended December 31, +2015 +2014 +(in thousands) +Severance costs +$ +5,472 +$ +12,500 +Lease / contract exit and related costs +2,623 +4,251 +Other (1) +633 +7,766 +Total restructuring charges +$ +8,728 +$ +24,517 +_______________________________________________________________________________ +(1) +The amounts in 'Other' consist of various asset and inventory impairment charges prompted by the aforementioned restructuring plan, legal fees and facility maintenance fees. +The following table summarizes the Company's total restructuring charges incurred during the years ended December 31, 2015 and 2014 by reportable segment: +Year Ended December 31, +2015 +2014 +(in thousands) +Americas +$ +890 +$ +4,259 +Asia Pacific +3,542 +7,422 +Europe +2,824 +3,934 +Corporate +1,472 +8,902 +Total restructuring charges +$ +8,728 +$ +24,517 +The following table summarizes the Company's accrued restructuring balance and associated activity from December 31, 2014 through December 31, 2015: +December 31, 2014 +Additions +Cash +Payments +Adjustments(2) +December 31, 2015 +(in thousands) +Severance costs +$ +3,154 +$ +5,472 +$ +(8,000 +) +$ +— +$ +626 +Lease/ contract exit and related costs +1,401 +2,623 +(3,807 +) +(217 +) +— +Other (1) +304 +633 +(595 +) +— +342 +Total accrued restructuring +$ +4,859 +$ +8,728 +$ +(12,402 +) +$ +(217 +) +$ +968 +_______________________________________________________________________________ +(1) Includes expenses related to exiting stores and legal fees. +(2) Represents reversal of prior year accrual as a result of subleasing an exited facility at a better than anticipated rate. +As of December 31, 2014, Crocs had a liability of approximately $4.9 million related to locations already closed and reductions in workforce in accrued restructuring on the consolidated balance sheet. As of December 31, 2015, the liability had reduced to $1.0 million , which was subsequently paid in 2016. +F-40 \ No newline at end of file diff --git a/raw/filings/0001334036/2016/0001628280-17-002068/filing_metadata.csv b/raw/filings/0001334036/2016/0001628280-17-002068/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..a5820072ba4955e2f7851bebca8374039ba0b04d --- /dev/null +++ b/raw/filings/0001334036/2016/0001628280-17-002068/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2017-03-01,2016-12-31,2017-03-01T22:07:16.000Z,0001628280-17-002068,crox-20161231x10k.htm,10-K,15315270,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000162828017002068/crox-20161231x10k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000162828017002068/,2016,2016,1 diff --git a/raw/filings/0001334036/2016/0001628280-17-002068/item1.txt b/raw/filings/0001334036/2016/0001628280-17-002068/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e637886b1f65563f0e4c09eaa3a860b9e1a6cec1 --- /dev/null +++ b/raw/filings/0001334036/2016/0001628280-17-002068/item1.txt @@ -0,0 +1,214 @@ +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our," or "us") are engaged in the design, development, manufacturing, worldwide marketing, distribution and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear featuring comfort, color, and functionality. The Company, a Delaware corporation, is the successor to a Colorado corporation of the same name, and was originally organized in 1999 as a limited liability company. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite, as well as casual lifestyle footwear that use a range of materials. Our Croslite TM material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international retailers and distributors, and directly to consumers through our company-operated retail stores, outlets, e-commerce store sites, and kiosks. +Since the initial introduction of our original Classic clog designs in 2002, we have expanded our product ranges to include a variety of styles and products. Going forward, we are focusing on our core molded styles, clogs, sandals, flips and slides as well as developing select casual styles. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels, our own Crocs single-branded stores including both full price and outlet stores, our own e-commerce sites, traditional multi-branded stores including family footwear stores, sporting goods stores and a variety of specialty and independent retail channels, and third-party e-commerce sites. In select markets we also sell to distributors that are typically granted the rights to distribute our products in a given geographical area. +Products +Our product offerings have grown significantly since we first introduced the single-style clog in six colors in 2002. Recognized across the world for our iconic clog silhouette, we have taken the successful formula of a simple design aesthetic paired with modern comfort and expanded into a wide variety of casual footwear products including sandals, flips and slides, shoes, and boots that meet the needs of the whole family. +At the heart of our brand reside the Classic and Crocband clogs, our most iconic styles for adults and kids - product that embodies our innovation in molding, simplicity of design and all-day comfort. A key differentiating feature of our footwear products is our proprietary closed-cell resin Croslite material, which is uniquely suited for comfort and functionality. For further information on Croslite, see Raw Materials below. +We strive to provide our global consumer with a year-round product assortment featuring fun, comfortable, casual, colorful, and innovative styles. Our collections are designed to meet the needs of the family by focusing on key wearing occasions. Our goal is to deliver product assortments for the family with all of the comfort, features and benefits Crocs is known for. +The unique look and feel of the Classic clog can be experienced throughout our entire product line due to the use and design of Croslite. We have expanded our core molded product line, with the addition of dual density technology, warm lined styles, sandals, flips and slides, shoes and boots. We enjoy highly successful licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allows us to bring popular global franchises and characters to life on our product in a fun, exciting way. +We continue to leverage our expertise and innovation in injection molding to create a fresh, distinctive point of view in the casual footwear market and to deliver a winning combination of comfort, style and versatility to our consumer year round. +Sales and Marketing +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. Our marketing efforts center on story-telling across diverse wearing occasions and product silhouettes. For the years ended December 31, 2016 , 2015 , and 2014 , total advertising costs were approximately $56.0 million, $58.2 million, and $44.7 million, respectively. +We run our business across three major geographic regions: the Americas, Asia Pacific, and Europe, which are discussed in more detail in Business Segments and Geographic Information below. In developing our market growth and expansion strategies, we prioritize five core markets including: (i) the United States, (ii) Japan, (iii) China, (iv) South Korea and (v) Germany. These countries have been identified as large-scale geographies where we believe the greatest opportunities for growth exist. We are also focusing our marketing efforts on these countries in an effort to increase customer awareness of both our brand and our full product range. +2 +Table of Contents +We have three primary sales channels: wholesale, which includes distributors, Crocs owned retail, and Crocs e-commerce (discussed in more detail below). Our marketing efforts are aimed at driving business to both our wholesale partners and our company-operated Crocs retail stores and e-commerce sites. Our marketing efforts in the wholesale and retail channels are focused on social and digital outreach to consumers to shop and visual merchandising. Company operated retail stores provide a unique opportunity to engage with consumers at a deeper level by showcasing our full assortment of molded and casual footwear. No single wholesale customer accounted for 10% or more of our revenues for any of the years ended December 31, 2016 , 2015 , and 2014 . +Wholesale Channel +During the years ended December 31, 2016 , 2015 , and 2014 , approximately 52.7%, 54.2% and 55.7% of revenues, respectively, were derived through the wholesale channel which consists of distributors and third-party retailers. Wholesale customers include family footwear retailers, national and regional retail chains, sporting goods stores, independent footwear retailers as well as e-tailers. +Many of our agreements allow us to accept returns from wholesale customers for defective products, on an exception basis, and to extend pricing discounts in lieu of such returns. We also may accept returns from our wholesale customers, on an exception basis, for the purpose of stock re-balancing, to ensure that our products are merchandised in the proper assortments. +Outside the United States, in addition to wholesale customers, we use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years, are generally terminable upon 30 days prior notice, and have minimum sales requirements that allow us to terminate or renegotiate the contract if minimum requirements are not met. +Retail Channel +During the years ended December 31, 2016 , 2015 , and 2014 , approximately 34.7%, 34.7%, and 35.5%, respectively, of our revenues were derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full-price retail locations, outlet locations, kiosk and store-in-store locations. Our three types of store platforms enable us to promote the breadth of our product offering in high-traffic, highly visible locations. With the worldwide consumer shift in shopping patterns out of traditional retail to e-commerce, we are focused on carefully managing and reducing our physical retail portfolio. We intend to continue to moderate the pace of our retail expansion in 2017 with a focus on outlet locations as well as enhancing the profitability of existing locations. We opened 83 company-operated stores during the year ended December 31, 2016 and closed 84 company-operated stores. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +Full-Price Retail Locations +Our company-operated full-price retail locations allow us to effectively showcase the full extent of our product ranges to consumers. In addition, our full-price retail locations provide us with the opportunity to interact with our consumers directly. The optimal space for our retail locations is between approximately 1,500 and 1,800 square feet, and is located in high-traffic shopping malls or districts. During the year ended December 31, 2016, we closed 66 stores and opened 19 new full-price retail stores. As of December 31, 2016 , 2015 , and 2014 , we operated 228 , 275, and 311 full-price retail stores, respectively. +Outlet Locations +Our company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built for outlet products in certain locations. Outlet locations are similar in size to our full-price retail stores; however, they are generally located within outlet shopping centers. During the year ended December 31, 2016, we closed four outlet locations and opened 50 outlet locations. As of December 31, 2016 , 2015 , and 2014 , we operated 232 , 186, and 174 outlet stores, respectively. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other high foot traffic areas. With efficient use of retail space, and limited capital investment, we believe that kiosks and store-in-store locations can be an effective vehicle for marketing our products where this business model is applicable. During the year ended December 31, 2016 , we closed 14 kiosk and store-in-store locations and opened 14 new kiosk and store-in-store locations. As of December 31, 2016 , 2015 , and 2014 , we operated 98 , 98, and 100 kiosks and store-in-stores, respectively. +3 +Table of Contents +The following table illustrates the net change in 2016 with respect to the number of our company-operated retail locations by reportable operating segment and country: +Company-Operated Retail Locations +December 31, 2015 +Opened +Closed +December 31, 2016 +Americas +United States +179 +7 +12 +174 +Canada +10 +— +— +10 +Puerto Rico +7 +— +1 +6 +Total Americas +196 +7 +13 +190 +Asia Pacific +Korea +84 +9 +6 +87 +Japan +52 +1 +4 +49 +China +55 +43 +19 +79 +Hong Kong +21 +5 +9 +17 +Singapore +15 +3 +— +18 +Australia +11 +5 +8 +8 +United Arab Emirates +14 +1 +3 +12 +South Africa +9 +— +9 +— +Total Asia Pacific +261 +67 +58 +270 +Europe +Russia +37 +2 +3 +36 +Germany +18 +— +— +18 +Great Britain +10 +— +3 +7 +France +12 +— +2 +10 +Netherlands +6 +— +1 +5 +Finland +5 +— +1 +4 +Spain +6 +— +1 +5 +Austria +— +7 +1 +6 +Other +8 +— +1 +7 +Total Europe +102 +9 +13 +98 +Total +559 +83 +84 +558 +_______________________________________________________________________________ +E-commerce Channel +As of December 31, 2016 , we offered our products through 12 company-operated e-commerce sites worldwide. We also offer our products through third-party e-commerce sites. Revenues from third-party e-commerce sites are reported in our wholesale channel. During the years ended December 31, 2016 , 2015 , and 2014 , approximately 12.6% , 11.1% and 8.8%, respectively, of our revenues were derived from sales through our e-commerce channel. Our e-commerce presence enables us to have increased access to our consumers and provides us with an opportunity to educate them about our products and brand. Improving our e-commerce capabilities is one of our key growth strategies. We will continue to improve our consumer's online experience, and our in stock reliability and will look for new ways to leverage digital technologies to connect with consumers, including mobile optimization of our sites. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and Europe. We also have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable operating segment threshold, including manufacturing operations located in Mexico and Italy, and corporate operations. See additional discussion of our segments and geographic information, including results of operations and assets by segment and geography in Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II — Item 8. Financial Statements and Supplementary Data of this Annual Report. +4 +Table of Contents +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in North and South America. Regional wholesale channel customers consist of a broad range of family footwear, sporting goods and e-tailers as well as independent retailers and distributors. The Americas retail channel sells directly to consumers through 190 company-operated retail store locations in the Americas as well as through e-commerce sites. During the years ended December 31, 2016 , 2015 , and 2014 , revenues from the Americas segment were approximately 45.1%, 43.7%, and 40.9% of our consolidated revenues, respectively. Specifically, revenues from the United States were approximately 37.1%, 35.8%, and 36.3% of our consolidated revenues, respectively, for the years ended December 31, 2016 , 2015 , and 2014 . +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, Africa and the Middle East. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell products directly to consumers through 270 company-operated retail stores located in Asia as well as through our e-commerce sites. During the years ended December 31, 2016 , 2015 , and 2014 , revenues from our Asia Pacific segment were 38.1%, 39.0%, and 39.6%, of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Western Europe, Eastern Europe and Russia. The Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell our products directly to consumers through 98 company-operated retail stores located in Europe as well as through our e-commerce sites. During the years ended December 31, 2016 , 2015 , and 2014 , revenues from the Europe segment were 16.7 %, 17.3%, and 19.5% of our consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. During the year ended December 31, 2016, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Russia, and Italy. We also utilize third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico, and Italy. As of December 31, 2016, our company-operated warehouse and distribution facilities provided us with approximately 0.9 million square feet and our third-party operated distribution facilities provided us with approximately 0.5 million square feet. We also ship a portion of our products directly to our wholesale customers from our internal and third-party manufacturers. +Raw Materials +Croslite, our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our accessories. Croslite is soft, durable, and allows our products to be non-marking and extremely lightweight. Croslite is carefully formulated to create extremely lightweight, odor-resistant, water-resistant and non-marking footwear that conforms to the shape of the foot and increases comfort. +We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. +Croslite material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other production inputs such as color dyes. We have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may also in the future identify and utilize materials produced by other suppliers as an alternative to, or in addition to, the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to produce the Croslite products are readily available for purchase from multiple suppliers. +Since our inception in 2002, we have substantially increased the number of footwear products we offer. Many of these new products are constructed using leather, textile fabrics, or other non-Croslite materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. We also outsource the compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third-party in Europe. +5 +Table of Contents +Research, Design and Development +We continue to dedicate significant resources to product design and development as we expand the footwear styles we offer based on opportunities we identify in the marketplace. Our design and development process is highly collaborative and we continually strive to improve our development function so we can bring products to market quickly and at reduced costs, while maintaining product quality. We spent $11.9 million, $14.0 million, and $16.7 million in research, design, and development activities for the years ended December 31, 2016 , 2015 , and 2014 , respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or to provide support to our internal production processes. +In the years ended December 31, 2016 , 2015 , and 2014 , we manufactured approximately 14.6%, 11.3%, and 13.9%, respectively, of our footwear products internally. We sourced the remaining footwear production from multiple third-party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2016 , 2015 , and 2014 , our largest third-party manufacturer in China produced approximately 23.4%, 26.6%, and 27.5%, respectively, of our third-party footwear unit volume. We do not have written supply agreements with our primary third-party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress and patent protections to establish, protect and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks and copyrights are crucial to the successful marketing and sale of our products. We will continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We also intend to continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formula by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter are typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our product line to include more winter oriented styles to reduce the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions, or general economic conditions, or consumer confidence. Accordingly, +6 +Table of Contents +results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders, and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules and the timing of product shipments. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model differences around the globe, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to, Nike Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as Genesco, Inc., Macy's Inc., Dillard's, Inc., Dick's Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, pricing, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite material, our prices, our expanded product line, and our distribution network continue to position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new companies who have been attracted to the market with products similar to ours as the result of the unique design and success of our footwear products. +Foreign Currency Fluctuations on Revenues and Net Income (Loss) +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiary’s functional currency. Likewise, our U.S. companies are also exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar. +We have experienced, and will continue to experience, changes in international currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings. +Changes in exchange rates have a direct effect on our reported U.S. Dollar consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the U.S. Dollar reporting currency using average exchange rates each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly by differences in the exchange rates used to translate the operating results of our international subsidiaries. +For example, in our European segment, when the U.S. Dollar strengthens relative to the Euro, our reported U.S. Dollar results are less than if there had been no change in the exchange rate, because more Euros are required to generate the same U.S. Dollar translated amount. Conversely, when the U.S. Dollar weakens relative to the Euro, the reported U.S. Dollar results of our Europe segment are higher compared to a period with a stronger U.S. Dollar relative to the Euro. Similarly, the reported U.S. Dollar results of our Asia Pacific segment, where the functional currencies are primarily the Japanese Yen, Chinese Yuan, Korean Won and the Singapore Dollar, are comparatively lower or higher when the U.S. Dollar strengthens or weakens, respectively, relative to these currencies. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Form 10-K for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar consolidated statements of operations for the years ended December 31, 2016 and 2015. +7 +Table of Contents +Employees +As of December 31, 2016 , we had approximately 5,068 full-time, part-time, and seasonal employees, of which approximately 3,390 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended . These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained at www.sec.gov or at the SEC's public reference room at 100 F Street, N.E., Washington, D.C. 20549. Copies of any of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +8 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2016/0001628280-17-002068/item13.txt b/raw/filings/0001334036/2016/0001628280-17-002068/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..5e11e4d9b0ab98cf4b3ce7d79c79e4c411062d84 --- /dev/null +++ b/raw/filings/0001334036/2016/0001628280-17-002068/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2017 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2016 . \ No newline at end of file diff --git a/raw/filings/0001334036/2016/0001628280-17-002068/item9a.txt b/raw/filings/0001334036/2016/0001628280-17-002068/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..88f2b0d8dba97c66e08dbe663b029bb30a695f86 --- /dev/null +++ b/raw/filings/0001334036/2016/0001628280-17-002068/item9a.txt @@ -0,0 +1,20 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange Act"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2016, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management's control objectives. +Management's Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2016, based on the framework and criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2016. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2016, as stated in the report which appears herein. +Changes in Internal Controls over Financial Reporting +During 2016, the Company completed a number of initiatives designed to remediate certain material weaknesses with respect to internal controls over the Company's financial close process and inventory. Specifically, management completed the following with respect to its internal controls. +Financial Close Process. +The Company implemented internal control procedures over the financial close process, including: (i) added internal control review and documentation procedures that ensure that all manual journal entries, including deferred income tax and period end adjusting entries, are properly documented and reviewed by competent personnel; (ii) global account reconciliation procedures that ensure all key accounts are properly reconciled on a timely basis, documented and reviewed by competent personnel; (iii) hired personnel with the requisite skills in income taxes and accounting; (iv) improved the organizational structure of our tax and accounting departments; and (v) provided training to global accounting process owners on policies and controls over account analysis, documentation, review, and approval of manual journal entries, and data integrity procedures. +Inventory Accounting Controls . +The Company implemented internal control procedures over inventory accounting controls, including: (i) additional procedures to ensure all inventory physical observations and counts are performed timely, all resulting adjustments are recorded and appropriately documented in our inventory management system; (ii) additional inventory reconciliation procedures to ensure our inventory management system is appropriately reconciled to the general ledger on a regular basis; (iii) improvements to our analysis +61 +Table of Contents +of inventory cost absorption to ensure the proper valuation; (iv) provided training to our supply chain personnel to ensure appropriate understanding of our inventory policies and procedures including the importance of timely and accurate recording; and (v) hired additional personnel to our inventory management team to implement and maintain our inventory accounting controls. +As described above in “Management’s Annual Report on Internal Control Over Financial Reporting”, the Company concluded that its internal control over financial reporting was effective as of December 31, 2016 based, in part, on the effectiveness of the changed and new controls implemented during 2016 as described above. +Other than the changes described above, there have been no changes in our internal controls over financial reporting (as defined in Rule 13(a)-15(f) of the Exchange Act) during the year ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. +62 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2016/0001628280-17-002068/rp_note.txt b/raw/filings/0001334036/2016/0001628280-17-002068/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2016/0001628280-17-002068/rpt_disclosure.txt b/raw/filings/0001334036/2016/0001628280-17-002068/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..32a727f721b9aff086b8289b2a55ce7eaf7d9303 --- /dev/null +++ b/raw/filings/0001334036/2016/0001628280-17-002068/rpt_disclosure.txt @@ -0,0 +1,78 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Investment Agreement with Blackstone +On January 27, 2014, we issued to Blackstone and certain of its permitted transferees (together with Blackstone, the "Blackstone Purchasers"), 200,000 +shares of our Series A convertible preferred stock for an aggregate purchase price of $198 million, or $990 per share, pursuant to the Investment Agreement. In connection with the +issuance of the convertible preferred stock (the "Closing") and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2 million and reimbursed Blackstone's transaction fees +and expenses of approximately $4 million. As of March 31, 2017, the Blackstone Purchasers collectively owned all of our outstanding shares of convertible preferred stock and, on an +as-converted basis, approximately 15.7% of our outstanding common stock. Mr. Ribatt was a permitted transferee of Blackstone and purchased 1,000 shares of our Series A convertible +preferred stock. +As +discussed above under "Proposal 1 - Election of Directors," the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as the +Blackstone Purchasers (i) beneficially own at least 95% of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement or +(ii) maintain beneficial ownership of at least 12.5% of the our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors +to our Board. For so long as the Blackstone Purchasers beneficially own shares of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement that +represent less than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right +to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject +to applicable law and stock exchange rules. Blackstone's ownership currently exceeds the Two-Director Threshold. Blackstone designated Messrs. Melwani and Giordano for nomination to our Board +and had previously nominated Mr. Ribatt. +Pursuant +to the Investment Agreement, Blackstone is subject to certain standstill restrictions which generally restrict Blackstone from acquiring more than 25% of our outstanding common stock until +the date on which Blackstone is no longer entitled to designate any directors to our Board. In addition, subject to certain customary exceptions, Blackstone was restricted from transferring any shares +of the convertible preferred stock until the second anniversary of the Closing and, for so long as any convertible preferred stock is outstanding, may not transfer any shares of convertible preferred +stock to certain of our competitors (as defined in the Investment Agreement) or holders of 25% or more of our common stock. Blackstone also has certain preemptive rights and information rights under +the Investment Agreement, which are subject to certain conditions. +Certificate of Designations +Pursuant to the Certificate of Designations of Series A Convertible Preferred Stock filed with the Delaware Secretary of State on January 24, +2014, which establishes the designations, preferences, and other rights of the convertible preferred stock: +• The convertible preferred stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and +dissolution; +• The Blackstone Purchasers are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value of +$1,000 per share; +21 +Table of Contents +• If we fail to make timely dividend payments to the holders of our convertible preferred stock, the dividend rate will increase to 8% per annum +until such time as all accrued but unpaid dividends have been paid in full; +• The Blackstone Purchasers are entitled to receive any dividends declared or paid on our common stock and are entitled to vote together with the +holders of our common stock as a single class, in each case, on an as-converted basis; +• The Blackstone Purchasers have certain limited special approval rights, including with respect to the issuance by us of pari passu or senior equity securities; +• The Blackstone Purchasers may, at any time, require us to convert their shares of convertible preferred stock into shares of common stock at an +implied conversion price of $14.50 per share, subject to certain adjustments; +• At our election, all or a portion of the convertible preferred stock will be convertible into the relevant number of shares of common stock on +or after the third anniversary of the Closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days; +• The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share caps and other restrictions; +• At any time after the eighth anniversary of the Closing, we will have the right to redeem, and the Blackstone Purchasers will have the right to +require us to repurchase, all or any portion of the convertible preferred stock at 100% of the stated value, plus all accrued but unpaid dividends; and +• Upon certain change in control events involving us, the Blackstone Purchasers can require us to repurchase their shares of convertible +preferred stock at 101% of the stated value plus all accrued but unpaid dividends. +Registration Rights Agreement +In connection with the Closing, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the "Registration Rights Agreement"), pursuant +to which we have agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of the shares of convertible preferred stock and any shares of +common stock issued upon conversion of the convertible preferred stock. The Registration Rights Agreement contains customary terms and conditions, including certain customary indemnification +obligations. +RGIS Services +We receive inventory count services from RGIS, LLC ("RGIS"), an affiliate of Blackstone. During 2016, we paid RGIS approximately $400,000 for inventory +services received. +Optiv, Inc. +We received cyber security and consulting services from Optiv, Inc. ("Optiv"), an affiliate of Blackstone. During 2016, we paid Optiv approximately +$200,000 for such services. +Kronos Incorporated +We received workforce management services from Kronos Incorporated ("Kronos"), an affiliate of Blackstone. During 2016, we paid Kronos approximately $200,000 +for such services. +22 +Table of Contents +Policy on Transactions with Related Persons +Our Code of Business Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, +or greater than five percent stockholders, or one of the aforementioned's immediate family members (each, a "related person"), have a material interest be approved or ratified by the Audit Committee +if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of +business transactions in which directors have an interest as part of the Board's annual director independence review, and our Code of Business Conduct and Ethics permits the full Board to waive any +conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems +appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. The full Board approved each of the transactions disclosed above. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate of +incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' fees), judgments, fines +and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, +arising out of such person's services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We +believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +23 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2017/0001628280-18-002437/filing.txt b/raw/filings/0001334036/2017/0001628280-18-002437/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..89b69d8baf2b33bc4b33b30beedaf41d077e8572 --- /dev/null +++ b/raw/filings/0001334036/2017/0001628280-18-002437/filing.txt @@ -0,0 +1,5261 @@ +10-K +1 +crox201712311710-k.htm +10-K +Document +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +________________________________________________________________________________________________________________________________ +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2017 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer +Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K. o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company or emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer o +Accelerated filer ý +Non-accelerated filer o +(do not check if a +smaller reporting company) +Smaller reporting company o +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2017 was approximately $432.1 million . For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock outstanding as of February 20, 2018 was 68,830,820 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2018 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2017 . +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding: +• +our expectations regarding future trends, expectations, and performance of our business; +• +our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• +our expectations about the impact of our strategic plans; and +• +our expectations regarding our level of capital expenditures in 2018 +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I — Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this report, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. +i +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2017 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +9 +Item 1B. +Unresolved Staff Comments +21 +Item 2. +Properties +22 +Item 3. +Legal Proceedings +22 +Item 4. +Mine Safety Disclosures +22 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +23 +Item 6. +Selected Financial Data +25 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +27 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +45 +Item 8. +Financial Statements and Supplementary Data +46 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +46 +Item 9A. +Controls and Procedures +46 +Item 9B. +Other Information +48 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +49 +Item 11. +Executive Compensation +49 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +49 +Item 13. +Certain Relationships and Related Transactions and Director Independence +50 +Item 14. +Principal Accounting Fees and Services +50 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +51 +Item 16. +Form 10-K Summary +56 +Signatures +57 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, manufacturing, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. All of our products utilize our proprietary closed-cell resin, called Croslite TM , along with a range of other materials. Our Croslite TM material enables us to produce innovative, lightweight footwear. The Company, a Delaware corporation, is the successor to a Colorado corporation of the same name, and was originally organized in 1999 as a limited liability company. +Products +Our product offerings have grown significantly since we first introduced the single-style clog in six colors in 2002. Recognized across the world for our iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals, flips and slides, shoes, and boots that meet the needs of the whole family. +At the heart of our brand are the Classic and Crocband clogs, our most iconic styles for adults and children - products that embody our innovation in molding, simplicity of design, and all-day comfort. A key differentiating feature of our footwear products is our proprietary closed-cell resin Croslite TM material, which is uniquely suited for comfort and functionality. The unique look and feel of the Classic clog can be experienced throughout our entire product line due to the use and design of Croslite TM . For further information on Croslite TM , see ‘Raw Materials’ below. +We strive to provide our global consumer with comfortable, casual, colorful, and innovative footwear styles. Our collections are designed to meet the needs of the family by focusing on key wearing occasions. Our goal is to deliver casual product assortments with all of the comfort, features, and benefits Crocs is known for. We enjoy licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Sales and Marketing +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. Our marketing efforts center on presenting our clog and sandal silhouettes. For the years ended December 31, 2017 , 2016 , and 2015 , total marketing costs, inclusive of advertising, production, promotional, and agency expenses, were approximately $59.1 million , $56.0 million , and $58.2 million , respectively. +We run our business across three major geographic regions: the Americas, Asia Pacific, and Europe, which are discussed in more detail in ‘Business Segments and Geographic Information’ below. We prioritize five core markets including: (i) the United States, (ii) Japan, (iii) China, (iv) South Korea and (v) Germany. These countries have been identified as large-scale geographies where we believe the greatest opportunities for growth exist. We are also concentrating our marketing efforts on these countries, in an effort to increase customer awareness of both our brand and our full product range. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 90 countries, primarily through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic wholesalers as well as international wholesalers and distributors; our retail channel includes company-operated stores; and our e-commerce channel includes company-operated e-commerce sites. +Wholesale Channel +During the years ended December 31, 2017 , 2016 , and 2015 , approximately 52.4% , 52.7%, and 54.2% of revenues, respectively, were derived through our wholesale channel. Wholesale customers include family footwear retailers, national and regional retail chains, sporting goods stores, independent footwear retailers, and e-tailers. +2 +Table of Contents +Outside the United States, in addition to wholesale customers, we use distributors in select markets where we believe such arrangements are preferable to direct sales. These distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and have minimum purchase requirements that allow us to terminate or renegotiate the contract if such minimum requirements are not met. No single wholesale customer accounted for 10% or more of our revenues for any of the years ended December 31, 2017 , 2016 , and 2015 . +Retail Channel +During the years ended December 31, 2017 , 2016 , and 2015 , approximately 33.0% , 34.7%, and 34.7%, respectively, of our revenues were derived from sales through our retail channel. We operate our retail channel through three platforms: company-operated full-price retail and outlet stores, kiosks, and store-in-store locations, which enable us to promote the breadth of our product offering in high-traffic, high-visibility locations. With the worldwide consumer shift toward e-commerce, we are carefully managing and reducing our retail fleet, especially full-priced retail stores, and focusing on enhancing the profitability of this channel. We opened 19 company-operated stores during the year ended December 31, 2017 and closed 130 company-operated stores, including 37 transfers of company-operated stores to distributors. This activity is being taken in connection with the store reduction plan announced early in 2017, pursuant to which we intend to reduce our net retail store count by 160 as of December 31, 2018, compared to December 31, 2016. +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product ranges to consumers and provide us with the opportunity to interact with our consumers directly. The optimal space for our retail stores is between approximately 1,500 and 1,800 square feet, and is located in high-traffic shopping malls or districts. During the year ended December 31, 2017 , we closed 73 and opened 6 full-price retail stores. As of December 31, 2017 , 2016 , and 2015 , we operated 161, 228, and 275 full-price retail stores, respectively. This net reduction of 67 company-operated full-price retail stores during the year ended December 31, 2017 is in line with our continued focus on rationalization of our retail store fleet. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products in certain stores. Outlet stores are similar in size to our full-price retail stores; however, they are generally located within outlet shopping centers. During the year ended December 31, 2017 , we closed 30 outlet stores and opened 13 outlet stores. As of December 31, 2017 , 2016 , and 2015 , we operated 215, 232, and 186 outlet stores, respectively. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other high foot traffic areas. With efficient use of retail space, and limited capital investment, we believe that kiosks and store-in-store locations can be an effective vehicle for marketing our products in certain geographic areas. During the year ended December 31, 2017 , we closed 27 kiosk and store-in-store locations and opened no new kiosk and store-in-store locations. As of December 31, 2017 , 2016 , and 2015 , we operated 71, 98, and 98 kiosks and store-in-store locations, respectively. +3 +Table of Contents +Company-Operated Retail Stores +The following table illustrates the net change in 2017 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2016 +Opened +Closed/Transferred (1) +December 31, 2017 +Americas +United States +174 +2 +15 +161 +Canada +10 +— +1 +9 +Puerto Rico +6 +— +1 +5 +Total Americas +190 +2 +17 +175 +Asia Pacific +Korea +87 +4 +5 +86 +China +79 +9 +46 +42 +Japan (2) +44 +— +24 +30 +20 +Hong Kong +17 +1 +3 +15 +Singapore +18 +— +4 +14 +Australia (2) +13 +— +4 +9 +United Arab Emirates +12 +1 +13 +— +Total Asia Pacific +270 +15 +99 +186 +Europe +Russia +36 +1 +1 +36 +Germany +18 +— +3 +15 +France +10 +— +— +10 +Austria +6 +— +— +6 +Netherlands +5 +1 +2 +4 +Spain +5 +— +1 +4 +Great Britain +7 +— +4 +3 +Finland +4 +— +1 +3 +Other +7 +— +2 +5 +Total Europe +98 +2 +14 +86 +Total +558 +19 +130 +447 +(1) We completed the transfer of 37 company-operated stores in the Middle East and China to distributors during the period. +(2) We reclassified five stores between Australia and Japan as of December 31, 2016. +E-commerce Channel +As of December 31, 2017 , we offered our products through 13 company-operated e-commerce sites worldwide. During the years ended December 31, 2017 , 2016 , and 2015 , approximately 14.6% , 12.6%, and 11.1%, respectively, of our revenues were derived from sales through our e-commerce channel. Our e-commerce presence enables us to have increased access to our consumers and provides us with an opportunity to educate them about our products and brand. Improving our e-commerce capabilities is one of our key growth strategies, as we continue to leverage increasingly sophisticated digital technologies to enhance the consumer experience and drive sales. We also offer our products through third-party e-commerce sites (e-tailers) and marketplaces. Revenues from third-party e-commerce sites and marketplaces where we have a wholesale relationship are reported in our wholesale channel. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and Europe. Other businesses aggregates insignificant operating segments that do not meet the reportable operating segment threshold, including company-operated manufacturing facilities located in Mexico and Italy as well as corporate operations. See additional discussion of our segments and geographic information, including results of operations and assets by segment and geography in Note 14 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +4 +Table of Contents +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in North and South America. Regional wholesale channel customers consist of a broad range of family footwear and sporting goods stores, e-tailers, and independent retailers and distributors. The Americas retail channel sells directly to consumers through 175 company-operated retail stores in the Americas as well as through our e-commerce site. During the years ended December 31, 2017 , 2016 , and 2015 , revenues from the Americas segment were approximately 46.9% , 45.1%, and 43.7% of our consolidated revenues, respectively. Specifically, revenues from the United States were approximately 38.0% , 37.1% , and 35.8% of our consolidated revenues, respectively, for the years ended December 31, 2017 , 2016 , and 2015 . +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, Africa, and the Middle East. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell products directly to consumers through 186 company-operated retail stores located in Asia Pacific as well as through our e-commerce sites. During the years ended December 31, 2017 , 2016 , and 2015 , revenues from our Asia Pacific segment were 36.1% , 38.1%, and 39.0% of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Western Europe, Eastern Europe, and Russia. The Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell our products directly to consumers through 86 company-operated retail stores located in Europe as well as through our e-commerce sites. During the years ended December 31, 2017 , 2016 , and 2015 , revenues from the Europe segment were 16.9% , 16.7 %, and 17.3% of our consolidated revenues, respectively. +Raw Materials +Croslite TM , our branded proprietary closed-cell resin, is the primary material formulation used in the majority of our footwear and some of our accessories. Croslite TM material is formulated to create soft, durable, extremely lightweight, water-resistant footwear that increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. +Croslite TM material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other production inputs such as color dyes. We have identified multiple suppliers that produce the elastomer resins used in the Croslite TM material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to produce Croslite TM products are readily available for purchase from multiple suppliers. +Since our inception in 2002, we have increased the number of footwear products we offer, and some of these products are constructed using leather, textile fabrics, or other non-Croslite TM materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. +Research, Design, and Development +We continue to leverage our expertise and innovation in injection molding to create a fresh, distinctive point of view in the casual footwear market and to deliver a winning combination of comfort, style, value and versatility to our consumer. We dedicate significant resources to product design and development based on opportunities we identify in the marketplace. Our design and development process is highly collaborative and we continually strive to improve our development function so we can bring products to market quickly, while maintaining product quality. We spent $13.4 million , $11.9 million , and $14.0 million on research, design, and development activities for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally-diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We contract with third-party manufacturers to produce certain of our footwear styles. +5 +Table of Contents +In the years ended December 31, 2017 , 2016 , and 2015 , we manufactured approximately 13.4%, 14.6%, and 11.3%, respectively, of our footwear products internally. We sourced the remaining footwear production from multiple third-party manufacturers primarily in China and Vietnam. During the years ended December 31, 2017 , 2016 , and 2015 , our largest third-party manufacturer, operating in both China and Vietnam, produced approximately 41.3%, 43.2%, and 47.5%, respectively, and our second largest third-party manufacturer, operating in Vietnam, produced approximately 19.0%,11.5%, and 9.4%, respectively, of our third-party footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. During the year ended December 31, 2017 , we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Russia, and Italy. We also utilized third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Russia, Brazil, Puerto Rico, and Italy. As of December 31, 2017 , our company-operated warehouse and distribution facilities provided us with approximately 0.9 million square feet and our third-party operated distribution facilities provided us with approximately 0.2 million square feet. We also ship a portion of our products directly to our wholesale customers from our internal and third-party manufacturers. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We will continue to strategically register, both domestically and internationally, the trademarks and patents covering the product designs and branding that we utilize today and those we develop in the future. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials covered by our trademark Croslite TM and used to produce our shoes, to be a valuable trade secret. The Croslite TM material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of shoes. We believe the comfort and utility of our products depend on the properties achieved from the compounding of the Croslite TM material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter are typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other +6 +Table of Contents +factors, including the timing of new model introductions, general economic conditions, and consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders, and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules and the timing of product shipments. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model differences around the globe, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: Nike Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with footwear retailers such as Genesco, Inc., Macy’s Inc., Dillard’s, Inc., Dick’s Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, pricing, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite TM material, our prices, our product line, and our distribution network continue to position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. Furthermore, we face competition from new companies which have been attracted to the market with products similar to ours as the result of the unique design and success of our footwear products. +Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar. +We have experienced, and will continue to experience, changes in international currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that they occur. +Changes in exchange rates have a direct effect on our reported U.S. Dollar consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the U.S. Dollar reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates used to translate the operating results of our international subsidiaries. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar consolidated statements of operations for the years ended December 31, 2017 , 2016 , and 2015 . +7 +Table of Contents +Employees +As of December 31, 2017 , we had approximately 4,382 full-time, part-time, and seasonal employees, of which approximately 2,808 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained at www.sec.gov or at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. Copies of any of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +8 +Table of Contents +ITEM 1A. Risk Factors +The reader should carefully consider the following risk factors and all other information presented within this report. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, or access to sources of financing. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to predict all risk factors, nor can it assess the impact of all such risk factors on our business. You should carefully consider each of the following risks described below in conjunction with all other information presented in this report. +Risks Specific to Our Company +Our success depends substantially on the value of our brand and failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs global brand. To be successful in the future, particularly outside of the U.S., where the Crocs global brand is less well-known and perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brand across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be out of style, outdated, or otherwise undesirable. Brand value is based in part on consumer perceptions on a variety of subjective qualities. In the past, several footwear companies including ours have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Consumer demand for our products and our brand equity could also diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. Business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brand and adversely impact our business. +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast geographic demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to: +• +Strengthen our brand globally; +• +Focus on relevant geographies and markets, product innovation and profitable new growth platforms while maintaining demand for our current offerings; +• +Effectively manage our company-operated retail stores (including closures of existing stores) while meeting operational and financial targets at the retail store level; +• +Successfully implement our previously identified $75 to $85 million annual selling, general and administrative reduction plan; +• +Accurately forecast the global demand for our products and the timely execution of supply chain strategies to deliver product around the globe efficiently based on that demand; +• +Use and protect the Crocs brand and our other intellectual property in new markets and territories; +• +Achieve and maintain a strong competitive position in new and existing markets; +• +Attract and retain qualified wholesalers and distributors; +• +Consolidate our distribution and supply chain network to leverage resources and simplify our fulfillment process; and +9 +Table of Contents +• +Execute multi-channel advertising and marketing campaigns to effectively communicate our message directly to our consumers and employees. +If we are unable to successfully implement any of the above mentioned strategies and the many other factors mentioned throughout these risk factors, our business may fail to grow, our brand may suffer, and our business and financial results may be adversely impacted. +There can be no assurance that the strategic plans we have begun to implement will be successful. +We believe our strategic initiatives will better position Crocs to adapt to changing consumer demands and global economic developments. We are focusing on our core molded footwear heritage by narrowing our product line with an emphasis on higher margin units, as well as developing innovative new casual lifestyle footwear platforms. By streamlining the product portfolio and reducing non-core product development, we believe we will create a more powerful consumer connection to the brand. +We are refining our business model around the world by prioritizing direct investment in larger-scale geographies to focus our resources on the demographics with the largest growth prospects, moving away from direct investment in the retail and wholesale businesses in smaller markets, and transferring significant commercial responsibilities to distributors in smaller markets and in markets where local expertise is advantageous. Further, we intend to expand our engagement with leading wholesale accounts in select markets to drive sales growth, optimize product placement and enhance brand reputation. +In 2017 we identified annual reductions in SG&A in the amount of $75 to $85 million which, once implemented, are projected to generate an annual $30 to $35 million improvement in earnings before interest and taxes by 2019, compared to 2016. We achieved approximately $23 million of these SG&A reductions in 2017 while incurring approximately $10 million of costs to re-set our variable compensation. We remain on track to achieve the targeted SG&A reductions by 2019. We incurred $11 million in non-recurring charges to achieve these SG&A reductions in 2017 and expect to incur approximately $5 million in non-recurring charges in 2018, for a total of $16 million of non-recurring charges associated with our SG&A reduction plan. We reduced our company-operated retail stores in 2017 by 111 and anticipate an additional reduction of approximately 50 company-operated retail stores in 2018, thereby reducing our total store count to approximately 400 from 558 over a two year period. The majority of company-operated store closures are occurring as store leases expire. +While these strategic plans, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance that this will be the case, or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +If our online e-commerce sites do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites as well as third-party e-commerce sites. Any failure on our part or third-parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our merchandise could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, and spend substantially more than we do on product marketing. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, launch more extensive or diverse product lines and more quickly develop new products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +10 +Table of Contents +Refining our footwear product line may be difficult and expensive. If we are unable to do so successfully, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully refine our footwear product line, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. Our development schedules for new products are difficult to predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles and product lines and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We have a limited history of introducing new products in certain target markets; as such, we may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses and there can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position and result in long-term harm to our business and financial results. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions and other factors affecting consumer demand. In addition, sales to our wholesale customers are generally subject to rights of cancellation and rescheduling by the customer. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages which can result in lower sales, delays in shipments to customers, expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. A decline in demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our financial success may be limited to the strength of our relationships with and the success of our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributors customers to carry our products. We do not have long-term contracts and sales to our wholesalers and distributors are generally on an order-by-order basis and subject to cancellation and rescheduling. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses and reduced cash flows if our collection efforts are unsuccessful. For example, we recorded an increase in allowance for doubtful accounts receivable in 2015, primarily as a result of delayed payments and payment defaults from certain distributor partners in China. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations and our ability to grow our product line. +Changes in foreign exchange rates, most significantly but not limited to the Singapore Dollar, Chinese Yuan, Japanese Yen, Korean Won, and the Euro could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar (“USD”). We pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. Our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, product price pressures, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to +11 +Table of Contents +finance. In 2017 , we experienced a decrease of approximately $1.2 million in our Asia Pacific segment revenues as a result of increases in the value of Asian currencies relative to the USD, and an increase of approximately $4.4 million in our Europe revenues as a result of increases in the Euro and Russian Ruble relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies would adversely impact our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and as a result our forward contracts may not prove effective in reducing our exposures. +We conduct significant business activity outside the U.S. which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. In addition to foreign manufacturing, we operate retail stores and sell our products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks including: tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; delays associated with the manufacture, transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to increased security concerns; restrictions on the transfer of funds; restrictions, due to privacy laws, on the handling and transfer of consumer and other personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; expropriation and nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions; longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; difficulties in enforcing contractual and intellectual property rights; greater risk that our business partners do not comply with our policies and procedures relating to labor, health and safety; and increased accounting and internal control costs. In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we operate. We cannot assure that there will be not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. For example, the European Union’s new General Data Protection Regulation, or similar evolving privacy laws in other jurisdictions, may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. +In addition, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries and a materially negative effect on our brands and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners or agents will not violate our policies. +Uncertainty about current and future global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, or other economic factors. If global economic and financial market conditions deteriorate or remain weak for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +12 +Table of Contents +• +Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results. +• +Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, cause reduced product orders or product order cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• +If consumer demand for our products declines, we may not be able to profitably establish new retail stores, or continue to operate existing stores, due to higher fixed costs of the retail business. +• +A decrease in credit available to our wholesale or distributor customers, product suppliers and other service providers, or financial institutions that are counterparties to our credit facility or derivative instruments may result in credit pressures other financial difficulties or insolvency for these parties, with a potential adverse impact on our ability to obtain future financing, our business and our financial results. +• +If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment by our wholesalers. +• +If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +Opening company-operated global retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2017, we opened, closed, and operated 19, 130, and 447 retail stores, respectively. +Although our strategic plan initiatives include a net reduction in our retail sales channel, we intend to continue to open new retail locations globally. Our ability to open new stores, including kiosks and store-in-store locations, successfully depends on our ability to identify suitable store locations, negotiate acceptable lease terms, hire, train, and retain store personnel and satisfy the fashion preferences in new geographic areas. Many of our company-operated retail stores are located in shopping malls and outlet malls and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick and mortar retail to e-commerce channels, which may contribute to declining foot traffic in company-operated retail locations. Continued reduced customer foot traffic could reduce sales at our company-operated retail stores or hinder our ability to open retail stores in new markets, which could in turn negatively affect our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, terrorism, social or military events or otherwise, is likely to adversely affect sales in our existing stores. +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows or the closure of a store could result in impairment of leasehold improvements, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. For example, during 2017, 2016, and 2015, we recorded impairments of which $0.5 million , $2.7 million , and $9.6 million , respectively, related to our retail stores. These impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +13 +Table of Contents +We depend heavily on third-party manufacturers located outside the U.S. +Third-party manufacturers located in Vietnam and China produced the majority of our footwear products in 2017 and are expected to do so in 2018. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines or meet our quality standards. +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, changes in governmental policies and the imposition of tariffs, import and export controls, and other barriers. We may not be able to offset any interruption or decrease in supply of our products by increasing production in our internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can adversely affect our product margins. +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, increases in labor costs, changes in international trade agreements and tariffs, or adverse weather conditions could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. For example, the Trump Administration has suggested modifying existing trade agreements and/or imposing tariffs on foreign products. Changes in existing trade agreements, including the North American Free Trade Agreement (“NAFTA”), or the imposition of tariffs on our products could have a material adverse effect on our operations and financial results. +We manufacture a portion of our products which causes us to incur greater fixed costs. Any difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of operations. +We produce a portion of our footwear products at company-operated manufacturing facilities in Mexico and Italy. There are significant fixed costs associated with the ownership and operations of these facilities and, as a result, efficient production of a sufficient volume of products is necessary to enable recovery of these costs. In addition, the manufacture of our products from the Croslite TM material requires the use of a complex process and we may experience difficulty in producing footwear that meets our high quality control standards. We absorb the manufacturing and disposal costs of products that do not meet our quality standards. Further, significant excess capacity at any of our manufacturing facilities as a result of increased efficiencies in our supply chain process or continued volume declines, could result in under-utilization of our facilities, which could lead to excess fixed overhead costs per unit and reduced product margins. Any increases in our manufacturing costs, lack of operating efficiency or product quality could adversely impact our product margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges faced by our third-party manufacturers, including our ability to scale our production capabilities to meet the needs of our customers. Our manufacturing may also be disrupted for reasons beyond our control, including work stoppages, fires, earthquakes, floods or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in a timely manner and could have a material and adverse effect on our business and financial results. +Our third-party manufacturing operations must comply with labor, trade and other laws; failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall which could result in critical media coverage and harm our business, brand and reputation and cause us to incur additional costs. +14 +Table of Contents +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business, or results. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite TM products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market issues related to supply and demand for our raw materials. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of the Croslite TM material, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and designs on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brand, our success and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others intellectual property rights, continued sales of such competing products by third parties could harm our brand or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, the integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite TM material and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. A significant portion of our revenues are attributable to footwear styles that are more suitable for fair weather and are derived from sales in the northern hemisphere. We typically experience our highest sales activity during the second and third quarters of the calendar year, when there is warmer +15 +Table of Contents +weather in the northern hemisphere. The effects of favorable or unfavorable weather on sales can be significant enough to affect our quarterly results which could adversely affect our common stock price. Quarterly results may also fluctuate as a result of other factors, including new style introductions, general economic conditions or changes in consumer preferences. Results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses, and expansion of existing businesses, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back office systems. Issues in implementing or integrating new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations and require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or data security breach could harm our reputation and/or our ability to effectively operate our business. +We rely heavily on the use of information technology systems and networks across all business functions. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We rely exclusively on third-party information services providers worldwide for our information technology functions including network, help desk, hardware and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments. We use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. We also have outsourced a significant portion of work associated with our finance and accounting, human resources, and other information technology functions to third-party service providers. Despite our current security and cybersecurity measures, our systems, and those of our third-party service providers, we may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, and interruption or loss of valuable business data. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of retail and internet sales, significant costs for data restoration, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our e-commerce business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers' or employees' personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network becomes compromised, it could give rise to unwanted media attention, materially damage our customer relationships, harm our business, our reputation, and our financial results, which could result in fines or lawsuits, and may increase the costs we incur to protect against such information security breaches, such as increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +16 +Table of Contents +Failure to continue to obtain or maintain high-quality endorsers of our products could harm our business . +We establish relationships with celebrity endorsers to develop, evaluate, and promote our products, as well as strengthen our brand. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brand visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers associated with our products that harm the public image and reputations of those endorsers could also seriously harm our brand image with consumers and, as a result, could have an adverse effect on our sales and financial condition. +Our senior revolving credit facility agreement (the “Credit Agreement”) contains financial covenants that require us to maintain certain financial measures and ratios and includes restrictive covenants that limit our ability to take certain actions. A breach of restrictive covenants may cause us to be in default under the Credit Agreement, and our lenders could foreclose on our assets. +Our Credit Agreement requires us to maintain certain financial covenants. A failure to maintain current revenue levels or an inability to control costs or capital expenditures could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Credit Agreement. We may not have sufficient assets to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lender. If we are unable to repay the indebtedness, the lender could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Credit Agreement. +The Credit Agreement also contains certain restrictive covenants that limit, and in some circumstances prohibit our ability to, among other things: incur additional debt, sell, lease or transfer our assets, pay dividends on our common stock, make capital expenditures and investments, guarantee debt or obligations, create liens, repurchase our common stock, enter into transactions with our affiliates and enter into certain merger, consolidation or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S. business and financial results. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the Tax Act, could be repatriated without incurring additional U.S. federal income taxes, noting that some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and the results of tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the United States and foreign jurisdictions for prior tax years. Please refer to Item 3. Legal Proceedings in Part I of this Form 10-K as well as Note 13 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements for additional details regarding current tax audits. Although we believe our tax estimates are reasonable and we intend to defend our positions through litigation if necessary, the final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. Recent developments, including U.S. tax reform, the European Commission’s investigations of local country tax authority rulings and whether those rulings comply with European Union rules on state aid, as well as the Organization for Economic Co-operation and Development’s +17 +Table of Contents +project on Base Erosion and Profit Shifting, continue to change long-standing tax principles. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +The ongoing effects of the U.S. Tax Cuts and Jobs Act (“Tax Act”) and the refinement of provisional estimates could make our results difficult to predict. +Our effective tax rate may fluctuate in the future as a result of the Tax Act, which was enacted on December 22, 2017. The Tax Act introduces significant changes to U.S. income tax law that may have a meaningful impact on our provision for income taxes in the future. Accounting for the income tax effects of the Tax Act requires significant judgments and estimates in the interpretation and calculations of the provisions of the Tax Act. +Additionally, on December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of accounting principles generally accepted in the United States of America in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. Specifically, SAB 118 provides a measurement period for companies to evaluate the impacts of the Tax Act on their financial statements. This measurement period begins in the reporting period that includes the enactment date and ends when an entity has obtained, prepared, and analyzed the information that was needed in order to complete the accounting requirements, and cannot exceed one year. +Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our financial statements for the year ended December 31, 2017. The U.S. Treasury Department, the Internal Revenue Service (“IRS”), and other standard-setting bodies may issue guidance on how the provisions of the Tax Act will be applied or otherwise administered that is different from our interpretation. As we collect and prepare necessary data, and interpret the Tax Act and any additional guidance issued by the IRS or other standard-setting bodies, we may make adjustments to the provisional amounts that could materially affect our financial position and results of operations as well as our effective tax rate in the period in which the adjustments are made. +We are subject to periodic litigation, which could result in unexpected expense of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Item 3 . Legal Proceedings in Part I of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings or any future legal proceedings could have an adverse impact on our business, and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear. Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite TM , our branded proprietary closed-cell resin, is the primary raw material used in our footwear and some of our accessories. Croslite TM is carefully formulated to create soft, durable, extremely lightweight, odor-resistant, water-resistant, and non-marking footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +We depend on key personnel across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive +18 +Table of Contents +results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +If our internal controls are ineffective, our operating results and market confidence in our reported financial information could be adversely affected. +Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal controls or if we experience difficulties in their implementation, our business and operating results and market confidence in our reported financial information could be harmed, we could incur significant costs to evaluate and remediate weaknesses, and we could fail to meet our financial reporting obligations. +As of December 31, 2015, we identified material weaknesses in our internal control over financial reporting, which led us to conclude that our internal control over financial reporting as of such date was not effective. The material weaknesses identified were related to controls over the period end closing procedures and inventory monitoring, which were remediated as of December 31, 2016. The existence of a material weakness precludes management from concluding that our internal control over financial reporting is effective and precludes our independent auditors from issuing an unqualified opinion that our internal controls are effective. In addition, a material weakness could cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock. We also can make no assurances that we will be able to remediate any future internal control deficiencies timely and in a cost effective manner. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we are unable to satisfactorily remediate future deficiencies or if we discover other deficiencies in our internal control over financial reporting, such deficiencies may lead to misstatements in our financial statements or otherwise negatively impact our business, financial results and reputation. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +Labor disruptions could adversely impact our business. +Our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threat to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing or manufacturing seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States. +Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board, the Securities and Exchange Commission, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant impact on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change . +Extreme weather conditions or natural disasters could negatively impact our operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including damage to our supply chain, manufacturing or distribution centers, retail stores, changes in consumer preferences or spending priorities, energy shortages, and public health issues, could harm or disrupt our operations or the operations of our vendors other suppliers, or customers, or result in economic instability that +19 +Table of Contents +may negatively impact our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. +Risks Specific to Our Capital Stock +The issuance of Series A Convertible Preferred Stock (“Series A”) to Blackstone Capital Partners VI L.P. (“Blackstone”) in 2014 and certain of its permitted transferees reduces the relative voting power of holders of our common stock, may dilute the ownership of such holders, and may adversely affect the market price of our common stock. +The Company issued shares of Series A Convertible Preferred Stock (“Series A Preferred Stock”) to Blackstone and certain of its permitted transferees (collectively, the “Blackstone Purchasers”) in January 2014. The Blackstone Purchasers currently own all of the outstanding shares of Series A Preferred Stock, and based on the number of shares of our common stock outstanding as of December 31, 2017, the Blackstone Purchasers collectively own Series A Preferred Stock convertible into approximately 16.7% of our common stock. Holders of the Series A Preferred Stock are entitled to receive dividends declared or paid on the Company’s common stock and are entitled to vote together with the holders of the Company’s common stock as a single class, in each case, on an as-converted basis. Holders of the Series A Preferred Stock also have certain limited special approval rights, including with respect to the issuance of pari passu or senior equity securities of the Company. +Conversion of the Series A Preferred Stock to common stock will dilute the ownership interest of existing holders of our common stock, and any sales in the public market of the common stock issuable upon conversion of the Series A Preferred Stock could adversely affect prevailing market prices of our common stock. We have granted the Blackstone Purchasers registration rights in respect of the shares of Series A Preferred Stock and any shares of common stock issued upon conversion of the Series A Preferred Stock. These registration rights would facilitate the resale of such securities into the public market, and any such resale would increase the number of shares of our common stock available for public trading. Sales by the Blackstone Purchasers of a substantial number of shares of our common stock in the public market, or the perception that such sales might occur, could have a material adverse effect on the price of our common stock. +We are required to pay regular dividends on the Series A issued to Blackstone, which ranks senior to our common stock, and we may be required under certain circumstances to repurchase the outstanding shares of Series A Preferred Stock; such obligations could adversely affect our liquidity and financial condition. +The Series A Preferred Stock ranks senior to our common stock with respect to dividend rights, and holders of Series A Preferred Stock are entitled to quarterly cumulative cash dividends at a rate of 6.0% per annum of the stated value of $1,000 per share. If we fail to make timely dividend payments, the dividend rate will increase to 8.0% per annum until such time as all accrued but unpaid dividends have been paid in full. In addition, the holders of our Series A Preferred Stock have certain redemption rights, including upon certain change in control events involving us, which, if exercised, could require us to repurchase all of the outstanding shares of Series A Preferred Stock at 100% or more of the stated value of the shares, plus all accrued but unpaid dividends. Our obligations to pay regular dividends to the holders of our Series A Preferred Stock or any required repurchase of the outstanding shares of Series A Preferred Stock could impact our liquidity and reduce the amount of cash flows available for working capital, capital expenditures, growth opportunities, acquisitions, and other general corporate purposes. Our obligations to the holders of Series A Preferred Stock could also limit our ability to obtain additional financing or increase our borrowing costs, which could have an adverse effect on our business and financial results. +Blackstone may exercise significant influence over us, including through its ability to elect up to two members of our Board of Directors. +As of December 31, 2017, the shares of Series A Preferred Stock owned by the Blackstone Purchasers represent approximately 16.7% of the voting rights of our common stock, on an as-converted basis, so the Blackstone Purchasers will have the ability to significantly influence the outcome of any matter submitted for the vote of our stockholders. In addition, the Certificate of Designations of the Series A Preferred Stock grants certain consent rights to the holders of Series A Preferred Stock in respect of certain actions by the Company, including the issuance of pari passu or senior equity securities of the Company, certain amendments to our certificate of incorporation or bylaws, any increase in the size of our Board of Directors (the “Board”) above eight members, the payment of certain distributions to our stockholders, and the origination or refinancing of a certain level of indebtedness. The Blackstone Purchasers may have interests that diverge from, or even conflict with, those of our other stockholders. For example, Blackstone and its affiliates may have an interest in directly or indirectly pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their other equity investments, even though such transactions might involve risks to us. Blackstone and its affiliates are in the business of making or advising on investments in companies, including businesses that may directly or indirectly compete with certain portions of our business. They may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us. +20 +Table of Contents +In addition, the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as the Blackstone Purchasers (i) beneficially own at least 95% of the Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement or (ii) maintain beneficial ownership of at least 12.5% of our outstanding common stock (the “Two-Director Threshold”), Blackstone will have the right to designate for nomination two directors to our Board. For so long as the Blackstone Purchasers beneficially own shares of Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement that represent less than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. +ITEM 1B. Unresolved Staff Comments +None. +21 +Table of Contents +ITEM 2. Properties +Our principal executive and administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado 80503. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for kiosk, store-in-store, manufacturing, office, retail, and warehouse space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, use, and approximate size of our principal properties, and the reportable operating segment are given below. +Location +Reportable Operating Segment +Use +Approximate +Square Feet +Expiration (1) +León, Mexico (2) +Other Businesses +Manufacturing/warehouse +392,000 +Mar 2019 +Ontario, California +Americas +Warehouse +339,000 +Mar 2019 +Rotterdam, the Netherlands +Europe +Warehouse +174,000 +Dec 2021 +Narita, Japan +Asia Pacific +Warehouse +156,000 +Apr 2019 +Niwot, Colorado +Americas +Corporate headquarters and regional office +98,000 +Jun 2021 +Padova, Italy +Other Businesses +Manufacturing/warehouse/office +45,000 +Sep 2018 +Hoofddorp, the Netherlands +Europe +Regional office +31,000 +May 2020 +Shenzhen, China +Asia Pacific +Regional office +22,000 +Mar 2018 +Singapore +Asia Pacific +Regional office +17,000 +Dec 2018 +Westwood, Massachusetts +Americas +Global commercial center +16,000 +Sep 2021 +Shanghai, China +Asia Pacific +Regional office +13,000 +Jul 2018 +Tokyo, Japan +Asia Pacific +Regional office +13,000 +Oct 2018 +(1) Expiration of the initial or existing lease term, excluding optional renewals. +(2) The Mexico property consists of a manufacturing facility and a warehouse, which are approximately 226,000 square feet and 166,000 square feet, respectively. +Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operations needs. We also lease 447 retail, outlet, and kiosk/store-in-store locations worldwide. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +We were subjected to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, we were notified about the issuance of assessments totaling 14.4 million Brazilian Real (“BRL”), or approximately $4.3 million, plus interest and penalties, for the period January 2010 through May 2011. We have disputed these assessments and asserted defenses to the claims. On February 25, 2015, we received additional assessments totaling 33.3 million BRL, or approximately $10.1 million, plus interest and penalties, related to the remainder of the audit period. We have also disputed these assessments and asserted defenses to these claims in administrative appeals. On August 29, 2017, the Company received a favorable ruling on its appeal of the first assessment, which dismissed all fines, penalties, and interest. The tax authorities have requested a special appeal to that decision. If the appeal is accepted, Crocs will have the opportunity to both defend the appeal as well as challenge it procedurally. Should the Brazilian Tax Authority prevail in this final administrative appeal, Crocs may still challenge the assessments through the court system, which would likely require the posting of a bond. Additionally, the second appeal for the remaining assessments is scheduled to be heard on March 1, 2018. The Company has not recorded these items within the consolidated financial statements. Due to the inherent uncertainty of litigation and legal challenges, it is not possible to accurately predict the timing or outcome of this matter or to estimate an amount of loss, if any. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business and financial results. +ITEM 4. Mine Safety Disclosures +Not applicable. +22 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the NASDAQ Global Select Market under the stock symbol “CROX.” The following table shows the high and low sales prices of our common stock for the periods indicated. +2017 +High +Low +First quarter +$ +7.54 +$ +6.26 +Second quarter +7.81 +5.93 +Third quarter +9.85 +7.42 +Fourth quarter +13.34 +8.64 +2016 +High +Low +First quarter +$ +10.16 +$ +8.09 +Second quarter +11.50 +7.63 +Third quarter +12.54 +8.02 +Fourth quarter +8.99 +6.70 +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite Index and the Dow Jones U.S. Footwear Index from December 31, 2012 through December 31, 2017 . The graph assumes an investment of $100.00 on December 31, 2012 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. +23 +Table of Contents +Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corporation., adidas AG, Skechers U.S.A., Inc., Steven Madden Ltd. and Wolverine World Wide, Inc., among other companies. As Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of our stock have an effect on this index. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 82 as of February 20, 2018 . +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements do not permit us to pay cash dividends on our common stock. In addition, the Certificate of Designations governing the Series A Convertible Preferred Stock restricts us from declaring and paying certain dividends on our common stock if we fail to pay all accumulated and unpaid regular dividends and/or declared and unpaid participating dividends to which the preferred holders are entitled. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to compliance with covenants under any then-existing financing agreements and the terms of the Certificate of Designations. +Purchases of Equity Securities by the Issuer +Issuer Purchases of Equity Securities +Period +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly +Announced Plans or Programs (1) +Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs +October 1-31, 2017 +1,306,409 +$ +9.86 +1,306,409 +$ +78,777,549 +November 1-30, 2017 +556,763 +10.69 +556,763 +72,825,981 +December 1-31, 2017 +372,549 +10.82 +372,549 +68,796,140 +Total +2,235,721 +$ +10.22 +2,235,721 +$ +68,796,140 +(1) On December 26, 2013, the Company’s Board of Directors approved and authorized a program to repurchase up to $350.0 million of our common stock. As of December 31, 2017 , approximately $68.8 million remained available for repurchase under our share repurchase authorization. On February 20, 2018, the Board approved an increased repurchase authorization up to $500.0 million of our common stock. The number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under our revolving credit facility, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. +24 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five years. The information in this table should be read in conjunction with our consolidated financial statements and accompanying notes presented in Item 8. Financial Statements and Supplementary Data , and Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operations in Part II of this Annual Report on Form 10-K. +Year Ended December 31, +2017 +2016 +2015 +2014 +2013 +(in thousands, except per share data) +Revenues +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +$ +1,198,223 +$ +1,192,680 +Cost of sales +506,292 +536,109 +579,825 +603,893 +569,482 +Restructuring charges (1) +— +— +— +3,985 +— +Gross profit +517,221 +500,164 +510,805 +590,345 +623,198 +Gross margin +50.5 +% +48.3 +% +46.8 +% +49.3 +% +52.3 +% +Selling, general and administrative expenses +494,601 +503,174 +559,095 +565,712 +549,154 +Selling, general and administrative expenses as a % of revenues +48.3 +% +48.6 +% +51.3 +% +47.2 +% +46.0 +% +Restructuring charges (1) +— +— +8,728 +20,532 +— +Asset impairments (2) +5,284 +3,144 +15,306 +8,827 +10,949 +Income (loss) from operations +$ +17,336 +$ +(6,154 +) +$ +(72,324 +) +$ +(4,726 +) +$ +63,095 +Income (loss) before income taxes +$ +18,180 +$ +(7,213 +) +$ +(74,744 +) +$ +(8,549 +) +$ +59,959 +Income tax expense (benefit) +7,942 +(9,281 +) +(8,452 +) +3,623 +(49,539 +) +Net income (loss) +10,238 +(16,494 +) +(83,196 +) +(4,926 +) +10,420 +Dividends on Series A convertible preferred stock +(12,000 +) +(12,000 +) +(11,833 +) +(11,301 +) +— +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(3,532 +) +(3,244 +) +(2,978 +) +(2,735 +) +— +Net income (loss) attributable to common stockholders +$ +(5,294 +) +$ +(31,738 +) +$ +(98,007 +) +$ +(18,962 +) +$ +10,420 +Net income (loss) per common share: +Basic +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +Diluted +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +$ +0.12 +Weighted average common shares: +Basic +72,255 +73,371 +75,604 +85,140 +87,989 +Diluted +72,255 +73,371 +75,604 +85,140 +89,089 +Cash provided by (used in) operating activities +$ +98,264 +$ +39,754 +$ +9,698 +$ +(11,651 +) +$ +83,464 +Cash used in investing activities +(10,972 +) +(18,657 +) +(18,627 +) +(57,992 +) +(69,758 +) +Cash provided by (used in) financing activities (3) +(65,370 +) +(16,443 +) +(101,260 +) +23,431 +(1,161 +) +(1) We commenced restructuring in July 2014 and concluded in December 2015. +(2) Asset impairments consist of impairments of long-lived assets of retail locations in all years, as well as a $4.8 million write-off of a discontinued project in 2017 and $0.4 million of goodwill impairment in 2016. +(3) Cash used in financing activities includes approximately $50.0 million , $85.9 million and $145.9 million including commissions used to repurchase the Company’s common shares during 2017, 2015, and 2014, respectively. The Company did not repurchase shares in 2016 or 2013. +25 +Table of Contents +December 31, +2017 +2016 +2015 +2014 +2013 +(in thousands) +Cash and cash equivalents +$ +172,128 +$ +147,565 +$ +143,341 +$ +267,512 +$ +317,144 +Inventories +130,347 +147,029 +168,192 +171,012 +162,341 +Working capital +268,031 +276,335 +278,852 +441,523 +453,149 +Total assets +543,695 +566,390 +608,020 +806,931 +875,159 +Long-term liabilities +18,379 +17,966 +19,294 +27,849 +63,487 +Total stockholders' equity +185,865 +220,383 +245,972 +452,518 +624,744 +26 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, manufacturing, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. All of our products utilize our proprietary closed-cell resin, called Croslite TM , along with a range of other materials. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 90 countries, through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic wholesalers as well as international wholesalers and distributors; our retail channel includes company-operated stores; and our e-commerce channel includes company-operated e-commerce sites. +Known or Anticipated Trends +Based on our recent operating results and current perspectives on our operating environment, we anticipate certain trends to impact our operating results: +• +Consumer spending preferences continue to shift toward e-commerce and away from brick and mortar stores. This has resulted in continued sales growth in our e-commerce channel, as well as on various e-tail sites operated by wholesalers, and contributed to declining foot traffic in our retail locations. +• +We anticipate lower retail revenues and selling, general and administrative expenses (“SG&A”) as we close less productive stores as leases expire and transfer select company-operated stores to distributors. Distributor revenues are reported within our wholesale channel. +• +A cautious retail environment may negatively affect customer purchasing trends. +• +Foreign exchange rate volatility may continue to impact our reported U.S. Dollar results from our foreign operations. +• +In 2017 we identified annual reductions in SG&A in the amount of $75 to $85 million which, once implemented, are projected to generate an annual $30 to $35 million improvement in earnings before interest and taxes by 2019, compared to 2016. We achieved approximately $23 million of these SG&A reductions in 2017 while incurring approximately $10 million of costs to re-set our variable compensation. We remain on track to achieve the targeted SG&A reductions by 2019. We incurred $11 million in non-recurring charges to achieve these SG&A reductions in 2017 and expect to incur approximately $5 million in non-recurring charges in 2018, for a total of $16 million of non-recurring charges associated with our SG&A reduction plan. We reduced our company-operated retail stores in 2017 by 111 and anticipate an additional reduction of approximately 50 company-operated retail stores in 2018, thereby reducing our total store count to approximately 400 from 558 over a two year period. The majority of company-operated store closures are occurring as store leases expire. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance. We believe it also provides a useful baseline for analyzing trends in our operations. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +27 +Table of Contents +2017 Financial Highlights +Revenues were $1,023.5 million for the year ended December 31, 2017, a 1.2% decrease compared to the year ended December 31, 2016. The decrease in 2017 revenues compared to 2016 revenues was due to the net effects of: (i) higher sales volumes, despite a net reduction of 111 company-operated retail stores, which increased revenues by $39.6 million , or 3.8% ; (ii) lower average selling prices as our product and channel mix continued to change, which decreased revenues by $57.2 million , or 5.5% ; and (iii) favorable changes in exchange rates, which increased revenues by $4.8 million , or 0.5% . +The following were significant developments in our businesses during the year ended December 31, 2017 : +• +We sold 57.9 million pairs of shoes worldwide, an increase of 3.1% from 56.1 million pairs in 2016 . +• +Gross margin improved 220 basis points compared to 2016 to 50.5% for the year ended December 31, 2017 . We drove this improvement by continuing to prioritize high margin molded product, improving our go to market capabilities, and better managing promotions. +• +SG&A was $494.6 million , a decrease of $8.6 million , or 1.7% , compared to 2016 . This includes the effects of $17.0 million in non-recurring charges and approximately $10 million of incremental costs related to variable compensation in 2017. +• +Income from operations improved by $23.5 million , after incurring approximately $17.0 million in non-recurring charges, for the year ended December 31, 2017 compared to last year’s loss of $6.2 million . +• +Net loss attributable to common stockholders improved $26.4 million to a loss of $5.3 million compared to a loss of $31.7 million in 2016 . Basic and diluted net loss per common share was $0.07 for the year ended December 31, 2017 , compared to a loss of $0.43 per common share for the year ended December 31, 2016 . +• +We continued to focus on improving the efficiency and effectiveness of our operations, including carefully managing and reducing our retail fleet, especially full-priced retail stores, and focusing on enhancing the profitability of this channel. During the year ended December 31, 2017 , we opened a total of 19 stores and closed or transferred to distributors 130 stores for a net reduction of 111 company-operated retail stores. +• +We continued to focus on simplifying our product line and disciplined inventory management to allow investment in higher margin, faster-turning product and reduced our inventory by $16.7 million , or 11.3% , from $147.0 million to $130.3 million . +• +During 2017 , we repurchased 5.7 million shares of common stock at an aggregate cost of $50.0 million . +Future Outlook +We intend to continue our strategic plans for long-term improvement and growth of the business, which comprise these key initiatives: +(1) simplifying our business to reduce costs, +(2) improving the quality of our revenues, and +(3) positioning ourselves to return to sustainable, profitable growth. +We believe these initiatives will better position Crocs to adapt to changing customer demands and global economic developments. We are focusing on our core molded footwear heritage by narrowing our product line with an emphasis on higher margin units, as well as developing innovative new casual lifestyle footwear platforms. By streamlining the product portfolio and reducing non-core product development, we believe we will create a more powerful consumer connection to the brand. +We are refining our business model around the world, prioritizing direct investment in larger-scale geographies to focus our resources on the demographics with the largest growth prospects, moving away from direct investment in retail and wholesale businesses in smaller markets, and transferring significant commercial responsibilities to distributors and other third-parties. Further, we intend to expand our engagement with leading wholesale accounts in select markets to drive sales growth, optimize product placement, and enhance brand reputation. +28 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2017 , 2016 , and 2015 +Year Ended December 31, +$ Change +% Change +2017 +2016 +2015 +2017-2016 +2016-2015 +2017-2016 +2016-2015 +(in thousands, except per share data, margin, and average selling price data) +Revenues +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +$ +(12,760 +) +$ +(54,357 +) +(1.2 +)% +(5.0 +)% +Cost of sales +506,292 +536,109 +579,825 +29,817 +43,716 +5.6 +% +7.5 +% +Gross profit +517,221 +500,164 +510,805 +17,057 +(10,641 +) +3.4 +% +(2.1 +)% +Selling, general and administrative expenses +494,601 +503,174 +567,823 +8,573 +64,649 +1.7 +% +11.4 +% +Asset impairments +5,284 +3,144 +15,306 +(2,140 +) +12,162 +(68.1 +)% +79.5 +% +Income (loss) from operations +17,336 +(6,154 +) +(72,324 +) +23,490 +66,170 +381.7 +% +91.5 +% +Foreign currency gain (loss), net +563 +(2,454 +) +(3,332 +) +3,017 +878 +122.9 +% +26.4 +% +Interest income +870 +692 +967 +178 +(275 +) +25.7 +% +(28.4 +)% +Interest expense +(869 +) +(836 +) +(969 +) +(33 +) +133 +(3.9 +)% +13.7 +% +Other income +280 +1,539 +914 +(1,259 +) +625 +(81.8 +)% +68.4 +% +Income (loss) before income taxes +18,180 +(7,213 +) +(74,744 +) +25,393 +67,531 +352.0 +% +90.3 +% +Income tax expense +7,942 +9,281 +8,452 +1,339 +(829 +) +14.4 +% +(9.8 +)% +Net income (loss) +10,238 +(16,494 +) +(83,196 +) +26,732 +66,702 +(162.1 +)% +(80.2 +)% +Dividends on Series A convertible preferred stock +(12,000 +) +(12,000 +) +(11,833 +) +— +(167 +) +— +% +(1.4 +)% +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(3,532 +) +(3,244 +) +(2,978 +) +(288 +) +(266 +) +(8.9 +)% +(8.9 +)% +Net loss attributable to common stockholders +$ +(5,294 +) +$ +(31,738 +) +$ +(98,007 +) +$ +26,444 +$ +66,269 +83.3 +% +67.6 +% +Net loss per common share: +Basic +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +$ +0.36 +$ +0.87 +83.7 +% +66.9 +% +Diluted +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +$ +0.36 +$ +0.87 +83.7 +% +66.9 +% +Gross margin (1) +50.5 +% +48.3 +% +46.8 +% +220bp +150bp +4.6 +% +3.2 +% +Operating margin (1) +1.7 +% +(0.6 +)% +(6.6 +)% +230bp +600bp +383.3 +% +90.9 +% +Footwear unit sales +57,850 +56,097 +57,763 +1,753 +(1,666 +) +3.1 +% +(2.9 +)% +Average footwear selling price +$ +17.31 +$ +18.21 +$ +18.53 +$ +(0.90 +) +$ +(0.32 +) +(4.9 +)% +(1.7 +)% +(1) Changes for gross margin and operating margin are shown in basis points (“bp”). +Revenues. Revenues decrease d $12.8 million , or 1.2% , during the year ended December 31, 2017, compared to the same period in 2016. The revenues decreased primarily due to the sale of our Taiwan business in the fourth quarter of 2016, the sale of our Middle East business in the second quarter of 2017, reductions in the number of company-operated retail stores, and additional actions taken to optimize our wholesale, retail, and e-commerce channels. The revenue decline associated with store closures and transfers was approximately $39.1 million. Higher sales volumes increased revenues by $39.6 million , or 3.8% , offset by lower average footwear selling prices, which decreased revenues by approximately $57.2 million , or 5.5% , as our product and channel mix continued to change. Favorable exchange rate activity drove an increase of $4.8 million , or 0.5% . +29 +Table of Contents +During the year ended December 31, 2016, revenues decreased 5.0% compared to the same period in 2015. The decrease in revenues is due to the net impact of (i) a $46.3 million, or 4.2%, decrease associated with lower sales volumes, (ii) a $4.7 million, or 0.5%, decrease associated with lower average selling prices per pair, and (iii) a $3.4 million, or 0.3%, decrease associated with unfavorable changes in foreign currency rates. +Cost of sales. During the year ended December 31, 2017 , cost of sales decreased by $29.8 million , or 5.6% , compared to the same period in 2016 . Lower average costs per unit were primarily the result of changes in our product mix, reflecting an ongoing focus on core molded products, which cost less to produce, and continued supply chain cost reductions, including a reallocation of third-party manufacturing production to lower-cost suppliers within the Asia Pacific region. Higher unit sales volume increased cost of sales by $16.8 million , or 3.1% , but was more than offset by a reduction of approximately $49.6 million , or 9.3% , due to lower average costs per unit, while foreign currency translation drove an increase of $3.0 million , or 0.6% . +During the year ended December 31, 2016, cost of sales decreased $43.7 million, or 7.5%, compared to the same period in 2015. The decrease in cost of sales was primarily due to the net impact of: (i) a $24.6 million, or 4.2%, decrease due to lower sales volumes, (ii) an $18.6 million, or 3.2%, decrease due to a lower average cost per unit sold, and (iii) a $0.5 million, or 0.1%, decrease due to the impact of foreign currency translation. +Gross profit. During the year ended December 31, 2017 , gross profit increased $17.1 million , or 3.4% , and gross margin increased 220 basis points to 50.5% , compared to the same period in 2016 . The increase in gross profit was primarily due to our ongoing focus on higher margin core molded products, particularly clogs and sandals, and our reduction of low-margin European discount channel sales. A decrease of $0.3 million , or 0.1% , resulted from a decrease in our average selling price per unit which exceeded a decrease in average cost per unit, and an increase of approximately $15.7 million , or 3.1% , resulted from higher sales unit volumes. Foreign currency translation drove an increase of $1.7 million , or 0.3% , to gross profit. +During the year ended December 31, 2016, gross profit decreased $10.6 million, or 2.1%, and gross margin increased 143 basis points to 48.3% compared to the same period in 2015. The decrease in gross profit is primarily due to the net impact of: (i) a $21.6 million, or 4.2%, decrease due to lower sales volumes, (ii) a $14.0 million, or 2.7%, increase due to the combined impact of a lower average cost of sales per unit partially offset by a lower average selling price, and (iii) a $3.0 million, or 0.6%, decrease due to the unfavorable impact of foreign currency translation. Gross profit declined by approximately $1.0 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +Selling, general and administrative expenses. SG&A decreased $8.6 million , or 1.7% , during the year ended December 31, 2017 , compared to the same period in 2016 . This includes the effects of $17.0 million in non-recurring charges and approximately $10 million of incremental costs related to variable compensation in 2017. The decrease was primarily due to the combined impacts of a decrease in facilities expenses of $ 13.1 million as a result of fewer company-operated retail stores and the sales of our Taiwan and Middle East businesses, and lower bad debts expense of $3.8 million . These savings were offset in part by higher marketing expenses of $3.1 million and higher net other expenses of $ 5.2 million , which were individually insignificant. +SG&A decreased $55.9 million, or 10.0%, during the year ended December 31, 2016 compared to the same period in 2015. This change was primarily driven by (i) bad debt expense decrease of $22.8 million, (ii) an $8.7 million decrease in rent expenses associated with contingent rents and closed retail stores partially offset by (iii) $4.3 million increase in outside services expense. During the year ended December 31, 2016, our bad debt expense was $3.2 million compared to $26.0 million in the same period in the prior year. Substantially all of this decrease in bad debt expense was due to stricter credit collection policies from our China operations, which is included in our Asia Pacific segment. Restructuring charges of $8.7 million were incurred in 2015, while none were incurred in 2016 . +Asset impairment charges. During the years ended December 31, 2017 , 2016 , and 2015, we incurred $0.5 million , $2.7 million , and $15.3 million , respectively, in retail asset impairment charges related to certain underperforming retail locations that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores’ assets over their remaining economic lives. In addition, during the year ended December 31, 2017 , we incurred additional charges of $4.8 million related to a discontinued project. In the year ended December 31, 2016 , we incurred $0.4 million of goodwill impairment. +Foreign currency gain (loss), net. Foreign currency gain (loss), net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on foreign currency derivative instruments. During the year ended December 31, 2017 , we recognized realized and unrealized net foreign currency gains of $0.6 million compared to net losses of $2.5 million during the year ended December 31, 2016 . During the year ended December 31, 2015, we recognized realized and unrealized net foreign currency losses of $3.3 million . +30 +Table of Contents +Income tax expense . During the year ended December 31, 2017 , we recognized income tax expense of $7.9 million on pre-tax book income of $18.2 million , representing an effective tax rate of 43.7% , compared to income tax expense of $9.3 million on pre-tax book loss of $7.2 million in 2016, which represented an effective tax rate of 128.7% . Our effective tax rate has varied dramatically in recent years due to differences in our profitability level and relative operating earnings across multiple jurisdictions, and is most notably impacted by the significant amount of operating losses that cannot be benefited for tax purposes. +The following are some of our key jurisdictions and the income tax expense for each in 2017 , 2016 , and 2015 , respectively: +For the Year Ended December 31, +2017 +2016 +2015 +Income Tax Jurisdiction +Net Income (Loss) Before Income Taxes +Income Tax Expense (Benefit) +Net Income (Loss) Before Income Taxes +Income Tax Expense (Benefit) +Net Income (Loss) Before Income Taxes +Income Tax Expense (Benefit) +(in thousands) +United States +$ +(34,406 +) +$ +2,809 +$ +(55,617 +) +$ +437 +$ +(83,537 +) +$ +(3,345 +) +Netherlands +25,859 +2,813 +39,184 +4,711 +25,988 +4,262 +Japan +2,615 +909 +(5,229 +) +— +(69 +) +2,345 +Canada +547 +208 +740 +361 +(850 +) +(391 +) +China +5,413 +(470 +) +821 +(473 +) +(21,572 +) +4,433 +Korea +2,321 +829 +2,529 +511 +4,141 +1,081 +Other +15,831 +844 +10,359 +3,734 +1,155 +67 +Total +$ +18,180 +$ +7,942 +$ +(7,213 +) +$ +9,281 +$ +(74,744 +) +$ +8,452 +Effective tax rate +43.7 +% +128.7 +% +11.3 +% +The differences in total tax expense and effective rate variance in the table above resulted primarily from the following factors: we recognized tax expense resulting from the Tax Act as well as increased withholding taxes related to intercompany activity which is likely to recur in the U.S; we decreased withholding tax expense in the Netherlands; we recognized net income and tax expense after incurring losses in prior years in Japan; and we recognized net income and a tax benefit as a result of recognizing the benefit of prior year tax losses in China. +Effective Income Tax Rate Reconciliation +The following provide additional information about the effective income tax rate reconciliation presented in Note 11 — Income Taxes in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K: +• +'U.S. tax on foreign earnings' includes the impact of the tax expense accrued on undistributed foreign earnings net of the related foreign tax credits. During 2017, the Tax Act significantly changed the U.S. taxation of foreign earnings. As a result, the impact of the transition tax as well as current year distributions, and reversal of the deferred tax liability associated with undistributed earnings and profits attributable to foreign subsidiaries, the Company is reflecting a $32.4 million tax benefit, which equates to a 178.4% favorable impact on the rate reconciliation. The total income tax provision impact of this benefit is offset by a corresponding change in the valuation allowance. +• +‘Enacted changes in tax law’ represents the estimated impact of the Tax Act of $17.6 million, equating to a 97.1% unfavorable impact. The Tax Act was enacted on December 22, 2017 and introduces significant changes to U.S. income tax law. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings. Additionally, in 2017 we were subject to a one-time transition tax on accumulated foreign subsidiary earnings for which U.S. tax was not previously accrued. +• +The change in 'Foreign differential' is principally driven by differences in pre-tax book income between the periods compared and the source of this income, which is subject to different jurisdictional tax rates. During 2017, the effect of rate differences resulted in an $11.8 million tax benefit, or 64.7% favorable rate impact, compared to a $12.6 million tax benefit, or 175% favorable rate impact, in 2016. The change was driven primarily by tax expense relative to profitable jurisdictions, partially offset by operating losses in certain jurisdictions where the Company has determined that it is not more likely than not to realize the associated tax benefits. Further, we employ a tax planning strategy that directly impacts the total tax expense directly attributable to the level of foreign earnings in the specific jurisdictions. However, we note that the impact on the effective tax rate is different due to book earnings recorded in 2017 compared to 2016. Through +31 +Table of Contents +at least 2019, we expect to continue to have an equivalent favorable impact on the tax provision and effective tax rate based on the specific foreign earnings. +• +‘Non-deductible/non-taxable items’ resulted in a $6.0 million tax expense in 2017, representing an unfavorable rate impact of 33.0%, compared to a $2.7 million tax expense in 2016, representing an unfavorable rate impact of 37.4%. The expense recognized in 2017 primarily relates to non-deductible executive and foreign share-based compensation, which we anticipate will recur in the foreseeable future, and the write-off of non-deductible goodwill, which we do not expect to recur in the foreseeable future. +• +We continue to evaluate the realizability of our deferred tax assets. The impact of changes in valuation accounts to the effective tax rate was $24.4 million recorded on deferred tax assets that are not anticipated to be realized, equating to a 134.2% unfavorable impact. The specific circumstances regarding management's assertion of the realizability of certain deferred tax assets is discussed as part of the disclosures in Note 11 — Income Taxes . We maintain total valuation allowances of approximately $119.5 million as of December 31, 2017, which may be reduced in the future depending upon the achieved or sustained profitability of certain entities. +• +During both 2017 and 2016, we recorded tax expense for audits settled during the year of $0.4 million and $0.3 million, respectively. The amount included in settlements during 2017 is netted against total uncertain tax position releases during the same period relating to the same positions. Furthermore, in Note 11 — Income Taxes the ‘Uncertain tax benefits’ line item in 2017 includes net accruals related to current year positions recorded, and is consistent with amounts accrued during prior years. We have released a significant portion of historical uncertain tax benefits based on effective and actual settlements. There is not currently an expectation that uncertain tax positions will significantly impact our tax expense on an ongoing basis. +• +We incur state income tax losses during the period due to net operating losses recorded in the U.S., as well as applicable state modifications related to the taxability of foreign dividends. The tax provision benefit of these losses are offset by a valuation allowance. We are subject to certain minimal state income taxes. +In 2017, we began operating under a tax holiday in one of our foreign jurisdictions. This tax holiday is in effect through 2022, and may be extended if certain additional requirements are met. The tax holiday is conditional upon our meeting certain employment and investment thresholds. The impact of the tax holiday in 2017 decreased tax expense in that jurisdiction by approximately $0.1 million and had no impact to our reported earnings per diluted share. +32 +Table of Contents +Revenues by Channel +Year Ended December 31, +% Change +Constant Currency % Change (1) +2017 +2016 +2015 +2017-2016 +2016-2015 +2017-2016 +2016-2015 +(in thousands) +Wholesale: +Americas +$ +211,342 +$ +202,211 +$ +210,887 +4.5 +% +(4.1 +)% +3.8 +% +(2.6 +)% +Asia Pacific +215,762 +232,541 +255,897 +(7.2 +)% +(9.1 +)% +(7.2 +)% +(10.3 +)% +Europe +108,142 +110,511 +123,131 +(2.1 +)% +(10.2 +)% +(3.8 +)% +(9.3 +)% +Other businesses +870 +745 +1,096 +16.8 +% +(32.0 +)% +13.4 +% +(32.1 +)% +Total wholesale +536,116 +546,008 +591,011 +(1.8 +)% +(7.6 +)% +(2.4 +)% +(7.3 +)% +Retail: +Americas +188,367 +191,855 +197,306 +(1.8 +)% +(2.8 +)% +(1.9 +)% +(2.6 +)% +Asia Pacific +108,868 +125,037 +136,320 +(12.9 +)% +(8.3 +)% +(12.7 +)% +(8.9 +)% +Europe +40,998 +42,712 +44,873 +(4.0 +)% +(4.8 +)% +(8.4 +)% +(0.4 +)% +Total retail +338,233 +359,604 +378,499 +(5.9 +)% +(5.0 +)% +(6.4 +)% +(4.6 +)% +E-commerce: +Americas +80,437 +72,940 +68,017 +10.3 +% +7.2 +% +10.1 +% +7.5 +% +Asia Pacific +45,036 +37,500 +32,274 +20.1 +% +16.2 +% +22.8 +% +17.8 +% +Europe +23,691 +20,221 +20,829 +17.2 +% +(2.9 +)% +14.0 +% +(2.8 +)% +Total e-commerce +149,164 +130,661 +121,120 +14.2 +% +7.9 +% +14.4 +% +8.5 +% +Total revenues +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +(1.2 +)% +(5.0 +)% +(1.7 +)% +(4.7 +)% +(1) Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +Wholesale channel revenues. During the year ended December 31, 2017 , revenues from our wholesale channel decreased $9.9 million , or 1.8% , compared to the year ended December 31, 2016 . A $35.1 million , or 6.4% , decrease was due to lower average selling prices as we shifted to higher margin, lower-priced molded product. Higher sales volumes increased revenues by approximately $21.9 million , or 4.0% , despite the impact of strategic reductions in sales via discount channels in our Europe operating segment as well as the decline in our wholesale business in Japan while we strengthen our wholesale network. The effect of foreign currency translation was an increase of $3.3 million , or 0.6% , to revenues. +During the year ended December 31, 2016 , revenues from our wholesale channel decreased $45.0 million , or 7.6% , compared to the same period in 2015 . The decrease in wholesale channel revenues was primarily due to the net impact of: (i) a $42.0 million, or 7.1%, decrease in sales volumes, (ii) a $3.6 million, or 1.0%, decrease due to a lower average selling price, and (iii) a $1.5 million, or 0.4%, decrease due to the unfavorable impact of foreign currency translation. Sales volumes for the year ended December 31, 2016 were negatively impacted by approximately $8.4 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +Retail channel revenues. During the year ended December 31, 2017 , revenues from our retail channel decreased $21.4 million , or 5.9% , compared to the year ended December 31, 2016 . Sales volumes decreased by approximately $12.8 million , or 3.6% , primarily due to a net decrease of 111 company-operated retail stores as we optimized our store fleet and shifted our store mix from full-price retail to outlet. Average selling prices were lower by $10.3 million , or 2.9% , as we shifted to higher margin, lower-priced molded product. These declines were partially offset by an increase of $1.7 million , or 0.6% , from foreign currency translation. +During the year ended December 31, 2016 , revenues from our retail channel decreased $18.9 million , or 5.0% , compared to the same period in 2015 . The decrease in retail channel revenues was due to the net impact of: (i) a $13.8 million, or 3.7%, decrease in sales volumes, (ii) a $3.6 million, or 1.0%, decrease due to a lower average selling price, and (iii) a $1.5 million, or 0.4%, decrease due to the unfavorable impact of foreign currency translation. +E-commerce channel revenues. During the year ended December 31, 2017 , revenues from our e-commerce channel increased $18.5 million , or 14.2% , compared to the year ended December 31, 2016 . We invested in marketing with an enhanced digital +33 +Table of Contents +focus, and we continued to grow our e-commerce team and work toward global adoption of best practices. Revenues increased by approximately $30.6 million , or 23.4% , due to higher sales volumes, partially offset by decreases of $11.8 million , or 9.0% , due to lower average selling prices and $0.3 million , or 0.2% , due to the unfavorable impact of foreign currency translation. +During the year ended December 31, 2016 , revenues from our e-commerce channel increased $9.5 million , or 7.9% , compared to the same period in 2015 . The increase in e-commerce revenues was due to the net impact of: (i) a $30.2 million, or 24.9%, increase in sales volumes (primarily due to increased sales volumes in the Americas and Asia Pacific segments), (ii) a $20.0 million, or 16.4%, decrease due to a lower average selling price, and (iii) a $0.7 million, or 0.6%, decrease due to the unfavorable impact of foreign currency translation. +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2017 , 2016 , and 2015: +Year Ended December 31, +% Change +Constant Currency % Change (1) +2017 +2016 +2015 +2017-2016 +2016-2015 +2017-2016 +2016-2015 +(in thousands) +Revenues: +Americas +$ +480,146 +$ +467,006 +$ +476,210 +2.8 +% +(1.9 +)% +2.5 +% +(0.7 +)% +Asia Pacific (2) +369,667 +395,078 +424,491 +(6.4 +)% +(6.9 +)% +(6.1 +)% +0.8 +% +Europe +172,830 +173,444 +188,833 +(0.4 +)% +(8.1 +)% +(2.9 +)% +(1.7 +)% +Segment revenues +1,022,643 +1,035,528 +1,089,534 +(1.2 +)% +(5.0 +)% +(1.7 +)% +(0.3 +)% +Other businesses +870 +745 +1,096 +16.8 +% +(32.0 +)% +13.4 +% +0.1 +% +Total consolidated revenues +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +(1.2 +)% +(5.0 +)% +(1.7 +)% +(0.3 +)% +Income from operations: +Americas +$ +86,880 +$ +58,844 +$ +49,422 +47.6 +% +19.1 +% +48.0 +% +(2.8 +)% +Asia Pacific +79,273 +78,907 +48,447 +0.5 +% +62.9 +% +0.5 +% +2.8 +% +Europe +25,736 +17,757 +15,629 +44.9 +% +13.6 +% +42.2 +% +(1.6 +)% +Segment income from operations +191,889 +155,508 +113,498 +23.4 +% +37.0 +% +23.2 +% +(0.2 +)% +Reconciliation of segment income from operations to income (loss) before income taxes: +Other businesses +(22,861 +) +(26,935 +) +(30,092 +) +(15.1 +)% +(10.5 +)% +Unallocated corporate +(151,692 +) +(134,727 +) +(155,730 +) +12.6 +% +(13.5 +)% +Total consolidated income (loss) from operations +17,336 +(6,154 +) +(72,324 +) +(381.7 +)% +(91.5 +)% +Foreign currency transaction gain (loss), net +563 +(2,454 +) +(3,332 +) +(122.9 +)% +(26.4 +)% +Interest income +870 +692 +967 +25.7 +% +(28.4 +)% +Interest expense +(869 +) +(836 +) +(969 +) +3.9 +% +(13.7 +)% +Other income +280 +1,539 +914 +(81.8 +)% +68.4 +% +Income (loss) before income taxes +$ +18,180 +$ +(7,213 +) +$ +(74,744 +) +(352.0 +)% +(90.3 +)% +(1) Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) Revenues for the year ended December 31, 2016 were negatively impacted by approximately $8.4 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +34 +Table of Contents +Americas Operating Segment +Revenues. During the year ended December 31, 2017 , revenues for our Americas segment increased $13.1 million , or 2.8% , compared to the year ended December 31, 2016 . The increase in revenues was led by a 10.3% increase in e-commerce revenues, while a modest increase in wholesale revenues was partially offset by a decrease in retail revenues, reflecting 15 fewer company-operated retail stores compared to last year. Higher sales volumes resulted in an increase of approximately $17.0 million , or 3.7% , while lower average selling prices resulted in a decrease of $5.5 million , or 1.2% , and foreign currency translation resulted in an increase of $1.6 million , or 0.3% . +During the year ended December 31, 2016, revenues for our Americas segment decreased $9.2 million, or 1.9%, compared to the same period in 2015. The decrease in the Americas segment revenues was due to the net impact of: (i) a $13.6 million, or 2.9%, decrease related to lower sales volumes, (ii) an $8.0 million, or 1.7%, increase related to an increase in the average selling price, and (iii) a $3.6 million, or 0.7%, decrease due to the unfavorable impact of foreign currency translation. +Income from Operations. During the year ended December 31, 2017 , income from operations for our Americas segment was $86.9 million , an increase of $28.0 million , or 47.6% . Gross profit increased $21.4 million , or 9.5% , and gross margin increased 310 basis points to 51.4% , compared to the year ended December 31, 2016 . The increase in gross profit is due to the net impact of an increase of $10.3 million , or 4.6% , due to higher sales volumes, despite a net reduction of 15 company-operated retail locations, an increase of $10.9 million , or 4.8% , due to a decrease in our average cost per unit which exceeded a decrease in average selling price per unit, and an increase of $0.2 million , or 0.1% , from foreign currency translation. +During the year ended December 31, 2017 , SG&A for our Americas segment decreased $5.3 million , or 3.2% , compared to the same period in 2016 . The decrease in SG&A was primarily due to the net impact of a decrease of $3.1 million in facilities expenses as a result of reductions in the number of company-operated retail stores and our SG&A reduction efforts, and a net decrease of $2.2 million in services, information technology, and other expenses. Impairment expense related to company-operated retail stores decreased by $1.3 million compared to 2016. +During the year ended December 31, 2016, income from operations for our Americas segment was $58.8 million , an increase of $9.4 million, or 19.1%. Gross profit increased $1.0 million, or 0.4%, and gross margin increased 120 basis points to 48.3% compared to the same period in 2015. The increase in the Americas segment gross profit is due to the net impact of a $6.4 million, or 2.9%, decrease due to lower sales volumes, a $9.3 million, or 4.2%, increase due to the combined impact of a higher average selling price and a lower average cost of sales per unit, and a $1.9 million, or 0.9%, decrease due to the impact of foreign currency translation. +During the year ended December 31, 2016, SG&A for our Americas segment decreased $1.7 million, or 1.0%, compared to the same period in 2015. +Asia Pacific Operating Segment +Revenues. During the year ended December 31, 2017 , revenues for our Asia Pacific segment decreased $25.4 million , or 6.4% , compared to the year ended December 31, 2016 . Wholesale revenues were lower as we continued to pursue business model changes to drive higher quality revenues and improve profitability across Asia, including the sales of our Taiwan and Middle East businesses and the strengthening of our wholesale network in Japan. Retail revenues decreased as a result of a net reduction of 84 company-operated retail stores. E-commerce revenues increased by 20.1% , with particularly strong performance in China. An increase in sales volumes of approximately $38.9 million , or 9.8% , was offset by a decrease in average selling prices of $63.1 million , or 15.9% , as we shifted to higher margin, lower-priced molded product. The impact of foreign currency translation was a decrease of $1.2 million , or 0.3% . +During the year ended December 31, 2016, revenues for our Asia Pacific segment decreased $29.4 million, or 6.9%, compared to the same period in 2015. The decrease in the Asia Pacific segment revenues was due to the net impact of: (i) a $2.4 million, or 0.6%, decrease due to lower sales volumes, (ii) a $30.3 million, or 7.1%, decrease in the average selling price and (iii) a $3.3 million, or 0.8%, increase due to the favorable impact of foreign currency translation. Sales volumes for the year ended December 31, 2016 were negatively impacted by approximately $8.4 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +Income from Operations. During the year ended December 31, 2017 , income from operations for our Asia Pacific segment was $79.3 million , an increase of $0.4 million , or 0.5% . Gross profit decreased $16.1 million , or 7.2% , and gross margin decreased 50 basis points to 55.8% compared to the year ended December 31, 2016 as our channel mix shifted toward a more outlet-focused retail footprint. The decrease in the Asia Pacific segment gross profit was due to the net impact of an increase in unit sales volumes +35 +Table of Contents +of $22.7 million , or 10.2% , offset by a decrease in our average selling prices that exceeded the decline in our average costs per unit of $38.0 million , or 17.1% , and a decrease of $0.8 million , or 0.3% , from foreign currency translation. +During the year ended December 31, 2017 , SG&A for our Asia Pacific segment decreased $15.8 million , or 11.1% , compared to the same period in 2016 . The decrease in SG&A was primarily due to the net impact of decreases of $3.2 million in salaries and wages and $8.0 million in facilities expenses as a result of the reduction in the number of company-operated retail stores and our SG&A reduction efforts, including the sale of our Middle East business, lower bad debts expense of $0.9 million , and a decrease of $3.7 million in services and other costs, none of which were individually significant. Impairment expense related to company operated retail stores decreased by $0.6 million compared to 2016. +During the year ended December 31, 2016, income from operations for our Asia Pacific segment was $78.9 million , an increase of $30.5 million, or 62.9%. Gross profit decreased $8.5 million, or 3.7%, and gross margin increased 190 basis points to 56.3% compared to the same period in 2015. The decrease in the Asia Pacific segment gross profit is due to the net impact of: (i) a $1.3 million, or 0.6%, decrease due to lower sales volumes, (ii) a $8.8 million, or 3.7%, decrease due to lower average selling prices in excess of a lower average cost per unit, and (iii) a $1.5 million, or 0.6%, increase due to the impact of foreign currency translation. Gross profit declined by approximately $0.1 million as a result of the sale of our South Africa operations, which was completed on April 15, 2016. +During the year ended December 31, 2016, SG&A for our Asia Pacific segment decreased $29.6 million, or 17.2%, compared to the same period in 2015. The decrease in SG&A was primarily due to the net impact of: (i) a $25.4 million decrease associated with bad debt expense, (ii) a $5.5 million increase associated with services, (iii) a $6.3 million decrease in sales expense, (iv) a $5.0 million decrease in rent expense, and (v) other items that are individually insignificant. +Europe Operating Segment +Revenues. During the year ended December 31, 2017 , revenues for our Europe segment decreased $0.6 million , or 0.4% , compared to the year ended December 31, 2016 , as we continued to reduce discount channel sales and company-operated stores, while growing our e-commerce business. Approximately $16.4 million , or 9.4% , of the decrease was due to lower unit sales volumes, partially offset by an increase of $11.4 million , or 6.6% , from higher average selling prices, and an increase of $4.4 million , or 2.4% , from foreign currency translation. +During the year ended December 31, 2016, revenues for our Europe segment decreased $15.4 million, or 8.1%, compared to the same period in 2015. The decrease in the Europe segment revenues was due to the net impact of: (i) a $22.8 million, or 12.1%, decrease due to lower sales volumes, (ii) a $10.6 million, or 5.7%, increase due to higher average selling prices, and (iii) a $3.2 million, or 1.7%, decrease due to the impact of foreign currency translation. +Income from Operations. During the year ended December 31, 2017 , income from operations for our Europe segment was $25.7 million , an increase of $8.0 million , or 44.9% . Gross profit increased $3.8 million , or 4.5% , and gross margin increased by 240 basis points to 51.3% compared to the year ended December 31, 2016 . The increase in the Europe segment gross profit is due to the net impact of a decrease of $9.7 million , or 11.4% , due to lower unit sales volumes, offset by an increase of $11.2 million , or 13.2% , due to increases in average selling prices, and an increase of $2.3 million , or 2.7% , from foreign currency translation. +During the year ended December 31, 2017 , SG&A for our Europe segment decreased $3.5 million , or 5.2% , compared to the same period in 2016 . The decrease in SG&A was primarily due to decreases in facilities expenses of $3.3 million as a result of the net reduction of 12 company-operated retail stores and SG&A reduction efforts, and lower bad debt expense of $2.4 million , offset in part by an increase in services and other costs of $2.2 million , none of which were individually significant. Impairment expense decreased by $0.7 million compared to 2016. +During the year ended December 31, 2016, income from operations for our Europe segment was $17.8 million , an increase of $2.1 million, or 13.6%. Gross profit decreased $4.2 million, or 4.7%, and gross margin increased 180 basis points to 48.9% compared to the same period in 2015. The decrease in the Europe segment gross profit was due to the net impact of: (i) a $10.8 million, or 12.1%, decrease due to lower sales volumes, (ii) an $8.3 million, or 9.3%, increase due to a higher average selling price in excess of higher costs per unit, and (iii) a $1.7 million, or 1.9%, decrease due to the impact of foreign currency translation. +During the year ended December 31, 2016, SG&A for our Europe segment decreased $2.6 million, or 3.8%, compared to the same period in 2015. The decrease in SG&A was primarily due to the net impact of: (i) a $2.0 increase in bad debt expense, (ii) a $0.9 million decrease in rent expense, and (iv) other items that are individually insignificant. +36 +Table of Contents +Other Businesses, Unallocated Corporate +During the year ended December 31, 2017 , total net costs within ‘Other businesses’ and ‘Unallocated corporate’ increased by $12.9 million , or 8.0% , compared to the same period in 2016 . The increase was due to an increase of $9.8 million in salaries and wages, primarily related to our variable compensation, an increase of $7.8 million in marketing expenses, primarily related to our endorsement and promotional activities, and increased impairments of $4.8 million , which were partially offset by a decrease of $3.8 million in travel and entertainment costs and a decrease of $7.7 million in supply chain costs. Services and other costs, none of which were individually significant, increased by $2.0 million . +During the year ended December 31, 2016, total net costs within ‘Other businesses’ and ‘Unallocated corporate’ decreased by $24.2 million , or 13.0% , compared to the same period in 2015. The decrease was primarily due to decreases in corporate unallocated SG&A costs as a result of our SG&A cost reduction efforts. +Store Locations and Comparable Store Sales +The table below illustrates the overall change in the number of our company-operated retail locations by type of store and reportable operating segment: +December 31, 2015 +Opened +Closed/Transferred +December 31, 2016 +Opened +Closed/Transferred +December 31, 2017 +Type: +Kiosk/store-in- store +98 +14 +14 +98 +— +27 +71 +Retail stores +275 +19 +66 +228 +6 +73 +161 +Outlet stores +186 +50 +4 +232 +13 +30 +215 +Total +559 +83 +84 +558 +19 +130 +447 +Operating segment: +Americas +196 +7 +13 +190 +2 +17 +175 +Asia Pacific +261 +67 +58 +270 +15 +99 +186 +Europe +102 +9 +13 +98 +2 +14 +86 +Total +559 +83 +84 +558 +19 +130 +447 +Comparable retail store sales and direct to consumer comparable store sales by reportable operating segment are as follows: +Constant Currency (1) +Year Ended December 31, +2017 +2016 +2015 +Comparable retail store sales (2) +Americas +1.3 +% +(2.3 +)% +(3.2 +)% +Asia Pacific +(1.9 +)% +(5.9 +)% +(4.5 +)% +Europe +(1.6 +)% +1.9 +% +3.0 +% +Global +— +% +(3.0 +)% +(2.8 +)% +Constant Currency (1) +Year Ended December 31, +2017 +2,016 +2016 +2015 +Direct to consumer comparable store sales (includes retail and e-commerce) (2) +Americas +3.9 +% +0.3 +% +3.3 +% +Asia Pacific +6.4 +% +(0.4 +)% +3.0 +% +Europe +4.1 +% +0.2 +% +7.8 +% +Global +4.7 +% +0.1 +% +3.9 +% +(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. Constant currency represents current period results that have been retranslated using exchange rates used in the prior comparative period. +37 +Table of Contents +(2) Comparable store status is determined on a monthly basis. Comparable store sales includes the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period. +Liquidity and Capital Resources +We anticipate our cash flows from operations and available borrowings under our Senior Revolving Credit Facility (as described below) will be sufficient to meet the ongoing liquidity needs of our business for the next twelve months. As of December 31, 2017 , we had $172.1 million in cash and cash equivalents and up to $99.4 million in available borrowings under our revolving credit facility. As of December 31, 2016 , we had $147.6 million in cash and cash equivalents and up to $78.7 million in available borrowings under our revolving credit facility. At December 31, 2017 , $124.4 million of our cash and cash equivalents was held in international locations, compared to $121.9 million at December 31, 2016 . See “Repatriation of Cash” below for more information. We believe our cash on hand and cash flows from operations will be sufficient to meet our liquidity needs for at least the next 12 months. Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, +2017 vs. 2016 +2017 +2016 +(in thousands) +Cash provided by operating activities +$ +98,264 +$ +39,754 +$ +58,510 +Cash used in investing activities +(10,972 +) +(18,657 +) +7,685 +Cash used in financing activities +(65,370 +) +(16,443 +) +(48,927 +) +Effect of exchange rate changes on cash +2,641 +(430 +) +3,071 +Net increase in cash and cash equivalents +$ +24,563 +$ +4,224 +$ +20,339 +Year Ended December 31, 2017 +Operating Activities. Cash provided by operating activities increased $58.5 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 . The increase in cash provided by operating activities resulted from a favorable change in net income as adjusted for non-cash items of $27.6 million , and a favorable change in our operating assets and liabilities of $30.9 million . Net income as adjusted for non-cash items increased due to: (i) an increase of $26.7 million from higher net income; (ii) an increase of $10.1 million from net unrealized foreign currency remeasurement and forward contract activity; (iii) a decrease of $3.8 million in bad debts; (iv) and a decrease of $5.4 million in other non-cash items. +Investing Activities. The $7.7 million decrease in cash used in investing activities for the year ended December 31, 2017 compared to the year ended December 31, 2016 is primarily due to the net impact of: (i) a $9.1 million decrease in capital expenditures for property, equipment, and software; (ii) a decrease in proceeds from asset disposals of $0.9 million ; (iii) a $0.6 million decrease in restricted cash; and (iii) an increase of $0.1 million related to other investing activities. +Financing Activities. The $48.9 million increase in cash used in financing activities for the year ended December 31, 2017 compared to the year ended December 31, 2016 resulted from (i) repurchases of 5.7 million shares of our common stock for $50.0 million ; partially offset by (ii) lower net repayments on borrowings of $0.9 million ; and (iii) a net decrease of $0.2 million of cash used in other financing activities. +Working Capital. Changes in cash from working capital for the year ended December 31, 2017 compared to the year ended December 31, 2016 were due primarily to the following: (i) a favorable change of $2.9 million from lower inventory levels, due to enhanced inventory management; (ii) a favorable change of $23.4 million in prepaid expenses and other assets; (iii) an unfavorable change of $1.8 million due to an increase in accounts receivable; and (iv) a favorable change in accounts payable and accrued liabilities of $1.2 million ; and (v) a net favorable changes in income taxes of $5.1 million . Cash and cash equivalents increased by $24.6 million to $172.1 million as of December 31, 2017 . +38 +Table of Contents +Senior Revolving Credit Facility +In order to provide additional liquidity in the future and to help support our strategic goals, our revolving credit facility (“the Facility”), pursuant to an Amended and Restated Credit agreement (“the Credit Agreement”), provides for borrowings of up to $100.0 million through February 2021 (increased from $80.0 million in October 2017). The Facility contains financial covenants that restrict certain actions by us, including limitations on: (i) stock repurchases to $50.0 million per year, subject to certain restrictions; and (ii) capital expenditures and commitments to $50.0 million per year. The Credit Agreement also permits intercompany loans of up to $375.0 million and requires the Company to meet certain financial covenant ratios that become effective when average outstanding borrowings under the Credit Agreement, including letters of credit, exceed the lesser of $40.0 million or 40% of the total commitments during certain periods or if the outstanding borrowings exceed the borrowing base. If the financial covenant ratios are in effect, the Company must maintain a minimum fixed charge coverage ratio of 1.10 to 1.00, and a maximum leverage ratio of 2.00 to 1.00. As of December 31, 2017 , the Company was in compliance with all financial covenants. +As of December 31, 2017 , we had no outstanding borrowings on the Facility and $0.6 million of outstanding letters of credit, resulting in $99.4 million of available credit for future financing needs. +In January 2018, the Company entered into a revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch, or the “CMBC Facility,” which provides the Company a revolving loan facility of up to 30.0 million RMB, or $4.6 million , subject to consent by the lender. The CMBC Facility will mature in January 2019 . For RMB loans under the CMBC Facility, interest is based on a benchmark interest rate plus a certain number of basis points upon agreement by the lender and the Company at the time of borrowing. The CMBC Facility may be canceled or suspended at any time by either party. +In February 2018, the Company entered into an amendment to the Credit Agreement which enables the Company repurchase up to $100 million of its common stock each year, subject to certain restrictions, and increased the limit on cumulative stock repurchases from $350 million to $600 million . +Notes Payable +As of December 31, 2017 , we had $0.7 million of current debt outstanding under notes payable, bearing fixed interest rates ranging from 1.95% to 2.83% . +Stock Repurchase Plan Authorizations +On December 26, 2013, the Board approved the repurchase of up to $350.0 million of our common stock. The number, price, structure, and timing of the repurchases will be at our sole discretion and may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. +During the year ended December 31, 2017 , we repurchased 5.7 million shares of our common stock at a cost of $50.0 million . As of December 31, 2017 , we had $68.8 million of remaining common stock repurchase authorizations under our 2013 stock repurchase plan. During the year ended December 31, 2016 , we made no stock repurchases. +On February 20, 2018, the Board approved an increased repurchase authorization up to $500.0 million of our common stock. +Capital Expenditures +During the year ended December 31, 2017 , we paid $13.1 million for property, equipment, and software, compared to $22.2 million during the year ended December 31, 2016 . Capital expenditures during the year ended December 31, 2017 related primarily to information technology investments, opening new retail stores, and renovating existing stores. For 2018, we expect to invest approximately $20 million in capital expenditure improvements, primarily information technology and supply chain enhancements. +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +39 +Table of Contents +As a result of the Tax Act, most of the cash held outside of the U.S. could be repatriated to the U.S. without incurring additional U.S. federal income taxes. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. As of December 31, 2017, we held $124.4 million of our total $172.1 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $124.4 million, $1.1 million could potentially be restricted. If the remaining $123.3 million were to be immediately repatriated to the U.S., no additional U.S. federal income tax expense would be incurred. +Off-Balance Sheet Arrangements +We had no material off-balance sheet arrangements as of December 31, 2017 , other than certain operating lease and purchase commitments, which are described in Note 13 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Contractual Obligations +The Company has a supply agreement which provides the Company the right to purchase certain raw materials used to manufacture its products. The supply agreement requires that the Company meet minimum purchase requirements throughout the term of the agreement, which renews annually on January 1st unless terminated by either party. Historically, the minimum purchase requirements have not been onerous and the Company does not expect them to become onerous in the future. Depending on the material purchased, pricing is based either on contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations, and raw material prices. Pursuant to the agreement, the Company guarantees the payment for certain third-party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.2 million as of December 31, 2017 ). +The following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2017 : +Total +Less than +1 Year +1 - 3 Years +3 - 5 Years +More than +5 Years +(in thousands) +Operating lease obligations (1) +$ +210,511 +$ +53,329 +$ +65,363 +$ +39,493 +$ +52,326 +Inventory purchase obligations with third-party manufacturers (2) +122,699 +122,699 +— +— +— +Dividends payable (3) +48,866 +12,000 +24,000 +12,866 +— +Other contracts (4) +35,580 +24,011 +8,349 +3,220 +— +Minimum licensing royalties (5) +3,010 +2,954 +56 +— +— +Debt obligations (6) +662 +662 +— +— +— +Capital lease obligations (7) +44 +14 +24 +6 +— +Total +$ +421,372 +$ +215,669 +$ +97,792 +$ +55,585 +$ +52,326 +(1) Our operating lease obligations consist of leases for retail stores, offices, warehouses, vehicles, and equipment expiring at various dates through 2033. This balance represents the minimum cash commitment under contract to various third parties for operating lease obligations including the effect of rent escalation clauses and deferred rent and minimum sublease rentals due in the future under non-cancelable subleases. This balance does not include certain contingent rent clauses that may require additional rental amounts based on sales volume, inventories, etc. as these amounts are not determinable for future periods. +(2) Our inventory purchase obligations with third-party manufacturers consist of open purchase orders for footwear products and include an immaterial amount of purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third-party manufacturers are expected to be paid within one year. +(3) Dividends payable are associated with our Series A Preferred Stock at a rate of 6.0% of the stated value of the stock. The amounts represent +expected dividend payments over the eight year redemption accretion period ending January 27, 2022. +(4) Other contracts consist of various agreements with third-party providers, primarily for IT and financial services, distribution and logistics service providers, and other agreements. +(5) Our minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our footwear and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for future periods. +(6) Our current debt obligations consist of two notes payable related to insurance premiums. +(7) Our capital lease obligations consist of leases for office equipment expiring at various dates through 2021. This balance represents the minimum cash commitment under contract to various third-parties for capital lease obligations. +40 +Table of Contents +Excluded from the table above is a $5.4 million liability for unrecognized tax benefits as of December 31, 2017 , as we cannot make a reliable estimate of the period in which the liability will be settled, if ever. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and non-GAAP financial measures, is based on the consolidated financial statements which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Reserves for Uncollectible Accounts Receivable +We make ongoing estimates related to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events, and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge, respectively, to ‘Selling, general and administrative expenses’ in our consolidated statement of operations in the period in which we made such a determination. See Item 15 — Schedule II to the accompanying consolidated financial statements for an analysis of the activity in our allowance for doubtful accounts. +Sales Returns, Allowances and Discounts +A significant area of judgment affecting reported revenues and net income involves estimating reserves for sales returns, allowances, and discounts, which represent the portion of revenues not expected to be realized. Wholesale revenues are reduced by estimates of returns, allowance, discounts, and contractual discounts to major customers. We also may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments, and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. We also record reductions to revenues for estimated customer credits as a result of price markdowns in certain markets. Revenues in our retail and e-commerce channels are also reduced by an estimate of returns. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns, allowances and discounts may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances and discounts have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns, allowances and discounts as of December 31, 2017 would have decreased our 2017 revenues by approximately $7.0 million. See Item 15 — Schedule II to the accompanying consolidated financial statements for an analysis of the activity in our sales returns, allowances and discounts. +41 +Table of Contents +Inventory Valuation +Our products are sold through wholesale distribution channels department stores, sporting goods stores, distributors, national, regional and independent retailers. We also sell directly to consumers through company-operated, full-price retail stores, kiosks, store-in-store locations, outlet stores, and e-commerce sites. Substantially all of our inventories are finished goods, which are stated at the lower of cost or net realizable value, with cost determined using the moving average cost method. +We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end of life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value and the difference is recorded in ‘Cost of sales’ in our consolidated statements of operations. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and recorded within ‘Cost of sales’ in our consolidated statements of operations. +Impairment of Other Long-Lived Assets +Property and equipment along with other long-lived assets are evaluated for impairment periodically whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. Testing of long-lived assets for impairment is at the level of an asset group, which is the is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +During 2017 , 2016 , and 2015 , we recorded non-cash impairment of $5.3 million , $3.1 million , and $15.3 million , respectively, to reduce the net carrying value of certain long-lived assets to their estimated fair values, including a $4.8 million write-off for a discontinued project in 2017, $0.4 million related to goodwill in 2016, and $0.5 million , $2.7 million , and $15.3 million , respectively, related to underperforming company-operated retail stores. See Note 3 — Property and Equipment, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +Share-Based Compensation +Stock Options +Stock options are granted to employees and non-employee directors with exercise prices equal to the fair market value of our common stock on the date of grant. We use the Black-Scholes option-pricing model to estimate the grant date fair value of stock options, which requires the use of assumptions, including the expected term of the option, expected volatility of our stock price, our expected dividend yield, and the risk-free interest rate, among others. These assumptions reflect our best estimates, however; they involve inherent uncertainties including market conditions and employee behavior that are generally outside of our control. Generally, once stock option values are determined, accounting practices do not permit them to be changed, even if the estimates used are different from actual results. We expense all share-based compensation awarded to employees and non-employee directors based on the grant date fair value of the awards over the requisite service period, adjusted for forfeitures. +42 +Table of Contents +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +We grant RSAs to our non-employee directors, time-based RSUs to certain executive and non-executive employees, and performance-based RSUs to certain executives. The grant date fair values of RSAs and time-based RSUs are based on the closing market price of our common stock on the grant date, adjusted for dividend rights during the vesting period. Our performance-based RSUs vest based upon attainment of certain performance conditions, including earnings levels, revenue and cash flow targets, and certification by our Compensation Committee. The grant date fair value of these awards is estimated using a Monte Carlo simulation valuation model. This pricing model utilizes multiple input variables that determine the probability of satisfying each performance condition stipulated in the terms of the award to estimate its grant date fair value. Compensation expense, net of forfeitures, is recognized over the employees’ requisite service period when attainment of the performance goals is deemed probable, which involves judgment as to achievement of certain performance metrics. +Contingencies and Legal Proceedings +We are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. In addition, if it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. Management considers many factors in making these assessments. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 13 — Commitments and Contingencies and Note 15 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional information regarding our contingencies and legal proceedings. +Income Taxes +We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions, determining our provision for income taxes, and evaluating the impact of the Tax Act. The Tax Act was enacted on December 22, 2017 and introduces significant changes to U.S. income tax law. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings which is referred to as the global intangible low-taxed income. In addition, in 2017 we are subject to a one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax. Accounting for the income tax effects of the Tax Act requires significant judgments and estimates in the interpretation and calculations of the provisions of the Tax Act. +We continue to evaluate the impacts of the Tax Act. As we further understand its implications, as well as the related, and yet to be issued, regulator rules, regulations and interpretations, our effective tax rate could be impacted. Additional impacts from the Tax Act will be recorded as they are identified during the measurement period pursuant to Staff Accounting Bulletin No. 118 ("SAB 118"). Our determination of the tax effects of the Tax Act will be completed no later than one year from the enactment date as permitted under SAB 118. Any adjustments to provisional amounts that are identified during the measurement period will be recorded and disclosed in the reporting period in which the adjustment is determined. The complexity of the Tax Act could necessitate the need to use the full one year measurement period to adequately interpret, analyze and conclude upon the tax effects of the Tax Act as of the enactment date. +We account for income taxes using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense’ line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +43 +Table of Contents +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-US subsidiaries as of December 31, 2017 which are considered to be indefinitely reinvested outside of the United States. +See Note 11 — Income Taxes in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements, and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +44 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility and certain financial instruments. +Borrowings under our Facility bear interest at a variable rate. For domestic rate loans, including swing loans, the interest rate is equal to a daily base rate plus a margin ranging from 0.50% to 0.75% based on certain conditions. For domestic London Interbank Borrowing Rate (“LIBOR”) rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.50% to 1.75% based on certain conditions. +Borrowings under our Facility are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. As of December 31, 2017 and 2016 , there were no borrowings outstanding under our Facility. +Foreign Currency Exchange Risk +As a global company, we have significant revenues and costs denominated in currencies other than the USD. We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiary’s functional currency. Likewise, our U.S. companies are also exposed to the risk of gains and losses and the resulting changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. +We have experienced and will continue to experience changes in foreign currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur. As of December 31, 2017 , the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $224.7 million . The net fair value of these contracts at December 31, 2017 was a liability of $0.4 million . +The effects of changes in prevailing market interest rates earned on these investments on interest income during the year ended December 31, 2017 is not significant to our consolidated results of operations, financial condition, or cash flows. +Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates used to translate the operating results of our international subsidiaries. For example, in our Europe operating segment, when the USD strengthens relative to the Euro, our reported USD results are lower than if there had been no change in the exchange rate, because more Euros are required to generate the same USD translated amount. Conversely, when the USD weakens relative to the Euro, the reported USD results of our Europe operating segment are higher compared to a period with a stronger USD relative to the Euro. Similarly, the reported USD results of our Asia Pacific operating segment, where the functional currencies are primarily the Japanese Yen, Chinese Yuan, Korean Won and the Singapore Dollar, are comparatively lower or higher when the USD strengthens or weakens, respectively, relative to these currencies. +An increase of 1% of the value of the USD relative to foreign currencies would have increased our income before taxes during the year ended December 31, 2017 by approximately $0.1 million . The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statement of operations for the years ended December 31, 2017 , 2016 , and 2015. +45 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2017 , to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting (“ICFR”) as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2017 , based on the framework and criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2017 . +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2017 , as stated in the report which appears herein. +46 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2017, of the Company and our report dated February 28, 2018, expressed an unqualified opinion on those consolidated financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 28, 2018 +47 +Table of Contents +ITEM 9B. Other Information +None. +48 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2017 . +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, our code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct and ethics policy as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2017 . +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2017 , with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 3.7 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2017 . +Plan Category +Number of +Securities to be Issued +on Exercise of +Outstanding +Options and Rights (2) +Weighted Average +Exercise Price of +Outstanding +Options (3) +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders (1) +3,682,751 +$ +11.00 +3,511,206 +Equity compensation plans not approved by stockholders +— +— +— +Total +3,682,751 +$ +11.00 +3,511,206 +(1) On June 8, 2015, the Company’s stockholders approved the Crocs, Inc. 2015 Equity Incentive Plan (the “Plan”). The number of shares available for issuance under the Plan (subject to changes in capitalization) consist of (i) 7.0 million newly available shares; (ii) 1.2 million shares available for issuance under the 2007 Plan as of June 8, 2015; and (iii) 2007 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 8, 2015. The Plan provides for the grant of incentive and non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, and other share-based awards. The Plan became effective immediately upon stockholder approval. +(2) Assumes target performance for performance-based equity awards. +(3) The weighted average exercise price of outstanding options pertains to 0.5 million shares issuable on the exercise of outstanding options and rights. +49 +Table of Contents +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2017 . +ITEM 14. Principal Accounting Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2017 . +50 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedules +The following consolidated financial statement schedule of Crocs Inc. and its subsidiaries is filed as a part of this report: +• +Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +51 +Table of Contents +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.1 +* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.’s Annual Report on Form 10-K, filed on March 17, 2009). +10.2 +* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the “2007 Plan”) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.3 +* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.4 +* +Form of Non-Statutory Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.5 +* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.6 +* +Form of Restricted Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.7 +* +Crocs, Inc. 2008 Cash Incentive Plan (As Amended and Restated) (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 7, 2017). +10.8 +* +Crocs, Inc. 2015 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +10.9 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders (the “Amended and Restated Credit Agreement”) (incorporated herein by reference to Crocs, Inc.’s Current Report on Form 8-K, filed on December 19, 2011). +10.10 +First Amendment to the Amended and Restated Credit Agreement, dated December 10, 2012, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Crocs, Inc.’s Current Report on Form 8-K, filed on December 11, 2012). +10.11 +Second Amendment to Amended and Restated Credit Agreement, dated June 12, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on July 30, 2013). +52 +Table of Contents +Exhibit +Number +Description +10.12 +Third Amendment to Amended and Restated Credit Agreement, dated December 27, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 30, 2013). +10.13 +Fourth Amendment to Amended and Restated Credit Agreement, dated March 27, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.14 +Fifth Amendment to Amended and Restated Credit Agreement, dated September 26, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on October 29, 2014). +10.15 +Sixth Amendment to Amended and Restated Credit Agreement, dated April 2, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2015). +10.16 +Seventh Amendment to Amended and Restated Credit Agreement, dated April 21, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2015). +10.17 +Eighth Amendment to Amended and Restated Credit Agreement, dated September 1, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.18 +Ninth Amendment to Amended and Restated Credit Agreement, dated November 3, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.19 +Tenth Amendment to Amended and Restated Credit Agreement, dated December 24, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.29 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 29, 2016). +10.20 +Eleventh Amendment to Amended and Restated Credit Agreement, dated February 18, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., and PNC Bank, National Association, as a lender and administrative agent. (incorporated herein by reference to Exhibit 10.30 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 29, 2016). +10.21 +Twelfth Amendment to Amended and Restated Credit Agreement, dated June 13, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2016). +10.22 +Thirteenth Amendment to Amended and Restated Credit Agreement, dated November 22, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.32 to Crocs, Inc.’s Annual Report on Form 10-K, filed on March 1, 2017). +10.23 +† +Fourteenth Amendment to Amended and Restated Credit Agreement, dated October 13, 2017, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent. +53 +Table of Contents +Exhibit +Number +Description +10.24 +† +Fifteenth Amendment to Amended and Restated Credit Agreement, dated February 22, 2018, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent. +10.25 +* +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.26 +Investment Agreement, dated December 28, 2013, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 30, 2013). +10.27 +First Amendment to Investment Agreement, dated January 27, 2014, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +10.28 +Second Amendment to Investment Agreement, dated June 6, 2017, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 7, 2017). +10.29 +Registration Rights Agreement, dated January 27, 2014 (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +10.30 +* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.31 +* +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +10.32 +* +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.33 +* +Employment Offer Letter, dated December 15, 2014, between Crocs, Inc. and Gregg Ribatt (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 15, 2014). +10.34 +* +Consulting Agreement, dated February 27, 2017, between Crocs, Inc. and Gregg Ribatt (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.35 +* +Employment Offer Letter, dated November 4, 2015, between Crocs, Inc. and Carrie Teffner (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on November 5, 2015). +21 +† +Subsidiaries of the registrant. +23.1 +† +Consent of Deloitte & Touche LLP. +31.1 +† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 +† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 +† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS +† +XBRL Instance Document +54 +Table of Contents +Exhibit +Number +Description +101.SCH +† +XBRL Taxonomy Extension Schema Document +101.CAL +† +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF +† +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB +† +XBRL Taxonomy Extension Label Linkbase Document +101.PRE +† +XBRL Taxonomy Extension Presentation Linkbase Document +* Compensatory plan or arrangement. +† Filed herewith. +55 +Table of Contents +Item 16. Form 10–K Summary. +None. +56 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 28, 2018 . +CROCS, INC. +a Delaware Corporation +By: +/s/ ANDREW REES +Name: +Andrew Rees +Title: +President and Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ ANDREW REES +President, Chief Executive Officer, and Director (Principal Executive Officer) +February 28, 2018 +Andrew Rees +/s/ CARRIE W. TEFFNER +Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) +February 28, 2018 +Carrie W. Teffner +/s/ THOMAS J. SMACH +Chairman of the Board +February 28, 2018 +Thomas J. Smach +/s/ IAN M. BICKLEY +Director +February 28, 2018 +Ian M. Bickley +/s/ RONALD L. FRASCH +Director +February 28, 2018 +Ronald L. Frasch +/s/ PRAKASH A. MELWANI +Director +February 28, 2018 +Prakash A. Melwani +/s/ GREGG S. RIBATT +Director +February 28, 2018 +Gregg S. Ribatt +/s/ DOUGLAS J. TREFF +Director +February 28, 2018 +Douglas J. Treff +/s/ DOREEN A. WRIGHT +Director +February 28, 2018 +Doreen A. Wright +57 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F- 2 +Consolidated Statements of Operations for the Years Ended December 31, 2017, 2016, and 2015 +F- 3 +Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016, and 2015 +F- 4 +Consolidated Balance Sheets as of December 31, 2017 and 2016 +F- 5 +Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2017, 2016, and 2015 +F- 6 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016, and 2015 +F- 7 +Notes to Consolidated Financial Statements +F- 8 +Schedule II: Valuation and Qualifying Accounts +F- 35 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2017, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2018, expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 28, 2018 +We have served as the Company's auditor since 2005. +F- 2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Year Ended December 31, +2017 +2016 +2015 +Revenues +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +Cost of sales +506,292 +536,109 +579,825 +Gross profit +517,221 +500,164 +510,805 +Selling, general and administrative expenses +494,601 +503,174 +567,823 +Asset impairments +5,284 +3,144 +15,306 +Income (loss) from operations +17,336 +(6,154 +) +(72,324 +) +Foreign currency gain (loss), net +563 +(2,454 +) +(3,332 +) +Interest income +870 +692 +967 +Interest expense +(869 +) +(836 +) +(969 +) +Other income, net +280 +1,539 +914 +Income (loss) before income taxes +18,180 +(7,213 +) +(74,744 +) +Income tax expense +7,942 +9,281 +8,452 +Net income (loss) +10,238 +(16,494 +) +(83,196 +) +Dividends on Series A convertible preferred stock +(12,000 +) +(12,000 +) +(11,833 +) +Dividend equivalents on Series A convertible preferred shares related to redemption value accretion and beneficial conversion feature +(3,532 +) +(3,244 +) +(2,978 +) +Net loss attributable to common stockholders +$ +(5,294 +) +$ +(31,738 +) +$ +(98,007 +) +Net loss per common share: +Basic +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +Diluted +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +Weighted average common shares outstanding: +Basic +72,255 +73,371 +75,604 +Diluted +72,255 +73,371 +75,604 +The accompanying notes are an integral part of these consolidated financial statements. +F- 3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +Year Ended December 31, +2017 +2016 +2015 +Net income (loss) +$ +10,238 +$ +(16,494 +) +$ +(83,196 +) +Other comprehensive income (loss): +Foreign currency gain (loss), net +12,202 +(4,683 +) +(32,561 +) +Total comprehensive income (loss) +$ +22,440 +$ +(21,177 +) +$ +(115,757 +) +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2017 +2016 +ASSETS +Current assets: +Cash and cash equivalents +$ +172,128 +$ +147,565 +Accounts receivable, net of allowances of $31,389 and $48,138, respectively +83,518 +78,297 +Inventories +130,347 +147,029 +Income taxes receivable +3,652 +2,995 +Other receivables +10,664 +14,642 +Restricted cash - current +2,144 +2,534 +Prepaid expenses and other assets +22,596 +32,413 +Total current assets +425,049 +425,475 +Property and equipment, net of accumulated depreciation and amortization of $91,806 and $88,603, respectively +35,032 +44,090 +Intangible assets, net +56,427 +72,700 +Goodwill +1,688 +1,480 +Deferred tax assets, net +10,174 +6,825 +Restricted cash +2,783 +2,547 +Other assets +12,542 +13,273 +Total assets +$ +543,695 +$ +566,390 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +66,381 +$ +61,927 +Accrued expenses and other liabilities +84,446 +78,282 +Income taxes payable +5,515 +6,593 +Current portion of borrowings and capital lease obligations +676 +2,338 +Total current liabilities +157,018 +149,140 +Long-term income taxes payable +6,081 +4,464 +Other liabilities +12,298 +13,502 +Total liabilities +175,397 +167,106 +Commitments and contingencies: +Series A convertible preferred stock, 0.2 million shares outstanding, liquidation preference $203 million +182,433 +178,901 +Stockholders’ equity: +Preferred stock, par value $0.001 per share, none outstanding +— +— +Common stock, par value $0.001 per share, 94.8 million and 93.9 million issued, 68.8 million and 73.6 million shares outstanding, respectively +95 +94 +Treasury stock, at cost, 26.0 million and 20.3 million shares, respectively +(334,312 +) +(284,237 +) +Additional paid-in capital +373,045 +364,397 +Retained earnings +190,431 +195,725 +Accumulated other comprehensive loss +(43,394 +) +(55,596 +) +Total stockholders’ equity +185,865 +220,383 +Total liabilities and stockholders’ equity +$ +543,695 +$ +566,390 +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock +Treasury Stock +Additional +Paid-in +Capital +Retained +Earnings +Accumulated +Other +Comprehensive +Loss +Total +Stock-holders' +Equity +Shares +Amount +Shares +Amount +Balance at December 31, 2014 +78,516 +$ +92 +13,809 +$ +(200,424 +) +$ +345,732 +$ +325,470 +$ +(18,352 +) +$ +452,518 +Share-based compensation +— +— +— +— +11,186 +— +— +11,186 +Tax shortfall from share-based plans +— +— +— +— +(2,841 +) +— +— +(2,841 +) +Exercises of stock options and issuance of restricted stock awards +810 +2 +(34 +) +2,437 +(836 +) +— +— +1,603 +Repurchases of common stock +(6,475 +) +— +6,475 +(85,926 +) +— +— +— +(85,926 +) +Series A preferred dividends +— +— +— +— +— +(11,833 +) +— +(11,833 +) +Series A preferred accretion +— +— +— +— +— +(2,978 +) +— +(2,978 +) +Net loss +— +— +— +— +— +(83,196 +) +— +(83,196 +) +Other comprehensive loss +— +— +— +— +— +— +(32,561 +) +(32,561 +) +Balance at December 31, 2015 +72,851 +$ +94 +20,250 +$ +(283,913 +) +$ +353,241 +$ +227,463 +$ +(50,913 +) +$ +245,972 +Share-based compensation +— +— +— +— +10,736 +— +— +10,736 +Exercises of stock options and issuance of restricted stock awards +749 +— +37 +(324 +) +420 +— +— +96 +Series A preferred dividends +— +— +— +— +— +(12,000 +) +— +(12,000 +) +Series A preferred accretion +— +— +— +— +— +(3,244 +) +— +(3,244 +) +Net loss +— +— +— +— +— +(16,494 +) +— +(16,494 +) +Other comprehensive loss +— +— +— +— +— +— +(4,683 +) +(4,683 +) +Balance at December 31, 2016 +73,600 +$ +94 +20,287 +$ +(284,237 +) +$ +364,397 +$ +195,725 +$ +(55,596 +) +$ +220,383 +Share-based compensation +— +— +— +— +11,619 +— +— +11,619 +Exercises of stock options and issuance of restricted stock awards +850 +1 +41 +(75 +) +(2,971 +) +— +— +(3,045 +) +Repurchases of common stock +(5,659 +) +— +5,659 +(50,000 +) +— +— +— +(50,000 +) +Series A preferred dividends +— +— +— +— +— +(12,000 +) +— +(12,000 +) +Series A preferred accretion +— +— +— +— +— +(3,532 +) +— +(3,532 +) +Net income +— +— +— +— +— +10,238 +— +10,238 +Other comprehensive gain +— +— +— +— +— +— +12,202 +12,202 +Balance at December 31, 2017 +68,791 +$ +95 +25,987 +$ +(334,312 +) +$ +373,045 +$ +190,431 +$ +(43,394 +) +$ +185,865 +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2017 +2016 +2015 +Cash flows from operating activities: +Net income (loss) +$ +10,238 +$ +(16,494 +) +$ +(83,196 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depreciation and amortization +33,130 +34,043 +35,993 +Unrealized foreign currency (gain) loss, net +1,025 +(9,027 +) +(814 +) +Share-based compensation +9,773 +10,736 +11,236 +Asset impairments +5,284 +3,144 +15,306 +(Recovery) provision for doubtful accounts, net +(589 +) +3,230 +25,997 +Deferred taxes +(3,093 +) +(388 +) +289 +Other non-cash items +(2,406 +) +503 +7,137 +Changes in operating assets and liabilities: +Accounts receivable, net of allowances +620 +2,408 +(15,604 +) +Inventories +23,319 +20,371 +(8,586 +) +Prepaid expenses and other assets +18,907 +(4,532 +) +1,755 +Accounts payable +(2,714 +) +(1,354 +) +23,260 +Accrued expenses and other liabilities +5,489 +2,884 +5,088 +Income taxes +(719 +) +(5,770 +) +(8,163 +) +Cash provided by operating activities +98,264 +39,754 +9,698 +Cash flows from investing activities: +Purchases of property, equipment, and software +(13,117 +) +(22,194 +) +(18,486 +) +Proceeds from disposal of property and equipment +1,579 +2,438 +(2 +) +Change in restricted cash +566 +1,199 +(139 +) +Other +— +(100 +) +— +Cash used in investing activities +(10,972 +) +(18,657 +) +(18,627 +) +Cash flows from financing activities: +Proceeds from bank borrowings +5,500 +31,582 +— +Repayments of bank borrowings and capital lease obligations +(8,611 +) +(35,640 +) +(5,290 +) +Dividends—Series A preferred stock +(12,000 +) +(12,000 +) +(11,900 +) +Repurchases of common stock +(50,000 +) +— +(85,926 +) +Other +(259 +) +(385 +) +1,856 +Cash used in financing activities +(65,370 +) +(16,443 +) +(101,260 +) +Effect of exchange rate changes on cash and cash equivalents +2,641 +(430 +) +(13,982 +) +Net change in cash and cash equivalents +24,563 +4,224 +(124,171 +) +Cash and cash equivalents—beginning of year +147,565 +143,341 +267,512 +Cash and cash equivalents—end of year +$ +172,128 +$ +147,565 +$ +143,341 +Cash paid for interest +$ +434 +$ +653 +$ +917 +Cash paid for income taxes +13,208 +12,344 +19,923 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1 . BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of “the Company,” “Crocs,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. The Company is engaged in the design, development, manufacturing, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. Our reportable operating segments include: the Americas, operating in North and South America; Asia Pacific, operating throughout Asia, Australia, New Zealand, Africa, and the Middle East; and Europe, operating throughout Western Europe, Eastern Europe, and Russia. +Basis of Presentation and Consolidation +The Company’s consolidated financial statements include its accounts and those of its wholly-owned subsidiaries, and reflect all adjustments which are necessary for a fair statement of financial position, results of operations, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, depreciation, and provisions for contingencies are reasonable based on information available at the time they are made. Management also makes estimates in the assessments of potential losses in relation to tax matters and threatened or pending legal proceedings (see Note 11 — Income Taxes and Note 15 — Legal Proceedings ).To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassifications +The Company has reclassified certain amounts on the consolidated statements of operations, consolidated balance sheets, consolidated statements of cash flows, and Note 7 — Derivative Financial Instruments to conform to current period presentation. +Transactions with Affiliates +The Company receives services from three subsidiaries of Blackstone Capital Partners VI L.P. (“Blackstone”). Blackstone and certain of its permitted transferees currently beneficially own all the outstanding shares of the Company’s Series A Convertible Preferred Stock, which is convertible into approximately 16.7% of the Company’s common stock as of December 31, 2017 . Blackstone also has the right to nominate two representatives to serve on the Company’s Board of Directors (the “Board”). +Certain Blackstone subsidiaries provide various services to the Company, including inventory count, cybersecurity and consulting, and workforce management services. The Company incurred expenses of $0.7 million , $0.8 million , and $0.9 million for the years ended December 31, 2017 , 2016 , and 2015 respectively, for these services, which are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Revenue Recognition +Revenue is recognized when persuasive evidence of an arrangement exists, the significant risks and rewards of ownership, including title and risk of loss, are transferred to the customer or distributor, the collection of the related receivables is probable, and the selling price is fixed or determinable. Title passes on shipment to or on receipt by the customer depending on the country in which the sale occurs and the agreement terms with the customer. We also may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments. The estimated costs of sales incentives, discounts, returns, price promotions, rebates, and loyalty and coupon programs are reported as a reduction of revenues. +F- 8 +Table of Contents +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, depreciation, packaging, and other manufacturing overheads and costs. +Research, Design, and Development Expenses +We continue to dedicate significant resources to product design and development based on opportunities we identify in the marketplace. We incurred expenses of $13.4 million , $11.9 million , and $14.0 million in research, design, and development activities for the years ended December 31, 2017 , 2016 , and 2015 , respectively, which are expensed as incurred and are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Selling, General and Administrative Expenses +Our selling, general and administrative expenses include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of the Company’s promotional expenses result from payments under endorsement contracts. Expenses under endorsement contracts are expensed on a straight-line basis over the related annual contract terms. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, were $59.1 million , $56.0 million , and $58.2 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. Prepaid advertising and promotional endorsement costs of $7.0 million and $4.5 million , were included in other current assets in the consolidated balance sheets at December 31, 2017 and 2016 , respectively. +Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources and information technology. Selling, general and administrative expenses consist primarily of labor and outside services, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to non-production equipment and share-based compensation. +Other Income, Net +Other income, net primarily includes gains and losses associated with activities not directly related to making and selling footwear, as well as certain gains or losses on sales of non-operating assets. +Foreign Currency Gain (Loss), Net +Foreign currency gain (loss), net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of an entity, and realized and unrealized gains and losses on forward foreign exchange derivative contracts. Realized foreign exchange gains and losses are reported in the operating segment in which they occur. Foreign exchange gains and losses on intercompany balances and forward foreign exchange derivative contracts are reported within the Corporate segment. +Other Comprehensive Income (Loss) +Our foreign subsidiaries use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into U.S. dollars using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss) +F- 9 +Table of Contents +(“OCI”), until the substantial disposition of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. Our OCI consists entirely of cumulative translation gains and losses. +Income Taxes +Income taxes are accounted for using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See Note 11 — Income Taxes for further discussion. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from sales. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. The Company reports receivables from credit card companies, if expected to be received within five days, in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Consolidated Statements of Cash Flows - Supplemental Schedule of Non-Cash Investing and Financing Activities +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Accrued purchases of property, equipment, and software +$ +2,195 +$ +2,728 +$ +851 +Accretion of dividend equivalents +3,532 +3,244 +2,978 +Vendor financed insurance premiums +1,450 +2,082 +— +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. The Company reduces the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting the Company’s customer base, and historical collection experience. Specific provisions are recorded for individual receivables when the Company becomes aware of a customer’s inability to meet its financial obligations. The Company writes off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Item 15, Schedule II for more information. +Inventories +Inventories are valued at the lower of cost or net realizable value. We regularly evaluate inventory and estimate net realizable value using several assumptions including estimated future demand and market conditions, as well as other observable factors such as current sell-through of the Company’s products, recent changes in product demand, global and regional economic conditions, historical experience selling through liquidation and price discounted channels, and the amount of inventory on hand. If the estimated inventory net realizable value is less than its carrying value, the carrying value is adjusted to net realizable value and the resulting charge is recorded in ‘Cost of sales’ in the consolidated statements of operations. As of December 31, 2017 and 2016 , our finished goods inventories accounted for approximately 97.5% and 96.8% , respectively, of our consolidated inventories, with the remaining balance comprised of raw materials and work-in-process. +F- 10 +Table of Contents +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and have the following ranges: machinery and equipment: 2 to 5 years; furniture, fixtures, and other: 2 to 10 years. Leasehold improvements are stated at cost and amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of manufacturing assets is included in cost of sales in our consolidated statements of operations. Depreciation related to corporate, non-product, and non-manufacturing assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets and the resulting gain or loss, if any, is reflected in ‘Income (Loss) from operations’ in the consolidated statements of operations. +Properties held under capital lease are depreciated using the straight-line method over the estimated useful life or the lease term, whichever is shorter. +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. Our annual test is performed as of the last day of our fiscal fourth quarter. We continuously monitor the performance of our definite-lived intangible assets and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +Direct costs of acquiring or developing internal-use computer software, including costs of employees, are capitalized and classified within intangible assets. Software maintenance and training costs are expensed in the period incurred. Initial costs associated with internally-developed-and-used software are expensed until it is determined that the project has reached the application development stage, after which subsequent additions, modifications, or upgrades are capitalized to the extent that they add functionality. The Company’s capitalized software consists primarily of enterprise resource system software, warehouse management software, and point of sale software. Amortization for software is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 2 to 7 years. Amortization of capitalized software used in manufacturing activities is included in ‘Cost of sales’ in the consolidated statements of operations. Amortization related to corporate, non-product, and non-manufacturing assets, such as the Company’s global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of operations. +Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 7 to 25 years. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. The Company assesses recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and records a loss from impairment if the carrying value is more than its undiscounted cash flows. For assets involved in Crocs’ retail business, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. Assets or asset groups to be abandoned or from which no future benefit is expected are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 3 — Property and Equipment, Net for a discussion of impairment losses recorded during the periods presented. +Share-Based Compensation +The Company’s share-based compensation plans provides for stock options, restricted stock, and stock performance awards to be granted to plan participants, which includes certain officers, employees, and members of the Board. The grant date fair value of awards granted under these plans is amortized over the vesting period using the straight-line method. The grant date fair value of stock options is calculated using a Black Scholes option pricing model. The grant date fair value of time-based restricted stock +F- 11 +Table of Contents +units (“RSUs”) and restricted stock awards (“RSAs”) is based on the closing market price of our common stock on the grant date, adjusted for dividend rights during the vesting period; the grant date fair value of performance-based RSUs is estimated using a Monte Carlo simulation valuation model. Share-based compensation expense associated with manufacturing and retail employees is included in ‘Cost of sales’ in the consolidated statements of operations. Share-based compensation expense associated with selling, marketing, and administrative employees is included in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. See also Note 10 — Share-Based Compensation for additional information related to share-based compensation. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the two-class method. Participating securities are included in the computation of EPS on a pro-rata, if-converted basis. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in the Company’s earnings. The dilutive effect of each participating security, if any, is calculated using the more dilutive of the two-class method described above. Anti-dilutive securities are excluded from diluted EPS. See Note 12 — Earnings per Share for additional information. +Derivative Foreign Currency Contracts +The Company enters into foreign currency forward contracts (“contracts”) to mitigate the potential impact of foreign currency exchange rate risk. By policy, the Company does not enter into these contracts for trading purposes or speculation. The fair value of the contracts is reported either as an asset or liability in our consolidated balance sheets. Changes in the fair value of our contracts are recorded in ‘Foreign currency gain (loss), net’ in our consolidated statements of operations. The Company did not designate any derivative instruments for hedge accounting during any of the periods presented. See Note 7 — Derivative Financial Instruments for further information. +Foreign Currency Translation and Remeasurement +The financial position and operating results of the Company’s foreign operations are reported using their respective local currency as the functional currency. The Company recognizes and reports remeasurement gains and losses within ‘Foreign currency gain (loss), net’ in the consolidated statements of operations. +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). The Company utilizes a combination of market and income approaches to value derivative instruments. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level +Inputs +1 +Unadjusted quoted prices in active markets for identical assets and liabilities. +2 +Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 +Unobservable inputs for the asset or liability. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +The Company’s non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 6 — Fair Value Measurements for further discussion related to fair value measurements. +F- 12 +Table of Contents +2 . RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Inventory Measurement +In July 2015, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance to measure in-scope inventory at the lower of cost or net realizable value. The Company adopted this guidance on January 1, 2017 on a prospective basis. The adoption did not have a significant effect on our consolidated financial position or results of operations. +New Accounting Pronouncements Not Yet Adopted +Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income +In February 2018, the FASB issued authoritative guidance that permits reclassification of the income tax effects of the 2017 U.S. Tax Cuts and Jobs Act (“Tax Act”) on other accumulated comprehensive income (“AOCI”) to retained earnings. This guidance may be adopted retrospectively to each period (or periods) in which the income tax effects of the Tax Act related to items remaining in AOCI are recognized, or at the beginning of the period of adoption. The guidance becomes effective for for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. The Company is currently assessing the adoption method and the impact that adopting this new accounting standard will have on its consolidated financial statements. +Stock Compensation Scope of Modification Accounting +In May 2017, the FASB issued authoritative guidance intended to clarify those changes to terms and conditions of share-based compensation awards that are required to be accounted for as modifications of existing share-based awards. This guidance is to be applied prospectively and becomes effective for annual reporting periods beginning after December 15, 2017, including interim periods within those periods, with early adoption permitted during any interim period. The Company does not expect this standard will have a material impact on the Company’s consolidated financial statements. +Clarifying the Definition of a Business +In January 2017, the FASB issued authoritative guidance intended to clarify the definition of a business, for purposes of determining whether a business has been acquired or sold, and consequently whether transactions should be accounted for as acquisitions or disposals of a business or as acquisitions or disposals of assets. This guidance is to be applied prospectively and becomes effective for annual reporting periods beginning after December 15, 2017, including interim periods within those periods. The Company does not expect this standard to have a material impact on its consolidated financial statements. +Statement of Cash Flows - Classification and Change in Restricted Cash +In August 2016, the FASB issued authoritative guidance intended to clarify how entities should classify certain cash receipts and cash payments on the statement of cash flows. Further, in November 2016, the FASB issued guidance requiring that restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. These updates are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods, with early adoption permitted, and will be applied retrospectively to all periods presented. The Company will implement this standard beginning in the quarter ended March 31, 2018 and the impact will result in a change in financial statement presentation and disclosure within the statement of cash flows. +Prepaid Stored-Value Products +In March 2016, the FASB issued guidance related to the recognition of breakage for certain prepaid stored-value products. This update aligns recognition of the financial liabilities related to prepaid stored-value products (for example, prepaid gift cards), with Topic 606, Revenue from Contracts with Customers , for non-financial liabilities. In general, certain of these liabilities may be extinguished proportionally in earnings as redemptions occur, or when redemption is remote if issuers are not entitled to the unredeemed stored value. This standard is effective for annual periods (including interim periods) beginning after December 15, 2017, with early adoption permitted. The Company has elected the modified retrospective method of adoption. The Company has completed a review of its prepaid stored-value products and has determined that the impact of adoption is immaterial to the consolidated financial statements. +F- 13 +Table of Contents +Leases +In February 2016, the FASB issued authoritative guidance intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance, lessees will be required to recognize a right-of-use asset and a lease liability, measured on a discounted basis, at the commencement date for all leases with terms greater than twelve months. Additionally, this guidance will require disclosures to help investors and other financial statement users to better understand the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements. The guidance should be applied under a modified retrospective transition approach for leases existing at the beginning of the earliest comparative period presented in the adoption-period financial statements. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. +The Company will adopt this guidance beginning with the quarterly reporting period ending March 31, 2019. In July 2017, the Company established an implementation team and engaged external advisers to develop a multi-phase plan to assess the Company’s leasing arrangements, as well as any changes to accounting policies, processes or information systems necessary to adopt the requirements of the new standard. The Company is evaluating the full impact this guidance will have on its consolidated financial statements, and expects that adoption will result in significant increases in lease-related assets and liabilities on its consolidated balance sheet. +Revenue Recognition +In May 2014, the FASB issued authoritative guidance related to new accounting requirements for the recognition of revenue from contracts with customers. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for the goods or services. Subsequent to the release of this guidance, the FASB has issued additional updates intended to provide interpretive clarifications and to reduce the cost and complexity of applying the new revenue recognition standard both at transition and on an ongoing basis. The new standard and related amendments are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. +In December 2016, the Company established an implementation team and engaged external advisers to develop a multi-phase plan to assess the Company’s business and contracts, as well as any changes to accounting policies, processes or information systems necessary to adopt the requirements of the new standard. The Company has elected the modified retrospective method of adoption. The Company has completed a review of its revenue contracts and terms and has determined that the impact of adoption is immaterial to the consolidated financial statements. Concurrent with adoption, the Company will change its presentation of product returns in the consolidated balance sheets by reporting an asset for the right to receive returned product and a return liability. In addition, customer payments received in advance of delivery will be reported as a contract liability in the Company’s consolidated balance sheets. The Company will provide additional information along with required disclosures in its consolidated financial statements in its quarterly report for the period ended March 31, 2018. +Other Pronouncements +Other new pronouncements issued but not effective until after December 31, 2017 are not expected to have a material impact on the Company’s consolidated financial statements. +F- 14 +Table of Contents +3 . PROPERTY AND EQUIPMENT, NET +Property and equipment, net consists of the following: +December 31, +2017 +2016 +(in thousands) +Machinery and equipment +$ +33,109 +$ +33,163 +Leasehold improvements +72,961 +73,363 +Furniture, fixtures, and other +19,776 +19,358 +Construction-in-progress +992 +6,809 +Property and equipment +126,838 +132,693 +Less: Accumulated depreciation and amortization +(91,806 +) +(88,603 +) +Property and equipment, net +$ +35,032 +$ +44,090 +Asset Retirement Obligations +The Company is contractually obligated under certain of its lease agreements to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. At December 31, 2017 and 2016 , liabilities for asset retirement obligations were $3.1 million and $2.8 million , respectively, and are reported in ‘Other liabilities’ in the consolidated balance sheets. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Cost of sales +$ +2,278 +$ +1,755 +$ +1,764 +Selling, general and administrative expenses +12,723 +13,312 +14,533 +Total depreciation and amortization expense +$ +15,001 +$ +15,067 +$ +16,297 +Gains/Losses on Disposals +The Company recognized net gains on disposals of property and equipment of $0.8 million for the year ended December 31, 2017 and net losses on disposals of property of $0.5 million , and $1.4 million , respectively, for the years ended December 31, 2016 and 2015 , which are included in ‘Selling, general and administrative expenses’ in the consolidated statement of operations. +F- 15 +Table of Contents +Asset Impairments +During the years ended December 31, 2017 , 2016 , and 2015 , the Company recorded impairments of $0.5 million , $2.7 million , and $9.6 million , respectively, for underperforming retail stores. During the year ended December 31, 2015, an additional impairment of $ 5.7 million related to the disposal of the Company's business in South Africa was recorded. Long-lived asset impairments by reportable operating segment, were: +Year Ended December 31, +2017 +2016 +2015 +Asset Impairment +Number of +Stores +Asset Impairment +Number of +Stores +Asset Impairment +Number of +Stores +(in thousands, except store count data) +Americas +$ +455 +3 +$ +1,703 +12 +$ +7,237 +27 +Asia Pacific (1) +— +— +672 +21 +6,450 +36 +Europe +75 +1 +338 +9 +1,584 +21 +Total +$ +530 +4 +$ +2,713 +42 +$ +15,271 +84 +(1) In 2015, the Company recorded impairment of nine retail stores in South Africa of $5.7 million . +4 . GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +All of our goodwill is in the Europe segment. The changes in goodwill for the years ended December 31, 2017 and 2016 were: +Goodwill +(in thousands) +Balance at January 1, 2016 +$ +1,973 +Foreign currency translation +(62 +) +Impairment +(431 +) +Balance at December 31, 2016 +1,480 +Foreign currency translation +208 +Balance at December 31, 2017 +$ +1,688 +Accumulated goodwill impairment at December 31, 2017 was $0.8 million . +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2017 +December 31, 2016 +Gross +Accum. Amortiz. +Net +Gross +Accum. Amortiz. +Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software +$ +143,275 +$ +(90,219 +) +$ +53,056 +$ +142,358 +$ +(74,530 +) +$ +67,828 +Patents, copyrights, and trademarks +5,636 +(4,969 +) +667 +6,438 +(5,471 +) +967 +Other +214 +(214 +) +— +2,855 +(2,855 +) +— +Intangible assets not subject to amortization: +In progress (1) +2,378 +— +2,378 +3,616 +— +3,616 +Trademarks and other +326 +— +326 +289 +— +289 +Total +$ +151,829 +$ +(95,402 +) +$ +56,427 +$ +155,556 +$ +(82,856 +) +$ +72,700 +(1) In the year ended December 31, 2017 , we recorded a write-off of $4.8 million for a discontinued project. +F- 16 +Table of Contents +At December 31, 2017 , the weighted average remaining useful life of intangibles subject to amortization was approximately 6.5 years. +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Cost of sales +$ +4,550 +$ +5,127 +$ +5,848 +Selling, general and administrative expenses +13,579 +13,849 +13,848 +Total amortization expense +$ +18,129 +$ +18,976 +$ +19,696 +Estimated future annual amortization expense of intangible assets is: +As of December 31, 2017 +(in thousands) +2018 +$ +16,231 +2019 +14,009 +2020 +11,306 +2021 +11,052 +2022 +603 +Thereafter +522 +Total +$ +53,723 +5 . ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2017 +2016 +(in thousands) +Accrued compensation and benefits +$ +34,955 +$ +20,898 +Professional services +10,835 +10,900 +Accrued rent and occupancy +8,535 +7,335 +Fulfillment, freight, and duties (1) +6,921 +14,572 +Royalties payable and deferred revenue +6,193 +7,475 +Sales/use and value added taxes payable +3,509 +4,978 +Other (2) +13,498 +12,124 +Total accrued expenses and other liabilities +$ +84,446 +$ +78,282 +(1) Includes customs duty legal accrual liability at December 31, 2016 , which was settled in April 2017. +(2) Includes current liabilities related to Series A Preferred Stock dividends at December 31, 2017 and 2016 . Other accrued liabilities at December 31, 2017 and 2016 also includes net derivative liabilities. +6 . FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of the Company’s derivative instruments. The Company’s derivative instruments are foreign currency forward exchange contracts. The Company manages credit risk of its derivative instruments on the basis of its net exposure with its counterparty. All of the Company’s derivative instruments are classified as Level 2 and are reported in the consolidated balance sheets within ‘Accrued expenses and +F- 17 +Table of Contents +other liabilities’ at December 31, 2017 and 2016. The fair values of the Company’s derivative instruments were liabilities of $0.4 million and $0.2 million at December 31, 2017 and 2016 , respectively. See Note 7 — Derivative Financial Instruments for more information. +The carrying amounts of the Company’s cash and cash equivalents, accounts receivable, accounts payable, and current accrued expenses and other liabilities approximate their fair value as recorded due to the short-term maturity of these instruments. +The Company’s borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. The fair values of the Company’s outstanding notes payable approximate their carrying values at December 31, 2017 and 2016 , based on interest rates currently available to the Company for similar borrowings and were: +December 31, 2017 +December 31, 2016 +Carrying Value +Fair +Value +Carrying Value +Fair +Value +(in thousands) +Borrowings and capital lease obligations +$ +706 +$ +706 +$ +2,378 +$ +2,378 +Non-Financial Assets and Liabilities +The Company’s non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. The Company recorded write-offs for a discontinued project and impairments to reduce the carrying values of goodwill associated with certain reporting units and certain retail store assets to zero as follows: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Discontinued project +$ +4,754 +$ +— +$ +— +Retail store asset impairment +530 +2,713 +15,306 +Goodwill impairment +— +431 +— +The Company’s goodwill is reported within its Europe operating segment. +7 . DERIVATIVE FINANCIAL INSTRUMENTS +The Company transacts business in various foreign countries and is therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar amounts of revenues, costs, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, the Company enters into forward contracts to buy and sell foreign currency. By policy, the Company does not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts that the Company enters into are over-the-counter instruments transacted with highly-rated financial institutions. The Company was not required to and did not post collateral as of December 31, 2017 or 2016 . +The Company’s derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets. The Company reports derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. Changes in fair value are recognized within ‘Foreign currency gain (loss), net’ in the consolidated statements of operations. For the consolidated statements of cash flows, the Company classifies cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities.’ +F- 18 +Table of Contents +Results of Derivative Activities +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, reported within ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, 2017 +December 31, 2016 +Derivative Assets +Derivative Liabilities +Derivative Assets +Derivative Liabilities +(in thousands) +Forward foreign currency exchange contracts +$ +1,241 +$ +(1,647 +) +$ +6,541 +$ +(6,698 +) +Netting of counterparty contracts +(1,241 +) +1,241 +(6,541 +) +6,541 +Foreign currency forward contract derivatives +$ +— +$ +(406 +) +$ +— +$ +(157 +) +The notional amounts of outstanding foreign currency forward exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2017 +December 31, 2016 +Notional +Fair Value +Notional +Fair Value +(in thousands) +Singapore Dollar +$ +73,455 +$ +364 +$ +94,763 +$ +(2,611 +) +Euro +37,718 +(122 +) +71,228 +(1,441 +) +Japanese Yen +30,688 +(89 +) +87,171 +4,180 +South Korean Won +15,888 +(134 +) +8,278 +407 +British Pound Sterling +13,233 +80 +14,332 +(660 +) +Other currencies +53,698 +(505 +) +52,449 +(32 +) +Total +$ +224,680 +$ +(406 +) +$ +328,221 +$ +(157 +) +Latest maturity date +January 2018 +January 2017 +Amounts reported in ‘Foreign currency gain (loss), net’ in the consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Foreign currency transaction gains +$ +2,284 +$ +10,814 +$ +3,980 +Foreign currency forward exchange contracts losses +(1,721 +) +(13,268 +) +(7,312 +) +Foreign currency gain (loss), net +$ +563 +$ +(2,454 +) +$ +(3,332 +) +8 . REVOLVING CREDIT FACILITY AND BANK BORROWINGS +The Company’s borrowings were as follows: +December 31, +2017 +2016 +(in thousands) +Notes payable +$ +662 +$ +2,329 +Capital lease obligations +44 +49 +Total borrowings and capital lease obligations +706 +2,378 +Less: Current portion of borrowings and capital lease obligations +676 +2,338 +Total long-term capital lease obligations +$ +30 +$ +40 +F- 19 +Table of Contents +Senior Revolving Credit Facility +In December 2011, the Company entered into a revolving credit facility (the “Facility”), pursuant to an Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association (“PNC”), as a lender and administrative agent for the lenders. The Credit Agreement, as amended, contains certain covenants that restrict certain actions by the Company, including (i) payment of dividends and limitations on: (ii) stock repurchases to $50.0 million per year, subject to certain restrictions; and (iii) capital expenditures and commitments to $50.0 million per year. The Credit Agreement also permits intercompany loans of up to $375.0 million and requires the Company to meet certain financial covenant ratios that become effective when average outstanding borrowings under the Credit Agreement, including letters of credit, exceed the lesser of $40.0 million or 40% of the total commitments during certain periods or if the outstanding borrowings exceed the borrowing base. If the financial covenant ratios are in effect, the Company must maintain a minimum fixed charge coverage ratio of 1.10 to 1.00, and a maximum leverage ratio of 2.00 to 1.00. As of December 31, 2017 , the Company was in compliance with all financial covenants. +The Facility, as amended, provides for borrowings of up to $100.0 million through February 2021. Borrowings under the Facility for domestic base rate loans, including swing loans, bear interest at a daily base rate plus a margin ranging from 0.50% to 0.75% . Domestic London Interbank Borrowing Rate (“LIBOR”) loans bear interest equal to a LIBOR rate plus a margin ranging from 1.50% to 1.75% . +As of December 31, 2017 , the total commitments available from the lenders under the Facility were $100.0 million . At December 31, 2017 , the Company had no outstanding borrowings and $ 0.6 million in outstanding letters of credit under the Facility, which reduce the amounts available for borrowing under the terms of the Facility. As of December 31, 2017 and 2016 , the Company had $ 99.4 million and $78.7 million , respectively, of available borrowing capacity under the Facility. +In February 2018, the Company entered into an amendment to the Credit Agreement which enables the Company repurchase up to $100 million of its common stock each year, subject to certain restrictions, and increased the limit on cumulative stock repurchases from $350 million to $600 million . +Asia Revolving Credit Facilities +The Company’s revolving credit facility agreement with HSBC Bank (China) Company Limited, Shanghai Branch (“HSBC”), or the “HSBC Facility,” provides the Company uncommitted dual currency revolving loan facilities of up to 40.0 million Chinese Renminbi (“RMB”), or $6.1 million , with a combined facility limit of RMB 60.0 million , or $9.2 million . As of December 31, 2017 and 2016 , borrowings under the HSBC Facility remained suspended at the discretion of HSBC. The HSBC Facility matures in February 2021 . +For U.S. Dollar loans under the HSBC facility, the interest rate is 2.10% per annum plus LIBOR for three months or any other period as may be determined by HSBC at the end of each three month interest period. For RMB loans under the HSBC Facility, interest equals the one year benchmark lending rate effective on the loan draw-down date set forth by the People’s Bank of China plus 10% , payable on the maturity date of the related loan. The HSBC Facility may be canceled or suspended at any time at the discretion of the lender and contains provisions requiring the Company to maintain compliance with certain restrictive covenants. +In January 2018, the Company entered into a revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”), which provides the Company a revolving loan facility of up to 30.0 million RMB, or $4.6 million , subject to consent by the lender. The CMBC Facility will mature in January 2019 . For RMB loans under the CMBC Facility, interest is based on a benchmark interest rate plus a certain number of basis points upon agreement by the lender and the Company at the time of borrowing. The CMBC Facility may be canceled or suspended at any time by either party. +Notes Payable +Notes payable incur interest at fixed rates ranging from 1.95% to 2.83% and mature in 2018. The weighted average interest rate on outstanding borrowings as of December 31, 2017 and 2016 was 2.30% and 2.41% , respectively. +F- 20 +Table of Contents +Maturities +The maturities of the Company’s debt and capital lease obligations were: +As of +December 31, 2017 +(in thousands) +2018 +$ +676 +2019 +13 +2020 +11 +2021 +6 +Total principal debt maturities and capital lease obligations +706 +Less: current portion +676 +Non-current portion +$ +30 +9 . EQUITY +Common Stock +The Company has one class of common stock with a par value of $0.001 per share. There are 250 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +Common Stock Repurchase Program +On December 26, 2013, the Board of Directors approved and authorized a program to repurchase up to $350 million of our common stock. The number, price, and timing of the repurchases are at the Company’s sole discretion, subject to certain restrictions on repurchases under the Company’s Revolving Credit Facility, and may be made depending on market conditions, liquidity needs, or other factors. The Company’s Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate the Company to acquire any amount of its common stock. Under Delaware state law, these shares are not retired, and the issuer has the right to resell any of the shares repurchased. +During 2017 , the Company repurchased 5.7 million shares of its common stock at a cost of $50.0 million , including commissions. During 2016 , the Company did not repurchase any of its common stock. During 2015, the Company repurchased 6.5 million shares at a cost of $85.9 million including commissions. As of December 31, 2017 , the Company had remaining authorization to repurchase approximately $68.8 million of its common stock, subject to restrictions under its Credit Agreement. +On February 20, 2018, the Board increased the repurchase authorization to $500.0 million of our common stock. +Preferred Stock +The Company has authorized and available for issuance 4.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized and 0.2 million were issued and outstanding as of December 31, 2017 and 2016 . +Series A Convertible Preferred Stock +The Company is authorized to issue up to 1.0 million shares of Series A Preferred Stock, par value $0.001 per share, of which 0.2 million shares were issued to Blackstone and certain of its permitted transferees in January 2014. The Series A Preferred Stock has a stated value of $1,000 per share. +Participation Rights and Dividends +Holders of the Series A Preferred Stock are entitled to receive dividends declared or paid on the Company’s common stock and are entitled to vote together with the holders of the Company’s common stock as a single class, in each case, on an as-converted basis. Holders of the Series A Preferred Stock also have certain limited special approval rights, including with respect to the issuance of pari passu or senior equity securities of the Company. +F- 21 +Table of Contents +The Series A Preferred Stock ranks senior to the Company’s common stock with respect to rights to preferred dividends, liquidation, winding-up, and dissolution. Holders of Series A Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6.0% per annum. If the Company fails to make timely dividend payments, the dividend rate will increase to 8.0% per annum until such time as all accrued but unpaid dividends have been paid in full. As of December 31, 2017 and 2016 , the Company had accrued preferred dividends of $3.0 million , which are reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. These accrued dividends were paid in cash in January 2018 and 2017, respectively. +Conversion Rights of the Company and Blackstone +The Series A Preferred Stock is convertible at the option of the holders at any time into shares of common stock at a conversion price of $14.50 per share, subject to adjustment for customary anti-dilution provisions. Provided the closing price of the Company’s common stock has been equal to or greater than $29.00 for 20 consecutive trading days, the Company may elect to convert all or a portion of the Series A Preferred Stock into an equivalent number of shares of common stock. At December 31, 2017 , had the holders converted or the Company been entitled to exercise its conversion right, the Series A Preferred Stock would have been convertible into 13,793,100 shares of common stock. +Redemption Rights of the Company and Blackstone +The Company has the option to redeem the Series A Preferred Stock anytime on or after January 27, 2022, for 100% of the stated redemption value of $200 million plus all accrued and unpaid dividends. +Blackstone has the option to cause the redemption of the Series A Preferred Stock any time after January 27, 2022, or upon a change in control. Further, upon certain change of control events, Blackstone can require the Company to repurchase the Series A Preferred Stock at 101% of the redemption value plus all accrued and unpaid dividends. The carrying value of the Series A Preferred Stock is accreted up to its $200 million redemption value on a straight-line basis through the redemption date. +Beneficial Conversion Feature +The Company’s Series A Convertible Preferred Stock (“Series A Preferred Stock”) included a beneficial conversion feature. The Company recognized the beneficial conversion feature in additional paid-in capital. Accretion expense is recorded over the eight years from the date of issuance through the redemption date utilizing the effective interest method. +10 . SHARE-BASED COMPENSATION +The Company’s share-based compensation awards are issued under the 2015 Equity Incentive Plan (“2015 Plan”) and two predecessor plans, the 2005 Equity Incentive Plan (“2005 Plan”) and the 2007 Equity Incentive Plan (“2007 Plan”). Any awards that expire or are forfeited under the 2007 Plan become available for issuance under the 2015 Plan. The Company accounts for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. There were 3,511,206 shares of common stock reserved and authorized for issuance at December 31, 2017 , under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +Share-Based Compensation Expense +Pre-tax share-based compensation expense reported in the Company’s consolidated statements of operations was as follows: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Cost of sales +$ +379 +$ +488 +$ +539 +Selling, general and administrative expenses +9,394 +10,199 +10,697 +Total share-based compensation expense +$ +9,773 +$ +10,687 +$ +11,236 +F- 22 +Table of Contents +Stock Option Activity +Stock option activity during the year ended December 31, 2017 was: +Shares +Weighted Average Exercise Price +Weighted Average Contractual Life (Years) +Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2016 +518 +$ +16.90 +3.99 +$ +186 +Granted +200 +6.98 +Exercised +(16 +) +6.00 +Forfeited or expired +(161 +) +25.52 +Outstanding as of December 31, 2017 +541 +$ +11.00 +5.37 +$ +1,918 +Exercisable at December 31, 2017 +320 +$ +13.28 +2.78 +$ +786 +Vested and expected to vest at December 31, 2017 +541 +$ +11.00 +5.37 +$ +1,918 +During the years ended December 31, 2017 and 2015 , stock options were valued using a Black Scholes option pricing model using the following assumptions. No stock options were granted during 2016. +Year Ended December 31, +2017 +2015 +Expected volatility +40.7% +42.5% +Dividend yield +— +— +Risk-free interest rate +1.76% +1.50% - 1.72% +Expected life (in years) +4.00 +4.00 +The weighted average grant date fair value of stock options granted during the years ended December 31, 2017 and 2015 was approximately $2.37 and $4.74 per share, respectively. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2017 , 2016 , and 2015 was $0.1 million , $0.5 million , and $1.7 million , respectively. During the years ended December 31, 2017 , 2016 , and 2015 , the Company received $0.1 million , $0.4 million and $1.9 million cash in connection with the exercise of stock options. The total grant date fair value of stock options vested during the years ended December 31, 2017 , 2016 , and 2015 was $0.1 million , $0.3 million , and $0.7 million , respectively. +As of December 31, 2017 , the Company had $0.5 million of total unrecognized share-based compensation expense related to unvested options, which is expected to be amortized over the remaining weighted average period of 2.29 years. +Stock options under the 2005 Plan, 2007 Plan, and 2015 Plan generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years, and expire ten years after the date of grant. +Restricted Stock Awards and Restricted Stock Units Activity +From time to time, restricted stock awards (“RSAs”) and restricted stock units (“RSUs”) are granted to employees. RSAs and RSUs generally vest over three years, depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive a share of common stock upon vesting. RSUs have dividend equivalent rights which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. The Company grants both time-based RSUs and performance-based RSUs. +Time-based RSUs are typically granted on an annual basis to certain executive and non-executive employees and vest on a straight-line basis in three annual installments, beginning one year after the grant date. During the years ended December 31, 2017 , 2016 , and 2015 , the Board approved grants of 1.1 million , 1.0 million , and 1.2 million time-based RSUs, respectively. +Performance-based RSUs are granted on an annual basis to certain executive employees and consist of a time-based and performance-based component. Under the time-based component, RSUs vest at the end of each of the three years, beginning one year from the grant date. The performance targets and vesting conditions for performance-based RSUs are based on achievement +F- 23 +Table of Contents +of multiple weighted performance goals, and vest upon certification by the compensation committee plus an additional service period. The fair value of performance-based awards is estimated using a Monte Carlo simulation valuation model. This pricing model utilizes multiple input variables that determine the probability of satisfying each performance condition stipulated in the terms of the award to estimate its grant date fair value. Compensation expense, net of forfeitures, is updated for the Company’s expected performance level against each related goal at the end of each reporting period. During the years ended December 31, 2017 , 2016 , and 2015 , the Board approved the grant of 1.3 million , 1.2 million , and 1.5 million RSUs, respectively, to certain executive employees as part of the performance incentive program. +RSA and RSU activity during the year ended December 31, 2017 was: +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted Average Grant Date Fair Value +Shares +Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2016 +11 +$ +10.28 +3,855 +$ +10.31 +Granted +35 +6.84 +2,434 +6.84 +Vested +(29 +) +8.19 +(764 +) +10.88 +Forfeited +— +N/A +(1,734 +) +9.60 +Unvested at December 31, 2017 +17 +$ +6.84 +3,791 +$ +7.99 +RSAs vested during the years ended December 31, 2017 , 2016 , and 2015 consisted entirely of time-based awards. The total grant date fair value of RSAs vested was $0.2 million in each of the years ended December 31, 2017 , 2016 , and 2015 . +As of December 31, 2017 , unrecognized share-based compensation expense for RSAs was $0.1 million , which is expected to amortize over a remaining weighted average period of 0.43 years. +RSUs vested during the year ended December 31, 2017 consisted of 696,083 time-based awards and 68,317 performance-based awards. RSUs vested during the year ended December 31, 2016 consisted of 599,071 time-based awards and 31,396 performance-based awards. RSUs vested during the year ended December 31, 2015 consisted of 437,132 time-based awards and 67,893 performance-based awards. The total grant date fair value of RSUs vested during the years ended December 31, 2017 , 2016 , and 2015 was $8.3 million , $8.0 million and $8.2 million , respectively. +As of December 31, 2017 , unrecognized share-based compensation expenses for time-based and performance-based RSUs were $9.9 million and $3.8 million , respectively, and are expected to amortize over a remaining weighted average period of 1.56 years and 1.94 years, respectively. +11 . INCOME TAXES +U.S. Federal Income Tax Reform +On December 22, 2017, H.R. 1, also known as the Tax Cuts and Jobs Act (“Tax Act”), was enacted in the U.S. This enactment resulted in a number of significant changes to U.S. federal income tax law for U.S. corporations. Most notably, the statutory U.S. federal corporate income tax rate was changed from 35% to 21% for corporations. In addition to the change in the corporate income tax rate, the Tax Act further introduced a number of other changes including a one-time transition tax via a mandatory deemed repatriation of post-1986 undistributed foreign earnings and profits; the introduction of a tax on global intangible low-taxed income (“GILTI”) for tax years beginning after December 31, 2017; the limitation of deductible net interest to 30% of adjustable taxable income; the further limitation of the deductibility of share-based compensation of certain highly compensated employees; the ability to elect to accelerate bonus depreciation on certain qualified assets; and the Base Erosion and Anti-Abuse Tax ("BEAT"), amongst other changes. +Additionally, on December 22, 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. Specifically, SAB 118 provides a measurement period for companies to evaluate the impacts of the Tax Act on their financial statements. This measurement period may not exceed one year and begins in the reporting period that includes the +F- 24 +Table of Contents +enactment date and ends when an entity has obtained, prepared, and analyzed the information necessary to complete the accounting requirements. +Transition Tax +The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax. We have recorded provisional amounts based on estimates of the effects of the Tax Act as the analysis requires significant data from our foreign subsidiaries that is not regularly collected or analyzed. The U.S. federal transition tax liability, net of newly generated income tax credits, is an obligation of $17.1 million . The Company has existing foreign tax credits and other attributes which fully offset this transition tax obligation. The associated deferred tax assets that offset the obligation have a full valuation allowance, so there is no net impact to income tax expense. +Deferred Tax Effects +The Tax Act reduces the U.S. statutory tax rate from 35% to 21% for years after 2017. Accordingly, we have remeasured our deferred tax positions as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. The remeasurement resulted in a net decrease in deferred tax assets of $0.6 million and a $0.1 million change in the valuation allowance. Therefore, we recognized a deferred tax expense of $0.7 million to reflect the reduced U.S. tax rate and other effects of the Tax Act. We have not collected the necessary data to complete our analysis of the effect of the Tax Act on the underlying deferred taxes and as such, the amounts recorded as of December 31, 2017 are provisional. +The net tax expense recognized in 2017 related to the Tax Act which was not offset by a change in valuation allowance was $0.7 million . As we complete our analysis of the impacts of the Tax Act and incorporate additional guidance that may be issued by the U.S. Treasury Department, the IRS, or other standard-setting bodies, we may identify additional effects not reflected as of December 31, 2017. Additionally, we consider these amounts preliminary as we continue to evaluate the impacts of the Tax Act and further understand its implications, as well as the related, and yet to be issued, regulator rules, regulations, and interpretations. For example, subsequent to the enactment, the FASB staff has concluded that companies should make an accounting policy election to account for the tax effects of GILTI either as a component of income tax expense in the future period the tax arises, or as a component of deferred taxes on the related investments in foreign subsidiaries. We are currently evaluating the GILTI provisions of the Tax Act and the related implications and have not finalized our accounting policy election; however, we have preliminarily concluded that we will record GILTI provisions as a periodic expense as incurred and, therefore, have not recorded deferred taxes for GILTI as of December 31, 2017. We will continue to evaluate in future periods and will finalize our accounting policy election at that time. Additional impacts of the Tax Act will be recorded as they are identified during the measurement period pursuant to SAB 118. Any adjustments to provisional amounts that are identified during the measurement period will be recorded and disclosed in the reporting period in which the adjustment is determined. The complexity of the Tax Act could necessitate the need to use the full one year measurement period to adequately interpret, analyze, and conclude upon the tax effects of the Tax Act as of the enactment date. +Finally, BEAT is a new minimum tax on international payments as a means to reduce the ability of multi-national companies to erode the U.S. tax base through deductible related-party payments. We do not have any material deductible related party payments originating from the U.S. to our foreign subsidiaries that this would apply to. As a result, BEAT is not expected to have a material impact on our income tax expense. +F- 25 +Table of Contents +Income Taxes +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Income (loss) before taxes: +U.S. +$ +(34,406 +) +$ +(55,617 +) +$ +(83,537 +) +Foreign +52,586 +48,404 +8,793 +Total income (loss) before taxes +$ +18,180 +$ +(7,213 +) +$ +(74,744 +) +Income tax expense: +Current income taxes: +U.S. federal +$ +1,383 +$ +49 +$ +480 +U.S. state +127 +126 +195 +Foreign +9,525 +9,494 +7,488 +Total current income taxes +11,035 +9,669 +8,163 +Deferred income taxes: +U.S. federal +1,300 +263 +(3,902 +) +U.S. state +— +— +(118 +) +Foreign +(4,393 +) +(651 +) +4,309 +Total deferred income taxes +(3,093 +) +(388 +) +289 +Total income tax expense +$ +7,942 +$ +9,281 +$ +8,452 +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Income tax expense and rate attributable to: +Federal +$ +6,363 +35.0 +% +$ +(2,524 +) +(35.0 +)% +$ +(26,160 +) +(35.0 +)% +State, net of federal benefit +53 +0.3 +(202 +) +(2.8 +) +(543 +) +(0.7 +) +Foreign differential +(11,768 +) +(64.7 +) +(12,624 +) +(175.0 +) +(3,678 +) +(4.9 +) +Enacted changes in tax law +17,645 +97.1 +— +— +— +— +Non-deductible / non-taxable items +6,006 +33.0 +2,694 +37.4 +(2,181 +) +(2.9 +) +Change in valuation allowance +24,400 +134.2 +16,041 +222.4 +10,892 +14.5 +U.S. tax on foreign earnings +(32,427 +) +(178.4 +) +23,130 +320.6 +82,311 +110.0 +Foreign tax credits +(7,980 +) +(43.9 +) +(18,581 +) +(257.6 +) +(49,432 +) +(66.1 +) +Uncertain tax positions +1,054 +5.8 +19 +0.3 +(3,952 +) +(5.3 +) +Audit settlements +354 +1.9 +253 +3.5 +1,167 +1.6 +Stock compensation windfall / shortfall +882 +4.9 +2,120 +29.4 +— +— +Deferred income tax account adjustments +2,679 +14.7 +(842 +) +(11.7 +) +— +— +Other +681 +3.8 +(203 +) +(2.8 +) +28 +0.1 +Effective income tax expense and rate +$ +7,942 +43.7 +% +$ +9,281 +128.7 +% +$ +8,452 +11.3 +% +F- 26 +Table of Contents +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We recorded a provisional adjustment to our U.S. deferred income taxes as of December 31, 2017 to reflect the reduction in the U.S. statutory tax rate from 35% to 21% resulting from the Tax Act. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2017 +2016 +(in thousands) +Non-current deferred tax assets: +Stock compensation expense +$ +2,940 +$ +4,597 +Long-term accrued expenses +20,728 +26,127 +Net operating loss +42,956 +36,424 +Intangible assets +1,620 +3,654 +Future uncertain tax position offset +498 +396 +Unrealized loss on foreign currency +119 +— +Foreign tax credit +67,655 +69,586 +Other +2,792 +5,481 +Valuation allowance +(119,494 +) +(90,900 +) +Total non-current deferred tax assets +$ +19,814 +$ +55,365 +Non-current deferred tax liabilities: +Intangible assets +$ +— +$ +(41 +) +Unremitted earnings of foreign subsidiary +— +(32,427 +) +Property and equipment +(9,640 +) +(16,072 +) +Total non-current deferred tax liabilities +$ +(9,640 +) +$ +(48,540 +) +During 2017, additional valuation allowances of $28.6 million were recorded on deferred tax assets that are not anticipated to be realized. The change in the valuation allowance includes $24.4 million related to income tax expense and $4.2 million which does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation adjustment. During 2016, additional valuation allowances of $34.3 million were recorded. The change in the 2016 valuation allowance includes $16.0 million related to income tax expense and $18.3 million which does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to the adoption in 2016 of U.S. GAAP guidance related to income tax effect of share-based compensation and changes in cumulative translation adjustment. +We annually receive cash from our foreign subsidiaries’ current year earnings. The transition tax in the Tax Act imposes a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. As a result of the transition tax, the Company no longer has a deferred tax liability associated with undistributed earnings and profits. Furthermore, as of December 31, 2017, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +During 2017, we recorded additional tax loss carryforwards in certain foreign jurisdictions which aggregate to $18.8 million , primarily driven by operational losses recognized based on local statutory accounting requirements. As these carryforwards were generated in jurisdictions where we have historically had book losses or do not have strong future projections related to those operations, we concluded that it was more likely than not that the associated net operating losses would not be realized, and thus recorded a valuation allowance on the majority of the associated deferred tax assets. As of December 31, 2017, Crocs maintains a valuation allowance of $119.5 million . +F- 27 +Table of Contents +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Unrecognized tax benefit as of January 1 +$ +4,750 +$ +4,957 +$ +8,444 +Gross increases in tax positions in prior period +1,025 +646 +643 +Gross decreases in tax positions in prior period +— +(664 +) +(385 +) +Gross increases in tax positions in current period +966 +245 +549 +Settlements +(123 +) +(238 +) +(4,126 +) +Lapse of statute of limitations +(414 +) +(196 +) +(168 +) +Unrecognized tax benefit as of December 31 +$ +6,204 +$ +4,750 +$ +4,957 +The Company recorded a net expense of $1.5 million related to increases in 2017 unrecognized tax benefits combined with amounts effectively settled under audit. Unrecognized tax benefits as of December 31, 2017 relate to tax years that are currently open under the statute of limitation. The primary impact of uncertain tax positions on the rate reconciliation includes audit settlements, net increases in position changes, and accrued interest expense. +Interest and penalties related to income tax liabilities are included in ‘Income tax expense’ in the consolidated statement of operations. For the years ended December 31, 2017 , 2016 , and 2015 , Crocs recorded approximately $0.2 million , $0.2 million , and $0.2 million , respectively, of penalties and interest. During the year ended December 31, 2017 , Crocs released $0.2 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $0.7 million , $0.6 million , and $0.5 million , as of December 31, 2017 , 2016 , and 2015 , respectively. +Unrecognized tax benefits of $6.2 million , $4.8 million and $5.0 million as of December 31, 2017 , 2016 , and 2015 , respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2017 : +Netherlands +2005 to 2017 +Canada +2010 to 2017 +Japan +2011 to 2017 +China +2011 to 2017 +Singapore +2014 to 2017 +United States +2010 to 2017 +The Company is currently under audit in Taiwan. U.S state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for the Company are generally subject to examination for the years 2012 to 2017 . +The Company has recorded deferred tax assets related to U.S. federal tax carryforwards, including foreign tax credits and net operating losses, which expire at various dates between 2023 and 2037 of $48.6 million and $57.3 million at December 31, 2017 and 2016 , respectively. The Company has recorded deferred tax assets related to U.S. state tax net operating loss carryforwards which expire at various dates between 2017 and 2037 of $12.5 million and $9.4 million at December 31, 2017 and 2016 , respectively. The Company has recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2021 and those which do not expire of $49.5 million and $39.3 million as of December 31, 2017 and 2016 , respectively. +F- 28 +Table of Contents +12 . EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2017 , 2016 , and 2015 were as follows: +Year Ended December 31, +2017 +2016 +2015 +(in thousands, except per share data) +Numerator: +Net loss attributable to common stockholders - basic and diluted +$ +(5,294 +) +$ +(31,738 +) +$ +(98,007 +) +Denominator: +Weighted average common shares outstanding - basic and diluted +72,255 +73,371 +75,604 +Net loss per common share: +Basic +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +Diluted +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +For the years ended December 31, 2017 , 2016 , and 2015 , respectively, all outstanding shares issued under share-based compensation awards, and all potentially convertible Series A Preferred Stock shares were excluded from the calculation of diluted EPS because the effect was anti-dilutive. If converted, Series A Preferred Stock would represent approximately 16.7% of the Company’s common stock outstanding, or 13.8 million additional common shares as of December 31, 2017 . +13 . COMMITMENTS AND CONTINGENCIES +Rental Commitments and Contingencies +The Company rents retail stores, offices and warehouses, vehicles, and equipment under operating leases expiring at various dates through 2033 . Rent expense for leases with escalations or rent holidays is recognized on a straight-line basis over the lease term beginning on the lease inception date. Certain leases also provide for contingent rents, which are generally determined as a percent of sales in excess of specified levels. A contingent rent liability is recognized together with the corresponding rent expense when specified levels have been achieved or when the Company determines that achieving the specified levels during the period is probable. +Future minimum lease payments under operating leases as of the date shown were as follows: +December 31, 2017 +(in thousands) +2018 +$ +53,329 +2019 +36,816 +2020 +28,547 +2021 +22,843 +2022 +16,650 +Thereafter +52,326 +Total minimum lease payments +$ +210,511 +Minimum sublease rental income of $ 0.2 million under non-cancelable subleases, and contingent rentals, which may be paid under certain retail store leases on a basis of percentage of sales in excess of stipulated amounts, are excluded from the commitment schedule. +F- 29 +Table of Contents +Rent expense under operating leases was as follows: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Minimum rentals (1) +$ +78,961 +$ +88,182 +$ +96,579 +Contingent rentals +14,294 +14,596 +14,929 +Less: Sublease rentals +(182 +) +(187 +) +(322 +) +Total rent expense +$ +93,073 +$ +102,591 +$ +111,186 +(1) Minimum rentals include all lease payments as well as fixed and variable common area maintenance, parking, and storage fees, which were approximately $10.0 million , $10.2 million , and $9.1 million during the years ended December 31, 2017 , 2016 , and 2015 , respectively. +Purchase Commitments +Under the terms of an annual supply agreement, the Company guarantees payment for certain third-party manufacturer purchases of raw materials used in the manufacture of its products, up to a maximum of € 3.5 million (approximately $4.2 million as of December 31, 2017 ). +As of December 31, 2017 and 2016 , the Company had purchase commitments with other third-party manufacturers, primarily for materials and supplies used in the manufacture of the Company’s products, for an aggregate of $ 122.7 million and $125.9 million , respectively. +Government Tax Audits +The Company is regularly subject to, and is currently undergoing, audits by various tax authorities in the United States and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. See Note 15 — Legal Proceedings for additional information. +Other +During its normal course of business, the Company may make certain indemnities, commitments, and guarantees under which it may be required to make payments in relation to certain matters. The Company cannot determine a range of estimated future payments and has not recorded any liability for such payments in the accompanying consolidated balance sheets. +See Note 15 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +F- 30 +Table of Contents +14 . OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +The Company has three reportable operating segments: the Americas, Asia Pacific, and Europe. ‘Other businesses’ aggregates insignificant operating segments that do not meet the reportable segment threshold, including manufacturing operations located in Mexico and Italy, and corporate operations. +Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. Revenues for ‘Other businesses’ include non-footwear product sales to external customers that are excluded from the measurement of segment operating revenues and income. +Segment performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment operating income and income (loss) from operations consist of other businesses and unallocated corporate expenses, as well as inter-segment eliminations. The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Revenues: +Americas +$ +480,146 +$ +467,006 +$ +476,210 +Asia Pacific +369,667 +395,078 +424,491 +Europe +172,830 +173,444 +188,833 +Segment revenues +1,022,643 +1,035,528 +1,089,534 +Other businesses +870 +745 +1,096 +Total consolidated revenues +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +Income from operations: +Americas (1) +$ +86,880 +$ +58,844 +$ +49,422 +Asia Pacific (2) +79,273 +78,907 +48,447 +Europe (3) +25,736 +17,757 +15,629 +Segment income from operations +191,889 +155,508 +113,498 +Reconciliation of segment income from operations to income (loss) before income taxes: +Other businesses +(22,861 +) +(26,935 +) +(30,092 +) +Unallocated corporate (4) +(151,692 +) +(134,727 +) +(155,730 +) +Total consolidated income (loss) from operations +17,336 +(6,154 +) +(72,324 +) +Foreign currency gain (loss), net +563 +(2,454 +) +(3,332 +) +Interest income +870 +692 +967 +Interest expense +(869 +) +(836 +) +(969 +) +Other income +280 +1,539 +914 +Income (loss) before income taxes +$ +18,180 +$ +(7,213 +) +$ +(74,744 +) +Depreciation and amortization: +Americas +$ +5,473 +$ +5,787 +$ +7,401 +Asia Pacific +3,464 +4,264 +3,913 +Europe +1,878 +2,133 +2,229 +Total segment depreciation and amortization +10,815 +12,184 +13,543 +Other businesses +6,748 +6,830 +7,634 +Unallocated corporate +15,567 +15,029 +14,816 +Total consolidated depreciation and amortization +$ +33,130 +$ +34,043 +$ +35,993 +(1) Includes $0.5 million , $1.7 million , and $7.2 million of asset impairment charges related to 3 , 12 , and 27 underperforming retail locations for the years ended December 31, 2017 , 2016 and 2015 , respectively. +(2) Includes $0.0 million , $0.7 million , and $0.7 million of asset impairment charges related to 0 , 21 , and 27 underperforming retail locations for the years ended December 31, 2017 , 2016 and 2015 , respectively. +F- 31 +Table of Contents +(3) Includes less than $0.1 million , $0.3 million , and $1.6 million of asset impairment charges related to 1 , 9 , and 21 underperforming retail locations for the years ended December 31, 2017 , 2016 and 2015 , respectively. Additionally in the year ended December 31, 2016, the Company recorded $0.4 million in impairment charges related to goodwill in our Europe operating segment. +(4) Includes a $4.8 million write-off related to a discontinued project for the year ended December 31, 2017 . Also includes corporate support and administrative functions, costs associated with share-based compensation, research and development, marketing, legal, restructuring, depreciation and amortization of corporate and other assets not allocated to operating segments, and intersegment eliminations. +The following table sets forth asset information related to reportable operating segments as of the dates shown: +December 31, +2017 +2016 +(in thousands) +Long-lived assets: +Americas +$ +17,129 +$ +22,406 +Asia Pacific +4,171 +6,524 +Europe +4,609 +5,091 +Total segment long-lived assets +25,909 +34,021 +Supply Chain +17,396 +21,872 +Corporate and other +49,842 +62,377 +Total long-lived assets +$ +93,147 +$ +118,270 +Total consolidated assets: +Americas +$ +158,641 +$ +181,404 +Asia Pacific +161,646 +154,862 +Europe +76,537 +87,894 +Total segment assets +396,824 +424,160 +Supply Chain +37,793 +43,039 +Corporate and other +109,078 +99,191 +Total consolidated assets +$ +543,695 +$ +566,390 +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2017 , 2016 and 2015 . The following table sets forth certain geographical information regarding Crocs’ revenues for the periods as shown: +Year Ended December 31, +2017 +2016 +2015 +(in thousands) +Location: +United States +$ +388,847 +$ +384,939 +$ +392,463 +International (1) +634,666 +651,334 +698,167 +Total revenues +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +(1) For the year ended December 31, 2016, sales in Japan represented approximately 10.6% of consolidated revenues. +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2017 +2016 +(in thousands) +Location: +United States +$ +23,396 +$ +29,420 +International +11,636 +14,670 +Total property and equipment, net +$ +35,032 +$ +44,090 +F- 32 +Table of Contents +15 . LEGAL PROCEEDINGS +The Company was subjected to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, the Company was notified about the issuance of assessments totaling 14.4 million Brazilian Real (“BRL”), or approximately $4.3 million , plus interest and penalties, for the period January 2010 through May 2011. The Company has disputed these assessments and asserted defenses to the claims. On February 25, 2015, the Company received additional assessments totaling 33.3 million BRL, or approximately $10.1 million , plus interest and penalties, related to the remainder of the audit period. The Company has also disputed these assessments and asserted defenses to these claims in administrative appeals. On August 29, 2017, the Company received a favorable ruling on its appeal of the first assessment, which dismissed all fines, penalties, and interest. The tax authorities have requested a special appeal to that decision. If the appeal is accepted, Crocs will have the opportunity to both defend the appeal as well as challenge it procedurally. Should the Brazilian Tax Authority prevail in this final administrative appeal, Crocs may still challenge the assessments through the court system, which would likely require the posting of a bond. Additionally, the second appeal for the remaining assessments is scheduled to be heard on March 1, 2018. The Company has not recorded these items within the consolidated financial statements. Due to the inherent uncertainty of litigation and legal challenges, it is not possible to accurately predict the timing or outcome of this matter or to estimate an amount of loss, if any. +For all other claims and other disputes, the Company has accrued estimated losses of $1.8 million within ‘Accrued expenses and other liabilities’ in its consolidated balance sheet as of December 31, 2017 . Where the Company is able to estimate possible losses or a range of possible losses, the Company estimates that as of December 31, 2017 , losses associated with these claims and other disputes are immaterial. +The Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims. The Company is not party to any other pending legal proceedings that it believes would reasonably have a material adverse impact on its business, financial position, results of operations, or cash flows. +16 . EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +The Company sponsors a qualified defined contribution benefit plan (the “Plan”), covering substantially all of its U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. The Company makes matching contributions to the plans equal to 100% of the first 3% , and up to 50% of the next 2% of salary contributed by an eligible employee. Participants are vested 100% in the Company’s matching contributions when made. Contributions made by the Company under the Plan were $5.5 million , $5.8 million and $6.0 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +F- 33 +Table of Contents +17 . UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +March 31, 2017 +June 30, 2017 +September 30, 2017 +December 31, 2017 +(in thousands, except per share data) +Revenues +$ +267,907 +$ +313,221 +$ +243,273 +$ +199,112 +Gross profit +133,584 +169,807 +123,463 +90,367 +Income (loss) from operations +15,582 +29,446 +2,685 +(30,377 +) +Net income (loss) +11,010 +21,960 +1,629 +(24,361 +) +Net income (loss) attributable to common shareholders +7,155 +18,086 +(2,263 +) +(28,272 +) +Basic income (loss) per common share +$ +0.08 +$ +0.21 +$ +(0.03 +) +$ +(0.41 +) +Diluted income (loss) per common share +$ +0.08 +$ +0.20 +$ +(0.03 +) +$ +(0.41 +) +For the Quarter Ended +March 31, 2016 +June 30, 2016 +September 30, 2016 +December 31, 2016 +(in thousands, except per share data) +Revenues +$ +279,140 +$ +323,828 +$ +245,888 +$ +187,417 +Gross profit +129,366 +169,640 +122,434 +78,724 +Income (loss) from operations +14,243 +20,605 +(1,215 +) +(39,787 +) +Net income (loss) +10,146 +15,537 +(1,533 +) +(40,644 +) +Net income (loss) attributable to common shareholders +6,361 +11,735 +(5,352 +) +(44,482 +) +Basic income (loss) per common share +$ +0.07 +$ +0.13 +$ +(0.07 +) +$ +(0.60 +) +Diluted income (loss) per common share +$ +0.07 +$ +0.13 +$ +(0.07 +) +$ +(0.60 +) +During the three months ended December 31, 2017 , we identified the following factors affecting the comparability of information between periods: +• +Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter of the year relative to the other quarters. +• +Income from operations for the quarter ended December 31, 2017 improved by $9.4 million compared to the fourth quarter of 2016, primarily driven by higher revenues, partially offset by additional charges of $6.3 million related to a noncash write-off and contract termination fee for a discontinued project. +During the three months ended December 31, 2016 we identified the following factors affecting the comparability of information between periods: +• +Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter relative to the other quarters. For the quarter ended December 31, 2016 revenue decreased 10.2% as compared to the same quarter of the prior year which was primarily driven by a decrease in sales in the Wholesale and Retail segments. +• +Income from operations for the quarter ended June 30, 2016 was negatively impacted by an increase of $18.3 million in marketing expense related to the Spring/Summer line advertising campaigns. ‘Selling, general and administrative’ expenses, otherwise, remained relatively constant across the quarters, with some fluctuation between periods in relation to contingent rent expense that is driven by sales. +F- 34 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period +Charged to Costs and Expenses +Deductions +Balance at End of Period +(in thousands) +Year Ended December 31, 2017 +Allowance for doubtful accounts +$ +32,856 +$ +1,235 +$ +(15,766 +) +$ +18,325 +Reserve for sales returns and allowances +6,121 +65,562 +(66,700 +) +4,983 +Reserve for unapplied rebates +9,161 +9,318 +(10,398 +) +8,081 +Total +$ +48,138 +$ +76,115 +$ +(92,864 +) +$ +31,389 +Year Ended December 31, 2016 +Allowance for doubtful accounts +$ +36,368 +$ +6,079 +$ +(9,591 +) +$ +32,856 +Reserve for sales returns and allowances +4,639 +72,995 +(71,513 +) +6,121 +Reserve for unapplied rebates +8,357 +9,036 +(8,232 +) +9,161 +Total +$ +49,364 +$ +88,110 +$ +(89,336 +) +$ +48,138 +Year Ended December 31, 2015 +Allowance for doubtful accounts +$ +13,609 +$ +26,225 +$ +(3,466 +) +$ +36,368 +Reserve for sales returns and allowances +7,214 +71,649 +(74,224 +) +4,639 +Reserve for unapplied rebates +11,569 +11,106 +(14,318 +) +8,357 +Total +$ +32,392 +$ +108,980 +$ +(92,008 +) +$ +49,364 +F- 35 \ No newline at end of file diff --git a/raw/filings/0001334036/2017/0001628280-18-002437/filing_metadata.csv b/raw/filings/0001334036/2017/0001628280-18-002437/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..1ce48653c49b5f4af6f5a333b675caa1300d00c0 --- /dev/null +++ b/raw/filings/0001334036/2017/0001628280-18-002437/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2018-02-28,2017-12-31,2018-02-28T17:21:54.000Z,0001628280-18-002437,crox201712311710-k.htm,10-K,11946360,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000162828018002437/crox201712311710-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000162828018002437/,2017,2017,1 diff --git a/raw/filings/0001334036/2017/0001628280-18-002437/item1.txt b/raw/filings/0001334036/2017/0001628280-18-002437/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..b4f030b031b3ae96e1b8ee7fa275b78e87e23601 --- /dev/null +++ b/raw/filings/0001334036/2017/0001628280-18-002437/item1.txt @@ -0,0 +1,206 @@ +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, manufacturing, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. All of our products utilize our proprietary closed-cell resin, called Croslite TM , along with a range of other materials. Our Croslite TM material enables us to produce innovative, lightweight footwear. The Company, a Delaware corporation, is the successor to a Colorado corporation of the same name, and was originally organized in 1999 as a limited liability company. +Products +Our product offerings have grown significantly since we first introduced the single-style clog in six colors in 2002. Recognized across the world for our iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals, flips and slides, shoes, and boots that meet the needs of the whole family. +At the heart of our brand are the Classic and Crocband clogs, our most iconic styles for adults and children - products that embody our innovation in molding, simplicity of design, and all-day comfort. A key differentiating feature of our footwear products is our proprietary closed-cell resin Croslite TM material, which is uniquely suited for comfort and functionality. The unique look and feel of the Classic clog can be experienced throughout our entire product line due to the use and design of Croslite TM . For further information on Croslite TM , see ‘Raw Materials’ below. +We strive to provide our global consumer with comfortable, casual, colorful, and innovative footwear styles. Our collections are designed to meet the needs of the family by focusing on key wearing occasions. Our goal is to deliver casual product assortments with all of the comfort, features, and benefits Crocs is known for. We enjoy licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Sales and Marketing +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. Our marketing efforts center on presenting our clog and sandal silhouettes. For the years ended December 31, 2017 , 2016 , and 2015 , total marketing costs, inclusive of advertising, production, promotional, and agency expenses, were approximately $59.1 million , $56.0 million , and $58.2 million , respectively. +We run our business across three major geographic regions: the Americas, Asia Pacific, and Europe, which are discussed in more detail in ‘Business Segments and Geographic Information’ below. We prioritize five core markets including: (i) the United States, (ii) Japan, (iii) China, (iv) South Korea and (v) Germany. These countries have been identified as large-scale geographies where we believe the greatest opportunities for growth exist. We are also concentrating our marketing efforts on these countries, in an effort to increase customer awareness of both our brand and our full product range. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 90 countries, primarily through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic wholesalers as well as international wholesalers and distributors; our retail channel includes company-operated stores; and our e-commerce channel includes company-operated e-commerce sites. +Wholesale Channel +During the years ended December 31, 2017 , 2016 , and 2015 , approximately 52.4% , 52.7%, and 54.2% of revenues, respectively, were derived through our wholesale channel. Wholesale customers include family footwear retailers, national and regional retail chains, sporting goods stores, independent footwear retailers, and e-tailers. +2 +Table of Contents +Outside the United States, in addition to wholesale customers, we use distributors in select markets where we believe such arrangements are preferable to direct sales. These distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and have minimum purchase requirements that allow us to terminate or renegotiate the contract if such minimum requirements are not met. No single wholesale customer accounted for 10% or more of our revenues for any of the years ended December 31, 2017 , 2016 , and 2015 . +Retail Channel +During the years ended December 31, 2017 , 2016 , and 2015 , approximately 33.0% , 34.7%, and 34.7%, respectively, of our revenues were derived from sales through our retail channel. We operate our retail channel through three platforms: company-operated full-price retail and outlet stores, kiosks, and store-in-store locations, which enable us to promote the breadth of our product offering in high-traffic, high-visibility locations. With the worldwide consumer shift toward e-commerce, we are carefully managing and reducing our retail fleet, especially full-priced retail stores, and focusing on enhancing the profitability of this channel. We opened 19 company-operated stores during the year ended December 31, 2017 and closed 130 company-operated stores, including 37 transfers of company-operated stores to distributors. This activity is being taken in connection with the store reduction plan announced early in 2017, pursuant to which we intend to reduce our net retail store count by 160 as of December 31, 2018, compared to December 31, 2016. +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product ranges to consumers and provide us with the opportunity to interact with our consumers directly. The optimal space for our retail stores is between approximately 1,500 and 1,800 square feet, and is located in high-traffic shopping malls or districts. During the year ended December 31, 2017 , we closed 73 and opened 6 full-price retail stores. As of December 31, 2017 , 2016 , and 2015 , we operated 161, 228, and 275 full-price retail stores, respectively. This net reduction of 67 company-operated full-price retail stores during the year ended December 31, 2017 is in line with our continued focus on rationalization of our retail store fleet. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products in certain stores. Outlet stores are similar in size to our full-price retail stores; however, they are generally located within outlet shopping centers. During the year ended December 31, 2017 , we closed 30 outlet stores and opened 13 outlet stores. As of December 31, 2017 , 2016 , and 2015 , we operated 215, 232, and 186 outlet stores, respectively. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other high foot traffic areas. With efficient use of retail space, and limited capital investment, we believe that kiosks and store-in-store locations can be an effective vehicle for marketing our products in certain geographic areas. During the year ended December 31, 2017 , we closed 27 kiosk and store-in-store locations and opened no new kiosk and store-in-store locations. As of December 31, 2017 , 2016 , and 2015 , we operated 71, 98, and 98 kiosks and store-in-store locations, respectively. +3 +Table of Contents +Company-Operated Retail Stores +The following table illustrates the net change in 2017 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2016 +Opened +Closed/Transferred (1) +December 31, 2017 +Americas +United States +174 +2 +15 +161 +Canada +10 +— +1 +9 +Puerto Rico +6 +— +1 +5 +Total Americas +190 +2 +17 +175 +Asia Pacific +Korea +87 +4 +5 +86 +China +79 +9 +46 +42 +Japan (2) +44 +— +24 +30 +20 +Hong Kong +17 +1 +3 +15 +Singapore +18 +— +4 +14 +Australia (2) +13 +— +4 +9 +United Arab Emirates +12 +1 +13 +— +Total Asia Pacific +270 +15 +99 +186 +Europe +Russia +36 +1 +1 +36 +Germany +18 +— +3 +15 +France +10 +— +— +10 +Austria +6 +— +— +6 +Netherlands +5 +1 +2 +4 +Spain +5 +— +1 +4 +Great Britain +7 +— +4 +3 +Finland +4 +— +1 +3 +Other +7 +— +2 +5 +Total Europe +98 +2 +14 +86 +Total +558 +19 +130 +447 +(1) We completed the transfer of 37 company-operated stores in the Middle East and China to distributors during the period. +(2) We reclassified five stores between Australia and Japan as of December 31, 2016. +E-commerce Channel +As of December 31, 2017 , we offered our products through 13 company-operated e-commerce sites worldwide. During the years ended December 31, 2017 , 2016 , and 2015 , approximately 14.6% , 12.6%, and 11.1%, respectively, of our revenues were derived from sales through our e-commerce channel. Our e-commerce presence enables us to have increased access to our consumers and provides us with an opportunity to educate them about our products and brand. Improving our e-commerce capabilities is one of our key growth strategies, as we continue to leverage increasingly sophisticated digital technologies to enhance the consumer experience and drive sales. We also offer our products through third-party e-commerce sites (e-tailers) and marketplaces. Revenues from third-party e-commerce sites and marketplaces where we have a wholesale relationship are reported in our wholesale channel. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and Europe. Other businesses aggregates insignificant operating segments that do not meet the reportable operating segment threshold, including company-operated manufacturing facilities located in Mexico and Italy as well as corporate operations. See additional discussion of our segments and geographic information, including results of operations and assets by segment and geography in Note 14 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +4 +Table of Contents +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in North and South America. Regional wholesale channel customers consist of a broad range of family footwear and sporting goods stores, e-tailers, and independent retailers and distributors. The Americas retail channel sells directly to consumers through 175 company-operated retail stores in the Americas as well as through our e-commerce site. During the years ended December 31, 2017 , 2016 , and 2015 , revenues from the Americas segment were approximately 46.9% , 45.1%, and 43.7% of our consolidated revenues, respectively. Specifically, revenues from the United States were approximately 38.0% , 37.1% , and 35.8% of our consolidated revenues, respectively, for the years ended December 31, 2017 , 2016 , and 2015 . +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, Africa, and the Middle East. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell products directly to consumers through 186 company-operated retail stores located in Asia Pacific as well as through our e-commerce sites. During the years ended December 31, 2017 , 2016 , and 2015 , revenues from our Asia Pacific segment were 36.1% , 38.1%, and 39.0% of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Western Europe, Eastern Europe, and Russia. The Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment, plus distributors in select markets. We also sell our products directly to consumers through 86 company-operated retail stores located in Europe as well as through our e-commerce sites. During the years ended December 31, 2017 , 2016 , and 2015 , revenues from the Europe segment were 16.9% , 16.7 %, and 17.3% of our consolidated revenues, respectively. +Raw Materials +Croslite TM , our branded proprietary closed-cell resin, is the primary material formulation used in the majority of our footwear and some of our accessories. Croslite TM material is formulated to create soft, durable, extremely lightweight, water-resistant footwear that increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. +Croslite TM material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers, together with certain other production inputs such as color dyes. We have identified multiple suppliers that produce the elastomer resins used in the Croslite TM material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to produce Croslite TM products are readily available for purchase from multiple suppliers. +Since our inception in 2002, we have increased the number of footwear products we offer, and some of these products are constructed using leather, textile fabrics, or other non-Croslite TM materials. We, or our third-party manufacturers, obtain these materials from a number of third-party sources and we believe these materials are broadly available. +Research, Design, and Development +We continue to leverage our expertise and innovation in injection molding to create a fresh, distinctive point of view in the casual footwear market and to deliver a winning combination of comfort, style, value and versatility to our consumer. We dedicate significant resources to product design and development based on opportunities we identify in the marketplace. Our design and development process is highly collaborative and we continually strive to improve our development function so we can bring products to market quickly, while maintaining product quality. We spent $13.4 million , $11.9 million , and $14.0 million on research, design, and development activities for the years ended December 31, 2017 , 2016 , and 2015 , respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally-diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We contract with third-party manufacturers to produce certain of our footwear styles. +5 +Table of Contents +In the years ended December 31, 2017 , 2016 , and 2015 , we manufactured approximately 13.4%, 14.6%, and 11.3%, respectively, of our footwear products internally. We sourced the remaining footwear production from multiple third-party manufacturers primarily in China and Vietnam. During the years ended December 31, 2017 , 2016 , and 2015 , our largest third-party manufacturer, operating in both China and Vietnam, produced approximately 41.3%, 43.2%, and 47.5%, respectively, and our second largest third-party manufacturer, operating in Vietnam, produced approximately 19.0%,11.5%, and 9.4%, respectively, of our third-party footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. During the year ended December 31, 2017 , we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Russia, and Italy. We also utilized third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Russia, Brazil, Puerto Rico, and Italy. As of December 31, 2017 , our company-operated warehouse and distribution facilities provided us with approximately 0.9 million square feet and our third-party operated distribution facilities provided us with approximately 0.2 million square feet. We also ship a portion of our products directly to our wholesale customers from our internal and third-party manufacturers. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We will continue to strategically register, both domestically and internationally, the trademarks and patents covering the product designs and branding that we utilize today and those we develop in the future. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials covered by our trademark Croslite TM and used to produce our shoes, to be a valuable trade secret. The Croslite TM material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of shoes. We believe the comfort and utility of our products depend on the properties achieved from the compounding of the Croslite TM material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter are typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other +6 +Table of Contents +factors, including the timing of new model introductions, general economic conditions, and consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders, and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules and the timing of product shipments. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model differences around the globe, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: Nike Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with footwear retailers such as Genesco, Inc., Macy’s Inc., Dillard’s, Inc., Dick’s Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, pricing, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite TM material, our prices, our product line, and our distribution network continue to position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. Furthermore, we face competition from new companies which have been attracted to the market with products similar to ours as the result of the unique design and success of our footwear products. +Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar. +We have experienced, and will continue to experience, changes in international currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that they occur. +Changes in exchange rates have a direct effect on our reported U.S. Dollar consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the U.S. Dollar reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates used to translate the operating results of our international subsidiaries. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar consolidated statements of operations for the years ended December 31, 2017 , 2016 , and 2015 . +7 +Table of Contents +Employees +As of December 31, 2017 , we had approximately 4,382 full-time, part-time, and seasonal employees, of which approximately 2,808 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained at www.sec.gov or at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. Copies of any of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +8 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2017/0001628280-18-002437/item13.txt b/raw/filings/0001334036/2017/0001628280-18-002437/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..59c53b3a8ebe0cf64a37bd97b9b93ea49d84acc6 --- /dev/null +++ b/raw/filings/0001334036/2017/0001628280-18-002437/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2017 . \ No newline at end of file diff --git a/raw/filings/0001334036/2017/0001628280-18-002437/item9a.txt b/raw/filings/0001334036/2017/0001628280-18-002437/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..80b115f01ff38eae929f245a73f73f1e84e32a40 --- /dev/null +++ b/raw/filings/0001334036/2017/0001628280-18-002437/item9a.txt @@ -0,0 +1,25 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2017 , to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting (“ICFR”) as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2017 , based on the framework and criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2017 . +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2017 , as stated in the report which appears herein. +46 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2017, of the Company and our report dated February 28, 2018, expressed an unqualified opinion on those consolidated financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 28, 2018 +47 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2017/0001628280-18-002437/rp_note.txt b/raw/filings/0001334036/2017/0001628280-18-002437/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2017/0001628280-18-002437/rpt_disclosure.txt b/raw/filings/0001334036/2017/0001628280-18-002437/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..0ea31aeb8bdd97dd93e2f3d9a06b2bb5fdd15359 --- /dev/null +++ b/raw/filings/0001334036/2017/0001628280-18-002437/rpt_disclosure.txt @@ -0,0 +1,42 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Investment Agreement with Blackstone +On January 27, 2014, we issued to Blackstone and certain of its permitted transferees (together with Blackstone, the “Blackstone Purchasers”), 200,000 shares of our Series A convertible preferred stock for an aggregate purchase price of $198 million, or $990 per share, pursuant to the Investment Agreement. In connection with the issuance of the convertible preferred stock (the “Closing”) and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2 million and reimbursed Blackstone’s transaction fees and expenses of approximately $4 million. As of March 31, 2018 , the Blackstone Purchasers collectively owned all of our outstanding shares of convertible preferred stock and, on an as-converted basis, approximately 16.8% of our outstanding common stock. Mr. Ribatt was a permitted transferee of Blackstone and purchased 1,000 shares of our Series A convertible preferred stock. +As discussed above under “Proposal 1 - Election of Directors,” the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as the Blackstone Purchasers (i) beneficially own at least 95% of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement or (ii) maintain beneficial ownership of at least 12.5% of our outstanding common stock (the “Two-Director Threshold”), Blackstone will have the right to designate for nomination two directors to our Board. For so long as the Blackstone Purchasers beneficially own shares of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement that represent less than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. Blackstone’s ownership currently exceeds the Two-Director Threshold. Blackstone designated Mr. Melwani for nomination to our Board. Blackstone may choose to nominate a second director in the future. +Pursuant to the Investment Agreement, Blackstone is subject to certain standstill restrictions which generally restrict Blackstone from acquiring more than 25% of our outstanding common stock until the date on which Blackstone is no longer entitled to designate any directors to our Board. In addition, subject to certain customary exceptions, Blackstone was restricted from transferring any shares of the convertible preferred stock until the second anniversary of the Closing and, for so long as any convertible preferred stock is outstanding, may not transfer any shares of convertible preferred stock to certain of our competitors (as defined in the Investment Agreement) or holders of 25% or more of our common stock. Blackstone also has certain preemptive rights and information rights under the Investment Agreement, which are subject to certain conditions. +Series A Convertible Preferred Stock Certificate of Designations +Pursuant to the Certificate of Designations of Series A Convertible Preferred Stock filed with the Delaware Secretary of State on January 24, 2014, which establishes the designations, preferences, and other rights of the convertible preferred stock: +• +The convertible preferred stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and dissolution; +• +The Blackstone Purchasers are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value of $1,000 per share; +• +If we fail to make timely dividend payments to the holders of our convertible preferred stock, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in full; +• +The Blackstone Purchasers are entitled to receive any dividends declared or paid on our common stock and are entitled to vote together with the holders of our common stock as a single class, in each case, on an as-converted basis; +• +The Blackstone Purchasers have certain limited special approval rights, including with respect to the issuance by us of pari passu or senior equity securities; +• +The Blackstone Purchasers may, at any time, require us to convert their shares of convertible preferred stock into shares of common stock at an implied conversion price of $14.50 per share, subject to certain adjustments; +• +At our election, all or a portion of the convertible preferred stock will be convertible into the relevant number of shares of common stock on or after the third anniversary of the Closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days; +• +The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share caps and other restrictions; +17 +• +At any time after the eighth anniversary of the Closing, we will have the right to redeem, and the Blackstone Purchasers will have the right to require us to repurchase, all or any portion of the convertible preferred stock at 100% of the stated value, plus all accrued but unpaid dividends; and +• +Upon certain change in control events involving us, the Blackstone Purchasers can require us to repurchase their shares of convertible preferred stock at 101% of the stated value plus all accrued but unpaid dividends. +Registration Rights Agreement +In connection with the Closing, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the “Registration Rights Agreement”), pursuant to which we have agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of the shares of convertible preferred stock and any shares of common stock issued upon conversion of the convertible preferred stock. The Registration Rights Agreement contains customary terms and conditions, including certain customary indemnification obligations. +RGIS Services +We receive inventory count services from RGIS, LLC (“RGIS”), an affiliate of Blackstone. During 2017 , we paid RGIS approximately $363,000 for inventory services received. +Optiv, Inc. +We received cyber security and consulting services from Optiv, Inc. (“Optiv”), an affiliate of Blackstone. During 2017 , we paid Optiv approximately $177,000 for such services. +Kronos Incorporated +We received workforce management services from Kronos Incorporated (“Kronos”), an affiliate of Blackstone. During 2017 , we paid Kronos approximately $191,000 for such services. +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. The full Board approved each of the transactions disclosed above. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +18 \ No newline at end of file diff --git a/raw/filings/0001334036/2018/0001334036-19-000012/filing.txt b/raw/filings/0001334036/2018/0001334036-19-000012/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..7908315fde5c7a658df28e047358463445caec2c --- /dev/null +++ b/raw/filings/0001334036/2018/0001334036-19-000012/filing.txt @@ -0,0 +1,5427 @@ +10-K +1 +crox12311810-k.htm +10-K +Document +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +________________________________________________________________________________________________________________________________ +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2018 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer +Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to submit such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K. o +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company or emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +Smaller reporting company o +Emerging growth company o +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 29, 2018 was approximately $857.0 million . For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock outstanding as of February 20, 2019 was 73,336,332 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2019 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2018 . +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding: +• +our expectations regarding future trends, selling, general and administrative cost savings, expectations, and performance of our business; +• +our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• +our expectations about the impact of our strategic plans; and +• +our expectations regarding our level of capital expenditures in 2019. +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I — Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this Annual Report on Form 10-K, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. +i +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2018 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +7 +Item 1B. +Unresolved Staff Comments +19 +Item 2. +Properties +20 +Item 3. +Legal Proceedings +20 +Item 4. +Mine Safety Disclosures +20 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +21 +Item 6. +Selected Financial Data +23 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +25 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +43 +Item 8. +Financial Statements and Supplementary Data +44 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +44 +Item 9A. +Controls and Procedures +44 +Item 9B. +Other Information +46 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +47 +Item 11. +Executive Compensation +47 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +47 +Item 13. +Certain Relationships and Related Transactions and Director Independence +47 +Item 14. +Principal Accounting Fees and Services +48 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +49 +Item 16. +Form 10-K Summary +54 +Signatures +55 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The Company, a Delaware corporation, is the successor to a Colorado corporation of the same name, and was originally organized in 1999 as a limited liability company. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for men, women and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals, flips and slides, which we collectively refer to as sandals, shoes, and boots that meet the needs of the whole family. In 2018, Crocs reinforced its mission of “everyone comfortable in their own shoes” with the second year of its global Come As You Are™ campaign . +Crocs offers a broad portfolio of all-season products, while remaining true to its core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking and odor-resistant qualities that Crocs fans know and love. Since sales began in 2002, Crocs has sold more than 630 million pairs of shoes in more than 90 countries. +At the heart of our brand’s DNA are our clogs and sandals. The Classic Clog and Crocband, our most iconic silhouette for adults and children, embody our innovation in molding, simplicity of design, and all-day comfort. The unique look and feel of the Classic clog can be experienced throughout the vast majority of our product line due to the use and design of Croslite TM . Sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +We are now using Croslite TM with two new technologies in our LiteRide TM and Reviva TM collections, as we focus on visible comfort technology. LiteRide TM features comfort focused, proprietary foam insoles which are soft, lightweight and resilient, and our newest collection, Reviva TM , features a footbed with built-in air bubbles providing bounce and a massage effect. +We strive to provide our global consumers with comfortable, casual, colorful, and innovative footwear styles, with a focus on molded product. Our collections address many wearing occasions and meet the needs of the entire family. We enjoy licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Sales and Marketing +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. We prioritize five core markets including: (i) the U.S., (ii) Japan, (iii) China, (iv) South Korea and (v) Germany. These countries represent key geographies where we believe the greatest opportunities for growth exist. We are also concentrating our marketing efforts on these countries, in an effort to increase customer awareness of both our brand and our full product range. +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories that allow for personalization. We are expanding our sandal offerings as we pursue a greater share of a large market, with no clear global leader. We are investing in designer and celebrity collaborations and celebrity brand ambassadors to raise consumer engagement with our brand. For the years ended December 31, 2018 , 2017 , and 2016 , total marketing costs, inclusive of advertising, production, promotional, and agency expenses, including variable marketing expenses, were $68.6 million , $59.1 million , and $56.0 million , respectively. +2 +Table of Contents +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 90 countries through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand retailers, e-tailers, and distributors; our retail channel consists of company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2018 , 2017 , and 2016 , 53.1% , 52.4%, and 52.7% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel is made up of e-tailers, distributors, and traditional brick-and-mortar accounts, e-commerce sites operated by wholesalers, and in certain countries, also includes partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements are not met. No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2018 , 2017 , and 2016 . +Retail Channel +During the years ended December 31, 2018 , 2017 , and 2016 , 30.1% , 33.0%, and 34.7%, respectively, of our revenues were derived through our retail channel. We operate through three platforms: company-operated full-price retail and outlet stores, kiosks, and store-in-store locations. With the worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores, and focusing on enhancing the profitability of this channel. In the third quarter of 2018, we completed the store reduction program announced in early 2017 and ended 2018 with 383 company-operated stores, down from 558 at December 31, 2016. During the year ended December 31, 2018 , we closed 68 and opened 4 company-operated stores. +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. We believe the optimal space for our retail stores is between 1,500 and 1,800 square feet, located in high foot-traffic shopping malls or districts. During the year ended December 31, 2018 , we closed 42 and opened 1 full-price retail store. As of December 31, 2018 , 2017 , and 2016 , we operated 120 , 161, and 228 full-price retail stores, respectively. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. Outlet stores are similar in size to our full-price retail stores; however, they are generally located within outlet shopping centers. During the year ended December 31, 2018 , we closed 23 and opened 3 outlet stores. As of December 31, 2018 , 2017 , and 2016 , we operated 195 , 215, and 232 outlet stores, respectively. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot traffic areas. With efficient use of retail space, and limited capital investment, we believe that kiosks and store-in-store locations can be effective vehicles for marketing our products in certain geographic areas. During the year ended December 31, 2018 , we closed 3 kiosk and store-in-store locations, with no new openings. As of December 31, 2018 , 2017 , and 2016 , we operated 68 , 71, and 98 kiosks and store-in-store locations, respectively. +3 +Table of Contents +Company-Operated Retail Stores +The following table illustrates the net change in 2018 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2017 +Opened +Closed/Transferred +December 31, 2018 +Americas +United States +161 +1 +7 +155 +Canada +9 +— +— +9 +Puerto Rico +5 +— +1 +4 +Total Americas +175 +1 +8 +168 +Asia Pacific +Korea +86 +1 +1 +86 +China +42 +2 +16 +28 +Japan +20 +— +6 +14 +Singapore +14 +— +— +14 +Australia +9 +— +— +9 +Hong Kong +15 +— +13 +2 +Total Asia Pacific +186 +3 +36 +153 +EMEA +Russia +36 +— +5 +31 +Germany +15 +— +1 +14 +France +10 +— +2 +8 +Austria +6 +— +— +6 +Netherlands +4 +— +1 +3 +Spain +4 +— +4 +— +Great Britain +3 +— +3 +— +Finland +3 +— +3 +— +Other +5 +— +5 +— +Total EMEA +86 +— +24 +62 +Total +447 +4 +68 +383 +E-commerce Channel +As of December 31, 2018 , we offered our products through 13 company-operated e-commerce sites worldwide and also through third-party marketplaces. During the years ended December 31, 2018 , 2017 , and 2016 , 16.8% , 14.6%, and 12.6%, respectively, of our revenues were derived through this channel. Our e-commerce presence facilitates increased access to our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and EMEA . In the third quarter of 2018, certain revenues and expenses previously reported within the Asia Pacific segment were shifted to the EMEA segment. The previously reported amounts for these segments and channels have been revised for the years ended December 31, 2017 and 2016 to conform to the current period presentation. Other businesses aggregates insignificant operating segments, including company-operated manufacturing facilities located in Mexico and Italy, which ceased operations in 2018. +Americas +The Americas segment consists of revenues and expenses related to product sales in North and South America. Americas wholesale channel customers consist of a broad range of family footwear and sporting goods stores, e-tailers, and independent retailers and distributors. The Americas retail channel sells directly to consumers through 168 company-operated retail stores and Americas e- +4 +Table of Contents +commerce channel sales are generated through company-operated e-commerce sites. During the years ended December 31, 2018 , 2017 , and 2016 , revenues from the Americas segment were 47.8% , 46.9%, and 45.1% of our consolidated revenues, respectively. Revenues from the U.S. were 40.7% , 38.0% , and 37.1% of our consolidated revenues, respectively, for the years ended December 31, 2018 , 2017 , and 2016 . +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related to product sales throughout Asia, Australia, and New Zealand. Asia Pacific wholesale channel customers consist of a broad range of retailers similar to those in the Americas, plus distributors in select markets. We also sell products directly to consumers through 153 company-operated retail stores as well as through company-operated e-commerce sites and third-party marketplaces. During the years ended December 31, 2018 , 2017 , and 2016 , revenues from our Asia Pacific segment were 31.7% , 32.8%, and 34.2% of our consolidated revenues, respectively. +Europe, Middle East, and Africa +The EMEA segment consists of revenues and expenses related to product sales throughout Europe, Russia, the Middle East, and Africa. The EMEA segment wholesale channel customers consist of a broad range of retailers, similar to those in the Americas, plus distributors in select markets. We also sell our products directly to consumers through 62 company-operated retail stores as well as through our e-commerce sites. During the years ended December 31, 2018 , 2017 , and 2016 , revenues from our EMEA segment were 20.2% , 20.2%, and 20.6% of our consolidated revenues, respectively. +Raw Materials +Croslite TM , our proprietary closed-cell resin brand, is the primary material formulation used in the vast majority of our footwear and some of our accessories. Croslite TM is formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties and develop new properties for specific applications. +Croslite TM is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in Croslite TM . In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce Croslite TM products are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using leather, textile fabrics, or other non-Croslite TM materials, such as LiteRide TM . These materials are obtained from a number of third-party sources and we believe these materials are also broadly available. +Sourcing +Our strategy is to maintain a flexible, globally-diversified, low-cost third-party manufacturing capability. Our company-operated production facilities in Mexico and Italy, which had produced less than 15% of our products during each of the past three years, ceased operations in 2018. +We source the remaining footwear production from multiple third-party manufacturers, primarily in Vietnam and China. During the years ended December 31, 2018 , 2017 , and 2016 , our largest third-party manufacturer, operating in both Vietnam and China, produced 44.5%, 41.3%, and 43.2%, respectively, and our second largest third-party manufacturer, operating in Vietnam, produced 21.4%, 19.0%, and 11.5%, respectively, of our footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2018 , we stored our finished goods inventory in company-operated warehouse and distribution and logistics facilities located in the U.S., the Netherlands, and Japan. We also utilized third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2018 , our company-operated warehouse and distribution facilities provided us with 0.7 million square feet, and our third-party operated distribution facilities provided us with 0.2 million square feet. We also ship directly to certain of our wholesale customers from our third-party manufacturers. +5 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering the product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite TM , LiteRide TM , and Reviva TM valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite TM and LiteRide TM , which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting by monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter are typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, but not limited to, the timing of new model introductions, general economic conditions, and consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +A significant portion of orders from our wholesale customers and distributors remain unfilled as of any given date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders, and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules and the timing of product shipments. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model differences around the globe, and because backlog is cancelable at any time prior to shipment, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, +6 +Table of Contents +and e-commerce businesses compete with companies including, but not limited to: NIKE Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with footwear retailers such as Genesco, Inc., Macy’s Inc., Dillard’s, Inc., Dick’s Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite TM material, our prices, our product line, and our distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. +Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in international currency exchange rates (“exchange rates”) on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar. +We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of operations and the value of our assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of monetary assets and liabilities that are denominated in currencies other than that of our subsidiaries. Changes in the fair value of these forward contracts are recognized in earnings in the period that they occur. +Changes in exchange rates have a direct effect on our reported U.S. Dollar consolidated financial statements because we translate the statements of operations and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. As a result, comparisons of reported results between reporting periods may be impacted significantly due to changes in the exchange rates used to translate the operating results of our international subsidiaries. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar consolidated statements of operations for the years ended December 31, 2018 , 2017 , and 2016 . +Employees +As of December 31, 2018 , we had 3,901 full-time, part-time, and seasonal employees, of which 2,577 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +ITEM 1A. Risk Factors +The reader should carefully consider the following risk factors and all other information presented within this Annual Report on Form 10-K. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, or access to sources of financing. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to predict all risk factors, nor can it assess the impact of all such risk factors on our business. You should carefully consider each of the following risks described below in conjunction with all other information presented in this report. +7 +Table of Contents +Risks Specific to Our Company +Our success depends substantially on the value of our brand; failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs global brand. To be successful in the future, particularly outside of the U.S., where the Crocs global brand is less well-known and perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brand across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be out of style, outdated, or otherwise undesirable. Brand value is based in part on consumer perceptions on a variety of subjective qualities. In the past, several footwear companies, including ours, have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Consumer demand for our products and our brand equity could also diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. Business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brand and adversely impact our business. +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast geographic demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to: +• +Strengthen our brand globally; +• +Focus on relevant geographies and markets, product innovation and profitable new growth platforms while maintaining demand for our current offerings; +• +Effectively manage our company-operated retail stores, including closures of existing stores, while meeting operational and financial targets at the retail store level; +• +Accurately forecast the global demand for our products and the timely execution of supply chain strategies to deliver product around the globe efficiently based on that demand; +• +Use and protect the Crocs brand and our other intellectual property in new and existing markets and territories; +• +Achieve and maintain a strong competitive position in new and existing markets; +• +Attract and retain qualified wholesalers and distributors; +• +Consolidate our distribution and supply chain network to leverage resources and simplify our fulfillment process; +• +Maintain and enhance our social digital marketing capabilities and digital commerce capabilities; and +• +Execute multi-channel advertising, marketing, and social media campaigns to effectively communicate our message directly to our consumers and employees. +If we are unable to successfully implement any of the above mentioned strategies and the many other factors mentioned throughout these risk factors, our business may fail to grow, our brand may suffer, and our business and financial results may be adversely impacted. +There can be no assurance that the strategic plans we have been implementing will continue to be successful or that future strategic plans will be successful. +We believe our strategic initiatives will better position Crocs to adapt to changing consumer demands and global economic developments. We are focusing on our core molded footwear heritage by narrowing our product line with an emphasis on higher +8 +Table of Contents +margin products, as well as developing innovative new casual lifestyle footwear platforms. By streamlining the product portfolio and reducing non-core product development, we believe we will create a more powerful consumer connection to the brand. +We are refining our business model around the world by prioritizing direct investment in larger-scale geographies to focus our resources on the demographics with the largest growth prospects, moving away from direct investment in the retail and wholesale businesses in smaller markets, and transferring significant commercial responsibilities to distributors in smaller markets and in markets where local expertise is advantageous. Further, we intend to expand our engagement with leading wholesale accounts in select markets and increase our use of social media to drive sales growth, optimize product placement and enhance brand reputation. We intend to also expand our engagement with the consumer through enhancing our social digital marketing capabilities. +While these strategic plans, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance that this will be the case, or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +If our online e-commerce sites, or those of our customers, do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites as well as third-party e-commerce sites. Any failure on our part or third-parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our products could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including unauthorized access and denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, as well our financial results. +We rely heavily on the use of information technology systems and networks across all business functions, as do our business partners. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We rely exclusively on third-party information services providers worldwide for our information technology functions including network, help desk, hardware and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments. We use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. We also have outsourced a significant portion of work associated with our finance and accounting, human resources, and other information technology functions to third-party service providers. Despite our current security and cybersecurity measures, our systems, and those of our third-party service providers, we may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, and interruption or loss of valuable business data. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of sales, significant costs for data restoration, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks on a daily basis. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers' or employees' personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network is breached, it could give rise to unwanted media attention, materially damage our customer relationships, or harm our business, our reputation, and our financial results, which could result in fines or lawsuits. The costs we incur to protect against such information security breaches may materially increase, including increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. Our business partners in our supply chain and customer base also rely significantly on information technology. Despite their existing cybersecurity procedures and controls, if their information systems become compromised, it could, among other things, cause delays in our product fulfillment or reduce our sales, which could harm our business. +In addition, the European Union’s new General Data Protection Regulation and other similar privacy laws impose additional obligations on companies regarding the handling of personal data and provide certain individual privacy rights to persons whose +9 +Table of Contents +data is stored, and they may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes and the associated costs may have a material adverse impact on our business and results of operations. +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, and spend substantially more than we do on product marketing. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, launch more extensive or diverse product lines and more quickly develop new and popular products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Our brand value could be harmed by a number of factors, including some outside of our control. +Our brand value depends, in part, on our ability to maintain a positive consumer perception of our corporate integrity and brand culture. Negative claims or publicity involving us, our products or any of our key employees, endorsers or business partners could materially damage our reputation and brand image, regardless of whether such claims are accurate. Social media, which accelerates and potentially amplifies the scope of negative publicity, can accelerate, and increase the impact of, negative claims. Adverse publicity about regulatory or legal action against us, or by us, could also damage our reputation and brand image, undermine consumer confidence in us and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Maintaining, promoting and growing our brand will also depend on our design and marketing efforts, including product innovation and product quality advertising and consumer campaigns. In addition, our success in preserving and strengthening our brand image depends on our ability to adapt to a rapidly changing media environment, including our increasing reliance on social media and digital dissemination of advertising campaigns. If the reputation or image of our brand is harmed or if we receive negative publicity, then our product sales, financial condition and results of operations could be materially and adversely affected. +Continuing to rationalize our existing product assortment and introducing new products may be difficult and expensive. If we are unable to do so successfully, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully continue to refine our footwear product line, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. Our development schedules for new products are difficult to predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles and product lines and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We have a limited history of introducing new products in certain target markets; as such, we may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses. There can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brand, erode our competitive position and result in long-term harm to our business and financial results. +10 +Table of Contents +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions and other factors affecting consumer demand. In addition, purchase orders from our wholesale customers are generally subject to rights of cancellation and rescheduling by the wholesaler. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in losses or lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages which can result in lower sales, delays in shipments to customers, expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. Excess inventory or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our financial success depends in part on the strength of our relationships with, and the success of, our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributors customers to carry our products. We do not have long-term contracts and sales to our wholesalers and distributors are generally on an order-by-order basis and subject to cancellation and rescheduling. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses and reduced cash flows if our collection efforts are unsuccessful. We have recorded material allowances for doubtful accounts in the past and could do so again in the future. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations and our ability to grow our product line. +Changes in foreign exchange rates, most significantly but not limited to the Euro, Russian Ruble, Japanese Yen, Chinese Yuan, South Korean Won, or other global currencies could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar (“USD”). Our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, product price pressures, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. We pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. In 2018 , we experienced an increase of approximately $6.7 million in our Asia Pacific segment revenues as a result of increases in the value of Asian currencies relative to the USD, and an increase of approximately $8.7 million in our EMEA revenues as a result of increases in the Euro and decreases in the Russian Ruble relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies, adversely impacts our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and, as a result, our forward contracts may not prove effective in reducing our exposures. +We conduct significant business activity outside the U.S. which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. We operate retail stores and sell our products to retailers outside of the U.S. and utilize foreign-based third-party manufacturers. Foreign manufacturing and sales activities are subject to numerous risks including: tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; delays associated with the manufacture, transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to increased security concerns; restrictions on the transfer of funds; restrictions and potential penalties, due to privacy laws, on the handling and transfer of consumer and other personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; expropriation and nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions; longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; difficulties in enforcing contractual and intellectual property rights; greater +11 +Table of Contents +risk that our business partners do not comply with our policies and procedures relating to labor, health and safety; and increased accounting and internal control costs. In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we operate. We cannot assure that there will be not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. For more information, please see “- We depend solely on third-party manufacturers located outside the U.S. ” and “- Our business relies significantly on the use of information technology. A significant disruption to our operational technology or data security breach could harm our reputation and/or our ability to effectively operate our business .” +In addition, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries and a materially negative effect on our brand and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners or agents will not violate our policies. +Changes in global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, or other economic factors. If global economic and financial market conditions deteriorate or remain weak for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• +Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results. +• +Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, cause reduced product orders or product order delays or cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• +If consumer demand for our products declines, we may not be able to profitably establish new retail stores, or continue to operate existing retail stores, due to higher fixed costs of the retail business. +• +A decrease in credit available to our wholesale or distributor customers, product suppliers and other service providers, or financial institutions that are counterparties to our credit facility or derivative instruments may result in credit pressures, other financial difficulties, or insolvency for these parties, with a potential adverse impact on our business, our financial results, or our ability to obtain future financing,. +• +If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment of our accounts receivable. +• +If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +12 +Table of Contents +Opening and operating company-operated retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2018, we opened 4 and closed 68 retail stores, and we operated 383 retail stores at December 31, 2018 . +Although our strategic plan initiatives included a net reduction in our retail sales channel, we intend to continue to open new retail locations globally. Our ability to open new stores, including kiosks and store-in-store locations, successfully depends on our ability to identify suitable store locations, negotiate acceptable lease terms, hire, train, and retain store personnel and satisfy the fashion preferences in new geographic areas. Many of our company-operated retail stores are located in shopping malls and outlet malls and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick and mortar retail to e-commerce channels, which may contribute to declining foot traffic in company-operated retail locations. Continued reduced customer foot traffic could reduce sales at our company-operated retail stores, including kiosks and store-in-store locations, or hinder our ability to open retail stores in new markets, including kiosks and store-in-store locations, which could in turn negatively affect our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, terrorism, social or military events or otherwise, is likely to adversely affect sales in our existing stores. +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows or the closure of a store could result in impairment of leasehold improvements, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. For example, during 2018, 2017, and 2016, we recorded impairments of which $0.9 million , $0.5 million , and $2.7 million , respectively, related to our retail stores. These impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +We depend solely on third-party manufacturers located outside of the U.S. +All of our footwear products are manufactured by third-party manufacturers, the majority of which are located in Vietnam and China. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines or meet our quality standards. +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, changes in governmental policies and the imposition of tariffs, import and export controls, and other barriers. Since we ceased internal manufacturing in 2018, we can no longer offset any interruption or decrease in supply of our products by increasing production in internal manufacturing facilities, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can increase our transportation costs and adversely affect our product margins. +13 +Table of Contents +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, increases in labor costs, changes in international trade agreements and tariffs, or adverse weather conditions could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. For example, the Trump Administration has instituted trade policies that include the re-negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the U.S., economic sanctions on individuals, corporations or countries, and other government regulations affecting trade between the U.S. and other countries where we conduct our business. It may be time-consuming and expensive for us to alter our business operations in order to adapt to or comply with any such changes. +Furthermore, as a result of recent policy changes and U.S. government proposals, there may be greater restrictions and economic disincentives on international trade. The tariffs and other changes in U.S. trade policy could trigger retaliatory actions by affected countries, and certain foreign governments have instituted or are considering imposing trade sanctions on certain U.S. goods. For example, in 2018, the U.S. government announced tariffs on certain steel and aluminum products imported into the U.S., which has resulted in reciprocal tariffs from the European Union on goods imported from the U.S. In September 2018, the U.S. government placed additional tariffs of approximately $200 billion on goods imported from China. China has already imposed tariffs on a wide range of U.S. products in retaliation for tariffs on steel and aluminum. Additional tariffs could be imposed by China in response to the proposal to increase tariffs on products imported from China. Certain products that we sell in the U.S. are manufactured in China. Any further escalation of trade tensions could have a significant, adverse effect on world trade and the world economy. While we are unable to predict whether or how the recently enacted tariffs will impact our business, the imposition of tariffs on items imported by us from China could require us to increase prices to our customers or, if unable to do so, result in lowering our gross margin on products sold. Tariffs on footwear imported from China could have a material adverse effect on our business and results of operations. +We, similar to many other companies with overseas operations, import and sell products in other countries besides China that could be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition and results of operations. +Our third-party manufacturing operations must comply with labor, trade and other laws. Failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall which could result in critical media coverage and harm our business, brand and reputation and cause us to incur additional costs. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business, or results. For more information, please see “- We depend solely on third-party manufacturers located outside the U.S. ” +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite TM and LiteRide TM products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market issues related to supply and demand for our raw materials. We may have to pay substantially +14 +Table of Contents +higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of the Croslite TM and LiteRide TM materials, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and designs on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brand, our success and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others intellectual property rights, continued sales of such competing products by third parties could harm our brand or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brand is associated with inferior counterfeit reproductions, the integrity and reputation of our brand could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite TM material and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. A significant portion of our revenues are attributable to footwear styles that are more suitable for fair weather and are derived from sales in the northern hemisphere. We typically experience our highest sales activity during the first three quarters of the calendar year, when there is warmer weather in the northern hemisphere. The effects of favorable or unfavorable weather on sales can be significant enough to affect our quarterly results which could adversely affect our common stock price. Quarterly results may also fluctuate as a result of other factors, including new style introductions, general economic conditions or changes in consumer preferences. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, expansion of existing businesses or operations, and acquisitions of new businesses, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect, or implementation issues, or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +15 +Table of Contents +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back office systems. Issues in implementing or integrating new business operations and new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations and require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +Failure to continue to obtain or maintain high-quality endorsers of our products could harm our business . +We establish relationships with celebrity endorsers to develop, evaluate, and promote our products, as well as strengthen our brand. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brand visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers associated with our products that harm the public image and reputations of those endorsers could also seriously harm our brand image with consumers and, as a result, could have an adverse effect on our sales and financial condition. +Our senior revolving credit facility agreement (as amended to date, the “Credit Agreement”) contains financial covenants that require us to maintain certain financial measures and ratios and includes restrictive covenants that limit our ability to take certain actions. A breach of any of those restrictive covenants may cause us to be in default under the Credit Agreement, and our lenders could foreclose on our assets. +Our Credit Agreement requires us to maintain certain financial covenants. A failure to maintain current revenue levels or an inability to control costs or capital expenditures could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Credit Agreement. We may not have sufficient assets to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lender. If we are unable to repay the indebtedness, the lender could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Credit Agreement. +The Credit Agreement also contains certain restrictive covenants that limit, and in some circumstances prohibit our ability to, among other things: incur additional debt, sell, lease or transfer our assets, pay dividends on our common stock, make capital expenditures and investments, guarantee debt or obligations, create liens, repurchase our common stock, enter into transactions with our affiliates and enter into certain merger, consolidation or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S. and our business and financial results. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the U.S. Tax Cuts and Jobs Act (the “Tax Act”), could be repatriated without incurring additional U.S. federal income taxes, although some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the U.S. and foreign jurisdictions for prior tax years. Please refer to Note 14 — Commitments and Contingencies and Note 16 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details regarding current tax +16 +Table of Contents +audits. The final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. Recent developments, including U.S. tax reform, the European Commission’s investigations of local country tax authority rulings and whether those rulings comply with European Union rules on state aid, as well as the Organization for Economic Co-operation and Development’s project on Base Erosion and Profit Shifting, continue to change long-standing tax principles. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +We are subject to periodic litigation, which could result in unexpected expenditures of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Note 16 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings or any future legal proceedings could have an adverse impact on our business, and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear, such as our branded Croslite TM , LiteRide TM , and Reviva TM . Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite TM , our branded proprietary closed-cell resin, is the primary raw material used in the vast majority of our footwear and some of our accessories. Croslite TM is carefully formulated to create soft, durable, extremely lightweight, and water-resistant footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +We depend on key personnel across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +If our internal controls are ineffective, our operating results and market confidence in our reported financial information could be adversely affected. +Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal controls or if we experience difficulties in their implementation, our business and operating results and market confidence in our reported financial information could be harmed, we could incur significant costs to evaluate and remediate weaknesses, and we could fail to meet our financial reporting obligations. +The existence of a material weakness precludes management from concluding that our internal control over financial reporting is effective and precludes our independent auditors from issuing an unqualified opinion that our internal controls are effective. In +17 +Table of Contents +addition, a material weakness could cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock. We also can make no assurances that we will be able to remediate any future internal control deficiencies timely and in a cost effective manner. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we are unable to satisfactorily remediate future deficiencies or if we discover other deficiencies in our internal control over financial reporting, such deficiencies may lead to misstatements in our financial statements or otherwise negatively impact our business, financial results and reputation. +Labor disruptions could adversely impact our business. +Our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threats to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing, or manufacturing and selling seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +Our reported financial results may be adversely affected by changes in United States generally accepted accounting principles. +Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board, the Securities and Exchange Commission, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant impact on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change . +Extreme weather conditions or natural disasters could negatively impact our operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including damage to our supply chain, manufacturing or distribution centers, retail stores, changes in consumer preferences or spending priorities, energy shortages, and public health issues, could harm or disrupt our operations or the operations of our vendors other suppliers, or customers, or result in economic instability that may negatively impact our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. +Risks Specific to Our Capital Stock +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +Future sales of common stock by Blackstone Capital Partners VI L.P. and certain of its permitted transferees or affiliates (“Blackstone”) may adversely affect the market price of our common stock. +We issued shares of Series A Convertible Preferred Stock (“Series A Preferred”) to Blackstone and certain of its permitted transferees (collectively, the “Blackstone Purchasers”) in January 2014. In December 2018, we repurchased 100,000 shares of Series A Preferred from the Blackstone Purchasers and the Blackstone Purchasers converted their remaining shares of Series A Preferred into 6,896,548 shares of common stock. +18 +Table of Contents +Subject to certain exceptions, the Blackstone Purchasers agreed not to transfer the shares of common stock they received under the share repurchase agreement until, and including, the date immediately prior to the first date (the “Lock-Up Release Date”) on which our trading window opens following release of our Quarterly Report on Form 10-Q to be filed with the SEC for the quarterly period ended June 30, 2019 (but in any event, the Lock-Up Release Date shall be no later than August 12, 2019). After the Lock-Up Release Date, sales of a substantial number of shares of common stock by Blackstone could adversely affect prevailing market prices of our common stock. We have granted the Blackstone Purchasers registration rights in respect to the shares to facilitate the resale of such securities into the public market. Sales by Blackstone of a substantial number of shares of our common stock in the public market, or the perception that such sales might occur, could have a material adverse effect on the price of our common stock. +Blackstone may exercise significant influence over us, including through its ability to elect up to one member of our Board of Directors (the “Board”). +As of December 31, 2018, the shares of common stock owned by Blackstone represented approximately 9.4% of the voting rights of our common stock, so Blackstone will have the ability to significantly influence the outcome of any matter submitted for the vote of our stockholders. Blackstone may have interests that diverge from, or even conflict with, those of our other stockholders. For example, Blackstone and its affiliates may have an interest in directly or indirectly pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their other equity investments, even though such transactions might involve risks to us. Blackstone and its affiliates are in the business of making or advising on investments in companies, including businesses that may directly or indirectly compete with certain portions of our business. They may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us. +In addition, the investment agreement with Blackstone grants Blackstone certain rights to designate directors to serve on our Board. For so long as Blackstone beneficially owns shares of common stock that represent more than 25% of the number of shares of the as-converted common stock initially purchased pursuant to this investment agreement, Blackstone will have the right to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. As of December 31, 2018, Blackstone has the right to designate for nomination one director to our Board, but continues to have two designees currently serving on the Board. +ITEM 1B. Unresolved Staff Comments +None. +19 +Table of Contents +ITEM 2. Properties +Our principal executive and administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado 80503. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for office, warehouse, and retail, including kiosk and store-in-store, space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, use, and approximate size of our principal properties, and the reportable operating segment are given below. +Location +Reportable Operating Segment +Use +Approximate +Square Feet +Dayton, Ohio (1) +Americas +Warehouse +555,000 +Ontario, California (1) +Americas +Warehouse +399,000 +Rotterdam, the Netherlands +EMEA +Warehouse +174,000 +Narita, Japan +Asia Pacific +Warehouse +156,000 +Niwot, Colorado +Americas +Corporate headquarters and regional office +98,000 +Padova, Italy +Other Businesses +Product development office +45,000 +Hoofddorp, the Netherlands +EMEA +Regional office +31,000 +Shenzhen, China +Asia Pacific +Regional office +22,000 +Singapore +Asia Pacific +Regional office +17,000 +Westwood, Massachusetts +Americas +Global commercial center +16,000 +Shanghai, China +Asia Pacific +Regional office +11,000 +(1) In the fourth quarter of 2018, the Company entered into a lease agreement for a new distribution center in Dayton, Ohio, which is expected to replace the Company’s existing facility in Ontario, California in 2019. +Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operational needs. We also lease 383 retail locations worldwide. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +In January 2019, Crocs entered into a lease, which will commence in March 2020, for its new corporate headquarters and regional office in Broomfield, Colorado. The new location is approximately 88,000 square feet, and the relocation from our Niwot office is planned for early 2020. +ITEM 3. Legal Proceedings +A discussion of legal matters is found in Note 16 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +ITEM 4. Mine Safety Disclosures +Not applicable. +20 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the NASDAQ Global Select Market under the stock symbol “CROX.” +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite Index and the Dow Jones U.S. Footwear Index from December 31, 2013 through December 31, 2018 . The graph assumes an investment of $100.00 on December 31, 2013 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corporation., adidas AG, Skechers U.S.A., Inc., Steven Madden Ltd. and Wolverine World Wide, Inc., among other companies. As Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of our stock have an effect on this index. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 82 as of February 20, 2019 . +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements do not permit us to pay cash dividends on our common stock. +21 +Table of Contents +Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to compliance with covenants under any then-existing financing agreements. +Purchases of Equity Securities by the Issuer +Issuer Purchases of Equity Securities +Period +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly +Announced Plans or Programs (1) +Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs +October 1-31, 2018 +821,059 +$ +19.26 +821,059 +$ +165,987,464 +November 1-30, 2018 +49,937 +25.00 +49,937 +164,739,623 +December 1-31, 2018 (2) +368,351 +24.49 +368,351 +155,723,037 +Total +1,239,347 +$ +21.05 +1,239,347 +$ +155,723,037 +(1) On December 26, 2013, the Company’s Board of Directors approved and authorized a program to repurchase up to $350.0 million of our common stock, and on February 20, 2018, the Board approved an increased repurchase authorization up to $500.0 million of our common stock. As of December 31, 2018 , approximately $155.7 million remained available for repurchase under our share repurchase authorization. The number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under our revolving credit facility, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. +(2) Number of shares purchased in December 2018 does not include 100,000 shares of Series A Convertible Preferred Stock purchased for an aggregate cost of $183.7 million . See Note 9 — Equity in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +22 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five years. The information in this table should be read in conjunction with our consolidated financial statements and accompanying notes presented in Item 8. Financial Statements and Supplementary Data , and Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operations in Part II of this Annual Report on Form 10-K. +Year Ended December 31, +2018 +2017 +2016 +2015 +2014 +(in thousands, except per share data) +Revenues +$ +1,088,205 +$ +1,023,513 +$ +1,036,273 +$ +1,090,630 +$ +1,198,223 +Cost of sales +528,051 +506,292 +536,109 +579,825 +603,893 +Restructuring charges (1) +— +— +— +— +3,985 +Gross profit +560,154 +517,221 +500,164 +510,805 +590,345 +Gross margin +51.5 +% +50.5 +% +48.3 +% +46.8 +% +49.3 +% +Selling, general and administrative expenses +495,028 +494,601 +503,174 +559,095 +565,712 +Selling, general and administrative expenses as a % of revenues +45.5 +% +48.3 +% +48.6 +% +51.3 +% +47.2 +% +Restructuring charges (1) +— +— +— +8,728 +20,532 +Asset impairments (2) +2,182 +5,284 +3,144 +15,306 +8,827 +Income (loss) from operations +$ +62,944 +$ +17,336 +$ +(6,154 +) +$ +(72,324 +) +$ +(4,726 +) +Income (loss) before income taxes +$ +65,157 +$ +18,180 +$ +(7,213 +) +$ +(74,744 +) +$ +(8,549 +) +Income tax expense (benefit) +14,720 +7,942 +(9,281 +) +(8,452 +) +3,623 +Net income (loss) +50,437 +10,238 +(16,494 +) +(83,196 +) +(4,926 +) +Dividends on Series A convertible preferred stock (3) +(108,224 +) +(12,000 +) +(12,000 +) +(11,833 +) +(11,301 +) +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature (3) +(11,429 +) +(3,532 +) +(3,244 +) +(2,978 +) +(2,735 +) +Net loss attributable to common stockholders +$ +(69,216 +) +$ +(5,294 +) +$ +(31,738 +) +$ +(98,007 +) +$ +(18,962 +) +Net loss per common share: +Basic +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +Diluted +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +$ +(1.30 +) +$ +(0.22 +) +Weighted average common shares: +Basic +68,421 +72,255 +73,371 +75,604 +85,140 +Diluted +68,421 +72,255 +73,371 +75,604 +85,140 +Cash provided by (used in) operating activities +$ +114,162 +$ +98,264 +$ +39,754 +$ +9,698 +$ +(11,651 +) +Cash used in investing activities (4) +(10,110 +) +(11,538 +) +(19,856 +) +(18,488 +) +(56,790 +) +Cash provided by (used in) financing activities (5) +(148,802 +) +(65,370 +) +(16,443 +) +(101,260 +) +23,431 +(1) We commenced a restructuring in July 2014 and concluded in December 2015. +(2) Asset impairments consist of impairments of long-lived assets of retail locations in all years, as well as a $1.3 million write-off of supply chain assets in 2018, a $4.8 million write-off of a discontinued project in 2017, and $0.4 million of goodwill impairment in 2016. +(3) On December 5, 2018, all issued and outstanding shares of Series A Convertible Preferred Stock were repurchased in exchange for cash or converted to common stock. As a result, amounts reported for the year ended December 31, 2018, include amounts resulting from the repurchase and conversion, in addition to payments made to induce conversion and accretion of dividend equivalents prior to December 5, 2018. +(4) Prior year amounts have been recast to reflect adoption of new guidance requiring that restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts reported in the statements of cash flows. For more information, see Note 2 — Recent Accounting Pronouncements . +(5) Cash used in financing activities for the year ended December 31, 2018 reflects the impacts of $183.7 million used to repurchase Series A Preferred in 2018 and $120.0 million of borrowings. Cash used in financing activities also includes approximately $63.1 million , $50.0 +23 +Table of Contents +million, $85.9 million, and $145.9 million, including commissions, used to repurchase shares of the Company’s common stock during 2018, 2017, 2015, and 2014, respectively. The Company did not repurchase shares in 2016. +December 31, +2018 +2017 +2016 +2015 +2014 +(in thousands) +Cash and cash equivalents +$ +123,367 +$ +172,128 +$ +147,565 +$ +143,341 +$ +267,512 +Inventories +124,491 +130,347 +147,029 +168,192 +171,012 +Working capital +195,807 +268,031 +276,335 +278,852 +441,523 +Total assets (1) +468,901 +543,695 +566,390 +608,020 +806,931 +Long-term liabilities +134,102 +18,379 +17,966 +19,294 +27,849 +Total stockholders' equity +150,308 +185,865 +220,383 +245,972 +452,518 +(1) Prior year amounts have not been recasted to reflect adoption of new revenue recognition guidance as of January 1, 2018. For more information, see Note 2 — Recent Accounting Pronouncements . +24 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. The vast majority of our products utilize our proprietary closed-cell resin, called Croslite TM , along with a range of other materials. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 85 countries, through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic wholesalers as well as international wholesalers and distributors; our retail channel includes company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party-operated marketplace activity. +Known or Anticipated Trends +Based on our recent operating results and our assessment of the current operating environment, we anticipate certain trends to impact our future operating results: +• +Consumer spending preferences continue to shift toward e-commerce and away from brick and mortar stores. This has resulted in continued sales growth in our e-commerce channel, as well as on various e-tail sites operated by wholesalers, and contributed to declining foot traffic in our retail locations. +• +A cautious retail environment may negatively affect customer purchasing trends. +• +Foreign exchange rate volatility will continue to impact our reported U.S. Dollar results from our foreign operations. +• +In 2017 we identified annual reductions in ‘Selling, general and administrative expenses’ (“SG&A”) in the amount of $75 to $85 million, which we projected would generate an annual $30 to $35 million improvement in earnings before interest and taxes in 2019, compared to 2016 (“SG&A reduction plan”). We have successfully completed our SG&A reduction plan, by eliminating approximately $75 million of annualized expenses that previously burdened our cost structure. We have elected to reinvest some of those savings in marketing and our e-commerce business, to further strengthen our brand and drive incremental sales growth. +• +As a result of the repurchase and conversion of our Series A Convertible Preferred Stock on December 5, 2018, we will no longer be required to pay $12 million annually in preferred stock dividends. +• +Non-recurring charges relating to the Company’s new distribution center are expected to reduce gross margin by approximately 100 basis points in 2019. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +25 +Table of Contents +2018 Financial and Operational Highlights +Revenues were $1,088.2 million for the year ended December 31, 2018 , a 6.3% increase compared to the year ended December 31, 2017 . The increase in 2018 revenues compared to 2017 revenues was due to the net effects of: (i) higher sales volumes, which increased revenues by $25.8 million , or 2.5% ; (ii) higher average selling prices as our product and channel mix continued to change, which increased revenues by $27.7 million , or 2.7% ; and (iii) favorable changes in exchange rates, which increased revenues by $11.2 million , or 1.1% . +The following were significant developments affecting our businesses and capital structure during the year ended December 31, 2018 : +• +In 2018, the impact of operating with a net of 64 fewer company-operated stores and certain business model changes reduced our revenues by approximately $60 million. +• +We sold 59.8 million pairs of shoes worldwide, an increase of 3.4% from 57.9 million pairs in 2017 . +• +Gross margin improved 100 basis points compared to 2017 to 51.5% for the year ended December 31, 2018 . We drove this improvement by continuing to prioritize high-margin molded products, increasing prices on select products, and conducting fewer promotions in combination with better inventory management. +• +SG&A was $495.0 million , an increase of $0.4 million , or 0.1% , compared to 2017 . As a percent of revenues, SG&A improved 280 basis points to 45.5% of revenues. This included $21.1 million of non-recurring charges associated with our previously announced SG&A reduction plan, the completion of the closure of all company-operated manufacturing and related distribution facilities, and some charges related to the relocation of our corporate headquarters, which is planned for early 2020. +• +Income from operations was $62.9 million for the year ended December 31, 2018 compared to income from operations of $17.3 million for the year ended December 31, 2017 . Income from operations as a percent of revenues rose to 5.8% compared to 1.7% in 2017. +• +In December 2018, we completed a transaction with Blackstone to repurchase 100,000 shares of Series A Convertible Preferred Stock (“Series A Preferred”) for $183.7 million and to convert the remaining 100,000 shares of Series A Preferred into 6,896,548 shares of our common stock, which resulted in the elimination of $12 million in annual dividends and an overhang on our common stock. Crocs also agreed to pay Blackstone a $15 million inducement payment in connection with the transaction. +• +Net loss attributable to common stockholders was $69.2 million compared to a loss of $5.3 million in 2017 , including the accounting treatment for charges incurred related to the repurchase and conversion of our Series A Preferred. Basic and diluted net loss per common share was $1.01 for the year ended December 31, 2018 , compared to a basic and diluted net loss per common share of $0.07 for the year ended December 31, 2017 . +• +To continue improving the efficiency and profitability of our retail business we closed or transferred to distributors 68 stores in 2018, 61.8% of which were full-priced locations, for a net reduction of 64 company-operated retail stores. Since we began our store reduction program early in 2017, we have closed a net total of 175 stores and reduced our total company-operated store count to 383 from 558 at the end of 2016. The majority of these store closures occurred upon expiration of the leases. We have also placed greater priority on outlet stores, so that they now represent 50.9% of our store base, up from 41.6% at the end of 2016. +• +We continued to focus on simplifying our product line and disciplined inventory management to allow investment in higher margin, faster-turning product. As a result, we reduced our inventory by $5.9 million , or 4.5% , from $130.3 million to $124.5 million . +• +During 2018 , we repurchased 3.6 million shares of common stock at an aggregate cost of $63.1 million and eliminated the overhang of 6.9 million shares (on an as-converted basis) associated with the repurchase of 100,000 shares of the Series A Preferred. +26 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2018 , 2017 , and 2016 +Year Ended December 31, +$ Change +% Change +2018 +2017 +2016 +2018-2017 +2017-2016 +2018-2017 +2017-2016 +(in thousands, except per share data, margin, and average selling price data) +Revenues +$ +1,088,205 +$ +1,023,513 +$ +1,036,273 +$ +64,692 +$ +(12,760 +) +6.3 +% +(1.2 +)% +Cost of sales +528,051 +506,292 +536,109 +(21,759 +) +29,817 +(4.3 +)% +5.6 +% +Gross profit +560,154 +517,221 +500,164 +42,933 +17,057 +8.3 +% +3.4 +% +Selling, general and administrative expenses +495,028 +494,601 +503,174 +(427 +) +8,573 +(0.1 +)% +1.7 +% +Asset impairments +2,182 +5,284 +3,144 +3,102 +(2,140 +) +58.7 +% +(68.1 +)% +Income (loss) from operations +62,944 +17,336 +(6,154 +) +45,608 +23,490 +263.1 +% +381.7 +% +Foreign currency gains (losses), net +1,318 +563 +(2,454 +) +755 +3,017 +134.1 +% +122.9 +% +Interest income +1,281 +870 +692 +411 +178 +47.2 +% +25.7 +% +Interest expense +(955 +) +(869 +) +(836 +) +(86 +) +(33 +) +(9.9 +)% +(3.9 +)% +Other income +569 +280 +1,539 +289 +(1,259 +) +103.2 +% +(81.8 +)% +Income (loss) before income taxes +65,157 +18,180 +(7,213 +) +46,977 +25,393 +258.4 +% +352.0 +% +Income tax expense +14,720 +7,942 +9,281 +(6,778 +) +1,339 +(85.3 +)% +14.4 +% +Net income (loss) +50,437 +10,238 +(16,494 +) +40,199 +26,732 +392.6 +% +(162.1 +)% +Dividends on Series A convertible preferred stock +(108,224 +) +(12,000 +) +(12,000 +) +(96,224 +) +— +801.9 +% +— +% +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature +(11,429 +) +(3,532 +) +(3,244 +) +(7,897 +) +(288 +) +(223.6 +)% +(8.9 +)% +Net loss attributable to common stockholders +$ +(69,216 +) +$ +(5,294 +) +$ +(31,738 +) +$ +(63,922 +) +$ +26,444 +(1,207.4 +)% +83.3 +% +Net loss per common share: +Basic +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +$ +(0.94 +) +$ +0.36 +(1,342.9 +)% +83.7 +% +Diluted +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +$ +(0.94 +) +$ +0.36 +(1,342.9 +)% +83.7 +% +Gross margin (1) +51.5 +% +50.5 +% +48.3 +% +100bp +220bp +2.0 +% +4.6 +% +Operating margin (1) +5.8 +% +1.7 +% +(0.6 +)% +410bp +230bp +241.2 +% +383.3 +% +Selling, general and administrative expenses as a percentage of revenues +45.5 +% +48.3 +% +48.6 +% +280 +bp +30 +bp +5.8 +% +0.6 +% +Footwear unit sales +59,815 +57,850 +56,097 +1,965 +1,753 +3.4 +% +3.1 +% +Average footwear selling price - nominal basis +$ +17.71 +$ +17.31 +$ +18.21 +$ +0.40 +$ +(0.90 +) +2.3 +% +(4.9 +)% +(1) Changes for gross margin and operating margin are shown in basis points (“bp”). +Revenues. Revenues increase d $64.7 million , or 6.3% , during the year ended December 31, 2018 compared to the same period in 2017 . The increase in revenues was driven by 22.5% growth in our e-commerce channel and 7.8% growth in our wholesale +27 +Table of Contents +channel, which more than offset a reduction in our retail channel of 3.2% . The decrease in retail revenues was driven by our targeted reduction in the number of company-operated retail stores, partially offset by same store sales growth in our remaining company-operated retail stores. Higher unit sales volume, particularly in our clog and sandal silhouettes, increased revenues by $25.8 million , or 2.5% , and an increase of $27.7 million , or 2.7% , was attributable to higher average selling price (“ASP”) as a result of changes in product mix, reduced promotional activities, and price increases. Favorable exchange rate activity drove an increase of $11.2 million , or 1.1% . +Revenues decreased $12.8 million, or 1.2%, during the year ended December 31, 2017 compared to the same period in 2016. The revenues decreased primarily due to the sale of our Taiwan business in the fourth quarter of 2016, the sale of our Middle East business in the second quarter of 2017, reductions in the number of company-operated retail stores, and additional actions taken to optimize our wholesale, retail, and e-commerce channels. The revenue decline associated with store closures and transfers was approximately $39.1 million. Higher unit sales volume increased revenues by $39.6 million, or 3.8%, offset by lower ASP, which decreased revenues by approximately $57.2 million, or 5.5%, as our product and channel mix continued to change. Favorable exchange rate activity drove an increase of $4.8 million, or 0.5%. +Cost of sales. Cost of sales increased by $21.8 million , or 4.3% , during the year ended December 31, 2018 compared to the same period in 2017 . Higher unit sales volume resulted in an increase of $17.2 million , or 3.4% , partially offset by a decrease of $0.7 million , or 0.1% , due to a lower average cost per unit. Lower average cost per unit were primarily the result of product mix, reflecting our ongoing focus on core molded products, which cost less to produce, and continued supply chain cost reductions. The effect of foreign currency translation was an increase of $5.3 million , or 1.0% . +Cost of sales decreased by $29.8 million, or 5.6%, during the year ended December 31, 2017 compared to the same period in 2016. Lower average cost per unit was primarily the result of changes in our product mix, reflecting an ongoing focus on core molded products, which cost less to produce, and continued supply chain cost reductions, including a reallocation of third-party manufacturing production to lower-cost suppliers within the Asia Pacific region. Higher unit sales volume increased cost of sales by $16.8 million, or 3.1%, but was more than offset by a reduction of approximately $49.6 million, or 9.3%, due to lower average costs per unit, while foreign currency translation drove an increase of $3.0 million, or 0.6%. +Gross profit. Gross profit increased $42.9 million , or 8.3% , during the year ended December 31, 2018 compared to the same period in 2017 . Gross margin improved 100 basis points to 51.5% compared to the same period in 2017, driven by favorable product mix, reduced promotional activities, less excess and obsolete inventory, and the favorable impact of currency on inventory costs in our overseas markets. Higher unit sales volume drove an increase of approximately $17.6 million , or 3.4% , and an increase of $19.4 million , or 3.8% , resulted from a higher ASP. Foreign currency translation drove an increase of $5.9 million , or 1.1% , to gross profit. +During the year ended December 31, 2017, gross profit increased $17.0 million, or 3.4%, and gross margin increased 220 basis points to 50.5%, compared to the same period in 2016. The increase in gross profit was primarily due to our ongoing focus on higher margin core molded products, particularly clogs and sandals, and our reduction of low-margin European discount channel sales. A decrease of $0.3 million, or 0.1%, resulted from a decrease in our ASP which exceeded a decrease in average cost per unit, and an increase of approximately $15.7 million, or 3.1%, resulted from higher unit sales volume. Foreign currency translation drove an increase of $1.6 million, or 0.4%, to gross profit. +Selling, general and administrative expenses. SG&A increased $0.4 million , or 0.1% , during the year ended December 31, 2018 , compared to the same period in 2017 . As a percent of sales, SG&A improved by 280 basis points to 45.5% . The increase in our SG&A expenses was due to non-recurring expenses of $21.1 million related to the SG&A reduction plan, the closure of our manufacturing facilities, and also our planned corporate relocation, compared to non-recurring charges of $17.0 million in 2017, primarily related to our SG&A reduction plan and a discontinued project. SG&A also included higher marketing expense of $9.5 million and higher compensation expense of $3.7 million. The increase in compensation expense reflects higher variable compensation expense associated with higher revenues, partially offset by decreases associated with our SG&A reduction plan and supply chain initiatives. These increases were partially offset by decreases of $11.7 million in professional service fees, $8.5 million in facilities expense as a result of fewer company-owned retail stores, and a net increase in other expenses of $3.3 million. +SG&A decreased $8.6 million, or 1.7%, during the year ended December 31, 2017, compared to the same period in 2016. This includes the effects of $17.0 million in non-recurring charges and approximately $10 million of incremental costs related to variable compensation in 2017. The decrease was primarily due to the combined impacts of a decrease in facilities expenses of $13.1 million as a result of fewer company-operated retail stores and the sales of our Taiwan and Middle East businesses, and lower bad debts expense of $3.8 million. These savings were offset in part by higher marketing expenses of $3.1 million and higher net other expenses of $5.2 million, which were individually insignificant. +28 +Table of Contents +Asset impairment charges. During the years ended December 31, 2018 , 2017 , and 2016 , we incurred $0.9 million , $0.5 million , and $2.7 million , respectively, in retail asset impairment charges related to certain underperforming retail locations that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores’ assets over their remaining economic lives. In addition, during the year ended December 31, 2018 , we incurred additional charges of $1.3 million associated with the closure of company-operated manufacturing and distribution facilities. During the year ended December 31, 2017 , we incurred $4.8 million related to a discontinued project. In the year ended December 31, 2016 , we incurred $0.4 million of goodwill impairment. +Foreign currency gain (loss), net. Foreign currency gain (loss), net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on foreign currency derivative instruments. During the year ended December 31, 2018 , we recognized realized and unrealized net foreign currency gains of $1.3 million compared to net gains of $0.6 million during the year ended December 31, 2017 . During the year ended December 31, 2016 , we recognized realized and unrealized net foreign currency losses of $2.5 million . +Income tax expense . During the year ended December 31, 2018, we recognized income tax expense of $14.7 million on pre-tax book income of $65.2 million, representing an effective tax rate of 22.6%, compared to income tax expense of $7.9 million on pre-tax book loss of $18.2 million in 2017, which represented an effective tax rate of 43.7% and income tax expense of $9.3 million on pre-tax book loss of $7.2 million in 2016, which represented an effective tax rate of 128.7%. Our effective tax rate has varied dramatically in recent years due to differences in our profitability level and relative operating earnings across multiple jurisdictions, and is most notably impacted by the significant amount of operating losses that cannot be utilized for tax purposes. +Effective Income Tax Rate Reconciliation +The following provides additional information about the effective income tax rate reconciliation presented in Note 12 — Income Taxes in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K: +• +The change in 'Foreign differential' is principally driven by differences in pre-tax book income between the periods compared and the source of this income, which is subject to different jurisdictional tax rates. During 2018, the effect of rate differences resulted in an $7.6 million tax expense, or an 11.6% unfavorable rate impact, compared to a $11.8 million tax benefit, or a 64.7% favorable rate impact, in 2017. The change was driven primarily by tax expense relative to profitable jurisdictions, partially offset by operating losses in certain jurisdictions where the Company has determined that it is not more likely than not to realize the associated tax benefits. Further, we employ a tax planning strategy that directly impacts the total tax expense directly attributable to the level of foreign earnings in the specific jurisdictions. However, we note that the impact on the effective tax rate is different due to book earnings recorded in 2018 compared to 2017. +• +‘Enacted changes in tax law’ represents the transition tax and rate change impacts of the Tax Act. During the year ended December 31, 2018, we completed our accounting for the Tax Act. As such, we finalized our measurement period adjustments in relation to Staff Accounting Bulletin No. 118 (“SAB 118”) and recognized measurement period adjustments related to deemed repatriation tax and valuation allowance on certain foreign tax credits. We have not changed our indefinite reinvestment assertion. While we consider our accounting for the Tax Act to be complete, we continue to evaluate new guidance and legislation as it is issued. For 2018, we recorded a $0.5 million tax expense, or an 0.8% unfavorable rate impact, compared to a $17.6 million tax expense, or 97.1% unfavorable rate impact in 2017. +• +‘GILTI, net’ represents the net global intangible low-taxed income impacts of the Tax Act. We have elected to account for the impact of global intangible low tax income based on the period cost method. The reported amounts are the net GILTI inclusions before applicable foreign tax credits. For 2018, we recorded a $3.4 million tax expense, or 5.3% unfavorable rate impact. +• +‘Non-deductible/non-taxable items’ resulted in a $3.6 million tax expense in 2018, representing an unfavorable rate impact of 5.5%, compared to a $6.0 million tax expense in 2017, representing an unfavorable rate impact of 33.0%. The expense recognized in 2018 primarily relates to non-deductible executive and foreign share-based compensation, which we anticipate will recur in the foreseeable future. +• +We continue to evaluate the realizability of our deferred tax assets. The impact of ‘Changes in valuation allowance’ to the effective tax rate was a favorable $5.3 million, equating to an 8.1% favorable rate impact. The specific circumstances regarding management's assertion of the realizability of certain deferred tax assets is discussed as part of the disclosures in Note 12 — Income Taxes . We maintain total valuation allowances of approximately $113.2 million as of December 31, 2018, which may be reduced in the future depending upon the achieved or sustained profitability of certain entities. +29 +Table of Contents +• +'U.S. tax on foreign earnings' includes the impact of the tax expense accrued on undistributed foreign earnings net of the related foreign tax credits. There is no income tax provision impact associated with this activity in 2018. During 2017, the Tax Act significantly changed the U.S. taxation of foreign earnings. As a result, the impact of the transition tax as well as distributions, and reversal of the deferred tax liability associated with undistributed earnings and profits attributable to foreign subsidiaries, in 2017 the Company recorded a $32.4 million tax benefit, which equated to a 178.4% favorable impact on the rate reconciliation. +• +During both 2018 and 2017, we recorded tax expense for ‘Audits settlements’ during the year of $0.2 million and $0.4 million, respectively. The amount included in settlements during 2018 and 2017 is netted against total uncertain tax position releases during the same period relating to the same positions. Furthermore, in Note 12 — Income Taxes the ‘Uncertain tax benefits’ line item in 2018 includes net accruals related to current year positions recorded, and is consistent with amounts accrued during prior years. We have released a portion of historical uncertain tax benefits based on effective and actual settlements. There is not currently an expectation that uncertain tax positions will significantly impact our tax expense on an ongoing basis. +• +During both 2018 and 2017, we recorded state income tax expenses including the impact of certain minimal state income taxes. +In 2017, we began operating under a tax holiday in one of our foreign jurisdictions. This tax holiday is in effect through 2022, and may be extended if certain additional requirements are met. The tax holiday is conditioned upon our meeting certain employment and investment thresholds. The impact of the tax holiday in 2018 decreased tax expense in that jurisdiction by approximately $0.1 million and had no impact to our reported earnings per diluted share. +Revenues by Channel +Year Ended December 31, +% Change +Constant Currency % Change (1) +2018 +2017 +2016 +2018-2017 +2017-2016 +2018-2017 +2017-2016 +(in thousands) +Wholesale: +Americas +$ +216,797 +$ +211,342 +$ +202,211 +2.6 +% +4.5 +% +4.6 +% +3.8 +% +Asia Pacific (2) +203,110 +184,995 +200,060 +9.8 +% +(7.5 +)% +7.9 +% +(7.3 +)% +EMEA (2) +154,992 +138,909 +142,992 +11.6 +% +(2.9 +)% +6.0 +% +(4.8 +)% +Other businesses +3,145 +870 +745 +261.5 +% +16.8 +% +261.8 +% +13.4 +% +Total wholesale +578,044 +536,116 +546,008 +7.8 +% +(1.8 +)% +6.5 +% +(2.4 +)% +Retail: +Americas +204,806 +188,367 +191,855 +8.7 +% +(1.8 +)% +8.8 +% +(1.9 +)% +Asia Pacific (2) +87,264 +106,041 +117,778 +(17.7 +)% +(10.0 +)% +(19.4 +)% +(9.7 +)% +EMEA (2) +35,358 +43,825 +49,971 +(19.3 +)% +(12.3 +)% +(19.4 +)% +(16.0 +)% +Total retail +327,428 +338,233 +359,604 +(3.2 +)% +(5.9 +)% +(3.7 +)% +(6.4 +)% +E-commerce: +Americas +98,589 +80,437 +72,940 +22.6 +% +10.3 +% +22.6 +% +10.1 +% +Asia Pacific +54,224 +45,036 +37,446 +20.4 +% +20.3 +% +17.0 +% +22.9 +% +EMEA +29,920 +23,691 +20,275 +26.3 +% +16.8 +% +22.5 +% +13.7 +% +Total e-commerce +182,733 +149,164 +130,661 +22.5 +% +14.2 +% +20.9 +% +14.4 +% +Total revenues +$ +1,088,205 +$ +1,023,513 +$ +1,036,273 +6.3 +% +(1.2 +)% +5.2 +% +(1.7 +)% +(1) Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) In the third quarter of 2018, certain revenues previously reported within the ‘Asia Pacific’ segment were shifted to the ‘Europe, Middle East, and Africa’ (“ EMEA ”) segment. The previously reported amounts for wholesale and retail revenues in these regions for the years ended December 31, 2017 and 2016 as well as e-commerce revenues for the year ended December 31, 2016 have been revised to conform to the current year presentation. See ‘Impact on revenues of segment composition change’ table below for more information. +30 +Table of Contents +Impact on revenues of segment composition change: +Year Ended December 31, +2017 +2016 +Increase (Decrease) +(in thousands) +Wholesale: +Asia Pacific +$ +(30,767 +) +$ +(32,481 +) +EMEA +30,767 +32,481 +Retail: +Asia Pacific +(2,827 +) +(7,259 +) +EMEA +2,827 +7,259 +E-commerce: +Asia Pacific +— +(54 +) +EMEA +— +54 +Wholesale channel revenues. During the year ended December 31, 2018 , revenues from our wholesale channel increased $41.9 million , or 7.8% , compared to the year ended December 31, 2017 . An increase of $29.4 million , or 5.5% , resulted from higher unit sales volume due to increased customer demand from distributors and from e-tail customers as consumers shift towards online purchasing. A $5.5 million , or 1.0% , increase was due to higher ASP. The effect of foreign currency translation was an increase of $7.0 million , or 1.3% , to revenues. +During the year ended December 31, 2017, revenues from our wholesale channel decreased $9.9 million, or 1.8%, compared to the year ended December 31, 2016. A $35.1 million, or 6.4%, decrease was due to a lower ASP as we shifted to higher margin, lower-priced molded product. Higher unit sales volume increased revenues by approximately $21.9 million, or 4.0%, despite the impact of strategic reductions in sales via discount channels in our EMEA operating segment as well as the decline in our wholesale business in Japan while we strengthened our wholesale network. The effect of foreign currency translation was an increase of $3.3 million, or 0.6%, to revenues +Retail channel revenues. During the year ended December 31, 2018 , revenues from our retail channel decreased $10.8 million , or 3.2% , compared to the year ended December 31, 2017 . The decrease in retail channel revenues was due to targeted reductions in our company-operated retail store fleet, consistent with our store reduction plan, partially offset by ASP gains and favorable foreign currency impacts. As of December 31, 2018 , we operated 64 fewer stores compared to December 31, 2017 . Unit sales volume decreased revenues by $25.3 million , or 7.5% . Favorable product mix and improved quality of revenues, the results of less promotional discounting and improved inventory composition, resulted in a higher ASP impact of $12.8 million , or 3.8% . An increase of $1.7 million , or 0.5% , resulted from foreign currency translation. +During the year ended December 31, 2017, revenues from our retail channel decreased $21.4 million, or 5.9%, compared to the year ended December 31, 2016. Unit sales volume decreased revenues by approximately $12.8 million, or 3.6%, primarily due to a net decrease of 111 company-operated retail stores as we optimized our store fleet and shifted our store mix from full-price retail to outlet. ASP was lower by $10.3 million, or 2.9%, as we shifted to higher margin, lower-priced molded product. These declines were partially offset by an increase of $1.7 million, or 0.6%, from foreign currency translation. +E-commerce channel revenues. Revenues from our e-commerce channel, which includes our own e-commerce sites as well as our sales through third-party marketplaces, increased $33.6 million , or 22.5% , during the year ended December 31, 2018 compared to the year ended December 31, 2017 as this channel continued to grow in each region. Revenues increased by approximately $21.8 million , or 14.6% , due to higher unit sales volume, and higher ASP related to mix contributed an additional $9.4 million , or 6.3% . Favorable foreign currency translation resulted in an increase of $2.4 million , or 1.6% +During the year ended December 31, 2017, revenues from our e-commerce channel increased $18.5 million, or 14.2%, compared to the year ended December 31, 2016. We invested in marketing with an enhanced digital focus, and we continued to grow our e-commerce team and work toward global adoption of best practices. Revenues increased by approximately $30.6 million, or 23.4%, due to higher unit sales volume, partially offset by decreases of $11.8 million, or 9.0%, due to lower ASP and $0.3 million, or 0.2%, due to the unfavorable impact of foreign currency translation. +31 +Table of Contents +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2018 , 2017 , and 2016: +Year Ended December 31, +% Change +Constant Currency % Change (1) +2018 +2017 +2016 +2018-2017 +2017-2016 +2018-2017 +2017-2016 +(in thousands) +Revenues: +Americas +$ +520,192 +$ +480,146 +$ +467,006 +8.3 +% +2.8 +% +9.2 +% +2.5 +% +Asia Pacific (2) +344,598 +336,073 +355,284 +2.5 +% +(5.4 +)% +0.5 +% +(4.9 +)% +EMEA (2) +220,270 +206,424 +213,238 +6.7 +% +(3.2 +)% +2.5 +% +(5.7 +)% +Segment revenues +1,085,060 +1,022,643 +1,035,528 +6.1 +% +(1.2 +)% +5.0 +% +(1.7 +)% +Other businesses +3,145 +870 +745 +261.5 +% +16.8 +% +261.8 +% +13.4 +% +Total consolidated revenues +$ +1,088,205 +$ +1,023,513 +$ +1,036,273 +6.3 +% +(1.2 +)% +5.2 +% +(1.7 +)% +Income from operations: (3) +Americas +$ +138,940 +$ +96,740 +$ +72,689 +43.6 +% +33.1 +% +45.4 +% +33.4 +% +Asia Pacific +82,780 +72,950 +67,077 +13.5 +% +8.8 +% +11.1 +% +9.1 +% +EMEA +59,539 +37,185 +34,114 +60.1 +% +9.0 +% +52.6 +% +6.2 +% +Segment income from operations +281,259 +206,875 +173,880 +36.0 +% +19.0 +% +34.6 +% +23.2 +% +Reconciliation of segment income from operations to income (loss) before income taxes: +Other businesses (4) +(55,583 +) +(22,861 +) +(26,935 +) +143.1 +% +(15.1 +)% +Unallocated corporate and other (5) +(162,732 +) +(166,678 +) +(153,099 +) +(2.4 +)% +8.9 +% +Total consolidated income (loss) from operations +62,944 +17,336 +(6,154 +) +263.1 +% +(381.7 +)% +Foreign currency transaction gain (loss), net +1,318 +563 +(2,454 +) +134.1 +% +122.9 +% +Interest income +1,281 +870 +692 +47.2 +% +25.7 +% +Interest expense +(955 +) +(869 +) +(836 +) +9.9 +% +(3.9 +)% +Other income +569 +280 +1,539 +103.2 +% +(81.8 +)% +Income (loss) before income taxes +$ +65,157 +$ +18,180 +$ +(7,213 +) +258.4 +% +352.0 +% +(1) Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ segment were shifted to the ‘ EMEA ’ segment. The previously reported amounts for revenues and income from operations for the years ended December 31, 2017 and 2016 have also been revised to conform to the current period presentation. See ‘Impact of segment composition change’ table below for more information. +(3) In 2018, certain global marketing expenses previously reported within the operating segments were managed and reported within ‘Unallocated corporate and other’. The previously reported amounts for income from operations for the years ended December 31, 2017 and 2016 have been revised to conform to the current year presentation. See ‘Impact of global marketing expense realignment’ table below for more information. +(4) “Other businesses” increases are primarily due to costs incurred in conjunction with the closure of company-operated manufacturing and distribution facilities, which ceased operations in 2018, increased variable compensation associated with higher revenues, and other expenses as a result of outsourcing, and other supply chain cost changes. +(5) “Unallocated corporate and other” includes corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, and depreciation and amortization of corporate and other assets not allocated to operating segments. +32 +Table of Contents +Impact of segment composition change: +Year Ended December 31, +2017 +2016 +Increase (Decrease) +(in thousands) +Impact on revenues: +Asia Pacific +$ +(33,594 +) +$ +(39,794 +) +EMEA +33,594 +39,794 +Impact on income from operations: +Asia Pacific +(10,166 +) +(13,451 +) +EMEA +10,166 +13,451 +Impact of global marketing expense realignment: +Year Ended December 31, +2017 +2016 +Increase (Decrease) +(in thousands) +Impact on income from operations: +Americas +$ +9,860 +$ +13,845 +Asia Pacific +3,843 +1,621 +EMEA +1,283 +2,906 +Unallocated corporate and other +(14,986 +) +(18,372 +) +Americas Operating Segment +Revenues. During the year ended December 31, 2018 , revenues for our Americas segment increased $40.0 million , or 8.3% , compared to the year ended December 31, 2017 . The growth was led by a 22.6% increase in e-commerce revenues due to increased traffic and units per transaction. Retail revenues increased by 8.7% , despite operating 7 fewer retail stores compared to the same period last year, due to comparable sales growth of 14.0% . Higher unit sales volume resulted in an increase of approximately $22.0 million , or 4.6% , while higher ASP resulted in an increase of $22.3 million , or 4.6% . The effect of foreign currency translation was a decrease of $4.3 million , or 0.9% . +During the year ended December 31, 2017, revenues for our Americas segment increased $13.1 million, or 2.8%, compared to the year ended December 31, 2016. The increase was led by a 10.3% increase in e-commerce revenues, while a modest increase in wholesale revenues was partially offset by a decrease in retail revenues, reflecting 15 fewer company-operated retail stores compared to last year. Higher unit sales volume resulted in an increase of approximately $17.0 million, or 3.7%, while lower ASP resulted in a decrease of $5.5 million, or 1.2%, and foreign currency translation resulted in an increase of $1.6 million, or 0.3%. +Income from Operations. During the year ended December 31, 2018 , income from operations for our Americas segment was $138.9 million , an increase of $42.2 million , or 43.6% . Gross profit for the year ended December 31, 2018 increased $39.0 million , or 15.8% , and gross margin increased 360 basis points to 55.0% , compared to the year ended December 31, 2017 . The increase in gross profit is due to the net impact of an increase of $10.7 million , or 4.3% , due to higher unit sales volume, an increase of $30.7 million , or 12.4% , due to a decrease in our average cost per unit which exceeded a decrease in ASP, and a decrease of $2.4 million , or 0.9% , from foreign currency translation. +During the year ended December 31, 2018 , SG&A for our Americas segment decreased $2.9 million , or 1.9% , compared to the same period in 2017 . The decrease in SG&A was primarily due to decreases of $2.3 million in facilities expenses as a result of reductions in the number of company-operated retail stores and our SG&A reduction efforts and a net decrease of $0.6 million in services and other expenses. Impairment expense related to company-operated retail stores decreased by $0.3 million compared to 2017 . +During the year ended December 31, 2017, income from operations for our Americas segment was $96.7 million , an increase of $24.1 million, or 33.1%. Gross profit for the year ended December 31, 2017 increased $21.4 million, or 9.5%, and gross margin increased 310 basis points to 51.4%, compared to the year ended December 31, 2016. The increase in gross profit is due to the net impact of an increase of $10.3 million, or 4.6%, due to higher sales volumes, despite a net reduction of 15 company-operated retail stores, an increase of $10.9 million, or 4.8%, due to a decrease in our average cost per unit which exceeded a decrease in ASP, and an increase of $0.2 million, or 0.1%, from foreign currency translation. +33 +Table of Contents +During the year ended December 31, 2017, SG&A for our Americas segment decreased $1.4 million, or 0.9%, compared to the same period in 2016. The decrease in SG&A was primarily due to the net impact of a decrease of $3.1 million in facilities expenses as a result of reductions in the number of company-operated retail stores and our SG&A reduction efforts, offset by a net increase of $1.7 million in marketing and other expenses. Impairment expense related to company-operated retail stores decreased by $1.3 million compared to 2016. +Asia Pacific Operating Segment +Revenues. During the year ended December 31, 2018 , revenues for our Asia Pacific segment increased $8.5 million , or 2.5% , compared to the year ended December 31, 2017 . E-commerce revenues increased by 20.4% , with growth in every country in which we operate, and wholesale revenues increased by 9.8% . Retail revenues decreased by 17.7% as a result of 33 fewer company-operated retail stores compared to December 31, 2017. For all channels combined, there was an increase in unit sales volume of $0.5 million , or 0.1% , and an increase in ASP of $1.3 million , or 0.4% .The impact of foreign currency translation was an increase of $6.7 million , or 2.0% . +During the year ended December 31, 2017, revenues for our Asia Pacific segment decreased $19.2 million , or 5.4% , compared to the year ended December 31, 2016. Wholesale revenues were lower as we continued to pursue business model changes to drive higher quality revenues and improve profitability across the Asia Pacific region, including the sales of our Taiwan and Middle East businesses and the strengthening of our wholesale network in Japan. Retail revenues decreased as a result of a net reduction of 84 company-operated retail stores. E-commerce revenues increased by 20.3% , with particularly strong performance in China. An increase in unit sales volume of approximately $34.7 million, or 9.8%, was offset by a decrease in ASP of $52.2 million, or 14.7%, as we shifted to higher margin, lower-priced molded product. The impact of foreign currency translation was a decrease of $1.7 million, or 0.5%. +Income from Operations. During the year ended December 31, 2018 , income from operations for our Asia Pacific segment was $82.8 million , an increase of $9.8 million , or 13.5% . Gross profit for the year ended December 31, 2018 increased $2.0 million , or 1.0% , and gross margin decreased 80 basis points to 56.1% compared to the year ended December 31, 2017 as our channel mix continued to shift toward a more outlet-focused retail footprint. The decrease in Asia Pacific segment gross profit was due to the net impact of an increase in unit sales volumes of $6.0 million , or 3.1% , offset by a decrease in our ASP that exceeded the decline in our average cost per unit of $8.0 million , or 4.2% , and an increase of $4.0 million , or 2.1% , from foreign currency translation. +During the year ended December 31, 2018 , SG&A for our Asia Pacific segment decreased $8.5 million , or 7.2% , compared to the same period in 2017 . The decrease in SG&A was primarily due to decreases of $4.9 million in facilities expenses, a result of the reduction in the number of company-operated retail stores and our SG&A reduction efforts, and of $4.7 million in salaries and wages, partially offset by lower recoveries of bad debt of $1.6 million, and a net decrease of $0.5 million in services and other costs. Impairment expense related to company-operated retail stores increased by $0.7 million compared to 2017. +During the year ended December 31, 2017, income from operations for our Asia Pacific segment was $73.0 million , an increase of $5.9 million , or 8.8% . Gross profit for the year ended December 31, 2017 decreased $10.5 million, or 5.2%, and gross margin increased 10 basis points to 56.9% compared to the year ended December 31, 2016 as our channel mix shifted toward a more outlet-focused retail footprint. The decrease in the Asia Pacific segment gross profit was due to the net impact of an increase in unit sales volumes of $18.3 million, or 9.1%, offset by a decrease in our ASP that exceeded the decline in our average cost per unit of $27.9 million, or 13.8%, and a decrease of $1.0 million, or 0.5%, from foreign currency translation. +During the year ended December 31, 2017, SG&A for our Asia Pacific segment decreased $15.9 million, or 11.9%, compared to the same period in 2016. The decrease in SG&A was primarily due to the net impact of decreases of $2.2 million in salaries and wages and $7.5 million in facilities expense as a result of the reduction in the number of company-operated retail stores and our SG&A reduction efforts, including the sale of our Middle East business, decreased marketing expense of $3.3 million, lower bad debt expense of $0.9 million, and a decrease of $2.0 million in services and other costs. Impairment expense related to company-operated retail stores decreased by $0.5 million compared to 2016. +Europe, Middle East, and Africa Operating Segment +Revenues. During the year ended December 31, 2018 , revenues for our EMEA segment increased $13.8 million , or 6.7% , compared to the year ended December 31, 2017 . E-commerce revenue grew 26.3% , reflecting higher online traffic, and wholesale revenue grew 11.6% , more than offsetting a decline of 19.3% in retail results as we operated 24 fewer retail stores in the region compared to last year. Approximately $1.1 million , or 0.5% , of the increase was due to higher unit sales volumes, and a higher ASP drove an increase of $4.0 million , or 2.0% , while the impact of foreign currency translation was an increase of $8.7 million , or 4.2% . +34 +Table of Contents +During the year ended December 31, 2017, revenues for our EMEA segment decreased $6.8 million , or 3.2% , compared to the year ended December 31, 2016, as we continued to reduce discount channel sales and company-operated retail stores, while growing our e-commerce business. Approximately $13.6 million, or 6.4%, of the decrease was due to lower unit sales volumes, partially offset by an increase of $1.5 million, or 0.7%, from a higher ASP, and an increase of $5.3 million, or 2.5%, from foreign currency translation. +Income from Operations. During the year ended December 31, 2018 , income from operations for our EMEA segment was $59.5 million , an increase of $22.4 million , or 60.1% . Gross profit for the year ended December 31, 2018 increased $12.2 million , or 11.7% , and gross margin increased by 240 basis points to 52.7% compared to the year ended December 31, 2017 . The increase in our EMEA segment gross profit is due to an increase of $2.1 million , or 2.0% , due to higher unit sales volumes, an increase of $5.9 million , or 5.6% , due to an increase in ASP, and an increase of $4.2 million , or 4.1% , from foreign currency translation. +During the year ended December 31, 2018 , SG&A for our EMEA segment decreased $10.1 million , or 15.1% , compared to the same period in 2017 . The decrease in SG&A was primarily due to a decrease in facilities expense of $4.3 million as a result of the net reduction of 24 company-operated retail stores and SG&A reduction efforts, lower compensation expense of $3.3 million, and lower bad debt expense of $1.0 million , as well as a net decrease in services and other costs of $1.5 million. Impairment expense decreased by $0.1 million compared to 2017. +During the year ended December 31, 2017, income from operations for our EMEA segment was $37.2 million , an increase of $3.1 million , or 9.0% . Gross profit for the year ended December 31, 2017 decreased $1.7 million, or 1.6%, and gross margin increased by 80 basis points to 50.3% compared to the year ended December 31, 2016. The increase in the EMEA segment gross profit is due to the net impact of a decrease of $6.6 million, or 6.2%, due to lower unit sales volumes, offset by an increase of $2.1 million, or 2.0%, due to an increase in ASP, and an increase of $2.8 million, or 2.6%, from foreign currency translation. +During the year ended December 31, 2017, SG&A for our EMEA segment decreased $4.0 million, or 5.6%, compared to the same period in 2016. The decrease in SG&A was primarily due to a decrease in facilities expense of $3.8 million, a result of the net reduction of 24 company-operated retail stores and SG&A reduction efforts, and lower bad debt expense of $2.5 million, offset in part by an increase in services and other costs of $2.3 million, none of which were individually significant. Impairment expense decreased by $0.8 million compared to 2016. +Other Businesses, Unallocated Corporate +During the year ended December 31, 2018 , total net costs within ‘Other businesses’ and ‘Unallocated corporate’ increased by $28.8 million, or 16.0%, compared to the same period in 2017 . The increase was due to a $16.3 million increase in compensation costs, primarily related to higher variable compensation associated with higher revenues, $13.7 million in expenses related to our Mexico and Italy manufacturing and distribution facility closures, including the recognition of $4.4 million in non-cash cumulative foreign currency translation, an increase of $5.0 million in marketing expenses, primarily related to our endorsement and promotional activities, and $1.3 million related to our corporate headquarters relocation project, partially offset by a decrease of $10.7 million in professional services. Other costs, none of which were individually significant, increased by a net of $3.2 million. +During the year ended December 31, 2017, total net costs within ‘Other businesses’ and ‘Unallocated corporate’ increased by $9.5 million , or 5.3% , compared to the same period in 2016. The increase was due to an increase of $9.8 million in salaries and wages, primarily related to our variable compensation, an increase of $4.4 million in marketing expenses, primarily related to our endorsement and promotional activities, and increased impairments of $4.8 million, which were partially offset by a decrease of $3.8 million in travel and entertainment costs and a decrease of $7.7 million in supply chain costs. Services and other costs, none of which were individually significant, increased by $2.0 million. +35 +Table of Contents +Store Locations and Comparable Store Sales +The table below illustrates the overall change in the number of our company-operated retail locations by type of store and reportable operating segment: +December 31, 2016 +Opened +Closed/Transferred +December 31, 2017 +Opened +Closed/Transferred +December 31, 2018 +Type: +Outlet stores +232 +13 +30 +215 +3 +23 +195 +Retail stores +228 +6 +73 +161 +1 +42 +120 +Kiosk/store-in- store +98 +— +27 +71 +— +3 +68 +Total +558 +19 +130 +447 +4 +68 +383 +Operating segment: +Americas +190 +2 +17 +175 +1 +8 +168 +Asia Pacific (1) +258 +14 +86 +186 +3 +36 +153 +EMEA (1) +110 +3 +27 +86 +— +24 +62 +Total +558 +19 +130 +447 +4 +68 +383 +(1) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ operating segment were shifted to the ‘ EMEA ’ operating segment. The previously reported store counts as of December 31, 2017 and 2016 and activity for the year ended December 31, 2017 have also been revised to conform to the current period presentation. +Comparable retail store sales and direct-to-consumer comparable store sales by reportable operating segment are as follows: +Constant Currency (1) +Year Ended December 31, +2018 +2017 +2016 +Comparable retail store sales (2) +Americas +14.0 +% +1.3 +% +(2.3 +)% +Asia Pacific (3) +4.0 +% +(2.0 +)% +(6.1 +)% +EMEA (3) +10.1 +% +(1.4 +)% +1.1 +% +Global +10.8 +% +— +% +(3.0 +)% +Constant Currency (1) +Year Ended December 31, +2018 +2017 +2016 +Direct-to-consumer comparable store sales (includes retail and e-commerce) (2) +Americas +16.7 +% +3.9 +% +0.3 +% +Asia Pacific (3) +8.8 +% +6.5 +% +(0.2 +)% +EMEA (3) +15.6 +% +4.0 +% +(0.2 +)% +Global +14.3 +% +4.7 +% +0.1 +% +(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. Constant currency represents current period results that have been retranslated using exchange rates used in the prior comparative period. See the “Use of Non-GAAP Financial Measures” section for additional information. +(2) Comparable store status is determined on a monthly basis. Comparable store sales includes the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period. +(3) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ operating segment were shifted to the ‘ EMEA ’ operating segment. The previously reported comparable retail store sales and direct-to-consumer comparable store sales for the ‘ EMEA ’ and ‘Asia Pacific’ operating segments for the years ended December 31, 2017 and 2016 have also been revised to conform to the current period presentation. +36 +Table of Contents +Liquidity and Capital Resources +Our liquidity position as of December 31, 2018 was: +December 31, 2018 +(in thousands) +Cash and cash equivalents +$ +123,367 +Available borrowings +129,400 +As of December 31, 2018 , we had $123.4 million in cash and cash equivalents and up to $129.4 million in available borrowings under our revolving credit facilities. We believe that our cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Senior Revolving Credit Facility and other financing instruments will be sufficient to meet the ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, among other factors, could impact our business and liquidity. +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, cash flows from operating activities during our fourth quarter are typically lower than those in our first three quarters, as customer receivables and inventories rise in preparation for the Spring/Summer season. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +As a result of the Tax Act, most of the cash held outside of the U.S. could be repatriated to the U.S. without incurring additional U.S. federal income taxes. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. As of December 31, 2018, we held $94.7 million of our total $123.4 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $94.7 million, $1.2 million could potentially be restricted. If the remaining $93.5 million were to be immediately repatriated to the U.S., no additional U.S. federal income tax expense would be incurred. +Senior Revolving Credit Facility +In December 2011, the Company entered into a revolving credit facility (the “Facility”), pursuant to an Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. The Credit Agreement contains certain covenants that restrict certain actions by the Company, including (i) stock repurchases to an aggregate of $250.0 million per year, subject to certain restrictions; and (ii) capital expenditures and commitments to $70.0 million per year. The Credit Agreement also permits intercompany loans of up to $375.0 million and requires the Company to meet certain financial covenant ratios that become effective when average outstanding borrowings under the Credit Agreement, including letters of credit, exceed the lesser of $40.0 million or 40% of the total commitments during certain periods or if the outstanding borrowings exceed the borrowing base. If the financial covenant ratios are in effect, the Company must maintain a minimum fixed charge coverage ratio of 1.10 to 1.00, and a maximum leverage ratio of (i) 3.00 to 1.00 at December 31, 2018 and March 31, 2019, (ii) 2.75 to 1.00 at June 30, 2019, and (iii) 2.50 to 1.00 at September 30, 2019 and the last day of each quarter thereafter. As of December 31, 2018 , the Company was in compliance with all financial covenants under the Credit Agreement. +At December 31, 2018 , the Company had $120.0 million in outstanding borrowings, maturing in February 2021 , and $ 0.6 million in outstanding letters of credit under the Facility, resulting in $ 129.4 million of available credit for future financing needs. +37 +Table of Contents +On February 6, 2019, the Company entered into the Eighteenth Amendment to the Amended and Restated Credit Agreement which increased the total commitments under the Credit Agreement to $300.0 million from $250.0 million. +The Company also has revolving credit facilities in Asia, from which the Company had no borrowings during the years ended December 31, 2018 and 2017 or outstanding at December 31, 2018 or 2017 . +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, +2018-2017 +2018 +2017 +(in thousands) +Cash provided by operating activities +$ +114,162 +$ +98,264 +$ +15,898 +Cash used in investing activities +(10,110 +) +(11,538 +) +1,428 +Cash used in financing activities +(148,802 +) +(65,370 +) +(83,432 +) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +(4,775 +) +3,053 +(7,828 +) +Net change in cash, cash equivalents, and restricted cash +$ +(49,525 +) +$ +24,409 +$ +(73,934 +) +Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted +for non-cash items and changes in working capital. Cash provided by operating activities increased $15.9 million for the year ended December 31, 2018 compared to the year ended December 31, 2017 . The increase in cash provided by operating activities resulted from the combined impacts of an increase in net income adjusted for non-cash items, which resulted in a favorable change of $48.8 million , and an unfavorable change in our operating assets and liabilities of $32.9 million . The favorable change in net income adjusted for non-cash items was driven primarily by higher net income of $40.2 million , as well as higher losses on disposals of property and equipment, higher deferred tax expenses, and higher non-cash share-based compensation. This was offset in part by lower depreciation and amortization expenses, lower asset impairments, and a gain in unrealized foreign currency compared to a loss in 2017. Higher accounts receivable, reflective of higher revenues, drove a use of cash $25.2 million higher compared to 2017. Changes in inventories were a $25.3 million use of cash compared to the same period in 2017, changes in prepaid expenses and other assets were a $9.2 million use of cash compared to 2017, and changes in income taxes contributed an additional use of cash of $1.4 million . Increased accounts payable, accrued expenses, and other liabilities at December 31, 2018 compared to December 31, 2017 , were a source of $28.2 million in cash as we improved our cash management. +Investing Activities. The $1.4 million decrease in cash used in investing activities for the year ended December 31, 2018 compared to the year ended December 31, 2017 is primarily due to lower net capital asset expenditures, as we are opening fewer new stores and remodeling fewer stores each year as our retail fleet is reduced. Capital spend during the twelve months ended December 31, 2018 related primarily to information technology investments and improvements to distribution center and retail store assets. +Financing Activities. The $83.4 million increase in cash used in financing activities for the year ended December 31, 2018 compared to the year ended December 31, 2017 resulted from: (i) the repurchase of outstanding Series A Preferred for $183.7 million , (ii) cash dividends paid of $9.0 million and payments to induce conversion of the Series A Preferred of $12.0 million , compared to $12.0 million of dividends paid in 2017; and (iii) repurchases of our common stock for $63.1 million compared to $50.0 million during 2017. These increases in cash used were partially offset by higher borrowings of $114.5 million , used to partially fund the repurchase of Series A Preferred and payments to induce conversion, and lower repayments on borrowings of $7.9 million . +Stock Repurchase Plan Authorizations +On February 20, 2018, the Board of Directors approved an increase in our repurchase authorization, allowing for repurchase of up to $500.0 million of our common stock. The number, price, and timing of the repurchases are at the Company’s sole discretion, subject to certain restrictions on repurchases under the Company’s Facility, and may be made depending on market conditions, liquidity needs, or other factors. The Company’s Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate the Company to acquire any amount of its common stock. +38 +Table of Contents +The Company repurchased 3.6 million shares of its common stock at a cost of $63.1 million , including commissions, and 5.7 million shares of its common stock at a cost of $50.0 million , including commissions, during the years ended December 31, 2018 and 2017 , respectively. +Series A Convertible Preferred Stock Repurchase +On December 5, 2018, pursuant to the terms of a Share Repurchase Agreement among the Company and holders of the Series A Preferred, (i) the Company repurchased from the holders of the Series A Preferred, 100,000 shares of Series A Preferred with a carrying value of $100.0 million for an aggregate cash payment of $183.7 million, (ii) the holders of the Series A Preferred converted the remaining 100,000 shares of Series A Preferred that they owned into 6,896,548 shares of common stock, and (iii) the Company paid to the holders of the Series A Preferred an aggregate cash payment of $15.0 million to induce conversion, of which $12.0 million was paid at closing, with the remaining $3.0 million paid in January 2019. +Off-Balance Sheet Arrangements +We had no material off-balance sheet arrangements as of December 31, 2018 , other than certain operating lease and purchase commitments, which are described in Note 14 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Contractual Obligations +The following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2018 : +Total +Less than +1 Year +1 - 3 Years +3 - 5 Years +More than +5 Years +(in thousands) +Operating lease obligations (1) +$ +198,672 +$ +42,455 +$ +66,013 +$ +36,055 +$ +54,149 +Inventory purchase obligations with third-party manufacturers (2) +165,269 +165,269 +— +— +— +Other contracts (3) +44,405 +34,909 +8,094 +1,402 +— +Minimum licensing royalties (4) +2,818 +2,014 +804 +— +— +Debt obligations (5) +120,000 +— +120,000 +— +— +Total +$ +531,164 +$ +244,647 +$ +194,911 +$ +37,457 +$ +54,149 +(1) Our operating lease obligations consist of leases for real estate, which includes retail, warehouse, distribution center, and office spaces, expiring at various dates through 2033. This balance represents the minimum cash commitment under contract to various third parties for operating lease obligations, including $25.4 million related to the new distribution center in Dayton, Ohio. Operating lease obligations include the effect of rent escalation clauses and deferred rent, but does not include certain contingent rent clauses that may require additional rental amounts based on sales volume, inventories, etc. as these amounts are not determinable for future periods. +(2) Our inventory purchase obligations with third-party manufacturers consist of open purchase orders for footwear products and include an immaterial amount of purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third-party manufacturers are expected to be paid within one year. +(3) Other contracts include $23.1 million of future commitments related to the new distribution center in Dayton, Ohio, the final inducement payment of $3.0 million, paid in January 2019, related to the conversion of Series A Preferred, and various agreements with third-party providers, primarily for information technology and financial services. +(4) Our minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our footwear and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for future periods. +(5) Our debt obligations consist of long-term borrowings on our Facility, maturing in February 2021 . +In January 2019, the Company entered into a lease for its new corporate headquarters and regional office in Broomfield, Colorado. The contractual commitment related to this lease, with payments beginning in March 2020 and continuing through August 2030, is approximately $20.4 million. +Excluded from the table above is a $3.7 million liability for unrecognized tax benefits as of December 31, 2018 , as we cannot make a reliable estimate of the period in which the liability will be settled, if ever. +39 +Table of Contents +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and non-GAAP financial measures, is based on the consolidated financial statements which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Reserves for Uncollectible Accounts Receivable +We make ongoing estimates related to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events, and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge, respectively, to ‘Selling, general and administrative expenses’ in our consolidated statement of operations in the period in which we made such a determination. See Item 15 — Schedule II to the accompanying consolidated financial statements for an analysis of the activity in our allowance for doubtful accounts. +Sales Returns, Allowances and Discounts +A significant area of judgment affecting reported revenues and net income involves estimating reserves for sales returns, allowances, and discounts, which represent the portion of revenues not expected to be realized. Wholesale revenues are reduced by estimates of returns, allowance, discounts, and contractual discounts to major customers. We also may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments, and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. We also record reductions to revenues for estimated customer credits as a result of price markdowns in certain markets. Revenues in our retail and e-commerce channels are also reduced by an estimate of returns. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns, allowances and discounts may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances and discounts have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns, allowances and discounts as of December 31, 2018 would have decreased our 2018 revenues by approximately $5.5 million. See Item 15 — Schedule II to the accompanying consolidated financial statements for an analysis of the activity in our sales returns, allowances and discounts. +Impairment of Other Long-Lived Assets +Property and equipment along with other long-lived assets are evaluated for impairment periodically whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. Testing of long-lived assets for impairment is at the level of an asset group, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. In +40 +Table of Contents +evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +During 2018 , 2017 , and 2016 , we recorded non-cash impairment of $2.2 million , $5.3 million , and $3.1 million , respectively, to reduce the net carrying value of certain long-lived assets to their estimated fair values, including a $1.3 million to reduce the carrying values of certain supply chain assets related to the closure of our Mexico and Italy manufacturing and distribution facilities, +$4.8 million write-off for a discontinued project in 2017, $0.4 million related to goodwill in 2016, and $0.9 million , $0.5 million , and $2.7 million , respectively, related to underperforming company-operated retail stores. See Note 3 — Property and Equipment, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +Contingencies and Legal Proceedings +We are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. In addition, if it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. Management considers many factors in making these assessments. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 14 — Commitments and Contingencies and Note 16 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional information regarding our contingencies and legal proceedings. +Income Taxes +As a result of the Tax Act, we recorded provisional estimates in accordance with SAB 118, during the year ended December 31, 2017 in relation to the revaluation of our net deferred tax assets at the lower U.S. corporate income tax rate and the additional tax expense associated with the deemed repatriation tax. During the year ended December 31, 2018, we recorded measurement period adjustments related to the provisional estimates. We have not changed our indefinite reinvestment assertion, and we have elected to account for the impact of global intangible low tax income based on the period cost method. While we consider our accounting for the Tax Act to be complete, we continue to evaluate new guidance and legislation as it is issued. +We account for income taxes using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense’ line in the accompanying consolidated statements of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +41 +Table of Contents +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-U.S. subsidiaries as of December 31, 2018 which are considered to be indefinitely reinvested outside of the U.S. +See Note 12 — Income Taxes in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements, and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +42 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Facility and certain financial instruments. +Borrowings under our Facility bear interest at a variable rate. For domestic rate loans, including swing loans, the interest rate is equal to a daily base rate plus a margin of 0.75%. For domestic London Interbank Borrowing Rate (“LIBOR”) rate loans, the interest rate is equal to a LIBOR rate plus a margin of 1.75% as of December 31, 2018 . +Borrowings under our Facility are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. As of December 31, 2018 , we had $120.0 million in outstanding borrowings and $ 0.6 million in outstanding letters of credit under our Facility. As of December 31, 2017 , there were no borrowings outstanding under our Facility. If our $120.0 million borrowings had been outstanding for the full year ended December 31, 2018, a hypothetical increase of 1% in the interest rate on these borrowings would have increased interest expense by $1.2 million. +Foreign Currency Exchange Risk +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar (“USD”). We are exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiary’s functional currency. Likewise, our U.S. companies are also exposed to the risk of gains and losses and the resulting changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. +We have experienced and will continue to experience changes in foreign currency rates, impacting both results of operations and the value of assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur. As of December 31, 2018 , the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $194.6 million . The net fair value of these contracts at December 31, 2018 was a liability of $1.3 million . +Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates used to translate the operating results of our international subsidiaries. For example, in our EMEA operating segment, where the functional currencies are primarily the Euro and the Russian Ruble, when the USD strengthens relative to the Euro, our reported USD results are lower than if there had been no change in the exchange rate, because more Euros are required to generate the same USD translated amount. Conversely, when the USD weakens relative to the Euro, the reported USD results of our EMEA operating segment are higher compared to a period with a stronger USD relative to the Euro. Similarly, the reported USD results of our Asia Pacific operating segment, where the functional currencies are primarily the Japanese Yen, Chinese Yuan, and Korean Won, are comparatively lower or higher when the USD strengthens or weakens, respectively, relative to these currencies. +An increase of 1% of the value of the USD relative to foreign currencies would have decreased our income before taxes during the year ended December 31, 2018 by approximately $0.9 million . The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statement of operations for the years ended December 31, 2018 , 2017 , and 2016 . +43 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2018 , to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting (“ICFR”) as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2018 , based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2018 . +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2018 , as stated in the report which appears herein. +Changes in Internal Control Over Financial Reporting +In the three months ended December 31, 2018 , in order to facilitate our adoption of the new lease accounting standard on January 1, 2019, we implemented internal controls to help ensure we adequately evaluated our lease arrangements and assessed the impact to our financial statements. We are in the process of finalizing the implementation of new software to address the new lease guidance requirements. We expect to continue to implement additional internal controls related to the adoption of this standard in the first quarter of 2019. There have been no other changes during the three months ended December 31, 2018 to our ICFR, as defined in Exchange Act Rule 13a-15(f), that materially affected or are reasonably likely to materially affect our ICFR. +44 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2018, of the Company and our report dated February 28, 2019, expressed an unqualified opinion on those consolidated financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 28, 2019 +45 +Table of Contents +ITEM 9B. Other Information +None. +46 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2019 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission (“SEC”) within 120 days after December 31, 2018 . +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our code of ethics is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, that code for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our code of ethics as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2019 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2018 . +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2019 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2018 , with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 2.7 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2018 . +Plan Category +Number of +Securities to be Issued +on Exercise of +Outstanding +Options and Rights (2) +Weighted Average +Exercise Price of +Outstanding +Options (3) +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders (1) +2,746,793 +$ +11.05 +2,448,728 +Equity compensation plans not approved by stockholders +— +— +— +Total +2,746,793 +$ +11.05 +2,448,728 +(1) On June 8, 2015, the Company’s stockholders approved the Crocs, Inc. 2015 Equity Incentive Plan (the “Plan”). The number of shares available for issuance under the Plan (subject to changes in capitalization) consist of (i) 7.0 million newly available shares; (ii) 1.2 million shares available for issuance under the 2007 Plan as of June 8, 2015; and (iii) 2007 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 8, 2015. The Plan provides for the grant of incentive and non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, and other share-based awards. The Plan became effective immediately upon stockholder approval. +(2) The number of shares outstanding includes restricted stock awards and restricted stock units that were outstanding on December 31, 2018 and assumes target performance for performance-based equity awards. +(3) The weighted average exercise price of outstanding options pertains to 0.4 million shares issuable on the exercise of outstanding options and rights. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2019 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2018 . +47 +Table of Contents +ITEM 14. Principal Accounting Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2019 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2018 . +48 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedules +The following consolidated financial statement schedule of Crocs Inc. and its subsidiaries is filed as a part of this report: +• +Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +49 +Table of Contents +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.1 +* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.’s Annual Report on Form 10-K, filed on March 17, 2009). +10.2 +* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the “2007 Plan”) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.3 +* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.4 +* +Form of Non-Statutory Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.5 +* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.6 +* +Form of Restricted Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.7 +* +Crocs, Inc. 2008 Cash Incentive Plan (As Amended and Restated) (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 7, 2017). +10.8 +* +Crocs, Inc. 2015 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +10.9 +* +Andrew Rees Performance-Vested Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 13, 2018). +10.10 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders (the “Amended and Restated Credit Agreement”) (incorporated herein by reference to Crocs, Inc.’s Current Report on Form 8-K, filed on December 19, 2011). +10.11 +First Amendment to the Amended and Restated Credit Agreement, dated December 10, 2012, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Crocs, Inc.’s Current Report on Form 8-K, filed on December 11, 2012). +50 +Table of Contents +Exhibit +Number +Description +10.12 +Second Amendment to Amended and Restated Credit Agreement, dated June 12, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on July 30, 2013). +10.13 +Third Amendment to Amended and Restated Credit Agreement, dated December 27, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 30, 2013). +10.14 +Fourth Amendment to Amended and Restated Credit Agreement, dated March 27, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on May 1, 2014). +10.15 +Fifth Amendment to Amended and Restated Credit Agreement, dated September 26, 2014, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on October 29, 2014). +10.16 +Sixth Amendment to Amended and Restated Credit Agreement, dated April 2, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2015). +10.17 +Seventh Amendment to Amended and Restated Credit Agreement, dated April 21, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2015). +10.18 +Eighth Amendment to Amended and Restated Credit Agreement, dated September 1, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.19 +Ninth Amendment to Amended and Restated Credit Agreement, dated November 3, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 9, 2015). +10.20 +Tenth Amendment to Amended and Restated Credit Agreement, dated December 24, 2015, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.29 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 29, 2016). +10.21 +Eleventh Amendment to Amended and Restated Credit Agreement, dated February 18, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., and PNC Bank, National Association, as a lender and administrative agent. (incorporated herein by reference to Exhibit 10.30 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 29, 2016). +10.22 +Twelfth Amendment to Amended and Restated Credit Agreement, dated June 13, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2016). +10.23 +Thirteenth Amendment to Amended and Restated Credit Agreement, dated November 22, 2016, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.32 to Crocs, Inc.’s Annual Report on Form 10-K, filed on March 1, 2017). +51 +Table of Contents +Exhibit +Number +Description +10.24 +Fourteenth Amendment to Amended and Restated Credit Agreement, dated October 13, 2017, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.23 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 28, 2018). +10.25 +Fifteenth Amendment to Amended and Restated Credit Agreement, dated February 22, 2018, among Crocs, Inc., Crocs Retail, LLC, Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.24 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 28, 2018). +10.26 +Sixteenth Amendment to Amended and Restated Credit Agreement, dated November 5, 2018, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 8, 2018). +10.27 +Seventeenth Amendment to Amended and Restated Credit Agreement, dated December 2, 2018, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 3, 2018). +10.28 +Eighteenth Amendment to Amended and Restated Credit Agreement, dated February 6, 2019, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on February 12, 2019). +10.29 +* +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on October 4, 2018). +10.30 +Investment Agreement, dated December 28, 2013, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 30, 2013). +10.31 +First Amendment to Investment Agreement, dated January 27, 2014, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +10.32 +Second Amendment to Investment Agreement, dated June 6, 2017, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 7, 2017). +10.33 +Registration Rights Agreement, dated January 27, 2014 (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +10.34 +* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.35 +* +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +10.36 +* +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.37 +* +Employment Offer Letter, dated December 15, 2014, between Crocs, Inc. and Gregg Ribatt (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 15, 2014). +10.38 +* +Consulting Agreement, dated February 27, 2017, between Crocs, Inc. and Gregg Ribatt (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +52 +Table of Contents +Exhibit +Number +Description +10.39 +* +Employment Offer Letter, dated November 4, 2015, between Crocs, Inc. and Carrie Teffner (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on November 5, 2015). +10.40 +* +Employment Offer Letter, dated August 1, 2018, between Crocs, Inc. and Anne Mehlman (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2018). +10.41 +Share Repurchase Agreement, dated December 2, 2018, by and among Crocs, Inc., Blackstone Capital Partners VI L.P. and Blackstone Family Investment Partnership VI-ESC L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 3, 2018). +21 +† +Subsidiaries of the registrant. +23.1 +† +Consent of Deloitte & Touche LLP. +31.1 +† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 +† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 +† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS +† +XBRL Instance Document +101.SCH +† +XBRL Taxonomy Extension Schema Document +101.CAL +† +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF +† +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB +† +XBRL Taxonomy Extension Label Linkbase Document +101.PRE +† +XBRL Taxonomy Extension Presentation Linkbase Document +* Compensatory plan or arrangement. +† Filed herewith. +53 +Table of Contents +Item 16. Form 10–K Summary. +None. +54 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 28, 2019 . +CROCS, INC. +a Delaware Corporation +By: +/s/ ANDREW REES +Name: +Andrew Rees +Title: +President and Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature +Title +Date +/s/ ANDREW REES +President, Chief Executive Officer, and Director (Principal Executive Officer) +February 28, 2019 +Andrew Rees +/s/ ANNE MEHLMAN +Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) +February 28, 2019 +Anne Mehlman +/s/ THOMAS J. SMACH +Chairman of the Board +February 28, 2019 +Thomas J. Smach +/s/ IAN M. BICKLEY +Director +February 28, 2019 +Ian M. Bickley +/s/ RONALD L. FRASCH +Director +February 28, 2019 +Ronald L. Frasch +/s/ WILLIAM GRAY +Director +February 28, 2019 +William Gray +/s/ PRAKASH A. MELWANI +Director +February 28, 2019 +Prakash A. Melwani +/s/ DOUGLAS J. TREFF +Director +February 28, 2019 +Douglas J. Treff +/s/ DOREEN A. WRIGHT +Director +February 28, 2019 +Doreen A. Wright +55 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F- 2 +Consolidated Statements of Operations for the Years Ended December 31, 2018, 2017, and 2016 +F- 3 +Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2018, 2017, and 2016 +F- 4 +Consolidated Balance Sheets as of December 31, 2018 and 2017 +F- 5 +Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2018, 2017, and 2016 +F- 6 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017, and 2016 +F- 7 +Notes to Consolidated Financial Statements +F- 8 +Schedule II: Valuation and Qualifying Accounts +F- 38 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income (loss), stockholders' equity, and cash flows, for each of the three years in the period ended December 31, 2018, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2019, expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 28, 2019 +We have served as the Company's auditor since 2005. +F- 2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Year Ended December 31, +2018 +2017 +2016 +Revenues +$ +1,088,205 +$ +1,023,513 +$ +1,036,273 +Cost of sales +528,051 +506,292 +536,109 +Gross profit +560,154 +517,221 +500,164 +Selling, general and administrative expenses +495,028 +494,601 +503,174 +Asset impairments +2,182 +5,284 +3,144 +Income (loss) from operations +62,944 +17,336 +(6,154 +) +Foreign currency gains (losses), net +1,318 +563 +(2,454 +) +Interest income +1,281 +870 +692 +Interest expense +(955 +) +(869 +) +(836 +) +Other income, net +569 +280 +1,539 +Income (loss) before income taxes +65,157 +18,180 +(7,213 +) +Income tax expense +14,720 +7,942 +9,281 +Net income (loss) +50,437 +10,238 +(16,494 +) +Dividends on Series A convertible preferred stock (1) +(108,224 +) +(12,000 +) +(12,000 +) +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature (1) +(11,429 +) +(3,532 +) +(3,244 +) +Net loss attributable to common stockholders +$ +(69,216 +) +$ +(5,294 +) +$ +(31,738 +) +Net loss per common share: +Basic +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +Diluted +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +Weighted average common shares outstanding: +Basic +68,421 +72,255 +73,371 +Diluted +68,421 +72,255 +73,371 +(1) On December 5, 2018, all issued and outstanding shares of Series A Convertible Preferred Stock were repurchased in exchange for cash or converted to common stock. As a result, amounts reported for the year ended December 31, 2018, include amounts resulting from the repurchase and conversion, in addition to dividends, payments to induce conversion, and accretion of dividend equivalents prior to December 5, 2018. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies , for additional information. +The accompanying notes are an integral part of these consolidated financial statements. +F- 3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) +(in thousands) +Year Ended December 31, +2018 +2017 +2016 +Net income (loss) +$ +50,437 +$ +10,238 +$ +(16,494 +) +Other comprehensive income (loss): +Foreign currency gains (losses), net +(6,846 +) +12,202 +(4,683 +) +Reclassification of foreign currency translation loss to income (1) +(4,412 +) +— +— +Total comprehensive income (loss) +$ +39,179 +$ +22,440 +$ +(21,177 +) +(1) Reclassification of cumulative foreign currency translation adjustment upon closure of manufacturing operations, presented within ‘Selling, general and administrative expenses’ on the consolidated statement of operations. +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2018 +2017 +ASSETS +Current assets: +Cash and cash equivalents +$ +123,367 +$ +172,128 +Accounts receivable, net of allowances of $20,477 and $31,389, respectively +97,627 +83,518 +Inventories +124,491 +130,347 +Income taxes receivable +3,041 +3,652 +Other receivables +7,703 +10,664 +Restricted cash - current +1,946 +2,144 +Prepaid expenses and other assets +22,123 +22,596 +Total current assets +380,298 +425,049 +Property and equipment, net +22,211 +35,032 +Intangible assets, net +45,690 +56,427 +Goodwill +1,614 +1,688 +Deferred tax assets, net +8,663 +10,174 +Restricted cash +2,217 +2,783 +Other assets +8,208 +12,542 +Total assets +$ +468,901 +$ +543,695 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +77,231 +$ +66,381 +Accrued expenses and other liabilities +102,171 +84,460 +Income taxes payable +5,089 +5,515 +Current portion of borrowings +— +662 +Total current liabilities +184,491 +157,018 +Long-term income taxes payable +4,656 +6,081 +Long-term borrowings +120,000 +— +Other liabilities +9,446 +12,298 +Total liabilities +318,593 +175,397 +Commitments and contingencies: +Series A convertible preferred stock, 0.0 million and 0.2 million shares outstanding, liquidation preference $0 million and $203 million, respectively +— +182,433 +Stockholders’ equity: +Preferred stock, par value $0.001 per share, none outstanding +— +— +Common stock, par value $0.001 per share, 103.0 million and 94.8 million issued, 73.3 million and 68.8 million shares outstanding, respectively +103 +95 +Treasury stock, at cost, 29.7 million and 26.0 million shares, respectively +(397,491 +) +(334,312 +) +Additional paid-in capital +481,133 +373,045 +Retained earnings +121,215 +190,431 +Accumulated other comprehensive loss +(54,652 +) +(43,394 +) +Total stockholders’ equity +150,308 +185,865 +Total liabilities and stockholders’ equity +$ +468,901 +$ +543,695 +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock +Treasury Stock +Additional +Paid-in +Capital +Retained +Earnings +Accumulated +Other +Comprehensive +Loss +Total +Stock-holders' +Equity +Shares +Amount +Shares +Amount +Balance at December 31, 2015 +72,851 +$ +94 +20,250 +$ +(283,913 +) +$ +353,241 +$ +227,463 +$ +(50,913 +) +$ +245,972 +Share-based compensation +— +— +— +— +10,736 +— +— +10,736 +Exercises of stock options and issuance of restricted stock awards +749 +— +37 +(324 +) +420 +— +— +96 +Series A preferred dividends +— +— +— +— +— +(12,000 +) +— +(12,000 +) +Series A preferred accretion +— +— +— +— +— +(3,244 +) +— +(3,244 +) +Net loss +— +— +— +— +— +(16,494 +) +— +(16,494 +) +Other comprehensive loss +— +— +— +— +— +— +(4,683 +) +(4,683 +) +Balance at December 31, 2016 +73,600 +$ +94 +20,287 +$ +(284,237 +) +$ +364,397 +$ +195,725 +$ +(55,596 +) +$ +220,383 +Share-based compensation +— +— +— +— +11,619 +— +— +11,619 +Exercises of stock options and issuance of restricted stock awards +850 +1 +41 +(75 +) +(2,971 +) +— +— +(3,045 +) +Repurchases of common stock +(5,659 +) +— +5,659 +(50,000 +) +— +— +— +(50,000 +) +Series A preferred dividends +— +— +— +— +— +(12,000 +) +— +(12,000 +) +Series A preferred accretion +— +— +— +— +— +(3,532 +) +— +(3,532 +) +Net income +— +— +— +— +— +10,238 +— +10,238 +Other comprehensive income +— +— +— +— +— +— +12,202 +12,202 +Balance at December 31, 2017 +68,791 +$ +95 +25,987 +$ +(334,312 +) +$ +373,045 +$ +190,431 +$ +(43,394 +) +$ +185,865 +Share-based compensation +— +— +— +— +13,732 +— +— +13,732 +Exercises of stock options and issuance of restricted stock awards +1,238 +1 +49 +(48 +) +(725 +) +— +— +(772 +) +Repurchases of common stock +(3,620 +) +— +3,620 +(63,131 +) +— +— +— +(63,131 +) +Series A preferred repurchase (1) +— +— +— +(84,224 +) +(84,224 +) +Series A preferred conversion (2) +6,897 +7 +— +— +99,993 +— +— +100,000 +Series A preferred dividends (3) +— +— +— +— +— +(24,000 +) +— +(24,000 +) +Series A preferred accretion, net (4) +— +— +— +— +(6,138 +) +(11,429 +) +— +(17,567 +) +Net income +— +— +— +— +— +50,437 +— +50,437 +Other comprehensive loss +— +— +— +— +— +— +(11,258 +) +(11,258 +) +Other +— +— +— +— +1,226 +— +— +1,226 +Balance at December 31, 2018 +73,306 +$ +103 +29,656 +$ +(397,491 +) +$ +481,133 +$ +121,215 +$ +(54,652 +) +$ +150,308 +(1) Repurchase premium is the difference between cash paid and the carrying value of 100,000 shares of Series A Convertible Preferred Stock repurchased, including other costs associated with the transaction. +(2) Represents the issuance of common stock upon conversion of 100,000 shares of Series A Convertible Preferred Stock. +(3) Represents Series A Convertible Preferred Stock cash dividends declared and paid of $9.0 million , and $15.0 million of payments paid and payable to induce conversion. +(4) Represents total accretion of $17.6 million , net of $6.1 million acquired value of beneficial conversion feature attributable to repurchased Series A Convertible Preferred Stock. +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2018 +2017 +2016 +Cash flows from operating activities: +Net income (loss) +$ +50,437 +$ +10,238 +$ +(16,494 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depreciation and amortization +29,250 +33,130 +34,043 +Unrealized foreign currency (gain) loss, net +(1,455 +) +1,025 +(9,027 +) +(Gain) loss on disposals of assets +5,019 +(842 +) +547 +Share-based compensation +13,105 +9,773 +10,736 +Asset impairments +2,182 +5,284 +3,144 +Provision (recovery) for doubtful accounts, net +711 +(589 +) +3,230 +Deferred taxes +959 +(3,093 +) +(388 +) +Other non-cash items +1,994 +(1,564 +) +(44 +) +Changes in operating assets and liabilities: +Accounts receivable, net of allowances +(24,623 +) +620 +2,408 +Inventories +(1,987 +) +23,319 +20,371 +Prepaid expenses and other assets +9,703 +18,907 +(4,532 +) +Accounts payable +12,953 +(2,714 +) +(1,354 +) +Accrued expenses and other liabilities +18,065 +5,489 +2,884 +Income taxes +(2,151 +) +(719 +) +(5,770 +) +Cash provided by operating activities +114,162 +98,264 +39,754 +Cash flows from investing activities: +Purchases of property, equipment, and software +(11,979 +) +(13,117 +) +(22,194 +) +Proceeds from disposal of property and equipment +1,856 +1,579 +2,438 +Other +13 +— +(100 +) +Cash used in investing activities +(10,110 +) +(11,538 +) +(19,856 +) +Cash flows from financing activities: +Proceeds from borrowings +120,000 +5,500 +31,582 +Repayments of borrowings +(662 +) +(8,611 +) +(35,627 +) +Series A preferred stock repurchase +(183,724 +) +— +— +Dividends — Series A convertible preferred stock (1) +(21,015 +) +(12,000 +) +(12,000 +) +Repurchases of common stock +(63,131 +) +(50,000 +) +— +Other +(270 +) +(259 +) +(398 +) +Cash used in financing activities +(148,802 +) +(65,370 +) +(16,443 +) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +(4,775 +) +3,053 +(255 +) +Net change in cash, cash equivalents, and restricted cash +(49,525 +) +24,409 +3,200 +Cash, cash equivalents, and restricted cash—beginning of year +177,055 +152,646 +149,446 +Cash, cash equivalents, and restricted cash—end of year +$ +127,530 +$ +177,055 +$ +152,646 +Cash paid for interest +$ +462 +$ +434 +$ +653 +Cash paid for income taxes +18,633 +13,208 +12,344 +(1) Represents Series A Convertible Preferred Stock cash dividends declared and paid of $9.0 million and $12.0 million paid to induce conversion for the year ended December 31, 2018 . +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1 . BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of the “Company,” “Crocs,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. The Company is engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. Our reportable operating segments include: the Americas, operating in North and South America; Asia Pacific, operating throughout Asia, Australia, and New Zealand; and Europe, Middle East, and Africa (“ EMEA ”), operating throughout Europe, Russia, the Middle East, and Africa. +Basis of Presentation and Consolidation +The Company’s consolidated financial statements include its accounts and those of its wholly-owned subsidiaries, and reflect all adjustments which are necessary for a fair statement of financial position, results of operations, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, depreciation, and provisions for contingencies are reasonable based on information available at the time they are made. Management also makes estimates in the assessments of potential losses in relation to tax matters and threatened or pending legal proceedings (see Note 12 — Income Taxes and Note 16 — Legal Proceedings ).To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassifications +The Company has reclassified certain amounts on the consolidated balance sheets, the consolidated statements of cash flows, and Note 2 — Recent Accounting Pronouncements , Note 5 — Accrued Expenses and Other Liabilities , Note 6 — Fair Value Measurements , Note 8 — Revolving Credit Facility and Bank Borrowings , Note 12 — Income Taxes , and Note 14 — Commitments and Contingencies to conform to current period presentation. +Transactions with Affiliates +The Company receives services from three subsidiaries of Blackstone Capital Partners VI L.P. (“Blackstone”). Blackstone and certain of its permitted transferees beneficially owned all the outstanding shares of the Company’s Series A Convertible Preferred Stock (“Series A Preferred”) until December 5, 2018, the closing date of an agreement with Blackstone and certain of its permitted transferees, whereby: (i) the Company repurchased 100,000 shares of Series A Preferred for an aggregate purchase price of $183.7 million ; (ii) the Series A Preferred holders converted the remaining 100,000 shares of Series A Preferred into 6,896,548 shares of common stock; and (iii) the Company paid the holders $15.0 million to induce conversion, of which $12.0 million was paid at closing, with the remaining $3.0 million paid in January 2019. +The Company applied the accounting prescribed in Appendix D, Topic No. D-42 “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock,” as summarized in Emerging Issues Task Force abstracts for the repurchase and conversion. For accounting purposes, the repurchase was categorized as a redemption and the payments to induce conversion were treated as deemed dividends. For more information on the repurchase and conversion, see Note 9 — Equity . For more information on the earnings per share impact of the repurchase and conversion, see Note 13 — Earnings per Share . +F- 8 +Table of Contents +Certain Blackstone subsidiaries provide various services to the Company, including inventory count services, cybersecurity and consulting, and workforce management services. The Company incurred expenses of $0.8 million , $0.7 million , and $0.8 million for the years ended December 31, 2018 , 2017 , and 2016 respectively, for these services, which are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Revenue Recognition +Revenues are recognized in the amount expected to be received in exchange for goods when control of the products transfers to customers, and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount and must be estimated. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. We also may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments. The estimated costs of sales incentives, discounts, returns, price promotions, rebates, and loyalty and coupon programs are reported as a reduction of revenues. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, procure, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, depreciation, packaging, and other manufacturing overheads and costs. During 2018, we transitioned all production of our products to third-party contract manufacturers. +Research, Design, and Development Expenses +We continue to dedicate significant resources to product design and development based on opportunities we identify in the marketplace. We incurred expenses of $14.1 million , $13.4 million , and $11.9 million in research, design, and development activities for the years ended December 31, 2018 , 2017 , and 2016 , respectively, which are expensed as incurred and are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Selling, General and Administrative Expenses +Our selling, general and administrative expenses include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of the Company’s promotional expenses result from payments under endorsement contracts. Expenses under endorsement contracts are expensed on a straight-line basis over the related annual contract terms. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, including variable marketing expenses, were $68.6 million , $59.1 million , and $56.0 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. Prepaid advertising and promotional endorsement expenses of $7.5 million and $7.0 million , were included in ‘Prepaid expenses and other assets’ in the consolidated balance sheets at December 31, 2018 and 2017 , respectively. +Selling, general and administrative expenses consist primarily of labor and outside services, rent expense, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to corporate, non-product, and non-manufacturing assets and share-based compensation. Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources and information technology. +F- 9 +Table of Contents +Other Income, Net +Other income, net primarily includes gains and losses associated with activities not directly related to making and selling footwear, as well as certain gains or losses on sales of non-operating assets. +Foreign Currency Gains (Losses), Net +Foreign currency gains (losses), net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of an entity, and realized and unrealized gains and losses on forward foreign currency exchange derivative contracts. Realized foreign exchange gains and losses are reported in the operating segment in which they occur. Foreign exchange gains and losses on intercompany balances and forward foreign exchange derivative contracts are reported within corporate operations. +Other Comprehensive Income (Loss) +Our foreign subsidiaries use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into U.S. dollars using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss), until the substantial disposition of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. +Income Taxes +Income taxes are accounted for using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See Note 12 — Income Taxes for further discussion. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. The Company reports receivables from credit card companies, if expected to be received within five days, in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. The Company reduces the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting the Company’s customer base, and historical collection experience. Specific provisions are recorded for individual receivables when the Company becomes aware of a customer’s inability to meet its financial obligations. The Company writes off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Item 15, Schedule II for more information. +Inventories +Inventories are stated at the lower of cost or net realizable value. Effective January 1, 2018, the Company completed implementation of a new inventory costing system for approximately 95% of its inventories. In connection with the implementation, the Company changed its method of inventory costing from a moving average cost method to a first-in-first-out method. The Company believes this change in accounting principle is preferable because it results in more precision and consistency in global and regional inventory costs, more efficient analysis and better matching of inventory costs with revenues, better matches the physical flow of inventories, +F- 10 +Table of Contents +and improves comparability with industry peers. The change from the Company’s former inventory cost method did not have a material effect on inventory or cost of sales, and, as a result, prior comparative financial statements have not been restated. +We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end-of-life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value and the difference is recorded in ‘Cost of sales’ in our consolidated statements of operations. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and recorded within ‘Cost of sales’ in our consolidated statements of operations. +As of December 31, 2018 and 2017 , our finished goods inventories accounted for approximately 100.0% and 97.5% , respectively, of our consolidated inventories, and the remaining balance consisted of raw materials and work-in-process. +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and have the following ranges: machinery and equipment: 2 to 5 years; furniture, fixtures, and other: 2 to 10 years. Leasehold improvements are stated at cost and amortized on a straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of manufacturing assets is included in cost of sales in our consolidated statements of operations for 2016, 2017, and through the third quarter of 2018 when all manufacturing was transferred to third-party manufacturers. Depreciation related to corporate, non-product, and non-manufacturing assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets and the resulting gain or loss, if any, is reflected in ‘Income (loss) from operations’ in the consolidated statements of operations. +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. Our annual test is performed as of the last day of our fiscal fourth quarter. We continuously monitor the performance of our definite-lived intangible assets and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +Direct costs of acquiring or developing internal-use computer software, including costs of employees, are capitalized and classified within intangible assets. Software maintenance and training costs are expensed in the period incurred. Initial costs associated with internally-developed-and-used software are expensed until it is determined that the project has reached the application development stage, after which subsequent additions, modifications, or upgrades are capitalized to the extent that they add functionality. The Company’s capitalized software consists primarily of enterprise resource system software, warehouse management software, and point of sale software. Amortization for software is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 2 to 8 years. Amortization of capitalized software used in manufacturing activities is included in ‘Cost of sales’ in the consolidated statements of operations for 2016, 2017, and through the third quarter of 2018 when all manufacturing was transferred to third-party manufacturers. Amortization related to corporate, non-product, and non-manufacturing assets, such as the Company’s global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of operations. +Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 7 to 25 years. +Disposals of Property and Equipment and Intangible Assets +The Company recognized net losses on disposals of property and equipment and intangible assets of $4.8 million and $0.5 million , respectively, for the years ended December 31, 2018 and 2016 , and net gains on disposals of property and equipment and intangible +F- 11 +Table of Contents +assets of $0.8 million for the year ended December 31, 2017 , which are included in ‘Selling, general and administrative expenses’ in the consolidated statement of operations. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. The Company assesses recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and records a loss from impairment if the carrying value is more than its undiscounted cash flows. For assets involved in Crocs’ retail business, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. Assets or asset groups to be abandoned or from which no future benefit is expected are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 3 — Property and Equipment, Net for a discussion of impairment losses recorded during the periods presented. +Share-Based Compensation +Share-based compensation expense associated with manufacturing and retail employees is included in ‘Cost of sales’ in the consolidated statements of operations. Share-based compensation expense associated with selling, marketing, and administrative employees is included in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Stock Options +Stock options are granted with exercise prices equal to the fair market value of our common stock on the date of grant. We use the Black-Scholes option-pricing model to estimate the grant date fair value of stock options, which requires the use of assumptions, including the expected term of the option, expected volatility of our stock price, our expected dividend yield, and the risk-free interest rate, among others. These assumptions reflect our best estimates, however; they involve inherent uncertainties including market conditions and employee behavior that are generally outside of our control. We expense all share-based compensation awarded based on the grant date fair value of the awards using the straight-line method over the requisite service period, adjusted for forfeitures. +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +The Company grants RSAs, service-condition RSUs, performance-condition RSUs, and market-condition RSUs. The grant date fair values of RSAs and service-condition and performance-condition RSUs are based on the closing market price of our common stock on the grant date; the grant date fair value and derived service period of market-condition RSUs is estimated using a Monte Carlo simulation valuation model. Our service-condition RSUs vest based on continued service; our performance-condition RSUs vest based on achievement of multiple weighted performance goals, certification of performance achievement by the Compensation Committee of the Board of Directors, and continued service; our market-condition RSUs vest based on the market price of the Company’s stock. Compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service period. For performance-condition RSUs, compensation expense is updated for the Company’s expected performance level against performance goals at the end of each reporting period, which involves judgment as to achievement of certain performance metrics. +See Note 11 — Share-Based Compensation for additional information related to share-based compensation. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the two-class method. Participating securities are included in the computation of EPS on a pro-rata, if-converted basis. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in the Company’s earnings. The dilutive effect of each participating security, if any, is calculated using the more dilutive of the two-class method described above. Anti-dilutive securities are excluded from diluted EPS. See Note 13 — Earnings per Share for additional information. +Derivative Foreign Currency Contracts +The Company enters into forward foreign currency exchange contracts (“contracts”) to mitigate the potential impact of foreign currency exchange rate risk. By policy, the Company does not enter into these contracts for trading purposes or speculation. The fair value of the contracts is reported either as an asset or liability in our consolidated balance sheets. Changes in the fair value of +F- 12 +Table of Contents +our contracts are recorded in ‘Foreign currency gains (losses), net’ in our consolidated statements of operations. The Company did not designate any derivative instruments for hedge accounting during any of the periods presented. See Note 7 — Derivative Financial Instruments for further information. +Foreign Currency Translation and Remeasurement +The financial position and operating results of the Company’s foreign subsidiaries are reported using their respective local currency as the functional currency. The Company recognizes and reports remeasurement gains and losses within ‘Foreign currency gains (losses), net’ in the consolidated statements of operations. Cumulative translation gain and losses are reported within ‘Other comprehensive income (loss)’. +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). The Company utilizes a combination of market and income approaches to value derivative instruments. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level +Inputs +1 +Unadjusted quoted prices in active markets for identical assets and liabilities. +2 +Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 +Unobservable inputs for the asset or liability. +The Company categorizes fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +The Company’s non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 6 — Fair Value Measurements for further discussion related to estimated fair value measurements. +Consolidated Statements of Cash Flows - Supplemental Schedule of Non-Cash Investing and Financing Activities +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Accrued purchases of property, equipment, and software +$ +1,141 +$ +2,195 +$ +2,728 +Series A preferred stock conversion +100,000 +— +— +Series A preferred stock accretion, net (1) +17,567 +3,532 +3,244 +Vendor financed insurance premiums +— +1,450 +2,082 +(1) Represents total accretion of $17.6 million , net of $6.1 million acquired value of beneficial conversion feature attributable to repurchased Series A Preferred. +2 . RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Income Tax Accounting Implications of the Tax Cuts and Jobs Act +In March 2018, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on the income tax accounting implications of the U.S. Tax Cuts and Job Act (“Tax Act”), addressing the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain +F- 13 +Table of Contents +income tax effects of the Tax Act. As a result of the Tax Act, we recorded provisional estimates in accordance with Staff Accounting Bulletin No. 118 ("SAB 118"), Income Tax Accounting Implications of the Tax Cuts and Jobs Act , during the year ended December 31, 2017 in relation to the revaluation of our net deferred tax assets at the lower U.S. corporate income tax rate and the additional tax expense associated with the deemed repatriation tax. During the year ended December 31, 2018, we recorded measurement period adjustments related to the provisional estimates. We now consider our accounting for the Tax Act complete. For more information, see Note 12 — Income Taxes . +Stock Compensation Scope of Modification Accounting +In May 2017, the FASB issued authoritative guidance intended to clarify those changes to terms and conditions of share-based compensation awards that are required to be accounted for as modifications of existing share-based awards. The Company adopted this guidance as of January 1, 2018. The adoption did not have an impact on our consolidated financial position or results of operations. +Statements of Cash Flows - Classification and Change in Restricted Cash +In August 2016, the FASB issued authoritative guidance intended to clarify how entities should classify certain cash receipts and cash payments in the statements of cash flows. In November 2016, the FASB issued additional guidance requiring that restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts reported in the statements of cash flows. The guidance is applied retrospectively to all periods presented and is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. The Company adopted this guidance as of January 1, 2018. As a result of the adoption, the Company changed the presentation in its statements of cash flows for all periods presented. +Prepaid Stored-Value Products +In March 2016, the FASB issued guidance related to the recognition of breakage for certain prepaid stored-value products. The standard is effective for annual periods (including interim periods) beginning after December 15, 2017. The Company adopted this guidance as of January 1, 2018. The adoption did not have a significant impact on our consolidated financial position or results of operations. +Revenue Recognition +In May 2014, the FASB issued authoritative guidance related to revenue recognition from contracts with customers. On January 1, 2018, the Company adopted the guidance using the modified retrospective method. The comparative information presented in the consolidated financial statements was not restated and is reported under the accounting standards in effect for the periods presented. The adoption of this guidance did not have, and is not expected to have, a significant impact on our reported revenues, gross margins, income from operations, or cash flows from operations. +Substantially all of the Company’s revenues are recognized when control of product passes to customers when the products are shipped or delivered. Effective January 1, 2018, the Company changed its balance sheet presentation for expected product returns by reporting a product return asset for the right to receive returned products and a returns liability for amounts expected to be refunded to customers as a result of product returns. The product return asset is reported within ‘Prepaid expenses and other assets’ in the consolidated balance sheet. The returns liability and payments received from customers for future delivery of products are reported within ‘Accrued liabilities and other expenses’ in the consolidated balance sheet. +The Company elected to account for shipping and handling costs associated with outbound freight after control of product passes to customers as fulfillment costs, which are expensed as incurred and included in ‘Cost of sales’ in our consolidated statements of operations. There is no change to the Company’s comparative reporting of shipping and handling costs as a result of adoption. +The Company elected to expense incremental costs to obtain customer contracts, consisting primarily of commission incentives, when incurred and reports these costs within ‘Selling, general and administrative expenses’ in its consolidated statement of operations. There is no change to the Company’s comparative reporting of incremental costs to obtain customer contracts as a result of adoption. +F- 14 +Table of Contents +The impact of adoption on the January 1, 2018 consolidated balance sheet was: +December 31, 2017 +Impact of Adoption (1) +January 1, 2018 +(in thousands) +Assets: +Accounts receivable, net +$ +83,518 +$ +1,801 +$ +85,319 +Prepaid expenses and other assets +22,596 +1,555 +24,151 +Liabilities: +Accrued expenses and other liabilities +84,460 +3,356 +87,816 +(1) Prior to adoption, product return assets and return liabilities were reported within ‘Accounts receivable, net’, within the allowance for doubtful accounts. As of the adoption date, the product return assets were reclassified and reported as a component of ‘Prepaid expenses and other assets’, and return liabilities were reclassified to ‘Accrued expenses and other liabilities’ in the Company’s consolidated balance sheet. +The impact of the new revenue recognition guidance on our consolidated balance sheet as of December 31, 2018 was: +December 31, 2018 +Balances Without Adoption +Effects of New Guidance (1) +As Reported +(in thousands) +Assets: +Accounts receivable, net +$ +93,994 +$ +3,633 +$ +97,627 +Prepaid expenses and other assets +19,327 +2,796 +22,123 +Liabilities: +Accrued expenses and other liabilities +95,742 +6,429 +102,171 +(1) The new revenue recognition guidance requires comparative disclosures of the effects of the new guidance on the Company’s consolidated financial statements for all interim periods and the annual period during the year of adoption. The new guidance did not have a significant effect on the Company’s consolidated statements of operations for the year ended December 31, 2018 . +See Note 10 — Revenues for additional disclosures. +New Accounting Pronouncements Not Yet Adopted +Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income +In February 2018, the FASB issued authoritative guidance that permits reclassification of the income tax effects of the Tax Act on accumulated other comprehensive income (“AOCI”) to retained earnings. This guidance may be adopted retrospectively to each period (or periods) in which the income tax effects of the Tax Act related to items remaining in AOCI are recognized, or at the beginning of the period of adoption. The guidance becomes effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. The Company is currently assessing the adoption method and the impact that adopting this new accounting standard will have on its consolidated financial statements. +Leases +The Company’s lease portfolio consists primarily of real estate assets, which includes retail, warehouse, distribution center, and office spaces. Some of our retail lease agreements include variable payments based on a percentage of retail sales over contractual amounts, and others include periodic payment adjustment for inflation. Some of our leases also require us to pay maintenance, utilities, real estate taxes, insurance, and other operating expenses associated with the leased space. Based upon the nature of the items leased and the structure of the leases, substantially all of the Company’s leases are classified as operating leases and will continue to be operating leases under the new accounting standard discussed below. +F- 15 +Table of Contents +In February 2016, the FASB issued authoritative guidance intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance, lessees will be required to recognize a right-of-use asset and a lease liability, measured on a discounted basis, at the commencement date for all leases with terms greater than twelve months. Additionally, this guidance requires disclosures to help investors and other financial statement users to better understand the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements. This guidance and related amendments are effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. +In July 2017, the Company established an implementation team and engaged external advisers and solution providers to develop a multi-phase plan to assess the Company’s leasing arrangements, as well as any changes to accounting policies, processes, or necessary systems. The Company procured the necessary software and services to facilitate adoption of the guidance, completed a detailed review of its leases and other contractual arrangements, assessed its systems and business processes, and related accounting procedures and controls requirements. The Company selected and implemented new software to support adoption of the new standard. +The Company has elected all of the available transition practical expedients, including the ‘package of practical expedients’, which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. The Company has elected not to apply ‘hindsight’ when adopting the standard for determining the reasonably certain lease term and in assessing impairments. The Company has elected the short-term lease exemption, which means the Company will not recognize a right-of-use asset or liability for leases that qualify for the short-term exemption and will recognize those lease expenses on a straight-line basis over the lease term in its consolidated statements of operations. Further, the Company has elected to not separate lease and non-lease components for all of its leases. The Company will also take a portfolio approach in applying its incremental borrowing rate based upon the information available to the Company at the adoption date to calculate the present value of the lease liabilities over the lease terms. +The Company will adopt this new lease standard on January 1, 2019. Additionally, the Company will elect the modified retrospective method of adoption with the cumulative-effect recognized through retained earnings upon adoption and will not restate prior periods. While the Company has not completed its evaluation of impairment of right-of-use assets upon adoption, the Company expects that the rationalization of the company-operated retail stores and impairments incurred in the historical periods prior to adoption will result, at a minimum, in an impairment of retail store right-of use-assets recognized through retained earnings upon adoption. The Company will finalize its accounting assessment and quantitative impact of the adoption during the first quarter of fiscal year 2019. The Company is finalizing its implementation related to policies, processes and internal controls over lease recognition to assist in the application of the new lease standard as well as completing the implementation of new software to address the new lease guidance requirements. +We expect that this standard will have a material effect on our financial statements. While we continue to assess all of the effects of the new standard, we expect adoption to result in recognition of significant new right-of-use assets and lease liabilities in the Company’s consolidated balance sheet, and significant new disclosures in the footnotes to the Company’s consolidated financial statements. We are unable to quantify the impact at this time. The Company does not expect that adoption of the standard will have a significant effect on the consolidated operating income or the cash flows of the Company. The Company's bank covenants under our Senior Revolving Credit Facility will not be affected by the adoption of this new standard. +We have also entered into additional real estate leases that will commence in 2019 that will be accounted for under the new lease guidance. Future undiscounted obligations related to our real estate leases in effect as of December 31, 2018, as well as those real estate leases entered into prior to December 31, 2018 that contain lease commencement dates after January 1, 2019, are included in the table of future obligations disclosed in Note 14 — Commitments and Contingencies . +Implementation Costs Incurred in Cloud Computing Arrangements +In August 2018, the FASB issued authoritative guidance related to the treatment of implementation costs incurred in a hosting arrangement that is considered a service contract. This guidance becomes effective for annual reporting periods beginning after December 15, 2019, including interim periods within those periods, with early adoption permitted, and will be applied prospectively to all implementation costs incurred after the date of adoption. The Company does not expect this standard to have a material impact on its consolidated financial statements. +F- 16 +Table of Contents +Other Pronouncements +Other new pronouncements issued but not effective until after December 31, 2018 are not expected to have a material impact on the Company’s consolidated financial statements. +3 . PROPERTY AND EQUIPMENT, NET +‘Property and equipment, net’ consists of the following: +December 31, +2018 +2017 +(in thousands) +Leasehold improvements +$ +63,702 +$ +72,961 +Machinery and equipment +20,054 +33,109 +Furniture, fixtures, and other +16,779 +19,776 +Construction-in-progress +2,632 +992 +Property and equipment +103,167 +126,838 +Less: Accumulated depreciation and amortization +(80,956 +) +(91,806 +) +Property and equipment, net +$ +22,211 +$ +35,032 +Asset Retirement Obligations +The Company is contractually obligated under certain of its lease agreements to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. At December 31, 2018 and 2017 , liabilities for asset retirement obligations were $2.0 million and $3.1 million , respectively, and are reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Cost of sales +$ +1,422 +$ +2,278 +$ +1,755 +Selling, general and administrative expenses +11,180 +12,723 +13,312 +Total depreciation and amortization expense +$ +12,602 +$ +15,001 +$ +15,067 +F- 17 +Table of Contents +Asset Impairments +During the years ended December 31, 2018 , 2017 , and 2016 , the Company recorded impairments of $0.9 million , $0.5 million , and $2.7 million , respectively, for underperforming retail stores. During the year ended December 31, 2018 , the Company recorded impairment expenses of $1.3 million to reduce the carrying values of certain supply chain assets related to the closure of our Mexico and Italy manufacturing and distribution facilities, included in ‘Other businesses,’ to their estimated fair values. Impairments for retail stores by reportable operating segment, were: +Year Ended December 31, +2018 +2017 +2016 +Asset Impairment +Number of +Stores +Asset Impairment +Number of +Stores +Asset Impairment +Number of +Stores +(in thousands, except store count data) +Americas +$ +138 +1 +$ +455 +3 +$ +1,703 +12 +Asia Pacific (1) +760 +12 +— +— +573 +19 +EMEA (1) +— +— +75 +1 +437 +11 +Total +$ +898 +13 +$ +530 +4 +$ +2,713 +42 +(1) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ segment were shifted to the ‘ EMEA ’ segment. The previously reported amounts for asset impairment for retail stores for the years ended December 31, 2016 have also been revised to conform to the current period presentation. See ‘Impacts of segment composition change’ table below for more information. +Impacts of segment composition change: +Year Ended December 31, 2016 +Increase (Decrease) +Impacts on retail store asset impairment: +Asia Pacific +$ +(99 +) +EMEA +99 +Impacts on number of retail stores impaired: +Asia Pacific +(2 +) +EMEA +2 +4 . GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +All of our goodwill is in the EMEA segment. The changes in goodwill for the years ended December 31, 2018 and 2017 were: +Goodwill +(in thousands) +Balance at January 1, 2017 +$ +1,480 +Foreign currency translation +208 +Balance at December 31, 2017 +1,688 +Foreign currency translation +(74 +) +Balance at December 31, 2018 +$ +1,614 +Accumulated goodwill impairment at December 31, 2018 was $0.8 million . +F- 18 +Table of Contents +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2018 +December 31, 2017 +Gross +Accum. Amortiz. +Net +Gross +Accum. Amortiz. +Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software +$ +138,857 +$ +(97,900 +) +$ +40,957 +$ +143,275 +$ +(90,219 +) +$ +53,056 +Patents, copyrights, and trademarks +5,338 +(4,588 +) +750 +5,636 +(4,969 +) +667 +Other +— +— +— +214 +(214 +) +— +Intangible assets not subject to amortization: +In progress (1) +3,906 +— +3,906 +2,378 +— +2,378 +Trademarks and other +77 +— +77 +326 +— +326 +Total +$ +148,178 +$ +(102,488 +) +$ +45,690 +$ +151,829 +$ +(95,402 +) +$ +56,427 +(1) In the year ended December 31, 2017 , we recorded a write-off of $4.8 million for a discontinued project. +At December 31, 2018 , the weighted average remaining useful life of intangibles subject to amortization was approximately 6.6 years. +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Cost of sales +$ +3,889 +$ +4,550 +$ +5,127 +Selling, general and administrative expenses +12,759 +13,579 +13,849 +Total amortization expense +$ +16,648 +$ +18,129 +$ +18,976 +Estimated future annual amortization expense of intangible assets is: +As of December 31, 2018 +(in thousands) +2019 +$ +14,368 +2020 +12,142 +2021 +11,893 +2022 +1,446 +2023 +928 +Thereafter +930 +Total +$ +41,707 +F- 19 +Table of Contents +5 . ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2018 +2017 +(in thousands) +Accrued compensation and benefits +$ +43,970 +$ +34,955 +Fulfillment, freight, and duties +12,234 +6,921 +Professional services +11,124 +10,835 +Accrued rent and occupancy +6,956 +8,535 +Return liabilities (1) +6,429 +— +Sales/use and value added taxes payable +5,601 +3,509 +Royalties payable and deferred revenue +3,356 +6,193 +Other (2) +12,501 +13,512 +Total accrued expenses and other liabilities +$ +102,171 +$ +84,460 +(1) Return liabilities are presented within ‘Accrued expenses and other liabilities’ upon adoption of new authoritative guidance on revenue recognition effective January 1, 2018, as described in Note 2 — Recent Accounting Pronouncements . +(2) Includes accrued payments to induce conversion of Series A Preferred at December 31, 2018 and accrued dividends for Series A Preferred at December 31, 2017 . +6 . FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of the Company’s derivative instruments. The Company’s derivative instruments are forward foreign currency exchange contracts. The Company manages credit risk of its derivative instruments on the basis of its net exposure with its counterparty. All of the Company’s derivative instruments are classified as Level 2 of the fair value hierarchy and are reported in the consolidated balance sheets within ‘Accrued expenses and other liabilities’ at December 31, 2018 and 2017 . The fair values of the Company’s derivative instruments were liabilities of $1.3 million and $0.4 million at December 31, 2018 and 2017 , respectively. See Note 7 — Derivative Financial Instruments for more information. +The carrying amounts of the Company’s cash, cash equivalents, and restricted cash, accounts receivable, accounts payable, and current accrued expenses and other liabilities approximate their fair value as recorded due to the short-term maturity of these instruments. +The Company’s borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. The fair values of the Company’s outstanding borrowings approximate their carrying values at December 31, 2018 and 2017 , based on interest rates currently available to the Company for similar borrowings and were: +December 31, 2018 +December 31, 2017 +Carrying Value +Fair +Value +Carrying Value +Fair +Value +(in thousands) +Borrowings +$ +120,000 +$ +120,000 +$ +662 +$ +662 +Non-Financial Assets and Liabilities +The Company’s non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +F- 20 +Table of Contents +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. The Company recorded impairments as follows: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Supply chain assets impairment +$ +1,284 +$ +— +$ +— +Retail store assets impairment +898 +530 +2,713 +Discontinued project +— +4,754 +— +Goodwill impairment +— +— +431 +Total asset impairments +$ +2,182 +$ +5,284 +$ +3,144 +The Company’s goodwill is reported within its EMEA operating segment. +7 . DERIVATIVE FINANCIAL INSTRUMENTS +The Company transacts business in various foreign countries and is therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar amounts of revenues, expenses, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, the Company enters into forward contracts to buy and sell foreign currency. By policy, the Company does not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts that the Company enters into are over-the-counter instruments transacted with highly-rated financial institutions. The Company was not required to and did not post collateral as of December 31, 2018 or 2017 . +The Company’s derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets. The Company reports derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. Changes in fair value are recognized within ‘Foreign currency gains (losses), net’ in the consolidated statements of operations. For the consolidated statements of cash flows, the Company classifies cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities.’ +Results of Derivative Activities +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, reported within ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, 2018 +December 31, 2017 +Derivative Assets +Derivative Liabilities +Derivative Assets +Derivative Liabilities +(in thousands) +Forward foreign currency exchange contracts +$ +943 +$ +(2,256 +) +$ +1,241 +$ +(1,647 +) +Netting of counterparty contracts +(943 +) +943 +(1,241 +) +1,241 +Foreign currency forward contract derivatives +$ +— +$ +(1,313 +) +$ +— +$ +(406 +) +F- 21 +Table of Contents +The notional amounts of outstanding forward foreign currency exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2018 +December 31, 2017 +Notional +Fair Value +Notional +Fair Value +(in thousands) +Euro +$ +34,959 +$ +(92 +) +$ +37,718 +$ +(122 +) +Singapore Dollar +34,584 +254 +73,455 +364 +Japanese Yen +25,561 +(178 +) +30,688 +(89 +) +British Pound Sterling +22,185 +183 +13,233 +80 +South Korean Won +9,408 +63 +15,888 +(134 +) +Other currencies +67,885 +(1,543 +) +53,698 +(505 +) +Total +$ +194,582 +$ +(1,313 +) +$ +224,680 +$ +(406 +) +Latest maturity date +January 2019 +January 2018 +Amounts reported in ‘Foreign currency gains (losses), net’ in the consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Foreign currency transaction gains +$ +552 +$ +2,284 +$ +10,814 +Foreign currency forward exchange contracts gains (losses) +766 +(1,721 +) +(13,268 +) +Foreign currency gains (losses), net +$ +1,318 +$ +563 +$ +(2,454 +) +8 . REVOLVING CREDIT FACILITY AND BANK BORROWINGS +The Company’s borrowings were as follows: +December 31, +2018 +2017 +(in thousands) +Revolving credit facilities +$ +120,000 +$ +— +Notes payable +— +662 +Total borrowings +120,000 +662 +Less: Current portion of borrowings +— +662 +Total long-term borrowings +$ +120,000 +$ +— +The weighted average interest rate on outstanding borrowings as of December 31, 2018 and 2017 was 4.69% and 2.30% , respectively. +Senior Revolving Credit Facility +In December 2011, the Company entered into a revolving credit facility (the “Facility”), pursuant to an Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. The Credit Agreement contains certain covenants that restrict certain actions by the Company, including (i) stock repurchases to an aggregate of $250.0 million per year, subject to certain restrictions; and (ii) capital expenditures and commitments to $70.0 million per year. The Credit Agreement also permits intercompany loans of up to $375.0 million and requires the Company to meet certain financial covenant ratios that become effective when average outstanding borrowings under the Credit Agreement, including letters of credit, exceed the lesser of $40.0 million or 40% of the total commitments during certain periods or if the outstanding borrowings exceed the borrowing base. If the financial covenant ratios are in effect, the Company must maintain a minimum fixed charge coverage ratio of 1.10 to 1.00, and a maximum leverage ratio of (i) 3.00 to 1.00 at December 31, 2018 and March 31, 2019, (ii) 2.75 to 1.00 at June 30, 2019, and (iii) 2.50 to 1.00 at September +F- 22 +Table of Contents +30, 2019 and the last day of each quarter thereafter. As of December 31, 2018 , the Company was in compliance with all financial covenants under the Credit Agreement. +The Facility, as amended, provides for borrowings of up to $250.0 million through February 2021 . Borrowings under the Facility for domestic base rate loans, including swing loans, bear interest at a daily base rate plus a margin of 0.75% . Domestic London Interbank Borrowing Rate (“LIBOR”) loans bear interest equal to a LIBOR rate plus a margin of 1.75% as of December 31, 2018 . +As of December 31, 2018 , the total commitments available from the lenders under the Facility were $250.0 million . At December 31, 2018 , the Company had $120.0 million in outstanding borrowings, used to partially fund the repurchase of Series A Preferred, which are due in February 2021 , and $ 0.6 million in outstanding letters of credit under the Facility, which reduces amounts available for borrowing under the Facility. As of December 31, 2018 and 2017 , the Company had $ 129.4 million and $99.4 million , respectively, of available borrowing capacity under the Facility. +On February 6, 2019, the Company entered into the Eighteenth Amendment to the Amended and Restated Credit Agreement which increased the total commitments under the Credit Agreement to $300.0 million from $250.0 million . +The Company also has revolving credit facilities in Asia, from which the Company had no borrowings during the years ended December 31, 2018 and 2017 or outstanding at December 31, 2018 or 2017 . +9 . EQUITY +Common Stock +The Company has one class of common stock with a par value of $0.001 per share. There are 250 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +Common Stock Repurchase Program +On February 20, 2018, the Board of Directors approved an increase in our repurchase authorization, allowing for repurchase of up to $500.0 million of our common stock. The number, price, and timing of the repurchases are at the Company’s sole discretion, subject to certain restrictions on repurchases under the Company’s Senior Revolving Credit Facility, and may be made depending on market conditions, liquidity needs, or other factors. The Company’s Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate the Company to acquire any amount of its common stock. Under Delaware state law, these shares are not retired, and the issuer has the right to resell any of the shares repurchased. +The Company repurchased 3.6 million shares of its common stock at a cost of $63.1 million , including commissions, and 5.7 million shares of its common stock at a cost of $50.0 million , including commissions, during the years ended December 31, 2018 and 2017 , respectively. The Company did not repurchase any of its common stock during the year ended December 31, 2016 . As of December 31, 2018 , the Company had remaining authorization to repurchase approximately $155.7 million of its common stock, subject to restrictions under its Credit Agreement. +Preferred Stock +The Company has authorized and available for issuance 4.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized and none were issued and outstanding as of December 31, 2018 . +Series A Convertible Preferred Stock +The Company is authorized to issue up to 1.0 million shares of Series A Preferred, par value $0.001 per share, none of which were issued and outstanding as of December 31, 2018 . Prior to the December 5, 2018 repurchase and conversion discussed below, the previously outstanding Series A Preferred participated on a pro rata if converted basis in earnings attributable to common stockholders, but did not participate in net losses attributable to common stockholders. +Repurchase and Conversion +On December 5, 2018, all of the outstanding Series A Preferred shares were repurchased or converted to common stock. As a result, the Company recognized the remaining unamortized original issue discount and beneficial conversion feature accretion of +F- 23 +Table of Contents +$14.7 million , and settled the beneficial conversion feature related to the repurchased Series A Preferred of $6.1 million , resulting in a net increase of $8.6 million in ‘Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature’ in the statement of operations. The Company repurchased 100,000 shares of Series A Preferred with a carrying value of $100.0 million in exchange for a cash payment of $183.7 million . The repurchase payment in excess of the carrying value of $83.7 million is reported within ‘Dividends on Series A convertible preferred stock’ in the statement of operations. The remaining 100,000 shares of Series A Preferred were converted to 6,896,548 shares common stock. In connection with the conversion, the Company paid $15.0 million in cash to induce conversion, of which $12.0 million was paid at closing, with the remaining $3.0 million paid in January 2019. In addition, the Company paid other costs associated with this transaction of $0.5 million . The $15.0 million inducement dividend and the $0.5 million of other costs are reported within ‘Dividends on Series A convertible preferred stock’ in the statement of operations. +Participation Rights and Dividends +Prior to the repurchase and conversion of the Series A Preferred, holders of Series A Preferred were entitled to cumulative preferred dividends payable quarterly in cash at a rate of 6.0% per annum. As of December 31, 2018 , the Company had accrued payments to induce conversion of $3.0 million , which were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheet. As of December 31, 2017 , the Company had accrued preferred dividends of $3.0 million , which were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheet. These accrued dividends were paid in cash in January 2018. +10 . REVENUES +The Company adopted authoritative guidance related to the recognition of revenue from contracts with customers effective January 1, 2018 using the modified retrospective method. The comparative information presented in the condensed consolidated financial statements was not restated and is reported under the accounting standards in effect for the periods presented. See ‘Revenue Recognition’ in Note 2 — Recent Accounting Pronouncements for a discussion of the significant changes resulting from adoption of the guidance. The adoption of the guidance did not have a significant impact on revenues. +Revenues by reportable operating segment and by channel were: +Year Ended December 31, 2018 +Americas +Asia Pacific +EMEA +Other Businesses +Total +(in thousands) +Wholesale +$ +216,797 +$ +203,110 +$ +154,992 +$ +3,145 +$ +578,044 +Retail +204,806 +87,264 +35,358 +— +327,428 +E-commerce +98,589 +54,224 +29,920 +— +182,733 +Total revenues +$ +520,192 +$ +344,598 +$ +220,270 +$ +3,145 +$ +1,088,205 +Revenues are recognized in the amount expected to be received in exchange when control of the products transfers to customers, and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount and must be estimated. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. During the year ended December 31, 2018 , the Company recognized a net increase of $0.8 million to wholesale revenues due to changes in estimates related to products transferred to customers in prior periods. There were no changes to estimates in retail and e-commerce channels during the year ended December 31, 2018 . +The Company elected to exclude from revenues taxes assessed by governmental authorities, including value-added and other sales-related taxes, that are imposed on and concurrent with revenue-producing activities, and as a result there is no change in presentation from prior comparative periods. +The following is a description of our principal revenue-generating activities by distribution channel. The Company has three reportable operating segments and sells its products using three primary distribution channels. For more detailed information about reportable operating segments, see Note 15 — Operating Segments and Geographic Information . +Wholesale Channel +For the majority of wholesale customers, control transfers and revenues are recognized when the product is shipped or delivered from a manufacturing facility or distribution center to the wholesale customer. In certain cases, control of the product transfers +F- 24 +Table of Contents +and revenues are recognized when the customer receives the product at the designated delivery point. For certain customers, primarily in the Asia Pacific region, cash payment from customers is required in advance of delivery and revenues are recognized upon the later of cash receipt or delivery of the product. For a small number of customers in the Asia Pacific region, products are sold on consignment and revenues are recognized on a sell-through basis. Wholesale customers are invoiced when products are shipped or delivered. +The Company has arrangements that grant certain wholesale customers exclusive licenses, concurrent with the terms of the related distribution agreements, to use the Company’s intellectual property in exchange for a sales-based royalty. Sales-based royalty revenues are recognized over the terms of the related license agreements as sales are made by the wholesalers. +Retail Channel +The Company transfers control of products and recognizes revenues at Company-operated retail stores at the point of sale, in exchange for cash or other payment, primarily debit or credit card. A portion of the transaction price charged to our customers is variable, primarily due to promotional discounts or allowances, and terms that permit retail customers to exchange or return products for a full refund within a limited period of time. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +E-commerce Channel +In the e-commerce channel, the Company transfers control and recognizes revenues when the product is shipped from the distribution centers. Payment from customers is primarily through debit and credit card and is made at the time the customer order is shipped. +Similar to the retail channel, a portion of the amount of revenue is variable, primarily due to sales returns, discounts, and other promotional allowances offered to our customers. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments are made when the most likely amount of consideration changes. +Contract Liabilities +Contract liabilities consist of advance cash deposits received from wholesale customers to secure product orders in connection with selling seasons, and payments received in advance of delivery. As products are shipped and control transfers, the Company recognizes the deferred revenue in ‘Revenues’ in the consolidated statements of operations. At January 1 and December 31, 2018 , $1.3 million and $1.6 million , respectively, of deferred revenues associated with advance customer deposits were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. Deferred revenues of $2.5 million , including the balance recorded at adoption on January 1, 2018 of $1.3 million , were recognized in revenues during the year ended December 31, 2018 . The deferred revenues at December 31, 2018 are expected to be recognized in revenues during the first quarter of 2019 as products are shipped or delivered. +Refund Liabilities +Refund liabilities, primarily associated with product sales returns, retrospective volume rebates, and early payment discounts are estimated based on an analysis of historical experience, and adjustments to revenues made when the most likely amount of consideration expected changes. At January 1 and December 31, 2018 , $3.4 million and $6.4 million , respectively, of refund liabilities, primarily associated with product returns, were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +11 . SHARE-BASED COMPENSATION +The Company’s share-based compensation awards are issued under the 2015 Equity Incentive Plan (“2015 Plan”) and predecessor plan, the 2007 Equity Incentive Plan (“2007 Plan”). Any awards that expire or are forfeited under the 2007 Plan become available for issuance under the 2015 Plan. The Company accounts for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. As of December 31, 2018 , 2.4 million shares of common stock remained available for future issuance under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +F- 25 +Table of Contents +Share-Based Compensation Expense +Pre-tax share-based compensation expense reported in the Company’s consolidated statements of operations was: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Cost of sales +$ +362 +$ +379 +$ +488 +Selling, general and administrative expenses +12,743 +9,394 +10,199 +Total share-based compensation expense +$ +13,105 +$ +9,773 +$ +10,687 +Stock Option Activity +Stock option activity during the year ended December 31, 2018 was: +Shares +Weighted Average Exercise Price +Weighted Average Contractual Life (Years) +Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2017 +541 +$ +11.00 +5.37 +$ +1,918 +Granted +— +— +Exercised +(152 +) +8.36 +Forfeited or expired +(27 +) +25.09 +Outstanding as of December 31, 2018 +362 +$ +11.05 +5.68 +$ +5,407 +Exercisable at December 31, 2018 +226 +$ +13.40 +4.08 +$ +2,846 +Vested and expected to vest at December 31, 2018 +362 +$ +11.05 +5.68 +$ +5,407 +No stock options were granted during 2018 or 2016. During the year ended December 31, 2017 , stock options were valued using a Black Scholes option pricing model using the following assumptions. +Year Ended December 31, 2017 +Expected volatility +40.7% +Dividend yield +— +Risk-free interest rate +1.76% +Expected life (in years) +4.0 +The weighted average grant date fair value of stock options granted during the year ended December 31, 2017 was approximately $2.37 per share. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2018 , 2017 , and 2016 was $1.7 million , $0.1 million , and $0.5 million , respectively. During the years ended December 31, 2018 , 2017 , and 2016 , the Company received $1.3 million , $0.1 million , and $0.4 million cash in connection with the exercise of stock options. +As of December 31, 2018 , the Company had $0.2 million of total unrecognized share-based compensation expense related to unvested options, which is expected to be amortized over the remaining weighted average period of 1.4 years. +Stock options under the 2015 Plan and 2007 Plan generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years, and expire ten years after the date of grant. +F- 26 +Table of Contents +Restricted Stock Awards and Restricted Stock Units Activity +From time to time, the Company grants RSAs and RSUs. RSAs and RSUs generally vest over three years , depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive a share of common stock upon vesting. RSUs have dividend equivalent rights which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. The Company grants service-condition RSUs, performance-condition RSUs, and market-condition RSUs. +Service-condition RSUs are typically granted on an annual basis and vest over time in three equal annual installments, beginning one year after the grant date. During the years ended December 31, 2018 , 2017 , and 2016 , the Company granted 0.4 million , 1.1 million , and 1.0 million service-condition RSUs, respectively. +Performance-condition RSUs are typically granted on an annual basis and consist of a performance-based and service-based component. The performance targets and vesting conditions for performance-condition RSUs are based on achievement of multiple weighted performance goals. The number of performance-condition RSUs ultimately awarded may be between 0% and 200% , based on performance. These RSUs vest in three equal annual installments beginning one year after the grant date, pending certification of performance achievement by the Compensation Committee and continued service. The fair value of performance-condition awards is based on the closing market price of our common stock on the grant date. Compensation expense, net of forfeitures, is updated for the Company’s expected performance level against performance goals at the end of each reporting period. The Company also periodically grants market-condition RSUs to certain executives. The grant date fair value and derived service period for market-condition RSUs are estimated using a Monte Carlo simulation valuation model. During the years ended December 31, 2018 , 2017 , and 2016 , the Company granted 1.0 million , 1.3 million , and 1.2 million performance- and market-condition RSUs, respectively. +RSA and RSU activity during the year ended December 31, 2018 was: +Restricted Stock Awards (1) +Restricted Stock Units +Shares +Weighted Average Grant Date Fair Value +Shares +Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2017 +17 +$ +6.84 +3,791 +$ +7.99 +Granted +13 +18.61 +1,404 +14.34 +Vested +(24 +) +10.09 +(1,123 +) +8.60 +Forfeited +— +— +(1,320 +) +7.67 +Unvested at December 31, 2018 +6 +$ +18.61 +2,752 +$ +11.58 +(1) Excludes shares granted to members of the Board for annual equity awards. +The weighted average grant date fair value of RSAs granted during the years ended December 31, 2018 , 2017 , and 2016 was $18.61 , $6.84 , and $10.28 per share. RSAs vested during the years ended December 31, 2018 , 2017 , and 2016 consisted entirely of service-based awards. The total grant date fair value of RSAs vested was $0.2 million in each of the years ended December 31, 2018 , 2017 , and 2016 . +As of December 31, 2018 , unrecognized share-based compensation expense for RSAs was $0.1 million , which is expected to amortize over a remaining weighted average period of 0.4 years. +The weighted average grant date fair value of RSUs granted during the years ended December 31, 2018 , 2017 , and 2016 was $14.34 , $6.84 , and $9.16 per share. RSUs vested during the year ended December 31, 2018 consisted of 0.9 million service-condition awards and 0.2 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2017 consisted of 0.7 million service-condition awards and 0.1 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2016 consisted of 0.6 million service-condition awards and less than 0.1 million performance- and market-condition awards. The total grant date fair value of RSUs vested during the years ended December 31, 2018 , 2017 , and 2016 was $9.7 million , $8.3 million and $8.0 million , respectively. +F- 27 +Table of Contents +As of December 31, 2018 , unrecognized share-based compensation expenses for service-condition RSUs were $7.7 million and for performance- and market-condition RSUs were $6.4 million , and are expected to amortize over remaining weighted average periods of 1.3 years and 2.4 years, respectively. +12 . INCOME TAXES +As a result of the Tax Act, we recorded provisional estimates in accordance with SAB 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act , during the year ended December 31, 2017 in relation to the revaluation of our net deferred tax assets at the lower U.S. corporate income tax rate and the additional tax expense associated with the deemed repatriation tax. During the year ended December 31, 2018, we recorded measurement period adjustments related to the provisional estimates. While we consider our accounting for the Tax Act to be complete, we continue to evaluate new guidance and legislation as it is issued. We have not changed our indefinite reinvestment assertion, and we have elected to account for the impact of global intangible low tax income based on the period cost method. +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Income (loss) before taxes: +U.S. +$ +10,088 +$ +(34,406 +) +$ +(55,617 +) +Foreign +55,069 +52,586 +48,404 +Total income (loss) before taxes +$ +65,157 +$ +18,180 +$ +(7,213 +) +Income tax expense: +Current income taxes: +U.S. federal +$ +1,156 +$ +1,383 +$ +49 +U.S. state +246 +127 +126 +Foreign +12,359 +9,525 +9,494 +Total current income taxes +13,761 +11,035 +9,669 +Deferred income taxes: +U.S. federal +276 +1,300 +263 +U.S. state +— +— +— +Foreign +683 +(4,393 +) +(651 +) +Total deferred income taxes +959 +(3,093 +) +(388 +) +Total income tax expense +$ +14,720 +$ +7,942 +$ +9,281 +F- 28 +Table of Contents +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Income tax expense and rate attributable to: +Federal +$ +13,683 +21.0 +% +$ +6,363 +35.0 +% +$ +(2,524 +) +(35.0 +)% +State, net of federal benefit +1,271 +2.0 +% +53 +0.3 +% +(202 +) +(2.8 +)% +Foreign differential +7,630 +11.6 +% +(11,768 +) +(64.7 +)% +(12,624 +) +(175.0 +)% +Enacted changes in tax law +495 +0.8 +% +17,645 +97.1 +% +— +— +% +GILTI, net +3,443 +5.3 +% +— +— +% +— +— +% +Non-deductible / non-taxable items +3,602 +5.5 +% +6,006 +33.0 +% +2,694 +37.4 +% +Change in valuation allowance +(5,304 +) +(8.1 +)% +24,400 +134.2 +% +16,041 +222.4 +% +U.S. tax on foreign earnings +— +— +% +(32,427 +) +(178.4 +)% +23,130 +320.6 +% +Foreign tax credits +(7,709 +) +(11.9 +)% +(7,980 +) +(43.9 +)% +(18,581 +) +(257.6 +)% +Uncertain tax positions +(1,696 +) +(2.6 +)% +1,054 +5.8 +% +19 +0.3 +% +Audit settlements +183 +0.3 +% +354 +1.9 +% +253 +3.5 +% +Share-based compensation +764 +1.2 +% +882 +4.9 +% +2,120 +29.4 +% +Deferred income tax account adjustments +(25 +) +— +% +2,679 +14.7 +% +(842 +) +(11.7 +)% +Other +(1,617 +) +(2.5 +)% +681 +3.8 +% +(203 +) +(2.8 +)% +Effective income tax expense and rate +$ +14,720 +22.6 +% +$ +7,942 +43.7 +% +$ +9,281 +128.7 +% +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We recorded a provisional adjustment to our U.S. deferred income taxes as of December 31, 2017 to reflect the reduction in the U.S. statutory tax rate from 35% to 21% resulting from the Tax Act. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2018 +2017 +(in thousands) +Non-current deferred tax assets: +Share-based compensation expense +$ +2,051 +$ +2,940 +Accruals, reserves, and other expenses +18,734 +20,728 +Net operating loss +37,727 +42,956 +Intangible assets +1,363 +1,620 +Future uncertain tax position offset +654 +498 +Unrealized loss on foreign currency +— +119 +Foreign tax credit +66,321 +67,655 +Other +2,957 +2,792 +Valuation allowance +(113,237 +) +(119,494 +) +Total non-current deferred tax assets +$ +16,570 +$ +19,814 +Non-current deferred tax liabilities: +Intangible assets +$ +(164 +) +$ +— +Property and equipment +(7,332 +) +(9,640 +) +Other +(411 +) +— +Total non-current deferred tax liabilities +$ +(7,907 +) +$ +(9,640 +) +During 2018, valuation allowances on deferred tax assets that are not anticipated to be realized decreased by $6.3 million . The change in the valuation allowance includes $5.3 million related to income tax expense and $1.0 million which does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation +F- 29 +Table of Contents +adjustment. During 2017, additional valuation allowances of $28.6 million were recorded. The change in the 2017 valuation allowance includes $24.4 million related to income tax expense and $4.2 million which does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to changes in cumulative translation adjustment. +Our deferred tax valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss and credit carryforwards from operations in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. Based on this analysis, we have determined that the valuation allowances recorded in each period presented are appropriate. +During 2018, we recorded additional tax loss carryforwards in certain foreign jurisdictions which aggregate to $8.5 million , primarily driven by operational losses recognized based on local statutory accounting requirements. As these carryforwards were generated in jurisdictions where we have historically had book losses or do not have strong future projections related to those operations, we concluded that it was more likely than not that the associated net operating losses would not be realized, and thus recorded a valuation allowance on the majority of the associated deferred tax assets. As of December 31, 2018, the Company maintained a valuation allowance of $113.2 million . +The Company recorded deferred tax assets related to U.S. federal tax carryforwards, including foreign tax credits and net operating losses, which expire at various dates between 2023 and 2038 of $46.6 million and $48.6 million at December 31, 2018 and 2017, respectively. The Company recorded deferred tax assets related to U.S. state tax net operating loss carryforwards which expire at various dates between 2019 and 2038 of $11.1 million and $12.5 million at December 31, 2018 and 2017, respectively. The Company recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2020 and those which do not expire of $47.7 million and $49.9 million as of December 31, 2018 and 2017, respectively. +We annually receive cash from our foreign subsidiaries’ current year earnings. The transition tax in the Tax Act imposed a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. Furthermore, as of December 31, 2018, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Unrecognized tax benefit as of January 1 +$ +6,204 +$ +4,750 +$ +4,957 +Additions in tax positions in prior period +250 +683 +646 +Reductions in tax positions in prior period +(690 +) +— +(634 +) +Additions in tax positions in current period +461 +966 +245 +Settlements +(621 +) +(123 +) +(238 +) +Lapse of statute of limitations +(1,045 +) +(414 +) +(196 +) +Cumulative foreign currency translation adjustment +(48 +) +342 +(30 +) +Unrecognized tax benefit as of December 31 +$ +4,511 +$ +6,204 +$ +4,750 +The Company recorded a net benefit of $1.7 million related to decreases in 2018 unrecognized tax benefits combined with amounts effectively settled under audit. Unrecognized tax benefits as of December 31, 2018 relate to tax years that are currently open under the statute of limitation. The primary impact of uncertain tax positions on the rate reconciliation includes audit settlements, net increases in position changes, and accrued interest expense. +Interest and penalties related to income tax liabilities are included in ‘Income tax expense’ in the consolidated statements of operations. For the years ended December 31, 2018, 2017, and 2016, the Company recorded approximately $0.2 million , $0.2 million , and $0.2 million , respectively, of penalties and interest. During the year ended December 31, 2018, Crocs released $0.2 +F- 30 +Table of Contents +million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $0.6 million , $0.7 million , and $0.6 million , as of December 31, 2018, 2017, and 2016, respectively. +Unrecognized tax benefits of $4.5 million , $6.2 million and $4.8 million as of December 31, 2018, 2017, and 2016, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2018 : +The Netherlands +2005 to 2018 +Canada +2011 to 2018 +Japan +2012 to 2018 +China +2008 to 2018 +Singapore +2014 to 2018 +United States +2010 to 2018 +The Company is currently under audit in Japan and Taiwan. U.S. state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for the Company are generally subject to examination for the years 2013 to 2018. +13 . EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2018 , 2017 , and 2016 were as follows: +Year Ended December 31, +2018 +2017 +2016 +(in thousands, except per share data) +Numerator: +Net loss attributable to common stockholders (1) +$ +(69,216 +) +$ +(5,294 +) +$ +(31,738 +) +Denominator: +Weighted average common shares outstanding - basic and diluted +68,421 +72,255 +73,371 +Net loss per common share: +Basic +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +Diluted +$ +(1.01 +) +$ +(0.07 +) +$ +(0.43 +) +(1) Net loss attributable to common stockholders for the year ended December 31, 2018 reflects the repurchase and conversion of Series A Preferred. +For the years ended December 31, 2018 , 2017 and 2016 , all outstanding shares issued under share-based compensation awards were excluded from the calculation of diluted EPS because the effect was anti-dilutive. For the years ended December 31, 2017 and 2016 , all potentially convertible Series A Preferred shares were excluded from the calculation of diluted EPS because the effect was anti-dilutive. See Note 9 — Equity for additional information regarding the repurchase and conversion of Series A Preferred. +14 . COMMITMENTS AND CONTINGENCIES +Rental Commitments and Contingencies +The Company rents primarily real estate, which includes retail, warehouse, distribution center, and office spaces, under operating leases expiring at various dates through 2033 . Rent expense for leases with escalations or rent holidays is recognized on a straight-line basis over the lease term beginning on the lease inception date. Certain leases also provide for contingent rents, which are generally determined as a percent of sales in excess of specified amounts. A contingent rent liability is recognized together with the corresponding rent expense when specified amounts have been achieved or when the Company determines that achieving the specified amounts during the period is probable. +F- 31 +Table of Contents +Future minimum lease payments under operating leases were: +As of +December 31, 2018 +(in thousands) +2019 +$ +42,455 +2020 +36,299 +2021 +29,714 +2022 +20,721 +2023 +15,334 +Thereafter +54,149 +Total minimum lease payments (1) +$ +198,672 +(1) Includes future minimum lease payments of $25.4 million related to the new distribution center in Dayton, Ohio. +Rent expense under operating leases was as follows: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Minimum rentals (1) +$ +66,049 +$ +78,779 +$ +87,995 +Contingent rentals +14,297 +14,294 +14,596 +Total rent expense +$ +80,346 +$ +93,073 +$ +102,591 +(1) Minimum rentals include all lease payments as well as fixed and variable common area maintenance, parking, and storage fees, which were approximately $9.3 million , $10.0 million , and $10.2 million during the years ended December 31, 2018 , 2017 , and 2016 , respectively. +Purchase Commitments +As of December 31, 2018 and 2017 , the Company had purchase commitments to its third-party manufacturers, primarily for materials and supplies used in the manufacture of the Company’s products, for an aggregate of $ 165.3 million and $122.7 million , respectively. +Other +As of December 31, 2018 , the Company had commitments of $23.1 million related to its investment in the new distribution center in Dayton, Ohio, in addition to the related future minimum lease payments disclosed above. +In January 2019, the Company entered into a lease for its new corporate headquarters and regional office in Broomfield, Colorado. The contractual commitment related to this lease, with payments beginning in March 2020 and continuing through August 2030, is approximately $20.4 million . +The Company is regularly subject to, and is currently undergoing, audits by various tax authorities in the U.S. and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. +During its normal course of business, the Company may make certain indemnities, commitments, and guarantees under which it may be required to make payments in relation to certain matters. The Company cannot determine a range of estimated future payments and has not recorded any liability for such payments in the accompanying consolidated balance sheets. +See Note 16 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +F- 32 +Table of Contents +15 . OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +The Company has three reportable operating segments: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“ EMEA ”). ‘Other businesses’ aggregates insignificant operating segments that do not meet the reportable segment threshold, including company-operated manufacturing operations and corporate operations. +Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. Revenues for ‘Other businesses’ include non-footwear product sales to external customers that are excluded from the measurement of segment operating revenues and income. +Segment performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income (loss) from operations consist of other businesses and unallocated corporate expenses, as well as inter-segment eliminations. The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Revenues: +Americas +$ +520,192 +$ +480,146 +$ +467,006 +Asia Pacific (1) +344,598 +336,073 +355,284 +EMEA (1) +220,270 +206,424 +213,238 +Segment revenues +1,085,060 +1,022,643 +1,035,528 +Other businesses +3,145 +870 +745 +Total consolidated revenues +$ +1,088,205 +$ +1,023,513 +$ +1,036,273 +Income from operations: (2) +Americas (3) +$ +138,940 +$ +96,740 +$ +72,689 +Asia Pacific (1)(4) +82,780 +72,950 +67,077 +EMEA (1)(5) +59,539 +37,185 +34,114 +Segment income from operations +281,259 +206,875 +173,880 +Reconciliation of segment income from operations to income (loss) before income taxes: +Other businesses (6) +(55,583 +) +(22,861 +) +(26,935 +) +Unallocated corporate (2)(7) +(162,732 +) +(166,678 +) +(153,099 +) +Total consolidated income (loss) from operations +62,944 +17,336 +(6,154 +) +Foreign currency gains (losses), net +1,318 +563 +(2,454 +) +Interest income +1,281 +870 +692 +Interest expense +(955 +) +(869 +) +(836 +) +Other income +569 +280 +1,539 +Income (loss) before income taxes +$ +65,157 +$ +18,180 +$ +(7,213 +) +Depreciation and amortization: +Americas +$ +4,640 +$ +5,473 +$ +5,787 +Asia Pacific (8) +2,049 +3,405 +3,974 +EMEA (8) +1,252 +1,937 +2,423 +Total segment depreciation and amortization +7,941 +10,815 +12,184 +Other businesses +5,256 +6,748 +6,830 +Unallocated corporate +16,053 +15,567 +15,029 +Total consolidated depreciation and amortization +$ +29,250 +$ +33,130 +$ +34,043 +(1) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ segment were shifted to the ‘ EMEA ’ segment. The previously reported amounts for revenues and income from operations for the years ended December 31, 2017 and 2016 have also been revised to conform to the current period presentation. See ‘Impacts of segment composition change’ table below for more information. +F- 33 +Table of Contents +(2) In 2018, certain global marketing expenses previously reported within the operating segments are managed and reported within ‘Unallocated corporate and other’. The previously reported amounts for income from operations for the years ended December 31, 2017 and 2016 have been revised to conform to the current year presentation. See ‘Impacts of global marketing expense realignment’ table below for more information. +(3) Includes $0.1 million , $0.5 million , and $1.7 million of asset impairment charges related to 1 , 3 , and 12 underperforming retail locations for the years ended December 31, 2018 , 2017 and 2016 , respectively. +(4) Includes $0.8 million and $0.6 million of asset impairment charges related to 12 and 19 underperforming retail locations for the years ended December 31, 2018 and 2016 , respectively. +(5) Includes less than $0.1 million and $0.4 million of asset impairment charges related to 1 and 11 underperforming retail locations for the years ended December 31, 2017 and 2016 , respectively. Additionally in the year ended December 31, 2016, the Company recorded $0.4 million in impairment charges related to goodwill in our EMEA operating segment. +(6) “Other businesses” increases are primarily due to costs incurred in conjunction with the closure of company-operated manufacturing and distribution facilities, which ceased operations in 2018, increased variable compensation associated with higher revenues, and other expenses as a result of outsourcing, and other supply chain cost changes. +(7) Includes a $4.8 million write-off related to a discontinued project for the year ended December 31, 2017 . Also includes corporate support and administrative functions, costs associated with share-based compensation, research and development, marketing, legal, depreciation and amortization of corporate and other assets not allocated to operating segments, and intersegment eliminations. +(8) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ segment were shifted to the ‘ EMEA ’ segment. The previously reported amounts for depreciation and amortization for the years ended December 31, 2017 and 2016 have also been revised to conform to the current period presentation. See ‘Impacts of segment composition change’ table below for more information. +Impacts of segment composition change: +Year Ended December 31, +2017 +2016 +Increase (Decrease) +(in thousands) +Impacts on revenues: +Asia Pacific +$ +(33,594 +) +$ +(39,794 +) +EMEA +33,594 +39,794 +Impacts on income from operations: +Asia Pacific +(10,166 +) +(13,451 +) +EMEA +10,166 +13,451 +Impacts on depreciation and amortization: +Asia Pacific +(59 +) +(290 +) +EMEA +59 +290 +Impacts of global marketing expense realignment: +Year Ended December 31, +2017 +2016 +Increase (Decrease) +(in thousands) +Impacts on income from operations: +Americas +$ +9,860 +$ +13,845 +Asia Pacific +3,843 +1,621 +EMEA +1,283 +2,906 +Unallocated corporate and other +(14,986 +) +(18,372 +) +F- 34 +Table of Contents +The following table sets forth asset information related to reportable operating segments as of the dates shown: +December 31, +2018 +2017 +(in thousands) +Long-lived assets: +Americas +$ +12,977 +$ +17,129 +Asia Pacific +1,831 +4,171 +EMEA +3,125 +4,609 +Total segment long-lived assets +17,933 +25,909 +Supply Chain +11,996 +17,396 +Corporate and other +39,586 +49,842 +Total long-lived assets +$ +69,515 +$ +93,147 +Total consolidated assets: +Americas +$ +157,016 +$ +158,641 +Asia Pacific (1) +139,679 +144,384 +EMEA (1) +66,021 +93,799 +Total segment assets +362,716 +396,824 +Supply Chain +31,108 +37,793 +Corporate and other +75,077 +109,078 +Total consolidated assets +$ +468,901 +$ +543,695 +(1) In the third quarter of 2018, certain revenues and expenses previously reported within the ‘Asia Pacific’ segment were shifted to the ‘ EMEA ’ segment. The previously reported amount for consolidated assets for the year ended December 31, 2017 has also been revised to conform to the current period presentation. See ‘Impacts of segment composition change’ table below for more information. +Impacts of segment composition change: +Year Ended December 31, +2017 +Increase (Decrease) +(in thousands) +Impacts on consolidated assets: +Asia Pacific +$ +(17,262 +) +EMEA +17,262 +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2018 , 2017 and 2016 . The following table sets forth certain geographical information regarding Crocs’ revenues for the periods as shown: +Year Ended December 31, +2018 +2017 +2016 +(in thousands) +Location: +United States +$ +442,544 +$ +388,847 +$ +384,939 +International (1) +645,661 +634,666 +651,334 +Total revenues +$ +1,088,205 +$ +1,023,513 +$ +1,036,273 +(1) For the year ended December 31, 2016, sales in Japan represented approximately 10.6% of consolidated revenues. +F- 35 +Table of Contents +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2018 +2017 +(in thousands) +Location: +United States +$ +17,489 +$ +23,396 +International +4,722 +11,636 +Total property and equipment, net +$ +22,211 +$ +35,032 +16 . LEGAL PROCEEDINGS +The Company was subjected to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, the Company was notified about the issuance of assessments totaling 14.4 million Brazilian Real (“BRL”), or approximately $3.7 million , plus interest and penalties, for the period January 2010 through May 2011. The Company has disputed these assessments and asserted defenses to the claims. On February 25, 2015, the Company received additional assessments totaling 33.3 million BRL, or approximately $8.6 million , plus interest and penalties, related to the remainder of the audit period. The Company has also disputed these assessments and asserted defenses to these claims in administrative appeals. On August 29, 2017, the Company received a favorable ruling on its appeal of the first assessment, which dismissed all fines, penalties, and interest. The tax authorities have requested a special appeal to that decision. If the appeal is accepted, Crocs will have the opportunity to both defend the appeal as well as challenge it procedurally. Should the Brazilian Tax Authority prevail in this final administrative appeal, Crocs may still challenge the assessments through the court system, which would likely require the posting of a bond. Additionally, the second appeal for the remaining assessments was heard on March 22, 2018. That decision was partially favorable and resulted in an approximately 38% reduction in principal, penalties, and interest, leaving approximately $5.3 million , plus interest and penalties, at risk for those assessments. The tax authorities have appealed that decision. Crocs filed a response to the tax authorities’ appeal as well as a separate appeal against the unfavorable portion of the ruling. We have not recorded these items within the consolidated financial statements as it is not possible at this time to predict the timing or outcome of this matter or to estimate a potential amount of loss, if any. +For all other claims and disputes, the Company has accrued estimated losses of $0.2 million within ‘Accrued expenses and other liabilities’ in its consolidated balance sheet as of December 31, 2018 . Where the Company is able to estimate reasonably possible losses or a range of reasonably possible losses, the Company estimates that as of December 31, 2018 , reasonably possible losses associated with these claims and other disputes are immaterial. +Although the Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, the Company is not party to any other pending legal proceedings that it believes would reasonably have a material adverse impact on its business, financial results, and cash flows. +17 . EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +The Company sponsors a qualified defined contribution benefit plan (the “Plan”), covering substantially all of its U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. The Company makes matching contributions to the plans equal to 100% of the first 3% , and up to 50% of the next 2% of salary contributed by an eligible employee. Participants are vested 100% in the Company’s matching contributions when made. Contributions made by the Company under the Plan were $5.4 million , $5.5 million and $5.8 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. +F- 36 +Table of Contents +18 . UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +March 31, 2018 +June 30, 2018 +September 30, 2018 +December 31, 2018 +(in thousands, except per share data) +Revenues (1) +$ +283,148 +$ +328,004 +$ +261,064 +$ +215,989 +Gross profit +139,873 +181,400 +139,059 +99,822 +Income (loss) from operations +25,922 +37,064 +13,895 +(13,937 +) +Net income (loss) +16,454 +34,377 +10,492 +(10,886 +) +Net income (loss) attributable to common shareholders (2) +12,523 +30,426 +6,520 +(118,685 +) +Basic income (loss) per common share +$ +0.15 +$ +0.37 +$ +0.08 +$ +(1.72 +) +Diluted income (loss) per common share +$ +0.15 +$ +0.35 +$ +0.07 +$ +(1.72 +) +(1) Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter of the year relative to the other quarters. +(2) The balance in ‘Net income (loss) attributable to common shareholders’ for the three months ended December 31, 2018 was impacted by the repurchase and conversion of Series A Convertible Preferred Stock. See Note 9 — Equity and the consolidated statement of operations for more information. +For the Quarter Ended +March 31, 2017 +June 30, 2017 +September 30, 2017 +December 31, 2017 +(in thousands, except per share data) +Revenues (1) +$ +267,907 +$ +313,221 +$ +243,273 +$ +199,112 +Gross profit +133,584 +169,807 +123,463 +90,367 +Income (loss) from operations (2) +15,582 +29,446 +2,685 +(30,377 +) +Net income (loss) +11,010 +21,960 +1,629 +(24,361 +) +Net income (loss) attributable to common shareholders +7,155 +18,086 +(2,263 +) +(28,272 +) +Basic income (loss) per common share +$ +0.08 +$ +0.21 +$ +(0.03 +) +$ +(0.41 +) +Diluted income (loss) per common share +$ +0.08 +$ +0.20 +$ +(0.03 +) +$ +(0.41 +) +(1) Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter of the year relative to the other quarters. +(2) ‘Income (loss) from operations’ for the three months ended December 31, 2017 includes additional charges of $6.3 million related to a non-cash write-off and contract termination fee for a discontinued project. +F- 37 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period +Charged to Costs and Expenses +Deductions (1) +Balance at End of Period +(in thousands) +Year Ended December 31, 2018 +Allowance for doubtful accounts +$ +18,325 +$ +711 +$ +(8,077 +) +$ +10,959 +Reserve for sales returns and allowances +4,983 +71,865 +(74,107 +) +2,741 +Reserve for unapplied rebates +8,081 +8,604 +(9,908 +) +6,777 +Total +$ +31,389 +$ +81,180 +$ +(92,092 +) +$ +20,477 +Year Ended December 31, 2017 +Allowance for doubtful accounts +$ +32,856 +$ +1,235 +$ +(15,766 +) +$ +18,325 +Reserve for sales returns and allowances +6,121 +65,562 +(66,700 +) +4,983 +Reserve for unapplied rebates +9,161 +9,318 +(10,398 +) +8,081 +Total +$ +48,138 +$ +76,115 +$ +(92,864 +) +$ +31,389 +Year Ended December 31, 2016 +Allowance for doubtful accounts +$ +36,368 +$ +6,079 +$ +(9,591 +) +$ +32,856 +Reserve for sales returns and allowances +4,639 +72,995 +(71,513 +) +6,121 +Reserve for unapplied rebates +8,357 +9,036 +(8,232 +) +9,161 +Total +$ +49,364 +$ +88,110 +$ +(89,336 +) +$ +48,138 +(1) Deductions include accounts written off, net of recoveries, and the effects of foreign currency translation, as well as the impact of the adoption of the new revenue recognition guidance on ‘Accounts receivable, net’ on the Company’s consolidated balance sheet, as described in Note 2 — Recent Accounting Pronouncements . +F- 38 \ No newline at end of file diff --git a/raw/filings/0001334036/2018/0001334036-19-000012/filing_metadata.csv b/raw/filings/0001334036/2018/0001334036-19-000012/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..8c1a197ba82f450ca8cb241e886c0af944a5695e --- /dev/null +++ b/raw/filings/0001334036/2018/0001334036-19-000012/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2019-02-28,2018-12-31,2019-02-28T18:08:57.000Z,0001334036-19-000012,crox12311810-k.htm,10-K,12950643,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000133403619000012/crox12311810-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000133403619000012/,2018,2018,1 diff --git a/raw/filings/0001334036/2018/0001334036-19-000012/item1.txt b/raw/filings/0001334036/2018/0001334036-19-000012/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..905f29dd8a149ead67b62352c734ea783e9215a5 --- /dev/null +++ b/raw/filings/0001334036/2018/0001334036-19-000012/item1.txt @@ -0,0 +1,195 @@ +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The Company, a Delaware corporation, is the successor to a Colorado corporation of the same name, and was originally organized in 1999 as a limited liability company. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for men, women and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals, flips and slides, which we collectively refer to as sandals, shoes, and boots that meet the needs of the whole family. In 2018, Crocs reinforced its mission of “everyone comfortable in their own shoes” with the second year of its global Come As You Are™ campaign . +Crocs offers a broad portfolio of all-season products, while remaining true to its core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking and odor-resistant qualities that Crocs fans know and love. Since sales began in 2002, Crocs has sold more than 630 million pairs of shoes in more than 90 countries. +At the heart of our brand’s DNA are our clogs and sandals. The Classic Clog and Crocband, our most iconic silhouette for adults and children, embody our innovation in molding, simplicity of design, and all-day comfort. The unique look and feel of the Classic clog can be experienced throughout the vast majority of our product line due to the use and design of Croslite TM . Sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +We are now using Croslite TM with two new technologies in our LiteRide TM and Reviva TM collections, as we focus on visible comfort technology. LiteRide TM features comfort focused, proprietary foam insoles which are soft, lightweight and resilient, and our newest collection, Reviva TM , features a footbed with built-in air bubbles providing bounce and a massage effect. +We strive to provide our global consumers with comfortable, casual, colorful, and innovative footwear styles, with a focus on molded product. Our collections address many wearing occasions and meet the needs of the entire family. We enjoy licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Sales and Marketing +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. We prioritize five core markets including: (i) the U.S., (ii) Japan, (iii) China, (iv) South Korea and (v) Germany. These countries represent key geographies where we believe the greatest opportunities for growth exist. We are also concentrating our marketing efforts on these countries, in an effort to increase customer awareness of both our brand and our full product range. +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories that allow for personalization. We are expanding our sandal offerings as we pursue a greater share of a large market, with no clear global leader. We are investing in designer and celebrity collaborations and celebrity brand ambassadors to raise consumer engagement with our brand. For the years ended December 31, 2018 , 2017 , and 2016 , total marketing costs, inclusive of advertising, production, promotional, and agency expenses, including variable marketing expenses, were $68.6 million , $59.1 million , and $56.0 million , respectively. +2 +Table of Contents +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 90 countries through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand retailers, e-tailers, and distributors; our retail channel consists of company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2018 , 2017 , and 2016 , 53.1% , 52.4%, and 52.7% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel is made up of e-tailers, distributors, and traditional brick-and-mortar accounts, e-commerce sites operated by wholesalers, and in certain countries, also includes partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements are not met. No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2018 , 2017 , and 2016 . +Retail Channel +During the years ended December 31, 2018 , 2017 , and 2016 , 30.1% , 33.0%, and 34.7%, respectively, of our revenues were derived through our retail channel. We operate through three platforms: company-operated full-price retail and outlet stores, kiosks, and store-in-store locations. With the worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores, and focusing on enhancing the profitability of this channel. In the third quarter of 2018, we completed the store reduction program announced in early 2017 and ended 2018 with 383 company-operated stores, down from 558 at December 31, 2016. During the year ended December 31, 2018 , we closed 68 and opened 4 company-operated stores. +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. We believe the optimal space for our retail stores is between 1,500 and 1,800 square feet, located in high foot-traffic shopping malls or districts. During the year ended December 31, 2018 , we closed 42 and opened 1 full-price retail store. As of December 31, 2018 , 2017 , and 2016 , we operated 120 , 161, and 228 full-price retail stores, respectively. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. Outlet stores are similar in size to our full-price retail stores; however, they are generally located within outlet shopping centers. During the year ended December 31, 2018 , we closed 23 and opened 3 outlet stores. As of December 31, 2018 , 2017 , and 2016 , we operated 195 , 215, and 232 outlet stores, respectively. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot traffic areas. With efficient use of retail space, and limited capital investment, we believe that kiosks and store-in-store locations can be effective vehicles for marketing our products in certain geographic areas. During the year ended December 31, 2018 , we closed 3 kiosk and store-in-store locations, with no new openings. As of December 31, 2018 , 2017 , and 2016 , we operated 68 , 71, and 98 kiosks and store-in-store locations, respectively. +3 +Table of Contents +Company-Operated Retail Stores +The following table illustrates the net change in 2018 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2017 +Opened +Closed/Transferred +December 31, 2018 +Americas +United States +161 +1 +7 +155 +Canada +9 +— +— +9 +Puerto Rico +5 +— +1 +4 +Total Americas +175 +1 +8 +168 +Asia Pacific +Korea +86 +1 +1 +86 +China +42 +2 +16 +28 +Japan +20 +— +6 +14 +Singapore +14 +— +— +14 +Australia +9 +— +— +9 +Hong Kong +15 +— +13 +2 +Total Asia Pacific +186 +3 +36 +153 +EMEA +Russia +36 +— +5 +31 +Germany +15 +— +1 +14 +France +10 +— +2 +8 +Austria +6 +— +— +6 +Netherlands +4 +— +1 +3 +Spain +4 +— +4 +— +Great Britain +3 +— +3 +— +Finland +3 +— +3 +— +Other +5 +— +5 +— +Total EMEA +86 +— +24 +62 +Total +447 +4 +68 +383 +E-commerce Channel +As of December 31, 2018 , we offered our products through 13 company-operated e-commerce sites worldwide and also through third-party marketplaces. During the years ended December 31, 2018 , 2017 , and 2016 , 16.8% , 14.6%, and 12.6%, respectively, of our revenues were derived through this channel. Our e-commerce presence facilitates increased access to our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and EMEA . In the third quarter of 2018, certain revenues and expenses previously reported within the Asia Pacific segment were shifted to the EMEA segment. The previously reported amounts for these segments and channels have been revised for the years ended December 31, 2017 and 2016 to conform to the current period presentation. Other businesses aggregates insignificant operating segments, including company-operated manufacturing facilities located in Mexico and Italy, which ceased operations in 2018. +Americas +The Americas segment consists of revenues and expenses related to product sales in North and South America. Americas wholesale channel customers consist of a broad range of family footwear and sporting goods stores, e-tailers, and independent retailers and distributors. The Americas retail channel sells directly to consumers through 168 company-operated retail stores and Americas e- +4 +Table of Contents +commerce channel sales are generated through company-operated e-commerce sites. During the years ended December 31, 2018 , 2017 , and 2016 , revenues from the Americas segment were 47.8% , 46.9%, and 45.1% of our consolidated revenues, respectively. Revenues from the U.S. were 40.7% , 38.0% , and 37.1% of our consolidated revenues, respectively, for the years ended December 31, 2018 , 2017 , and 2016 . +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related to product sales throughout Asia, Australia, and New Zealand. Asia Pacific wholesale channel customers consist of a broad range of retailers similar to those in the Americas, plus distributors in select markets. We also sell products directly to consumers through 153 company-operated retail stores as well as through company-operated e-commerce sites and third-party marketplaces. During the years ended December 31, 2018 , 2017 , and 2016 , revenues from our Asia Pacific segment were 31.7% , 32.8%, and 34.2% of our consolidated revenues, respectively. +Europe, Middle East, and Africa +The EMEA segment consists of revenues and expenses related to product sales throughout Europe, Russia, the Middle East, and Africa. The EMEA segment wholesale channel customers consist of a broad range of retailers, similar to those in the Americas, plus distributors in select markets. We also sell our products directly to consumers through 62 company-operated retail stores as well as through our e-commerce sites. During the years ended December 31, 2018 , 2017 , and 2016 , revenues from our EMEA segment were 20.2% , 20.2%, and 20.6% of our consolidated revenues, respectively. +Raw Materials +Croslite TM , our proprietary closed-cell resin brand, is the primary material formulation used in the vast majority of our footwear and some of our accessories. Croslite TM is formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties and develop new properties for specific applications. +Croslite TM is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in Croslite TM . In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce Croslite TM products are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using leather, textile fabrics, or other non-Croslite TM materials, such as LiteRide TM . These materials are obtained from a number of third-party sources and we believe these materials are also broadly available. +Sourcing +Our strategy is to maintain a flexible, globally-diversified, low-cost third-party manufacturing capability. Our company-operated production facilities in Mexico and Italy, which had produced less than 15% of our products during each of the past three years, ceased operations in 2018. +We source the remaining footwear production from multiple third-party manufacturers, primarily in Vietnam and China. During the years ended December 31, 2018 , 2017 , and 2016 , our largest third-party manufacturer, operating in both Vietnam and China, produced 44.5%, 41.3%, and 43.2%, respectively, and our second largest third-party manufacturer, operating in Vietnam, produced 21.4%, 19.0%, and 11.5%, respectively, of our footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2018 , we stored our finished goods inventory in company-operated warehouse and distribution and logistics facilities located in the U.S., the Netherlands, and Japan. We also utilized third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2018 , our company-operated warehouse and distribution facilities provided us with 0.7 million square feet, and our third-party operated distribution facilities provided us with 0.2 million square feet. We also ship directly to certain of our wholesale customers from our third-party manufacturers. +5 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering the product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite TM , LiteRide TM , and Reviva TM valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite TM and LiteRide TM , which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting by monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter are typically less than revenues generated during our first three quarters, when the northern hemisphere is experiencing warmer weather. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, but not limited to, the timing of new model introductions, general economic conditions, and consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +A significant portion of orders from our wholesale customers and distributors remain unfilled as of any given date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders, and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules and the timing of product shipments. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and business model differences around the globe, and because backlog is cancelable at any time prior to shipment, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, +6 +Table of Contents +and e-commerce businesses compete with companies including, but not limited to: NIKE Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with footwear retailers such as Genesco, Inc., Macy’s Inc., Dillard’s, Inc., Dick’s Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite TM material, our prices, our product line, and our distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. +Effects of Changes in Exchange Rates on Translated Results of International Subsidiaries +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We are exposed to the risk of gains and losses resulting from changes in international currency exchange rates (“exchange rates”) on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of gains and losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the U.S. Dollar. +We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of operations and the value of our assets and liabilities denominated in foreign currencies. We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of monetary assets and liabilities that are denominated in currencies other than that of our subsidiaries. Changes in the fair value of these forward contracts are recognized in earnings in the period that they occur. +Changes in exchange rates have a direct effect on our reported U.S. Dollar consolidated financial statements because we translate the statements of operations and financial position of our international subsidiaries to U.S. Dollars using current period exchange rates. As a result, comparisons of reported results between reporting periods may be impacted significantly due to changes in the exchange rates used to translate the operating results of our international subsidiaries. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our U.S. Dollar consolidated statements of operations for the years ended December 31, 2018 , 2017 , and 2016 . +Employees +As of December 31, 2018 , we had 3,901 full-time, part-time, and seasonal employees, of which 2,577 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. \ No newline at end of file diff --git a/raw/filings/0001334036/2018/0001334036-19-000012/item13.txt b/raw/filings/0001334036/2018/0001334036-19-000012/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..81b5fb3c1172ec10d6f13e83755a9837426bda4d --- /dev/null +++ b/raw/filings/0001334036/2018/0001334036-19-000012/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2019 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2018 . +47 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2018/0001334036-19-000012/item9a.txt b/raw/filings/0001334036/2018/0001334036-19-000012/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..d3912e4711c4faf462bbf6ac6543941145e6adcd --- /dev/null +++ b/raw/filings/0001334036/2018/0001334036-19-000012/item9a.txt @@ -0,0 +1,27 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures as such item is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2018 , to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting (“ICFR”) as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2018 , based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2018 . +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2018 , as stated in the report which appears herein. +Changes in Internal Control Over Financial Reporting +In the three months ended December 31, 2018 , in order to facilitate our adoption of the new lease accounting standard on January 1, 2019, we implemented internal controls to help ensure we adequately evaluated our lease arrangements and assessed the impact to our financial statements. We are in the process of finalizing the implementation of new software to address the new lease guidance requirements. We expect to continue to implement additional internal controls related to the adoption of this standard in the first quarter of 2019. There have been no other changes during the three months ended December 31, 2018 to our ICFR, as defined in Exchange Act Rule 13a-15(f), that materially affected or are reasonably likely to materially affect our ICFR. +44 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2018, of the Company and our report dated February 28, 2019, expressed an unqualified opinion on those consolidated financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 28, 2019 +45 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2018/0001334036-19-000012/rp_note.txt b/raw/filings/0001334036/2018/0001334036-19-000012/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2018/0001334036-19-000012/rpt_disclosure.txt b/raw/filings/0001334036/2018/0001334036-19-000012/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..7593fb3ffa28b13f2ae933d22f108a672a7f75d6 --- /dev/null +++ b/raw/filings/0001334036/2018/0001334036-19-000012/rpt_disclosure.txt @@ -0,0 +1,20 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Investment Agreement with Blackstone +On January 27, 2014, we issued to the Blackstone Purchasers an aggregate of 200,000 shares of our convertible preferred stock for an aggregate purchase price of $198 million, or $990 per share, pursuant to the Investment Agreement. In connection with the issuance of the convertible preferred stock (the “Closing”) and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2 million and reimbursed Blackstone’s transaction fees and expenses of approximately $4 million. Mr. Ribatt, our former Chief Executive Officer and former member of our Board, was a permitted transferee of Blackstone and purchased 1,000 shares of our convertible preferred stock. On December 5, 2018, we repurchased 100,000 shares of convertible preferred stock from the Blackstone Purchasers and the Blackstone Purchasers converted their remaining shares of convertible preferred stock into an aggregate of 6,896,548 shares of our common stock. +As discussed above under “Proposal 1 - Election of Directors,” the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as the Blackstone Purchasers beneficially own shares of common stock that represent more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. Blackstone currently has the right to designate for nomination one director to our Board. Each of Messrs. Gray and Melwani was previously designated by Blackstone for election to our Board in accordance with the terms of the Investment Agreement. +Pursuant to the Investment Agreement, Blackstone is subject to certain standstill restrictions which generally restrict Blackstone from acquiring more than 25% of our outstanding common stock until the date on which Blackstone is no longer entitled to designate any directors to our Board. Blackstone also has certain preemptive rights and information rights under the Investment Agreement, which are subject to certain conditions. Furthermore, subject to certain exceptions, Blackstone agreed not to transfer the shares of common stock it received in connection with the share repurchase until, and including, the date immediately prior to the first date (the “Lock-Up Release Date”) on which our trading window opens following release of our quarterly report on Form 10-Q to be filed with the SEC for the quarterly period ended June 30, 2019 (but in any event, the Lock-Up Release Date shall be no later than August 12, 2019). +Registration Rights Agreement +In connection with the Closing, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the “Registration Rights Agreement”), pursuant to which we have agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of its shares of common stock. The Registration Rights Agreement contains customary terms and conditions, including certain customary indemnification obligations. +RGIS Services +We receive inventory count services from RGIS, LLC (“RGIS”), an affiliate of Blackstone. During 2018 , we paid RGIS approximately $214,000 for inventory services received. +Optiv, Inc. +We received cyber security and consulting services from Optiv, Inc. (“Optiv”), an affiliate of Blackstone. During 2018 , we paid Optiv approximately $466,000 for such services. +Kronos Incorporated +We received workforce management services from Kronos Incorporated (“Kronos”), an affiliate of Blackstone. During 2018 , we paid Kronos approximately $159,000 for such services. +22 +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. The full Board approved each of the transactions disclosed above. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +23 \ No newline at end of file diff --git a/raw/filings/0001334036/2019/0001334036-20-000010/filing.txt b/raw/filings/0001334036/2019/0001334036-20-000010/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..db013ecbdbc11468e6e92169425bb75ebfcee3f3 --- /dev/null +++ b/raw/filings/0001334036/2019/0001334036-20-000010/filing.txt @@ -0,0 +1,2105 @@ +crox-20191231 +false FY 2019 0001334036 --12-31 — — 0001334036 2019-01-01 2019-12-31 iso4217:USD 0001334036 2019-06-28 xbrli:shares 0001334036 2020-02-20 0001334036 2018-01-01 2018-12-31 0001334036 2017-01-01 2017-12-31 0001334036 us-gaap:RetainedEarningsMember 2019-01-01 2019-12-31 iso4217:USD xbrli:shares 0001334036 2019-12-31 0001334036 2018-12-31 0001334036 us-gaap:CommonStockMember 2016-12-31 0001334036 us-gaap:TreasuryStockMember 2016-12-31 0001334036 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EXCHANGE COMMISSION +Washington, D.C. 20549 +________________________________________________________________________________________________________________________________ +FORM 10-K +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2019 +or +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware 20-2164234 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +7477 East Dry Creek Parkway +Niwot , Colorado 80503 +( 303 ) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: Trading symbol: Name of each exchange on which registered: +Common Stock, par value $0.001 per share CROX The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company or emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. +Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company Emerging growth company +☒ ☐ ☐ ☐ ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 28, 2019 was approximately $ 879.4 million. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock, par value $0.001 per shares, outstanding as of February 20, 2020 was 68,268,347 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2020 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2019. +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding: +• our expectations regarding future trends, selling, general and administrative cost savings, expectations, and performance of our business; +• our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• our expectations about the impact of our strategic plans; and +• our expectations regarding the impact on the business of the coronavirus disease 2019. +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this Annual Report on Form 10-K, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. +i +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2019 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +7 +Item 1B. +Unresolved Staff Comments +19 +Item 2. +Properties +19 +Item 3. +Legal Proceedings +19 +Item 4. +Mine Safety Disclosures +20 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +21 +Item 6. +Selected Financial Data +23 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +25 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +38 +Item 8. +Financial Statements and Supplementary Data +39 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +39 +Item 9A. +Controls and Procedures +39 +Item 9B. +Other Information +41 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +42 +Item 11. +Executive Compensation +42 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +42 +Item 13. +Certain Relationships and Related Transactions and Director Independence +42 +Item 14. +Principal Accounting Fees and Services +42 +PART IV +Item 15. +Exhibits, Financial Statement Schedule +43 +Item 16. +Form 10-K Summary +46 +Signatures +47 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contains Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. Crocs, Inc., a Delaware corporation, is the successor to a Colorado corporation of the same name and was originally organized in 1999 as a limited liability company. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for men, women and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals, wedges, flips and slides, that meet the needs of the whole family. In 2019, Crocs reinforced its mission of “everyone comfortable in their own shoes” with the third year of its global Come As You Are™ campaign. +Crocs offers a broad portfolio of all-season products, while remaining true to its core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking and odor-resistant qualities that Crocs fans know and love. Since sales began in 2002, Crocs has sold more than 700 million pairs of shoes globally. +At the heart of our brand’s DNA are our clogs and sandals. The Classic Clog, our most iconic style for adults and children, embodies our innovation in molding, simplicity of design, and all-day comfort. The unique look and feel of the Classic Clog can be experienced throughout the vast majority of our product line due to the use and design of Croslite TM . Sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +We are now using Croslite TM with new technologies in our LiteRide TM collection, as we focus on visible comfort technology. LiteRide TM features comfort focused, proprietary foam insoles which are soft, lightweight and resilient. +We strive to provide our global consumers with comfortable, casual, colorful, and innovative footwear styles, with a focus on molded product. Our collections address many wearing occasions and meet the needs of the entire family. We enjoy licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Environmental, Social, and Governance Initiatives +As one of the world’s largest footwear companies, we can make a positive global impact on the footwear industry and our planet by committing to transparent, socially conscious, and sustainable business practices. +We are in the process of creating a clear and impactful framework of sustainability initiatives throughout our global business, specifically focusing on our supply chain and product lifecycle. This will include, but is not limited to, examining opportunities in waste reduction, energy usage, materials, and packaging. +At Crocs, we also strive to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards. To this end, we have implemented measures to ensure our supply chain complies with these standards, including the conducting of both scheduled and unannounced social compliance audits. +We also monitor chemicals and substances in our supply chain for compliance with legal and regulatory requirements consistent with our Restricted Substances Policy, and we expect our contracted factories and suppliers to take a proactive stance in eliminating any hazardous substances in the manufacturing of Crocs products. +2 +Table of Contents +At Crocs, we believe that our vision to make “everyone comfortable in their own shoes” starts with our people. To ensure that we remain an employer of choice for the most talented workforce in the footwear industry, we have implemented initiatives across our business and geographies to develop leadership capabilities, enable meaningful professional experiences, offer a compelling employee value proposition, and create a transparent, collaborative culture that embraces all different kinds. We are also committed to an equitable total rewards philosophy and provide high levels of pay transparency in all regions and are proud of our culture of inclusion, which features diversity at all levels. +Sales and Marketing +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. We prioritize five core markets including: (i) the U.S., (ii) Japan, (iii) China, (iv) South Korea, and (v) Germany. These countries represent key geographies where we believe the greatest opportunities for growth exist. We are also concentrating our marketing efforts on these countries, to increase customer awareness of both our brand and our full product range. +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories that allow for personalization. We are expanding our sandal offerings as we pursue a greater share of a large market with no clear global leader. We are continuing to invest in designer, celebrity, and brand collaborations, as well as celebrity brand ambassadors to raise consumer engagement with our brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 85 countries through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand retailers, e-tailers, and distributors; our retail channel consists of company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2019, 2018, and 2017, 53.3%, 53.1%, and 52.4% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors, and in certain countries, partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements are not met. +No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2019, 2018, and 2017. +Retail Channel +During the years ended December 31, 2019, 2018, and 2017, 28.2%, 30.1%, and 33.0%, respectively, of our revenues were derived through our retail channel. We operate our retail channel through three platforms: company-operated full-price retail and outlet stores, kiosks, and store-in-store locations. With the worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2019, we had 367 company-operated stores. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for information on store locations by platform. +3 +Table of Contents +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. We believe the optimal location for our retail stores is in high foot-traffic shopping malls or districts. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. Outlet stores are generally located within outlet shopping centers. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space, and limited capital investment, we believe kiosks and store-in-store locations can be effective vehicles for marketing our products in certain geographic areas. +Company-Operated Retail Stores +The following table illustrates the net change during 2019 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2018 Opened Closed/Transferred December 31, 2019 +Americas +United States 155 1 3 153 +Canada 9 — — 9 +Puerto Rico 4 — 1 3 +Total Americas 168 1 4 165 +Asia Pacific +Korea 86 3 4 85 +China 28 6 11 23 +Japan 14 — 2 12 +Singapore 14 3 — 17 +Australia 9 — 2 7 +Hong Kong 2 — 1 1 +Total Asia Pacific 153 12 20 145 +EMEA +Russia 31 1 2 30 +Germany 14 1 — 15 +France 8 — 2 6 +Austria 6 — 2 4 +The Netherlands 3 — 1 2 +Total EMEA 62 2 7 57 +Total 383 15 31 367 +E-commerce Channel +As of December 31, 2019, we offered our products through 13 company-operated e-commerce sites worldwide and also on third-party marketplaces. During the years ended December 31, 2019, 2018, and 2017, 18.5%, 16.8%, and 14.6%, respectively, of our revenues were derived through this channel. Our e-commerce presence facilitates increased access to our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly +4 +Table of Contents +sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and EMEA. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our operating segments. +Raw Materials +Croslite TM , our proprietary closed-cell resin brand, is the primary material formulation used in the vast majority of our footwear and some of our accessories. Croslite TM is formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties and develop new properties for specific applications. +Croslite TM is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in Croslite TM . In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce Croslite TM products are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using leather, textile fabrics, or other non-Croslite TM materials, such as LiteRide TM . These materials are obtained from a number of third-party sources and we believe these materials are also broadly available. +Sourcing +Our strategy is to maintain a flexible, globally-diversified, low-cost third-party manufacturing capability. We source our footwear production from multiple third-party manufacturers, primarily in Vietnam and China. During the years ended December 31, 2019, 2018, and 2017, our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 38%, 45%, and 41%, respectively, and our second largest third-party manufacturer, primarily operating in Vietnam, produced approximately 21%, 21%, and 19%, respectively, of our footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. See the risk factor “ We depend solely on third-party manufacturers located outside of the U.S.” , included in Item 1A. Risk Factors for information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. During 2019, we moved our U.S. distribution center from Ontario, California to Dayton, Ohio. As of December 31, 2019, we stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S., the Netherlands, and Japan. We also utilized third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2019, our company-operated warehouse and distribution facilities provided us with 1.0 million square feet, and our third-party operated distribution facilities provided us with 0.3 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +5 +Table of Contents +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering the product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite TM , LiteRide TM , and Reviva TM , among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite TM and LiteRide TM , which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting by monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter, when the northern hemisphere is experiencing cooler weather, are typically less than revenues generated during our first three quarters. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, but not limited to, the timing of new model introductions, general economic conditions, and consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +A significant portion of orders from our wholesale customers and distributors remain unfilled as of any given date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules, and the timing of product shipments. Backlog also is affected by the timing of customers’ orders and product availability. Due to these factors and business model differences around the globe, and because backlog is cancelable at any time prior to shipment, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and should not be relied upon. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with footwear retailers such as Genesco, Inc., Macy’s Inc., Dillard’s, Inc., Dick’s Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite TM material, our prices, our product line, and our distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, +6 +Table of Contents +longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. +Employees +As of December 31, 2019, we had 3,803 full-time, part-time, and seasonal employees, of which 2,728 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +ITEM 1A. Risk Factors +You should carefully consider the following risk factors and all other information presented within this Annual Report on Form 10-K. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, access to sources of financing, or stock price. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Because we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for us to predict all risk factors, nor can we assess the impact of all such risk factors on our business. Please also refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K. +Risks Specific to Our Company +Our success depends substantially on the value of our brand; failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs global brand. To be successful in the future, particularly outside of the U.S., where the Crocs global brand is less well-known and perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brand across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be out of style, outdated, or otherwise undesirable. Maintaining, promoting, and growing our brand will depend on our design and marketing efforts, including product innovation and quality, advertising and consumer campaigns, as well as our ability to adapt to a rapidly changing media environment, including our reliance on social media and digital dissemination of advertising campaigns. +In the past, several footwear companies, including ours, have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Consumer demand for our products and our brand equity could also diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. +Adverse publicity about regulatory or legal action against us, or by us, could also damage our reputation and brand image, undermine consumer confidence in us and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Negative claims or publicity involving us, our products or any of our key employees, endorsers, or business partners could materially damage our reputation and brand image, regardless of whether such claims are accurate. Social media, which accelerates and potentially amplifies the scope of negative publicity, can accelerate, and increase the impact of, negative claims. Further, business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brand and adversely impact our business. +7 +Table of Contents +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast geographic demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. We are focusing on our core molded footwear heritage by narrowing our product line with an emphasis on higher margin products, as well as developing innovative new casual lifestyle footwear platforms. +Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to: +• Strengthen our brand globally; +• Focus on relevant geographies and markets, product innovation, and profitable growth, while maintaining demand for our current offerings; +• Effectively manage our company-operated retail stores to meet operational and financial targets at the retail store level; +• Accurately forecast the global demand for our products, consolidate our distribution and supply chain network to leverage resources, simplify our fulfillment process, and deliver product around the globe efficiently; +• Use and protect the Crocs brand and our other intellectual property in new and existing markets and territories; +• Achieve and maintain a strong competitive position in new and existing markets; +• Attract and retain qualified wholesalers and distributors; +• Maintain and enhance our social digital marketing capabilities and digital commerce capabilities; and +• Execute multi-channel advertising, marketing, and social media campaigns to effectively communicate our message directly to our consumers and employees. +While these strategies, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance this will be the case or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +If our online e-commerce sites, or those of our customers, do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites and third-party e-commerce sites. Any failure on our part or third-parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our products could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including unauthorized access and denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results. +We rely heavily on the use of information technology systems and networks across all business functions, as do our business partners. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We rely exclusively on third-party information services providers worldwide for our information technology functions including network, help desk, hardware and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing, and collection of payments. We use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. We also have outsourced a significant portion of work associated with our finance and accounting, human resources, customer service, and other information technology functions to third-party service providers. Despite our current security and cybersecurity measures, our systems and +8 +Table of Contents +those of our third-party service providers may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, and interruption or loss of valuable business data, and we have been subject to, and will continue to be subject to, various third party attacks and phishing scams. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of sales, significant costs for data restoration, the inability to interpret data timely to enhance operations, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks on a daily basis. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers’ or employees’ personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network is breached, it could give rise to unwanted media attention, materially damage our customer relationships, or harm our business, our reputation, and our financial results, which could result in fines or lawsuits. The costs we incur to protect against such information security breaches may materially increase, including increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. Our business partners in our supply chain and customer base also rely significantly on information technology. Despite their existing cybersecurity procedures and controls, if their information systems become compromised, it could, among other things, cause delays in our product fulfillment or reduce our sales, which could harm our business. +In addition, the European Union’s General Data Protection Regulation, the California Consumer Privacy Act, and other similar privacy laws impose additional obligations on companies regarding the handling of personal data and provide certain individual privacy rights to persons whose data is stored. These regulations may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations, and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes and the associated costs may have a material adverse impact on our business and results of operations. +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, and spend substantially more on product marketing than we do. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, launch more extensive or diverse product lines, and more quickly develop new and popular products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Continuing to rationalize our existing product assortment and introducing new products may be difficult and expensive. If we are unable to do so successfully, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully continue to refine our footwear product line, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles and product lines and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a +9 +Table of Contents +material increase in our selling, general and administrative expenses. There can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brand, erode our competitive position, and result in long-term harm to our business and financial results. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting consumer demand. In addition, purchase orders from our wholesale customers are generally subject to rights of cancellation and rescheduling by the wholesaler. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in losses or lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in lower sales, delays in shipments to customers, expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. Excess inventory, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our financial success depends in part on the strength of our relationships with, and the success of, our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributor customers to carry our products. We do not have long-term contracts and sales to our wholesalers and distributors are generally on an order-by-order basis and subject to cancellation and rescheduling. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms, which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses, and reduced cash flows if our collection efforts are unsuccessful. We have recorded material allowances for doubtful accounts in the past and could do so again in the future. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations, and our ability to grow our product line. +Changes in foreign exchange rates, most significantly but not limited to the Euro, Russian Ruble, Japanese Yen, Chinese Yuan, South Korean Won, or other global currencies could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar (“USD”). We are exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of operations and the value of our assets and liabilities denominated in foreign currencies. +Further, our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, product price pressures, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. We pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. In 2019, we experienced a decrease of approximately $11.0 million in our Asia Pacific segment revenues as a result of decreases in the value of Asian currencies relative to the USD, and a decrease of approximately $13.5 million in our EMEA revenues, primarily as a result of decreases in the Euro relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies, adversely impacts our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and, as a result, our forward contracts may not prove effective in reducing our exposures. +10 +Table of Contents +We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. We operate retail stores and sell our products to retailers outside of the U.S. and utilize foreign-based third-party manufacturers. Foreign manufacturing and sales activities are subject to numerous risks including: tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; delays associated with the manufacture, transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to increased security concerns; restrictions on the transfer of funds; restrictions and potential penalties due to privacy laws on the handling and transfer of consumer and other personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; expropriation and nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions; longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; difficulties in enforcing contractual and intellectual property rights; greater risk that our business partners do not comply with our policies and procedures relating to labor, health and safety; and increased accounting and internal control costs. In addition, we are subject to customs laws and regulations with respect to our export and import activity, which are complex and vary within legal jurisdictions in which we operate. We cannot ensure there will be not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. For more information, please see “ We depend solely on third-party manufacturers located outside the U.S. ” and “ Our business relies significantly on the use of information technology. A significant disruption to our operational technology or data security breach could harm our reputation and/or our ability to effectively operate our business .” +In addition, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties; criminal sanctions against us, our officers, or our employees; prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries; and a materially negative effect on our brand and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners, or agents will not violate our policies. +Changes in global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, or other economic factors. If global economic and financial market conditions deteriorate, or remain weak, for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results; +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, cause reduced product orders or product order delays or cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins; +11 +Table of Contents +• If consumer demand for our products declines, we may not be able to profitably operate existing retail stores, due to higher fixed costs of the retail business; +• A decrease in credit available to our wholesale or distributor customers, product suppliers and other service providers, or financial institutions that are counterparties to our credit facility or derivative instruments may result in credit pressures, other financial difficulties, or insolvency for these parties, with a potential adverse impact on our business, our financial results, or our ability to obtain future financing; +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms, which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment of our accounts receivable; and +• If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +Our supply chain and retail sales in China may be materially adversely impacted due to the coronavirus disease 2019 (“COVID-19”) outbreak. +In December 2019, COVID-19 began to impact the population of Wuhan, China. We rely upon the facilities of our third-party manufacturers in China to support our business in China, as well as to export our products throughout the world. We opened six company-operated retail stores in China in 2019. The outbreak has resulted in significant governmental measures being implemented to control the spread of the virus, including, among others, restrictions on manufacturing and the movement of employees in many regions of the country. As a result of COVID-19 and the measures designed to contain the spread of the virus, our third-party manufacturers may not have the materials, capacity, or capability to manufacture our products according to our schedule and specifications. If our third-party manufacturers’ operations are curtailed, we may need to seek alternate manufacturing sources, which may be more expensive. Alternate sources may not be available or may result in delays in shipments to us from our supply chain and subsequently to our customers, each of which would affect our results of operations. While the disruptions and restrictions on the ability to travel, quarantines, and temporary closures of the facilities of our third-party manufacturers and suppliers, as well as general limitations on movement in the region are expected to be temporary, the duration of the production and supply chain disruption, and related financial impact, cannot be estimated at this time. Should the production and distribution closures continue for an extended period of time, the impact on our supply chain in China and globally could have a material adverse effect on our results of operations and cash flows. See “ We depend solely on third-party manufacturers located outside the U.S. ” The COVID-19 outbreak could also delay our release or delivery of new or product offerings or require us to make unexpected changes to such offerings, which may materially adversely affect our business and operating results. Finally, as a result of the governmental restrictions to control the spread of the COVID-19 outbreak, we have experienced, along with wholesale partner stores, store closures and a decrease in consumer traffic in China, which will have a material adverse effect on our results of operations in our Asia Pacific segment. Our operating results could also continue to be adversely affected to the extent that the COVID-19 outbreak harms the Chinese economy in general. In addition, the COVID-19 outbreak could evolve into a worldwide health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our products and materially adversely affect our business, operating results, and financial condition. +Operating company-operated retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location, and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2019, we opened 15 and closed 31 retail stores, and we operated 367 retail stores at December 31, 2019. +Many of our company-operated retail stores are located in shopping malls and outlet malls and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot-traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick and mortar retail to e-commerce channels, which may contribute to declining foot-traffic in company-operated retail locations. Continued reduced customer foot-traffic could reduce sales at our company-operated retail stores, including kiosks and store-in-store locations, or hinder our ability to open retail stores in new markets, including kiosks and store-in-store +12 +Table of Contents +locations, which could in turn negatively affect our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting from an economic slowdown, political, terrorism, social, or military events, natural disasters, public health issues, or otherwise, is likely to adversely affect sales in our existing stores. +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows or the closure of a store could result in impairment of leasehold improvements, impairment of right-of-use assets, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. For example, during 2016, we recorded $2.7 million of impairments related to our retail stores. These impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +We depend solely on third-party manufacturers located outside of the U.S. +All of our footwear products are manufactured by third-party manufacturers, the majority of which are located in Vietnam and China. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity, and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders. During the years ended December 31, 2019, 2018, and 2017, our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 38%, 45%, and 41%, respectively, and our second largest third-party manufacturer, primarily operating in Vietnam, produced approximately 21%, 21%, and 19%, respectively, of our footwear unit volume. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines, or meet our quality standards. +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, changes in governmental policies and the imposition of tariffs, import and export controls, and other barriers. Because we ceased internal manufacturing in 2018, we can no longer offset any interruption or decrease in supply of our products by increasing production in internal manufacturing facilities, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can increase our transportation costs and adversely affect our product margins. +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, increases in labor costs, changes in international trade agreements and tariffs, adverse weather conditions, or public health issues could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. For example, the Trump Administration has instituted trade policies that include the re-negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the U.S., economic sanctions on individuals, corporations, or countries, and other government regulations affecting trade between the U.S. and other countries where we conduct our business. It may be time-consuming and expensive for us to alter our business operations in order to adapt to or comply with any such changes. +Furthermore, as a result of recent policy changes and U.S. government proposals, there may be greater restrictions and economic disincentives on international trade. The tariffs and other changes in U.S. trade policy could trigger retaliatory actions by affected countries, and certain foreign governments have instituted or are considering imposing trade sanctions on certain U.S. goods. For example, in September 2019, the U.S. government placed additional tariffs on certain goods, including footwear, imported from China. Certain products that we sell in the U.S. are manufactured in China. Any further escalation of trade tensions could have a significant, adverse effect on world trade and the world economy. While we are unable to predict whether or how the recently enacted tariffs will impact our business, the imposition of tariffs on items imported by us from +13 +Table of Contents +China could require us to increase prices to our customers or, if unable to do so, result in lowering our gross margin on products sold. Tariffs on footwear imported from China could have a material adverse effect on our business and results of operations. +We, similar to many other companies with overseas operations, import and sell products in other countries besides China that could be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition, and results of operations. +Our third-party manufacturing operations must comply with labor, trade and other laws. Failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental, and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall, which could result in critical media coverage; harm our business, brand, and reputation; and cause us to incur additional costs. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business or results. For more information, please see “ We depend solely on third-party manufacturers located outside the U.S. ” +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite TM and LiteRide TM products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market conditions related to supply and demand for our raw materials. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins, or if we are unable to procure sufficient quantities of the Croslite TM and LiteRide TM materials, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and designs on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brand, our success, and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others intellectual property rights, continued sales of such competing products by third parties could harm our brand or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brand is associated with inferior +14 +Table of Contents +counterfeit reproductions, the integrity and reputation of our brand could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite TM material and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information, and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. A significant portion of our revenues are attributable to footwear styles that are more suitable for fair weather and are derived from sales in the northern hemisphere. We typically experience our highest sales activity during the first three quarters of the calendar year, compared to the fourth quarter, when there is cooler weather in the northern hemisphere. The effects of favorable or unfavorable weather on sales can be significant enough to affect our quarterly results, which could adversely affect our common stock price. Quarterly results may also fluctuate as a result of other factors, including new style introductions, general economic conditions, or changes in consumer preferences. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, expansion of existing businesses or operations, and acquisitions of new businesses, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect, or implementation issues, or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back office systems. We have also moved to a new distribution center in Dayton, Ohio to serve our North American businesses. As our business grows, we may also need to make further investments in business systems and distribution capabilities. Issues in implementing or integrating new business operations and new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, issues with transitioning to or operating our new Dayton distribution center, cost overruns, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations, require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +Failure to continue to obtain or maintain high-quality endorsers of our products could harm our business . +We establish relationships with celebrity endorsers to develop, evaluate, and promote our products, as well as strengthen our brand. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brand visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers associated with our products that harm the public image and reputations of those endorsers could also seriously harm our brand image with consumers and, as a result, could have an adverse effect on our sales and financial condition. +15 +Table of Contents +Our senior revolving credit facility agreement (as amended to date, the “Credit Agreement”) contains financial covenants that require us to maintain certain financial measures and ratios and includes restrictive covenants that limit our ability to take certain actions. A breach of any of those restrictive covenants may cause us to be in default under the Credit Agreement, and our lenders could foreclose on our assets. +Our Credit Agreement requires us to maintain certain financial covenants. A decline in our operating performance could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Credit Agreement. We may not have sufficient funds to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lenders. If we are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Credit Agreement. +The Credit Agreement also contains certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt; sell, lease or transfer our assets; pay dividends on our common stock; make capital expenditures and investments; guarantee debt or obligations; create liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +Changes in the method for determining LIBOR and/or the potential replacement of LIBOR could adversely affect our results of operations. +In July 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. Our Credit Agreement states that, should LIBOR cease to exist or should another rate become widely recognized as the benchmark rate for USD loans, a rate substantially equivalent to the LIBOR rate in effect prior to its replacement, will be used. +At this time, the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions convened by the U.S. Federal Reserve, has recommended the Secured Overnight Financing Rate (“SOFR”) as a more robust reference rate alternative to U.S. Dollar LIBOR. SOFR is calculated based on short-term repurchase agreements, backed by Treasury securities. SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk, as is the case with LIBOR. SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question. +In September 2019, the Financial Accounting Standards Board proposed guidance that would help facilitate the market transition from existing reference rates to alternative rates. However, at this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates, or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere. Uncertainty as to the nature of such potential changes, alternative reference rates, including SOFR, or other reforms may adversely affect the trading market for LIBOR-based securities, including ours. Furthermore, if LIBOR ceases to exist or a replacement rate is used to determine the interest rate on borrowings under our Credit Agreement, our borrowing cost may increase materially. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. +As the future of LIBOR at this time is uncertain, the potential effect of any future changes cannot yet be determined, but may have an adverse impact on our interest expense and, thus, our results of operations. +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S., our business, and financial results +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the U.S. +16 +Table of Contents +Tax Cuts and Jobs Act (the “Tax Act”), could be repatriated without incurring additional U.S. federal income taxes, although some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the U.S. and foreign jurisdictions for prior tax years. Please refer to Note 15 — Commitments and Contingencies and Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details regarding current tax audits. The final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. Recent developments, including U.S. tax reform, the European Commission’s investigations of local country tax authority rulings and whether those rulings comply with European Union rules on state aid, as well as the Organization for Economic Co-operation and Development’s project on Base Erosion and Profit Shifting, continue to change long-standing tax principles. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +We are subject to periodic litigation, which could result in unexpected expenditures of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings, or any future legal proceedings, could have an adverse impact on our business and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear, such as our branded Croslite TM , LiteRide TM , and Reviva TM . Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite TM , our branded proprietary closed-cell resin, is the primary raw material used in the vast majority of our footwear and some of our accessories. Croslite TM is carefully formulated to create soft, durable, extremely lightweight, and water-resistant footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +17 +Table of Contents +We depend on employees across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +Further, our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threats to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing, or manufacturing and selling seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +If our internal controls are ineffective, our operating results and market confidence in our reported financial information could be adversely affected. +Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal controls or if we experience difficulties in their implementation, our business and operating results and market confidence in our reported financial information could be harmed, we could incur significant costs to evaluate and remediate weaknesses, and we could fail to meet our financial reporting obligations. +The existence of a material weakness precludes management from concluding that our internal control over financial reporting is effective and precludes our independent auditors from issuing an unqualified opinion that our internal controls are effective. In addition, a material weakness could cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock. We can make no assurances that we will be able to remediate any future internal control deficiencies timely and in a cost effective manner. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we are unable to satisfactorily remediate future deficiencies or if we discover other deficiencies in our internal control over financial reporting, such deficiencies may lead to misstatements in our financial statements or otherwise negatively impact our business, financial results and reputation. +Extreme weather conditions, natural disasters, or other events outside of our control could negatively impact our operating results and financial condition. +The effects of climate change or natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including damage to our supply chain, manufacturing or distribution centers, retail stores, changes in consumer preferences or spending priorities, energy shortages, and public health issues, could harm or disrupt our operations or the operations of our vendors, other suppliers, or customers, or result in economic instability that may negatively impact our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. +18 +Table of Contents +Risks Specific to Our Capital Stock +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado 80503. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for office, warehouse, and retail, including kiosk and store-in-store, space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, use, and approximate size of our principal properties, and the reportable operating segment are given below. +Location Reportable Operating Segment Use Approximate +Square Feet +Dayton, Ohio Americas Warehouse 555,000 +Dordrecht, the Netherlands (1) +EMEA Warehouse 392,000 +Rotterdam, the Netherlands (1) +EMEA Warehouse 284,000 +Narita, Japan Asia Pacific Warehouse 156,000 +Niwot, Colorado (2) +Americas Corporate headquarters and regional office 98,000 +Broomfield, Colorado (2) +Americas Corporate headquarters and regional office 88,000 +Hoofddorp, the Netherlands EMEA Regional office 29,000 +Singapore Asia Pacific Regional office 17,000 +Westwood, Massachusetts Americas Global commercial center 16,000 +(1) In the fourth quarter of 2019, we entered into a lease agreement for a new distribution center in Dordrecht, the Netherlands, which is expected to replace to our existing distribution center in Rotterdam, the Netherlands in 2021. +(2) We plan to relocate our corporate headquarters from Niwot, Colorado to Broomfield, Colorado in early 2020. +Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operational needs. We also lease 367 retail locations worldwide. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +A discussion of legal matters is found in Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +19 +Table of Contents +ITEM 4. Mine Safety Disclosures +Not applicable. +20 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the Nasdaq Global Select Market under the stock symbol “CROX.” +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the Nasdaq Composite Index and the Dow Jones U.S. Footwear Index from December 31, 2014 through December 31, 2019. The graph assumes an investment of $100.00 on December 31, 2014 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. Footwear Index includes NIKE, Inc., Deckers Outdoor Corporation, Skechers U.S.A., Inc., Steven Madden Ltd., and Wolverine World Wide, Inc. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 75 as of February 20, 2020. +21 +Table of Contents +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements include restrictions on cash dividends paid on our common stock. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to, among other things, our results of operations, financial condition, level of indebtedness, capital requirements, and compliance with covenants under any then-existing financing agreements. +Purchases of Equity Securities by the Issuer +Period Total Number of Shares Purchased Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly +Announced Plans or Programs (1) +Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs (1) +October 1-31, 2019 — $ — — $ 522,333,622 +November 1-30, 2019 394,935 34.73 394,935 508,626,261 +December 1-31, 2019 — — — 508,626,261 +Total 394,935 $ 34.73 394,935 $ 508,626,261 +(1) On February 20, 2018, the Board approved and authorized a program to repurchase up to $500.0 million of our common stock, and on May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $500.0 million of our common stock. As of December 31, 2019, approximately $508.6 million remained available for repurchase under our share repurchase authorization. The number, price, structure and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under our revolving credit facility, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. +22 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five years. The information in this table should be read in conjunction with our consolidated financial statements and accompanying notes presented in Part II - Item 8. Financial Statements and Supplementary Data and Part II - Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operations of this Annual Report on Form 10-K. +Year Ended December 31, +2019 2018 2017 2016 2015 +(in thousands, except per share data) +Revenues $ 1,230,593 $ 1,088,205 $ 1,023,513 $ 1,036,273 $ 1,090,630 +Cost of sales 613,537 528,051 506,292 536,109 579,825 +Gross profit 617,056 560,154 517,221 500,164 510,805 +Gross margin 50.1 % 51.5 % 50.5 % 48.3 % 46.8 % +Selling, general and administrative expenses +488,407 495,028 494,601 503,174 559,095 +Selling, general and administrative expenses as a % of revenues +39.7 % 45.5 % 48.3 % 48.6 % 51.3 % +Restructuring charges (1) +— — — — 8,728 +Asset impairments (2) +— 2,182 5,284 3,144 15,306 +Income (loss) from operations $ 128,649 $ 62,944 $ 17,336 $ (6,154) $ (72,324) +Income (loss) before income taxes $ 119,322 $ 65,157 $ 18,180 $ (7,213) $ (74,744) +Income tax expense (benefit) (175) 14,720 7,942 (9,281) (8,452) +Net income (loss) 119,497 50,437 10,238 (16,494) (83,196) +Dividends on Series A convertible preferred stock (3) +— (108,224) (12,000) (12,000) (11,833) +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature (3) +— (11,429) (3,532) (3,244) (2,978) +Net loss attributable to common stockholders +$ 119,497 $ (69,216) $ (5,294) $ (31,738) $ (98,007) +Net income (loss) per common share: +Basic $ 1.70 $ (1.01) $ (0.07) $ (0.43) $ (1.30) +Diluted $ 1.66 $ (1.01) $ (0.07) $ (0.43) $ (1.30) +Weighted average common shares: +Basic 70,357 68,421 72,255 73,371 75,604 +Diluted 71,771 68,421 72,255 73,371 75,604 +Cash provided by operating activities +$ 89,958 $ 114,162 $ 98,264 $ 39,754 $ 9,698 +Cash used in investing activities (36,236) (10,110) (11,538) (19,856) (18,488) +Cash used in financing activities (4) +(68,638) (148,802) (65,370) (16,443) (101,260) +(1) We commenced a restructuring in July 2014 and concluded in December 2015. +(2) Asset impairments consist of impairments of long-lived assets of retail locations in all years, as well as a $1.3 million write-off of supply chain assets in 2018, a $4.8 million write-off of a discontinued project in 2017, and $0.4 million of goodwill impairment in 2016. +(3) On December 5, 2018, all issued and outstanding shares of Series A Convertible Preferred Stock (“Series A Preferred”) were repurchased in exchange for cash or converted to common stock. As a result, amounts reported for the year ended December 31, 2018 include amounts resulting from the repurchase and conversion, in addition to payments made to induce conversion and accretion of dividend equivalents prior to December 5, 2018. +(4) Cash used in financing activities for the year ended December 31, 2018 reflects the impacts of $183.7 million used to repurchase Series A Preferred in 2018 and $120.0 million of borrowings. Cash used in financing activities also includes approximately $147.2 million, $63.1 million, $50.0 million, and $85.9 million, including commissions, used to repurchase shares of our common stock during 2019, 2018, 2017, and 2015, respectively. We did not repurchase shares in 2016. +23 +Table of Contents +December 31, +2019 2018 2017 2016 2015 +(in thousands) +Cash and cash equivalents $ 108,253 $ 123,367 $ 172,128 $ 147,565 $ 143,341 +Inventories 172,028 124,491 130,347 147,029 168,192 +Working capital (1) +168,159 195,807 268,031 276,335 278,852 +Total assets (1) +738,802 468,901 543,695 566,390 608,020 +Long-term liabilities (1) +349,674 134,102 18,379 17,966 19,294 +Total stockholders’ equity 131,905 150,308 185,865 220,383 245,972 +(1) Prior year amounts have not been recast to reflect adoption of revenue recognition guidance as of January 1, 2018, which impacts ‘Total Assets’, or adoption of new lease guidance as of January 1, 2019, which impacts ‘Working capital’, ‘Total assets’, and ‘Long-term liabilities’. See Note 2 — Recent Accounting Pronouncements of the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information on our adoption of the new lease standard. +24 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “our,” or “us”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contain Croslite TM material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 85 countries, through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand brick-and-mortar retailers, e-tailers, and distributors; our retail channel includes company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party-operated marketplace activity. +Known or Anticipated Trends +Based on our recent operating results and our assessment of the current operating environment, we anticipate certain trends will continue to impact our future operating results: +• Consumer spending preferences continue to shift toward e-commerce and away from brick and mortar stores. This has resulted in continued sales growth in our e-commerce channel, as well as with various e-tail partners in the wholesale channel. +• A cautious purchasing environment may negatively affect customer purchasing trends. +• Foreign exchange rate volatility will continue to impact our reported U.S. Dollar results from our foreign operations. +• Following the reductions in ‘Selling, general and administrative expenses’ (“SG&A”) from our 2017 strategic plan, we continue to see leverage in our SG&A spending, while still investing in our future growth. +• We will incur charges affecting gross margin relating to our new distribution center in the Netherlands. +• We currently expect revenues will be negatively impacted as a result of disruptions to our Asia business from COVID-19 in 2020. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +2019 Financial and Operational Highlights +Revenues were $1,230.6 million for the year ended December 31, 2019, a 13.1% increase compared to the year ended December 31, 2018. The increase in 2019 revenues compared to 2018 revenues was due to the net effects of: (i) higher sales volumes, which increased revenues by $103.0 million, or 9.5%, (ii) higher average selling prices as we increased prices on certain products and reduced discounts and promotions, which increased revenues by $67.2 million, or 6.2%; and (iii) unfavorable changes in exchange rates, which decreased revenues by $27.8 million, or 2.6%. +25 +Table of Contents +The following were significant developments affecting our businesses and capital structure during the year ended December 31, 2019: +• We sold 67.1 million pairs of shoes worldwide, an increase from 59.8 million pairs in 2018. +• Gross margin was 50.1% compared to 51.5% in 2018, a decline of 140 basis points, partially as a result of transition costs associated with relocation of our distribution center in the U.S. in 2019 and our distribution center in the Netherlands, which is expected to replace our existing facility in 2021. Unfavorable changes in foreign exchange rates decreased gross profit by $13.9 million and offset the improvement of further refined product mix, reduced promotional activities, and increased prices on select products. +• SG&A was $488.4 million, a decrease of $6.6 million, or 1.3%, compared to 2018. As a percent of revenues, SG&A improved 580 basis points to 39.7% of revenues. SG&A expense included $2.9 million of non-recurring charges associated with various cost reduction initiatives compared to $21.1 million of non-recurring charges in 2018 associated with the completion of the closure of our company-operated manufacturing and distribution facilities in Mexico and Italy and our SG&A reduction plan, and some prior year charges related to the relocation of our corporate headquarters, which is planned for early 2020. +• Income from operations was $128.6 million for the year ended December 31, 2019 compared to income from operations of $62.9 million for the year ended December 31, 2018. Our operating margin rose to 10.5% compared to 5.8% in 2018. +• Net income attributable to common stockholders was $119.5 million compared to a loss of $69.2 million in 2018, which included charges incurred related to the repurchase and conversion of our Series A Preferred required by GAAP. Diluted net income per common share was $1.66 for the year ended December 31, 2019, compared to a diluted net loss per common share of $1.01 for the year ended December 31, 2018. +• To continue improving the efficiency and profitability of our retail business we closed or transferred to distributors 31 stores in 2019, 48.4% of which were full-priced locations, for a net reduction of 16 company-operated retail stores. Since we began our store reduction program early in 2017, we have closed a net total of 191 stores and reduced our total company-operated store count to 367 from 558 at the end of 2016. The majority of these store closures occurred upon expiration of the leases. We have also placed greater priority on outlet stores, so that they now represent 52.6% of our store base, up from 41.6% at the end of 2016. +• During 2019, we repurchased 6.1 million shares of common stock at an aggregate cost of $147.2 million. +• In November 2019, Blackstone Capital Partners VI L.P. and certain of its permitted transferees sold its remaining 6,899,027 shares of our common stock in an underwritten public offering. +26 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2019 and 2018 +A discussion of our year-to-date comparison between 2019 and 2018 is presented below. A discussion of the changes in our results of operations between the years ended December 31, 2018 and December 31, 2017 has been omitted from this Annual Report on Form 10-K, but may be found in Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 28, 2019, which is available free of charge on the SEC’s website at www.sec.gov and our corporate website (www.crocs.com). +Year Ended December 31, $ Change % Change +2019 2018 2019-2018 2019-2018 +(in thousands, except per share data, margin, and average selling price data) +Revenues $ 1,230,593 $ 1,088,205 $ 142,388 13.1 % +Cost of sales 613,537 528,051 (85,486) (16.2) % +Gross profit 617,056 560,154 56,902 10.2 % +Selling, general and administrative expenses +488,407 495,028 6,621 1.3 % +Asset impairments +— 2,182 2,182 100.0 % +Income from operations +128,649 62,944 65,705 104.4 % +Foreign currency gains (losses), net +(1,323) 1,318 (2,641) (200.4) % +Interest income 601 1,281 (680) (53.1) % +Interest expense (8,636) (955) (7,681) (804.3) % +Other income, net +31 569 (538) (94.6) % +Income before income taxes +119,322 65,157 54,165 83.1 % +Income tax expense (benefit) +(175) 14,720 14,895 101.2 % +Net income +119,497 50,437 69,060 136.9 % +Dividends on Series A convertible preferred stock +— (108,224) 108,224 100.0 % +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature +— (11,429) 11,429 100.0 % +Net income (loss) attributable to common stockholders +$ 119,497 $ (69,216) $ 188,713 272.6 % +Net income (loss) per common share: +Basic $ 1.70 $ (1.01) $ 2.71 268.3 % +Diluted $ 1.66 $ (1.01) $ 2.67 264.4 % +Gross margin (1) +50.1 % 51.5 % (140) bp (2.7) % +Operating margin (1) +10.5 % 5.8 % 470 bp 81.0 % +Selling, general and administrative expenses as a percentage of revenues +39.7 % 45.5 % 580 bp 12.7 % +Footwear unit sales 67,051 59,815 7,236 12.1 % +Average footwear selling price - nominal basis $ 17.81 $ 17.71 $ 0.10 0.6 % +(1) Changes for gross margin and operating margin are shown in basis points (“bp”). +27 +Table of Contents +Revenues by Channel +Year Ended December 31, % Change +Constant +Currency % Change (1) +2019 2018 2019-2018 2019-2018 +(in thousands) +Wholesale: +Americas $ 275,284 $ 216,797 27.0 % 28.3 % +Asia Pacific 207,405 203,110 2.1 % 4.9 % +EMEA 173,480 154,992 11.9 % 18.6 % +Other businesses 58 3,145 (98.2) % (98.2) % +Total wholesale 656,227 578,044 13.5 % 16.8 % +Retail: +Americas 241,694 204,806 18.0 % 18.1 % +Asia Pacific 74,793 87,264 (14.3) % (10.8) % +EMEA 30,875 35,358 (12.7) % (8.8) % +Total retail 347,362 327,428 6.1 % 7.5 % +E-commerce: +Americas 123,537 98,589 25.3 % 25.5 % +Asia Pacific 65,874 54,224 21.5 % 25.6 % +EMEA 37,593 29,920 25.6 % 31.6 % +Total e-commerce 227,004 182,733 24.2 % 26.5 % +Total revenues $ 1,230,593 $ 1,088,205 13.1 % 15.6 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +The primary drivers of the changes in revenues were: +2019 vs. 2018 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Total revenues $ 102,986 9.5 % $ 67,180 6.2 % $ (27,778) (2.6) % $ 142,388 13.1 % +(1) The change due to price is based on the change in average selling price on a constant currency basis (“ASP”). +Revenues. The increase in sales volume was primarily due to increases in the sales volumes of our clog and sandal silhouettes, while the increase in ASP was primarily a result of changes in product mix, reduced promotional activities, and price increases. These changes were partially offset by a decrease due to foreign currency translation, primarily as a result of fluctuations in the Euro, Korean Won, and Chinese Yuan. Increases in e-commerce revenues of 24.2%, as a result of continued focus on digital commerce, and wholesale revenues of 13.5%, as a result of higher sell-through in the Americas and EMEA, were the primary drivers of the overall increase in revenue. Retail revenues increased 6.1%, despite operating a net 16 fewer retail stores compared to the same period last year. +Cost of sales. Cost of sales increased compared to 2018 due to higher sales volume of $65.8 million, or 12.5%, and higher average cost per unit on a constant currency basis (“AUC”), a result of reduced purchasing power related to currency changes, of $33.6 million, or 6.4%. Foreign currency translation resulted in a decrease of $13.9 million, or 2.6%. +Gross profit. Gross margin was 50.1% compared to 51.5% in 2018, driven in part by transition costs associated with the relocation of our distribution centers in the U.S. and the Netherlands and reduced purchasing power related to currency changes, offset in part by better performance from a product mix perspective. Gross profit increased $56.9 million, or 10.2%. Higher unit sales volume drove an increase of approximately $37.2 million, or 6.6%, and ASP, partially offset by higher AUC, led to an increase of $33.6 million, or 6.0%. Foreign currency translation partially offset the gross profit increase by $13.9 million, or 2.5%. +28 +Table of Contents +Selling, general and administrative expenses. SG&A decreased $6.6 million, or 1.3%, during the year ended December 31, 2019 compared to 2018. As a percent of sales, SG&A improved by 580 basis points to 39.7%. The net decrease was in part due to non-recurring charges of $2.9 million in 2019, compared to $21.1 million in 2018. The prior year charges were primarily related to the closure of our company-operated manufacturing and distribution facilities and our SG&A reduction plan, which was completed in 2018. There was also a decrease in facilities expense of $9.0 million, primarily due to the reduction of company-operated retail stores. These decreases were partially offset by an additional investment in marketing of $14.5 million, professional services expenses of $5.3 million and other net expenses of $0.8 million to support revenue growth. +Asset impairment charges. During the year ended December 31, 2019, we incurred no impairment charges. During the year ended December 31, 2018, we incurred $0.9 million in retail asset impairment charges related to certain underperforming retail locations that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores’ assets over their remaining economic lives. In addition, during the year ended December 31, 2018, we incurred charges of $1.3 million associated with the closure of company-operated manufacturing and distribution facilities. +Foreign currency gain (loss), net. Foreign currency gain (loss), net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on foreign currency derivative instruments. During the year ended December 31, 2019, we recognized realized and unrealized net foreign currency losses of $1.3 million compared to net gains of $1.3 million during the year ended December 31, 2018. +Income tax expense (benefit) . During the year ended December 31, 2019, we recognized an income tax benefit of $0.2 million on pre-tax book income of $119.3 million, representing an effective tax rate of (0.1)%, compared to income tax expense of $14.7 million on pre-tax book income of $65.2 million in 2018, which represented an effective tax rate of 22.6%. During the year ended December 31, 2019, we reduced a portion of the valuation allowance recorded against certain deferred tax assets and recognized excess tax benefits related to share-based compensation, resulting in a lower effective tax rate as compared to 2018. Our effective tax rate has varied dramatically in recent years due to differences in our profitability level and relative operating earnings across multiple jurisdictions and was significantly impacted by the change in the valuation allowance. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance, we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. Certain jurisdictions for which we have historically recorded significant valuation allowances now have a sufficient history of sustained profitability as of December 31, 2019. As a result, valuation allowances recorded against deferred tax assets decreased by $34.2 million for the year ended December 31, 2019. +The 2019 impact of changes in valuation allowances to the effective tax rate was a favorable $33.7 million, equating to a 28.2% impact. There is also a $0.5 million reduction of the valuation allowance related to cumulative translation adjustment. We maintain valuation allowances of approximately $79.0 million as of December 31, 2019, which may be reduced in the future depending upon the achieved profitability of certain jurisdictions as well as the magnitude of the profitability. +In 2017, we began operating under a tax holiday in one of our foreign jurisdictions. This tax holiday is in effect through 2022, and may be extended if certain additional requirements are met. The tax holiday is conditional based upon meeting certain employment and investment thresholds. The impact of the tax holiday in 2019 decreased tax expense in that jurisdiction by approximately $0.2 million and had no impact to our reported earnings per diluted share. +29 +Table of Contents +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2019 and 2018. +Year Ended December 31, % Change +Constant +Currency % Change (1) +2019 2018 2019-2018 2019-2018 +(in thousands) +Revenues: +Americas $ 640,515 $ 520,192 23.1 % 23.7 % +Asia Pacific 348,072 344,598 1.0 % 4.2 % +EMEA 241,948 220,270 9.8 % 16.0 % +Segment revenues 1,230,535 1,085,060 13.4 % 16.0 % +Other businesses 58 3,145 (98.2) % (98.2) % +Total consolidated revenues +$ 1,230,593 $ 1,088,205 13.1 % 15.6 % +Income from operations: +Americas $ 204,868 $ 138,940 47.5 % 48.1 % +Asia Pacific 80,645 82,780 (2.6) % 0.5 % +EMEA 70,326 59,539 18.1 % 25.0 % +Segment income from operations +355,839 281,259 26.5 % 29.2 % +Reconciliation of segment income from operations to income (loss) before income taxes: +Other businesses (54,936) (55,583) (1.2) % +Unallocated corporate and other (2) +(172,254) (162,732) 5.9 % +Total consolidated income (loss) from operations +128,649 62,944 104.4 % +Foreign currency transaction gain (loss), net (1,323) 1,318 (200.4) % +Interest income 601 1,281 (53.1) % +Interest expense (8,636) (955) 804.3 % +Other income 31 569 (94.6) % +Income (loss) before income taxes $ 119,322 $ 65,157 83.1 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) “Unallocated corporate and other” includes corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, and depreciation and amortization of corporate and other assets not allocated to operating segments. +The primary drivers of changes in revenues by operating segment were: +2019 vs. 2018 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Segment Revenues: +Americas $ 56,469 10.9 % $ 67,068 12.9 % $ (3,214) (0.6) % $ 120,323 23.1 % +Asia Pacific 13,194 3.8 % 1,305 0.4 % (11,025) (3.2) % 3,474 1.0 % +EMEA 36,410 16.5 % (1,193) (0.5) % (13,539) (6.1) % 21,678 9.8 % +Total segment revenues +$ 106,073 9.8 % $ 67,180 6.2 % $ (27,778) (2.6) % $ 145,475 13.4 % +(1) The change due to price for revenues is based on ASP, as defined earlier in this section. +30 +Table of Contents +Americas +Revenues. The increase in revenues for our Americas segment was primarily due to increased volume, driven by increased demand as consumer affinity for the Crocs brand strengthens, and increased ASP, resulting from positive changes in product mix, reduced promotional activities, and price increases. Overall, wholesale and e-commerce revenues contributed the largest increases of 27.0% and 25.3%, respectively, due to higher sell-through in brick-and-mortar accounts and continued focus on digital commerce. Retail revenues increased 18.0%, despite operating 3 fewer retail stores compared to the same period last year due to increased traffic in our retail locations. +Income from Operations. During the year ended December 31, 2019, income from operations for our Americas segment was $204.9 million, an increase of $65.9 million, or 47.5%. Gross profit for the year ended December 31, 2019 increased $69.9 million, or 24.4%, and gross margin increased 50 basis points to 55.5%, compared to the year ended December 31, 2018. The increase in gross profit was due to the net impact of an increase of $24.4 million, or 8.5%, due to higher unit sales volume and an increase of $47.2 million, or 16.5%, due to increased ASP, partially offset by higher AUC. There was also a decrease of $1.7 million, or 0.6%, from foreign currency translation. +During the year ended December 31, 2019, SG&A for our Americas segment increased by $4.1 million, or 2.8%, compared to 2018. This was primarily due to increases of $3.4 million in compensation expense from hourly wage increases for retail employees and increased commissions to support business growth, $2.7 million in professional services expense from various volume-based services driven primarily by our e-commerce channel, and an additional investment in marketing of $1.7 million to support revenue growth. These increases were partially offset by decreases in facilities expense, primarily related to savings due to the net reduction of 3 stores, and other net expenses of $3.7 million. +Asia Pacific Operating Segment +Revenues. Increases in revenue due to sales volume in the Asia Pacific segment were partially offset by negative foreign currency changes, primarily due to fluctuations in the Korean Won and Chinese Yuan. The increase in revenues for our Asia Pacific segment was primarily due to a 21.5% increase in e-commerce revenues, which were up on a constant currency basis as a result of our focus on digital commerce and opening new marketplaces, partially offset by a 14.3% decrease in retail revenues as a result of 8 fewer company-operated stores. +Income from Operations. During the year ended December 31, 2019, income from operations for our Asia Pacific segment was $80.6 million, a decrease of $2.1 million, or 2.6%. Gross profit for the year ended December 31, 2019 decreased $7.4 million, or 3.8%, and gross margin decreased 270 basis points to 53.4% compared to the year ended December 31, 2018. The decrease in Asia Pacific segment gross profit was due to an increase in our AUC that outpaced the increase in our ASP by $7.7 million, or 4.0%, driven largely by reduced purchasing power related to currency changes, and a decrease of $6.1 million, or 3.1%, from foreign currency translation, partially offset by the net impact of an increase in unit sales volumes of $6.4 million, or 3.3%. +During the year ended December 31, 2019, SG&A for our Asia Pacific segment decreased $4.5 million, or 4.1%, compared to the same period in 2018. This was primarily due to lower facilities expense of $5.5 million from store closures and lower compensation, depreciation, and other expenses of $7.9 million. These were partially offset by an additional investment in marketing of $6.2 million to support revenue growth and increases in other expenses of $2.7 million. +Europe, Middle East, and Africa Operating Segment +Revenues. The increase in revenues for our EMEA segment was primarily due to increased volume driven by increased demand as consumer affinity for the Crocs brand strengthens, partially offset by decreased ASP and decreased foreign currency translation, which resulted from fluctuations in the Euro. E-commerce revenues increased 25.6%, reflecting higher online traffic, and wholesale revenues increased 11.9% as a result of sell-through, which more than offset a decline in retail results of 12.7% as we operated 5 fewer retail stores in the region compared to last year. +Income from Operations. During the year ended December 31, 2019, income from operations for our EMEA segment was $70.3 million, an increase of $10.8 million, or 18.1%. Gross profit for the year ended December 31, 2019 increased $5.4 million, or 4.7%, and gross margin decreased by 250 basis points to 50.2% compared to the year ended December 31, 2018. The increase in our EMEA segment gross profit is from $18.0 million, or 15.5%, of higher volumes, particularly in the wholesale channel, partially offset by a decrease of $5.9 million, or 5.1%, as a result of reduced purchasing power related to currency changes and a decrease of $6.7 million, or 5.8%, from foreign currency translation. +31 +Table of Contents +During the year ended December 31, 2019, SG&A for our EMEA segment decreased $5.4 million, or 9.5%, compared to the same period in 2018. Store closures drove a decrease in facilities expense of $2.4 million, compensation expense decreased $2.3 million, and other expenses, including professional services expense and depreciation expense, decreased $2.6 million. These decreases were partially offset by an additional investment in marketing and other expenses of $1.9 million. +Other Businesses and Unallocated Corporate +During the year ended December 31, 2019, total net costs within ‘Other businesses’ and ‘Unallocated corporate’ increased by $8.9 million, or 4.1%, compared to the same period in 2018. The net increase was in part due to higher net supply chain costs of $11.0 million, an additional investment in marketing of $6.1 million, and net increases other costs, including information technology and professional services expenses, of $5.5 million. These increases were partially offset by a decrease in non-recurring charges of $13.7 million, related to the prior year closure of our company-operated manufacturing and distribution facilities. +Store Locations and Comparable Store Sales +The table below illustrates the overall change in the number of our company-operated retail locations by type of store and reportable operating segment: +December 31, 2018 Opened Closed/Transferred December 31, 2019 +Type: +Outlet stores 195 10 12 193 +Retail stores 120 4 15 109 +Kiosk/store-in- store +68 1 4 65 +Total 383 15 31 367 +Operating segment: +Americas 168 1 4 165 +Asia Pacific 153 12 20 145 +EMEA 62 2 7 57 +Total 383 15 31 367 +Comparable retail store sales and direct-to-consumer comparable store sales by reportable operating segment are as follows: +Constant Currency (1) +Year Ended December 31, +2019 2018 +Comparable retail store sales (2) +Americas 18.8 % 14.0 % +Asia Pacific (2.0) % 4.0 % +EMEA 5.0 % 10.1 % +Global 12.4 % 10.8 % +Constant Currency (1) +Year Ended December 31, +2019 2018 +Direct-to-consumer comparable store sales (includes retail and e-commerce) (2) +Americas 21.0 % 16.7 % +Asia Pacific 5.6 % 8.8 % +EMEA 13.3 % 15.6 % +Global 16.0 % 14.3 % +(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. See the “Use of Non-GAAP Financial Measures” section for additional information. +(2) Comparable store status is determined on a monthly basis. Comparable store sales includes the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed +32 +Table of Contents +stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period. +Liquidity and Capital Resources +Our liquidity position as of December 31, 2019 was: +December 31, 2019 +(in thousands) +Cash and cash equivalents $ 108,253 +Available borrowings 240,400 +As of December 31, 2019, we had $108.3 million in cash and cash equivalents and up to $240.4 million in available borrowings under our Facility (as defined below). We believe that our cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Facility and other financing agreements will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, among other factors, could impact our business and liquidity. +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter, when the northern hemisphere is experiencing cooler weather, are typically less than revenues generated during our first three quarters. Accordingly, cash flows from operating activities during our first quarter are typically lower as we collect on the related fourth quarter customer receivables and as customer receivables and inventories rise in preparation for the Spring/Summer season. Cash flows from operating activities generated during our second and third quarters are generally higher, when the northern hemisphere is experiencing warmer weather. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +As a result of the Tax Act, most of the cash held outside of the U.S. could be repatriated to the U.S. without incurring additional U.S. federal income taxes. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. As of December 31, 2019, we held $78.4 million of our total $108.3 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. None of the $78.4 million could potentially be restricted. If the $78.4 million were to be immediately repatriated to the U.S., no additional U.S. federal income tax expense would be incurred. +Senior Revolving Credit Facility +In July 2019, Crocs, Inc. and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders, which provides for a revolving credit facility of $450.0 million, which can be increased by an additional $150.0 million subject to certain conditions (the “Facility”). Borrowings under the Credit Agreement bear interest at a variable rate based on a domestic base rate, defined as the highest of (i) the Federal Funds open rate, plus 0.25%, (ii) the Prime Rate, and (iii) the Daily LIBOR rate, plus 1%, or at a LIBOR rate, plus an applicable margin ranging from 1.00% to 1.875% based on our leverage ratio. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers, and guaranteed by certain other subsidiaries of the Borrowers. As of December 31, 2019, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2019, the total commitments available from the lenders under the Facility were $450.0 million. At December 31, 2019, we had $205.0 million in outstanding borrowings, which are due when the Facility matures in July 2024, +33 +Table of Contents +and $4.6 million in outstanding letters of credit under the Facility, which reduces amounts available for borrowing under the Facility. As of December 31, 2019 and 2018, we had $240.4 million and $129.4 million, respectively, of available borrowing capacity under the Facility. +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, +$ Change +2019-2018 +2019 2018 +(in thousands) +Cash provided by operating activities $ 89,958 $ 114,162 $ (24,204) +Cash used in investing activities (36,236) (10,110) (26,126) +Cash used in financing activities (68,638) (148,802) 80,164 +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +(569) (4,775) 4,206 +Net change in cash, cash equivalents, and restricted cash $ (15,485) $ (49,525) $ 34,040 +Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted for non-cash items and changes in working capital. Cash provided by operating activities decreased $24.2 million for the year ended December 31, 2019 compared to the year ended December 31, 2018. This change was in part driven by higher net income adjusted for non-cash items of $99.1 million, offset by changes in operating assets and liabilities of $123.3 million. The change in operating assets and liabilities was primarily a result of higher inventories associated with higher revenues, higher prepaid expenses, in part related to celebrity endorsement agreements and certain information technology expenditures, and changes in income taxes. +Investing Activities. The $26.1 million increase in cash used in investing activities for the year ended December 31, 2019 compared to the year ended December 31, 2018 is primarily due to higher net capital asset expenditures related to the opening of our new distribution center in Dayton, Ohio. +Financing Activities. The $80.2 million decrease in cash used in financing activities for the year ended December 31, 2019 compared to the year ended December 31, 2018 resulted primarily from the net impact of the 2018 repurchase of outstanding Series A Preferred for $183.7 million, the related inducement payment of $12.0 million, and the reduction in cash dividends paid on Series A Preferred of $9.0 million, all of which were partially offset by the $3.0 million final inducement payment made in 2019. These decreases in cash used were partially offset by a $84.1 million increase in repurchases of our common stock, as detailed below, and a $34.3 million reduction in net borrowings against the Facility. There were other uses of cash in financing activities of $3.1 million, primarily due to costs associated with amending the Credit Agreement and other fees. +Stock Repurchases +On February 20, 2018, the Board of Directors approved and authorized a program to repurchase up to $500.0 million of our common stock, and on May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $500.0 million of our common stock. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under our revolving credit facility, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. +We repurchased 6.1 million shares of our common stock at a cost of $147.2 million, including commissions, and 3.6 million shares of our common stock at a cost of $63.1 million, including commissions, during the years ended December 31, 2019 and 2018, respectively. See Note 10 — Equity in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information on our repurchases and repurchase authorizations. +Series A Convertible Preferred Stock Repurchase +On December 5, 2018, pursuant to the terms of a Share Repurchase Agreement among us and holders of the Series A Preferred (i) we repurchased from the holders of the Series A Preferred, 100,000 shares of Series A Preferred with a carrying value of +34 +Table of Contents +$100.0 million for an aggregate cash payment of $183.7 million, (ii) the holders of the Series A Preferred converted the remaining 100,000 shares of Series A Preferred that they owned into 6,896,548 shares of common stock, and (iii) we paid to the holders of the Series A Preferred an aggregate cash payment of $15.0 million to induce conversion, of which $12.0 million was paid at closing, with the remaining $3.0 million paid in January 2019. +Off-Balance Sheet Arrangements +We had no material off-balance sheet arrangements as of December 31, 2019, other than certain purchase commitments, which are described in Note 15 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Contractual Obligations +The following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2019: +Total Less than +1 Year 1 - 3 Years 3 - 5 Years More than +5 Years +(in thousands) +Operating lease obligations (1) +$ 220,346 $ 52,434 $ 80,745 $ 38,171 $ 48,996 +Inventory purchase obligations with third-party manufacturers (2) +155,513 155,513 — — — +Other contracts (3) +79,707 19,714 22,410 11,864 25,719 +Minimum licensing royalties (4) +914 879 35 — — +Debt obligations (5) +205,000 — — 205,000 — +Interest on debt obligations (6) +30,851 6,765 13,494 10,592 — +Total $ 692,331 $ 235,305 $ 116,684 $ 265,627 $ 74,715 +(1) Our operating lease obligations consist of leases for real estate, which includes retail, warehouse, distribution center, and office spaces, expiring at various dates through 2033. This balance represents the minimum cash commitment under contract to various third parties for operating lease obligations. +(2) Our inventory purchase obligations with third-party manufacturers consist of open purchase orders for footwear products and include an immaterial amount of purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third-party manufacturers are expected to be paid within one year. +(3) Other contracts include $20.4 million of future lease commitments and $4.7 million of net other commitments related to our new corporate headquarters in Broomfield, Colorado and $24.6 million of future lease commitments related to our new distribution center in Dordrecht, the Netherlands. +(4) Our minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our footwear and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for future periods. +(5) Our debt obligations consist of long-term borrowings on our Facility, maturing in July 2024. +(6) Future interest payment obligations, which are estimated by assuming the amounts outstanding under our Facility and the interest rates in effect as of December 31, 2019, will remain constant into the future. This is only an estimate, as actual amounts borrowed and rates will vary over time, based on a domestic base rate or LIBOR rate, as described in the “Senior Revolving Credit Facility” section. +Excluded from the table above is a $4.2 million liability for unrecognized tax benefits as of December 31, 2019, as we cannot make a reliable estimate of the period in which the liability will be settled, if ever. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and non-GAAP financial measures, is based on the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often +35 +Table of Contents +based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Reserves for Uncollectible Accounts Receivable, Sales Returns, Allowances, Discounts, and Rebates +We make ongoing estimates related to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability or unwillingness of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events, and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge, respectively, to ‘Selling, general and administrative expenses’ in our consolidated statement of operations in the period in which we made such a determination. +Additionally, a significant area of judgment affecting reported revenues and net income involves estimating reserves for sales returns, allowances, discounts, and rebates, which represent the portion of revenues not expected to be realized. Wholesale revenues are reduced by estimates of returns, allowances, discounts, contractual discounts to major customers, and rebates. We also may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments, and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Further, we record reductions to revenues for estimated customer credits as a result of price markdowns in certain markets. Revenues in our retail and e-commerce channels are also reduced by an estimate of returns. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns, allowances, discounts, and rebates may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances, discounts, and rebates have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns, allowances, discounts, and rebates as of December 31, 2019 would have decreased our 2019 revenues by approximately $0.1 million. +See Schedule II in Part IV - Item 15. Exhibits, Financial Statement Schedule to the accompanying consolidated financial statements for an analysis of the activity in our reserves for uncollectible accounts receivable, sales returns, allowances, and discounts. +Impairment of Long-Lived Assets +Property and equipment along with other long-lived assets are evaluated for impairment periodically whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. Testing of long-lived assets for impairment is at the level of an asset group, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or +36 +Table of Contents +significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +During 2019, we did not record any impairment charges. During 2018, and 2017, we recorded non-cash impairment of $2.2 million and $5.3 million, respectively, to reduce the net carrying value of certain long-lived assets to their estimated fair values, including $1.3 million to reduce the carrying values of certain supply chain assets related to the closure of our Mexico and Italy manufacturing and distribution facilities in 2018 and $4.8 million write-off for a discontinued project in 2017. During 2018 and 2017, we recorded non-cash impairment of $0.9 million and $0.5 million, respectively, related to underperforming company-operated retail stores. See Note 3 — Property and Equipment, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +Income Taxes +As a result of the Tax Act, we recorded provisional estimates in accordance with GAAP, during 2017 in relation to the revaluation of our net deferred tax assets at the lower U.S. corporate income tax rate and the additional tax expense associated with the deemed repatriation tax. During the year ended December 31, 2018, we recorded measurement period adjustments related to the provisional estimates. We have not changed our indefinite reinvestment assertion, and we have elected to account for the impact of global intangible low tax income (“GILTI”) based on the period cost method. While we consider our accounting for the Tax Act to be complete, we continue to evaluate new guidance and legislation as it is issued. +We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of GILTI as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense (benefit)’ line in the accompanying consolidated statements of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-U.S. subsidiaries as of December 31, 2019, which are considered to be indefinitely reinvested outside of the U.S. +See Note 13 — Income Taxes in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements, and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +37 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Facility and certain financial instruments. +Borrowings under our Facility bear interest at a variable rate based on a domestic base rate or a LIBOR rate, plus an applicable margin, and are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control. See the risk factor “ Changes in the method for determining LIBOR and/or the potential replacement of LIBOR could adversely affect our results of operations” , included in Part I - Item 1A. Risk Factors for further information on risks related to our interest rate. +As of December 31, 2019, we had $205.0 million in outstanding borrowings and $4.6 million in outstanding letters of credit under our Facility. As of December 31, 2018, we had $120.0 million in outstanding borrowings and $0.6 million in outstanding letters of credit under our Facility. +A hypothetical increase of 1% in the interest rate on these borrowings would have increased interest expense by $2.1 million for the year ended December 31, 2019. +Foreign Currency Exchange Risk +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates in effect at the time such exchange rates are used to translate the operating results of our international subsidiaries. +An increase of 1% of the value of the USD relative to foreign currencies would have decreased our income before taxes during the year ended December 31, 2019 by approximately $0.8 million, excluding the impact on our purchasing power. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. +We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur. As of December 31, 2019, the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $134.3 million. The net fair value of these contracts at December 31, 2019 was an asset of $0.1 million. See Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for a discussion of risks to our business and financial results associated with foreign currencies. +We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of December 31, 2019, a 10% appreciation in the value of the USD would result in a net decrease in the fair value of our derivative portfolio of approximately $3.1 million. +See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statement of operations for the years ended December 31, 2019 and 2018. +38 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2019, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2019, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2019. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2019, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +39 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated February 27, 2020, expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company’s adoption of a new accounting standard. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “ Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 27, 2020 +40 +Table of Contents +ITEM 9B. Other Information +None. +41 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2020 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2019. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our code of ethics is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, that code for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our code of ethics as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2020 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2019. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2020 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2019, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 2.0 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2019. +Plan Category +Number of +Securities to be Issued +on Exercise of +Outstanding +Options, Warrants, and Rights (1) +Weighted Average +Exercise Price of +Outstanding +Options, Warrants, and Rights (2) +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders (3) +2,003,022 $ 10.45 2,359,145 +Equity compensation plans not approved by stockholders +— — — +Total 2,003,022 $ 10.45 2,359,145 +(1) The number of shares outstanding includes restricted stock awards and restricted stock units that were outstanding on December 31, 2019 and assumes target performance for performance-based equity awards. +(2) The weighted average exercise price of outstanding options pertains to 0.3 million shares issuable on the exercise of outstanding options. +(3) On June 8, 2015, our stockholders approved the Crocs, Inc. 2015 Equity Incentive Plan (the “Plan”). The number of shares available for issuance under the Plan (subject to changes in capitalization) as of its date of adoption consisted of (i) 7.0 million newly available shares; (ii) 1.2 million shares available for issuance under the 2007 Plan as of June 8, 2015; and (iii) 2007 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 8, 2015. The Plan provides for the grant of incentive and non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, and other share-based awards. The Plan became effective immediately upon stockholder approval. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2020 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2019. +ITEM 14. Principal Accounting Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2020 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2019. +42 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedule +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedule +The following consolidated financial statement schedule of Crocs Inc. and its subsidiaries is filed as a part of this report: +• Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +43 +Table of Contents +(3) Exhibit list +Exhibit +Number Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +4.2 † +Description of Registrant's Securities. +10.1 * +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.’s Annual Report on Form 10-K, filed on March 17, 2009). +10.2 * +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the “2007 Plan”) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.3 * +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.4 * +Form of Non-Statutory Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.5 * +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.6 * +Form of Restricted Stock Unit Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.7 * +Crocs, Inc. 2008 Cash Incentive Plan (As Amended and Restated) (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 7, 2017). +10.8 * +Crocs, Inc. 2015 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +10.9 * +Andrew Rees Performance-Vested Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 13, 2018). +10.10 +Second Amended and Restated Credit Agreement, dated July 26, 2019, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole book runner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent , and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc. ’ s Quarterly Report on Form 10-Q, filed August 1, 2019). +10.11 * +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on October 4, 2018). +44 +Table of Contents +Exhibit +Number Description +10.12 * +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.13 * +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +10.14 * +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.15 * +Employment Offer Letter, dated August 1, 2018, between Crocs, Inc. and Anne Mehlman (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2018). +21 † +Subsidiaries of the registrant. +23.1 † +Consent of Deloitte & Touche LLP. +31.1 † +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 † +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 + +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS † XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH † XBRL Taxonomy Extension Schema Document +101.CAL † XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF † XBRL Taxonomy Extension Definition Linkbase Document +101.LAB † XBRL Taxonomy Extension Label Linkbase Document +101.PRE † XBRL Taxonomy Extension Presentation Linkbase Document +104 Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101). +* Compensatory plan or arrangement. +† Filed herewith. ++ Furnished herewith. +45 +Table of Contents +Item 16. Form 10–K Summary. +None. +46 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 27, 2020. +CROCS, INC. +a Delaware Corporation +By: /s/ ANDREW REES +Name: Andrew Rees +Title: President and Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ ANDREW REES President, Chief Executive Officer, and Director (Principal Executive Officer) February 27, 2020 +Andrew Rees +/s/ ANNE MEHLMAN Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 27, 2020 +Anne Mehlman +/s/ THOMAS J. SMACH Chairman of the Board February 27, 2020 +Thomas J. Smach +/s/ IAN M. BICKLEY Director February 27, 2020 +Ian M. Bickley +/s/ RONALD L. FRASCH Director February 27, 2020 +Ronald L. Frasch +/s/ WILLIAM GRAY Director February 27, 2020 +William Gray +/s/ BETH J. KAPLAN Director February 27, 2020 +Beth J. Kaplan +/s/ PRAKASH A. MELWANI Director February 27, 2020 +Prakash A. Melwani +/s/ DOUGLAS J. TREFF Director February 27, 2020 +Douglas J. Treff +/s/ DOREEN A. WRIGHT Director February 27, 2020 +Doreen A. Wright +47 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F- 2 +Consolidated Statements of Operations for the Years Ended December 31, 2019, 2018, and 2017 +F- 4 +Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2019, 2018, and 2017 +F- 5 +Consolidated Balance Sheets as of December 31, 2019 and 2018 +F- 6 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2019, 2018, and 2017 +F- 7 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2019, 2018, and 2017 +F- 8 +Notes to Consolidated Financial Statements +F- 9 +Schedule II: Valuation and Qualifying Accounts +F- 36 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2020, expressed an unqualified opinion on the Company’s internal control over financial reporting. +Change in Accounting Principle +As discussed in Notes 2 and 6 to the consolidated financial statements, effective January 1, 2019, the Company adopted FASB ASC Topic 842, Leases, using the modified retrospective transition approach. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Income Taxes — Realizability of Deferred Tax Assets — Refer to Note 13 to the consolidated financial statements +Critical Audit Matter Description +The Company recognizes deferred income taxes for tax attributes and for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the deferred tax liability or asset is expected to be settled or realized. A valuation allowance is provided to offset deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Future realization of deferred tax assets depends on the existence of sufficient taxable income of the appropriate character. Sources of taxable income +F- 2 +Table of Contents +considered in the evaluation of deferred tax asset realization include future reversals of deferred tax assets and liabilities, expected future taxable income, taxable income in prior carryback years if permitted under the tax law, and tax planning strategies. Management has recorded valuation allowances for those deferred tax assets not expected to be realized. As the Company has achieved a sufficient history of sustained profitability, including taxable income in appropriate jurisdictions, a portion of the valuation allowance was reduced by $34.2 million during the year ended December 31, 2019. The Company maintains valuation allowances of $79.0 million as of December 31, 2019 for deferred tax assets not expected to be realized in the future. +We identified management’s determination that it is more likely than not that sufficient taxable income will be generated in the future to realize deferred tax assets as a critical audit matter because of the significant judgments and estimates management makes related to taxable income across multiple jurisdictions. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our income tax specialists, when performing audit procedures to evaluate the reasonableness of management’s estimates of taxable income. +How the Critical Audit Matter Was Addressed in the Audit +Our audit procedures related to the determination that it is more likely than not that certain of the Company’s deferred tax assets will be realized included the following, among others: +• We tested the effectiveness of controls over deferred tax assets, including management’s controls over the estimates of taxable income and the determination of whether it is more likely than not that the deferred tax assets will be realized. +• We evaluated the reasonableness of the methods, assumptions, and judgments used by management to determine whether a deferred tax asset would be realized in the future. +• With the assistance of our income tax specialists, we evaluated whether the sources of management’s estimated taxable income were of the appropriate character and sufficient to utilize the deferred tax assets under the relevant tax law. +• We evaluated management’s ability to accurately estimate taxable income by comparing actual results to management’s historical estimates and evaluating whether there have been any changes that would affect management’s ability to continue accurately estimating taxable income. +• We tested the reasonableness of management’s estimates of taxable income by comparing the estimates to: +– Expiration dates or carryforward periods of tax attributes. +– Available and intended tax planning strategies. +– Internal budgets. +– Internal communications to management and the Board of Directors. +– Forecasted information included in Company press releases as well as in analyst and industry reports for the Company and certain of its peer companies. +– Management’s history of carrying out its stated plans and its ability to carry out its plans considering contractual commitments, available financing, or debt covenants. +• We evaluated whether the estimates of future taxable income were consistent with evidence obtained in other areas of the audit. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 27, 2020 +We have served as the Company’s auditor since 2005. +F- 3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Year Ended December 31, +2019 2018 2017 +Revenues +$ 1,230,593 $ 1,088,205 $ 1,023,513 +Cost of sales +613,537 528,051 506,292 +Gross profit +617,056 560,154 517,221 +Selling, general and administrative expenses +488,407 495,028 494,601 +Asset impairments +— 2,182 5,284 +Income from operations +128,649 62,944 17,336 +Foreign currency gains (losses), net +( 1,323 ) 1,318 563 +Interest income +601 1,281 870 +Interest expense +( 8,636 ) ( 955 ) ( 869 ) +Other income, net +31 569 280 +Income before income taxes +119,322 65,157 18,180 +Income tax expense (benefit) +( 175 ) 14,720 7,942 +Net income +119,497 50,437 10,238 +Dividends on Series A convertible preferred stock (1) +— ( 108,224 ) ( 12,000 ) +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature (1) +— ( 11,429 ) ( 3,532 ) +Net income (loss) attributable to common stockholders +$ 119,497 $ ( 69,216 ) $ ( 5,294 ) +Net income (loss) per common share: +Basic +$ 1.70 $ ( 1.01 ) $ ( 0.07 ) +Diluted +$ 1.66 $ ( 1.01 ) $ ( 0.07 ) +Weighted average common shares outstanding: +Basic +70,357 68,421 72,255 +Diluted +71,771 68,421 72,255 +(1) On December 5, 2018, all issued and outstanding shares of Series A Convertible Preferred Stock were repurchased in exchange for cash or converted to common stock. As a result, amounts reported for the year ended December 31, 2018, include amounts resulting from the repurchase and conversion, in addition to dividends, payments to induce conversion, and accretion of dividend equivalents prior to December 5, 2018. +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(in thousands) +Year Ended December 31, +2019 2018 2017 +Net income +$ 119,497 $ 50,437 $ 10,238 +Other comprehensive income: +Foreign currency gains (losses), net +( 3,659 ) ( 6,846 ) 12,202 +Reclassification of foreign currency translation loss to income (1) +( 68 ) ( 4,412 ) — +Total comprehensive income +$ 115,770 $ 39,179 $ 22,440 +(1) Represents the reclassification of cumulative foreign currency translation adjustment upon liquidation of foreign subsidiaries during the year ended December 31, 2019 and upon closure of manufacturing operations during the year ended December 31, 2018, both of which are presented within ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2019 2018 +ASSETS +Current assets: +Cash and cash equivalents +$ 108,253 $ 123,367 +Accounts receivable, net of allowances of $ 18,797 and $ 20,477 , respectively +108,199 97,627 +Inventories +172,028 124,491 +Income taxes receivable +1,341 3,041 +Other receivables +8,711 7,703 +Restricted cash — current +1,500 1,946 +Prepaid expenses and other assets +25,350 22,123 +Total current assets +425,382 380,298 +Property and equipment, net +47,405 22,211 +Intangible assets, net +47,095 45,690 +Goodwill +1,578 1,614 +Deferred tax assets, net +24,747 8,663 +Restricted cash +2,292 2,217 +Right-of-use assets +182,228 — +Other assets +8,075 8,208 +Total assets +$ 738,802 $ 468,901 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ 95,754 $ 77,231 +Accrued expenses and other liabilities +108,677 102,171 +Income taxes payable +4,207 5,089 +Current operating lease liabilities +48,585 — +Total current liabilities +257,223 184,491 +Long-term income taxes payable +4,522 4,656 +Long-term borrowings +205,000 120,000 +Long-term operating lease liabilities +140,148 — +Other liabilities +4 9,446 +Total liabilities +606,897 318,593 +Commitments and contingencies +Stockholders’ equity: +Common stock, par value $ 0.001 per share, 104.0 million and 103.0 million issued, 68.2 million and 73.3 million shares outstanding, respectively +104 103 +Treasury stock, at cost, 35.8 million and 29.7 million shares, respectively +( 546,208 ) ( 397,491 ) +Additional paid-in capital +495,903 481,133 +Retained earnings +240,485 121,215 +Accumulated other comprehensive loss +( 58,379 ) ( 54,652 ) +Total stockholders’ equity +131,905 150,308 +Total liabilities and stockholders’ equity +$ 738,802 $ 468,901 +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock Treasury Stock Additional +Paid-in +Capital Retained +Earnings +Accumulated +Other +Comprehensive +(Loss) +Total +Stock-holders' +Equity +Shares Amount Shares Amount +Balance at December 31, 2016 +73,600 $ 94 20,287 $ ( 284,237 ) $ 364,397 $ 195,725 $ ( 55,596 ) $ 220,383 +Share-based compensation — — — — 11,619 — — 11,619 +Exercises of stock options and issuance of restricted stock awards +850 1 41 ( 75 ) ( 2,971 ) — — ( 3,045 ) +Repurchases of common stock ( 5,659 ) — 5,659 ( 50,000 ) — — — ( 50,000 ) +Series A preferred dividends — — — — — ( 12,000 ) — ( 12,000 ) +Series A preferred accretion — — — — — ( 3,532 ) — ( 3,532 ) +Net income +— — — — — 10,238 — 10,238 +Other comprehensive income +— — — — — — 12,202 12,202 +Balance at December 31, 2017 +68,791 $ 95 25,987 $ ( 334,312 ) $ 373,045 $ 190,431 $ ( 43,394 ) $ 185,865 +Share-based compensation — — — — 13,732 — — 13,732 +Exercises of stock options and issuance of restricted stock awards +1,238 1 49 ( 48 ) ( 725 ) — — ( 772 ) +Repurchases of common stock ( 3,620 ) — 3,620 ( 63,131 ) — — — ( 63,131 ) +Series A preferred repurchase (1) +— — — — — ( 84,224 ) — ( 84,224 ) +Series A preferred conversion (2) +6,897 7 — — 99,993 — — 100,000 +Series A preferred dividends (3) +— — — — — ( 24,000 ) — ( 24,000 ) +Series A preferred accretion, net (4) +— — — — ( 6,138 ) ( 11,429 ) — ( 17,567 ) +Net income +— — — — — 50,437 — 50,437 +Other comprehensive loss +— — — — — — ( 11,258 ) ( 11,258 ) +Other — — — — 1,226 — — 1,226 +Balance at December 31, 2018 +73,306 $ 103 29,656 $ ( 397,491 ) $ 481,133 $ 121,215 $ ( 54,652 ) $ 150,308 +Adjustments to beginning retained earnings (5) +— — — — — ( 227 ) — ( 227 ) +Share-based compensation — — — — 14,412 — — 14,412 +Exercises of stock options and issuance of restricted stock awards +1,008 1 58 ( 1,527 ) 358 — — ( 1,168 ) +Repurchases of common stock ( 6,082 ) — 6,082 ( 147,190 ) — — — ( 147,190 ) +Net income +— — — — — 119,497 — 119,497 +Other comprehensive loss +— — — — — — ( 3,727 ) ( 3,727 ) +Balance at December 31, 2019 +68,232 $ 104 35,796 $ ( 546,208 ) $ 495,903 $ 240,485 $ ( 58,379 ) $ 131,905 +(1) Represents a repurchase premium, which is the difference between cash paid and the carrying value of 100,000 shares of Series A Convertible Preferred Stock repurchased, including other costs associated with the transaction. +(2) Represents the issuance of common stock upon conversion of 100,000 shares of Series A Convertible Preferred Stock. +(3) Represents Series A Convertible Preferred Stock cash dividends declared and paid of $ 9.0 million, and $ 15.0 million of payments paid and payable to induce conversion. +(4) Represents total accretion of $ 17.6 million, net of $ 6.1 million acquired value of beneficial conversion feature attributable to repurchased Series A Convertible Preferred Stock. +(5) The decrease to beginning retained earnings is as a result of the adoption of new lease accounting standards as of January 1, 2019, as discussed in Note 2 — Recent Accounting Pronouncements. +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2019 2018 2017 +Cash flows from operating activities: +Net income +$ 119,497 $ 50,437 $ 10,238 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +24,213 29,250 33,130 +Unrealized foreign currency loss (gain), net +( 1,140 ) ( 1,455 ) 1,025 +Loss (gain) on disposals of assets +( 213 ) 5,019 ( 842 ) +Share-based compensation +14,412 13,105 9,773 +Asset impairments +— 2,182 5,284 +Operating lease cost +60,142 — — +Provision (recovery) for doubtful accounts, net +1,566 711 ( 589 ) +Deferred taxes +( 16,259 ) 959 ( 3,093 ) +Other non-cash items +( 963 ) 1,994 ( 1,564 ) +Changes in operating assets and liabilities: +Accounts receivable, net of allowances +( 15,015 ) ( 24,623 ) 620 +Inventories +( 48,156 ) ( 1,987 ) 23,319 +Prepaid expenses and other assets +( 4,012 ) 9,703 18,907 +Accounts payable +6,032 12,953 ( 2,714 ) +Accrued expenses and other liabilities +13,265 18,065 5,489 +Operating lease liabilities +( 64,313 ) — — +Income taxes +902 ( 2,151 ) ( 719 ) +Cash provided by operating activities +89,958 114,162 98,264 +Cash flows from investing activities: +Purchases of property, equipment, and software +( 36,576 ) ( 11,979 ) ( 13,117 ) +Proceeds from disposal of property and equipment +616 1,856 1,579 +Other +( 276 ) 13 — +Cash used in investing activities +( 36,236 ) ( 10,110 ) ( 11,538 ) +Cash flows from financing activities: +Proceeds from borrowings +315,000 120,000 5,500 +Repayments of borrowings +( 230,000 ) ( 662 ) ( 8,611 ) +Series A preferred stock repurchase +— ( 183,724 ) — +Dividends — Series A convertible preferred stock (1) +( 2,985 ) ( 21,015 ) ( 12,000 ) +Repurchases of common stock +( 147,190 ) ( 63,131 ) ( 50,000 ) +Other +( 3,463 ) ( 270 ) ( 259 ) +Cash used in financing activities +( 68,638 ) ( 148,802 ) ( 65,370 ) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +( 569 ) ( 4,775 ) 3,053 +Net change in cash, cash equivalents, and restricted cash +( 15,485 ) ( 49,525 ) 24,409 +Cash, cash equivalents, and restricted cash — beginning of year 127,530 177,055 152,646 +Cash, cash equivalents, and restricted cash — end of year $ 112,045 $ 127,530 $ 177,055 +Cash paid for interest $ 7,519 $ 462 $ 434 +Cash paid for income taxes 16,050 18,633 13,208 +(1) Represents $ 3.0 million paid to induce conversion of Series A Convertible Preferred Stock to common stock during the year ended December 31, 2019 and Series A Convertible Preferred Stock cash dividends declared and paid of $ 9.0 million and $ 12.0 million paid to induce conversion during the year ended December 31, 2018. +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of the “Company,” “Crocs,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. We are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. Our reportable operating segments include: the Americas, operating in North and South America; Asia Pacific, operating throughout Asia, Australia, and New Zealand; and Europe, Middle East, and Africa (“EMEA”), operating throughout Europe, Russia, the Middle East, and Africa. +Basis of Presentation and Consolidation +Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries, and reflect all adjustments which are necessary for a fair statement of financial position, results of operations, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, and depreciation and amortization. +Additionally, we are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. If it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 17 — Legal Proceedings for additional information regarding our contingencies and legal proceedings. +To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassifications +We have reclassified certain amounts in Note 13 — Income Taxes to conform to current period presentation. +Transactions with Affiliates +During the year ended December 31, 2019, we received services from three affiliates of Blackstone Capital Partners VI L.P. (“Blackstone”). Blackstone and certain of its permitted transferees beneficially owned 6,899,027 shares of our common stock until Blackstone sold 6,864,545 shares of common stock held directly by Blackstone and its affiliates on November 4, 2019 in an underwritten public offering. The other 34,482 shares of common stock were held by Gregg S. Ribatt, our former Chief Executive Officer and former member of our Board of Directors, which Blackstone may have been deemed to beneficially own, and were sold by Mr. Ribatt in October 2019. We incurred expenses to Blackstone’s legal counsel of $ 0.3 million in relation to this transaction. +F- 9 +Table of Contents +Certain Blackstone affiliates provide various services to us, including inventory count services, cybersecurity and consulting, and workforce management services. We incurred expenses for services from these affiliates of $ 2.2 million through November 4, 2019, and $ 0.8 million and $ 0.7 million in the years ended December 31, 2018 and 2017, respectively. Expenses related to these services are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Revenue Recognition +See Note 11 — Revenues for a summary of our revenue recognition policy. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, procure, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, depreciation, packaging, and other manufacturing overhead and costs. +Research, Design, and Development Expenses +We continue to dedicate significant resources to product design and development based on opportunities we identify in the marketplace. We incurred expenses of $ 11.8 million, $ 14.1 million, and $ 13.4 million in research, design, and development activities for the years ended December 31, 2019, 2018, and 2017, respectively, which are expensed as incurred and are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Selling, General and Administrative Expenses +Our selling, general and administrative expenses include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of our promotional expenses result from payments under endorsement contracts. Expenses under endorsement contracts are recognized as performance is received over the term of each endorsement agreement. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, including variable marketing expenses, were $ 83.2 million, $ 68.6 million, and $ 59.1 million for the years ended December 31, 2019, 2018, and 2017, respectively. Prepaid advertising and promotional endorsement expenses of $ 11.6 million and $ 7.5 million, were included in ‘Prepaid expenses and other assets’ in the consolidated balance sheets at December 31, 2019 and 2018, respectively. +Selling, general and administrative expenses consist primarily of labor and outside services, rent expense, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to corporate and non-product assets and share-based compensation. Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources, and information technology. +Other Income, Net +Other income, net primarily includes gains and losses associated with activities not directly related to making and selling footwear, as well as certain gains or losses on sales of non-operating assets. +Foreign Currency Gains (Losses), Net +Foreign currency gains (losses), net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of +F- 10 +Table of Contents +an entity, and realized and unrealized gains and losses on forward foreign currency exchange derivative contracts. Realized foreign exchange gains and losses are reported in the operating segment in which they occur. Foreign exchange gains and losses on intercompany balances and forward foreign exchange derivative contracts are reported within corporate operations. +Other Comprehensive Income +Our foreign subsidiaries use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into U.S. Dollars using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss), until the substantial disposition of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. +Income Taxes +Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See Note 13 — Income Taxes for further discussion. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. We report receivables from credit card companies, if expected to be received within five days, in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. We reduce the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting our customer base, and historical collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial obligations. We write off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Schedule II in Part IV - Item 15. Exhibits, Financial Statement Schedule for more information. +Inventories +Inventories are comprised of finished goods and are stated at the lower of cost or net realizable value. Effective January 1, 2018, we completed implementation of a new inventory costing system for approximately 95 % of our inventories. In connection with the implementation, we changed our method of inventory costing from a moving average cost method to a first-in-first-out method. We believe this change in accounting principle is preferable because it results in more precision and consistency in global and regional inventory costs, more efficient analysis, and better matching of inventory costs with revenues, it better matches the physical flow of inventories, and it improves comparability with industry peers. The change from our former inventory cost method did not have a material effect on inventory or cost of sales, and, as a result, prior comparative financial statements have not been restated. +We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end-of-life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its +F- 11 +Table of Contents +carrying value, the carrying value is adjusted to the market value and the difference is recorded in ‘Cost of sales’ in our consolidated statements of operations. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and recorded within ‘Cost of sales’ in our consolidated statements of operations. +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and have the following ranges: machinery and equipment: 2 to 10 years; furniture, fixtures, and other: 2 to 10 years. Leasehold improvements are stated at cost and amortized on a straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of warehouse- and distribution-related assets is included in cost of sales in our consolidated statements of operations. In 2017 and through the third quarter of 2018, when all manufacturing was transferred to third-party manufacturers, cost of sales also included depreciation related to manufacturing assets. Depreciation related to corporate, non-product, and non-manufacturing assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets and the resulting gain or loss, if any, is reflected in ‘Income from operations’ in the consolidated statements of operations. +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. Our annual test is performed as of the last day of our fiscal fourth quarter. We continuously monitor the performance of our definite-lived intangible assets and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +Direct costs of acquiring or developing internal-use computer software, including costs of employees, are capitalized and classified within intangible assets. Software maintenance and training costs are expensed in the period incurred. Initial costs associated with internally-developed-and-used software are expensed until it is determined that the project has reached the application development stage, after which subsequent additions, modifications, or upgrades are capitalized to the extent that they add functionality. Our capitalized software consists primarily of enterprise resource system software, warehouse management software, and point of sale software. Amortization for software is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 2 to 8 years. Amortization of capitalized software used in warehouse- and distribution-related activities is included in ‘Cost of sales’ in the consolidated statements of operations. In 2017 and through the third quarter of 2018, when all manufacturing was transferred to third-party manufacturers, cost of sales also included amortization related to capitalized software used in manufacturing. Amortization related to corporate, non-product, and non-manufacturing assets, such as our global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of operations. +Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 7 to 25 years. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. We assess recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and record a loss from impairment if the carrying value is more than its undiscounted cash flows. For assets involved in Crocs’ retail business, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets, leasehold improvements, and right-of-use assets related to our retail locations for impairment. Assets or asset groups to be abandoned or from which no future benefit is expected are written down to zero in the period it is determined they will no longer be used and +F- 12 +Table of Contents +are removed entirely from service. See Note 3 — Property and Equipment, Net for a discussion of impairment losses recorded during the periods presented. +Share-Based Compensation +Stock Options +Stock options are granted with exercise prices equal to the fair market value of our common stock on the date of grant. We use the Black-Scholes option-pricing model to estimate the grant date fair value of stock options, which requires the use of assumptions, including the expected term of the option, expected volatility of our stock price, our expected dividend yield, and the risk-free interest rate, among others. These assumptions reflect our best estimates, however; they involve inherent uncertainties including market conditions and employee behavior that are generally outside of our control. We expense all share-based compensation awarded based on the grant date fair value of the awards using the straight-line method over the requisite service period, adjusted for forfeitures as they occur. +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +We grant RSAs, service-condition RSUs, performance-condition RSUs, and market-condition RSUs. The grant date fair values of RSAs, service-condition RSUs, and performance-condition RSUs are based on the closing market price of our common stock on the grant date; the grant date fair value and derived service period of market-condition RSUs is estimated using a Monte Carlo simulation valuation model. Our service-condition RSUs vest based on continued service; our performance-condition RSUs vest based on achievement of multiple weighted performance goals, certification of performance achievement by the Compensation Committee of the Board of Directors, and continued service; our market-condition RSUs vest based on the market price of our stock. Compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service period. For performance-condition RSUs, compensation expense is updated for our expected performance level against performance goals at the end of each reporting period, which involves judgment as to achievement of certain performance metrics. +See Note 12 — Share-Based Compensation for additional information related to share-based compensation. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the treasury stock method. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in our earnings and is calculated by adjusting weighted average outstanding shares, assuming conversion of all potentially dilutive stock options and awards. Anti-dilutive securities are excluded from diluted EPS. See Note 14 — Earnings per Share for additional information. +Derivative Foreign Currency Contracts +We enter into forward foreign currency exchange contracts to mitigate the potential impact of foreign currency exchange rate risk. By policy, we do not enter into these contracts for trading purposes or speculation. The fair value of these contracts is reported either as an asset or liability in our consolidated balance sheets. Changes in the fair value of these contracts are recorded in ‘Foreign currency gains (losses), net’ in our consolidated statements of operations. We did not designate any derivative instruments for hedge accounting during any of the periods presented. See Note 8 — Derivative Financial Instruments for further information. +F- 13 +Table of Contents +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). We utilize a combination of market and income approaches to value derivative instruments. Our financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level Inputs +1 Unadjusted quoted prices in active markets for identical assets and liabilities. +2 Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 Unobservable inputs for the asset or liability. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +Our non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 7 — Fair Value Measurements for further discussion related to estimated fair value measurements. +Consolidated Statements of Cash Flows - Supplemental Schedule of Non-Cash Investing and Financing Activities +Year Ended December 31, +2019 2018 2017 +(in thousands) +Accrued purchases of property, equipment, and software $ 15,206 $ 1,141 $ 2,195 +Series A preferred stock conversion — 100,000 — +Series A preferred stock accretion, net (1) +— 17,567 3,532 +Vendor financed insurance premiums — — 1,450 +(1) Represents total accretion of $ 17.6 million, net of $ 6.1 million acquired value of beneficial conversion feature attributable to repurchased Series A Convertible Preferred Stock for the year ended December 31, 2018. +2. RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income +In February 2018, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance that permits reclassification of the income tax effects of the U.S. Tax Cuts and Job Act (“Tax Act”) on accumulated other comprehensive income (“AOCI”) to retained earnings. This guidance may be adopted retrospectively to each period (or periods) in which the income tax effects of the Tax Act related to items remaining in AOCI are recognized, or at the beginning of the period of adoption. The guidance became effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. This guidance became effective during the first quarter of 2019; however, we did not elect to make the optional reclassification. Our policy is to release stranded tax effects from AOCI using either a specific identification approach or portfolio approach based on the nature of the underlying item. +F- 14 +Table of Contents +Leases +In February 2016, the FASB issued authoritative guidance related to accounting for leases. On January 1, 2019, we adopted the guidance using the modified retrospective method applied as of the date of adoption. The comparative information presented in the consolidated financial statements was not restated and is reported under the accounting standards in effect for the periods presented. +We have elected all of the available transition practical expedients, including the ‘package of practical expedients’, which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. We have elected not to apply ‘hindsight’ when adopting the standard for determining the reasonably certain lease term and in assessing impairments. We have elected the short-term lease exemption, which means we have not and will not recognize a right-of-use asset or liability for leases that qualify for the short-term exemption and will recognize those lease expenses on a straight-line basis over the lease term in our consolidated statements of operations. Further, we have elected to combine lease and non-lease components for all of our leases. +Adoption of the new standard resulted in the recognition of right-of-use assets and liabilities of approximately $ 176.1 million and $ 187.4 million, respectively, as of January 1, 2019, with additional adjustments to ‘Prepaid expenses and other assets’, ‘Accrued expenses and other liabilities’, and ‘Retained earnings’. As a result of the adoption of new lease accounting standards, we assessed the initial right-of-use assets for impairment and recorded non-cash impairments of $ 0.2 million within ‘Retained earnings’ in our consolidated balance sheet. The adoption of this guidance did not have a significant impact on the consolidated statements of operations or cash flows. +New Accounting Pronouncements Not Yet Adopted +Measurement of Credit Losses +In June 2016, and through subsequent amendments, the FASB issued guidance that requires the measurement and recognition of expected credit losses for financial assets. This new model replaces the existing “current incurred loss” model with a forward-looking “current expected credit loss” model. This guidance becomes effective for annual reporting periods beginning after December 15, 2019, including interim periods within those periods. At this time, based on the nature of our financial instruments included within the scope of this standard, which are primarily trade and other receivables, and our initial analyses, we do not expect this standard to have a material impact on our consolidated financial statements. +Implementation Costs Incurred in Cloud Computing Arrangements +In August 2018, the FASB issued authoritative guidance related to the treatment of implementation costs incurred in a hosting arrangement that is considered a service contract. This guidance becomes effective for annual reporting periods beginning after December 15, 2019, including interim periods within those periods, with early adoption permitted, and will be applied prospectively to all implementation costs incurred after the date of adoption. Upon adoption, we do not expect this standard to have a material impact on our consolidated financial statements. +Simplifying Accounting for Income Taxes +In December 2019, the FASB issued new guidance to simplify the accounting for income taxes by removing certain exceptions to the general principles and also simplification of areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. The standard will be effective for annual reporting periods beginning after December 15, 2020, including interim reporting periods within those periods. We are currently evaluating the impact of adopting this new accounting guidance on our consolidated financial statements. +Other Pronouncements +Other new pronouncements issued but not effective until after December 31, 2019 are not expected to have a material impact on our consolidated financial statements. +F- 15 +Table of Contents +3. PROPERTY AND EQUIPMENT, NET +‘ Property and equipment, net’ consists of the following: +December 31, +2019 2018 +(in thousands) +Leasehold improvements $ 64,540 $ 63,702 +Machinery and equipment 39,011 20,054 +Furniture, fixtures, and other 19,761 16,779 +Construction-in-progress 3,697 2,632 +Property and equipment 127,009 103,167 +Less: Accumulated depreciation and amortization ( 79,604 ) ( 80,956 ) +Property and equipment, net $ 47,405 $ 22,211 +Asset Retirement Obligations +We are contractually obligated, under certain of our lease agreements, to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. Asset retirement obligations were not material to the consolidated balance sheets in the years ended December 31, 2019 or 2018. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Cost of sales $ 1,711 $ 1,422 $ 2,278 +Selling, general and administrative expenses 7,174 11,180 12,723 +Total depreciation and amortization expense $ 8,885 $ 12,602 $ 15,001 +Disposals of Property and Equipment and Intangible Assets +We recognized net gains on disposals of property and equipment and intangible assets of $ 0.2 million and $ 0.8 million, respectively, for the years ended December 31, 2019 and 2017, and net losses on disposals of property and equipment and intangible assets of $ 4.8 million for the year ended December 31, 2018, which are included in ‘Selling, general and administrative expenses’ in the consolidated statement of operations. +Asset Impairments +We recorded no asset impairments during the year ended December 31, 2019. During the years ended December 31, 2018 and 2017, we recorded impairments of $ 0.9 million and $ 0.5 million, respectively, for underperforming retail stores. Impairments for retail stores by reportable operating segment, were: +Year Ended December 31, +2018 2017 +Asset Impairment Number of +Stores Asset Impairment Number of +Stores +(in thousands, except store count data) +Americas $ 138 1 $ 455 3 +Asia Pacific 760 12 — — +EMEA — — 75 1 +Total $ 898 13 $ 530 4 +F- 16 +Table of Contents +During the year ended December 31, 2018, we recorded impairment expenses of $ 1.3 million to reduce the carrying values of certain supply chain assets related to the closure of our Mexico and Italy manufacturing and distribution facilities, included in ‘Other businesses,’ to their estimated fair values. +4. GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +All of our goodwill is in the EMEA segment. The changes in goodwill for the years ended December 31, 2019 and 2018 were: +Goodwill +(in thousands) +Balance at December 31, 2017 +$ 1,688 +Foreign currency translation ( 74 ) +Balance at December 31, 2018 +1,614 +Foreign currency translation ( 36 ) +Balance at December 31, 2019 +$ 1,578 +Accumulated goodwill impairment at December 31, 2019 was $ 0.8 million. +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2019 December 31, 2018 +Gross Accum. Amortiz. Net Gross Accum. Amortiz. Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software $ 120,620 $ ( 78,387 ) $ 42,233 $ 138,857 $ ( 97,900 ) $ 40,957 +Patents, copyrights, and trademarks 4,988 ( 4,373 ) 615 5,338 ( 4,588 ) 750 +Intangible assets not subject to amortization: +In progress 4,170 — 4,170 3,906 — 3,906 +Trademarks and other 77 — 77 77 — 77 +Total $ 129,855 $ ( 82,760 ) $ 47,095 $ 148,178 $ ( 102,488 ) $ 45,690 +At December 31, 2019, the weighted average remaining useful life of intangibles subject to amortization was approximately 6.3 years. +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Cost of sales $ 3,398 $ 3,889 $ 4,550 +Selling, general and administrative expenses 11,930 12,759 13,579 +Total amortization expense $ 15,328 $ 16,648 $ 18,129 +F- 17 +Table of Contents +Estimated future annual amortization expense of intangible assets is: +As of +December 31, 2019 +(in thousands) +2020 $ 15,284 +2021 14,941 +2022 4,303 +2023 3,658 +2024 2,620 +Thereafter 2,042 +Total $ 42,848 +5. ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2019 2018 +(in thousands) +Accrued compensation and benefits $ 42,460 $ 43,970 +Fulfillment, freight, and duties 20,110 12,234 +Professional services 13,361 11,124 +Accrued rent and occupancy (1) +4,682 6,956 +Return liabilities 7,090 6,429 +Sales/use and value added taxes payable 6,843 5,601 +Royalties payable and deferred revenue 3,740 3,356 +Other (2) +10,391 12,501 +Total accrued expenses and other liabilities $ 108,677 $ 102,171 +(1) At December 31, 2019, includes accrued rent and occupancy costs for leases with original terms of one year or less, which are excluded from recognition under the new lease accounting guidance adopted as of January 1, 2019. See Note 2 — Recent Accounting Pronouncements for more information. +(2) At December 31, 2018, includes accrued payments of $ 3.0 million to induce the conversion of Series A Convertible Preferred Stock into shares of common stock. +6. LEASES +We adopted authoritative guidance related to leases effective January 1, 2019 using the modified retrospective method. The comparative information presented in the consolidated financial statements was not restated and is reported under the accounting standards in effect for the periods presented. See ‘Leases’ in Note 2 — Recent Accounting Pronouncements for a discussion of the significant changes resulting from adoption of the guidance. +Our lease portfolio consists primarily of real estate assets, which includes retail, warehouse, distribution center, and office spaces, under operating leases expiring at various dates through 2033. Leases with an original term of twelve months or less are not reported in the consolidated balance sheet; expense for these short-term leases is recognized on a straight-line basis over the lease term. +Many leases include one or more options to renew, with renewal terms that, if exercised by us, may extend the lease term. The exercise of these renewal options is at our discretion. When assessing the likelihood of a renewal or termination, we consider the significance of leasehold improvements, availability of alternative locations, and the cost of relocation or replacement, among other considerations. The depreciable lives of leasehold improvements are the shorter of the useful lives of the improvements or the expected lease term. We determine the lease term for each lease based on the terms of each contract and factor in renewal and early termination options if such options are reasonably certain to be exercised. +F- 18 +Table of Contents +Due to our centralized treasury function, we utilize a portfolio approach to discount our lease obligations. We assess the expected lease term at lease inception, and discount the lease using a fully-secured annual incremental borrowing rate, adjusted for time value corresponding with the expected lease term. +Certain of our retail store leases include rental payments based upon a percentage of retail sales in excess of a minimum fixed rental. In some cases, there is no fixed minimum rental and the entire rental payment is based upon a percentage of sales. Certain of our warehouse leases have rental payments that vary based upon the volume of product placed in storage. In addition, certain leases include rental payments adjusted periodically for changes in price level indexes. We recognize expense for these types of payments as incurred and report them as variable lease expense. +Right-of-Use Assets and Operating Lease Liabilities +Amounts reported in the consolidated balance sheet were: +December 31, 2019 +(in thousands) +Assets: +Right-of-use assets $ 182,228 +Liabilities: +Current operating lease liabilities $ 48,585 +Long-term operating lease liabilities 140,148 +Total operating lease liabilities $ 188,733 +Lease Costs and Other Information +Lease-related costs, reported within ‘Cost of sales’ and ‘Selling, general and administrative expenses’, were: +Year Ended December 31, 2019 +(in thousands) +Operating lease cost $ 60,142 +Short-term lease cost 3,771 +Variable lease cost 16,936 +Total lease costs $ 80,849 +Other information related to leases, including supplemental cash flow information, consists of: +Year Ended December 31, 2019 +(in thousands) +Cash paid for operating leases $ 63,241 +Right-of-use assets obtained in exchange for operating lease liabilities (1) +233,437 +(1) Includes $ 176.1 million for operating leases existing on January 1, 2019 and a net $ 57.3 million for operating leases that commenced or were modified in the year ended December 31, 2019. +As of +December 31, 2019 +Weighted average remaining lease term (in years) 5.9 +Weighted average discount rate 4.8 % +F- 19 +Table of Contents +Maturities +The maturities of our operating lease liabilities were: +As of +December 31, 2019 +(in thousands) +2020 $ 52,434 +2021 47,607 +2022 33,138 +2023 23,943 +2024 14,228 +Thereafter 48,996 +Total future minimum lease payments 220,346 +Less: imputed interest ( 31,613 ) +Total operating lease liabilities $ 188,733 +Leases That Have Not Yet Commenced +As of December 31, 2019, we had significant obligations for leases that have not yet commenced related to our office relocation and new EMEA distribution center projects. In the first quarter of 2019, we entered into a lease for our new corporate headquarters and regional office in Broomfield, Colorado. The contractual commitment related to this lease, with payments beginning in March 2020 and continuing through August 2030, is approximately $ 20.4 million, with expected net capital investments totaling $ 7.0 million. In the fourth quarter of 2019, we entered into a lease for a new distribution center in Dordrecht, the Netherlands, which is expected to replace our existing distribution center in Rotterdam by the end of 2021. The contractual commitment related to this lease, with payments expected to begin in January 2021 and continuing through December 2030, is approximately € 21.9 million, or $ 24.6 million, with expected total capital investments of approximately € 20.0 million, or $ 22.4 million. +Comparative Information as Reported Under Previous Accounting Standards +The following comparative information is reported based upon previous accounting standards in effect for the periods presented. +Future minimum lease payments under operating leases were: +As of +December 31, 2018 +(in thousands) +2019 $ 42,455 +2020 36,299 +2021 29,714 +2022 20,721 +2023 15,334 +Thereafter 54,149 +Total minimum lease payments (1) +$ 198,672 +(1) Includes future minimum lease payments of $ 25.4 million related to the new distribution center in Dayton, Ohio. +F- 20 +Table of Contents +Rent expense for operating leases was: +Year Ended December 31, +2018 2017 +(in thousands) +Minimum rentals (1) +$ 66,049 $ 78,779 +Contingent rentals 14,297 14,294 +Total rent expense $ 80,346 $ 93,073 +(1) Minimum rentals include all lease payments as well as fixed and variable common area maintenance, parking, and storage fees, which were approximately $ 9.3 million and $ 10.0 million for the years ended December 31, 2018 and 2017, respectively. +7. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of our derivative instruments. Our derivative instruments are forward foreign currency exchange contracts. We manage credit risk of our derivative instruments on the basis of our net exposure with our counterparty. All of our derivative instruments are classified as Level 2 of the fair value hierarchy and are reported in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2019 and 2018. The fair values of our derivative instruments were an asset of $ 0.1 million and a liability of $ 1.3 million at December 31, 2019 and 2018, respectively. See Note 8 — Derivative Financial Instruments for more information. +The carrying amounts of our cash, cash equivalents, and restricted cash, accounts receivable, accounts payable, and current accrued expenses and other liabilities approximate their fair value as recorded due to the short-term maturity of these instruments. +Our borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. The fair values of our outstanding borrowings approximate their carrying values at December 31, 2019 and 2018, based on interest rates currently available to us for similar borrowings and were: +December 31, 2019 December 31, 2018 +Carrying Value Fair +Value Carrying Value Fair +Value +(in thousands) +Borrowings $ 205,000 $ 205,000 $ 120,000 $ 120,000 +Non-Financial Assets and Liabilities +Our non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. We recorded impairments as follows: +Year Ended December 31, +2018 2017 +(in thousands) +Supply chain assets impairment $ 1,284 $ — +Retail store assets impairment 898 530 +Discontinued project — 4,754 +Total asset impairments $ 2,182 $ 5,284 +F- 21 +Table of Contents +8. DERIVATIVE FINANCIAL INSTRUMENTS +We transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar amounts of revenues, expenses, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we enter into forward contracts to buy and sell foreign currency. By policy, we do not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts we enter into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to and did not post collateral as of December 31, 2019 or 2018. +Our derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets. We report derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. Changes in fair value are recognized within ‘Foreign currency gains (losses), net’ in the consolidated statements of operations. For the consolidated statements of cash flows, we classify cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities. ’ +Results of Derivative Activities +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, reported within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, 2019 December 31, 2018 +Derivative Assets Derivative Liabilities Derivative Assets Derivative Liabilities +(in thousands) +Forward foreign currency exchange contracts $ 535 $ ( 424 ) $ 943 $ ( 2,256 ) +Netting of counterparty contracts ( 424 ) 424 ( 943 ) 943 +Foreign currency forward contract derivatives $ 111 $ — $ — $ ( 1,313 ) +The notional amounts of outstanding forward foreign currency exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2019 December 31, 2018 +Notional Fair Value Notional Fair Value +(in thousands) +Euro $ 46,757 $ 36 $ 34,959 $ ( 92 ) +Singapore Dollar 31,255 344 34,584 254 +Japanese Yen 11,823 63 25,561 ( 178 ) +South Korean Won 10,328 ( 82 ) 9,408 63 +British Pound Sterling 9,155 ( 104 ) 22,185 183 +Other currencies 24,969 ( 146 ) 67,885 ( 1,543 ) +Total $ 134,287 $ 111 $ 194,582 $ ( 1,313 ) +Latest maturity date January 2020 January 2019 +Amounts reported in ‘Foreign currency gains (losses), net’ in the consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Foreign currency transaction gains (losses) $ ( 356 ) $ 552 $ 2,284 +Foreign currency forward exchange contracts gains (losses) ( 967 ) 766 ( 1,721 ) +Foreign currency gains (losses), net +$ ( 1,323 ) $ 1,318 $ 563 +F- 22 +Table of Contents +9. REVOLVING CREDIT FACILITY AND BANK BORROWINGS +Our borrowings were as follows: +December 31, +2019 2018 +(in thousands) +Revolving credit facilities $ 205,000 $ 120,000 +Less: Current portion of borrowings — — +Total long-term borrowings $ 205,000 $ 120,000 +The weighted average interest rate on outstanding borrowings as of December 31, 2019 and 2018 was 3.96 % and 4.69 %, respectively. +Senior Revolving Credit Facility +In July 2019, Crocs, Inc. and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders, which provides for a revolving credit facility of $ 450.0 million, which can be increased by an additional $ 150.0 million subject to certain conditions (the “Facility”). Borrowings under the Credit Agreement allow for us to borrow at either a variable rate based on a domestic base rate, defined as the highest of (i) the Federal Funds open rate, plus 0.25 %, (ii) the Prime Rate, and (iii) the Daily LIBOR rate, plus 1 %, or at a LIBOR rate, plus an applicable margin ranging from 1.00 % to 1.875 % based on our leverage ratio. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers, and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement requires us to maintain a minimum interest coverage ratio of 4.00 to 1.00, and a maximum leverage ratio of (i) 3.50 to 1.00 from September 30, 2019 to September 30, 2020, and (ii) 3.25 to 1.00 from December 31, 2020 and thereafter (subject to an increase to 4.00 to 1.00 in the event of certain permitted acquisitions or stock repurchases). The Credit Agreement permits (i) stock repurchases so long as after giving effect to such stock repurchases, the maximum leverage ratio does not exceed the applicable maximum leverage ratio, less 0.25 ; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $ 40.0 million. As of December 31, 2019, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2019, the total commitments available from the lenders under the Facility were $ 450.0 million. At December 31, 2019, we had $ 205.0 million in outstanding borrowings, which are due when the Facility matures in July 2024, and $ 4.6 million in outstanding letters of credit under the Facility, which reduces amounts available for borrowing under the Facility. As of December 31, 2019 and 2018, we had $ 240.4 million and $ 129.4 million, respectively, of available borrowing capacity under the Facility. +We also have a suspended revolving credit facility in Asia, under which we had no borrowings during the years ended December 31, 2019 and 2018 or outstanding at December 31, 2019 or 2018. +10. EQUITY +Common Stock +We have one class of common stock with a par value of $ 0.001 per share. There are 250.0 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +F- 23 +Table of Contents +Common Stock Repurchase Program +On February 20, 2018, the Board of Directors approved and authorized a program to repurchase up to $ 500.0 million of our common stock, and on May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $ 500.0 million of our common stock. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under our revolving credit facility, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and the issuer has the right to resell any of the shares repurchased. +We repurchased 6.1 million shares of our common stock at a cost of $ 147.2 million, including commissions during the year ended December 31, 2019. We repurchased 3.6 million shares of our common stock at a cost of $ 63.1 million, including commissions, during the year ended December 31, 2018. We repurchased 5.7 million shares of our common stock at a cost of $ 50.0 million during the year ended December 31, 2017. As of December 31, 2019, we had remaining authorization to repurchase approximately $ 508.6 million of our common stock, subject to restrictions under our Credit Agreement. +Preferred Stock +We have authorized and available for issuance 5.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized as Series A Convertible Preferred Stock with a par value of $ 0.001 per share and none were issued and outstanding as of December 31, 2019. +2018 Repurchase and Conversion +On December 5, 2018, all of the outstanding Series A Preferred shares were repurchased or converted to common stock. As a result, we recognized the remaining unamortized original issue discount and beneficial conversion feature accretion of $ 14.7 million, and settled the beneficial conversion feature related to the repurchased Series A Preferred of $ 6.1 million, resulting in a net increase of $ 8.6 million in ‘Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature’ in the consolidated statement of operations. We repurchased 100,000 shares of Series A Preferred with a carrying value of $ 100.0 million in exchange for a cash payment of $ 183.7 million. The repurchase payment in excess of the carrying value of $ 83.7 million is reported within ‘Dividends on Series A convertible preferred stock’ in the consolidated statement of operations for the year ended December 31, 2018. The remaining 100,000 shares of Series A Preferred were converted to 6,896,548 shares common stock. In connection with the conversion, we paid $ 15.0 million in cash to induce conversion, of which $ 12.0 million was paid at closing, with the remaining $ 3.0 million paid in January 2019. In addition, we paid other costs associated with this transaction of $ 0.5 million. The $ 15.0 million inducement dividend and the $ 0.5 million of other costs are reported within ‘Dividends on Series A convertible preferred stock’ in the consolidated statement of operations for the year ended December 31, 2018. Subsequently, in November 2019, Blackstone sold all shares of its common stock in an underwritten public offering. +11. REVENUES +We adopted authoritative guidance related to the recognition of revenue from contracts with customers effective January 1, 2018 using the modified retrospective method. The 2017 comparative information presented in the consolidated financial statements was not restated and is reported under the accounting standards in effect for the periods presented. +Revenues by reportable operating segment and by channel were: +Year Ended December 31, 2019 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 275,284 $ 207,405 $ 173,480 $ 58 $ 656,227 +Retail 241,694 74,793 30,875 — 347,362 +E-commerce 123,537 65,874 37,593 — 227,004 +Total revenues $ 640,515 $ 348,072 $ 241,948 $ 58 $ 1,230,593 +F- 24 +Table of Contents +Year Ended December 31, 2018 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 216,797 $ 203,110 $ 154,992 $ 3,145 $ 578,044 +Retail 204,806 87,264 35,358 — 327,428 +E-commerce 98,589 54,224 29,920 — 182,733 +Total revenues $ 520,192 $ 344,598 $ 220,270 $ 3,145 $ 1,088,205 +Revenues are recognized in the amount expected to be received in exchange when control of the products transfers to customers, and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. During the year ended December 31, 2019, we recognized a net increase of $ 0.4 million to wholesale revenues and a decrease of $ 0.1 million to e-commerce revenues due to changes in estimates related to products transferred to customers in prior periods. During the year ended December 31, 2018, we recognized a net increase of $ 0.8 million to wholesale revenues and no change to e-commerce revenues due to changes in estimates related to products transferred to customers in prior periods. There were no changes to estimates in retail channels during the years ended December 31, 2019 and 2018. +We elected to exclude from revenues taxes assessed by governmental authorities, including value-added and other sales-related taxes, that are imposed on and concurrent with revenue-producing activities, and as a result there is no change in presentation from prior comparative periods. +We also elected to expense incremental costs to obtain customer contracts, consisting primarily of commission incentives, when incurred because the related amortization period is short-term. These costs are reported within ‘Selling, general and administrative expenses’ in our consolidated statement of operations. +The following is a description of our principal revenue-generating activities by distribution channel. We have three reportable operating segments and sell our products using three primary distribution channels. For more detailed information about reportable operating segments, see Note 16 — Operating Segments and Geographic Information. +Wholesale Channel +For the majority of wholesale customers, control transfers and revenues are recognized when the product is shipped or delivered from a manufacturing facility or distribution center to the wholesale customer. In certain cases, control of the product transfers and revenues are recognized when the customer receives the product at the designated delivery point. For certain customers, primarily in the Asia Pacific region, cash payment from customers is required in advance of delivery and revenues are recognized upon the later of cash receipt or delivery of the product. For a small number of customers in the Asia Pacific region, products are sold on consignment and revenues are recognized on a sell-through basis. Wholesale customers are invoiced when products are shipped or delivered. +We have arrangements that grant certain wholesale customers exclusive licenses, concurrent with the terms of the related distribution agreements, to use our intellectual property in exchange for a sales-based royalty. Sales-based royalty revenues are recognized over the terms of the related license agreements as sales are made by the wholesalers. +Retail Channel +We transfer control of products and recognize revenues at Company-operated retail stores at the point of sale, in exchange for cash or other payment, primarily debit or credit card. A portion of the transaction price charged to our customers is variable, primarily due to promotional discounts or allowances, and terms that permit retail customers to exchange or return products for a full refund within a limited period of time. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +F- 25 +Table of Contents +E-commerce Channel +In the e-commerce channel, we transfer control and recognize revenues when the product is shipped from the distribution centers. Payment from customers is primarily through debit and credit card and is made at the time the customer order is shipped. +Similar to the retail channel, a portion of the amount of revenue is variable, primarily due to sales returns, discounts, and other promotional allowances offered to our customers. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments are made when the most likely amount of consideration changes. +Contract Liabilities +Contract liabilities consist of advance cash deposits received from wholesale customers to secure product orders in connection with selling seasons, and payments received in advance of delivery. As products are shipped and control transfers, we recognize the deferred revenue in ‘Revenues’ in the consolidated statements of operations. At December 31, 2019 and 2018, $ 1.2 million and $ 1.6 million, respectively, of deferred revenues associated with advance customer deposits were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. Deferred revenues of $ 2.0 million, including the balance recorded at December 31, 2018 of $ 1.6 million, were recognized in revenues during the year ended December 31, 2019. The deferred revenues at December 31, 2019 are expected to be recognized in revenues during the first quarter of 2020 as products are shipped or delivered. +Refund Liabilities +Refund liabilities, primarily associated with product sales returns, retrospective volume rebates, and early payment discounts are estimated based on an analysis of historical experience, and adjustments to revenues made when the most likely amount of consideration expected changes. At December 31, 2019 and 2018, $ 7.1 million and $ 6.4 million, respectively, of refund liabilities, primarily associated with product returns, were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +12. SHARE-BASED COMPENSATION +Our share-based compensation awards are issued under the 2015 Equity Incentive Plan (“2015 Plan”) and predecessor plan, the 2007 Equity Incentive Plan (“2007 Plan”). Any awards that expire or are forfeited under the 2007 Plan become available for issuance under the 2015 Plan. We account for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. As of December 31, 2019, 2.4 million shares of common stock remained available for future issuance under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +Share-Based Compensation Expense +Pre-tax share-based compensation expense reported in the consolidated statements of operations was: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Cost of sales $ 580 $ 362 $ 379 +Selling, general and administrative expenses 13,832 12,743 9,394 +Total share-based compensation expense $ 14,412 $ 13,105 $ 9,773 +F- 26 +Table of Contents +Stock Option Activity +Stock option activity during the year ended December 31, 2019 was: +Number of Options Weighted Average Exercise Price Weighted Average Contractual Life (Years) Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2018 +362 $ 11.05 5.68 $ 5,407 +Granted — — +Exercised ( 27 ) 13.25 +Forfeited or expired ( 20 ) 17.54 +Outstanding as of December 31, 2019 +315 $ 10.45 5.28 $ 9,904 +Exercisable at December 31, 2019 +248 $ 11.38 4.71 $ 7,577 +Vested and expected to vest at December 31, 2019 +315 $ 10.45 5.28 $ 9,904 +No stock options were granted during 2019 or 2018. During the year ended December 31, 2017, stock options were valued using a Black Scholes option pricing model using the following assumptions. +Year Ended December 31, 2017 +Expected volatility 40.7 % +Dividend yield — +Risk-free interest rate 1.76 % +Expected life (in years) 4.0 +The weighted average grant date fair value of stock options granted during the year ended December 31, 2017 was approximately $ 2.37 per share. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2019, 2018, and 2017 was $ 0.4 million, $ 1.7 million, and $ 0.1 million, respectively. During the years ended December 31, 2019, 2018, and 2017, we received $ 0.4 million, $ 1.3 million, and $ 0.1 million cash in connection with the exercise of stock options. +As of December 31, 2019, we had $ 0.1 million of total unrecognized share-based compensation expense related to unvested options, which is expected to be amortized over the remaining weighted average period of 0.4 years. +Stock options under the 2015 Plan and 2007 Plan generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years , and expire ten years after the date of grant. +Restricted Stock Awards and Restricted Stock Units Activity +From time to time, we grant RSAs and RSUs. RSAs and RSUs generally vest over three years , depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive a share of common stock upon vesting. RSUs have dividend equivalent rights, which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. We grant service-condition RSUs, performance-condition RSUs, and market-condition RSUs. +Service-condition RSUs are typically granted on an annual basis and vest over time in three equal annual installments, beginning one year after the grant date. During the years ended December 31, 2019, 2018, and 2017, we granted 0.3 million, 0.4 million, and 1.1 million service-condition RSUs, respectively. +Performance-condition RSUs are typically granted on an annual basis and consist of a performance-based and service-based component. The performance targets and vesting conditions for performance-condition RSUs are based on achievement of multiple weighted performance goals. The number of performance-condition RSUs ultimately awarded may be between 0 % and 200 %, based on performance. These RSUs vest in three equal annual installments beginning one year after the grant date, pending certification of performance achievement by the Compensation Committee and continued service. The fair value of performance-condition awards is based on the closing market price of our common stock on the grant date. Compensation +F- 27 +Table of Contents +expense, net of forfeitures, is updated for our expected performance level against performance goals at the end of each reporting period. We also periodically grant market-condition RSUs to certain executives. The grant date fair value and derived service period for market-condition RSUs are estimated using a Monte Carlo simulation valuation model. During the years ended December 31, 2019, 2018, and 2017, we granted 0.5 million, 1.0 million, and 1.3 million performance- and market-condition RSUs, respectively. +RSA and RSU activity during the year ended December 31, 2019 was: +Restricted Stock Awards Restricted Stock Units +Shares Weighted Average Grant Date Fair Value Shares Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2018 +6 $ 18.61 2,752 $ 11.58 +Granted 12 20.53 817 25.37 +Vested ( 13 ) 20.00 ( 997 ) 9.92 +Forfeited — — ( 645 ) 11.79 +Unvested at December 31, 2019 +5 $ 19.39 1,927 $ 17.77 +The weighted average grant date fair value of RSAs granted during the years ended December 31, 2019, 2018, and 2017 was $ 20.53 , $ 18.61 , and $ 6.84 per share. RSAs vested during the years ended December 31, 2019, 2018, and 2017 consisted entirely of service-based awards. The total grant date fair value of RSAs vested was $ 0.2 million in each of the years ended December 31, 2019, 2018, and 2017. +As of December 31, 2019, unrecognized share-based compensation expense for RSAs was $ 0.1 million, which is expected to amortize over a remaining weighted average period of 0.4 years. +The weighted average grant date fair value of RSUs granted during the years ended December 31, 2019, 2018, and 2017 was $ 25.37 , $ 14.34 , and $ 6.84 per share. RSUs vested during the year ended December 31, 2019 consisted of 0.6 million service-condition awards and 0.4 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2018 consisted of 0.9 million service-condition awards and 0.2 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2017 consisted of 0.7 million service-condition awards and 0.1 million performance- and market-condition awards. The total grant date fair value of RSUs vested during the years ended December 31, 2019, 2018, and 2017 was $ 9.9 million, $ 9.7 million and $ 8.3 million, respectively. +As of December 31, 2019, unrecognized share-based compensation expenses for service-condition RSUs were $ 8.5 million and for performance- and market-condition RSUs were $ 5.0 million, and are expected to amortize over remaining weighted average periods of 1.3 years and 1.6 years, respectively. +13. INCOME TAXES +During the year ended December 31, 2017, as a result of the Tax Act, we recorded provisional estimates related to the revaluation of our net deferred tax assets at the lower U.S. corporate income tax rate and the additional tax expense associated with the deemed repatriation tax. During the year ended December 31, 2018, we recorded measurement period adjustments related to the provisional estimates. While we consider our accounting for the Tax Act to be complete, we continue to evaluate new guidance and legislation as it is issued. We have not changed our indefinite reinvestment assertion, and we have elected to account for the impact of global intangible low tax income based on the period cost method. +F- 28 +Table of Contents +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Income (loss) before taxes: +U.S. $ 58,822 $ 10,088 $ ( 34,406 ) +Foreign 60,500 55,069 52,586 +Total income (loss) before taxes $ 119,322 $ 65,157 $ 18,180 +Income tax expense (benefit): +Current income taxes: +U.S. federal $ 1,284 $ 1,156 $ 1,383 +U.S. state 1,427 246 127 +Foreign 13,373 12,359 9,525 +Total current income taxes 16,084 13,761 11,035 +Deferred income taxes: +U.S. federal ( 10,249 ) 276 1,300 +U.S. state ( 3,579 ) — — +Foreign ( 2,431 ) 683 ( 4,393 ) +Total deferred income taxes ( 16,259 ) 959 ( 3,093 ) +Total income tax expense (benefit) $ ( 175 ) $ 14,720 $ 7,942 +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Income tax expense and rate attributable to: +Federal income tax rate $ 25,058 21.0 % $ 13,683 21.0 % $ 6,363 35.0 % +State income tax rate, net of federal benefit +5,983 5.0 % 1,271 2.0 % 53 0.3 % +Foreign income tax rate differential 1,994 1.7 % 7,630 11.6 % ( 11,768 ) ( 64.7 ) % +Enacted changes in tax law 634 0.5 % 495 0.8 % 17,645 97.1 % +GILTI, net 7,585 6.4 % 3,443 5.3 % — — % +Non-deductible / non-taxable items 6,727 5.7 % 3,602 5.5 % 6,006 33.0 % +Change in valuation allowance ( 33,691 ) ( 28.2 ) % ( 5,304 ) ( 8.1 ) % 24,400 134.2 % +U.S. tax on foreign earnings — — % — — % ( 32,427 ) ( 178.4 ) % +Foreign tax credits ( 12,541 ) ( 10.5 ) % ( 7,709 ) ( 11.9 ) % ( 7,980 ) ( 43.9 ) % +Uncertain tax positions 278 0.2 % ( 1,696 ) ( 2.6 ) % 1,054 5.8 % +Audit settlements 391 0.3 % 183 0.3 % 354 1.9 % +Share-based compensation ( 2,715 ) ( 2.3 ) % 764 1.2 % 882 4.9 % +Deferred income tax account adjustments — — % ( 25 ) — % 2,679 14.7 % +Other 122 0.1 % ( 1,617 ) ( 2.5 ) % 681 3.8 % +Effective income tax expense and rate $ ( 175 ) ( 0.1 ) % $ 14,720 22.6 % $ 7,942 43.7 % +F- 29 +Table of Contents +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2019 2018 +(in thousands) +Non-current deferred tax assets: +Share-based compensation expense $ 2,218 $ 2,051 +Accruals, reserves, and other expenses 13,726 18,734 +Net operating loss 29,997 37,727 +Intangible assets 990 1,363 +Foreign tax credit 64,355 66,321 +Operating lease liabilities (1) +36,996 — +Other 4,467 3,611 +Valuation allowance ( 79,023 ) ( 113,237 ) +Total non-current deferred tax assets $ 73,726 $ 16,570 +Non-current deferred tax liabilities: +Unrealized gain on foreign currency $ ( 529 ) $ ( 164 ) +Property and equipment ( 13,713 ) ( 7,332 ) +Right-of-use assets (1) +( 34,470 ) — +Other ( 267 ) ( 411 ) +Total non-current deferred tax liabilities $ ( 48,979 ) $ ( 7,907 ) +(1) Adoption of new lease accounting guidance as of January 1, 2019, as described in Note 2 — Recent Accounting Pronouncements, resulted in the recognition of a right-of-use asset deferred tax liability and an operating lease liability deferred tax asset. These temporary differences will reverse over the life of the leases. +During 2019, valuation allowances recorded against deferred tax assets decreased by $ 34.2 million. The change in the valuation allowance includes $ 33.7 million related to income tax expense and $ 0.5 million, which does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to changes in cumulative translation adjustment. During 2018, valuation allowances decreased by $ 6.3 million. The change in the valuation allowance includes $ 5.3 million related to income tax expense and $ 1.0 million which does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation adjustment. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. As of December 31, 2019, certain jurisdictions, for which we have historically recorded significant valuation allowances, have sufficient history of sustained profitability. As a result, valuation allowances recorded against deferred tax assets decreased by $ 34.2 million. +In certain other jurisdictions, we recorded additional attributes, primarily driven by operational losses recognized based on local tax accounting requirements. These carryforwards were generated in jurisdictions where results indicate it is not more likely than not the deferred tax assets would be realized. We maintain a valuation allowance against the majority of these deferred tax assets. +We have recorded deferred tax assets related to U.S. federal tax carryforwards, including foreign tax credits and other tax credits, which expire at various dates between 2024 and 2039 of $ 39.7 million and $ 46.6 million as of December 31, 2019 and 2018, respectively. We recorded deferred tax assets related to U.S. state tax net operating loss carryforwards which expire at +F- 30 +Table of Contents +various dates between 2020 and those which do not expire of $ 6.7 million and $ 11.1 million at December 31, 2019 and 2018, respectively. We recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2020 and those which do not expire of $ 48.0 million and $ 47.7 million as of December 31, 2019 and 2018, respectively. The valuation allowance maintained against our U.S. deferred tax assets as of December 31, 2019 primarily relates to foreign tax credits and state net operating losses carryforwards that have a limited carryforward period and are not anticipated to be utilized prior to expiration. We also maintain a valuation allowance against a portion of the foreign carryforwards. +The transition tax in the Tax Act imposed a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. Furthermore, as of December 31, 2019, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Unrecognized tax benefit as of January 1 $ 4,511 $ 6,204 $ 4,750 +Additions in tax positions taken in prior period 631 250 683 +Reductions in tax positions taken in prior period ( 1,532 ) ( 690 ) — +Additions in tax positions taken in current period 1,786 461 966 +Settlements ( 391 ) ( 621 ) ( 123 ) +Lapse of statute of limitations ( 368 ) ( 1,045 ) ( 414 ) +Cumulative foreign currency translation adjustment ( 24 ) ( 48 ) 342 +Unrecognized tax benefit as of December 31 $ 4,613 $ 4,511 $ 6,204 +We recorded a net expense of $ 0.3 million related to increases in 2019 unrecognized tax benefits combined with amounts effectively settled under audit. Unrecognized tax benefits as of December 31, 2019 relate to tax years that are currently open under the statute of limitation. The primary impact of uncertain tax benefits on the rate reconciliation includes audit settlements, net increases in position changes, and accrued interest expense. +Interest and penalties related to income tax liabilities are included in ‘Income tax expense (benefit)’ in the consolidated statements of operations. For the years ended December 31, 2019, 2018, and 2017, we recorded approximately $ 0.4 million, $ 0.2 million, and $ 0.2 million, respectively, of penalties and interest. During the year ended December 31, 2019, we released $ 0.2 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $ 0.7 million, $ 0.6 million, and $ 0.7 million, as of December 31, 2019, 2018, and 2017, respectively. +Unrecognized tax benefits of $ 4.0 million, $ 4.5 million and $ 6.2 million as of December 31, 2019, 2018, and 2017, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2019: +The Netherlands 2005 to 2019 +Canada 2011 to 2019 +Japan 2012 to 2019 +China 2009 to 2019 +Singapore 2014 to 2019 +United States 2010 to 2019 +We are currently under audit in Japan and Taiwan. U.S. state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for us are generally subject to examination for the years 2014 to 2019. Although the timing of income tax audit +F- 31 +Table of Contents +resolutions and negotiations with taxing authorities is highly uncertain, we do not anticipate a significant change in the total amount of unrecognized tax benefits within the next twelve months. +14. EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2019, 2018, and 2017 were as follows: +Year Ended December 31, +2019 2018 2017 +(in thousands, except per share data) +Numerator: +Net income (loss) attributable to common stockholders (1) +$ 119,497 $ ( 69,216 ) $ ( 5,294 ) +Denominator: +Weighted average common shares outstanding - basic 70,357 68,421 72,255 +Plus: dilutive effect of stock options and unvested restricted stock units +1,414 — — +Weighted average common shares outstanding - diluted +71,771 68,421 72,255 +Net income (loss) per common share: +Basic $ 1.70 $ ( 1.01 ) $ ( 0.07 ) +Diluted $ 1.66 $ ( 1.01 ) $ ( 0.07 ) +(1) Net loss attributable to common stockholders for the year ended December 31, 2018 reflects the repurchase and conversion of Series A Convertible Preferred Stock . +For the year ended December 31, 2019, no outstanding shares issued under share-based compensation awards were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. For the years ended December 31, 2018 and 2017, all outstanding shares issued under share-based compensation awards were excluded from the calculation of diluted EPS because the effect was anti-dilutive. Additionally, for the year ended December 31, 2017, all potentially convertible Series A Preferred shares were excluded from the calculation of diluted EPS because the effect was anti-dilutive. +15. COMMITMENTS AND CONTINGENCIES +Purchase Commitments +As of December 31, 2019 and 2018, we had purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products, for an aggregate of $ 155.5 million and $ 165.3 million, respectively. We expect to fulfill our commitments under these agreements in the normal course of business, and as such, no liability has been recorded. +Other +We are regularly subject to, and is currently undergoing, audits by various tax authorities in the U.S. and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. +During our normal course of business, we may make certain indemnities, commitments, and guarantees under which it may be required to make payments in relation to certain matters. We cannot determine a range of estimated future payments and has not recorded any liability for such payments in the accompanying consolidated balance sheets. +See Note 17 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +F- 32 +Table of Contents +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have three reportable operating segments: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”). ‘Other businesses’ aggregates insignificant operating segments that do not meet the reportable segment threshold, including corporate operations and, in 2018 and 2017, company-operated manufacturing facilities, which substantially ceased operations in the third quarter of 2018. +Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. Revenues for ‘Other businesses’ include non-footwear and accessories product sales to external customers that are excluded from the measurement of segment operating revenues and income. +Segment performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income from operations consist of other businesses and unallocated corporate expenses, as well as inter-segment eliminations. We do not report asset information by segment because that information is not used to evaluate performance or allocate resources between segments. The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Revenues: +Americas $ 640,515 $ 520,192 $ 480,146 +Asia Pacific 348,072 344,598 336,073 +EMEA 241,948 220,270 206,424 +Segment revenues 1,230,535 1,085,060 1,022,643 +Other businesses 58 3,145 870 +Total consolidated revenues $ 1,230,593 $ 1,088,205 $ 1,023,513 +Income from operations: +Americas $ 204,868 $ 138,940 $ 96,740 +Asia Pacific 80,645 82,780 72,950 +EMEA 70,326 59,539 37,185 +Segment income from operations 355,839 281,259 206,875 +Reconciliation of segment income from operations to income before income taxes: +Other businesses ( 54,936 ) ( 55,583 ) ( 22,861 ) +Unallocated corporate (1) +( 172,254 ) ( 162,732 ) ( 166,678 ) +Total consolidated income from operations 128,649 62,944 17,336 +Foreign currency gains (losses), net ( 1,323 ) 1,318 563 +Interest income 601 1,281 870 +Interest expense ( 8,636 ) ( 955 ) ( 869 ) +Other income 31 569 280 +Income before income taxes $ 119,322 $ 65,157 $ 18,180 +Depreciation and amortization: +Americas $ 3,593 $ 4,640 $ 5,473 +Asia Pacific 963 2,049 3,405 +EMEA 793 1,252 1,937 +Total segment depreciation and amortization 5,349 7,941 10,815 +Other businesses 5,234 5,256 6,748 +Unallocated corporate 13,630 16,053 15,567 +Total consolidated depreciation and amortization $ 24,213 $ 29,250 $ 33,130 +(1) Includes corporate support and administrative functions, costs associated with share-based compensation, research and development, marketing, legal, depreciation and amortization of corporate and other assets not allocated to operating segments, and intersegment eliminations. +F- 33 +Table of Contents +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2019, 2018 and 2017. The following table sets forth certain geographical information regarding Crocs’ revenues for the periods as shown: +Year Ended December 31, +2019 2018 2017 +(in thousands) +Location: +United States $ 563,473 $ 442,544 $ 388,847 +International 667,120 645,661 634,666 +Total revenues $ 1,230,593 $ 1,088,205 $ 1,023,513 +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2019 2018 +(in thousands) +Location: +United States $ 41,745 $ 17,489 +International 5,660 4,722 +Total property and equipment, net $ 47,405 $ 22,211 +17. LEGAL PROCEEDINGS +We were subjected to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, we were notified about the issuance of assessments totaling 14.4 million Brazilian Real (“BRL”), or approximately $ 3.6 million, plus interest and penalties, for the period January 2010 through May 2011. We have disputed these assessments and asserted defenses to the claims. On February 25, 2015, we received additional assessments totaling 33.3 million BRL, or approximately $ 8.3 million, plus interest and penalties, related to the remainder of the audit period. We also disputed these assessments and asserted defenses to these claims in administrative appeals. On August 29, 2017, we received a favorable ruling on our appeal of the first assessment, which dismissed all fines, penalties, and interest. The tax authorities have appealed that decision and we have challenged the appeal on both the merits and procedure. Additionally, the second appeal for the remaining assessments was heard on March 22, 2018. That decision was partially favorable for Crocs and resulted in an approximately 38 % reduction in principal, penalties, and interest, leaving approximately $ 5.1 million, plus interest and penalties, at risk for those assessments. The tax authorities have appealed that decision and Crocs has filed a response to the tax authorities’ appeal as well as a separate appeal against the unfavorable portion of the ruling. Should the Brazilian Tax Authority prevail in this final administrative appeal, we may still challenge the assessments through the court system, which would likely require the posting of a bond. We have not recorded these items within the consolidated financial statements as it is not possible at this time to predict the timing or outcome of this matter or to estimate a potential amount of loss, if any. +For all other claims and disputes, we have accrued estimated losses of $ 0.2 million within ‘Accrued expenses and other liabilities’ in our consolidated balance sheet as of December 31, 2019. As we are able, we estimate reasonably possible losses or a range of reasonably possible losses for claims and other disputes. As of December 31, 2019, reasonably possible losses could potentially exceed amounts accrued by up to $ 1.4 million. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, other than as set forth above, we are not party to any other pending legal proceedings that it believes would reasonably have a material adverse impact on our business, financial results, and cash flows. +18. EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +We sponsor a qualified defined contribution benefit plan (the “Plan”), covering substantially all of our U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. We make matching contributions to the plans equal to 100 % of the first 3 %, and up to 50 % of the next 2 % of salary contributed by an eligible employee. Participants +F- 34 +Table of Contents +are vested 100 % in our matching contributions when made. Contributions made by us under the Plan were $ 5.1 million, $ 5.4 million and $ 5.5 million for the years ended December 31, 2019, 2018, and 2017, respectively. +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +March 31, 2019 June 30, 2019 September 30, 2019 December 31, 2019 +(in thousands, except per share data) +Revenues (1) +$ 295,949 $ 358,899 $ 312,766 $ 262,979 +Gross profit 137,615 189,379 163,824 126,238 +Income from operations +32,578 47,831 39,884 8,356 +Net income (2) +24,710 39,198 35,676 19,913 +Net income attributable to common shareholders (2) +24,710 39,198 35,676 19,913 +Basic income per common share (3) +$ 0.34 $ 0.55 $ 0.52 $ 0.29 +Diluted income per common share (3) +$ 0.33 $ 0.55 $ 0.51 $ 0.29 +(1) Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter of the year relative to the other quarters. +(2) During the three months ended December 31, 2019, we reduced a portion of the valuation allowance recorded against certain deferred tax assets, resulting in a tax benefit. See Note 13 — Income Taxes for more information. +(3) Basic and diluted income per common share are computed independently for each of the quarters presented. Therefore, the sum of the quarters may not equal the annual amounts presented in the consolidated statements of operations. +For the Quarter Ended +March 31, 2018 June 30, 2018 September 30, 2018 December 31, 2018 +(in thousands, except per share data) +Revenues (1) +$ 283,148 $ 328,004 $ 261,064 $ 215,989 +Gross profit 139,873 181,400 139,059 99,822 +Income (loss) from operations +25,922 37,064 13,895 ( 13,937 ) +Net income (loss) +16,454 34,377 10,492 ( 10,886 ) +Net income (loss) attributable to common shareholders (2) +12,523 30,426 6,520 ( 118,685 ) +Basic income (loss) per common share +$ 0.15 $ 0.37 $ 0.08 $ ( 1.72 ) +Diluted income (loss) per common share +$ 0.15 $ 0.35 $ 0.07 $ ( 1.72 ) +(1) Due to the seasonal nature of our products, we experience decreased revenues in the fourth quarter of the year relative to the other quarters. +(2) The balance in ‘Net income (loss) attributable to common shareholders’ for the three months ended December 31, 2018 was impacted by the repurchase and conversion of Series A Convertible Preferred Stock. See Note 10 — Equity and the consolidated statement of operations for more information. +F- 35 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period Charged to Costs and Expenses +Deductions (1) +Balance at End of Period +(in thousands) +Year Ended December 31, 2019 +Allowance for doubtful accounts $ 10,959 $ 1,566 $ ( 4,249 ) $ 8,276 +Reserve for sales returns and allowances 2,741 73,027 ( 70,507 ) 5,261 +Reserve for unapplied rebates 6,777 6,837 ( 8,354 ) 5,260 +Total $ 20,477 $ 81,430 $ ( 83,110 ) $ 18,797 +Year Ended December 31, 2018 +Allowance for doubtful accounts $ 18,325 $ 711 $ ( 8,077 ) $ 10,959 +Reserve for sales returns and allowances 4,983 71,865 ( 74,107 ) 2,741 +Reserve for unapplied rebates 8,081 8,604 ( 9,908 ) 6,777 +Total $ 31,389 $ 81,180 $ ( 92,092 ) $ 20,477 +Year Ended December 31, 2017 +Allowance for doubtful accounts $ 32,856 $ 1,235 $ ( 15,766 ) $ 18,325 +Reserve for sales returns and allowances 6,121 65,562 ( 66,700 ) 4,983 +Reserve for unapplied rebates 9,161 9,318 ( 10,398 ) 8,081 +Total $ 48,138 $ 76,115 $ ( 92,864 ) $ 31,389 +(1) Deductions include accounts written off, net of recoveries, and the effects of foreign currency translation. +F- 36 \ No newline at end of file diff --git a/raw/filings/0001334036/2019/0001334036-20-000010/filing_metadata.csv b/raw/filings/0001334036/2019/0001334036-20-000010/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..f291b8181e4888f0f83909e53f709d799e967e06 --- /dev/null +++ b/raw/filings/0001334036/2019/0001334036-20-000010/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2020-02-27,2019-12-31,2020-02-27T17:34:05.000Z,0001334036-20-000010,crox-20191231.htm,10-K,14949977,1,1,https://www.sec.gov/Archives/edgar/data/1334036/000133403620000010/crox-20191231.htm,https://www.sec.gov/Archives/edgar/data/1334036/000133403620000010/,2019,2019,1 diff --git a/raw/filings/0001334036/2019/0001334036-20-000010/item1.txt b/raw/filings/0001334036/2019/0001334036-20-000010/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..28bd10721e380448d473330f37a2b211f123d77c --- /dev/null +++ b/raw/filings/0001334036/2019/0001334036-20-000010/item1.txt @@ -0,0 +1,96 @@ +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for men, women, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contains Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. Crocs, Inc., a Delaware corporation, is the successor to a Colorado corporation of the same name and was originally organized in 1999 as a limited liability company. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for men, women and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals, wedges, flips and slides, that meet the needs of the whole family. In 2019, Crocs reinforced its mission of “everyone comfortable in their own shoes” with the third year of its global Come As You Are™ campaign. +Crocs offers a broad portfolio of all-season products, while remaining true to its core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking and odor-resistant qualities that Crocs fans know and love. Since sales began in 2002, Crocs has sold more than 700 million pairs of shoes globally. +At the heart of our brand’s DNA are our clogs and sandals. The Classic Clog, our most iconic style for adults and children, embodies our innovation in molding, simplicity of design, and all-day comfort. The unique look and feel of the Classic Clog can be experienced throughout the vast majority of our product line due to the use and design of Croslite TM . Sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +We are now using Croslite TM with new technologies in our LiteRide TM collection, as we focus on visible comfort technology. LiteRide TM features comfort focused, proprietary foam insoles which are soft, lightweight and resilient. +We strive to provide our global consumers with comfortable, casual, colorful, and innovative footwear styles, with a focus on molded product. Our collections address many wearing occasions and meet the needs of the entire family. We enjoy licensing partnerships with Disney, Marvel, Nickelodeon, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Environmental, Social, and Governance Initiatives +As one of the world’s largest footwear companies, we can make a positive global impact on the footwear industry and our planet by committing to transparent, socially conscious, and sustainable business practices. +We are in the process of creating a clear and impactful framework of sustainability initiatives throughout our global business, specifically focusing on our supply chain and product lifecycle. This will include, but is not limited to, examining opportunities in waste reduction, energy usage, materials, and packaging. +At Crocs, we also strive to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards. To this end, we have implemented measures to ensure our supply chain complies with these standards, including the conducting of both scheduled and unannounced social compliance audits. +We also monitor chemicals and substances in our supply chain for compliance with legal and regulatory requirements consistent with our Restricted Substances Policy, and we expect our contracted factories and suppliers to take a proactive stance in eliminating any hazardous substances in the manufacturing of Crocs products. +2 +Table of Contents +At Crocs, we believe that our vision to make “everyone comfortable in their own shoes” starts with our people. To ensure that we remain an employer of choice for the most talented workforce in the footwear industry, we have implemented initiatives across our business and geographies to develop leadership capabilities, enable meaningful professional experiences, offer a compelling employee value proposition, and create a transparent, collaborative culture that embraces all different kinds. We are also committed to an equitable total rewards philosophy and provide high levels of pay transparency in all regions and are proud of our culture of inclusion, which features diversity at all levels. +Sales and Marketing +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. We prioritize five core markets including: (i) the U.S., (ii) Japan, (iii) China, (iv) South Korea, and (v) Germany. These countries represent key geographies where we believe the greatest opportunities for growth exist. We are also concentrating our marketing efforts on these countries, to increase customer awareness of both our brand and our full product range. +Each season we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories that allow for personalization. We are expanding our sandal offerings as we pursue a greater share of a large market with no clear global leader. We are continuing to invest in designer, celebrity, and brand collaborations, as well as celebrity brand ambassadors to raise consumer engagement with our brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 85 countries through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand retailers, e-tailers, and distributors; our retail channel consists of company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2019, 2018, and 2017, 53.3%, 53.1%, and 52.4% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors, and in certain countries, partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements are not met. +No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2019, 2018, and 2017. +Retail Channel +During the years ended December 31, 2019, 2018, and 2017, 28.2%, 30.1%, and 33.0%, respectively, of our revenues were derived through our retail channel. We operate our retail channel through three platforms: company-operated full-price retail and outlet stores, kiosks, and store-in-store locations. With the worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2019, we had 367 company-operated stores. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for information on store locations by platform. +3 +Table of Contents +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. We believe the optimal location for our retail stores is in high foot-traffic shopping malls or districts. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. Outlet stores are generally located within outlet shopping centers. +Kiosk / Store-in-Store Locations +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space, and limited capital investment, we believe kiosks and store-in-store locations can be effective vehicles for marketing our products in certain geographic areas. +Company-Operated Retail Stores +The following table illustrates the net change during 2019 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2018 Opened Closed/Transferred December 31, 2019 +Americas +United States 155 1 3 153 +Canada 9 — — 9 +Puerto Rico 4 — 1 3 +Total Americas 168 1 4 165 +Asia Pacific +Korea 86 3 4 85 +China 28 6 11 23 +Japan 14 — 2 12 +Singapore 14 3 — 17 +Australia 9 — 2 7 +Hong Kong 2 — 1 1 +Total Asia Pacific 153 12 20 145 +EMEA +Russia 31 1 2 30 +Germany 14 1 — 15 +France 8 — 2 6 +Austria 6 — 2 4 +The Netherlands 3 — 1 2 +Total EMEA 62 2 7 57 +Total 383 15 31 367 +E-commerce Channel +As of December 31, 2019, we offered our products through 13 company-operated e-commerce sites worldwide and also on third-party marketplaces. During the years ended December 31, 2019, 2018, and 2017, 18.5%, 16.8%, and 14.6%, respectively, of our revenues were derived through this channel. Our e-commerce presence facilitates increased access to our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly +4 +Table of Contents +sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, and EMEA. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our operating segments. +Raw Materials +Croslite TM , our proprietary closed-cell resin brand, is the primary material formulation used in the vast majority of our footwear and some of our accessories. Croslite TM is formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties and develop new properties for specific applications. +Croslite TM is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in Croslite TM . In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce Croslite TM products are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using leather, textile fabrics, or other non-Croslite TM materials, such as LiteRide TM . These materials are obtained from a number of third-party sources and we believe these materials are also broadly available. +Sourcing +Our strategy is to maintain a flexible, globally-diversified, low-cost third-party manufacturing capability. We source our footwear production from multiple third-party manufacturers, primarily in Vietnam and China. During the years ended December 31, 2019, 2018, and 2017, our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 38%, 45%, and 41%, respectively, and our second largest third-party manufacturer, primarily operating in Vietnam, produced approximately 21%, 21%, and 19%, respectively, of our footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. See the risk factor “ We depend solely on third-party manufacturers located outside of the U.S.” , included in Item 1A. Risk Factors for information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. During 2019, we moved our U.S. distribution center from Ontario, California to Dayton, Ohio. As of December 31, 2019, we stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S., the Netherlands, and Japan. We also utilized third-party operated distribution centers located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2019, our company-operated warehouse and distribution facilities provided us with 1.0 million square feet, and our third-party operated distribution facilities provided us with 0.3 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +5 +Table of Contents +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering the product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite TM , LiteRide TM , and Reviva TM , among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using exclusive supply agreements for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite TM and LiteRide TM , which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting by monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Seasonality +Due to the seasonal nature of our footwear, which is more heavily focused on styles suitable for warm weather, revenues generated during our fourth quarter, when the northern hemisphere is experiencing cooler weather, are typically less than revenues generated during our first three quarters. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, but not limited to, the timing of new model introductions, general economic conditions, and consumer confidence. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of expected results for any other quarter or for any other year. +Backlog +A significant portion of orders from our wholesale customers and distributors remain unfilled as of any given date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog, which can be canceled by our customers at any time prior to shipment. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders and excludes potential sales in our retail and e-commerce channels. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedules, and the timing of product shipments. Backlog also is affected by the timing of customers’ orders and product availability. Due to these factors and business model differences around the globe, and because backlog is cancelable at any time prior to shipment, we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and should not be relied upon. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with footwear retailers such as Genesco, Inc., Macy’s Inc., Dillard’s, Inc., Dick’s Sporting Goods, Inc., The Finish Line Inc., and Foot Locker, Inc. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, our Croslite TM material, our prices, our product line, and our distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, +6 +Table of Contents +longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. +Employees +As of December 31, 2019, we had 3,803 full-time, part-time, and seasonal employees, of which 2,728 were engaged in retail-related functions. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. \ No newline at end of file diff --git a/raw/filings/0001334036/2019/0001334036-20-000010/item13.txt b/raw/filings/0001334036/2019/0001334036-20-000010/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..9df31ef1b123061906cf51fe983e13834e812f8f --- /dev/null +++ b/raw/filings/0001334036/2019/0001334036-20-000010/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2020 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2019. \ No newline at end of file diff --git a/raw/filings/0001334036/2019/0001334036-20-000010/item9a.txt b/raw/filings/0001334036/2019/0001334036-20-000010/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..1939e0b52862c0ba8fa30a23c2d8aea8ca17a5b0 --- /dev/null +++ b/raw/filings/0001334036/2019/0001334036-20-000010/item9a.txt @@ -0,0 +1,27 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2019, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2019, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2019. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2019, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +39 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated February 27, 2020, expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company’s adoption of a new accounting standard. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “ Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 27, 2020 +40 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2019/0001334036-20-000010/rp_note.txt b/raw/filings/0001334036/2019/0001334036-20-000010/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2019/0001334036-20-000010/rpt_disclosure.txt b/raw/filings/0001334036/2019/0001334036-20-000010/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4c59dc0df3a7d24cbcda30496b1874ff4ee39e08 --- /dev/null +++ b/raw/filings/0001334036/2019/0001334036-20-000010/rpt_disclosure.txt @@ -0,0 +1,19 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Investment Agreement with Blackstone +On January 27, 2014, we issued to Blackstone Capital Partners VI L.P. (“Blackstone”) and certain of its permitted transferees (collectively, the “Blackstone Purchasers”) an aggregate of 200,000 shares of our Series A Preferred Convertible Preferred Stock (“convertible preferred stock”) for an aggregate purchase price of $198 million, or $990 per share, pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, the “Investment Agreement”). In connection with the issuance of the convertible preferred stock (the “Closing”) and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2 million and reimbursed Blackstone’s transaction fees and expenses of approximately $4 million. Mr. Ribatt, our former Chief Executive Officer and former member of our Board, was a permitted transferee of Blackstone and purchased 1,000 shares of our convertible preferred stock. As a result, Blackstone became a beneficial owner of greater than 5% of our outstanding common stock. On December 5, 2018, we repurchased 100,000 shares of convertible preferred stock from the Blackstone Purchasers and the Blackstone Purchasers converted their remaining shares of convertible preferred stock into an aggregate of 6,896,548 shares of our common stock. In October 2019, Mr. Ribatt sold his 34,482 shares of our common stock. On November 4, 2019, the Blackstone Purchasers sold their 6,864,545 shares of our common stock in an underwritten public offering. As of such date, the Investment Agreement was terminated in accordance with its terms. In connection with the termination of the Investment Agreement, Mr. Melwani and Mr. Gray, who were designated by Blackstone under the Investment Agreement, are not standing for re-election and their terms expire at the Annual Meeting. +Registration Rights Agreement +In connection with the Closing, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the “Registration Rights Agreement”), pursuant to which we agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of its shares of common stock. The Registration Rights Agreement contained customary terms and conditions, including certain customary indemnification obligations and a covenant that we would bear all costs, fees and expenses in connection with any resale of the Blackstone Purchasers’ shares of common stock. On November 4, 2019, the Blackstone Purchasers sold all 6,864,545 shares of our common stock in an underwritten public offering and we incurred approximately $0.6 million of expenses under the Registration Rights Agreement in connection with the sale of such shares by the Blackstone Purchasers. As of such date, the Registration Rights Agreement was terminated in accordance with its terms. +RGIS Services +We received inventory count services from RGIS, LLC (“RGIS”), an affiliate of Blackstone. Through November 4, 2019 (the date Blackstone ceased to be an affiliate of us), we paid RGIS approximately $282,000 for inventory services received. +Optiv, Inc. +We received cyber security and consulting services from Optiv, Inc. (“Optiv”), an affiliate of Blackstone. Through November 4, 2019 (the date Blackstone ceased to be an affiliate of us), we paid Optiv approximately $1.6 million for such services. +Kronos Incorporated +We received workforce management services from Kronos Incorporated (“Kronos”), an affiliate of Blackstone. Through November 4, 2019 (the date Blackstone ceased to be an affiliate of us), we paid Kronos approximately $312,000 for such services. +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee +25 +must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. The full Board approved each of the transactions disclosed above. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +26 \ No newline at end of file diff --git a/raw/filings/0001334036/2020/0001334036-21-000035/filing.txt b/raw/filings/0001334036/2020/0001334036-21-000035/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..6d5060833ed07dca9b1abc1c6f2a2106948fb259 --- /dev/null +++ b/raw/filings/0001334036/2020/0001334036-21-000035/filing.txt @@ -0,0 +1,2135 @@ +crox-20201231 +false FY 2020 0001334036 us-gaap:AccountingStandardsUpdate201602Member 0001334036 2020-01-01 2020-12-31 iso4217:USD 0001334036 2020-06-30 xbrli:shares 0001334036 2021-02-16 0001334036 2019-01-01 2019-12-31 0001334036 2018-01-01 2018-12-31 iso4217:USD xbrli:shares 0001334036 2020-12-31 0001334036 2019-12-31 0001334036 us-gaap:CommonStockMember 2017-12-31 0001334036 us-gaap:TreasuryStockMember 2017-12-31 0001334036 us-gaap:AdditionalPaidInCapitalMember 2017-12-31 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EXCHANGE COMMISSION +Washington, D.C. 20549 +________________________________________________________________________________________________________________________________ +FORM 10-K +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31 , 2020 +or +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware 20-2164234 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +13601 Via Varra +Broomfield , Colorado 80020 +( 303 ) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: Trading symbol: Name of each exchange on which registered: +Common Stock, par value $0.001 per share CROX The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. +Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company Emerging growth company +☒ ☐ ☐ ☐ ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2020 was approximately $ 2.1 billion. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock, par value $0.001 per shares, outstanding as of February 16, 2021 was 65,439,867 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2021 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2020. +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding +• our expectations regarding the impact of the novel coronavirus (“COVID-19”) pandemic on our business, financial condition, operating results, capital expenditures, and liquidity; +• our expectations regarding future trends, selling, general and administrative cost savings, expectations, and performance of our business; +• our belief that we have sufficient liquidity to fund our business operations during the next twelve months; and +• our expectations about the impact of our strategic plans. +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this Annual Report on Form 10-K, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. +i +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2020 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +8 +Item 1B. +Unresolved Staff Comments +21 +Item 2. +Properties +21 +Item 3. +Legal Proceedings +21 +Item 4. +Mine Safety Disclosures +22 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +23 +Item 6. +Selected Financial Data +25 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +27 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +42 +Item 8. +Financial Statements and Supplementary Data +43 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +43 +Item 9A. +Controls and Procedures +43 +Item 9B. +Other Information +45 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +46 +Item 11. +Executive Compensation +46 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +46 +Item 13. +Certain Relationships and Related Transactions and Director Independence +46 +Item 14. +Principal Accountant Fees and Services +46 +PART IV +Item 15. +Exhibits, Financial Statement Schedule +47 +Item 16. +Form 10-K Summary +51 +Signatures +52 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. The vast majority of shoes within our collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2020 with the fourth year of our global “Come As You Are™” campaign. +We offer a broad portfolio of all-season products, while remaining true to our core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. +At the heart of our brand’s DNA are our clogs, sandals, and Jibbitz™ charms. The Classic Clog, our most iconic style for adults and children, embodies our innovation in molding, simplicity of design, and all-day comfort. The unique feel of the Classic Clog can be experienced throughout the vast majority of our product line due to the use and design of Croslite™. Sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. Jibbitz™ charms enhance the consumer experience by providing an outlet for customization and heightening our message of “Come As You Are™.” +We also use Croslite™ material formulations in connection with new material technologies used in our LiteRide™ collection, as we focus on visible comfort technology. LiteRide™ features comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +We strive to provide our global consumers with comfortable, casual, colorful, and innovative footwear styles, with a focus on molded product. Our collections address many wearing occasions and meet the needs of the entire family. We enjoy licensing partnerships with Disney, including Marvel and Lucasfilm, Universal Studios, Nintendo, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Environmental, Social, and Governance (“ESG”) Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry and our planet by committing to transparent, socially conscious, and sustainable business practices. +Through our ESG Program, we expect to continue to advance our sustainable business practices with the goal of consistently delivering products that exceed customer and consumer expectations. We believe the progress of our ESG efforts is best served by disclosing goals and relevant metrics, and, to this end, we are aligning our program with the United Nations Sustainable Development Goals (“SDGs”) and the Sustainability Accounting Standards Board (“SASB”) framework for reporting and disclosure in order to establish specific goals, targets, and policies to enhance our ESG progress. +Environmental +We are committed to reducing our impact on the environment by focusing on sustainability initiatives in our operations and throughout our supply chain and product lifecycle. +2 +Table of Contents +In 2020, we identified four key areas of focus: (i) incorporating more sustainable product ingredients; (ii) disclosing efforts and progress towards reducing greenhouse gas (“GHG”) emissions, energy, water consumption, and waste; (iii) transitioning to more environmentally friendly packaging; and (iv) exploring sustainable solutions for product end of life. +We have also joined the Sustainable Apparel Coalition (“SAC”) for the purpose of baselining and establishing goals across emissions, energy and water use, and waste reduction/disposal for both our internal brand activities as well as our factory partners. Crocs is also working to align with Science-Based Targets for the purpose of developing meaningful GHG emissions reduction goals that support the prevention of climate change. +Social +Human Capital +At Crocs, our vision to make “everyone comfortable in their own shoes” starts with our people. As of December 31, 2020, we employed approximately 4,600 employees in the Americas, EMEA, and Asia Pacific. This includes approximately 2,600 employees in our retail stores, 1,000 employees at our corporate/regional offices, and 1,000 employees at our distribution centers. +We are committed to the health and safety of our employees and customers. In response to COVID-19, our corporate offices, retail stores, and distribution centers have implemented various elevated safety protocols, in accordance with local guidelines and regulations, including temperature checks, mandatory mask policies, social distancing, access to hand sanitizer, plexiglass partitions, and enhanced cleaning of the facilities. To support our workforce, we also implemented a supplemental sick policy for our U.S. workforce with additional hours available for paid time off related to COVID-19. +To ensure that we remain an employer of choice for what we believe is the most talented workforce in the footwear industry, we have implemented initiatives across our business and geographies to develop leadership capabilities, enable meaningful professional experiences, offer a compelling employee value proposition, and create a transparent, collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” We are also committed to an equitable total rewards philosophy as well as pay transparency in all regions. +We are proud of our culture of inclusion, which encompasses regular employee listening, employee-led inclusivity councils, and diversity at all levels. Crocs strives to create a culture of inclusion where employees can freely contribute equally regardless of gender, age, ethnicity, disability, or sexual orientation. Our Code of Ethics codifies these values. +Investing in talent is a key component of our human capital strategy. Crocs is committed to identifying and developing the next generation of leadership. We conduct an annual talent and succession review with our CEO and Board of Directors (“Board”) with a focus on accelerating talent development, strengthening succession pipelines, and advancing diversity representation for our most critical roles. +We continue to emphasize employee development and training. We have established a culture of learning and development, with robust training at all levels on a wide range of topics from Leading for Respect and Inclusion, Thriving through Adversity (for instance, during the COVID-19 pandemic), Leading for Innovation, and Facilitating Team Communication. +Crocs is committed to providing an employee value proposition that is compelling, market-competitive, and performance-based. Our compensation programs, practices, and policies reflect our commitment. We aim to generally position total direct compensation within a competitive range of the market median, with differentiation based on tenure, skills, proficiency, and performance to attract and retain key talent. +Our regular employee engagement surveys reflect a highly engaged global workforce, with, among others, high scores returned by employees recommending “Crocs as a great place to work” and saying “it is easy for people with diverse backgrounds to be accepted.” +Social Capital +At Crocs, we strive to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards. To this end, we have implemented measures to ensure our supply chain complies with these standards, including utilizing internal and external parties to conduct both scheduled and unannounced social compliance reviews. We also maintain a factory Social Compliance Code of Conduct and a certification process – our contracted factories and direct suppliers sign an annual Statement of Compliance, verifying that their operations are in +3 +Table of Contents +compliance with all local laws and customs regarding hiring practices, wages, and working conditions, as well as our Code of Conduct. +We also monitor chemicals and substances in our supply chain for compliance with legal and regulatory requirements consistent with our Restricted Substances Policy and expect our contracted factories and suppliers to take a proactive stance in eliminating any hazardous chemicals or substances in the manufacture of Crocs products. +Community +Giving back to the community is extremely important to us. Through our global “Crocs Cares” program, we focus on providing shoes to address human needs, funds to support those in need, and time to enable our employees to support their local communities. To this end, we have donated over one million pairs of shoes in the past five years, and in 2020 donated over 860,000 pairs of shoes to frontline healthcare workers and other organizations as part of our “A Free Pair for Healthcare” program. +Governance +At Crocs, we have strong corporate governance mechanisms in place, along with robust internal controls over our financial reporting framework. We also have Enterprise Risk Management and Ethics & Compliance program frameworks, with regular updates provided to our Board committees as well as our Board. For our ESG efforts, Crocs has established an ESG/sustainability management and oversight framework under the direction of our Executive Vice President, Chief Legal & Risk Officer. The Governance and Nominating Committee of our Board oversees our ESG efforts. +Our commitment to diversity and inclusion is reflected in our Board, comprised of 38% female members as of December 31, 2020. We are continuing efforts to expand our Board’s diversity. +Sales and Marketing +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. We prioritize five core markets including: (i) the U.S., (ii) Japan, (iii) China, (iv) South Korea, and (v) Germany. These countries represent key geographies where we believe the greatest opportunities for growth exist. We also concentrate our marketing efforts on these countries, to increase customer awareness of both our brand and our full product range. +Each season, we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, that allow for personalization. We are expanding our sandal offerings as we pursue a greater share of a large market that currently has no clear global leader. We are continuing to invest in designer, celebrity, and brand collaborations, as well as celebrity brand ambassadors to raise consumer engagement with our brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 80 countries through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our retail channel consists of company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2020, 2019, and 2018, 50.0%, 53.3%, and 53.1% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors in certain countries, including partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. In 2020, as a result of the COVID-19 pandemic, many of our wholesale brick-and-mortar retailers were closed for a portion of the year. +4 +Table of Contents +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. In 2020, as a result of the COVID-19 pandemic, many of our distributors’ stores were closed for a portion of the year and in many cases experienced lower traffic due to the decline in tourism. +No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2020, 2019, and 2018. +Retail Channel +During the years ended December 31, 2020, 2019, and 2018, 24.1%, 28.2%, and 30.1%, respectively, of our revenues were derived through our retail channel. During 2020, as a result of the COVID-19 pandemic, our global retail stores were closed for a portion of the year. However, the vast majority of our stores were open as of December 31, 2020. We operate our retail channel through three platforms: company-operated full-price retail stores, outlet stores, and store-in-store locations. With the continued worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2020, we had 351 company-operated stores. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for information on store locations by platform. +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. We believe the optimal location for our full-price retail stores is in high foot-traffic shopping malls or districts. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. Outlet stores are generally located within outlet shopping centers. +Store-in-Store Locations +Our company-operated store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space, and limited fixed cost and capital investment, we believe store-in-store locations can be effective vehicles for selling our products in certain geographic areas. +5 +Table of Contents +Company-Operated Retail Stores +The following table illustrates the net change during 2020 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2019 Opened Closed December 31, 2020 +Americas +United States 153 2 1 154 +Canada 9 — 1 8 +Puerto Rico 3 — — 3 +Total Americas 165 2 2 165 +Asia Pacific +Korea 85 5 — 90 +China 23 1 6 18 +Japan 12 — — 12 +Singapore 17 — — 17 +Australia 7 1 8 — +Hong Kong 1 — 1 — +Total Asia Pacific 145 7 15 137 +EMEA +Russia 30 2 6 26 +Germany 15 — 1 14 +France 6 — 2 4 +Austria 4 — 1 3 +The Netherlands 2 — — 2 +Total EMEA 57 2 10 49 +Total 367 11 27 351 +E-commerce Channel +As of December 31, 2020, we offered our products through 13 company-operated e-commerce sites worldwide and also on third-party marketplaces. During the years ended December 31, 2020, 2019, and 2018, 25.9%, 18.5%, and 16.8%, respectively, of our revenues were derived through this channel. Our e-commerce presence facilitates increased access to our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: the Americas, Asia Pacific, and EMEA. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our operating segments. +Raw Materials +Croslite™, our proprietary closed-cell resin brand, incorporates the primary material formulations used in the vast majority of our footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties and develop new properties for specific applications. +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In +6 +Table of Contents +the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using leather, textile fabrics, or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources and we believe these materials are also broadly available. +Sourcing +Our strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in Vietnam and China. During the years ended December 31, 2020, 2019, and 2018, our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 46%, 38%, and 45%, respectively, and our second largest third-party manufacturer, also operating in both Vietnam and China, produced approximately 22%, 17%, and 15%, respectively, of our footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. See the risk factor under “Risks Related to International Operations — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2020, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands, as well as in a leased third-party operated distribution center in Japan. During 2020, we increased throughput as a result of the prior year move of our U.S. distribution center from Ontario, California to Dayton, Ohio, and we expanded the Ohio campus to further increase our distribution capacity in the Americas. In 2020, construction began on a new EMEA distribution center in the Netherlands, which is expected to be fully operational in 2021, and we completed the relocation of our third-party operated Asia Pacific distribution center within Japan. We also utilized third-party operated distribution centers located in China, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2020, our company-operated and leased warehouse and distribution facilities provided us with 1.8 million square feet, and our third-party operated distribution facilities provided us with 0.5 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality +7 +Table of Contents +agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, our material formulations, our prices, our product line, and our distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +ITEM 1A. Risk Factors +You should carefully consider the following risk factors and all other information presented within this Annual Report on Form 10-K. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, access to sources of financing, or stock price. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Because we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for us to predict all risk factors, nor can we assess the impact of all such risk factors on our business. Please also refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K. +Risks Related to Our Products +Our success depends substantially on the value of our brand; failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs global brand. To be successful in the future, particularly outside of the U.S., where the Crocs global brand may be less well-known or perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brand across all sales +8 +Table of Contents +channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be out of style, outdated, or otherwise undesirable. Maintaining, promoting, and growing our brand will depend on our design and marketing efforts, including product innovation and quality, advertising and consumer campaigns, as well as our ability to adapt to a rapidly changing media environment, including our reliance on social media and digital dissemination of advertising campaigns. +In the past, several footwear companies, including ours, have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Consumer demand for our products and our brand equity could also diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. +Adverse publicity about regulatory or legal action against us, or by us, could also damage our reputation and brand image, undermine consumer confidence in us, and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Negative claims or publicity involving us, our products, or any of our key employees, endorsers, or business partners could materially damage our reputation and brand image, regardless of whether such claims are accurate. Social media, which accelerates and potentially amplifies the scope of negative publicity, can accelerate, and increase the impact of, negative claims. Further, business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brand and adversely impact our business. +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, and spend substantially more on product marketing than we do. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, launch more extensive or diverse product lines, and more quickly develop new and popular products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Continuing to rationalize our existing product assortment and introducing new products may be difficult and expensive. If we are unable to do so successfully, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully continue to refine our footwear product line, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles and product lines, and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses. There can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful. Failure to gain market acceptance for new +9 +Table of Contents +products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brand, erode our competitive position, and result in long-term harm to our business and financial results. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and design rights on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brand, our success, and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement or other infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others intellectual property rights, continued sales of such competing products by third parties could harm our brand or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brand is associated with inferior counterfeit reproductions, the integrity and reputation of our brand could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite™ material formulations and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information, and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement, and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Failure to continue to obtain or maintain high-quality endorsers of our products could harm our business . +We establish relationships with both celebrity endorsers and design, celebrity, and brand collaborators to develop, evaluate, and promote our products, as well as strengthen our brand. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brand visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers and collaborators associated with our products that harm the public image and reputations of those endorsers and collaborators could also seriously harm our brand image with consumers and, as a result, could have an adverse effect on our sales and financial condition. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear, such as our branded Croslite™ and LiteRide™ materials. Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite™, our branded proprietary closed-cell resin, is the primary raw material used in the vast majority of our footwear and some of our accessories. Croslite™ is carefully formulated to create soft, durable, extremely lightweight, and water-resistant footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +10 +Table of Contents +Risks Related to the Economy +The COVID-19 pandemic has had an adverse impact, and may have a future material adverse impact, on our business, operations, liquidity, financial condition, and results of operations. +In 2020, the COVID-19 pandemic drove global uncertainty and disruption and has spread throughout the geographic regions in which we run our business and where our suppliers, third-party manufacturers, retail stores, wholesale customers, and consumers are located. The pandemic has had a material impact on our retail and wholesale channel revenues, predominately in the first half of 2020, and the total impact of the pandemic on us will depend on developments outside of our control, including, among other factors, the duration and spread of the outbreak, actions that may be taken by governmental authorities to contain the outbreak or mitigate its impact, including related restrictions on movement and commercial activities, the economic or other impacts on our wholesale partners, the impact on and recovery time of our supply chain, consequential staffing shortages, manufacturing delays and the uncertainty with respect to the accessibility of additional liquidity or to the capital markets. +While the vast majority of our company-operated stores, our partner stores, and our wholesale partner stores were open as of December 31, 2020, some may close again upon additional COVID-19 outbreaks. At this time, we cannot reasonably estimate the length of time of any remaining closures, if further closures will occur, or if consumers will return to purchasing our products at historical levels in retail locations. The inability to sell our products in our retail or wholesale channels has had and may continue to have a material adverse effect on our revenues and results of operations. +We also rely upon the facilities of our third-party manufacturers outside of the U.S. to support our business as well as to export our products throughout the world. As a result of COVID-19 and the measures designed to contain the spread of the virus, our third-party manufacturers may not have the materials, capacity, or capability to manufacture our products according to our schedule and specifications, which may negatively impact our ability to manage inventories. If our third-party manufacturers’ operations are curtailed, we may need to seek alternate manufacturing sources, which may be unavailable, more expensive, or face the same constraints. The possibility of and the duration of any production or supply chain disruption, and related financial impact, if any, cannot be estimated at this time. Should any production and distribution closures continue for an extended period of time, the impact on our global supply chain could have a material adverse effect on our results of operations and cash flows. See the risk factor under “ Risks Related to International Operations — We depend solely on third-party manufacturers located outside the U.S .” for more information. +The effects of COVID-19 could affect our ability to successfully operate in many ways, including, but not limited to, the following factors: +• the impact of the pandemic on the economies and financial markets of the countries and regions in which we operate, including a prolonged global recession, a decline in consumer confidence and spending, or a further increase in unemployment levels, has resulted, and could continue to result, in consumers having less disposable income and, in turn, decreased sales of our products; +• “shelter in place” and other similar mandated or suggested isolation protocols, which have disrupted, and could continue to disrupt, our retail locations, partner stores, and brick-and-mortar retailers via store closures or reduced operating hours and decreased retail traffic; +• difficulty accessing debt and equity on attractive terms, or at all, and a severe disruption and instability in the global financial markets or deterioration in credit and financing conditions may affect our ability to access capital necessary to operate our business; +• our ability, if necessary, to reduce operating costs and conserve cash; +• our inability to obtain additional rent and other relief from our landlords if additional retail stores close in response to another outbreak, which may involve litigation or other disruptions; +• the failure of our wholesale customers, to whom we extend credit, to pay amounts owed to us on time, or at all, particularly if such customers are significantly impacted by COVID-19; +• the risk that even after the pandemic has initially subsided, fear of COVID-19 re-occurrence could cause customers to avoid public places where our stores and those of our wholesale partners are located such as malls and outlets; +• operational risk, including, but not limited to, cybersecurity risks as a result of extended remote work arrangements and restrictions on employee travel; and +11 +Table of Contents +• we may be required to revise certain accounting estimates and judgments such as, but not limited to, those related to the valuation of long-lived assets and deferred tax assets, which could have a material adverse effect on our financial position and results of operations. +The rapid development and fluidity of the pandemic precludes any prediction as to the ultimate impact of COVID-19. The full extent of the impact and effects of COVID-19 on our future business, operations, liquidity, financial condition, and results of operations remain uncertain at this time. +Risks Related to Our Supply Chain +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions, including as a result of the COVID-19 pandemic, and other factors affecting consumer demand. In addition, purchase orders from our wholesale customers are generally subject to rights of cancellation and rescheduling by the wholesaler. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in losses or lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in lower sales, delays in shipments to customers, expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. Excess inventory, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our third-party manufacturing operations must comply with labor, trade, and other laws. Failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental, and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall, which could result in critical media coverage; harm our business, brand, and reputation; and cause us to incur additional costs. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business or results. See the risk factor under “Risks Related to International Operations — We depend solely on third-party manufacturers located outside the U.S.” for more information. +We depend on a number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite™ and LiteRide™ formulations, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market conditions related to supply and demand for our raw materials and any resulting shortages in supply, including those that may be caused by the COVID-19 pandemic. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins, or if we are unable to procure sufficient quantities of the materials that go into the Croslite™ and LiteRide™ formulations, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, +12 +Table of Contents +which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Risks Related to International Operations +Changes in foreign exchange rates, most significantly but not limited to the Euro, Russian Ruble, Brazilian Real, South Korean Won, Japanese Yen, or other global currencies could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar (“USD”). We are exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of operations and the value of our assets and liabilities denominated in foreign currencies. +Further, our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, gross margin compression, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. We pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. In 2020, we experienced decreases of approximately $5.7 million in our Americas segment revenues, primarily as a result of decreases in the value of the Brazilian Real relative to the USD, approximately $3.0 million in our Asia Pacific segment revenues as a result of decreases in the value of Asian currencies relative to the USD, and a decrease of approximately $1.9 million in our EMEA revenues, primarily as a result of decreases in the Russian Ruble relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies, adversely impacts our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and, as a result, our forward contracts may not prove effective in reducing our exposures. +We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. We operate retail stores and sell our products to retailers outside of the U.S. and utilize foreign-based third-party manufacturers. Foreign manufacturing and sales activities are subject to numerous risks, including +• tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; +• delays associated with the manufacture, transportation, and delivery of products; +• increased transportation costs due to distance, energy prices, or other factors; +• delays in the transportation and delivery of goods due to increased security concerns; +• restrictions on the transfer of funds; +• restrictions and potential penalties due to privacy laws on the handling and transfer of consumer and other personal information; +• changes in governmental policies and regulations; +• political unrest, changes in law, terrorism, natural disasters, public health issues like the COVID-19 pandemic, or war, any of which can interrupt commerce; +• potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; +• expropriation and nationalization; +• difficulties in managing foreign operations effectively and efficiently from the U.S.; +13 +Table of Contents +• difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions; +• longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; +• difficulties in enforcing contractual and intellectual property rights; +• greater risk that our business partners do not comply with our policies and procedures relating to labor, health, and safety; and +• increased accounting and internal control costs. +In addition, we are subject to customs laws and regulations with respect to our export and import activity, which are complex and vary within legal jurisdictions in which we operate. We cannot ensure there will be not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. For more information, please see the risk factors under “ Risks Related to International Operations — We depend solely on third-party manufacturers located outside the U.S. ” and “ Risks Specific to Our Company and Strategy — Our business relies significantly on the use of information technology. A significant disruption to our operational technology or data security breach could harm our reputation and/or our ability to effectively operate our business.” +Furthermore, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties; criminal sanctions against us, our officers, or our employees; prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries; and a materially negative effect on our brand and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners, or agents will not violate our policies. +We depend solely on third-party manufacturers located outside of the U.S. +All of our footwear products are manufactured by third-party manufacturers, the majority of which are located in Vietnam and China. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity, and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders. During the years ended December 31, 2020, 2019, and 2018, our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 46%, 38%, and 45%, respectively, and our second largest third-party manufacturer, also operating in both Vietnam and China, produced approximately 22%, 17%, and 15%, respectively, of our footwear unit volume. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines, or meet our quality standards. Furthermore, disruption at the facilities of our third-party manufacturing partners as a result of COVID-19, including through the effects of facility closures, reductions in operating hours, labor shortages, and real-time changes in operating procedures, including additional cleaning and disinfection procedures, could have a material adverse effect on our supply chain. See the risk factor under “Risks Related to the Economy — The COVID-19 pandemic has had, and may continue to have, a material adverse impact on our business, operations, liquidity, financial condition, and results of operations.” +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, including those caused by the COVID-19 pandemic, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, changes in governmental policies and the imposition of tariffs, import and export controls, and other barriers. Because we ceased internal manufacturing in 2018, we can no longer offset any interruption or decrease in supply of our products by increasing production in internal manufacturing facilities, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can increase our transportation costs and adversely affect our product margins. +14 +Table of Contents +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, increases in labor costs, changes in international trade agreements and tariffs, adverse weather conditions, or public health issues, such as the COVID-19 pandemic, could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. +We, similar to many other companies with overseas operations, import and sell products in other countries that could be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition, and results of operations. +Changes in global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, public health issues like the COVID-19 pandemic, or other economic factors. If global economic and financial market conditions deteriorate, or remain weak, for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results. +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, cause reduced product orders or product order delays or cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• If consumer demand for our products declines, we may not be able to profitably operate existing retail stores, due to higher fixed costs of the retail business. +• A decrease in credit available to our wholesale or distributor customers, product suppliers and other service providers, or financial institutions that are counterparties to our Facility (as defined below) or derivative instruments may result in credit pressures, other financial difficulties, or insolvency for these parties, with a potential adverse impact on our business, our financial results, or our ability to obtain future financing. +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms, which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment of our accounts receivable. +• If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +Risks Specific to Our Company and Strategy +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. We are focusing on our core molded footwear heritage by +15 +Table of Contents +narrowing our product line with an emphasis on higher margin products, as well as developing innovative new casual lifestyle footwear platforms. +Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to +• strengthen and maintain our brand globally; +• focus on relevant geographies and markets, product innovation, and profitable growth, while maintaining demand for our current offerings; +• effectively manage our company-operated retail stores to meet operational and financial targets at the retail store level; +• accurately forecast the global demand for our products, consolidate our distribution and supply chain network to leverage resources, simplify our fulfillment process, and deliver product around the globe efficiently; +• use and protect the Crocs brand and our other intellectual property in new and existing markets and territories; +• achieve and maintain a strong competitive position in new and existing markets; +• attract and retain qualified wholesalers and distributors, including partner store operators; +• maintain and enhance our social digital marketing capabilities and digital commerce capabilities; and +• execute multi-channel advertising, marketing, collaboration, and social media campaigns to effectively communicate our message directly to our consumers and employees. +While these strategies, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance this will be the case or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results. +We rely heavily on the use of information technology systems and networks across all business functions, as do our business partners. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We rely on third-party information services providers worldwide for many of our information technology functions including network, hardware, and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing, and collection of payments. We use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. Furthermore, the importance of such information technology systems and networks increased in 2020 due to many of our employees working remotely as a result of the COVID-19 pandemic. We also have outsourced a significant portion of work associated with our finance and accounting, human resources, customer service, and other information technology functions to third-party service providers. Despite our current security and cybersecurity measures, our systems and those of our third-party service providers may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, and interruption or loss of valuable business data, and we have been subject to, and will continue to be subject to, various third-party attacks and phishing scams. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of sales, significant costs for data restoration, the inability to interpret data timely to enhance operations, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks on a daily basis. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers’ or employees’ personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network is breached, it could give rise to unwanted media attention, materially damage our customer relationships, or harm our business, our reputation, and our financial results, which could result in fines or lawsuits. The costs we incur to protect against such information security breaches may materially increase, including increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. Our business partners in our supply chain and +16 +Table of Contents +customer base also rely significantly on information technology. Despite their existing cybersecurity procedures and controls, if their information systems become compromised, it could, among other things, cause delays in our product fulfillment or reduce our sales, which could harm our business. +In addition, the European Union’s General Data Protection Regulation, the California Consumer Privacy Act, and other similar evolving privacy laws impose additional obligations on companies regarding the handling of personal data and provide certain individual privacy rights to persons whose data is stored. These regulations may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations, and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes and the associated costs may have a material adverse impact on our business and results of operations. +If our online e-commerce sites, or those of our customers, do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites and third-party e-commerce sites. This shift to e-commerce further accelerated in 2020 as a result of COVID-19. Any failure on our part or on the part of third parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our products could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including unauthorized access and denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Our financial success depends in part on the strength of our relationships with, and the success of, our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributor customers to carry our products. We do not have long-term contracts with most wholesale customers, and sales to these customers are generally on an order-by-order basis and subject to cancellation and rescheduling. Our contracts with distributors typically have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms, which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses, and reduced cash flows if our collection efforts are unsuccessful. We have recorded material allowances for doubtful accounts in the past and could do so again in the future. Additionally, in 2020, as a result of the COVID-19 pandemic, we recorded $4.1 million of bad debt expense associated with global distributors. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations, and our ability to grow our product line. +Operating company-operated retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably, or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location, and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2020, we opened 11 and closed 27 retail stores, and we operated 351 retail stores at December 31, 2020. Additionally, during 2020, as a result of the COVID-19 pandemic, our global retail stores were closed for a portion of the year. +Many of our company-operated retail stores are located in shopping malls and outlet malls, and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot-traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick-and-mortar retail to e-commerce channels, both prior to, and as a result of, the COVID-19 pandemic, which may contribute to declining foot-traffic in company-operated retail locations. Continued reduced customer foot-traffic could reduce sales at our company-operated retail stores, including store-in-store locations, or hinder our ability to open retail stores in new markets, which could in turn negatively affect our business and financial results. Similarly, customer foot-traffic as a result of store closures, reduced operating hours, social distancing restrictions, and/or changes in consumer behavior as a result of the COVID-19 pandemic could also have a material adverse effect on our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. +17 +Table of Contents +Any substantial decrease in tourism, resulting from an economic slowdown, political, terrorism, social, or military events, natural disasters, public health issues like the COVID-19 pandemic, or otherwise, is likely to adversely affect sales in our existing stores. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, expansion of existing businesses or operations, and acquisitions of new businesses, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect, or implementation issues, or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back office systems. We have also moved to, and subsequently expanded, a new distribution center in Dayton, Ohio to serve our North American businesses and have planned a new company-operated distribution center in The Netherlands and new third-party operated distribution center in Japan to serve our EMEA and Asia Pacific businesses, respectively. As our business grows, we may also need to make further investments in business systems and distribution capabilities. Issues in implementing or integrating new business operations and new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, issues with transitioning to or operating our new distribution centers, cost overruns, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations, require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +We depend on employees across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +Further, our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threats to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing, or manufacturing and selling seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +We are subject to periodic litigation, which could result in unexpected expenditures of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings, or any future legal proceedings, could have an adverse impact on our business and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +18 +Table of Contents +Extreme weather conditions, natural disasters, public health issues, or other events outside of our control could negatively impact our operating results and financial condition. +The effects of climate change, natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, and public health issues like the COVID-19 pandemic, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including damage to our supply chain, manufacturing or distribution centers, retail stores, changes in consumer preferences or spending priorities, and energy shortages, have in the past could in the future harm or disrupt our operations or the operations of our vendors, other suppliers, or customers, or result in economic instability that may negatively impact our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +Financial and Accounting Risks +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows, or the closure of a store could result in impairment of leasehold improvements, impairment of right-of-use assets, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. Impairment charges may increase as we continue to evaluate our retail operations. In 2020, we recorded $20.0 million of impairments to our long-lived assets for a retail store in New York City and $1.1 million to our long-lived assets for our former corporate headquarters. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, which could increase the volatility of the price of our common stock. +Quarterly results may also fluctuate as a result of several factors, including new style introductions, general economic conditions, or changes in consumer preferences. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +Our senior revolving credit facility agreement (as amended to date, the “Credit Agreement”) contains financial covenants that require us to maintain certain financial measures and ratios and includes restrictive covenants that limit our ability to take certain actions. A breach of any of those restrictive covenants may cause us to be in default under the Credit Agreement, and our lenders could foreclose on our assets. +Our Credit Agreement requires us to maintain certain financial covenants. A decline in our operating performance could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Credit Agreement. We may not have sufficient funds to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lenders. If we are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Credit Agreement. +19 +Table of Contents +The Credit Agreement also contains certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt; sell, lease or transfer our assets; pay dividends on our common stock; make capital expenditures and investments; guarantee debt or obligations; create liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +Changes in the method for determining LIBOR and/or the potential replacement of LIBOR could adversely affect our results of operations. +In July 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. Our Credit Agreement states that, should LIBOR cease to exist or should another rate become widely recognized as the benchmark rate for USD loans, a rate substantially equivalent to the LIBOR rate in effect prior to its replacement, will be used. +At this time, the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions convened by the U.S. Federal Reserve, has recommended the Secured Overnight Financing Rate (“SOFR”) as a more robust reference rate alternative to U.S. Dollar LIBOR. SOFR is calculated based on short-term repurchase agreements, backed by Treasury securities. SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk, as is the case with LIBOR. SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question. +In March 2020, the Financial Accounting Standards Board issued guidance related to reference rate reform to help facilitate the market transition from existing reference rates to alternative rates. This guidance was available for adoption at the time of its issuance, but we did not adopt it in the year ended December 31, 2020. Further, at this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates, or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere. Uncertainty as to the nature of such potential changes, alternative reference rates, including SOFR, or other reforms may adversely affect the trading market for LIBOR-based securities, including ours. Furthermore, if LIBOR ceases to exist or a replacement rate is used to determine the interest rate on borrowings under our Credit Agreement, our borrowing cost may increase materially. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. +As the future of LIBOR at this time is uncertain, the potential effect of any future changes cannot yet be determined but may have an adverse impact on our interest expense and, thus, our results of operations. +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S., our business, and financial results. +We have substantial cash requirements in the U.S., but a significant portion of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested, and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the U.S. Tax Cuts and Jobs Act (the “Tax Act”), could be repatriated without incurring additional U.S. federal income taxes, although some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or +20 +Table of Contents +tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the U.S. and foreign jurisdictions for prior tax years. Please refer to Note 15 — Commitments and Contingencies and Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details regarding current tax audits. The final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. Recent developments, including U.S. tax reform, the European Commission’s investigations of local country tax authority rulings and whether those rulings comply with European Union rules on state aid, as well as the Organization for Economic Co-operation and Development’s project on Base Erosion and Profit Shifting, continue to change long-standing tax principles. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 13601 Via Varra, Broomfield, Colorado 80020. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for office, warehouse, and retail, including store-in-store, space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, use, and approximate size of our principal properties, and the reportable operating segment are given below. +Location Reportable Operating Segment Use Approximate Square Feet +Dayton, Ohio Americas Warehouse 1,270,000 +Dordrecht, the Netherlands (1) +EMEA Warehouse 517,000 +Rotterdam, the Netherlands (1) +EMEA Warehouse 284,000 +Narita, Japan Asia Pacific Warehouse 156,000 +Broomfield, Colorado Americas Corporate headquarters and regional office 88,000 +Hoofddorp, the Netherlands EMEA Regional office 29,000 +Singapore Asia Pacific Regional office 17,000 +Westwood, Massachusetts Americas Global commercial center 16,000 +(1) In 2019 and 2020, we entered into a lease agreement and subsequent amendments for a new distribution center in Dordrecht, the Netherlands, which is expected to replace to our existing distribution center in Rotterdam, the Netherlands in 2021. +Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operational needs. We also lease 351 retail locations worldwide as of December 31, 2020. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +A discussion of legal matters is found in Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +21 +Table of Contents +ITEM 4. Mine Safety Disclosures +Not applicable. +22 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the Nasdaq Global Select Market under the stock symbol “CROX.” +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the Nasdaq Composite Index and the Dow Jones U.S. Footwear Index from December 31, 2015 through December 31, 2020. The graph assumes an investment of $100.00 on December 31, 2015 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. Footwear Index includes NIKE, Inc., Deckers Outdoor Corporation, Skechers U.S.A., Inc., Steven Madden Ltd., and Wolverine World Wide, Inc. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 69 as of February 16, 2021. +23 +Table of Contents +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements include restrictions on cash dividends paid on our common stock. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to, among other things, our results of operations, financial condition, level of indebtedness, capital requirements, and compliance with covenants under any then-existing financing agreements. +Purchases of Equity Securities by the Issuer +Period Total Number of Shares Purchased Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) +Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs (1) +October 1-31, 2020 25,000 $ 52.55 25,000 $ 468,172,495 +November 1-30, 2020 +Open market or privately negotiated purchases 98,310 54.51 98,310 462,815,330 +November 2020 ASR (2) +1,530,113 81.69 1,530,113 337,815,330 +December 1-31, 2020 — — — 337,815,330 +Total (3) +1,653,423 $ 79.64 1,653,423 $ 337,815,330 +(1) On February 20, 2018, the Board approved and authorized a program to repurchase up to $500.0 million of our common stock, and on May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $500.0 million of our common stock. As of December 31, 2020, approximately $337.8 million remained available for repurchase under our share repurchase authorization. The number, price, structure, and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under our Facility, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. +(2) In November 2020, we entered into an accelerated share repurchase arrangement (“ASR”) to repurchase $125.0 million of our common stock. In exchange for an up-front payment of $125.0 million, the financial institution that was party to the ASR committed to deliver to us shares of our common stock during the ASR’s purchase period, which ended in January 2021. At the inception of the arrangement, 1.5 million shares were delivered and retired at an average price of $81.69 (note that this average price is based on a partial share delivery in 2020). Subsequently, the purchase period ended in January 2021, at which time an additional 0.5 million shares were delivered and retired. The average price paid per share for the complete ASR, which includes shares delivered in January 2021, was $62.76. +(3) The total average price paid per share of $79.64 for the three months ended December 31, 2020 is based on the November 2020 initial share delivery under our ASR (see footnote (2)). The total average price paid per share for the three months ended December 31, 2020, including the impact of the final ASR share delivery in January 2021, was $62.25. +24 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five years. The information in this table should be read in conjunction with our consolidated financial statements and accompanying notes presented in Item 8. Financial Statements and Supplementary Data and Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operations of this Annual Report on Form 10-K. +Year Ended December 31, +2020 2019 2018 2017 2016 +(in thousands, except per share data) +Revenues $ 1,385,951 $ 1,230,593 $ 1,088,205 $ 1,023,513 $ 1,036,273 +Cost of sales 636,003 613,537 528,051 506,292 536,109 +Gross profit 749,948 617,056 560,154 517,221 500,164 +Gross margin 54.1 % 50.1 % 51.5 % 50.5 % 48.3 % +Selling, general and administrative expenses +514,753 488,407 495,028 494,601 503,174 +Selling, general and administrative expenses as a % of revenues +37.1 % 39.7 % 45.5 % 48.3 % 48.6 % +Asset impairments (1) +21,071 — 2,182 5,284 3,144 +Income (loss) from operations $ 214,124 $ 128,649 $ 62,944 $ 17,336 $ (6,154) +Income (loss) before income taxes $ 206,979 $ 119,322 $ 65,157 $ 18,180 $ (7,213) +Income tax expense (benefit) (2) +(105,882) (175) 14,720 7,942 (9,281) +Net income (loss) 312,861 119,497 50,437 10,238 (16,494) +Dividends on Series A convertible preferred stock (2) +— — (108,224) (12,000) (12,000) +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature (3) +— — (11,429) (3,532) (3,244) +Net loss attributable to common stockholders +$ 312,861 $ 119,497 $ (69,216) $ (5,294) $ (31,738) +Net income (loss) per common share: +Basic $ 4.64 $ 1.70 $ (1.01) $ (0.07) $ (0.43) +Diluted $ 4.56 $ 1.66 $ (1.01) $ (0.07) $ (0.43) +Weighted average common shares: +Basic 67,386 70,357 68,421 72,255 73,371 +Diluted 68,544 71,771 68,421 72,255 73,371 +Cash provided by operating activities +$ 266,902 $ 89,958 $ 114,162 $ 98,264 $ 39,754 +Cash used in investing activities (41,762) (36,236) (10,110) (11,538) (19,856) +Cash used in financing activities (4) +(198,038) (68,638) (148,802) (65,370) (16,443) +(1) Asset impairments consist of impairments to long-lived assets for retail locations in all years, as well as a $1.1 million write-off for our former corporate headquarters in 2020, a $1.3 million write-off of supply chain assets in 2018, a $4.8 million write-off of a discontinued project in 2017, and $0.4 million of goodwill impairment in 2016. +(2) In the three months ended December 31, 2020, we completed an intra-entity transfer of certain intellectual property rights, primarily to align with current and future international operations. The transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. As a result, we recognized a tax benefit of $127.7 million for the year ended December 31, 2020. +(3) On December 5, 2018, all issued and outstanding shares of Series A Convertible Preferred Stock (“Series A Preferred”) were repurchased in exchange for cash or converted to common stock. As a result, amounts reported for the year ended December 31, 2018 include amounts resulting from the repurchase and conversion, in addition to payments made to induce conversion and accretion of dividend equivalents prior to December 5, 2018. +(4) Cash used in financing activities for the year ended December 31, 2018 reflects the impacts of $183.7 million used to repurchase Series A Preferred in 2018 and $120.0 million of borrowings. Cash used in financing activities also includes approximately $170.8 million, $147.2 million, $63.1 million, and $50.0 million, including commissions, used to repurchase shares of our common stock during 2020, 2019, 2018, and 2017, respectively. We did not repurchase shares in 2016. +25 +Table of Contents +December 31, +2020 2019 2018 2017 2016 +(in thousands) +Cash and cash equivalents $ 135,802 $ 108,253 $ 123,367 $ 172,128 $ 147,565 +Inventories 175,121 172,028 124,491 130,347 147,029 +Working capital (1) +201,257 168,159 195,807 268,031 276,335 +Total assets (1) +1,118,723 738,802 468,901 543,695 566,390 +Long-term liabilities (1) +536,506 349,674 134,102 18,379 17,966 +Total stockholders’ equity 290,633 131,905 150,308 185,865 220,383 +(1) Prior year amounts have not been recast to reflect adoption of revenue recognition guidance as of January 1, 2018, which impacts ‘Total Assets,’ or adoption of new lease guidance as of January 1, 2019, which impacts ‘Working capital’, ‘Total assets’, and ‘Long-term liabilities.’ +26 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 80 countries, through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our retail channel consists of company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party marketplaces. +Known or Anticipated Trends +Based on our recent operating results and our assessment of the current operating environment, we anticipate certain trends will continue to impact our future operating results: +• The COVID-19 pandemic has impacted our business globally in 2020, including through store closures and reduced operating hours, primarily during the second quarter of the year. Despite this, in 2020, we saw strong sales in e-commerce and strong sell-through in e-tail and wholesale partner sites, as consumers migrated to online shopping. The vast majority of our 351 company-operated stores were open at December 31, 2020. To ensure the well-being of our employees and customers, our corporate offices, retail stores, and distribution centers have implemented various elevated safety protocols, in accordance with local guidelines and regulations, including temperature checks, mandatory mask policies, social distancing, access to hand sanitizer, plexiglass partitions, and enhanced cleaning of the facilities. Our corporate offices have also actively managed attendance levels in accordance with local guidelines and regulations, and many of our corporate employees have continued to successfully conduct business virtually. We expect these measures to continue into 2021 until the population is vaccinated for COVID-19 to such a degree that these measures are no longer necessary. +• Digital growth, which was a priority in 2020 and a growing consumer trend, remains a key focus for 2021, along with a focus on clogs, sandals, personalization, and visible comfort technology, and growth in China, which remains a significant long-term opportunity. Digital sales include sales through our company-owned website, third-party marketplaces, and e-tailers. +• We expect revenue growth in 2021, primarily driven by our Americas and EMEA segments, and expect to incur costs affecting gross margin for investments in our distribution center network. Additionally, we plan to be able to continue leveraging SG&A as revenues grows in 2021. +• We were cash flow positive for the year ended December 31, 2020, despite the negative impacts of the global pandemic. As of December 31, 2020, we have returned to standard payment terms with our customers and vendors after encountering term extension requests from some customers and more strictly managing accounts payable in the first part of the year. At December 31, 2020, there were $180.0 million of borrowings outstanding on our credit facility after net repayments of $25.0 million during 2020. Our borrowings may continue to fluctuate as we manage our liquidity needs. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board of Directors, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to +27 +Table of Contents +evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +2020 Financial and Operational Highlights +Revenues were $1,386.0 million for the year ended December 31, 2020, a 12.6% increase compared to the year ended December 31, 2019. The increase in 2020 revenues compared to 2019 revenues was due to the net effects of: (i) higher sales volumes, which increased revenues by $24.5 million, or 2.0%; (ii) higher average selling prices as a result of favorable channel mix, reduced discounts and promotions, and increased prices on certain products, which increased revenues by $141.5 million, or 11.5%; and (iii) unfavorable changes in exchange rates, which decreased revenues by $10.6 million, or 0.9%. +The following were significant developments affecting our businesses and capital structure during the year ended December 31, 2020: +• Digital sales represented 41.5% of 2020 revenues, compared to 31.1% in 2019. Direct-to-consumer comparable sales grew 39.2% in 2020, compared to 2019. +• We sold 69.1 million pairs of shoes worldwide, an increase from 67.1 million pairs in 2019, despite volume declines as a result of the COVID-19 pandemic. +• Gross margin was 54.1% compared to 50.1% in 2019, an increase of 400 basis points, primarily as a result of fewer promotions, favorable product mix, higher pricing, and increased sales of charms per shoe. +• SG&A was $514.8 million, an increase of $26.3 million, or 5.4%, compared to 2019. As a percent of revenues, SG&A improved 260 basis points to 37.1% of revenues, as reductions from several actions taken in response to the COVID-19 pandemic, including the elimination of certain temporary and permanent corporate and regional roles and a reduction in travel and related costs, were offset by higher variable costs associated with higher revenues and costs incurred as a result of COVID-19, including $9.9 million of inventory donations to frontline healthcare workers and other organizations. +• We recognized $21.1 million in asset impairments, related primarily to a retail store location in New York City. +• Income from operations was $214.1 million for the year ended December 31, 2020 compared to income from operations of $128.6 million for the year ended December 31, 2019. Our operating margin rose to 15.4%, compared to 10.5% in 2019. +• In December 2020, we completed a series of transactions that included a transfer of certain intellectual property rights among wholly-owned subsidiaries and resulted in the recognition of a $127.7 million tax benefit. +• Net income was $312.9 million compared to $119.5 million in 2019. Diluted net income per common share was $4.56 for the year ended December 31, 2020, compared to a diluted net income per common share of $1.66 for the year ended December 31, 2019. +• During 2020, we repurchased 3.2 million shares of common stock at an aggregate cost of $170.8 million, including a $125.0 million accelerated share repurchase agreement (“ASR”) in November 2020. For more information on the ASR, refer to Liquidity and Capital Resources , which appears in a forthcoming subsection within Management’s Discussion and Analysis of Financial Condition and Results of Operations . +28 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2020 and 2019 +A discussion of our comparison between 2020 and 2019 is presented below. A discussion of the changes in our results of operations between the years ended December 31, 2019 and December 31, 2018 has been omitted from this Annual Report on Form 10-K but may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on February 27, 2020, which is available free of charge on the SEC’s website at www.sec.gov and our corporate website (www.crocs.com). +Year Ended December 31, $ Change % Change +Favorable (Unfavorable) +2020 2019 2020-2019 2020-2019 +(in thousands, except per share data, margin, and average selling price data) +Revenues $ 1,385,951 $ 1,230,593 $ 155,358 12.6 % +Cost of sales 636,003 613,537 (22,466) (3.7) % +Gross profit 749,948 617,056 132,892 21.5 % +Selling, general and administrative expenses +514,753 488,407 (26,346) (5.4) % +Asset impairments +21,071 — (21,071) (100.0) % +Income from operations +214,124 128,649 85,475 66.4 % +Foreign currency gains (losses), net +(1,128) (1,323) 195 14.7 % +Interest income 215 601 (386) (64.2) % +Interest expense (6,742) (8,636) 1,894 21.9 % +Other income, net +510 31 479 1,545.2 % +Income before income taxes +206,979 119,322 87,657 73.5 % +Income tax benefit +(105,882) (175) 105,707 60,404.0 % +Net income +$ 312,861 $ 119,497 $ 193,364 161.8 % +Net income per common share: +Basic $ 4.64 $ 1.70 $ 2.94 172.9 % +Diluted $ 4.56 $ 1.66 $ 2.90 174.7 % +Gross margin (1) +54.1 % 50.1 % 400 bp 8.0 % +Operating margin (1) +15.4 % 10.5 % 490 bp 46.7 % +Selling, general and administrative expenses as a percentage of revenues +37.1 % 39.7 % 260 bp 6.5 % +Footwear unit sales 69,087 67,051 2,036 3.0 % +Average footwear selling price - nominal basis (2) +$ 19.91 $ 18.21 $ 1.70 9.3 % +(1) Changes for gross margin and operating margin are shown in basis points (“bp”). +(2) Average footwear selling price is calculated as footwear and charms revenues divided by footwear units. +29 +Table of Contents +Revenues by Channel +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2020 2019 2020-2019 2020-2019 +(in thousands) +Wholesale: +Americas $ 390,930 $ 275,284 42.0 % 44.0 % +Asia Pacific 133,416 207,405 (35.7) % (34.7) % +EMEA 168,410 173,480 (2.9) % (2.0) % +Other businesses 163 58 181.0 % 181.0 % +Total wholesale 692,919 656,227 5.6 % 7.0 % +Retail: +Americas 249,238 241,694 3.1 % 3.1 % +Asia Pacific 64,789 74,793 (13.4) % (12.5) % +EMEA 19,989 30,875 (35.3) % (33.7) % +Total retail 334,016 347,362 (3.8) % (3.5) % +E-commerce: +Americas 223,445 123,537 80.9 % 81.0 % +Asia Pacific 80,310 65,874 21.9 % 22.2 % +EMEA 55,261 37,593 47.0 % 46.8 % +Total e-commerce 359,016 227,004 58.2 % 58.3 % +Total revenues $ 1,385,951 $ 1,230,593 12.6 % 13.5 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +The primary drivers of the changes in revenues were: +2020 vs. 2019 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Total revenues $ 24,466 2.0 % $ 141,467 11.5 % $ (10,575) (0.9) % $ 155,358 12.6 % +(1) The change due to price is based on the change in average selling price on a constant currency basis (“ASP”). +Revenues. Despite the impact of the COVID-19 pandemic, which had the most significant adverse impact on sales in the first half of the year, revenues increased for the full year ended December 31, 2020. Sales volumes, which were lower in all regions in the first two quarters of the year, rebounded in the second half of the year, as retail locations, partner stores, and brick-and-mortar retailers reopened as COVID-19 restrictions were lifted. Increased ASP, especially in the Americas, was the largest contributor to higher revenues in 2020, as a result of fewer promotions and discounts, higher pricing on certain products, channel mix from higher sales in our e-commerce channel, which typically sells at a higher price, and increased sales of charms per shoe. Our continued focus on digital commerce, which was further bolstered by consumer migration to online shopping during the pandemic, led to an increase of 58.2% in e-commerce channel revenues. Currency fluctuations, primarily in the Brazilian Real, Russian Ruble, and Korean Won, had a negative impact on revenues. +Cost of sales. Cost of sales increased compared to 2019 due to higher average cost per unit on a constant currency basis (“AUC”) of $9.5 million, or 1.5%, due to increased e-commerce sales, which carry higher freight and fulfillment costs. Additionally, AUC increased as a result of continued investment in our global supply chain during 2020. Higher sales volume of $18.1 million, or 3.0%, also increased cost of sales, while foreign currency translation resulted in a decrease in cost of sales of $5.1 million, or 0.8%. +Gross profit. Gross margin was 54.1% compared to 50.1% in 2019, while gross profit increased $132.9 million, or 21.5%. This was primarily a result of net higher ASP and AUC, which led to an increase of $132.0 million, or 21.4%, due to fewer +30 +Table of Contents +promotions and discounts, favorable product mix, and higher pricing. Additionally, higher volume increased gross profit by $6.3 million, or 1.0%, while negative currency fluctuations decreased gross profit by $5.4 million, or 0.9% +Selling, general and administrative expenses. SG&A increased $26.3 million, or 5.4%, during the year ended December 31, 2020 compared to 2019. SG&A was higher due to inventory donations of $9.9 million to frontline healthcare workers and other organizations, net higher marketing costs of $9.5 million due to higher variable marketing associated with increased e-commerce sales, and higher bad debt expense of $4.2 million, mostly due to the impacts of COVID-19 on certain global distributors, and other net increases, including higher variable compensation and sales commissions, of $2.7 million. However, SG&A improved as a percent of sales by 260 basis points to 37.1% from 39.7% in 2019. This was primarily a result of higher revenues leveraging our fixed cost base, coupled with several actions taken in response to the COVID-19 pandemic, including the elimination of certain temporary and permanent corporate and regional roles and a decrease in travel and related costs. +Asset impairment charges. During the year ended December 31, 2020, we incurred $20.0 million in impairment charges to the right-of-use asset and store assets for a retail location in New York City and $1.1 million in impairment charges to the right-of-use asset for our former corporate headquarters. During the year ended December 31, 2019, we incurred no impairment charges. +Foreign currency gains (losses), net. Foreign currency gains (losses), net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on foreign currency derivative instruments. During the year ended December 31, 2020, we recognized realized and unrealized net foreign currency losses of $1.1 million compared to net losses of $1.3 million during the year ended December 31, 2019. +Income tax benefit. During the year ended December 31, 2020, we recognized an income tax benefit of $105.9 million on pre-tax book income of $207.0 million, representing an effective tax rate of (51.2)%, compared to income tax benefit of $0.2 million on pre-tax book income of $119.3 million in 2019, which represented an effective tax rate of (0.1)%. During the year ended December 31, 2020, we recognized a foreign deferred income tax benefit as a result of an intra-entity intellectual property rights transfer, resulting in a lower effective tax rate as compared to 2019. Our effective tax rate has varied dramatically in recent years due to the intra-entity intellectual property rights transfer, differences in our profitability level and relative operating earnings across multiple jurisdictions. and by changes in the valuation allowance. +During the three months ended December 31, 2020, we completed an intra-entity transfer of certain intellectual property rights primarily to align with current and future international operations. The transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. We recorded a deferred tax asset of $492.5 million, net of a reserve for uncertain tax positions of $197.0 million, and further reduced by a valuation allowance of $167.8 million. Based on available objective evidence, management believes that $167.8 million of the deferred tax asset, to the extent not offset by reserves for uncertain tax positions, is not more-likely-than-not to be realizable as of December 31, 2020 and, therefore, is offset by a valuation allowance. As such, a net deferred tax asset of $127.7 million was recognized along with a corresponding foreign deferred income tax benefit. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results, and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance as of December 31, 2020, we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions, and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. Certain jurisdictions for which we have historically recorded significant valuation allowances now have a sufficient history of sustained profitability as of December 31, 2020. During 2020, valuation allowances recorded against deferred tax assets, not associated with the intra-entity intellectual property rights transfer, decreased by $20.2 million. +The 2020 impact of changes in valuation allowances to the effective tax rate was an unfavorable impact of $143.0 million, equating to a 69.0% unfavorable impact. There is also a $4.6 million change in the valuation allowance related to cumulative translation adjustments. We maintain valuation allowances of approximately $226.7 million as of December 31, 2020, which may be reduced in the future depending upon the achieved profitability of certain jurisdictions as well as the magnitude of the profitability. +31 +Table of Contents +In 2017, we began operating under a tax holiday in one of our foreign jurisdictions. This tax holiday is in effect through 2022, and may be extended if certain additional requirements are met. The tax holiday is conditional based upon meeting certain employment and investment thresholds. The impact of the tax holiday in 2020 had no impact to tax expense or to our reported earnings per diluted share. +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2020 and 2019. +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2020 2019 2020-2019 2020-2019 +(in thousands) +Revenues: +Americas $ 863,613 $ 640,515 34.8 % 35.7 % +Asia Pacific 278,515 348,072 (20.0) % (19.2) % +EMEA 243,660 241,948 0.7 % 1.5 % +Segment revenues 1,385,788 1,230,535 12.6 % 13.5 % +Other businesses 163 58 181.0 % 181.0 % +Total consolidated revenues +$ 1,385,951 $ 1,230,593 12.6 % 13.5 % +Income from operations: +Americas $ 361,930 $ 204,868 76.7 % 77.4 % +Asia Pacific 47,442 80,645 (41.2) % (40.4) % +EMEA 63,314 70,326 (10.0) % (8.2) % +Segment income from operations +472,686 355,839 32.8 % 33.7 % +Reconciliation of segment income from operations to income (loss) before income taxes: +Other businesses (56,556) (54,936) (2.9) % +Unallocated corporate and other (2) +(202,006) (172,254) (17.3) % +Total consolidated income from operations +214,124 128,649 66.4 % +Foreign currency gains (losses), net (1,128) (1,323) 14.7 % +Interest income 215 601 (64.2) % +Interest expense (6,742) (8,636) 21.9 % +Other income, net 510 31 1,545.2 % +Income before income taxes +$ 206,979 $ 119,322 73.5 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) “Unallocated corporate and other” includes corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, and depreciation and amortization of corporate and other assets not allocated to operating segments. +32 +Table of Contents +The primary drivers of changes in revenues by operating segment were: +2020 vs. 2019 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Segment Revenues: +Americas $ 104,080 16.2 % $ 124,725 19.5 % $ (5,707) (0.9) % $ 223,098 34.8 % +Asia Pacific (76,302) (21.9) % 9,704 2.8 % (2,959) (0.9) % (69,557) (20.0) % +EMEA (3,417) (1.4) % 7,038 2.9 % (1,909) (0.8) % 1,712 0.7 % +Total segment revenues +$ 24,361 2.0 % $ 141,467 11.5 % $ (10,575) (0.9) % $ 155,253 12.6 % +(1) The change due to price for revenues is based on ASP, as defined earlier in this section. +Americas +Revenues. The Americas segment had the largest segment revenue growth for the year ended December 31, 2020, with significant increases due to both ASP and volume, slightly offset by negative currency fluctuations, primarily in the Brazilian Real. E-commerce revenues, which increased 80.9%, and wholesale revenues, which increased 42.0%, contributed to this growth, while we also saw growth in retail revenues of 3.1%, despite temporary store closures for part of the year as a result of the COVID-19 pandemic. ASP increased in all channels as a result of less promotional activity, product mix, price increases, and increased sales of charms per shoe, while higher volumes in our e-commerce and wholesale channels more than offset lower volume in our retail channel. This was in part a result of COVID-19-related closures that drove a consumer shift to online shopping. +Income from Operations. During the year ended December 31, 2020, income from operations for our Americas segment was $361.9 million, an increase of $157.1 million, or 76.7% from 2019. Gross profit for the year ended December 31, 2020 increased $174.1 million, or 48.9%, and gross margin increased 590 basis points to 61.4%, compared to the year ended December 31, 2019. Gross profit increased $132.7 million, or 37.3%, due to higher ASP and lower AUC. ASP increased as a result of channel mix due to higher sales in our e-commerce channel, less promotional activity, and favorable product mix. This was further supplemented by lower AUC as a result of product mix, partially offset by channel mix and higher distribution center costs from the expansion of our U.S. distribution center. Gross profit also increased $43.6 million, or 12.2%, due to sales volume. Foreign currency translation decreased gross profit by $2.2 million, or 0.6%. +During the year ended December 31, 2020, SG&A for our Americas segment increased by $17.0 million, or 11.3%, compared to 2019. This was primarily due to an increase in marketing costs of $10.2 million due to higher variable marketing associated with a higher share of e-commerce sales, $8.3 million of inventory donations associated with COVID-19, and an increase in other net costs of $3.5 million, in part due to bad debt expense recognized related to the impact of COVID-19 on our distributors. These increases were offset by a decrease of $5.0 million in compensation expense, primarily due to the temporary closure of, and reduction of store hours at, our retail stores during the year and the permanent elimination of certain roles in response to COVID-19. +Asia Pacific Operating Segment +Revenues. The decrease in revenues in our Asia Pacific segment was primarily due to lower sales volumes in our wholesale and retail channels, as a result of store closures, decreased customer traffic, and lack of tourism, all of which were brought about by the pandemic. An increase in e-commerce revenues partially offset these declines. Foreign currency fluctuations, primarily in the Korean Won, also decreased revenue slightly. Increased ASP, due to channel mix, fewer promotions, less discounting, and increased sales of charms per shoe, partially offset these declines. +Income from Operations. During the year ended December 31, 2020, income from operations for our Asia Pacific segment was $47.4 million, a decrease of $33.2 million, or 41.2%. Gross profit for the year ended December 31, 2020 decreased $36.0 million, or 19.4%, while gross margin increased 40 basis points to 53.8%, compared to the year ended December 31, 2019. The decrease in gross profit was largely due to lower volume of $34.1 million, or 18.4%, particularly in our wholesale channel, as a result of the lack of tourism in our distributors’ markets and temporary closures of our wholesale partners’ brick-and-mortar stores during the pandemic. Foreign currency fluctuations also decreased gross profit by $1.5 million or 0.8%. Finally, higher +33 +Table of Contents +ASP, net of AUC, of $2.0 million, due to the shift in direct-to-consumer revenues, was offset by a pandemic-related inventory write-off of $2.4 million. +During the year ended December 31, 2020, SG&A for our Asia Pacific segment decreased $2.8 million, or 2.6%, compared to the same period in 2019. This was due in part to reductions in compensation expense of $3.2 million due to the temporary and permanent elimination of certain roles in response to COVID-19, facilities expense of $3.2 million as a result of store closures in Australia and Hong Kong and COVID-19 related rent abatements, primarily in Singapore, and travel and related costs of $2.0 million. These decreases were offset by an increase in SG&A from donations of inventory to frontline healthcare workers and other organizations of $1.4 million, higher bad debt expense of $1.2 million, in part due to the impact of COVID-19 on distributor partners, an increase in marketing costs of $1.2 million due to variable marketing associated with a higher share of e-commerce sales, and higher other net costs of $1.8 million. +Europe, Middle East, and Africa Operating Segment +Revenues. The increase in revenues for our EMEA segment compared to the year ended December 31, 2019, was due to increased ASP, primarily in our e-commerce channel as a result of less discounting, offset in part by lower volumes. E-commerce volume increases of 33.4% were more than offset by retail volume decreases of 36.4% and wholesale volume decreases of 2.7%, as consumers shifted to online shopping during the pandemic. Negative foreign currency fluctuations in the Russian Ruble, partially offset by positive fluctuations in the Euro, also reduced revenues. +Income from Operations. During the year ended December 31, 2020, income from operations for our EMEA segment was $63.3 million, a decrease of $7.0 million, or 10.0%. Gross profit for the year ended December 31, 2020 decreased $5.3 million, or 4.4%, and gross margin decreased by 250 basis points to 47.7% compared to the year ended December 31, 2019. The decrease in our EMEA segment gross profit was due to lower volumes of $3.6 million, or 3.0%, primarily in our retail channel, and negative foreign currency fluctuations of $1.3 million, or 1.1%. Higher AUC in our wholesale channel due to increased distribution costs at our EMEA distribution center was mostly offset by higher ASP in our e-commerce channel as a result of fewer promotions and discounts and price increases, for a total decrease to gross profit of $0.4 million or 0.3%. +During the year ended December 31, 2020, SG&A for our EMEA segment increased $1.7 million, or 3.3%, compared to the same period in 2019, primarily due to increased marketing cost of $2.5 million as a result of higher variable marketing associated with a higher share of e-commerce sales and increased other net costs of $0.7 million, offset by a reduction in compensation expense of $1.5 million. +Other Businesses and Unallocated Corporate +During the year ended December 31, 2020, total net costs within ‘Other businesses’ and ‘Unallocated corporate’ increased by $31.4 million, or 13.8%, compared to the same period in 2019. This increase was primarily due to a $20.0 million impairment to the right-of-use asset and store assets for a retail location in New York City, a $1.1 million impairment to the right-of-use asset for our former corporate headquarters, higher compensation expense of $13.2 million due to higher variable compensation and sales commissions associated with higher revenues, and an increase in facilities expense of $3.0 million due to duplicate rent costs associated with our new corporate headquarters and higher insurance premiums. These higher costs were partially offset by a lower investment in brand marketing of $4.4 million as a result of COVID-19 and decreases in travel, professional services, and other net costs of $1.5 million. +34 +Table of Contents +Store Locations and Comparable Store Sales +The table below illustrates the overall change in the number of our company-operated retail locations by type of store and reportable operating segment: +December 31, 2019 Opened Closed December 31, 2020 +Type: +Outlet stores 193 6 13 186 +Retail stores 109 4 13 100 +Store-in-store +65 1 1 65 +Total 367 11 27 351 +Operating segment: +Americas 165 2 2 165 +Asia Pacific 145 7 15 137 +EMEA 57 2 10 49 +Total 367 11 27 351 +Digital sales, which includes sales through our company-owned website, third-party marketplaces, and e-tailers (which are reported in our wholesale channel), as a percent of total revenues, by operating segment were: +Year Ended December 31, +2020 2019 +Digital sales as a percent of total revenues: +Americas 38.5 % 29.5 % +Asia Pacific 39.2 % 28.1 % +EMEA 54.8 % 39.9 % +Global 41.5 % 31.1 % +Comparable retail store sales and direct-to-consumer comparable sales by reportable operating segment are as follows: +Constant Currency (1) +Year Ended December 31, +2020 2019 +Comparable retail store sales (2) +Americas 32.8 % 18.8 % +Asia Pacific (1.2) % (2.0) % +EMEA (5.4) % 5.0 % +Global 21.2 % 12.4 % +Constant Currency (1) +Year Ended December 31, +2020 2019 +Direct-to-consumer comparable sales (includes retail and e-commerce) (2) +Americas 54.4 % 21.0 % +Asia Pacific 9.6 % 5.6 % +EMEA 29.7 % 13.3 % +Global 39.2 % 16.0 % +(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. See the “Use of Non-GAAP Financial Measures” section for additional information. +(2) Comparable store status is determined on a monthly basis. Comparable store sales includes the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure and in the same month in the following year. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce revenues are based on same site sales period over period. +35 +Table of Contents +Liquidity and Capital Resources +Our liquidity position as of December 31, 2020 was: +December 31, 2020 +(in thousands) +Cash and cash equivalents $ 135,802 +Available borrowings 319,400 +As of December 31, 2020, we had $135.8 million in cash and cash equivalents and up to $319.4 million in available borrowings under our Facility (as defined below), which was amended in March 2020 to provide additional flexibility and borrowing commitments to operate in a business landscape impacted by the COVID-19 pandemic. We also entered into two revolving credit facility agreements in Asia during 2020, which are discussed in more detail under “Asia Revolving Credit Facilities” below. Throughout the year, we took several defensive measures to maximize liquidity in response to COVID-19, including reducing expenses, primarily through the temporary and permanent elimination of certain corporate and regional roles, extending payment terms with vendors, managing inventory levels by constraining incoming supply and focusing on core product, deferring discretionary capital expenditures, and suspending our share repurchase and foreign currency exchange derivative programs for a portion of the year. We began to reinvest in the business in the second half of the year and resumed both our share repurchase and foreign currency exchange derivative programs. We plan to continue to closely monitor our costs and adjust as needed in response to changes in the market. +As of December 31, 2020, we have largely returned to standard payment terms with our vendors and customers after encountering term extension requests from some customers, recognizing bad debt expense of $4.1 million in the year ended December 31, 2020 associated with global distributors as a result of the COVID-19 pandemic, and more strictly managing accounts payable in the first part of the year. Through December 31, 2020, we also received rent concessions from landlords of $6.0 million, the majority of which were either paid back during the year or are expected to be paid back by the end of 2021. +We believe that our cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Facility and other financing agreements will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all, especially in light of the market volatility and uncertainty as a result of the COVID-19 outbreak. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets, in each case, in light of the market volatility and uncertainty as a result of the COVID-19 pandemic, among other factors, could impact our business and liquidity. +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +All of the cash held outside of the U.S. could be repatriated to the U.S. without incurring additional U.S. federal income taxes. As of December 31, 2020, we held $71.1 million of our total $135.8 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. None of the $71.1 million held in international locations is limited by local regulations. +Senior Revolving Credit Facility +In July 2019, Crocs, Inc. and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders, which provides for a revolving credit facility of $500.0 million, which can be increased by an additional $100.0 million subject to certain conditions (the “Facility”). Borrowings under the Credit Agreement bear interest at a variable rate based on (A) a domestic base rate (defined as the highest of (i) the Federal Funds open rate, plus 0.25%, (ii) the Prime Rate, and (iii) the Daily LIBOR rate, plus 1.00%), plus an applicable margin ranging from 0.25% to 0.875% based on our leverage ratio, or (B) a LIBOR rate, plus an applicable margin ranging from 1.25% to 1.875% based on +36 +Table of Contents +our leverage ratio. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement requires us to maintain a minimum interest coverage ratio of 4.00 to 1.00, and a maximum leverage ratio of (i) 3.50 to 1.00 from the quarter ended December 31, 2020 to the quarter ended December 31, 2021 and (ii) 3.25 to 1.00 from the quarter ending March 31, 2022 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $40.0 million. As of December 31, 2020, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2020, the total commitments available from the lenders under the Facility were $500.0 million. At December 31, 2020, we had $180.0 million in outstanding borrowings, which are due when the Facility matures in July 2024, and $0.6 million in outstanding letters of credit under the Facility, which reduces amounts available for borrowing under the Facility. As of December 31, 2020 and 2019, we had $319.4 million and $240.4 million, respectively, of available borrowing capacity under the Facility. Our borrowings may continue to fluctuate as we manage our liquidity needs. +Asia Revolving Credit Facilities +Our revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”) provides up to 30.0 million RMB, or $4.6 million at current exchange rates, and matures in May 2021. For RMB loans under the CMBC Facility, interest is determined at the time of borrowing based on variable rates in effect at that time. +The revolving credit facility with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”) provides up to an equivalent of $5.0 million and matures in June 2021. For RMB loans under the Citibank Facility, interest is based on a National Interbank Funding Center 1-year prime rate, plus 65 basis points. For USD loans under the Citibank Facility, interest is based on a LIBOR rate, plus 1.5%. +We had no borrowings under our Asia revolving facilities during the years ended December 31, 2020 and 2019 or outstanding at December 31, 2020 or 2019. +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, +$ Change +2020-2019 +2020 2019 +(in thousands) +Cash provided by operating activities $ 266,902 $ 89,958 $ 176,944 +Cash used in investing activities (41,762) (36,236) (5,526) +Cash used in financing activities (198,038) (68,638) (129,400) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +126 (569) 695 +Net change in cash, cash equivalents, and restricted cash $ 27,228 $ (15,485) $ 42,713 +Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted for non-cash items and changes in working capital. Cash provided by operating activities increased $176.9 million for the year ended December 31, 2020 compared to the year ended December 31, 2019. This change was driven by higher net income adjusted for non-cash items of $66.7 million, offset by a net decrease in operating assets and liabilities of $243.7 million. +Investing Activities. The $5.5 million increase in cash used in investing activities for the year ended December 31, 2020 compared to the year ended December 31, 2019 is primarily due to the relocation of our Corporate headquarters in Broomfield and continued investment in our U.S. distribution center. +Financing Activities. The $129.4 million increase in cash used in financing activities for the year ended December 31, 2020 compared to the year ended December 31, 2019 resulted primarily from a decrease in borrowings of $110.0 million, net of repayments, on our Facility and an increase of $23.6 million in repurchases of our common stock, as detailed below. The increase was offset by less cash used in other financing activities of $3.0 million, associated with the final payment made in +37 +Table of Contents +2019 related to the conversion of our Series A Convertible Preferred Stock that did not recur in the current year, and $1.2 million, primarily due to costs associated with amending the Credit Agreement that did not recur in the current year. +Stock Repurchases +On February 20, 2018, the Board of Directors approved and authorized a program to repurchase up to $500.0 million of our common stock, and on May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $500.0 million of our common stock. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under our revolving credit facility, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +We repurchased 3.2 million shares of our common stock at a cost of $170.8 million, including commissions, during the year ended December 31, 2020. This includes 1.5 million shares delivered under a $125.0 million November 2020 accelerated share repurchase arrangement (“ASR”). Under the ASR, a financial institution delivers shares of our common stock during the purchase period in exchange for an up-front payment. The total number of shares ultimately delivered under the ASR, and therefore the average repurchase price paid per share, is determined based on the volume-weighted average price of our common stock during the purchase period. The purchase period for this ASR ended in January 2021, at which time an additional 0.5 million shares were delivered. The shares received are recorded in the periods they are delivered, and the up-front payment is accounted for as a reduction to stockholders’ equity in our consolidated balance sheet in the period the payment is made. +During the year ended December 31, 2019, we repurchased 6.1 million shares of our common stock at a cost of $147.2 million, including commissions. See Note 10 — Equity in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information on our repurchases and repurchase authorizations. +Off-Balance Sheet Arrangements +We had no material off-balance sheet arrangements as of December 31, 2020, other than certain purchase commitments, which are described in Note 15 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Contractual Obligations +The following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2020: +Total Less than +1 Year 1 - 3 Years 3 - 5 Years More than +5 Years +(in thousands) +Operating lease obligations (1) +$ 225,273 $ 50,559 $ 71,579 $ 34,803 $ 68,332 +Inventory purchase obligations with third-party manufacturers (2) +220,800 220,800 — — — +Other contracts (3) +96,377 26,674 29,122 18,501 22,080 +Minimum licensing royalties (4) +722 697 25 — — +Debt obligations (5) +180,000 — — 180,000 — +Interest on debt obligations (6) +13,030 3,650 7,300 2,080 — +Total $ 736,202 $ 302,380 $ 108,026 $ 235,384 $ 90,412 +(1) Our operating lease obligations consist of leases for real estate, which includes retail, warehouse, distribution center, and office spaces, expiring at various dates through 2033. This balance represents the minimum cash commitment under contract to various third parties for operating lease obligations. +(2) Our inventory purchase obligations with third-party manufacturers consist of open purchase orders for footwear products and include an immaterial amount of purchase commitments with certain third-party manufacturers for yet-to-be-received finished product where title passes to us upon receipt. All purchase obligations with third-party manufacturers are expected to be paid within one year. +38 +Table of Contents +(3) Other contracts include $36.1 million of future lease commitments related to our new distribution center in the Netherlands, which is expected to be fully operational in 2021, and $31.5 million of operating costs related to our new third-party operated distribution center in Japan. +(4) Our minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our footwear and accessories. Royalty obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for future periods. +(5) Our debt obligations consist of long-term borrowings on our Facility, maturing in July 2024. +(6) Future interest payment obligations, which are estimated by assuming the amounts outstanding under our Facility and the interest rates in effect as of December 31, 2020, will remain constant into the future. This is only an estimate, as actual amounts borrowed and rates will vary over time, based on a domestic base rate or LIBOR rate, as described in the “Senior Revolving Credit Facility” section. +Excluded from the table above is a $205.8 million liability for unrecognized tax benefits as of December 31, 2020, as we cannot make a reliable estimate of the period in which the liability will be settled, if ever. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and non-GAAP financial measures, is based on the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Reserves for Uncollectible Accounts Receivable, Sales Returns, Allowances, Discounts, and Rebates +We make ongoing estimates related to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability or unwillingness of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events, and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge, respectively, to ‘Selling, general and administrative expenses’ in our consolidated statement of operations in the period in which we made such a determination. +Additionally, a significant area of judgment affecting reported revenues and net income involves estimating reserves for sales returns, allowances, discounts, and rebates, which represent the portion of revenues not expected to be realized. Wholesale revenues are reduced by estimates of returns, allowances, discounts, contractual discounts to major customers, and rebates. We also may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments, and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Further, we record reductions to revenues for estimated customer credits as a result of price markdowns in certain markets. Revenues in our retail and e-commerce channels are also reduced by an estimate of returns. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns, allowances, discounts, and rebates may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. +39 +Table of Contents +Historically, actual amounts of customer returns, allowances, discounts, and rebates have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns, allowances, discounts, and rebates as of December 31, 2020 would have an immaterial impact on our 2020 revenues. +See Schedule II in Part IV - Item 15. Exhibits, Financial Statement Schedule to the accompanying consolidated financial statements of this Annual Report on Form 10-K for an analysis of the activity in our reserves for uncollectible accounts receivable, sales returns, allowances, and discounts. +Impairment of Long-Lived Assets +Property and equipment along with other long-lived assets are evaluated for impairment periodically whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. Testing of long-lived assets for impairment is at the level of an asset group, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +In 2020, we recorded non-cash impairments of $20.0 million to reduce the net carrying value of certain long-lived assets to their estimated fair values for a retail store in New York City and $1.1 million for our former corporate headquarters. During 2019, we did not record any impairment charges. During 2018, we recorded non-cash impairment of $2.2 million to reduce the net carrying value of certain long-lived assets to their estimated fair values, including $1.3 million to reduce the carrying values of certain supply chain assets related to the closure of our Mexico and Italy manufacturing and distribution facilities and $0.9 million related to underperforming company-operated retail stores. See Note 3 — Property and Equipment, Net in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +Income Taxes +As a result of the Tax Act, we recorded provisional estimates in accordance with GAAP, during 2017 in relation to the revaluation of our net deferred tax assets at the lower U.S. corporate income tax rate and the additional tax expense associated with the deemed repatriation tax. During the year ended December 31, 2018, we recorded measurement period adjustments related to the provisional estimates. We have not changed our indefinite reinvestment assertion, and we have elected to account for the impact of global intangible low tax income (“GILTI”) based on the period cost method. While we consider our accounting for the Tax Act to be complete, we continue to evaluate new guidance and legislation as it is issued. +During the three months ended December 31, 2020, we completed an intra-entity transfer of certain intellectual property rights primarily to align with current and future international operations. This transaction was executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain therefore may ultimately differ materially from our actual results. +We have recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +40 +Table of Contents +We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of GILTI as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense (benefit)’ line in the accompanying consolidated statements of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-U.S. subsidiaries as of December 31, 2020, which are considered to be indefinitely reinvested outside of the U.S. +See Note 13 — Income Taxes in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements, and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +41 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Facility and certain financial instruments. +Borrowings under our Facility bear interest at a variable rate based on a domestic base rate or a LIBOR rate, plus an applicable margin, and are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control. See the risk factor under “Financial and Accounting Risk — Changes in the method for determining LIBOR and/or the potential replacement of LIBOR could adversely affect our results of operations” included in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for further information on risks related to our interest rate. +As of December 31, 2020, we had $180.0 million in outstanding borrowings and $0.6 million in outstanding letters of credit under our Facility. As of December 31, 2019, we had $205.0 million in outstanding borrowings and $4.6 million in outstanding letters of credit under our Facility. +A hypothetical increase of 1% in the interest rate on these borrowings would have increased interest expense by $2.4 million for the year ended December 31, 2020. +Foreign Currency Exchange Risk +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates in effect at the time such exchange rates are used to translate the operating results of our international subsidiaries. +An increase of 1% of the value of the USD relative to foreign currencies would have decreased our revenues during the year ended December 31, 2020 by approximately $5.6 million. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. +We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur. As of December 31, 2020, the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $119.0 million. The net fair value of these contracts at December 31, 2020 was a liability of $0.4 million. See Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for a discussion of risks to our business and financial results associated with foreign currencies. +We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of December 31, 2020, a 10% appreciation in the value of the USD would result in a net decrease in the fair value of our derivative portfolio of approximately $0.4 million. +See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statement of operations for the years ended December 31, 2020 and 2019. +42 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2020, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2020, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2020. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2020, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2020, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +43 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2020, based on criteria established in I nternal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2020, of the Company and our report dated February 23, 2021, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 23, 2021 +44 +Table of Contents +ITEM 9B. Other Information +None. +45 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2020. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our code of ethics is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, that code for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our code of ethics as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2020. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2020, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 1.8 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2020. +Plan Category +Number of Securities to be Issued on Exercise of Outstanding +Options, Warrants, and Rights (1) +Weighted Average Exercise Price of Outstanding +Options, Warrants, and Rights (2) +Number of Securities Remaining Available for Future Issuance Under Plans, Excluding Securities Available in First Column +Equity compensation plans approved by stockholders (3) +1,819,694 $ 8.29 4,960,140 +Equity compensation plans not approved by stockholders +— — — +Total 1,819,694 $ 8.29 4,960,140 +(1) The number of shares outstanding includes restricted stock awards and restricted stock units that were outstanding on December 31, 2020 and assumes target performance for performance-based equity awards. +(2) The weighted average exercise price of outstanding options pertains to 0.2 million shares issuable on the exercise of outstanding options. +(3) On June 10, 2020, our stockholders approved the Crocs, Inc. 2020 Equity Incentive Plan (the “Plan”). The number of shares of our common stock available for issuance under the Plan consisted of (i) 3.8 million newly available shares, (ii) 1.4 million shares of our common stock available for issuance under the 2015 Plan as of June 10, 2020, and (iii) 2015 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 10, 2020. The number of shares authorized for issuance under the Plan is subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. The Plan became effective immediately upon stockholder approval. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2020. +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2020. +46 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedule +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedule +The following consolidated financial statement schedule of Crocs, Inc. and its subsidiaries is filed as a part of this report: +• Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +47 +Table of Contents +(3) Exhibit list +Exhibit +Number Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +4.2 +Description of Registrant's Securities (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Annual Report on Form 10-K filed on February 27, 2020). +10.1 * +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.’s Annual Report on Form 10-K, filed on March 17, 2009). +10.2 * +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the “2007 Plan”) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.3 * +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.4 * +Form of Non-Statutory Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.5 * +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.6 * +Form of Restricted Stock Unit Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 1, 2011). +10.7 * +Crocs, Inc. 2008 Cash Incentive Plan (As Amended and Restated) (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 7, 2017). +10.8 * +Crocs, Inc. 2015 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +10.9 * +Andrew Rees Performance-Vested Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 13, 2018). +10.10 +Second Amended and Restated Credit Agreement, dated July 26, 2019, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed August 1, 2019). +48 +Table of Contents +Exhibit +Number Description +10.11 +First Amendment to Second Amended and Restated Credit Agreement, dated March 26, 2020, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent, and PNC Bank, National Association, as administrative agent (incorporated by reference herein to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed March 30, 2020). +10.12 † +Second Amendment to Second Amended and Restated Credit Agreement, dated November 13, 2020, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent. +10.13 * +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on October 4, 2018). +10.14 * +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.15 * +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +10.16 * +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.17 * +Employment Offer Letter, dated August 1, 2018, between Crocs, Inc. and Anne Mehlman (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2018). +10.18 * +Crocs, Inc. 20 20 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 11 , 20 20 ). +10.19 * +Employment Offer Letter dated September 10, 2020 between Crocs, Inc. and Michelle Poole (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on September 14, 2020). +21 † +Subsidiaries of the registrant. +23.1 † +Consent of Deloitte & Touche LLP. +31.1 † +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 † +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 + +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS † XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH † XBRL Taxonomy Extension Schema Document +101.CAL † XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF † XBRL Taxonomy Extension Definition Linkbase Document +49 +Table of Contents +Exhibit +Number Description +101.LAB † XBRL Taxonomy Extension Label Linkbase Document +101.PRE † XBRL Taxonomy Extension Presentation Linkbase Document +104 Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101). +* Compensatory plan or arrangement. +† Filed herewith. ++ Furnished herewith. +50 +Table of Contents +Item 16. Form 10–K Summary. +None. +51 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 23, 2021. +CROCS, INC. +a Delaware Corporation +By: /s/ ANDREW REES +Name: Andrew Rees +Title: Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ ANDREW REES Chief Executive Officer and Director (Principal Executive Officer) February 23, 2021 +Andrew Rees +/s/ ANNE MEHLMAN Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 23, 2021 +Anne Mehlman +/s/ THOMAS J. SMACH Chairman of the Board February 23, 2021 +Thomas J. Smach +/s/ IAN M. BICKLEY Director February 23, 2021 +Ian M. Bickley +/s/ RONALD L. FRASCH Director February 23, 2021 +Ronald L. Frasch +/s/ CHARISSE FORD HUGHES Director February 23, 2021 +Charisse Ford Hughes +/s/ BETH J. KAPLAN Director February 23, 2021 +Beth J. Kaplan +/s/ DOUGLAS J. TREFF Director February 23, 2021 +Douglas J. Treff +/s/ DOREEN A. WRIGHT Director February 23, 2021 +Doreen A. Wright +52 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F- 2 +Consolidated Statements of Operations for the Years Ended December 31, 2020, 2019, and 2018 +F- 5 +Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2020, 2019, and 2018 +F- 6 +Consolidated Balance Sheets as of December 31, 2020 and 2019 +F- 7 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2020, 2019, and 2018 +F- 8 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2020, 2019, and 2018 +F- 9 +Notes to Consolidated Financial Statements +F- 10 +Schedule II: Valuation and Qualifying Accounts +F- 36 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Consolidated Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows, for each of the three years in the period ended December 31, 2020, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 23, 2021, expressed an unqualified opinion on the Company's internal control over financial reporting. +Change in Accounting Principle +As discussed in Note 6 to the consolidated financial statements, effective January 1, 2019, due the adoption of FASB ASC Topic 842, Leases, using the modified retrospective transition approach. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Income Taxes —Intra-entity Intellectual Property Transaction - Valuation of Deferred Tax Asset and Uncertain Tax Positions — Refer to Note 13 to the consolidated financial statements +Critical Audit Matter Description +The Company recognizes deferred income taxes for tax attributes and for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the deferred tax liability or asset is expected to be settled or realized. The Company takes a two-step approach for recognizing and measuring tax benefits taken or +F- 2 +Table of Contents +expected to be taken in a return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. +In December 2020, the Company completed a series of transactions resulting in changes to their international legal structure, including a transfer of certain intellectual property rights among wholly-owned subsidiaries to the Netherlands. The transfer resulted in a step-up in tax basis of intellectual property rights and a corresponding increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. The Company recorded a deferred tax asset of $492.5 million and related uncertain tax positions of $197.0 million. +We identified management’s valuation of the deferred tax asset and related uncertain tax positions resulting from the Company’s transfer of certain intellectual property to its Netherlands subsidiary as a critical audit matter because of the significant judgments and estimates that were required to be made by management to properly value the deferred tax asset and uncertain tax positions. The judgments and estimates were related to the Company’s interpretation of related tax laws and regulations, as well as the use of estimates and assumptions regarding future events. +As a result, we utilized a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions for the measurement of the deferred tax asset related to the forecasts of future revenue growth and the selection of the discount rate. We also utilized a high degree of auditor judgment and an increased extent of effort, including the need to involve our income tax specialists, when performing audit procedures to evaluate whether management’s judgments in interpreting and applying tax laws and estimates and assumptions regarding future settlement were appropriate in determining the value of the uncertain tax positions. +How the Critical Audit Matter Was Addressed in the Audit +Our audit procedures related to the forecasts of future revenue growth and discount rate used by management to measure the deferred tax asset and the uncertain tax position included the following, among others: +• We tested the effectiveness of management’s controls over the determination of the measurement of deferred tax asset, such as controls related to management’s selection of the discount rate and forecasts of future revenues, and management’s controls over the measurement of the uncertain tax position, such as controls related to the evaluation of subjective estimates in the amounts to be realized. +• We evaluated the reasonableness of management’s revenue forecasts by comparing to: +– Historical revenue growth rates +– Historical revenue growth rates of peer companies +– Internal communications to management and the Board of Directors +– Forecasted information included in Company press releases as well as in analyst and industry reports +– Expected macroeconomic trends. +• With the assistance of our fair value specialists, we evaluated the reasonableness of the discount rate by: +– Testing the source information underlying the determination of the discount rate and the mathematical accuracy of the calculation +– Developing a range of independent estimates and comparing those to the discount rate selected by management. +• With the assistance of our tax specialists, we evaluated the measurement of uncertain tax positions. Our procedures included the following, among others: +– Reviewed the Company’s analysis of the uncertain tax positions and evaluated the reasonableness of the assumptions and calculations the Company used to develop the amount of the related uncertain tax positions +– Obtained the Company’s supporting documentation to assess the technical tax merits applicable to Dutch and international transfer pricing standards, the more-likely-than-not recognition and measurement thresholds and evaluated the application of these relevant tax laws in the Company’s recognition determination +– Evaluated the Company’s measurement of the liability using our knowledge of international, domestic, and local income tax laws, as well as settlement activity from the relevant income tax authorities. +F- 3 +Table of Contents +/s/ Deloitte & Touche LLP +Denver, Colorado +February 23, 2021 +We have served as the Company’s auditor since 2005. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Year Ended December 31, +2020 2019 2018 +Revenues +$ 1,385,951 $ 1,230,593 $ 1,088,205 +Cost of sales +636,003 613,537 528,051 +Gross profit +749,948 617,056 560,154 +Selling, general and administrative expenses +514,753 488,407 495,028 +Asset impairments +21,071 — 2,182 +Income from operations +214,124 128,649 62,944 +Foreign currency gains (losses), net +( 1,128 ) ( 1,323 ) 1,318 +Interest income +215 601 1,281 +Interest expense +( 6,742 ) ( 8,636 ) ( 955 ) +Other income, net +510 31 569 +Income before income taxes +206,979 119,322 65,157 +Income tax expense (benefit) +( 105,882 ) ( 175 ) 14,720 +Net income +312,861 119,497 50,437 +Dividends on Series A convertible preferred stock (1) +— — ( 108,224 ) +Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature (1) +— — ( 11,429 ) +Net income (loss) attributable to common stockholders +$ 312,861 $ 119,497 $ ( 69,216 ) +Net income (loss) per common share: +Basic +$ 4.64 $ 1.70 $ ( 1.01 ) +Diluted +$ 4.56 $ 1.66 $ ( 1.01 ) +Weighted average common shares outstanding: +Basic +67,386 70,357 68,421 +Diluted +68,544 71,771 68,421 +(1) On December 5, 2018, all issued and outstanding shares of Series A Convertible Preferred Stock were repurchased in exchange for cash or converted to common stock. As a result, amounts reported for the year ended December 31, 2018 include amounts resulting from the repurchase and conversion, in addition to dividends, payments to induce conversion, and accretion of dividend equivalents prior to December 5, 2018. +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(in thousands) +Year Ended December 31, +2020 2019 2018 +Net income +$ 312,861 $ 119,497 $ 50,437 +Other comprehensive income: +Foreign currency gains (losses), net +2,189 ( 3,659 ) ( 6,846 ) +Reclassification of foreign currency translation loss to income (1) +( 164 ) ( 68 ) ( 4,412 ) +Total comprehensive income +$ 314,886 $ 115,770 $ 39,179 +(1) Represents the reclassification of cumulative foreign currency translation adjustment upon liquidation of foreign subsidiaries during the years ended December 31, 2020 and 2019, and upon closure of manufacturing operations during the year ended December 31, 2018, both of which are presented within ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2020 2019 +ASSETS +Current assets: +Cash and cash equivalents +$ 135,802 $ 108,253 +Restricted cash — current +1,542 1,500 +Accounts receivable, net of allowances of $ 21,093 and $ 18,797 , respectively +149,847 108,199 +Inventories +175,121 172,028 +Income taxes receivable +1,857 1,341 +Other receivables +10,816 8,711 +Prepaid expenses and other assets +17,856 25,350 +Total current assets +492,841 425,382 +Property and equipment, net +57,467 47,405 +Intangible assets, net +37,636 47,095 +Goodwill +1,719 1,578 +Deferred tax assets, net +350,784 24,747 +Restricted cash +1,929 2,292 +Right-of-use assets +167,421 182,228 +Other assets +8,926 8,075 +Total assets +$ 1,118,723 $ 738,802 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ 112,778 $ 95,754 +Accrued expenses and other liabilities +126,704 108,677 +Income taxes payable +5,038 4,207 +Current operating lease liabilities +47,064 48,585 +Total current liabilities +291,584 257,223 +Long-term income taxes payable +205,974 4,522 +Long-term borrowings +180,000 205,000 +Long-term operating lease liabilities +146,401 140,148 +Other liabilities +4,131 4 +Total liabilities +828,090 606,897 +Commitments and contingencies +Stockholders’ equity: +Common stock, par value $ 0.001 per share, 105.0 million and 104.0 million issued, 65.9 million and 68.2 million shares outstanding, respectively +105 104 +Treasury stock, at cost, 39.1 million and 35.8 million shares, respectively +( 688,849 ) ( 546,208 ) +Additional paid-in capital +482,385 495,903 +Retained earnings +553,346 240,485 +Accumulated other comprehensive loss +( 56,354 ) ( 58,379 ) +Total stockholders’ equity +290,633 131,905 +Total liabilities and stockholders’ equity +$ 1,118,723 $ 738,802 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock Treasury Stock Additional +Paid-in +Capital Retained +Earnings +Accumulated +Other +Comprehensive +(Loss) +Total +Stock-holders' +Equity +Shares Amount Shares Amount +Balance at December 31, 2017 +68,791 $ 95 25,987 $ ( 334,312 ) $ 373,045 $ 190,431 $ ( 43,394 ) $ 185,865 +Share-based compensation — — — — 13,732 — — 13,732 +Exercises of stock options and issuance of restricted stock awards +1,238 1 49 ( 48 ) ( 725 ) — — ( 772 ) +Repurchases of common stock ( 3,620 ) — 3,620 ( 63,131 ) — — — ( 63,131 ) +Series A preferred repurchase (1) +— — — — — ( 84,224 ) — ( 84,224 ) +Series A preferred conversion (2) +6,897 7 — — 99,993 — — 100,000 +Series A preferred dividends (3) +— — — — — ( 24,000 ) — ( 24,000 ) +Series A preferred accretion, net (4) +— — — — ( 6,138 ) ( 11,429 ) — ( 17,567 ) +Net income +— — — — — 50,437 — 50,437 +Other comprehensive loss +— — — — — — ( 11,258 ) ( 11,258 ) +Other — — — — 1,226 — — 1,226 +Balance at December 31, 2018 +73,306 $ 103 29,656 $ ( 397,491 ) $ 481,133 $ 121,215 $ ( 54,652 ) $ 150,308 +Adjustments to beginning retained earnings (5) +— — — — — ( 227 ) — ( 227 ) +Share-based compensation — — — — 14,412 — — 14,412 +Exercises of stock options and issuance of restricted stock awards +1,008 1 58 ( 1,527 ) 358 — — ( 1,168 ) +Repurchases of common stock ( 6,082 ) — 6,082 ( 147,190 ) — — — ( 147,190 ) +Net income +— — — — — 119,497 — 119,497 +Other comprehensive loss +— — — — — — ( 3,727 ) ( 3,727 ) +Balance at December 31, 2019 +68,232 $ 104 35,796 $ ( 546,208 ) $ 495,903 $ 240,485 $ ( 58,379 ) $ 131,905 +Share-based compensation — — — — 16,361 — — 16,361 +Exercises of stock options and issuance of restricted stock awards +836 1 124 ( 3,059 ) 1,371 — — ( 1,687 ) +Repurchases of common stock ( 3,212 ) — 3,212 ( 139,582 ) ( 31,250 ) — — ( 170,832 ) +Net income +— — — — — 312,861 — 312,861 +Other comprehensive income +— — — — — — 2,025 2,025 +Balance at December 31, 2020 +65,856 $ 105 39,132 $ ( 688,849 ) $ 482,385 $ 553,346 $ ( 56,354 ) $ 290,633 +(1) Represents a repurchase premium, which is the difference between cash paid and the carrying value of 100,000 shares of Series A Convertible Preferred Stock repurchased, including other costs associated with the transaction. +(2) Represents the issuance of common stock upon conversion of 100,000 shares of Series A Convertible Preferred Stock. +(3) Represents Series A Convertible Preferred Stock cash dividends declared and paid of $ 9.0 million, and $ 15.0 million of payments paid and payable to induce conversion. +(4) Represents total accretion of $ 17.6 million, net of $ 6.1 million acquired value of beneficial conversion feature attributable to repurchased Series A Convertible Preferred Stock. +(5) The decrease to beginning retained earnings is as a result of the prior year adoption of new lease accounting standards as of January 1, 2019. +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2020 2019 2018 +Cash flows from operating activities: +Net income +$ 312,861 $ 119,497 $ 50,437 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +27,619 24,213 29,250 +Operating lease cost +61,583 60,142 — +Inventory donations 8,994 109 84 +Provision for doubtful accounts, net +5,779 1,566 711 +Share-based compensation +16,361 14,412 13,105 +Unrealized foreign currency loss (gain), net +126 ( 1,140 ) ( 1,455 ) +Loss (gain) on disposals of assets +340 ( 213 ) 5,019 +Asset impairments +21,071 — 2,182 +Deferred taxes +( 325,061 ) ( 16,259 ) 959 +Other non-cash items +4,841 ( 1,072 ) 1,910 +Changes in operating assets and liabilities: +Accounts receivable, net of allowances +( 47,045 ) ( 15,015 ) ( 24,623 ) +Inventories +( 13,462 ) ( 48,156 ) ( 1,987 ) +Prepaid expenses and other assets +5,007 ( 4,012 ) 9,703 +Accounts payable +23,229 6,032 12,953 +Accrued expenses and other liabilities +22,358 13,265 18,065 +Operating lease liabilities +( 61,178 ) ( 64,313 ) — +Income taxes +203,479 902 ( 2,151 ) +Cash provided by operating activities +266,902 89,958 114,162 +Cash flows from investing activities: +Purchases of property, equipment, and software +( 42,033 ) ( 36,576 ) ( 11,979 ) +Proceeds from disposal of property and equipment +463 616 1,856 +Other +( 192 ) ( 276 ) 13 +Cash used in investing activities +( 41,762 ) ( 36,236 ) ( 10,110 ) +Cash flows from financing activities: +Proceeds from borrowings +210,000 315,000 120,000 +Repayments of borrowings +( 235,000 ) ( 230,000 ) ( 662 ) +Series A preferred stock repurchase +— — ( 183,724 ) +Dividends — Series A convertible preferred stock (1) +— ( 2,985 ) ( 21,015 ) +Repurchases of common stock +( 170,832 ) ( 147,190 ) ( 63,131 ) +Other +( 2,206 ) ( 3,463 ) ( 270 ) +Cash used in financing activities +( 198,038 ) ( 68,638 ) ( 148,802 ) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +126 ( 569 ) ( 4,775 ) +Net change in cash, cash equivalents, and restricted cash +27,228 ( 15,485 ) ( 49,525 ) +Cash, cash equivalents, and restricted cash — beginning of year 112,045 127,530 177,055 +Cash, cash equivalents, and restricted cash — end of year $ 139,273 $ 112,045 $ 127,530 +Cash paid for interest $ 6,658 $ 7,519 $ 462 +Cash paid for income taxes 20,816 16,050 18,633 +(1) Represents $ 3.0 million paid to induce conversion of Series A Convertible Preferred Stock to common stock during the year ended December 31, 2019 and Series A Convertible Preferred Stock cash dividends declared and paid of $ 9.0 million and $ 12.0 million paid to induce conversion during the year ended December 31, 2018. +The accompanying notes are an integral part of these consolidated financial statements. +F- 9 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of the “Company,” “Crocs,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. We are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. Our reportable operating segments include: the Americas, operating in North and South America; Asia Pacific, operating throughout Asia, Australia, and New Zealand; and Europe, Middle East, and Africa (“EMEA”), operating throughout Europe, Russia, the Middle East, and Africa. +Basis of Presentation and Consolidation +Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries, and they reflect all adjustments which are necessary for a fair statement of financial position, results of operations, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, valuation allowances, uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, and depreciation and amortization, are reasonable based on information available at the time they are made. +Additionally, we are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. If it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 17 — Legal Proceedings for additional information regarding our contingencies and legal proceedings. +The full impact of COVID-19 is unknown and cannot be reasonably estimated as of the reporting date. However, we have made appropriate accounting estimates based on the facts and circumstances available as of the reporting date. +To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassifications +We have reclassified certain amounts in Note 13 — Income Taxes and on the consolidated statements of cash flows to conform to current period presentation. +Transactions with Affiliates +In 2019, we received services from three affiliates of Blackstone Capital Partners VI L.P. (“Blackstone”). Blackstone and certain of its permitted transferees beneficially owned 6,899,027 shares of our common stock until Blackstone sold 6,864,545 shares of common stock held directly by Blackstone and its affiliates on November 4, 2019 in an underwritten public offering. The other 34,482 shares of common stock were held by Gregg S. Ribatt, our former Chief Executive Officer and former +F- 10 +Table of Contents +member of our Board of Directors, which Blackstone may have been deemed to beneficially own, and were sold by Mr. Ribatt in October 2019. We incurred expenses to Blackstone’s legal counsel of $ 0.3 million in relation to this transaction. +Certain Blackstone affiliates provide various services to us, including inventory count services, cybersecurity and consulting, and workforce management services. We incurred expenses for services from these affiliates of $ 2.2 million during the period of Blackstone’s beneficial ownership in 2019 and $ 0.8 million in the year ended December 31, 2018. Expenses related to these services are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. We report receivables from credit card companies, if expected to be received within five days, in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. We reduce the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting our customer base, and historical collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial obligations. We write off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Schedule II in Item 15. Exhibits, Financial Statement Schedule of this Annual Report on Form 10-K for more information. +Inventories +Inventories are comprised of finished goods, are stated at the lower of cost or net realizable value, and recognized using the first-in-first-out method of inventory costing. We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end-of-life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value, and the difference is recorded in ‘Cost of sales’ in our consolidated statements of operations. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and recorded within ‘Cost of sales’ in our consolidated statements of operations. +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives. The useful lives are reviewed periodically and range from 2 to 10 years for machinery and equipment and furniture, fixtures and others. Leasehold improvements are stated at cost and amortized on a straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of warehouse- and distribution-related assets is included in ‘Cost of sales’ in our consolidated statements of operations. In 2017 and through the third quarter of 2018, when all manufacturing was transferred to third-party manufacturers, cost of sales also included depreciation related to manufacturing assets. Depreciation related to retail store, corporate, non-product, and non-manufacturing assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets and the resulting gain or loss, if any, is reflected in ‘Income from operations’ in the consolidated statements of operations. +F- 11 +Table of Contents +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. Our annual test is performed as of the last day of our fiscal fourth quarter. We continuously monitor the performance of our definite-lived intangible assets and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +Direct costs of acquiring or developing internal-use computer software, including costs of employees, are capitalized and classified within intangible assets. Software maintenance and training costs are expensed in the period incurred. Initial costs associated with internally-developed-and-used software are expensed until it is determined that the project has reached the application development stage, after which subsequent additions, modifications, or upgrades are capitalized to the extent that they add functionality. Our capitalized software consists primarily of enterprise resource system software, warehouse management software, and point of sale software. Amortization for software is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 2 to 8 years. Amortization of capitalized software used in warehouse- and distribution-related activities is included in ‘Cost of sales’ in the consolidated statements of operations. Through the third quarter of 2018, when all manufacturing was transferred to third-party manufacturers, cost of sales also included amortization related to capitalized software used in manufacturing. Amortization related to corporate, non-product, and non-manufacturing assets, such as our global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of operations. +Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 7 to 25 years. +Leases +See Note 6 — Leases for a summary of our policy related to the recognition of right-of-use assets, operating lease liabilities, and the related costs. +Derivative Foreign Currency Contracts +We enter into forward foreign currency exchange contracts to mitigate the potential impact of foreign currency exchange rate risk. By policy, we do not enter into these contracts for trading purposes or speculation. The fair value of these contracts is reported either as an asset or liability in our consolidated balance sheets. Changes in the fair value of these contracts are recorded in ‘Foreign currency gains (losses), net’ in our consolidated statements of operations. We did not designate any derivative instruments for hedge accounting during any of the periods presented. See Note 8 — Derivative Financial Instruments for further information. +Other Comprehensive Income +Our foreign subsidiaries use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into U.S. Dollars using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss), until the substantial disposition of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. +Revenue Recognition +See Note 11 — Revenues for a summary of our revenue recognition policy. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +F- 12 +Table of Contents +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, procure, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, depreciation, packaging, and other warehouse and distribution overhead and costs. +Selling, General and Administrative Expenses +Selling, general and administrative expenses consist primarily of labor and outside services, rent expense, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to corporate and non-product assets and share-based compensation. Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources, and information technology. +Our selling, general and administrative expenses also include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of our promotional expenses result from payments under endorsement contracts. Endorsement-related expenses are recognized as performance is received over the term of each endorsement agreement. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, including variable marketing expenses, were $ 101.0 million, $ 83.2 million, and $ 68.6 million for the years ended December 31, 2020, 2019, and 2018, respectively. Prepaid advertising and promotional endorsement expenses of $ 2.0 million and $ 11.6 million, were included in ‘Prepaid expenses and other assets’ in the consolidated balance sheets at December 31, 2020 and 2019, respectively. +Research, Design, and Development Expenses +We continue to dedicate resources to product design and development based on opportunities we identify in the marketplace. We incurred expenses of $ 10.2 million, $ 11.8 million, and $ 14.1 million in research, design, and development activities for the years ended December 31, 2020, 2019, and 2018, respectively, which are expensed as incurred and are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Share-Based Compensation +Stock Options +Stock options are granted with exercise prices equal to the fair market value of our common stock on the date of grant. We use the Black-Scholes option-pricing model to estimate the grant date fair value of stock options, which requires the use of assumptions, including the expected term of the option, expected volatility of our stock price, our expected dividend yield, and the risk-free interest rate, among others. These assumptions reflect our best estimates; however, they involve inherent uncertainties including market conditions and employee behavior that are generally outside of our control. We expense all share-based compensation awarded based on the grant date fair value of the awards using the straight-line method over the requisite service period, adjusted for forfeitures as they occur. +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +We grant RSAs, service-condition RSUs, performance-condition RSUs, and market-condition RSUs. The grant date fair values of RSAs, service-condition RSUs, and performance-condition RSUs are based on the closing market price of our common stock on the grant date; the grant date fair value and derived service period of market-condition RSUs are estimated using a Monte Carlo simulation valuation model. Our service-condition RSUs vest based on continued service; our performance-condition RSUs vest based on achievement of multiple weighted performance goals, certification of performance achievement by the Compensation Committee of the Board of Directors, and continued service; and our market-condition RSUs vest based on the market price of our stock. Compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service period. For performance-condition RSUs, compensation expense is updated for our expected performance level against +F- 13 +Table of Contents +performance goals at the end of each reporting period, which involves judgment as to the achievement of certain performance metrics. +See Note 12 — Share-Based Compensation for additional information related to share-based compensation. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. We assess recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and record a loss from impairment if the carrying value is more than its undiscounted cash flows. For assets involved in Crocs’ retail business, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets, leasehold improvements, and right-of-use assets related to our retail locations for impairment. Assets or asset groups to be abandoned or from which no future benefit is expected are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 3 — Property and Equipment, Net and Note 6 — Leases for a discussion of impairment losses recorded during the periods presented. +Foreign Currency Gains (Losses), Net +Foreign currency gains (losses), net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of an entity, and realized and unrealized gains and losses on forward foreign currency exchange derivative contracts. Realized foreign exchange gains and losses are reported in the operating segment in which they occur. Foreign exchange gains and losses on intercompany balances and forward foreign exchange derivative contracts are reported within corporate operations. +Other Income, Net +Other income, net primarily includes gains and losses associated with activities not directly related to making and selling footwear, as well as certain gains or losses on sales of non-operating assets. +Income Taxes +Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statements of operations. See Note 13 — Income Taxes for further discussion. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the treasury stock method. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in our earnings and is calculated by adjusting weighted average outstanding shares, assuming conversion of all potentially dilutive stock options and awards. Anti-dilutive securities are excluded from diluted EPS. See Note 14 — Earnings per Share for additional information. +F- 14 +Table of Contents +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). We utilize a combination of market and income approaches to value derivative instruments. Our financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level Inputs +1 Unadjusted quoted prices in active markets for identical assets and liabilities. +2 Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 Unobservable inputs for the asset or liability. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +Our non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 7 — Fair Value Measurements for further discussion related to estimated fair value measurements. +Consolidated Statements of Cash Flows - Supplemental Schedule of Non-Cash Investing and Financing Activities +Year Ended December 31, +2020 2019 2018 +(in thousands) +Accrued purchases of property, equipment, and software $ 4,222 $ 15,206 $ 1,141 +Series A preferred stock conversion — — 100,000 +Series A preferred stock accretion, net (1) +— — 17,567 +(1) Represents total accretion of $ 17.6 million, net of $ 6.1 million acquired value of beneficial conversion feature attributable to repurchased Series A Convertible Preferred Stock for the year ended December 31, 2018. +2. RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Measurement of Credit Losses +In June 2016, and through subsequent amendments, the Financial Accounting Standards Board (“FASB”) issued guidance that requires the measurement and recognition of expected credit losses for financial assets. This new model replaces the existing “current incurred loss” model with a forward-looking “current expected credit loss” model. On January 1, 2020, we adopted this guidance on a modified retrospective basis. Based on the nature of our financial instruments included within the scope of this standard, which are primarily trade and other receivables, the adoption did not have a material effect on our consolidated financial statements. +Implementation Costs Incurred in Cloud Computing Arrangements +In August 2018, the FASB issued authoritative guidance related to the treatment of implementation costs incurred in a hosting arrangement that is considered a service contract. On January 1, 2020, we adopted this guidance on a prospective basis. The adoption did not have a material effect on our consolidated financial statements. +F- 15 +Table of Contents +New Accounting Pronouncements Not Yet Adopted +Simplifying Accounting for Income Taxes +In December 2019, the FASB issued new guidance to simplify the accounting for income taxes by removing certain exceptions to the general principles and also simplification of areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. The standard will be effective for annual reporting periods beginning after December 15, 2020, including interim reporting periods within those periods. We do not expect this standard to have a material impact on our consolidated financial statements. +Reference Rate Reform +In March 2020, the FASB issued optional guidance related to reference rate reform, which provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable for our borrowing instruments, which use LIBOR as a reference rate, and is available for adoption effective immediately but is only available through December 31, 2022. We are currently evaluating the potential impact of this standard on our consolidated financial statements. +Other Pronouncements +Other new pronouncements issued but not effective until after December 31, 2020 are not expected to have a material impact on our consolidated financial statements. +3. PROPERTY AND EQUIPMENT, NET +‘Property and equipment, net’ consists of the following: +December 31, +2020 2019 +(in thousands) +Leasehold improvements $ 66,661 $ 64,540 +Machinery and equipment 47,107 39,011 +Furniture, fixtures, and other 21,817 19,761 +Construction-in-progress 8,187 3,697 +Property and equipment 143,772 127,009 +Less: Accumulated depreciation and amortization ( 86,305 ) ( 79,604 ) +Property and equipment, net $ 57,467 $ 47,405 +Asset Retirement Obligations +We are contractually obligated, under certain of our lease agreements, to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. Asset retirement obligations were not material to the consolidated balance sheets in the years ended December 31, 2020 or 2019. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Cost of sales $ 3,921 $ 1,711 $ 1,422 +Selling, general and administrative expenses 7,914 7,174 11,180 +Total depreciation and amortization expense $ 11,835 $ 8,885 $ 12,602 +F- 16 +Table of Contents +Disposals of Property and Equipment and Intangible Assets +We recognized net losses on disposals of property and equipment and intangible assets of $ 0.3 million and $ 4.8 million, respectively, for the years ended December 31, 2020 and 2018, and a net gain on disposals of property and equipment and intangible assets of $ 0.2 million for the year ended December 31, 2019, which are included in ‘Selling, general and administrative expenses’ in the consolidated statement of operations. +Additionally, we impaired our leasehold improvement assets for a retail location in the year ended December 31, 2020, as described in Note 7 — Fair Value Measurements. +4. GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +In the years ended December 31, 2020 and 2019, there were no changes to our goodwill, which is in our EMEA segment, aside from immaterial changes related to foreign currency translation. At December 31, 2020, accumulated goodwill impairment was $ 0.8 million. +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2020 December 31, 2019 +Gross Accum. Amortiz. Net Gross Accum. Amortiz. Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software $ 124,544 $ ( 92,075 ) $ 32,469 $ 120,620 $ ( 78,387 ) $ 42,233 +Patents, copyrights, and trademarks 3,774 ( 3,351 ) 423 4,988 ( 4,373 ) 615 +Intangible assets not subject to amortization: +In progress 4,660 — 4,660 4,170 — 4,170 +Trademarks and other 84 — 84 77 — 77 +Total $ 133,062 $ ( 95,426 ) $ 37,636 $ 129,855 $ ( 82,760 ) $ 47,095 +At December 31, 2020, the weighted average remaining useful life of intangibles subject to amortization was approximately 6.4 years. +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Cost of sales $ 3,975 $ 3,398 $ 3,889 +Selling, general and administrative expenses 11,809 11,930 12,759 +Total amortization expense $ 15,784 $ 15,328 $ 16,648 +F- 17 +Table of Contents +Estimated future annual amortization expense of intangible assets is: +As of +December 31, 2020 +(in thousands) +2021 $ 15,731 +2022 5,180 +2023 4,548 +2024 3,378 +2025 2,106 +Thereafter 1,949 +Total $ 32,892 +5. ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2020 2019 +(in thousands) +Accrued compensation and benefits $ 48,870 $ 42,460 +Professional services 18,478 13,361 +Fulfillment, freight, and duties 17,868 20,110 +Sales/use and value added taxes payable 12,480 6,843 +Return liabilities 6,906 7,090 +Royalties payable and deferred revenue 6,254 3,740 +Accrued rent and occupancy 3,818 4,682 +Other 12,030 10,391 +Total accrued expenses and other liabilities $ 126,704 $ 108,677 +6. LEASES +Our lease portfolio consists primarily of real estate assets, which includes retail, warehouse, distribution center, and office spaces, under operating leases expiring at various dates through 2033. Leases with an original term of twelve months or less are not reported in the consolidated balance sheets; expense for these short-term leases is recognized on a straight-line basis over the lease term. +Many leases include one or more options to renew, with renewal terms that, if exercised by us, may extend the lease term. The exercise of these renewal options is at our discretion. When assessing the likelihood of a renewal or termination, we consider the significance of leasehold improvements, availability of alternative locations, and the cost of relocation or replacement, among other considerations. The depreciable lives of leasehold improvements are the shorter of the useful lives of the improvements or the expected lease term. We determine the lease term for each lease based on the terms of each contract and factor in renewal and early termination options if such options are reasonably certain to be exercised. +Due to our centralized treasury function, we utilize a portfolio approach to discount our lease obligations. We assess the expected lease term at lease inception and discount the lease using a fully-secured annual incremental borrowing rate, adjusted for time value corresponding with the expected lease term. +Certain of our retail store leases include rental payments based upon a percentage of retail sales in excess of a minimum fixed rental. In some cases, there is no fixed minimum rental and the entire rental payment is based upon a percentage of sales. Certain of our warehouse leases have rental payments that vary based upon the volume of product placed in storage. In addition, certain leases include rental payments adjusted periodically for changes in price level indices. We recognize expense for these types of payments as incurred and report them as variable lease expense. +As a result of the COVID-19 pandemic, we received lease concessions from landlords in the form of rent deferrals and rent abatements in the year ended December 31, 2020. We chose to implement the policy election provided by the FASB in April +F- 18 +Table of Contents +2020 to record rent concessions as if no modification to lease contracts were made, and thus no changes to the lease obligations were recorded in respect to these concessions. As of December 31, 2020, we had outstanding deferred rent of $ 0.4 million. In the year ended December 31, 2020, we received rent abatements of $ 1.5 million. +Right-of-Use Assets and Operating Lease Liabilities +Amounts reported in the consolidated balance sheets were: +December 31, +2020 2019 +(in thousands) +Assets: +Right-of-use assets $ 167,421 $ 182,228 +Liabilities: +Current operating lease liabilities $ 47,064 $ 48,585 +Long-term operating lease liabilities 146,401 140,148 +Total operating lease liabilities $ 193,465 $ 188,733 +Lease Costs and Other Information +Lease-related costs reported within ‘Cost of sales’ and ‘Selling, general and administrative expenses’ were: +Year Ended December 31, +2020 2019 +(in thousands) +Operating lease cost $ 61,583 $ 60,142 +Short-term lease cost 4,898 3,771 +Variable lease cost 15,691 16,936 +Total lease costs $ 82,172 $ 80,849 +Other information related to leases, including supplemental cash flow information, consists of: +Year Ended December 31, +2020 2019 +(in thousands) +Cash paid for operating leases $ 59,579 $ 63,241 +Right-of-use assets obtained in exchange for operating lease liabilities (1) +55,369 233,437 +(1) In the year ended December 31, 2019, we adopted authoritative guidance related to leases. Therefore, the prior period amount presented here includes $ 176.1 million for operating leases existing on January 1, 2019 and a net $ 57.3 million for operating leases that commenced or were modified in the year ended December 31, 2019. +The weighted average remaining lease term and discount rate related to our lease liabilities as of December 31, 2020 were 6.7 years and 4.4 %, respectively. As of December 31, 2019, the weighted average remaining lease term and discount rate related to our lease liabilities were 5.9 years and 4.8 %, respectively. +We also impaired our right-of-use assets for a retail location and our former corporate headquarters, as described in Note 7 — Fair Value Measurements. +F- 19 +Table of Contents +Maturities +The maturities of our operating lease liabilities were: +As of +December 31, 2020 +(in thousands) +2021 $ 50,559 +2022 40,697 +2023 30,882 +2024 20,489 +2025 14,314 +Thereafter 68,332 +Total future minimum lease payments 225,273 +Less: imputed interest ( 31,808 ) +Total operating lease liabilities $ 193,465 +Leases That Have Not Yet Commenced +As of December 31, 2020, we had significant obligations for a lease not yet commenced related to our new EMEA distribution center. In the fourth quarter of 2019, we entered into a lease for a new distribution center in Dordrecht, the Netherlands, which is expected to replace our existing distribution center in Rotterdam by the end of 2021. The contractual commitment related to this lease, as amended, with payments expected to begin in the second quarter of 2021 and continuing through December 2030, is approximately € 30 million, or $ 36 million, with expected total capital investments of approximately € 30 million, or $ 36 million, through 2023. +Comparative Information as Reported Under Previous Accounting Standards +We adopted authoritative guidance related to leases effective January 1, 2019 using the modified retrospective method. The 2018 comparative information presented in the consolidated financial statements was not restated and is reported under the accounting standards in effect for the periods presented, as shown below: +Rent expense for operating leases was: +Year Ended December 31, 2018 +(in thousands) +Minimum rentals (1) +$ 66,049 +Contingent rentals 14,297 +Total rent expense $ 80,346 +(1) Minimum rentals include all lease payments as well as fixed and variable common area maintenance, parking, and storage fees, which were approximately $ 9.3 million for the year ended December 31, 2018. +7. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of our derivative instruments. Our derivative instruments are forward foreign currency exchange contracts. We manage credit risk of our derivative instruments on the basis of our net exposure with our counterparty. All of our derivative instruments are classified as Level 2 of the fair value hierarchy and are reported in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2020 and 2019. The fair values of our derivative instruments were a liability of $ 0.4 million and an asset of $ 0.1 million at December 31, 2020 and 2019, respectively. See Note 8 — Derivative Financial Instruments for more information. +F- 20 +Table of Contents +The carrying amounts of our cash, cash equivalents, and restricted cash, accounts receivable, accounts payable, and current accrued expenses and other liabilities approximate their fair value as recorded due to the short-term maturity of these instruments. +Our borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. The fair values of our outstanding borrowings approximate their carrying values at December 31, 2020 and 2019, based on interest rates currently available to us for similar borrowings, and were: +December 31, 2020 December 31, 2019 +Carrying Value Fair +Value Carrying Value Fair +Value +(in thousands) +Borrowings $ 180,000 $ 180,000 $ 205,000 $ 205,000 +During the year ended December 31, 2020, we also recorded inventory donations of $ 9.9 million at fair value within ‘Selling, general and administrative expenses’ in our consolidated statements of operations. We did not record material inventory donations in the years ended December 31, 2019 or 2018. +Non-Financial Assets and Liabilities +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. We recorded impairments as follows: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Supply chain assets impairment $ — $ — $ 1,284 +Retail store assets impairment (1) +2,412 — 898 +Right-of-use assets impairment (1) +18,659 — — +Total asset impairments $ 21,071 $ — $ 2,182 +(1) During the year ended December 31, 2020, we recognized impairments for a retail location in New York City of $ 2.4 million to retail store assets and $ 17.6 million to the right-of-use asset. We also recognized an impairment of $ 1.1 million to the right-of-use asset for our corporate headquarters in Niwot, Colorado, as a result of our relocation to Broomfield, Colorado. +8. DERIVATIVE FINANCIAL INSTRUMENTS +We transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar amounts of revenues, expenses, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we may enter into forward contracts to buy and sell foreign currency. By policy, we do not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts we enter into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to and did not post collateral as of December 31, 2020 or 2019. +Our derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets. We report derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. Changes in fair value are recognized within ‘Foreign currency gains (losses), net’ in the consolidated statements of operations. For the consolidated statements of cash flows, we classify cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities. ’ +F- 21 +Table of Contents +Results of Derivative Activities +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, are reported within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ in the consolidated balance sheets and were: +December 31, 2020 December 31, 2019 +Derivative Assets Derivative Liabilities Derivative Assets Derivative Liabilities +(in thousands) +Forward foreign currency exchange contracts $ 794 $ ( 1,225 ) $ 535 $ ( 424 ) +Netting of counterparty contracts ( 794 ) 794 ( 424 ) 424 +Foreign currency forward contract derivatives $ — $ ( 431 ) $ 111 $ — +The notional amounts of outstanding forward foreign currency exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2020 December 31, 2019 +Notional Fair Value Notional Fair Value +(in thousands) +Euro $ 28,851 $ ( 82 ) $ 46,757 $ 36 +Singapore Dollar 24,211 457 31,255 344 +Indian Rupee 18,937 ( 134 ) 17,088 ( 1 ) +Japanese Yen 17,447 ( 240 ) 11,823 63 +British Pound Sterling 16,134 ( 182 ) 9,155 ( 104 ) +South Korean Won 3,741 ( 56 ) 10,328 ( 82 ) +Other currencies 9,675 ( 194 ) 7,881 ( 145 ) +Total $ 118,996 $ ( 431 ) $ 134,287 $ 111 +Latest maturity date January 2021 January 2020 +Amounts reported in ‘Foreign currency gains (losses), net’ in the consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Foreign currency transaction gains (losses) $ 941 $ ( 356 ) $ 552 +Foreign currency forward exchange contracts gains (losses) ( 2,069 ) ( 967 ) 766 +Foreign currency gains (losses), net +$ ( 1,128 ) $ ( 1,323 ) $ 1,318 +9. REVOLVING CREDIT FACILITY AND BANK BORROWINGS +Our borrowings were as follows: +December 31, +2020 2019 +(in thousands) +Revolving credit facilities $ 180,000 $ 205,000 +Less: Current portion of borrowings — — +Total long-term borrowings $ 180,000 $ 205,000 +The weighted average interest rate on outstanding borrowings as of December 31, 2020 and 2019 was 2.53 % and 3.96 %, respectively. +F- 22 +Table of Contents +Senior Revolving Credit Facility +In July 2019, Crocs, Inc. and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders, which provides for a revolving credit facility of $ 500.0 million, which can be increased by an additional $ 100.0 million subject to certain conditions (the “Facility”). Borrowings under the Credit Agreement bear interest at a variable rate based on (A) a domestic base rate (defined as the highest of (i) the Federal Funds open rate, plus 0.25 %, (ii) the Prime Rate, and (iii) the Daily LIBOR rate, plus 1.00 %), plus an applicable margin ranging from 0.25 % to 0.875 % based on our leverage ratio, or (B) a LIBOR rate, plus an applicable margin ranging from 1.25 % to 1.875 % based on our leverage ratio. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement requires us to maintain a minimum interest coverage ratio of 4.00 to 1.00, and a maximum leverage ratio of (i) 3.50 to 1.00 from the quarter ended December 31, 2020 to the quarter ended December 31, 2021 and (ii) 3.25 to 1.00 from the quarter ending March 31, 2022 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $ 40.0 million. As of December 31, 2020, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2020, the total commitments available from the lenders under the Facility were $ 500.0 million. At December 31, 2020, we had $ 180.0 million in outstanding borrowings, which are due when the Facility matures in July 2024, and $ 0.6 million in outstanding letters of credit under the Facility, which reduces amounts available for borrowing under the Facility. As of December 31, 2020 and 2019, we had $ 319.4 million and $ 240.4 million, respectively, of available borrowing capacity under the Facility. +Asia Revolving Credit Facilities +Our revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”) provides up to 30.0 million RMB, or $ 4.6 million at current exchange rates, and matures in May 2021. For RMB loans under the CMBC Facility, interest is determined at the time of borrowing based on variable rates in effect at that time. +The revolving credit facility with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”) provides up to an equivalent of $ 5.0 million and matures in June 2021. For RMB loans under the Citibank Facility, interest is based on a National Interbank Funding Center 1-year prime rate, plus 65 basis points. For USD loans under the Citibank Facility, interest is based on a LIBOR rate, plus 1.5 %. +We had no borrowings under our Asia revolving facilities during the years ended December 31, 2020 and 2019 or outstanding at December 31, 2020 or 2019. +10. EQUITY +Common Stock +We have one class of common stock with a par value of $ 0.001 per share. There are 250.0 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +Common Stock Repurchase Program +On February 20, 2018, the Board of Directors approved and authorized a program to repurchase up to $ 500.0 million of our common stock, and on May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $ 500.0 million of our common stock. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under our revolving credit facility, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +F- 23 +Table of Contents +We repurchased 3.2 million shares of our common stock at a cost of $ 170.8 million, including commissions, during the year ended December 31, 2020. This includes 1.5 million shares delivered under a $ 125.0 million November 2020 accelerated share repurchase arrangement (“ASR”). Under the ASR, a financial institution delivers shares of our common stock during the purchase period in exchange for an up-front payment. The total number of shares ultimately delivered under the ASR, and therefore the average repurchase price paid per share, is determined based on the volume-weighted average price of our common stock during the purchase period. The purchase period for this ASR ended in January 2021, at which time an additional 0.5 million shares were delivered. The shares received are recorded in the periods they are delivered, and the up-front payment is accounted for as a reduction to stockholders’ equity in our consolidated balance sheet in the period the payment is made. As of December 31, 2020, we had remaining authorization to repurchase approximately $ 337.8 million of our common stock, subject to restrictions under our Credit Agreement. +During the year ended December 31, 2019, we repurchased 6.1 million shares of our common stock at a cost of $ 147.2 million, including commissions, and during the year ended December 31, 2018, we repurchased 3.6 million shares of our common stock at a cost of $ 63.1 million, including commissions. +Preferred Stock +We have authorized and available for issuance 5.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized as Series A Convertible Preferred Stock (“Series A Preferred”) with a par value of $ 0.001 per share and none were issued and outstanding as of December 31, 2020. +2018 Repurchase and Conversion +On December 5, 2018, all of the outstanding Series A Preferred was repurchased or converted to common stock. As a result, we recognized the remaining unamortized original issue discount and beneficial conversion feature accretion of $ 14.7 million, and settled the beneficial conversion feature related to the repurchased Series A Preferred of $ 6.1 million, resulting in a net increase of $ 8.6 million in ‘Dividend equivalents on Series A convertible preferred stock related to redemption value accretion and beneficial conversion feature’ in the consolidated statement of operations. We repurchased 100,000 shares of Series A Preferred with a carrying value of $ 100.0 million in exchange for a cash payment of $ 183.7 million. The repurchase payment in excess of the carrying value of $ 83.7 million is reported within ‘Dividends on Series A convertible preferred stock’ in the consolidated statement of operations for the year ended December 31, 2018. The remaining 100,000 shares of Series A Preferred were converted to 6,896,548 shares common stock. In connection with the conversion, we paid $ 15.0 million in cash to induce conversion, of which $ 12.0 million was paid at closing, with the remaining $ 3.0 million paid in January 2019. In addition, we paid other costs associated with this transaction of $ 0.5 million. The $ 15.0 million inducement dividend and the $ 0.5 million of other costs are reported within ‘Dividends on Series A convertible preferred stock’ in the consolidated statement of operations for the year ended December 31, 2018. Subsequently, in November 2019, Blackstone sold all shares of its common stock in an underwritten public offering. +11. REVENUES +Revenues by reportable operating segment and by channel were: +Year Ended December 31, 2020 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 390,930 $ 133,416 $ 168,410 $ 163 $ 692,919 +Retail 249,238 64,789 19,989 — 334,016 +E-commerce 223,445 80,310 55,261 — 359,016 +Total revenues $ 863,613 $ 278,515 $ 243,660 $ 163 $ 1,385,951 +F- 24 +Table of Contents +Year Ended December 31, 2019 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 275,284 $ 207,405 $ 173,480 $ 58 $ 656,227 +Retail 241,694 74,793 30,875 — 347,362 +E-commerce 123,537 65,874 37,593 — 227,004 +Total revenues $ 640,515 $ 348,072 $ 241,948 $ 58 $ 1,230,593 +Year Ended December 31, 2018 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 216,797 $ 203,110 $ 154,992 $ 3,145 $ 578,044 +Retail 204,806 87,264 35,358 — 327,428 +E-commerce 98,589 54,224 29,920 — 182,733 +Total revenues $ 520,192 $ 344,598 $ 220,270 $ 3,145 $ 1,088,205 +Revenues are recognized in the amount expected to be received in exchange for when control of the products transfers to customers, and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. During the year ended December 31, 2020, we recognized a net increase of $ 0.6 million to wholesale revenues and an increase of $ 1.1 million to e-commerce revenues due to changes in estimates related to products transferred to customers in prior periods. During the year ended December 31, 2019, we recognized a net increase of $ 0.4 million to wholesale revenues and a decrease of $ 0.1 million to e-commerce revenues due to changes in estimates related to products transferred to customers in prior periods. During the year ended December 31, 2018, we recognized a net increase of $ 0.8 million to wholesale revenues and no change to e-commerce revenues due to changes in estimates related to products transferred to customers in prior periods. There were no changes to estimates in retail channels during the years ended December 31, 2020, 2019, and 2018. +We have elected to exclude from revenues taxes assessed by governmental authorities, including value-added and other sales-related taxes, that are imposed on and concurrent with revenue-producing activities. +We have also elected to expense incremental costs to obtain customer contracts, consisting primarily of commission incentives, when incurred because the related amortization period is short-term. These costs are reported within ‘Selling, general and administrative expenses’ in our consolidated statement of operations. +The following is a description of our principal revenue-generating activities by distribution channel. We have three reportable operating segments and sell our products using three primary distribution channels. For more detailed information about reportable operating segments, see Note 16 — Operating Segments and Geographic Information. +Wholesale Channel +For the majority of wholesale customers, control transfers and revenues are recognized when the product is shipped or delivered from a manufacturing facility or distribution center to the wholesale customer. In certain cases, control of the product transfers and revenues are recognized when the customer receives the product at the designated delivery point. For certain customers, primarily in the Asia Pacific region, cash payment is required in advance of delivery and revenues are recognized upon delivery of the product. For a small number of customers in the Asia Pacific region, products are sold on consignment and revenues are recognized on a sell-through basis. Wholesale customers are invoiced when products are shipped or delivered. +We have arrangements that grant certain wholesale customers exclusive licenses, concurrent with the terms of the related distribution agreements, to use our intellectual property in exchange for a sales-based royalty. Sales-based royalty revenues are recognized over the terms of the related license agreements as sales are made by the wholesalers. +F- 25 +Table of Contents +Retail Channel +We transfer control of products and recognize revenues at Company-operated retail stores at the point of sale, in exchange for cash or other payment, primarily debit or credit card. A portion of the transaction price charged to our customers is variable, primarily due to promotional discounts or allowances, and terms that permit retail customers to exchange or return products for a full refund within a limited period of time. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +E-commerce Channel +In the e-commerce channel, we transfer control and recognize revenues when the product is shipped from the distribution centers. Payment from customers is primarily through debit and credit card, and other e-payment methods, and is made at the time the customer order is shipped. +Similar to the retail channel, a portion of the amount of revenue is variable, primarily due to sales returns and discounts, offered to our customers. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments are made when the most likely amount of consideration changes. +Contract Liabilities +Contract liabilities consist of advance cash deposits received from wholesale customers to secure product orders in connection with selling seasons and payments received in advance of delivery. As products are shipped and control transfers, we recognize the deferred revenue in ‘Revenues’ in the consolidated statements of operations. At December 31, 2020 and 2019, $ 0.7 million and $ 1.2 million, respectively, of deferred revenues associated with advance customer deposits were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +Refund Liabilities +Refund liabilities, primarily associated with product sales returns, retrospective volume rebates, and early payment discounts are estimated based on an analysis of historical experience, and adjustments to revenues made when the most likely amount of consideration expected changes. At December 31, 2020 and 2019, $ 6.9 million and $ 7.1 million, respectively, of refund liabilities, primarily associated with product returns, were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +12. SHARE-BASED COMPENSATION +On June 10, 2020, our stockholders approved the Crocs, Inc. 2020 Equity Incentive Plan (the “2020 Plan”). The 2020 Plan provides for the grant of incentive and non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, and other stock-based awards. The 2020 Plan replaces our 2015 Equity Incentive Plan (the “2015 Plan”), and no further awards will be made under the 2015 Plan after the effective date of the 2020 Plan. Additionally, any awards that expire or are forfeited under the 2015 Plan become available for issuance under the 2020 Plan. We account for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. As of December 31, 2020, 5.0 million shares of common stock remained available for future issuance under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +Share-Based Compensation Expense +Pre-tax share-based compensation expense reported in the consolidated statements of operations was: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Cost of sales $ 210 $ 580 $ 362 +Selling, general and administrative expenses 16,151 13,832 12,743 +Total share-based compensation expense $ 16,361 $ 14,412 $ 13,105 +F- 26 +Table of Contents +Stock Option Activity +Stock option activity during the year ended December 31, 2020 was: +Number of Options Weighted Average Exercise Price Weighted Average Contractual Life (Years) Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2019 +315 $ 10.45 5.28 $ 9,904 +Granted — — +Exercised ( 83 ) 16.42 +Forfeited or expired — — +Outstanding as of December 31, 2020 +232 $ 8.29 5.84 $ 12,586 +Exercisable at December 31, 2020 +232 $ 8.29 5.84 $ 12,586 +Vested and expected to vest at December 31, 2020 +232 $ 8.29 5.84 $ 12,586 +No stock options were granted during 2020, 2019, or 2018. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2020, 2019, and 2018 was $ 0.8 million, $ 0.4 million, and $ 1.7 million, respectively. During the years ended December 31, 2020, 2019, and 2018, we received $ 1.4 million, $ 0.4 million, and $ 1.3 million cash, respectively, in connection with the exercise of stock options. As of December 31, 2020, we did no t have any unrecognized share-based compensation expense related to unvested options. +Stock options under our equity incentive plans generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years , and expire ten years after the date of grant. +Restricted Stock Awards and Restricted Stock Units Activity +From time to time, we grant RSAs and RSUs. RSAs and RSUs generally vest over three years , depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive shares of common stock upon vesting. RSUs have dividend equivalent rights, which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. We grant service-condition RSUs, performance-condition RSUs, and, less frequently, market-condition RSUs. +Service-condition RSUs are typically granted on an annual basis and vest over time in three equal annual installments, beginning one year after the grant date. During the years ended December 31, 2020, 2019, and 2018, we granted 0.6 million, 0.3 million, and 0.4 million service-condition RSUs, respectively. +Performance-condition RSUs are typically granted on an annual basis and consist of a performance-based and service-based component. The performance targets and vesting conditions for performance-condition RSUs are based on achievement of multiple weighted performance goals. The number of performance-condition RSUs ultimately awarded may be between 0 % and 200 %, based on performance. These RSUs vest in three equal annual installments beginning one year after the grant date, pending certification of performance achievement by the Compensation Committee of our Board of Directors and continued service. The fair value of performance-condition awards is based on the closing market price of our common stock on the grant date. Compensation expense, net of forfeitures, is updated for our expected performance level against performance goals at the end of each reporting period. We also periodically grant market-condition RSUs to certain executives. The grant date fair value and derived service period for market-condition RSUs are estimated using a Monte Carlo simulation valuation model. During the years ended December 31, 2020, 2019, and 2018, we granted 0.5 million, 0.5 million, and 1.0 million performance- and market-condition RSUs, respectively. +F- 27 +Table of Contents +RSA and RSU activity during the year ended December 31, 2020 was: +Restricted Stock Awards Restricted Stock Units +Shares Weighted Average Grant Date Fair Value Shares Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2019 +5 $ 19.39 1,927 $ 17.77 +Granted 6 38.10 1,113 29.14 +Vested ( 6 ) 28.35 ( 854 ) 13.95 +Forfeited ( 2 ) 23.47 ( 356 ) 24.01 +Unvested at December 31, 2020 +3 $ 37.79 1,830 $ 25.25 +The weighted average grant date fair value of RSAs granted during the years ended December 31, 2020, 2019, and 2018 was $ 38.10 , $ 20.53 , and $ 18.61 per share, respectively. RSAs vested during the years ended December 31, 2020, 2019, and 2018 consisted entirely of service-condition awards. The total grant date fair value of RSAs vested was $ 0.2 million in each of the years ended December 31, 2020, 2019, and 2018. +As of December 31, 2020, unrecognized share-based compensation expense for RSAs was $ 0.1 million, which is expected to amortize over a remaining weighted average period of 0.4 years. +The weighted average grant date fair value of RSUs granted during the years ended December 31, 2020, 2019, and 2018 was $ 29.14 , $ 25.37 , and $ 14.34 per share, respectively. RSUs vested during the year ended December 31, 2020 consisted of 0.5 million service-condition awards and 0.4 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2019 consisted of 0.6 million service-condition awards and 0.4 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2018 consisted of 0.9 million service-condition awards and 0.2 million performance- and market-condition awards. The total grant date fair value of RSUs vested during the years ended December 31, 2020, 2019, and 2018 was $ 11.9 million, $ 9.9 million and $ 9.7 million, respectively. +As of December 31, 2020, unrecognized share-based compensation expenses for service-condition RSUs were $ 17.1 million and for performance- and market-condition RSUs were $ 5.7 million, and are expected to amortize over remaining weighted average periods of 1.9 years and 1.6 years, respectively. +13. INCOME TAXES +During the year ended December 31, 2017, as a result of the Tax Act, we recorded provisional estimates related to the revaluation of our net deferred tax assets at the lower U.S. corporate income tax rate and the additional tax expense associated with the deemed repatriation tax. During the year ended December 31, 2018, we recorded measurement period adjustments related to the provisional estimates. While we consider our accounting for the Tax Act to be complete, we continue to evaluate new guidance and legislation as it is issued. We have not changed our indefinite reinvestment assertion, and we have elected to account for the impact of global intangible low tax income based on the period cost method. +During the three months ended December 31, 2020, we completed an intra-entity transfer of certain intellectual property rights primarily to align with current and future international operations. This transaction was executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain therefore may ultimately differ materially from our actual results. +We have recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +The transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. We recorded a deferred tax asset of $ 492.5 million, +F- 28 +Table of Contents +net of a reserve for uncertain tax positions of $ 197.0 million, and further reduced by a valuation allowance of $ 167.8 million. Based on available objective evidence, management believes that $ 167.8 million of the deferred tax asset, to the extent not offset by reserves for uncertain tax positions, is not more-likely-than-not to be realizable as of December 31, 2020 and, therefore, is offset by a valuation allowance. As such, a net deferred tax asset of $ 127.7 million was recognized along with a corresponding foreign deferred income tax benefit. +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Income before taxes: +U.S. $ 133,574 $ 58,822 $ 10,088 +Foreign 73,405 60,500 55,069 +Total income before taxes $ 206,979 $ 119,322 $ 65,157 +Income tax expense (benefit): +Current income taxes: +U.S. federal $ 698 $ 1,284 $ 1,156 +U.S. state 6,577 1,427 246 +Foreign 211,904 13,373 12,359 +Total current income taxes 219,179 16,084 13,761 +Deferred income taxes: +U.S. federal 529 ( 10,249 ) 276 +U.S. state ( 2,381 ) ( 3,579 ) — +Foreign ( 323,209 ) ( 2,431 ) 683 +Total deferred income taxes ( 325,061 ) ( 16,259 ) 959 +Total income tax expense (benefit) $ ( 105,882 ) $ ( 175 ) $ 14,720 +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Income tax expense and rate attributable to: +Federal income tax rate $ 43,466 21.0 % $ 25,058 21.0 % $ 13,683 21.0 % +State income tax rate, net of federal benefit +7,231 3.5 % 5,983 5.0 % 1,271 2.0 % +Foreign income tax rate differential ( 6,060 ) ( 2.9 ) % 1,994 1.7 % 7,630 11.6 % +GILTI, net 7,515 3.6 % 7,585 6.4 % 3,443 5.3 % +Non-deductible / non-taxable items 6,871 3.3 % 6,727 5.7 % 3,602 5.5 % +Change in valuation allowance 143,012 69.0 % ( 33,691 ) ( 28.2 ) % ( 5,304 ) ( 8.1 ) % +Foreign tax credits ( 15,904 ) ( 7.7 ) % ( 11,907 ) ( 10.0 ) % ( 7,214 ) ( 11.1 ) % +Uncertain tax positions 200,571 96.9 % 278 0.2 % ( 1,696 ) ( 2.6 ) % +Share-based compensation ( 1,303 ) ( 0.6 ) % ( 2,715 ) ( 2.3 ) % 764 1.2 % +Intra-Entity IP Transfer ( 492,470 ) ( 237.9 ) % — — % — — % +Other 1,189 0.6 % 513 0.4 % ( 1,459 ) ( 2.2 ) % +Effective income tax expense and rate $ ( 105,882 ) ( 51.2 ) % $ ( 175 ) ( 0.1 ) % $ 14,720 22.6 % +F- 29 +Table of Contents +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2020 2019 +(in thousands) +Non-current deferred tax assets: +Share-based compensation expense $ 1,934 $ 2,218 +Accruals, reserves, and other expenses 16,905 13,726 +Net operating loss 26,842 29,997 +Intangible assets 493,701 990 +Foreign tax credit 38,948 64,355 +Operating lease liabilities 41,391 36,996 +Other 5,601 4,467 +Valuation allowance ( 226,655 ) ( 79,023 ) +Total non-current deferred tax assets $ 398,667 $ 73,726 +Non-current deferred tax liabilities: +Unrealized gain on foreign currency $ ( 506 ) $ ( 529 ) +Property and equipment ( 13,583 ) ( 13,713 ) +Right-of-use assets ( 33,769 ) ( 34,470 ) +Other ( 25 ) ( 267 ) +Total non-current deferred tax liabilities $ ( 47,883 ) $ ( 48,979 ) +During 2020, valuation allowances recorded against deferred tax assets increased by $ 147.6 million. The change in the valuation allowance includes $ 143.0 million related to income tax benefit and $ 4.6 million that does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to changes in cumulative translation adjustments. During 2019, valuation allowances decreased by $ 34.2 million. The change in the valuation allowance includes $ 33.7 million related to income tax expense and $ 0.5 million that does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation adjustments. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions, and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. Certain jurisdictions, for which we have historically recorded significant valuation allowances, have sufficient history of sustained profitability as of December 31, 2020. During 2020, valuation allowances recorded against deferred tax assets, not associated with the intra-entity intellectual property rights transfer, decreased by $ 20.2 million. +In certain other jurisdictions, we recorded additional attributes, primarily driven by operational losses recognized based on local tax accounting requirements. These carryforwards were generated in jurisdictions where results indicate it is not more likely than not the deferred tax assets would be realized. We maintain a valuation allowance against the majority of these balances. +We have included in the table above deferred tax assets related to U.S. federal tax carryforwards, including foreign tax credits and other tax credits, which expire at various dates between 2026 and 2040 of $ 5.8 million and $ 39.7 million as of December 31, 2020 and 2019, respectively. We have included in the table above deferred tax assets related to U.S. state tax net operating loss carryforwards, some of which expire at various dates beginning in 2022 and some of which do not expire, of $ 3.6 million and $ 6.7 million at December 31, 2020 and 2019, respectively. We have recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2021 and those which do not +F- 30 +Table of Contents +expire of $ 58.4 million and $ 48.0 million as of December 31, 2020 and 2019, respectively. We maintain a valuation allowance against a portion of the foreign carryforwards and other attributes. +The transition tax in the Tax Act imposed a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. Furthermore, as of December 31, 2020, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Unrecognized tax benefit as of January 1 $ 4,613 $ 4,511 $ 6,204 +Additions in tax positions taken in prior period 519 631 250 +Reductions in tax positions taken in prior period ( 340 ) ( 1,532 ) ( 690 ) +Additions in tax positions taken in current period 200,947 1,786 461 +Settlements ( 294 ) ( 391 ) ( 621 ) +Lapse of statute of limitations ( 258 ) ( 368 ) ( 1,045 ) +Cumulative foreign currency translation adjustment 1,022 ( 24 ) ( 48 ) +Unrecognized tax benefit as of December 31 $ 206,209 $ 4,613 $ 4,511 +We recorded a net expense of $ 200.6 million related to increases in 2020 unrecognized tax benefits combined with amounts effectively settled under audit. Unrecognized tax benefits as of December 31, 2020 relate to tax years that are currently open under the statute of limitation. The primary impact of uncertain tax benefits on the rate reconciliation includes audit settlements, net increases in position changes, and accrued interest expense. +Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Our assessments are based on estimates and assumptions using the best available information to management. However, our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible change related to our uncertain tax positions, and such changes could be significant. +Interest and penalties related to income tax liabilities are included in ‘Income tax expense (benefit)’ in the consolidated statements of operations. For the years ended December 31, 2020, 2019, and 2018, we recorded approximately $ 0.6 million, $ 0.4 million, and $ 0.2 million, respectively, of penalties and interest. During the year ended December 31, 2020, we released $ 0.1 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $ 1.2 million, $ 0.7 million, and $ 0.6 million, as of December 31, 2020, 2019, and 2018, respectively. +Unrecognized tax benefits of $ 205.6 million, $ 4.0 million and $ 4.5 million as of December 31, 2020, 2019, and 2018, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2020: +The Netherlands 2005 to 2020 +Canada 2012 to 2020 +Japan 2013 to 2020 +China 2010 to 2020 +Singapore 2015 to 2020 +United States 2010 to 2020 +F- 31 +Table of Contents +We are currently under audit in China. U.S. state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for us are generally subject to examination for the years 2015 to 2020. Although the timing of income tax audit resolutions and negotiations with taxing authorities is highly uncertain, we do not anticipate a significant change in the total amount of unrecognized tax benefits within the next twelve months. +14. EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2020, 2019, and 2018 were as follows: +Year Ended December 31, +2020 2019 2018 +(in thousands, except per share data) +Numerator: +Net income (loss) attributable to common stockholders (1) +$ 312,861 $ 119,497 $ ( 69,216 ) +Denominator: +Weighted average common shares outstanding - basic 67,386 70,357 68,421 +Plus: Dilutive effect of stock options and unvested restricted stock units +1,158 1,414 — +Weighted average common shares outstanding - diluted +68,544 71,771 68,421 +Net income (loss) per common share: +Basic $ 4.64 $ 1.70 $ ( 1.01 ) +Diluted $ 4.56 $ 1.66 $ ( 1.01 ) +(1) Net loss attributable to common stockholders for the year ended December 31, 2018 reflects the repurchase and conversion of Series A Convertible Preferred Stock . +For the years ended December 31, 2020 and 2019, no outstanding shares issued under share-based compensation awards were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. For the year ended December 31, 2018, all outstanding shares issued under share-based compensation awards were excluded from the calculation of diluted EPS because the effect was anti-dilutive. +15. COMMITMENTS AND CONTINGENCIES +Purchase Commitments +As of December 31, 2020 and 2019, we had purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products, for an aggregate of $ 220.8 million and $ 155.5 million, respectively. We expect to fulfill our commitments under these agreements in the normal course of business, and as such, no liability has been recorded. +Other +We are regularly subject to, and are currently undergoing, audits by various tax authorities in the U.S. and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. +During our normal course of business, we may make certain indemnities, commitments, and guarantees under which we may be required to make payments in relation to certain matters. We cannot determine a range of estimated future payments and have not recorded any liability for such payments in the accompanying consolidated balance sheets. +See Note 17 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +F- 32 +Table of Contents +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have three reportable operating segments: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”). ‘Other businesses’ aggregates insignificant operating segments that do not meet the reportable segment threshold, including corporate operations and, in 2018, company-operated manufacturing facilities, which substantially ceased operations in the third quarter of 2018. +Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. Revenues for ‘Other businesses’ include non-footwear and accessories product sales to external customers that are excluded from the measurement of segment operating revenues and income. +Segment performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income from operations consist of other businesses and unallocated corporate expenses, as well as inter-segment eliminations. We do not report asset information by segment because that information is not used to evaluate performance or allocate resources between segments. The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Revenues: +Americas $ 863,613 $ 640,515 $ 520,192 +Asia Pacific 278,515 348,072 344,598 +EMEA 243,660 241,948 220,270 +Segment revenues 1,385,788 1,230,535 1,085,060 +Other businesses 163 58 3,145 +Total consolidated revenues $ 1,385,951 $ 1,230,593 $ 1,088,205 +Income from operations: +Americas $ 361,930 $ 204,868 $ 138,940 +Asia Pacific 47,442 80,645 82,780 +EMEA 63,314 70,326 59,539 +Segment income from operations 472,686 355,839 281,259 +Reconciliation of segment income from operations to income before income taxes: +Other businesses ( 56,556 ) ( 54,936 ) ( 55,583 ) +Unallocated corporate (1) +( 202,006 ) ( 172,254 ) ( 162,732 ) +Total consolidated income from operations 214,124 128,649 62,944 +Foreign currency gains (losses), net ( 1,128 ) ( 1,323 ) 1,318 +Interest income 215 601 1,281 +Interest expense ( 6,742 ) ( 8,636 ) ( 955 ) +Other income, net 510 31 569 +Income before income taxes $ 206,979 $ 119,322 $ 65,157 +Depreciation and amortization: +Americas $ 3,528 $ 3,593 $ 4,640 +Asia Pacific 1,138 963 2,049 +EMEA 730 793 1,252 +Total segment depreciation and amortization 5,396 5,349 7,941 +Other businesses 8,015 5,234 5,256 +Unallocated corporate 14,208 13,630 16,053 +Total consolidated depreciation and amortization $ 27,619 $ 24,213 $ 29,250 +(1) Includes corporate support and administrative functions, costs associated with share-based compensation, research and development, marketing, legal, depreciation and amortization of corporate and other assets not allocated to operating segments, and intersegment eliminations. +F- 33 +Table of Contents +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2020, 2019 and 2018. The following table sets forth certain geographical information regarding Crocs’ revenues for the periods as shown: +Year Ended December 31, +2020 2019 2018 +(in thousands) +Location: +United States $ 802,952 $ 563,473 $ 442,544 +International (1) +582,999 667,120 645,661 +Total revenues $ 1,385,951 $ 1,230,593 $ 1,088,205 +(1) No individual international country represented 10% or more of consolidated revenues in any of the years presented. +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2020 2019 +(in thousands) +Location: +United States $ 49,527 $ 41,745 +International (1) +7,940 5,660 +Total property and equipment, net $ 57,467 $ 47,405 +(1) No individual international country represented 10% or more of consolidated net property and equipment assets in any of the years presented. +17. LEGAL PROCEEDINGS +We were subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, we were notified about the issuance of assessments totaling 14.4 million Brazilian Real (“BRL”), or approximately $ 2.8 million at current exchange rates, plus interest and penalties, for the period January 2010 through May 2011. We disputed these assessments and asserted defenses to the claims. On February 25, 2015, we received additional assessments totaling 33.3 million BRL, or approximately $ 6.4 million at current exchange rates, plus interest and penalties, related to the remainder of the audit period. We also disputed these assessments and asserted defenses to these claims in administrative appeals. On August 29, 2017, we received a favorable ruling on our appeal of the first assessment, which dismissed all fines, penalties, and interest. The tax authorities have appealed that decision and we have challenged the appeal on both the merits and procedure. Additionally, the second appeal for the remaining assessments was heard on March 22, 2018. That decision was partially favorable for us and resulted in an approximately 38 % reduction in principal, penalties, and interest, leaving approximately $ 4.0 million, plus interest and penalties, at risk for those assessments. The tax authorities have appealed that decision and Crocs has filed a response to the tax authorities’ appeal as well as a separate appeal against the unfavorable portion of the ruling. Should the Brazilian Tax Authority prevail in this final administrative appeal, we may still challenge the assessments through the court system, which would likely require the posting of a bond. We have not recorded these items within the consolidated financial statements as it is not possible at this time to predict the timing or outcome of this matter or to estimate a potential amount of loss, if any. +For all other claims and disputes, we have accrued estimated losses of $ 0.1 million within ‘Accrued expenses and other liabilities’ in our consolidated balance sheet as of December 31, 2020. As we are able, we estimate reasonably possible losses or a range of reasonably possible losses for claims and other disputes. As of December 31, 2020, we estimated that reasonably possible losses could potentially exceed amounts accrued by up to $ 0.9 million. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, other than as set forth above, we are not party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business, financial results, and cash flows. +F- 34 +Table of Contents +18. EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +We sponsor a qualified defined contribution benefit plan (the “Plan”), covering substantially all of our U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. We make matching contributions to the plans equal to 100 % of the first 3 %, and up to 50 % of the next 2 % of salary contributed by an eligible employee. Participants are vested 100 % in our matching contributions when made. Contributions made by us under the Plan were $ 4.7 million, $ 5.1 million and $ 5.4 million for the years ended December 31, 2020, 2019, and 2018, respectively. +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +March 31, 2020 June 30, 2020 September 30, 2020 December 31, 2020 +(in thousands, except per share data) +Revenues $ 281,160 $ 331,549 $ 361,736 $ 411,506 +Gross profit 134,162 179,933 206,769 229,084 +Income from operations +20,812 56,595 72,086 64,631 +Net income (1) +11,091 56,551 61,889 183,330 +Basic income per common share (2) +$ 0.16 $ 0.84 $ 0.92 $ 2.75 +Diluted income per common share (2) +$ 0.16 $ 0.83 $ 0.91 $ 2.69 +(1) During the three months ended December 31, 2020, we completed an intra-entity transfer of certain intellectual property rights, resulting in the recognition of a $ 127.7 million tax benefit. See Note 13 — Income Taxes for more information. Additionally, in the three months ended December 31, 2020, we recorded an impairment for a retail location in New York City of $ 20.0 million and for our former corporate headquarters of $ 1.1 million. +(2) Basic and diluted income per common share are computed independently for each of the quarters presented. Therefore, the sum of the quarters may not equal the annual amounts presented in the consolidated statements of operations. Additionally, for the three months ended December 31, 2020, basic and diluted income per common share include the impact of the repurchase of 1.7 million shares of our common stock for $ 131.7 million, including a $ 125.0 million ASR, as described in more detail in Note 10 — Equity. +For the Quarter Ended +March 31, 2019 June 30, 2019 September 30, 2019 December 31, 2019 +(in thousands, except per share data) +Revenues $ 295,949 $ 358,899 $ 312,766 $ 262,979 +Gross profit 137,615 189,379 163,824 126,238 +Income from operations +32,578 47,831 39,884 8,356 +Net income (1) +24,710 39,198 35,676 19,913 +Basic income per common share (2) +$ 0.34 $ 0.55 $ 0.52 $ 0.29 +Diluted income per common share (2) +$ 0.33 $ 0.55 $ 0.51 $ 0.29 +(1) During the three months ended December 31, 2019, we reduced a portion of the valuation allowance recorded against certain deferred tax assets, resulting in a tax benefit. +(2) Basic and diluted income per common share are computed independently for each of the quarters presented. Therefore, the sum of the quarters may not equal the annual amounts presented in the consolidated statements of operations. +F- 35 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period Charged to Costs and Expenses +Deductions (1) +Balance at End of Period +(in thousands) +Year Ended December 31, 2020 +Allowance for doubtful accounts $ 8,276 $ 5,779 $ ( 2,901 ) $ 11,154 +Reserve for sales returns and allowances 5,261 95,740 ( 95,219 ) 5,782 +Reserve for unapplied rebates 5,260 4,920 ( 6,023 ) 4,157 +Total $ 18,797 $ 106,439 $ ( 104,143 ) $ 21,093 +Year Ended December 31, 2019 +Allowance for doubtful accounts $ 10,959 $ 1,566 $ ( 4,249 ) $ 8,276 +Reserve for sales returns and allowances 2,741 73,027 ( 70,507 ) 5,261 +Reserve for unapplied rebates 6,777 6,837 ( 8,354 ) 5,260 +Total $ 20,477 $ 81,430 $ ( 83,110 ) $ 18,797 +Year Ended December 31, 2018 +Allowance for doubtful accounts $ 18,325 $ 711 $ ( 8,077 ) $ 10,959 +Reserve for sales returns and allowances 4,983 71,865 ( 74,107 ) 2,741 +Reserve for unapplied rebates 8,081 8,604 ( 9,908 ) 6,777 +Total $ 31,389 $ 81,180 $ ( 92,092 ) $ 20,477 +(1) Deductions include accounts written off, net of recoveries, and the effects of foreign currency translation. +F- 36 \ No newline at end of file diff --git a/raw/filings/0001334036/2020/0001334036-21-000035/filing_metadata.csv b/raw/filings/0001334036/2020/0001334036-21-000035/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..4fd44f7aa5226b07dd4e0067552244b6fde8c274 --- /dev/null +++ b/raw/filings/0001334036/2020/0001334036-21-000035/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2021-02-23,2020-12-31,2021-02-23T17:12:29.000Z,0001334036-21-000035,crox-20201231.htm,10-K,12844012,1,1,https://www.sec.gov/Archives/edgar/data/1334036/000133403621000035/crox-20201231.htm,https://www.sec.gov/Archives/edgar/data/1334036/000133403621000035/,2020,2020,1 diff --git a/raw/filings/0001334036/2020/0001334036-21-000035/item1.txt b/raw/filings/0001334036/2020/0001334036-21-000035/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..112259714de140ddedffebb1adcab9f05fe51092 --- /dev/null +++ b/raw/filings/0001334036/2020/0001334036-21-000035/item1.txt @@ -0,0 +1,112 @@ +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. The vast majority of shoes within our collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2020 with the fourth year of our global “Come As You Are™” campaign. +We offer a broad portfolio of all-season products, while remaining true to our core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. +At the heart of our brand’s DNA are our clogs, sandals, and Jibbitz™ charms. The Classic Clog, our most iconic style for adults and children, embodies our innovation in molding, simplicity of design, and all-day comfort. The unique feel of the Classic Clog can be experienced throughout the vast majority of our product line due to the use and design of Croslite™. Sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. Jibbitz™ charms enhance the consumer experience by providing an outlet for customization and heightening our message of “Come As You Are™.” +We also use Croslite™ material formulations in connection with new material technologies used in our LiteRide™ collection, as we focus on visible comfort technology. LiteRide™ features comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +We strive to provide our global consumers with comfortable, casual, colorful, and innovative footwear styles, with a focus on molded product. Our collections address many wearing occasions and meet the needs of the entire family. We enjoy licensing partnerships with Disney, including Marvel and Lucasfilm, Universal Studios, Nintendo, and Warner Bros., among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Environmental, Social, and Governance (“ESG”) Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry and our planet by committing to transparent, socially conscious, and sustainable business practices. +Through our ESG Program, we expect to continue to advance our sustainable business practices with the goal of consistently delivering products that exceed customer and consumer expectations. We believe the progress of our ESG efforts is best served by disclosing goals and relevant metrics, and, to this end, we are aligning our program with the United Nations Sustainable Development Goals (“SDGs”) and the Sustainability Accounting Standards Board (“SASB”) framework for reporting and disclosure in order to establish specific goals, targets, and policies to enhance our ESG progress. +Environmental +We are committed to reducing our impact on the environment by focusing on sustainability initiatives in our operations and throughout our supply chain and product lifecycle. +2 +Table of Contents +In 2020, we identified four key areas of focus: (i) incorporating more sustainable product ingredients; (ii) disclosing efforts and progress towards reducing greenhouse gas (“GHG”) emissions, energy, water consumption, and waste; (iii) transitioning to more environmentally friendly packaging; and (iv) exploring sustainable solutions for product end of life. +We have also joined the Sustainable Apparel Coalition (“SAC”) for the purpose of baselining and establishing goals across emissions, energy and water use, and waste reduction/disposal for both our internal brand activities as well as our factory partners. Crocs is also working to align with Science-Based Targets for the purpose of developing meaningful GHG emissions reduction goals that support the prevention of climate change. +Social +Human Capital +At Crocs, our vision to make “everyone comfortable in their own shoes” starts with our people. As of December 31, 2020, we employed approximately 4,600 employees in the Americas, EMEA, and Asia Pacific. This includes approximately 2,600 employees in our retail stores, 1,000 employees at our corporate/regional offices, and 1,000 employees at our distribution centers. +We are committed to the health and safety of our employees and customers. In response to COVID-19, our corporate offices, retail stores, and distribution centers have implemented various elevated safety protocols, in accordance with local guidelines and regulations, including temperature checks, mandatory mask policies, social distancing, access to hand sanitizer, plexiglass partitions, and enhanced cleaning of the facilities. To support our workforce, we also implemented a supplemental sick policy for our U.S. workforce with additional hours available for paid time off related to COVID-19. +To ensure that we remain an employer of choice for what we believe is the most talented workforce in the footwear industry, we have implemented initiatives across our business and geographies to develop leadership capabilities, enable meaningful professional experiences, offer a compelling employee value proposition, and create a transparent, collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” We are also committed to an equitable total rewards philosophy as well as pay transparency in all regions. +We are proud of our culture of inclusion, which encompasses regular employee listening, employee-led inclusivity councils, and diversity at all levels. Crocs strives to create a culture of inclusion where employees can freely contribute equally regardless of gender, age, ethnicity, disability, or sexual orientation. Our Code of Ethics codifies these values. +Investing in talent is a key component of our human capital strategy. Crocs is committed to identifying and developing the next generation of leadership. We conduct an annual talent and succession review with our CEO and Board of Directors (“Board”) with a focus on accelerating talent development, strengthening succession pipelines, and advancing diversity representation for our most critical roles. +We continue to emphasize employee development and training. We have established a culture of learning and development, with robust training at all levels on a wide range of topics from Leading for Respect and Inclusion, Thriving through Adversity (for instance, during the COVID-19 pandemic), Leading for Innovation, and Facilitating Team Communication. +Crocs is committed to providing an employee value proposition that is compelling, market-competitive, and performance-based. Our compensation programs, practices, and policies reflect our commitment. We aim to generally position total direct compensation within a competitive range of the market median, with differentiation based on tenure, skills, proficiency, and performance to attract and retain key talent. +Our regular employee engagement surveys reflect a highly engaged global workforce, with, among others, high scores returned by employees recommending “Crocs as a great place to work” and saying “it is easy for people with diverse backgrounds to be accepted.” +Social Capital +At Crocs, we strive to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards. To this end, we have implemented measures to ensure our supply chain complies with these standards, including utilizing internal and external parties to conduct both scheduled and unannounced social compliance reviews. We also maintain a factory Social Compliance Code of Conduct and a certification process – our contracted factories and direct suppliers sign an annual Statement of Compliance, verifying that their operations are in +3 +Table of Contents +compliance with all local laws and customs regarding hiring practices, wages, and working conditions, as well as our Code of Conduct. +We also monitor chemicals and substances in our supply chain for compliance with legal and regulatory requirements consistent with our Restricted Substances Policy and expect our contracted factories and suppliers to take a proactive stance in eliminating any hazardous chemicals or substances in the manufacture of Crocs products. +Community +Giving back to the community is extremely important to us. Through our global “Crocs Cares” program, we focus on providing shoes to address human needs, funds to support those in need, and time to enable our employees to support their local communities. To this end, we have donated over one million pairs of shoes in the past five years, and in 2020 donated over 860,000 pairs of shoes to frontline healthcare workers and other organizations as part of our “A Free Pair for Healthcare” program. +Governance +At Crocs, we have strong corporate governance mechanisms in place, along with robust internal controls over our financial reporting framework. We also have Enterprise Risk Management and Ethics & Compliance program frameworks, with regular updates provided to our Board committees as well as our Board. For our ESG efforts, Crocs has established an ESG/sustainability management and oversight framework under the direction of our Executive Vice President, Chief Legal & Risk Officer. The Governance and Nominating Committee of our Board oversees our ESG efforts. +Our commitment to diversity and inclusion is reflected in our Board, comprised of 38% female members as of December 31, 2020. We are continuing efforts to expand our Board’s diversity. +Sales and Marketing +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. We prioritize five core markets including: (i) the U.S., (ii) Japan, (iii) China, (iv) South Korea, and (v) Germany. These countries represent key geographies where we believe the greatest opportunities for growth exist. We also concentrate our marketing efforts on these countries, to increase customer awareness of both our brand and our full product range. +Each season, we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, that allow for personalization. We are expanding our sandal offerings as we pursue a greater share of a large market that currently has no clear global leader. We are continuing to invest in designer, celebrity, and brand collaborations, as well as celebrity brand ambassadors to raise consumer engagement with our brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 80 countries through three distribution channels: wholesale, retail, and e-commerce. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our retail channel consists of company-operated stores; and our e-commerce channel includes company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2020, 2019, and 2018, 50.0%, 53.3%, and 53.1% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors in certain countries, including partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. In 2020, as a result of the COVID-19 pandemic, many of our wholesale brick-and-mortar retailers were closed for a portion of the year. +4 +Table of Contents +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. In 2020, as a result of the COVID-19 pandemic, many of our distributors’ stores were closed for a portion of the year and in many cases experienced lower traffic due to the decline in tourism. +No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2020, 2019, and 2018. +Retail Channel +During the years ended December 31, 2020, 2019, and 2018, 24.1%, 28.2%, and 30.1%, respectively, of our revenues were derived through our retail channel. During 2020, as a result of the COVID-19 pandemic, our global retail stores were closed for a portion of the year. However, the vast majority of our stores were open as of December 31, 2020. We operate our retail channel through three platforms: company-operated full-price retail stores, outlet stores, and store-in-store locations. With the continued worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2020, we had 351 company-operated stores. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for information on store locations by platform. +Full-Price Retail Stores +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. We believe the optimal location for our full-price retail stores is in high foot-traffic shopping malls or districts. +Outlet Stores +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. Outlet stores are generally located within outlet shopping centers. +Store-in-Store Locations +Our company-operated store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space, and limited fixed cost and capital investment, we believe store-in-store locations can be effective vehicles for selling our products in certain geographic areas. +5 +Table of Contents +Company-Operated Retail Stores +The following table illustrates the net change during 2020 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2019 Opened Closed December 31, 2020 +Americas +United States 153 2 1 154 +Canada 9 — 1 8 +Puerto Rico 3 — — 3 +Total Americas 165 2 2 165 +Asia Pacific +Korea 85 5 — 90 +China 23 1 6 18 +Japan 12 — — 12 +Singapore 17 — — 17 +Australia 7 1 8 — +Hong Kong 1 — 1 — +Total Asia Pacific 145 7 15 137 +EMEA +Russia 30 2 6 26 +Germany 15 — 1 14 +France 6 — 2 4 +Austria 4 — 1 3 +The Netherlands 2 — — 2 +Total EMEA 57 2 10 49 +Total 367 11 27 351 +E-commerce Channel +As of December 31, 2020, we offered our products through 13 company-operated e-commerce sites worldwide and also on third-party marketplaces. During the years ended December 31, 2020, 2019, and 2018, 25.9%, 18.5%, and 16.8%, respectively, of our revenues were derived through this channel. Our e-commerce presence facilitates increased access to our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: the Americas, Asia Pacific, and EMEA. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our operating segments. +Raw Materials +Croslite™, our proprietary closed-cell resin brand, incorporates the primary material formulations used in the vast majority of our footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties and develop new properties for specific applications. +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In +6 +Table of Contents +the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using leather, textile fabrics, or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources and we believe these materials are also broadly available. +Sourcing +Our strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in Vietnam and China. During the years ended December 31, 2020, 2019, and 2018, our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 46%, 38%, and 45%, respectively, and our second largest third-party manufacturer, also operating in both Vietnam and China, produced approximately 22%, 17%, and 15%, respectively, of our footwear unit volume. We believe that the manufacturing capabilities required to produce our footwear are broadly available. See the risk factor under “Risks Related to International Operations — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2020, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands, as well as in a leased third-party operated distribution center in Japan. During 2020, we increased throughput as a result of the prior year move of our U.S. distribution center from Ontario, California to Dayton, Ohio, and we expanded the Ohio campus to further increase our distribution capacity in the Americas. In 2020, construction began on a new EMEA distribution center in the Netherlands, which is expected to be fully operational in 2021, and we completed the relocation of our third-party operated Asia Pacific distribution center within Japan. We also utilized third-party operated distribution centers located in China, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2020, our company-operated and leased warehouse and distribution facilities provided us with 1.8 million square feet, and our third-party operated distribution facilities provided us with 0.5 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality +7 +Table of Contents +agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Under Armour, Inc., Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, our material formulations, our prices, our product line, and our distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. \ No newline at end of file diff --git a/raw/filings/0001334036/2020/0001334036-21-000035/item13.txt b/raw/filings/0001334036/2020/0001334036-21-000035/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..77156b260a266b073b676e375bedbdb0e824b7a3 --- /dev/null +++ b/raw/filings/0001334036/2020/0001334036-21-000035/item13.txt @@ -0,0 +1,2 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2020. \ No newline at end of file diff --git a/raw/filings/0001334036/2020/0001334036-21-000035/item9a.txt b/raw/filings/0001334036/2020/0001334036-21-000035/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..627e8db4222b84dae4bec6a26066358342551a09 --- /dev/null +++ b/raw/filings/0001334036/2020/0001334036-21-000035/item9a.txt @@ -0,0 +1,27 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2020, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2020, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2020. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2020, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2020, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +43 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2020, based on criteria established in I nternal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2020, of the Company and our report dated February 23, 2021, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 23, 2021 +44 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2020/0001334036-21-000035/rp_note.txt b/raw/filings/0001334036/2020/0001334036-21-000035/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2020/0001334036-21-000035/rpt_disclosure.txt b/raw/filings/0001334036/2020/0001334036-21-000035/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..7b23bae1b89ce1a96ac1c43a192175bd64e73a25 --- /dev/null +++ b/raw/filings/0001334036/2020/0001334036-21-000035/rpt_disclosure.txt @@ -0,0 +1,8 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Since January 1, 2020, there have been no related person transactions in which we were or are to be a participant and the amount involved exceeds $120,000 and in which any current related person had or will have a direct or indirect material interest. +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +25 \ No newline at end of file diff --git a/raw/filings/0001334036/2021/0001334036-22-000011/filing.txt b/raw/filings/0001334036/2021/0001334036-22-000011/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..3b851f65b1f0c6988351dc74404b74adae5359af --- /dev/null +++ b/raw/filings/0001334036/2021/0001334036-22-000011/filing.txt @@ -0,0 +1,2186 @@ +crox-20211231 +false FY 2021 0001334036 http://fasb.org/us-gaap/2021-01-31#AccountingStandardsUpdate201602Member 33 33 33 0001334036 2021-01-01 2021-12-31 0001334036 2021-06-30 iso4217:USD 0001334036 2022-02-09 xbrli:shares 0001334036 2020-01-01 2020-12-31 0001334036 2019-01-01 2019-12-31 iso4217:USD xbrli:shares 0001334036 2021-12-31 0001334036 2020-12-31 0001334036 us-gaap:CommonStockMember 2018-12-31 0001334036 us-gaap:TreasuryStockMember 2018-12-31 0001334036 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No. 0-51754 +________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware 20-2164234 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +13601 Via Varra +Broomfield , Colorado 80020 +( 303 ) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: Trading symbol: Name of each exchange on which registered: +Common Stock, par value $0.001 per share CROX The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. +Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company Emerging growth company +☒ ☐ ☐ ☐ ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2021 was approximately $ 4.6 billion. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock, par value $0.001 per shares, outstanding as of February 9, 2022 was 58,353,973 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2022 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2021. +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding +• our expectations regarding future trends, selling, general and administrative cost savings, expectations, and performance of our business; +• our expectations regarding supply chain disruptions and related cost increases; +• our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• our expectations about the impact of our strategic plans; +• the anticipated consummation of the HEYDUDE Acquisition (as defined herein) and the timing and benefits thereof; and +• our intent to achieve various Environmental, Social, and Governance initiatives. +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this Annual Report on Form 10-K, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. +Risks Factors Summary +Our business is subject to a number of risks and uncertainties, including those described in Part I, Item 1A. Risk Factors of this Annual Report on Form 10-K. These risks include, but are not limited to, the following: +• our substantial dependence on the value of our brand and our failure to strengthen and preserve this value; +• the significant competition that we face; +• introducing new products, which may be difficult and expensive; +• our failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand; +• our failure to continue to obtain or maintain high-quality endorsers of our products; +• our reliance on technical innovation to compete in the market for our products; +• the COVID-19 pandemic; +• supply chain disruptions, which could interrupt product manufacturing and global logistics and increase product costs; +• our dependence on third-party manufacturers located outside of the U.S.; +• our dependence on the global supply chain and impacts of supply chain constraints and inflationary pressure; +• our inability to accurately forecast consumer demand; +• our third-party manufacturing operations, which must comply with labor, trade, and other laws; +• our dependence on a number of suppliers for key production materials, and any disruption in the supply of such materials; +i +Table of Contents +• changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan, or other global currencies; +• the fact that we conduct significant business activity outside the U.S., which exposes us to risks of international commerce; +• changes in global economic conditions, which may adversely affect consumer spending and the financial health of our customers and others with whom we do business; +• our inability to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products; +• our significant reliance on the use of information technology; +• our online e-commerce sites, or those of our customers, not functioning effectively; +• the dependence of our financial success in part on the strength of our relationships with, and the success of, our wholesale and distributor customers; +• the substantial fixed costs we incur with respect to company-operated retail stores; +• if substantial investments in businesses and operations fail to produce expected returns; +• our dependence on employees across the globe; +• periodic litigation, which could result in unexpected expenditures of time and resources; +• global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations; +• the provisions in our restated certificate of incorporation, amended and restated bylaws, and Delaware law that could discourage a third-party from acquiring us; +• the significant operating and financial restrictions that our Revolving Credit Agreement (as defined herein) and the Indentures (as defined herein) each impose, and those that we expect the Term Loan B Credit Agreement (as defined herein) will impose, on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities; +• changes in the method for determining LIBOR (as defined herein) and/or the replacement of LIBOR; +• our indebtedness as well as the ability to meet payment obligations under our Revolving Credit Agreement and the Notes (as defined herein); +• our ability to incur substantially more debt; +• that we may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations; +• the fluctuations to which our quarterly revenues and operating results are subject; +• the risks of maintaining significant cash abroad; +• changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation; +• our failure to meet analyst and investor expectations; +• our ability to realize the benefits from the HEYDUDE Acquisition being substantially dependent on our ability to continue to grow HEYDUDE; +• the announcement and pendency of the HEYDUDE Acquisition; +• the failure to complete the HEYDUDE Acquisition in a timely manner or at all; +• the incurrence by us of substantial indebtedness in connection with the financing of the HEYDUDE Acquisition; and +• the transaction fees and costs that we will incur in connection with the HEYDUDE Acquisition. +ii +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2021 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +10 +Item 1B. +Unresolved Staff Comments +27 +Item 2. +Properties +27 +Item 3. +Legal Proceedings +27 +Item 4. +Mine Safety Disclosures +27 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +28 +Item 6. +[Reserved] +29 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +30 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +47 +Item 8. +Financial Statements and Supplementary Data +48 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +48 +Item 9A. +Controls and Procedures +48 +Item 9B. +Other Information +50 +Item 9C. +Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +50 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +51 +Item 11. +Executive Compensation +51 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +51 +Item 13. +Certain Relationships and Related Transactions and Director Independence +51 +Item 14. +Principal Accountant Fees and Services +52 +PART IV +Item 15. +Exhibits, Financial Statement Schedule +53 +Item 16. +Form 10-K Summary +57 +Signatures +58 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. The vast majority of shoes within our collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. Within these regions, we prioritize five core markets where we believe the greatest opportunities for growth exist: (i) China, (ii) Japan, (iii) South Korea, (iv) the U.S., and (v) Western Europe. +Our Vision +Our brand philosophy has our consumer at its heart. As a global brand “of the people, for the people,” we have successfully created a brand with a broad democratic appeal and accessible price points that is aligned with global megatrends such as casualization and personalization. Our brand philosophy and vision has been an important driver of our results and we believe will continue to be important as we realize the full potential of our brand. To that end, in 2021, we continued our message of “Come As You Are” in all regions and channels. +Our growth framework is driven by four strategic areas of focus: (i) growing digital sales, (ii) gaining market share in sandals, (iii) growth opportunities in Asia, and (iv) ongoing product and marketing innovation. +Growing Digital Sales +Digital sales include sales directly to consumers through our company-owned websites, third-party marketplaces, and wholesale sales to our global e-tailers. Our digital sales in 2021 were 36.7% of revenues, compared to 41.5% of revenues in 2020, which was higher than 2021 partially as a result of consumer migration to online shopping during the COVID-19 pandemic, and 31.1% of revenues in 2019. We plan to grow our percentage of digital sales by elevating our consumer experience, personalizing the consumer journey, and investing in capabilities to grow consumer lifetime value. We believe our digital connection with our consumers will allow us to remain nimble and maximize the full potential of the Crocs brand, while staying focused on the online channels in which our consumers are increasingly shopping. +Gaining Sandals Market Share +Sandals have long been a focus of the Company, as a large and accessible growth avenue for the brand. While we have increased sales of sandals in recent years, we believe there is an opportunity for additional growth. We discuss sandals in more depth under “Innovation in Products” below. +Growth Opportunities in Asia +As a brand with a well-established global footprint, we believe we have a long-term sales growth opportunity in the Asia Pacific segment. Our five core markets include three markets in Asia: China, Japan, and South Korea. China, in particular, which is the second largest footwear market in the world and represented about 20% of global footwear sales in 2020, is a key focus for us. Our strategy for China growth focuses on penetrating the digital channel, investing in an ‘always on’ marketing playbook to drive brand awareness and relevance, driving store growth and increased productivity within our mono-branded partner portfolio, and opening and operating a focused set of stores within major cities and in key outlet centers. +2 +Table of Contents +Innovation in Products and Marketing +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2021 as we continued to bring to our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, Crocs socks, and increased personalization through our Jibbitz™ charms accessories. +We offer a broad portfolio of all-season products, while remaining true to our core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ products. LiteRide™ features comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +At the heart of our brand’s DNA are our clogs, sandals, and Jibbitz™ charms — key product pillars that we believe will drive the majority of our long-term growth. +Clogs +The Classic Clog, our most iconic style for adults and children, embodies our innovation in molding, simplicity of design, and all-day comfort. The clog product silhouette is comfortable, versatile, and accessible. It provides a blank canvas for self-expression, while naturally lending itself to innovation, including the silhouette’s expansion into height, sport, adventure, and enhanced visible comfort technologies. Our product innovation and marketing over the past several years has driven clog relevance, which in turn has created brand relevance to consumers and led to increased sales. On-trend color and prints create highly compelling newness, allowing us to highlight the latest trends in our seasonal launches. Additionally, we have made our clog a year-round silhouette via innovations such as fuzz, used in our lined footwear collection. +We anticipate the clog market will continue to expand as many new brands enter the category in the luxury, sports, and fashion spaces, and that we will continue to increase our consumer base through product design and marketing activations. We intend to continue to drive future clog growth and relevance around the world. +Sandals +We believe sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. The sandals silhouette category allows us to access new consumers and broader wearing occasions as well as convert our existing clog consumers. The current sandals market is fragmented with no single dominant player, which we believe offers us the opportunity to expand. Unlike clogs where our focus is on driving relevance, with sandals, our focus is on and opportunity lies with driving awareness and consideration. +Our expectation for the potential future growth of sandals is driven by several factors. First, clog relevance with consumers has converted to interest in sandals. Our recent brand metric studies show high levels of sandal consideration from consumers, matching clog consideration in many markets. This has been driven through marketing investments which have focused advertising campaigns and collaborations on the sandal silhouette and sandal product design that incorporates personalization. Additionally, while sandals are more seasonal than clogs, they still represent a year-round opportunity, particularly in the digital channel and our warmer markets. +Personalization +Personalization has been part of our culture since the very first pair of Crocs was created. Jibbitz™ charms enhance the consumer experience by providing an outlet for customization and self-expression, driving overall consumer engagement and retention, and heightening our message of “Come As You Are™” in all channels and regions. Personalization is a unique selling proposition and is an important part of our brand. Jibbitz™ drive high levels of engagement and purchase frequency. We intend to continue to position personalization at the heart of our brand experience, and expect it will continue to be a strong driver of sales in both the clog and sandal categories. +3 +Table of Contents +Our products also meet the needs of the entire family. We enjoy licensing partnerships with Disney, including Marvel and Lucasfilm, Warner Bros., Nintendo, and Nickelodeon, among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Marketing +We concentrate our marketing efforts on our five core markets to increase customer awareness of both our brand and our full product range. Each season, we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, that allow for personalization. We continue to invest in globally integrated advertising campaigns, as well as designer, celebrity and influencer, and brand partnerships, ranging from popular artists like Justin Bieber to a wide range of well-known brands such as Balenciaga and Hidden Valley Ranch. Innovation is not only core to our brand values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our fans to give them new and innovative reasons to continue to choose Crocs. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +HEYDUDE Acquisition +On December 22, 2021, we entered into a definitive agreement to acquire the HEYDUDE brand (the “HEYDUDE Acquisition”), a privately-owned casual footwear brand, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”). +The HEYDUDE Acquisition will further diversify our product portfolio under two brands. The HEYDUDE brand provides an ultra-light and comfortable casual footwear product that aligns with our vision. The Securities Purchase Agreement provides that we will purchase all of the issued and outstanding equity securities of HEYDUDE for a purchase price of $2.05 billion in cash (the “Cash Consideration”) and 2,852,280 in Crocs shares to be issued to one of the sellers (the “Equity Consideration Shares”). The Equity Consideration Shares will be subject to a lock-up period beginning on the closing date (the “Closing Date”) of the HEYDUDE Acquisition and continuing to, and including, the date that is 12 months after the Closing Date, provided that (a) on the date that is six months after the Closing Date, 50% of the Equity Consideration Shares will be released from the lock-up, and (b) on the date that is twelve months after the Closing Date, the remaining 50% of the Equity Consideration Shares will be released from the lock-up. The Cash Consideration is subject to adjustment based on, among other things, the cash, indebtedness, transaction expenses, and working capital of HEYDUDE as of the closing of the HEYDUDE Acquisition. We expect to finance the Cash Consideration by entering into the $2.0 billion Term Loan B Facility (as defined herein) and borrowing $50.0 million under the Revolving Facility (as defined herein). +The HEYDUDE Acquisition is expected to close in February 2022, subject to customary closing conditions. +The foregoing description of the Securities Purchase Agreement and the transactions contemplated thereby do not purport to be complete and are subject to, and qualified in their entirety by, the full text of the Securities Purchase Agreement, a copy of which is attached as Exhibit 2.1 to our Current Report on Form 8-K, filed on December 23, 2021. +Environmental, Social, and Governance (“ESG”) Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry and our planet by committing to transparent, socially conscious, and sustainable business practices. All information in the below ESG discussion pertains to the Crocs brand as of December 31, 2021. +Through our established ESG Program, we intend to continuously advance our sustainable business practices with the goal of consistently delivering products that exceed customer and consumer expectations. We believe the progress of our ESG efforts is best served by disclosing goals and relevant metrics, and, to this end, we have aligned our program with the United Nations Sustainable Development Goals (“SDGs”) and the Sustainability Accounting Standards Board (“SASB”) framework for reporting and disclosure guidance in order to share our ESG progress. Our ESG initiatives complement our “ Green Comes in Every Color ” campaign, which is focused on providing Comfort Without Carbon, Comfort for our Communities, and Comfort for all People. +4 +Table of Contents +Additional information related to our ESG initiatives and achievements will be published in our fiscal year 2021 ESG Report in the first half of 2022, which will be available on the Investor Relations section of our website located at www.crocs.com. The content provided in our ESG Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +Environmental +We are committed to reducing our impact on the environment by focusing on sustainability initiatives in our operations and throughout our supply chain and product lifecycle. +In 2021, we established our ambition of becoming a Net Zero brand by 2030. We also identified four areas of focus for our sustainability strategy: (i) transitioning to more sustainable product ingredients; (ii) responsible resource use; (iii) implementing more environmentally friendly packaging; and (iv) exploring sustainable solutions for product end of life. +Our transition to more sustainable ingredients was highlighted by our announcement of production on our “shoe of the future” powered by a new bio-based Croslite. This more sustainable Croslite incorporates Dow’s new ECOLIBRIUM TM Technology that transforms sustainably-sourced waste and by-products from other industries into a shoe that has all the comfort you expect from Crocs but with a lower environmental impact than other materials. During 2021, we also eliminated leather from our product line to become a 100% vegan brand. +To keep shoes on feet and out of landfills, we donated thousands of unsold Crocs to those in need around the world. We also announced our partnership with ThredUP to give previously used items a second life and help create a more comfortable world. +We remain a member of the Sustainable Apparel Coalition to ensure our efforts are aligned with industry guidance and best practices. We also continue to leverage the Higg Index suite of tools for baselining and establishing goals across emissions, energy and water use, and waste reduction/disposal for both our internal brand activities as well as our factory partners. We continue working to align with Science-Based Targets for the purpose of developing meaningful GHG emissions reduction goals that support the prevention of climate change. +Social +Human Capital +At Crocs, our vision to make “everyone comfortable in their own shoes” starts with our people. As of December 31, 2021, we employed approximately 5,770 employees in the Americas, EMEA, and Asia Pacific. This includes approximately 3,300 employees in our retail stores, 1,400 employees at our corporate/regional offices, and 1,000 employees at our distribution centers. +We are committed to the health and safety of our employees and customers. In response to COVID-19, our corporate offices, retail stores, and distribution centers have maintained various elevated safety protocols, in accordance with local guidelines and regulations. To support our workforce, we also implemented a supplemental sick policy in 2020 for our U.S. workforce with additional hours available for paid time off related to COVID-19, which we continued for 2021 and 2022. +To ensure that we remain an employer of choice for what we believe is the most talented workforce in the footwear industry, we have implemented initiatives across our business and geographies to develop leadership capabilities, enable meaningful professional experiences, offer a compelling employee value proposition, and create a transparent, collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” We are also committed to an equitable total rewards philosophy as well as pay transparency in all regions. +We are proud of our culture of inclusion, which encompasses regular employee listening, employee-led inclusivity councils, and diversity at all levels. Crocs strives to create a culture of inclusion while creating a comfortable workplace through progressive people-practices where employees can freely contribute equally regardless of gender, age, race, ethnicity, national origin, disability, religion, immigration status, or sexual orientation, gender identity or expressions. Our Code of Ethics codifies these values. Crocs is also a premier partner of the UN Foundation’s #EqualEverywhere: Champions for Change Campaign promoting their global push for gender equality. +Investing in talent is a key component of our human capital strategy. Crocs is committed to identifying and developing the next generation of leadership. We conduct an annual talent and succession review with our CEO and Board of Directors (“Board”) +5 +Table of Contents +with a focus on accelerating talent development, strengthening succession pipelines, and advancing diversity representation for our most critical roles. +We continue to emphasize employee development and training. We have established a culture of learning and development, with robust training at all levels on a wide range of topics from Cultivating a Sense of Belonging, Thriving through Adversity (for instance, during the COVID-19 pandemic), Guiding Dynamic Decision Making, and Facilitating Team Communication. +Crocs is committed to providing an employee value proposition that is compelling, market-competitive, and performance-based. Our compensation programs, practices, and policies reflect our commitment. We aim to generally position total direct compensation within a competitive range of the market median, with differentiation based on tenure, skills, proficiency, and performance to attract and retain key talent, and have taken aggressive steps to advance hourly wages for our workforce across the globe, including increasing our hourly workers’ average wage above $15 per hour in the U.S. and Puerto Rico as of December 31, 2021. Additionally, all full- and part-time employees based in North America are eligible for sick leave accrual based on hours worked, and we follow all applicable illness and leave requirements globally. +Our regular employee engagement surveys reflect a highly engaged global workforce, with, among others, high scores returned by employees recommending “Crocs as a great place to work” and saying “it is easy for people with diverse backgrounds to be accepted.” +Social Capital +At Crocs, we strive to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards. To this end, we have implemented measures to ensure our supply chain complies with these standards, including utilizing internal and external parties to conduct both scheduled and unannounced social compliance reviews. We also maintain a factory Social Compliance Code of Conduct and a certification process – our contracted factories and direct suppliers sign an annual Statement of Compliance, verifying that their operations are in compliance with all local laws and customs regarding hiring practices, wages, and working conditions, as well as our Code of Conduct. We recently joined the Fair Labor Association in an effort to provide further resources and transparency for protecting worker rights throughout our supply chain. +We also monitor chemicals and substances in our supply chain for compliance with legal and regulatory requirements consistent with our Restricted Substances Policy and expect our contracted factories and suppliers to take a proactive stance in eliminating any hazardous chemicals or substances in the manufacture of Crocs products. We recently joined the Apparel & Footwear International RSL Management Working Group to help reduce the use and impact of harmful substances in our supply chain. +Community +Giving back to the community is extremely important to us. Through our global “Crocs Cares” program, we focus on providing shoes, funds, and employee time to address timely human needs, to support social inclusion and equality, and to enable our employees to collaborate and give back within their local communities. In the past two years alone, we have donated over one million pairs of shoes, including our donation in 2020 of over 860,000 pairs of shoes to frontline healthcare workers and other organizations around the world as part of our “A Free Pair for Healthcare” program and additional donations in 2021 of 150,000 pairs of shoes across multiple organizations. Additionally, thanks to the generosity of our consumers in 2021, we also raised nearly $2.5 million for Feeding America, enabling over 25 million meals for those in need. +Governance +At Crocs, we have strong corporate governance mechanisms in place, along with robust internal controls over our financial reporting framework. We also have Enterprise Risk Management and Ethics & Compliance program frameworks, with regular updates provided to our Board and its committees. For our ESG efforts, Crocs has established an ESG/sustainability management and oversight framework under the direction of our Executive Vice President, Chief Legal and Risk Officer. The Governance and Nominating Committee of our Board, comprised of three independent directors, oversees our ESG efforts and receives quarterly updates on the progress of our ESG program. +Our commitment to diversity and inclusion is reflected in our Board, consisting of 38% female representation and 13% racial/ethnic minority representation as of December 31, 2021. +6 +Table of Contents +We also continue to conduct annual in-person and online compliance training for all corporate employees as well as retail and distribution center management and maintain a global ethics hotline, which is administered by our Legal department. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 85 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our DTC channel includes retail, in which we sell through company-operated stores, and e-commerce, in which we sell through company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2021, 2020, and 2019, 50.8%, 50.0%, and 53.3% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors in certain countries, including partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2021, 2020, and 2019. +Direct-to-Consumer Channel +During the years ended December 31, 2021, 2020, and 2019, 49.2%, 50.0%, and 46.7%, respectively, of our revenues were derived through our DTC channel. +Retail +During 2020, as a result of the COVID-19 pandemic, our global retail stores were closed for a portion of the year. However, the vast majority of our stores were open throughout 2021. We operate our retail channel through three platforms: company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. With the continued worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2021, we had 373 company-operated stores. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for information on store locations by platform. +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2021, we had 107 full-price retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. As of December 31, 2021, we had 193 outlet stores. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and limited fixed cost and capital investment we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2021, we had 73 kiosks and store-in-store locations. +7 +Table of Contents +The following table illustrates the net change during 2021 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2020 Opened Closed December 31, 2021 +Americas +United States 154 9 1 162 +Canada 8 — — 8 +Puerto Rico 3 — — 3 +Total Americas 165 9 1 173 +Asia Pacific +Korea 90 3 4 89 +China 18 19 3 34 +Japan 12 1 — 13 +Singapore 17 — — 17 +Total Asia Pacific 137 23 7 153 +EMEA +Russia 26 1 1 26 +Germany 14 — — 14 +France 4 — 2 2 +Austria 3 — — 3 +The Netherlands 2 — — 2 +Total EMEA 49 1 3 47 +Total 351 33 11 373 +E-commerce +As of December 31, 2021, we offered our products through 14 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: the Americas, Asia Pacific, and EMEA. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our operating segments. +Raw Materials +Croslite™, our proprietary closed-cell resin brand, incorporates the primary material formulations used in the vast majority of our footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various ESG initiatives described in the previous section. +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +8 +Table of Contents +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +Sourcing, Distribution, and Logistics +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in Vietnam and China. In response to production delays in 2021 associated with the COVID-19 pandemic, particularly in Vietnam, we have further diversified our manufacturers. These delays are further described in the risk factor under “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K. +During the years ended December 31, 2021, 2020, and 2019, approximately 56%, 75%, and 61%, respectively, of our production was in Vietnam, while our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 34%, 46%, and 38%, respectively, and our second largest third-party manufacturer, primarily operating in both Vietnam and China, produced approximately 30%, 22%, and 17%, respectively, of our footwear unit volume. We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available. Additionally, we began to further diversify our manufacturers in 2021 to add capacity in other countries, particularly China and Indonesia, in response to Vietnam factory closures as a result of COVID-19. See the risk factor under “Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with sourcing. +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2021, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2021, we opened a new EMEA distribution center in the Netherlands and began further expansion of our U.S. distribution center in Ohio to increase distribution capacity and increase automation, which we expect will maximize throughput and support our anticipated growth. We also utilized third-party operated distribution centers located in Japan, China, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2021, our company-operated warehouse and distribution facilities provided us with 1.6 million square feet, and our third-party operated distribution facilities provided us with 0.5 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +As a result of global industry-wide logistics challenges in 2021, we implemented several mitigating measures including: (i) prioritizing top-selling products and narrowing product assortment, which has and will continue to improve factory throughput, (ii) maintaining flexibility by leveraging air freight and reducing our dependency on congested West Coast ports in the United States by adding East Coast trans-shipment capabilities, and (iii) strategically allocating units and prioritizing our key growth initiatives. With the actions taken to date and our future plans, we believe Crocs is well-positioned to withstand these supply challenges. See the risk factor under “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with sourcing. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, +9 +Table of Contents +trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, though litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +ITEM 1A. Risk Factors +You should carefully consider the following risk factors and all other information presented within this Annual Report on Form 10-K. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, access to sources of financing, or stock price. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Because we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for us to predict all risk factors, nor can we assess the impact of all such risk factors on our business. Please also refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K. +10 +Table of Contents +Risks Related to Our Products +Our success depends substantially on the value of our brand; failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs global brand. To be successful in the future, particularly outside of the U.S., where the Crocs global brand may be less well-known or perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brand across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be out of style, outdated, or otherwise undesirable. Maintaining, promoting, and growing our brand will depend on our design and marketing efforts, including product innovation and quality, advertising and consumer campaigns, as well as our ability to adapt to a rapidly changing media environment, including our reliance on social media and digital dissemination of advertising campaigns. +In the past, several footwear companies, including ours, have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Consumer demand for our products and our brand equity could also diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. +Adverse publicity about regulatory or legal action against us, or by us, could also damage our reputation and brand image, undermine consumer confidence in us, and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Negative claims or publicity involving us, our products, or any of our key employees, endorsers, or business partners could materially damage our reputation and brand image, regardless of whether such claims are accurate. Social media, which accelerates and potentially amplifies the scope of negative publicity, can accelerate, and increase the impact of, negative claims. Further, business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brand and adversely impact our business. +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, less reliance on a small number of brands or product lines, and spend substantially more on product marketing than we do. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, price their products more aggressively in the face of inflationary pressures, launch more extensive or diverse product lines, and more quickly develop new and popular products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Introducing new products may be difficult and expensive. If we are unable to do so successfully, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully continue to evolve our footwear product line to appeal to our consumers, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles and product lines, and +11 +Table of Contents +we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses. There can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful or that we will dedicate our limited marketing resources to the right product lines. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brand, erode our competitive position, and result in long-term harm to our business and financial results. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand could divert sales, damage our brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and design rights on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brand, our success, and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement or other infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others’ intellectual property rights, continued sales of such competing products by third parties could harm our brand or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brand is associated with inferior counterfeit reproductions, the integrity and reputation of our brand could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite™ material formulations and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information, and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement, and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Failure to continue to obtain or maintain high-quality endorsers of our products could harm our business . +We establish relationships with both celebrity endorsers and design, celebrity, and brand collaborators to develop, evaluate, and promote our products, as well as strengthen our brand. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brand visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers and collaborators associated with our products that harm the public image and reputations of those endorsers and collaborators could also seriously harm our brand image with consumers and, as a result, could have an adverse effect on our sales and financial condition. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear, such as our branded Croslite™ and LiteRide™ materials. Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite™, our branded proprietary closed-cell resin, is the primary raw material used in the vast majority of our footwear and some of our accessories. Croslite™ is carefully formulated to create soft, durable, extremely lightweight, and water-resistant footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties +12 +Table of Contents +for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +Risks Related to the Economy +The COVID-19 pandemic has had an adverse impact, and may have a future material adverse impact, on our business, operations, liquidity, financial condition, and results of operations. +Since 2020, the COVID-19 pandemic has driven global uncertainty and disruption and has spread throughout the geographic regions in which we run our business and where our suppliers, third-party manufacturers, retail stores, wholesale customers, and consumers are located. The pandemic has had a material impact on our retail and wholesale channel revenues, predominately in the first half of 2020, and the total impact of the pandemic on us will depend on developments outside of our control, including, among other factors, the duration and spread of COVID-19 and related variants, the efficacy and adoption of vaccines against COVID-19 and related variants, actions that may be taken by governmental authorities to contain COVID-19 or mitigate its impact, including related restrictions on movement and commercial activities, the economic or other impacts on our wholesale partners, the impact on and recovery time of our supply chain, consequential staffing shortages, manufacturing delays and the uncertainty with respect to the accessibility of additional liquidity or to the capital markets. +While the vast majority of our company-operated stores, our partner stores, and our wholesale partner stores were open as of December 31, 2021, some may close again upon additional COVID-19 outbreaks. At this time, we cannot reasonably estimate the length of time of any remaining closures, if further closures will occur, or if consumers will return to purchasing our products at historical levels in retail locations. The inability to sell our products in our retail or wholesale channels has had and may continue to have a material adverse effect on our revenues and results of operations. +We also rely upon the facilities of our third-party manufacturers outside of the U.S. to support our business as well as to export our products throughout the world. As a result of COVID-19 and the measures designed to contain the spread of the virus, our third-party manufacturers have not had at times in the past, and may not have in the future, the materials, capacity, or capability to manufacture our products according to our schedule and specifications, which has in the past, and may in the future, negatively impact our ability to manage inventories. If our third-party manufacturers’ operations are curtailed, as they have been in the past, we may need to seek alternate manufacturing sources, which may be unavailable, more expensive, or face the same constraints. Should any production and distribution closures continue for an extended period of time, the impact on our global supply chain could have a material adverse effect on our results of operations and cash flows. See the risk factor under “ Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside the U.S .” and “ Risks Related to Our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results ” for more information. +The effects of COVID-19 could affect our ability to successfully operate in many ways, including, but not limited to, the following factors: +• the impact of the pandemic on the economies and financial markets of the countries and regions in which we operate +• “shelter in place” and other similar mandated or suggested isolation protocols, which have disrupted, and could continue to disrupt, our retail locations, partner stores, and brick-and-mortar retailers via store closures or reduced operating hours and decreased retail traffic; +• the risk that for a prolonged period, fear of COVID-19 or variants could cause customers to avoid public places where our stores and those of our wholesale partners are located such as malls and outlets; and +• operational risk, including, but not limited to, cybersecurity risks as a result of extended remote work arrangements and restrictions on employee travel. +The rapid development and fluidity of the pandemic precludes any prediction as to the ultimate impact of COVID-19. The full extent of the impact and effects of COVID-19 on our future business, operations, liquidity, financial condition, and results of operations remain uncertain at this time. +13 +Table of Contents +Risks Related to Our Supply Chain +Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs. +We rely on third-party manufacturers outside of the U.S. to produce our products. Global industry-wide logistics challenges negatively impacted us during the year ended December 31, 2021, during which some of our third-party factories in Vietnam were closed for several weeks due to COVID-19 outbreaks. Our third-party factories in Vietnam have resumed operations, though with some at reduced capacity, after being shut down. Closures and factory disruptions may recur if additional COVID-19 break-outs occur in Vietnam or other countries where we rely on third-party manufacturers to produce our products. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +We also rely on international shipping to transport our products to their various geographic markets. During the year ended December 31, 2021, international shipping to the U.S. was disrupted and delayed due to congestion in west coast ports. Continued or additional delays in shipping may cause us to have to use more expensive air freight or other more costly methods to ship our products. In addition, global inflation has contributed to already higher incremental freight costs and such inflation may continue to result in higher freight costs. Failure to adequately produce and timely ship our products to customers could lead to lost potential revenue, failure to meet customer demand, strained relationships with customers, including wholesales, and diminished brand loyalty. +Despite our actions to mitigate these impacts, we expect to still be impacted by global logistics challenges in 2022. Specifically, we plan to invest in higher cost air freight in 2022 to bolster our inventory positions for the first half of 2022 in all regions, which will add to our expenses and impact our profit margins. +We depend solely on third-party manufacturers located outside of the U.S. +All of our footwear products are manufactured by third-party manufacturers, the majority of which are located in Vietnam and China. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity, and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders. During the years ended December 31, 2021, 2020, and 2019, approximately 56%, 75%, and 61%, respectively, of our production was in Vietnam, while our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 34%, 46%, and 38%, respectively, and our second largest third-party manufacturer, primarily operating in both Vietnam and China, produced approximately 30%, 22%, and 17%, respectively, of our footwear unit volume. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines, or meet our quality standards. Furthermore, due to the relative concentration of our third party manufacturers, disruption at the facilities of our third-party manufacturing partners as a result of COVID-19 or otherwise, including through the effects of facility closures, reductions in operating hours and labor shortages had an adverse effect on our supply chain in 2021 and may have a material adverse effect in the future. For example, in the third quarter of 2021 many of our third-party manufacturing facilities in Vietnam were closed or not operating at full capacity due to local COVID-19 outbreaks and safety protocols, which negatively impacted our financial results. See the risk factor under “ Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” and “Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results.” +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, including those caused by the COVID-19 pandemic, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, changes in governmental policies or laws and the imposition of tariffs, import and export controls, and other barriers. Because we do not manufacture products internally, we cannot offset any interruption or decrease in supply of our products by increasing production in internal manufacturing facilities, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can increase our transportation costs and adversely affect our product margins. +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, changes in legislation and policies, increases in labor costs, changes in international trade agreements and tariffs, adverse weather conditions, or public health issues, such as +14 +Table of Contents +the COVID-19 pandemic, could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. +We, similar to many other companies with overseas operations, import and sell products in other countries that could be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition, and results of operations. See the risk factor under “Risks Related to International Operations — We conduct significant business activity outside the U.S., which exposes us to risks of international commerce.” +Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results. +Our operations have been, and may continue to be, impacted by supply chain constraints and raw material shortages, resulting in increased material costs, longer lead times, port congestion, and increased freight costs caused, in part, by the COVID-19 pandemic, the uncertain economic environment, and macroeconomic trends. In addition, current or future governmental policies may increase the risk of inflation, which could further increase the costs of raw materials and components for our business. Similarly, if costs of goods continue to increase, our suppliers may seek price increases from us. If we are unable to mitigate the impact of supply chain constraints and inflationary pressure through price increases or other measures, our results of operations and financial condition could be negatively impacted. Even if we are able to raise the prices of our products, consumers might react negatively to such price increases, which could have a material adverse effect on, among other things, our brand, reputation, and sales. If our competitors substantially lower their prices, we may lose customers and mark down prices. Our profitability may be impacted by lower prices, which may negatively impact gross margins. Even though we are working to alleviate supply chain constraints through various measures, we are unable to predict the impact of these constraints on the timing of revenue and operating costs of our business in the near future. Raw material supply shortages and supply chain constraints, including cost inflation, have impacted and could continue to negatively impact our ability to meet increased demand, which in turn could impact our net sales revenues and market share. In addition, in 2021, shortages of raw materials and disruption to the global supply chain including the blockage in the Suez Canal, container costs, port congestion, and Vietnam factory closures, negatively impacted costs and inventory availability and may continue to have a negative impact on future results and profitability. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting consumer demand. In addition, purchase orders from our wholesale customers are generally subject to rights of cancellation and rescheduling by the wholesaler. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in losses or lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in lower sales, delays in shipments to customers, expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. Excess inventory, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our third-party manufacturing operations must comply with labor, trade, and other laws. Failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental, and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall, which could result in critical media coverage; harm our business, brand, and reputation; and cause us to incur additional costs. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our +15 +Table of Contents +imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business or results. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +We depend on a number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite™ and LiteRide™ formulations, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market conditions related to supply and demand for our raw materials and any resulting shortages in supply, as well as impacts of any global shipping or logistics delays. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins, or if we are unable to procure sufficient quantities of the materials that go into the Croslite™ and LiteRide™ formulations, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Risks Related to International Operations +Changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan, or other global currencies could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar (“USD”). We are exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of operations and the value of our assets and liabilities denominated in foreign currencies. +Further, our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, gross margin compression, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. We pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. In 2021, we experienced increases of approximately $1.5 million in our Americas segment revenues, primarily as a result of increases in the value of the Canadian Dollar relative to the USD, approximately $11.8 million in our Asia Pacific segment revenues as a result of increases in the value of Asian currencies relative to the USD, and approximately $10.9 million in our EMEA revenues, primarily as a result of increases in the Euro relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies, adversely impacts our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and, as a result, our forward contracts may not prove effective in reducing our exposures. +We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. We operate retail stores and sell our products to retailers outside of the U.S. and utilize foreign-based third-party manufacturers. Foreign manufacturing and sales activities are subject to numerous risks, including +• tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; +16 +Table of Contents +• delays associated with the manufacture, transportation, and delivery of products, including related to global port backlog; +• increased transportation costs due to distance, energy prices, inflation, or other factors; +• delays in the transportation and delivery of goods due to increased security concerns; +• restrictions on the transfer of funds; +• restrictions and potential penalties due to privacy laws on the handling and transfer of consumer and other personal information; +• changes in governmental policies and regulations; +• political unrest, changes in law, terrorism, natural disasters, public health issues like the COVID-19 pandemic, or war, any of which can interrupt commerce; +• potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; +• expropriation and nationalization; +• difficulties in managing foreign operations effectively and efficiently from the U.S.; +• difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions; +• longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; +• difficulties in enforcing contractual and intellectual property rights; +• greater risk that our business partners do not comply with our policies and procedures relating to labor, health, and safety; and +• increased accounting and internal control costs. +In addition, we are subject to customs laws and regulations with respect to our export and import activity, which are complex and vary within legal jurisdictions in which we operate. We cannot ensure there will be not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. For example, on December 23, 2021, the Uyghur Forced Labor Prevention Act, which effectively prohibits imports of any goods made either wholly or in part in a certain area of China, was signed into law, which generally prohibits importing goods made with forced labor into the U.S., subject to certain exceptions. While we do not currently expect that this law will directly affect our supply chain, since we do not believe that our suppliers source materials from such area of China for the products they sell to us or use to manufacture our products, other companies’ attempts to shift suppliers in response to this law or other policy developments could result in shortages, delays, and/or price increases that could disrupt our own supply chain or cause our suppliers to renegotiate existing arrangements with us or fail to perform on such obligations. For more information, please see the risk factors under “ Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside the U.S. ” and “ Risks Specific to Our Company and Strategy — Our business relies significantly on the use of information technology. A significant disruption to our operational technology or data security breach could harm our reputation and/or our ability to effectively operate our business.” +Furthermore, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties; criminal sanctions against us, our officers, or our employees; prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries; and a materially negative effect on our brand and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners, or agents will not violate our policies. +17 +Table of Contents +Changes in global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, public health issues like the COVID-19 pandemic, or other economic factors. If global economic and financial market conditions deteriorate, or remain weak, for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results. +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, cause reduced product orders or product order delays or cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• If consumer demand for our products declines, we may not be able to profitably operate existing retail stores, due to higher fixed costs of the retail business. +• A decrease in credit available to our wholesale or distributor customers, product suppliers and other service providers, or financial institutions that are counterparties to our Revolving Facility or derivative instruments may result in credit pressures, other financial difficulties, or insolvency for these parties, with a potential adverse impact on our business, our financial results, or our ability to obtain future financing. +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms, which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment of our accounts receivable. +• If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +Risks Specific to Our Company and Strategy +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. We are focusing on our core molded footwear heritage by narrowing our product line with an emphasis on higher margin products, as well as developing innovative new casual lifestyle footwear platforms. +Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to +• strengthen and maintain our brand globally; +• focus on relevant geographies and markets, product innovation, and profitable growth, while maintaining demand for our current offerings; +• effectively manage our company-operated retail stores to meet operational and financial targets at the retail store level; +• accurately forecast the global demand for our products, consolidate our distribution and supply chain network to leverage resources, simplify our fulfillment process, and deliver product around the globe efficiently; +18 +Table of Contents +• use and protect the Crocs brand and, following the completion of the HEYDUDE Acquisition, the HEYDUDE brand, and our other intellectual property in new and existing markets and territories; +• achieve and maintain a strong competitive position in new and existing markets; +• attract and retain qualified wholesalers and distributors, including partner store operators; +• maintain and enhance our digital marketing capabilities and digital commerce capabilities; and +• execute multi-channel advertising, marketing, collaboration, and social media campaigns to effectively communicate our message directly to our consumers and employees. +While these strategies, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance this will be the case or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results. +We rely heavily on the use of information technology systems and networks across all business functions, as do our business partners. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We rely on third-party information services providers worldwide for many of our information technology functions including network, hardware, and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing, and collection of payments. We use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. We also have outsourced a significant portion of work associated with our finance and accounting, human resources, customer service, and other information technology functions to third-party service providers. Despite our current security and cybersecurity measures, our systems and those of our third-party service providers may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, ransomware attacks, and interruption or loss of valuable business data, and we have been subject to, and will continue to be subject to, various third-party attacks and phishing scams. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of sales, significant costs for data restoration, the inability to interpret data timely to enhance operations, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks on a daily basis. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers’ or employees’ personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network is breached, it could give rise to unwanted media attention, materially damage our customer relationships, or harm our business, our reputation, and our financial results, which could result in fines or lawsuits. The costs we incur to protect against such information security breaches may materially increase, including increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. Our business partners in our supply chain and customer base also rely significantly on information technology. Despite their existing cybersecurity procedures and controls, if their information systems become compromised, it could, among other things, cause delays in our product fulfillment or reduce our sales, which could harm our business. +In addition, the European Union’s General Data Protection Regulation, the California Consumer Privacy Act, and other similar evolving privacy laws impose additional obligations on companies regarding the handling of personal data and provide certain individual privacy rights to persons whose data is stored. These regulations may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations, and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes and the associated costs may have a material adverse impact on our business and results of operations. +19 +Table of Contents +If our online e-commerce sites, or those of our customers, do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites and third-party e-commerce sites. Any failure on our part or on the part of third parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our products could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including unauthorized access and denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Our financial success depends in part on the strength of our relationships with, and the success of, our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributor customers to carry our products. We do not have long-term contracts with most wholesale customers, and sales to these customers are generally on an order-by-order basis and subject to cancellation and rescheduling. Our contracts with distributors typically have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms, which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses, and reduced cash flows if our collection efforts are unsuccessful. We have recorded material allowances for doubtful accounts in the past and could do so again in the future. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations, and our ability to grow our product line. +Operating company-operated retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably, or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location, and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2021, we opened 33 and closed 11 retail stores, and we operated 373 retail stores at December 31, 2021. +Many of our company-operated retail stores are located in shopping malls and outlet malls, and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot-traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick-and-mortar retail to e-commerce channels, both prior to, and as a result of, the COVID-19 pandemic, which may contribute to declining foot-traffic in company-operated retail locations. Continued reduced customer foot-traffic could reduce sales at our company-operated retail stores, including kiosks and store-in-store locations, or hinder our ability to open retail stores in new markets, which could in turn negatively affect our business and financial results. Similarly, customer foot-traffic as a result of store closures, reduced operating hours, and social distancing restrictions as a result of the COVID-19 pandemic could also have a material adverse effect on our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism, resulting from an economic slowdown, political, terrorism, social, or military events, natural disasters, public health issues like the COVID-19 pandemic, or otherwise, is likely to adversely affect sales in our existing stores. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, expansion of existing businesses or operations, and acquisitions of new businesses, such as the pending HEYDUDE acquisition, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect, or implementation issues, or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +20 +Table of Contents +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back office systems. We have also moved to, and subsequently expanded, a new distribution center in Dayton, Ohio to serve our North American businesses, and have moved to a new company-operated distribution center in The Netherlands and a new third-party operated distribution center in Japan to serve our EMEA and Asia Pacific businesses, respectively. As our business grows, we may also need to make further investments in business systems and distribution capabilities. Issues in implementing or integrating new business operations, such as the pending HEYDUDE acquisition, and new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, issues with transitioning to or operating our new distribution centers, cost overruns, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations, require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +We depend on employees across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +Further, our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threats to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing, or manufacturing and selling seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +We are subject to periodic litigation, which could result in unexpected expenditures of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings, or any future legal proceedings, could have an adverse impact on our business and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +Global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations, could negatively impact our operating results and financial condition. +The effects of climate change, natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, and public health issues like the COVID-19 pandemic, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including damage to our supply chain, manufacturing or distribution centers, retail stores, changes in consumer preferences or spending priorities, and energy shortages, have in the past and could in the future harm or disrupt our operations or the operations of our vendors, other suppliers, or customers, or result in economic instability that may negatively impact our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. +21 +Table of Contents +We have made a public commitment regarding a plan to be a Net Zero brand by 2030 through sustainable ingredients and packaging as well as responsible resource use and exploring innovative product afterlife solutions. Although we intend to meet these commitments, we may be required to expend significant resources to do so, which could increase our operational costs. Further, there can be no assurance of the extent to which our commitment will be achieved, or that any future investments we make in furtherance of achieving such target and goal will meet investor expectations or legal standards, if any, regarding sustainability performance. Moreover, we may determine that it is in the best interest of our Company and our stockholders to prioritize other business, social, governance or sustainable investments over the achievement of our current commitments based on economic, technological developments, regulatory and social factors, business strategy or pressure from investors, activist groups or other stakeholders. If we are unable to meet these commitments, then we could incur adverse publicity and reaction from investors, activist groups or other stakeholders, which could adversely impact the perception of us and our products and services by current and potential customers, as well as investors, which could in turn adversely impact our results of operations. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware law contain provisions that could discourage a third-party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +Indebtedness Risks +Our senior revolving credit facility agreement (as amended to date, the “Revolving Credit Agreement”) and the Indentures each impose, and we expect the Term Loan B Credit Agreement will impose, significant operating and financial restrictions on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities. A breach of any of those restrictive covenants may cause us to be in default under the Revolving Credit Agreement, the expected Term Loan B Credit Agreement and/or the Indentures, and our lenders could foreclose on our assets. +Our Credit Agreement requires us to maintain certain financial covenants. A decline in our operating performance could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Revolving Credit Agreement. We may not have sufficient funds to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lenders. If we are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Revolving Credit Agreement. The foregoing risks would also apply to the Term Loan B Credit Agreement we expect to enter into upon consummation of the HEYDUDE acquisition. +The Revolving Credit Agreement and the Indentures also contain, and we expect the Term Loan B Credit Agreement will contain, certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt or issue preferred stock; sell, lease or transfer our assets; pay dividends on, and make other distributions on, or redeem or repurchase, our common stock; make certain capital expenditures and investments; guarantee debt or obligations; create certain liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, incur or guarantee additional debt, incur certain liens, enter into transactions with affiliates, transfer or sell certain assets, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. The terms of any future indebtedness we may incur could include more restrictive covenants. We cannot assure you that we will be able to maintain compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the lenders and/or amend the covenants. Our failure to comply with the restrictive covenants described above as well as other terms of our indebtedness could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms or cannot refinance these borrowings, our results of operations and financial condition could be adversely affected. +22 +Table of Contents +Changes in the method for determining the London Interbank Offered Rate (“LIBOR”) and/or the replacement of LIBOR could adversely affect our results of operations. +In July 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intended to phase out LIBOR by the end of 2021. LIBOR is in the process of being discontinued. While certain U.S. Dollar LIBOR settings will continue to be published on the current basis until June 30, 2023, all other LIBOR settings either are no longer being published or are being published only for a limited time and only on a “synthetic” basis (i.e., not on the basis of submissions made by panel banks). The regulator of the administrator of LIBOR has prohibited any new use of LIBOR by firms subject to its supervision, and certain regulators in the United States have stated that no new contracts using U.S. Dollar LIBOR should be entered into after 2021. Our Revolving Credit Agreement states that, should LIBOR cease to exist or should another rate become widely recognized as the benchmark rate for USD loans, a rate substantially equivalent to the LIBOR rate in effect prior to its replacement, will be used. Furthermore, the amendment to the Revolving Credit Agreement and the Term Loan B Credit Agreement that we expect to enter into upon consummation of the HEYDUDE Acquisition are expected to utilize SOFR (as defined below). However, the consequences of the adoption of any such alternative reference rates cannot be predicted and could have an adverse impact on the amount of interest and commitment fees that we pay under the Revolving Facility. Likewise, the unavailability of LIBOR may have an adverse impact on interest rates and other financing costs under other debt instruments and other financial obligations of ours, as well as the market value of and the payments we receive under any LIBOR-linked securities or investments that we may own from time to time. In addition, financial markets generally may be adversely affected by the discontinuation of LIBOR, the uncertainties regarding its discontinuation, the alternative reference rates that are being or may be used in place of LIBOR and other issues related to LIBOR. Any of the foregoing could adversely affect our results of operations and financial condition. +At this time, the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions convened by the U.S. Federal Reserve, has recommended the Secured Overnight Financing Rate (“SOFR”) as a more robust reference rate alternative to U.S. Dollar LIBOR. SOFR is calculated based on short-term repurchase agreements, backed by Treasury securities. SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it is a rate that does not take into account bank credit risk, as is the case with LIBOR. SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Because of these and other differences, there is no assurance that SOFR will perform in the same way as LIBOR would have performed at any time, and there is no guarantee that it is a comparable substitute for LIBOR. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question. +In March 2020, the Financial Accounting Standards Board issued guidance related to reference rate reform to help facilitate the market transition from existing reference rates to alternative rates. This guidance was available for adoption at the time of its issuance, but we have not yet adopted it as of December 31, 2021. Further, at this time, it is not possible to predict the effect of any establishment of alternative reference rates or any other reforms that may be enacted in the United Kingdom or elsewhere. Uncertainty as to the nature of such potential changes, alternative reference rates, including SOFR, or other reforms may adversely affect the trading market for LIBOR-based securities, including ours. Furthermore, if LIBOR ceases to exist or a replacement rate is used to determine the interest rate on borrowings under our Revolving Credit Agreement, our borrowing cost may increase materially. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. +As the future of LIBOR and SOFR at this time is uncertain, the potential effect of any future changes cannot yet be determined but may have an adverse impact on our interest expense and, thus, our results of operations. +Our indebtedness could adversely affect our business, financial condition, and results of operations, as well as the ability to meet payment obligations under our Revolving Credit Agreement and the Notes. +As of December 31, 2021, we had $771.4 million in total indebtedness outstanding (net of $13.6 million of unamortized issuance costs related to the issuance of the Notes). We also expect to enter into an agreement (the “Term Loan B Credit Agreement”) with respect to a new senior secured term loan B facility in an aggregate principal amount equal to $2.0 billion (the “Term Loan B Facility”) and borrow $50.0 million under the Revolving Facility to finance the HEYDUDE Acquisition in part as well as exercise the accordion provision on the Revolving Credit Agreement to increase the borrowing capacity under the Credit Agreement by $100.0 million. Subject to the limits contained in the Revolving Credit Agreement, the Indentures, the expected Term Loan B Credit Agreement and the applicable agreements governing our other existing indebtedness, we may be able to incur substantial additional debt from time to time. If we do so, the risks related to our level of debt could increase. Specifically, our level of debt could have important consequences, including the following: +23 +Table of Contents +• making it more difficult for us to meet our obligations with respect to our debt; +• reducing the availability of cash flow to fund future working capital, capital expenditures, acquisitions or other general corporate purposes; +• limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate purposes; +• requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions or other general corporate purposes; +• increasing our vulnerability to general adverse economic and industry conditions; +• exposing us to the risk of increased interest rates as certain of our borrowings are at variable rates of interest; +• placing us at a disadvantage compared to other, less leveraged competitors; +• increasing our cost of borrowing; and +• limiting our flexibility in planning for changes in our business and reacting to changes in the industry in which we compete. +Furthermore, if we are unable to meet our debt service obligations or should we fail to comply with our financial and other negative covenants contained in the agreements governing our indebtedness, we may be required to refinance all or part of our debt, sell important strategic assets at unfavorable prices, incur additional indebtedness or issue common stock or other equity securities. We may not be able to, at any given time, refinance our debt, sell assets, incur additional indebtedness or issue equity securities on terms acceptable to us, in amounts sufficient to meet our needs. If we are able to raise additional funds through the issuance of equity securities, such issuance would also result in dilution to our stockholders. Our inability to service our obligations or refinance our debt could have a material and adverse effect on our business, financial condition or operating results. In addition, our debt obligations may limit our ability to make required investments in capacity, technology, or other areas of our business, which could have a material adverse effect on our business, financial condition, or operating results. +Any of these factors could have an adverse effect on our business, financial condition and results of operations and our ability to meet our debt payment obligations. See also “HEYDUDE Acquisition Risks — The incurrence by us of substantial indebtedness in connection with the financing of the HEYDUDE Acquisition may have an adverse impact on our liquidity, limit our flexibility in responding to other business opportunities, and increase our vulnerability to adverse economic and industry conditions.” +Despite our current level of indebtedness, we may be able to incur substantially more debt, which could increase the risks to our financial condition described above. +We may be able to incur substantial additional indebtedness in the future, such as the debt we are incurring to finance the HEYDUDE Acquisition in part. Although certain of the agreements governing our existing indebtedness contain restrictions on the incurrence of additional indebtedness and entering into certain types of other transactions, these restrictions are subject to a number of qualifications and exceptions, including compliance with various financial conditions. Additional indebtedness incurred in compliance with our existing debt instruments could be substantial. To the extent new debt is added to our current debt levels, the substantial leverage risks described in the immediately preceding risk factor would increase. +As of December 31, 2021, we had approximately $771.4 million in total indebtedness outstanding (net of $13.6 million of unamortized issuance costs related to the issuance of the Notes), including $85.0 million outstanding under the Revolving Facility, with total borrowing capacity of approximately $414.7 million thereunder (including $0.3 million of letters of credit outstanding as of such date). We also expect to enter into the Term Loan B Facility in an aggregate principal amount equal to $2.0 billion to finance the HEYDUDE Acquisition in part, as well as exercise the accordion provision on the Revolving Credit Agreement to increase the borrowing capacity under the Revolving Credit Agreement by $100.0 million. +24 +Table of Contents +Financial and Accounting Risks +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows, or the closure of a store could result in impairment of leasehold improvements, impairment of right-of-use assets, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. Impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, which could increase the volatility of the price of our common stock. +Quarterly results may also fluctuate as a result of several factors, including new style introductions, general economic conditions, or changes in consumer preferences. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any other year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S., our business, and financial results. +We have substantial cash requirements in the U.S., but a significant portion of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested, and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the U.S. Tax Cuts and Jobs Act, could be repatriated without incurring additional U.S. federal income taxes, although some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the U.S. and foreign jurisdictions for prior tax years. Please refer to Note 15 — Commitments and Contingencies and Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details regarding current tax audits. The final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. Recent developments, including U.S. tax reform, the European Commission’s investigations of local country tax authority rulings and whether those rulings comply with European Union rules on state aid, as well as the Organization for Economic Co-operation and Development’s project on Base Erosion and Profit Shifting, continue to change long-standing tax principles. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These +25 +Table of Contents +estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +HEYDUDE Acquisition Risks +Our ability to realize the benefits from the HEYDUDE Acquisition is substantially dependent on our ability to continue to grow HEYDUDE. +Our ability to realize the benefits from the HEYDUDE Acquisition is substantially dependent on our ability to continue to grow HEYDUDE. Combining with Crocs may not accelerate the growth and success of HEYDUDE and the HEYDUDE business may not perform as expected. If we are unsuccessful at, among other things, building HEYDUDE’s brand awareness, enhancing its digital capabilities, leveraging our wholesale relationships to enhance distribution, investing in HEYDUDE’s infrastructure as well as sales and business operations, leveraging our distribution for global growth and/or investing to scale our supply chain and gain efficiencies, our sales could be adversely affected, and our business could suffer. In addition, HEYDUDE’s product sales may not meet our expectations. +Moreover, HEYDUDE depends on a limited number of third-party manufacturers that are concentrated in China to produce its products. Due to the relative concentration of HEYDUDE’s third-party manufacturers, disruption at the facilities of such third-party manufacturing partners as a result of COVID-19 or otherwise, including through the effects of facility closures, reductions in operating hours and labor shortages may have a material adverse effect in the future. See the risk factors under “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs,” “Risks Related to Our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results” and “Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” +Further, our ability to realize the benefits from the HEYDUDE Acquisition may be dependent on the savings resulting from the timely and effective integration of the operations of Crocs and HEYDUDE. The process of integrating the operations of Crocs and HEYDUDE could encounter unexpected costs and delays, which include: the loss of key personnel; the loss of key customers; the loss of key suppliers; and unanticipated issues in integrating sales, marketing, and administrative functions. If we are unable to timely and effectively integrate the operations of Crocs and HEYDUDE, our costs could be adversely affected, and our business could suffer. +The announcement and pendency of the HEYDUDE Acquisition may have an adverse effect on our business, financial condition, operating results, and cash flows. +On December 22, 2021, we entered into the Securities Purchase Agreement relating to the HEYDUDE Acquisition. +Upon the terms and subject to the conditions set forth in the Securities Purchase Agreement, we will pay consideration to the sellers of $2.05 billion in cash, subject to adjustment, and we will issue to one of the sellers 2,852,280 shares of our common stock, based on the average of the volume-weighted average price of our common stock for the 20 days immediately prior to the signing date. +Uncertainty about the effect of the HEYDUDE Acquisition on our employees, partners, customers and other third parties may disrupt our sales and marketing or other key business activities and may have a material adverse effect on our business, financial condition, operating results, and cash flows. There can be no assurance we will be able to attract and retain key talent to the same extent that we have previously been able to attract and retain employees. Any loss or distraction of such employees could have a material adverse effect on our business, financial condition and operating results. In addition, we have devoted, and will continue to devote, significant management and other internal resources towards the completion of the HEYDUDE Acquisition and planning for integration, which could materially adversely affect our business, financial condition, operating results, and cash flows. +The incurrence by us of substantial indebtedness in connection with the financing of the HEYDUDE Acquisition may have an adverse impact on our liquidity, limit our flexibility in responding to other business opportunities, and increase our vulnerability to adverse economic and industry conditions. +We expect to incur a significant amount of indebtedness in connection with the financing of the HEYDUDE Acquisition, which we expect will be funded, in part, using borrowings under a new Term Loan B Facility in an aggregate principal amount equal to $2.0 billion. The use of indebtedness to finance the HEYDUDE Acquisition will reduce our liquidity and could cause us to +26 +Table of Contents +place more reliance on cash generated from operations to pay principal and interest on our debt, thereby reducing the availability of our cash flow for working capital and capital expenditure needs or to pursue other potential strategic plans. We expect that the agreements we will enter into with respect to the indebtedness we will incur to finance the HEYDUDE Acquisition will contain certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt or issue preferred stock; sell, lease or transfer our assets; pay dividends on, and make other distributions on, or redeem or repurchase, our common stock; make certain capital expenditures and investments; guarantee debt or obligations; create certain liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, incur or guarantee additional debt, incur certain liens, enter into transactions with affiliates, transfer or sell certain assets, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. Our ability to comply with these negative covenants can be affected by events beyond our control. In addition, a breach of the negative covenants could result in an event of default with respect to the indebtedness, which, if not cured or waived, could result in the indebtedness becoming immediately due and payable and could have a material adverse effect on our business, financial condition, or operating results. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 13601 Via Varra, Broomfield, Colorado 80020. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for office, warehouse, and retail, including kiosk and store-in-store, space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, use, and approximate size of our principal properties, and the reportable operating segment are given below. +Location Reportable Operating Segment Use Approximate Square Feet +Dayton, Ohio Americas Warehouse 1,270,000 +Dordrecht, the Netherlands EMEA Warehouse 517,000 +Rotterdam, the Netherlands EMEA Warehouse 174,000 +Broomfield, Colorado (1) +Americas Corporate headquarters and regional office 88,000 +Oudenbosch, the Netherlands EMEA Warehouse 75,000 +Hoofddorp, the Netherlands EMEA Regional office 47,000 +Singapore Asia Pacific Regional office 17,000 +Westwood, Massachusetts Americas Global commercial center 16,000 +(1) In November 2021, we entered into a lease to move our corporate headquarters to a new location, also in Broomfield, with an approximate size of 190,000 square feet. We plan to complete the move of our corporate headquarters in 2023. +We believe these properties, particularly our distribution centers and warehouses, along with various third party distribution centers not included above, are adequate for our operations. Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operational needs. We also lease 373 retail locations worldwide as of December 31, 2021. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +A discussion of legal matters is found in Note 17 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +ITEM 4. Mine Safety Disclosures +Not applicable. +27 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the Nasdaq Global Select Market under the stock symbol “CROX.” +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the Nasdaq Composite Index and the Dow Jones U.S. Footwear Index from December 31, 2016 through December 31, 2021. The graph assumes an investment of $100.00 on December 31, 2016 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. Footwear Index includes NIKE, Inc., Deckers Outdoor Corporation, Skechers U.S.A., Inc., Steven Madden Ltd., and Wolverine World Wide, Inc. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 68 as of February 9, 2022. +28 +Table of Contents +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements include restrictions on cash dividends paid on our common stock. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to, among other things, our results of operations, financial condition, level of indebtedness, capital requirements, and compliance with covenants under any then-existing financing agreements. +Purchases of Equity Securities by the Issuer +Period Total Number of Shares Purchased Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) +Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs (1) +October 1-31, 2021 (2) +2,657,125 $ 188.17 2,657,125 $ 1,050,000,098 +November 1-30, 2021 +— — — 1,050,000,098 +December 1-31, 2021 (2) +528,250 +(2) +528,250 1,050,000,098 +Total 3,185,375 $ 156.97 3,185,375 $ 1,050,000,098 +(1) On April 23, 2021, the Board approved a $712.2 million increase to our share repurchase authorization. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. As of December 31, 2021, approximately $1,050.0 million remained available for repurchase under our share repurchase authorization. The number, price, structure, and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. In the immediate term, we plan to prioritize repayments of debt, including debt incurred to finance a part of the HEYDUDE Acquisition, and thus have suspended our share repurchase program until such time that our gross leverage is under 2.0x. We do not expect this to occur in 2022. +(2) Effective October 2021, we entered into an accelerated share repurchase arrangement (“ASR”) to repurchase $500.0 million of our common stock. In exchange for an up-front payment of $500.0 million, the financial institution that was party to the ASR committed to deliver to us shares of our common stock during the ASR’s purchase period, which ended in December 2021. In October 2021, 2.7 million shares were delivered at an average price of $188.17 (which is based on a partial share delivery in October 2021). Subsequently, in December 2021, an additional 0.5 million shares were delivered. The average price paid per share for the complete ASR was $156.97. +ITEM 6. [Reserved] +29 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within Crocs’ collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 85 countries, through two distribution channels: wholesale and direct-to-consumer. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our direct-to-consumer channel includes company-operated retail stores, company-operated e-commerce sites, and third-party marketplaces. +Known or Anticipated Trends +Based on our recent operating results and our assessment of the current operating environment, we anticipate certain trends will continue to impact our future operating results: +• On December 22, 2021, we entered into a definitive agreement to acquire HEYDUDE, a privately-owned casual footwear brand, pursuant to the Securities Purchase Agreement. Upon closing, the HEYDUDE Acquisition will further diversify our product portfolio under two brands. The Securities Purchase Agreement provides that we will purchase all of the issued and outstanding equity securities of HEYDUDE for a purchase price of $2.05 billion in cash and 2,852,280 in Crocs shares. We expect to finance the Cash Consideration by entering into the $2.0 billion Term Loan B Facility and borrowing $50.0 million under the Revolving Facility. The HEYDUDE Acquisition is expected to close in February 2022, subject to customary closing conditions. +• Global industry-wide logistics challenges impacted us to some degree in the year ended December 31, 2021, particularly in the second half of the year, with some of our factories in Vietnam closed for several weeks or not operating at full capacity during the third and fourth quarters, and into the first quarter of 2022. We expect the situation to remain fluid as COVID-19 break-out rates fluctuate, including any deterioration in circumstances related to COVID-19 variants, and whether vaccination rates increase in the country. However, we have taken and will continue to take several measures to ensure continued future growth and strong gross margins in 2022, including: (i) prioritizing top-selling products and narrowing product assortment, which has and should continue to improve factory throughput, (ii) maintaining flexibility by leveraging air freight and reducing our dependency on congested West Coast ports in the United States by adding East Coast trans-shipment capabilities, and (iii) strategically allocating units and prioritizing our key growth initiatives. With the actions taken to date and our future plans, we believe Crocs is well-positioned to withstand these supply challenges. +• Despite these actions, we expect to still be impacted by global logistics challenges in 2022. Specifically, we plan to invest approximately $75 million in air freight in 2022 to bolster our inventory positions for the first half of the year in all regions. Supported by the health of our brand, wholesale orders for the first half of 2022 have been strong. However, we expect to have limitations around demand fulfillment in the first half of the year. +• Global inflation has also begun to impact our business, contributing to incremental freight costs, increased wages, particularly in our distribution centers, and increased raw materials cost. We expect this trend will continue in 2022. +• Consumer demand for the Crocs brand continues to be strong, fueled by increased marketing investment and compelling product, and is leading to strong sales growth, particularly in our clog silhouette and charms. +• In 2021, we invested, and plan to continue to invest, in selling, general and administrative expenses (“SG&A”), including marketing, talent, and digital commerce, to fuel long-term growth, while continuing to leverage revenue growth. +• In the year ended December 31, 2021, we repurchased $1.0 billion of shares, including accelerated share repurchases of $300.0 million in the three months ended June 30, 2021 and $500.0 million in the three months ended December 31, 2021. In the immediate term, we plan to prioritize repayments of debt, including debt incurred to finance a part of the HEYDUDE Acquisition, and thus have suspended our share repurchase program until such time that our gross leverage is under 2.0x. We do not expect this to occur in 2022. +• Our year-over-year results comparing the years ended December 31, 2021 and 2020 discussed below are impacted to some extent by prior year store closures and operating hour reductions as a result of the COVID-19 impact in 2020. +30 +Table of Contents +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +2021 Financial and Operational Highlights +Revenues were $2,313.4 million for the year ended December 31, 2021, a 66.9% increase compared to the year ended December 31, 2020. The increase in 2021 revenues compared to 2020 revenues was due to the net effects of: (i) higher sales volumes, which increased revenues by $637.4 million, or 46.0%, driven by continued increased consumer demand for our products, some of which was due to improved sales in our DTC businesses as the pandemic subsided; (ii) higher average selling prices, which increased revenues by $265.9 million, or 19.2%, as a result of increased prices and reduced promotions and discounts; and (iii) favorable changes in exchange rates, which increased revenues by $24.2 million, or 1.7%. +The following were significant developments affecting our businesses during the year ended December 31, 2021: +• Revenues grew in all regional segments and channels compared to the year ended December 31, 2020. Our Americas segment revenues grew 86.1%, or 85.9% on a constant currency basis, while our EMEA segment revenues grew 46.2%, or 41.7% on a constant currency basis, and our Asia segment revenues grew 25.7%, or 21.5% on a constant currency basis. +• We sold 103.0 million pairs of shoes worldwide, an increase from 69.1 million pairs in 2020. +• Gross margin was 61.4% compared to 54.1% in 2020, an increase of 730 basis points, primarily as a result of increased pricing and fewer promotions and discounts, as well as favorable product and channel mix. +• SG&A was $737.2 million, an increase of $222.4 million, or 43.2%, compared to 2020, primarily as a result of increased investments in talent, marketing, and projects to fuel future growth. However, as a percent of revenues, SG&A improved 520 basis points to 31.9% of revenues as a result of strong sales growth and our continued leveraging of operating costs. +• Income from operations was $683.1 million for the year ended December 31, 2021 compared to income from operations of $214.1 million for the year ended December 31, 2020. Our operating margin rose to 29.5%, compared to 15.4% in 2020. +• Net income was $725.7 million compared to $312.9 million in 2020. Diluted net income per common share was $11.39 for the year ended December 31, 2021, compared to a diluted net income per common share of $4.56 for the year ended December 31, 2020. +• During 2021, we issued $700.0 million of senior notes and at December 31, 2021, we had $414.7 million in available borrowing capacity under our Revolving Facility. +• We incurred costs of $6.4 million in the fourth quarter of 2021 in association with our planned HEYDUDE Acquisition, which is expected to close in February 2022, subject to customary closing conditions. +31 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2021 and 2020 +A discussion of our comparison between 2021 and 2020 is presented below. A discussion of the changes in our results of operations between the years ended December 31, 2020 and December 31, 2019 has been omitted from this Annual Report on Form 10-K but may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on February 23, 2021, which is available free of charge on the SEC’s website at www.sec.gov and our corporate website (www.crocs.com). +However, as a result of changes made in the presentation of certain costs between ‘Unallocated corporate and other’ and our regional segments in the year ended December 31, 2021, as described in more detail under “Reportable Operating Segments” below, we have included a discussion of the changes between the years ended December 31, 2020 and December 31, 2019, as revised to conform to current period segment presentation. The consolidated results of operations below have not changed from prior year presentation. +Year Ended December 31, $ Change % Change +Favorable (Unfavorable) +2021 2020 2021-2020 2021-2020 +(in thousands, except per share data, margin, and average selling price data) +Revenues $ 2,313,416 $ 1,385,951 $ 927,465 66.9 % +Cost of sales 893,196 636,003 (257,193) (40.4) % +Gross profit 1,420,220 749,948 670,272 89.4 % +Selling, general and administrative expenses +737,156 514,753 (222,403) (43.2) % +Asset impairments +— 21,071 21,071 100.0 % +Income from operations +683,064 214,124 468,940 219.0 % +Foreign currency losses, net +(140) (1,128) 988 87.6 % +Interest income 775 215 560 260.5 % +Interest expense (21,647) (6,742) (14,905) (221.1) % +Other income, net +1,797 510 1,287 252.4 % +Income before income taxes +663,849 206,979 456,870 220.7 % +Income tax benefit +(61,845) (105,882) (44,037) (41.6) % +Net income +$ 725,694 $ 312,861 $ 412,833 132.0 % +Net income per common share: +Basic $ 11.62 $ 4.64 $ 6.98 150.4 % +Diluted $ 11.39 $ 4.56 $ 6.83 149.8 % +Gross margin (1) +61.4 % 54.1 % 730 bp 13.5 % +Operating margin (1) +29.5 % 15.4 % 1,410 bp 91.6 % +Selling, general and administrative expenses as a percentage of revenues +31.9 % 37.1 % 520 bp 14.0 % +Footwear unit sales 102,962 69,087 33,875 49.0 % +Average footwear selling price - nominal basis (2) +$ 22.27 $ 19.91 $ 2.36 11.9 % +(1) Changes for gross margin and operating margin are shown in basis points (“bp”). +(2) Average footwear selling price is calculated as footwear and charms revenues divided by footwear units. +32 +Table of Contents +Revenues by Channel +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2021 2020 2021-2020 2021-2020 +(in thousands) +Wholesale: +Americas $ 727,264 $ 390,930 86.0 % 86.1 % +Asia Pacific 184,335 133,416 38.2 % 34.3 % +EMEA 262,395 168,410 55.8 % 50.4 % +Other businesses 87 163 (46.6) % (46.6) % +Total wholesale 1,174,081 692,919 69.4 % 67.4 % +Direct-to-consumer (2) : +Americas 879,748 472,683 86.1 % 85.7 % +Asia Pacific 165,825 145,099 14.3 % 9.8 % +EMEA 93,762 75,250 24.6 % 22.2 % +Total direct-to-consumer 1,139,335 693,032 64.4 % 62.9 % +Total revenues $ 2,313,416 $ 1,385,951 66.9 % 65.2 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) Direct-to-consumer revenues consist of sales generated through our company-operated retail stores (previously our “Retail” channel) and company-operated e-commerce websites and third-party e-commerce marketplaces (previously our “E-commerce” channel). +The primary drivers of the changes in revenues were: +2021 vs. 2020 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Total revenues $ 637,382 46.0 % $ 265,923 19.2 % $ 24,160 1.7 % $ 927,465 66.9 % +(1) The change due to price is based on the change in average selling price on a constant currency basis (“ASP”). +Revenues. In the year ended December 31, 2021, revenues increased compared to 2020, primarily as a result of volume increases in all segments, led by our Americas segment, and all channels, led by our wholesale channel. This was due to increased consumer demand, attributable in part to cycling prior year negative COVID-19 impacts on prior year wholesale and retail store revenues, including traffic limitations in stores and reduced operating hours. Higher ASPs also contributed to higher revenues in all segments and channels, primarily in our direct-to-consumer (“DTC”) channel, as a result of increased pricing and fewer promotions and discounts, while foreign exchange fluctuations increased revenues due to favorable changes in the Euro, Korean Won, and Chinese Yuan. +Cost of sales. Cost of sales increased compared to 2020, primarily due to higher volume of $280.7 million, or 44.1% and foreign currency fluctuations, which increased cost of sales by $10.6 million, or 1.7%. These increases were partially offset by lower average cost per unit on a constant currency basis (“AUC”) of $34.1 million, or 5.4%, as a result of favorable product mix, moderated by higher freight costs associated with global supply chain disruptions, including the blockage in the Suez Canal in the first quarter of 2021 and container costs, port congestion, and Vietnam factory closures in the third and fourth quarters of 2021. +Gross profit. Gross margin was 61.4% compared to 54.1% in 2020, due to increased pricing, fewer promotions and discounts, and favorable product and channel mix. Gross profit increased $670.3 million, or 89.4%, due to higher volumes of $356.7 million, or 47.6%, the combined impact of higher ASP and lower AUC of $300.1 million, or 40.0%, and favorable foreign currency fluctuations of $13.5 million, or 1.8%. +33 +Table of Contents +Selling, general and administrative expenses. SG&A as a percent of revenue improved to 31.9% during the year ended December 31, 2021 compared to 2020, as a result of strong sales growth and our continued efforts to leverage operating costs, while SG&A expenses increased $222.4 million, or 43.2% in the same period. This increase was driven by additional marketing investments of $80.0 million, which together with higher compensation expense and related costs of $79.0 million as a result of increased employee headcount and higher variable and executive compensation, compounded by the prior year temporary and permanent elimination of certain roles in response to COVID-19, both supported the growth of the business. Services costs increased $43.8 million from increased spending on consulting associated with supply chain investments, higher variable costs associated with sales growth, and costs related to our pending HEYDUDE Acquisition, and facilities expense was up $21.3 million primarily as a result of variable rent associated with higher sales. Other costs, including information technology expenses, were up by $15.3 million, offset in part by lower inventory donations of $8.6 million as a result of prior year COVID-19 donations to frontline healthcare workers and other organizations that did not recur at the same magnitude in the current year and lower bad debt expense of $8.4 million, mostly due to the prior year COVID-19 related impact on our distributors that did not recur in the current year, as well as collections on previously reserved bad debt expense. +Asset impairment charges. During the year ended December 31, 2021, we did not incur impairment charges. During the year ended December 31, 2020, we incurred $20.0 million in impairment charges to the right-of-use asset and store assets for a retail location in New York City and $1.1 million in impairment charges to the right-of-use asset for our former corporate headquarters. +Foreign currency losses, net. Foreign currency losses, net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on foreign currency derivative instruments. During the year ended December 31, 2021, we recognized realized and unrealized net foreign currency losses of $0.1 million compared to net losses of $1.1 million during the year ended December 31, 2020. +Income tax benefit. During the year ended December 31, 2021, we recognized an income tax benefit of $61.8 million on pre-tax book income of $663.8 million, representing an effective tax rate of (9.3)%, compared to an income tax benefit of $105.9 million on pre-tax book income of $207.0 million in 2020, which represented an effective tax rate of (51.2)%. The prior year effective tax rate is lower primarily due to the prior year net foreign deferred income tax benefit as a result of an intra-entity intellectual property rights transfer of $127.7 million, partially offset by the current year release of valuation allowances and the current year foreign deferred income tax benefit as a result of an intra-entity intellectual property rights transfer. Our effective tax rate has varied dramatically in recent years due to the intra-entity intellectual property rights transfer, differences in our profitability levels and relative operating earnings across multiple jurisdictions, and by changes in the valuation allowance. +During the three months ended December 31, 2021, we completed an intra-entity transfer of certain intellectual property rights primarily to align with current and future international operations. The transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. We recorded a deferred tax asset of $40.3 million, net of a reserve for uncertain tax positions of $16.1 million. As such, a net deferred tax asset of $24.2 million was recognized along with a corresponding foreign deferred income tax benefit. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results, and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance as of December 31, 2021, we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions, and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. In 2021, a jurisdiction for which we have historically recorded significant valuation allowances enacted a favorable change in the tax law related to net operating loss carryforwards. This change in tax law impacted the assessment of valuation allowances in the jurisdiction as the reversal of existing deferred tax assets would generate indefinite carryforward net operating losses instead of losses with a limited carryforward period. During 2021, valuation allowances recorded against deferred tax assets decreased by $200.2 million. +The 2021 impact of changes in valuation allowances to the effective tax rate was a favorable impact of $192.3 million, equating to a 29.0% favorable impact. There is also a $7.9 million change in the valuation allowance related to cumulative translation adjustments. We maintain valuation allowances of approximately $26.5 million as of December 31, 2021, which may be +34 +Table of Contents +reduced in the future depending upon the achieved profitability of certain jurisdictions as well as the magnitude of the profitability. +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2021, 2020, and 2019. As a result of changes made in the presentation of certain costs between ‘Unallocated corporate and other’ and our regional segments in the year ended December 31, 2021, as described in more detail below, we have included a discussion of the changes in our results of operations between the years ended December 31, 2020 and December 31, 2019, as revised to conform to current period presentation. +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2021 2020 2019 2021-2020 2020-2019 2021-2020 +(in thousands) +Revenues: +Americas $ 1,607,012 $ 863,613 $ 640,515 86.1 % 34.8 % 85.9 % +Asia Pacific 350,160 278,515 348,072 25.7 % (20.0) % 21.5 % +EMEA 356,157 243,660 241,948 46.2 % 0.7 % 41.7 % +Segment revenues 2,313,329 1,385,788 1,230,535 66.9 % 12.6 % 65.2 % +Unallocated corporate and other (3) +87 163 58 (46.6) % 181.0 % (46.6) % +Total consolidated revenues $ 2,313,416 $ 1,385,951 $ 1,230,593 66.9 % 12.6 % 65.2 % +Income from operations: +Americas (2) +$ 778,310 $ 323,512 $ 179,199 140.6 % 80.5 % 139.6 % +Asia Pacific (2) +71,936 32,830 60,724 119.1 % (45.9) % 109.0 % +EMEA (2) +111,539 65,914 64,771 69.2 % 1.8 % 63.9 % +Segment income from operations +961,785 422,256 304,694 127.8 % 32.8 % 125.5 % +Reconciliation of segment income from operations to income (loss) before income taxes: +Unallocated corporate and other (2)(3) +(278,721) (208,132) (176,045) (33.9) % (18.2) % +Total consolidated income from operations +683,064 214,124 128,649 219.0 % 66.4 % +Foreign currency losses, net (140) (1,128) (1,323) 87.6 % 14.7 % +Interest income 775 215 601 260.5 % (64.2) % +Interest expense (21,647) (6,742) (8,636) (221.1) % 21.9 % +Other income, net 1,797 510 31 252.4 % 1,545.2 % +Income before income taxes +$ 663,849 $ 206,979 $ 119,322 220.7 % 73.5 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) In the first quarter of 2021, certain costs previously reported within ‘Other Businesses’ were shifted to the Americas, Asia Pacific, and EMEA segments. Additionally, any costs remaining in ‘Other Businesses,’ including depreciation and amortization, have been consolidated into ‘Unallocated corporate and other.’ In the second quarter of 2021, certain marketing expenses previously reported within ‘Unallocated corporate and other’ were shifted to the Americas, Asia Pacific, and EMEA segments. The previously reported amounts for income from operations for the years ended December 31, 2020 and 2019 have been revised to conform to current period presentation. See the ‘Impacts of segment composition change’ and ‘Impacts of marketing expense allocations’ tables below for more information. +(3) “Unallocated corporate and other” includes corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, and depreciation and amortization of corporate and other assets not allocated to operating segments. +35 +Table of Contents +Impacts of segment composition change: +Year Ended December 31, +2020 2019 +(in thousands) +Impacts on income from operations: +Americas $ (29,285) $ (12,123) +Asia Pacific (4,512) (6,497) +EMEA 4,410 (3,240) +Total impact on segment income from operations $ (29,387) $ (21,860) +Unallocated corporate and other $ 29,387 $ 21,860 +Impacts of marketing expense allocations: +Year Ended December 31, +2020 2019 +(in thousands) +Impacts on income from operations: +Americas $ (9,133) $ (13,546) +Asia Pacific (10,100) (13,424) +EMEA (1,810) (2,315) +Total impact on segment income from operations $ (21,043) $ (29,285) +Unallocated corporate and other $ 21,043 $ 29,285 +The primary drivers of changes in revenues by operating segment were: +2021 vs. 2020 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Segment Revenues: +Americas $ 522,792 60.5 % $ 219,144 25.4 % $ 1,463 0.2 % $ 743,399 86.1 % +Asia Pacific 24,881 8.9 % 34,987 12.6 % 11,777 4.2 % 71,645 25.7 % +EMEA 89,785 36.8 % 11,792 4.8 % 10,920 4.5 % 112,497 46.2 % +Total segment revenues +$ 637,458 46.0 % $ 265,923 19.2 % $ 24,160 1.7 % $ 927,541 66.9 % +(1) The change due to price for revenues is based on ASP, as defined earlier in this section. +Americas +Revenues. The Americas segment grew revenues 86.1% for the year ended December 31, 2021 compared 2020, as a result of higher volume and higher ASPs in both our wholesale and DTC channels. Volume was up versus prior year as a result of continued increased consumer demand, partially due to the prior year negative impact of COVID-19 on our brick-and-mortar stores. Higher ASPs also contributed to higher sales due mostly to higher pricing and fewer promotions and discounts, primarily in our DTC channel, as well as favorable product mix. Currency fluctuations had an immaterial impact on revenues. +The Americas segment grew in the year ended December 31, 2020, compared to 2019, with significant increases due to both ASP and volume, slightly offset by negative currency fluctuations, primarily in the Brazilian Real. DTC revenues increased 29.4%, primarily due to e-commerce growth, and wholesale revenues increased 42.0%. ASP increased in all channels as a result of less promotional activity, product mix, price increases, and increased sales of charms per shoe, while higher volumes in the +36 +Table of Contents +e-commerce component of our DTC channel and wholesale channel more than offset lower volume in the retail component of our DTC channel. This was in part a result of COVID-19-related closures that drove a consumer shift to online shopping. +Income from Operations. During the year ended December 31, 2021, income from operations for our Americas segment was $778.3 million, an increase of $454.8 million, or 140.6% from 2020. Gross profit for the year ended December 31, 2021 increased $544.2 million, or 108.7%, and gross margin increased 700 basis points to 65.0%, compared to the year ended December 31, 2020. Gross profit increased $299.7 million, or 59.9%, due to sales volume increases in both channels, and increased $241.1 million, or 48.2%, due to higher ASP and lower AUC as a result of favorable product mix, including increased sales of charms per shoe, higher prices and fewer promotions and discounts, favorable channel mix, and increased efficiencies in our U.S. distribution network, partially offset by higher inbound freight costs. Immaterial favorable foreign currency fluctuations also increased gross profit. +During the year ended December 31, 2021, SG&A for our Americas segment increased by $89.4 million, or 50.5%, compared to 2020. This was primarily due to an investment in marketing of $50.0 million to support growth, higher compensation and related costs of $24.7 million as a result of increased headcount associated with the growth of the business and the prior year temporary and permanent elimination of certain roles in response to COVID-19, and $14.4 million in facilities costs, mostly associated with variable rent driven by higher retail sales. Additionally, higher services costs of $6.8 million and other costs of $5.6 million resulted predominantly from variable costs associated with higher sales. These increases were offset by lower donations of inventory of $8.3 million as a result of prior year COVID-19 donations to frontline healthcare workers that did not recur in the current year and lower bad debt expense of $3.8 million as a result of the prior year impact of COVID-19 on our distributors and subsequent collections in the current year. +During the year ended December 31, 2020, income from operations for our Americas segment was $323.5 million, an increase of $144.3 million, or 80.5% from 2019. Gross profit for the year ended December 31, 2020 increased $156.9 million, or 45.7%, and gross margin increased 432 basis points to 58.0%, compared to the year ended December 31, 2019. Gross profit increased $119.1 million, or 34.7%, due to higher ASP and lower AUC. ASP increased as a result of channel mix due to higher DTC e-commerce sales, less promotional activity, and favorable product mix. This was further supplemented by lower AUC as a result of product mix, partially offset by channel mix and higher distribution center costs from the expansion of our U.S. distribution center. Gross profit also increased $40.0 million, or 11.6%, due to sales volume. Foreign currency translation decreased gross profit by $2.2 million, or 0.6%. +During the year ended December 31, 2020, SG&A for our Americas segment increased by $12.6 million, or 7.7%, compared to 2019. This was primarily due to an increase in marketing costs of $5.8 million due to higher variable marketing associated with a higher share of e-commerce sales, $8.3 million of inventory donations associated with COVID-19, and an increase in other net costs of $3.5 million, in part due to bad debt expense recognized related to the impact of COVID-19 on our distributors. These increases were offset by a decrease of $5.0 million in compensation expense, primarily due to the temporary closure of, and reduction of store hours at, our retail stores during the year and the permanent elimination of certain roles in response to COVID-19. +Asia Pacific Operating Segment +Revenues. Revenues in our Asia Pacific segment increased in the year ended December 31, 2021 compared to 2020, as a result of volume increases in our wholesale channel driven in part by cycling prior year negative COVID-19 impacts on our distributor markets and ASP increases in both channels, as a result of increased pricing and fewer promotions and discounts. Revenue also increased as a result of fluctuations in foreign currency, including the Korean Won and Chinese Yuan. +The decrease in revenues in our Asia Pacific segment in the year ended December 31, 2020, compared to 2019, was primarily due to lower sales volumes in our wholesale channel and retail component of our DTC channel, as a result of store closures, decreased customer traffic, and lack of tourism, all of which were brought about by the pandemic. An increase in e-commerce DTC revenues partially offset these declines. Foreign currency fluctuations, primarily in the Korean Won, also decreased revenue slightly. Increased ASP, due to channel mix, fewer promotions and discounts, less discounting, and increased sales of charms per shoe, partially offset these declines. +Income from Operations. During the year ended December 31, 2021, income from operations for our Asia Pacific segment was $71.9 million, an increase of $39.1 million, or 119.1%. Gross profit for the year ended December 31, 2021 increased $63.5 million, or 43.7%, while gross margin increased 740 basis points to 59.6%, compared to the year ended December 31, 2020. The increase in gross profit was largely due to higher ASPs and lower AUCs, on a net basis, of $46.7 million, or 32.1%, resulting from price increases and less promotional activity, favorable product mix, and greater purchasing power from +37 +Table of Contents +currency changes. Higher volume of $8.9 million, or 6.2%, and favorable currency fluctuations of $7.8 million, or 5.4%, also contributed to higher gross profit. +During the year ended December 31, 2021, SG&A for our Asia Pacific segment increased $24.4 million, or 21.7%, compared to the same period in 2020, primarily due to increased investment in marketing of $17.6 million to support growth, an increase in facilities expense of $5.1 million associated with variable rent driven by higher retail sales, an increase in compensation expense and related costs of $4.2 million, and an increase in other net costs, including variable costs associated with revenue growth, of $1.3 million. These increases were partially offset by lower bad debt expense of $2.5 million, primarily from net charges taken in the prior year in response to COVID-19, and prior year inventory donations to healthcare workers and other organizations of $1.4 million, neither of which recurred in 2021. +During the year ended December 31, 2020, income from operations for our Asia Pacific segment was $32.8 million, a decrease of $27.9 million, or 45.9%. Gross profit for the year ended December 31, 2020 decreased $34.0 million, or 19.0%, while gross margin increased 70 basis points to 52.2%, compared to the year ended December 31, 2019. The decrease in gross profit was largely due to lower volume of $33.7 million, or 18.8%, particularly in our wholesale channel, as a result of the lack of tourism in our distributors’ markets and temporary closures of our wholesale partners’ brick-and-mortar stores during the pandemic. Foreign currency fluctuations also decreased gross profit by $1.8 million or 1.0%. Finally, higher ASP, net of AUC, of $3.9 million, due to the shift in direct-to-consumer revenues, was offset by a pandemic-related inventory write-off of $2.4 million. +During the year ended December 31, 2020, SG&A for our Asia Pacific segment decreased $6.1 million, or 5.2%, compared to the same period in 2019. This was due in part to reductions in compensation expense of $3.2 million due to the temporary and permanent elimination of certain roles in response to COVID-19, facilities expense of $3.2 million as a result of store closures in Australia and Hong Kong and COVID-19 related rent abatements, primarily in Singapore, marketing cost of $2.2 million, and travel and related costs of $2.0 million. These decreases were offset by an increase in SG&A from donations of inventory to frontline healthcare workers and other organizations of $1.4 million, higher bad debt expense of $1.2 million, in part due to the impact of COVID-19 on distributor partners, and higher other net costs of $1.9 million. +Europe, Middle East, and Africa Operating Segment +Revenues. Revenues increased for our EMEA segment compared to the year ended December 31, 2020, most significantly as a result of higher volumes in both channels, particularly in wholesale, resulting from increased product demand and cycling prior year negative COVID-19 impacts which further increased the disparity between the two periods. Higher ASPs in all channels, as a result of price increases and fewer promotions and discounts, and favorable foreign currency fluctuations in the Euro also increased revenues. +The increase in revenues for our EMEA segment in the year ended December 31, 2020, compared 2019, was due to increased ASP, primarily in our DTC channel as a result of less discounting, offset in part by lower volumes. Within our DTC channel, e-commerce volume increases of 33.4% were more than offset by retail volume decreases of 36.4%, and wholesale volume decreases of 2.7%, as consumers shifted to online shopping during the pandemic. Negative foreign currency fluctuations in the Russian Ruble, partially offset by positive fluctuations in the Euro, also reduced revenues. +Income from Operations. During the year ended December 31, 2021, income from operations for our EMEA segment was $111.5 million, an increase of $45.6 million, or 69.2%. Gross profit for the year ended December 31, 2021 increased $59.7 million, or 49.5%, and gross margin increased by 110 basis points to 50.6% compared to the year ended December 31, 2020. The increase in our EMEA segment gross profit was due to higher volumes of $42.4 million, or 35.1%, primarily in our wholesale channel, and higher ASPs, supplemented by slightly lower AUCs, of $12.3 million, or 10.2%, as a result of purchasing power gains, favorable product mix, and price increases and fewer promotions and discounts, offset in part by higher freight costs. Favorable foreign currency fluctuations of $5.1 million, or 4.2% also contributed to higher gross profit. +During the year ended December 31, 2021, SG&A for our EMEA segment increased $14.1 million, or 25.8%, compared to the same period in 2020. Additional investments in marketing to support growth of $10.2 million, higher compensation expense and related costs of $3.5 million, and higher facilities and other net costs of $2.2 million were offset in part by $1.8 million lower bad debt expense. +During the year ended December 31, 2020, income from operations for our EMEA segment was $65.9 million, a decrease of $1.1 million, or 1.8%. Gross profit for the year ended December 31, 2020 increased $2.4 million, or 2.0%, and gross margin increased by 60 basis points to 49.5% compared to the year ended December 31, 2019. The decrease in our EMEA segment gross profit was due to lower volumes of $3.6 million, or 3.1%, primarily in the retail component of our DTC channel, and +38 +Table of Contents +negative foreign currency fluctuations of $1.2 million, or 1.1%. Higher ASP in the e-commerce component of our DTC channel as a result of fewer promotions and discounts and price increases led to a total increase to gross profit of $7.2 million or 6.1%. +During the year ended December 31, 2020, SG&A for our EMEA segment increased $1.3 million, or 2.2%, compared to the same period in 2019, primarily due to increased marketing cost of $2.1 million as a result of higher variable marketing associated with a higher share of e-commerce sales and increased other net costs of $0.7 million, offset by a reduction in compensation expense of $1.5 million. +Unallocated Corporate and Other +During the year ended December 31, 2021, total net costs within ‘Unallocated corporate and other’ increased by $70.6 million, or 33.9%, compared to the same period in 2020. This was primarily driven by an increase in compensation expense of $46.6 million due to increased employee headcount and the related hiring costs and higher variable and executive compensation, as well as higher services costs of $35.2 million as a result of supply chain investments, legal expenses, and costs associated with our pending HEYDUDE Acquisition. We also had higher information technology costs of $10.7 million. These increases were partially offset by prior year impairment charges of $21.1 million, primarily related to a retail location in New York City, that did not recur in the current year, and lower other net costs of $0.8 million. +During the year ended December 31, 2020, total net costs within ‘Unallocated Corporate and Other’ increased by $32.1 million, or 18.2%, compared to the same period in 2019. This increase was primarily due to a $20.0 million impairment to the right-of-use asset and store assets for a retail location in New York City, a $1.1 million impairment to the right-of-use asset for our former corporate headquarters, higher compensation expense of $13.2 million due to higher variable compensation and sales commissions associated with higher revenues, and an increase in facilities expense of $3.0 million due to duplicate rent costs associated with our new corporate headquarters and higher insurance premiums. There were also increases in various other costs, including marketing, of $6.2 million. These higher costs were partially offset by lower supply chain costs of $7.6 million due to the impact of favorable foreign currency on purchasing power and favorable sourcing mix and decreases in travel, professional services, and other costs of $3.8 million. +Store Locations and Digital Sales Percentage +The table below illustrates the overall change in the number of our company-operated retail locations by reportable operating segment: +December 31, 2020 Opened Closed December 31, 2021 +Operating segment: +Americas 165 9 1 173 +Asia Pacific 137 23 7 153 +EMEA 49 1 3 47 +Total 351 33 11 373 +Digital sales, which includes sales through our company-owned website, third-party marketplaces, and e-tailers (which are reported in our wholesale channel), as a percent of total revenues, by operating segment were: +Year Ended December 31, +2021 2020 +Digital sales as a percent of total revenues: +Americas 33.5 % 38.5 % +Asia Pacific 37.1 % 39.2 % +EMEA 50.7 % 54.8 % +Global 36.7 % 41.5 % +The 2020 digital sales percentages were impacted to some extent by the COVID-19 pandemic, which increased digital penetration when brick-and-mortar stores were closed during such time-frame. Nonetheless, we expect digital sales to continue to increase going forward. +39 +Table of Contents +As a result of temporary store closures across the globe due to COVID-19, primarily in the year ended December 31, 2020, we have not presented direct-to-consumer comparable sales. +Liquidity and Capital Resources +Our liquidity position as of December 31, 2021 was: +December 31, 2021 +(in thousands) +Cash and cash equivalents $ 213,197 +Available borrowings 414,725 +As of December 31, 2021, we had $213.2 million in cash and cash equivalents and up to $414.7 million in available borrowings under our Revolving Facility. We believe that our cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Revolving Facility and other financing agreements will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. Additionally, in March 2021 and August 2021, we completed the issuance and sale of $350.0 million aggregate principal amount of 2029 Notes (as defined below) and $350.0 million aggregate principal amount of 2031 Notes (as defined below), respectively. In the year ended December 31, 2021, we repurchased $1.0 billion of shares, including accelerated share repurchases of $300.0 million in the three months ended June 30, 2021 and $500.0 million in the three months ended December 31, 2021. As a result of the HEYDUDE Acquisition, we have suspended our share repurchase program, as described in more detail below. +The consideration for the HEYDUDE Acquisition will be comprised of $2.05 billion in cash and 2,852,280 in Crocs shares. The transaction is expected to close in February 2022, subject to customary closing conditions. To finance the Cash Consideration, in the first quarter of 2022, we expect to enter into the $2.0 billion Term Loan B Credit Agreement, as well as borrow $50.0 million under our Revolving Facility, which we will amend to update certain terms and conditions, including covenants, to be more favorable to the pending HEYDUDE Acquisition. We also intend to exercise the accordion provision to increase our borrowing capacity from $500.0 million to $600.0 million. In 2022, we plan to use excess cash generated by our operations to repay our outstanding debt, including debt incurred to finance a part of the HEYDUDE Acquisition, and, as such, we have suspended our share repurchase program until such time that our gross leverage is under 2.0x. We do not expect this to occur in 2022. See the risk factor under “HEYDUDE Acquisition Risks — The incurrence by us of substantial indebtedness in connection with the financing of the HEYDUDE Acquisition may have an adverse impact on our liquidity, limit our flexibility in responding to other business opportunities, and increase our vulnerability to adverse economic and industry conditions” included in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for further information on liquidity risks associated with the HEYDUDE Acquisition. +Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets could each impact our business and liquidity. +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +All of the cash held outside of the U.S. could be repatriated to the U.S. without incurring additional U.S. federal income taxes. As of December 31, 2021, we held $97.7 million of our total $213.2 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. None of the $97.7 million held in international locations is limited by local regulations. +40 +Table of Contents +Senior Revolving Credit Facility +In July 2019, Crocs, Inc. and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Revolving Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders, which provides for a revolving credit facility of $500.0 million, which can be increased by an additional $100.0 million subject to certain conditions (the “Revolving Facility”). Borrowings under the Revolving Credit Agreement bear interest at a variable rate based on (A) a domestic base rate (defined as the highest of (i) the Federal Funds open rate, plus 0.25%, (ii) the Prime Rate, and (iii) the Daily LIBOR rate, plus 1.00%), plus an applicable margin ranging from 0.25% to 0.875% based on our leverage ratio, or (B) a LIBOR rate, plus an applicable margin ranging from 1.25% to 1.875% based on our leverage ratio. Borrowings under the Revolving Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Revolving Credit Agreement required us to maintain a minimum interest coverage ratio of 4.00 to 1.00 and a maximum leverage ratio of 3.50 to 1.00 from the quarter ended December 31, 2020 to the quarter ended December 31, 2021. Additionally, the Revolving Credit Agreement requires us to maintain a minimum interest coverage ratio of 4.00 to 1.00 and a maximum leverage ratio of 3.25 to 1.00 from the quarter ending March 31, 2022 and thereafter (subject to adjustment in certain circumstances). The Revolving Credit Agreement permits (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Revolving Credit Agreement of at least $40.0 million. As of December 31, 2021, we were in compliance with all financial covenants under the Revolving Credit Agreement. +As of December 31, 2021, the total commitments available from the lenders under the Revolving Facility were $500.0 million. At December 31, 2021, we had $85.0 million in outstanding borrowings, which are due when the Revolving Facility matures in July 2024, and $0.3 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2021 and 2020, we had $414.7 million and $319.4 million, respectively, of available borrowing capacity under the Revolving Facility. See above regarding our plans to amend and increase our borrowing capacity. +Senior Notes Issuances +On March 12, 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.250% Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (“the March Indenture”). Additionally, on August 10, 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.125% Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (“the August Indenture” and, together with the March Indenture, the “Indentures”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +The Company will have the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company may redeem up to 40% of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company may redeem up to 40% of the aggregate principal amount of the 2031 Notes at a redemption price of 104.125% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Revolving Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Revolving Credit Agreement and by each of the Company’s +41 +Table of Contents +wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; declare and pay dividends or repurchase or redeem capital stock or make other restricted payments; declare and pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2021, we were in compliance with all financial covenants under the Indentures. +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, $ Change % Change +2021 2020 Favorable (Unfavorable) +(in thousands) +Cash provided by operating activities $ 567,165 $ 266,902 $ 300,263 112.5 % +Cash used in investing activities (55,925) (41,762) (14,163) (33.9) % +Cash used in financing activities (429,638) (198,038) (231,600) (116.9) % +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +(3,950) 126 (4,076) (3234.9) % +Net change in cash, cash equivalents, and restricted cash $ 77,652 $ 27,228 $ 50,424 185.2 % +Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted for non-cash items and changes in working capital. Cash provided by operating activities increased $300.3 million for the year ended December 31, 2021 compared to the year ended December 31, 2020. This change was driven by higher net income adjusted for non-cash items of $477.2 million, partly offset by a net decrease in operating assets and liabilities of $176.9 million. +Investing Activities. The $14.2 million increase in cash used in investing activities for the year ended December 31, 2021 compared to the year ended December 31, 2020 is primarily due an increase in the purchases of property, equipment, and software, related to the expansion of our distribution centers. +Financing Activities. The $231.6 million increase in cash used in financing activities for the year ended December 31, 2021 compared to the year ended December 31, 2020 resulted primarily from an increase of $829.1 million in repurchases of our common stock, as detailed below, and a decrease in borrowings of $70.0 million, net of repayments, on our Revolving Facility. Additionally, there was an increase of $17.1 million in repurchases of common stock for tax withholding, an increase of $14.2 million in deferred debt issuance costs, primarily related to the Notes issuances, and an increase of cash used in other financing activities of $1.2 million. The overall increase in cash used in financing activities was offset by an increase in proceeds from the Notes issuances of $700.0 million. +Stock Repurchases +On February 20, 2018, the Board approved and authorized a program to repurchase up to $500.0 million of our common stock, and on May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $500.0 million of our common stock. On April 23, 2021, the Board approved a $712.2 million increase to our share repurchase authorization. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +We repurchased 8.2 million shares of our common stock at a cost of $1,000.0 million, including commissions, during the year ended December 31, 2021. This includes 3.2 million shares delivered under the $500.0 million accelerated share repurchase arrangement (“ASR”) entered into in September 2021, 2.9 million shares delivered under the $300.0 million ASR entered into in April 2021, and 0.5 million shares delivered in January 2021 at the conclusion of the purchase period for the ASR entered +42 +Table of Contents +into in November 2020. Under each ASR, a financial institution delivered shares of our common stock during the purchase period in exchange for an up-front payment. The total number of shares ultimately delivered under the ASR, and therefore the average repurchase price paid per share, was determined based on the volume-weighted average price of our common stock during the purchase period. As of December 31, 2021, we had remaining authorization to repurchase approximately $1,050.0 million of our common stock, subject to restrictions under the agreements governing our indebtedness. +During the year ended December 31, 2020, we repurchased 3.2 million shares of our common stock at a cost of $170.8 million, including commissions. This included 1.5 million shares delivered under a $125.0 million November 2020 ASR. +In 2022, we plan to use excess cash generated by our operations to repay debt, including debt incurred to finance a part of the HEYDUDE Acquisition and, as such, we have suspended our share repurchase program until such time that our gross leverage is under 2.0x. We do not expect this to occur in 2022. +See Note 10 — Equity in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information on our repurchases and repurchase authorizations. +Contractual Obligations +We believe we have sufficient liquidity to fund our operations and meet our short-term and long-term obligations. Our material future cash obligations as of December 31, 2021 include the following: +Less than 1 Year Thereafter Total +(approximately, in thousands) +Debt-related: +Debt obligations (1) +$ — $ 771,400 $ 771,400 +Interest on debt obligations (2) +30,700 214,700 245,400 +Lease-related (3) : +Lease obligations +44,900 175,600 220,500 +Obligations for leases not yet commenced 1,700 81,400 83,100 +Other: +Distribution and logistics obligations (4) +57,700 900 58,600 +Total $ 135,000 $ 1,244,000 $ 1,320,400 +(1) Net of $13.6 million of unamortized issuance costs related to the issuance of the Notes. +(2) Represents future interest payment obligations, which are estimated by assuming the amounts outstanding under our Revolving Facility and the interest rates in effect as of December 31, 2021, will remain constant into the future. This is only an estimate, as actual amounts borrowed and rates will vary over time, based on a domestic base rate or LIBOR rate, as described in the “Senior Revolving Credit Facility” section. +(3) Our operating lease obligations consist of leases for real estate, which includes retail, warehouse, distribution center, and office spaces and represent the minimum cash commitment under contract to various third parties for operating lease obligations. For more information on our leases obligations and obligations for leases not yet commenced, refer to Note 6 — Leases in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +(4) Represents material contractual obligations associated with global distribution and logistics projects. +We also have purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products, for an aggregate of $274.9 million. We expect to fulfill our commitments under these agreements in the next twelve months in the normal course of business and are only liable for the portion of the purchase obligations that have been purchased by the third-party manufacturer or manufactured by the vendor, with the remainder cancellable without penalty. Refer to Note 15 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +We had no material off-balance sheet arrangements as of December 31, 2021, other than certain purchase commitments, as described in the preceding paragraph. +43 +Table of Contents +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and non-GAAP financial measures, is based on the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Reserves for Uncollectible Accounts Receivable, Sales Returns, Allowances, Discounts, and Rebates +We make ongoing estimates related to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability or unwillingness of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events, and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability or unwillingness to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge, respectively, to ‘Selling, general and administrative expenses’ in our consolidated statement of operations in the period in which we made such a determination. +Additionally, a significant area of judgment affecting reported revenues and net income involves estimating reserves for sales returns, allowances, discounts, and rebates, which represent the portion of revenues not expected to be realized. Wholesale revenues are reduced by estimates of returns, allowances, discounts, contractual discounts to major customers, and rebates. We also may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments, and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Further, we record reductions to revenues for estimated customer credits as a result of price markdowns in certain markets. Revenues in our retail and e-commerce channels are also reduced by an estimate of returns. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns, allowances, discounts, and rebates may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances, discounts, and rebates have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns, allowances, discounts, and rebates as of December 31, 2021 would have an immaterial impact on our 2021 revenues. +See Schedule II in Part IV - Item 15. Exhibits, Financial Statement Schedule to the accompanying consolidated financial statements of this Annual Report on Form 10-K for an analysis of the activity in our reserves for uncollectible accounts receivable, sales returns, allowances, and discounts. +Impairment of Long-Lived Assets +Property and equipment along with other long-lived assets are evaluated for impairment periodically whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. Testing of long-lived assets for impairment is at the level of an asset group, which is the lowest level for which identifiable cash flows are largely independent +44 +Table of Contents +of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +In 2021, we did not record impairments to reduce the net carrying value of certain long-lived assets. In 2020, we recorded non-cash impairments of $20.0 million to reduce the net carrying value of certain long-lived assets to their estimated fair values for a retail store in New York City and $1.1 million for our former corporate headquarters. During 2019, we did not record any impairment charges. See Note 3 — Property and Equipment, Net in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +Income Taxes +In 2020, we completed changes to our international legal structure that created an amortizable step-up in tax basis of the intangible asset and a corresponding increase in foreign deferred tax assets based on the fair value of the intellectual property (“IP”). As of December 31, 2021, the related net deferred tax asset is $449.9 million, net of a reserve for uncertain tax positions of $189.9 million. Additionally, during the three months ended December 31, 2021, we completed an intra-entity transfer of certain IP rights primarily to align with current and future international operations. This transfer also resulted in a step-up in tax basis of IP rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred IP rights. We recorded a deferred tax asset of $40.3 million, net of a reserve for uncertain tax positions of $16.1 million, which resulted in a net deferred tax asset of $24.2 million, and a corresponding foreign deferred income tax benefit. This transaction was executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from our actual results. +In order to support and sustain the amortizable tax basis (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands subsidiary serves as the principal Crocs corporate headquarters outside of the U.S. and already performs significant functions in support of the economic ownership of the IP in the Netherlands. In 2021, we undertook many additional activities to align business operations that support the economic substance of the IP in the Netherlands. +We have also recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of GILTI as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less +45 +Table of Contents +than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense (benefit)’ line in the accompanying consolidated statements of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-U.S. subsidiaries as of December 31, 2021, which are considered to be indefinitely reinvested outside of the U.S. +See Note 13 — Income Taxes in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements, and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +46 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Revolving Facility and certain financial instruments. +Borrowings under our Revolving Facility bear interest at a variable rate based on a domestic base rate or a LIBOR rate, plus an applicable margin, and are therefore subject to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control. See the risk factor under “Financial and Accounting Risk — Changes in the method for determining the London Interbank Offered Rate (“LIBOR”) and/or the replacement of LIBOR could adversely affect our results of operations” included in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for further information on risks related to our interest rate. +As of December 31, 2021, we had long-term borrowings with a face value of $785.0 million, comprised of $85.0 million of borrowings under the Revolving Facility, the Notes, which carry a fixed rate, and $0.3 million in outstanding letters of credit under our Revolving Facility. +A hypothetical increase of 1% in the interest rate on these variable rate borrowings would have increased interest expense by $0.9 million for the year ended December 31, 2021. +Foreign Currency Exchange Risk +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates in effect at the time such exchange rates are used to translate the operating results of our international subsidiaries. +An increase of 1% of the value of the USD relative to foreign currencies would have decreased our revenues and income before taxes during the year ended December 31, 2021 by approximately $7.8 million and $1.4 million, respectively. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. +We enter into forward foreign exchange contracts to buy or sell various foreign currencies to selectively protect against volatility in the value of non-functional currency denominated monetary assets and liabilities. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur. As of December 31, 2021, the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $147.7 million. The net fair value of these contracts at December 31, 2021 was a liability of $0.2 million. See Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for a discussion of risks to our business and financial results associated with foreign currencies. +We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of December 31, 2021, a 10% appreciation in the value of the USD would result in a net decrease in the fair value of our derivative portfolio of approximately $0.9 million. +See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statement of operations for the years ended December 31, 2021 and 2020. +47 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2021, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2021, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2021. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2021, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2021, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +48 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2021, of the Company and our report dated February 16, 2022, expressed an unqualified opinion on those consolidated financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 16, 2022 +49 +Table of Contents +ITEM 9B. Other Information +None. +ITEM 9C. Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +None. +50 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2022 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2021. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our code of ethics is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, that code for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our code of ethics as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2022 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2021. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2022 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2021, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 1.6 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2021. +Plan Category +Number of Securities to be Issued on Exercise of Outstanding +Options, Warrants, and Rights (1) +Weighted Average Exercise Price of Outstanding +Options, Warrants, and Rights (2) +Number of Securities Remaining Available for Future Issuance Under Plans, Excluding Securities Available in First Column +Equity compensation plans approved by stockholders (3) +1,573,233 $ 7.78 4,323,301 +Equity compensation plans not approved by stockholders +— — — +Total 1,573,233 $ 7.78 4,323,301 +(1) The number of shares outstanding includes restricted stock awards and restricted stock units that were outstanding on December 31, 2021 and assumes target performance for performance-based equity awards. +(2) The weighted average exercise price of outstanding options pertains to 0.2 million shares issuable on the exercise of outstanding options. +(3) On June 10, 2020, our stockholders approved the Crocs, Inc. 2020 Equity Incentive Plan (the “Plan”). The number of shares of our common stock available for issuance under the Plan consisted of (i) 3.8 million newly available shares, (ii) 1.4 million shares of our common stock available for issuance under the 2015 Plan as of June 10, 2020, and (iii) 2015 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 10, 2020. The number of shares authorized for issuance under the Plan is subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. The Plan became effective immediately upon stockholder approval. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2022 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2021. +51 +Table of Contents +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2022 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2021. +52 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedule +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedule +The following consolidated financial statement schedule of Crocs, Inc. and its subsidiaries is filed as a part of this report: +• Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +53 +Table of Contents +(3) Exhibit list +Exhibit +Number Description +2.1# +Securities Purchase Agreement, dated as of December 22, 2021, by and among: (i) Crocs, Inc.; (ii) Full Fortune Wealth Limited; (iii) Mr. Daniele Guidi; (iv) Full Fortune Intellectual Limited; (v) Full Fortune Worldwide Limited; (vi) Full Fortune Online Limited; (vii) Happy One LLC; (viii) Lucky Top Inc.; (ix) Mr. Alessandro Rosano; and (x) Full Fortune Wealth Limited, in its capacity as representative and agent for Sellers (incorporated by reference to Exhibit 2.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 23, 2021) . +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +4.2 +Description of Registrant's Securities (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Annual Report on Form 10-K filed on February 27, 2020). +4.3 +Indenture (including Form of Global 4.250% Senior Notes due 2029), dated March 12, 2021, by and among Crocs, Inc., the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 12, 2021). +4.4 +Indenture (including Form of Global 4.125% Senior Notes due 2031), dated August 10, 2021, by and among Crocs, Inc. the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on August 10, 2021). +10.1 * +Crocs, Inc. 2015 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +10.2 * +Andrew Rees Performance-Vested Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 13, 2018). +10.3 * +Form of Performance-Vested Restricted Stock Award (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 13, 2021). +10.4 +Second Amended and Restated Credit Agreement, dated July 26, 2019, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed August 1, 2019). +10.5 +First Amendment to Second Amended and Restated Credit Agreement, dated March 26, 2020, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent, and PNC Bank, National Association, as administrative agent (incorporated by reference herein to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed March 30, 2020). +54 +Table of Contents +Exhibit +Number Description +10.6 +Second Amendment to Second Amended and Restated Credit Agreement, dated November 13, 2020, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent ( incorporated by reference herein to Exhib it 10.1 2 to Crocs, Inc. ’ s Annual Report on Form 10-K, filed February 23, 2021 ). +10.7 † +Third Amendment to Second Amended and Restated Credit Agreement, dated July 23, 2021, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PNC Bank, National Association, as administrative agent. +10.8 * +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on October 4, 2018). +10.9 * +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.10 * +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +10.11 * +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.12 * +Employment Offer Letter, dated August 1, 2018, between Crocs, Inc. and Anne Mehlman (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2018). +10.13 * +Crocs, Inc. 20 20 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 11 , 20 20 ). +10.14 * +Employment Offer Letter dated September 10, 2020 between Crocs, Inc. and Michelle Poole (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on September 14, 2020). +10.15 * +Employment Offer Letter, dated January 29, 2020, between Crocs, Inc. and Elaine Boltz (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on April 27, 2021). +21 † +Subsidiaries of the registrant. +23.1 † +Consent of Deloitte & Touche LLP. +31.1 † +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 † +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 + +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS † XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH † XBRL Taxonomy Extension Schema Document +55 +Table of Contents +Exhibit +Number Description +101.CAL † XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF † XBRL Taxonomy Extension Definition Linkbase Document +101.LAB † XBRL Taxonomy Extension Label Linkbase Document +101.PRE † XBRL Taxonomy Extension Presentation Linkbase Document +104 Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101). +* Compensatory plan or arrangement. +# Certain exhibits and schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted exhibits or schedules upon request; provided that the Company may request confidential treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. +† Filed herewith. ++ Furnished herewith. +56 +Table of Contents +Item 16. Form 10–K Summary. +None. +57 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 16, 2022. +CROCS, INC. +a Delaware Corporation +By: /s/ ANDREW REES +Name: Andrew Rees +Title: Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ ANDREW REES Chief Executive Officer and Director (Principal Executive Officer) February 16, 2022 +Andrew Rees +/s/ ANNE MEHLMAN Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 16, 2022 +Anne Mehlman +/s/ THOMAS J. SMACH Chairman of the Board February 16, 2022 +Thomas J. Smach +/s/ IAN M. BICKLEY Director February 16, 2022 +Ian M. Bickley +/s/ RONALD L. FRASCH Director February 16, 2022 +Ronald L. Frasch +/s/ TRACY GARDNER Director February 16, 2022 +Tracy Gardner +/s/ CHARISSE FORD HUGHES Director February 16, 2022 +Charisse Ford Hughes +/s/ BETH J. KAPLAN Director February 16, 2022 +Beth J. Kaplan +/s/ DOUGLAS J. TREFF Director February 16, 2022 +Douglas J. Treff +58 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) +F- 2 +Consolidated Statements of Operations for the Years Ended December 31, 2021, 2020, and 2019 +F- 4 +Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2021, 2020, and 2019 +F- 5 +Consolidated Balance Sheets as of December 31, 2021 and 2020 +F- 6 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2021, 2020, and 2019 +F- 7 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2021, 2020, and 2019 +F- 8 +Notes to Consolidated Financial Statements +F- 9 +Schedule II: Valuation and Qualifying Accounts +F- 37 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows, for each of the three years in the period ended December 31, 2021, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 16, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Income Taxes —Evaluation of the Deferred Tax Asset resulting from Intra-entity Intellectual Property Transactions — Refer to Note 13 to the consolidated financial statements +Critical Audit Matter Description +The Company recognizes deferred income taxes for tax attributes and for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the deferred tax liability or asset is expected to be settled or realized. In 2020, the Company completed a series of transactions resulting in changes to their international legal structure, including the sale of certain intellectual property (“IP”) rights between wholly-owned subsidiaries to the Netherlands. The sale entitles the Netherlands entity to profits resulting from the IP and created an amortizable step-up in tax basis of the intangible asset and a corresponding increase in foreign deferred tax assets based on the fair value of the IP. The related net deferred tax asset is $449.9 million as of December 31, 2021. +F- 2 +Table of Contents +In order to support and sustain the amortizable tax basis (and associated deferred tax asset), the Company must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of tax laws of each associated tax jurisdiction. In 2021, the Company undertook many activities to align the business operations that support the economic substance of the IP in the Netherlands. +We identified management’s evaluation of the economic substance necessary to support the ownership and service of the IP and the corresponding deferred tax asset related to this IP as a critical audit matter because of the significant judgments and interpretations of tax laws that were made by management. +We utilized a high degree of auditor judgment and an increased extent of effort, including the need to involve our income tax specialists with the appropriate skills and knowledge, when performing audit procedures to evaluate whether management’s judgments in interpreting and applying tax laws were appropriate in determining the substance of the deferred tax asset as of December 31, 2021. +How the Critical Audit Matter Was Addressed in the Audit +Our audit procedures related to the Company’s evaluation of the deferred tax asset resulting from the intra-entity IP transfer included the following, among others: +• We tested the effectiveness of management’s controls over the determination of the economic substance of the IP. +• We evaluated the activities undertaken by the Company to support the economic substance, including determination of the functions performed and the considerations necessary to service the IP. +• With the assistance of our tax specialists, we evaluated the economic substance of the deferred tax asset. Our procedures included the following, among others: +– Obtained the Company’s supporting documentation to assess the technical tax merits applicable to the Netherlands and international transfer pricing standards and evaluated the application of these relevant tax laws in the Company’s recognition determination. +– Evaluated the economic substance of the Company’s deferred tax asset using our knowledge of international, domestic, and local income tax laws, as well as settlement activity from the relevant income tax authorities. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 16, 2022 +We have served as the Company’s auditor since 2005. +F- 3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Year Ended December 31, +2021 2020 2019 +Revenues +$ 2,313,416 $ 1,385,951 $ 1,230,593 +Cost of sales +893,196 636,003 613,537 +Gross profit +1,420,220 749,948 617,056 +Selling, general and administrative expenses +737,156 514,753 488,407 +Asset impairments +— 21,071 — +Income from operations +683,064 214,124 128,649 +Foreign currency losses, net +( 140 ) ( 1,128 ) ( 1,323 ) +Interest income +775 215 601 +Interest expense +( 21,647 ) ( 6,742 ) ( 8,636 ) +Other income, net +1,797 510 31 +Income before income taxes +663,849 206,979 119,322 +Income tax benefit +( 61,845 ) ( 105,882 ) ( 175 ) +Net income +$ 725,694 $ 312,861 $ 119,497 +Net income per common share: +Basic +$ 11.62 $ 4.64 $ 1.70 +Diluted +$ 11.39 $ 4.56 $ 1.66 +Weighted average common shares outstanding: +Basic +62,464 67,386 70,357 +Diluted +63,718 68,544 71,771 +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(in thousands) +Year Ended December 31, +2021 2020 2019 +Net income +$ 725,694 $ 312,861 $ 119,497 +Other comprehensive income: +Foreign currency gains (losses), net +( 20,484 ) 2,189 ( 3,659 ) +Reclassification of foreign currency translation loss to income (1) +— ( 164 ) ( 68 ) +Total comprehensive income +$ 705,210 $ 314,886 $ 115,770 +(1) Represents the reclassification of cumulative foreign currency translation adjustment upon liquidation of foreign subsidiaries during the year ended December 31, 2020, and upon closure of manufacturing operations during the year ended December 31, 2019, both of which are presented within ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2021 2020 +ASSETS +Current assets: +Cash and cash equivalents +$ 213,197 $ 135,802 +Restricted cash — current +65 1,542 +Accounts receivable, net of allowances of $ 20,715 and $ 21,093 , respectively +182,629 149,847 +Inventories +213,520 175,121 +Income taxes receivable +22,301 1,857 +Other receivables +12,252 10,816 +Prepaid expenses and other assets +22,605 17,856 +Total current assets +666,569 492,841 +Property and equipment, net +108,398 57,467 +Intangible assets, net +28,802 37,636 +Goodwill +1,600 1,719 +Deferred tax assets, net +567,201 350,784 +Restricted cash +3,663 1,929 +Right-of-use assets +160,768 167,421 +Other assets +8,067 8,926 +Total assets +$ 1,545,068 $ 1,118,723 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ 162,145 $ 112,778 +Accrued expenses and other liabilities +166,887 126,704 +Income taxes payable +16,279 5,038 +Current operating lease liabilities +42,932 47,064 +Total current liabilities +388,243 291,584 +Long-term income taxes payable +219,744 205,974 +Long-term borrowings +771,390 180,000 +Long-term operating lease liabilities +149,237 146,401 +Other liabilities +2,372 4,131 +Total liabilities +1,530,986 828,090 +Commitments and contingencies +Stockholders’ equity: +Common stock, par value $ 0.001 per share, 105.9 million and 105.0 million issued, 58.3 million and 65.9 million shares outstanding, respectively +106 105 +Treasury stock, at cost, 47.6 million and 39.1 million shares, respectively +( 1,684,262 ) ( 688,849 ) +Additional paid-in capital +496,036 482,385 +Retained earnings +1,279,040 553,346 +Accumulated other comprehensive loss +( 76,838 ) ( 56,354 ) +Total stockholders’ equity +14,082 290,633 +Total liabilities and stockholders’ equity +$ 1,545,068 $ 1,118,723 +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock Treasury Stock Additional +Paid-in +Capital Retained +Earnings +Accumulated +Other +Comprehensive +(Loss) +Total +Stock-holders' +Equity +Shares Amount Shares Amount +Balance at December 31, 2018 +73,306 $ 103 29,656 $ ( 397,491 ) $ 481,133 $ 121,215 $ ( 54,652 ) $ 150,308 +Adjustments to beginning retained earnings (1) +— — — — — ( 227 ) — ( 227 ) +Share-based compensation — — — — 14,412 — — 14,412 +Exercises of stock options and issuance of restricted stock awards +1,008 1 58 ( 1,527 ) 358 — — ( 1,168 ) +Repurchases of common stock ( 6,082 ) 6,082 ( 147,190 ) — — — ( 147,190 ) +Net income +— — — — — 119,497 — 119,497 +Other comprehensive loss +— — — — — — ( 3,727 ) ( 3,727 ) +Balance at December 31, 2019 +68,232 $ 104 35,796 $ ( 546,208 ) $ 495,903 $ 240,485 $ ( 58,379 ) $ 131,905 +Share-based compensation — — — — 16,361 — — 16,361 +Exercises of stock options and issuance of restricted stock awards +836 1 124 ( 3,059 ) 1,371 — — ( 1,687 ) +Repurchases of common stock ( 3,212 ) 3,212 ( 139,582 ) ( 31,250 ) — — ( 170,832 ) +Net income +— — — — — 312,861 — 312,861 +Other comprehensive income +— — — — — — 2,025 2,025 +Balance at December 31, 2020 +65,856 $ 105 39,132 $ ( 688,849 ) $ 482,385 $ 553,346 $ ( 56,354 ) $ 290,633 +Share-based compensation — — — — 38,122 — — 38,122 +Exercises of stock options and issuance of restricted stock awards +716 1 209 ( 20,119 ) 235 — — ( 19,883 ) +Repurchases of common stock ( 8,242 ) — 8,242 ( 975,294 ) ( 24,706 ) — — ( 1,000,000 ) +Net income +— — — — — 725,694 — 725,694 +Other comprehensive loss +— — — — — — ( 20,484 ) ( 20,484 ) +Balance at December 31, 2021 +58,330 $ 106 47,583 $ ( 1,684,262 ) $ 496,036 $ 1,279,040 $ ( 76,838 ) $ 14,082 +(1) The decrease to beginning retained earnings is as a result of the prior year adoption of new lease accounting standards as of January 1, 2019. +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2021 2020 2019 +Cash flows from operating activities: +Net income +$ 725,694 $ 312,861 $ 119,497 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +31,976 27,619 24,213 +Operating lease cost +58,283 61,583 60,142 +Inventory donations 1,264 8,994 109 +Provision (recovery) for doubtful accounts, net +( 2,629 ) 5,779 1,566 +Share-based compensation +38,122 16,361 14,412 +Asset impairments +— 21,071 — +Deferred taxes +( 241,283 ) ( 325,061 ) ( 16,259 ) +Other non-cash items +264 5,307 ( 2,425 ) +Changes in operating assets and liabilities: +Accounts receivable, net of allowances +( 35,063 ) ( 47,045 ) ( 15,015 ) +Inventories +( 43,063 ) ( 13,462 ) ( 48,156 ) +Prepaid expenses and other assets +( 6,212 ) 5,007 ( 4,012 ) +Accounts payable +34,868 23,229 6,032 +Accrued expenses and other liabilities +38,448 22,358 13,265 +Right-of-use assets and operating lease liabilities +( 52,752 ) ( 61,178 ) ( 64,313 ) +Income taxes +19,248 203,479 902 +Cash provided by operating activities +567,165 266,902 89,958 +Cash flows from investing activities: +Purchases of property, equipment, and software +( 55,916 ) ( 42,033 ) ( 36,576 ) +Proceeds from disposal of property and equipment +6 463 616 +Other +( 15 ) ( 192 ) ( 276 ) +Cash used in investing activities +( 55,925 ) ( 41,762 ) ( 36,236 ) +Cash flows from financing activities: +Proceeds from notes issuance 700,000 — — +Proceeds from bank borrowings +390,000 210,000 315,000 +Repayments of bank borrowings +( 485,000 ) ( 235,000 ) ( 230,000 ) +Deferred debt issuance costs +( 14,755 ) ( 518 ) ( 1,796 ) +Dividends — Series A convertible preferred stock (1) +— — ( 2,985 ) +Repurchases of common stock +( 1,000,000 ) ( 170,832 ) ( 147,190 ) +Repurchases of common stock for tax withholding +( 20,119 ) ( 3,060 ) ( 1,527 ) +Other +236 1,372 ( 140 ) +Cash used in financing activities +( 429,638 ) ( 198,038 ) ( 68,638 ) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +( 3,950 ) 126 ( 569 ) +Net change in cash, cash equivalents, and restricted cash +77,652 27,228 ( 15,485 ) +Cash, cash equivalents, and restricted cash — beginning of year 139,273 112,045 127,530 +Cash, cash equivalents, and restricted cash — end of year $ 216,925 $ 139,273 $ 112,045 +Cash paid for interest $ 10,210 $ 6,658 $ 7,519 +Cash paid for income taxes 159,680 20,816 16,050 +Accrued purchases of property, equipment, and software 15,831 4,222 15,206 +(1) Represents $ 3.0 million paid to induce conversion of Series A Convertible Preferred Stock to common stock during the year ended December 31, 2019. +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of the “Company,” “Crocs,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. We are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the global leader in the sale of molded footwear characterized by functionality, comfort, color, and lightweight design. Our reportable operating segments include: the Americas, operating in North and South America; Asia Pacific, operating throughout Asia, Australia, and New Zealand; and Europe, Middle East, and Africa (“EMEA”), operating throughout Europe, Russia, the Middle East, and Africa. +Basis of Presentation and Consolidation +Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries, and they reflect all adjustments which are necessary for a fair statement of results of operations, financial position, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, valuation allowances, uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, and depreciation and amortization, are reasonable based on information available at the time they are made. +Additionally, we are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. If it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 17 — Legal Proceedings for additional information regarding our contingencies and legal proceedings. +The full impact of COVID-19 is unknown and cannot be reasonably estimated as of the reporting date. However, we have made appropriate accounting estimates based on the facts and circumstances available as of the reporting date. +To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassifications +We have reclassified certain amounts in Note 13 — Income Taxes and on the consolidated statements of cash flows to conform to current period presentation. +Transactions with Affiliates +In 2019, we received services from three affiliates of Blackstone Capital Partners VI L.P. (“Blackstone”). Blackstone and certain of its permitted transferees beneficially owned 6,899,027 shares of our common stock until Blackstone sold 6,864,545 shares of common stock held directly by Blackstone and its affiliates on November 4, 2019 in an underwritten public offering. The other 34,482 shares of common stock were held by Gregg S. Ribatt, our former Chief Executive Officer and former +F- 9 +Table of Contents +member of our Board of Directors, which Blackstone may have been deemed to beneficially own, and were sold by Mr. Ribatt in October 2019. We incurred expenses to Blackstone’s legal counsel of $ 0.3 million in relation to this transaction. +Certain Blackstone affiliates provide various services to us, including inventory count services, cybersecurity and consulting, and workforce management services. We incurred expenses for services from these affiliates of $ 2.2 million during the period of Blackstone’s beneficial ownership in 2019. Expenses related to these services are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. We report receivables from credit card companies, if expected to be received within five days, in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. We reduce the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting our customer base, and historical collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial obligations. We write off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Schedule II in Item 15. Exhibits, Financial Statement Schedule of this Annual Report on Form 10-K for more information. +Inventories +Inventories are comprised of finished goods, are stated at the lower of cost or net realizable value, and recognized using the first-in-first-out method of inventory costing. We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end-of-life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value, and the difference is recorded in ‘Cost of sales’ in our consolidated statements of operations. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and they are recorded within ‘Cost of sales’ in our consolidated statements of operations. +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives. The useful lives are reviewed periodically and range from 2 to 10 years for machinery and equipment and furniture, fixtures and others. Leasehold improvements are stated at cost and amortized on a straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of warehouse- and distribution-related assets is included in ‘Cost of sales’ in our consolidated statements of operations. Depreciation related to retail store, corporate, non-product, and non-manufacturing assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets, and the resulting gain or loss, if any, is reflected in ‘Income from operations’ in the consolidated statements of operations. +F- 10 +Table of Contents +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. Our annual test is performed as of the last day of our fiscal fourth quarter. We continuously monitor the performance of our definite-lived intangible assets and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +Direct costs of acquiring or developing internal-use computer software, including costs of employees, are capitalized and classified within intangible assets. Software maintenance and training costs are expensed in the period incurred. Initial costs associated with internally-developed-and-used software are expensed until it is determined that the project has reached the application development stage, after which subsequent additions, modifications, or upgrades are capitalized to the extent that they add functionality. Our capitalized software consists primarily of enterprise resource system software, warehouse management software, and point of sale software. Amortization for software is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 2 to 8 years. Amortization of capitalized software used in warehouse- and distribution-related activities is included in ‘Cost of sales’ in the consolidated statements of operations. Amortization related to corporate, non-product, and non-manufacturing assets, such as our global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of operations. +Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and range from 7 to 25 years. +Leases +Our lease portfolio consists primarily of real estate assets, which includes retail, warehouse, distribution center, and office spaces, under operating leases expiring at various dates through 2033. Leases with an original term of twelve months or less are not reported in the consolidated balance sheets; expense for these short-term leases is recognized on a straight-line basis over the lease term. +Many leases include one or more options to renew, with renewal terms that, if exercised by us, may extend the lease term. The exercise of these renewal options is at our discretion. When assessing the likelihood of a renewal or termination, we consider the significance of leasehold improvements, availability of alternative locations, and the cost of relocation or replacement, among other considerations. The depreciable lives of leasehold improvements are the shorter of the useful lives of the improvements or the expected lease term. We determine the lease term for each lease based on the terms of each contract and factor in renewal and early termination options if such options are reasonably certain to be exercised. +Due to our centralized treasury function, we utilize a portfolio approach to discount our lease obligations. We assess the expected lease term at lease inception and discount the lease using a fully-secured annual incremental borrowing rate, adjusted for time value corresponding with the expected lease term. +Certain of our retail store leases include rental payments based upon a percentage of retail sales in excess of a minimum fixed rental. In some cases, there is no fixed minimum rental and the entire rental payment is based upon a percentage of sales. In addition, certain leases include rental payments adjusted periodically for changes in price level indices. We recognize expense for these types of payments as incurred and report them as variable lease expense. See Note 6 — Leases for additional information. +Derivative Foreign Currency Contracts +We enter into forward foreign currency exchange contracts to mitigate the potential impact of foreign currency exchange rate risk. By policy, we do not enter into these contracts for trading purposes or speculation. The fair value of these contracts is reported either as an asset or liability in our consolidated balance sheets. Changes in the fair value of these contracts are recorded in ‘Foreign currency losses, net’ in our consolidated statements of operations. We did not designate any derivative instruments for hedge accounting during any of the periods presented. See Note 8 — Derivative Financial Instruments for further information. +F- 11 +Table of Contents +Other Comprehensive Income +Our foreign subsidiaries use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into U.S. Dollars using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss), until the substantial disposition of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. +Revenue Recognition +See Note 11 — Revenues for a summary of our revenue recognition policy. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, procure, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, depreciation, packaging, and other warehouse and distribution overhead and costs. +Selling, General and Administrative Expenses +Selling, general and administrative expenses consist primarily of labor and outside services, rent expense, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to corporate and non-product assets and share-based compensation. Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources, and information technology. +Our selling, general and administrative expenses also include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of our promotional expenses result from payments under endorsement contracts. Endorsement-related expenses are recognized as performance is received over the term of each endorsement agreement. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, including variable marketing expenses, were $ 172.7 million, $ 101.0 million, and $ 83.2 million for the years ended December 31, 2021, 2020, and 2019, respectively. Prepaid advertising and promotional endorsement expenses of $ 1.2 million and $ 2.0 million, were included in ‘Prepaid expenses and other assets’ in the consolidated balance sheets at December 31, 2021 and 2020, respectively. +Research, Design, and Development Expenses +We continue to dedicate resources to product design and development based on opportunities we identify in the marketplace. We incurred expenses of $ 13.7 million, $ 10.2 million, and $ 11.8 million in research, design, and development activities for the years ended December 31, 2021, 2020, and 2019, respectively, which are expensed as incurred and are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +F- 12 +Table of Contents +Share-Based Compensation +Stock Options +Stock options are granted with exercise prices equal to the fair market value of our common stock on the date of grant. We use the Black-Scholes option-pricing model to estimate the grant date fair value of stock options, which requires the use of assumptions, including the expected term of the option, expected volatility of our stock price, our expected dividend yield, and the risk-free interest rate, among others. These assumptions reflect our best estimates; however, they involve inherent uncertainties including market conditions and employee behavior that are generally outside of our control. We expense all share-based compensation awarded based on the grant date fair value of the awards using the straight-line method over the requisite service period, adjusted for forfeitures as they occur. +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +We grant RSAs, service-condition RSUs, performance-condition RSUs, and market-condition RSUs. The grant date fair values of RSAs, service-condition RSUs, and performance-condition RSUs are based on the closing market price of our common stock on the grant date; the grant date fair value and derived service period of market-condition RSUs are estimated using a Monte Carlo simulation valuation model. Our service-condition RSUs vest based on continued service; our performance-condition RSUs vest based on achievement of multiple weighted performance goals, certification of performance achievement by the Compensation Committee of the Board of Directors, and continued service; and our market-condition RSUs vest based on the market price of our stock and continued service. Compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service period. For performance-condition RSUs, compensation expense is updated for our expected performance level against performance goals at the end of each reporting period, which involves judgment as to the achievement of certain performance metrics. +See Note 12 — Share-Based Compensation for additional information related to share-based compensation. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. We assess recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and record a loss from impairment if the carrying value is more than its undiscounted cash flows. For assets involved in Crocs’ retail business, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets, leasehold improvements, and right-of-use assets related to our retail locations for impairment. Assets or asset groups to be abandoned are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 3 — Property and Equipment, Net and Note 6 — Leases for a discussion of impairment losses recorded during the periods presented. +Foreign Currency Losses, Net +Foreign currency losses, net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of an entity and realized and unrealized gains and losses on forward foreign currency exchange derivative contracts. +Other Income, Net +Other income, net primarily includes gains and losses associated with activities not directly related to making and selling footwear. +F- 13 +Table of Contents +Income Taxes +Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statements of operations. See Note 13 — Income Taxes for further discussion. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the treasury stock method. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in our earnings and is calculated by adjusting weighted average outstanding shares, assuming conversion of all potentially dilutive stock options and awards. Anti-dilutive securities are excluded from diluted EPS. See Note 14 — Earnings per Share for additional information. +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). We utilize a combination of market and income approaches to value derivative instruments. Our financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level Inputs +1 Unadjusted quoted prices in active markets for identical assets and liabilities. +2 Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 Unobservable inputs for the asset or liability. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +Our non-financial assets, which primarily consist of property and equipment, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 7 — Fair Value Measurements for further discussion related to estimated fair value measurements. +2. RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Simplifying Accounting for Income Taxes +In December 2019, the FASB issued new guidance to simplify the accounting for income taxes by removing certain exceptions to the general principles and also simplification of areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements, and interim recognition of enactment of tax laws or rate changes. On January 1, 2021, we adopted the guidance. The adoption did not have a material effect on our consolidated financial statements. +F- 14 +Table of Contents +New Accounting Pronouncements Not Yet Adopted +Reference Rate Reform +In March 2020, the FASB issued optional guidance related to reference rate reform, which provides practical expedients for contract modifications and certain hedging relationships associated with the transition from reference rates that are expected to be discontinued. This guidance is applicable for our revolving borrowing instruments, which use LIBOR as a reference rate, and is available for adoption effective immediately, but is only available through December 31, 2022. We are currently evaluating the potential impact of this standard on our consolidated financial statements. +Business Combinations +In October 2021, the FASB issued new guidance primarily related to the accounting for contract assets and contract liabilities from contracts with customers in a business combination. The standard will be effective for annual reporting periods beginning after December 31, 2022, including interim reporting periods within those periods, with early adoption permitted. We are currently evaluating the impact of adopting this new accounting guidance on our consolidated financial statements. +Other Pronouncements +Other new pronouncements issued but not effective until after December 31, 2021 are not expected to have a material impact on our consolidated financial statements. +3. PROPERTY AND EQUIPMENT, NET +‘Property and equipment, net’ consists of the following: +December 31, +2021 2020 +(in thousands) +Leasehold improvements $ 64,625 $ 66,661 +Machinery and equipment 53,976 47,107 +Furniture, fixtures, and other 20,210 21,817 +Construction-in-progress 53,332 8,187 +Property and equipment 192,143 143,772 +Less: Accumulated depreciation and amortization ( 83,745 ) ( 86,305 ) +Property and equipment, net $ 108,398 $ 57,467 +Asset Retirement Obligations +We are contractually obligated, under certain of our lease agreements, to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. Asset retirement obligations were not material to the consolidated balance sheets in the years ended December 31, 2021 or 2020. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Cost of sales $ 6,234 $ 3,921 $ 1,711 +Selling, general and administrative expenses 8,708 7,914 7,174 +Total depreciation and amortization expense $ 14,942 $ 11,835 $ 8,885 +F- 15 +Table of Contents +Disposals of Property and Equipment and Intangible Assets +We recognized net gains on disposals of property and equipment and intangible assets of $ 0.3 million and $ 0.2 million, respectively, for the years ended December 31, 2021 and 2019, and a net loss on disposals of property and equipment and intangible assets of $ 0.3 million for the year ended December 31, 2020, which are included in ‘Selling, general and administrative expenses’ in the consolidated statement of operations. +Additionally, we impaired our leasehold improvement assets for a retail location in the year ended December 31, 2020, as described in Note 7 — Fair Value Measurements. +4. GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +In the years ended December 31, 2021 and 2020, there were no changes to our goodwill, which is in our EMEA segment, aside from immaterial changes related to foreign currency translation. At December 31, 2021, accumulated goodwill impairment was $ 0.8 million. +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2021 December 31, 2020 +Gross Accum. Amortiz. Net Gross Accum. Amortiz. Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software $ 128,843 $ ( 104,637 ) $ 24,206 $ 124,544 $ ( 92,075 ) $ 32,469 +Patents, copyrights, and trademarks 4,308 ( 3,530 ) 778 3,774 ( 3,351 ) 423 +Intangible assets not subject to amortization: +In progress 3,739 — 3,739 4,660 — 4,660 +Trademarks and other 79 — 79 84 — 84 +Total $ 136,969 $ ( 108,167 ) $ 28,802 $ 133,062 $ ( 95,426 ) $ 37,636 +At December 31, 2021, the weighted average remaining useful life of intangibles subject to amortization was approximately 5.9 years. +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Cost of sales $ 4,779 $ 3,975 $ 3,398 +Selling, general and administrative expenses 12,255 11,809 11,930 +Total amortization expense $ 17,034 $ 15,784 $ 15,328 +F- 16 +Table of Contents +Estimated future annual amortization expense of intangible assets is: +As of +December 31, 2021 +(in thousands) +2022 $ 6,999 +2023 6,280 +2024 5,107 +2025 3,805 +2026 2,132 +Thereafter 661 +Total $ 24,984 +5. ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2021 2020 +(in thousands) +Accrued compensation and benefits $ 62,945 $ 48,870 +Professional services 33,997 18,478 +Fulfillment, freight, and duties 15,629 17,868 +Sales/use and value added taxes payable 13,049 12,480 +Return liabilities 10,342 6,906 +Accrued rent and occupancy 7,431 3,818 +Royalties payable and deferred revenue 7,425 6,254 +Other 16,069 12,030 +Total accrued expenses and other liabilities $ 166,887 $ 126,704 +6. LEASES +As a result of the COVID-19 pandemic, we received lease concessions from landlords in the form of rent abatements and rent deferrals in the years ended December 31, 2021 and 2020. We chose to implement the policy election provided by the FASB in April 2020 to record rent concessions as if no modification to lease contracts were made, and thus no changes to the lease obligations were recorded in respect to these concessions. In the year ended December 31, 2021, we received $ 1.4 million of rent abatements, and we had an immaterial amount of outstanding deferred rent as of December 31, 2021. In the year ended December 31, 2020, we received rent abatements of $ 1.5 million, and we had outstanding deferred rent of $ 0.4 million as of December 31, 2020. +Right-of-Use Assets and Operating Lease Liabilities +Amounts reported in the consolidated balance sheets were: +December 31, +2021 2020 +(in thousands) +Assets: +Right-of-use assets $ 160,768 $ 167,421 +Liabilities: +Current operating lease liabilities $ 42,932 $ 47,064 +Long-term operating lease liabilities 149,237 146,401 +Total operating lease liabilities $ 192,169 $ 193,465 +F- 17 +Table of Contents +Lease Costs and Other Information +Lease-related costs reported within ‘Cost of sales’ and ‘Selling, general and administrative expenses’ were: +Year Ended December 31, +2021 2020 +(in thousands) +Operating lease cost $ 58,283 $ 61,583 +Short-term lease cost 7,585 4,898 +Variable lease cost 32,490 15,691 +Total lease costs $ 98,358 $ 82,172 +Other information related to leases, including supplemental cash flow information, consists of: +Year Ended December 31, +2021 2020 +(in thousands) +Cash paid for operating leases $ 61,412 $ 59,579 +Right-of-use assets obtained in exchange for operating lease liabilities 55,035 55,369 +The weighted average remaining lease term and discount rate related to our lease liabilities as of December 31, 2021 were 7.1 years and 3.8 %, respectively. As of December 31, 2020, the weighted average remaining lease term and discount rate related to our lease liabilities were 6.7 years and 4.4 %, respectively. +We also impaired our right-of-use assets for a retail location and our former corporate headquarters in the year ended December 31, 2020, as described in Note 7 — Fair Value Measurements. +Maturities +The maturities of our operating lease liabilities were: +As of +December 31, 2021 +(in thousands) +2022 $ 44,898 +2023 38,819 +2024 25,802 +2025 18,934 +2026 16,605 +Thereafter 75,421 +Total future minimum lease payments 220,479 +Less: imputed interest ( 28,310 ) +Total operating lease liabilities $ 192,169 +Leases That Have Not Yet Commenced +As of December 31, 2021, we had significant obligations for a lease not yet commenced related to the expansion of our Americas distribution center in Dayton, Ohio. The total contractual commitment related to the lease, with payments expected to begin in the first quarter of 2022 and continue through September 2032, is approximately $ 39 million. Additionally, as of December 31, 2021, we had significant obligations for a lease not yet commenced related to the upcoming move of our corporate headquarters within Broomfield, Colorado. The total contractual commitment related to this lease, with regular payments expected to begin in November 2023 and continue through September 2033, is approximately $ 44 million. +F- 18 +Table of Contents +7. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of our derivative instruments. Our derivative instruments are forward foreign currency exchange contracts. We manage credit risk of our derivative instruments on the basis of our net exposure with our counterparty. All of our derivative instruments are classified as Level 2 of the fair value hierarchy and are reported in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2021 and 2020. The fair values of our derivative instruments were a liability of $ 0.2 million and a liability of $ 0.4 million at December 31, 2021 and 2020, respectively. See Note 8 — Derivative Financial Instruments for more information. +The carrying amounts of our cash, cash equivalents, and restricted cash, accounts receivable, accounts payable, and current accrued expenses and other liabilities approximate their fair value as recorded due to the short-term maturity of these instruments. +Our borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. During the year ended December 31, 2021, we completed the issuance and sale of $ 350.0 million aggregate principal amount of 2029 Notes (as defined below) and $ 350.0 million aggregate principal amount of 2031 Notes (as defined below), as described in more detail in Note 9 — Long-Term Borrowings. The Notes (as defined below) are classified as Level 1 of the fair value hierarchy and are reported in our consolidated balance sheet at face value, less unamortized issuance costs. The carrying and fair values of our revolving credit facilities approximate their carrying values at December 31, 2021 and 2020 based on interest rates currently available to us for similar borrowings. The carrying values and fair values of our borrowing instruments as of December 31, 2021 and 2020 were: +December 31, 2021 December 31, 2020 +Carrying Value Fair +Value Carrying Value Fair +Value +(in thousands) +2029 Notes $ 350,000 $ 346,281 $ — $ — +2031 Notes 350,000 341,250 — — +Revolving credit facilities 85,000 85,000 180,000 180,000 +Inventory donations were immaterial during the years ended December 31, 2021 or 2019. During the year ended December 31, 2020, we recorded inventory donations of $ 9.9 million at fair value within ‘Selling, general and administrative expenses’ in our consolidated statements of operations. +Non-Financial Assets and Liabilities +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. We recorded impairments as follows: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Retail store assets impairment (1) +$ — $ 2,412 $ — +Right-of-use assets impairment (1) +— 18,659 — +Total asset impairments $ — $ 21,071 $ — +(1) During the year ended December 31, 2020 , we recognized impairments for a retail location in New York City of $ 2.4 million to retail store assets and $ 17.6 million to the right-of-use asset. We also recognized an impairment of $ 1.1 million to the right-of-use asset for our corporate headquarters in Niwot, Colorado, as a result of our relocation to Broomfield, Colorado. +F- 19 +Table of Contents +8. DERIVATIVE FINANCIAL INSTRUMENTS +We transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar amounts of revenues, expenses, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we may enter into forward contracts to buy and sell foreign currency. By policy, we do not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts we enter into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to and did not post collateral as of December 31, 2021 or 2020. +Our derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets. We report derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. Changes in fair value are recognized within ‘Foreign currency losses, net’ in the consolidated statements of operations. For the consolidated statements of cash flows, we classify cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities. ’ +Results of Derivative Activities +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, are reported within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ in the consolidated balance sheets and were: +December 31, 2021 December 31, 2020 +Derivative Assets Derivative Liabilities Derivative Assets Derivative Liabilities +(in thousands) +Forward foreign currency exchange contracts $ 724 $ ( 938 ) $ 794 $ ( 1,225 ) +Netting of counterparty contracts ( 724 ) 724 ( 794 ) 794 +Foreign currency forward contract derivatives $ — $ ( 214 ) $ — $ ( 431 ) +The notional amounts of outstanding forward foreign currency exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2021 December 31, 2020 +Notional Fair Value Notional Fair Value +(in thousands) +Singapore Dollar $ 43,723 $ ( 296 ) $ 24,211 $ 457 +British Pound Sterling 25,795 104 16,134 ( 182 ) +Euro 21,198 162 28,851 ( 82 ) +South Korean Won 14,201 ( 112 ) 3,741 ( 56 ) +Japanese Yen 12,910 80 17,447 ( 240 ) +Indian Rupee 10,379 ( 86 ) 18,937 ( 134 ) +Other currencies 19,481 ( 66 ) 9,675 ( 194 ) +Total $ 147,687 $ ( 214 ) $ 118,996 $ ( 431 ) +Latest maturity date January 2022 January 2021 +Amounts reported in ‘Foreign currency losses, net’ in the consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +F- 20 +Table of Contents +Year Ended December 31, +2021 2020 2019 +(in thousands) +Foreign currency transaction gains (losses) +$ 100 $ 941 $ ( 356 ) +Foreign currency forward exchange contracts losses +( 240 ) ( 2,069 ) ( 967 ) +Foreign currency losses, net +$ ( 140 ) $ ( 1,128 ) $ ( 1,323 ) +9. LONG-TERM BORROWINGS +Our borrowings were as follows: +Stated Interest Rate Effective Interest Rate December 31, +Maturity 2021 2020 +(in thousands) +Notes issuance of $ 350.0 million +2029 4.250 % 4.64 % $ 350,000 $ — +Notes issuance of $ 350.0 million +2031 4.125 % 4.35 % 350,000 — +Revolving credit facilities 85,000 180,000 +Total face value of long-term borrowings 785,000 180,000 +Less: +Unamortized issuance costs 13,610 — +Current portion of borrowings — — +Total long-term borrowings $ 771,390 $ 180,000 +Senior Revolving Credit Facility +In July 2019, Crocs, Inc. and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Revolving Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders, which provides for a revolving credit facility of $ 500.0 million, which can be increased by an additional $ 100.0 million subject to certain conditions (the “Revolving Facility”). Borrowings under the Revolving Credit Agreement bear interest at a variable rate based on (A) a domestic base rate (defined as the highest of (i) the Federal Funds open rate, plus 0.25 %, (ii) the Prime Rate, and (iii) the Daily LIBOR rate, plus 1.00 %), plus an applicable margin ranging from 0.25 % to 0.875 % based on our leverage ratio, or (B) a LIBOR rate, plus an applicable margin ranging from 1.25 % to 1.875 % based on our leverage ratio. Borrowings under the Revolving Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Revolving Credit Agreement required us to maintain a minimum interest coverage ratio of 4.00 to 1.00 and a maximum leverage ratio of 3.50 to 1.00 from the quarter ended December 31, 2020 to the quarter ended December 31, 2021. Additionally, the Revolving Credit Agreement requires us to maintain a minimum interest coverage ratio of 4.00 to 1.00 and a maximum leverage ratio of 3.25 to 1.00 from the quarter ending March 31, 2022 and thereafter (subject to adjustment in certain circumstances). The Revolving Credit Agreement permits (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Revolving Credit Agreement of at least $ 40.0 million. As of December 31, 2021, we were in compliance with all financial covenants under the Revolving Credit Agreement. +As of December 31, 2021, the total commitments available from the lenders under the Revolving Facility were $ 500.0 million. At December 31, 2021, we had $ 85.0 million in outstanding borrowings, which are due when the Revolving Facility matures in July 2024, and $ 0.3 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2021 and 2020, we had $ 414.7 million and $ 319.4 million, respectively, of available borrowing capacity under the Revolving Facility. +F- 21 +Table of Contents +Asia Revolving Credit Facilities +Our revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”), matured in May 2021 and provided up to 30.0 million RMB, or $ 4.7 million using current exchange rates as of May 2021. We renewed the CMBC Facility, effective January 2022. The CMBC Facility now provides a revolving credit facility of up to 10.0 million RMB, or $ 1.6 million at current exchange rates, and matures in January 2023. For RMB loans under the CMBC Facility, interest is determined at the time of borrowing based on variable rates in effect at that time. +The revolving credit facility with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”) provides up to an equivalent of $ 10.0 million. For RMB loans under the Citibank Facility, interest is based on a National Interbank Funding Center 1-year prime rate, plus 65 basis points. For USD loans under the Citibank Facility, interest is based on a LIBOR rate, plus 1.5 %. +We had no borrowings under our Asia revolving facilities during the years ended December 31, 2021 and 2020 or outstanding at December 31, 2021 or 2020. +Senior Notes Issuances +On March 12, 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.250 % Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (“the March Indenture”). Additionally, on August 10, 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.125 % Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (“the August Indenture” and, together with the March Indenture, the “Indentures”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +The Company will have the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company may redeem up to 40 % of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company may redeem up to 40 % of the aggregate principal amount of the 2031 Notes at a redemption price of 104.125 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Revolving Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Revolving Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $ 25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; declare and pay dividends or repurchase or redeem capital stock or make other restricted payments; declare and pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2021, we were in compliance with all financial covenants under the Indentures. +F- 22 +Table of Contents +10. EQUITY +Common Stock +We have one class of common stock with a par value of $ 0.001 per share. There are 250.0 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +Common Stock Repurchase Program +On February 20, 2018, the Board of Directors approved and authorized a program to repurchase up to $ 500.0 million of our common stock. On May 5, 2019, the Board approved an increase to the repurchase authorization of an additional $ 500.0 million of our common stock. On April 23, 2021, the Board approved a $ 712.2 million increase to our share repurchase authorization. Additionally, on September 23, 2021, the Board approved an increase of $ 1,000.0 million to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +We repurchased 8.2 million shares of our common stock at a cost of $ 1,000.0 million, including commissions, during the year ended December 31, 2021. This includes 3.2 million shares delivered under the $ 500.0 million accelerated share repurchase arrangement (“ASR”) entered into in September 2021, 2.9 million shares delivered under the $ 300.0 million ASR entered into in April 2021, and 0.5 million shares delivered in January 2021 at the conclusion of the purchase period for the ASR entered into in November 2020. Under each ASR, a financial institution delivered shares of our common stock during the purchase period in exchange for an up-front payment. The total number of shares ultimately delivered under the ASR, and therefore the average repurchase price paid per share, was determined based on the volume-weighted average price of our common stock during the purchase period. The shares received were recorded in the period they were delivered, and the up-front payment was accounted for as a reduction to stockholders’ equity in our consolidated balance sheet in the period the payment was made. As of December 31, 2021, we had remaining authorization to repurchase approximately $ 1,050.0 million of our common stock, subject to restrictions under the agreements governing our indebtedness. +During the year ended December 31, 2020, we repurchased 3.2 million shares of our common stock at a cost of $ 170.8 million, including commissions. This included 1.5 million shares delivered under a $ 125.0 million November 2020 ASR. During the year ended December 31, 2019, we repurchased 6.1 million shares of our common stock at a cost of $ 147.2 million, including commissions. +Preferred Stock +We have authorized and available for issuance 5.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized as Series A Convertible Preferred Stock with a par value of $ 0.001 per share and none were issued and outstanding as of December 31, 2021. +11. REVENUES +Revenues by reportable operating segment and by channel were: +Year Ended December 31, 2021 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 727,264 $ 184,335 $ 262,395 $ 87 $ 1,174,081 +Direct-to-consumer (1) +879,748 165,825 93,762 — 1,139,335 +Total revenues $ 1,607,012 $ 350,160 $ 356,157 $ 87 $ 2,313,416 +F- 23 +Table of Contents +Year Ended December 31, 2020 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 390,930 $ 133,416 $ 168,410 $ 163 $ 692,919 +Direct-to-consumer (1) +472,683 145,099 75,250 — 693,032 +Total revenues $ 863,613 $ 278,515 $ 243,660 $ 163 $ 1,385,951 +Year Ended December 31, 2019 +Americas Asia Pacific EMEA Other Businesses Total +(in thousands) +Channel: +Wholesale $ 275,284 $ 207,405 $ 173,480 $ 58 $ 656,227 +Direct-to-consumer (1) +365,231 140,667 68,468 — 574,366 +Total revenues $ 640,515 $ 348,072 $ 241,948 $ 58 $ 1,230,593 +(1) Direct-to-consumer revenues consist of sales generated through our company-operated retail stores (previously our “Retail” channel) and company-operated e-commerce websites and third-party e-commerce marketplaces (previously our “E-commerce” channel). +Revenues are recognized in the amount expected to be received in exchange for when control of the products transfers to customers and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. During the year ended December 31, 2021, we recognized no changes to estimates for wholesale or direct-to-consumer revenues. During the year ended December 31, 2020, we recognized a net increase of $ 0.6 million to wholesale revenues and an increase of $ 1.1 million to direct-to-consumer revenues due to changes in estimates related to products transferred to customers in prior periods. During the year ended December 31, 2019, we recognized a net increase of $ 0.4 million to wholesale revenues and a decrease of $ 0.1 million to direct-to-consumer revenues due to changes in estimates related to products transferred to customers in prior periods. +We have also elected to expense incremental costs to obtain customer contracts, consisting primarily of commission incentives, when incurred because the related amortization period is short-term. These costs are reported within ‘Selling, general and administrative expenses’ in our consolidated statement of operations. +The following is a description of our principal revenue-generating activities by distribution channel. We have three reportable operating segments and sell our products using two primary distribution channels. For more detailed information about reportable operating segments, see Note 16 — Operating Segments and Geographic Information. +Wholesale Channel +For the majority of wholesale customers, control transfers and revenues are recognized when the product is shipped or delivered from a manufacturing facility or distribution center to the wholesale customer. In certain cases, control of the product transfers and revenues are recognized when the customer receives the product at the designated delivery point. For certain customers, primarily in the Asia Pacific region, cash payment is required in advance of delivery and revenues are recognized upon the transfer of control to the customer. For a small number of customers in the Asia Pacific region, products are sold on consignment and revenues are recognized on a sell-through basis. +We have arrangements that grant certain wholesale customers exclusive licenses, concurrent with the terms of the related distribution agreements, to use our intellectual property in exchange for a sales-based royalty. Sales-based royalty revenues are recognized over the terms of the related license agreements as sales are made by the wholesalers. +Direct-to-Consumer Channel +Direct-to-consumer revenues consist of sales generated through our company-operated retail stores (previously our “Retail” channel) and company-operated e-commerce websites and third-party e-commerce marketplaces (previously our “E-commerce” +F- 24 +Table of Contents +channel). We transfer control of products and recognize revenues at company-operated retail stores at the point of sale, in exchange for cash or other payment. For sales made through company-operated e-commerce websites and third-party e-commerce marketplaces, we transfer control and recognize revenues when the product is shipped from the distribution centers, the point at which payment, primarily through debit and credit card and other e-payment methods, is made. A portion of the transaction price charged to our customers is variable, primarily due to promotional discounts or allowances. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +Contract Liabilities +Contract liabilities consist of advance cash deposits received from wholesale customers to secure product orders in connection with selling seasons and payments received in advance of delivery. As products are shipped and control transfers, we recognize the deferred revenue in ‘Revenues’ in the consolidated statements of operations. At December 31, 2021 and 2020, $ 0.1 million and $ 0.7 million, respectively, of deferred revenues associated with advance customer deposits were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +Refund Liabilities +Refund liabilities, primarily associated with product sales returns, retrospective volume rebates, and early payment discounts are estimated based on an analysis of historical experience, and adjustments to revenues made when the most likely amount of consideration expected changes. At December 31, 2021 and 2020, $ 10.3 million and $ 6.9 million, respectively, of refund liabilities, primarily associated with product returns, were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +12. SHARE-BASED COMPENSATION +Our share-based compensation awards are issued under the 2020 Equity Incentive Plan (“2020 Plan”) and predecessor plan, the 2015 Equity Incentive Plan (“2015 Plan”). Any awards that expire or are forfeited under the 2015 Plan become available for issuance under the 2020 Plan. We account for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. As of December 31, 2021, 4.3 million shares of common stock remained available for future issuance under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +Share-Based Compensation Expense +Pre-tax share-based compensation expense reported in the consolidated statements of operations was: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Cost of sales $ 461 $ 210 $ 580 +Selling, general and administrative expenses 37,661 16,151 13,832 +Total share-based compensation expense $ 38,122 $ 16,361 $ 14,412 +F- 25 +Table of Contents +Stock Option Activity +Stock option activity during the year ended December 31, 2021 was: +Number of Options Weighted Average Exercise Price Weighted Average Contractual Life (Years) Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2020 +232 $ 8.29 5.84 $ 12,586 +Granted — — +Exercised ( 15 ) 15.73 +Forfeited or expired — — +Outstanding as of December 31, 2021 +217 $ 7.78 5.14 $ 26,076 +Exercisable at December 31, 2021 +217 $ 7.78 5.14 $ 26,076 +Vested at December 31, 2021 +217 $ 7.78 5.14 $ 26,076 +No stock options were granted during 2021, 2020, or 2019. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2021, 2020, and 2019 was $ 0.8 million, $ 0.8 million, and $ 0.4 million, respectively. During the years ended December 31, 2021, 2020, and 2019, we received $ 0.2 million, $ 1.4 million, and $ 0.4 million cash, respectively, in connection with the exercise of stock options. As of December 31, 2021, we did no t have any unrecognized share-based compensation expense related to unvested options. +Stock options under our equity incentive plans generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years , and expire ten years after the date of grant. +Restricted Stock Awards and Restricted Stock Units Activity +From time to time, we grant RSAs and RSUs. RSAs and RSUs generally vest over three years , depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive shares of common stock upon vesting. RSUs have dividend equivalent rights, which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. We grant service-condition RSUs, performance-condition RSUs, and market-condition RSUs. +Service-condition RSUs are typically granted on an annual basis and vest over time in three equal annual installments, beginning one year after the grant date. During the years ended December 31, 2021, 2020, and 2019, we granted 0.2 million, 0.6 million, and 0.3 million service-condition RSUs, respectively. +Performance-condition RSUs are typically granted on an annual basis and consist of a performance-based and service-based component. The performance targets and vesting conditions for performance-condition RSUs are based on achievement of multiple weighted performance goals. The number of performance-condition RSUs ultimately awarded may be between 0 % and 200 %, based on performance. These RSUs vest in three equal annual installments beginning one year after the grant date, pending certification of performance achievement by the Compensation Committee of our Board of Directors and continued service. The fair value of performance-condition awards is based on the closing market price of our common stock on the grant date. Compensation expense, net of forfeitures, is updated for our probable expected performance level against performance goals at the end of each reporting period. +We also periodically grant market-condition RSUs to certain executives. The grant date fair value and derived service period for market-condition RSUs are estimated using a Monte Carlo simulation model. On January 11, 2021, our Board awarded 0.4 million market-condition RSUs to certain senior executives (“January market-condition RSUs”). For the executives to earn the target number of shares, the 30 trading day average of the daily volume weighted average trading price of the common stock must meet or exceed certain performance hurdles. Any earned shares will also be subject to time vesting. When a performance hurdle is met or exceeded, one third of the earned portion of the RSUs will vest immediately, and the remaining two thirds will be subject to the executive’s continued employment, with one third vesting one year later and the remaining one third vesting two years later, but in no case later than the fourth anniversary of the award, in each case, subject to certain change in control provisions. As of December 31, 2021, each of the performance hurdles of the January market-condition RSUs had been met or exceeded. +F- 26 +Table of Contents +During the years ended December 31, 2021, 2020, and 2019, we granted 0.6 million, 0.5 million, and 1.0 million performance- and market-condition RSUs, respectively. +RSA and RSU activity during the year ended December 31, 2021 was: +Restricted Stock Awards Restricted Stock Units +Shares Weighted Average Grant Date Fair Value Shares Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2020 +3 $ 37.79 1,830 $ 25.25 +Granted 5 88.68 774 76.28 +Vested ( 6 ) 63.24 ( 895 ) 27.79 +Forfeited — — ( 254 ) 31.67 +Unvested at December 31, 2021 +2 $ 105.18 1,455 $ 49.70 +The weighted average grant date fair value of RSAs granted during the years ended December 31, 2021, 2020, and 2019 was $ 88.68 , $ 38.10 , and $ 20.53 per share, respectively. RSAs vested during the years ended December 31, 2021, 2020, and 2019 consisted entirely of service-condition awards. The total grant date fair value of RSAs vested in the years ended December 31, 2021, 2020, and 2019 was $ 0.4 million, $ 0.2 million and $ 0.2 million, respectively. +As of December 31, 2021, unrecognized share-based compensation expense for RSAs was $ 0.1 million, which is expected to amortize over a remaining weighted average period of 0.4 years. +The weighted average grant date fair value of RSUs granted during the years ended December 31, 2021, 2020, and 2019 was $ 76.28 , $ 29.14 , and $ 25.37 per share, respectively. RSUs vested during the year ended December 31, 2021 consisted of 0.4 million service-condition awards and 0.5 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2020 consisted of 0.5 million service-condition awards and 0.4 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2019 consisted of 0.6 million service-condition awards and 0.4 million performance- and market-condition awards. The total grant date fair value of RSUs vested during the years ended December 31, 2021, 2020, and 2019 was $ 24.9 million, $ 11.9 million and $ 9.9 million, respectively. +As of December 31, 2021, unrecognized share-based compensation expenses for service-condition RSUs were $ 20.4 million and for performance- and market-condition RSUs were $ 18.5 million, and are expected to amortize over remaining weighted average periods of 1.5 years and 1.8 years, respectively. +13. INCOME TAXES +During the three months ended December 31, 2021, we completed an intra-entity transfer of certain intellectual property rights primarily to align with current and future international operations. This transaction was executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain, and, therefore, may ultimately differ materially from our actual results. +We have recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +F- 27 +Table of Contents +In order to support and sustain the amortizable tax basis (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the intellectual property owned and serviced in the Netherlands. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands subsidiary serves as the principal Crocs corporate headquarters outside of the U.S. and already performs significant functions in support of the economic ownership of the intellectual property in the Netherlands. In 2021, we undertook many additional activities to align business operations that support the economic substance of the intellectual property in the Netherlands. +The transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. We recorded a deferred tax asset of $ 40.3 million, net of a reserve for uncertain tax positions of $ 16.1 million. As such, a net deferred tax asset of $ 24.2 million was recognized along with a corresponding foreign deferred income tax benefit. +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Income before taxes: +U.S. $ 510,706 $ 133,574 $ 58,822 +Foreign 153,143 73,405 60,500 +Total income before taxes $ 663,849 $ 206,979 $ 119,322 +Income tax expense (benefit): +Current income taxes: +U.S. federal $ 94,548 $ 698 $ 1,284 +U.S. state 28,460 6,577 1,427 +Foreign 56,430 211,904 13,373 +Total current income taxes 179,438 219,179 16,084 +Deferred income taxes: +U.S. federal 791 529 ( 10,249 ) +U.S. state 32 ( 2,381 ) ( 3,579 ) +Foreign ( 242,106 ) ( 323,209 ) ( 2,431 ) +Total deferred income taxes ( 241,283 ) ( 325,061 ) ( 16,259 ) +Total income tax benefit +$ ( 61,845 ) $ ( 105,882 ) $ ( 175 ) +F- 28 +Table of Contents +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Income tax expense and rate attributable to: +Federal income tax rate $ 139,408 21.0 % $ 43,466 21.0 % $ 25,058 21.0 % +State income tax rate, net of federal benefit +22,952 3.5 % 7,231 3.5 % 5,983 5.0 % +Foreign income tax rate differential 18,890 2.8 % ( 6,060 ) ( 2.9 ) % 1,994 1.7 % +GILTI, net 14,157 2.1 % 7,515 3.6 % 7,585 6.4 % +Non-deductible / non-taxable items 9,637 1.5 % 6,871 3.3 % 6,727 5.7 % +Change in valuation allowance ( 192,337 ) ( 29.0 ) % 143,012 69.0 % ( 33,691 ) ( 28.2 ) % +Foreign tax credits ( 19,925 ) ( 3.0 ) % ( 15,904 ) ( 7.7 ) % ( 12,541 ) ( 10.4 ) % +Research and development credits ( 13,104 ) ( 2.0 ) % ( 148 ) ( 0.1 ) % ( 189 ) ( 0.2 ) % +Uncertain tax positions 21,341 3.2 % 200,571 96.9 % 278 0.2 % +Share-based compensation ( 11,930 ) ( 1.8 ) % ( 1,303 ) ( 0.6 ) % ( 2,715 ) ( 2.3 ) % +Intra-Entity IP Transfer ( 41,858 ) ( 6.3 ) % ( 492,470 ) ( 237.9 ) % — — % +Enacted changes in tax law ( 9,554 ) ( 1.4 ) % — — % 634 0.5 % +Other 478 0.1 % 1,337 0.7 % 702 0.5 % +Effective income tax expense and rate $ ( 61,845 ) ( 9.3 ) % $ ( 105,882 ) ( 51.2 ) % $ ( 175 ) ( 0.1 ) % +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2021 2020 +(in thousands) +Non-current deferred tax assets: +Share-based compensation expense $ 2,706 $ 1,934 +Accruals, reserves, and other expenses 24,346 16,905 +Net operating loss 24,573 26,842 +Intangible assets 502,100 493,701 +Foreign tax credit 39,442 38,948 +Operating lease liabilities 35,755 41,391 +Other 5,811 5,601 +Valuation allowance ( 26,467 ) ( 226,655 ) +Total non-current deferred tax assets $ 608,266 $ 398,667 +Non-current deferred tax liabilities: +Unrealized gain on foreign currency $ — $ ( 506 ) +Property and equipment ( 12,189 ) ( 13,583 ) +Right-of-use assets ( 28,598 ) ( 33,769 ) +Other ( 278 ) ( 25 ) +Total non-current deferred tax liabilities $ ( 41,065 ) $ ( 47,883 ) +During 2021, valuation allowances recorded against deferred tax assets decreased by $ 200.2 million. The change in the valuation allowance includes $ 192.3 million related to income tax benefit and $ 7.9 million that does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to changes in cumulative translation adjustments. During 2020, valuation allowances increased by $ 147.6 million. The change in the valuation allowance +F- 29 +Table of Contents +includes $ 143.0 million related to income tax expense and $ 4.6 million that does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation adjustments. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions, and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. During the three months ended June 30, 2021, a jurisdiction for which we have historically recorded significant valuation allowances enacted a favorable change in the tax law related to net operating loss carryforwards. The change in tax law impacted the assessment of valuation allowances in the jurisdiction as the reversal of existing deferred tax assets would generate indefinite carryforward net operating losses instead of losses with a limited carryforward period. During 2021, valuation allowances recorded against deferred tax assets decreased by $ 200.2 million. +In certain other jurisdictions, we recorded additional attributes, primarily driven by operational losses recognized based on local tax accounting requirements. These carryforwards were generated in jurisdictions where results indicate it is not more likely than not the deferred tax assets would be realized. We maintain a valuation allowance against the majority of these balances. +During 2021, all U.S. federal tax credits were utilized. We have included in the table above the prior year deferred tax assets related to U.S. federal tax carryforwards, including foreign tax credits and other tax credits, of $ 5.8 million as of December 31, 2020. We have included in the table above deferred tax assets related to U.S. state tax net operating loss carryforwards, some of which expire at various dates beginning in 2031 and some of which do not expire, of $ 2.4 million and $ 3.6 million at December 31, 2021 and 2020, respectively. We have recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2022 and those which do not expire of $ 61.5 million and $ 58.4 million as of December 31, 2021 and 2020, respectively. We maintain a valuation allowance against a portion of the foreign carryforwards and other attributes. +The transition tax in the Tax Act imposed a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. Furthermore, as of December 31, 2021, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Unrecognized tax benefit as of January 1 $ 206,209 $ 4,613 $ 4,511 +Additions in tax positions taken in prior period 6,169 519 631 +Reductions in tax positions taken in prior period ( 963 ) ( 340 ) ( 1,532 ) +Additions in tax positions taken in current period 23,061 200,947 1,786 +Settlements ( 763 ) ( 294 ) ( 391 ) +Lapse of statute of limitations ( 342 ) ( 258 ) ( 368 ) +Cumulative foreign currency translation adjustment ( 14,972 ) 1,022 ( 24 ) +Unrecognized tax benefit as of December 31 $ 218,399 $ 206,209 $ 4,613 +We recorded a net expense of $ 21.3 million related to increases in 2021 unrecognized tax benefits combined with amounts effectively settled under audit. Unrecognized tax benefits as of December 31, 2021 relate to tax years that are currently open under the statute of limitation. The primary impact of uncertain tax benefits on the rate reconciliation includes audit settlements, net increases in position changes, and accrued interest expense. +Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Our assessments are based on estimates and assumptions using the best available information to management. However, our +F- 30 +Table of Contents +estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible change related to our uncertain tax positions, and such changes could be significant. +Interest and penalties related to income tax liabilities are included in ‘Income tax benefit’ in the consolidated statements of operations. For the years ended December 31, 2021, 2020, and 2019, we recorded approximately $ 1.0 million, $ 0.6 million, and $ 0.4 million, respectively, of penalties and interest. During the year ended December 31, 2021, we released $ 0.1 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $ 2.0 million, $ 1.2 million, and $ 0.7 million, as of December 31, 2021, 2020, and 2019, respectively. +Unrecognized tax benefits of $ 218.7 million, $ 205.6 million, and $ 4.0 million as of December 31, 2021, 2020, and 2019, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2021: +The Netherlands 2009 to 2021 +Canada 2014 to 2021 +Japan 2014 to 2021 +China 2011 to 2021 +Singapore 2017 to 2021 +United States 2007 to 2021 +We are currently under audit in China. U.S. state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for us are generally subject to examination for the years 2016 to 2021. Although the timing of income tax audit resolutions and negotiations with taxing authorities is highly uncertain, we do not anticipate a significant change in the total amount of unrecognized tax benefits within the next twelve months. +14. EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2021, 2020, and 2019 were as follows: +Year Ended December 31, +2021 2020 2019 +(in thousands, except per share data) +Numerator: +Net income attributable to common stockholders +$ 725,694 $ 312,861 $ 119,497 +Denominator: +Weighted average common shares outstanding - basic 62,464 67,386 70,357 +Plus: Dilutive effect of stock options and unvested restricted stock units +1,254 1,158 1,414 +Weighted average common shares outstanding - diluted +63,718 68,544 71,771 +Net income per common share: +Basic $ 11.62 $ 4.64 $ 1.70 +Diluted $ 11.39 $ 4.56 $ 1.66 +For the year ended December 31, 2021, there were less than 0.1 million outstanding shares issued under share-based compensation awards that were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. For the years ended December 31, 2020 and 2019, no outstanding shares issued under share-based compensation awards were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. +F- 31 +Table of Contents +15. COMMITMENTS AND CONTINGENCIES +Purchase Commitments +As of December 31, 2021 and 2020, we had purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products, for an aggregate of $ 274.9 million and $ 220.8 million, respectively. We expect to fulfill our commitments under these agreements in the normal course of business, and as such, no liability has been recorded. +HEYDUDE Acquisition +On December 22, 2021, we entered into a definitive agreement to acquire the HEYDUDE brand (the “HEYDUDE Acquisition”), a privately-owned casual footwear brand, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”). The Securities Purchase Agreement provides that we will purchase all of the issued and outstanding equity securities of HEYDUDE for a purchase price of $ 2.05 billion in cash (the “Cash Consideration”) and 2,852,280 in Crocs shares to be issued to one of the sellers. The Cash Consideration is subject to adjustment based on, among other things, the cash, indebtedness, transaction expenses, and working capital of HEYDUDE as of the closing of the HEYDUDE Acquisition. The HEYDUDE Acquisition is expected to close in February 2022, subject to customary closing conditions. +Other +We are regularly subject to, and are currently undergoing, audits by various tax authorities in the U.S. and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. +During our normal course of business, we may make certain indemnities, commitments, and guarantees under which we may be required to make payments in relation to certain matters. We cannot determine a range of estimated future payments and have not recorded any liability for such payments in the accompanying consolidated balance sheets. +See Note 17 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +16. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have three reportable operating segments: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”). Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. +Segment performance is evaluated based on segment results without allocating corporate expenses, or indirect general, administrative, and other expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income from operations consist of other businesses and unallocated corporate expenses, as well as inter-segment eliminations. +In the three months ended March 31, 2021, certain costs previously reported within ‘Other Businesses’ were shifted to the Americas, Asia Pacific, and EMEA segments, as applicable, to reflect changes in the way management evaluates segment performance, makes operating decisions, and allocates resources. Additionally, any costs remaining in ‘Other Businesses,’ including depreciation and amortization, had been consolidated into ‘Unallocated corporate and other.’ The previously reported amounts for income from operations for the years ended December 31, 2020 and 2019 have been revised to conform to current period presentation, as shown in the following tables. +In the three months ended June 30, 2021, to reflect changes in the way management evaluates segment performance, makes operating decisions, and allocates resources, and as a response to our incremental investments in marketing in line with our growth, certain marketing expenses previously reported within ‘Unallocated corporate and other’ were shifted to the Americas, Asia Pacific, and EMEA segments, as applicable, to better align these investments with segment profitability. The previously reported amounts for income from operations for the years ended December 31, 2020 and 2019 have been revised to conform to current period presentation, as shown in the following tables. +We do not report asset information by segment because that information is not used to evaluate performance or allocate resources between segments. +F- 32 +Table of Contents +The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Revenues: +Americas $ 1,607,012 $ 863,613 $ 640,515 +Asia Pacific 350,160 278,515 348,072 +EMEA 356,157 243,660 241,948 +Segment revenues 2,313,329 1,385,788 1,230,535 +Other businesses 87 163 58 +Total consolidated revenues $ 2,313,416 $ 1,385,951 $ 1,230,593 +Income from operations (1)(2) : +Americas $ 778,310 $ 323,512 $ 179,199 +Asia Pacific 71,936 32,830 60,724 +EMEA 111,539 65,914 64,771 +Total segment income from operations 961,785 422,256 304,694 +Reconciliation of segment income from operations to income before income taxes: +Unallocated corporate and other (1)(2) +( 278,721 ) ( 208,132 ) ( 176,045 ) +Total consolidated income from operations 683,064 214,124 128,649 +Foreign currency gains (losses), net ( 140 ) ( 1,128 ) ( 1,323 ) +Interest income 775 215 601 +Interest expense ( 21,647 ) ( 6,742 ) ( 8,636 ) +Other income, net 1,797 510 31 +Income before income taxes $ 663,849 $ 206,979 $ 119,322 +Depreciation and amortization: +Americas $ 7,747 $ 3,528 $ 3,593 +Asia Pacific 1,629 1,138 963 +EMEA 1,728 730 793 +Total segment depreciation and amortization 11,104 5,396 5,349 +Unallocated corporate and other (1)(2) +20,872 22,223 18,864 +Total consolidated depreciation and amortization $ 31,976 $ 27,619 $ 24,213 +(1) In the first quarter of 2021, certain costs previously reported within ‘Other Businesses’ were shifted to the Americas, Asia Pacific, and EMEA segments. Additionally, any costs remaining in ‘Other Businesses,’ including depreciation and amortization, have been consolidated into ‘Unallocated corporate and other.’ In the second quarter of 2021, certain marketing expenses previously reported within ‘Unallocated corporate and other’ were shifted to the Americas, Asia Pacific, and EMEA segments. The previously reported amounts for income from operations for the years ended December 31, 2020 and 2019 have been revised to conform to current period presentation. See the ‘Impacts of segment composition change’ and ‘Impacts of marketing expense allocations’ tables below for more information. +(2) Unallocated corporate and other primarily includes corporate support and administrative functions, certain royalty income, costs associated with share-based compensation, research and development, brand marketing, legal, and depreciation and amortization of corporate and other assets not allocated to operating segments. +F- 33 +Table of Contents +Impacts of segment composition change: +Year Ended December 31, +2020 2019 +(in thousands) +Impacts on income from operations: +Americas $ ( 29,285 ) $ ( 12,123 ) +Asia Pacific ( 4,512 ) ( 6,497 ) +EMEA 4,410 ( 3,240 ) +Total impact on segment income from operations $ ( 29,387 ) $ ( 21,860 ) +Unallocated corporate and other $ 29,387 $ 21,860 +Impacts of marketing expense allocations: +Year Ended December 31, +2020 2019 +(in thousands) +Impacts on income from operations: +Americas $ ( 9,133 ) $ ( 13,546 ) +Asia Pacific ( 10,100 ) ( 13,424 ) +EMEA ( 1,810 ) ( 2,315 ) +Total impact on segment income from operations $ ( 21,043 ) $ ( 29,285 ) +Unallocated corporate and other $ 21,043 $ 29,285 +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2021, 2020 and 2019. The following table sets forth certain geographical information regarding Crocs’ revenues for the periods as shown: +Year Ended December 31, +2021 2020 2019 +(in thousands) +Location: +United States $ 1,507,482 $ 802,952 $ 563,473 +International (1) +805,934 582,999 667,120 +Total revenues $ 2,313,416 $ 1,385,951 $ 1,230,593 +(1) No individual international country represented 10% or more of consolidated revenues in any of the years presented. +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2021 2020 +(in thousands) +Location: +United States $ 80,613 $ 49,527 +International (1) +27,785 7,940 +Total property and equipment, net $ 108,398 $ 57,467 +(1) During the year ended December 31, 2021, property and equipment, net in the Netherlands represented approximately 20 % of consolidated property and equipment, net, comprised primarily of property and equipment related to the distribution center in Dordrecht and the warehouses in Rotterdam and Oudenbosch. No other individual country represented 10% or more of consolidated property and equipment, net in any of the years presented. +F- 34 +Table of Contents +17. LEGAL PROCEEDINGS +We were subject to an audit by the Brazilian Federal Tax Authorities related to imports of footwear from China between 2010 and 2014. On January 13, 2015, we were notified about the issuance of assessments totaling 14.4 million Brazilian Real (“BRL”), or approximately $ 2.6 million at current exchange rates, plus interest and penalties, for the period January 2010 through May 2011. We disputed these assessments and asserted defenses to the claims. On February 25, 2015, we received additional assessments totaling 33.3 million BRL, or approximately $ 6.0 million at current exchange rates, plus interest and penalties, related to the remainder of the audit period. We also disputed these assessments and asserted defenses to these claims in administrative appeals. On August 29, 2017, we received a favorable ruling on our appeal of the first assessment, which dismissed all fines, penalties, and interest. The tax authorities have appealed that decision and we challenged the appeal on both the merits and procedure. Additionally, the second appeal for the remaining assessments was heard on March 22, 2018. That decision was partially favorable for us and resulted in an approximately 38 % reduction in principal, penalties, and interest. The tax authorities have appealed that decision, and we filed a response to the tax authorities’ appeal as well as a separate appeal against the unfavorable portion of the ruling. Taking current rulings into consideration, we estimate the remaining principal for these assessments to be $ 4.5 million at current exchange rates, plus interest and penalties. Should the Brazilian Tax Authority prevail in these final administrative appeals, we may challenge the assessments through the court system, which would likely require the posting of a bond. We have not recorded these items within the consolidated financial statements as it is not possible at this time to predict the timing or outcome of this matter or to estimate a potential amount of loss, if any. +For all other claims and disputes, we have accrued estimated losses of $ 1.5 million within ‘Accrued expenses and other liabilities’ in our consolidated balance sheet as of December 31, 2021. As we are able, we estimate reasonably possible losses or a range of reasonably possible losses for claims and other disputes. As of December 31, 2021, we estimated that reasonably possible losses could potentially exceed amounts accrued by an immaterial amount. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, other than as set forth above, we are not party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business, financial results, and cash flows. +18. EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +We sponsor a qualified defined contribution benefit plan (the “Plan”), covering substantially all of our U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. We make matching contributions to the plans equal to 100 % of the first 3 %, and up to 50 % of the next 2 % of salary contributed by an eligible employee. Participants are vested 100 % in our matching contributions when made. Contributions made by us under the Plan were $ 7.4 million, $ 4.7 million and $ 5.1 million for the years ended December 31, 2021, 2020, and 2019, respectively. +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +For the Quarter Ended +March 31, 2021 June 30, 2021 September 30, 2021 December 31, 2021 +(in thousands, except per share data) +Revenues $ 460,098 $ 640,773 $ 625,919 $ 586,626 +Gross profit 253,219 395,181 399,796 372,024 +Income from operations +124,686 195,322 203,068 159,988 +Net income (1) +98,398 318,954 153,489 154,853 +Basic income per common share (2) +$ 1.50 $ 5.02 $ 2.47 $ 2.63 +Diluted income per common share (2) +$ 1.47 $ 4.93 $ 2.42 $ 2.57 +(1) During the three months ended June 30, 2021, a jurisdiction for which we have historically recorded significant valuation allowances enacted a favorable change in the tax law related to net operating loss carryforwards. This change in tax law impacted the assessment of valuation allowances in the jurisdiction. This resulted in a $ 176.9 million discrete tax benefit for the release of valuation allowances resulting from the enactment of this tax law change. +(2) Basic and diluted income per common share are computed independently for each of the quarters presented. Therefore, the sum of the quarters may not equal the annual amounts presented in the consolidated statements of operations. +F- 35 +Table of Contents +For the Quarter Ended +March 31, 2020 June 30, 2020 September 30, 2020 December 31, 2020 +(in thousands, except per share data) +Revenues $ 281,160 $ 331,549 $ 361,736 $ 411,506 +Gross profit 134,162 179,933 206,769 229,084 +Income from operations +20,812 56,595 72,086 64,631 +Net income (1) +11,091 56,551 61,889 183,330 +Basic income (loss) per common share (2) +$ 0.16 $ 0.84 $ 0.92 $ 2.75 +Diluted income (loss) per common share (2) +$ 0.16 $ 0.83 $ 0.91 $ 2.69 +(1) During the three months ended December 31, 2020, we completed an intra-entity transfer of certain intellectual property rights, resulting in the recognition of a $ 127.7 million tax benefit. See Note 13 — Income Taxes for more information. Additionally, in the three months ended December 31, 2020, we recorded an impairment for a retail location in New York City of $ 20.0 million and for our former corporate headquarters of $ 1.1 million. +(2) Basic and diluted income per common share are computed independently for each of the quarters presented. Therefore, the sum of the quarters may not equal the annual amounts presented in the consolidated statements of operations. Additionally, for the three months ended December 31, 2020, basic and diluted income per common share include the impact of the repurchase of 1.7 million shares of our common stock for $ 131.7 million, including a $ 125.0 million ASR, as described in more detail in Note 10 — Equity. +F- 36 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period Charged to Costs and Expenses +Deductions (1) +Balance at End of Period +(in thousands) +Year Ended December 31, 2021 +Allowance for doubtful accounts $ 11,154 $ — $ ( 3,326 ) $ 7,828 +Reserve for sales returns and allowances 5,782 148,893 ( 145,069 ) 9,606 +Reserve for unapplied rebates 4,157 4,678 ( 5,554 ) 3,281 +Total $ 21,093 $ 153,571 $ ( 153,949 ) $ 20,715 +Year Ended December 31, 2020 +Allowance for doubtful accounts $ 8,276 $ 5,779 $ ( 2,901 ) $ 11,154 +Reserve for sales returns and allowances 5,261 95,740 ( 95,219 ) 5,782 +Reserve for unapplied rebates 5,260 4,920 ( 6,023 ) 4,157 +Total $ 18,797 $ 106,439 $ ( 104,143 ) $ 21,093 +Year Ended December 31, 2019 +Allowance for doubtful accounts $ 10,959 $ 1,566 $ ( 4,249 ) $ 8,276 +Reserve for sales returns and allowances 2,741 73,027 ( 70,507 ) 5,261 +Reserve for unapplied rebates 6,777 6,837 ( 8,354 ) 5,260 +Total $ 20,477 $ 81,430 $ ( 83,110 ) $ 18,797 +(1) Deductions include accounts written off, net of recoveries, and the effects of foreign currency translation. +F- 37 \ No newline at end of file diff --git a/raw/filings/0001334036/2021/0001334036-22-000011/filing_metadata.csv b/raw/filings/0001334036/2021/0001334036-22-000011/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..a3d01df99d5b59c32c057a0543fbd57f80a6cf2e --- /dev/null +++ b/raw/filings/0001334036/2021/0001334036-22-000011/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2022-02-16,2021-12-31,2022-02-16T17:45:12.000Z,0001334036-22-000011,crox-20211231.htm,10-K,13152845,1,1,https://www.sec.gov/Archives/edgar/data/1334036/000133403622000011/crox-20211231.htm,https://www.sec.gov/Archives/edgar/data/1334036/000133403622000011/,2021,2021,1 diff --git a/raw/filings/0001334036/2021/0001334036-22-000011/item1.txt b/raw/filings/0001334036/2021/0001334036-22-000011/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..ae6a86a3154e5a48f4b46ee9091e5cf12eded87a --- /dev/null +++ b/raw/filings/0001334036/2021/0001334036-22-000011/item1.txt @@ -0,0 +1,138 @@ +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “Crocs,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. The vast majority of shoes within our collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. +We run our business across three geographic regions: the Americas, Asia Pacific, and Europe, Middle East, and Africa (“EMEA”), which are discussed in more detail in “Business Segments and Geographic Information” below. Within these regions, we prioritize five core markets where we believe the greatest opportunities for growth exist: (i) China, (ii) Japan, (iii) South Korea, (iv) the U.S., and (v) Western Europe. +Our Vision +Our brand philosophy has our consumer at its heart. As a global brand “of the people, for the people,” we have successfully created a brand with a broad democratic appeal and accessible price points that is aligned with global megatrends such as casualization and personalization. Our brand philosophy and vision has been an important driver of our results and we believe will continue to be important as we realize the full potential of our brand. To that end, in 2021, we continued our message of “Come As You Are” in all regions and channels. +Our growth framework is driven by four strategic areas of focus: (i) growing digital sales, (ii) gaining market share in sandals, (iii) growth opportunities in Asia, and (iv) ongoing product and marketing innovation. +Growing Digital Sales +Digital sales include sales directly to consumers through our company-owned websites, third-party marketplaces, and wholesale sales to our global e-tailers. Our digital sales in 2021 were 36.7% of revenues, compared to 41.5% of revenues in 2020, which was higher than 2021 partially as a result of consumer migration to online shopping during the COVID-19 pandemic, and 31.1% of revenues in 2019. We plan to grow our percentage of digital sales by elevating our consumer experience, personalizing the consumer journey, and investing in capabilities to grow consumer lifetime value. We believe our digital connection with our consumers will allow us to remain nimble and maximize the full potential of the Crocs brand, while staying focused on the online channels in which our consumers are increasingly shopping. +Gaining Sandals Market Share +Sandals have long been a focus of the Company, as a large and accessible growth avenue for the brand. While we have increased sales of sandals in recent years, we believe there is an opportunity for additional growth. We discuss sandals in more depth under “Innovation in Products” below. +Growth Opportunities in Asia +As a brand with a well-established global footprint, we believe we have a long-term sales growth opportunity in the Asia Pacific segment. Our five core markets include three markets in Asia: China, Japan, and South Korea. China, in particular, which is the second largest footwear market in the world and represented about 20% of global footwear sales in 2020, is a key focus for us. Our strategy for China growth focuses on penetrating the digital channel, investing in an ‘always on’ marketing playbook to drive brand awareness and relevance, driving store growth and increased productivity within our mono-branded partner portfolio, and opening and operating a focused set of stores within major cities and in key outlet centers. +2 +Table of Contents +Innovation in Products and Marketing +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. Recognized globally for our unmistakable iconic clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2021 as we continued to bring to our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, Crocs socks, and increased personalization through our Jibbitz™ charms accessories. +We offer a broad portfolio of all-season products, while remaining true to our core molded footwear heritage. The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ products. LiteRide™ features comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +At the heart of our brand’s DNA are our clogs, sandals, and Jibbitz™ charms — key product pillars that we believe will drive the majority of our long-term growth. +Clogs +The Classic Clog, our most iconic style for adults and children, embodies our innovation in molding, simplicity of design, and all-day comfort. The clog product silhouette is comfortable, versatile, and accessible. It provides a blank canvas for self-expression, while naturally lending itself to innovation, including the silhouette’s expansion into height, sport, adventure, and enhanced visible comfort technologies. Our product innovation and marketing over the past several years has driven clog relevance, which in turn has created brand relevance to consumers and led to increased sales. On-trend color and prints create highly compelling newness, allowing us to highlight the latest trends in our seasonal launches. Additionally, we have made our clog a year-round silhouette via innovations such as fuzz, used in our lined footwear collection. +We anticipate the clog market will continue to expand as many new brands enter the category in the luxury, sports, and fashion spaces, and that we will continue to increase our consumer base through product design and marketing activations. We intend to continue to drive future clog growth and relevance around the world. +Sandals +We believe sandals are a natural extension of our brand, leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. The sandals silhouette category allows us to access new consumers and broader wearing occasions as well as convert our existing clog consumers. The current sandals market is fragmented with no single dominant player, which we believe offers us the opportunity to expand. Unlike clogs where our focus is on driving relevance, with sandals, our focus is on and opportunity lies with driving awareness and consideration. +Our expectation for the potential future growth of sandals is driven by several factors. First, clog relevance with consumers has converted to interest in sandals. Our recent brand metric studies show high levels of sandal consideration from consumers, matching clog consideration in many markets. This has been driven through marketing investments which have focused advertising campaigns and collaborations on the sandal silhouette and sandal product design that incorporates personalization. Additionally, while sandals are more seasonal than clogs, they still represent a year-round opportunity, particularly in the digital channel and our warmer markets. +Personalization +Personalization has been part of our culture since the very first pair of Crocs was created. Jibbitz™ charms enhance the consumer experience by providing an outlet for customization and self-expression, driving overall consumer engagement and retention, and heightening our message of “Come As You Are™” in all channels and regions. Personalization is a unique selling proposition and is an important part of our brand. Jibbitz™ drive high levels of engagement and purchase frequency. We intend to continue to position personalization at the heart of our brand experience, and expect it will continue to be a strong driver of sales in both the clog and sandal categories. +3 +Table of Contents +Our products also meet the needs of the entire family. We enjoy licensing partnerships with Disney, including Marvel and Lucasfilm, Warner Bros., Nintendo, and Nickelodeon, among others, which allow us to bring popular global franchises and characters to life on our product in a fun, exciting way. +Marketing +We concentrate our marketing efforts on our five core markets to increase customer awareness of both our brand and our full product range. Each season, we focus on presenting a compelling brand story and experience for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms. We are growing our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, that allow for personalization. We continue to invest in globally integrated advertising campaigns, as well as designer, celebrity and influencer, and brand partnerships, ranging from popular artists like Justin Bieber to a wide range of well-known brands such as Balenciaga and Hidden Valley Ranch. Innovation is not only core to our brand values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our fans to give them new and innovative reasons to continue to choose Crocs. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +HEYDUDE Acquisition +On December 22, 2021, we entered into a definitive agreement to acquire the HEYDUDE brand (the “HEYDUDE Acquisition”), a privately-owned casual footwear brand, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”). +The HEYDUDE Acquisition will further diversify our product portfolio under two brands. The HEYDUDE brand provides an ultra-light and comfortable casual footwear product that aligns with our vision. The Securities Purchase Agreement provides that we will purchase all of the issued and outstanding equity securities of HEYDUDE for a purchase price of $2.05 billion in cash (the “Cash Consideration”) and 2,852,280 in Crocs shares to be issued to one of the sellers (the “Equity Consideration Shares”). The Equity Consideration Shares will be subject to a lock-up period beginning on the closing date (the “Closing Date”) of the HEYDUDE Acquisition and continuing to, and including, the date that is 12 months after the Closing Date, provided that (a) on the date that is six months after the Closing Date, 50% of the Equity Consideration Shares will be released from the lock-up, and (b) on the date that is twelve months after the Closing Date, the remaining 50% of the Equity Consideration Shares will be released from the lock-up. The Cash Consideration is subject to adjustment based on, among other things, the cash, indebtedness, transaction expenses, and working capital of HEYDUDE as of the closing of the HEYDUDE Acquisition. We expect to finance the Cash Consideration by entering into the $2.0 billion Term Loan B Facility (as defined herein) and borrowing $50.0 million under the Revolving Facility (as defined herein). +The HEYDUDE Acquisition is expected to close in February 2022, subject to customary closing conditions. +The foregoing description of the Securities Purchase Agreement and the transactions contemplated thereby do not purport to be complete and are subject to, and qualified in their entirety by, the full text of the Securities Purchase Agreement, a copy of which is attached as Exhibit 2.1 to our Current Report on Form 8-K, filed on December 23, 2021. +Environmental, Social, and Governance (“ESG”) Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry and our planet by committing to transparent, socially conscious, and sustainable business practices. All information in the below ESG discussion pertains to the Crocs brand as of December 31, 2021. +Through our established ESG Program, we intend to continuously advance our sustainable business practices with the goal of consistently delivering products that exceed customer and consumer expectations. We believe the progress of our ESG efforts is best served by disclosing goals and relevant metrics, and, to this end, we have aligned our program with the United Nations Sustainable Development Goals (“SDGs”) and the Sustainability Accounting Standards Board (“SASB”) framework for reporting and disclosure guidance in order to share our ESG progress. Our ESG initiatives complement our “ Green Comes in Every Color ” campaign, which is focused on providing Comfort Without Carbon, Comfort for our Communities, and Comfort for all People. +4 +Table of Contents +Additional information related to our ESG initiatives and achievements will be published in our fiscal year 2021 ESG Report in the first half of 2022, which will be available on the Investor Relations section of our website located at www.crocs.com. The content provided in our ESG Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +Environmental +We are committed to reducing our impact on the environment by focusing on sustainability initiatives in our operations and throughout our supply chain and product lifecycle. +In 2021, we established our ambition of becoming a Net Zero brand by 2030. We also identified four areas of focus for our sustainability strategy: (i) transitioning to more sustainable product ingredients; (ii) responsible resource use; (iii) implementing more environmentally friendly packaging; and (iv) exploring sustainable solutions for product end of life. +Our transition to more sustainable ingredients was highlighted by our announcement of production on our “shoe of the future” powered by a new bio-based Croslite. This more sustainable Croslite incorporates Dow’s new ECOLIBRIUM TM Technology that transforms sustainably-sourced waste and by-products from other industries into a shoe that has all the comfort you expect from Crocs but with a lower environmental impact than other materials. During 2021, we also eliminated leather from our product line to become a 100% vegan brand. +To keep shoes on feet and out of landfills, we donated thousands of unsold Crocs to those in need around the world. We also announced our partnership with ThredUP to give previously used items a second life and help create a more comfortable world. +We remain a member of the Sustainable Apparel Coalition to ensure our efforts are aligned with industry guidance and best practices. We also continue to leverage the Higg Index suite of tools for baselining and establishing goals across emissions, energy and water use, and waste reduction/disposal for both our internal brand activities as well as our factory partners. We continue working to align with Science-Based Targets for the purpose of developing meaningful GHG emissions reduction goals that support the prevention of climate change. +Social +Human Capital +At Crocs, our vision to make “everyone comfortable in their own shoes” starts with our people. As of December 31, 2021, we employed approximately 5,770 employees in the Americas, EMEA, and Asia Pacific. This includes approximately 3,300 employees in our retail stores, 1,400 employees at our corporate/regional offices, and 1,000 employees at our distribution centers. +We are committed to the health and safety of our employees and customers. In response to COVID-19, our corporate offices, retail stores, and distribution centers have maintained various elevated safety protocols, in accordance with local guidelines and regulations. To support our workforce, we also implemented a supplemental sick policy in 2020 for our U.S. workforce with additional hours available for paid time off related to COVID-19, which we continued for 2021 and 2022. +To ensure that we remain an employer of choice for what we believe is the most talented workforce in the footwear industry, we have implemented initiatives across our business and geographies to develop leadership capabilities, enable meaningful professional experiences, offer a compelling employee value proposition, and create a transparent, collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” We are also committed to an equitable total rewards philosophy as well as pay transparency in all regions. +We are proud of our culture of inclusion, which encompasses regular employee listening, employee-led inclusivity councils, and diversity at all levels. Crocs strives to create a culture of inclusion while creating a comfortable workplace through progressive people-practices where employees can freely contribute equally regardless of gender, age, race, ethnicity, national origin, disability, religion, immigration status, or sexual orientation, gender identity or expressions. Our Code of Ethics codifies these values. Crocs is also a premier partner of the UN Foundation’s #EqualEverywhere: Champions for Change Campaign promoting their global push for gender equality. +Investing in talent is a key component of our human capital strategy. Crocs is committed to identifying and developing the next generation of leadership. We conduct an annual talent and succession review with our CEO and Board of Directors (“Board”) +5 +Table of Contents +with a focus on accelerating talent development, strengthening succession pipelines, and advancing diversity representation for our most critical roles. +We continue to emphasize employee development and training. We have established a culture of learning and development, with robust training at all levels on a wide range of topics from Cultivating a Sense of Belonging, Thriving through Adversity (for instance, during the COVID-19 pandemic), Guiding Dynamic Decision Making, and Facilitating Team Communication. +Crocs is committed to providing an employee value proposition that is compelling, market-competitive, and performance-based. Our compensation programs, practices, and policies reflect our commitment. We aim to generally position total direct compensation within a competitive range of the market median, with differentiation based on tenure, skills, proficiency, and performance to attract and retain key talent, and have taken aggressive steps to advance hourly wages for our workforce across the globe, including increasing our hourly workers’ average wage above $15 per hour in the U.S. and Puerto Rico as of December 31, 2021. Additionally, all full- and part-time employees based in North America are eligible for sick leave accrual based on hours worked, and we follow all applicable illness and leave requirements globally. +Our regular employee engagement surveys reflect a highly engaged global workforce, with, among others, high scores returned by employees recommending “Crocs as a great place to work” and saying “it is easy for people with diverse backgrounds to be accepted.” +Social Capital +At Crocs, we strive to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards. To this end, we have implemented measures to ensure our supply chain complies with these standards, including utilizing internal and external parties to conduct both scheduled and unannounced social compliance reviews. We also maintain a factory Social Compliance Code of Conduct and a certification process – our contracted factories and direct suppliers sign an annual Statement of Compliance, verifying that their operations are in compliance with all local laws and customs regarding hiring practices, wages, and working conditions, as well as our Code of Conduct. We recently joined the Fair Labor Association in an effort to provide further resources and transparency for protecting worker rights throughout our supply chain. +We also monitor chemicals and substances in our supply chain for compliance with legal and regulatory requirements consistent with our Restricted Substances Policy and expect our contracted factories and suppliers to take a proactive stance in eliminating any hazardous chemicals or substances in the manufacture of Crocs products. We recently joined the Apparel & Footwear International RSL Management Working Group to help reduce the use and impact of harmful substances in our supply chain. +Community +Giving back to the community is extremely important to us. Through our global “Crocs Cares” program, we focus on providing shoes, funds, and employee time to address timely human needs, to support social inclusion and equality, and to enable our employees to collaborate and give back within their local communities. In the past two years alone, we have donated over one million pairs of shoes, including our donation in 2020 of over 860,000 pairs of shoes to frontline healthcare workers and other organizations around the world as part of our “A Free Pair for Healthcare” program and additional donations in 2021 of 150,000 pairs of shoes across multiple organizations. Additionally, thanks to the generosity of our consumers in 2021, we also raised nearly $2.5 million for Feeding America, enabling over 25 million meals for those in need. +Governance +At Crocs, we have strong corporate governance mechanisms in place, along with robust internal controls over our financial reporting framework. We also have Enterprise Risk Management and Ethics & Compliance program frameworks, with regular updates provided to our Board and its committees. For our ESG efforts, Crocs has established an ESG/sustainability management and oversight framework under the direction of our Executive Vice President, Chief Legal and Risk Officer. The Governance and Nominating Committee of our Board, comprised of three independent directors, oversees our ESG efforts and receives quarterly updates on the progress of our ESG program. +Our commitment to diversity and inclusion is reflected in our Board, consisting of 38% female representation and 13% racial/ethnic minority representation as of December 31, 2021. +6 +Table of Contents +We also continue to conduct annual in-person and online compliance training for all corporate employees as well as retail and distribution center management and maintain a global ethics hotline, which is administered by our Legal department. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 85 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our DTC channel includes retail, in which we sell through company-operated stores, and e-commerce, in which we sell through company-operated e-commerce sites and third-party marketplaces. +Wholesale Channel +During the years ended December 31, 2021, 2020, and 2019, 50.8%, 50.0%, and 53.3% of revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors in certain countries, including partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +No single wholesale customer accounted for 10% or more of our total revenues for any of the years ended December 31, 2021, 2020, and 2019. +Direct-to-Consumer Channel +During the years ended December 31, 2021, 2020, and 2019, 49.2%, 50.0%, and 46.7%, respectively, of our revenues were derived through our DTC channel. +Retail +During 2020, as a result of the COVID-19 pandemic, our global retail stores were closed for a portion of the year. However, the vast majority of our stores were open throughout 2021. We operate our retail channel through three platforms: company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. With the continued worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2021, we had 373 company-operated stores. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for information on store locations by platform. +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2021, we had 107 full-price retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. As of December 31, 2021, we had 193 outlet stores. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and limited fixed cost and capital investment we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2021, we had 73 kiosks and store-in-store locations. +7 +Table of Contents +The following table illustrates the net change during 2021 in the number of our company-operated retail stores by reportable operating segment and country: +December 31, 2020 Opened Closed December 31, 2021 +Americas +United States 154 9 1 162 +Canada 8 — — 8 +Puerto Rico 3 — — 3 +Total Americas 165 9 1 173 +Asia Pacific +Korea 90 3 4 89 +China 18 19 3 34 +Japan 12 1 — 13 +Singapore 17 — — 17 +Total Asia Pacific 137 23 7 153 +EMEA +Russia 26 1 1 26 +Germany 14 — — 14 +France 4 — 2 2 +Austria 3 — — 3 +The Netherlands 2 — — 2 +Total EMEA 49 1 3 47 +Total 351 33 11 373 +E-commerce +As of December 31, 2021, we offered our products through 14 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Business Segments and Geographic Information +We have three reportable operating segments based on the geographic nature of our operations: the Americas, Asia Pacific, and EMEA. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 16 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our operating segments. +Raw Materials +Croslite™, our proprietary closed-cell resin brand, incorporates the primary material formulations used in the vast majority of our footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various ESG initiatives described in the previous section. +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All of the other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +8 +Table of Contents +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +Sourcing, Distribution, and Logistics +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in Vietnam and China. In response to production delays in 2021 associated with the COVID-19 pandemic, particularly in Vietnam, we have further diversified our manufacturers. These delays are further described in the risk factor under “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K. +During the years ended December 31, 2021, 2020, and 2019, approximately 56%, 75%, and 61%, respectively, of our production was in Vietnam, while our largest third-party manufacturer, operating in both Vietnam and China, produced approximately 34%, 46%, and 38%, respectively, and our second largest third-party manufacturer, primarily operating in both Vietnam and China, produced approximately 30%, 22%, and 17%, respectively, of our footwear unit volume. We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available. Additionally, we began to further diversify our manufacturers in 2021 to add capacity in other countries, particularly China and Indonesia, in response to Vietnam factory closures as a result of COVID-19. See the risk factor under “Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with sourcing. +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2021, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2021, we opened a new EMEA distribution center in the Netherlands and began further expansion of our U.S. distribution center in Ohio to increase distribution capacity and increase automation, which we expect will maximize throughput and support our anticipated growth. We also utilized third-party operated distribution centers located in Japan, China, Australia, Korea, Singapore, India, Russia, and Brazil. As of December 31, 2021, our company-operated warehouse and distribution facilities provided us with 1.6 million square feet, and our third-party operated distribution facilities provided us with 0.5 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +As a result of global industry-wide logistics challenges in 2021, we implemented several mitigating measures including: (i) prioritizing top-selling products and narrowing product assortment, which has and will continue to improve factory throughput, (ii) maintaining flexibility by leveraging air freight and reducing our dependency on congested West Coast ports in the United States by adding East Coast trans-shipment capabilities, and (iii) strategically allocating units and prioritizing our key growth initiatives. With the actions taken to date and our future plans, we believe Crocs is well-positioned to withstand these supply challenges. See the risk factor under “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with sourcing. +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, +9 +Table of Contents +trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, though litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components, confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution network position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. \ No newline at end of file diff --git a/raw/filings/0001334036/2021/0001334036-22-000011/item13.txt b/raw/filings/0001334036/2021/0001334036-22-000011/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..4a26102c47705dd533f36d486e3b7ac7b11d9cc1 --- /dev/null +++ b/raw/filings/0001334036/2021/0001334036-22-000011/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2022 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2021. +51 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2021/0001334036-22-000011/item9a.txt b/raw/filings/0001334036/2021/0001334036-22-000011/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..0afcae2418ac86ef35b91bade69951eea2670d05 --- /dev/null +++ b/raw/filings/0001334036/2021/0001334036-22-000011/item9a.txt @@ -0,0 +1,27 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2021, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2021, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2021. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2021, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2021, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +48 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2021, of the Company and our report dated February 16, 2022, expressed an unqualified opinion on those consolidated financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 16, 2022 +49 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2021/0001334036-22-000011/rp_note.txt b/raw/filings/0001334036/2021/0001334036-22-000011/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2021/0001334036-22-000011/rpt_disclosure.txt b/raw/filings/0001334036/2021/0001334036-22-000011/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..d8d911d6fcd6c88733607a0a51969e74a96453a1 --- /dev/null +++ b/raw/filings/0001334036/2021/0001334036-22-000011/rpt_disclosure.txt @@ -0,0 +1,8 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Since January 1, 2021, there have been no related person transactions in which we were or are to be a participant and the amount involved exceeds $120,000 and in which any current related person had or will have a direct or indirect material interest. +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. 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REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31 , 2022 +or +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware 20-2164234 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +13601 Via Varra +Broomfield , Colorado 80020 +( 303 ) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: Trading symbol: Name of each exchange on which registered: +Common Stock, par value $0.001 per share CROX The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. +Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company Emerging growth company +☒ ☐ ☐ ☐ ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2022 was approximately $ 2.2 billion. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock, par value $0.001 per shares, outstanding as of February 9, 2023 was 61,751,732 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2023 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2022. +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding +• our expectations regarding future trends, selling, general and administrative cost savings, expectations, and performance of our business; +• our expectations regarding leveraging selling, general and administrative expense as a percent of revenues; +• our expectations regarding leveraging our global presence, innovative marketing, and scale infrastructure to grow HEYDUDE and to create significant shareholder value; +• our expectations regarding supply chain disruptions and related cost increases; +• our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• our expectations about the impact of our strategic plans; and +• our intent to achieve various Environmental, Social, and Governance initiatives. +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this Annual Report on Form 10-K, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements, except as required by applicable law. +Risks Factors Summary +Our business is subject to a number of risks and uncertainties, including those described in Part I, Item 1A. Risk Factors of this Annual Report on Form 10-K. These risks include, but are not limited to, the following: +• our substantial dependence on the value of our brands and our failure to strengthen and preserve this value; +• the significant competition that we face; +• introducing new products, which may be difficult and expensive; +• our failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand; +• our failure to continue to obtain or maintain high-quality endorsers of our products; +• our reliance on technical innovation to compete in the market for our products; +• the COVID-19 pandemic; +• changes in global economic conditions, which may adversely affect consumer spending and the financial health of our customers and others with whom we do business; +• the war between Russia and Ukraine; +• supply chain disruptions, which could interrupt product manufacturing and global logistics and increase product costs; +• our dependence on third-party manufacturers located outside of the U.S.; +• our dependence on the global supply chain and impacts of supply chain constraints and inflationary pressure; +• our inability to accurately forecast consumer demand; +i +Table of Contents +• our third-party manufacturing operations, which must comply with labor, trade, and other laws; +• our dependence on a number of suppliers for key production materials, and any disruption in the supply of such materials; +• changes in foreign exchange rates, most significantly but not limited to the Euro and South Korean Won, or other global currencies; +• the fact that we conduct significant business activity outside the U.S., which exposes us to risks of international commerce; +• our inability to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products; +• our significant reliance on the use of information technology; +• our online e-commerce sites, or those of our customers, not functioning effectively; +• the dependence of our financial success in part on the strength of our relationships with, and the success of, our wholesale and distributor customers; +• the substantial fixed costs we incur with respect to company-operated retail stores; +• if substantial investments in businesses and operations fail to produce expected returns; +• our dependence on employees across the globe; +• periodic litigation, which could result in unexpected expenditures of time and resources; +• global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations; +• the provisions in our restated certificate of incorporation, amended and restated bylaws, and Delaware law that could discourage a third-party from acquiring us; +• increasing scrutiny from investors, regulators, and other key stakeholders with respect to our ESG (as defined below) practices; +• the significant operating and financial restrictions that our Revolving Credit Agreement (as defined herein), the Term Loan B Credit Agreement (as defined herein), and the Indentures (as defined herein) each impose will impose, on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities; +• our indebtedness as well as the ability to meet payment obligations under our Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Notes (as defined herein); +• our ability to incur substantially more debt; +• that we may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations; +• that we may incur impairments of the carrying value of our goodwill and other intangible assets; +• the fluctuations to which our quarterly revenues and operating results are subject; +• the risks of maintaining significant cash abroad; +• changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation; +• our failure to meet analyst and investor expectations; +• our ability to realize the benefits from the Acquisition (as defined below); and +• the incurrence by us of substantial indebtedness in connection with the financing of the Acquisition. +ii +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2022 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +9 +Item 1B. +Unresolved Staff Comments +27 +Item 2. +Properties +27 +Item 3. +Legal Proceedings +28 +Item 4. +Mine Safety Disclosures +28 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +29 +Item 6. +[Reserved] +30 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +31 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +50 +Item 8. +Financial Statements and Supplementary Data +51 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +51 +Item 9A. +Controls and Procedures +51 +Item 9B. +Other Information +54 +Item 9C. +Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +54 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +55 +Item 11. +Executive Compensation +55 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +55 +Item 13. +Certain Relationships and Related Transactions and Director Independence +55 +Item 14. +Principal Accountant Fees and Services +56 +PART IV +Item 15. +Exhibits, Financial Statement Schedule +57 +Item 16. +Form 10-K Summary +61 +Signatures +62 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. +On February 17, 2022 (the “Acquisition Date”), we acquired (the “Acquisition”) 100% of the equity of a privately-owned casual footwear brand business (“HEYDUDE”), pursuant to a securities purchase agreement (the “SPA”) entered into on December 22, 2021. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The majority of HEYDUDE sales are currently in the United States. +The consolidated results reported for the year ended December 31, 2022 represent the Crocs Brand and ‘Enterprise corporate’ for the full year and the HEYDUDE Brand for the partial period beginning on the Acquisition Date through December 31, 2022 (the “Partial Period”); for the years ended December 31, 2021 and 2020, the results represent the Crocs Brand and ‘Enterprise corporate’ only. +Our reportable operating segments include: (i) North America for the Crocs Brand, operating throughout the United States of America (the “United States” or the “U.S.”) and Canada, (ii) Asia Pacific for the Crocs Brand, operating throughout Asia, Australia, and New Zealand; (iii) Europe, Middle East, Africa, and Latin America (“EMEALA”) for the Crocs Brand; and (iv) the HEYDUDE Brand, which are discussed in more detail in “Business Segments and Geographic Information” below. Within the regions in which we operate, we prioritize six core markets for the Crocs Brand where we believe the greatest opportunities for growth exist: (i) China, (ii) India, (iii) Japan, (iv) South Korea, (v) the U.S., and (vi) Western Europe. +Our Vision +At the heart of our brands is our consumers. We have brands, with a broad democratic appeal and accessible price points, which are aligned with global megatrends such as casualization and personalization. The philosophy and vision for our brands has been an important driver of our results and, we believe, will continue to be important as we strive to realize the full potential of our brands. To that end, in 2022, we continued our message of “Come As You Are” in all regions and channels for the Crocs Brand. During the year, we added the HEYDUDE Brand to our portfolio, which we believe is an ideal fit with the Crocs Brand and long-term consumer trends given its focus on casualization, comfort-led functionality, sustainability, and personalization. +Our growth framework is driven by five strategic areas of focus: +• Growing digital sales — Digital sales include sales directly to consumers through our company-owned websites, third-party marketplaces, and wholesale sales to our global e-tailers. Our digital sales in 2022 were 37.8% of consolidated revenues, compared to 36.7% and 41.5% of consolidated revenues in 2021 and 2020, respectively. +• Gaining sandals market share for the Crocs Brand — Sandals have long been a focus of the Crocs Brand as a large and accessible growth avenue for the brand. We believe sandals are a natural extension of the Crocs Brand and allow us to access new consumers by leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +• Increasing awareness and distribution for the HEYDUDE Brand — We acquired HEYDUDE in February 2022 and have embarked, and plan to continue to embark, on various marketing activities to drive higher awareness. We have also entered into a lease not yet commenced for a new HEYDUDE distribution center in Las Vegas, Nevada, to expand our distribution capabilities of the HEYDUDE Brand. +• Growth opportunities internationally — As a company with a well-established global footprint, we believe we have a long-term sales growth opportunity internationally. Our international sales in 2022 were 29.4% of consolidated revenues, compared to 32.8% and 39.9% of consolidated revenues in 2021 and 2020, respectively. This includes sales in 2022 for the HEYDUDE Brand, which operates primarily in the United States. Our six core markets for the Crocs Brand include five international markets, and more specifically, four markets in Asia: China, India, Japan, and South Korea. Additionally, we intend to further expand the HEYDUDE Brand in Europe beginning in 2023. +2 +Table of Contents +• Ongoing product and marketing innovation — At the heart of our Crocs Brand’s DNA are our clogs, sandals, and Jibbitz™ charms, which are key product pillars that we believe will drive long-term growth. We continue to grow our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, for personalization. The addition of the HEYDUDE Brand to our portfolio provides an innovative loafer concept that is differentiated through quality and comfort. From a marketing perspective, we continue to invest in globally integrated digital advertising campaigns, as well as designer, celebrity and influencer, and brand partnerships. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. We offer a broad portfolio of all-season products, while remaining true to our core casual footwear heritage. +Crocs Brand +Recognized globally for our unmistakable iconic molded clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2022 as we repeatedly brought our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, and increased personalization through our Jibbitz™ charms accessories. +The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ products. LiteRide™ features comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +HEYDUDE Brand +In 2022, we added HEYDUDE to our portfolio, whose shoes have a versatile silhouette with many wearing occasions that focus on casualization, comfort-led functionality, and personalization. HEYDUDE utilizes leading technologies including a flex-and-fold outsole and ergonomic insole. The shoes are known for being lightweight, flexible, and soft, with design and functional flexibility for convenience. +Marketing +Each season, we focus on presenting compelling brand stories and experiences for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms for the Crocs Brand and our versatile loafer silhouette for the HEYDUDE Brand. We continue to invest in globally integrated marketing campaigns, as well as designer, celebrity and influencer, and brand partnerships, ranging from popular artists like Luke Combs to a wide range of well-known brands such as 7-Eleven. Innovation is not only core to our brands’ values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our customers to give them new and innovative reasons to continue to choose the Crocs Brand and HEYDUDE Brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Environmental, Social, and Governance (“ESG”) Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry, for people, and for our planet. An explanation of our progress toward more transparent, socially conscious, and sustainable business practices will be provided in our fiscal year 2022 ESG report, which is expected to be published in the first half of 2023. Our ESG report will be made available on the Investor Relations section of our website located at www.investors.crocs.com. Except where specified otherwise, all information in the forthcoming ESG report and below ESG discussion pertains to Crocs, Inc. as of December 31, 2022. The content provided in our ESG Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +We intend to continuously advance our business practices towards our goal of consistently delivering products that exceed customer and consumer expectations with neither undue degradation to the planet nor harm to the communities with which we interact globally as part of our effort to create a more comfortable world for all. We believe the progress of our ESG efforts is +3 +Table of Contents +best understood by disclosing measurable and relevant goals and metrics, and, to this end, we continue to align our reporting with the Sustainability Accounting Standards Board (“SASB”) framework. +Environmental +We are committed to reducing our impact on the environment and are particularly focused on carbon reduction, sustainable operations, and product circularity. +In 2022, we completed our first Greenhouse Gas inventory of the Crocs Brand based on 2021 data. We are in the process of redefining our 2021 baseline to account for the HEYDUDE Brand and completing our 2022 Greenhouse Gas inventory for the full enterprise as we continue on our journey to Net Zero. In the past year, we continued the integration of a new, more sustainable bio-based alternative for our Croslite ™ materials in partnership with Dow Chemical’s new ECOLIBRIUM ™ Technology; renewed our membership with the Sustainable Apparel Coalition; and continued to enhance our tracking of our energy use, water use, and waste generation. More detail on these initiatives, as well as our ambitions, will be provided in our upcoming ESG report. +Social +As of December 31, 2022, we employed nearly 6,680 employees globally, including approximately 3,480 employees in our retail stores, 1,880 employees at our corporate/regional offices, and 1,320 employees at our distribution centers. +We believe we have among the most talented workforce in the footwear industry and continue to improve and implement new initiatives to remain an employer of choice across all of our businesses and geographies. These initiatives include pay transparency in hiring, offering employee training and developing leadership capabilities, enabling meaningful professional experiences, offering a compelling employee value proposition and fair wages, and creating a collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” Crocs, Inc. strives to create a culture of inclusion through progressive people-practices that support and empower all employees regardless of gender, age, race, ethnicity, national origin, disability, religion, immigration status, or sexual orientation, gender identity, or expressions. We are proud of the workplace culture we have created and will continue to engage our employees to hear where we still have room for improvement. To that end, our regular employee engagement scores continue to meet or surpass industry benchmarks and reflect a highly engaged global workforce. +Our efforts around inclusion, collaboration, and human rights extend through our supply chain. We work to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards, inclusive of occupational safety and chemical safety. In addition, we maintain numerous measures to ensure our supply chain complies with our Social Compliance Code of Conduct and Restricted Substances Policy, as well as with all local laws and customs regarding hiring practices, wages, and working conditions. +We also seek to extend the reach of our social and environmental standards through our global “Crocs Cares” program, through which we focus on providing shoes, funds, and employee time to support social inclusion and equality, and respond to our communities’ needs in times of crises. This is an ever-evolving program, informed by key stakeholder priorities. In 2022, Crocs, Inc. supported school students in the communities impacted by the Marshall Fire in Colorado, Ukrainian refugees, and frontline healthcare workers. Thanks to the generosity of our consumers and employees, we continued to generate donations to Feeding America, providing meals to families in need. +Governance +Strong corporate governance mechanisms, along with robust internal controls over our financial reporting framework, are the foundation for our ESG progress. In 2022, we formed an Environmental, Social, and Governance Steering Committee (the “ESG Committee”) of our board of directors (the “Board”), comprised of three independent directors, overseeing our ESG efforts and receiving quarterly updates on the development of our ESG program. Specifically, the ESG Committee assists the Board in (i) carrying out the responsibilities delegated by the Board regarding the review and oversight of our goals, policies, procedures and disclosures related to sustainability and ESG matters and (ii) its oversight of the sustainability and ESG matters material to us, our employees, our communities, and the planet. Additionally, we regularly review our Enterprise Risk Management and Ethics & Compliance program frameworks to account for our social and environmental risks and opportunities, specifically including those related to climate change. All material findings and updates are elevated to and discussed with our Board, which includes 38% female and 13% historically underrepresented racial/ethnic members as of +4 +Table of Contents +December 31, 2022. In 2022, Crocs, Inc. formalized its ESG/Sustainability department with a newly created VP, Global Head of Sustainability position reporting directly to our Chief Executive Officer. +We believe our employees are critical to the maintenance of strong corporate governance and, to that end, we continue to conduct annual in-person and online compliance trainings for all corporate employees, as well as retail and distribution center management. We also maintain a global ethics hotline, which is monitored by our Legal department, should any of our stakeholders identify concerns or have grievances. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 85 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our DTC channel includes e-commerce, in which we sell through company-operated e-commerce sites and third-party marketplaces, and retail, in which we sell through company-operated stores. +Wholesale Channel +During the years ended December 31, 2022, 2021, and 2020, 54.9%, 50.8%, and 50.0% of our consolidated revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors in certain countries, including partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +Direct-to-Consumer Channel +Our DTC channel includes company-operated e-commerce sites, third-party marketplaces, company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. During the years ended December 31, 2022, 2021, and 2020, 45.1%, 49.2%, and 50.0%, respectively, of our consolidated revenues were derived through our DTC channel. +E-commerce +As of December 31, 2022, we offered our products through 14 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Retail +With the continued worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2022, we had 340 and 5 company-operated stores for the Crocs Brand and HEYDUDE Brand, respectively. +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2022, we had 82 full-price Crocs Brand retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. As of December 31, 2022, we had 194 Crocs Brand outlet stores and 5 HEYDUDE Brand temporary clearance stores. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and +5 +Table of Contents +limited fixed cost and capital investment, we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2022, we had 64 Crocs Brand kiosks and store-in-store locations. +The following table illustrates the net change during 2022 in the number of our Crocs Brand company-operated retail stores by reportable operating segment and country: +December 31, 2021 Opened Closed December 31, 2022 +North America +United States 162 9 11 160 +Canada 8 — — 8 +Puerto Rico 3 — — 3 +Total North America +173 9 11 171 +Asia Pacific +Korea 89 1 1 89 +China 34 3 4 33 +Japan 13 1 1 13 +Singapore 17 — 1 16 +Total Asia Pacific 153 5 7 151 +EMEALA +Russia 26 2 28 — +Germany 14 — 3 11 +France 2 — — 2 +Austria 3 1 1 3 +The Netherlands 2 — — 2 +Total EMEALA +47 3 32 18 +Total 373 17 50 340 +During the year ended December 31, 2022, we opened 5 HEYDUDE Brand company-operated temporary clearance stores in the United States, all of which remained open as of December 31, 2022. We did not close any HEYDUDE Brand retail stores. +Business Segments and Geographic Information +We have four reportable operating segments. For the Crocs Brand, we have three reportable operating segments based on the geographic nature of our operations: North America, Asia Pacific, and EMEALA. Our HEYDUDE Brand also became a reportable segment on the Acquisition Date. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 17 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our reportable operating segments. +Raw Materials +Crocs Brand +Croslite™, our proprietary closed-cell resin material, incorporates the primary material formulations used in the vast majority of our Crocs Brand footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various ESG initiatives described in the previous section. +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +6 +Table of Contents +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +HEYDUDE Brand +The primary raw materials for the HEYDUDE Brand are fabrics, including polyester and cotton, Ethylene-vinyl acetate (“EVA”) insoles and outsoles, and other materials such as leather. We purchase this material from a select group of third-party sources, and we believe these materials are broadly available. +Sourcing +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in: +• Vietnam and China for the Crocs Brand. During the years ended December 31, 2022, 2021, and 2020, approximately 53%, 56%, and 75%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the vast majority of operations in Vietnam and China, produced approximately 42%, 34%, and 46% of our production during the years ended December 31, 2022, 2021, and 2020, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 27%, 30%, and 22% of our production during the years ended December 31, 2022, 2021, and 2020, respectively. +• China for the HEYDUDE Brand. +We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available. See the risk factor under “Risks Related to our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2022, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2022, we further expanded our U.S. distribution centers in Ohio and Nevada for the Crocs Brand and HEYDUDE Brand, respectively, to increase distribution capacity. Additionally, in 2022, we entered into a lease not yet commenced related to a new HEYDUDE distribution center in Nevada, which we plan to open in late 2023 to help support future growth. We also utilized third-party operated distribution centers located in the United States, Japan, China, Australia, Korea, Singapore, India, Brazil, and the United Kingdom. As of December 31, 2022, our company-operated warehouse and distribution facilities provided us with 3.2 million square feet, and our third-party operated distribution facilities provided us with 0.3 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +As a result of global industry-wide logistics challenges in 2021, we implemented several mitigating measures in 2022 including: (i) prioritizing top-selling products and narrowing product assortment, which has improved factory throughput, (ii) maintaining flexibility by leveraging air freight and reducing our dependency on congested West Coast ports in the United States by adding East Coast trans-shipment capabilities, and (iii) strategically allocating units and prioritizing our key growth initiatives. With the actions taken to date and our future plans, we believe we are well-positioned to withstand these supply challenges. See the risk factors under “Risks Related to our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results” and “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with distribution and logistics. +7 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks for the Crocs Brand include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. Our major trademarks for the HEYDUDE Brand include the HEYDUDE logo and word mark. The HEYDUDE word mark is registered in the U.S., the European Union, China, and Singapore, among others. Protection for the HEYDUDE logo has been filed in the U.S. and we intend to extend to foreign jurisdictions within the required time period. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, through litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our Crocs Brand footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our Crocs Brand products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components and confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our Crocs Brand products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution networks position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +8 +Table of Contents +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +ITEM 1A. Risk Factors +You should carefully consider the following risk factors and all other information presented within this Annual Report on Form 10-K. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, access to sources of financing, or stock price. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Because we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for us to predict all risk factors, nor can we assess the impact of all such risk factors on our business. Please also refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K. +Risks Related to Our Products +Our success depends substantially on the value of our brands; failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs and HEYDUDE brands. To be successful in the future, particularly outside of the U.S., where our brands may be less well-known or perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brands across all sales channels. We may have difficulty managing our brands’ image across markets and international borders as certain consumers may perceive our brands’ image to be out of style, outdated, or otherwise undesirable. Maintaining, promoting, and growing our brands will depend on our design and marketing efforts, including product innovation and quality, advertising and consumer campaigns, as well as our ability to adapt to a rapidly changing media environment, including our reliance on social media and digital dissemination of advertising campaigns. +In the past, several footwear companies, including ours, have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Consumer demand for our products and our brands’ equity could also diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. +Adverse publicity about regulatory or legal action against us, or by us, could also damage our reputation and brands’ image, undermine consumer confidence in us, and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Negative claims or publicity involving us, our products, or any of our key employees, endorsers, or business partners could materially damage our reputation and brands’ image, regardless of whether such claims are accurate. Social media, which accelerates and potentially amplifies the scope of negative publicity, can accelerate, and increase the impact of, negative claims. Further, business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brands and adversely impact our business. +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, less reliance on a small number of brands +9 +Table of Contents +or product lines, and spend substantially more on product marketing than we do. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, price their products more aggressively in the face of inflationary pressures, launch more extensive or diverse product lines, and more quickly develop new and popular products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Introducing new products may be difficult and expensive. If we are unable to do so successfully, our brands may be adversely affected, and we may not be able to maintain or grow our current revenue and profit levels. +To successfully continue to evolve our footwear product line to appeal to our consumers, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brands may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brands’ image may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles and product lines, and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses. There can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful or that we will dedicate our limited marketing resources to the right product lines. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position, and result in long-term harm to our business and financial results. +See also the risk factor under “HEYDUDE Acquisition Risks — Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE.” +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brands’ image, and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and design rights on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brands, our success, and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement or other infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others’ intellectual property rights, continued sales of such competing products by third parties could harm our brands or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, the integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite™ material formulations and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information, and other unpatented proprietary information. The agreements +10 +Table of Contents +we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement, and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Failure to continue to obtain or maintain high-quality endorsers of our products could harm our business . +We establish relationships with both celebrity endorsers and design, celebrity, and brand collaborators to develop, evaluate, and promote our products, as well as strengthen our brands. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brands’ visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers and collaborators associated with our products that harm the public image and reputations of those endorsers and collaborators could also seriously harm our brands’ image with consumers and, as a result, could have an adverse effect on our sales and financial condition. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear, such as our branded Croslite™ and LiteRide™ materials. Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite™, our branded proprietary closed-cell resin, is the primary raw material used in the vast majority of our Crocs Brand footwear and some of our accessories. Croslite™ is carefully formulated to create soft, durable, extremely lightweight, and water-resistant footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +Risks Related to the Economy +The COVID-19 pandemic has had an adverse impact, and may have a future material adverse impact, on our business, operations, liquidity, financial condition, and results of operations. +Since 2020, the COVID-19 pandemic has driven global uncertainty and disruption and has spread throughout the geographic regions in which we run our business and where our suppliers, third-party manufacturers, retail stores, wholesale customers, and consumers are located. While the vast majority of our company-operated stores, our partner stores, and our wholesale partner stores were open as of December 31, 2022, some may close again upon additional COVID-19 outbreaks. At this time, we cannot reasonably estimate the length of time of any remaining closures, if further closures will occur, or if consumers will return to purchasing our products at historical levels in retail locations. The inability to sell our products in our retail or wholesale channels has had and may continue to have a material adverse effect on our revenues and results of operations. +We also rely upon the facilities of our third-party manufacturers outside of the U.S. to support our business as well as to export our products throughout the world. As a result of COVID-19 and the measures designed to contain the spread of the virus, our third-party manufacturers have not had at times in the past, and may not have in the future, the materials, capacity, or capability to manufacture our products according to our schedule and specifications, which has in the past, and may in the future, negatively impact our ability to manage inventories. If our third-party manufacturers’ operations are curtailed, as they have been in the past, we may need to seek alternate manufacturing sources, which may be unavailable, be more expensive, or face the same constraints. Should any production and distribution closures continue for an extended period of time, the impact on our global supply chain could have a material adverse effect on our results of operations and cash flows. See the risk factor under “ Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside the U.S .” and “ Risks Related to Our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results ” for more information. +In addition, the COVID-19 pandemic has, among other things, caused global macroeconomic uncertainty, disrupted consumer spending and supply chains, contributed to various global shipping delays and port congestions, and created significant volatility and disruption of financial markets. Global supply chain disruptions during the year ended December 31, 2022 negatively impacted our gross margins and net income and could continue to do so in 2023 and beyond, which could have a material adverse effect on the business, financial condition, and results of operations. +11 +Table of Contents +The effects of COVID-19 could affect our ability to successfully operate in many ways, including, but not limited to, the following factors: +• the impact of the pandemic on the economies and financial markets of the countries and regions in which we operate; +• the impact on our supply chain, including, but not limited to, staffing shortages, cost inflation, and shipping delays; and +• operational risk, including, but not limited to, cybersecurity risks as a result of extended remote work arrangements and restrictions on employee travel. +The rapid development and fluidity of the pandemic precludes any prediction as to the ultimate impact of COVID-19. The full extent of the impact and effects of COVID-19 on our future business, operations, liquidity, financial condition, and results of operations continues to remain uncertain at this time. +Changes in global economic conditions, including, but not limited to, those driven by inflation, may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers, wholesalers, and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, increased labor costs, declines in asset values, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, public health issues like the COVID-19 pandemic, or other economic factors, certain of which effects, including cost inflation, we experienced in 2022 and currently expect to continue to experience in 2023. +Global inflation, elevated interest rates, global industry-wide logistics challenges, and foreign currency fluctuations resulting in a stronger U.S. Dollar (“USD”), have impacted, and we expect will continue to impact, our business, contributing to, among other things, incremental freight costs, increased wages, particularly in our distribution centers, and increased raw material costs. A stronger USD also results in costs for foreign goods purchased in USD but recognized in foreign currencies (“purchasing power”) that are unfavorable. +If global economic and financial market conditions deteriorate, or remain weak, for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results. See the risk factor “Changes in foreign exchange rates, most significantly but not limited to the Euro and South Korean Won, or other global currencies could have a material adverse effect on our business and financial results” for more information. +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers and cause reduced product orders or product order delays or cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• If consumer demand for our products declines, we may not be able to profitably operate existing retail stores, due to higher fixed costs of the retail business. +• A decrease in credit available to our wholesale or distributor customers, product suppliers, and other service providers, or financial institutions that are counterparties to our Revolving Facility (as defined herein) or derivative instruments may result in credit pressures, other financial difficulties, or insolvency for these parties, with a potential adverse impact on our business, our financial results, or our ability to obtain future financing. +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms, which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment of our accounts receivable. +• If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +12 +Table of Contents +• If we are unable to mitigate the impact of supply chain constraints and inflationary pressure through price increases or other measures, our results of operations and financial condition could be negatively impacted. Furthermore, even if we are able to raise the prices of our products, consumers might react negatively to such price increases, which could have a material adverse effect on, among other things, our brands, reputation, and sales. +The Federal Reserve recently raised interest rates multiple times in response to concerns about inflation and it may raise them again. Higher interest rates, coupled with reduced government spending and volatility in financial markets may also increase economic uncertainty and negatively affect consumer spending. Similarly, the ongoing war between Russia and Ukraine has created extreme volatility in the global capital markets and is expected to continue to have further global economic consequences, including disruptions of the global supply chain and energy markets. See “ The ongoing war between Russia and Ukraine could cause further disruptions in the global economy as well as a negative impact on our business, financial condition and results of operations .” Any such volatility and disruptions may adversely affect our business or the third parties on whom we rely. If the equity and credit markets deteriorate, including as a result of political unrest or war, it may make any necessary debt or equity financing more difficult to obtain in a timely manner or on favorable terms, more costly or more dilutive. Increased inflation rates have already, and may continue to, adversely affect us by increasing our costs, including labor and employee benefit costs. In addition, higher inflation and macro turmoil and uncertainty could also adversely affect our customers, which could reduce demand for our products. +The ongoing war between Russia and Ukraine could cause further disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations. +The ongoing war between Russia and Ukraine has adversely affected the global economy, resulted in heightened economic sanctions against Russia from the United States, the United Kingdom, the European Union, and the international community, and has resulted in geopolitical instability. As a result of the ongoing war between Russia and Ukraine, we stopped DTC business operations in Russia in early 2022. Even though revenues from Russia represented less than 3% of our consolidated revenues in 2021, the year prior to the war’s commencement, the impact of these government sanctions, as well as retaliatory actions taken by Russia and the United States and foreign government bodies have negatively impacted the global economy. This has driven increases to the cost of transportation, energy, and supplies and macro financial impacts resulting from the exclusion of Russian financial institutions from the global banking system, which have had, and could continue to have, a material adverse effect on our business, financial condition, results of operations, supply chain, intellectual property, partners, customers or employees and may expose us to adverse legal proceedings in Russia in the future. Further escalation of geopolitical tensions related to the war between Russia and Ukraine, including increased trade barriers or restrictions on global trade, could result in, among other things, broader impacts that expand into other markets, cyberattacks, supply chain and logistics disruptions, lower consumer demand, and changes to foreign exchange rates and financial markets, any of which may adversely affect our business and supply chain. +Risks Related to Our Supply Chain +Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs. +We rely on third-party manufacturers outside of the U.S. to produce our products. Global industry-wide logistics challenges negatively impacted us during the year ended December 31, 2022, during which some of our third-party factories in Vietnam and China were closed for several weeks due to COVID-19 outbreaks. Closures and factory disruptions may recur if additional COVID-19 break-outs occur in countries where we rely on third-party manufacturers to produce our products. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +We also rely on international shipping to transport our products to their various geographic markets. During the year ended December 31, 2022, international shipping to the U.S. was disrupted and delayed due to congestion in west coast ports. Continued or additional delays in shipping may cause us to have to use more expensive air freight or other more costly methods to ship our products. The ongoing COVID-19 pandemic and related governmental and port facility actions have caused delays in shipments of our products. During the year ended December 31, 2022, our third-party manufacturers, distribution centers, where we manage our inventory, and our third-party partners experienced disruptions that impacted our supply chain and increased global lead-time for our products, including port congestion, temporary closures, and worker shortages. Additionally, as a consequence of the COVID-19 pandemic, reductions in the number of ocean carrier voyages and capacity have delayed the arrival of imports and increased ocean transport costs globally. Ongoing ocean carrier consolidations, reduced capacity, congestion at major international gateways, and other economic factors are currently making ocean transportation increasingly difficult and unpredictable. Further, in the U.S., trucking costs have risen dramatically due to driver shortages, increased labor costs, and safety, environmental, and labor regulations. As supply chain disruptions continue and we manage product availability, the timing of sales to our wholesale partners and consumers may continue to be impacted, and we face increased +13 +Table of Contents +risk of order cancellations. In addition, global inflation has contributed to already higher incremental freight costs and such inflation may continue to result in higher freight costs. Failure to adequately produce and timely ship our products to customers could lead to lost potential revenue, failure to meet customer demand, strained relationships with customers, including wholesalers, and diminished brand loyalty. +Despite our actions to mitigate these impacts, we were negatively impacted by global logistics challenges in 2022 and still expect to be negatively impacted by these challenges in 2023. For example, during the year ended December 31, 2022, we expended $67 million on an air freight program initiated as a result of partial COVID-19-related factory closures in Vietnam at the end of 2021. +However, our inventory in transit at December 31, 2022 was significantly higher than our inventory in transit at the year ended December 31, 2021, and these pressures have negatively impacted our gross margin and net income and may continue to do so in future periods. At December 31, 2022, our inventories balance was $471.6 million. While the majority of the total increase in inventories of 120.8% over December 31, 2021 was due to the addition of the HEYDUDE Brand in the first quarter of 2022, inventories for the Crocs Brand were also up 41.9% compared to the prior year. Throughout 2021 and into the first half of 2022, inventories were historically lean across the footwear industry as a result of factory closures and other supply chain delays, as described above. However, in recent months, elevated inventory levels have caused the industry, including us, to become more promotional, which has impacted gross margins on the impacted products. This is particularly true in North America. We expect these challenges to remain fluid as macroeconomic and inflationary pressures continue and foreign exchange rates fluctuate. +We depend solely on third-party manufacturers located outside of the U.S. +All of our footwear products are manufactured by third-party manufacturers, the majority of which are located in Vietnam, Indonesia, and China. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity, and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders. During the years ended December 31, 2022, 2021, and 2020, approximately 53%, 56%, and 75%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the vast majority of operations in Vietnam and China, produced approximately 42%, 34%, and 46% of our production during the years ended December 31, 2022, 2021, and 2020, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 27%, 30%, and 22% of our production during the years ended December 31, 2022, 2021, and 2020, respectively. During the Partial Period, the majority of production was in China for the HEYDUDE Brand. Furthermore, because our third-party manufacturers are concentrated in Asia, we may be subject to an increased risk of supply chain disruption, particularly in the event of a natural disaster, pandemic, such as the COVID-19 pandemic, epidemic, geopolitical tension, or other event impacting the region outside of our control. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines, or meet our quality standards. Furthermore, due to the relative concentration of our third-party manufacturers, disruption at the facilities of our third-party manufacturing partners as a result of COVID-19 or otherwise, including through the effects of facility closures, reductions in operating hours and labor shortages had an adverse effect on our supply chain in 2021 and 2022 and may have a material adverse effect in the future. For example, at the end of 2021 and into the first quarter of 2022, many of our third-party manufacturing facilities in Vietnam were closed or not operating at full capacity due to local COVID-19 outbreaks and safety protocols, which negatively impacted our financial results. See the risk factor under “ Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” and “Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results.” +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, including those caused by the COVID-19 pandemic, work stoppages, political instability, including the ongoing war between Russia and Ukraine, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, cost inflation, changes in governmental policies or laws, and the imposition of tariffs, import and export controls, and other barriers. Because we do not manufacture products internally, we cannot offset any interruption or decrease in supply of our products by increasing production in internal manufacturing facilities, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. For example, during the year ended December 31, 2022, we incurred approximately $67 million on an air freight program initiated as a result of partial COVID-19-related factory closures in Vietnam at the end of 2021. The cost of fuel is a +14 +Table of Contents +significant component in transportation costs. Increases in the price of petroleum products can increase our transportation costs and adversely affect our product margins. +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, changes in legislation and policies, increases in labor costs, changes in international trade agreements and tariffs, adverse weather conditions, or public health issues, such as the COVID-19 pandemic, could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. +We, similar to many other companies with overseas operations, import and sell products in other countries that could be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition, and results of operations. See the risk factor under “Risks Related to International Operations — We conduct significant business activity outside the U.S., which exposes us to risks of international commerce.” +Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results. +Our operations have been, and may continue to be, impacted by supply chain constraints and raw material shortages, resulting in increased material costs, longer lead times, port congestion, and increased freight costs caused, in part, by the COVID-19 pandemic, the uncertain economic environment, and macroeconomic trends. In addition, current or future governmental policies may increase the risk of inflation, which could further increase the costs of raw materials and components for our business. Similarly, if costs of goods continue to increase, our suppliers may seek price increases from us. If we are unable to mitigate the impact of supply chain constraints and inflationary pressure through price increases or other measures, our results of operations and financial condition could be negatively impacted. Even if we are able to raise the prices of our products, consumers might react negatively to such price increases, which could have a material adverse effect on, among other things, our brands, reputation, and sales. If our competitors substantially lower their prices, we may lose customers and mark down prices. Our profitability may be impacted by lower prices, which may negatively impact gross margins. Even though we are working to alleviate supply chain constraints through various measures, we are unable to predict the impact of these constraints on the timing of revenue and operating costs of our business in the near future. Raw material supply shortages and supply chain constraints, including cost inflation, have impacted and could continue to negatively impact our ability to meet increased demand, which in turn could impact our net sales revenues and market share. In addition, COVID-19-related closures negatively impacted our supply chain in Vietnam in the first quarter of 2022 and in China in the second quarter of 2022. We expect the situation to remain fluid as COVID-19 break-out rates, including any deterioration in circumstances related to COVID-19 variants, and foreign exchange rates fluctuate, and inflationary pressure continues. See the risk factor under “Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs.” +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting consumer demand. In addition, purchase orders from our wholesale customers are generally subject to rights of cancellation and rescheduling by the wholesaler. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in losses or lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in lower sales, delays in shipments to customers, and expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. Excess inventory, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our third-party manufacturing operations must comply with labor, trade, and other laws. Failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental, and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brands, and discourage customers from buying our +15 +Table of Contents +products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall, which could result in critical media coverage; harm our business, brands, and reputation; and cause us to incur additional costs. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business or results. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +For example, China’s Xinjiang Uyghur Autonomous Region (the “XUAR”) is the source of large amounts of cotton and textiles for the global apparel and footwear supply chain. The United States Treasury Department placed sanctions on China’s Xinjiang Production and Construction Corporation (“XPCC”) for serious human rights abuses against ethnic minorities in XUAR. Additionally, the Uyghur Forced Labor Prevention Act (“UFLPA”), empowers the U.S. Customs and Border Protection Agency (the “U.S. CBP”) to withhold release of items produced in whole or in part in the XUAR, or produced by companies included on a government-created UFLPA entity list, creating a presumption that such goods were produced using forced labor. XPCC controls many of the cotton farms and much of the textile industry in the region, and many large factories in XUAR produce fabrics and yarn for apparel and footwear. +Although we do not believe that our suppliers source materials from such area of China for the products they sell to us or use to manufacture our products, we have no known involvement with XPCC or its subsidiaries and affiliates, and we prohibit our suppliers from doing business with XPCC or using forced labor, we do not have the ability to completely map our supply chain, and we could be subject to penalties, fines or sanctions if any of the suppliers from which we purchase goods is found to have dealings, directly or indirectly, with XPCC or entities it controls. Additionally, our products or materials (including potentially non-cotton materials) could be held or delayed by the U.S. CBP, which would cause delays and unexpectedly and negatively affect our inventory levels. Even if we were not subject to penalties, fines or sanctions, if products we source are linked in any way to XPCC, the XUAR, or an entity on the UFLPA entity list, our reputation could be damaged. In addition, the UFLPA has induced greater supply chain compliance costs and delays to us and to our suppliers. Compliance with the UFLPA could continue to affect the global supply chain, the price and scarcity of traceable cotton in the marketplace and could lead to an increase in our cost of goods sold, which may have an adverse effect on our profitability. +See the risk factor under “ Risks Related to International Operations — We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. ” +We depend on a number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite™ and LiteRide™ formulations, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market conditions related to supply and demand for our raw materials and any resulting shortages in supply, as well as impacts of any global shipping or logistics delays. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins, or if we are unable to procure sufficient quantities of the materials that go into the Croslite™ and LiteRide™ formulations, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +16 +Table of Contents +Risks Related to International Operations +Changes in foreign exchange rates, most significantly but not limited to the Euro and South Korean Won, or other global currencies could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the USD. We are exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of operations and the value of our assets and liabilities denominated in foreign currencies. +In accordance with our operating practices, we hedge a significant portion of our foreign currency transaction exposures arising in the ordinary course of business to reduce risks in our cash flows and earnings. We use cash flow hedges to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. Currency forward agreements involve fixing the exchange rates for delivery of a specified amount of foreign currency on a specified date. The currency forward agreements are typically settled in USD for their fair value at or close to their settlement date. We may also use currency option contracts under which we will pay a premium for the right to sell a specified amount of a foreign currency prior to the maturity date of the option. Our hedging strategy may not be effective in reducing all risks, and no hedging strategy can completely insulate us from foreign exchange risk. Further, our use of derivative financial instruments may expose us to counterparty risks. Although we only enter into hedging contracts with counterparties having investment grade credit ratings, it is possible that the credit quality of a counterparty could be downgraded or a counterparty could default on its obligations, which could have a material adverse impact on our financial condition, results of operations, and cash flows. +Further, our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, gross margin compression, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. For the Crocs Brand, we pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. In 2022, we experienced decreases of approximately $2.6 million in our North America segment revenues, primarily as a result of decreases in the value of the Canadian Dollar relative to the USD, approximately $41.0 million in our Asia Pacific segment revenues as a result of decreases in the value of Asian currencies, primarily the South Korean Won, relative to the USD, and approximately $60.1 million in our EMEALA revenues, primarily as a result of decreases in the Euro relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies, adversely impacts our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and, as a result, our forward contracts may not prove effective in reducing our exposures. +We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. We operate retail stores and sell our products to retailers outside of the U.S. and utilize foreign-based third-party manufacturers. Foreign manufacturing and sales activities are subject to numerous risks, including: +• tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; +• delays associated with the manufacture, transportation, and delivery of products, including related to global port backlog or congestion; +• increased transportation costs due to distance, energy prices, inflation, or other factors; +• delays in the transportation and delivery of goods due to increased security concerns; +• restrictions on the transfer of funds; +• restrictions and potential penalties due to privacy laws on the handling and transfer of consumer and other personal information; +17 +Table of Contents +• changes in governmental policies and regulations; +• political unrest, such as the ongoing war between Russia and Ukraine, changes in law, terrorism, natural disasters, public health issues like the COVID-19 pandemic, or war, any of which can interrupt commerce; +• potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; +• expropriation and nationalization; +• difficulties in managing foreign operations effectively and efficiently from the U.S.; +• difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions; +• longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; +• difficulties in enforcing contractual and intellectual property rights; +• greater risk that our business partners do not comply with our policies and procedures relating to labor, health, and safety; +• UFLPA detentions by U.S. Customs resulting in revenue loss and adverse media exposure; and +• increased accounting and internal control costs. +In addition, we are subject to customs laws and regulations with respect to our export and import activity, which are complex and vary within legal jurisdictions in which we operate. We cannot ensure there will not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. For example, on December 23, 2021, the UFPLA, which effectively prohibits imports of any goods made either wholly or in part in a certain area of China, was signed into law, which generally prohibits importing goods made with forced labor into the U.S., subject to certain exceptions. While we do not currently expect that this law will directly affect our supply chain, since we do not believe that our suppliers source materials from such area of China for the products they sell to us or use to manufacture our products, other companies’ attempts to shift suppliers in response to this law or other policy developments could result in, among other things, shortages, delays, and/or price increases that could disrupt our own supply chain or cause our suppliers to renegotiate existing arrangements with us or fail to perform on such obligations. In addition, the ongoing war between Russia and Ukraine has adversely affected the global economy, resulted in heightened economic sanctions against Russia from the United States, the United Kingdom, the European Union, and the international community, and has resulted in geopolitical instability. For more information, please see the risk factors under “Risks Related to the Economy — The ongoing war between Russia and Ukraine could cause further disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations,” “Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside the U.S.,” “ Risks Related to our Supply Chain — Our third-party manufacturing operations must comply with labor, trade, and other laws. Failure to do so may adversely affect us ,” and “Risks Specific to Our Company and Strategy — Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results” +Furthermore, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties; criminal sanctions against us, our officers, or our employees; prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries; and a materially negative effect on our brands and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners, or agents will not violate our policies. +18 +Table of Contents +Risks Specific to Our Company and Strategy +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brands’ image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. We are focusing on our core casual footwear heritage by narrowing our product line with an emphasis on higher margin products, as well as developing innovative new casual lifestyle footwear platforms. +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow and integrate HEYDUDE. If we are unsuccessful at, among other things, building HEYDUDE’s brand awareness, enhancing its digital capabilities, leveraging our wholesale relationships to enhance distribution, investing in HEYDUDE’s infrastructure as well as sales and business operations, integrating employees into our company culture, leveraging our distribution for global growth and/or investing to scale our supply chain and gain efficiencies, our sales could be adversely affected, and our business could suffer. In addition, HEYDUDE’s product sales may not meet our expectations. See the risk under “HEYDUDE Acquisition Risks — Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE.” +Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to +• strengthen and maintain our brands; +• focus on relevant geographies and markets, product innovation, and profitable growth, while maintaining demand for our current offerings; +• effectively manage our company-operated retail stores to meet operational and financial targets at the retail store level; +• accurately forecast the global demand for our products, consolidate our distribution and supply chain network to leverage resources, simplify our fulfillment process, and deliver product around the globe efficiently; +• use and protect the Crocs and HEYDUDE brands and our other intellectual property in new and existing markets and territories; +• achieve and maintain a strong competitive position in new and existing markets; +• attract and retain qualified wholesalers and distributors, including partner store operators; +• maintain and enhance our digital marketing capabilities and digital commerce capabilities; and +• execute multi-channel advertising, marketing, collaboration, and social media campaigns to effectively communicate our message directly to our consumers and employees. +While these strategies, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance this will be the case or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results. +We rely heavily on the use of information technology systems and networks across all business functions, as do our business partners. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We rely on third-party information services providers worldwide for many of our information technology functions including network, hardware, and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing, and collection of payments. We use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. We also have outsourced a significant +19 +Table of Contents +portion of work associated with our finance and accounting, human resources, customer service, and other information technology functions to third-party service providers. Despite our current security and cybersecurity measures, our systems and those of our third-party service providers may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, ransomware attacks, and interruption or loss of valuable business data, and we have been subject to, and will continue to be subject to, various third-party attacks and phishing scams. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of sales, significant costs for data restoration, the inability to interpret data timely to enhance operations, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks on a daily basis. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers’ or employees’ personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network is breached, it could give rise to unwanted media attention, materially damage our customer relationships, or harm our business, our reputation, and our financial results, which could result in fines or lawsuits. The costs we incur to protect against such information security breaches may materially increase, including increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. Our business partners in our supply chain and customer base also rely significantly on information technology. Despite their existing cybersecurity procedures and controls, if their information systems become compromised, it could, among other things, cause delays in our product fulfillment or reduce our sales, which could harm our business. +In addition, the European Union’s General Data Protection Regulation, the California Consumer Privacy Act, and other similar evolving privacy laws impose additional obligations on companies regarding the handling of personal data and provide certain individual privacy rights to persons whose data is stored. These regulations may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations, and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes and the associated costs may have a material adverse impact on our business and results of operations. +If our online e-commerce sites, or those of our customers, do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites and third-party e-commerce sites. Any failure on our part or on the part of third parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our products could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including unauthorized access and denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Our financial success depends in part on the strength of our relationships with, and the success of, our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributor customers to carry our products. We do not have long-term contracts with most wholesale customers, and sales to these customers are generally on an order-by-order basis and subject to cancellation and rescheduling. Our contracts with distributors typically have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms, which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses, and reduced cash flows if our collection efforts are unsuccessful. We have recorded material allowances for doubtful accounts in the past and could do so again in the future. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations, and our ability to grow our product line. +20 +Table of Contents +Operating company-operated retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably, or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location, and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2022, we opened 22 and closed 50 retail stores, and we operated 345 retail stores at December 31, 2022. +Many of our company-operated retail stores are located in shopping malls and outlet malls, and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot-traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick-and-mortar retail to e-commerce channels, both prior to, and as a result of, the COVID-19 pandemic, which may contribute to declining foot-traffic in company-operated retail locations. Continued reduced customer foot-traffic could reduce sales at our company-operated retail stores, including kiosks and store-in-store locations, or hinder our ability to open retail stores in new markets, which could in turn negatively affect our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism, resulting from an economic slowdown, political, terrorism, social, or military events, natural disasters, public health issues like the COVID-19 pandemic, or otherwise, is likely to adversely affect sales in our existing stores. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, expansion of existing businesses or operations, and acquisitions of new businesses, such as HEYDUDE, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect, or implementation issues, or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back-office systems. We have also moved to, and subsequently expanded, a new distribution center in Dayton, Ohio to serve our North American businesses for the Crocs Brand, and have moved to a new company-operated distribution center in the Netherlands and a new third-party operated distribution center in Japan to serve our EMEALA and Asia Pacific businesses, respectively, for the Crocs Brand. Additionally, we have expanded our HEYDUDE Brand distribution center in Las Vegas, Nevada, and we are further expanding our distribution capabilities of the HEYDUDE Brand by constructing a distribution facility in Nevada set to open in late 2023. As our business grows, we may also need to make further investments in business systems and distribution capabilities. Issues in implementing or integrating new business operations, such as HEYDUDE, and new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, issues with transitioning to or operating our new distribution centers, cost overruns, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations, require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +21 +Table of Contents +We depend on employees across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +Further, our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threats to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing, or manufacturing and selling seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +We are subject to periodic litigation, which could result in unexpected expenditures of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings, or any future legal proceedings, could have an adverse impact on our business and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +Global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations, could negatively impact our operating results and financial condition. +The effects of climate change, natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, and public health issues like the COVID-19 pandemic, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including damage to our supply chain, such as availability of raw materials, increased manufacturing costs and disruptions to productivity of our third-party manufacturers, manufacturing or distribution centers, or retail stores, changes in consumer preferences or spending priorities, and energy shortages, have in the past and could in the future harm or disrupt our operations or the operations of our vendors, other suppliers, or customers, or result in economic instability that may negatively impact our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. Many governmental and other regulatory bodies worldwide are enacting regulations to mitigate the impacts of climate change. If we, our suppliers, or our third-party manufacturers are required to comply with these laws and regulations, or if we choose to take additional voluntary steps to reduce or mitigate our impact on the climate, we may experience increased costs for energy, production, transportation, and raw materials, increased capital expenditures, or increased insurance premiums and deductibles, each of which could adversely impact our operations. In addition, inconsistent regulations among jurisdictions may also affect our cost to comply with such laws and regulations. Any assessment of the potential impact of future climate change legislation, regulations, or industry standards, as well as any international treaties and accords, is uncertain given the wide scope of potential regulatory change in the countries in which we operate. +In 2021, we made a public commitment regarding a plan to be Net Zero by 2030. Although we intend to meet these commitments, we may be required to expend significant resources to do so, which could increase our operational costs. Further, there can be no assurance of the extent to which our commitment will be achieved, or that any future investments we make in furtherance of achieving such target and goal will meet investor expectations or legal standards, if any, regarding sustainability performance. As our business context continues to change, such as with the acquisition of HEYDUDE, we will continue to evaluate pathways and feasibility of our carbon reduction journey. Moreover, we may determine that it is in the best interest of +22 +Table of Contents +our Company and our stockholders to prioritize other business, social, governance or sustainable investments over the achievement of our current commitments based on economic, technological developments, regulatory and social factors, business strategy or pressure from investors, activist groups or other stakeholders. If we are unable to meet these commitments, then we could incur adverse publicity and reaction from investors, activist groups or other stakeholders, which could adversely impact the perception of us and our products and services by current and potential customers, as well as investors, which could in turn adversely impact our results of operations. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware law contain provisions that could discourage a third-party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +Increasing scrutiny from investors, regulators, and other key stakeholders with respect to our ESG practices may impose additional costs on us or expose us to new or additional risks. +Investor advocacy groups, certain institutional investors, investment funds, stockholders, customers, consumers and regulators, such as the SEC, are increasingly focused on corporate responsibility, specifically on the ESG practices of companies. These parties have placed increased importance on the implications of the social cost of their investments. From time to time, we communicate certain ESG initiatives and goals to market participants and our customers and business partners. Any corporate responsibility disclosure we make may include our policies, practices, initiatives, and goals on a variety of social and ethical matters, corporate governance, environmental compliance, sustainability, employee health and safety practices, human capital management, product quality, supply chain management, and workforce inclusion and diversity. Although we have undertaken significant efforts to improve and implement our ESG initiatives, it is possible that the aforementioned parties may not be satisfied with such disclosures, our ESG practices, or the speed with which we adopt and/or implement our plans. Moreover, the preparation of sustainability metrics requires management to establish criteria, make determinations as to the relevancy of information to be included, and make assumptions that affect reported information. The selection by management of different but acceptable measurement techniques could result in materially different amounts or metrics being reported. If our ESG practices do not meet investor or other stakeholder expectations and standards, which continue to evolve, or if we are perceived or deemed to have not appropriately responded to the growing concern for ESG issues, regardless of whether there is a legal requirement to do so, we may suffer from reputational damage from stakeholders and consumers and our business and financial condition could be materially and adversely affected. We may also incur additional costs or require additional resources to monitor such stakeholder expectations and standards and to meet our targets and commitments. Further, we could fail, or be perceived to fail, to achieve our ESG initiatives or goals, or we could fail to fully and accurately report our progress on such initiatives and goals, which could negatively impact our business. +Indebtedness Risks +Our senior revolving credit facility agreement (as amended to date, the “Revolving Credit Agreement”), the Term Loan B Credit Agreement, and the Indentures each impose significant operating and financial restrictions on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities. A breach of any of those restrictive covenants may cause us to be in default under the Revolving Credit Agreement, the Term Loan B Credit Agreement and/or the Indentures, and our lenders could foreclose on our assets. +Our Revolving Credit Agreement requires us to maintain certain financial covenants. A decline in our operating performance could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Revolving Credit Agreement. We may not have sufficient funds to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lenders. If we are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Revolving Credit Agreement. The foregoing risks also apply to the Term Loan B Credit Agreement. +The Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Indentures also contain certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt or issue +23 +Table of Contents +preferred stock; sell, lease or transfer our assets; pay dividends on, and make other distributions on, or redeem or repurchase, our common stock; make certain capital expenditures and investments; guarantee debt or obligations; create certain liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, incur or guarantee additional debt, incur certain liens, enter into transactions with affiliates, transfer or sell certain assets, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. The terms of any future indebtedness we may incur could include more restrictive covenants. We cannot assure you that we will be able to maintain compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the lenders and/or amend the covenants. Our failure to comply with the restrictive covenants described above as well as other terms of our indebtedness could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms or cannot refinance these borrowings, our results of operations and financial condition could be adversely affected. +Our indebtedness could adversely affect our business, financial condition, and results of operations, as well as the ability to meet payment obligations under our Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Notes. +As of December 31, 2022, we had $2,322.4 million in total indebtedness outstanding (net of $57.0 million of unamortized issuance costs related to the issuance of the Notes). To finance the Acquisition in part, we entered into an agreement (the “Term Loan B Credit Agreement”) with respect to a new senior secured term loan B facility in an aggregate principal amount equal to $2.0 billion (the “Term Loan B Facility”) and borrowed $50.0 million under the Revolving Facility. Subject to the limits contained in the Revolving Credit Agreement, the Indentures, the Term Loan B Credit Agreement and the applicable agreements governing our other existing indebtedness, we may be able to incur substantial additional debt from time to time. If we do so, the risks related to our level of debt could increase. Specifically, our level of debt could have important consequences, including the following: +• making it more difficult for us to meet our obligations with respect to our debt; +• reducing the availability of cash flow to fund future working capital, capital expenditures, acquisitions or other general corporate purposes; +• limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate purposes; +• requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions or other general corporate purposes; +• increasing our vulnerability to general adverse economic and industry conditions; +• exposing us to the risk of increased interest rates as certain of our borrowings are at variable rates of interest; +• placing us at a disadvantage compared to other, less leveraged competitors; +• increasing our cost of borrowing; and +• limiting our flexibility in planning for changes in our business and reacting to changes in the industry in which we compete. +Furthermore, if we are unable to meet our debt service obligations or should we fail to comply with our financial and other negative covenants contained in the agreements governing our indebtedness, we may be required to refinance all or part of our debt, sell important strategic assets at unfavorable prices, incur additional indebtedness or issue common stock or other equity securities. We may not be able to, at any given time, refinance our debt, sell assets, incur additional indebtedness or issue equity securities on terms acceptable to us, in amounts sufficient to meet our needs. If we are able to raise additional funds through the issuance of equity securities, such issuance would also result in dilution to our stockholders. Our inability to service our obligations or refinance our debt could have a material and adverse effect on our business, financial condition or operating results. In addition, our debt obligations may limit our ability to make required investments in capacity, technology, or other areas of our business, which could have a material adverse effect on our business, financial condition, or operating results. +Any of these factors could have an adverse effect on our business, financial condition, and results of operations and our ability to meet our debt payment obligations. See also “HEYDUDE Acquisition Risks — The incurrence by us of substantial indebtedness in connection with the financing of the Acquisition may have an adverse impact on our liquidity, limit our +24 +Table of Contents +flexibility in responding to other business opportunities, and increase our vulnerability to adverse economic and industry conditions.” +Despite our current level of indebtedness, we may be able to incur substantially more debt, which could increase the risks to our financial condition described above. +We may be able to incur substantial additional indebtedness in the future, such as the debt we incurred to finance the Acquisition in part. Although certain of the agreements governing our existing indebtedness contain restrictions on the incurrence of additional indebtedness and entering into certain types of other transactions, these restrictions are subject to a number of qualifications and exceptions, including compliance with various financial conditions. Additional indebtedness incurred in compliance with our existing debt instruments could be substantial. To the extent new debt is added to our current debt levels, the substantial leverage risks described in the immediately preceding risk factor would increase. +As of December 31, 2022, we had approximately $2,322.4 million in total indebtedness outstanding (net of $57.0 million of unamortized issuance costs related to the issuance of the Notes), including $1,675.0 million outstanding on the Term Loan B Facility. We had no borrowings outstanding under the Revolving Facility, with total borrowing capacity of approximately $748.7 million thereunder (including $1.3 million of letters of credit outstanding as of such date). +Financial and Accounting Risks +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows, or the closure of a store could result in impairment of leasehold improvements, impairment of right-of-use assets, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. Impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +We may incur impairments of the carrying value of our goodwill and other intangible assets, which could have a material adverse effect on our business and financial results. +In connection with the Acquisition, we allocated approximately $713.3 million and $1,780.0 million to goodwill and indefinite-lived intangible assets, respectively. These assets are tested for impairment at least annually, using estimates and assumptions affected by factors such as economic and industry conditions and changes in operating performance. Additionally, in conjunction with the impairment tests, we also reassess the indefinite-life classification. Potential resulting charges from an impairment of goodwill or our indefinite-lived intangible, as well as reclassification of an indefinite-lived to a definite-lived intangible, could have a material adverse effect on our business and results of operations. +The testing of our goodwill for impairment is predicated upon our determination of our reporting units. Any change to the conclusion of our reporting units or the aggregation of components within our reporting units could result in a different outcome to our annual impairment test. Although the fair values of our HEYDUDE Brand reporting unit goodwill and indefinite-lived intangible assets are either equal to or in excess of their carrying values, the fair values are sensitive to the aforementioned potential unfavorable changes that could have an adverse impact on future analyses. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 5 — Goodwill and Intangible Assets, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, which could increase the volatility of the price of our common stock. +Quarterly results may also fluctuate as a result of several factors, including new style introductions, general economic conditions, or changes in consumer preferences. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any other year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +25 +Table of Contents +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S., our business, and financial results. +We have substantial cash requirements in the U.S., but a significant portion of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested, and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the U.S. Tax Cuts and Jobs Act, could be repatriated without incurring additional U.S. federal income taxes, although some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the U.S. and foreign jurisdictions for prior tax years. Please refer to Note 14 — Income Taxes and Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details regarding current tax audits. The final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. Recent developments, including the Inflation Reduction Act, the European Commission’s investigations of local country tax authority rulings and whether those rulings comply with European Union rules on state aid, as well as the Organization for Economic Co-operation and Development’s project on Base Erosion and Profit Shifting, continue to change long-standing tax principles. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly, and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +HEYDUDE Acquisition Risks +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE. +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE. Combining with Crocs, Inc. may not accelerate the growth and success of HEYDUDE, and the HEYDUDE business may not perform as expected. If we are unsuccessful at, among other things, building HEYDUDE’s brand awareness, enhancing its digital capabilities, leveraging our wholesale relationships to enhance distribution, investing in HEYDUDE’s infrastructure as well as sales and business operations, leveraging our distribution for global growth and/or investing to scale our supply chain and gain efficiencies, our sales could be adversely affected, and our business could suffer. In addition, HEYDUDE’s product sales may not meet our expectations. +Moreover, HEYDUDE depends on a limited number of third-party manufacturers that are concentrated in China to produce its +products. Due to the relative concentration of HEYDUDE’s third-party manufacturers, disruption at the facilities of such third-party manufacturing partners as a result of COVID-19 or otherwise, including through the effects of facility closures, reductions in operating hours and labor shortages may have a material adverse effect in the future. See the risk factors under “ Risks +26 +Table of Contents +Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs ,” “ Risks Related to Our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results ,” and “ Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S. ” +Further, our ability to realize the benefits from the Acquisition may be dependent on the savings resulting from the timely and effective integration of the operations of the Crocs and HEYDUDE Brands. The process of integrating the operations of the Crocs and HEYDUDE Brands could encounter unexpected costs and delays, which include: the loss of key personnel; the loss of key customers; the loss of key suppliers; and unanticipated issues in integrating sales, marketing, and administrative functions. If we are unable to timely and effectively integrate the operations of the Crocs and HEYDUDE Brands, our costs could be adversely affected, and our business could suffer. +The incurrence by us of substantial indebtedness in connection with the financing of the Acquisition may have an adverse impact on our liquidity, limit our flexibility in responding to other business opportunities, and increase our vulnerability to adverse economic and industry conditions. +We incurred a significant amount of indebtedness in connection with the financing of the Acquisition, which was funded, in part, using borrowings under the Term Loan B Facility in an aggregate principal amount equal to $2.0 billion. The use of indebtedness to finance the Acquisition reduced our liquidity and could cause us to place more reliance on cash generated from operations to pay principal and interest on our debt, thereby reducing the availability of our cash flow for working capital and capital expenditure needs or to pursue other potential strategic plans. The agreements we entered into with respect to the indebtedness we incurred to finance the Acquisition contain certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt or issue preferred stock; sell, lease or transfer our assets; pay dividends on, and make other distributions on, or redeem or repurchase, our common stock; make certain capital expenditures and investments; guarantee debt or obligations; create certain liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, incur or guarantee additional debt, incur certain liens, enter into transactions with affiliates, transfer or sell certain assets, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. Our ability to comply with these negative covenants can be affected by events beyond our control. In addition, a breach of the negative covenants could result in an event of default with respect to the indebtedness, which, if not cured or waived, could result in the indebtedness becoming immediately due and payable and could have a material adverse effect on our business, financial condition, or operating results. +ITEM 1B. Unresolved Staff Comments +None. +27 +Table of Contents +ITEM 2. Properties +Our principal executive and administrative offices are located at 13601 Via Varra, Broomfield, Colorado 80020. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for office, warehouse, and retail, including kiosk and store-in-store, space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations and expire at various dates through the year 2033. The general location, use, and approximate size of our principal properties, as well as the reportable operating segment that utilizes each property, are given below. +Location Reportable Operating Segment(s) Use Approximate Square Feet +Dayton, Ohio North America Distribution center 2,037,000 +Dordrecht, the Netherlands EMEALA Distribution center 517,000 +Las Vegas, Nevada HEYDUDE Brand Distribution center 456,000 +Rotterdam, the Netherlands EMEALA Warehouse 172,000 +Broomfield, Colorado (1) +North America Regional office and Crocs Brand headquarters 88,000 +Oudenbosch, the Netherlands EMEALA Warehouse 75,000 +Hoofddorp, the Netherlands EMEALA Regional office 47,000 +Westwood, Massachusetts North America, HEYDUDE Brand Regional office and HEYDUDE Brand headquarters 23,000 +Singapore Asia Pacific Regional office 17,000 +(1) In 2021, we entered into a lease to move our corporate headquarters to a new location, also in Broomfield, Colorado, with an approximate size of 190,000 square feet. During 2022, we gained access to and began construction on the new location. We plan to complete the move of our corporate headquarters in 2023. +We believe these properties, particularly our distribution centers and warehouses, along with various third-party distribution centers not included above, are adequate for our operations. Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operational needs. We also lease 345 retail locations worldwide as of December 31, 2022. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +A discussion of legal matters is found in Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +ITEM 4. Mine Safety Disclosures +Not applicable. +28 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the Nasdaq Global Select Market under the stock symbol “CROX.” +Performance Graph +The following performance graph illustrates a five-year comparison from December 31, 2017 through December 31, 2022 of cumulative total return of our common stock, compared to the Nasdaq Composite Total Return Index and the Dow Jones U.S. Footwear Total Return Index, both of which are new published industry indices we have selected to use beginning this year, and compared to the Nasdaq Composite Index and the Dow Jones U.S. Footwear Index, the published industry indices we previously used for the purposes of this disclosure. We believe each of the Nasdaq Composite Total Return Index and Dow Jones U.S. Footwear Total Return Index better reflects the market in which we operate and the companies with which we compete. The graph assumes an investment of $100.00 on December 31, 2017 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Total Return Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. Footwear Index includes NIKE, Inc., Deckers Outdoor Corporation, Skechers U.S.A., Inc., Steven Madden Ltd., and Wolverine World Wide, Inc. The Nasdaq Composite Total Return Index is a market capitalization-weighted index that includes reinvestment of all cash distributions of index members and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 46 as of February 9, 2023. +29 +Table of Contents +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements include restrictions on cash dividends paid on our common stock. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to, among other things, our results of operations, financial condition, level of indebtedness, capital requirements, and compliance with covenants under any then-existing financing agreements. +Purchases of Equity Securities by the Issuer +On April 23, 2021, the Board approved a $712.2 million increase to our share repurchase authorization. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. As of December 31, 2022, approximately $1,050.0 million remained available for repurchase under our share repurchase authorization. The number, price, structure, and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. In the immediate term, we plan to continue to prioritize repayments of debt, including debt incurred to finance a part of the Acquisition, and in the year ended December 31, 2022, we suspended our share repurchase program until such time that our gross leverage is under 2.0x. Accordingly, we did not repurchase any shares of our common stock during the year ended December 31, 2022. +ITEM 6. [Reserved] +30 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within the Crocs Brand’s collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 85 countries, through two distribution channels: wholesale and direct-to-consumer. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our direct-to-consumer channel includes company-operated retail stores, company-operated e-commerce sites, and third-party marketplaces. +Known or Anticipated Trends +Based on our recent operating results and our assessment of the current operating environment, we anticipate certain trends will continue to impact our future operating results: +• On February 17, 2022 (the “Acquisition Date”), we acquired (the “Acquisition”) 100% of the equity of a privately-owned casual footwear brand business (“HEYDUDE”), pursuant to a securities purchase agreement (the “SPA”) entered into on December 22, 2021. HEYDUDE is engaged in the business of distributing and selling casual footwear, including footwear under the brand name “HEYDUDE.” The Acquisition has enabled us to further diversify our product portfolio under two brands. We intend to leverage our global presence, innovative marketing, and scale infrastructure to grow HEYDUDE and to create significant shareholder value. For more information on the Acquisition, refer to Note 3 — Acquisition of HEYDUDE in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on this Form 10-K. The consolidated results reported for the year ended December 31, 2022 represent the Crocs Brand and ‘Enterprise corporate’ for the full year and the HEYDUDE Brand for the partial period beginning on the Acquisition Date through December 31, 2022 (the “Partial Period”); for the years ended December 31, 2021 and 2020, the results represent the Crocs Brand and ‘Enterprise corporate’ only. +• Consumer spending habits, including spending for the products that we sell, are affected by various macroeconomic factors, such as, among other things, prevailing global economic conditions, inflation, including the costs of basic necessities and other goods, levels of employment, salaries and wage rates, consumer confidence and consumer perception of economic conditions. In addition, consumer purchasing patterns may be influenced by consumers’ disposable income. Recently, we have also been impacted by adverse macroeconomic and geopolitical conditions, such as the war between Russia and Ukraine, which has increased global supply chain, logistics, and inflationary challenges. Global inflation, elevated interest rates, global industry-wide logistics challenges, and foreign currency fluctuations resulting in a stronger USD, have impacted, and we expect will continue to impact, our business, contributing to, among other things, incremental freight costs, increased wages, particularly in our distribution centers, and increased raw materials costs. A stronger USD also results in costs for foreign goods purchased in USD but recognized in foreign currencies (“purchasing power”) that are unfavorable. In the year ended December 31, 2022, we incurred air freight costs of approximately $67 million, which helped mitigate supply delays as a result of Vietnam factory closures. We do not intend to use a significant amount of air freight in 2023. At December 31, 2022, our inventories balance was $471.6 million. The majority of the total increase in inventories of 120.8% over December 31, 2021 was due to the addition of the HEYDUDE Brand in the first quarter of 2022. Inventories for the Crocs Brand were also up 41.9% as of December 31, 2022. Throughout 2021 and into the first half of 2022, inventories were historically lean across the footwear industry as a result of factory closures and other supply chain delays. However, more recently, elevated inventory levels have caused the industry, including us, to become more promotional. This is particularly true in North America. We expect these challenges to remain fluid as macroeconomic and inflationary pressures continue and foreign exchange rates fluctuate. +31 +Table of Contents +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +2022 Financial and Operational Highlights +Revenues were $3,555.0 million for the year ended December 31, 2022, a 53.7% increase compared to the year ended December 31, 2021. The increase in 2022 revenues compared to 2021 revenues was due to the net effects of: (i) the addition of HEYDUDE Brand revenues of $895.9 million as a result of the Acquisition, which increased revenues by 38.7%; (ii) higher Crocs Brand sales volumes, which increased revenues by $294.1 million, or 12.7%; (iii) higher average selling prices for the Crocs Brand, which increased revenues by $155.3 million, or 6.7%, as a result of increased pricing; and (iv) unfavorable changes in exchange rates, which decreased revenues by $103.7 million, or 4.5% for the Crocs Brand. +The following were significant developments affecting our businesses during the year ended December 31, 2022: +• We acquired HEYDUDE on February 17, 2022, which contributed revenues of $895.9 million in the Partial Period. The HEYDUDE Brand became a new reportable operating segment as of the Acquisition Date. +• We grew Crocs Brand revenues 14.9%, despite significant foreign currency headwinds and supply chain challenges, compared to the same period in 2021, led by our Asia Pacific segment, which grew revenues 35.3%, or 47.0% on a constant currency basis, and our EMEALA segment, which grew revenues 32.1%, or 46.8% on a constant currency basis. Our North America segment revenues grew 5.8%, or 6.0% on a constant currency basis. +• We sold 115.6 million pairs of shoes worldwide for the Crocs Brand, an increase from 103.0 million pairs in 2021. We sold 30.5 million pairs of shoes for the HEYDUDE Brand in the Partial Period. +• Gross margin was 52.3% compared to 61.4% in 2021, a decrease of 910 basis points. Gross margin for the Crocs Brand was 56.3%, a decrease of 510 basis points from last year, as a result of ongoing global inflation, which negatively impacted material and freight costs, and higher distribution and logistics costs as a result of continued supply chain challenges. This includes air freight costs, which impacted gross margin by approximately 220 basis points. Higher pricing and favorable product mix partially offset these decreases. Gross margin for the HEYDUDE Brand was 40.8%, which is inclusive of an approximately 690 basis points unfavorable impact from a non-cash step-up of acquired HEYDUDE inventory to fair value and also represents the continued effect of unfavorable pre-acquisition freight contracts on inventory costs, which are recognized in gross margin as inventory is sold, and higher inventory storage costs as we work to expand HEYDUDE distribution centers to support a larger business. To that end, in 2022, we entered into a lease not yet commenced for a new HEYDUDE distribution center in Nevada. +• Selling, general & administrative expenses (“SG&A”) was $1,009.5 million, an increase of $272.4 million, or 36.9%, compared to 2021, primarily as a result of investments in marketing and headcount as we continue to grow the business, costs related to the acquisition and integration of HEYDUDE, and incremental operating costs associated with operating the HEYDUDE Brand. However, as a percent of revenues, SG&A improved 350 basis points to 28.4% of revenues as a result of strong sales growth and our continued leveraging of operating costs. +• Income from operations was $850.8 million for the year ended December 31, 2022 compared to income from operations of $683.1 million for the year ended December 31, 2021. Our operating margin declined to 23.9%, compared to 29.5% in 2021. +• Net income was $540.2 million compared to $725.7 million in 2021. Diluted net income per common share was $8.71 for the year ended December 31, 2022, compared to a diluted net income per common share of $11.39 for the year ended +32 +Table of Contents +December 31, 2021. These amounts include an income tax expense of $178.3 million in 2022 and an income tax benefit of $61.8 million in 2021, as described in more detail under Income tax expense (benefit) below. +Results of Operations +Comparison of the Years Ended December 31, 2022 and 2021 +A discussion of our comparison between 2022 and 2021 is presented below. A discussion of the changes in our results of operations between the years ended December 31, 2021 and December 31, 2020 has been omitted from this Annual Report on Form 10-K but may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 16, 2022, which is available free of charge on the SEC’s website at www.sec.gov and our corporate website (www.crocs.com). +Year Ended December 31, $ Change % Change +Favorable (Unfavorable) +2022 2021 2022-2021 2022-2021 +(in thousands, except per share data, margin, and average selling price data) +Revenues $ 3,554,985 $ 2,313,416 $ 1,241,569 53.7 % +Cost of sales 1,694,703 893,196 (801,507) (89.7) % +Gross profit 1,860,282 1,420,220 440,062 31.0 % +Selling, general and administrative expenses +1,009,526 737,156 (272,370) (36.9) % +Income from operations +850,756 683,064 167,692 24.5 % +Foreign currency gains (losses), net +3,228 (140) 3,368 2,405.7 % +Interest income 1,020 775 245 31.6 % +Interest expense (136,158) (21,647) (114,511) (529.0) % +Other income (expense), net +(338) 1,797 (2,135) (118.8) % +Income before income taxes +718,508 663,849 54,659 8.2 % +Income tax expense (benefit) +178,349 (61,845) (240,194) (388.4) % +Net income +$ 540,159 $ 725,694 $ (185,535) (25.6) % +Net income per common share: +Basic $ 8.82 $ 11.62 $ (2.80) (24.1) % +Diluted $ 8.71 $ 11.39 $ (2.68) (23.5) % +Gross margin (1) +52.3 % 61.4 % (910) bp (14.8) % +Operating margin (1) +23.9 % 29.5 % (560) bp (19.0) % +Selling, general and administrative expenses as a percentage of revenues (1) +28.4 % 31.9 % 350 bp 11.0 % +Footwear unit sales: +Crocs Brand 115,558 102,962 12,596 12.2 % +HEYDUDE Brand (3) +30,519 — — — % +Average footwear selling price - nominal basis (2) : +Crocs Brand $ 22.72 $ 22.27 $ 0.45 2.0 % +HEYDUDE Brand (3) +$ 29.35 $ — $ — — % +(1) Changes for gross margin, operating margin, and SG&A as a percentage of revenues are shown in basis points (“bp”). +(2) Average footwear selling price is calculated as footwear and charms revenues divided by footwear units. +(3) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period, and there are no comparative amounts for the year ended December 31, 2021. +33 +Table of Contents +Revenues by Channel +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2022 2021 2022-2021 2022-2021 +(in thousands) +Crocs Brand: +Wholesale $ 1,377,302 $ 1,174,081 17.3 % 23.4 % +Direct-to-consumer 1,281,823 1,139,335 12.5 % 15.3 % +Total Crocs Brand 2,659,125 2,313,416 14.9 % 19.4 % +HEYDUDE Brand (2) : +Wholesale 574,140 — — % — % +Direct-to-consumer 321,720 — — % — % +Total HEYDUDE Brand 895,860 — — % — % +Total consolidated revenues (2) +$ 3,554,985 $ 2,313,416 53.7 % 58.2 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period, and there are no comparative amounts for the year ended December 31, 2021. +Revenues. In the year ended December 31, 2022, revenues increased $1,241.6 million, or 53.7%, compared to 2021, driven by (i) the addition of HEYDUDE Brand revenues of $895.9 million during the Partial Period, (ii) higher volume in all Crocs Brand segments of $294.1 million, or 12.7%, led by our EMEALA and Asia Pacific segments, and (iii) higher average selling price on a constant currency basis (“ASP”) in the Crocs Brand of $155.3 million, or 6.7%, as a result of strategic increased pricing in all regions. Unfavorable foreign currency fluctuations, most significantly in the Euro and South Korean Won, decreased Crocs Brand revenues by $103.7 million, or 4.5%. +Cost of sales. Cost of sales increased compared to 2021, in part due to the addition of the HEYDUDE Brand, which had cost of sales in the Partial Period that were in line with its contributions to revenues discussed above. Higher average cost per unit on a constant currency basis (“AUC”) in the Crocs Brand of $186.0 million, or 20.8%, resulted mostly from higher distribution and logistics and material costs, driven in part by the use of air freight to combat supply chain disruptions and inflation. Higher volume in the Crocs Brand contributed $132.0 million, or 14.8%, to the increase in cost of sales, while foreign currency fluctuations in the Crocs Brand reduced cost of sales by $49.2 million, or 5.5%. +Gross margin and gross profit. Gross margin was 52.3% compared to 61.4% in 2021. Gross margin for the Crocs Brand was 56.3% compared to 61.4% in 2021, due primarily to higher material and freight costs, as described above, offset in part by higher pricing and favorable product mix. Gross margin for the HEYDUDE Brand was 40.8%, which is inclusive of an approximately 690 basis points unfavorable impact from a non-cash step-up of acquired HEYDUDE inventory to fair value. This gross margin also represents the continued effect of unfavorable pre-acquisition freight contracts on inventory costs, which are recognized in gross margin as inventory is sold, and higher inventory storage costs as we work to expand HEYDUDE distribution centers to support a larger business. +Gross profit increased $440.1 million, or 31.0%, primarily as a result of the addition of HEYDUDE, which contributed to the majority of the increase, as well as higher sales volumes in the Crocs Brand of $162.1 million, or 11.4%. These increases were offset in part by unfavorable foreign currency fluctuations of $54.5 million, or 3.9%, and the net impact of higher AUCs and higher ASPs, which decreased gross profit by $30.7 million, or 2.2%. +Selling, general and administrative expenses. SG&A as a percent of revenue improved to 28.4% during the year ended December 31, 2022 compared to 2021, as a result of strong sales growth and our continued efforts to leverage operating costs, while SG&A expenses increased $272.4 million, or 36.9% in the same period. We have continued to invest in marketing to fuel growth, with an increase of $88.1 million to SG&A, primarily associated with investments in marketing in the Crocs Brand, including for our digital business, as well as investments in marketing for our new HEYDUDE Brand during the Partial Period. Additionally, costs of $38.2 million associated with the Acquisition and related integration, including consulting, legal, statutory, and accounting fees, as well as certain compensation costs, contributed to the increase. There was an increase in sales +34 +Table of Contents +commissions of $36.9 million, due mostly to HEYDUDE, which used more costly external representatives prior to the Acquisition, at which point we began to transition to a more cost-effective model. Other increases in compensation costs of $27.7 million were due primarily to increased employee headcount as we have grown the Company over the last year, offset in part by lower variable compensation. Other increases in professional services costs of $22.2 million were due to variable costs associated with revenue growth and contract labor costs and an increase in facilities expenses of $15.3 million was driven by duplicate rent costs associated with our upcoming headquarters move, lease exit costs and penalties associated with the shutdown of our direct operations in Russia, and variable rent associated with higher revenues. There were net increases in other costs, including information technology, depreciation and amortization, and travel and related costs, of $44.0 million. +Foreign currency gains (losses), net. Foreign currency gains (losses), net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on certain foreign currency derivative instruments. During the year ended December 31, 2022, we recognized realized and unrealized net foreign currency gains of $3.2 million compared to net losses of $0.1 million during the year ended December 31, 2021. +Income tax expense (benefit). During the year ended December 31, 2022, we recognized an income tax expense of $178.3 million on pre-tax book income of $718.5 million, representing an effective tax rate of 24.8%, compared to an income tax benefit of $61.8 million on pre-tax book income of $663.8 million in 2021, which represented an effective tax rate of (9.3)%. The prior year effective tax rate is lower primarily due to the prior year net foreign deferred income tax benefit as a result of an intra-entity intellectual property rights transfer of $127.7 million and the prior year release of valuation allowances. Our effective tax rate has varied dramatically in recent years due to the intra-entity intellectual property rights transfer, differences in our profitability levels and relative operating earnings across multiple jurisdictions, and by changes in the valuation allowance. +During the three months ended December 31, 2021, we completed an intra-entity transfer of certain intellectual property rights primarily to align with current and future international operations. The transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. We recorded a deferred tax asset of $40.3 million, net of a reserve for uncertain tax positions of $16.1 million. As such, a net deferred tax asset of $24.2 million was recognized along with a corresponding foreign deferred income tax benefit. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance as of December 31, 2022, we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. In 2021, a jurisdiction for which we have historically recorded significant valuation allowances enacted a favorable change in the tax law related to net operating loss carryforwards. This change in tax law impacted the assessment of valuation allowances in the jurisdiction as the reversal of existing deferred tax assets would generate indefinite carryforward net operating losses instead of losses with a limited carryforward period. During 2022, valuation allowances recorded against deferred tax assets increased by $1.7 million. +The 2022 impact of changes in valuation allowances to the effective tax rate was an unfavorable impact of $4.4 million, equating to a 0.6% unfavorable impact. There is also a $2.7 million favorable change in the valuation allowance related to cumulative translation adjustments. We maintain valuation allowances of approximately $28.1 million as of December 31, 2022, which may be reduced in the future depending upon the achieved profitability of certain jurisdictions as well as the magnitude of the profitability. +35 +Table of Contents +Reportable Operating Segments +The following table sets forth information related to our reportable operating business segments for the years ended December 31, 2022, 2021, and 2020. As a result of changes made in the presentation of certain amounts between our segments in the year ended December 31, 2022, as described in more detail below, we have included a discussion of the changes in our results of operations between the years December 31, 2021 and 2020, as revised to conform to current period presentation. +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2022 2021 2020 2022-2021 2021-2020 2022-2021 +(in thousands) +Revenues: +North America (2) +$ 1,644,630 $ 1,553,891 $ 832,540 5.8 % 86.6 % 6.0 % +Asia Pacific 473,935 350,160 278,515 35.3 % 25.7 % 47.0 % +EMEALA (2) +540,534 409,278 274,733 32.1 % 49.0 % 46.8 % +Brand corporate (3) +26 87 163 (70.1) % (46.6) % (70.1) % +Crocs Brand revenues 2,659,125 2,313,416 1,385,951 14.9 % 66.9 % 19.4 % +HEYDUDE Brand revenues (4) +895,860 — — — % — % — % +Total consolidated revenues $ 3,554,985 $ 2,313,416 $ 1,385,951 53.7 % 66.9 % 58.2 % +Income from operations: +North America (2) +$ 683,350 $ 755,723 $ 313,913 (9.6) % 140.7 % (9.4) % +Asia Pacific 145,011 71,936 32,830 101.6 % 119.1 % 119.5 % +EMEALA (2) +153,976 134,126 75,513 14.8 % 77.6 % 28.1 % +Brand corporate (3) +(130,312) (100,391) (92,833) (29.8) % (8.1) % (31.4) % +Crocs Brand income from operations +852,025 861,394 329,423 (1.1) % 161.5 % 2.4 % +HEYDUDE Brand income from operations (4) +211,361 — — — % — % — % +Enterprise corporate (3) +(212,630) (178,330) (115,299) (19.2) % (54.7) % (19.2) % +Total consolidated income from operations +850,756 683,064 214,124 24.5 % 219.0 % 29.0 % +Foreign currency gains (losses), net 3,228 (140) (1,128) 2,405.7 % 87.6 % +Interest income 1,020 775 215 31.6 % 260.5 % +Interest expense (136,158) (21,647) (6,742) (529.0) % (221.1) % +Other income (expense), net (338) 1,797 510 (118.8) % 252.4 % +Income before income taxes +$ 718,508 $ 663,849 $ 206,979 8.2 % 220.7 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) In the first quarter of 2022, certain revenues and expenses associated with our Latin America businesses previously reported in our ‘Americas’ segment were shifted into the ‘EMEA’ segment. To reflect this change, we renamed our ‘Americas’ segment to ‘North America’ and renamed our ‘EMEA’ segment to ‘EMEALA.’ As a result of these changes, the previously reported amounts for revenues and income from operations for the years ended December 31, 2021 and 2020 have been revised to conform to current period presentation. Refer to Part I - Item 1. Financial Statements in our Quarterly Report on Form 10-Q for the period ended June 30, 2022 for more information. +(3) In the first quarter of 2022, as a result of the Acquisition, all costs previously reported in “Unallocated corporate and other” were recast between ‘Brand corporate’ costs associated with the Crocs Brand and ‘Enterprise corporate’ costs, each of which is defined in Note 17 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. As a result of these changes, the previously reported amounts for income from operations for the years ended December 31, 2021 and 2020 have been revised to conform +36 +Table of Contents +to current period presentation. Refer to Part I - Item 1. Financial Statements in our Quarterly Report on Form 10-Q for the period ended June 30, 2022 for more information. +(4) We acquired HEYDUDE on February 17, 2022 and added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period, and there are no comparative amounts for the years ended December 31, 2021 or 2020. +The primary drivers of changes in revenues by operating segment were: +2022 vs. 2021 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Segment Revenues: +Crocs Brand: +North America +$ 78,337 5.0 % $ 14,962 1.0 % $ (2,560) (0.2) % $ 90,739 5.8 % +Asia Pacific 96,775 27.6 % 68,038 19.4 % (41,038) (11.7) % 123,775 35.3 % +EMEALA +119,029 29.1 % 72,311 17.8 % (60,084) (14.7) % 131,256 32.1 % +HEYDUDE Brand (2) +— — % — — % — — % — — % +Total segment revenues $ 294,141 12.7 % $ 155,311 6.7 % $ (103,682) (4.5) % $ 345,770 14.9 % +(1) The change due to price for revenues is based on ASP, as defined earlier in this section. +(2) We acquired HEYDUDE on February 17, 2022 and added the HEYDUDE Brand as a new reportable operating segment. Therefore, there are no comparative amounts for the year ended December 31, 2021. +2021 vs. 2020 +Volume +Price (1) +Foreign Exchange Total +$ Change % Change $ Change % Change $ Change % Change $ Change % Change +(in thousands) +Segment Revenues: +Crocs Brand: +North America +$ 505,949 60.7 % $ 212,462 25.5 % $ 2,940 0.4 % $ 721,351 86.6 % +Asia Pacific 24,881 8.9 % 34,987 12.6 % 11,777 4.2 % $ 71,645 25.7 % +EMEALA +107,379 39.1 % 17,723 6.5 % 9,443 3.4 % $ 134,545 49.0 % +Total segment revenues $ 638,209 46.1 % $ 265,172 19.1 % $ 24,160 1.7 % $ 927,541 66.9 % +(1) The change due to price for revenues is based on ASP, as defined earlier in this section. +Crocs Brand +North America Operating Segment +Revenues. The North America segment grew revenues 5.8% for the year ended December 31, 2022 compared 2021, primarily as a result of higher volume in our DTC channel. Higher ASPs due to higher pricing, offset in part by increased promotional activity in the second half of the year, also drove revenue growth. Currency fluctuations had an insignificant negative impact on revenues. +The North America segment grew revenues 86.6% for the year ended December 31, 2021 compared to 2020, as a result of higher volume and higher ASPs in both our wholesale and DTC channels. Volume was up versus 2020 as a result of continued increased consumer demand, partially due to the prior year negative impact of COVID-19 on our brick-and-mortar stores. Higher ASPs also contributed to higher sales due mostly to higher pricing and fewer promotions and discounts, primarily in our DTC channel, as well as favorable product mix. Currency fluctuations had an insignificant impact on revenues. +Income from Operations. During the year ended December 31, 2022, income from operations for our North America segment was $683.4 million, a decrease of $72.4 million, or 9.6% from 2021. Gross profit for the year ended December 31, 2022 +37 +Table of Contents +decreased $33.1 million, or 3.2%, compared to the year ended December 31, 2021. Gross profit was lower as a result of a decrease of $94.4 million, or 9.2%, due primarily to higher AUC as a result of higher material and freight costs, due in part to inflation and in part to air freight used to combat supply chain disruptions, mostly in the first half of the year. This was offset in part by higher ASP, as described above. Insignificant unfavorable foreign currency fluctuations also slightly decreased gross profit. These decreases were offset by increased volume of $63.1 million, or 6.2%. +During the year ended December 31, 2022, SG&A for our North America segment increased by $39.3 million, or 15.0%, compared to 2021. This was due in part to an increase in variable costs associated with higher revenues, particularly in our DTC channel. Additionally, compensation costs increased primarily due to investments in employee headcount, including retail labor, which also had higher wages in 2022 compared to 2021. +During the year ended December 31, 2021, income from operations for our North America segment was $755.7 million, an increase of $441.8 million, or 140.7% from 2020. Gross profit for the year ended December 31, 2021 increased $530.9 million, or 109.0%. Gross profit increased $292.7 million, or 60.1%, due to sales volume increases in both channels, and increased $232.8 million, or 47.8%, due to higher ASP and lower AUC as a result of favorable product mix, including increased sales of charms per shoe, higher prices and fewer promotions and discounts, favorable channel mix, and increased efficiencies in our U.S. distribution network, partially offset by higher inbound freight costs. Favorable foreign currency fluctuations in the CAD also increased gross profit by $5.4 million, or 1.1%. +During the year ended December 31, 2021, SG&A for our North America segment increased by $89.1 million, or 51.4%, compared to 2020. This was primarily due to an investment in marketing to support growth, higher compensation and related costs as a result of increased headcount associated with the growth of the business and the 2020 temporary and permanent elimination of certain roles in response to COVID-19, and higher facilities costs, mostly associated with variable rent driven by higher retail sales. Additionally, higher services and other costs resulted predominantly from variable costs associated with higher sales. These increases were offset by lower donations of inventory as a result of 2020 COVID-19 donations to frontline healthcare workers that did not recur in 2021. +Asia Pacific Operating Segment +Revenues. Revenues in our Asia Pacific segment increased in the year ended December 31, 2022 compared to 2021, as a result of volume increases, primarily in India, South Korea, and with distributors in Southeast Asia, which benefited from COVID-19 re-openings and the partial return of tourism to the region over the prior year. ASPs also increased revenues as a result of higher pricing and less discounting. Negative fluctuations in foreign currency, primarily in the South Korean Won, Japanese Yen, and Indian Rupee, partially offset these increases. +Revenues in our Asia Pacific segment increased in the year ended December 31, 2021 compared to 2020, as a result of volume increases in our wholesale channel driven in part by cycling 2020 negative COVID-19 impacts on our distributor markets and ASP increases in both channels, as a result of increased pricing and fewer promotions and discounts. Revenue also increased as a result of fluctuations in foreign currency, including the South Korean Won and Chinese Yuan. +Income from Operations. During the year ended December 31, 2022, income from operations for our Asia Pacific segment was $145.0 million, an increase of $73.1 million, or 101.6%. Gross profit for the year ended December 31, 2022 increased $78.4 million, or 37.6%, compared to the year ended December 31, 2021. An increase of $52.1 million, or 25.0% in gross profit was largely due to higher ASPs from price increases and less promotional activity, partially offset by higher AUCs, resulting from unfavorable purchasing power and higher material and duties costs. Higher volume of $51.7 million, or 24.8%, also increased gross profit, while unfavorable currency fluctuations, primarily in the South Korean Won, of $25.4 million, or 12.2%, partially offset these increases. +During the year ended December 31, 2022, SG&A for our Asia Pacific segment increased $5.3 million, or 3.9%, compared to the same period in 2021, due to increases in variable facilities costs and compensation costs. +During the year ended December 31, 2021, income from operations for our Asia Pacific segment was $71.9 million, an increase of $39.1 million, or 119.1%, from 2020. Gross profit for the year ended December 31, 2021 increased $63.5 million, or 43.7%, compared to the year ended December 31, 2020. The increase in gross profit was largely due to higher ASPs and lower AUCs, on a net basis, of $46.7 million, or 32.1%, resulting from price increases and less promotional activity, favorable product mix, and greater purchasing power from currency changes. Higher volume of $8.9 million, or 6.2%, and favorable currency fluctuations of $7.8 million, or 5.4%, also contributed to higher gross profit. +38 +Table of Contents +During the year ended December 31, 2021, SG&A for our Asia Pacific segment increased $24.4 million, or 21.7%, compared to the same period in 2020, primarily due to increased investment in marketing to support growth, an increase in facilities expense associated with variable rent driven by higher retail sales, an increase in compensation expense and related costs, and an increase in variable costs associated with revenue growth. These increases were partially offset by lower bad debt expense, primarily from net charges taken in the 2020 in response to COVID-19, and 2020 inventory donations to healthcare workers and other organizations, neither of which recurred in 2021. +EMEALA Operating Segment +Revenues. Revenues increased for our EMEALA segment compared to the year ended December 31, 2021, despite significant unfavorable currency headwinds due to fluctuations in the Euro and the shutdown of our direct operations in Russia as a result of the Ukraine war. This performance was driven by increased volume, with growth particularly strong in our wholesale channel. Additionally, increased ASPs, driven by increased prices and product mix, contributed to revenue growth. Unfavorable foreign currency fluctuations in the Euro partially offset these increases. +Revenues in our EMEALA segment increased in the year ended December 31, 2021 compared to the year ended December 31, 2020, most significantly as a result of higher volumes in both channels, particularly in wholesale, resulting from increased product demand and cycling 2020 negative COVID-19 impacts which further increased the disparity between the two periods. Higher ASPs in all channels, as a result of price increases and fewer promotions and discounts, and favorable foreign currency fluctuations, primarily in the Euro, also increased revenues. +Income from Operations. During the year ended December 31, 2022, income from operations for our EMEALA segment was $154.0 million, an increase of $19.9 million, or 14.8%. Gross profit for the year ended December 31, 2022 increased $40.3 million, or 19.5%, compared to the year ended December 31, 2021. The increase in our EMEALA segment gross profit was due to higher volumes of $56.6 million, or 27.3%, primarily in our wholesale channel. Higher ASPs, as described above, partially offset by higher AUCs, primarily due to unfavorable purchasing power and higher material and freight costs, also increased gross profit by $11.6 million, or 5.6%. Foreign currency headwinds of $27.8 million, or 13.4%, partially offset these increases. +During the year ended December 31, 2022, SG&A for our EMEALA segment increased $20.4 million, or 28.1%, compared to the same period in 2021. This was primarily due to various costs associated with the shutdown of our direct operations in Russia, including the recognition of cumulative translation adjustments into earnings, as well as severance and lease exit costs and penalties. Marketing costs, including investments in digital marketing, also increased. +During the year ended December 31, 2021, income from operations for our EMEALA segment was $134.1 million, an increase of $58.6 million, or 77.6%, compared to 2020. Gross profit for the year ended December 31, 2021 increased $73.0 million, or 54.4%, compared to the year ended December 31, 2020. The increase in our EMEALA segment gross profit was due to higher volumes of $50.0 million, or 37.3%, primarily in our wholesale channel, and higher ASPs, supplemented by slightly lower AUCs, of $19.9 million, or 14.8%, as a result of purchasing power gains, favorable product mix, and price increases and fewer promotions and discounts, offset in part by higher freight costs. Favorable foreign currency fluctuations of $3.0 million, or 2.3% also contributed to higher gross profit. +During the year ended December 31, 2021, SG&A for our EMEALA segment increased $14.4 million, or 24.6%, compared to the same period in 2020. Additional investments in marketing to support growth, higher compensation expense and related costs, and higher facilities costs were offset by lower bad debt expense. +Crocs Brand Corporate +During the year ended December 31, 2022, total net costs within ‘Brand corporate’ increased by $29.9 million, or 29.8%, compared to the same period in 2021. This was due to higher compensation expense as a result of increased headcount, a larger investment in brand marketing, and higher information technology costs. +During the year ended December 31, 2021, total net costs within ‘Brand corporate’ increased by $7.6 million, or 8.1%, compared to the same period in 2020. This was primarily driven by an increase in compensation expense due to increased employee headcount, as well as higher services costs as a result of supply chain investments. +HEYDUDE Brand +For the Partial Period, revenues attributable to the HEYDUDE Brand were $895.9 million, with more than half of this amount attributable to the wholesale channel at approximately 64%. We sold 30.5 million pairs of shoes during the Partial Period. +39 +Table of Contents +Income from operations during the Partial Period was $211.4 million and included a $62.3 million non-cash step-up of acquired HEYDUDE inventory to fair value and SG&A costs comprised primarily of marketing, sales commissions, compensation expense, and depreciation and amortization expense. +Refer to Note 3 — Acquisition of HEYDUDE in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +Enterprise Corporate +During the year ended December 31, 2022, total net costs within ‘Enterprise corporate’ increased $34.3 million, or 19.2%, compared to the same period in 2021. This was primarily due to costs associated with the acquisition and integration of HEYDUDE, including consulting, legal, statutory, and accounting fees, among others, of $38.2 million. There were also increases in facilities costs due to duplicate rent costs associated with our upcoming headquarters move and information technology costs. These increases were offset in part by decreases in compensation, primarily due to lower variable compensation, and depreciation and amortization. +During the year ended December 31, 2021, total net costs within ‘Enterprise corporate’ increased $63.0 million, or 54.7%, compared to the same period in 2020. This was primarily driven by an increase in compensation expense due to increased employee headcount and the related hiring costs and higher variable and executive compensation, as well as increased professional services costs due to higher legal expenses and costs associated with our then-pending HEYDUDE Acquisition. These increases were partially offset by 2020 impairment charges which did not recur in 2021. +Store Locations and Digital Sales Percentage +The table below illustrates the overall change in the number of our company-operated retail locations by reportable operating segment: +December 31, 2021 Opened Closed December 31, 2022 +Company-operated retail locations: +Crocs Brand: +North America +173 9 11 171 +Asia Pacific 153 5 7 151 +EMEALA +47 3 32 18 +Total Crocs Brand 373 17 50 340 +HEYDUDE Brand (1) +— 5 — 5 +Total 373 22 50 345 +(1) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new reportable operating segment. Therefore, there are no comparative amounts for the year ended December 31, 2021. +Digital sales, which includes sales through our company-owned website, third-party marketplaces, and e-tailers (which are reported in our wholesale channel), as a percent of total revenues, by reportable operating segment were: +Year Ended December 31, +2022 2021 +Digital sales as a percent of total revenues: +Crocs Brand 37.6 % 36.7 % +HEYDUDE Brand (1) +38.5 % — % +Total (2) +37.8 % 36.7 % +(1) We acquired HEYDUDE on February 17, 2022. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period, and there are no comparative amounts for the year ended December 31, 2021. +(2) For the year ended December 31, 2021, the digital sales as a percent of total revenues represents the Crocs Brand. See footnote (1) above. +40 +Table of Contents +Direct-to-consumer (“DTC”) comparable sales for the Crocs Brand are as follows: +Constant Currency (1) +Year Ended December 31, +2022 2021 +Direct-to-consumer comparable sales: (2) +Crocs Brand (3) +15.0 % N/A +(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. See the “Use of Non-GAAP Financial Measures” section for additional information. +(2) Comparable store status, as included in the DTC comparable sales figures above, is determined on a monthly basis. Comparable store sales include the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure and in the same month in the following year. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce comparable revenues are based on same site sales period over period. +(3) In the year ended December 31, 2021, as a result of the COVID-19 pandemic’s impact on 2020 sales, we did not disclose DTC comparable sales, as they were not meaningful. +Liquidity and Capital Resources +Our liquidity position as of December 31, 2022 was: +December 31, 2022 +(in thousands) +Cash and cash equivalents $ 191,629 +Available borrowings 755,789 +As of December 31, 2022, we had $191.6 million in cash and cash equivalents and up to $755.8 million of available borrowings, including $748.7 million remaining borrowing availability under the Revolving Facility (as defined below) and $7.1 million of remaining borrowing availability under the Asia revolving facilities. As of December 31, 2022, the Term Loan B Facility (as defined below) was fully drawn, and there was no available borrowing capacity. We believe that our cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Revolving Facility and other financing agreements will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. +We completed the Acquisition on February 17, 2022. The consideration for the Acquisition was comprised of $2.05 billion in cash (the “Cash Consideration”) and 2,852,280 of Crocs, Inc. shares. To finance the Cash Consideration, we entered into the $2.0 billion Term Loan B Facility and borrowed $50.0 million under our Revolving Facility. In the year ended December 31, 2022, we prioritized using excess cash generated by our operations to repay our outstanding debt, including debt incurred to finance a part of the Acquisition, and, as such, we suspended our share repurchase program until such time that our gross leverage is under 2.0x. See the risk factor under “HEYDUDE Acquisition Risks — The incurrence by us of substantial indebtedness in connection with the financing of the Acquisition may have an adverse impact on our liquidity, limit our flexibility in responding to other business opportunities, and increase our vulnerability to adverse economic and industry conditions” included in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for further information on liquidity risks associated with the Acquisition. +Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets could each impact our business and liquidity. +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +41 +Table of Contents +All of the cash held outside of the U.S. could be repatriated to the U.S. as of December 31, 2022 without incurring additional U.S. federal income taxes. In some countries, repatriation of certain foreign balances is restricted by local laws. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2022, we held $97.0 million of our total $191.6 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $97.0 million, $4.8 million could potentially be restricted by local laws. +Senior Revolving Credit Facility +In July 2019, the Company and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. Since that time, we have amended the Credit Agreement, which, as amended to date, provides for a revolving credit facility of $750.0 million, which can be increased by an additional $250.0 million subject to certain conditions (the “Revolving Facility”). Borrowings under the Credit Agreement bear interest at a variable interest rate based on (A) a Base Rate (defined as the highest of (i) the Overnight Bank Funding Rate (as defined in the Credit Agreement), plus 0.25%, (ii) the Prime Rate (as defined in the Credit Agreement), and (iii) the Daily Simple SOFR (as defined in the Credit Agreement), plus 1.00%), plus an applicable margin ranging from 0.25% to 0.875% based on our leverage ratio or 1.35% to 1.975% for the Daily Simple SOFR based on the leverage ratio, or (B) the Term SOFR Rate (as defined in the Credit Agreement), plus an applicable margin ranging from 1.35% to 1.975% based on our leverage ratio for one-month interest periods and 1.40% to 2.025% based on our leverage ratio for three-month interest periods. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement requires us to maintain a minimum interest coverage ratio of 3.00 to 1.00 and a maximum leverage ratio of (i) 4.00 to 1.00 from the quarter ended March 31, 2022 through, and including, the quarter ending December 31, 2023, (ii) 3.75 to 1.00 for the quarter ending March 31, 2024, (iii) 3.50 to 1.00 for the quarter ending June 30, 2024, and (iv) 3.25 to 1.00 for the quarter ending September 30, 2024 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits, among other things, (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $40.0 million. As of December 31, 2022, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2022, the total commitments available from the lenders under the Revolving Facility were $750.0 million. At December 31, 2022, we had no outstanding borrowings and $1.3 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2022 and 2021, we had $748.7 million and $414.7 million, respectively, of available borrowing capacity under the Revolving Facility, which matures November 2027. +Term Loan B Facility +On February 17, 2022, the Company entered into a credit agreement (the “Term Loan B Credit Agreement”) with Citibank, N.A., as administrative agent and lender, to among other things, finance a portion of the cash consideration for the Acquisition. +The Term Loan B Credit Agreement provides for an aggregate term loan B facility in the principal amount of $2.0 billion (the “Term Loan B Facility”), which is secured by substantially all of the Company’s and each subsidiary guarantor’s assets on a pari passu basis with their obligations arising from the Credit Agreement and is scheduled to mature on February 17, 2029, subject to certain exceptions set forth in the Term Loan B Credit Agreement. Additionally, subject to certain conditions, including, without limitation, satisfying certain leverage ratios, the Company may, at any time, on one or more occasions, add one or more new classes of term facilities and/or increase the principal amount of the loans of any existing class by requesting one or more incremental term facilities. +Each term loan borrowing which is an alternate base rate borrowing bears interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 2.50%. Each term loan borrowing which is a term benchmark borrowing bears interest at a rate per annum equal to the Adjusted Term SOFR Rate (as defined in the Term Loan B Credit Agreement) plus 3.50%. +Outstanding principal under the Term Loan B Facility is payable on the last business day of each March, June, September, and December, in a quarterly aggregate principal amount of $5.0 million. Quarterly aggregate principal payments began on June 30, +42 +Table of Contents +2022, with the remaining principal amount due on February 17, 2029, the maturity date. As of December 31, 2022, we had $1,675.0 million in outstanding principal and the Term Loan B Facility was fully drawn with no remaining borrowing capacity. +The Term Loan B Credit Agreement also contains customary affirmative and negative covenants, incurrence financial covenants, representations and warranties, events of default and other provisions. As of December 31, 2022, we were in compliance with all financial covenants under the Term Loan B Credit Agreement. +Asia Revolving Credit Facilities +During the year ended December 31, 2022, we had two revolving credit facilities in Asia, the revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”), which provides up to 10.0 million RMB, or $1.4 million at current exchange rates, and matures in January 2023, and the revolving credit facility with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”), which provides up to an equivalent of $10.0 million. For RMB loans under the CMBC Facility, interest is based on a National Interbank Funding Center 1-year prime rate, plus 65 basis points. For USD loans under the Citibank Facility, interest is mutually agreed upon prior to utilization of a loan. +As of December 31, 2022, we had no outstanding borrowings on the CMBC Facility, and we had borrowings outstanding of $4.3 million on the Citibank Facility, which are due in January 2023 and May 2023. We had no outstanding borrowings under our Asia revolving facilities at December 31, 2021. +Senior Notes Issuances +In March 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.250% Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, the “2029 Notes Indenture”). Additionally, in August 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.125% Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, “the 2031 Notes Indenture” and, together with the 2029 Notes Indenture, the “Indentures” and, each, an “Indenture”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +The Company will have the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company may redeem up to 40% of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company may redeem up to 40% of the aggregate principal amount of the 2031 Notes at a redemption price of 104.125% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; pay dividends or repurchase or redeem capital stock or make other restricted payments; declare or pay dividends or other payments; incur liens; enter into certain types of transactions with the +43 +Table of Contents +Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2022, we were in compliance with all financial covenants under the Notes. +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, $ Change % Change +2022 2021 Favorable (Unfavorable) +(in thousands) +Cash provided by operating activities +$ 603,142 $ 567,165 $ 35,977 6.3 % +Cash used in investing activities +(2,151,091) (55,925) (2,095,166) (3,746.4) % +Cash provided by (used in) financing activities +1,529,659 (429,638) 1,959,297 456.0 % +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +(3,750) (3,950) 200 5.1 % +Net change in cash, cash equivalents, and restricted cash $ (22,040) $ 77,652 $ (99,692) (128.4) % +Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted for non-cash items and changes in working capital. Cash provided by operating activities increased $36.0 million for the year ended December 31, 2022 compared to the year ended December 31, 2021. This change was driven by higher net income adjusted for non-cash items of $83.1 million, partly offset by a net decrease in operating assets and liabilities of $47.1 million. +Investing Activities. There was a $2,095.2 million increase in cash used in investing activities for the year ended December 31, 2022 compared to the year ended December 31, 2021. The increase is primarily due to the Cash Consideration for the Acquisition, net of cash acquired. Refer to Note 3 — Acquisition of HEYDUDE in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Additionally, there was a $48.3 million increase in the purchases of property and equipment related primarily to the expansion of our distribution centers in North America. +Financing Activities. Cash provided by financing activities increased by $1,959.3 million in the year ended December 31, 2022 compared to the year ended December 31, 2021. The increase was primarily due to an increase of $1,779.9 million in proceeds from borrowings, which includes borrowings under the Term Loan B Facility and the Revolving Facility that were used to finance the Acquisition in part. Additionally, there was a decrease in cash used by financing activities of $1,000.0 million in repurchases of common stock and $8.6 million in repurchases of common stock for tax withholding. The overall increase was offset by a $700.0 million decrease in proceeds from the Notes issuances that occurred in the year ended December 31, 2021 that did not recur in the current period, a $90.3 million increase in repayments of borrowings, and a $38.8 million increase in deferred debt issuance costs, primarily related to the Term Loan B Facility. We also had a $0.1 million increase in other cash used in financing activities. +Stock Repurchases +On April 23, 2021, the Board approved and authorized a program to repurchase up to $1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +During the year ended December 31, 2022, we did not repurchase any shares of our common stock. As of December 31, 2022, we had remaining authorization to repurchase approximately $1,050.0 million of our common stock, subject to restrictions under our Indentures, Credit Agreement, and Term Loan B Credit Agreement. +During the year ended December 31, 2021, we repurchased 8.2 million shares of our common stock at a cost of $1,000.0 million, including commissions. This included 3.2 million shares delivered under the $500.0 million accelerated share repurchase arrangement (“ASR”) entered into in September 2021, 2.9 million shares delivered under the $300.0 million ASR entered into in April 2021, and 0.5 million shares delivered in January 2021 at the conclusion of the purchase period for the +44 +Table of Contents +ASR entered into in November 2020. Under each ASR, a financial institution delivered shares of our common stock during the purchase period in exchange for an up-front payment. The total number of shares ultimately delivered under the ASR, and therefore the average repurchase price paid per share, was determined based on the volume-weighted average price of our common stock during the purchase period. The shares received were recorded in the period they were delivered, and the up-front payment was accounted for as a reduction to stockholders’ equity in our consolidated balance sheet in the period the payment was made. +In 2023, we plan to continue to use excess cash generated by our operations to repay debt, including debt incurred to finance a part of the Acquisition and, as such, we intend for our share repurchase program to remain suspended until such time that our gross leverage is under 2.0x. +See Note 11 — Equity in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information on our repurchases and repurchase authorizations. +Contractual Obligations +We believe we have sufficient liquidity to fund our operations and meet our short-term and long-term obligations. Our material future cash obligations as of December 31, 2022 include the following: +Less than 1 Year Thereafter Total +(approximately, in thousands) +Debt-related: +Debt obligations $ 33,400 $ 2,346,000 $ 2,379,400 +Interest on debt obligations (1) +139,300 247,600 386,900 +Purchase commitments (2) +370,300 — 370,300 +Lease-related (3) : +Lease obligations +60,800 251,700 312,500 +Obligations for leases not yet commenced — 75,000 75,000 +Other: +Distribution and logistics obligations (4) +18,100 — 18,100 +Total $ 621,900 $ 2,920,300 $ 3,542,200 +(1) Represents future interest payment obligations, which are estimated by assuming the amounts outstanding under our Term Loan B Facility, Notes, and Citibank Facility and the interest rates in effect as of December 31, 2022, will remain constant into the future. This is only an estimate, as actual amounts borrowed and rates may vary over time for certain borrowing instruments, as described in Note 10 — Borrowings. +(2) Represents purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products. We expect to fulfill our commitments under these agreements in the next twelve months in the normal course of business and are only liable for the portion of the purchase obligations that have been purchased by the third-party manufacturer or manufactured by the vendor, with the remainder cancellable without penalty. Refer to Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +(3) Our operating lease obligations consist of leases for real estate, which includes retail, warehouse, distribution center, and office spaces and represent the minimum cash commitment under contract to various third parties for operating lease obligations. For more information on our lease obligations and obligations for leases not yet commenced, refer to Note 7 — Leases in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +(4) Represents material contractual obligations associated with global distribution and logistics projects. +We had no material off-balance sheet arrangements as of December 31, 2022, other than certain purchase commitments, as described in the footnote (2) above. +45 +Table of Contents +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency, is based on the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Business Combinations +We account for business combinations using the acquisition method of accounting, which requires that once control is obtained, all of the assets acquired and liabilities assumed are recorded at their respective fair values at the date of acquisition. Contingent consideration, if any, is included within the purchase price and is recognized at its fair value on the acquisition date. We allocate the purchase price of acquired businesses to tangible assets and intangible assets based upon internal estimates of cash flows and consideration. We may also utilize third-party valuation specialists to assist in our determination of the fair value of assets acquired and liabilities assumed. Management estimates of fair value require a significant amount of management judgment, as the determination of fair values of identifiable assets and liabilities requires estimates and the use of valuation techniques when market value is not readily available. During the measurement period, which is up to one year from the acquisition date, adjustments to the assets acquired and liabilities assumed may be recorded, with the corresponding offset to goodwill. +During the year ended December 31, 2022, we acquired HEYDUDE. The aggregate closing price of the Acquisition was $2.3 billion. The fair value of the acquired assets was determined by management with the assistance of third-party valuation specialists. For certain assets and liabilities, those fair values were consistent with historical carrying values. The trademark was valued using the Multi Period Excess Earnings approach, and the customer relationships were valued using the distributor method. Key assumptions by management were used in valuing the trademark and customer relationships such as future revenue growth rates, earnings before interest, taxes, depreciation, and amortization (“EBITDA”), and market-based discount rates. +Refer to Note 3 — Acquisition of HEYDUDE in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details on the Acquisition. +Impairment of Goodwill and Indefinite-Lived Intangible Assets +Our goodwill and indefinite-lived intangible assets, which primarily consist of the HEYDUDE trademark, are not amortized. We evaluate the carrying value of our goodwill and indefinite-lived intangible assets at least annually or when an interim triggering event has occurred indicating potential impairment. During the year ended December 31, 2022, we changed our annual goodwill impairment testing date from the last day of our fiscal fourth quarter to the first day of our fiscal fourth quarter. Our impairment evaluations represent a critical accounting policy as they require significant judgments and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. +We perform our goodwill impairment testing for each reporting unit that has goodwill. During the year ended December 31, 2022, we had two reporting units, comprised of a reporting unit within the HEYDUDE Brand segment and a reporting unit within the EMEALA segment. During the years ended December 31, 2021 and 2020, we had one reporting unit in our EMEALA segment. We perform our indefinite-lived intangible impairment testing at the asset level. +46 +Table of Contents +When performing our annual test for impairment, we may assess goodwill and indefinite-lived intangible assets for potential impairment using either a qualitative or quantitative assessment. The qualitative assessment may evaluate factors such as macroeconomic conditions, industry and market considerations, and overall financial performance, among other factors. If we determine that it is more likely than not that the fair value of a reporting unit or an indefinite-lived intangible asset is less than its carrying value, a quantitative assessment is performed. For the quantitative assessment, we compare the estimated fair value of a reporting unit with its carrying value, including the goodwill assigned to the reporting unit. If carrying value of the reporting unit exceeds its estimated fair value, an impairment charge is recorded. +For the year ended December 31, 2022, we elected to bypass the qualitative assessment for the HEYDUDE Brand reporting unit goodwill and indefinite-lived trademark intangible asset and proceed directly to performing the quantitative goodwill and indefinite-lived intangible asset impairment tests with the assistance of third-party valuation specialists. We performed the quantitative assessments for the HEYDUDE Brand reporting unit goodwill using the discounted cash flow method and the guideline public company method. For the impairment testing of the indefinite-lived trademark, we used the Multi Period Excess Earnings approach. The primary assumptions developed by management and used in the quantitative analysis of the HEYDUDE Brand reporting unit and indefinite-lived trademark included future revenue growth rates and market-based discount rates. +Changes in the assumptions used to estimate the fair value of our goodwill and indefinite-lived intangible assets could result in impairment charges in future periods as the key assumptions are inherently uncertain, require significant judgment and are subject to change based on, among others, industry and geopolitical conditions, our ability to navigate changing macroeconomic conditions and trends as well as the timing and success of strategic initiatives. Certain factors, such as failure to achieve forecasted revenue growth rates or increases in the discount rates, have the potential to create variances in the estimated fair values of our goodwill and indefinite-lived intangible assets that could result in impairment charges. +Additionally for the years ended December 31, 2022, 2021, and 2020, we performed a qualitative assessment for the goodwill in our EMEALA segment, which indicated that it was more likely than not that the estimated fair value exceeded its carrying value. +We did not record any impairment charges in the years ended December 31, 2022, 2021, or 2020 based on the results of our goodwill and indefinite-lived intangible assets impairment testing. Refer to Note 1 — Basis of Presentation and Summary of Significant Accounting Policies and Note 5 — Goodwill and Intangible Assets, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to our goodwill and indefinite-lived intangible assets. +Impairment of Long-Lived Assets +Property and equipment, right-of-use assets, and definite-lived intangible assets, such as customer relationships and capitalized software, are evaluated for impairment whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. This represents a critical accounting policy as our impairment evaluations include significant judgments and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. Testing of long-lived assets for impairment is at the level of an asset group, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. For customer relationships, impairment testing is performed at the customer group level. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +In 2022 and 2021, we did not record impairments to reduce the net carrying value of certain long-lived assets. In 2020, we recorded non-cash impairments of $20.0 million to reduce the net carrying value of certain long-lived assets to their estimated fair values for a retail store in New York City and $1.1 million for our former corporate headquarters. See Note 4 — Property +47 +Table of Contents +and Equipment, Net in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +Revenues and Reserves for Sales Returns and Allowances +While our revenue recognition does not involve significant judgment, it does represent a key accounting policy as it is important to our results of operations. Revenues are recognized in the amount expected to be received in exchange for when control of the products transfers to customers. Revenues are reported net of various promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. An area of judgment affecting our reported revenues and net income involves estimating reserves for sales returns and allowances, which represent a portion of revenues not expected to be realized. Revenues in our direct-to-consumer channels are reduced by an estimate of returns. We may also accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Wholesale revenues are reduced by estimates of returns and allowances. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns and allowances may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances, discounts, and rebates have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns and allowances as of December 31, 2022 would have had an insignificant impact on our 2022 revenues. +See Schedule II in Part IV - Item 15. Exhibits, Financial Statement Schedule to the accompanying consolidated financial statements of this Annual Report on Form 10-K for an analysis of the activity in our reserves for uncollectible accounts receivable, sales returns, allowances, and discounts. +Income Taxes +Intellectual Property Income Tax Implications +In 2020 and in 2021, we completed changes to our international legal structure that created an amortizable step-up in tax basis of the intangible asset and a corresponding increase in foreign deferred tax assets based on the fair value of the intellectual property (“IP”). These transactions were executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of these transactions. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from our actual results. As of December 31, 2021, the related net deferred tax asset is $490.2 million, net of a reserve for uncertain tax positions of $206.0 million. As of December 31, 2022, the related net deferred tax asset is $438.5 million, net of a reserve for uncertain tax positions of $194.4 million. +In order to support and sustain the amortizable tax basis (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands subsidiary serves as the principal Crocs corporate headquarters outside of the U.S. and already performs significant functions in support of the economic ownership of the IP in the Netherlands. In 2021 and 2022, we undertook many additional activities to align business operations that support the economic substance of the IP in the Netherlands. +We have also recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +48 +Table of Contents +Income Tax Accounting +We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of GILTI as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense (benefit)’ line in the accompanying consolidated statements of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-U.S. subsidiaries as of December 31, 2022, which are considered to be indefinitely reinvested outside of the U.S. +See Note 14 — Income Taxes in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +49 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Revolving Facility and certain financial instruments. +As of December 31, 2022, we had borrowings with a face value of $2,379.3 million, comprised of the Notes, which carry a fixed interest rate, the Term Loan B Facility, and borrowings under our Asia revolving facilities. We also had $1.3 million in outstanding letters of credit under our Revolving Facility as of December 31, 2022. As of December 31, 2021, we had long-term borrowings with a face value of $785.0 million and $0.3 million in outstanding letters of credit under our Revolving Facility. +A hypothetical increase of 1% in the interest rate on the variable rate borrowings under our Term Loan B Facility and Revolving Facility would have increased interest expense by $18.1 million for the year ended December 31, 2022. +Foreign Currency Exchange Risk +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates in effect at the time such exchange rates are used to translate the operating results of our international subsidiaries. +An increase of 1% of the value of the USD relative to foreign currencies would have decreased our revenues and income before taxes during the year ended December 31, 2022 by approximately $10.8 million and $1.6 million, respectively. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. +In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we enter into forward contracts to buy and sell foreign currency. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur or in the period in which the hedged transaction affects earnings for derivatives classified as non-hedged or hedged, respectively, as defined in Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on this Form 10-K. As of December 31, 2022, the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $193.1 million. The fair value of these contracts at December 31, 2022 was an asset of $0.3 million and a liability of $1.1 million. See Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for a discussion of risks to our business and financial results associated with foreign currencies. +We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the USD. As of December 31, 2022, a 10% appreciation in the value of the USD would result in a net increase in the fair value of our derivative portfolio of approximately $0.3 million. +See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statements of operations for the years ended December 31, 2022 and 2021. +50 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of December 31, 2022. During the year ended December 31, 2022, we closed the Acquisition, as discussed in Note 3 — Acquisition of HEYDUDE in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. As such, the scope of our assessment of the effectiveness of our disclosure controls and procedures did not include internal controls over financial reporting at HEYDUDE. HEYDUDE represented approximately 25% of our total revenues for the year ended December 31, 2022 and 62% of our total assets as of December 31, 2022. This exclusion is consistent with the Securities and Exchange Commission (the “SEC”) staff’s guidance that an assessment of a recently acquired business may be omitted from the scope of our assessment of the effectiveness of disclosure controls and procedures that are also part of internal control over financial reporting in the year of acquisition. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2022, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2022, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2022, which does not include internal controls over financial reporting at HEYDUDE, as discussed above. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2022, as stated in their report, which appears herein. +51 +Table of Contents +Changes in Internal Control Over Financial Reporting +As noted above, we are in the process of integrating HEYDUDE into our overall internal control over financial reporting and will include HEYDUDE in Management’s Evaluation of Disclosure Controls and Procedures for the year ending December 31, 2023. This process may result in additions or changes to our internal control over financial reporting. In addition, as a result of the Acquisition, we have implemented new processes and controls over accounting for an acquisition during the year ended December 31, 2022, including determining the fair value of the assets acquired and liabilities assumed. +Additionally, in the three months ended December 31, 2022, we implemented internal controls over our annual goodwill and indefinite-lived intangible asset impairment analysis, as there was a material addition to our goodwill and indefinite-lived intangible asset balances during the year ended December 31, 2022 related to the acquisition of HEYDUDE, as described in Note 3 — Acquisition of HEYDUDE and Note 5 — Goodwill and Intangible Assets, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Except as described herein, there has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three or twelve months ended December 31, 2022, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +52 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2022 of the Company and our report dated February 16, 2023, expressed an unqualified opinion on those financial statements. +As described in “Management’s Report on Internal Control over Financial Reporting,” management excluded from its assessment the internal control over financial reporting at HEYDUDE, which was acquired on February 17, 2022, and whose financial statements constitute 62% of total assets and 25% of net sales of the consolidated financial statement amounts as of and for the year ended December 31, 2022. Accordingly, our audit did not include the internal control over financial reporting at HEYDUDE. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 16, 2023 +53 +Table of Contents +ITEM 9B. Other Information +None. +ITEM 9C. Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +None. +54 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2023 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2022. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our code of ethics is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, that code for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our code of ethics as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2023 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2022. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2023 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2022, with the exception of those items listed below. +Equity Compensation Plan Information +As shown in the table below, we reserved 1.2 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2022. +Plan Category +Number of Securities to be Issued on Exercise of Outstanding +Options, Warrants, and Rights (1) +Weighted Average Exercise Price of Outstanding +Options, Warrants, and Rights (2) +Number of Securities Remaining Available for Future Issuance Under Plans, Excluding Securities Available in First Column +Equity compensation plans approved by stockholders (3) +1,170,469 $ 7.44 3,895,974 +Equity compensation plans not approved by stockholders +— — — +Total 1,170,469 $ 7.44 3,895,974 +(1) The number of shares outstanding includes restricted stock awards and restricted stock units that were outstanding on December 31, 2022 and assumes target performance for performance-based equity awards. +(2) The weighted average exercise price of outstanding options pertains to 0.2 million shares issuable on the exercise of outstanding options. +(3) On June 10, 2020, our stockholders approved the Crocs, Inc. 2020 Equity Incentive Plan (the “Plan”). The number of shares of our common stock available for issuance under the Plan consisted of (i) 3.8 million newly available shares, (ii) 1.4 million shares of our common stock available for issuance under the 2015 Equity Incentive Plan (the “2015 Plan”) as of June 10, 2020, and (iii) 2015 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 10, 2020. The number of shares authorized for issuance under the Plan is subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. The Plan became effective immediately upon stockholder approval. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2023 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2022. +55 +Table of Contents +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2023 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2022. +56 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedule +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedule +The following consolidated financial statement schedule of Crocs, Inc. and its subsidiaries is filed as a part of this report: +• Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +57 +Table of Contents +(3) Exhibit list +Exhibit +Number Description +2.1 # +Securities Purchase Agreement, dated as of December 22, 2021, by and among: (i) Crocs, Inc.; (ii) Full Fortune Wealth Limited; (iii) Mr. Daniele Guidi; (iv) Full Fortune Intellectual Limited; (v) Full Fortune Worldwide Limited; (vi) Full Fortune Online Limited; (vii) Happy One LLC; (viii) Lucky Top Inc.; (ix) Mr. Alessandro Rosano; and (x) Full Fortune Wealth Limited, in its capacity as representative and agent for Sellers (incorporated herein by reference to Exhibit 2.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 23, 2021). +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +4.2 +Description of Registrant's Securities (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Annual Report on Form 10-K filed on February 27, 2020). +4.3 +Indenture (including Form of Global 4.250% Senior Notes due 2029), dated March 12, 2021, by and among Crocs, Inc., the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 12, 2021). +4.4 +Indenture (including Form of Global 4.125% Senior Notes due 2031), dated August 10, 2021, by and among Crocs, Inc. the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on August 10, 2021). +4.5 +First Supplemental Indenture, dated February 17, 2022, by and among Crocs, Inc., Hey Dude LLC, Happy One LLC and Lucky Top Inc. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +4.6 +First Supplemental Indenture, dated February 17, 2022, by and among Crocs, Inc., Hey Dude LLC, Happy One LLC and Lucky Top Inc. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +4.7 † +Second Supplemental Indenture, dated January 19, 2023, by and among Crocs, Inc., Crocs UK Holdings Limited, Crocs UK Fin Co Limited, Crocs Finance UK Limited, Crocs SG Fin Co. Pte. Ltd. and Crocs Malta Global Ltd. and U.S. Bank Trust Company, National Association, as trustee. +4.8 † +Second Supplemental Indenture, dated January 19, 2023, by and among Crocs, Inc., Crocs UK Holdings Limited, Crocs UK Fin Co Limited, Crocs Finance UK Limited, Crocs SG Fin Co. Pte. Ltd. and Crocs Malta Global Ltd. and U.S. Bank Trust Company, National Association, as trustee. +10.1 * +Crocs, Inc. 2015 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +58 +Table of Contents +Exhibit +Number Description +10.2 * +Andrew Rees Performance-Vested Restricted Stock Unit Agreement (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 13, 2018). +10.3 * +Form of Performance-Vested Restricted Stock Award (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 13, 2021). +10.4 +Second Amended and Restated Credit Agreement, dated July 26, 2019, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed August 1, 2019). +10.5 +First Amendment to Second Amended and Restated Credit Agreement, dated March 26, 2020, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent, and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed March 30, 2020). +10.6 +Second Amendment to Second Amended and Restated Credit Agreement, dated November 13, 2020, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.12 to Crocs, Inc.’s Annual Report on Form 10-K, filed February 23, 2021). +10.7 +Third Amendment to Second Amended and Restated Credit Agreement, dated July 23, 2021, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PNC Bank, National Association, as administrative agent (incorporated herein by reference herein to Exhibit 10.7 to Crocs, Inc.’s Annual Report on Form 10-K, filed February 16, 2022). +10.8 ## +Fourth Amendment to Second Amended and Restated Credit Agreement, dated February 17, 2022, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, Inc., Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +10.9 ## +Fifth Amendment to Second Amended and Restated Credit Agreement, dated November 30, 2022, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, Inc., Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, Bank of America, N.A., London Branch, as alternative currency swing loan lender and PNC Bank, National Association, as administrative agent, U.S. dollar swing loan lender and issuing lender (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 1, 2022. +10.10 ## +Term Loan Credit Agreement, dated February 17, 2022, by and among Crocs, Inc., the lenders from time to time party thereto and Citibank, N.A., as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +10.11 * +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on October 4, 2018). +10.12 * +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.13 * +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +59 +Table of Contents +Exhibit +Number Description +10.14 * +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.15 * +Employment Offer Letter, dated August 1, 2018, between Crocs, Inc. and Anne Mehlman (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2018). +10.16 * +Crocs, Inc. 2020 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 11, 2020). +10.17 * +Employment Offer Letter dated September 10, 2020 between Crocs, Inc. and Michelle Poole (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on September 14, 2020). +21 † +Subsidiaries of the registrant. +23.1 † +Consent of Deloitte & Touche LLP. +31.1 † +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 † +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 + +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS † XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH † XBRL Taxonomy Extension Schema Document +101.CAL † XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF † XBRL Taxonomy Extension Definition Linkbase Document +101.LAB † XBRL Taxonomy Extension Label Linkbase Document +101.PRE † XBRL Taxonomy Extension Presentation Linkbase Document +104 Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101). +* Compensatory plan or arrangement. +# Certain exhibits and schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted exhibits or schedules upon request; provided that the Company may request confidential treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. +## Schedules and exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K. The Company hereby undertakes to supplementally furnish copies of any omitted schedules and exhibits to the Securities and Exchange Commission upon request. +† Filed herewith. ++ Furnished herewith. +60 +Table of Contents +Item 16. Form 10–K Summary. +None. +61 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 16, 2023. +CROCS, INC. +a Delaware Corporation +By: /s/ ANDREW REES +Name: Andrew Rees +Title: Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ ANDREW REES Chief Executive Officer and Director (Principal Executive Officer) February 16, 2023 +Andrew Rees +/s/ ANNE MEHLMAN Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 16, 2023 +Anne Mehlman +/s/ THOMAS J. SMACH Chairman of the Board February 16, 2023 +Thomas J. Smach +/s/ IAN M. BICKLEY Director February 16, 2023 +Ian M. Bickley +/s/ RONALD L. FRASCH Director February 16, 2023 +Ronald L. Frasch +/s/ TRACY GARDNER Director February 16, 2023 +Tracy Gardner +/s/ CHARISSE FORD HUGHES Director February 16, 2023 +Charisse Ford Hughes +/s/ BETH J. KAPLAN Director February 16, 2023 +Beth J. Kaplan +/s/ DOUGLAS J. TREFF Director February 16, 2023 +Douglas J. Treff +62 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) +F- 2 +Consolidated Statements of Operations for the Years Ended December 31, 2022, 2021, and 2020 +F- 5 +Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2022, 2021, and 2020 +F- 6 +Consolidated Balance Sheets as of December 31, 2022 and 2021 +F- 7 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2022, 2021, and 2020 +F- 8 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2022, 2021, and 2020 +F- 9 +Notes to Consolidated Financial Statements +F- 10 +Schedule II: Valuation and Qualifying Accounts +F- 39 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2022 and 2021 , the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2022 , and the related notes and the financial schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022 , in conformity with accounting principles generally accepted in the United States of America . +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022 , based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 16, 2023 , expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current-period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate. +Income Taxes —Evaluation of the Deferred Tax Asset resulting from Intra-entity Intellectual Property Transactions — Refer to Note 14 to the consolidated financial statements +Critical Audit Matter Description +The Company recognizes deferred income taxes for tax attributes and for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the deferred tax liability or asset is expected to be settled or realized. In 2020, the Company completed a series of transactions resulting in changes to their international legal structure, including the sale of certain intellectual property (“IP”) rights between wholly-owned subsidiaries to the Netherlands. The sale entitles the Netherlands entity to profits resulting from the IP and created an amortizable step-up in the tax basis of the intangible asset and a corresponding increase in foreign deferred tax assets based on the fair value of the IP. The related net deferred tax asset is $401.2 million as of December 31, 2022. +In order to support and sustain the amortizable tax basis (and associated deferred tax asset), the Company must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands. +F- 2 +Table of Contents +The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of tax laws of each associated tax jurisdiction. In 2021 and 2022, the Company undertook many additional activities to align the business operations that support the economic substance of the IP in the Netherlands. +We identified management’s evaluation of the economic substance necessary to support the ownership and service of the IP and the corresponding deferred tax asset related to this IP as a critical audit matter because of the significant judgments and interpretations of tax laws that were made by management. +We utilized a high degree of auditor judgment and an increased extent of effort, including the need to involve our income tax specialists with the appropriate skills and knowledge, when performing audit procedures to evaluate whether management’s judgments in interpreting and applying tax laws were appropriate in determining the substance of the deferred tax asset as of December 31, 2022. +How the Critical Audit Matter Was Addressed in the Audit +Our audit procedures, performed with the assistance of our tax specialist, related to the Company’s evaluation of the deferred tax asset resulting from an intra-entity IP transfer included the following, among others: +• We evaluated the activities undertaken by the Company to support the economic substance, including determination of the functions performed and the considerations necessary to service the IP. +• Obtained the Company’s supporting documentation to assess the technical tax merits applicable to the Netherlands and international transfer pricing standards and evaluated the application of these relevant tax laws in the Company’s recognition determination. +• Evaluated the economic substance of the Company’s deferred tax asset using our knowledge of international, domestic, and local income tax laws, as well as settlement activity from the relevant income tax authorities. +Business Combination - Acquisition of HEYDUDE - Valuation of trademark and customer relationships - Refer to Note 3 to the financial statements +Critical Audit Matter Description +The Company acquired 100% of the equity of a privately-owned casual footwear brand business ("HEYDUDE") for $2.3 billion on February 17, 2022. The Company accounted for the acquisition under the acquisition method of accounting for business combinations. Accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values, including a trademark of $1,570.0 million and customer relationships of $210.0 million. Management estimated the fair value of the trademark using the multi-period excess earnings method. Management estimated the fair value of the customer relationships using the distributor method. The fair value determination of the trademark and customer relationships required management to make significant estimates and assumptions related to future revenue growth rates, earnings before interest, taxes, depreciation and amortization (“EBITDA”) and market-based discount rates. +Given the fair value determination of the trademark and customer relationships for HEYDUDE requires management to make significant estimates and assumptions related to future revenue growth rates, EBITDA and market-based discount rates, performing audit procedures to evaluate the reasonableness of these estimates and assumptions required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists. +How the Critical Audit Matter Was Addressed in the Audit +Our auditing procedures related to the future revenue growth rates, EBITDA and market-based discount rates included the following, among others: +• We obtained an understanding of management’s key assumptions in developing the forecast. +• We assessed the reasonableness of management's forecasts of future revenue growth rates and EBITDA by comparing the projections to historical results, macroeconomic data, industry data and certain peer companies. +• We evaluated whether the forecast of future revenue growth rates was consistent with projections used by the Company as well as other areas of the audit. +F- 3 +Table of Contents +• With the assistance of our fair value specialists, we evaluated the reasonableness of the market-based discount rate by: +– Testing the source information underlying the determination of the market-based discount rate and testing the mathematical accuracy of the calculation. +– Developing a range of independent estimates and comparing those to the market-based discount rate selected by management. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 16, 2023 +We have served as the Company’s auditor since 2005. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +(in thousands, except per share data) +Year Ended December 31, +2022 2021 2020 +Revenues +$ 3,554,985 $ 2,313,416 $ 1,385,951 +Cost of sales +1,694,703 893,196 636,003 +Gross profit +1,860,282 1,420,220 749,948 +Selling, general and administrative expenses +1,009,526 737,156 514,753 +Asset impairments +— — 21,071 +Income from operations +850,756 683,064 214,124 +Foreign currency gains (losses), net +3,228 ( 140 ) ( 1,128 ) +Interest income +1,020 775 215 +Interest expense +( 136,158 ) ( 21,647 ) ( 6,742 ) +Other income (expense), net +( 338 ) 1,797 510 +Income before income taxes +718,508 663,849 206,979 +Income tax expense (benefit) +178,349 ( 61,845 ) ( 105,882 ) +Net income +$ 540,159 $ 725,694 $ 312,861 +Net income per common share: +Basic +$ 8.82 $ 11.62 $ 4.64 +Diluted +$ 8.71 $ 11.39 $ 4.56 +Weighted average common shares outstanding: +Basic +61,220 62,464 67,386 +Diluted +62,006 63,718 68,544 +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(in thousands) +Year Ended December 31, +2022 2021 2020 +Net income +$ 540,159 $ 725,694 $ 312,861 +Other comprehensive income, net of tax: +Derivatives designated as hedging instruments: +Unrealized gains (losses) on derivative instruments +( 576 ) — — +Foreign currency gains (losses), net +( 17,929 ) ( 20,484 ) 2,189 +Reclassification of foreign currency translation gain (loss) to income (1) +( 8,148 ) — ( 164 ) +Total comprehensive income, net of tax +$ 513,506 $ 705,210 $ 314,886 +(1) Represents the reclassification of a cumulative foreign currency translation adjustment upon substantial liquidation of foreign subsidiaries which is presented within ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2022 2021 +ASSETS +Current assets: +Cash and cash equivalents +$ 191,629 $ 213,197 +Restricted cash — current +2 65 +Accounts receivable, net of allowances of $ 24,493 and $ 20,715 , respectively +295,594 182,629 +Inventories +471,551 213,520 +Income taxes receivable +14,752 22,301 +Other receivables +18,842 12,252 +Prepaid expenses and other assets +33,605 22,605 +Total current assets +1,025,975 666,569 +Property and equipment, net +181,529 108,398 +Intangible assets, net +1,800,167 28,802 +Goodwill +714,814 1,600 +Deferred tax assets, net +528,278 567,201 +Restricted cash +3,254 3,663 +Right-of-use assets +239,905 160,768 +Other assets +7,875 8,067 +Total assets +$ 4,501,797 $ 1,545,068 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ 230,821 $ 162,145 +Accrued expenses and other liabilities +239,424 166,887 +Income taxes payable +89,211 16,279 +Current borrowings +24,362 — +Current operating lease liabilities +57,456 42,932 +Total current liabilities +641,274 388,243 +Deferred tax liabilities, net (1) +302,030 176 +Long-term income taxes payable (1) +224,837 219,568 +Long-term borrowings +2,298,027 771,390 +Long-term operating lease liabilities +215,119 149,237 +Other liabilities +2,579 2,372 +Total liabilities +3,683,866 1,530,986 +Stockholders’ equity: +Common stock, par value $ 0.001 per share, 109.5 million and 105.9 million issued, 61.7 million and 58.3 million shares outstanding, respectively +110 106 +Treasury stock, at cost, 47.7 million and 47.6 million shares, respectively +( 1,695,501 ) ( 1,684,262 ) +Additional paid-in capital +797,614 496,036 +Retained earnings +1,819,199 1,279,040 +Accumulated other comprehensive loss +( 103,491 ) ( 76,838 ) +Total stockholders’ equity +817,931 14,082 +Total liabilities and stockholders’ equity +$ 4,501,797 $ 1,545,068 +(1) Amounts for the year ended December 31, 2021 have been reclassified to conform to current period presentation. +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock Treasury Stock Additional +Paid-in +Capital Retained +Earnings +Accumulated +Other +Comprehensive +(Loss) +Total +Stock-holders' +Equity +Shares Amount Shares Amount +Balance at December 31, 2019 +68,232 $ 104 35,796 $ ( 546,208 ) $ 495,903 $ 240,485 $ ( 58,379 ) $ 131,905 +Share-based compensation — — — — 16,361 — — 16,361 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes +836 1 124 ( 3,059 ) 1,371 — — ( 1,687 ) +Repurchases of common stock ( 3,212 ) 3,212 ( 139,582 ) ( 31,250 ) — — ( 170,832 ) +Net income +— — — — — 312,861 — 312,861 +Other comprehensive income +— — — — — — 2,025 2,025 +Balance at December 31, 2020 +65,856 $ 105 39,132 $ ( 688,849 ) $ 482,385 $ 553,346 $ ( 56,354 ) $ 290,633 +Share-based compensation — — — — 38,122 — — 38,122 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes +716 1 209 ( 20,119 ) 235 — — ( 19,883 ) +Repurchases of common stock ( 8,242 ) — 8,242 ( 975,294 ) ( 24,706 ) — — ( 1,000,000 ) +Net income +— — — — — 725,694 — 725,694 +Other comprehensive loss +— — — — — — ( 20,484 ) ( 20,484 ) +Balance at December 31, 2021 +58,330 $ 106 47,583 $ ( 1,684,262 ) $ 496,036 $ 1,279,040 $ ( 76,838 ) $ 14,082 +Share-based compensation — — — — 31,303 — — 31,303 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes +567 1 147 ( 11,239 ) ( 118 ) — — ( 11,356 ) +Share issuance at Acquisition 2,852 3 — — 270,393 — — 270,396 +Net income +— — — — — 540,159 — 540,159 +Other comprehensive loss +— ( 26,653 ) ( 26,653 ) +Balance at December 31, 2022 +61,749 $ 110 47,730 $ ( 1,695,501 ) $ 797,614 $ 1,819,199 $ ( 103,491 ) $ 817,931 +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2022 2021 2020 +Cash flows from operating activities: +Net income +$ 540,159 $ 725,694 $ 312,861 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +39,229 31,976 27,619 +Loss on disposal of assets (1) +9,063 310 340 +Operating lease cost +66,012 58,283 61,583 +Inventory donations 2,770 1,264 8,994 +Provision (recovery) for doubtful accounts, net +1,101 ( 2,629 ) 5,779 +Share-based compensation +31,303 38,122 16,361 +Asset impairments +— — 21,071 +Deferred taxes +( 4,760 ) ( 241,283 ) ( 325,061 ) +Other non-cash items (1) +9,947 ( 46 ) 4,967 +Changes in operating assets and liabilities, net of acquired assets and assumed liabilities: +Accounts receivable, net of allowances +( 56,766 ) ( 35,063 ) ( 47,045 ) +Inventories +( 91,614 ) ( 43,063 ) ( 13,462 ) +Prepaid expenses and other assets +( 14,435 ) ( 6,212 ) 5,007 +Accounts payable +41,701 34,868 23,229 +Accrued expenses and other liabilities +38,629 38,448 22,358 +Right-of-use assets and operating lease liabilities +( 63,355 ) ( 52,752 ) ( 61,178 ) +Income taxes +54,158 19,248 203,479 +Cash provided by operating activities +603,142 567,165 266,902 +Cash flows from investing activities: +Purchases of property, equipment, and software +( 104,190 ) ( 55,916 ) ( 42,033 ) +Acquisition of HEYDUDE, net of cash acquired +( 2,046,881 ) — — +Other (1) +( 20 ) ( 9 ) 271 +Cash used in investing activities +( 2,151,091 ) ( 55,925 ) ( 41,762 ) +Cash flows from financing activities: +Proceeds from notes issuance — 700,000 — +Proceeds from bank borrowings +2,169,898 390,000 210,000 +Repayments of bank borrowings +( 575,285 ) ( 485,000 ) ( 235,000 ) +Deferred debt issuance costs +( 53,596 ) ( 14,755 ) ( 518 ) +Repurchases of common stock +— ( 1,000,000 ) ( 170,832 ) +Repurchases of common stock for tax withholding +( 11,477 ) ( 20,119 ) ( 3,060 ) +Other +119 236 1,372 +Cash provided by (used in) financing activities +1,529,659 ( 429,638 ) ( 198,038 ) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +( 3,750 ) ( 3,950 ) 126 +Net change in cash, cash equivalents, and restricted cash +( 22,040 ) 77,652 27,228 +Cash, cash equivalents, and restricted cash — beginning of year 216,925 139,273 112,045 +Cash, cash equivalents, and restricted cash — end of year $ 194,885 $ 216,925 $ 139,273 +Cash paid for interest $ 127,809 $ 10,210 $ 6,658 +Cash paid for income taxes 130,084 159,680 20,816 +Cash paid for operating leases 62,852 61,412 59,579 +Right-of-use assets obtained in exchange for operating lease liabilities, net of terminations 137,554 55,035 55,369 +Accrued purchases of property, equipment, and software 18,245 15,831 4,222 +Share issuance at Acquisition 270,396 — — +(1) Amounts for the years ended December 31, 2021 and 2020 have been reclassified to conform to current period presentation. +The accompanying notes are an integral part of these consolidated financial statements. +F- 9 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of the “Company,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. We are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the global leader in the sale of casual footwear characterized by functionality, comfort, color, and lightweight design. +On February 17, 2022, we acquired (the “Acquisition”) 100 % of the equity of a privately-owned casual footwear brand business (“HEYDUDE”), pursuant to a securities purchase agreement (the “SPA”) entered into on December 22, 2021. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” +Our reportable operating segments include: (i) North America for the Crocs Brand, operating throughout the United States and Canada; (ii) Asia Pacific for the Crocs Brand, operating throughout Asia, Australia, and New Zealand; (iii) Europe, Middle East, Africa and Latin America (“EMEALA”) for the Crocs Brand; and (iv) the HEYDUDE Brand. See Note 17 — Operating Segments and Geographic Information for additional information. +Basis of Presentation and Consolidation +Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries, and they reflect all adjustments which are necessary for a fair statement of results of operations, financial position, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, valuation allowances, uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, goodwill, and indefinite-lived intangible assets, and purchase price allocation for the Acquisition, as described in Note 3 — Acquisition of HEYDUDE, are reasonable based on information available at the time they are made. +Additionally, we are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. If it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 16 — Commitments and Contingencies for additional information regarding our contingencies and legal proceedings. +To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +F- 10 +Table of Contents +Reclassifications +We have reclassified certain amounts on the consolidated balance sheets, consolidated statements of cash flows, and in Note 17 — Operating Segments and Geographic Information to conform to current period presentation. +In the fourth quarter, management identified an error in its prior quarterly condensed consolidated statements of cash flows of $ 85.0 million within the amounts reported in ‘Proceeds from bank borrowings’ and ‘Repayments of bank borrowings.’ This amount had no impact on cash flows from financing activities. We have corrected this amount in the consolidated statement of cash flows for the year ended December 31, 2022 and do not consider it to be material to any of the reported interim periods. +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. We report receivables from credit card companies, if expected to be received within five days, in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. We reduce the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting our customer base, and historical collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial obligations. We write off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Schedule II in Item 15. Exhibits, Financial Statement Schedule of this Annual Report on Form 10-K for more information. +Inventories +Inventories are comprised of finished goods, are stated at the lower of cost or net realizable value, and are recognized using the first-in-first-out method of inventory costing. We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end-of-life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value, and the difference is recorded in ‘Cost of sales’ in our consolidated statements of operations. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and they are recorded within ‘Cost of sales’ in our consolidated statements of operations. +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives. The useful lives are reviewed periodically and typically range from 2 to 10 years for machinery and equipment and furniture, fixtures and others. Leasehold improvements are stated at cost and amortized on a straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of warehouse- and distribution-related assets is included in ‘Cost of sales’ in our consolidated statements of operations. Depreciation related to retail store, corporate, and non-product assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets, and the resulting gain or loss, if any, is reflected in ‘Income from operations’ in the consolidated statements of operations. +F- 11 +Table of Contents +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. During the year ended December 31, 2022, we changed our annual goodwill impairment testing date from the last day of our fiscal fourth quarter to the first day of our fiscal fourth quarter. +The excess of the purchase price over the fair value of acquired net assets represents goodwill. Our goodwill balance as of December 31, 2022 was $ 714.8 million and primarily related to the Acquisition. As of December 31, 2022, a goodwill amount of $ 713.3 million was assigned to the HEYDUDE Brand segment and consisted of the acquired workforce and economies of scale resulting from the Acquisition. +When performing our annual test for impairment, we may assess goodwill and indefinite-lived intangible assets for potential impairment using either a qualitative or quantitative assessment. Significant judgments and assumptions are required in such impairment evaluations. For the quantitative assessment, we compare the estimated fair value of a reporting unit with its carrying value, including the goodwill assigned to the reporting unit. If the carrying value of the reporting unit exceeds its estimated fair value, an impairment charge is recorded. For the year ended December 31, 2022, we elected to bypass the qualitative assessment for the HEYDUDE Brand reporting unit goodwill and indefinite-lived intangible assets and proceed directly to performing the quantitative goodwill and indefinite-lived intangible asset impairment tests. The estimated fair values of the HEYDUDE Brand reporting unit goodwill and indefinite-lived trademark exceeded their carrying values. Additionally for the years ended December 31, 2022, 2021, and 2020, we performed a qualitative assessment for the goodwill in our EMEALA segment, which indicated that it was more likely than not that the estimated fair value exceeded its carrying value. We did not record any impairment charges in the years ended December 31, 2022, 2021, or 2020 based on the results of our goodwill and indefinite-lived intangible assets impairment testing. +We continuously monitor the performance of our definite-lived intangible assets, which includes software, customer relationships, patents, copyrights, and certain trademarks, and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +We amortize our customer relationships on a straight-line basis over a useful life of 15 years. Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and typically range from 7 to 25 years. +Internal-Use Software and Cloud Computing Arrangements +We capitalize direct costs of materials and services used in the development and purchase of internal-use software. Amounts capitalized are amortized on a straight-line basis over a period of 2 to 8 years and are reported as a component of ‘Intangible assets, net’ in the consolidated balance sheets. +We also capitalize certain costs incurred during the application development stage of implementation of internal-use software in cloud computing arrangements. Amounts capitalized are amortized on a straight-line basis over the expected length of the related contract and are reported as a component of ‘Prepaid expenses and other assets’ and ‘Other assets’ in the consolidated balance sheets. +Amortization of capitalized software used in warehouse- and distribution-related activities is included in ‘Cost of sales’ in the consolidated statements of operations. Amortization related to corporate and non-product, assets, such as our global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of operations. +Leases +Our lease portfolio consists primarily of real estate assets, which includes retail, warehouse, distribution center, and office spaces, under operating leases expiring at various dates through 2033. Leases with an original term of twelve months or less are not reported in the consolidated balance sheets; expense for these short-term leases is recognized on a straight-line basis over the lease term. +Many leases include one or more options to renew, with renewal terms that, if exercised by us, may extend the lease term. The exercise of these renewal options is at our discretion. When assessing the likelihood of a renewal or termination, we consider +F- 12 +Table of Contents +the significance of leasehold improvements, availability of alternative locations, and the cost of relocation or replacement, among other considerations. The depreciable lives of leasehold improvements are the shorter of the useful lives of the improvements or the expected lease term. We determine the lease term for each lease based on the terms of each contract and factor in renewal and early termination options if such options are reasonably certain to be exercised. We do not generally believe such options are reasonably certain, and therefore, we have excluded them from the recorded right-of-use assets and operating lease liabilities. +Due to our centralized treasury function, we utilize a portfolio approach to discount our lease obligations. We assess the expected lease term at lease inception and discount the lease using a fully-secured annual incremental borrowing rate, adjusted for time value corresponding with the expected lease term. +Certain of our retail store leases include rental payments based upon a percentage of retail sales in excess of a minimum fixed rental. In some cases, there is no fixed minimum rental, and the entire rental payment is based upon a percentage of sales. In addition, certain leases include rental payments adjusted periodically for changes in price level indices. We recognize expense for these types of payments as incurred and report them as variable lease expense. See Note 7 — Leases for additional information. +Derivative Financial Instruments +We transact business in various foreign entities and are therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar (“USD”) amounts of revenues, expenses, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we may enter into forward contracts to buy and sell foreign currency. By policy, we do not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts we enter into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to and did not post collateral as of December 31, 2022 or 2021. +Our derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2022 and 2021. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain components of its risk, even though hedge accounting does not apply, or we elect not to apply hedge accounting. +We report derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. For the consolidated statements of cash flows, we classify cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities.’ +As of December 31, 2022, we have derivatives not designated as hedging instruments (“non-hedged derivatives”), which consist of foreign currency forward contracts primarily used to hedge monetary assets and liabilities denominated in non-functional currencies. For our non-hedged derivatives, changes in fair value are recognized within ‘Foreign currency gains (losses), net’ in the consolidated statements of operations. +We also have cash flow hedges (“hedged derivatives”) as of December 31, 2022. We are exposed to fluctuations in various foreign currencies against our functional currency, the U.S. Dollar. Specifically, we have subsidiaries that transact in currencies other than their functional currency. We use cash flow hedges to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. Currency forward agreements involve fixing the exchange rates for delivery of a specified amount of foreign currency on a specified date. The currency forward agreements are typically cash settled in USD for their fair value at or close to their settlement date. We may also use currency option contracts under which we will pay a premium for the right to sell a specified amount of a foreign currency prior to the maturity date of the option. +F- 13 +Table of Contents +For derivatives designated and that qualify as cash flow hedges of foreign exchange risk, the gain or loss on the derivative is recorded in ‘Accumulated other comprehensive loss’ in the consolidated balance sheets. In the period during which the hedged transaction affects earnings, the related gain or loss is subsequently reclassified to ‘Revenues’ or ‘Cost of sales’ in the consolidated statement of operations, which is consistent with the nature of the hedged transaction. +See Note 9 — Derivative Financial Instruments for further information on derivative financial instruments. +Other Comprehensive Income +Our foreign subsidiaries use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into USD using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss), until the substantial liquidation of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. During the year ended December 31, 2022, we recognized a net loss of $ 8.1 million of cumulative foreign currency translation adjustments related to the substantial liquidation of a foreign subsidiary. +Revenue Recognition +See Note 12 — Revenues for a summary of our revenue recognition policy. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, procure, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, licensing fees, depreciation, amortization, packaging, and other warehouse and distribution overhead and costs. +Selling, General and Administrative Expenses +Selling, general and administrative expenses consist primarily of labor and outside services, rent expense, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to corporate and non-product assets and share-based compensation. Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources, and information technology. +Our selling, general and administrative expenses also include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of our promotional expenses result from payments under endorsement contracts. Endorsement-related expenses are recognized as performance is received over the term of each endorsement agreement. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, including variable marketing expenses, were $ 260.8 million, $ 172.7 million, and $ 101.0 million for the years ended December 31, 2022, 2021, and 2020, respectively. +Share-Based Compensation +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +We grant RSAs, service-condition RSUs, performance-condition RSUs, and market-condition RSUs. The grant date fair values of RSAs, service-condition RSUs, and performance-condition RSUs are based on the closing market price of our common stock +F- 14 +Table of Contents +on the grant date; the grant date fair value and derived service period of market-condition RSUs are estimated using a Monte Carlo simulation valuation model. Our service-condition RSUs vest based on continued service; our performance-condition RSUs vest based on achievement of multiple weighted performance goals, certification of performance achievement by the Compensation Committee of the Board of Directors, and continued service; and our market-condition RSUs vest based on the market price of our stock and continued service. Compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service period. For performance-condition RSUs, compensation expense is updated for our expected performance level against performance goals at the end of each reporting period, which involves judgment as to the achievement of certain performance metrics. +See Note 13 — Share-Based Compensation for additional information related to share-based compensation. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. We assess recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and record a loss from impairment if the carrying value is more than its undiscounted cash flows. For customer relationships, impairment testing is performed at the customer group level. For assets involved in our retail businesses, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets, leasehold improvements, and right-of-use assets related to our retail locations for impairment. For all other long-lived assets, we perform impairment testing at the asset group level for which separately identifiable cash flows are available. Assets or asset groups to be abandoned are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 4 — Property and Equipment, Net, Note 5 — Goodwill and Intangible Assets, Net, and Note 7 — Leases for a discussion of impairment losses recorded during the periods presented. +Foreign Currency Gains (Losses), Net +Foreign currency gains (losses), net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of an entity and realized and unrealized gains and losses on forward foreign currency exchange derivative contracts that do not qualify for hedge accounting. +Other Income (Expense), Net +Other income (expense), net primarily includes gains and losses associated with activities not directly related to making and selling footwear. +Income Taxes +Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statements of operations. See Note 14 — Income Taxes for further discussion. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the treasury stock method. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in our earnings and is calculated by adjusting weighted average outstanding shares, assuming conversion of all potentially dilutive stock options and awards. Anti-dilutive securities are excluded from diluted EPS. See Note 15 — Earnings per Share for additional information. +F- 15 +Table of Contents +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). We utilize a combination of market and income approaches to value derivative instruments. Our financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level Inputs +1 Unadjusted quoted prices in active markets for identical assets and liabilities. +2 Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 Unobservable inputs for the asset or liability. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 8 — Fair Value Measurements for further discussion related to estimated fair value measurements. +2. RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Income Taxes +The CHIPS and Science Act of 2022 (CHIPS) and the Inflation Reduction Act (IRA) of 2022 were signed into law on August 9, 2022 and August 16, 2022, respectively. The legislation introduces new options for monetizing certain credits, a corporate alternative minimum tax, and a stock repurchase excise tax. The corporate alternative minimum tax and stock repurchase excise tax are effective as of January 1, 2023 and are the main provisions that may be applicable to us. The Company is currently evaluating the impact of CHIPS and IRA, but at present does not expect that any of the provisions included in these acts would result in a material impact to our deferred tax assets, liabilities, or income taxes payable. +Business Combinations +In October 2021, the FASB issued new guidance primarily related to the accounting for contract assets and liabilities from contracts with customers in a business combination. The standard will be effective for annual reporting periods beginning after December 31, 2022, including interim reporting periods within those periods, with early adoption permitted. On January 1, 2022, we early adopted this guidance on a prospective basis. The adoption did not have a material impact on our consolidated financial statements. +New Accounting Pronouncements Not Yet Adopted +New pronouncements issued but not effective until after December 31, 2022 are not expected to have a material impact on our consolidated financial statements. +3. ACQUISITION OF HEYDUDE +On February 17, 2022, (the “Acquisition Date”), we acquired 100 % of the equity of HEYDUDE, pursuant to the SPA. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The Acquisition allows us to diversify and expand our business by adding a second brand to the Crocs, Inc. portfolio. +The aggregate preliminary purchase price at the closing of the Acquisition was $ 2.3 billion. We paid aggregate consideration of $ 2.05 billion in cash (the “Cash Consideration”), subject to adjustment based on, among other things, the cash, indebtedness, +F- 16 +Table of Contents +transaction expenses, and working capital of the companies comprising HEYDUDE and their respective subsidiaries as of the Acquisition Date, and issued 2,852,280 shares of the Company’s common stock to one of the sellers (the “Equity Consideration Shares”). The Equity Consideration Shares are subject to a lock-up period beginning on the Acquisition Date and continuing to, and including, the date that is 12 months after the Acquisition Date, provided that (a) on the date that is six months after the Acquisition Date, 50 % of the Equity Consideration Shares were released from the lock-up, and (b) on the date that is twelve months after the Acquisition Date, the remaining 50 % of the Equity Consideration Shares will be released from the lock-up. In the year ended December 31, 2022, the purchase price paid to the sellers was finalized. +The Cash Consideration was financed via the Company’s entry into the $ 2.0 billion Term Loan B Facility (as defined below) and $ 50.0 million of borrowings under the Revolving Facility (as defined below). As a result of the Acquisition, HEYDUDE has become wholly owned by us. Accordingly, the results of HEYDUDE are included in our consolidated financial statements from the Acquisition Date through December 31, 2022 (the “Partial Period”) and are reported in the HEYDUDE operating segment. HEYDUDE contributed revenues of $ 895.9 million and income from operations of $ 211.4 million during the Partial Period. +Purchase Price Allocation +The Acquisition was accounted for in accordance with the ASC Topic 805 Business Combinations . As a result, we have applied acquisition accounting, which requires, among other things, that the assets acquired and liabilities assumed be recognized at their estimated fair values as of the Acquisition Date. For certain assets and liabilities, those fair values were consistent with historical carrying values. The fair value of inventory was determined using both a market approach and a cost approach. With respect to intangible assets, the estimated fair value was based on the Multi Period Excess Earnings approach for the trademark and the distributor method for the customer relationships. These models used primarily Level 2 and Level 3 inputs, including an estimate of future revenues, future cash flows, and discount rates. +The following table summarizes the preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed on the Acquisition Date: +February 17, 2022 +(in thousands) +Cash and cash equivalents $ 6,232 +Accounts receivable, net (1) +68,698 +Inventories (2) +155,773 +Prepaid expenses and other assets (3) +4,380 +Intangible assets (4) +1,780,000 +Goodwill (5) +713,308 +Right-of-use assets 2,844 +Accounts payable (3) +( 29,791 ) +Accrued expenses and other liabilities (6) +( 18,860 ) +Income taxes payable (7) +( 30,572 ) +Long-term deferred tax liability (7) +( 312,656 ) +Long-term income taxes payable (7) +( 13,004 ) +Operating lease liabilities ( 2,843 ) +Net assets acquired (8) +$ 2,323,509 +(1) Includes a valuation adjustment that decreased accounts receivable, net by $ 0.3 million during the Partial Period. +(2) Includes valuation adjustments that decreased inventories by $ 20.2 million and decreased accrued expenses by $ 20.2 million during the Partial Period, partially offset by a valuation adjustment that increased inventories by $ 4.7 million and decreased goodwill by $ 4.7 million. +(3) Includes a valuation adjustment of $ 1.4 million that increased prepaid expenses and other assets and increased accounts payable by $ 1.4 million during the Partial Period. +(4) Includes a decrease of $ 90.0 million due to a valuation adjustment related to customer relationships during the Partial Period. +(5) During the Partial Period, goodwill increased $ 72.8 million, $ 66.2 million of which relates to the valuation and tax adjustments described in footnotes (1), (2), (3), (6), (7) and $ 6.6 million of which relates to a working capital adjustment, as described in footnote (8). +F- 17 +Table of Contents +(6) Includes a net decrease of $ 20.8 million made during the Partial Period, comprised of net valuation adjustments of $ 21.8 million, partially offset by non-income tax adjustments of $ 1.0 million. +(7) Includes the impact of tax adjustments: a decrease of $ 2.4 million to income taxes payable, a decrease of $ 17.1 million to long-term deferred tax liability, and an increase of $ 0.6 million to long-term income taxes payable. +(8) During the Partial Period, the purchase price consideration was increased by $ 6.6 million associated with the finalization of purchase price. +The purchase price allocation for the Acquisition is preliminary. Valuation by management of certain assets and liabilities, is still in process, and therefore, the actual fair values may vary from these preliminary estimates. Final valuations are expected to be completed within one year of the Acquisition Date. +Intangible Assets +The components of intangible assets acquired in connection with the Acquisition were as follows: +Weighted-Average Useful Life Amortization Method Estimated Fair Value +(in thousands) +Customer relationships 15 Straight-line $ 210,000 +Trademark Indefinite — 1,570,000 +Total intangible assets $ 1,780,000 +Goodwill +The goodwill amount of $ 713.3 million at December 31, 2022 includes an aggregate adjustment of $ 72.8 million recorded in the year ended December 31, 2022 as a result of changes to preliminary valuation estimates and a working capital adjustment. The total goodwill amount acquired was assigned to the HEYDUDE reporting segment. None of the goodwill will be deductible for income tax purposes. +Escrow and Holdback Amounts +Additionally, $ 125.0 million of the Cash Consideration (the “Escrow Amount”) was placed in an escrow account to partially secure the indemnification obligations of the sellers, which will be released to the sellers, less any amounts that have been released to compensate the Company as provided in the SPA, after the date that is 18 months after the Acquisition Date. As of December 31, 2022, certain receivables have been recorded related to the Escrow Amount. Further, $ 8.5 million of the Cash Consideration (the “Adjustment Holdback Amount”) was held back and retained as security (but not as the sole source of recovery) for any downward adjustments to the purchase price made in accordance with the SPA. During the year ended December 31, 2022, the Adjustment Holdback Amount was paid to the sellers. +Acquisition-related Costs +Costs incurred to complete the Acquisition are expensed as incurred and included in ‘Selling, general, and administrative expenses’ in our consolidated statement of operations. During the year ended December 31, 2022, there were approximately $ 25.7 million of Acquisition-related costs recognized. These costs represent legal, professional, and transaction fees. +Unaudited Pro Forma Information +The following unaudited pro forma financial information for the year ended December 31, 2022 and 2021 combines the historical results of the Crocs and HEYDUDE Brands, assuming that the companies were combined as of January 1, 2021 and include business combination accounting effects from the Acquisition, including amortization charges from acquired intangible assets, adjustments to the fair value of inventory, interest expense on the financing transactions used to fund the Acquisition, and Acquisition-related transaction costs and tax-related effects. The pro forma information as presented below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the Acquisition had taken place on January 1, 2021. +F- 18 +Table of Contents +Year Ended December 31, +2022 2021 +(in thousands) +Revenues $ 3,645,291 $ 2,894,094 +Net income 614,463 706,853 +4. PROPERTY AND EQUIPMENT, NET +‘Property and equipment, net’ consists of the following: +December 31, +2022 2021 +(in thousands) +Machinery and equipment $ 146,821 $ 53,976 +Leasehold improvements 76,363 64,625 +Construction-in-progress 28,699 53,332 +Furniture, fixtures, and other 26,782 20,210 +Property and equipment 278,665 192,143 +Less: Accumulated depreciation and amortization ( 97,136 ) ( 83,745 ) +Property and equipment, net $ 181,529 $ 108,398 +Asset Retirement Obligations +We are contractually obligated, under certain of our lease agreements, to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. Asset retirement obligations were not significant to the consolidated balance sheets in the years ended December 31, 2022 or 2021. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Cost of sales $ 10,043 $ 6,234 $ 3,921 +Selling, general and administrative expenses 9,599 8,708 7,914 +Total depreciation and amortization expense $ 19,642 $ 14,942 $ 11,835 +Disposals of Property and Equipment and Intangible Assets +During the years ended December 31, 2022, 2021, and 2020, we recognized net losses on disposals of property and equipment and intangible assets of $ 1.0 million, $ 0.3 million, and $ 0.3 million, respectively. Gains and losses on disposals of property and equipment and intangible assets are included in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Additionally, we impaired our leasehold improvement assets for a retail location in the year ended December 31, 2020, as described in Note 8 — Fair Value Measurements. +F- 19 +Table of Contents +5. GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +The changes in goodwill for the years ended December 31, 2022 and 2021 were: +Goodwill +(in thousands) +Balance at December 31, 2020 +$ 1,719 +Foreign currency translation (1) +( 119 ) +Balance at December 31, 2021 +1,600 +HEYDUDE Acquisition 713,308 +Foreign currency translation (1) +( 94 ) +Balance at December 31, 2022 +$ 714,814 +(1) Foreign currency translation only relates to the goodwill in our EMEALA operating segment, as described below. +In the year ended December 31, 2022, there was an addition to our goodwill as a result of the acquisition of HEYDUDE. As of December 31, 2022, EMEALA and the HEYDUDE Brand had goodwill balances of $ 1.5 million and $ 713.3 million, respectively. In the year ended December 31, 2021, there were no changes to our goodwill aside from insignificant changes related to foreign currency translation. +At December 31, 2022, accumulated goodwill impairment was $ 0.8 million. +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2022 December 31, 2021 +Gross Accum. Amortiz. Net Gross Accum. Amortiz. Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software $ 132,295 $ ( 109,227 ) $ 23,068 $ 128,843 $ ( 104,637 ) $ 24,206 +Customer relationships 210,000 ( 12,250 ) 197,750 — — — +Patents, copyrights, and trademarks 5,124 ( 3,537 ) 1,587 4,308 ( 3,530 ) 778 +Intangible assets not subject to amortization: +HEYDUDE trademark 1,570,000 — 1,570,000 — — — +In progress 7,537 — 7,537 3,739 — 3,739 +Other 225 — 225 79 — 79 +Total $ 1,925,181 $ ( 125,014 ) $ 1,800,167 $ 136,969 $ ( 108,167 ) $ 28,802 +At December 31, 2022, the weighted average remaining useful life of intangibles subject to amortization was approximately 14.0 years. +F- 20 +Table of Contents +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Cost of sales $ 2,366 $ 4,779 $ 3,975 +Selling, general and administrative expenses 17,221 12,255 11,809 +Total amortization expense $ 19,587 $ 17,034 $ 15,784 +Estimated future annual amortization expense of intangible assets is: +As of +December 31, 2022 +(in thousands) +2023 $ 21,826 +2024 20,290 +2025 18,962 +2026 17,493 +2027 15,490 +Thereafter 128,344 +Total $ 222,405 +6. ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2022 2021 +(in thousands) +Accrued compensation and benefits $ 55,474 $ 62,945 +Professional services 45,351 33,997 +Fulfillment, freight, and duties 41,646 15,629 +Return liabilities 27,651 10,342 +Sales/use and value added taxes payable 27,249 13,049 +Royalties payable and deferred revenue 10,528 7,425 +Accrued rent and occupancy 8,972 7,431 +Other 22,553 16,069 +Total accrued expenses and other liabilities $ 239,424 $ 166,887 +F- 21 +Table of Contents +7. LEASES +Right-of-Use Assets and Operating Lease Liabilities +Amounts reported in the consolidated balance sheets were: +December 31, +2022 2021 +(in thousands) +Assets: +Right-of-use assets $ 239,905 $ 160,768 +Liabilities: +Current operating lease liabilities $ 57,456 $ 42,932 +Long-term operating lease liabilities 215,119 149,237 +Total operating lease liabilities $ 272,575 $ 192,169 +Lease Costs and Other Information +Lease-related costs reported within ‘Cost of sales’ and ‘Selling, general and administrative expenses’ were: +Year Ended December 31, +2022 2021 +(in thousands) +Operating lease cost $ 66,012 $ 58,283 +Short-term lease cost 9,590 7,585 +Variable lease cost 37,536 32,490 +Total lease costs $ 113,138 $ 98,358 +The weighted average remaining lease term and discount rate related to our lease liabilities as of December 31, 2022 were 6.9 years and 3.9 %, respectively. As of December 31, 2021, the weighted average remaining lease term and discount rate related to our lease liabilities were 7.1 years and 3.8 %, respectively. +Maturities +The maturities of our operating lease liabilities were: +As of +December 31, 2022 +(in thousands) +2023 $ 60,812 +2024 52,357 +2025 38,629 +2026 32,840 +2027 28,189 +Thereafter 99,700 +Total future minimum lease payments 312,527 +Less: imputed interest ( 39,952 ) +Total operating lease liabilities $ 272,575 +Leases That Have Not Yet Commenced +As of December 31, 2022, we had significant obligations for a lease not yet commenced related to a new HEYDUDE distribution center in Las Vegas, Nevada. The total commitment related to the lease, with payments expected to begin in the third quarter of 2023 and continue through December 2033, is approximately $ 75 million. +F- 22 +Table of Contents +8. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of our derivative instruments. Our derivative instruments are forward foreign currency exchange contracts. We manage credit risk of our derivative instruments on the basis of our net exposure with our counterparty. All of our derivative instruments are classified as Level 2 of the fair value hierarchy and are reported in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2022 and 2021, netted by counterparty. The fair values of our derivative instruments were an asset of $ 0.3 million and a liability $ 1.1 million at December 31, 2022 and a liability of $ 0.2 million at December 31, 2021. See Note 9 — Derivative Financial Instruments for more information. +The carrying amounts of our cash, cash equivalents, and restricted cash, accounts receivable, accounts payable, current accrued expenses and other liabilities, and our Asia revolving facilities approximate their fair value as recorded due to the short-term maturity of these instruments. +Our borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. During the year ended December 31, 2022, we entered into a credit agreement for an aggregate term loan B facility in the principal amount of $ 2.0 billion (the “Term Loan B Facility”), as described in more detail in Note 10 — Borrowings. The Term Loan B Facility is classified as Level 1 of the fair value hierarchy. The Notes (as defined below) are also classified as Level 1 of the fair value hierarchy and are reported in our consolidated balance sheet at face value, less unamortized issuance costs. The fair value of our Revolving Facility (as defined below) approximates its carrying value at December 31, 2021 based on interest rates currently available to us for similar borrowings. The carrying values and fair values of our borrowing instruments as of December 31, 2022 and 2021 were: +December 31, 2022 December 31, 2021 +Carrying Value Fair +Value Carrying Value Fair +Value +(in thousands) +Term Loan B Facility $ 1,675,000 $ 1,642,547 $ — $ — +2029 Notes 350,000 297,596 350,000 346,281 +2031 Notes 350,000 284,240 350,000 341,250 +Revolving Facility — — 85,000 85,000 +Non-Financial Assets and Liabilities +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, trademarks, customer relationships, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. We recorded impairments as follows: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Retail store assets impairment (1) +$ — $ — $ 2,412 +Right-of-use assets impairment (1) +— — 18,659 +Total asset impairments $ — $ — $ 21,071 +(1) During the year ended December 31, 2020, we recognized impairments for a retail location in New York City of $ 2.4 million to retail store assets and $ 17.6 million to the right-of-use asset. We also recognized an impairment of $ 1.1 million to the right-of-use asset for our corporate headquarters in Niwot, Colorado, as a result of our relocation to Broomfield, Colorado. +F- 23 +Table of Contents +9. DERIVATIVE FINANCIAL INSTRUMENTS +As of December 31, 2022, we have derivatives not designated as hedging instruments (“non-hedged derivatives”), which consist of foreign currency forward contracts primarily used to hedge monetary assets and liabilities denominated in non-functional currencies, and cash flow hedges (“hedged derivatives”). During the year ended December 31, 2022, there was a loss of $ 0.5 million recognized due to reclassification from ‘Accumulated other comprehensive loss’ to ‘Revenues’ or ‘Cost of sales’ related to our hedged derivatives. During the next twelve months, we estimate that a loss of approximately $ 0.8 million will be reclassified to the consolidated statement of operations. +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, are reported within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ in the consolidated balance sheets and were: +December 31, 2022 December 31, 2021 +Derivative Assets Derivative Liabilities Derivative Assets Derivative Liabilities +(in thousands) +Non-hedged derivatives: +Forward foreign currency exchange contracts $ 345 $ ( 360 ) $ 724 $ ( 938 ) +Netting of counterparty contracts ( 345 ) 345 ( 724 ) 724 +Foreign currency forward contract derivatives — ( 15 ) — ( 214 ) +Hedged derivatives: +Cash flow foreign currency contracts 348 ( 1,116 ) — — +Netting of counterparty contracts — — — — +Cash flow foreign currency contract derivatives 348 ( 1,116 ) — — +Total derivatives $ 348 $ ( 1,131 ) $ — $ ( 214 ) +The notional amounts of outstanding forward foreign currency exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2022 December 31, 2021 +Notional Fair Value Notional Fair Value +(in thousands) +Non-hedged derivatives: +Singapore Dollar $ 26,760 $ 207 $ 43,723 $ ( 296 ) +Indian Rupee 24,945 ( 10 ) 10,379 ( 86 ) +South Korean Won 18,403 ( 320 ) 14,201 ( 112 ) +British Pound Sterling 14,509 128 25,795 104 +Japanese Yen 8,953 9 12,910 80 +Euro 5,068 ( 29 ) 21,198 162 +Other currencies — — 19,481 ( 66 ) +Total non-hedged derivatives 98,638 ( 15 ) 147,687 ( 214 ) +Hedged derivatives: +Euro 51,914 ( 360 ) — — +British Pound Sterling 23,025 235 — — +South Korean Won 12,285 ( 756 ) — — +Indian Rupee 7,203 113 — — +Total hedged derivatives 94,427 ( 768 ) — — +Total derivatives $ 193,065 $ ( 783 ) $ 147,687 $ ( 214 ) +Latest maturity date, non-hedged derivatives April 2023 January 2022 +Latest maturity date, hedged derivatives June 2023 N/A +F- 24 +Table of Contents +Amounts reported in ‘Foreign currency gains (losses), net’ in the consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Non-hedged derivatives: +Foreign currency transaction gains (losses) +$ ( 2,858 ) $ 100 $ 941 +Foreign currency forward exchange contracts gains (losses) +6,086 ( 240 ) ( 2,069 ) +Foreign currency gains (losses), net +$ 3,228 $ ( 140 ) $ ( 1,128 ) +10. BORROWINGS +Our long-term borrowings were as follows: +Stated Interest Rate Effective Interest Rate December 31, +Maturity 2022 2021 +(in thousands) +Notes issuance of $ 350.0 million +2029 4.250 % 4.64 % $ 350,000 $ 350,000 +Notes issuance of $ 350.0 million +2031 4.125 % 4.35 % 350,000 350,000 +Term Loan B Facility 2029 1,675,000 — +Revolving Facility — 85,000 +Total face value of long-term borrowings 2,375,000 785,000 +Less: +Unamortized issuance costs 56,973 13,610 +Current portion of long-term borrowings (1) +20,000 — +Total long-term borrowings $ 2,298,027 $ 771,390 +(1) Represents the current portion of the borrowings on the Term Loan B facility. +At December 31, 2022 and 2021, $ 10.8 million and $ 10.4 million, respectively, of accrued interest related to our borrowings was reported in ‘Accounts payable’ in the consolidated balance sheets. +Senior Revolving Credit Facility +In July 2019, the Company and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. Since that time, we have amended the Credit Agreement, which, as amended to date, provides for a revolving credit facility of $ 750.0 million, which can be increased by an additional $ 250.0 million subject to certain conditions (the “Revolving Facility”). Borrowings under the Credit Agreement bear interest at a variable interest rate based on (A) a Base Rate (defined as the highest of (i) the Overnight Bank Funding Rate (as defined in the Credit Agreement), plus 0.25 %, (ii) the Prime Rate (as defined in the Credit Agreement), and (iii) the Daily Simple SOFR (as defined in the Credit Agreement), plus 1.00 %), plus an applicable margin ranging from 0.25 % to 0.875 % based on our leverage ratio or 1.35 % to 1.975 % for the Daily Simple SOFR based on the leverage ratio, or (B) the Term SOFR Rate (as defined in the Credit Agreement), plus an applicable margin ranging from 1.35 % to 1.975 % based on our leverage ratio for one-month interest periods and 1.40 % to 2.025 % based on our leverage ratio for three-month interest periods. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement requires us to maintain a minimum interest coverage ratio of 3.00 to 1.00 and a maximum leverage ratio of (i) 4.00 to 1.00 from the quarter ended March 31, 2022 through, and including, the quarter ending December 31, 2023, (ii) 3.75 to 1.00 for the quarter ending March 31, 2024, (iii) 3.50 to 1.00 for the quarter ending June 30, 2024, and (iv) 3.25 to 1.00 for the quarter ending September 30, 2024 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits, among other things, (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $ 40.0 million. As of December 31, 2022, we were in compliance with all financial covenants under the Credit Agreement. +F- 25 +Table of Contents +As of December 31, 2022, the total commitments available from the lenders under the Revolving Facility were $ 750.0 million. At December 31, 2022, we had no outstanding borrowings and $ 1.3 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2022 and 2021, we had $ 748.7 million and $ 414.7 million, respectively, of available borrowing capacity under the Revolving Facility, which matures November 2027. +Term Loan B Facility +On February 17, 2022, the Company entered into a credit agreement (the “Term Loan B Credit Agreement”) with Citibank, N.A., as administrative agent and lender, to among other things, finance a portion of the cash consideration for the Acquisition. +The Term Loan B Credit Agreement provides for an aggregate term loan B facility in the principal amount of $ 2.0 billion (the “Term Loan B Facility”), which is secured by substantially all of the Company’s and each subsidiary guarantor’s assets on a pari passu basis with their obligations arising from the Credit Agreement and is scheduled to mature on February 17, 2029, subject to certain exceptions set forth in the Term Loan B Credit Agreement. Additionally, subject to certain conditions, including, without limitation, satisfying certain leverage ratios, the Company may, at any time, on one or more occasions, add one or more new classes of term facilities and/or increase the principal amount of the loans of any existing class by requesting one or more incremental term facilities. +Each term loan borrowing which is an alternate base rate borrowing bears interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 2.50 %. Each term loan borrowing which is a term benchmark borrowing bears interest at a rate per annum equal to the Adjusted Term SOFR Rate (as defined in the Term Loan B Credit Agreement) plus 3.50 %. +Outstanding principal under the Term Loan B Facility is payable on the last business day of each March, June, September, and December, in a quarterly aggregate principal amount of $ 5.0 million. Quarterly aggregate principal payments began on June 30, 2022, with the remaining principal amount due on February 17, 2029, the maturity date. As of December 31, 2022, we had $ 1,675.0 million in outstanding principal and the Term Loan B Facility was fully drawn with no remaining borrowing capacity. +The Term Loan B Credit Agreement also contains customary affirmative and negative covenants, incurrence financial covenants, representations and warranties, events of default and other provisions. As of December 31, 2022, we were in compliance with all financial covenants under the Term Loan B Credit Agreement. +Asia Revolving Credit Facilities +During the year ended December 31, 2022, we had two revolving credit facilities in Asia, the revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”), which provides up to 10.0 million RMB, or $ 1.4 million at current exchange rates, and matures in January 2023, and the revolving credit facility with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”), which provides up to an equivalent of $ 10.0 million. For RMB loans under the CMBC Facility, interest is based on a National Interbank Funding Center 1-year prime rate, plus 65 basis points. For USD loans under the Citibank Facility, interest is mutually agreed upon prior to utilization of a loan. +As of December 31, 2022, we had no outstanding borrowings on the CMBC Facility, and we had borrowings outstanding of $ 4.3 million on the Citibank Facility, which are due in January 2023 and May 2023. We had no outstanding borrowings under our Asia revolving facilities at December 31, 2021. +Senior Notes Issuances +In March 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.250 % Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, the “2029 Notes Indenture”). Additionally, in August 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.125 % Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, “the 2031 Notes Indenture” and, together with the 2029 Notes Indenture, the “Indentures” and, each, an “Indenture”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +The Company will have the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an +F- 26 +Table of Contents +annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company may redeem up to 40 % of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company may redeem up to 40 % of the aggregate principal amount of the 2031 Notes at a redemption price of 104.125 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $ 25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; pay dividends or repurchase or redeem capital stock or make other restricted payments; declare or pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2022, we were in compliance with all financial covenants under the Notes. +11. EQUITY +Common Stock +We have one class of common stock with a par value of $ 0.001 per share. There are 250.0 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +Common Stock Repurchase Program +On April 23, 2021, the Board approved and authorized a program to repurchase up to $ 1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $ 1.0 billion to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +During the year ended December 31, 2022, we did not repurchase any shares of our common stock. As of December 31, 2022, we had remaining authorization to repurchase approximately $ 1,050.0 million of our common stock, subject to restrictions under our Indentures, Credit Agreement, and Term Loan B Credit Agreement. +During the year ended December 31, 2021, we repurchased 8.2 million shares of our common stock at a cost of $ 1,000.0 million, including commissions. This included 3.2 million shares delivered under the $ 500.0 million accelerated share repurchase arrangement (“ASR”) entered into in September 2021, 2.9 million shares delivered under the $ 300.0 million ASR entered into in April 2021, and 0.5 million shares delivered in January 2021 at the conclusion of the purchase period for the ASR entered into in November 2020. Under each ASR, a financial institution delivered shares of our common stock during the purchase period in exchange for an up-front payment. The total number of shares ultimately delivered under the ASR, and +F- 27 +Table of Contents +therefore the average repurchase price paid per share, was determined based on the volume-weighted average price of our common stock during the purchase period. The shares received were recorded in the period they were delivered, and the up-front payment was accounted for as a reduction to stockholders’ equity in our consolidated balance sheet in the period the payment was made. +Preferred Stock +We have authorized and available for issuance 5.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized as Series A Convertible Preferred Stock with a par value of $ 0.001 per share and none were issued and outstanding as of December 31, 2022. +12. REVENUES +Revenues by reportable operating segment and by channel were: +Year Ended December 31, 2022 +Crocs Brand +HEYDUDE Brand (1) +Total +(in thousands) +Channel: +Wholesale $ 1,377,302 $ 574,140 $ 1,951,442 +Direct-to-consumer 1,281,823 321,720 1,603,543 +Total revenues $ 2,659,125 $ 895,860 $ 3,554,985 +(1) The HEYDUDE Brand results reported for the year ended December 31, 2022 represent results for the Partial Period. +Year Ended December 31, 2021 +Crocs Brand HEYDUDE Brand Total +(in thousands) +Channel: +Wholesale $ 1,174,081 $ — $ 1,174,081 +Direct-to-consumer 1,139,335 — 1,139,335 +Total revenues $ 2,313,416 $ — $ 2,313,416 +Year Ended December 31, 2020 +Crocs Brand HEYDUDE Brand Total +(in thousands) +Channel: +Wholesale $ 692,919 $ — $ 692,919 +Direct-to-consumer 693,032 — 693,032 +Total revenues $ 1,385,951 $ — $ 1,385,951 +Revenues are recognized in the amount expected to be received in exchange for when control of the products transfers to customers and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. During the years ended December 31, 2022 and 2021, we recognized no changes to estimates for wholesale or direct-to-consumer revenues. During the year ended December 31, 2020, we recognized a net increase of $ 0.6 million to wholesale revenues and an increase of $ 1.1 million to direct-to-consumer revenues due to changes in estimates related to products transferred to customers in prior periods. +F- 28 +Table of Contents +We have also elected to expense incremental costs to obtain customer contracts, consisting primarily of commission incentives, when incurred because the related amortization period is short-term. These costs are reported within ‘Selling, general and administrative expenses’ in our consolidated statements of operations. +The following is a description of our principal revenue-generating activities by distribution channel. We have four reportable operating segments and sell our products using two primary distribution channels. For more detailed information about reportable operating segments, see Note 17 — Operating Segments and Geographic Information. +Wholesale Channel +For the majority of wholesale customers, control transfers and revenues are recognized when the product is shipped or delivered from a manufacturing facility or distribution center to the wholesale customer. In certain cases, control of the product transfers and revenues are recognized when the customer receives the product at the designated delivery point. For certain customers, primarily in international markets, cash payment is required in advance of delivery and revenues are recognized upon the transfer of control to the customer. We may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Wholesale revenues are reduced by estimates of returns and allowances based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +We have arrangements that grant certain wholesale customers exclusive licenses, concurrent with the terms of the related distribution agreements, to use our intellectual property in exchange for a sales-based royalty. Sales-based royalty revenues are recognized over the terms of the related license agreements as sales are made by the wholesalers. +Direct-to-Consumer Channel +Direct-to-consumer revenues consist of sales generated through our company-operated retail stores and company-operated e-commerce websites and third-party e-commerce marketplaces. We transfer control of products and recognize revenues at company-operated retail stores at the point of sale, in exchange for cash or other payment. For sales made through company-operated e-commerce websites and third-party e-commerce marketplaces, we transfer control and recognize revenues when the product is shipped from the distribution centers, the point at which payment, primarily through debit and credit card and other e-payment methods, is made. A portion of the transaction price charged to our customers is variable, primarily due to promotional discounts or allowances. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +Contract Liabilities +Contract liabilities consist of advance cash deposits received from wholesale customers to secure product orders in connection with selling seasons and payments received in advance of delivery. As products are shipped and control transfers, we recognize the deferred revenue in ‘Revenues’ in the consolidated statements of operations. At December 31, 2022 and 2021, we recorded $ 6.8 million and $ 0.1 million, respectively, of deferred revenues associated with advance customer deposits in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +Refund Liabilities +Refund liabilities, primarily associated with product sales returns, retrospective volume rebates, and early payment discounts are estimated based on an analysis of historical experience, and adjustments to revenues made when the most likely amount of consideration expected changes. At December 31, 2022 and 2021, $ 27.7 million and $ 10.3 million, respectively, of refund liabilities, primarily associated with product returns, were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +13. SHARE-BASED COMPENSATION +Our share-based compensation awards are issued under the 2020 Equity Incentive Plan (“2020 Plan”) and predecessor plan, the 2015 Equity Incentive Plan (“2015 Plan”). Any awards that expire or are forfeited under the 2015 Plan become available for issuance under the 2020 Plan. We account for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. As of December 31, 2022, 3.9 million shares of common stock +F- 29 +Table of Contents +remained available for future issuance under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +The majority of share-based compensation expense is reported in our consolidated statements of operations as ‘Selling, general and administrative expenses’ with an insignificant amount recorded within ‘Cost of sales.’ +Stock Option Activity +Stock option activity during the year ended December 31, 2022 was: +Number of Options Weighted Average Exercise Price Weighted Average Contractual Life (Years) Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2021 +217 $ 7.78 5.14 $ 26,076 +Granted — — +Exercised ( 7 ) 18.62 +Forfeited or expired — — +Outstanding as of December 31, 2022 +210 $ 7.44 4.28 $ 21,208 +Exercisable at December 31, 2022 +210 $ 7.44 4.28 $ 21,208 +Vested at December 31, 2022 +210 $ 7.44 4.28 $ 21,208 +No stock options were granted during 2022, 2021, or 2020. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2022, 2021, and 2020 was $ 0.4 million, $ 0.8 million, and $ 0.8 million, respectively. During the years ended December 31, 2022, 2021, and 2020, we received $ 0.1 million, $ 0.2 million, and $ 1.4 million cash, respectively, in connection with the exercise of stock options. As of December 31, 2022, we did no t have any unrecognized share-based compensation expense related to unvested options. +Stock options under our equity incentive plans generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years , and expire ten years after the date of grant. +Restricted Stock Awards and Restricted Stock Units Activity +From time to time, we grant RSAs and RSUs. RSAs and RSUs generally vest over three years , depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive shares of common stock upon vesting. RSUs have dividend equivalent rights, which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. We grant service-condition RSUs, performance-condition RSUs, and market-condition RSUs. +Service-condition RSUs are typically granted on an annual basis and vest over time in three equal annual installments, beginning one year after the grant date. During the years ended December 31, 2022, 2021, and 2020, we granted 0.2 million, 0.2 million, and 0.6 million service-condition RSUs, respectively. +Performance-condition RSUs are typically granted on an annual basis and consist of a performance-based and service-based component. The performance targets and vesting conditions for performance-condition RSUs are based on achievement of multiple weighted performance goals. The number of performance-condition RSUs ultimately awarded may be between 0 % and 200 %, based on performance. These RSUs vest in three equal annual installments beginning one year after the grant date, pending certification of performance achievement by the Compensation Committee of our Board of Directors and continued service. The fair value of performance-condition awards is based on the closing market price of our common stock on the grant date. Compensation expense, net of forfeitures, is updated for our probable expected performance level against performance goals at the end of each reporting period. We also periodically grant market-condition RSUs to certain executives. The grant date fair value and derived service period for market-condition RSUs are estimated using a Monte Carlo simulation model. During the years ended December 31, 2022, 2021, and 2020, we granted 0.3 million, 0.5 million, and 0.5 million performance- and market-condition RSUs, respectively. +F- 30 +Table of Contents +RSA and RSU activity during the year ended December 31, 2022 was: +Restricted Stock Awards Restricted Stock Units +Shares Weighted Average Grant Date Fair Value Shares Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2021 +2 $ 105.18 1,455 $ 49.70 +Granted 9 51.13 516 76.06 +Vested ( 6 ) 62.55 ( 688 ) 43.12 +Forfeited — — ( 102 ) 64.57 +Unvested at December 31, 2022 +5 $ 51.13 1,181 $ 62.93 +The weighted average grant date fair value of RSAs granted during the years ended December 31, 2022, 2021, and 2020 was $ 51.13 , $ 88.68 , and $ 38.10 per share, respectively. RSAs vested during the years ended December 31, 2022, 2021, and 2020 consisted entirely of service-condition awards. The total grant date fair value of RSAs vested in the years ended December 31, 2022, 2021, and 2020 was $ 0.3 million, $ 0.4 million and $ 0.2 million, respectively. +As of December 31, 2022, unrecognized share-based compensation expense for RSAs was $ 0.2 million, which is expected to amortize over a remaining weighted average period of 0.5 years. +The weighted average grant date fair value of RSUs granted during the years ended December 31, 2022, 2021, and 2020 was $ 76.06 , $ 76.28 , and $ 29.14 per share, respectively. RSUs vested during the year ended December 31, 2022 consisted of 0.3 million service-condition awards and 0.4 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2021 consisted of 0.4 million service-condition awards and 0.5 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2020 consisted of 0.5 million service-condition awards and 0.4 million performance- and market-condition awards. The total grant date fair value of RSUs vested during the years ended December 31, 2022, 2021, and 2020 was $ 29.7 million, $ 24.9 million and $ 11.9 million, respectively. +As of December 31, 2022, unrecognized share-based compensation expenses for service-condition RSUs were $ 20.1 million and for performance- and market-condition RSUs were $ 10.1 million, and are expected to amortize over remaining weighted average periods of 1.5 years and 1.6 years, respectively. +14. INCOME TAXES +During 2020 and 2021, we completed intra-entity transfers of certain intellectual property rights primarily to align with current and future international operations. These transactions were executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain, and, therefore, may ultimately differ materially from our actual results. +We have recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +In order to support and sustain the amortizable tax basis (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the intellectual property owned and serviced in the Netherlands. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands subsidiary serves as the principal Crocs corporate headquarters outside of the U.S. and already performs significant functions in support of the economic ownership of the intellectual property in the Netherlands. In 2021 and 2022, we undertook many additional activities to align business operations that support the economic substance of the intellectual property in the Netherlands. As of December 31, 2022, the net deferred tax asset related to the 2020 transfer is $ 401.2 million and to the 2021 transfer is $ 37.3 million. +F- 31 +Table of Contents +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Income before taxes: +U.S. $ 312,501 $ 510,706 $ 133,574 +Foreign 406,007 153,143 73,405 +Total income before taxes $ 718,508 $ 663,849 $ 206,979 +Income tax expense (benefit): +Current income taxes: +U.S. federal $ 76,092 $ 94,548 $ 698 +U.S. state 19,257 28,460 6,577 +Foreign 87,760 56,430 211,904 +Total current income taxes 183,109 179,438 219,179 +Deferred income taxes: +U.S. federal ( 12,032 ) 791 529 +U.S. state 861 32 ( 2,381 ) +Foreign 6,411 ( 242,106 ) ( 323,209 ) +Total deferred income taxes ( 4,760 ) ( 241,283 ) ( 325,061 ) +Total income tax expense (benefit) +$ 178,349 $ ( 61,845 ) $ ( 105,882 ) +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Income tax expense and rate attributable to: +Federal income tax rate $ 150,887 21.0 % $ 139,408 21.0 % $ 43,466 21.0 % +State income tax rate, net of federal benefit +15,981 2.2 % 22,952 3.5 % 7,231 3.5 % +Foreign income tax rate differential 12,405 1.7 % 18,890 2.8 % ( 6,060 ) ( 2.9 ) % +GILTI, net 4,834 0.7 % 14,157 2.1 % 7,515 3.6 % +Non-deductible / non-taxable items 3,743 0.5 % 9,637 1.5 % 6,871 3.3 % +Change in valuation allowance 4,414 0.6 % ( 192,337 ) ( 29.0 ) % 143,012 69.0 % +U.S. tax on foreign earnings 16,822 2.3 % — — % — — % +Foreign tax credits ( 28,087 ) ( 3.9 ) % ( 19,925 ) ( 3.0 ) % ( 15,904 ) ( 7.7 ) % +Research and development credits ( 5,488 ) ( 0.8 ) % ( 13,104 ) ( 2.0 ) % ( 148 ) ( 0.1 ) % +Uncertain tax positions 3,952 0.6 % 21,341 3.2 % 200,571 96.9 % +Share-based compensation ( 1,231 ) ( 0.2 ) % ( 11,930 ) ( 1.8 ) % ( 1,303 ) ( 0.6 ) % +Intra-Entity IP Transfer — — % ( 41,858 ) ( 6.3 ) % ( 492,470 ) ( 237.9 ) % +Enacted changes in tax law — — % ( 9,554 ) ( 1.4 ) % — — % +Other 117 0.1 % 478 0.1 % 1,337 0.7 % +Effective income tax expense and rate $ 178,349 24.8 % $ ( 61,845 ) ( 9.3 ) % $ ( 105,882 ) ( 51.2 ) % +F- 32 +Table of Contents +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2022 2021 +(in thousands) +Non-current deferred tax assets: +Share-based compensation expense $ 3,130 $ 2,706 +Accruals, reserves, and other expenses 24,324 24,346 +Net operating loss 21,455 24,573 +Intangible assets 438,712 502,100 +Foreign tax credit 45,746 39,442 +Operating lease liabilities 55,624 35,755 +Other 25,354 5,811 +Valuation allowance ( 28,118 ) ( 26,467 ) +Total non-current deferred tax assets $ 586,227 $ 608,266 +Non-current deferred tax liabilities: +Unrealized gain on foreign currency $ ( 1,760 ) $ — +Property and equipment ( 2,381 ) ( 12,189 ) +Right-of-use assets ( 47,641 ) ( 28,598 ) +Intangible assets ( 307,474 ) — +Other ( 723 ) ( 278 ) +Total non-current deferred tax liabilities $ ( 359,979 ) $ ( 41,065 ) +During 2022, valuation allowances recorded against deferred tax assets increased by $ 1.7 million. The change in the valuation allowance includes an increase of $ 4.4 million related to income tax expense and a decrease of $ 2.7 million that does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to changes in cumulative translation adjustments. During 2021, valuation allowances decreased by $ 200.2 million. The change in the valuation allowance includes $ 192.3 million related to income tax benefit and $ 7.9 million that does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation adjustments. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. During the three months ended June 30, 2021, a jurisdiction for which we have historically recorded significant valuation allowances enacted a favorable change in the tax law related to net operating loss carryforwards. The change in tax law impacted the assessment of valuation allowances in the jurisdiction as the reversal of existing deferred tax assets would generate indefinite carryforward net operating losses instead of losses with a limited carryforward period. During 2022, valuation allowances recorded against deferred tax assets increased by $ 1.7 million. +In certain other jurisdictions, we recorded additional attributes, primarily driven by operational losses recognized based on local tax accounting requirements. These carryforwards were generated in jurisdictions where results indicate it is not more likely than not the deferred tax assets would be realized. We maintain a valuation allowance against the majority of these balances. +During 2021, all U.S. federal tax credit carryforwards were utilized. We have included in the table above deferred tax assets related to U.S. state tax net operating loss carryforwards, some of which expire at various dates beginning in 2033 and some of +F- 33 +Table of Contents +which do not expire, of $ 1.4 million and $ 2.4 million at December 31, 2022 and 2021, respectively. We have recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2023 and those which do not expire of $ 66.4 million and $ 61.5 million as of December 31, 2022 and 2021, respectively. We maintain a valuation allowance against a portion of the foreign carryforwards and other attributes. +The transition tax in the Tax Act imposed a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. Furthermore, as of December 31, 2022, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Unrecognized tax benefit as of January 1 $ 218,399 $ 206,209 $ 4,613 +Additions in tax positions taken in prior period 1,697 6,169 519 +Reductions in tax positions taken in prior period ( 904 ) ( 963 ) ( 340 ) +Additions in tax positions taken in current period 2,948 23,061 200,947 +Settlements ( 375 ) ( 763 ) ( 294 ) +Lapse of statute of limitations ( 510 ) ( 342 ) ( 258 ) +Current year acquisitions 10,426 — — +Cumulative foreign currency translation adjustment ( 12,318 ) ( 14,972 ) 1,022 +Unrecognized tax benefit as of December 31 $ 219,363 $ 218,399 $ 206,209 +We recorded a net expense of $ 4.0 million related to increases in 2022 unrecognized tax benefits combined with amounts effectively settled under audit. Unrecognized tax benefits as of December 31, 2022 relate to tax years that are currently open under the statute of limitation. The primary impact of uncertain tax benefits on the rate reconciliation includes audit settlements, net increases in position changes, and accrued interest expense. +Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Our assessments are based on estimates and assumptions using the best available information to management. However, our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible change related to our uncertain tax positions, and such changes could be significant. +Interest and penalties related to income tax liabilities are included in ‘Income tax expense (benefit)’ in the consolidated statements of operations. For the years ended December 31, 2022, 2021, and 2020, we recorded approximately $ 3.8 million, $ 1.0 million, and $ 0.6 million, respectively, of penalties and interest. During the year ended December 31, 2022, we released $ 0.2 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $ 5.6 million, $ 2.0 million, and $ 1.2 million, as of December 31, 2022, 2021, and 2020, respectively. +Unrecognized tax benefits of $ 222.5 million, $ 218.7 million, and $ 205.6 million as of December 31, 2022, 2021, and 2020, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +F- 34 +Table of Contents +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2022: +The Netherlands 2010 to 2022 +Canada 2014 to 2022 +Hong Kong 2020 to 2022 +Japan 2014 to 2022 +China 2016 to 2022 +Singapore 2017 to 2022 +United States 2007 to 2022 +U.S state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for us are generally subject to examination for the years 2017 to 2022. Although the timing of income tax audit resolutions and negotiations with taxing authorities is highly uncertain, we do not anticipate a significant change in the total amount of unrecognized tax benefits within the next twelve months. +15. EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2022, 2021, and 2020 were as follows: +Year Ended December 31, +2022 2021 2020 +(in thousands, except per share data) +Numerator: +Net income attributable to common stockholders +$ 540,159 $ 725,694 $ 312,861 +Denominator: +Weighted average common shares outstanding - basic 61,220 62,464 67,386 +Plus: Dilutive effect of stock options and unvested restricted stock units +786 1,254 1,158 +Weighted average common shares outstanding - diluted +62,006 63,718 68,544 +Net income per common share: +Basic $ 8.82 $ 11.62 $ 4.64 +Diluted $ 8.71 $ 11.39 $ 4.56 +For the years ended December 31, 2022 and 2021, an insignificant number of outstanding shares issued under share-based compensation awards were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. For the year ended December 31, 2020, no outstanding shares issued under share-based compensation awards were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. +16. COMMITMENTS AND CONTINGENCIES +Purchase Commitments +As of December 31, 2022 and 2021, we had purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products, for an aggregate of $ 380.5 million and $ 274.9 million, respectively. We expect to fulfill our commitments under these agreements in the normal course of business, and as such, no liability has been recorded. +Other +We are regularly subject to, and are currently undergoing, audits by various tax authorities in the U.S. and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. +F- 35 +Table of Contents +During our normal course of business, we may make certain indemnities, commitments, and guarantees under which we may be required to make payments in relation to certain matters. We cannot determine a range of estimated future payments and have not recorded any liability for such payments in the accompanying consolidated balance sheets. +We are also subject to litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims. Other than as set forth below, we are not party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business, financial results, and cash flows. +For all claims and disputes, we have accrued estimated losses of $ 2.5 million within ‘Accrued expenses and other liabilities’ in our consolidated balance sheet as of December 31, 2022. As we are able, we estimate reasonably possible losses or a range of reasonably possible losses for claims and other disputes. As of December 31, 2022, we estimated that reasonably possible losses could potentially exceed amounts accrued by an insignificant amount. +17. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have four reportable operating segments. For the Crocs Brand, we have three reportable operating segments based on the geographic nature of our operations: North America, Asia Pacific, and Europe, Middle East, Africa, and Latin America (“EMEALA”). Our HEYDUDE Brand also became a reportable segment on the Acquisition Date. Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. +Additionally, Crocs ‘Brand corporate’ costs represent operating expense that includes product creation, design, and marketing expenses centrally managed for the Crocs Brand, as well as certain royalty income. Crocs Brand corporate costs are included within the Crocs Brand for presentation purposes to align with the way management views the Company. ‘Enterprise corporate’ costs include global corporate costs associated with both brands, including legal, information technology, human resources, and finance, as well as costs associated with global digital operations. +Each segment’s performance is evaluated based on segment results without allocating Brand corporate or Enterprise corporate expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income from operations consist of unallocated brand and enterprise corporate and other expenses, as well as inter-segment eliminations. +We do not report asset information by segment because that information is not used to evaluate performance or allocate resources between segments. +F- 36 +Table of Contents +The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Revenues: +North America (1) +$ 1,644,630 $ 1,553,891 $ 832,540 +Asia Pacific 473,935 350,160 278,515 +EMEALA (1) +540,534 409,278 274,733 +Brand corporate (2) +26 87 163 +Total Crocs Brand 2,659,125 2,313,416 1,385,951 +HEYDUDE Brand (3) +895,860 — — +Total consolidated revenues $ 3,554,985 $ 2,313,416 $ 1,385,951 +Income from operations: +North America (1) +$ 683,350 $ 755,723 $ 313,913 +Asia Pacific 145,011 71,936 32,830 +EMEALA (1) +153,976 134,126 75,513 +Brand corporate (2) +( 130,312 ) ( 100,391 ) ( 92,833 ) +Total Crocs Brand 852,025 861,394 329,423 +HEYDUDE Brand (3) +211,361 — — +Reconciliation of segment income from operations to income before income taxes: +Enterprise corporate (2) +( 212,630 ) ( 178,330 ) ( 115,299 ) +Total consolidated income from operations 850,756 683,064 214,124 +Foreign currency gains (losses), net 3,228 ( 140 ) ( 1,128 ) +Interest income 1,020 775 215 +Interest expense ( 136,158 ) ( 21,647 ) ( 6,742 ) +Other income (expense), net ( 338 ) 1,797 510 +Income before income taxes $ 718,508 $ 663,849 $ 206,979 +Depreciation and amortization: +North America (1) +$ 10,804 $ 7,669 $ 3,453 +Asia Pacific 2,113 1,629 1,138 +EMEALA (1) +3,221 1,806 805 +Brand corporate (2) +2,739 5,827 8,473 +Total Crocs Brand 18,877 16,931 13,869 +HEYDUDE Brand (3) +12,248 — — +Enterprise corporate (2) +8,104 15,045 13,750 +Total consolidated depreciation and amortization $ 39,229 $ 31,976 $ 27,619 +(1) In the first quarter of 2022, certain revenues and expenses associated with our Latin America businesses previously reported in our ‘Americas’ segment were shifted into the ‘EMEA’ segment to better align with how we manage our distributor business. To reflect this change, we renamed our ‘Americas’ segment to ‘North America’ and renamed our ‘EMEA’ segment to ‘EMEALA.’ As a result of these changes, the previously reported amounts for revenues, income from operations, and depreciation and amortization for the year ended December 31, 2021 and 2020 have been revised to conform to current period presentation. Refer to Part I - Item 1. Financial Statements in our Quarterly Report on Form 10-Q for the period ended June 30, 2022 for more information. +(2) In the first quarter of 2022, as a result of the Acquisition, all costs previously reported in “Unallocated corporate and other” were recast between ‘Brand corporate’ costs associated with the Crocs Brand and ‘Enterprise corporate’ costs, each of which is defined in the section preceding the above table. As a result of these changes, the previously reported amounts for income from operations and depreciation and amortization for the year ended December 31, 2021 and 2020 have been revised to conform to current period presentation. Refer to Part I - Item 1. Financial Statements in our Quarterly Report on Form 10-Q for the period ended June 30, 2022 for more information. +(3) We acquired HEYDUDE on February 17, 2022 and in connection therewith added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the partial period beginning on the Acquisition Date through December 31, 2022, and there are no comparative amounts for the years ended December 31, 2021 or 2020. +F- 37 +Table of Contents +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2022, 2021 and 2020. The following table sets forth certain geographical information regarding our consolidated revenues for the periods as shown: +Year Ended December 31, +2022 2021 2020 +(in thousands) +Location: +United States $ 2,438,923 $ 1,507,482 $ 802,952 +International (1) +1,116,062 805,934 582,999 +Total revenues $ 3,554,985 $ 2,313,416 $ 1,385,951 +(1) No individual international country represented 10% or more of consolidated revenues in any of the years presented. +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2022 2021 +(in thousands) +Location: +United States $ 148,078 $ 80,613 +International (1) +33,451 27,785 +Total property and equipment, net $ 181,529 $ 108,398 +(1) As of December 31, 2022 and 2021, property and equipment, net in the Netherlands represented approximately 15 % and 20 %, respectively, of consolidated property and equipment, net, comprised primarily of property and equipment related to the distribution center in Dordrecht and the warehouses in Rotterdam and Oudenbosch. No other individual international country represented 10% or more of consolidated property and equipment, net in any of the years presented. +18. EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +We sponsor a qualified defined contribution benefit plan (the “Plan”), covering substantially all of our U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. We make matching contributions to the plans equal to 100 % of the first 3 %, and up to 50 % of the next 2 % of salary contributed by an eligible employee. Participants are vested 100 % in our matching contributions when made. Contributions made by us under the Plan were $ 9.0 million, $ 7.4 million and $ 4.7 million for the years ended December 31, 2022, 2021, and 2020, respectively. +F- 38 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period Charged to Costs and Expenses +Deductions (1) +Balance at End of Period +(in thousands) +Year Ended December 31, 2022 +Allowance for doubtful accounts $ 7,828 $ 1,101 $ 1,584 $ 10,513 +Reserve for sales returns and allowances 9,606 192,543 ( 193,272 ) 8,877 +Reserve for unapplied rebates 3,281 6,107 ( 4,285 ) 5,103 +Total $ 20,715 $ 199,751 $ ( 195,973 ) $ 24,493 +Year Ended December 31, 2021 +Allowance for doubtful accounts $ 11,154 $ — $ ( 3,326 ) $ 7,828 +Reserve for sales returns and allowances 5,782 148,893 ( 145,069 ) 9,606 +Reserve for unapplied rebates 4,157 4,678 ( 5,554 ) 3,281 +Total $ 21,093 $ 153,571 $ ( 153,949 ) $ 20,715 +Year Ended December 31, 2020 +Allowance for doubtful accounts $ 8,276 $ 5,779 $ ( 2,901 ) $ 11,154 +Reserve for sales returns and allowances 5,261 95,740 ( 95,219 ) 5,782 +Reserve for unapplied rebates 5,260 4,920 ( 6,023 ) 4,157 +Total $ 18,797 $ 106,439 $ ( 104,143 ) $ 21,093 +(1) Deductions include accounts written off, net of recoveries, and the effects of foreign currency translation. +F- 39 \ No newline at end of file diff --git a/raw/filings/0001334036/2022/0001334036-23-000015/filing_metadata.csv b/raw/filings/0001334036/2022/0001334036-23-000015/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..69688fdce74df9f79929ddc9667747f79e629b90 --- /dev/null +++ b/raw/filings/0001334036/2022/0001334036-23-000015/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2023-02-16,2022-12-31,2023-02-16T19:31:26.000Z,0001334036-23-000015,crox-20221231.htm,10-K,13565532,1,1,https://www.sec.gov/Archives/edgar/data/1334036/000133403623000015/crox-20221231.htm,https://www.sec.gov/Archives/edgar/data/1334036/000133403623000015/,2022,2022,1 diff --git a/raw/filings/0001334036/2022/0001334036-23-000015/item1.txt b/raw/filings/0001334036/2022/0001334036-23-000015/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..1e4ff153bc27d1c69b049987ae7e06eb2e3329fd --- /dev/null +++ b/raw/filings/0001334036/2022/0001334036-23-000015/item1.txt @@ -0,0 +1,119 @@ +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. +On February 17, 2022 (the “Acquisition Date”), we acquired (the “Acquisition”) 100% of the equity of a privately-owned casual footwear brand business (“HEYDUDE”), pursuant to a securities purchase agreement (the “SPA”) entered into on December 22, 2021. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The majority of HEYDUDE sales are currently in the United States. +The consolidated results reported for the year ended December 31, 2022 represent the Crocs Brand and ‘Enterprise corporate’ for the full year and the HEYDUDE Brand for the partial period beginning on the Acquisition Date through December 31, 2022 (the “Partial Period”); for the years ended December 31, 2021 and 2020, the results represent the Crocs Brand and ‘Enterprise corporate’ only. +Our reportable operating segments include: (i) North America for the Crocs Brand, operating throughout the United States of America (the “United States” or the “U.S.”) and Canada, (ii) Asia Pacific for the Crocs Brand, operating throughout Asia, Australia, and New Zealand; (iii) Europe, Middle East, Africa, and Latin America (“EMEALA”) for the Crocs Brand; and (iv) the HEYDUDE Brand, which are discussed in more detail in “Business Segments and Geographic Information” below. Within the regions in which we operate, we prioritize six core markets for the Crocs Brand where we believe the greatest opportunities for growth exist: (i) China, (ii) India, (iii) Japan, (iv) South Korea, (v) the U.S., and (vi) Western Europe. +Our Vision +At the heart of our brands is our consumers. We have brands, with a broad democratic appeal and accessible price points, which are aligned with global megatrends such as casualization and personalization. The philosophy and vision for our brands has been an important driver of our results and, we believe, will continue to be important as we strive to realize the full potential of our brands. To that end, in 2022, we continued our message of “Come As You Are” in all regions and channels for the Crocs Brand. During the year, we added the HEYDUDE Brand to our portfolio, which we believe is an ideal fit with the Crocs Brand and long-term consumer trends given its focus on casualization, comfort-led functionality, sustainability, and personalization. +Our growth framework is driven by five strategic areas of focus: +• Growing digital sales — Digital sales include sales directly to consumers through our company-owned websites, third-party marketplaces, and wholesale sales to our global e-tailers. Our digital sales in 2022 were 37.8% of consolidated revenues, compared to 36.7% and 41.5% of consolidated revenues in 2021 and 2020, respectively. +• Gaining sandals market share for the Crocs Brand — Sandals have long been a focus of the Crocs Brand as a large and accessible growth avenue for the brand. We believe sandals are a natural extension of the Crocs Brand and allow us to access new consumers by leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +• Increasing awareness and distribution for the HEYDUDE Brand — We acquired HEYDUDE in February 2022 and have embarked, and plan to continue to embark, on various marketing activities to drive higher awareness. We have also entered into a lease not yet commenced for a new HEYDUDE distribution center in Las Vegas, Nevada, to expand our distribution capabilities of the HEYDUDE Brand. +• Growth opportunities internationally — As a company with a well-established global footprint, we believe we have a long-term sales growth opportunity internationally. Our international sales in 2022 were 29.4% of consolidated revenues, compared to 32.8% and 39.9% of consolidated revenues in 2021 and 2020, respectively. This includes sales in 2022 for the HEYDUDE Brand, which operates primarily in the United States. Our six core markets for the Crocs Brand include five international markets, and more specifically, four markets in Asia: China, India, Japan, and South Korea. Additionally, we intend to further expand the HEYDUDE Brand in Europe beginning in 2023. +2 +Table of Contents +• Ongoing product and marketing innovation — At the heart of our Crocs Brand’s DNA are our clogs, sandals, and Jibbitz™ charms, which are key product pillars that we believe will drive long-term growth. We continue to grow our clog silhouette with new colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, for personalization. The addition of the HEYDUDE Brand to our portfolio provides an innovative loafer concept that is differentiated through quality and comfort. From a marketing perspective, we continue to invest in globally integrated digital advertising campaigns, as well as designer, celebrity and influencer, and brand partnerships. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. We offer a broad portfolio of all-season products, while remaining true to our core casual footwear heritage. +Crocs Brand +Recognized globally for our unmistakable iconic molded clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2022 as we repeatedly brought our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, and increased personalization through our Jibbitz™ charms accessories. +The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ products. LiteRide™ features comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +HEYDUDE Brand +In 2022, we added HEYDUDE to our portfolio, whose shoes have a versatile silhouette with many wearing occasions that focus on casualization, comfort-led functionality, and personalization. HEYDUDE utilizes leading technologies including a flex-and-fold outsole and ergonomic insole. The shoes are known for being lightweight, flexible, and soft, with design and functional flexibility for convenience. +Marketing +Each season, we focus on presenting compelling brand stories and experiences for our new product introductions as well as our on-going core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms for the Crocs Brand and our versatile loafer silhouette for the HEYDUDE Brand. We continue to invest in globally integrated marketing campaigns, as well as designer, celebrity and influencer, and brand partnerships, ranging from popular artists like Luke Combs to a wide range of well-known brands such as 7-Eleven. Innovation is not only core to our brands’ values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our customers to give them new and innovative reasons to continue to choose the Crocs Brand and HEYDUDE Brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Environmental, Social, and Governance (“ESG”) Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry, for people, and for our planet. An explanation of our progress toward more transparent, socially conscious, and sustainable business practices will be provided in our fiscal year 2022 ESG report, which is expected to be published in the first half of 2023. Our ESG report will be made available on the Investor Relations section of our website located at www.investors.crocs.com. Except where specified otherwise, all information in the forthcoming ESG report and below ESG discussion pertains to Crocs, Inc. as of December 31, 2022. The content provided in our ESG Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +We intend to continuously advance our business practices towards our goal of consistently delivering products that exceed customer and consumer expectations with neither undue degradation to the planet nor harm to the communities with which we interact globally as part of our effort to create a more comfortable world for all. We believe the progress of our ESG efforts is +3 +Table of Contents +best understood by disclosing measurable and relevant goals and metrics, and, to this end, we continue to align our reporting with the Sustainability Accounting Standards Board (“SASB”) framework. +Environmental +We are committed to reducing our impact on the environment and are particularly focused on carbon reduction, sustainable operations, and product circularity. +In 2022, we completed our first Greenhouse Gas inventory of the Crocs Brand based on 2021 data. We are in the process of redefining our 2021 baseline to account for the HEYDUDE Brand and completing our 2022 Greenhouse Gas inventory for the full enterprise as we continue on our journey to Net Zero. In the past year, we continued the integration of a new, more sustainable bio-based alternative for our Croslite ™ materials in partnership with Dow Chemical’s new ECOLIBRIUM ™ Technology; renewed our membership with the Sustainable Apparel Coalition; and continued to enhance our tracking of our energy use, water use, and waste generation. More detail on these initiatives, as well as our ambitions, will be provided in our upcoming ESG report. +Social +As of December 31, 2022, we employed nearly 6,680 employees globally, including approximately 3,480 employees in our retail stores, 1,880 employees at our corporate/regional offices, and 1,320 employees at our distribution centers. +We believe we have among the most talented workforce in the footwear industry and continue to improve and implement new initiatives to remain an employer of choice across all of our businesses and geographies. These initiatives include pay transparency in hiring, offering employee training and developing leadership capabilities, enabling meaningful professional experiences, offering a compelling employee value proposition and fair wages, and creating a collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” Crocs, Inc. strives to create a culture of inclusion through progressive people-practices that support and empower all employees regardless of gender, age, race, ethnicity, national origin, disability, religion, immigration status, or sexual orientation, gender identity, or expressions. We are proud of the workplace culture we have created and will continue to engage our employees to hear where we still have room for improvement. To that end, our regular employee engagement scores continue to meet or surpass industry benchmarks and reflect a highly engaged global workforce. +Our efforts around inclusion, collaboration, and human rights extend through our supply chain. We work to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards, inclusive of occupational safety and chemical safety. In addition, we maintain numerous measures to ensure our supply chain complies with our Social Compliance Code of Conduct and Restricted Substances Policy, as well as with all local laws and customs regarding hiring practices, wages, and working conditions. +We also seek to extend the reach of our social and environmental standards through our global “Crocs Cares” program, through which we focus on providing shoes, funds, and employee time to support social inclusion and equality, and respond to our communities’ needs in times of crises. This is an ever-evolving program, informed by key stakeholder priorities. In 2022, Crocs, Inc. supported school students in the communities impacted by the Marshall Fire in Colorado, Ukrainian refugees, and frontline healthcare workers. Thanks to the generosity of our consumers and employees, we continued to generate donations to Feeding America, providing meals to families in need. +Governance +Strong corporate governance mechanisms, along with robust internal controls over our financial reporting framework, are the foundation for our ESG progress. In 2022, we formed an Environmental, Social, and Governance Steering Committee (the “ESG Committee”) of our board of directors (the “Board”), comprised of three independent directors, overseeing our ESG efforts and receiving quarterly updates on the development of our ESG program. Specifically, the ESG Committee assists the Board in (i) carrying out the responsibilities delegated by the Board regarding the review and oversight of our goals, policies, procedures and disclosures related to sustainability and ESG matters and (ii) its oversight of the sustainability and ESG matters material to us, our employees, our communities, and the planet. Additionally, we regularly review our Enterprise Risk Management and Ethics & Compliance program frameworks to account for our social and environmental risks and opportunities, specifically including those related to climate change. All material findings and updates are elevated to and discussed with our Board, which includes 38% female and 13% historically underrepresented racial/ethnic members as of +4 +Table of Contents +December 31, 2022. In 2022, Crocs, Inc. formalized its ESG/Sustainability department with a newly created VP, Global Head of Sustainability position reporting directly to our Chief Executive Officer. +We believe our employees are critical to the maintenance of strong corporate governance and, to that end, we continue to conduct annual in-person and online compliance trainings for all corporate employees, as well as retail and distribution center management. We also maintain a global ethics hotline, which is monitored by our Legal department, should any of our stakeholders identify concerns or have grievances. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 85 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our DTC channel includes e-commerce, in which we sell through company-operated e-commerce sites and third-party marketplaces, and retail, in which we sell through company-operated stores. +Wholesale Channel +During the years ended December 31, 2022, 2021, and 2020, 54.9%, 50.8%, and 50.0% of our consolidated revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, and distributors in certain countries, including partner store operators. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +Direct-to-Consumer Channel +Our DTC channel includes company-operated e-commerce sites, third-party marketplaces, company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. During the years ended December 31, 2022, 2021, and 2020, 45.1%, 49.2%, and 50.0%, respectively, of our consolidated revenues were derived through our DTC channel. +E-commerce +As of December 31, 2022, we offered our products through 14 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Retail +With the continued worldwide consumer shift toward e-commerce, we are carefully managing our retail fleet, especially full-priced retail stores. As of December 31, 2022, we had 340 and 5 company-operated stores for the Crocs Brand and HEYDUDE Brand, respectively. +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2022, we had 82 full-price Crocs Brand retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in certain of our outlet stores as well as built-for-outlet products. As of December 31, 2022, we had 194 Crocs Brand outlet stores and 5 HEYDUDE Brand temporary clearance stores. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and +5 +Table of Contents +limited fixed cost and capital investment, we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2022, we had 64 Crocs Brand kiosks and store-in-store locations. +The following table illustrates the net change during 2022 in the number of our Crocs Brand company-operated retail stores by reportable operating segment and country: +December 31, 2021 Opened Closed December 31, 2022 +North America +United States 162 9 11 160 +Canada 8 — — 8 +Puerto Rico 3 — — 3 +Total North America +173 9 11 171 +Asia Pacific +Korea 89 1 1 89 +China 34 3 4 33 +Japan 13 1 1 13 +Singapore 17 — 1 16 +Total Asia Pacific 153 5 7 151 +EMEALA +Russia 26 2 28 — +Germany 14 — 3 11 +France 2 — — 2 +Austria 3 1 1 3 +The Netherlands 2 — — 2 +Total EMEALA +47 3 32 18 +Total 373 17 50 340 +During the year ended December 31, 2022, we opened 5 HEYDUDE Brand company-operated temporary clearance stores in the United States, all of which remained open as of December 31, 2022. We did not close any HEYDUDE Brand retail stores. +Business Segments and Geographic Information +We have four reportable operating segments. For the Crocs Brand, we have three reportable operating segments based on the geographic nature of our operations: North America, Asia Pacific, and EMEALA. Our HEYDUDE Brand also became a reportable segment on the Acquisition Date. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 17 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our reportable operating segments. +Raw Materials +Crocs Brand +Croslite™, our proprietary closed-cell resin material, incorporates the primary material formulations used in the vast majority of our Crocs Brand footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various ESG initiatives described in the previous section. +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +6 +Table of Contents +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +HEYDUDE Brand +The primary raw materials for the HEYDUDE Brand are fabrics, including polyester and cotton, Ethylene-vinyl acetate (“EVA”) insoles and outsoles, and other materials such as leather. We purchase this material from a select group of third-party sources, and we believe these materials are broadly available. +Sourcing +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in: +• Vietnam and China for the Crocs Brand. During the years ended December 31, 2022, 2021, and 2020, approximately 53%, 56%, and 75%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the vast majority of operations in Vietnam and China, produced approximately 42%, 34%, and 46% of our production during the years ended December 31, 2022, 2021, and 2020, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 27%, 30%, and 22% of our production during the years ended December 31, 2022, 2021, and 2020, respectively. +• China for the HEYDUDE Brand. +We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available. See the risk factor under “Risks Related to our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2022, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2022, we further expanded our U.S. distribution centers in Ohio and Nevada for the Crocs Brand and HEYDUDE Brand, respectively, to increase distribution capacity. Additionally, in 2022, we entered into a lease not yet commenced related to a new HEYDUDE distribution center in Nevada, which we plan to open in late 2023 to help support future growth. We also utilized third-party operated distribution centers located in the United States, Japan, China, Australia, Korea, Singapore, India, Brazil, and the United Kingdom. As of December 31, 2022, our company-operated warehouse and distribution facilities provided us with 3.2 million square feet, and our third-party operated distribution facilities provided us with 0.3 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +As a result of global industry-wide logistics challenges in 2021, we implemented several mitigating measures in 2022 including: (i) prioritizing top-selling products and narrowing product assortment, which has improved factory throughput, (ii) maintaining flexibility by leveraging air freight and reducing our dependency on congested West Coast ports in the United States by adding East Coast trans-shipment capabilities, and (iii) strategically allocating units and prioritizing our key growth initiatives. With the actions taken to date and our future plans, we believe we are well-positioned to withstand these supply challenges. See the risk factors under “Risks Related to our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results” and “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with distribution and logistics. +7 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks for the Crocs Brand include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. Our major trademarks for the HEYDUDE Brand include the HEYDUDE logo and word mark. The HEYDUDE word mark is registered in the U.S., the European Union, China, and Singapore, among others. Protection for the HEYDUDE logo has been filed in the U.S. and we intend to extend to foreign jurisdictions within the required time period. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, through litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our Crocs Brand footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our Crocs Brand products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components and confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our Crocs Brand products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution networks position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +8 +Table of Contents +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. \ No newline at end of file diff --git a/raw/filings/0001334036/2022/0001334036-23-000015/item13.txt b/raw/filings/0001334036/2022/0001334036-23-000015/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..7faee08380eedf2d9b54960b097fb2de3282c7a7 --- /dev/null +++ b/raw/filings/0001334036/2022/0001334036-23-000015/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2023 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2022. +55 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2022/0001334036-23-000015/item9a.txt b/raw/filings/0001334036/2022/0001334036-23-000015/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..50a32863100590ac1a2c28adeabb3cd48b94efc2 --- /dev/null +++ b/raw/filings/0001334036/2022/0001334036-23-000015/item9a.txt @@ -0,0 +1,33 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of December 31, 2022. During the year ended December 31, 2022, we closed the Acquisition, as discussed in Note 3 — Acquisition of HEYDUDE in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. As such, the scope of our assessment of the effectiveness of our disclosure controls and procedures did not include internal controls over financial reporting at HEYDUDE. HEYDUDE represented approximately 25% of our total revenues for the year ended December 31, 2022 and 62% of our total assets as of December 31, 2022. This exclusion is consistent with the Securities and Exchange Commission (the “SEC”) staff’s guidance that an assessment of a recently acquired business may be omitted from the scope of our assessment of the effectiveness of disclosure controls and procedures that are also part of internal control over financial reporting in the year of acquisition. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2022, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2022, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2022, which does not include internal controls over financial reporting at HEYDUDE, as discussed above. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2022, as stated in their report, which appears herein. +51 +Table of Contents +Changes in Internal Control Over Financial Reporting +As noted above, we are in the process of integrating HEYDUDE into our overall internal control over financial reporting and will include HEYDUDE in Management’s Evaluation of Disclosure Controls and Procedures for the year ending December 31, 2023. This process may result in additions or changes to our internal control over financial reporting. In addition, as a result of the Acquisition, we have implemented new processes and controls over accounting for an acquisition during the year ended December 31, 2022, including determining the fair value of the assets acquired and liabilities assumed. +Additionally, in the three months ended December 31, 2022, we implemented internal controls over our annual goodwill and indefinite-lived intangible asset impairment analysis, as there was a material addition to our goodwill and indefinite-lived intangible asset balances during the year ended December 31, 2022 related to the acquisition of HEYDUDE, as described in Note 3 — Acquisition of HEYDUDE and Note 5 — Goodwill and Intangible Assets, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Except as described herein, there has been no change in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three or twelve months ended December 31, 2022, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +52 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2022 of the Company and our report dated February 16, 2023, expressed an unqualified opinion on those financial statements. +As described in “Management’s Report on Internal Control over Financial Reporting,” management excluded from its assessment the internal control over financial reporting at HEYDUDE, which was acquired on February 17, 2022, and whose financial statements constitute 62% of total assets and 25% of net sales of the consolidated financial statement amounts as of and for the year ended December 31, 2022. Accordingly, our audit did not include the internal control over financial reporting at HEYDUDE. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 16, 2023 +53 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2022/0001334036-23-000015/rp_note.txt b/raw/filings/0001334036/2022/0001334036-23-000015/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2022/0001334036-23-000015/rpt_disclosure.txt b/raw/filings/0001334036/2022/0001334036-23-000015/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4b29a447bda29d7fab97b54f5376749d22ffe153 --- /dev/null +++ b/raw/filings/0001334036/2022/0001334036-23-000015/rpt_disclosure.txt @@ -0,0 +1,8 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Since January 1, 2023, there have been no related person transactions in which we were or are to be a participant and the amount involved exceeds $120,000 and in which any current related person had or will have a direct or indirect material interest. +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +Director and Officer Indemnification +We have entered into agreements to indemnify our directors in addition to the indemnification provided for both directors and executive officers in our certificate of incorporation and bylaws. These documents, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +31 \ No newline at end of file diff --git a/raw/filings/0001334036/2023/0001334036-24-000025/filing.txt b/raw/filings/0001334036/2023/0001334036-24-000025/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..911238de431f01cb80434e36d58a574bdccd485b --- /dev/null +++ b/raw/filings/0001334036/2023/0001334036-24-000025/filing.txt @@ -0,0 +1,2222 @@ +crox-20231231 +false FY 2023 0001334036 2.3 http://fasb.org/us-gaap/2023#PrepaidExpenseAndOtherAssetsCurrent http://fasb.org/us-gaap/2023#AccruedLiabilitiesCurrent 0001334036 2023-01-01 2023-12-31 0001334036 2023-06-30 iso4217:USD 0001334036 2024-02-08 xbrli:shares 0001334036 crox:HEYDUDEMember 2022-02-17 2022-02-17 0001334036 2023-10-01 2023-12-31 0001334036 2022-01-01 2022-12-31 0001334036 2021-01-01 2021-12-31 iso4217:USD xbrli:shares 0001334036 2023-12-31 0001334036 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+________________________________________________________________________________________________________________________________ +FORM 10-K +☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31 , 2023 +or +☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware 20-2164234 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +500 Eldorado Boulevard , Building 5 +Broomfield , Colorado 80021 +( 303 ) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: Trading symbol: Name of each exchange on which registered: +Common Stock, par value $0.001 per share CROX The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. +Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company Emerging growth company +☒ ☐ ☐ ☐ ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2023 was approximately $ 6.8 billion. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock, par value $0.001 per share, outstanding as of February 8, 2024 was 60,498,530 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2024 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2023. +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding +• our expectations regarding future trends, selling, general and administrative cost savings, expectations, and performance of our business; +• our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• our expectations about the impact of our strategic plans; and +• our intent to achieve various Environmental, Social, and Governance initiatives. +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this Annual Report on Form 10-K, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements, except as required by applicable law. +Risks Factors Summary +Our business is subject to a number of risks and uncertainties, including those described in Part I, Item 1A. Risk Factors of this Annual Report on Form 10-K. These risks include, but are not limited to, the following: +• our substantial dependence on the value of our brands and our failure to strengthen and preserve this value; +• the significant competition that we face; +• introducing new products, which may be difficult and expensive; +• our failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand; +• our failure to continue to obtain or maintain high-quality endorsers of our products; +• our reliance on technical innovation to compete in the market for our products; +• changes in global economic conditions, which may adversely affect consumer spending and the financial health of our customers and others with whom we do business; +• ongoing wars, which could cause disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations; +• supply chain disruptions, which could interrupt product manufacturing and global logistics and increase product costs; +• our dependence on third-party manufacturers located outside of the U.S.; +• our dependence on the global supply chain and impacts of supply chain constraints and inflationary pressure; +• our inability to accurately forecast consumer demand; +• our third-party manufacturing operations, which must comply with labor, trade, and other laws; +• our dependence on a number of suppliers for key production materials, and any disruption in the supply of such materials; +i +Table of Contents +• changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan, or other global currencies; +• the fact that we conduct significant business activity outside the U.S., which exposes us to risks of international commerce; +• our inability to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products; +• our significant reliance on the use of information technology; +• the increasing prevalence of artificial intelligence represents risks and challenges; +• our online e-commerce sites, or those of our customers, not functioning effectively; +• the dependence of our financial success in part on the strength of our relationships with, and the success of, our wholesale and distributor customers; +• the substantial fixed costs we incur with respect to company-operated retail stores; +• if substantial investments in businesses and operations fail to produce expected returns; +• our dependence on employees across the globe; +• periodic litigation, which could result in unexpected expenditures of time and resources; +• global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations; +• the provisions in our restated certificate of incorporation, amended and restated bylaws, and Delaware law that could discourage a third-party from acquiring us; +• increasing scrutiny from investors, regulators, and other key stakeholders with respect to our environmental, social, and governance practices; +• the significant operating and financial restrictions that our Revolving Credit Agreement (as defined herein), the Term Loan B Credit Agreement (as defined herein), and the Indentures (as defined herein) each will impose, on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities; +• our indebtedness as well as the ability to meet payment obligations under our Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Notes (as defined herein); +• our ability to incur substantially more debt; +• that we may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations; +• that we may incur impairments of the carrying value of our goodwill and other intangible assets; +• the fluctuations to which our quarterly revenues and operating results are subject; +• the risks of maintaining significant cash abroad; +• changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation; +• our failure to meet analyst and investor expectations; +• our ability to realize the benefits from the Acquisition (as defined below); and +• the incurrence by us of substantial indebtedness in connection with the financing of the Acquisition. +ii +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2023 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +9 +Item 1B. +Unresolved Staff Comments +27 +Item 2. +Properties +28 +Item 3. +Legal Proceedings +29 +Item 4. +Mine Safety Disclosures +29 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +30 +Item 6. +[Reserved] +31 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +32 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +48 +Item 8. +Financial Statements and Supplementary Data +49 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +49 +Item 9A. +Controls and Procedures +49 +Item 9B. +Other Information +51 +Item 9C. +Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +51 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +52 +Item 11. +Executive Compensation +52 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +52 +Item 13. +Certain Relationships and Related Transactions and Director Independence +52 +Item 14. +Principal Accountant Fees and Services +53 +PART IV +Item 15. +Exhibits, Financial Statement Schedule +54 +Item 16. +Form 10-K Summary +59 +Signatures +60 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for all. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. +On February 17, 2022 (the “Acquisition Date”), we acquired (the “Acquisition”) 100% of the equity of a privately-owned casual footwear brand business (“HEYDUDE”), pursuant to a securities purchase agreement entered into on December 22, 2021. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The majority of HEYDUDE sales are currently in the United States. +Our business has continued to evolve in the period following the consummation of the Acquisition, as we have grown the brand and staffed and developed our leadership team at HEYDUDE. In the fourth quarter of 2023, to reflect changes in the way management evaluates performance, makes operating decisions, and allocates resources, we updated our reportable operating segments to be (i) Crocs Brand and (ii) HEYDUDE Brand, which are discussed in more detail in “Business Segments and Geographic Information” below. Within the regions in which we operate, we prioritize six core markets for the Crocs Brand where we believe the greatest opportunities for growth exist: (i) China, (ii) India, (iii) Japan, (iv) South Korea, (v) the U.S., and (vi) Western Europe. +Our Vision +At the heart of our brands is our consumers. We have brands, with a broad democratic appeal and accessible price points, which are aligned with global megatrends such as casualization and personalization. The philosophy and vision for our brands has been an important driver of our results and, we believe, will continue to be important as we strive to realize the full potential of our brands. To that end, in 2023, we continued our message of “Come As You Are” for the Crocs Brand and the slogan “Good To Go-To” for the HEYDUDE Brand. +Our growth framework is driven by five strategic areas of focus: +• Growing digital sales — Digital sales include sales directly to consumers through our company-owned websites and third-party marketplaces as well as wholesale sales to our global e-tailers. Our digital sales in 2023 were 37.9% of consolidated revenues, compared to 37.8% and 36.7% of consolidated revenues in 2022 and 2021, respectively. +• Gaining sandals market share for the Crocs Brand — Sandals have long been a focus of the Crocs Brand as a large and accessible growth avenue for the brand. We believe sandals are a natural extension of the Crocs Brand and allow us to access new consumers by leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +• Increasing awareness and distribution for the HEYDUDE Brand — We have embarked, and plan to continue to embark, on various marketing activities to drive higher awareness including, but not limited to, developing a pipeline of collaborations and brand activations. We have rightsized HEYDUDE’s wholesale distribution footprint and are evolving our channel diversification strategy through a thoughtful development of outlet retail. In 2023, we opened 5 HEYDUDE Brand outlet stores. +• Growth opportunities internationally — As a company with a well-established global footprint, we believe we have a long-term sales growth opportunity internationally. Our international sales in 2023 were 32.5% of consolidated revenues, compared to 29.4% and 32.8% of consolidated revenues in 2022 and 2021, respectively. This includes sales in 2023 and 2022 for the HEYDUDE Brand, which operates primarily in the United States. Our six core markets for the Crocs Brand include five international markets, and more specifically, four markets in Asia: China, India, Japan, and South Korea. +• Ongoing product and marketing innovation — At the heart of our Crocs Brand’s DNA are our clogs, sandals, and Jibbitz™ charms, which are key product pillars that we believe will drive long-term growth. We continue to grow our clog silhouette with new designs, colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, for personalization. The addition of the HEYDUDE Brand to our portfolio provides an innovative loafer concept that is differentiated through easy on and off, quality, and comfort. From a marketing perspective, we continue +2 +Table of Contents +to invest in globally integrated digital advertising campaigns, as well as designer, celebrity and influencer, and brand partnerships. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. We offer a broad portfolio of all-season products, while remaining true to our core casual footwear heritage. +Crocs Brand +Recognized globally for our unmistakable iconic molded clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2023 as we repeatedly brought our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, and increased personalization through our Jibbitz™ charms accessories. +The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ products. Our products containing LiteRide™ feature comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +HEYDUDE Brand +The HEYDUDE Brand offers shoes with a versatile silhouette with many wearing occasions that focus on casualization, comfort-led functionality, and personalization. The HEYDUDE Brand utilizes leading technologies including a flex-and-fold outsole and ergonomic insole. The shoes are known for being lightweight, flexible, and soft, with design and functional flexibility for convenience. +Marketing +Each season, we focus on presenting compelling brand stories and experiences for our new product introductions as well as our ongoing core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms for the Crocs Brand and our versatile loafer silhouette for the HEYDUDE Brand. We continue to invest in globally integrated marketing campaigns, as well as designer, celebrity and influencer, and brand partnerships, ranging from popular designers like Salehe Bembury to a wide range of well-known brands such as Mossy Oak, Levi’s, and Taco Bell. Innovation is not only core to our brands’ values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our customers to give them new and innovative reasons to continue to choose the Crocs Brand and HEYDUDE Brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Environmental, Social, and Governance Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry, for people, and for our planet. Our 2023 Comfort Report, which is expected to be published in the first half of 2024, is our third annual publication that provides an explanation of our progress towards more transparent, socially conscious, and sustainable business practices. Our Comfort Report will be made available on the Investor Relations section of our website located at www.investors.crocs.com. Except where specified otherwise, all information in the forthcoming Comfort Report and below environmental, social, and governance (“ESG”) discussion pertains to Crocs, Inc. as of December 31, 2023. The content provided in our Comfort Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +We intend to continuously advance our business practices towards our goal of consistently delivering products that exceed customer and consumer expectations with neither undue degradation to the planet nor harm to the communities with which we interact globally as part of our effort to create a more comfortable world for all. We believe the progress of our sustainability efforts is best understood by disclosing measurable and relevant goals and metrics, and, to this end, we continue to align our +3 +Table of Contents +reporting with the Sustainability Accounting Standards Board (“SASB”) and Taskforce on Climate-related Financial Disclosures (“TCFD”) frameworks. +Environmental +We are committed to reducing our impact on the environment and are particularly focused on carbon reduction, sustainable operations, and product circularity. +In 2023, we completed a Greenhouse Gas inventory for the Crocs, Inc. enterprise, including both the Crocs and HEYDUDE brands, based on 2022 data. We also redefined our 2021 baseline to account for the HEYDUDE Brand as part of our continued journey to Net Zero by 2040. In the past year, we continued the integration of our sustainable bio-based alternative materials as part of our Croslite™ compound, renewed our membership with the Sustainable Apparel Coalition, joined the Footwear Collective as a founding member, continued to enhance tracking of our energy use, water use, and waste generation, and had three key suppliers complete the Footwear Distributors and Retailers of America (“FDRA”) Footwear Factory Zero Waste Program. +In 2023, we also introduced “Give Old Crocs New Life,” a pilot circularity program in the United States that allows our Crocs consumers to return their gently worn or well-loved Crocs shoes to retail stores in 10 states to be donated to communities in need or repurposed into something new. +More detail on these initiatives, as well as our ambitions, will be provided in our upcoming Comfort Report. +Social +As of December 31, 2023, we employed nearly 7,030 employees globally, including approximately 3,650 employees in our retail stores, 2,040 employees at our corporate/regional offices, and 1,340 employees at our distribution centers. +We believe we have one of the most talented workforce in the footwear industry and continue to improve and implement new initiatives to remain an employer of choice across all of our businesses and geographies. These initiatives include pay transparency in hiring, offering employee training and developing leadership capabilities, enabling meaningful professional experiences, offering a compelling employee value proposition and fair wages, and creating a collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” We strive to create a culture of inclusion through progressive people-practices that support and empower all employees regardless of gender, age, race, ethnicity, national origin, disability, religion, immigration status, or sexual orientation, gender identity, or expressions. We are proud of the workplace culture we have created and will continue to engage our employees to hear where we still have room for improvement. To that end, our regular employee engagement scores continue to meet or surpass industry benchmarks and reflect a highly engaged global workforce. +Our efforts around inclusion, collaboration, and human rights extend through our supply chain. We work to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards, inclusive of occupational safety and chemical safety. In addition, we maintain numerous measures to ensure our supply chain complies with our Social Compliance Code of Conduct, Restricted Substances Policy, and Human Rights Policy, as well as with all local laws and customs regarding hiring practices, wages, and working conditions. +We also seek to extend the reach of our social and environmental standards through our global community giving program. We focus on providing shoes, funds, and employee time to support social inclusion and equality, and respond to our communities’ needs in times of crises. This program is informed by key stakeholder priorities. In 2023, we donated to non-profits such as the United Nations Foundation and Soles4Souls and supported communities impacted by earthquakes in Türkiye, as well as those impacted by the wildfires on Maui. Thanks to the generosity of our consumers and employees, we continue to generate donations to Feeding America, providing meals to families in need. +Governance +Strong corporate governance mechanisms, along with robust internal controls over our financial reporting framework, are the foundation for our progress toward our environmental and social ambitions. The basis of this is our Board of Directors, which was comprised of 29% female and 14% historically underrepresented racial/ethnic members as of December 31, 2023. +4 +Table of Contents +In 2023, our Environmental, Social, and Governance Steering Committee (the “ESG Committee”) of our board of directors (the “Board”), comprised of three independent directors and our Chief Executive Officer, continued its oversight of our ESG efforts and received quarterly updates on the development of our ESG program. Specifically, the ESG Committee assisted the Board in (i) carrying out the responsibilities delegated by the Board regarding the review and oversight of our goals, policies, procedures and disclosures related to sustainability and ESG matters and (ii) its oversight of the sustainability and ESG matters material to us, our employees, our communities, and the planet. Additionally, we regularly review our Enterprise Risk Management and Ethics & Compliance program frameworks to account for our social and environmental risks and opportunities, specifically including those related to climate change. All material findings and updates are elevated to and discussed with our Board. In 2023, Crocs, Inc. expanded its ESG/Sustainability department led by our VP, Global Head of Sustainability, who reports directly to our Chief Executive Officer. +We believe our employees are critical to the maintenance of strong corporate governance and, to that end, we continue to conduct annual in-person and online compliance trainings for all corporate employees, as well as retail and distribution center management. We also maintain a global ethics hotline, which is monitored by our Legal department, should any of our stakeholders identify concerns or have grievances. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 80 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our DTC channel includes e-commerce, in which we sell through company-operated e-commerce sites and third-party marketplaces, and retail, in which we sell through company-operated stores. +Wholesale Channel +During the years ended December 31, 2023, 2022, and 2021, 52.0%, 54.9%, and 50.8% of our consolidated revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, partner store operators, and international distributors. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +Direct-to-Consumer Channel +Our DTC channel includes company-operated e-commerce sites, third-party marketplaces, company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. During the years ended December 31, 2023, 2022, and 2021, 48.0%, 45.1%, and 49.2%, respectively, of our consolidated revenues were derived through our DTC channel. +E-commerce +As of December 31, 2023, we offered our products through 16 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Retail +With the continued worldwide consumer shift toward e-commerce, we carefully manage our retail fleet, especially full-priced retail stores. As of December 31, 2023, we had 349 and 14 company-operated stores for the Crocs Brand and HEYDUDE Brand, respectively. +5 +Table of Contents +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2023, we had 84 full-price Crocs Brand retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in our outlet stores as well as built-for-outlet products. As of December 31, 2023, we had 201 Crocs Brand outlet stores. We also had 5 HEYDUDE Brand outlet stores and 9 HEYDUDE Brand temporary clearance stores. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and limited fixed cost and capital investment, we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2023, we had 64 Crocs Brand kiosks and store-in-store locations. +The following table illustrates the net change during 2023 in the number of our company-operated retail stores (inclusive of full-price retail stores, outlet stores, kiosks, and store-in-store locations) by reportable operating segment and country: +December 31, 2022 Opened Closed December 31, 2023 +Crocs Brand +United States 160 7 4 163 +Korea 89 3 1 91 +China 33 5 2 36 +Singapore 16 1 — 17 +Japan 13 2 1 14 +Germany 11 1 1 11 +Canada 8 — — 8 +Austria 3 — — 3 +Puerto Rico 3 — — 3 +France 2 1 1 2 +The Netherlands 2 — 1 1 +Total Crocs Brand 340 20 11 349 +HEYDUDE Brand +United States 5 9 — 14 +Total HEYDUDE Brand 5 9 — 14 +Total 345 29 11 363 +Business Segments and Geographic Information +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 17 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our reportable operating segments. +Raw Materials +Crocs Brand +Croslite™, our proprietary closed-cell resin material, incorporates the primary material formulations used in the vast majority of our Crocs Brand footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various sustainability initiatives described in the previous section. +6 +Table of Contents +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +HEYDUDE Brand +The primary raw materials for the HEYDUDE Brand are fabrics, including polyester and cotton, Ethylene-vinyl acetate (“EVA”) insoles and outsoles, and other materials such as leather. We purchase this material from a select group of third-party sources, and we believe these materials are broadly available. +Sourcing +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in: +• Vietnam for the Crocs Brand. We have additional third-party manufacturers in China and Indonesia, among other countries. During the years ended December 31, 2023, 2022, and 2021, approximately 56%, 53%, and 56%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the vast majority of operations in Vietnam and China, produced approximately 47%, 42%, and 34% of our production during the years ended December 31, 2023, 2022, and 2021, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 26%, 27%, and 30% of our production during the years ended December 31, 2023, 2022, and 2021, respectively. +• China for the HEYDUDE Brand. During the year ended December 31, 2023, approximately 83% of our HEYDUDE Brand production was in China. +We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available for both brands. See the risk factor under “Risks Related to our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2023, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2023, we further expanded our U.S. distribution centers in Nevada for the HEYDUDE Brand to increase distribution capacity. We also utilized third-party operated distribution centers located in the United States, Japan, China, Australia, Korea, Singapore, India, Brazil, and the United Kingdom. As of December 31, 2023, our company-operated warehouse and distribution facilities provided us with 3.4 million square feet, and our third-party operated distribution facilities provided us with 0.9 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +See the risk factors under “Risks Related to our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results” and “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with distribution and logistics. +7 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks for the Crocs Brand include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. Our major trademarks for the HEYDUDE Brand include the HEYDUDE logo and word mark. The HEYDUDE word mark is registered in the U.S., the European Union, China, and Singapore, among others. Protection for the HEYDUDE logo has been filed in the U.S. and we intend to extend to foreign jurisdictions within the required time period. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, through litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our Crocs Brand footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our Crocs Brand products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components and confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our Crocs Brand products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution networks position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +8 +Table of Contents +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +ITEM 1A. Risk Factors +You should carefully consider the following risk factors and all other information presented within this Annual Report on Form 10-K. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, access to sources of financing, or stock price. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Because we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for us to predict all risk factors, nor can we assess the impact of all such risk factors on our business. Please also refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K. +Risks Related to Our Products +Our success depends substantially on the value of our brands; failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs and HEYDUDE brands. To be successful in the future, particularly outside of the U.S., where our brands may be relatively less well-known or perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brands across all sales channels. We may have difficulty managing the image of our brands across markets and international borders as certain consumers may perceive the image of either or both of our brands to be out of style, outdated, or otherwise undesirable. Maintaining, promoting, and growing our brands will depend on our design and marketing efforts, including product innovation and quality, advertising and consumer campaigns, as well as our ability to adapt to a rapidly changing media environment, including our continued reliance on social media and digital dissemination of advertising campaigns. +In the past, several footwear companies, including ours, have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses, and our business may be similarly affected in the future. Consumer demand for our products and the equity of our brands could also diminish significantly if we, among other things, fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. +Adverse publicity about regulatory or legal action against us, or by us, could also damage our reputation and the image of our brands, undermine consumer confidence in us, and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Negative claims or publicity involving us, our products, or any of our key employees, endorsers, or business partners could materially damage our reputation and the image of our brands, regardless of whether such claims are accurate. Social media, which accelerates and potentially amplifies the scope of negative publicity, can accelerate, and increase the impact of, negative claims. Further, business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brands and adversely impact our business. +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, less reliance on a small number of brands +9 +Table of Contents +or product lines, and spend substantially more on product marketing than we do. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, price their products more aggressively in the face of inflationary or other competitive pressures, launch more extensive or diverse product lines, and more quickly develop new and popular products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Introducing new products may be difficult and expensive. If we are unable to do so successfully, our brands may be adversely affected, and we may not be able to maintain or grow our current revenue and profit levels. +To successfully continue to evolve our footwear product line to appeal to our consumers, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brands may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, the image of our brands may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles and product lines, and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses. There can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful or that we will dedicate our limited marketing resources to the right product lines. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position, and result in long-term harm to our business and financial results. +See also the risk factor under “Risks Specific to Our Company and Strategy — Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE.” +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brands’ image, and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and design rights on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brands, our success, and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement or other infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others’ intellectual property rights, continued sales of such competing products by third parties could harm our brands or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, the integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite™ material formulations and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information, and other unpatented proprietary information. The agreements +10 +Table of Contents +we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement, and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Failure to continue to obtain or maintain high-quality endorsers of our products could harm our business . +We establish relationships with both celebrity endorsers and design, celebrity, and brand collaborators to develop, evaluate, and promote our products, as well as strengthen our brands. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brands’ visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers and collaborators associated with our products that harm the public image and reputations of those endorsers and collaborators could also seriously harm the image of our brands with consumers and, as a result, could have an adverse effect on our sales and financial condition. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear, such as our branded Croslite™ and LiteRide™ materials. Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite™, our branded proprietary closed-cell resin, is the primary raw material used in the vast majority of our Crocs Brand footwear and some of our accessories. Croslite™ is carefully formulated to create soft, durable, extremely lightweight, and water-resistant footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +Risks Related to the Economy +Changes in global economic conditions, including, but not limited to, those driven by inflation, may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers, wholesalers, and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, increased labor costs, declines in asset values, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, public health issues like the COVID-19 pandemic, or other economic factors, certain of which effects, including cost inflation, we experienced in 2022 and 2023 and currently expect to continue to experience in 2024. +Global inflation, elevated interest rates, global industry-wide logistics challenges, and foreign currency fluctuations resulting in a stronger U.S. Dollar (“USD”), have impacted, and we expect will continue to impact, our business, contributing to, among other things, incremental freight costs, increased wages, particularly in our distribution centers, and increased raw material costs. A stronger USD also results in costs for foreign goods purchased in USD but recognized in foreign currencies (“purchasing power”) that are unfavorable. +If global economic and financial market conditions deteriorate, or remain weak, for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results. See the risk factor “Changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan or other global currencies could have a material adverse effect on our business and financial results” for more information. +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers and cause reduced product orders or product order delays or cancellations from wholesale accounts that are directly +11 +Table of Contents +impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• If consumer demand for our products declines, we may not be able to profitably operate existing retail stores, due to higher fixed costs of the retail business. +• A decrease in credit available to our wholesale or distributor customers, product suppliers, and other service providers, or financial institutions that are counterparties to our Revolving Facility (as defined herein) or derivative instruments may result in credit pressures, other financial difficulties, or insolvency for these parties, with a potential adverse impact on our business, our financial results, or our ability to obtain future financing. +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms, which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment of our accounts receivable. +• If our manufacturers or other parties in our supply chain experience diminished liquidity, and as a result are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships. +• If we are unable to mitigate the impact of supply chain constraints and inflationary pressure through price increases or other measures, our results of operations and financial condition could be negatively impacted. Furthermore, even if we are able to raise the prices of our products, consumers might react negatively to such price increases, which could have a material adverse effect on, among other things, our brands, reputation, and sales. +The Federal Reserve recently raised interest rates multiple times in response to concerns about inflation and it may raise them again. Higher interest rates, coupled with reduced government spending and volatility in financial markets may also increase economic uncertainty and negatively affect consumer spending. Similarly, the ongoing war between Israel and Hamas has created extreme volatility in the global capital markets and is expected to continue to have further global economic consequences, including disruptions of the global supply chain and energy markets. See “ Ongoing wars could cause further disruptions in the global economy as well as a negative impact on our business, financial condition and results of operations .” Any such volatility and disruptions may adversely affect our business or the third parties on whom we rely. If the equity and credit markets deteriorate, including as a result of political unrest or war, it may make any necessary debt or equity financing more difficult to obtain in a timely manner or on favorable terms, more costly or more dilutive. Increased inflation rates have already, and may continue to, adversely affect us by increasing our costs, including labor and employee benefit costs. In addition, higher inflation and macro turmoil and uncertainty could also adversely affect our customers, which could reduce demand for our products. +Ongoing wars could cause further disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations. +The ongoing war between Israel and Hamas as well as the ongoing war between Russia and Ukraine have adversely affected the global economy and have resulted in geopolitical instability. While we derived immaterial revenues from markets in and around these conflict zones in 2023, the instability resulting from these wars could cause an adverse effect on our business, financial condition, results of operations, supply chain, intellectual property, partners, customers, or employees should tensions escalate. Further escalation of geopolitical tensions could also result in, among other things, broader impacts that expand into other markets, cyberattacks, supply chain and logistics disruptions, lower consumer demand, and changes to foreign exchange rates and financial markets, any of which may adversely affect our business and supply chain. +A pandemic, epidemic, or other public health emergency has had an adverse impact, and may have a future material adverse impact, on our business, operations, liquidity, financial condition, and results of operations. +Pandemics, including the COVID-19 pandemic, and other public health emergencies have, among other things, caused global macroeconomic uncertainty, disrupted consumer spending and supply chains, contributed to various global shipping delays and port congestions, and created significant volatility and disruption of financial markets. Global supply chain disruptions during fiscal years 2021 and 2022 negatively impacted our gross margins and net income and could continue to do so in the future, which could have a material adverse effect on the business, financial condition, and results of operations. +The effects of a pandemic, epidemic, or other public health emergency could affect our ability to successfully operate in many ways, including, but not limited to, the following factors: +• the impact of the pandemic on the economies and financial markets of the countries and regions in which we operate; +12 +Table of Contents +• the impact on our supply chain, including, but not limited to, staffing shortages, cost inflation, and shipping delays; and +• operational risk, including, but not limited to, cybersecurity risks as a result of extended remote work arrangements and restrictions on employee travel. +Risks Related to Our Supply Chain +Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs. +We rely on third-party manufacturers outside of the U.S. to produce our products. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +We also rely on international shipping to transport our products to their various geographic markets. During the year ended December 31, 2022, international shipping to the U.S. was disrupted and delayed due to congestion in west coast ports. Continued or additional delays in shipping may cause us to have to use more expensive air freight or other more costly methods to ship our products. During the year ended 2022, our third-party manufacturers, distribution centers, where we manage our inventory, and our third-party partners experienced disruptions that impacted our supply chain and increased global lead-time for our products, including port congestion, temporary closures, and worker shortages. Additionally, as a consequence of the COVID-19 pandemic, reductions in the number of ocean carrier voyages and capacity delayed the arrival of imports and increased ocean transport costs globally. Ongoing ocean carrier consolidations, reduced capacity, congestion at major international gateways, and other economic factors are currently making ocean transportation increasingly difficult and unpredictable. Further, in the U.S., trucking costs have risen dramatically due to driver shortages, increased labor costs, and safety, environmental, and labor regulations. As supply chain disruptions continue and we manage product availability, the timing of sales to our wholesale partners and consumers may continue to be impacted, and we face increased risk of order cancellations. In addition, global inflation has contributed to already higher incremental freight costs and such inflation may continue to result in higher freight costs. Failure to adequately produce and timely ship our products to customers could lead to lost potential revenue, failure to meet customer demand, strained relationships with customers, including wholesalers, and diminished brand loyalty. +Despite our actions to mitigate these impacts, we were negatively impacted by global logistics challenges in 2022. For example, during the year ended December 31, 2022, we expended $67 million on an air freight program initiated as a result of partial COVID-19-related factory closures in Vietnam at the end of 2021. +We depend solely on third-party manufacturers located outside of the U.S. +All of our footwear products are manufactured by third-party manufacturers, the majority of which are located in Vietnam, China, and Indonesia. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity, and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders. During the years ended December 31, 2023, 2022, and 2021, approximately 56%, 53%, and 56%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the vast majority of operations in Vietnam and China, produced approximately 47%, 42%, and 34% of our production during the years ended December 31, 2023, 2022, and 2021, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 26%, 27%, and 30% of our production during the years ended December 31, 2023, 2022, and 2021, respectively. During the year ended December 31, 2023, approximately 83% of our HEYDUDE Brand production was in China. During the Partial Period (as defined below), the majority of production was in China for the HEYDUDE Brand. Furthermore, because our third-party manufacturers are concentrated in Asia, we may be subject to an increased risk of supply chain disruption, particularly in the event of a natural disaster, pandemic, such as the COVID-19 pandemic, epidemic, geopolitical tension, or other event impacting the region outside of our control. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines, or meet our quality standards. Furthermore, due to the relative concentration of our third-party manufacturers, disruption at the facilities of our third-party manufacturing partners as a result of COVID-19 or otherwise, including through the effects of facility closures, reductions in operating hours and labor shortages had an adverse effect on our supply chain in 2021 and 2022 and may have a material adverse effect in the future. For example, at the end of 2021 and into the first quarter of 2022, many of our third-party manufacturing facilities in Vietnam were closed or not operating at full capacity due to local COVID-19 outbreaks and safety protocols, which negatively impacted our financial results. See the risk factor under “ Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” and “Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results.” +13 +Table of Contents +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, including those caused by the COVID-19 pandemic, work stoppages, political instability, including the ongoing war between Israel and Hamas, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, cost inflation, changes in governmental policies or laws, and the imposition of tariffs, import and export controls, and other barriers. Because we do not manufacture products internally, we cannot offset any interruption or decrease in supply of our products by increasing production in internal manufacturing facilities, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. For example, during the year ended December 31, 2022, we incurred approximately $67 million on an air freight program initiated as a result of partial COVID-19-related factory closures in Vietnam at the end of 2021. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can increase our transportation costs and adversely affect our product margins. +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, changes in legislation and policies, increases in labor costs, changes in international trade agreements and tariffs, adverse weather conditions, or public health issues, such as the COVID-19 pandemic, could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. +We, similar to many other companies with overseas operations, import and sell products in other countries that could be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition, and results of operations. See the risk factor under “Risks Related to International Operations — We conduct significant business activity outside the U.S., which exposes us to risks of international commerce.” +Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results. +Our operations have been, and may continue to be, impacted by supply chain constraints and raw material shortages, resulting in increased material costs, longer lead times, port congestion, and increased freight costs caused, in part, by the COVID-19 pandemic, the uncertain economic environment, and macroeconomic trends. In addition, current or future governmental policies may increase the risk of inflation, which could further increase the costs of raw materials and components for our business. Similarly, if costs of goods continue to increase, our suppliers may seek price increases from us. If we are unable to mitigate the impact of supply chain constraints and inflationary pressure through price increases or other measures, our results of operations and financial condition could be negatively impacted. Even if we are able to raise the prices of our products, consumers might react negatively to such price increases, which could have a material adverse effect on, among other things, our brands, reputation, and sales. If our competitors substantially lower their prices, we may lose customers and mark down prices. Our profitability may be impacted by lower prices, which may negatively impact gross margins. Even though we are working to alleviate supply chain constraints through various measures, we are unable to predict the impact of these constraints on the timing of revenue and operating costs of our business in the near future. Raw material supply shortages and supply chain constraints, including cost inflation, have impacted and could continue to negatively impact our ability to meet increased demand, which in turn could impact our net sales revenues and market share. In addition, COVID-19 related closures negatively impacted our supply chain in Vietnam in the first quarter of 2022 and in China in the second quarter of 2022. We expect the situation to remain fluid as COVID-19 break-out rates, including any deterioration in circumstances related to COVID-19 variants, and foreign exchange rates fluctuate, and inflationary pressure continues. See the risk factor under “Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs.” +14 +Table of Contents +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting consumer demand. In addition, purchase orders from our wholesale customers are generally subject to rights of cancellation and rescheduling by the wholesaler. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in losses or lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in lower sales, delays in shipments to customers, and expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. Excess inventory, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our third-party manufacturing operations must comply with labor, trade, and other laws. Failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental, and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brands, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall, which could result in critical media coverage; harm our business, brands, and reputation; and cause us to incur additional costs. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business or results. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +For example, China’s Xinjiang Uyghur Autonomous Region (the “XUAR”) is the source of large amounts of cotton and textiles for the global apparel and footwear supply chain. The United States Treasury Department placed sanctions on China’s Xinjiang Production and Construction Corporation (“XPCC”) for serious human rights abuses against ethnic minorities in XUAR. Additionally, the Uyghur Forced Labor Prevention Act (“UFLPA”), empowers the U.S. Customs and Border Protection Agency (the “U.S. CBP”) to withhold release of items produced in whole or in part in the XUAR, or produced by companies included on a government-created UFLPA entity list, creating a presumption that such goods were produced using forced labor. XPCC controls many of the cotton farms and much of the textile industry in the region, and many large factories in XUAR produce fabrics and yarn for apparel and footwear. +Although we do not believe that our suppliers source materials from such area of China for the products they sell to us or use to manufacture our products, we have no known involvement with XPCC or its subsidiaries and affiliates, and we prohibit our suppliers from doing business with XPCC or using forced labor, we do not have the ability to completely map our supply chain, and we could be subject to penalties, fines or sanctions if any of the suppliers from which we purchase goods is found to have dealings, directly or indirectly, with XPCC or entities it controls. Additionally, our products or materials (including potentially non-cotton materials) could be held or delayed by the U.S. CBP, which would cause delays and unexpectedly and negatively affect our inventory levels. Even if we were not subject to penalties, fines or sanctions, if products we source are linked in any way to XPCC, the XUAR, or an entity on the UFLPA entity list, our reputation could be damaged. In addition, the UFLPA has induced greater supply chain compliance costs and delays to us and to our suppliers. Compliance with the UFLPA could continue to affect the global supply chain, the price and scarcity of traceable cotton in the marketplace and could lead to an increase in our cost of goods sold, which may have an adverse effect on our profitability. +See the risk factor under “ Risks Related to International Operations — We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. ” +15 +Table of Contents +We depend on a number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite™ and LiteRide™ formulations, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market conditions related to supply and demand for our raw materials and any resulting shortages in supply, as well as impacts of any global shipping or logistics delays. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins, or if we are unable to procure sufficient quantities of the materials that go into the Croslite™ and LiteRide™ formulations, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Risks Related to International Operations +Changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan or other global currencies could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the USD. We are exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. companies are also exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of operations and the value of our assets and liabilities denominated in foreign currencies. +In accordance with our operating practices, we hedge a significant portion of our foreign currency transaction exposures arising in the ordinary course of business to reduce risks in our cash flows and earnings. We use cash flow hedges to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. Currency forward agreements involve fixing the exchange rates for delivery of a specified amount of foreign currency on a specified date. The currency forward agreements are typically settled in USD for their fair value at or close to their settlement date. We may also use currency option contracts under which we will pay a premium for the right to sell a specified amount of a foreign currency prior to the maturity date of the option. Our hedging strategy may not be effective in reducing all risks, and no hedging strategy can completely insulate us from foreign exchange risk. Further, our use of derivative financial instruments may expose us to counterparty risks. Although we only enter into hedging contracts with counterparties having investment grade credit ratings, it is possible that the credit quality of a counterparty could be downgraded or a counterparty could default on its obligations, which could have a material adverse impact on our financial condition, results of operations, and cash flows. +Further, our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, gross margin compression, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. For the Crocs Brand, we pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. In 2023, we experienced decreases of approximately $18.3 million in our Crocs Brand segment revenues, primarily as a result of decreases in the value of the Chinese Yuan, Argentine Peso, and Japanese Yen relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies, adversely impacts our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and, as a result, our forward contracts may not prove effective in reducing our exposures. +16 +Table of Contents +We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. We operate retail stores and sell our products to retailers outside of the U.S. and utilize foreign-based third-party manufacturers. Foreign manufacturing and sales activities are subject to numerous risks, including: +• tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; +• delays associated with the manufacture, transportation, and delivery of products, including related to global port backlog or congestion; +• increased transportation costs due to distance, energy prices, inflation, or other factors; +• delays in the transportation and delivery of goods due to increased security concerns; +• restrictions on the transfer of funds; +• restrictions and potential penalties due to privacy laws on the handling and transfer of consumer and other personal information; +• changes in governmental policies and regulations; +• political unrest, such as the ongoing war between Israel and Hamas, changes in law, terrorism, natural disasters, public health issues like the COVID-19 pandemic, or war, any of which can interrupt commerce; +• potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; +• expropriation and nationalization; +• difficulties in managing foreign operations effectively and efficiently from the U.S.; +• difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions; +• longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; +• difficulties in enforcing contractual and intellectual property rights; +• greater risk that our business partners do not comply with our policies and procedures relating to labor, health, and safety; +• UFLPA detentions by U.S. Customs resulting in revenue loss and adverse media exposure; and +• increased accounting and internal control costs. +In addition, we are subject to customs laws and regulations with respect to our export and import activity, which are complex and vary within legal jurisdictions in which we operate. We cannot ensure there will not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. For example, on December 23, 2021, the UFPLA, which effectively prohibits imports of any goods made either wholly or in part in a certain area of China, was signed into law, which generally prohibits importing goods made with forced labor into the U.S., subject to certain exceptions. While we do not currently expect that this law will directly affect our supply chain, since we do not believe that our suppliers source materials from such area of China for the products they sell to us or use to manufacture our products, other companies’ attempts to shift suppliers in response to this law or other policy developments could result in, among other things, shortages, delays, and/or price increases that could disrupt our own supply chain or cause our suppliers to renegotiate existing arrangements with us or fail to perform on such obligations. In addition, the ongoing war between Israel and Hamas has adversely affected the global economy. For more information, please see the risk factors under “Risks Related to the Economy — Ongoing wars could cause further disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations,” “Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside the U.S.,” “ Risks Related to our Supply Chain — Our third-party manufacturing operations must comply with labor, trade, and other +17 +Table of Contents +laws. Failure to do so may adversely affect us ,” and “Risks Specific to Our Company and Strategy — Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results.” +Furthermore, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties; criminal sanctions against us, our officers, or our employees; prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries; and a materially negative effect on our brands and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners, or agents will not violate our policies. +Risks Specific to Our Company and Strategy +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brands’ image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. We are focusing on our core casual footwear heritage by narrowing our product line with an emphasis on higher margin products, as well as developing innovative new casual lifestyle footwear platforms. +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow and integrate HEYDUDE. If we are unsuccessful at, among other things, building HEYDUDE’s brand awareness, enhancing its digital capabilities, leveraging our wholesale relationships to enhance distribution, investing in HEYDUDE’s infrastructure as well as sales and business operations, integrating employees into our company culture, leveraging our distribution for global growth and/or investing to scale our supply chain and gain efficiencies, our sales could be adversely affected, and our business could suffer. In addition, HEYDUDE’s product sales may not meet our expectations. See the risk under “— Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE.” +Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to +• strengthen and maintain our brands; +• focus on relevant geographies and markets, product innovation, and profitable growth, while maintaining demand for our current offerings; +• effectively manage our company-operated retail stores to meet operational and financial targets at the retail store level; +• accurately forecast the global demand for our products, consolidate our distribution and supply chain network to leverage resources, simplify our fulfillment process, and deliver product around the globe efficiently; +• use and protect the Crocs and HEYDUDE brands and our other intellectual property in new and existing markets and territories; +• achieve and maintain a strong competitive position in new and existing markets; +• attract and retain qualified wholesalers and distributors, including partner store operators; +• maintain and enhance our digital marketing capabilities and digital commerce capabilities; and +• execute multi-channel advertising, marketing, collaboration, and social media campaigns to effectively communicate our message directly to our consumers and employees. +While these strategies, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance this will be the case or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +18 +Table of Contents +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to grow HEYDUDE. +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE. Combining with Crocs, Inc. may not accelerate the growth and success of HEYDUDE, and the HEYDUDE business may not perform as expected. If we are unsuccessful at, among other things, building HEYDUDE’s brand awareness, enhancing its digital capabilities, leveraging our wholesale relationships to enhance distribution, investing in HEYDUDE’s infrastructure as well as sales and business operations, leveraging our distribution for global growth and/or investing to scale our supply chain and gain efficiencies, our sales could be adversely affected, and our business could suffer. In addition, HEYDUDE’s product sales may not meet our expectations. +Moreover, HEYDUDE depends on a limited number of third-party manufacturers that are concentrated in China to produce its +products. Due to the relative concentration of HEYDUDE’s third-party manufacturers, disruption at the facilities of such third-party manufacturing partners as a result of COVID-19 or otherwise, including through the effects of facility closures, reductions in operating hours and labor shortages may have a material adverse effect in the future. See the risk factors under “ Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs ,” “ Risks Related to Our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results ,” and “ Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S. ” +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results. +We rely heavily on the use of information technology systems and networks across all business functions, as do our business partners. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We also rely on third-party information services providers worldwide for many of our information technology functions including network, hardware, and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing, and collection of payments. In addition, we use information systems for certain human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. We also have outsourced a significant portion of work associated with our finance and accounting, human resources, customer service, and other information technology functions to third-party service providers. +In addition, we continuously assess and implement upgrades to improve our information technology systems globally. The expansion of our systems and infrastructure has required, and will continue to require, us to commit substantial financial, operational and technical resources. The development and implementation of new systems and any other future upgrades to our systems and information technology may require significant costs and divert our management’s attention and other resources from our core business. There are also no assurances these new systems and upgrades will provide us with the anticipated benefits and efficiencies. Similarly, the time and resources that management will need to devote to operations and upgrades, any delays due to the installation of any upgrade (and customer issues therewith), any resulting service outages, or the impact on the reliability of our data from any upgrade or any legacy system, may have a material adverse effect on our business, financial condition, control environment or results of operations. During these implementation periods, we also face a heightened risk of system interruptions and deficiencies or failures in our internal controls involving our information systems and processes. As a result, we could be adversely affected by system or network disruptions if new or upgraded information technology systems are defective, not installed properly or not properly integrated into our operations. Accordingly, system modification or integration failures could have a material adverse effect on our business, financial position, and results of operations. +Furthermore, despite our current security and cybersecurity measures, our systems and those of our third-party service providers may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, ransomware attacks, and interruption or loss of valuable business data, and we have been subject to, and will continue to be subject to, various third-party attacks and phishing scams. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of sales, significant costs for data restoration, the inability to interpret data timely to enhance operations, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks on a daily basis. Any breach of our network may result in the loss of +19 +Table of Contents +valuable business data, misappropriation of our consumers’ or employees’ personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network is breached, it could give rise to unwanted media attention, materially damage our customer relationships, or harm our business, our reputation, and our financial results, which could result in fines or lawsuits. The costs we incur to protect against such information security breaches may materially increase, including increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. Our business partners in our supply chain and customer base also rely significantly on information technology. Despite their existing cybersecurity procedures and controls, if their information systems become compromised, it could, among other things, cause delays in our product fulfillment or reduce our sales, which could harm our business. +In addition, the European Union’s General Data Protection Regulation, the California Consumer Privacy Act, and other similar evolving privacy laws impose additional obligations on companies regarding the handling of personal data and provide certain individual privacy rights to persons whose data is stored. These regulations may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations, and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes and the associated costs may have a material adverse impact on our business and results of operations. +Finally, the SEC has adopted new rules that require us to provide greater disclosures around cybersecurity risk management, strategy and governance, as well as disclose the occurrence of material cybersecurity incidents. We cannot predict or estimate the amount of additional costs we will incur in order to comply with these rules or the timing of such costs. These rules and regulations may also require us to report a cybersecurity incident before we have been able to fully assess its impact or remediate the underlying issue. Efforts to comply with such reporting requirements could divert management’s attention from our incident response and could potentially reveal system vulnerabilities to threat actors. Failure to timely report incidents under these or other similar rules could also result in monetary fines, sanctions, or subject us to other forms of liability. This regulatory environment is increasingly challenging and may present material obligations and risks to our business, including significantly expanded compliance burdens, costs and enforcement risks. +Artificial intelligence presents risks and challenges that can impact our business including by posing security risks to our confidential information, proprietary information, and personal data. +Issues in the development and use of artificial intelligence, combined with an uncertain regulatory environment, may result in reputational harm, liability, or other adverse consequences to our business operations. As with many technological innovations, artificial intelligence presents risks and challenges that could impact our business. We may adopt and integrate generative artificial intelligence tools into our systems for specific use cases reviewed by legal and information security. Our vendors may incorporate generative artificial intelligence tools into their offerings without disclosing this use to us, and the providers of these generative artificial intelligence tools may not meet existing or rapidly evolving regulatory or industry standards with respect to privacy and data protection and may inhibit our or our vendors’ ability to maintain an adequate level of service and experience. If we, our vendors, or our third-party partners experience an actual or perceived breach of privacy or security incident because of the use of generative artificial intelligence, we may lose valuable intellectual property and confidential information and our reputation and the public perception of the effectiveness of our security measures could be harmed. Further, bad actors around the world use increasingly sophisticated methods, including the use of artificial intelligence, to engage in illegal activities involving the theft and misuse of personal information, confidential information, and intellectual property. Any of these outcomes could damage our reputation, result in the loss of valuable property and information, and adversely impact our business. +If our online e-commerce sites, or those of our customers, do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites and third-party e-commerce sites. Consumers are also increasingly using mobile-based applications to engage with us and our competitors through digital experiences that are offered on mobile platforms, and we are increasingly using social media to interact with our consumers as a means to enhance their shopping experience. Any failure on our part or on the part of third parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our products and that continually meet the evolving expectations of online shoppers or any failure to provide attractive digital experiences could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including unauthorized access and denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +20 +Table of Contents +Our financial success depends in part on the strength of our relationships with, and the success of, our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributor customers to carry our products. We do not have long-term contracts with most wholesale customers, and sales to these customers are generally on an order-by-order basis and subject to cancellation and rescheduling. Our contracts with distributors typically have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms, which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses, and reduced cash flows if our collection efforts are unsuccessful. We have recorded material allowances for doubtful accounts in the past and could do so again in the future. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations, and our ability to grow our product line. +Operating company-operated retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably, or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location, and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2023, we opened 29 and closed 11 retail stores, and we operated 363 retail stores at December 31, 2023. +Many of our company-operated retail stores are located in shopping malls and outlet malls, and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot-traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick-and-mortar retail to e-commerce channels, both prior to, and as a result of, the COVID-19 pandemic, which may contribute to declining foot-traffic in company-operated retail locations. Continued reduced customer foot-traffic could reduce sales at our company-operated retail stores, including kiosks and store-in-store locations, or hinder our ability to open retail stores in new markets, which could in turn negatively affect our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism, resulting from an economic slowdown, political, terrorism, social, or military events, natural disasters, public health issues like the COVID-19 pandemic, or otherwise, is likely to adversely affect sales in our existing stores. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, expansion of existing businesses or operations, and acquisitions of new businesses, such as HEYDUDE, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect, or implementation issues, or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back-office systems. We have also moved to, and subsequently expanded, a new distribution center in Dayton, Ohio to serve our North American businesses for the Crocs Brand, and have moved to a new company-operated distribution center in the Netherlands and a new third-party operated distribution center in Japan to serve our international businesses for the Crocs Brand. Additionally, we have expanded our HEYDUDE Brand distribution center in Las Vegas, Nevada, and we further expanded our distribution capabilities of the HEYDUDE Brand by constructing a distribution facility in Nevada that opened in 2023. As our business grows, we may also need to make further investments in business systems and distribution capabilities. Issues in implementing or integrating new business operations, such as HEYDUDE, and new systems +21 +Table of Contents +with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, issues with transitioning to or operating our new distribution centers, cost overruns, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations, require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +We depend on employees across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +Further, our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threats to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing, or manufacturing and selling seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +We are subject to periodic litigation, which could result in unexpected expenditures of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings, or any future legal proceedings, could have an adverse impact on our business and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +Global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations, could negatively impact our operating results and financial condition. +The effects of climate change, natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, and public health issues like the COVID-19 pandemic, whether occurring in the U.S. or abroad, may disrupt our operations or the operations of our vendors, other suppliers, or customers. Consequences of these events could include property damage, infrastructure damage leading to the inability of our employees and third-parties to work, damage to our supply chain, unavailability of raw materials, increased manufacturing costs and disruptions to the productivity of our third-party manufacturers, disruptions to our distribution centers, disruptions to our retail stores, changes in consumer preferences or spending priorities, and energy shortages, which could result in negative impacts to our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. Many governmental and other regulatory bodies worldwide are enacting regulations to mitigate the impacts of climate change. If we, our suppliers, or our third-party manufacturers are required to comply with these laws and regulations, or if we choose to take additional voluntary steps to reduce or mitigate our impact on the climate, we may experience increased costs for energy, production, transportation, and raw materials, increased capital expenditures, or increased insurance premiums and deductibles, each of which could adversely impact our operations. In addition, inconsistent regulations among jurisdictions may also affect our cost to comply with such laws and regulations. Any assessment of the potential impact of future climate change legislation, regulations, or industry standards, as well as any international treaties and accords, is uncertain given the wide scope of potential regulatory change in the countries in which we operate. +22 +Table of Contents +In 2022, we updated our public, enterprise-wide commitment to be Net Zero by 2040. Although we intend to meet these commitments, we may be required to expend significant resources to do so, which could increase our operational costs. Further, there can be no assurance of the extent to which our commitment will be achieved, or that any future investments we make in furtherance of achieving such target and goal will meet investor expectations or legal standards, if any, regarding sustainability performance. As our business context continues to change, we will continue to evaluate pathways and feasibility of our carbon reduction journey. Moreover, we may determine that it is in the best interest of our Company and our stockholders to prioritize other business, social, governance or sustainable investments over the achievement of our current commitments based on economic, technological developments, regulatory and social factors, business strategy or pressure from investors, activist groups or other stakeholders. If we are unable to meet these commitments, then we could incur adverse publicity and reaction from investors, activist groups or other stakeholders, which could adversely impact the perception of us and our products and services by current and potential customers, as well as investors, which could in turn adversely impact our results of operations. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware law contain provisions that could discourage a third-party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +Increasing scrutiny from investors, regulators, and other key stakeholders with respect to our environmental, social, and governance practices may impose additional costs on us or expose us to new or additional risks. +Investor advocacy groups, certain institutional investors, investment funds, stockholders, customers, non-governmental organizations, consumers and regulators, such as the SEC, are increasingly focused on corporate responsibility, specifically on the ESG practices of companies. These parties have placed increased importance on the implications of the social cost of their investments. From time to time, we communicate certain ESG initiatives and goals to market participants and our customers and business partners. Any corporate responsibility disclosure we make may include our policies, practices, initiatives, and goals on a variety of social and ethical matters, corporate governance, environmental compliance, sustainability, employee health and safety practices, human capital management, product quality, supply chain management, and workforce inclusion and diversity. Although we have undertaken significant efforts to improve and implement our ESG initiatives, it is possible that the aforementioned parties may not be satisfied with such disclosures, our ESG practices, or the speed with which we adopt and/or implement our plans. The establishment of ESG criteria, as well as the collection of relevant ESG data, can be costly, challenging, and time consuming and is subject to evolving ESG reporting standards and regulations. If our ESG practices do not meet investor or other stakeholder expectations and standards, which continue to evolve, or if we are perceived or deemed to have not appropriately responded to the growing concern for ESG issues, regardless of whether there is a legal requirement to do so, we may suffer from reputational damage from stakeholders and consumers and our business and financial condition could be materially and adversely affected. We may also incur additional costs or require additional resources to monitor such stakeholder expectations and standards and to meet our targets and commitments. Further, we could fail, or be perceived to fail, to achieve our ESG initiatives or goals, or we could fail to fully and accurately report our progress on such initiatives and goals, which could negatively impact our business. +Indebtedness Risks +The Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Indentures (each as defined below) each impose significant operating and financial restrictions on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities. A breach of any of those restrictive covenants may cause us to be in default under the Revolving Credit Agreement, the Term Loan B Credit Agreement and/or the Indentures, and our lenders could foreclose on our assets. +Our Revolving Credit Agreement requires us to maintain certain financial covenants. A decline in our operating performance could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Revolving Credit Agreement. We may not have sufficient funds to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lenders. If we are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding or +23 +Table of Contents +collection proceedings with respect to our assets, all of which secure our indebtedness under the Revolving Credit Agreement. The foregoing risks also apply to the Term Loan B Credit Agreement. +The Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Indentures also contain certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt or issue preferred stock; sell, lease or transfer our assets; pay dividends on, and make other distributions on, or redeem or repurchase, our common stock; make certain capital expenditures and investments; guarantee debt or obligations; create certain liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, incur or guarantee additional debt, incur certain liens, enter into transactions with affiliates, transfer or sell certain assets, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +The terms of any future indebtedness we may incur could include more restrictive covenants. We cannot assure you that we will be able to maintain compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the lenders and/or amend the covenants. In addition, our ability to comply with these negative covenants can be affected by events beyond our control. Our failure to comply with the restrictive covenants described above as well as other terms of our indebtedness could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms or cannot refinance these borrowings, our results of operations and financial condition could be adversely affected. +Our indebtedness, including the incurrence by us of substantial indebtedness in connection with the financing of the Acquisition, could adversely affect our business, financial condition, and results of operations, as well as the ability to meet payment obligations under our Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Notes (as defined below). +As of December 31, 2023, we had $1,664.3 million in total indebtedness outstanding (net of $49.0 million of unamortized issuance costs related to the issuance of the Notes). To finance the Acquisition in part, we entered into an agreement (as amended prior to the February 2024 Amendment (as defined below), the “Term Loan B Credit Agreement”) with respect to a new senior secured term loan B facility in an aggregate principal amount equal to $2.0 billion (as amended prior to the February 2024 Amendment, the “Term Loan B Facility”) and borrowed $50.0 million under the Revolving Facility. The use of indebtedness to finance the Acquisition reduced our liquidity and could cause us to place more reliance on cash generated from operations to pay principal and interest on our debt, thereby reducing the availability of our cash flow for working capital and capital expenditure needs or to pursue other potential strategic plans. +Subject to the limits contained in the Revolving Credit Agreement, the Indentures, the Term Loan B Credit Agreement and the applicable agreements governing our other existing indebtedness, we may be able to incur substantial additional debt from time to time. If we do so, the risks related to our level of debt could increase. Specifically, our level of debt could have important consequences, including the following: +• making it more difficult for us to meet our obligations with respect to our debt; +• reducing the availability of cash flow to fund future working capital, capital expenditures, acquisitions or other general corporate purposes; +• limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate purposes; +• requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions or other general corporate purposes; +• increasing our vulnerability to general adverse economic and industry conditions; +• exposing us to the risk of increased interest rates as certain of our borrowings are at variable rates of interest; +• placing us at a disadvantage compared to other, less leveraged competitors; +• increasing our cost of borrowing; and +• limiting our flexibility in planning for changes in our business and reacting to changes in the industry in which we compete. +24 +Table of Contents +Furthermore, if we are unable to meet our debt service obligations or should we fail to comply with our financial and other negative covenants contained in the agreements governing our indebtedness, we may be required to refinance all or part of our debt, sell important strategic assets at unfavorable prices, incur additional indebtedness or issue common stock or other equity securities. We may not be able to, at any given time, refinance our debt, sell assets, incur additional indebtedness or issue equity securities on terms acceptable to us, in amounts sufficient to meet our needs. If we are able to raise additional funds through the issuance of equity securities, such issuance would also result in dilution to our stockholders. Our inability to service our obligations or refinance our debt could have a material and adverse effect on our business, financial condition or operating results. In addition, our debt obligations may limit our ability to make required investments in capacity, technology, or other areas of our business, which could have a material adverse effect on our business, financial condition, or operating results. +Any of these factors could have an adverse effect on our business, financial condition, and results of operations and our ability to meet our debt payment obligations. +Despite our current level of indebtedness, we may be able to incur substantially more debt, which could increase the risks to our financial condition described above. +We may be able to incur substantial additional indebtedness in the future, such as the debt we incurred to finance the Acquisition in part. Although certain of the agreements governing our existing indebtedness contain restrictions on the incurrence of additional indebtedness and entering into certain types of other transactions, these restrictions are subject to a number of qualifications and exceptions, including compliance with various financial conditions. Additional indebtedness incurred in compliance with our existing debt instruments could be substantial. To the extent new debt is added to our current debt levels, the substantial leverage risks described in the immediately preceding risk factor would increase. +As of December 31, 2023, we had approximately $1,664.3 million in total indebtedness outstanding (net of $49.0 million of unamortized issuance costs related to the issuance of the Notes), including $820.0 million outstanding on the Term Loan B Facility. We had borrowings outstanding of $190.0 million under the Revolving Facility, with total borrowing capacity of approximately $558.7 million thereunder (including $1.3 million of letters of credit outstanding as of such date). +Financial and Accounting Risks +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows, or the closure of a store could result in impairment of leasehold improvements, impairment of right-of-use assets, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. Impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +We may incur impairments of the carrying value of our goodwill and other intangible assets, which could have a material adverse effect on our business and financial results. +In connection with the Acquisition, we allocated approximately $710.0 million and $1,780.0 million to goodwill and indefinite-lived intangible assets, respectively. These assets are tested for impairment at least annually, using estimates and assumptions affected by factors such as economic and industry conditions and changes in operating performance. Additionally, in conjunction with the impairment tests, we also reassess the indefinite-life classification. Potential resulting charges from an impairment of goodwill or our indefinite-lived intangible, as well as reclassification of an indefinite-lived to a definite-lived intangible, could have a material adverse effect on our business and results of operations. +The testing of our goodwill for impairment is predicated upon our determination of our reporting units. Any change to the conclusion of our reporting units or the aggregation of components within our reporting units could result in a different outcome to our annual impairment test. Although the fair values of our HEYDUDE Brand reporting unit goodwill and indefinite-lived intangible assets are either equal to or in excess of their carrying values, the fair values are sensitive to the aforementioned potential unfavorable changes that could have an adverse impact on future analyses. See Part II - Item 7. +25 +Table of Contents +Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 5 — Goodwill and Intangible Assets, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, which could increase the volatility of the price of our common stock. +Quarterly results may also fluctuate as a result of several factors, including new style introductions, general economic conditions, or changes in consumer preferences. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any other year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S., our business, and financial results. +We have substantial cash requirements in the U.S., but a significant portion of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested, and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the U.S. Tax Cuts and Jobs Act, could be repatriated without incurring additional U.S. federal income taxes, although some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the U.S. and foreign jurisdictions for prior tax years. Please refer to Note 14 — Income Taxes and Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details regarding current tax audits. The final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. +Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. In August 2022, the U.S. government enacted the Inflation Reduction Act of 2022, which included among other provisions, a 15% minimum tax on “adjusted financial statement income” and became effective for us beginning January 1, 2023. Recently, intergovernmental organizations such as the Organization for Economic Co-operation and Development (“OECD”) and European Union (“EU”) have proposed changes to the existing tax laws of member countries. For example, the OECD has introduced model rules for a new 15% global minimum tax framework, as well as a proposal on the allocation of profit among tax jurisdictions in which companies operate. In December 2022, the EU member states agreed to incorporate the 15% global minimum tax into their respective domestic laws effective for fiscal years beginning on or after December 31, 2023. Additionally, several non-EU countries, including the United Kingdom, have recently proposed and/or adopted legislation consistent with the OECD global minimum tax framework. These tax laws and regulations could adversely impact our financial position and results of operations beyond 2024. Continued economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult, and prior decisions by tax authorities regarding treatments and positions of corporate income taxes could be subject to enforcement activities, as well as legislative investigation and inquiry, which could also result in changes in tax policies or prior tax rulings. The final resolution of such tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse effect on our financial performance. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +26 +Table of Contents +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly, and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 1C. Cybersecurity +We maintain a Cybersecurity Incident Response Plan that is an important component of our Cybersecurity Risk Management Program, which then integrates into our Enterprise Risk Management (“ERM”) Program. Our Cybersecurity Incident Response Plan is designed to facilitate a timely, consistent, and compliant response to actual or attempted cybersecurity incidents impacting the Company. The Cybersecurity Incident Response Plan is built on a framework that is aligned with publication 800-61 of the National Institute of Standards and Technology and is tailored to our people, processes, and technology. Cybersecurity Incident Response Plan phases include (1) preparation, (2) detection and analysis, which includes processes to assess the materiality of cybersecurity incidents and make timely reports, (3) containment, eradication, and recovery, and (4) post-incident activity. The Cybersecurity Incident Response Plan also defines the objectives, roles and responsibilities, and scope of our incident response program. +We maintain a formal information security training program for all employees that includes training on matters such as security awareness, phishing, and email security best practices. Employees are also required to complete compulsory training on compliance and data privacy. +We engage with third party assessors, consultants, and auditors to test our cybersecurity maturity and to drive continuous monitoring and improvements. The engagement includes having independent third parties perform compliance, technical, and maturity assessments, such as (1) attack surface assessment, (2) penetration testing assessment, and (3) cybersecurity maturity assessments. We also annually engage third parties and our internal audit department to assess our information security programs, whose findings are reported to the Audit Committee of the Board. +We rely on our information technology (“IT”) systems and networks in connection with our business activities. Some of these networks and systems are managed by third-party service providers and are not under our direct control. We have implemented processes to manage the cybersecurity risks associated with our use of third-party service providers through our vendor risk management program and an application governance policy. +Despite the security measures we have implemented, certain cyber incidents could materially disrupt operational systems. If our IT resources are compromised by an intentional attack and results in loss of trade secrets or other proprietary or competitively sensitive information; compromise personally identifiable information regarding customers or employees; delay our ability to deliver products to customers; jeopardize the security of our facilities; or cause other damage. Although the risks from cybersecurity threats, including as a result of any previous cybersecurity incidents, have not materially affected or are reasonably likely to materially affect the Company, including its business strategy, results of operations, or financial condition, such incidents could have a material adverse effect in the future as cyberattacks continue to increase in frequency and sophistication. We continuously seek to maintain a robust program of information security and controls, but the impact of a material cybersecurity incident could have an adverse effect on our competitive position, reputation, results of operations, financial condition, and cash flows. Additionally, while we have a cybersecurity program designed to protect and preserve the confidentiality, integrity, and availability of our information systems, we also maintain cybersecurity insurance to manage potential liabilities resulting from specific cyber-attacks. Although we maintain cybersecurity insurance, there can be no guarantee that our insurer(s) will cover specific claims, pay the full costs of an incident, or provide payment in a timely manner. +For more information, please see “Item 1A – Risk Factors – Risks Specific to Our Company and Strategy-Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results.” +27 +Table of Contents +The Audit Committee of the Board is responsible for monitoring and overseeing risk management from cybersecurity threats. In accordance with the Audit Committee’s charter, the Audit Committee is responsible for oversight of our ERM program, which includes cyber risk management. It is the Audit Committee’s responsibility to review and discuss with management the adequacy and effectiveness of our cybersecurity policies and the internal controls regarding cybersecurity and privacy related areas. To satisfy this responsibility, the Audit Committee receives periodic updates from management regarding our cybersecurity program. The updates may include information on, among other things, actual events or incidents, results of vulnerability assessments and penetration testing, results of security incident and event management monitoring, updates to the cybersecurity strategy and program, new or modified security policy recommendations, and cybersecurity risk in general. On at least an annual basis, management presents to the Audit Committee on cybersecurity strategy and framework, roadmaps for continued program maturity, key risk areas and related actions, and any significant incidents that have occurred or are reasonably likely to occur. The entire Board is invited to attend this annual cybersecurity meeting of the Audit Committee. +Our Executive Leadership Team is responsible for managing enterprise risk, which is inclusive of cybersecurity. The Chief Information Officer (“CIO”), a member of the Executive Leadership Team, and the Chief Information Security Officer (“CISO”), who reports to the CIO, are responsible for assessing and managing cybersecurity risk, including the prevention, detection, mitigation, and remediation of cybersecurity incidents. The CIO has over 30 years of experience in Information Technology and Operations including executive-level experience within the consumer goods industry. The CISO possesses relevant expertise in cybersecurity, including 25 years in both IT and cybersecurity. +The cybersecurity team reports to the CISO and has responsibility to prevent, mitigate, detect, and remediate cybersecurity incidents through various processes. These processes include regular vulnerability assessments and penetration testing, security incident and event management, continuous monitoring, and threat intelligence gathering. Additionally, we employ several third parties with expertise in specific cybersecurity risk areas. These third parties report to the CISO, who actively engages with these third parties to monitor their activities and compliance with service level agreements. Through these activities and monitoring, both internally and externally, any events or incidents identified will be escalated to the Board in accordance with our formal Cybersecurity Incident Response Plan. +ITEM 2. Properties +Our principal executive and administrative offices are located at 500 Eldorado Blvd., Building 5, Broomfield, CO 80021. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for office, warehouse, and retail, including kiosk and store-in-store, space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations and expire at various dates through the year 2034. The general location, use, and approximate size of our principal properties, as well as the reportable operating segment that utilizes each property, are given below. +Location Reportable Operating Segment(s) Use Approximate Square Feet +Las Vegas, Nevada (1) +HEYDUDE Brand Distribution center 1,500,000 +Dayton, Ohio Crocs Brand Distribution center 1,322,000 +Dordrecht, the Netherlands Crocs Brand, HEYDUDE Brand Distribution center 517,000 +Broomfield, Colorado Crocs Brand, HEYDUDE Brand Regional office and Crocs Brand headquarters 190,000 +Oudenbosch, the Netherlands Crocs Brand Warehouse 75,000 +Hoofddorp, the Netherlands Crocs Brand, HEYDUDE Brand Regional office 47,000 +Westwood, Massachusetts Crocs Brand, HEYDUDE Brand Regional office and HEYDUDE Brand headquarters 46,000 +Singapore Crocs Brand Regional office 17,000 +(1) In 2022, we entered into a lease to transfer our existing warehouses to a new single distribution center also in Las Vegas, Nevada, with an approximate size of 1,050,000 square feet. During 2023, we gained access to the new location. We plan to complete the move of these warehouses in 2024. +We believe these properties, particularly our distribution centers and warehouses, along with various third-party distribution centers not included above, are adequate for our operations. Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operational needs. We also lease 363 retail locations +28 +Table of Contents +worldwide as of December 31, 2023. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +A discussion of legal matters is found in Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +ITEM 4. Mine Safety Disclosures +Not applicable. +29 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the Nasdaq Global Select Market under the stock symbol “CROX.” +Performance Graph +The following performance graph illustrates a five-year comparison from December 31, 2018 through December 31, 2023 of cumulative total return of our common stock, the Nasdaq Composite Total Return Index, and the Dow Jones U.S. Footwear Total Return Index. The graph assumes an investment of $100.00 on December 31, 2018 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Total Return Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Nasdaq Composite Total Return Index is a market capitalization-weighted index that includes reinvestment of all cash distributions of index members and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 42 as of February 8, 2024. +30 +Table of Contents +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements include restrictions on cash dividends paid on our common stock. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to, among other things, our results of operations, financial condition, level of indebtedness, capital requirements, and compliance with covenants under any then-existing financing agreements. +Purchases of Equity Securities by the Issuer +Period Total Number of Shares Purchased Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) +Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs (1) +October 1-31, 2023 +275,419 $ 86.37 275,419 $ 876,232,951 +November 1-30, 2023 +14,184 85.87 14,184 875,015,198 +December 1-31, 2023 +— — — 875,015,198 +Total 289,603 $ 86.34 289,603 $ 875,015,198 +(1) On April 23, 2021, the Board approved and authorized a program to repurchase up to $1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. As of December 31, 2023, approximately $875.0 million remained available for repurchase under our share repurchase authorization. The number, price, structure, and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. +ITEM 6. [Reserved] +31 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for women, men, and children. We strive to be the world leader in innovative casual footwear for women, men, and children, combining comfort and style with a value that consumers want. The vast majority of shoes within the Crocs Brand’s collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 80 countries, through two distribution channels: wholesale and direct-to-consumer. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our direct-to-consumer channel includes company-operated retail stores, company-operated e-commerce sites, and third-party marketplaces. +Known or Anticipated Trends +Based on our recent operating results and our assessment of the current operating environment, we anticipate certain trends will continue to impact our future operating results: +• We are operating in an environment where consumers are feeling the effects of elevated interest rates and inflation, and as a result, they are spending more cautiously. In addition, geopolitical tensions remain across the globe, among other things. We are focused on making the right decisions for the health of our brands, maintaining tight inventory control, and investing in strategic initiatives to support durable long-term growth. +• The Crocs Brand continues to deliver strong revenue growth after building clog, sandal, and brand relevance across the globe over the last several years. Our strong product and marketing efforts continue to deliver newness and excitement to current brand fans. Asia, which is a strategic initiative for the Crocs Brand, continues to show growth, particularly in China. +• We acquired HEYDUDE in February 2022. Since the closing of the Acquisition, we have acquired new customers, gained share in strategic wholesale accounts, and improved brand awareness. We have also started to expand the HEYDUDE Brand internationally, specifically in Europe, where we have begun testing in a few direct markets, including the United Kingdom, Germany, and the Netherlands, as well as a few distributor markets. In 2023, we experienced some headwinds from non-comparable sales due to rapid expansion to U.S. strategic customers in 2022 and more cautious order patterns from several of our wholesale partners in the current year based on the overall macro-economic outlook. Additionally, to prioritize long-term marketplace health, we made a conscious decision in the third quarter of 2023 to stop price matching against grey market sellers on Amazon. While this has had, and we expect it to have, a negative impact on revenues initially, we believe this move will protect the brand and better position us in the market for full year 2024. +• We ended the year in a strong liquidity position with $149.3 million in cash and cash equivalents and up to $570.4 million in available borrowing capacity as of December 31, 2023. In the year ended December 31, 2023, we paid down $665.8 million of net borrowings, reducing total borrowings to $1.66 billion as of December 31, 2023. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +32 +Table of Contents +2023 Financial and Operational Highlights +Revenues were $3,962.3 million for the year ended December 31, 2023, an 11.5% increase compared to the year ended December 31, 2022. The increase in 2023 revenues compared to 2022 revenues was due to the net effects of: (i) higher average selling prices, which increased revenues by $261.1 million, or 7.3%; (ii) higher sales volume, which increased revenues by $164.4 million, or 4.6%, partially due to operating HEYDUDE for a full year in 2023 compared to 2022; and (iii) unfavorable changes in exchange rates, which decreased revenues by $18.1 million, or 0.5%. +The following were significant developments affecting our businesses during the year ended December 31, 2023: +• We grew Crocs Brand revenues 13.3%, despite foreign currency headwinds, compared to the same period in 2022. +• We sold 119.6 million pairs of shoes worldwide for the Crocs Brand, an increase from 115.6 million pairs in 2022. We sold 33.0 million pairs of shoes for the HEYDUDE Brand. +• Gross margin was 55.8% compared to 52.3% in 2022, an increase of 350 basis points. Gross margin for the Crocs Brand was 60.0%, an increase of 370 basis points from last year, primarily as a result of higher air freight costs in the prior year to combat supply chain disruptions that did not recur in the current year, lower inbound freight costs as the supply chain normalized, and higher ASP (as defined below). Product mix partially offset these increases. Gross margin for the HEYDUDE Brand was 44.0%, an increase of 320 basis points compared to the Partial Period. The gross margin in the prior year was inclusive of an approximately 690 basis points unfavorable impact from a non-cash step-up of acquired HEYDUDE inventory to fair value that did not recur in the current year. +• Selling, general & administrative expenses (“SG&A”) was $1,163.9 million, an increase of $154.4 million, or 15.3%, compared to 2022, primarily as a result of investments in talent and marketing as we continue to grow the business. As a percent of revenues, SG&A increased 100 basis points to 29.4% of revenues. +• Income from operations was $1,036.8 million for the year ended December 31, 2023 compared to income from operations of $850.8 million for the year ended December 31, 2022. Our operating margin improved to 26.2%, compared to 23.9% in 2022. +• Net income was $792.6 million compared to $540.2 million in 2022. Diluted net income per common share was $12.79 for the year ended December 31, 2023, compared to a diluted net income per common share of $8.71 for the year ended December 31, 2022. These amounts include an income tax expense of $83.7 million and $178.3 million in 2023 and 2022, respectively, as described in more detail under Income tax expense below. +Results of Operations +Comparison of the Years Ended December 31, 2023 and 2022 +A discussion of our comparison between 2023 and 2022 is presented below. A discussion of the changes in our results of operations between the years ended December 31, 2022 and December 31, 2021 has been omitted from this Annual Report on Form 10-K but may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 16, 2023, which is available free of charge on the SEC’s website at www.sec.gov and our corporate website (www.crocs.com). +33 +Table of Contents +Year Ended December 31, $ Change % Change +Favorable (Unfavorable) +2023 2022 2023-2022 2023-2022 +(in thousands, except per share data, margin, and average selling price data) +Revenues $ 3,962,347 $ 3,554,985 $ 407,362 11.5 % +Cost of sales 1,752,337 1,694,703 (57,634) (3.4) % +Gross profit 2,210,010 1,860,282 349,728 18.8 % +Selling, general and administrative expenses +1,163,940 1,009,526 (154,414) (15.3) % +Asset impairments +9,287 — (9,287) (100.0) % +Income from operations +1,036,783 850,756 186,027 21.9 % +Foreign currency gains (losses), net +(1,240) 3,228 (4,468) (138.4) % +Interest income 2,406 1,020 1,386 135.9 % +Interest expense (161,351) (136,158) (25,193) (18.5) % +Other expense, net +(326) (338) 12 3.6 % +Income before income taxes +876,272 718,508 157,764 22.0 % +Income tax expense +83,706 178,349 94,643 53.1 % +Net income +$ 792,566 $ 540,159 $ 252,407 46.7 % +Net income per common share: +Basic $ 12.91 $ 8.82 $ 4.09 46.4 % +Diluted $ 12.79 $ 8.71 $ 4.08 46.8 % +Gross margin (1) +55.8 % 52.3 % 350 bp 6.7 % +Operating margin (1) +26.2 % 23.9 % 230 bp 9.6 % +Selling, general and administrative expenses as a percentage of revenues (1) +29.4 % 28.4 % (100) bp (3.5) % +Footwear unit sales: +Crocs Brand 119,577 115,558 4,019 3.5 % +HEYDUDE Brand (3) +32,969 30,519 2,450 8.0 % +Average footwear selling price - nominal basis (2) : +Crocs Brand $ 24.92 $ 22.72 $ 2.20 9.7 % +HEYDUDE Brand (3) +$ 28.80 $ 29.35 $ (0.55) (1.9) % +(1) Changes for gross margin, operating margin, and SG&A as a percentage of revenues are shown in basis points (“bp”). +(2) Average footwear selling price is calculated as footwear and charms revenues divided by footwear units. +(3) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period. +34 +Table of Contents +Revenues by Channel +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2023 2022 2023-2022 2023-2022 +(in thousands) +Crocs Brand: +Wholesale $ 1,493,537 $ 1,377,302 8.4 % 9.3 % +Direct-to-consumer 1,519,417 1,281,823 18.5 % 19.0 % +Total Crocs Brand 3,012,954 2,659,125 13.3 % 14.0 % +HEYDUDE Brand (2) : +Wholesale 566,937 574,140 (1.3) % (1.3) % +Direct-to-consumer 382,456 321,720 18.9 % 18.9 % +Total HEYDUDE Brand 949,393 895,860 6.0 % 6.0 % +Total consolidated revenues (2) +$ 3,962,347 $ 3,554,985 11.5 % 12.0 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period. +Revenues. In the year ended December 31, 2023, revenues increased $407.4 million, or 11.5%, compared to 2022. Higher average selling price on a constant currency basis (“ASP”) increased revenues by $261.1 million, or 7.3%, primarily due to higher ASP in the Crocs Brand, mostly due to favorable product mix, increased pricing, lower discounting, and channel mix, partially offset by lower ASP in the HEYDUDE Brand as a result of more discounting than the prior year. Higher volume of $164.4 million, or 4.6%, also increased revenues, despite the termination of our relationship with a significant distributor in our Crocs Brand segment in the second quarter of 2023 after finding evidence of product diversion to the gray market outside of the distributor’s approved territories. Net unfavorable foreign currency fluctuations, most significantly unfavorability in the Chinese Yuan, Argentine Peso, and Japanese Yen, decreased revenues by $18.1 million, or 0.5%. +Gross margin. Gross margin was 55.8% compared to 52.3% in 2022. Gross margin for the Crocs Brand was 60.0% compared to 56.3% in 2022. The increase was due in part to lower freight costs of 430 basis points, primarily as a result of higher air freight costs in the prior year to combat supply chain disruptions, and higher ASP of 90 basis points, as described above. These increases were partially offset by unfavorable product mix of 120 basis points. Gross margin for the HEYDUDE Brand was 44.0% compared to 40.8% in the Partial Period. The gross margin for the Partial Period included a 690 basis points unfavorable impact from a non-cash step-up of acquired HEYDUDE inventory to fair value that did not recur in the current year. The gross margin during the year ended December 31, 2023 represents a 370 basis point impact due to higher distribution costs and a 230 basis point impact due to lower ASP, as described above. Gross margin for 2023 also reflects a 150 basis point impact due to favorable purchasing power, which is defined as purchasing foreign goods in the U.S. Dollar but recognizing the cost in foreign currencies. +In the years ended December 31, 2023 and 2022, cost of sales included $515.3 million and $457.0 million, respectively, of distribution expenses primarily related to receiving, inspecting, warehousing, and packaging product in owned and third-party warehouses, combined with transportation costs associated with delivering products from distribution centers to wholesale partners, retail stores, and end customers. +Selling, general and administrative expenses. SG&A as a percent of revenue increased to 29.4% during the year ended December 31, 2023 compared to 2022, as SG&A expenses increased $154.4 million, or 15.3%. This increase was partly driven by operating HEYDUDE for a full year in 2023 compared to the Partial Period in 2022. There were also higher compensation costs of $65.0 million, primarily associated with an investment in talent, and higher marketing costs of $56.6 million. Additionally, there was an increase in certain variable costs associated with higher revenues of $20.9 million, an increase in facilities costs of $14.2 million, and an increase in information technology costs of $11.0 million. The overall increase in SG&A expenses was partially offset by net decreases in other costs, due in part to prior year costs associated with the shutdown of our direct operations in Russia that did not recur in the current year, of $13.3 million. +35 +Table of Contents +Asset impairment charges. During the year ended December 31, 2023, we incurred $9.3 million in impairment charges to the right-of-use asset and leasehold improvement assets for our former headquarters. During the year ended December 31, 2022, we incurred no impairment charges. +Foreign currency gains (losses), net. Foreign currency gains (losses), net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on certain foreign currency derivative instruments. During the year ended December 31, 2023, we recognized realized and unrealized net foreign currency losses of $1.2 million compared to net gains of $3.2 million during the year ended December 31, 2022. +Interest expense. Interest expense during the year ended December 31, 2023 increased $25.2 million, or 18.5%, primarily due to having borrowings on the Term Loan B Facility for a full year in 2023, as well as higher weighted average interest rates on both the Term Loan B Facility and the Revolving Facility. +Income tax expense . During the year ended December 31, 2023, we recognized an income tax expense of $83.7 million on pre-tax book income of $876.3 million, representing an effective tax rate of 9.6%, compared to an income tax expense of $178.3 million on pre-tax book income of $718.5 million in 2022, which represented an effective tax rate of 24.8% . Th e current year effective tax rate is lower primarily due to the current year foreign net income tax benefit as a result of intra-entity transfers of certain intellectual property rights and the current year release of valuation allowances. Our effective tax rate has varied dramatically in recent years due to the intra-entity intellectual property rights transfer, differences in our profitability levels and relative operating earnings across multiple jurisdictions, and by changes in the valuation allowance. +During the three months ended December 31, 2023, we completed intra-entity transfers of certain intellectual property rights primarily to align with current and future international operations. Each transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. Foreign deferred tax assets increased by $611.4 million, inclusive of the reversal of certain deferred tax liabilities. This benefit was offset by an increase in uncertain tax positions of $318.6 million, and an incremental valuation allowance of $164.0 million for amounts not more-likely-than-not to be realized based on available objective evidence. As such, a net change in deferred tax asset of $128.9 million was recognized along with a corresponding foreign income tax benefit. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance as of December 31, 2023, we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. Separate from the intra-entity transfers of intellectual property rights the company released immaterial valuation allowances in various jurisdictions. Valuation allowances recorded against deferred tax assets increased by a net $155.4 million. +The 2023 impact of changes in valuation allowances to the effective tax rate was an unfavorable impact of $156.3 million, equating to a 17.8% unfavorable impact. There is also a $0.9 million favorable change in the valuation allowance related to cumulative translation adjustments. We maintain valuation allowances of approximately $183.5 million as of December 31, 2023, which may be reduced in the future depending upon the achieved profitability of certain jurisdictions as well as the magnitude of the profitability. +36 +Table of Contents +Reportable Operating Segments +The following table sets forth information related to our reportable operating segments for the years ended December 31, 2023 and 2022. +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2023 2022 2023-2022 2023-2022 +(in thousands) +Revenues: +Crocs Brand revenues (2) +$ 3,012,954 $ 2,659,125 13.3 % 14.0 % +HEYDUDE Brand revenues (3) +949,393 895,860 6.0 % 6.0 % +Total consolidated revenues $ 3,962,347 $ 3,554,985 11.5 % 12.0 % +Income from operations: +Crocs Brand income from operations (2) +$ 1,079,330 $ 852,025 26.7 % 25.7 % +HEYDUDE Brand income from operations (3) +212,386 211,361 0.5 % 0.5 % +Enterprise corporate (3) +(254,933) (212,630) (19.9) % (19.9) % +Total consolidated income from operations +1,036,783 850,756 21.9 % 20.9 % +Foreign currency gains (losses), net (1,240) 3,228 (138.4) % +Interest income 2,406 1,020 135.9 % +Interest expense (161,351) (136,158) (18.5) % +Other income (expense), net (326) (338) 3.6 % +Income before income taxes +$ 876,272 $ 718,508 22.0 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) Our business has continued to evolve in the period following the consummation of the Acquisition, as we have grown the brand and staffed and developed our leadership team at HEYDUDE. In the fourth quarter of 2023, to reflect changes in the way management evaluates performance, makes operating decisions, and allocates resources, we updated our reportable operating segments to be (i) Crocs Brand and (ii) HEYDUDE Brand. Each of the reportable operating segments derives its revenues from the sale of footwear, apparel, and accessories to external customers. Each segment’s performance is evaluated based on segment results without allocating Enterprise corporate expenses, which include global corporate costs associated with both brands such as legal, information technology, human resources, and finance. Segment profit and losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income from operations consist of unallocated Enterprise corporate and other expenses, as well as inter-segment eliminations. Our ‘North America,’ ‘Asia Pacific,’ and ‘EMEALA’ segments as well as revenues and expenses related to Crocs ‘Brand corporate’ have been consolidated to the ‘Crocs Brand.’ As a result of these changes, the previously reported amounts for revenues and income from operations for the year ended December 31, 2022 have been recast to conform to current period presentation. +(3) We acquired HEYDUDE on February 17, 2022 and added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period. +Crocs Brand +Revenues. The Crocs Brand segment grew revenues for the year ended December 31, 2023 compared to 2022, primarily as a result of higher ASPs, mostly due to product mix, increased pricing, and lower discounting. Higher volume, despite the termination of our relationship with a significant distributor in the second quarter of 2023 after finding evidence of product diversion to the gray market outside of the distributor’s approved territories, also contributed to the increase in revenues. The overall increase in revenues was partially offset by net unfavorable currency fluctuations driven by the Chinese Yuan, Argentine Peso, and Japanese Yen. +Income from Operations. During the year ended December 31, 2023, income from operations for our Crocs Brand segment was $1,079.3 million, an increase of $227.3 million, or 26.7% from 2022. Gross margin was 60.0% for the year ended December 31, 2023, an increase of 370 basis points compared to 2022. The increase in gross margin was partially due to lower freight costs, primarily as a result of higher air freight costs in the prior year to combat supply chain disruptions, and higher ASP, as discussed above. Product mix partially offset the overall increase to gross margin. +37 +Table of Contents +During the year ended December 31, 2023, SG&A for our Crocs Brand segment increased by $82.2 million, or 12.7%, compared to 2022. This was mainly driven by an increase in marketing costs and certain variable costs associated with higher revenues. The overall increase in SG&A was partially offset by prior year costs associated with the shutdown of our direct operations in Russia that did not recur in the current year. +HEYDUDE Brand +Revenues. During the year ended December 31, 2023, HEYDUDE revenues increased compared to the Partial Period in 2022, primarily due to higher volume, driven in part by operating HEYDUDE for a full year in 2023 compared to 2022. Lower ASPs, driven by increased discounting, and unfavorable channel mix partially offset the overall increase in revenues. +Income from Operations. Income from operations during the year ended December 31, 2023 was $212.4 million, an increase of $1.0 million, or 0.5%, compared to the Partial Period in 2022. Gross margin was 44.0% for the year ended December 31, 2023, an increase of 320 basis points. The increase in gross margin is largely due to a prior year unfavorable impact from a non-cash step-up of acquired HEYDUDE inventory to fair value, which did not recur in the current year. Gross margin for the year current year includes the unfavorable impact of increased distribution costs as well as lower ASP. These impacts were partially offset by favorable purchasing power. +During the year ended December 31, 2023, SG&A for the HEYDUDE Brand segment increased by $51.2 million, or 33.1%, partially due to operating HEYDUDE for a full year in 2023 compared to 2022. The increase is also due to an investment in marketing and talent as well as higher facilities costs, due in part to the opening of additional retail stores during year. +Enterprise Corporate +During the year ended December 31, 2023, total net costs within ‘Enterprise corporate’ increased $42.3 million, or 19.9%, compared to the same period in 2022. This was primarily due to increases in compensation costs, professional services, information technology costs, and a $9.3 million impairment of the right-of-use asset and leasehold improvement assets for our former corporate headquarters. These increases were offset in part by lower costs in 2023 associated with the prior year HEYDUDE acquisition and integration. +Store Locations and Digital Sales Percentage +The table below illustrates the overall change in the number of our company-operated retail locations by reportable operating segment: +December 31, 2022 Opened Closed December 31, 2023 +Company-operated retail locations: +Crocs Brand 340 20 11 349 +HEYDUDE Brand 5 9 — 14 +Total 345 29 11 363 +38 +Table of Contents +Digital sales, which includes sales through our company-owned website, third-party marketplaces, and e-tailers (which are reported in our wholesale channel), as a percent of total revenues, by reportable operating segment were: +Year Ended December 31, +2023 2022 +Digital sales as a percent of total revenues: +Crocs Brand 36.6 % 37.6 % +HEYDUDE Brand (1) +41.8 % 38.5 % +Total 37.9 % 37.8 % +(1) We acquired HEYDUDE on February 17, 2022. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period. +Direct-to-consumer (“DTC”) comparable sales are as follows: +Constant Currency (1) +Year Ended December 31, +2023 2022 +Direct-to-consumer comparable sales: (2) +Crocs Brand 15.5 % 15.0 % +HEYDUDE Brand (3) +3.6 % N/A +(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. See the “Use of Non-GAAP Financial Measures” section for additional information. +(2) Comparable store status, as included in the DTC comparable sales figures above, is determined on a monthly basis. Comparable store sales include the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure and in the same month in the following year. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce comparable revenues are based on same site sales period over period. +(3) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new operating segment. As such, in the year ended December 31, 2022, we did not disclose DTC comparable sales for the HEYDUDE Brand. +Liquidity and Capital Resources +Our liquidity position as of December 31, 2023 was: +December 31, 2023 +(in thousands) +Cash and cash equivalents $ 149,288 +Available borrowings 570,362 +As of December 31, 2023, we had $149.3 million in cash and cash equivalents and up to $570.4 million of available borrowings, including $558.7 million remaining borrowing availability under the Revolving Facility (as defined below) and $11.7 million of remaining borrowing availability under the Asia revolving facilities. As of December 31, 2023, the Term Loan B Facility (as in effect prior to the February 2024 Amendment) (as defined below) was fully drawn, and there was no available borrowing capacity. We believe that our cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Revolving Facility and other financing agreements will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. +Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets could each impact our business and liquidity. +39 +Table of Contents +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +All of the cash held outside of the U.S. could be repatriated to the U.S. as of December 31, 2023 without incurring additional U.S. federal income taxes. In some countries, repatriation of certain foreign balances is restricted by local laws. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2023, we held $90.7 million of our total $149.3 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $90.7 million, $2.9 million could potentially be restricted by local laws. +Senior Revolving Credit Facility +In July 2019, the Company and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. Since that time, we have amended the Credit Agreement, which, as amended to date, provides for a revolving credit facility of $750.0 million, which can be increased by an additional $250.0 million subject to certain conditions (the “Revolving Facility”). Borrowings under the Credit Agreement bear interest at a variable interest rate based on (A) a Base Rate (defined as the highest of (i) the Overnight Bank Funding Rate (as defined in the Credit Agreement), plus 0.25%, (ii) the Prime Rate (as defined in the Credit Agreement), and (iii) the Daily Simple SOFR (as defined in the Credit Agreement), plus 1.00%), plus an applicable margin ranging from 0.25% to 0.875% based on our leverage ratio or 1.35% to 1.975% for the Daily Simple SOFR based on the leverage ratio, or (B) the Term SOFR Rate (as defined in the Credit Agreement), plus an applicable margin ranging from 1.35% to 1.975% based on our leverage ratio for one-month interest periods and 1.40% to 2.025% based on our leverage ratio for three-month interest periods. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement requires us to maintain a minimum interest coverage ratio of 3.00 to 1.00 and a maximum leverage ratio of (i) 4.00 to 1.00 from the quarter ended March 31, 2022 through, and including, the quarter ended December 31, 2023, (ii) 3.75 to 1.00 for the quarter ending March 31, 2024, (iii) 3.50 to 1.00 for the quarter ending June 30, 2024, and (iv) 3.25 to 1.00 for the quarter ending September 30, 2024 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits, among other things, (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $40.0 million. As of December 31, 2023, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2023, the total commitments available from the lenders under the Revolving Facility were $750.0 million. At December 31, 2023, we had $190.0 million outstanding borrowings and $1.3 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2023 and 2022, we had $558.7 million and $748.7 million, respectively, of available borrowing capacity under the Revolving Facility, which matures November 2027. +Term Loan B Facility +On February 17, 2022, the Company entered into a credit agreement (the “Original Term Loan B Credit Agreement”) with Citibank, N.A., as administrative agent and lender, to among other things, finance a portion of the cash consideration for the Acquisition, which was amended on August 8, 2023 (the “August 2023 Amendment”) and on February 13, 2024 (the “February 2024 Amendment”). The Original Term Loan B Credit Agreement, as amended by the August 2023 Amendment and the February 2024 Amendment is referred to herein as the “Term Loan B Credit Agreement.” +The Original Term Loan B Credit Agreement provided for an aggregate term loan B facility in the principal amount of $2.0 billion. Prior to the February 2024 Amendment, the outstanding principal balance was $820.0 million. Among other things, the February 2024 Amendment provided for a new $820 million tranche of term loans (the “2024 Refinancing Term Loans” and, such facility, the “Term Loan B Facility”) to refinance the then-outstanding principal balance. The 2024 Refinancing Term Loans are secured by substantially all of the Company’s and each subsidiary guarantor’s assets on a pari passu basis with their obligations arising from the Term Loan B Credit Agreement and is scheduled to mature on February 17, +40 +Table of Contents +2029, subject to certain exceptions set forth in the Term Loan B Credit Agreement. Additionally, subject to certain conditions, including, without limitation, satisfying certain leverage ratios, the Company may, at any time, on one or more occasions, add one or more new classes of term facilities and/or increase the principal amount of the loans of any existing class by requesting one or more incremental term facilities. +Pursuant to the reduced interest rate margins applicable to the 2024 Refinancing Term Loans, each term loan borrowing which is an alternate base rate borrowing bears interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 1.25%. Each term loan borrowing which is a term SOFR borrowing bears interest at a rate per annum equal to the Adjusted Term SOFR Rate (as defined in the Term Loan B Credit Agreement) plus 2.25%. +Outstanding principal under the Term Loan B Facility is payable on the last business day of each March, June, September, and December, in a quarterly aggregate principal amount of $5.0 million. Quarterly aggregate principal payments began on June 30, 2022, with the remaining principal amount due on February 17, 2029, the maturity date. As of December 31, 2023, we had $820.0 million in outstanding principal and the Term Loan B Facility (as in effect prior to the February 2024 Amendment) was fully drawn with no remaining borrowing capacity. +The Term Loan B Credit Agreement also contains customary affirmative and negative covenants, incurrence financial covenants, representations and warranties, events of default and other provisions. As of December 31, 2023, we were in compliance with all financial covenants under the Term Loan B Credit Agreement. +Asia Revolving Credit Facilities +During the year ended December 31, 2023, we had two revolving credit facilities in Asia, the revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”), which matured in January 2023 and provided up to 10.0 million RMB, or $1.5 million at current exchange rates as of January 2023, and the revolving credit facility with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”), which provides up to an equivalent of $15.0 million. For RMB loans under the CMBC Facility, interest was based on a National Interbank Funding Center 1-year prime rate, plus 65 basis points. For USD loans under the Citibank Facility, interest is mutually agreed upon prior to utilization of a loan. +As of December 31, 2023, we had borrowings outstanding of $3.3 million on the Citibank Facility, which became due in January 2024. As of December 31, 2022, we had no outstanding borrowings on the CMBC Facility, and we had borrowings outstanding of $4.3 million on the Citibank Facility. +Senior Notes Issuances +In March 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.250% Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, the “2029 Notes Indenture”). Additionally, in August 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.125% Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, “the 2031 Notes Indenture” and, together with the 2029 Notes Indenture, the “Indentures” and, each, an “Indenture”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +The Company will have the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company may redeem up to 40% of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company may redeem up to 40% of the aggregate +41 +Table of Contents +principal amount of the 2031 Notes at a redemption price of 104.125% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; pay dividends or repurchase or redeem capital stock or make other restricted payments; declare or pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2023, we were in compliance with all financial covenants under the Notes. +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, $ Change % Change +2023 2022 Favorable (Unfavorable) +(in thousands) +Cash provided by operating activities +$ 930,444 $ 603,142 $ 327,302 54.3 % +Cash used in investing activities +(115,671) (2,151,091) 2,035,420 94.6 % +Cash provided by (used in) financing activities +(859,639) 1,529,659 (2,389,298) (156.2) % +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +3,078 (3,750) 6,828 182.1 % +Net change in cash, cash equivalents, and restricted cash $ (41,788) $ (22,040) $ (19,748) (89.6) % +Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted for non-cash items and changes in working capital. Cash provided by operating activities increased $327.3 million for the year ended December 31, 2023 compared to the year ended December 31, 2022. This change was driven by a net increase in operating assets and liabilities of $458.2 million, primarily due to income taxes and inventories, partially offset by the impact of higher net income adjusted for non-cash items of $130.9 million. +Investing Activities. There was a $2,035.4 million decrease in cash used in investing activities for the year ended December 31, 2023 compared to the year ended December 31, 2022. The decrease is primarily due to $2.05 billion paid in cash consideration for the Acquisition, net of cash acquired in the year ended December 31, 2022, that did not recur in the current year. Refer to Note 3 — Acquisition of HEYDUDE in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Additionally, there was an $11.4 million increase in the purchases of property and equipment related, primarily to the expansion of our distribution centers in North America. +Financing Activities. Cash provided by financing activities decreased by $2,389.3 million in the year ended December 31, 2023 compared to the year ended December 31, 2022. The decrease was primarily due to a decrease of $1,912.0 million in proceeds from borrowings, which includes borrowings under the Term Loan B Facility of $2.0 billion used to finance the Acquisition in part during the year ended December 31, 2022 that did not recur in the current year. Additionally, there was an increase in cash used by financing activities of $175.0 million in repurchases of common stock and $5.6 million in repurchases of common stock for tax withholding. There was also a $348.4 million increase in repayments of borrowings and a $0.2 million increase in other cash used in financing activities. The overall decrease was partially offset by a $51.9 million decrease in deferred debt issuance costs. +42 +Table of Contents +Stock Repurchases +On April 23, 2021, the Board approved and authorized a program to repurchase up to $1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +During the year ended December 31, 2023, we repurchased 1.7 million shares of our common stock at a cost of $175.0 million, including commissions. During the year ended December 31, 2022, we did not repurchase any shares of our common stock. +As of December 31, 2023, we had remaining authorization to repurchase approximately $875.0 million of our common stock, subject to restrictions under our Indentures, Credit Agreement, and Term Loan B Credit Agreement. +See Note 11 — Equity in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information on our repurchases and repurchase authorizations. +Contractual Obligations +We believe we have sufficient liquidity to fund our operations and meet our short-term and long-term obligations. Our material future cash obligations as of December 31, 2023 include the following: +Less than 1 Year Thereafter Total +(approximately, in thousands) +Debt-related: +Debt obligations (1) +$ 23,300 $ 1,641,000 $ 1,664,300 +Interest on debt obligations (2) +96,900 375,300 472,200 +Purchase commitments (3) +344,300 — 344,300 +Lease-related (4) : +Lease obligations +71,500 334,400 405,900 +Total $ 536,000 $ 2,350,700 $ 2,886,700 +(1) Net of $49.0 million of unamortized issuance costs. +(2) Represents future interest payment obligations, which are estimated by assuming the amounts outstanding under our Term Loan B Facility (as in effect prior to the February 2024 Amendment), Notes, Revolving Facility, and Citibank Facility and the interest rates in effect as of December 31, 2023, will remain constant into the future. This is only an estimate, as actual amounts borrowed and rates may vary over time for certain borrowing instruments, as described in Note 10 — Borrowings. +(3) Represents purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products. We expect to fulfill our commitments under these agreements in the next twelve months in the normal course of business and are only liable for the portion of the purchase obligations that have been purchased by the third-party manufacturer or manufactured by the vendor, with the remainder cancellable without penalty. Refer to Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +(4) Our operating lease obligations consist of leases for real estate, which includes retail, warehouse, distribution center, and office spaces and represent the minimum cash commitment under contract to various third parties for operating lease obligations. For more information on our lease obligations and obligations for leases not yet commenced, refer to Note 7 — Leases in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +We had no material off-balance sheet arrangements as of December 31, 2023, other than certain purchase commitments, as described in the footnote (2) above. +43 +Table of Contents +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency, is based on the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Impairment of Goodwill and Indefinite-Lived Intangible Assets +Our goodwill and indefinite-lived intangible assets, which primarily consist of the HEYDUDE trademark, are not amortized. We evaluate the carrying value of our goodwill and indefinite-lived intangible assets at least annually or when an interim triggering event has occurred indicating potential impairment. Our annual test is performed as of the first day of our fiscal fourth quarter. Our impairment evaluations represent a critical accounting policy as they require significant judgments and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. +We perform our goodwill impairment testing for each reporting unit that has goodwill. During the years ended December 31, 2023 and 2022, we had two reporting units, comprised of a reporting unit within the HEYDUDE Brand segment and a reporting unit within the Crocs Brand segment. During the year ended December 31, 2021, we had one reporting unit in our Crocs Brand segment. We perform our indefinite-lived intangible impairment testing at the asset level. +When performing our annual test for impairment, we may assess goodwill and indefinite-lived intangible assets for potential impairment using either a qualitative or quantitative assessment. The qualitative assessment may evaluate factors such as macroeconomic conditions, industry and market considerations, and overall financial performance, among other factors. If we determine that it is more likely than not that the fair value of a reporting unit or an indefinite-lived intangible asset is less than its carrying value, a quantitative assessment is performed. For the quantitative assessment, we compare the estimated fair value of a reporting unit with its carrying value, including the goodwill assigned to the reporting unit. If carrying value of the reporting unit exceeds its estimated fair value, an impairment charge is recorded. +For the year ended December 31, 2023, we performed a qualitative and quantitative assessment for the HEYDUDE Brand reporting unit goodwill, and we performed a quantitative assessment for the HEYDUDE Brand indefinite-lived intangible asset. Both quantitative assessments were performed with the assistance of third-party valuation specialists. We performed the quantitative assessment for the HEYDUDE Brand reporting unit goodwill using the discounted cash flow method and the guideline public company method. For the impairment testing of the indefinite-lived trademark, we used the Multi-Period Excess Earnings approach. The primary assumptions developed by management and used in the quantitative assessments of the HEYDUDE Brand reporting unit and indefinite-lived trademark included future revenue growth rates and market-based discount rates. The estimated fair values of the HEYDUDE Brand reporting unit goodwill and indefinite-lived trademark exceeded their carrying values. +For the year ended December 31, 2022, we performed a quantitative assessment for the HEYDUDE Brand reporting unit goodwill and the HEYDUDE Brand indefinite-lived intangible assets, each of which indicated the estimated fair values exceeded their carrying values. +Changes in the assumptions used to estimate the fair value of our goodwill and indefinite-lived intangible assets could result in impairment charges in future periods as the key assumptions are inherently uncertain, require significant judgment and are subject to change based on, among others, industry and geopolitical conditions, our ability to navigate changing macroeconomic conditions and trends as well as the timing and success of strategic initiatives. Certain factors, such as failure to +44 +Table of Contents +achieve forecasted revenue growth rates or increases in the discount rates, have the potential to create variances in the estimated fair values of our goodwill and indefinite-lived intangible assets that could result in impairment charges. +Additionally, for the years ended December 31, 2023, 2022, and 2021, we performed a qualitative assessment for the goodwill in our Crocs Brand segment, which indicated that it was more likely than not that the estimated fair value exceeded its carrying value. +We did not record any impairment charges in the years ended December 31, 2023, 2022, or 2021 based on the results of our goodwill and indefinite-lived intangible assets impairment testing. Refer to Note 1 — Basis of Presentation and Summary of Significant Accounting Policies and Note 5 — Goodwill and Intangible Assets, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to our goodwill and indefinite-lived intangible assets. +Impairment of Long-Lived Assets +Property and equipment, right-of-use assets, and definite-lived intangible assets, such as customer relationships and capitalized software, are evaluated for impairment whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. This represents a critical accounting policy as our impairment evaluations include significant judgments and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. Testing of long-lived assets for impairment is at the level of an asset group, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. For customer relationships, impairment testing is performed at the customer group level. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +In 2023, we recorded non-cash impairments of $9.3 million related to our former corporate headquarters. In 2022 and 2021, we did not record impairments to reduce the net carrying value of certain long-lived assets. See Note 8 — Fair Value Measurements in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +Revenues and Reserves for Sales Returns and Allowances +While our revenue recognition does not involve significant judgment, it does represent a key accounting policy as it is important to our results of operations. Revenues are recognized in the amount expected to be received in exchange for when control of the products transfers to customers. Revenues are reported net of various promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. An area of judgment affecting our reported revenues and net income involves estimating reserves for sales returns and allowances, which represent a portion of revenues not expected to be realized. Revenues in our direct-to-consumer channels are reduced by an estimate of returns. We may also accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Wholesale revenues are reduced by estimates of returns and allowances. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns and allowances may be caused by many factors, including, but not limited to whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances, discounts, and rebates have not differed significantly from our estimates. A +45 +Table of Contents +hypothetical 1% increase in our reserves for returns and allowances as of December 31, 2023 would have had an insignificant impact on our 2023 revenues. +See Schedule II in Part IV - Item 15. Exhibits, Financial Statement Schedule to the accompanying consolidated financial statements of this Annual Report on Form 10-K for an analysis of the activity in our reserves for uncollectible accounts receivable, sales returns, allowances, and discounts. +Income Taxes +Intellectual Property Income Tax Implications +During 2023, we completed intra-entity transfers of certain intellectual property (“IP”) rights primarily to align with current and future international operations. These transactions were executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of these transactions. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from our actual results. Foreign deferred tax assets increased by $611.4 million, inclusive of the reversal of certain deferred tax liabilities. This benefit was offset by an increase in uncertain tax positions of $318.6 million, and an incremental valuation allowance of $164.0 million for amounts not more-likely-than-not to be realized based on available objective evidence. As such, a net change in deferred tax asset of $128.9 million was recognized along with a corresponding foreign income tax benefit. +In 2020 and i n 2021, we also completed transactions that created an amortizable step-up in tax basis of the intangible asset and a corresponding increase in foreign deferred tax assets based on the fair value of that IP. These transactions were also executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of these transactions. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from our actual results. As of December 31, 2021, the related net deferred tax asset was $490.2 million, net of a reserve for uncertain tax positions of $206.0 million. As of December 31, 2022, the related net deferred tax asset was $438.5 million, net of a reserve for uncertain tax positions of $194.4 million. As of December 31, 2023, the related net deferred tax asset was $427.1 million, net of a reserve for uncertain tax positions of $200.5 million. +In order to support and sustain the amortizable tax basis for these transactions (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands and Singapore. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands and Singapore subsidiaries serve as the primary corporate headquarters outside of the U.S. and already perform significant functions in support of the economic ownership of the IP. In 2023, we undertook many additional activities to align business operations that support the economic substance of the IP. +We have also recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +46 +Table of Contents +Income Tax Accounting +We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of GILTI as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense (benefit)’ line in the accompanying consolidated statements of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-U.S. subsidiaries as of December 31, 2023, which are considered to be indefinitely reinvested outside of the U.S. +See Note 14 — Income Taxes in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +47 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Revolving Facility and certain financial instruments. +As of December 31, 2023, we had borrowings with a face value of $1,713.3 million, comprised of the Notes, which carry a fixed interest rate, the Term Loan B Facility (as in effect prior to the February 2024 Amendment), the Revolving Facility, and borrowings under our Asia revolving facility. We also had $1.3 million in outstanding letters of credit under our Revolving Facility as of December 31, 2023. As of December 31, 2022, we had long-term borrowings with a face value of $2,379.3 million and $1.3 million in outstanding letters of credit under our Revolving Facility. +A hypothetical increase of 1% in the interest rate on the variable rate borrowings under our Term Loan B Facility (as in effect prior to the February 2024 Amendment) and Revolving Facility would increase our interest expense over the next twelve months by $10.1 million based on the balances outstanding for these borrowings as of December 31, 2023. +Foreign Currency Exchange Risk +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of operations of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates in effect at the time such exchange rates are used to translate the operating results of our international subsidiaries. +An increase of 1% of the value of the USD relative to foreign currencies would have decreased our revenues and income before taxes during the year ended December 31, 2023 by approximately $13.8 million and $2.1 million, respectively. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. +In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we enter into forward contracts to buy and sell foreign currency. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur or in the period in which the hedged transaction affects earnings for derivatives classified as non-hedged or hedged, respectively, as defined in Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on this Form 10-K. As of December 31, 2023, the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $185.0 million. The fair value of these contracts at December 31, 2023 was an asset of $1.4 million and an insignificant liability. See Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for a discussion of risks to our business and financial results associated with foreign currencies. +We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the USD. As of December 31, 2023, a 10% appreciation in the value of the USD would result in a net decrease in the fair value of our derivative portfolio of approximately $1.5 million. +See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statements of operations for the years ended December 31, 2023 and 2022. +48 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of December 31, 2023. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2023, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2023, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2023. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2023, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +Internal controls over the HEYDUDE financial processes have been implemented and are included in Management’s Evaluation of Disclosure Controls and Procedures for the year ended December 31, 2023. This process resulted in additions and changes to our internal control over financial reporting. Except as described herein, there have been no other changes in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2023, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +49 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2023, of the Company and our report dated February 15, 2024, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 15, 2024 +50 +Table of Contents +ITEM 9B. Other Information +(a) On February 13, 2024, the Company, the subsidiary guarantors party thereto and Citibank, N.A., as administrative agent (the “Administrative Agent”), entered into a Refinancing Amendment (the “February 2024 Amendment”) to the Term Loan B Credit Agreement, dated February 17, 2022, among Crocs, Inc., the lenders from time to time party thereto and the Administrative Agent (as amended, restated, supplemented, waived or otherwise modified from time to time prior to the date hereof, the “Existing Term Loan B Credit Agreement,” and the Existing Term Loan B Credit Agreement, as amended by the February 2024 Amendment, the “Term Loan B Credit Agreement”). +Among other things, the February 2024 Amendment (i) provides for a new $820.0 million tranche of term loans maturing in 2029 (the “2024 Refinancing Term Loans”) and (ii) reduces the interest rate margins applicable to the approximately $820.0 million outstanding under the term loan B facility such that each term loan borrowing which is (1) an alternate base rate borrowing will bear interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 1.25%, and (2) a term SOFR borrowing will bear interest at a rate per annum equal to (a) the Adjusted Term SOFR Rate (as defined in the Term Loan B Credit Agreement), plus (b) 2.25%. The 2024 Refinancing Term Loans replaced and refinanced all outstanding term loans under the Existing Term Loan B Credit Agreement. +The foregoing summary of the February 2024 Amendment does not purport to be complete and is subject to and is qualified in its entirety by the terms of the February 2024 Amendment, which is attached to this Annual Report on Form 10-K as Exhibit 10.12 , and incorporated herein by reference. +(b) In the three months ended December 31, 2023, no directors or officers adopted or terminated a “Rule 10b5-1 trading arrangement” or a “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K. +ITEM 9C. Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +None. +51 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2024 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2023. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our code of ethics is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, that code for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our code of ethics as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2024 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2023. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2024 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2023, with the exception of those items listed below. +Equity Compensation Plan Information +As shown in the table below, we reserved 0.8 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2023. +Plan Category +Number of Securities to be Issued on Exercise of Outstanding +Options, Warrants, and Rights (1) +Weighted Average Exercise Price of Outstanding +Options, Warrants, and Rights (2) +Number of Securities Remaining Available for Future Issuance Under Plans, Excluding Securities Available in First Column +Equity compensation plans approved by stockholders (3) +839,840 $ 7.44 3,561,134 +Equity compensation plans not approved by stockholders +— — — +Total 839,840 $ 7.44 3,561,134 +(1) The number of shares outstanding includes restricted stock awards and restricted stock units that were outstanding on December 31, 2023 and assumes target performance for performance-based equity awards. +(2) The weighted average exercise price of outstanding options pertains to 0.2 million shares issuable on the exercise of outstanding options. +(3) On June 10, 2020, our stockholders approved the Crocs, Inc. 2020 Equity Incentive Plan (the “Plan”). The number of shares of our common stock available for issuance under the Plan consisted of (i) 3.8 million newly available shares, (ii) 1.4 million shares of our common stock available for issuance under the 2015 Equity Incentive Plan (the “2015 Plan”) as of June 10, 2020, and (iii) 2015 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 10, 2020. The number of shares authorized for issuance under the Plan is subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. The Plan became effective immediately upon stockholder approval. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2024 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2023. +52 +Table of Contents +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2024 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2023. +53 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedule +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedule +The following consolidated financial statement schedule of Crocs, Inc. and its subsidiaries is filed as a part of this report: +• Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +54 +Table of Contents +(3) Exhibit list +Exhibit +Number Description +2.1 # +Securities Purchase Agreement, dated as of December 22, 2021, by and among: (i) Crocs, Inc.; (ii) Full Fortune Wealth Limited; (iii) Mr. Daniele Guidi; (iv) Full Fortune Intellectual Limited; (v) Full Fortune Worldwide Limited; (vi) Full Fortune Online Limited; (vii) Happy One LLC; (viii) Lucky Top Inc.; (ix) Mr. Alessandro Rosano; and (x) Full Fortune Wealth Limited, in its capacity as representative and agent for Sellers (incorporated herein by reference to Exhibit 2.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 23, 2021). +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +4.2 +Description of Registrant's Securities (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Annual Report on Form 10-K filed on February 27, 2020). +4.3 +Indenture (including Form of Global 4.250% Senior Notes due 2029), dated March 12, 2021, by and among Crocs, Inc., the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 12, 2021). +4.4 +Indenture (including Form of Global 4.125% Senior Notes due 2031), dated August 10, 2021, by and among Crocs, Inc. the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on August 10, 2021). +4.5 +First Supplemental Indenture, dated February 17, 2022, by and among Crocs, Inc., Hey Dude LLC, Happy One LLC and Lucky Top Inc. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +4.6 +First Supplemental Indenture, dated February 17, 2022, by and among Crocs, Inc., Hey Dude LLC, Happy One LLC and Lucky Top Inc. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +4.7 +Second Supplemental Indenture, dated January 19, 2023, by and among Crocs, Inc., Crocs UK Holdings Limited, Crocs UK Fin Co Limited, Crocs Finance UK Limited, Crocs SG Fin Co. Pte. Ltd. and Crocs Malta Global Ltd. and U.S. Bank Trust Company, National Association, as trustee (inc orporated herein by ref erence to Exhibit 4.7 to Crocs, Inc. ’ s An nual Report on Form 10-K filed on February 16, 2023) . +4.8 +Second Supplemental Indenture, dated January 19, 2023, by and among Crocs, Inc., Crocs UK Holdings Limited, Crocs UK Fin Co Limited, Crocs Finance UK Limited, Crocs SG Fin Co. Pte. Ltd. and Crocs Malta Global Ltd. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.8 to Crocs, Inc. ’ s Annual Report on Form 10-K filed on February 16, 2023) . +10.1 * +Crocs, Inc. 2015 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +55 +Table of Contents +Exhibit +Number Description +10.2 * +Andrew Rees Performance-Vested Restricted Stock Unit Agreement (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 13, 2018). +10.3 * +Form of Performance-Vested Restricted Stock Award (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 13, 2021). +10.4 +Second Amended and Restated Credit Agreement, dated July 26, 2019, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed August 1, 2019). +10.5 +First Amendment to Second Amended and Restated Credit Agreement, dated March 26, 2020, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent, and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed March 30, 2020). +10.6 +Second Amendment to Second Amended and Restated Credit Agreement, dated November 13, 2020, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.12 to Crocs, Inc.’s Annual Report on Form 10-K, filed February 23, 2021). +10.7 +Third Amendment to Second Amended and Restated Credit Agreement, dated July 23, 2021, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PNC Bank, National Association, as administrative agent (incorporated herein by reference herein to Exhibit 10.7 to Crocs, Inc.’s Annual Report on Form 10-K, filed February 16, 2022). +10.8 ## +Fourth Amendment to Second Amended and Restated Credit Agreement, dated February 17, 2022, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, Inc., Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +10.9 ## +Fifth Amendment to Second Amended and Restated Credit Agreement, dated November 30, 2022, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, Inc., Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, Bank of America, N.A., London Branch, as alternative currency swing loan lender and PNC Bank, National Association, as administrative agent, U.S. dollar swing loan lender and issuing lender (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 1, 2022. +10.10 ## +Term Loan Credit Agreement, dated February 17, 2022, by and among Crocs, Inc., the lenders from time to time party thereto and Citibank, N.A., as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +10.11 ## +Refinancing Amendment, dated as of August 8, 2023, by and among Crocs, Inc., a Delaware corporation, the subsidiary guarantors party thereto, Citibank, N.A., as administrative agent, and each of the lenders party thereto (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on August 8, 2023). +10.12 +## +† +2024 Refinancing Amendment, dated as of February 13, 2024, by and among Crocs, Inc., a Delaware corporation, the subsidiary guarantors party thereto, Citibank, N.A., as administrative agent, and each of the lenders party thereto. +56 +Table of Contents +Exhibit +Number Description +10.13 * +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on October 4, 2018). +10.14 * +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 5, 2010). +10.15 * +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +10.16 * +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.17 * +Employment Offer Letter, dated August 1, 2018, between Crocs, Inc. and Anne Mehlman (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 7, 2018). +10.18 * +Crocs, Inc. 2020 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 11, 2020). +10.19 * +Employment Offer Letter dated September 10, 2020 between Crocs, Inc. and Michelle Poole (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on September 14, 2020). +21 † +Subsidiaries of the registrant. +23.1 † +Consent of Deloitte & Touche LLP. +31.1 † +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 † +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 + +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +97 +* +† +Incentive Compensation Recovery Policy. +101.INS † XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH † XBRL Taxonomy Extension Schema Document +101.CAL † XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF † XBRL Taxonomy Extension Definition Linkbase Document +101.LAB † XBRL Taxonomy Extension Label Linkbase Document +101.PRE † XBRL Taxonomy Extension Presentation Linkbase Document +104 Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101). +57 +Table of Contents +* Compensatory plan or arrangement. +# Certain exhibits and schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted exhibits or schedules upon request; provided that the Company may request confidential treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. +## Schedules and exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K. The Company hereby undertakes to supplementally furnish copies of any omitted schedules and exhibits to the Securities and Exchange Commission upon request. +† Filed herewith. ++ Furnished herewith. +58 +Table of Contents +Item 16. Form 10–K Summary. +None. +59 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 15, 2024. +CROCS, INC. +a Delaware Corporation +By: /s/ ANDREW REES +Name: Andrew Rees +Title: Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ ANDREW REES Chief Executive Officer and Director (Principal Executive Officer) February 15, 2024 +Andrew Rees +/s/ ANNE MEHLMAN Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 15, 2024 +Anne Mehlman +/s/ THOMAS J. SMACH Chairman of the Board February 15, 2024 +Thomas J. Smach +/s/ IAN M. BICKLEY Director February 15, 2024 +Ian M. Bickley +/s/ RONALD L. FRASCH Director February 15, 2024 +Ronald L. Frasch +/s/ CHARISSE FORD HUGHES Director February 15, 2024 +Charisse Ford Hughes +/s/ BETH J. KAPLAN Director February 15, 2024 +Beth J. Kaplan +/s/ JOHN REPLOGLE Director February 15, 2024 +John Replogle +/s/ NEERAJ TOLMARE Director February 15, 2024 +Neeraj Tolmare +/s/ DOUGLAS J. TREFF Director February 15, 2024 +Douglas J. Treff +60 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) +F- 2 +Consolidated Statements of Income for the Years Ended December 31, 2023, 2022, and 2021 +F- 4 +Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2023, 2022, and 2021 +F- 5 +Consolidated Balance Sheets as of December 31, 2023 and 2022 +F- 6 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2023, 2022, and 2021 +F- 7 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2023, 2022, and 2021 +F- 8 +Notes to Consolidated Financial Statements +F- 9 +Schedule II: Valuation and Qualifying Accounts +F- 39 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2023 and 2022, the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows, for each of the three years in the period ended December 31, 2023, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 15, 2024, expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matters +The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. +Income Taxes —Evaluation of the Deferred Tax Asset resulting from Intra-entity Intellectual Property Transactions — Refer to Note 14 to the consolidated financial statements +Critical Audit Matter Description +The Company recognizes deferred income taxes for tax attributes and for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the deferred tax liability or asset is expected to be settled or realized. The Company takes a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. +During 2023, the Company completed intra-entity transfers of certain intellectual property (“IP”) rights primarily to align with current and future international operations. These transactions were executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of these transactions. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from actual results. Foreign deferred tax assets increased by $611.4 million, inclusive of the reversal of certain deferred tax liabilities. This benefit was offset by an increase in uncertain tax positions of $318.6 million, and an incremental valuation allowance of $164.0 million for amounts not more-likely-than-not to be realized based on available objective evidence. As such, a net change in deferred tax asset of $128.9 million was recognized along with a corresponding foreign income tax benefit. +F- 2 +Table of Contents +We identified management’s valuation of the deferred tax asset and related uncertain tax positions resulting from the Company’s transfer of certain intellectual property to its Netherlands and Singapore subsidiaries as a critical audit matter because of the significant judgments and estimates that were required to be made by management to properly value the deferred tax asset and uncertain tax positions. The judgments and estimates were related to the Company’s interpretation of related tax laws and regulations, as well as the use of estimates and assumptions regarding future events. +As a result, we utilized a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value and transfer pricing specialists, when performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions for the measurement of the deferred tax asset related to the forecasts of future revenue growth and the selection of the discount rate. We also utilized a high degree of auditor judgment and an increased extent of effort, including the need to involve our income tax specialists, when performing audit procedures to evaluate whether management’s judgments in interpreting and applying tax laws and estimates and assumptions regarding future settlements were appropriate in determining the value of the uncertain tax positions. +How the Critical Audit Matter Was Addressed in the Audit +Our audit procedures, performed with the assistance of our fair value, tax, and transfer pricing specialists, related to the Company’s evaluation of the deferred tax asset resulting from the intra-entity IP transfers included the following, among others: +• We tested the effectiveness of management’s controls over the determination of the measurement of deferred tax asset, such as controls related to management’s selection of the discount rate and forecasts of future revenues, and management’s controls over the measurement of the uncertain tax position, such as controls related to the evaluation of subjective estimates in the amounts to be realized. +• We evaluated the reasonableness of management’s revenue forecasts by comparing to: +– Historical revenue growth rates +– Internal communications to management and the Board of Directors +– Forecasted information included in Company press releases as well as in analyst and industry reports +– Expected macroeconomic trends. +• With the assistance of our fair value specialists, we evaluated the reasonableness of the discount rate by testing the determination of the long-term growth rate. +• With the assistance of our tax and transfer pricing specialists, we evaluated the measurement of uncertain tax positions. Our procedures included the following, among others: +– Reviewed the Company’s analysis of the uncertain tax positions and evaluated the reasonableness of the assumptions and calculations the Company used to develop the amount of the related uncertain tax positions. +– Obtained the Company’s supporting documentation to assess the technical tax merits applicable to Dutch, Singapore, and international tax and transfer pricing standards, the more-likely-than-not recognition and measurement thresholds and evaluated the application of these relevant tax laws in the Company’s recognition determination. +– Evaluated the Company’s measurement of the liability using our knowledge of international, domestic, and local income tax laws, as well as settlement activity from the relevant income tax authorities. +– Tested the source information underlying the determination of the discount rate and the mathematical accuracy of the calculation. +– Developed a range of independent estimates and comparing those to the discount rate selected by management. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 15, 2024 +We have served as the Company's auditor since 2005. +F- 3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF INCOME +(in thousands, except per share data) +Year Ended December 31, +2023 2022 2021 +Revenues +$ 3,962,347 $ 3,554,985 $ 2,313,416 +Cost of sales +1,752,337 1,694,703 893,196 +Gross profit +2,210,010 1,860,282 1,420,220 +Selling, general and administrative expenses +1,163,940 1,009,526 737,156 +Asset impairments +9,287 — — +Income from operations +1,036,783 850,756 683,064 +Foreign currency gains (losses), net +( 1,240 ) 3,228 ( 140 ) +Interest income +2,406 1,020 775 +Interest expense +( 161,351 ) ( 136,158 ) ( 21,647 ) +Other income (expense), net +( 326 ) ( 338 ) 1,797 +Income before income taxes +876,272 718,508 663,849 +Income tax expense (benefit) +83,706 178,349 ( 61,845 ) +Net income +$ 792,566 $ 540,159 $ 725,694 +Net income per common share: +Basic +$ 12.91 $ 8.82 $ 11.62 +Diluted +$ 12.79 $ 8.71 $ 11.39 +Weighted average common shares outstanding: +Basic +61,386 61,220 62,464 +Diluted +61,952 62,006 63,718 +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(in thousands) +Year Ended December 31, +2023 2022 2021 +Net income +$ 792,566 $ 540,159 $ 725,694 +Other comprehensive income, net of tax: +Derivatives designated as hedging instruments: +Unrealized gains (losses) on derivative instruments +( 281 ) ( 576 ) — +Reclassification adjustment for realized gains (losses) on derivative instruments +563 — — +Net increase (decrease) from derivatives designated as hedging instruments +282 ( 576 ) — +Foreign currency gains (losses), net +7,441 ( 17,929 ) ( 20,484 ) +Reclassification of foreign currency translation gain (loss) to income (1) +— ( 8,148 ) — +Total comprehensive income, net of tax +$ 800,289 $ 513,506 $ 705,210 +(1) Represents the reclassification of a cumulative foreign currency translation adjustment upon substantial liquidation of foreign subsidiaries which is presented within ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2023 2022 +ASSETS +Current assets: +Cash and cash equivalents +$ 149,288 $ 191,629 +Restricted cash — current +2 2 +Accounts receivable, net of allowances of $ 27,591 and $ 24,493 , respectively +305,747 295,594 +Inventories +385,054 471,551 +Income taxes receivable +4,413 14,752 +Other receivables +21,071 18,842 +Prepaid expenses and other assets +45,129 33,605 +Total current assets +910,704 1,025,975 +Property and equipment, net +238,315 181,529 +Intangible assets, net +1,792,562 1,800,167 +Goodwill +711,588 714,814 +Deferred tax assets, net +667,972 528,278 +Restricted cash +3,807 3,254 +Right-of-use assets +287,440 239,905 +Other assets +31,446 7,875 +Total assets +$ 4,643,834 $ 4,501,797 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ 260,978 $ 230,821 +Accrued expenses and other liabilities +285,771 239,424 +Income taxes payable +65,952 89,211 +Current borrowings +23,328 24,362 +Current operating lease liabilities +62,267 57,456 +Total current liabilities +698,296 641,274 +Deferred tax liabilities, net +12,912 302,030 +Long-term income taxes payable +565,171 224,837 +Long-term borrowings +1,640,996 2,298,027 +Long-term operating lease liabilities +269,769 215,119 +Other liabilities +2,767 2,579 +Total liabilities +3,189,911 3,683,866 +Stockholders’ equity: +Common stock, par value $ 0.001 per share, 110.1 million and 109.5 million issued, 60.5 million and 61.7 million shares outstanding, respectively +110 110 +Treasury stock, at cost, 49.6 million and 47.7 million shares, respectively +( 1,888,869 ) ( 1,695,501 ) +Additional paid-in capital +826,685 797,614 +Retained earnings +2,611,765 1,819,199 +Accumulated other comprehensive loss +( 95,768 ) ( 103,491 ) +Total stockholders’ equity +1,453,923 817,931 +Total liabilities and stockholders’ equity +$ 4,643,834 $ 4,501,797 +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock Treasury Stock Additional +Paid-in +Capital Retained +Earnings +Accumulated +Other +Comprehensive +(Loss) +Total +Stock-holders' +Equity +Shares Amount Shares Amount +Balance at December 31, 2020 +65,856 $ 105 39,132 $ ( 688,849 ) $ 482,385 $ 553,346 $ ( 56,354 ) $ 290,633 +Share-based compensation — — — — 38,122 — — 38,122 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes 716 1 209 ( 20,119 ) 235 — — ( 19,883 ) +Repurchases of common stock ( 8,242 ) — 8,242 ( 975,294 ) ( 24,706 ) — — ( 1,000,000 ) +Net income +— — — — — 725,694 — 725,694 +Other comprehensive loss +— — — — — — ( 20,484 ) ( 20,484 ) +Balance at December 31, 2021 +58,330 $ 106 47,583 $ ( 1,684,262 ) $ 496,036 $ 1,279,040 $ ( 76,838 ) $ 14,082 +Share-based compensation — — — — 31,303 — — 31,303 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes +567 1 147 ( 11,239 ) ( 118 ) — — ( 11,356 ) +Share issuance at Acquisition 2,852 3 — — 270,393 — — 270,396 +Net income +— — — — — 540,159 — 540,159 +Other comprehensive loss +— — — — — — ( 26,653 ) ( 26,653 ) +Balance at December 31, 2022 +61,749 $ 110 47,730 $ ( 1,695,501 ) $ 797,614 $ 1,819,199 $ ( 103,491 ) $ 817,931 +Share-based compensation — — — — 29,072 — — 29,072 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes +427 — 147 ( 17,086 ) ( 1 ) — — ( 17,087 ) +Repurchases of common stock, including excise tax ( 1,681 ) — 1,681 ( 176,282 ) — — — ( 176,282 ) +Net income +— — — — — 792,566 — 792,566 +Other comprehensive income +— — — — — — 7,723 7,723 +Balance at December 31, 2023 +60,495 $ 110 49,558 $ ( 1,888,869 ) $ 826,685 $ 2,611,765 $ ( 95,768 ) $ 1,453,923 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2023 2022 2021 +Cash flows from operating activities: +Net income +$ 792,566 $ 540,159 $ 725,694 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +54,304 39,229 31,976 +Loss on disposal of assets +419 9,063 310 +Operating lease cost +79,543 66,012 58,283 +Inventory donations 2,078 2,770 1,264 +Provision (recovery) for doubtful accounts, net +3,568 1,101 ( 2,629 ) +Share-based compensation +29,072 31,303 38,122 +Asset impairments +9,287 — — +Deferred taxes +( 410,319 ) ( 4,760 ) ( 241,283 ) +Other non-cash items +3,401 9,947 ( 46 ) +Changes in operating assets and liabilities, net of acquired assets and assumed liabilities: +Accounts receivable, net of allowances +( 13,317 ) ( 56,766 ) ( 35,063 ) +Inventories +86,350 ( 91,614 ) ( 43,063 ) +Prepaid expenses and other assets +( 31,839 ) ( 14,435 ) ( 6,212 ) +Accounts payable +37,197 41,701 34,868 +Accrued expenses and other liabilities +46,695 38,629 38,448 +Right-of-use assets and operating lease liabilities +( 75,107 ) ( 63,355 ) ( 52,752 ) +Income taxes +316,546 54,158 19,248 +Cash provided by operating activities +930,444 603,142 567,165 +Cash flows from investing activities: +Purchases of property, equipment, and software +( 115,625 ) ( 104,190 ) ( 55,916 ) +Acquisition of HEYDUDE, net of cash acquired +— ( 2,046,881 ) — +Other +( 46 ) ( 20 ) ( 9 ) +Cash used in investing activities +( 115,671 ) ( 2,151,091 ) ( 55,925 ) +Cash flows from financing activities: +Proceeds from notes issuance — — 700,000 +Proceeds from bank borrowings +257,905 2,169,898 390,000 +Repayments of bank borrowings +( 923,703 ) ( 575,285 ) ( 485,000 ) +Deferred debt issuance costs +( 1,736 ) ( 53,596 ) ( 14,755 ) +Repurchases of common stock +( 175,019 ) — ( 1,000,000 ) +Repurchases of common stock for tax withholding +( 17,086 ) ( 11,477 ) ( 20,119 ) +Other +— 119 236 +Cash provided by (used in) financing activities +( 859,639 ) 1,529,659 ( 429,638 ) +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +3,078 ( 3,750 ) ( 3,950 ) +Net change in cash, cash equivalents, and restricted cash +( 41,788 ) ( 22,040 ) 77,652 +Cash, cash equivalents, and restricted cash — beginning of year 194,885 216,925 139,273 +Cash, cash equivalents, and restricted cash — end of year $ 153,097 $ 194,885 $ 216,925 +Cash paid for interest $ 151,621 $ 127,809 $ 10,210 +Cash paid for income taxes 179,721 130,084 159,680 +Cash paid for operating leases 74,729 62,852 61,412 +Right-of-use assets obtained in exchange for operating lease liabilities, net of terminations 120,865 137,554 55,035 +Accrued purchases of property, equipment, and software 7,668 18,245 15,831 +Share issuance at Acquisition — 270,396 — +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of the “Company,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. We are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for all. We strive to be the global leader in the sale of casual footwear characterized by functionality, comfort, color, and lightweight design. +On February 17, 2022, we acquired (the “Acquisition”) 100 % of the equity of a privately-owned casual footwear brand business (“HEYDUDE”), pursuant to a securities purchase agreement (the “SPA”) entered into on December 22, 2021. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” +Our business has continued to evolve in the period following the consummation of the HEYDUDE acquisition, as we have grown the brand and staffed and developed our leadership team at HEYDUDE. In the fourth quarter of 2023, to reflect changes in the way management evaluates performance, makes operating decisions, and allocates resources, we updated our reportable operating segments to be (i) Crocs Brand and (ii) HEYDUDE Brand. See Note 17 — Operating Segments and Geographic Information for additional information. +Basis of Presentation and Consolidation +Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries, and they reflect all adjustments which are necessary for a fair statement of results of operations, financial position, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns and allowances, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, valuation allowances, uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, goodwill, and indefinite-lived intangible assets, and purchase price allocation for the Acquisition, as described in Note 3 — Acquisition of HEYDUDE, are reasonable based on information available at the time they are made. +Additionally, we are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. If it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 16 — Commitments and Contingencies for additional information regarding our contingencies and legal proceedings. +To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassifications +We have reclassified certain amounts in Note 6 — Accrued Expenses and Other Liabilities, Note 12 — Revenues, and Note 17 — Operating Segments and Geographic Information to conform to current period presentation. +F- 9 +Table of Contents +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. We report receivables from credit card companies in cash and cash equivalents. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. We reduce the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting our customer base, and historical collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial obligations. We write off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Schedule II in Item 15. Exhibits, Financial Statement Schedule of this Annual Report on Form 10-K for more information. +Inventories +Inventories are comprised of finished goods, are stated at the lower of cost or net realizable value, and are recognized using the first-in-first-out method of inventory costing. We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end-of-life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value, and the difference is recorded in ‘Cost of sales’ in our consolidated statements of operations. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and they are recorded within ‘Cost of sales’ in our consolidated statements of operations. +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives. The useful lives are reviewed periodically and typically range from 2 to 10 years for machinery and equipment and furniture, fixtures and others. Leasehold improvements are stated at cost and amortized on a straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of warehouse- and distribution-related assets is included in ‘Cost of sales’ in our consolidated statements of operations. Depreciation related to retail store, corporate, and non-product assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of operations. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets, and the resulting gain or loss, if any, is reflected in ‘Income from operations’ in the consolidated statements of operations. +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. +The excess of the purchase price over the fair value of acquired net assets represents goodwill. Our goodwill balance as of December 31, 2023 was $ 711.6 million and primarily related to the acquisition of HEYDUDE during the year ended December 31, 2022. As of December 31, 2023, a goodwill amount of $ 710.0 million was assigned to the HEYDUDE Brand segment and consisted of the acquired workforce and economies of scale resulting from the Acquisition. +F- 10 +Table of Contents +When performing our annual test for impairment, we may assess goodwill and indefinite-lived intangible assets for potential impairment using either a qualitative or quantitative assessment. Significant judgments and assumptions are required in such impairment evaluations. For the quantitative assessment, we compare the estimated fair value of a reporting unit with its carrying value, including the goodwill assigned to the reporting unit. If the carrying value of the reporting unit exceeds its estimated fair value, an impairment charge is recorded. For the year ended December 31, 2023, we performed a qualitative and quantitative assessment for the HE YDUDE Brand reporting unit goodwill, and we performed a quantitative assessment for the HEYDUDE Brand indefinite-lived intangible assets. The estimated fair values of the HEYDUDE Brand reporting unit goodwill and indefinite-lived trademark exceeded their carrying values. For the year ended December 31, 2022, we performed a quantitative assessment for the HEYDUDE Brand reporting unit goodwill and the HEYDUDE Brand indefinite-lived intangible assets, each of which indicated the estimated fair values exceeded their carrying values. Additionally for the years ended December 31, 2023, 2022, and 2021, we performed a qualitative assessment for the goodwill in our Crocs Brand segment, which indicated that it was more likely than not that the estimated fair value exceeded its carrying value. We did not record any impairment charges in the years ended December 31, 2023, 2022, or 2021 based on the results of our goodwill and indefinite-lived intangible assets impairment testing. +We continuously monitor the performance of our definite-lived intangible assets, which includes software, customer relationships, patents, copyrights, and certain trademarks, and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +We amortize our customer relationships on a straight-line basis over a useful life of 15 years. Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and typically range from 7 to 25 years. +Internal-Use Software and Cloud Computing Arrangements +We capitalize direct costs of materials and services used in the development and purchase of internal-use software. Amounts capitalized are amortized on a straight-line basis over a period of 2 to 8 years and are reported as a component of ‘Intangible assets, net’ in the consolidated balance sheets. +We also capitalize certain costs incurred during the application development stage of implementation of internal-use software in cloud computing arrangements. Amounts capitalized are amortized on a straight-line basis over the expected length of the related contract and are reported as a component of ‘Other assets’ in the consolidated balance sheets. +Amortization of capitalized software used in warehouse- and distribution-related activities is included in ‘Cost of sales’ in the consolidated statements of operations. Amortization related to corporate and non-product, assets, such as our global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of operations. +Leases +Our lease portfolio consists primarily of real estate assets, which includes retail, warehouse, distribution center, and office spaces, under operating leases expiring at various dates through 2034. Leases with an original term of twelve months or less are not reported in the consolidated balance sheets; expense for these short-term leases is recognized on a straight-line basis over the lease term. +Many leases include one or more options to renew, with renewal terms that, if exercised by us, may extend the lease term. The exercise of these renewal options is at our discretion. When assessing the likelihood of a renewal or termination, we consider the significance of leasehold improvements, availability of alternative locations, and the cost of relocation or replacement, among other considerations. The depreciable lives of leasehold improvements are the shorter of the useful lives of the improvements or the expected lease term. We determine the lease term for each lease based on the terms of each contract and factor in renewal and early termination options if such options are reasonably certain to be exercised. We do not generally believe such options are reasonably certain, and therefore, we have excluded them from the recorded right-of-use assets and operating lease liabilities. +Due to our centralized treasury function, we utilize a portfolio approach to discount our lease obligations. We assess the expected lease term at lease inception and discount the lease using a fully-secured annual incremental borrowing rate, adjusted for time value corresponding with the expected lease term. +F- 11 +Table of Contents +Certain of our retail store leases include rental payments based upon a percentage of retail sales in excess of a minimum fixed rental. In some cases, there is no fixed minimum rental, and the entire rental payment is based upon a percentage of sales. In addition, certain leases include rental payments adjusted periodically for changes in price level indices. We recognize expense for these types of payments as incurred and report them as variable lease expense. See Note 7 — Leases for additional information. +Derivative Financial Instruments +We transact business in various foreign entities and are therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar (“USD”) amounts of revenues, expenses, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we may enter into forward contracts to buy and sell foreign currency. By policy, we do not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts we enter into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to and did not post collateral as of December 31, 2023 or 2022. +Our derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2023 and 2022. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain components of its risk, even though hedge accounting does not apply, or we elect not to apply hedge accounting. +We report derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. For the consolidated statements of cash flows, we classify cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities.’ +As of December 31, 2023, we have derivatives not designated as hedging instruments (“non-hedged derivatives”), which consist of foreign currency forward contracts primarily used to hedge monetary assets and liabilities denominated in non-functional currencies. For our non-hedged derivatives, changes in fair value are recognized within ‘Foreign currency gains (losses), net’ in the consolidated statements of operations. +We also have cash flow hedges (“hedged derivatives”) as of December 31, 2023. We are exposed to fluctuations in various foreign currencies against our functional currency, the USD. Specifically, we have subsidiaries that transact in currencies other than their functional currency. We use cash flow hedges to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. Currency forward agreements involve fixing the exchange rates for delivery of a specified amount of foreign currency on a specified date. The currency forward agreements are typically cash settled in USD for their fair value at or close to their settlement date. We may also use currency option contracts under which we will pay a premium for the right to sell a specified amount of a foreign currency prior to the maturity date of the option. +For derivatives designated and that qualify as cash flow hedges of foreign exchange risk, the gain or loss on the derivative is recorded in ‘Accumulated other comprehensive loss’ in the consolidated balance sheets. In the period during which the hedged transaction affects earnings, the related gain or loss is subsequently reclassified to ‘Revenues’ or ‘Cost of sales’ in the consolidated statement of operations, which is consistent with the nature of the hedged transaction. +See Note 9 — Derivative Financial Instruments for further information on derivative financial instruments. +F- 12 +Table of Contents +Other Comprehensive Income +Our foreign subsidiaries use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into USD using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss), until the substantial liquidation of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. During the year ended December 31, 2022, we recognized a net loss of $ 8.1 million of cumulative foreign currency translation adjustments related to the substantial liquidation of a foreign subsidiary. +Revenue Recognition +See Note 12 — Revenues for a summary of our revenue recognition policy. +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of operations. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, procure, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, licensing fees, depreciation, amortization, packaging, and other warehouse and distribution overhead and costs. +Selling, General and Administrative Expenses +Selling, general and administrative expenses consist primarily of labor and outside services, rent expense, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to corporate and non-product assets and share-based compensation. Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources, and information technology. +Our selling, general and administrative expenses include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of our promotional expenses result from payments under endorsement contracts. Endorsement-related expenses are recognized as performance is received over the term of each endorsement agreement. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, including variable marketing expenses, were $ 317.4 million, $ 260.8 million, and $ 172.7 million for the years ended December 31, 2023, 2022, and 2021, respectively. +Research, Design and Development Expenses +We continue to dedicate resources to product design and development based on opportunities we identify in the marketplace. We incurred expenses of $ 21.4 million, $ 18.7 million, and $ 13.7 million in research, design, and development activities for the years ended December 31, 2023, 2022, and 2021, respectively, which are expensed as incurred and are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Share-Based Compensation +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +We grant RSAs, service-condition RSUs, performance-condition RSUs, and market-condition RSUs. The grant date fair values of RSAs, service-condition RSUs, and performance-condition RSUs are based on the closing market price of our common stock +F- 13 +Table of Contents +on the grant date; the grant date fair value and derived service period of market-condition RSUs are estimated using a Monte Carlo simulation valuation model. Our service-condition RSUs vest based on continued service; our performance-condition RSUs vest based on achievement of multiple weighted performance goals, certification of performance achievement by the Compensation Committee of the Board of Directors, and continued service; and our market-condition RSUs vest based on the market price of our stock and continued service. Compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service period. For performance-condition RSUs, compensation expense is updated for our expected performance level against performance goals at the end of each reporting period, which involves judgment as to the achievement of certain performance metrics. +See Note 13 — Share-Based Compensation for additional information related to share-based compensation. +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. We assess recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and record a loss from impairment if the carrying value is more than its undiscounted cash flows. For customer relationships, impairment testing is performed at the customer group level. For assets involved in our retail businesses, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets, leasehold improvements, and right-of-use assets related to our retail locations for impairment. For all other long-lived assets, we perform impairment testing at the asset group level for which separately identifiable cash flows are available. Assets or asset groups to be abandoned are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 4 — Property and Equipment, Net, Note 5 — Goodwill and Intangible Assets, Net, and Note 7 — Leases for a discussion of impairment losses recorded during the periods presented. +Foreign Currency Gains (Losses), Net +Foreign currency gains (losses), net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of an entity and realized and unrealized gains and losses on forward foreign currency exchange derivative contracts that do not qualify for hedge accounting. +Other Income (Expense), Net +Other income (expense), net primarily includes gains and losses associated with activities not directly related to making and selling footwear. +Income Taxes +Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statements of operations. See Note 14 — Income Taxes for further discussion. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the treasury stock method. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in our earnings and is calculated by adjusting weighted average outstanding shares, assuming conversion of all potentially dilutive stock options and awards. Anti-dilutive securities are excluded from diluted EPS. See Note 15 — Earnings per Share for additional information. +F- 14 +Table of Contents +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). We utilize a combination of market and income approaches to value derivative instruments. Our financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level Inputs +1 Unadjusted quoted prices in active markets for identical assets and liabilities. +2 Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 Unobservable inputs for the asset or liability. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 8 — Fair Value Measurements for further discussion related to estimated fair value measurements. +2. RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Income Taxes +The CHIPS and Science Act of 2022 (CHIPS) and the Inflation Reduction Act (IRA) of 2022 were signed into law on August 9, 2022 and August 16, 2022, respectively. The legislation introduces new options for monetizing certain credits, a corporate alternative minimum tax, and a stock repurchase excise tax. The corporate alternative minimum tax and stock repurchase excise tax were effective as of January 1, 2023 and are the main provisions that are applicable to us. We are currently monitoring the impact of both the CHIPS and IRA but do not expect that any of the provisions included in these acts would result in a material impact to our deferred tax assets, liabilities, or income taxes payable. Additionally, we resumed our share repurchase program in July 2023. As such, we began recognizing an accrual for the new stock repurchase excise tax, which did not have a material impact on our consolidated financial position. +New Accounting Pronouncements Not Yet Adopted +Pillar Two Global Minimum Tax +On October 8, 2021, the Organization for Economic Co-operation and Development (“OECD”) released a statement on the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting, which agreed to a two-pillar solution to address tax challenges of the digital economy. On December 20, 2021, the OECD released Pillar Two model rules defining a 15% global minimum tax rate for large multinational corporations (the “Pillar Two Framework”). The OECD continues to release additional guidance and countries are implementing legislation with widespread adoption of the Pillar Two Framework expected by 2024. We are continuing to evaluate the Pillar Two Framework and its potential impact on future periods. +Income Taxes: Improvements to Income Tax Disclosure +In December 2023, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance related to the disclosure of rate reconciliation and income taxes paid. This guidance becomes effective for annual periods beginning after December 15, 2024 with early adoption permitted and should be applied on a prospective basis. We do not expect this standard to have a material impact on our consolidated financial statements, but it will require increased disclosures within the notes to our consolidated financial statements. +F- 15 +Table of Contents +Segment Reporting: Improvements to Reportable Segment Disclosures +In November 2023, the FASB issued authoritative guidance related to the segment disclosures. This guidance becomes effective for annual periods beginning after December 15, 2023 and interim periods beginning after December 15, 2024, with early adoption permitted and should be applied on a retrospective basis. We do not expect this standard to have a material impact on our consolidated financial statements, but it will require increased disclosures within the notes to our consolidated financial statements. +New pronouncements issued but not effective until after December 31, 2023 are not expected to have a material impact on our consolidated financial statements. +3. ACQUISITION OF HEYDUDE +On February 17, 2022, (the “Acquisition Date”), we acquired 100 % of the equity of HEYDUDE, pursuant to the SPA. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The Acquisition allows us to diversify and expand our business by adding a second brand to the Crocs, Inc. portfolio. +The aggregate preliminary purchase price at the closing of the Acquisition was $ 2.3 billion. We paid aggregate consideration of $ 2.05 billion in cash (the “Cash Consideration”), subject to adjustment based on, among other things, the cash, indebtedness, transaction expenses, and working capital of the companies comprising HEYDUDE and their respective subsidiaries as of the Acquisition Date, and issued 2,852,280 shares of the Company’s common stock to one of the sellers (the “Equity Consideration Shares”). The Equity Consideration Shares were subject to a lock-up period beginning on the Acquisition Date, which has since expired so all of the Equity Consideration Shares have been released from the lock-up. The purchase price paid to the sellers is final. +The Cash Consideration was financed via the Company’s entry into the $ 2.0 billion Term Loan B Facility (as defined below) and $ 50.0 million of borrowings under the Revolving Facility (as defined below). As a result of the Acquisition, HEYDUDE has become wholly owned by us. +Purchase Price Allocation +The Acquisition was accounted for in accordance with the ASC Topic 805 Business Combinations . As a result, we have applied acquisition accounting, which requires, among other things, that the assets acquired and liabilities assumed be recognized at their estimated fair values as of the Acquisition Date. For certain assets and liabilities, those fair values were consistent with historical carrying values. The fair value of inventory was determined using both a market approach and a cost approach. With respect to intangible assets, the estimated fair value was based on the Multi-Period Excess Earnings approach for the trademark and the distributor method for the customer relationships. These models used primarily Level 2 and Level 3 inputs, including an estimate of future revenues, future cash flows, and discount rates. +F- 16 +Table of Contents +The following table summarizes the final allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed on the Acquisition Date: +February 17, 2022 +(in thousands) +Cash and cash equivalents $ 6,232 +Accounts receivable, net 68,698 +Inventories 155,773 +Prepaid expenses and other assets (1) +7,880 +Intangible assets 1,780,000 +Goodwill (1) (2) +710,034 +Right-of-use assets 2,844 +Accounts payable (2) +( 30,017 ) +Accrued expenses and other liabilities ( 18,860 ) +Income taxes payable ( 30,572 ) +Long-term deferred tax liability +( 312,656 ) +Long-term income taxes payable ( 13,004 ) +Operating lease liabilities ( 2,843 ) +Net assets acquired $ 2,323,509 +(1) Includes a valuation adjustment that increased prepaid expenses and other assets by $ 3.5 million and decreased goodwill by $ 3.5 million during the three months ended March 31, 2023. +(2) Includes a valuation adjustment that increased goodwill by $ 0.2 million and increased accounts payable by $ 0.2 million during the three months ended March 31, 2023. +Intangible Assets +The components of intangible assets acquired in connection with the Acquisition were as follows: +Weighted-Average Useful Life Amortization Method Estimated Fair Value +(in thousands) +Customer relationships 15 Straight-line $ 210,000 +Trademark Indefinite — 1,570,000 +Total intangible assets $ 1,780,000 +Goodwill +The excess of the purchase price over the fair value of the acquired business’ net assets represents goodwill. The goodwill amount of $ 710.0 million at December 31, 2023 includes an aggregate adjustment of $ 3.3 million recorded in the three months March 31, 2023 as a result of changes to preliminary valuation estimates. The total goodwill amount acquired was assigned to the HEYDUDE reporting segment. None of the goodwill will be deductible for income tax purposes. The purchase price allocation was finalized during the three months ended March 31, 2023. +Escrow and Holdback Amounts +Additionally, $ 125.0 million of the Cash Consideration (the “Escrow Amount”) was placed in an escrow account to partially secure the indemnification obligations of the sellers. As of December 31, 2023, a substantial portion of the Escrow Amount remained in the escrow account in connection with claims that were noticed prior to the date that was 18 months after the Acquisition Date but was not yet resolved by that date, as provided in the SPA. Further, $ 8.5 million of the Cash Consideration (the “Adjustment Holdback Amount”) was held back and retained as security (but not as the sole source of recovery) for any downward adjustments to the purchase price made in accordance with the SPA. During the year ended December 31, 2022, the Adjustment Holdback Amount was paid to the sellers. +F- 17 +Table of Contents +Acquisition-related Costs +Costs incurred to complete the Acquisition are expensed as incurred and included in ‘Selling, general, and administrative expenses’ in our consolidated statement of operations. During the year ended December 31, 2023, no Acquisition-related costs were recognized. During the year ended December 31, 2022, there were approximately $ 25.7 million of Acquisition-related costs recognized. These costs represent legal, professional, and transaction fees. +Unaudited Pro Forma Information +The following unaudited pro forma financial information for the year ended December 31, 2022 and 2021 combines the historical results of the Crocs and HEYDUDE Brands, assuming that the companies were combined as of January 1, 2021 and include business combination accounting effects from the Acquisition, including amortization charges from acquired intangible assets, adjustments to the fair value of inventory, interest expense on the financing transactions used to fund the Acquisition, and Acquisition-related transaction costs and tax-related effects. The pro forma information as presented below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the Acquisition had taken place on January 1, 2021. +Year Ended December 31, +2022 2021 +(in thousands) +Revenues $ 3,645,291 $ 2,894,094 +Net income 614,463 706,853 +4. PROPERTY AND EQUIPMENT, NET +‘Property and equipment, net’ consists of the following: +December 31, +2023 2022 +(in thousands) +Machinery and equipment $ 163,919 $ 146,821 +Leasehold improvements 149,132 76,363 +Furniture, fixtures, and other 32,356 26,782 +Construction-in-progress 13,418 28,699 +Property and equipment 358,825 278,665 +Less: Accumulated depreciation and amortization ( 120,510 ) ( 97,136 ) +Property and equipment, net $ 238,315 $ 181,529 +Asset Retirement Obligations +We are contractually obligated, under certain of our lease agreements, to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. Asset retirement obligations were not significant to the consolidated balance sheets in the years ended December 31, 2023 or 2022. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Cost of sales $ 18,809 $ 10,043 $ 6,234 +Selling, general and administrative expenses 12,876 9,599 8,708 +Total depreciation and amortization expense $ 31,685 $ 19,642 $ 14,942 +F- 18 +Table of Contents +Disposals of Property and Equipment and Intangible Assets +During the years ended December 31, 2023, 2022, and 2021, we recognized net losses on disposals of property and equipment and intangible assets of $ 0.4 million, $ 1.0 million, and $ 0.3 million, respectively. Gains and losses on disposals of property and equipment and intangible assets are included in ‘Selling, general and administrative expenses’ in the consolidated statements of operations. +Additionally, we impaired our leasehold improvement assets for our former corporate headquarters in the year ended December 31, 2023, as described in Note 8 — Fair Value Measurements. +5. GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +The changes in goodwill for the years ended December 31, 2023 and 2022 were: +Goodwill +(in thousands) +Balance at December 31, 2021 +$ 1,600 +HEYDUDE Acquisition 713,308 +Foreign currency translation (1) +( 94 ) +Balance at December 31, 2022 +714,814 +HEYDUDE valuation adjustment (2) +( 3,274 ) +Foreign currency translation (1) +48 +Balance at December 31, 2023 +$ 711,588 +(1) Foreign currency translation only relates to the goodwill in our Crocs Brand operating segment, as described below. +(2) We acquired HEYDUDE on February 17, 2022, and the purchase price allocation was finalized during the year ended December 31, 2023, resulting in a change to the goodwill balance. During the year ended December 31, 2023, there were valuation adjustments that resulted in a net decrease to goodwill of $ 3.3 million . Refer to Note 3 — Acquisition of HEYDUDE for additional details. +At December 31, 2023, accumulated goodwill impairment was $ 0.8 million. +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2023 December 31, 2022 +Gross Accum. Amortiz. Net Gross Accum. Amortiz. Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software $ 136,343 $ ( 108,675 ) $ 27,668 $ 132,295 $ ( 109,227 ) $ 23,068 +Customer relationships 210,000 ( 26,250 ) 183,750 210,000 ( 12,250 ) 197,750 +Patents, copyrights, and trademarks 5,055 ( 3,686 ) 1,369 5,124 ( 3,537 ) 1,587 +Intangible assets not subject to amortization: +HEYDUDE trademark 1,570,000 — 1,570,000 1,570,000 — 1,570,000 +In progress 8,562 — 8,562 7,537 — 7,537 +Other 1,213 — 1,213 225 — 225 +Total $ 1,931,173 $ ( 138,611 ) $ 1,792,562 $ 1,925,181 $ ( 125,014 ) $ 1,800,167 +At December 31, 2023, the weighted average remaining useful life of intangibles subject to amortization was approximately 13.6 years. +F- 19 +Table of Contents +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Cost of sales $ 3,080 $ 2,366 $ 4,779 +Selling, general and administrative expenses 19,539 17,221 12,255 +Total amortization expense $ 22,619 $ 19,587 $ 17,034 +Estimated future annual amortization expense of intangible assets is: +As of +December 31, 2023 +(in thousands) +2024 $ 22,778 +2025 21,582 +2026 20,073 +2027 18,080 +2028 16,060 +Thereafter 114,214 +Total $ 212,787 +6. ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2023 2022 +(in thousands) +Professional services $ 80,986 $ 45,351 +Accrued compensation and benefits 70,245 55,474 +Return liabilities 38,644 27,651 +Sales/use and value added taxes payable 23,768 27,249 +Fulfillment, freight, and duties 22,269 41,646 +Royalties payable and deferred revenue 15,053 10,528 +Accrued rent and occupancy 8,246 8,972 +Accrued legal fees (1) +2,546 2,602 +Other (1) +24,014 19,951 +Total accrued expenses and other liabilities $ 285,771 $ 239,424 +(1) Amounts as of December 31, 2022 have been reclassified to conform to current period presentation. +F- 20 +Table of Contents +7. LEASES +Right-of-Use Assets and Operating Lease Liabilities +Amounts reported in the consolidated balance sheets were: +December 31, +2023 2022 +(in thousands) +Assets: +Right-of-use assets $ 287,440 $ 239,905 +Liabilities: +Current operating lease liabilities $ 62,267 $ 57,456 +Long-term operating lease liabilities 269,769 215,119 +Total operating lease liabilities $ 332,036 $ 272,575 +Lease Costs and Other Information +Lease-related costs reported within ‘Cost of sales’ and ‘Selling, general and administrative expenses’ were: +Year Ended December 31, +2023 2022 +(in thousands) +Operating lease cost $ 79,543 $ 66,012 +Short-term lease cost 13,258 9,590 +Variable lease cost 44,706 37,536 +Total lease costs $ 137,507 $ 113,138 +The weighted average remaining lease term and discount rate related to our lease liabilities as of December 31, 2023 were 7.1 years and 5.5 %, respectively. As of December 31, 2022, the weighted average remaining lease term and discount rate related to our lease liabilities were 6.9 years and 3.9 %, respectively. +We also impaired our right-of-use asset for our former corporate headquarters, as described in Note 8 — Fair Value Measurements. +Maturities +The maturities of our operating lease liabilities were: +As of +December 31, 2023 +(in thousands) +2024 $ 71,524 +2025 62,169 +2026 51,131 +2027 45,008 +2028 36,156 +Thereafter 139,898 +Total future minimum lease payments 405,886 +Less: imputed interest ( 73,850 ) +Total operating lease liabilities $ 332,036 +F- 21 +Table of Contents +8. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of our derivative instruments. Our derivative instruments are forward foreign currency exchange contracts. We manage credit risk of our derivative instruments on the basis of our net exposure with our counterparty. All of our derivative instruments are classified as Level 2 of the fair value hierarchy and are reported in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2023 and 2022, netted by counterparty. The fair values of our derivative instruments were an insignificant asset and an insignificant liability at December 31, 2023 and an insignificant asset and an insignificant liability at December 31, 2022. See Note 9 — Derivative Financial Instruments for more information. +The carrying amounts of our cash, cash equivalents, and restricted cash, accounts receivable, accounts payable, current accrued expenses and other liabilities, and our Asia revolving facilities approximate their fair value as recorded due to the short-term maturity of these instruments. +Our borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. During the year ended December 31, 2022, we entered into a credit agreement for an aggregate term loan B facility in the principal amount of $ 2.0 billion (the “Term Loan B Facility”), as described in more detail in Note 10 — Borrowings. The Term Loan B Facility is classified as Level 1 of the fair value hierarchy. The Notes (as defined below) are also classified as Level 1 of the fair value hierarchy and are reported in our consolidated balance sheet at face value, less unamortized issuance costs. The fair value of our Revolving Facility (as defined below) approximates its carrying value at December 31, 2023 and 2022 based on interest rates currently available to us for similar borrowings. The carrying values and fair values of our borrowing instruments as of December 31, 2023 and 2022 were: +December 31, 2023 December 31, 2022 +Carrying Value Fair +Value Carrying Value Fair +Value +(in thousands) +Term Loan B Facility $ 820,000 $ 824,100 $ 1,675,000 $ 1,642,547 +2029 Notes 350,000 313,987 350,000 297,596 +2031 Notes 350,000 296,742 350,000 284,240 +Revolving Facility 190,000 190,000 — — +Non-Financial Assets and Liabilities +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, trademarks, customer relationships, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. We recorded impairments as follows: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Leasehold improvement assets impairment (1) +$ 1,007 $ — $ — +Right-of-use assets impairment (1) +8,280 — — +Total asset impairments $ 9,287 $ — $ — +(1) During the year ended December 31, 2023, we recognized an impairment of $ 9.3 million for our former corporate headquarters in Broomfield, Colorado. +9. DERIVATIVE FINANCIAL INSTRUMENTS +As of December 31, 2023, we have derivatives not designated as hedging instruments (“non-hedged derivatives”), which consist of foreign currency forward contracts primarily used to hedge monetary assets and liabilities denominated in non- +F- 22 +Table of Contents +functional currencies, and cash flow hedges (“hedged derivatives”), which are used to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. During the year ended December 31, 2023 and December 31, 2022, there was a loss of $ 0.8 million and $ 0.5 million, respectively, recognized due to reclassification from ‘Accumulated other comprehensive loss’ to ‘Revenues’ or ‘Cost of sales’ related to our hedged derivatives. During the next twelve months, we estimate that a loss of less than $ 0.1 million will be reclassified to the consolidated statement of operations. +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, are reported within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ in the consolidated balance sheets and were: +December 31, 2023 December 31, 2022 +Derivative Assets Derivative Liabilities Derivative Assets Derivative Liabilities +(in thousands) +Non-hedged derivatives: +Forward foreign currency exchange contracts $ 2,850 $ ( 1,333 ) $ 345 $ ( 360 ) +Hedged derivatives: +Cash flow foreign currency contracts 142 ( 229 ) 348 ( 1,116 ) +Total derivatives 2,992 ( 1,562 ) 693 ( 1,476 ) +Netting of counterparty contracts ( 1,547 ) 1,547 ( 345 ) 345 +Total derivatives, net of counterparty contracts $ 1,445 $ ( 15 ) $ 348 $ ( 1,131 ) +The notional amounts of outstanding forward foreign currency exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2023 December 31, 2022 +Notional Fair Value Notional Fair Value +(in thousands) +Non-hedged derivatives: +Singapore Dollar $ 41,441 $ 1,507 $ 26,760 $ 207 +Euro 30,757 1,343 5,068 ( 29 ) +British Pound Sterling 17,662 ( 835 ) 14,509 128 +South Korean Won 9,759 ( 428 ) 18,403 ( 320 ) +Indian Rupee 5,291 ( 23 ) 24,945 ( 10 ) +Japanese Yen 969 ( 47 ) 8,953 9 +Total non-hedged derivatives 105,879 1,517 98,638 ( 15 ) +Hedged derivatives: +Euro 40,014 ( 186 ) 51,914 ( 360 ) +British Pound Sterling 22,320 135 23,025 235 +South Korean Won 11,093 ( 42 ) 12,285 ( 756 ) +Indian Rupee 5,703 6 7,203 113 +Total hedged derivatives 79,130 ( 87 ) 94,427 ( 768 ) +Total derivatives $ 185,009 $ 1,430 $ 193,065 $ ( 783 ) +Latest maturity date, non-hedged derivatives January 2024 April 2023 +Latest maturity date, hedged derivatives December 2024 June 2023 +F- 23 +Table of Contents +Amounts reported in ‘Foreign currency gains (losses), net’ in the consolidated statements of operations include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Foreign currency transaction gains (losses) +$ ( 1,992 ) $ ( 2,858 ) $ 100 +Foreign currency forward exchange contracts gains (losses) +752 6,086 ( 240 ) +Foreign currency gains (losses), net +$ ( 1,240 ) $ 3,228 $ ( 140 ) +10. BORROWINGS +Our long-term borrowings were as follows: +Stated Interest Rate Effective Interest Rate December 31, +Maturity 2023 2022 +(in thousands) +Notes issuance of $ 350.0 million +2029 4.250 % 4.64 % $ 350,000 $ 350,000 +Notes issuance of $ 350.0 million +2031 4.125 % 4.35 % 350,000 350,000 +Term Loan B Facility 2029 820,000 1,675,000 +Revolving Facility 190,000 — +Total face value of long-term borrowings 1,710,000 2,375,000 +Less: +Unamortized issuance costs 49,004 56,973 +Current portion of long-term borrowings (1) +20,000 20,000 +Total long-term borrowings $ 1,640,996 $ 2,298,027 +(1) Represents the current portion of the borrowings on the Term Loan B facility. +At December 31, 2023 and 2022, $ 10.7 million and $ 10.8 million, respectively, of accrued interest related to our borrowings was reported in ‘Accounts payable’ in the consolidated balance sheets. +Senior Revolving Credit Facility +In July 2019, the Company and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. Since that time, we have amended the Credit Agreement, which, as amended to date, provides for a revolving credit facility of $ 750.0 million, which can be increased by an additional $ 250.0 million subject to certain conditions (the “Revolving Facility”). Borrowings under the Credit Agreement bear interest at a variable interest rate based on (A) a Base Rate (defined as the highest of (i) the Overnight Bank Funding Rate (as defined in the Credit Agreement), plus 0.25 %, (ii) the Prime Rate (as defined in the Credit Agreement), and (iii) the Daily Simple SOFR (as defined in the Credit Agreement), plus 1.00 %), plus an applicable margin ranging from 0.25 % to 0.875 % based on our leverage ratio or 1.35 % to 1.975 % for the Daily Simple SOFR based on the leverage ratio, or (B) the Term SOFR Rate (as defined in the Credit Agreement), plus an applicable margin ranging from 1.35 % to 1.975 % based on our leverage ratio for one-month interest periods and 1.40 % to 2.025 % based on our leverage ratio for three-month interest periods. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement requires us to maintain a minimum interest coverage ratio of 3.00 to 1.00 and a maximum leverage ratio of (i) 4.00 to 1.00 from the quarter ended March 31, 2022 through, and including, the quarter ended December 31, 2023, (ii) 3.75 to 1.00 for the quarter ending March 31, 2024, (iii) 3.50 to 1.00 for the quarter ending June 30, 2024, and (iv) 3.25 to 1.00 for the quarter ending September 30, 2024 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits, among other things, (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $ 40.0 million. As of December 31, 2023, we were in compliance with all financial covenants under the Credit Agreement. +F- 24 +Table of Contents +As of December 31, 2023, the total commitments available from the lenders under the Revolving Facility were $ 750.0 million. At December 31, 2023, we had $ 190.0 million outstanding borrowings and $ 1.3 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2023 and 2022, we had $ 558.7 million and $ 748.7 million, respectively, of available borrowing capacity under the Revolving Facility, which matures November 2027. +Term Loan B Facility +On February 17, 2022, the Company entered into a credit agreement (the “Original Term Loan B Credit Agreement”) with Citibank, N.A., as administrative agent and lender, to among other things, finance a portion of the cash consideration for the Acquisition, which was amended on August 8, 2023 (the “August 2023 Amendment”) (the Original Term Loan B Credit Agreement, as amended by the Amendment, the “Existing Term Loan B Credit Agreement”). +The Original Term Loan B Credit Agreement provided for an aggregate term loan B facility in the principal amount of $ 2.0 billion. Among other things, the August 2023 Amendment provided for a new $ 1.18 billion tranche of term loans (the “2023 Refinancing Term Loans” and, such facility, the “Term Loan B Facility”), which is secured by substantially all of the Company’s and each subsidiary guarantor’s assets on a pari passu basis with their obligations arising from the Credit Agreement and is scheduled to mature on February 17, 2029, subject to certain exceptions set forth in the Existing Term Loan B Credit Agreement. Additionally, subject to certain conditions, including, without limitation, satisfying certain leverage ratios, the Company may, at any time, on one or more occasions, add one or more new classes of term facilities and/or increase the principal amount of the loans of any existing class by requesting one or more incremental term facilities. +Pursuant to the reduced interest rate margins applicable to the 2023 Refinancing Term Loans, each term loan borrowing which was an alternate base rate borrowing bore interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 2.00 %. Each term loan borrowing which was a term SOFR borrowing bore interest at a rate per annum equal to the Adjusted Term SOFR Rate (as defined in the Existing Term Loan B Credit Agreement) plus 3.00 %. +Outstanding principal under the Term Loan B Facility is payable on the last business day of each March, June, September, and December, in a quarterly aggregate principal amount of $ 5.0 million. Quarterly aggregate principal payments began on June 30, 2022, with the remaining principal amount due on February 17, 2029, the maturity date. As of December 31, 2023, we had $ 820.0 million in outstanding principal and the Term Loan B Facility was fully drawn with no remaining borrowing capacity. +The Existing Term Loan B Credit Agreement also contains customary affirmative and negative covenants, incurrence financial covenants, representations and warranties, events of default and other provisions. As of December 31, 2023, we were in compliance with all financial covenants under the Existing Term Loan B Credit Agreement. +Subsequently, on February 13, 2024, the Company, the subsidiary guarantors party thereto and Citibank, N.A., as administrative agent (the “Administrative Agent”), entered into a Refinancing Amendment (the “February 2024 Amendment”) to the Existing Term Loan B Credit Agreement (as amended by the February 2024 Amendment, the “Term Loan B Credit Agreement”). Among other things, the February 2024 Amendment (i) provides for a new $ 820.0 million tranche of term loans maturing in 2029 (the “2024 Refinancing Term Loans”) and (ii) reduces the interest rate margins applicable to the approximately $ 820.0 million outstanding under the term loan B facility such that each term loan borrowing which is (1) an alternate base rate borrowing will bear interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 1.25 %, and (2) a term SOFR borrowing will bear interest at a rate per annum equal to (a) the Adjusted Term SOFR Rate (as defined in the Term Loan B Credit Agreement), plus (b) 2.25 %. The 2024 Refinancing Term Loans replaced and refinanced all outstanding term loans under the Existing Term Loan B Credit Agreement. +Asia Revolving Credit Facilities +During the year ended December 31, 2023, we had two revolving credit facilities in Asia, the revolving credit facility with China Merchants Bank Company Limited, Shanghai Branch (the “CMBC Facility”), which matured in January 2023 and provided up to 10.0 million RMB, or $ 1.5 million at current exchange rates as of January 2023, and the revolving credit facility with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”), which provides up to an equivalent of $ 15.0 million. For RMB loans under the CMBC Facility, interest was based on a National Interbank Funding Center 1-year prime rate, plus 65 basis points. For USD loans under the Citibank Facility, interest is mutually agreed upon prior to utilization of a loan. +F- 25 +Table of Contents +As of December 31, 2023, we had borrowings outstanding of $ 3.3 million on the Citibank Facility, which became due in January 2024. As of December 31, 2022, we had no outstanding borrowings on the CMBC Facility, and we had borrowings outstanding of $ 4.3 million on the Citibank Facility. +Senior Notes Issuances +In March 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.250 % Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, the “2029 Notes Indenture”). Additionally, in August 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.125 % Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, “the 2031 Notes Indenture” and, together with the 2029 Notes Indenture, the “Indentures” and, each, an “Indenture”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +The Company will have the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company may redeem up to 40 % of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company may redeem up to 40 % of the aggregate principal amount of the 2031 Notes at a redemption price of 104.125 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $ 25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; pay dividends or repurchase or redeem capital stock or make other restricted payments; declare or pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2023, we were in compliance with all financial covenants under the Notes. +11. EQUITY +Common Stock +We have one class of common stock with a par value of $ 0.001 per share. There are 250.0 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +F- 26 +Table of Contents +Common Stock Repurchase Program +On April 23, 2021, the Board approved and authorized a program to repurchase up to $ 1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $ 1.0 billion to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +During the year ended December 31, 2023 we repurchased 1.7 million shares of our common stock at a cost of $ 175.0 million, including commissions. As of December 31, 2023, we also recorded an accrual for the stock repurchase excise tax of $ 1.3 million, which is reported in ‘Accrued expenses and other liabilities’ and ‘Treasury stock’ in our consolidated balance sheet. During the year ended December 31, 2022, we did not repurchase any shares of our common stock. +As of December 31, 2023, we had remaining authorization to repurchase approximately $ 875.0 million of our common stock, subject to restrictions under our Indentures, Credit Agreement, and Term Loan B Credit Agreement. +Preferred Stock +We have authorized and available for issuance 5.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized as Series A Convertible Preferred Stock with a par value of $ 0.001 per share and none were issued and outstanding as of December 31, 2023. +F- 27 +Table of Contents +12. REVENUES +Revenues by reportable operating segment and by channel were: +Year Ended December 31, +2023 2022 2021 +Crocs Brand: +North America: +Wholesale $ 652,943 $ 644,215 $ 674,230 +Direct-to-consumer 1,124,942 1,000,441 879,748 +Total North America (1) +1,777,885 1,644,656 1,553,978 +International: +Wholesale 840,594 733,087 499,851 +Direct-to-consumer 394,475 281,382 259,587 +Total International 1,235,069 1,014,469 759,438 +Total Crocs Brand $ 3,012,954 $ 2,659,125 $ 2,313,416 +Crocs Brand: +Total Wholesale $ 1,493,537 $ 1,377,302 $ 1,174,081 +Total Direct-to-consumer 1,519,417 1,281,823 1,139,335 +Total Crocs Brand 3,012,954 2,659,125 2,313,416 +HEYDUDE Brand: +Wholesale 566,937 574,140 — +Direct-to-consumer 382,456 321,720 — +Total HEYDUDE Brand (2) +949,393 895,860 — +Total consolidated revenues $ 3,962,347 $ 3,554,985 $ 2,313,416 +(1) North America includes the United States and Canada. +(2) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period, and there are no comparative amounts for the year ended December 31, 2021. The vast majority of HEYDUDE Brand revenues are derived from North America. +Revenues are recognized in the amount expected to be received in exchange for when control of the products transfers to customers and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. During the years ended December 31, 2023, 2022, and 2021, we recognized no changes to estimates for wholesale or direct-to-consumer revenues. +We have also elected to expense incremental costs to obtain customer contracts, consisting primarily of commission incentives, when incurred because the related amortization period is short-term. These costs are reported within ‘Selling, general and administrative expenses’ in our consolidated statements of operations. +The following is a description of our principal revenue-generating activities by distribution channel. We have two reportable operating segments and sell our products using two primary distribution channels. For more detailed information about reportable operating segments, see Note 17 — Operating Segments and Geographic Information. +Wholesale Channel +For the majority of wholesale customers, control transfers and revenues are recognized when the product is shipped or delivered from a manufacturing facility or distribution center to the wholesale customer. In certain cases, control of the product transfers and revenues are recognized when the customer receives the product at the designated delivery point. For certain customers, primarily in international markets, cash payment is required in advance of delivery and revenues are recognized upon the +F- 28 +Table of Contents +transfer of control to the customer. We may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Wholesale revenues are reduced by estimates of returns and allowances based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +We have arrangements that grant certain wholesale customers exclusive licenses, concurrent with the terms of the related distribution agreements, to use our intellectual property in exchange for a sales-based royalty. Sales-based royalty revenues are recognized over the terms of the related license agreements as sales are made by the wholesalers. +Direct-to-Consumer Channel +Direct-to-consumer revenues consist of sales generated through our company-operated retail stores and company-operated e-commerce websites and third-party e-commerce marketplaces. We transfer control of products and recognize revenues at company-operated retail stores at the point of sale, in exchange for cash or other payment. For sales made through company-operated e-commerce websites and third-party e-commerce marketplaces, we transfer control and recognize revenues when the product is shipped from the distribution centers, the point at which payment, primarily through debit and credit card and other e-payment methods, is made. A portion of the transaction price charged to our customers is variable, primarily due to promotional discounts or allowances. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +Contract Liabilities +Contract liabilities consist of advance cash deposits received from wholesale customers to secure product orders in connection with selling seasons and payments received in advance of delivery. As products are shipped and control transfers, we recognize the deferred revenue in ‘Revenues’ in the consolidated statements of operations. At December 31, 2023 and 2022, we recorded an insignificant amount and $ 6.8 million, respectively, of deferred revenues associated with advance customer deposits in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +Refund Liabilities +Refund liabilities, primarily associated with product sales returns, retrospective volume rebates, and early payment discounts are estimated based on an analysis of historical experience, and adjustments to revenues made when the most likely amount of consideration expected changes. At December 31, 2023 and 2022, $ 38.6 million and $ 27.7 million, respectively, of refund liabilities, primarily associated with product returns, were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +13. SHARE-BASED COMPENSATION +Our share-based compensation awards are issued under the 2020 Equity Incentive Plan (“2020 Plan”) and predecessor plan, the 2015 Equity Incentive Plan (“2015 Plan”). Any awards that expire or are forfeited under the 2015 Plan become available for issuance under the 2020 Plan. We account for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. As of December 31, 2023, 3.6 million shares of common stock remained available for future issuance under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +The majority of share-based compensation expense is reported in our consolidated statements of operations as ‘Selling, general and administrative expenses’ with an insignificant amount recorded within ‘Cost of sales.’ +F- 29 +Table of Contents +Stock Option Activity +Stock option activity during the year ended December 31, 2023 was: +Number of Options Weighted Average Exercise Price Weighted Average Contractual Life (Years) Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2022 +210 $ 7.44 4.28 $ 21,208 +Granted — — +Exercised — — +Forfeited or expired — — +Outstanding as of December 31, 2023 +210 $ 7.44 3.28 $ 18,053 +Exercisable at December 31, 2023 +210 $ 7.44 3.28 $ 18,053 +Vested at December 31, 2023 +210 $ 7.44 3.28 $ 18,053 +No stock options were granted during 2023, 2022, or 2021. No stock options were exercised during 2023. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2022 and 2021 was $ 0.4 million and $ 0.8 million, respectively. During the years ended December 31, 2022 and 2021, we received $ 0.1 million, and $ 0.2 million cash, respectively, in connection with the exercise of stock options. As of December 31, 2023, we did no t have any unrecognized share-based compensation expense related to unvested options. +Stock options under our equity incentive plans generally vest ratably over four years with the first vesting occurring one year from the date of grant, followed by monthly vesting for the remaining three years , and expire ten years after the date of grant. +Restricted Stock Awards and Restricted Stock Units Activity +From time to time, we grant RSAs and RSUs. RSAs and RSUs generally vest over three years , depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive shares of common stock upon vesting. RSUs have dividend equivalent rights, which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. We grant service-condition RSUs, performance-condition RSUs, and market-condition RSUs. +Service-condition RSUs are typically granted on an annual basis and vest over time in three equal annual installments, beginning one year after the grant date. During each of the years ended December 31, 2023, 2022, and 2021, we granted 0.2 million service-condition RSUs. +Performance-condition RSUs are typically granted on an annual basis and consist of a performance-based and service-based component. The performance targets and vesting conditions for performance-condition RSUs are based on achievement of multiple weighted performance goals. The number of performance-condition RSUs ultimately awarded may be between 0 % and 200 %, based on performance. These RSUs vest in three equal annual installments beginning one year after the grant date, pending certification of performance achievement by the Compensation Committee of our Board of Directors and continued service. The fair value of performance-condition awards is based on the closing market price of our common stock on the grant date. Compensation expense, net of forfeitures, is updated for our probable expected performance level against performance goals at the end of each reporting period. We also periodically grant market-condition RSUs to certain executives. The grant date fair value and derived service period for market-condition RSUs are estimated using a Monte Carlo simulation model. During the years ended December 31, 2023, 2022, and 2021, we granted 0.2 million, 0.3 million, and 0.5 million performance- and market-condition RSUs, respectively. +F- 30 +Table of Contents +RSA and RSU activity during the year ended December 31, 2023 was: +Restricted Stock Awards Restricted Stock Units +Shares Weighted Average Grant Date Fair Value Shares Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2022 +5 $ 51.13 1,181 $ 62.93 +Granted 4 105.95 440 122.97 +Vested ( 7 ) 69.62 ( 558 ) 55.68 +Forfeited — — ( 216 ) 83.58 +Unvested at December 31, 2023 +2 $ 105.95 847 $ 94.05 +The weighted average grant date fair value of RSAs granted during the years ended December 31, 2023, 2022, and 2021 was $ 105.95 , $ 51.13 , and $ 88.68 per share, respectively. RSAs vested during the years ended December 31, 2023, 2022, and 2021 consisted entirely of service-condition awards. The total grant date fair value of RSAs vested in the years ended December 31, 2023, 2022, and 2021 was $ 0.5 million, $ 0.3 million and $ 0.4 million, respectively. +As of December 31, 2023, unrecognized share-based compensation expense for RSAs was $ 0.2 million, which is expected to amortize over a remaining weighted average period of 0.5 years. +The weighted average grant date fair value of RSUs granted during the years ended December 31, 2023, 2022, and 2021 was $ 122.97 , $ 76.06 , and $ 76.28 per share, respectively. RSUs vested during the year ended December 31, 2023 consisted of 0.3 million service-condition awards and 0.3 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2022 consisted of 0.3 million service-condition awards and 0.4 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2021 consisted of 0.4 million service-condition awards and 0.5 million performance- and market-condition awards. The total grant date fair value of RSUs vested during the years ended December 31, 2023, 2022, and 2021 was $ 31.1 million, $ 29.7 million and $ 24.9 million, respectively. +As of December 31, 2023, unrecognized share-based compensation expenses for service-condition RSUs were $ 24.7 million and for performance- and market-condition RSUs were $ 8.9 million, and are expected to amortize over remaining weighted average periods of 1.7 years and 1.5 years, respectively. +14. INCOME TAXES +During the three months ended December 31, 2023, we completed intra-entity transfers of certain intellectual property rights primarily to align with current and future international operations. Each transfer resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the transferred intellectual property rights. Foreign deferred tax assets increased by $ 611.4 million, inclusive of the reversal of certain deferred tax liabilities. This benefit was offset by an increase in uncertain tax positions of $ 318.6 million, and an incremental valuation allowance of $ 164.0 million for amounts not more-likely-than-not to be realized based on available objective evidence. As such, a net change in deferred tax asset of $ 128.9 million was recognized along with a corresponding foreign income tax benefit. +During 2020 and 2021, w e completed an intra-entity transfer of certain intellectual property rights primarily to align with current and future international operations. The transaction was executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain, and, therefore, may ultimately differ materially from our actual results. +We have recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +F- 31 +Table of Contents +In order to support and sustain the amortizable tax basis for these transactions (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands and Singapore. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands and Singapore subsidiaries serve as the primary corporate headquarters outside of the U.S. and already perform significant functions in support of the economic ownership of the IP. In 2023, we undertook many additional activities to align business operations that support the economic substance of the IP. +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Income before taxes: +U.S. $ 309,098 $ 312,501 $ 510,706 +Foreign 567,174 406,007 153,143 +Total income before taxes $ 876,272 $ 718,508 $ 663,849 +Income tax expense (benefit): +Current income taxes: +U.S. federal $ 85,075 $ 76,092 $ 94,548 +U.S. state 21,884 19,257 28,460 +Foreign 387,066 87,760 56,430 +Total current income taxes 494,025 183,109 179,438 +Deferred income taxes: +U.S. federal ( 12,873 ) ( 12,032 ) 791 +U.S. state ( 1,662 ) 861 32 +Foreign ( 395,784 ) 6,411 ( 242,106 ) +Total deferred income taxes ( 410,319 ) ( 4,760 ) ( 241,283 ) +Total income tax expense (benefit) +$ 83,706 $ 178,349 $ ( 61,845 ) +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Income tax expense and rate attributable to: +Federal income tax rate $ 184,017 21.0 % $ 150,887 21.0 % $ 139,408 21.0 % +State income tax rate, net of federal benefit +16,854 1.9 % 15,981 2.2 % 22,952 3.5 % +Foreign income tax rate differential 31,495 3.6 % 12,405 1.7 % 18,890 2.8 % +GILTI, net 44,003 5.0 % 4,834 0.7 % 14,157 2.1 % +Non-deductible / non-taxable items ( 1,129 ) ( 0.1 ) % 3,743 0.5 % 9,637 1.5 % +Change in valuation allowance 156,312 17.8 % 4,414 0.6 % ( 192,337 ) ( 29.0 ) % +U.S. tax on foreign earnings 1,752 0.2 % 16,822 2.3 % — — % +Foreign tax credits ( 55,648 ) ( 6.4 ) % ( 28,087 ) ( 3.9 ) % ( 19,925 ) ( 3.0 ) % +Research and development credits ( 6,754 ) ( 0.8 ) % ( 5,488 ) ( 0.8 ) % ( 13,104 ) ( 2.0 ) % +Uncertain tax positions 330,819 37.8 % 3,952 0.6 % 21,341 3.2 % +Share-based compensation ( 2,097 ) ( 0.2 ) % ( 1,231 ) ( 0.2 ) % ( 11,930 ) ( 1.8 ) % +Intra-Entity IP Transfer ( 611,403 ) ( 69.8 ) % — — % ( 41,858 ) ( 6.3 ) % +Enacted changes in tax law — — % — — % ( 9,554 ) ( 1.4 ) % +Other ( 4,515 ) ( 0.4 ) % 117 0.1 % 478 0.1 % +Effective income tax expense and rate $ 83,706 9.6 % $ 178,349 24.8 % $ ( 61,845 ) ( 9.3 ) % +F- 32 +Table of Contents +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2023 2022 +(in thousands) +Non-current deferred tax assets: +Share-based compensation expense $ 3,248 $ 3,130 +Accruals, reserves, and other expenses 27,914 24,324 +Net operating loss 47,951 21,455 +Intangible assets 737,976 438,712 +Foreign tax credit 28,053 45,746 +Operating lease liabilities 71,012 55,624 +Other 43,661 25,354 +Valuation allowance ( 183,545 ) ( 28,118 ) +Total non-current deferred tax assets $ 776,270 $ 586,227 +Non-current deferred tax liabilities: +Unrealized gain on foreign currency $ — $ ( 1,760 ) +Property and equipment ( 13,948 ) ( 2,381 ) +Right-of-use assets ( 59,806 ) ( 47,641 ) +Intangible assets ( 46,177 ) ( 307,474 ) +Other ( 1,280 ) ( 723 ) +Total non-current deferred tax liabilities $ ( 121,211 ) $ ( 359,979 ) +The intra-entity transfers of intellectual property rights resulted in an increase in the intangible assets deferred tax asset of $ 352.4 million and an increase in the valuation allowance of $ 163.9 million. The intra-entity transfers of intellectual property rights resulted in a decrease in the intangible asset deferred tax liability of $ 259.0 million. +During 2023, valuation allowances recorded against deferred tax assets increased by $ 155.4 million. The change in the valuation allowance includes an increase of $ 156.3 million related to income tax expense and a decrease of $ 0.9 million that does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to changes in cumulative translation adjustments. During 2022, valuation allowances increased by $ 1.7 million. The change in the valuation allowance includes $ 4.4 million related to income tax benefit and $ 2.8 million that does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation adjustments. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. Separate from the intra-entity transfers of intellectual property rights the company released immaterial valuation allowances in various jurisdictions. Valuation allowances recorded against deferred tax assets increased by a net $ 155.4 million. +In certain other jurisdictions, we recorded additional attributes, primarily driven by operational losses recognized based on local tax accounting requirements. These carryforwards were generated in jurisdictions where results indicate it is not more likely than not the deferred tax assets would be realized. We maintain a valuation allowance against the majority of these balances. +F- 33 +Table of Contents +We have included in the table above deferred tax assets related to U.S. federal tax carryforwards of foreign tax credits and various state tax credits which expire starting in 2030 of $ 3.8 million and $ 0 million at December 31, 2023 and 2022, respectively. We have included in the table above deferred tax assets related to U.S. state tax net operating loss carryforwards, some of which expire at various dates beginning in 2034 and others of which do not expire, of $ 0.3 million and $ 1.4 million at December 31, 2023 and 2022, respectively. We have recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2024 and those which do not expire of $ 73.3 million and $ 66.4 million as of December 31, 2023 and 2022, respectively. +The transition tax in the Tax Act imposed a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. Furthermore, as of December 31, 2023, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Unrecognized tax benefit as of January 1 $ 219,363 $ 218,399 $ 206,209 +Additions in tax positions taken in prior period 3,690 1,697 6,169 +Reductions in tax positions taken in prior period ( 7 ) ( 904 ) ( 963 ) +Additions in tax positions taken in current period 325,058 2,948 23,061 +Settlements — ( 375 ) ( 763 ) +Lapse of statute of limitations ( 148 ) ( 510 ) ( 342 ) +Current year acquisitions — 10,426 — +Cumulative foreign currency translation adjustment 8,526 ( 12,318 ) ( 14,972 ) +Unrecognized tax benefit as of December 31 $ 556,482 $ 219,363 $ 218,399 +We recorded a net expense of $ 330.8 million related to increases in 2023 unrecognized tax benefits. The intra-entity transfers of intellectual property rights resulted in an increase in unrecognized tax benefits of $ 318.6 million. The primary impact of uncertain tax benefits on the rate reconciliation includes net increases in position changes and accrued interest expense. +Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Our assessments are based on estimates and assumptions using the best available information to management. However, our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible change related to our uncertain tax positions, and such changes could be significant. +Interest and penalties related to income tax liabilities are included in ‘Income tax expense (benefit)’ in the consolidated statements of operations. For the years ended December 31, 2023, 2022, and 2021, we recorded approximately $ 3.2 million, $ 3.8 million, and $ 1.0 million, respectively, of penalties and interest. During the year ended December 31, 2023, we released $ 0.1 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $ 8.8 million, $ 5.6 million, and $ 2.0 million, as of December 31, 2023, 2022, and 2021, respectively. +Unrecognized tax benefits of $ 562.0 million, $ 222.5 million, and $ 218.7 million as of December 31, 2023, 2022, and 2021, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +F- 34 +Table of Contents +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2023: +The Netherlands 2011 to 2023 +Canada 2015 to 2023 +Hong Kong 2020 to 2023 +Japan 2015 to 2023 +China 2017 to 2023 +Singapore 2018 to 2023 +United States 2007 to 2023 +U.S state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for us are generally subject to examination for the years 2018 to 2023. Although the timing of income tax audit resolutions and negotiations with taxing authorities is highly uncertain, we do not anticipate a significant change in the total amount of unrecognized tax benefits within the next twelve months. +15. EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2023, 2022, and 2021 were as follows: +Year Ended December 31, +2023 2022 2021 +(in thousands, except per share data) +Numerator: +Net income attributable to common stockholders +$ 792,566 $ 540,159 $ 725,694 +Denominator: +Weighted average common shares outstanding - basic 61,386 61,220 62,464 +Plus: Dilutive effect of stock options and unvested restricted stock units +566 786 1,254 +Weighted average common shares outstanding - diluted +61,952 62,006 63,718 +Net income per common share: +Basic $ 12.91 $ 8.82 $ 11.62 +Diluted $ 12.79 $ 8.71 $ 11.39 +For the years ended December 31, 2023, 2022, and 2021, an insignificant number of outstanding shares issued under share-based compensation awards were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. +16. COMMITMENTS AND CONTINGENCIES +Purchase Commitments +As of December 31, 2023 and 2022, we had purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products, for an aggregate of $ 344.3 million and $ 380.5 million, respectively. We expect to fulfill our commitments under these agreements in the normal course of business, and as such, no liability has been recorded. +Other +We are regularly subject to, and are currently undergoing, audits by various tax authorities in the U.S. and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. +During our normal course of business, we may make certain indemnities, commitments, and guarantees under which we may be required to make payments in relation to certain matters. We cannot determine a range of estimated future payments and have not recorded any liability for such payments in the accompanying consolidated balance sheets. +F- 35 +Table of Contents +We are also subject to litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims. Other than as set forth below, we are not party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business, financial results, and cash flows. +For all claims and disputes, we have accrued estimated losses of an insignificant amount within ‘Accrued expenses and other liabilities’ in our consolidated balance sheet as of December 31, 2023. As we are able, we estimate reasonably possible losses or a range of reasonably possible losses for claims and other disputes. As of December 31, 2023, we estimated that reasonably possible losses could potentially exceed amounts accrued by an insignificant amount. +17. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +Our business has continued to evolve in the period following the consummation of the HEYDUDE acquisition, as we have grown the brand and staffed and developed our leadership team at HEYDUDE. In the fourth quarter of 2023, to reflect changes in the way management evaluates performance, makes operating decisions, and allocates resources, we updated our reportable operating segments. +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand. Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. +Additionally, ‘Enterprise corporate’ costs include global corporate costs associated with both brands, including legal, information technology, human resources, and finance. +Each segment’s performance is evaluated based on segment results without allocating Enterprise corporate expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income from operations consist of unallocated enterprise corporate expenses. +We do not report asset information by segment because that information is not used to evaluate performance or allocate resources between segments. +F- 36 +Table of Contents +The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Revenues: +Crocs Brand (1) +$ 3,012,954 $ 2,659,125 $ 2,313,416 +HEYDUDE Brand (2) +949,393 895,860 — +Total consolidated revenues $ 3,962,347 $ 3,554,985 $ 2,313,416 +Income from operations: +Crocs Brand (1) +$ 1,079,330 $ 852,025 $ 861,394 +HEYDUDE Brand (2) +212,386 211,361 — +Reconciliation of segment income from operations to income before income taxes: +Enterprise corporate ( 254,933 ) ( 212,630 ) ( 178,330 ) +Total consolidated income from operations 1,036,783 850,756 683,064 +Foreign currency gains (losses), net ( 1,240 ) 3,228 ( 140 ) +Interest income 2,406 1,020 775 +Interest expense ( 161,351 ) ( 136,158 ) ( 21,647 ) +Other income (expense), net ( 326 ) ( 338 ) 1,797 +Income before income taxes $ 876,272 $ 718,508 $ 663,849 +Depreciation and amortization: +Crocs Brand (1) +$ 31,950 $ 18,877 $ 16,931 +HEYDUDE Brand (2) +14,200 12,248 — +Enterprise corporate 8,154 8,104 15,045 +Total consolidated depreciation and amortization $ 54,304 $ 39,229 $ 31,976 +(1) In the fourth quarter of 2023, to reflect changes in the way management evaluates performance, makes operating decisions, and allocates resources, we updated our reportable operating segments to be (i) Crocs Brand and (ii) HEYDUDE Brand. Our ‘North America,’ ‘Asia Pacific,’ and ‘EMEALA’ segments as well as revenues and expenses related to Crocs ‘Brand corporate’ have been consolidated to the ‘Crocs Brand.’ As a result of these changes, the previously reported amounts for revenues, income from operations, and depreciation and amortization for the years ended December 31, 2022 and 2021 have been recast to conform to current period presentation. +(2) We acquired HEYDUDE on February 17, 2022 and in connection therewith added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the partial period beginning on the Acquisition Date through December 31, 2022, and there are no comparative amounts for the year ended December 31, 2021. +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2023, 2022 and 2021. The following table sets forth certain geographical information regarding our consolidated revenues for the periods as shown: +Year Ended December 31, +2023 2022 2021 +(in thousands) +Location: +United States $ 2,573,663 $ 2,438,923 $ 1,507,482 +International (1) +1,388,684 1,116,062 805,934 +Total revenues $ 3,962,347 $ 3,554,985 $ 2,313,416 +(1) No individual international country represented 10% or more of consolidated revenues in any of the years presented. +F- 37 +Table of Contents +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2023 2022 +(in thousands) +Location: +United States $ 200,869 $ 148,078 +International (1) +37,446 33,451 +Total property and equipment, net $ 238,315 $ 181,529 +(1) As of December 31, 2023 and 2022, property and equipment, net in the Netherlands represented approximately 12 % and 15 %, respectively, of consolidated property and equipment, net, comprised primarily of property and equipment related to the distribution center in Dordrecht. No other individual international country represented 10% or more of consolidated property and equipment, net in any of the years presented. +18. EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +We sponsor a qualified defined contribution benefit plan (the “Plan”), covering substantially all of our U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. We make matching contributions to the plans equal to 100 % of the first 3 %, and up to 50 % of the next 2 % of salary contributed by an eligible employee. Participants are vested 100 % in our matching contributions when made. Contributions made by us under the Plan were $ 12.6 million, $ 9.0 million and $ 7.4 million for the years ended December 31, 2023, 2022, and 2021, respectively. +F- 38 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period Charged to Costs and Expenses +Deductions (1) +Balance at End of Period +(in thousands) +Year Ended December 31, 2023 +Allowance for doubtful accounts $ 10,513 $ 3,567 $ ( 453 ) $ 13,627 +Reserve for sales returns and allowances 8,877 271,990 ( 272,739 ) 8,128 +Reserve for unapplied rebates 5,103 8,181 ( 7,448 ) 5,836 +Total $ 24,493 $ 283,738 $ ( 280,640 ) $ 27,591 +Year Ended December 31, 2022 +Allowance for doubtful accounts $ 7,828 $ 1,101 $ 1,584 $ 10,513 +Reserve for sales returns and allowances 9,606 192,543 ( 193,272 ) 8,877 +Reserve for unapplied rebates 3,281 6,107 ( 4,285 ) 5,103 +Total $ 20,715 $ 199,751 $ ( 195,973 ) $ 24,493 +Year Ended December 31, 2021 +Allowance for doubtful accounts $ 11,154 $ — $ ( 3,326 ) $ 7,828 +Reserve for sales returns and allowances 5,782 148,893 ( 145,069 ) 9,606 +Reserve for unapplied rebates 4,157 4,678 ( 5,554 ) 3,281 +Total $ 21,093 $ 153,571 $ ( 153,949 ) $ 20,715 +(1) Deductions include accounts written off, net of recoveries, and the effects of foreign currency translation. +F- 39 \ No newline at end of file diff --git a/raw/filings/0001334036/2023/0001334036-24-000025/filing_metadata.csv b/raw/filings/0001334036/2023/0001334036-24-000025/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..d9dbbb0013f3d55e406b7cabb9546d4814f63330 --- /dev/null +++ b/raw/filings/0001334036/2023/0001334036-24-000025/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2024-02-15,2023-12-31,2024-02-15T20:51:10.000Z,0001334036-24-000025,crox-20231231.htm,10-K,12392513,1,1,https://www.sec.gov/Archives/edgar/data/1334036/000133403624000025/crox-20231231.htm,https://www.sec.gov/Archives/edgar/data/1334036/000133403624000025/,2023,2023,1 diff --git a/raw/filings/0001334036/2023/0001334036-24-000025/item1.txt b/raw/filings/0001334036/2023/0001334036-24-000025/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..49a55d4c753bcb0c26c74b1ac7dac857ef4ffcce --- /dev/null +++ b/raw/filings/0001334036/2023/0001334036-24-000025/item1.txt @@ -0,0 +1,115 @@ +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for all. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. +On February 17, 2022 (the “Acquisition Date”), we acquired (the “Acquisition”) 100% of the equity of a privately-owned casual footwear brand business (“HEYDUDE”), pursuant to a securities purchase agreement entered into on December 22, 2021. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The majority of HEYDUDE sales are currently in the United States. +Our business has continued to evolve in the period following the consummation of the Acquisition, as we have grown the brand and staffed and developed our leadership team at HEYDUDE. In the fourth quarter of 2023, to reflect changes in the way management evaluates performance, makes operating decisions, and allocates resources, we updated our reportable operating segments to be (i) Crocs Brand and (ii) HEYDUDE Brand, which are discussed in more detail in “Business Segments and Geographic Information” below. Within the regions in which we operate, we prioritize six core markets for the Crocs Brand where we believe the greatest opportunities for growth exist: (i) China, (ii) India, (iii) Japan, (iv) South Korea, (v) the U.S., and (vi) Western Europe. +Our Vision +At the heart of our brands is our consumers. We have brands, with a broad democratic appeal and accessible price points, which are aligned with global megatrends such as casualization and personalization. The philosophy and vision for our brands has been an important driver of our results and, we believe, will continue to be important as we strive to realize the full potential of our brands. To that end, in 2023, we continued our message of “Come As You Are” for the Crocs Brand and the slogan “Good To Go-To” for the HEYDUDE Brand. +Our growth framework is driven by five strategic areas of focus: +• Growing digital sales — Digital sales include sales directly to consumers through our company-owned websites and third-party marketplaces as well as wholesale sales to our global e-tailers. Our digital sales in 2023 were 37.9% of consolidated revenues, compared to 37.8% and 36.7% of consolidated revenues in 2022 and 2021, respectively. +• Gaining sandals market share for the Crocs Brand — Sandals have long been a focus of the Crocs Brand as a large and accessible growth avenue for the brand. We believe sandals are a natural extension of the Crocs Brand and allow us to access new consumers by leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. +• Increasing awareness and distribution for the HEYDUDE Brand — We have embarked, and plan to continue to embark, on various marketing activities to drive higher awareness including, but not limited to, developing a pipeline of collaborations and brand activations. We have rightsized HEYDUDE’s wholesale distribution footprint and are evolving our channel diversification strategy through a thoughtful development of outlet retail. In 2023, we opened 5 HEYDUDE Brand outlet stores. +• Growth opportunities internationally — As a company with a well-established global footprint, we believe we have a long-term sales growth opportunity internationally. Our international sales in 2023 were 32.5% of consolidated revenues, compared to 29.4% and 32.8% of consolidated revenues in 2022 and 2021, respectively. This includes sales in 2023 and 2022 for the HEYDUDE Brand, which operates primarily in the United States. Our six core markets for the Crocs Brand include five international markets, and more specifically, four markets in Asia: China, India, Japan, and South Korea. +• Ongoing product and marketing innovation — At the heart of our Crocs Brand’s DNA are our clogs, sandals, and Jibbitz™ charms, which are key product pillars that we believe will drive long-term growth. We continue to grow our clog silhouette with new designs, colors, graphics, licensed images, embellishments, and accessories, such as Jibbitz™ charms, for personalization. The addition of the HEYDUDE Brand to our portfolio provides an innovative loafer concept that is differentiated through easy on and off, quality, and comfort. From a marketing perspective, we continue +2 +Table of Contents +to invest in globally integrated digital advertising campaigns, as well as designer, celebrity and influencer, and brand partnerships. +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for women, men, and children. We offer a broad portfolio of all-season products, while remaining true to our core casual footwear heritage. +Crocs Brand +Recognized globally for our unmistakable iconic molded clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2023 as we repeatedly brought our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, and increased personalization through our Jibbitz™ charms accessories. +The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, lightweight, non-marking, and odor-resistant qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ products. Our products containing LiteRide™ feature comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +HEYDUDE Brand +The HEYDUDE Brand offers shoes with a versatile silhouette with many wearing occasions that focus on casualization, comfort-led functionality, and personalization. The HEYDUDE Brand utilizes leading technologies including a flex-and-fold outsole and ergonomic insole. The shoes are known for being lightweight, flexible, and soft, with design and functional flexibility for convenience. +Marketing +Each season, we focus on presenting compelling brand stories and experiences for our new product introductions as well as our ongoing core products. We employ social and digital marketing centered on showcasing our clog and sandal silhouettes and our Jibbitz™ charms for the Crocs Brand and our versatile loafer silhouette for the HEYDUDE Brand. We continue to invest in globally integrated marketing campaigns, as well as designer, celebrity and influencer, and brand partnerships, ranging from popular designers like Salehe Bembury to a wide range of well-known brands such as Mossy Oak, Levi’s, and Taco Bell. Innovation is not only core to our brands’ values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our customers to give them new and innovative reasons to continue to choose the Crocs Brand and HEYDUDE Brand. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Environmental, Social, and Governance Initiatives +As one of the world’s largest footwear companies, we strive to make a positive impact on the global footwear industry, for people, and for our planet. Our 2023 Comfort Report, which is expected to be published in the first half of 2024, is our third annual publication that provides an explanation of our progress towards more transparent, socially conscious, and sustainable business practices. Our Comfort Report will be made available on the Investor Relations section of our website located at www.investors.crocs.com. Except where specified otherwise, all information in the forthcoming Comfort Report and below environmental, social, and governance (“ESG”) discussion pertains to Crocs, Inc. as of December 31, 2023. The content provided in our Comfort Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +We intend to continuously advance our business practices towards our goal of consistently delivering products that exceed customer and consumer expectations with neither undue degradation to the planet nor harm to the communities with which we interact globally as part of our effort to create a more comfortable world for all. We believe the progress of our sustainability efforts is best understood by disclosing measurable and relevant goals and metrics, and, to this end, we continue to align our +3 +Table of Contents +reporting with the Sustainability Accounting Standards Board (“SASB”) and Taskforce on Climate-related Financial Disclosures (“TCFD”) frameworks. +Environmental +We are committed to reducing our impact on the environment and are particularly focused on carbon reduction, sustainable operations, and product circularity. +In 2023, we completed a Greenhouse Gas inventory for the Crocs, Inc. enterprise, including both the Crocs and HEYDUDE brands, based on 2022 data. We also redefined our 2021 baseline to account for the HEYDUDE Brand as part of our continued journey to Net Zero by 2040. In the past year, we continued the integration of our sustainable bio-based alternative materials as part of our Croslite™ compound, renewed our membership with the Sustainable Apparel Coalition, joined the Footwear Collective as a founding member, continued to enhance tracking of our energy use, water use, and waste generation, and had three key suppliers complete the Footwear Distributors and Retailers of America (“FDRA”) Footwear Factory Zero Waste Program. +In 2023, we also introduced “Give Old Crocs New Life,” a pilot circularity program in the United States that allows our Crocs consumers to return their gently worn or well-loved Crocs shoes to retail stores in 10 states to be donated to communities in need or repurposed into something new. +More detail on these initiatives, as well as our ambitions, will be provided in our upcoming Comfort Report. +Social +As of December 31, 2023, we employed nearly 7,030 employees globally, including approximately 3,650 employees in our retail stores, 2,040 employees at our corporate/regional offices, and 1,340 employees at our distribution centers. +We believe we have one of the most talented workforce in the footwear industry and continue to improve and implement new initiatives to remain an employer of choice across all of our businesses and geographies. These initiatives include pay transparency in hiring, offering employee training and developing leadership capabilities, enabling meaningful professional experiences, offering a compelling employee value proposition and fair wages, and creating a collaborative culture that “celebrates one-of-a-kinds and stands together with all different kinds.” We strive to create a culture of inclusion through progressive people-practices that support and empower all employees regardless of gender, age, race, ethnicity, national origin, disability, religion, immigration status, or sexual orientation, gender identity, or expressions. We are proud of the workplace culture we have created and will continue to engage our employees to hear where we still have room for improvement. To that end, our regular employee engagement scores continue to meet or surpass industry benchmarks and reflect a highly engaged global workforce. +Our efforts around inclusion, collaboration, and human rights extend through our supply chain. We work to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards, inclusive of occupational safety and chemical safety. In addition, we maintain numerous measures to ensure our supply chain complies with our Social Compliance Code of Conduct, Restricted Substances Policy, and Human Rights Policy, as well as with all local laws and customs regarding hiring practices, wages, and working conditions. +We also seek to extend the reach of our social and environmental standards through our global community giving program. We focus on providing shoes, funds, and employee time to support social inclusion and equality, and respond to our communities’ needs in times of crises. This program is informed by key stakeholder priorities. In 2023, we donated to non-profits such as the United Nations Foundation and Soles4Souls and supported communities impacted by earthquakes in Türkiye, as well as those impacted by the wildfires on Maui. Thanks to the generosity of our consumers and employees, we continue to generate donations to Feeding America, providing meals to families in need. +Governance +Strong corporate governance mechanisms, along with robust internal controls over our financial reporting framework, are the foundation for our progress toward our environmental and social ambitions. The basis of this is our Board of Directors, which was comprised of 29% female and 14% historically underrepresented racial/ethnic members as of December 31, 2023. +4 +Table of Contents +In 2023, our Environmental, Social, and Governance Steering Committee (the “ESG Committee”) of our board of directors (the “Board”), comprised of three independent directors and our Chief Executive Officer, continued its oversight of our ESG efforts and received quarterly updates on the development of our ESG program. Specifically, the ESG Committee assisted the Board in (i) carrying out the responsibilities delegated by the Board regarding the review and oversight of our goals, policies, procedures and disclosures related to sustainability and ESG matters and (ii) its oversight of the sustainability and ESG matters material to us, our employees, our communities, and the planet. Additionally, we regularly review our Enterprise Risk Management and Ethics & Compliance program frameworks to account for our social and environmental risks and opportunities, specifically including those related to climate change. All material findings and updates are elevated to and discussed with our Board. In 2023, Crocs, Inc. expanded its ESG/Sustainability department led by our VP, Global Head of Sustainability, who reports directly to our Chief Executive Officer. +We believe our employees are critical to the maintenance of strong corporate governance and, to that end, we continue to conduct annual in-person and online compliance trainings for all corporate employees, as well as retail and distribution center management. We also maintain a global ethics hotline, which is monitored by our Legal department, should any of our stakeholders identify concerns or have grievances. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 80 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our DTC channel includes e-commerce, in which we sell through company-operated e-commerce sites and third-party marketplaces, and retail, in which we sell through company-operated stores. +Wholesale Channel +During the years ended December 31, 2023, 2022, and 2021, 52.0%, 54.9%, and 50.8% of our consolidated revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international, multi-brand, brick-and-mortar retailers, e-tailers, partner store operators, and international distributors. Brick-and-mortar customers typically include family footwear retailers, national and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +Direct-to-Consumer Channel +Our DTC channel includes company-operated e-commerce sites, third-party marketplaces, company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. During the years ended December 31, 2023, 2022, and 2021, 48.0%, 45.1%, and 49.2%, respectively, of our consolidated revenues were derived through our DTC channel. +E-commerce +As of December 31, 2023, we offered our products through 16 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brand. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Retail +With the continued worldwide consumer shift toward e-commerce, we carefully manage our retail fleet, especially full-priced retail stores. As of December 31, 2023, we had 349 and 14 company-operated stores for the Crocs Brand and HEYDUDE Brand, respectively. +5 +Table of Contents +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2023, we had 84 full-price Crocs Brand retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in our outlet stores as well as built-for-outlet products. As of December 31, 2023, we had 201 Crocs Brand outlet stores. We also had 5 HEYDUDE Brand outlet stores and 9 HEYDUDE Brand temporary clearance stores. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and limited fixed cost and capital investment, we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2023, we had 64 Crocs Brand kiosks and store-in-store locations. +The following table illustrates the net change during 2023 in the number of our company-operated retail stores (inclusive of full-price retail stores, outlet stores, kiosks, and store-in-store locations) by reportable operating segment and country: +December 31, 2022 Opened Closed December 31, 2023 +Crocs Brand +United States 160 7 4 163 +Korea 89 3 1 91 +China 33 5 2 36 +Singapore 16 1 — 17 +Japan 13 2 1 14 +Germany 11 1 1 11 +Canada 8 — — 8 +Austria 3 — — 3 +Puerto Rico 3 — — 3 +France 2 1 1 2 +The Netherlands 2 — 1 1 +Total Crocs Brand 340 20 11 349 +HEYDUDE Brand +United States 5 9 — 14 +Total HEYDUDE Brand 5 9 — 14 +Total 345 29 11 363 +Business Segments and Geographic Information +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 17 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our reportable operating segments. +Raw Materials +Crocs Brand +Croslite™, our proprietary closed-cell resin material, incorporates the primary material formulations used in the vast majority of our Crocs Brand footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, lightweight, non-marking, and odor-resistant footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various sustainability initiatives described in the previous section. +6 +Table of Contents +Croslite™ is produced by compounding elastomer resins purchased from major chemical manufacturers, together with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +HEYDUDE Brand +The primary raw materials for the HEYDUDE Brand are fabrics, including polyester and cotton, Ethylene-vinyl acetate (“EVA”) insoles and outsoles, and other materials such as leather. We purchase this material from a select group of third-party sources, and we believe these materials are broadly available. +Sourcing +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in: +• Vietnam for the Crocs Brand. We have additional third-party manufacturers in China and Indonesia, among other countries. During the years ended December 31, 2023, 2022, and 2021, approximately 56%, 53%, and 56%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the vast majority of operations in Vietnam and China, produced approximately 47%, 42%, and 34% of our production during the years ended December 31, 2023, 2022, and 2021, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 26%, 27%, and 30% of our production during the years ended December 31, 2023, 2022, and 2021, respectively. +• China for the HEYDUDE Brand. During the year ended December 31, 2023, approximately 83% of our HEYDUDE Brand production was in China. +We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available for both brands. See the risk factor under “Risks Related to our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2023, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2023, we further expanded our U.S. distribution centers in Nevada for the HEYDUDE Brand to increase distribution capacity. We also utilized third-party operated distribution centers located in the United States, Japan, China, Australia, Korea, Singapore, India, Brazil, and the United Kingdom. As of December 31, 2023, our company-operated warehouse and distribution facilities provided us with 3.4 million square feet, and our third-party operated distribution facilities provided us with 0.9 million square feet, with additional area available based on inventory levels. We also ship directly to certain of our wholesale customers from our third-party manufacturers, and certain distributors pick up orders directly from our third-party manufacturers. +See the risk factors under “Risks Related to our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results” and “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with distribution and logistics. +7 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks for the Crocs Brand include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. Our major trademarks for the HEYDUDE Brand include the HEYDUDE logo and word mark. The HEYDUDE word mark is registered in the U.S., the European Union, China, and Singapore, among others. Protection for the HEYDUDE logo has been filed in the U.S. and we intend to extend to foreign jurisdictions within the required time period. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, through litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our Crocs Brand footwear covered by our trademark Croslite™ and LiteRide™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our Crocs Brand products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components and confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our Crocs Brand products depend on the properties achieved from the compounding of the Croslite™ and LiteRide™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution networks position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +8 +Table of Contents +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this report) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. \ No newline at end of file diff --git a/raw/filings/0001334036/2023/0001334036-24-000025/item13.txt b/raw/filings/0001334036/2023/0001334036-24-000025/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..8d434eea17b6e66f6184d6faf0c82eb4aae923be --- /dev/null +++ b/raw/filings/0001334036/2023/0001334036-24-000025/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2024 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2023. +52 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2023/0001334036-24-000025/item9a.txt b/raw/filings/0001334036/2023/0001334036-24-000025/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..025c7a5fd77867ac946cee58ac3dee5c23362b2f --- /dev/null +++ b/raw/filings/0001334036/2023/0001334036-24-000025/item9a.txt @@ -0,0 +1,28 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of December 31, 2023. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2023, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2023, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2023. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2023, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +Internal controls over the HEYDUDE financial processes have been implemented and are included in Management’s Evaluation of Disclosure Controls and Procedures for the year ended December 31, 2023. This process resulted in additions and changes to our internal control over financial reporting. Except as described herein, there have been no other changes in our internal control over financial reporting (as such term is defined in Rules 13a through 15(f) and 15(d) through 15(f) under the Exchange Act) that occurred during the three months ended December 31, 2023, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. +49 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2023, of the Company and our report dated February 15, 2024, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 15, 2024 +50 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2023/0001334036-24-000025/rp_note.txt b/raw/filings/0001334036/2023/0001334036-24-000025/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2023/0001334036-24-000025/rpt_disclosure.txt b/raw/filings/0001334036/2023/0001334036-24-000025/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..4b29a447bda29d7fab97b54f5376749d22ffe153 --- /dev/null +++ b/raw/filings/0001334036/2023/0001334036-24-000025/rpt_disclosure.txt @@ -0,0 +1,8 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Since January 1, 2023, there have been no related person transactions in which we were or are to be a participant and the amount involved exceeds $120,000 and in which any current related person had or will have a direct or indirect material interest. +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +Director and Officer Indemnification +We have entered into agreements to indemnify our directors in addition to the indemnification provided for both directors and executive officers in our certificate of incorporation and bylaws. These documents, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. 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+________________________________________________________________________________________________________________________________ +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware 20-2164234 +(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) +500 Eldorado Boulevard , Building 5 +Broomfield , Colorado 80021 +( 303 ) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of the Act: +Title of each class: Trading symbol: Name of each exchange on which registered: +Common Stock, par value $0.001 per share CROX The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +____________________________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ +Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company,” in Rule 12b-2 of the Exchange Act. +Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company Emerging growth company +☒ ☐ ☐ ☐ ☐ +If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ +Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ +If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐ +Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 28, 2024 was approximately $ 7.3 billion. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock, par value $0.001 per share, outstanding as of February 6, 2025 was 56,056,159 . +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant’s proxy statement for the 2025 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2024. +Table of Contents +Cautionary Note Regarding Forward-Looking Statements +This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. +Statements that refer to industry trends, projections of our future financial performance, anticipated trends in our business and other characterizations of future events or circumstances are forward-looking statements. These statements, which express management’s current views concerning future events or results, use words like “anticipate,” “assume,” “believe,” “continue,” “estimate,” “expect,” “future,” “intend,” “plan,” “project,” “strive,” and future or conditional tense verbs like “could,” “may,” “might,” “should,” “will,” “would,” and similar expressions or variations. Examples of forward-looking statements include, but are not limited to, statements we make regarding: +• our expectations regarding future trends expectations, and performance of our business; +• our expectations regarding the impact of economic trends on our business; +• our belief that we have sufficient liquidity to fund our business operations during the next twelve months; +• our expectations about the impact of our strategic plans; and +• our intent to achieve various Corporate Responsibility and Sustainability initiatives. +Forward-looking statements are subject to risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation, those described in Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K , elsewhere throughout this Annual Report on Form 10-K, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission (the “SEC”). Caution should be taken not to place undue reliance on any such forward-looking statements. Moreover, such forward-looking statements speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements, except as required by applicable law. +Risks Factors Summary +Our business is subject to a number of risks and uncertainties, including those described in Part I, Item 1A. Risk Factors of this Annual Report on Form 10-K. These risks include, but are not limited to, the following: +• our substantial dependence on the value of our brands and our failure to strengthen and preserve this value; +• the significant competition that we face; +• introducing new products, which may be difficult and expensive; +• our failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brand; +• our failure to continue to obtain or maintain high-quality endorsers of our products and social media influencers; +• our reliance on technical innovation to compete in the market for our products; +• changes in global economic conditions, which may adversely affect consumer spending and the financial health of our customers and others with whom we do business; +• ongoing wars, which could cause disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations; +• a pandemic, epidemic, or other public health emergency has had an adverse impact, and may have a future material adverse impact, on our business, operations, liquidity, financial condition, and results of operations; +• supply chain disruptions, which could interrupt product manufacturing and global logistics and increase product costs; +• our dependence on third-party manufacturers located outside of the U.S.; +• if we need to replace manufacturers or distribution centers; +• our dependence on the global supply chain and impacts of supply chain constraints and inflationary pressure; +• our inability to accurately forecast consumer demand; +• our third-party manufacturing operations, which must comply with labor, trade, and other laws; +i +Table of Contents +• our dependence on a number of suppliers for key production materials, and any disruption in the supply of such materials; +• changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan, or other global currencies; +• the adverse impact of government actions and regulations, such as export restrictions, tariffs, and other trade protection measures; +• the fact that we conduct significant business activity outside the U.S., which exposes us to risks of international commerce; +• our inability to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products; +• our ability to realize the benefits from the Acquisition; +• our significant reliance on the use of information technology; +• the increasing prevalence of artificial intelligence represents risks and challenges; +• our online e-commerce sites, or those of our customers, not functioning effectively; +• the dependence of our financial success in part on the strength of our relationships with, and the success of, our wholesale and distributor customers; +• the substantial fixed costs we incur with respect to company-operated retail stores; +• if substantial investments in businesses and operations fail to produce expected returns; +• our dependence on employees across the globe; +• periodic litigation, which could result in unexpected expenditures of time and resources; +• global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations; +• the provisions in our restated certificate of incorporation, amended and restated bylaws, and Delaware law that could discourage a third-party from acquiring us; +• increasing scrutiny from investors, regulators, and other key stakeholders with respect to our environmental, social, and governance practices; +• the significant operating and financial restrictions that our Revolving Credit Agreement (as defined herein), the Term Loan B Credit Agreement (as defined herein), and the Indentures (as defined herein) each will impose, on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities; +• our indebtedness as well as the ability to meet payment obligations under our Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Notes (as defined herein); +• our ability to incur substantially more debt; +• that we may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations; +• that we may incur impairments of the carrying value of our goodwill and other intangible assets; +• the fluctuations to which our quarterly revenues and operating results are subject; +• the risks of maintaining significant cash abroad; +• changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation; and +• our failure to meet analyst and investor expectations. +ii +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2024 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +9 +Item 1B. +Unresolved Staff Comments +28 +Item 1C. +Cybersecurity +29 +Item 2. +Properties +30 +Item 3. +Legal Proceedings +30 +Item 4. +Mine Safety Disclosures +30 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +31 +Item 6. +[Reserved] +32 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +33 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +49 +Item 8. +Financial Statements and Supplementary Data +50 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +50 +Item 9A. +Controls and Procedures +50 +Item 9B. +Other Information +52 +Item 9C. +Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +52 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +53 +Item 11. +Executive Compensation +53 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +53 +Item 13. +Certain Relationships and Related Transactions and Director Independence +53 +Item 14. +Principal Accountant Fees and Services +54 +PART IV +Item 15. +Exhibits, Financial Statement Schedule +55 +Item 16. +Form 10-K Summary +60 +Signatures +61 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for all. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. +On February 17, 2022 (the “Acquisition Date”), we acquired (the “Acquisition”) 100% of the equity of a privately-owned casual footwear brand business (“HEYDUDE”). HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The majority of HEYDUDE sales are currently in the United States. +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand, which are discussed in more detail in “Business Segments and Geographic Information” below. +Our Vision +At the heart of our brands are our consumers. We have brands with a broad democratic appeal and accessible price points, which are aligned with global megatrends such as casualization, comfort, and personalization. The philosophy and vision for our brands have been important drivers of our results and, we believe, will continue to be important as we strive to realize the full global potential of our brands. To that end, in 2024, we continued our message of “Come As You Are” for the Crocs Brand and the slogan “Good To Go-To” for the HEYDUDE Brand. +Our enterprise growth priorities are centered around three strategic areas of focus: +• Ignite our icons to drive awareness and relevance for our brands — Central to our Crocs Brand’s DNA are our clogs, sandals, and Jibbitz™ charms, which are key product pillars that we believe will drive long-term growth. Our Classic Clog is our icon, and we continue to grow our broader clog silhouette with new designs, colors, graphics, licensed properties and collaborations. The addition of the HEYDUDE Brand to our portfolio provides opportunity to play in a broader casual footwear market. The brand is known for its versatility, easy on and off characteristics, and comfort. The Wendy and Wally are distinct and innovative loafer silhouettes and represent our icons. +• Drive market share gains across our Tier 1 markets through strategic investment in talent, marketing, digital, and retail — For the Crocs Brand, we are focused on six Tier 1 markets: (i) China, (ii) India, (iii) Japan, (iv) South Korea, (v), the U.S., and (vi) Western Europe. Our international sales in 2024 were 44.1% of Crocs Brand revenues compared to 41.0% and 38.2% in 2023 and 2022, respectively. For the HEYDUDE Brand, which predominantly operates in the United States, we have embarked, and plan to continue to embark, on various marketing activities to drive higher awareness. This includes developing a pipeline of collaborations and brand activations. We have rightsized HEYDUDE’s wholesale distribution footprint and are evolving our channel diversification strategy through the thoughtful development of premium outlet retail stores. At the end of 2024 and 2023, we had a fleet of 52 and 14 HEYDUDE Brand outlet stores, respectively. +Across our portfolio, leading with digital remains a priority. Digital sales include sales directly to consumers through our company-owned websites and third-party marketplaces as well as wholesale sales to our global e-tailers. Our digital sales in 2024 were 37.2% of consolidated revenues, compared to 37.9% and 37.8% of consolidated revenues in 2023 and 2022, respectively. +• Attract new consumers by diversifying our product range and wearing occasions — For the Crocs Brand, we see opportunity to attract new consumers by driving diversification in wearing occasions. We believe sandals are a natural extension of the Crocs Brand and allow us to access new consumers by leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. In addition to the development of our sandals product pillar, we see further opportunity to expand into broader footwear silhouettes and lifestyle occasions. For the HEYDUDE Brand, our primary focus is diversification within our core Wendy and Wally silhouettes, while pursuing natural extensions into sneakers, dress casual, boots and sandals. +2 +Table of Contents +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for all. We offer a broad portfolio of all-season products, while remaining true to our core casual footwear heritage. +Crocs Brand +Recognized globally for our unmistakable iconic molded clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2024 as we repeatedly brought our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, and increased personalization through our Jibbitz™ charms accessories. +The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, and lightweight qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ and Free Feel Technology™ products. Our products containing LiteRide™ and Free Feel Technology™ feature comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +HEYDUDE Brand +The HEYDUDE Brand offers shoes with an iconic and versatile loafer silhouette with many wearing occasions that focus on casualization, comfort-led functionality, and personalization. The HEYDUDE Brand utilizes leading technologies including a flex-and-fold outsole and ergonomic insole. The shoes are known for being lightweight, flexible, and soft, with design and functional flexibility for convenience. +Marketing +Each season, we focus on presenting compelling brand stories and experiences for our new product introductions as well as our ongoing core products. We employ social and digital marketing centered on showcasing our clog, sandal silhouettes, and Jibbitz™ charms for the Crocs Brand and our versatile loafer silhouette for the HEYDUDE Brand. We continue to invest in partnerships including McDonald’s, Toy Story, Simone Rocha, Sydney Sweeney, and Jelly Roll. Innovation is not only core to our brands’ values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our customers to give them new and innovative reasons to continue to choose the Crocs and HEYDUDE brands. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Corporate Responsibility and Sustainability Initiatives +As one of the world’s largest footwear companies, we aim to make a positive impact on the global footwear industry, for people, and for our planet. Our 2024 Comfort Report, which is expected to be published in the first half of 2025, is our fourth annual publication that provides an explanation of our progress towards our purpose of creating a more comfortable world for all. Our Comfort Report will be made available on the Investor Relations section of our website located at www.investors.crocs.com. Except where specified otherwise, all information in the forthcoming Comfort Report and below corporate responsibility and sustainability (“CRS”) discussion pertains to Crocs, Inc. as of December 31, 2024. The content provided in our Comfort Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +We are continuously evaluating our business practices towards our goal of consistently delivering products that exceed customer and consumer expectations while meeting all regulatory and compliance requirements. We believe the progress of our sustainability efforts is best understood through transparent and comparable disclosures and, to this end, we continue to align our reporting with the Sustainability Accounting Standards Board (“SASB”) and the Taskforce on Climate-related Financial Disclosures (“TCFD”) frameworks. +3 +Table of Contents +Environmental +We are committed to taking steps to reduce our impact on the environment and are particularly focused on carbon reduction, sustainable operations, and product circularity. +In 2024, we completed a greenhouse gas inventory for the Crocs, Inc. enterprise, including both the Crocs and HEYDUDE brands, based on 2023 data. We also updated our 2022 and 2021 emissions based on updates in calculation methodology due to more accurate emission factors and advancements in data quality. In 2024, we increased the amount of bio-circular materials in our Croslite™ compound, reaching 25% bio-circular content on a mass balance basis as verified by the International Sustainability and Carbon Certification (“ISCC PLUS”), supporting our journey to Net Zero by 2040. We also maintained our membership with Cascale (formerly the Sustainable Apparel Coalition), continued to progress the work of the Footwear Collective as a founding member and enhanced the tracking of our energy use, water use, and waste generation. +In 2024, we also expanded “Old Crocs New Life,” a circularity program in the United States and Canada that allows our Crocs consumers to return their gently worn or well-loved Crocs shoes to over 160 retail stores or via a mail-back initiative to be donated to communities in need or repurposed into something new. We also launched our first “Keep it Going” classic clog, made of 25% post-consumer recycled content created from Crocs shoes we’ve taken back. +More detail on these initiatives, as well as our ambitions, will be provided in our upcoming Comfort Report. +Social +As of December 31, 2024, we employed more than 7,910 employees globally, including approximately 4,560 employees in our retail stores, 2,300 employees at our corporate/regional offices, and 1,050 employees at our distribution centers. +We believe we have one of the most talented workforces in the footwear industry and continue to improve and implement new initiatives to remain an employer of choice across all of our businesses and geographies. These initiatives include pay transparency in hiring, offering employee training and developing leadership capabilities, enabling meaningful professional experiences, offering a compelling employee value proposition, and creating a collaborative culture. We strive to create a culture of inclusion through people-practices that support and empower all employees. We are proud of the workplace culture we have created. To that end, our regular employee engagement scores continue to reflect a highly engaged global workforce. +Our efforts around inclusion, collaboration, and human rights extend through our supply chain. We work to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards, inclusive of occupational safety and chemical safety. In addition, we maintain numerous measures to ensure our supply chain complies with our Social Compliance Code of Conduct, Restricted Substances Policy, and Human Rights Policy, as well as with local laws and customs regarding hiring practices, wages, and working conditions. +We also seek to extend the reach of our impact through our global community giving program. In 2024, we launched our “Step Up to Greatness” program focused on supporting non-profit partners that help young people build new skills, grow confidence, and open doors to new opportunities. We also partnered with Big Brothers Big Sisters, the largest youth mentoring organization in the United States, to support them in empowering young people. We continued to show up for our communities in times of need, donating shoes and funds in the wake of crises, such as the impacts following the hurricanes in the southeastern United States in 2024. +Governance +Strong corporate governance mechanisms, along with robust internal controls over our financial reporting framework, are the foundation for our progress toward our environmental and social ambitions. The basis of this is our Board of Directors (the “Board”), which was comprised of 22% female and 22% historically underrepresented racial/ethnic members as of December 31, 2024. +In 2024, our Corporate Responsibility and Sustainability Steering Committee (the “CRS Committee”) of our Board, comprised of three independent directors, continued its oversight of our CRS efforts and received quarterly updates on the development of our CRS program. Specifically, the CRS Committee assisted the Board in (i) carrying out the responsibilities delegated by the Board regarding the review and oversight of our goals, policies, procedures and disclosures related to sustainability and CRS matters and (ii) its oversight of the sustainability and CRS matters material to us, our employees, our communities, and the planet. Additionally, we regularly review our Enterprise Risk Management and Ethics & Compliance program frameworks to account for our social and environmental risks and opportunities, specifically including those related to climate change. All +4 +Table of Contents +material findings and updates are elevated to and discussed with our Board quarterly by our Chief Sustainability Officer, who reports directly to our Chief Executive Officer. +We believe our employees are critical to the maintenance of strong corporate governance and, to that end, we continue to conduct annual in-person and online compliance trainings for all corporate employees, as well as retail and distribution center management. We also maintain a global ethics hotline, which is monitored by our Legal department, should any of our stakeholders identify concerns or have grievances. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 80 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). +Wholesale Channel +During the years ended December 31, 2024, 2023, and 2022, 50.3%, 52.0%, and 54.9% of our consolidated revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors. Brick-and-mortar customers typically include family footwear retailers, international, national, and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +Direct-to-Consumer Channel +Our DTC channel includes company-operated e-commerce sites, third-party marketplaces, company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. During the years ended December 31, 2024, 2023, and 2022, 49.7%, 48.0%, and 45.1%, respectively, of our consolidated revenues were derived through our DTC channel. +E-commerce +As of December 31, 2024, we offered our products through 23 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brands. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Retail +With the continued worldwide consumer shift toward e-commerce, we carefully manage our retail fleet, especially full-priced retail stores. As of December 31, 2024, we had 390 and 52 company-operated stores for the Crocs Brand and HEYDUDE Brand, respectively. +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2024, we had 87 full-price Crocs Brand retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in our outlet stores as well as built-for-outlet products. As of December 31, 2024, we had 232 Crocs Brand outlet stores and 52 HEYDUDE Brand outlet stores, of which 9 were clearance locations. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and limited fixed cost and capital investment, we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2024, we had 71 Crocs Brand kiosks and store-in-store locations. +5 +Table of Contents +The following table illustrates the net change during 2024 in the number of our company-operated retail stores (inclusive of full-price retail stores, outlet stores, kiosks, store-in-store locations, and temporary stores) by reportable operating segment and country: +December 31, 2023 Opened Closed December 31, 2024 +Crocs Brand +United States 163 13 4 172 +South Korea +91 4 — 95 +China 36 18 3 51 +Japan 14 7 — 21 +Singapore 17 — — 17 +Germany 11 1 2 10 +Canada 8 2 1 9 +Great Britain — 4 — 4 +Austria 3 — — 3 +Puerto Rico 3 — — 3 +France 2 — — 2 +The Netherlands 1 1 — 2 +Australia +— 1 — 1 +Total Crocs Brand 349 51 10 390 +HEYDUDE Brand +United States 14 39 1 52 +Total HEYDUDE Brand 14 39 1 52 +Total 363 90 11 442 +Business Segments and Geographic Information +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 17 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our reportable operating segments. +Raw Materials +Crocs Brand +Croslite™, our proprietary closed-cell resin material, incorporates the primary material formulations used in the vast majority of our Crocs Brand footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, and lightweight footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various sustainability initiatives described in the previous section. +Croslite™ is produced by compounding elastomer resins, purchased from major chemical manufacturers, with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™ and Free Feel Technology™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +6 +Table of Contents +HEYDUDE Brand +The primary raw materials for the HEYDUDE Brand are fabrics, including polyester and cotton, Ethylene-vinyl acetate (“EVA”) insoles and outsoles, and other materials such as leather and polyurethane. We purchase this material from a select group of third-party sources, and we believe these materials are broadly available. +Sourcing +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in: +• Vietnam for the Crocs Brand. We have additional third-party manufacturers in China, Indonesia, India, and Mexico, among other countries. During the years ended December 31, 2024, 2023, and 2022, approximately 51%, 56%, and 53%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the majority of operations in Vietnam, produced approximately 50%, 47%, and 42% of our production during the years ended December 31, 2024, 2023, and 2022, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 25%, 26%, and 27% of our production during the years ended December 31, 2024, 2023, and 2022, respectively. +• China for the HEYDUDE Brand. We have additional third-party manufacturers in Vietnam, Cambodia, Indonesia, and India. During the years ended December 31, 2024 and 2023, approximately 58% and 83%, respectively, of our HEYDUDE Brand production was in China. During the partial period beginning on the Acquisition Date through December 31, 2022 (the “Partial Period”), the vast majority of production was in China for the HEYDUDE Brand. +We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available for both brands. Nonetheless, see the risk factors under “Risks Related to our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” and “Risks Related to International Operations —Government actions and regulations, such as export restrictions, tariffs, and other trade protection measures could adversely affect our business” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2024, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2024, we further expanded our U.S. distribution centers in Nevada for the HEYDUDE Brand to increase distribution capacity. We also utilized third-party operated distribution centers located in the United States, Japan, China, Australia, South Korea, Singapore, India, Brazil, Canada, the Netherlands, and the United Kingdom. As of December 31, 2024, our company-operated warehouse and distribution facilities provided us with 2.9 million square feet, and our third-party operated distribution facilities provided us with 0.9 million square feet, with additional area available based on inventory levels. We also ship directly to certain wholesale customers from our third-party manufacturers and certain distributors pick up orders directly from our third-party manufacturers or from the port of entry. +See the risk factors under “Risks Related to our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results” and “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with distribution and logistics. +7 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks for the Crocs Brand include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. Our major trademarks for the HEYDUDE Brand include the HEYDUDE logo and word mark. The HEYDUDE word mark is registered in the U.S., the European Union, China, and Singapore, among others. Protection for the HEYDUDE logo has been filed in the U.S. and other countries and has moved to registration in some, including Singapore, the United Kingdom, and Australia among others. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, through litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our Crocs Brand footwear covered by our trademarks Croslite™, LiteRide™, and Free Feel Technology™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our Crocs Brand products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components and confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our Crocs Brand products depend on the properties achieved from the compounding of the Croslite™, LiteRide™, and Free Feel Technology™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. See the risk factor under “Risks Related to our Products — Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brands’ image, and adversely affect our business” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Birkenstock Holding plc., Steven Madden, Ltd., Wolverine World Wide, Inc., and V.F. Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution networks position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, +8 +Table of Contents +and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this Annual Report on Form 10-K) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. +ITEM 1A. Risk Factors +You should carefully consider the following risk factors and all other information presented within this Annual Report on Form 10-K. The risks set forth below are those that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to have a material adverse effect on our business, results of operations, cash flows, financial condition, liquidity, access to sources of financing, or stock price. The risks included here are not exhaustive and there may be additional risks that are not presently material or known. Because we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for us to predict all risk factors, nor can we assess the impact of all such risk factors on our business. Please also refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K. +Risks Related to Our Products +Our success depends substantially on the value of our brands; failure to strengthen and preserve this value, either through our actions or those of our business partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strength of the Crocs and HEYDUDE brands. To be successful in the future, particularly outside of the U.S., where our brands may be relatively less well-known or perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the value of our brands across all sales channels. We may have difficulty managing the image of our brands across markets and international borders as certain consumers may perceive the image of either or both of our brands to be out of style, outdated, or otherwise undesirable. Maintaining, promoting, and growing our brands will depend on our design and marketing efforts, including product innovation and quality, advertising and consumer campaigns, as well as our ability to adapt to a rapidly changing media environment, including our continued reliance on social media and digital dissemination of advertising campaigns. +In the past, several footwear companies, including ours, have experienced periods of rapid growth in revenues and earnings followed by periods of declining revenues and losses, and our business may be similarly affected in the future. Consumer demand for our products and the equity of our brands could also diminish significantly if we, among other things, fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations, or fail to deliver a consistently positive consumer experience in each of our markets. +Adverse publicity about regulatory or legal action against us, or by us, could also damage our reputation and the image of our brands, undermine consumer confidence in us, and reduce long-term demand for our products, even if the regulatory or legal action is unfounded or not material to our operations. Negative claims or publicity involving us, our products, or any of our key employees, endorsers, or business partners could materially damage our reputation and the image of our brands, regardless of whether such claims are accurate. Social media, which accelerates and potentially amplifies the scope of negative publicity, can accelerate, and increase the impact of, negative claims. Further, business incidents that erode consumer trust, such as perceived product safety issues, whether isolated or recurring, in particular incidents that receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our business and financial results. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including unauthorized uses of our trademarks by third parties, could harm our brands and adversely impact our business. See also the risk factor under “Risks Related to our Products — Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brands’ image, and adversely affect our business.” +9 +Table of Contents +We face significant competition. +The footwear industry is highly competitive. Our competitors include most major athletic and non-athletic footwear companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, less reliance on a small number of brands or product lines, and spend substantially more on product marketing than we do. Our competitors’ greater financial resources and capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry and general economic conditions, compete more effectively on the basis of price and production, price their products more aggressively in the face of inflationary or other competitive pressures, launch more extensive or diverse product lines, and more quickly develop new and popular products. Continued demand in the market for casual footwear and readily available offshore manufacturing capacity has also encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our products. If we are unable to compete successfully in the future, our sales and profits may decline, we may lose market share, our business and financial results may deteriorate, and the market price of our common stock would likely fall. +Introducing new products may be difficult and expensive. If we are unable to do so successfully, our brands may be adversely affected, and we may not be able to maintain or grow our current revenue and profit levels. +To successfully continue to evolve our footwear product line to appeal to our consumers, we must anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models, collaborations, and licenses that we introduce may not be successful with consumers or our brands may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, the image of our brands may suffer, our operating performance may decline, and we may not be able to execute our growth plans. +In producing new footwear models, collaborations, and licenses, we may encounter difficulties that we did not anticipate during the product development stage. If we are not able to efficiently manufacture new products in quantities sufficient to support wholesale, retail, and e-commerce distribution, we may not be able to recover our investment in the development of new styles, product lines, collaborations, and licenses, and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style, collaboration, or license may depend on our pricing. We may introduce products that are not popular, set the prices of new styles too high for the market to bear, or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses. There can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts will be successful or that we will dedicate our limited marketing resources to the right product lines. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position, and result in long-term harm to our business and financial results. +See also the risk factor under “Risks Specific to Our Company and Strategy — Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE.” +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brands’ image, and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress, and design rights on nearly all of our products. We believe that having distinctive marks that are readily identifiable trademarks and intellectual property is important to our brands, our success, and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark or design or utility patent infringement or other infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, or it is otherwise found that we infringe on others’ intellectual property rights, continued sales of such competing products by third parties could harm our brands or we may be forced to cease selling certain products, which could adversely impact our business, financial condition, revenues, and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, the integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims +10 +Table of Contents +attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information, and other unpatented proprietary rights and information related to, among other things, the Croslite™ material formulations and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information, and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information, and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement, and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Failure to continue to obtain or maintain high-quality endorsers of our products and social media influencers could harm our business . +We establish relationships with both celebrity endorsers and design, celebrity, and brand collaborators to develop, evaluate, and promote our products, as well as strengthen our brands. In a competitive environment, the costs associated with establishment and retention of these relationships may increase. If we are unable to maintain current associations and/or to establish new associations in the future, this could adversely affect our brands’ visibility and strength and result in a negative impact to financial results. In addition, actions taken by celebrity endorsers and collaborators associated with our products that harm the public image and reputations of those endorsers and collaborators could also seriously harm the image of our brands with consumers and, as a result, could have an adverse effect on our sales and financial condition. +Our marketing and advertising programs are critical to our ability to attract new consumers and retain existing consumers. We are increasingly using digital and social media platforms to drive further engagement with consumers, with a focus on social media influencers. However, we cannot assure that our marketing and advertising programs will be successful or appeal to our target consumers. Ineffective marketing and advertising programs could result in an inefficient use of funds and hinder our ability to maintain brand relevance, attract new consumers or retain existing consumers. +We rely on technical innovation to compete in the market for our products. +Our success relies on continued innovation in both materials and design of footwear, such as our branded Croslite™, LiteRide™, and Free Feel Technology™ materials. Research and development is a key part of our continued success and growth, and we rely on experts to develop and test our materials and products. Croslite™, our branded proprietary closed-cell resin, is the primary raw material used in the vast majority of our Crocs Brand footwear and some of our accessories. Croslite™ is carefully formulated to create soft, durable, extremely lightweight, and water-resistant footwear that conforms to the shape of the foot and increases comfort. We continue to invest in research and development in order to refine our materials to enhance these properties and to develop new properties for specific applications. We strive to produce footwear featuring fun, comfort, color, and functionality. If we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems. +Risks Related to the Economy +Changes in global economic conditions, including, but not limited to, those driven by inflation, may adversely affect consumer spending and the financial health of our customers and others with whom we do business, which may adversely affect our financial condition, results of operations, and cash resources. +Uncertainty about current and future global economic conditions may cause consumers, wholesalers, and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability, and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both globally and in specific markets, that may adversely affect the demand for our products including recessionary economic cycles, higher interest rates, higher fuel and other energy costs, increased labor costs, declines in asset values, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws, public health issues like the COVID-19 pandemic, or other economic factors, certain of which effects, including cost inflation, we experienced in 2023 and 2024 and currently expect to continue to experience in 2025. +11 +Table of Contents +Global inflation, elevated interest rates, global industry-wide logistics challenges, and foreign currency fluctuations resulting in a stronger U.S. Dollar (“USD”), have impacted, and we expect will continue to impact, our business, contributing to, among other things, incremental freight costs, increased wages, particularly in our distribution centers, and increased raw material costs. A stronger USD also results in costs for foreign goods purchased in USD but recognized in foreign currencies (“purchasing power”) that are unfavorable. +If global economic and financial market conditions deteriorate, or remain weak, for an extended period of time, the following factors, among others, could have a material adverse effect on our business and financial results: +• Changes in foreign currency exchange rates relative to the USD could have a material impact on our reported financial results. See the risk factor “Changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan or other global currencies could have a material adverse effect on our business and financial results” for more information. +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers and cause reduced product orders or product order delays or cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, difficulties managing inventories, higher discounts, and lower product margins. +• If consumer demand for our products declines, we may not be able to profitably operate existing retail stores, due to the higher fixed costs associated with our retail business compared to e-commerce distribution. +• A decrease in credit available to our wholesale or distributor customers, product suppliers, and other service providers, or financial institutions that are counterparties to our Revolving Facility (as defined herein) or derivative instruments may result in credit pressures, other financial difficulties, or insolvency for these parties, with a potential adverse impact on our business, our financial results, or our ability to obtain future financing. +• If our wholesale customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations, and/or the need to extend customer payment terms, which could lead to larger balances and delayed collection of our accounts receivable, reduced cash flows, greater expenses for collection efforts, and increased risk of nonpayment of our accounts receivable. +• If our manufacturers or other parties in our supply chain experience diminished liquidity, and, as a result, are unable to fulfill their obligations to us, we may be unable to provide our customers with our products in a timely manner, resulting in lost sales opportunities or a deterioration in our customer relationships, which could in turn negatively impact future sales. +• If we are unable to mitigate the impact of supply chain constraints and inflationary pressure through price increases or other measures, our results of operations and financial condition could be negatively impacted. Furthermore, even if we are able to raise the prices of our products, consumers might react negatively to such price increases, which could have a material adverse effect on, among other things, our brands, reputation, and sales. +In 2024, the Federal Reserve raised interest rates multiple times in response to concerns about inflation, though further interest rate changes remain uncertain. Higher interest rates, coupled with reduced government spending and volatility in financial markets may also increase economic uncertainty and negatively affect consumer spending. Similarly, the ongoing war between Israel and Hamas has created extreme volatility in the global capital markets and is expected to continue to have further global economic consequences, including disruptions of the global supply chain and energy markets. See “ Ongoing wars could cause further disruptions in the global economy as well as a negative impact on our business, financial condition and results of operations .” Any such volatility and disruptions may adversely affect our business or the third parties on whom we rely. If the equity and credit markets deteriorate, including as a result of political unrest or war, it may make any necessary debt or equity financing more difficult to obtain in a timely manner, on favorable terms, or more dilutive. Increased inflation rates have already, and may continue to, adversely affect us by increasing our costs, including labor and employee benefit costs. In addition, higher inflation and macro turmoil and uncertainty could also adversely affect our customers, which could reduce demand for our products. +Ongoing wars could cause further disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations. +The ongoing war between Israel and Hamas as well as the ongoing war between Russia and Ukraine have adversely affected the global economy and have resulted in geopolitical instability. While we derived immaterial revenues from markets in and around these conflict zones in 2024, the instability resulting from these wars could cause an adverse effect on our business, financial +12 +Table of Contents +condition, results of operations, supply chain, intellectual property, partners, customers, or employees should tensions escalate. Further escalation of geopolitical tensions could also result in, among other things, broader impacts that expand into other markets, cyberattacks, supply chain and logistics disruptions, lower consumer demand, and changes to foreign exchange rates and financial markets, any of which may adversely affect our business and supply chain. +A pandemic, epidemic, or other public health emergency has had an adverse impact, and may have a future material adverse impact, on our business, operations, liquidity, financial condition, and results of operations. +Pandemics, including the COVID-19 pandemic, epidemics, and other public health emergencies have, among other things, caused global macroeconomic uncertainty, disrupted consumer spending and supply chains, contributed to various global shipping delays and port congestions, and created significant volatility and disruption of financial markets. For example, global supply chain disruptions during fiscal years 2021 and 2022 negatively impacted our gross margins and net income and any pandemics, epidemics, and other public health emergencies could do so again in the future, which could have a material adverse effect on our business, financial condition, and results of operations. +The effects of a pandemic, epidemic, or other public health emergency could affect our ability to successfully operate in many ways, including, but not limited to, the following factors: +• the impact on the economies and financial markets of the countries and regions in which we operate; +• the impact on our supply chain, including, but not limited to, staffing shortages, closed factories, cost inflation, scarcity of raw materials, scrutiny or embargoing of goods produced in the infected areas, and shipping delays; +• reduced foot traffic at our retail stores and those of our wholesale customers due to forced closures or other operational restrictions, such as reduced capacity limits and operating hours, declines in tourism, and/or potential changes in consumer behavior and shopping preferences; and +• operational risk, including, but not limited to, cybersecurity risks as a result of extended remote work arrangements and restrictions on employee travel. +Risks Related to Our Supply Chain +Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs. +We rely on third-party manufacturers outside of the U.S. to produce our products. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +We also rely on international shipping to transport our products to their various geographic markets. During the year ended December 31, 2022, international shipping to the U.S. was disrupted and delayed due to congestion in west coast ports. Continued or additional delays in shipping may cause us to have to use more expensive air freight or other more costly methods to ship our products. During the year ended December 31, 2022, our third-party manufacturers, distribution centers, where we manage our inventory, and our third-party partners experienced disruptions that impacted our supply chain and increased global lead-time for our products, including port congestion, temporary closures, and worker shortages. Additionally, as a consequence of the COVID-19 pandemic, reductions in the number of ocean carrier voyages and capacity delayed the arrival of imports and increased ocean transport costs globally. We are facing challenges related to extended ocean transit times due to ongoing disruptions, including port strikes and delays at key transit points such as the Red Sea, Suez Canal, and Panama Canal. While these disruptions did not have a significant impact on our 2024 results, these factors, along with other global logistical issues, are contributing to continued unpredictability in ocean transportation. Additionally, supply chain labor costs have remained a significant pressure over the past 18 months, as meaningful increases in pay rates were implemented to ensure a sufficient and stable workforce. As supply chain disruptions continue and we manage product availability, the timing of sales to our wholesale partners and consumers may continue to be impacted, and we face increased risk of order cancellations. In addition, global inflation has contributed to already higher incremental freight costs and such inflation may continue to result in higher freight costs. Failure to adequately produce and timely ship our products to customers could lead to lost potential revenue, failure to meet customer demand, strained relationships with customers, including wholesalers, and diminished brand loyalty. +Despite our actions to mitigate these impacts, we have been negatively impacted by global logistics challenges in the past. For example, during the year ended December 31, 2022, we expended $67 million on an air freight program initiated as a result of partial COVID-19-related factory closures in Vietnam at the end of 2021. +13 +Table of Contents +We depend solely on third-party manufacturers located outside of the U.S. +All of our footwear products are manufactured by third-party manufacturers, the majority of which are located in Vietnam, China, Indonesia, India, and Mexico. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity, and meet our quality standards. We compete with other companies for the production capacity of our third-party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, from time to time we have experienced delays or inabilities to fulfill customer demand and orders, as discussed in more detail below. During the years ended December 31, 2024, 2023, and 2022, approximately 51%, 56%, and 53%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the majority of operations in Vietnam, produced approximately 50%, 47%, and 42% of our production during the years ended December 31, 2024, 2023, and 2022, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 25%, 26%, and 27% of our production during the years ended December 31, 2024, 2023, and 2022, respectively. During the years ended December 31, 2024 and 2023, approximately 58% and 83%, respectively, of our HEYDUDE Brand production was in China. During the Partial Period, the majority of production was in China for the HEYDUDE Brand. We cannot guarantee that any third-party manufacturer will have sufficient production capacity, meet our production deadlines, or meet our quality standards. Furthermore, due to the relative concentration of our third-party manufacturers, we may be subject to an increased risk of supply chain disruption, particularly in the event of a natural disaster, pandemic, such as the COVID-19 pandemic, epidemic, geopolitical tension, or other event impacting the region outside of our control. In addition, disruption at the facilities of our third-party manufacturing partners as a result of COVID-19 or otherwise, including through the effects of facility closures, reductions in operating hours and labor shortages had an adverse effect on our supply chain in 2021 and 2022 and may have a material adverse effect in the future. For example, at the end of 2021 and into the first quarter of 2022, many of our third-party manufacturing facilities in Vietnam were closed or not operating at full capacity due to local COVID-19 outbreaks and safety protocols, which negatively impacted our financial results. See the risk factor under “ Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs” and “Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results.” +Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, including those caused by the COVID-19 pandemic, work stoppages, political instability, including the ongoing war between Israel and Hamas, the ongoing war between Russia and Ukraine, expropriation, nationalization, foreign currency fluctuations, changing economic conditions, cost inflation, changes in governmental policies or laws, and the imposition of tariffs, import and export controls, and other barriers. Because we do not manufacture products internally, we cannot offset any interruption or decrease in supply of our products by increasing production in internal manufacturing facilities, and we may not be able to substitute suitable alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. For example, during the year ended December 31, 2022, we incurred approximately $67 million on an air freight program initiated as a result of partial COVID-19-related factory closures in Vietnam at the end of 2021. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can increase our transportation costs and adversely affect our product margins. +In addition, because our footwear products are manufactured outside the U.S., the possibility of adverse changes in trade or political relations between the U.S. and other countries, political instability, changes in legislation and policies, increases in labor costs, changes in international trade agreements and tariffs, adverse weather conditions, or public health issues, such as the COVID-19 pandemic, could significantly interfere with the production and shipment of our products, which would have a material adverse effect on our operations and financial results. +See the risk factors under “Risks Related to International Operations — Government actions and regulations, such as export restrictions, tariffs, and other trade protection measures could adversely affect our business” and “Risks Related to International Operations — We conduct significant business activity outside the U.S., which exposes us to risks of international commerce.” +Our business could suffer if we need to replace either our third-party manufacturers or our distribution centers. +We do not own or operate any manufacturing facilities and depend exclusively on third-party manufacturers to manufacture our products, the majority of which are located in Vietnam, China, and Indonesia. Accordingly, our success depends, in part, on our ability to identify reputable third-party manufacturers who can fulfill our orders timely and to our requirements, as well as the timely importation, customs clearance, and shipment of products to and from our various distribution centers. We also compete +14 +Table of Contents +with other companies for the production capacity of our third-party manufacturers. Some of these competitors may place larger orders than we do, and, as a result, may have an advantage or priority in securing production capacity. If we experience a significant increase in demand, or if an existing third-party manufacturer needs to be replaced, we may have to expand our third-party manufacturing capacity. We cannot guarantee that this potential additional capacity will be available when needed or on terms that are acceptable to us. We also enter into purchase order commitments specifying a time for delivery, method of payment, design and quality specifications, and other standard industry terms and conditions, but we do not have long-term contracts with any third-party manufacturer. Furthermore, none of the third-party manufacturers we use produce our products exclusively. +In addition, we rely on a number of company-operated and third-party operated distribution facilities around the world to warehouse and ship products to our customers and to our retail stores and perform other related logistics services. Our ability to meet our needs and the needs of our customers depends, in part, on the operation of these distribution centers. Our distribution centers generally utilize computer-controlled and automated equipment, which are subject to various risks, including software viruses, security breaches, power interruptions, or other system failures. If any of our distribution centers were to close or become inoperable or inaccessible for any reason, including, but not limited to, natural disasters, severe weather, labor shortages, fires, system failures, and/or pandemics, or if we fail to successfully consolidate existing facilities or transition to new facilities, we could experience a substantial loss of inventory, disruption of deliveries to our customers and our retail stores, increased costs, and longer lead times associated with the distribution of our products during the period that would be required to reopen or replace the facility. Any such disruptions could have a material adverse effect on our business, financial condition and results of operations. +We also rely upon third-party transportation providers for substantially all of our product shipments, including shipments to and from our distribution centers to our retail stores, and to our wholesale and DTC customers. Our utilization of these shipping services is subject to various risks, including, but not limited to, potential labor shortages (stemming from labor disputes, strikes, or otherwise), severe weather, and pandemics, which could delay the timing of shipments, and increases in wages and fuel prices, which could result in higher transportation costs. The continued increase in popularity of online shopping driven by changes in consumer shopping preferences has amplified certain of these risks, oftentimes resulting in capacity constraints. We have incurred, and may continue to incur, higher freight and other logistics costs as a result of certain of the foregoing factors. Any delays in the timing of our product shipments or increases in transportation costs could have a material adverse effect on our business, financial condition and results of operations. +Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results. +Our operations have been, and may continue to be, impacted by supply chain constraints and raw material shortages, resulting in increased material costs, longer lead times, port congestion, and increased freight costs, the uncertain economic environment, and macroeconomic trends. In addition, current or future governmental policies may increase the risk of inflation, which could further increase the costs of raw materials and components for our business. Similarly, if costs of goods continue to increase, our suppliers may seek price increases from us. If we are unable to mitigate the impact of supply chain constraints and inflationary pressure through price increases or other measures, our gross margins, results of operations and financial condition could be negatively impacted. Even if we are able to raise the prices of our products, consumers might react negatively to such price increases, which could have a material adverse effect on, among other things, our brands, reputation, and sales. If our competitors substantially lower their prices, we may lose customers and mark down prices. Our profitability may be impacted by lower prices, which may negatively impact gross margins. We are unable to predict the impact of these constraints on the timing of revenue and operating costs of our business in the near future. Raw material supply shortages and supply chain constraints, including cost inflation, have impacted, and could continue to negatively impact our ability to meet consumer demand, which in turn has impacted, and could in the future impact our net sales revenues and market share. In addition, COVID-19 related closures negatively impacted our supply chain in Vietnam in the first quarter of 2022 and in China in the second quarter of 2022. See the risk factor under “Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs.” +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting consumer demand. In addition, purchase orders from our wholesale customers are generally subject to rights of cancellation and rescheduling by the wholesaler. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in losses or lower gross margins. +15 +Table of Contents +Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in lower sales, delays in shipments to customers, and expedited shipping costs, and adversely affect our relationships with our customers and diminish brand loyalty. Excess inventory, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and financial results. +Our third-party manufacturing operations must comply with labor, trade, and other laws. Failure to do so may adversely affect us. +We require our third-party manufacturers to meet our quality control standards and footwear industry standards for working conditions and other matters, including compliance with applicable labor, environmental, and other laws; however, we do not control our third-party manufacturers or their respective labor practices. A failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental, and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brands, and discourage customers from buying our products. We also require our third-party manufacturers to meet certain product safety standards. A failure by any of our third-party manufacturers to adhere to such product safety standards could lead to a product recall, which could result in critical media coverage; harm our business, brands, and reputation; and cause us to incur additional costs. Additionally, our industry is subject to significant pricing pressure caused by many factors, including, but not limited to, continued inflationary pressure, intense competition and a highly promotional retail environment, consolidation in the retail industry, pressure from retailers to reduce the costs of our products, excess inventory levels in the marketplace, and changes in consumer spending habits and patterns. Although we plan to limit our promotional activity, these foregoing factors may require us to reduce our sales prices to retailers and consumers, which could cause our gross margin to decline. If our sales prices decline and we fail to sufficiently reduce our product costs or operating expenses, our profitability will, in turn decline. In addition, changes in our customer, channel, and geographic sales mix could have a negative impact on our profitability. Any of these outcomes could have a material adverse effect on our business, financial condition, and results of operations. +In addition, if we or our third-party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import, or the loss of our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, and fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes other charges, or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business or results of operations. See the risk factor under “We depend solely on third-party manufacturers located outside the U.S.” for more information. +For example, China’s Xinjiang Uyghur Autonomous Region (the “XUAR”) is the source of large amounts of cotton and textiles for the global apparel and footwear supply chain. The United States Treasury Department placed sanctions on China’s Xinjiang Production and Construction Corporation (“XPCC”) for serious human rights abuses against ethnic minorities in XUAR. Additionally, the Uyghur Forced Labor Prevention Act (“UFLPA”) empowers the U.S. Customs and Border Protection Agency (the “U.S. CBP”) to withhold release of items produced in whole or in part in the XUAR, or produced by companies included on a government-created UFLPA entity list, creating a presumption that such goods were produced using forced labor. XPCC controls many of the cotton farms and much of the textile industry in the region, and many large factories in XUAR produce fabrics and yarn for apparel and footwear. +Although we do not believe that our suppliers source materials from such area of China for the products they sell to us or use to manufacture our products, we have no known involvement with XPCC or its subsidiaries and affiliates, and we prohibit our suppliers from doing business with XPCC or using forced labor, we do not have the ability to completely map our supply chain, and we could be subject to penalties, fines or sanctions if any of the suppliers from which we purchase goods is found to have dealings, directly or indirectly, with XPCC or entities it controls. Additionally, our products or materials (including potentially non-cotton materials) could be held or delayed by the U.S. CBP, which would cause delays and unexpectedly and negatively affect our inventory levels. Even if we were not subject to penalties, fines or sanctions, if products we source are linked in any way to XPCC, the XUAR, or an entity on the UFLPA entity list, our reputation could be damaged. In addition, the UFLPA has induced greater supply chain compliance costs and delays to us and to our suppliers. Compliance with the UFLPA could continue to affect the global supply chain, the price and scarcity of traceable cotton in the marketplace and could lead to an increase in our cost of goods sold, which may have an adverse effect on our profitability. +See the risk factor under “ Risks Related to International Operations — We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. ” +16 +Table of Contents +We depend on a number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs. +We depend on a number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite™, LiteRide™, and Free Feel Technology™ formulations, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production schedules. We are also subject to market conditions related to supply and demand for our raw materials and any resulting shortages in supply, as well as impacts of any global shipping or logistics delays. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have an adverse impact on our product margins. If we are unable to obtain suitable elastomer resins, or if we are unable to procure sufficient quantities of the materials that go into the Croslite™, LiteRide™, and Free Feel Technology™ formulations, we may not be able to meet our production requirements in a timely manner or may need to modify our product characteristics, which could result in less favorable market acceptance, lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Risks Related to International Operations +Changes in foreign exchange rates, most significantly but not limited to the Euro, South Korean Won, and Chinese Yuan or other global currencies could have a material adverse effect on our business and financial results. +As a global company, we have significant revenues and costs denominated in currencies other than the USD. We are exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities within our international subsidiaries that are denominated in currencies other than the subsidiaries’ functional currencies. Likewise, our U.S. subsidiaries are also exposed to the risk of losses resulting from changes in exchange rates on monetary assets and liabilities that are denominated in a currency other than the USD. We have experienced, and will continue to experience, changes in exchange rates, impacting both our statements of income and the value of our assets and liabilities denominated in foreign currencies. +In accordance with our operating practices, we hedge a significant portion of our foreign currency transaction exposures arising in the ordinary course of business to reduce risks in our cash flows and earnings. We use cash flow hedges to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. Currency forward agreements involve fixing the exchange rates for delivery of a specified amount of foreign currency on a specified date. The currency forward agreements are typically settled in USD for their fair value at or close to their settlement date. We may also use currency option contracts under which we will pay a premium for the right to sell a specified amount of a foreign currency prior to the maturity date of the option. Our hedging strategy may not be effective in reducing all risks, and no hedging strategy can completely insulate us from foreign exchange risk. Further, our use of derivative financial instruments may expose us to counterparty risks. Although we only enter into hedging contracts with counterparties having investment grade credit ratings, it is possible that the credit quality of a counterparty could be downgraded or a counterparty could default on its obligations, which could have a material adverse impact on our financial condition, results of operations, and cash flows. +Further, our ability to sell our products in foreign markets and the USD value of the sales made in foreign currencies can be significantly influenced by changes in exchange rates. A decrease in the value of foreign currencies relative to the USD could result in lower revenues, gross margin compression, and increased losses from currency exchange rates. Foreign exchange rate volatility could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. For the Crocs Brand, we pay the majority of our third-party manufacturers, located primarily in Vietnam and China, in USD. For the HEYDUDE Brand, we pay the majority of our third-party manufacturers, located primarily in China, in Chinese Yuan. In 2024, we experienced decreases of approximately $29.8 million in our Crocs Brand segment revenues, primarily as a result of decreases in the value of the South Korean Won, Brazilian Real, Japanese Yen, and Chinese Yuan relative to the USD. Strengthening of the USD against Asian and European currencies, and various other global currencies, adversely impacts our USD reported results due to the impact on foreign currency translation. While we enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates on monetary assets and liabilities, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and, as a result, our forward contracts may not prove effective in reducing our exposures. +17 +Table of Contents +Government actions and regulations, such as export restrictions, tariffs, and other trade protection measures could adversely affect our business. +We, similar to many other companies with overseas operations, import and sell products in other countries that could be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, trade restrictions, or economic sanctions). Such changes have the potential to adversely impact our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition, and results of operations. +For example, in February 2025, the current U.S. presidential administration has imposed tariffs on foreign imports into the United States, including, most relevant to us, an additional 10% tariff on all imports from China and an additional 25% tariff on all imports from Mexico, which tariffs on imports from Mexico were subsequently suspended for 30 days in order to facilitate negotiations. As of the date of this Annual Report, the proposed tariffs on all imports from Mexico remain suspended. A predominant portion of the products we sell are originally manufactured in countries other than the U.S., such as China and Mexico. These tariffs will increase the cost of certain products and negatively impact our results of operations. At this time, it remains unclear what additional actions, if any, will be taken by the U.S. or other governments with respect to international trade agreements, the imposition of additional tariffs on goods imported into the U.S., tax policy related to international commerce, increased export control, sanctions and investment restrictions, or other trade matters. Although the ultimate scope and timing of any such actions is currently indeterminable, if implemented, they could have a material impact on our financial condition and results of operations. +Other effects of these changes, including impacts on the price of raw materials, responsive or retaliatory actions from governments, such as retaliatory tariffs on imports into China and Mexico from the U.S. and the opportunity for competitors not subject to such changes to establish a presence in markets where we participate, could also have significant impacts on our results of operations, though whether any of the foregoing actions will be taken remains unclear. Furthermore, we may not be able to increase prices for our products enough to offset tariffs, which could impact our margins. If we raise prices in response to tariffs, the demand for our products may go down, which could have a negative impact on our sales. We cannot predict what further action may be taken with respect to export restrictions, tariffs or trade relations between the U.S. and other governments, and any further changes in U.S. or international trade policy could have an adverse impact on our business, financial condition and results of operations. See also the risk factor under “We conduct significant business activity outside the U.S., which exposes us to risks of international commerce.” +We conduct significant business activity outside the U.S., which exposes us to risks of international commerce. +A significant portion of our revenues is generated from foreign sales. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations. We operate retail stores and sell our products to retailers outside of the U.S. and utilize foreign-based third-party manufacturers. Foreign manufacturing and sales activities are subject to numerous risks, including: +• tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; +• delays associated with the manufacture, transportation, and delivery of products, including related to global port backlog or congestion; +• increased transportation costs due to distance, energy prices, inflation, or other factors; +• delays in the transportation and delivery of goods due to increased security concerns; +• restrictions on the transfer of funds; +• restrictions and potential penalties due to privacy laws on the handling and transfer of consumer and other personal information; +• changes in governmental policies and regulations; +• political unrest, such as the ongoing war between Israel and Hamas, changes in law, terrorism, natural disasters, or public health issues like the COVID-19 pandemic, any of which can interrupt commerce; +• potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws; +• expropriation and nationalization; +18 +Table of Contents +• difficulties in managing foreign operations effectively and efficiently from the U.S.; +• difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions; +• longer accounts receivable payment terms and difficulties in collecting foreign accounts receivables; +• difficulties in enforcing contractual and intellectual property rights; +• greater risk that our business partners do not comply with our policies and procedures relating to labor, health, and safety; +• UFLPA detentions by U.S. CBP resulting in revenue loss and adverse media exposure; and +• increased accounting and internal control costs. +In addition, we are subject to customs laws and regulations with respect to our export and import activity, which are complex and vary within legal jurisdictions in which we operate. We cannot ensure there will not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations. For example, in 2021, the UFPLA, which effectively prohibits imports of any goods made either wholly or in part in a certain area of China, was signed into law, which generally prohibits importing goods made with forced labor into the U.S., subject to certain exceptions. While we do not currently expect that this law will directly affect our supply chain, since we do not believe that our suppliers source materials from such area of China for the products they sell to us or use to manufacture our products, other companies’ attempts to shift suppliers in response to this law or other policy developments could result in, among other things, shortages, delays, and/or price increases that could disrupt our own supply chain or cause our suppliers to renegotiate existing arrangements with us or fail to perform on such obligations. In addition, the ongoing war between Israel and Hamas as well as the ongoing war between Russia and Ukraine has adversely affected the global economy. For more information, please see the risk factors under “Risks Related to the Economy — Ongoing wars could cause further disruptions in the global economy as well as a negative impact on our business, financial condition, and results of operations,” “Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside the U.S.,” “ Risks Related to our Supply Chain — Our third-party manufacturing operations must comply with labor, trade, and other laws. Failure to do so may adversely affect us ,” and “Risks Specific to Our Company and Strategy — Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results.” +Furthermore, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties; criminal sanctions against us, our officers, or our employees; prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries; and a materially negative effect on our brands and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners, or agents will not violate our policies. +Risks Specific to Our Company and Strategy +We may be unable to successfully execute our long-term growth strategy, maintain or grow our current revenue and profit levels, or accurately forecast demand and supply for our products. +Our ability to maintain our revenue and profit levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brands’ image, our ability to bring compelling and profit enhancing footwear offerings to market, our ability to effectively manage or reduce expenses and our ability to expand within our current distribution channels and increase sales of our products into new locations internationally. +In addition, our ability to realize the benefits from the Acquisition is substantially dependent on our ability to grow and integrate HEYDUDE. If we are unsuccessful at, among other things, building HEYDUDE’s brand awareness, enhancing its digital capabilities, leveraging our wholesale relationships to enhance distribution, investing in HEYDUDE’s infrastructure as well as sales and business operations, leveraging our distribution for global growth and/or investing to scale our supply chain +19 +Table of Contents +and gain efficiencies, our sales could be adversely affected, and our business could suffer. In addition, HEYDUDE’s product sales may not meet our expectations. See the risk under “— Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE.” +Successfully executing our long-term growth and profitability strategy will depend on many factors, including our ability to +• strengthen and maintain our brands; +• focus on relevant geographies and markets, product innovation, and profitable growth, while maintaining demand for our current offerings; +• effectively manage our company-operated retail stores to meet operational and financial targets at the retail store level; +• accurately forecast the global demand for our products, consolidate our distribution and supply chain network to leverage resources, simplify our fulfillment process, and deliver product around the globe efficiently; +• use and protect the Crocs and HEYDUDE brands and our other intellectual property in new and existing markets and territories; +• achieve and maintain a strong competitive position in new and existing markets; +• attract and retain qualified wholesalers and distributors, including partner store operators; +• maintain and enhance our digital marketing capabilities and digital commerce capabilities; and +• execute multi-channel advertising, marketing, collaboration, and social media campaigns to effectively communicate our message directly to our consumers and employees. +While these strategies, along with other steps to be taken, are intended to improve and grow our business, there can be no assurance this will be the case or that additional steps or accrual of additional material expenses or accounting charges will not be required. If additional steps are required, there can be no assurance that they will be properly implemented or will be successful. +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to grow HEYDUDE. +Our ability to realize the benefits from the Acquisition is substantially dependent on our ability to continue to grow HEYDUDE. Combining with Crocs, Inc. may not accelerate the growth and success of HEYDUDE, and the HEYDUDE business may not perform as expected. If we are unsuccessful at, among other things, building HEYDUDE’s brand awareness, enhancing its digital capabilities, leveraging our wholesale relationships to enhance distribution, investing in HEYDUDE’s infrastructure as well as sales and business operations, leveraging our distribution for global growth and/or investing to scale our supply chain and gain efficiencies, our sales could be adversely affected, and our business could suffer. In addition, HEYDUDE’s product sales may not meet our expectations. +Moreover, HEYDUDE depends on a limited number of third-party manufacturers that are concentrated in China to produce its +products. Due to the relative concentration of HEYDUDE’s third-party manufacturers, disruption at the facilities of such third-party manufacturing partners, including through the effects of facility closures, reductions in operating hours and labor shortages may have a material adverse effect in the future. See the risk factors under “ Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and increase product costs ,” “ Risks Related to Our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results ,” and “ Risks Related to Our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S. ” +Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results. +We rely heavily on the use of information technology systems and networks across all business functions, as do our business partners. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, internet activity, and other network processes. We also rely on third-party information services providers worldwide for many of our information technology functions including network, hardware, and software configuration. Additionally, we rely on internal networks and information systems and other technology, including the internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing, and collection of payments. In addition, we use information systems for certain +20 +Table of Contents +human resource activities and to process our employee benefits, as well as to process financial information for internal and external reporting purposes and to comply with various reporting, legal, and tax requirements. We also have outsourced a significant portion of work associated with our finance and accounting, human resources, customer service, and other information technology functions to third-party service providers. +In addition, we continuously assess and implement upgrades to improve our information technology systems globally. The expansion of our systems and infrastructure has required, and will continue to require, us to commit substantial financial, operational and technical resources. The development and implementation of new systems and any other future upgrades to our systems and information technology may require significant costs and divert our management’s attention and other resources from our core business. There are also no assurances these new systems and upgrades will provide us with the anticipated benefits and efficiencies. Similarly, the time and resources that management will need to devote to operations and upgrades, any delays due to the installation of any upgrade (and customer issues therewith), any resulting service outages, or the impact on the reliability of our data from any upgrade or any legacy system, may have a material adverse effect on our business, financial condition, control environment or results of operations. During these implementation periods, we also face a heightened risk of system interruptions and deficiencies or failures in our internal controls involving our information systems and processes. As a result, we could be adversely affected by system or network disruptions if new or upgraded information technology systems are defective, not installed properly or not properly integrated into our operations. Accordingly, system modification or integration failures could have a material adverse effect on our business, financial position, and results of operations. +Furthermore, despite our current security and cybersecurity measures, our systems and those of our third-party service providers may be vulnerable to information security breaches, acts of vandalism, computer viruses, credit card fraud, phishing, ransomware attacks, and interruption or loss of valuable business data, and we have been subject to, and will continue to be subject to, various third-party attacks and phishing scams. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being unable to perform duties or communicate throughout the organization, loss of sales, significant costs for data restoration, the inability to interpret data timely to enhance operations, and other adverse impacts on our business and reputation. Denial of service attacks could also materially adversely affect our business. +We routinely possess sensitive customer and employee information. Hackers and data thieves are increasingly sophisticated and operate large-scale and complex automated attacks on a daily basis. Any breach of our network may result in the loss of valuable business data, misappropriation of our consumers’ or employees’ personal information, including credit card information, or a disruption of our business. Despite our existing cybersecurity procedures and controls, if our network is breached, it could give rise to unwanted media attention, materially damage our customer relationships, or harm our business, our reputation, and our financial results, which could result in fines or lawsuits. The costs we incur to protect against such information security breaches may materially increase, including increased investment in technology, the costs of compliance with consumer protection laws, and costs resulting from consumer fraud. Our business partners in our supply chain and customer base also rely significantly on information technology. Despite their existing cybersecurity procedures and controls, if their information systems become compromised, it could, among other things, cause delays in our product fulfillment or reduce our sales, which could harm our business. See Item 1C. Cybersecurity of this Annual Report on Form 10-K for more information on risks associated with cybersecurity procedures and controls. +In addition, the European Union’s General Data Protection Regulation, the California Consumer Privacy Act, and other similar evolving privacy laws impose additional obligations on companies regarding the handling of personal data and provide certain individual privacy rights to persons whose data is stored. These regulations may harm or alter the operations of our e-commerce business, add additional compliance costs and obligations, and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes and the associated costs may have a material adverse impact on our business and results of operations. Increased scrutiny by federal regulators, such as the Federal Trade Commission, and state attorney generals focused on the retail industry may cause us to experience increased privacy and cybersecurity costs such as, but not limited to, organizational changes, deploying additional personnel, acquiring and implementing enhanced privacy and security technologies on our e-commerce sites, mandatory employee training for those employees handling customer and employee personal data, engaging third-party experts and consultants, and the impact of unauthorized use of proprietary information, each of which may materially and adversely affect our business, financial condition and results of operations. +Finally, the SEC has adopted rules that require us to provide greater disclosures around cybersecurity risk management, strategy and governance, as well as disclose the occurrence of material cybersecurity incidents. These rules and regulations may also require us to report a cybersecurity incident before we have been able to fully assess its impact or remediate the underlying issue. Efforts to comply with such reporting requirements could divert management’s attention from our incident response and could potentially reveal system vulnerabilities to threat actors. Failure to timely report incidents under these or other similar rules could also result in monetary fines, sanctions, or subject us to other forms of liability. This regulatory environment is +21 +Table of Contents +increasingly challenging and may present material obligations and risks to our business, including significantly expanded compliance burdens, costs and enforcement risks. +Artificial intelligence presents risks and challenges that can impact our business including by posing security risks to our confidential information, proprietary information, and personal data. +Issues in the development and use of artificial intelligence, combined with an uncertain regulatory environment, may result in reputational harm, liability, or other adverse consequences to our business operations. As with many technological innovations, artificial intelligence presents risks and challenges that could impact our business. We have adopted and integrate generative artificial intelligence tools into our systems for specific use cases, such as marketing, product creation, planning, and general company operations, reviewed by legal and information security, and may continue to do so. Our vendors may incorporate generative artificial intelligence tools into their offerings without disclosing this use to us, and the providers of these generative artificial intelligence tools may not meet existing or rapidly evolving regulatory or industry standards with respect to privacy and data protection and may inhibit our or our vendors’ ability to maintain an adequate level of service and experience. If we, our vendors, or our third-party partners experience an actual or perceived breach of privacy or security incident because of the use of generative artificial intelligence, we may lose valuable intellectual property and confidential information and our reputation and the public perception of the effectiveness of our security measures could be harmed. Further, bad actors around the world use increasingly sophisticated methods, including the use of artificial intelligence, to engage in illegal activities involving the theft and misuse of personal information, confidential information, and intellectual property. Any of these outcomes could damage our reputation, result in the loss of valuable property and information, and adversely impact our business. +If our online e-commerce sites, or those of our customers, do not function effectively, our business and financial results could be materially adversely affected. +An increasing amount of our products are sold on our e-commerce sites and third-party e-commerce sites. Consumers are also increasingly using mobile-based applications to engage with us and our competitors through digital experiences that are offered on mobile platforms, and we are increasingly using social media to interact with our consumers as a means to enhance their shopping experience. Any failure on our part or on the part of third parties to provide effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of our products and that continually meet the evolving expectations of online shoppers or any failure to provide attractive digital experiences could place us at a competitive disadvantage, result in the loss of sales, and could have a material adverse impact on our business and financial results. Our e-commerce business may be particularly vulnerable to cyber threats including unauthorized access and denial of service attacks. Sales in our e-commerce channel may also divert sales from our retail and wholesale channels. +Our financial success depends in part on the strength of our relationships with, and the success of, our wholesale and distributor customers. +Our financial success is related to the willingness of our current and prospective wholesale and distributor customers to carry our products. We do not have long-term contracts with most wholesale customers, and sales to these customers are generally on an order-by-order basis and subject to cancellation and rescheduling. Our contracts with distributors typically have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. If we cannot fill orders in a timely manner, the sales of our products and our relationships may suffer. Alternatively, if our wholesalers or distributors experience diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in order cancellations and/or the need to extend payment terms, which could lead to larger outstanding balances, delays in collections of accounts receivable, increased expenses associated with collection efforts, increases in bad debt expenses, and reduced cash flows if our collection efforts are unsuccessful. We have recorded material allowances for doubtful accounts in the past and could do so again in the future. Future problems with customers may have a material adverse effect on our product sales, financial condition, results of operations, and our ability to grow our product line. +Operating company-operated retail stores incurs substantial fixed costs. If we are unable to generate sales, operate our retail stores profitably, or otherwise fail to meet expectations, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. +Opening and operating company-operated retail stores requires substantial financial commitments, including fixed costs, and are subject to numerous risks including consumer preferences, location, and other factors that we do not control. Declines in revenue and operating performance of our company-operated retail stores could cause us to record impairment charges and have a material adverse effect on our business and financial results. During 2024, we opened 90 and closed 11 retail stores, and we operated 442 retail stores at December 31, 2024. +22 +Table of Contents +Many of our company-operated retail stores are located in shopping malls and outlet malls, and our success depends in part on obtaining prominent locations and the overall ability of the malls to successfully generate and maintain customer traffic. We cannot control the success of individual malls or store closures by other retailers, which may lead to mall vacancies and reduced customer foot-traffic. In addition, consumer spending and shopping preferences have shifted, and may continue to further shift, away from brick-and-mortar retail to e-commerce channels, both prior to, and as a result of, the COVID-19 pandemic, which may contribute to declining foot-traffic in company-operated retail locations. Continued reduced customer foot-traffic could reduce sales at our company-operated retail stores, including kiosks and store-in-store locations, or hinder our ability to open retail stores in new markets, which could in turn negatively affect our business and financial results. In addition, some of our company-operated retail stores occupy street locations that are heavily dependent on customer traffic generated by tourism. Any substantial decrease in tourism, resulting from an economic slowdown, political, terrorism, social, or military events, natural disasters, public health issues like the COVID-19 pandemic, or otherwise, is likely to adversely affect sales in our stores. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, expansion of existing businesses or operations, and acquisitions of new businesses, such as HEYDUDE, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, significant investments are subject to risks and uncertainties. The failure of any significant investment to provide the returns or profitability we expect, or implementation issues, or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Specifically, over the last several years, we have implemented numerous information systems designed to support various areas of our business, including a fully-integrated global accounting, operations, and finance enterprise resource planning system, and warehouse management, order management, and internet point-of-sale systems, as well as various interfaces between these systems and supporting back-office systems. We have also moved to, and subsequently expanded, a new distribution center in Dayton, Ohio to serve our North American businesses for the Crocs Brand, and have moved to a new company-operated distribution center in the Netherlands and a new third-party operated distribution center in Japan to serve our international businesses for the Crocs Brand. Additionally, we have expanded our HEYDUDE Brand distribution center in Las Vegas, Nevada, and we further expanded our distribution capabilities of the HEYDUDE Brand by constructing a distribution facility in Nevada that opened in 2023. As our business grows, we may also need to make further investments in business systems and distribution capabilities. Issues in implementing or integrating new business operations, such as HEYDUDE, and new systems with our current operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, issues with transitioning to or operating our new distribution centers, cost overruns, or a breach in security of these systems could cause delays in product fulfillment and reduced efficiency of our operations, require significant additional capital investments to remediate, and may have an adverse effect on our business and financial results. +We depend on employees across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives and senior management can adversely impact our stock price, our results of operations, and our client relationships and may make recruiting for future management positions more difficult or may require us to offer more generous compensation packages to attract top executives. Changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. When we experience management turnover, we must successfully integrate any newly hired management personnel within our organization in a timely manner in order to achieve our operating objectives. The key initiatives directed by these executives may take time to implement and yield positive results, and there can be no guarantee they will be successful. If our new executives do not perform up to expectations, we may experience declines in our financial performance and/or delays or failures in achieving our long-term growth strategy. +Further, our business depends on our ability to source and distribute products in a timely, efficient, and cost-effective manner. Labor disputes impacting our suppliers, manufacturers, transportation carriers, or ports pose significant threats to our business, particularly if such disputes result in work slowdowns, lockouts, strikes or other disruptions during our peak importing, or manufacturing and selling seasons. Any such disruption could result in delayed or canceled orders by customers, unplanned inventory accumulation or shortages, and increased transportation and labor costs, negatively impacting our results of operations and financial position. +23 +Table of Contents +We are subject to periodic litigation, which could result in unexpected expenditures of time and resources. +From time to time, we initiate litigation or are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. For a detailed discussion of our current material legal proceedings, see Note 18 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. An unfavorable outcome in any of these proceedings, or any future legal proceedings, could have an adverse impact on our business and financial results. In addition, any significant litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +Global climate change, including extreme weather conditions, natural disasters, public health issues, or other events outside of our control, as well as related regulations, could negatively impact our operating results and financial condition. +The effects of climate change, natural disasters such as earthquakes, hurricanes, tsunamis, or other adverse weather and climate conditions, and public health issues like the COVID-19 pandemic, whether occurring in the U.S. or abroad, may disrupt our operations or the operations of our vendors, other suppliers, or customers. Consequences of these events could include property damage, infrastructure damage leading to the inability of our employees and third parties to work, damage to our supply chain, unavailability of raw materials, increased manufacturing costs and disruptions to the productivity of our third-party manufacturers, disruptions to our distribution centers, disruptions to our retail stores, changes in consumer preferences or spending priorities, and energy shortages, which could result in negative impacts to our operating results and financial condition. Additionally, certain catastrophes are not covered by our general insurance policies, which could result in significant unrecoverable losses. Many governmental and other regulatory bodies worldwide are enacting regulations to mitigate the impacts of climate change. If we, our suppliers, or our third-party manufacturers are required to comply with these laws and regulations, or if we choose to take additional voluntary steps to reduce or mitigate our impact on the climate, we may experience increased costs for energy, production, transportation, and raw materials, increased capital expenditures, or increased insurance premiums and deductibles, each of which could adversely impact our operations. In addition, inconsistent regulations among jurisdictions may also affect our cost to comply with such laws and regulations. Any assessment of the potential impact of future climate change legislation, regulations, or industry standards, as well as any international treaties and accords, is uncertain given the wide scope of potential regulatory change in the countries in which we operate. +We have a public, enterprise-wide commitment to be Net Zero by 2040. Although we intend to meet these commitments, we may be required to expend significant resources to do so, which could increase our operational costs. Further, there can be no assurance of the extent to which our commitment will be achieved, or that any future investments we make in furtherance of achieving such target and goal will meet investor expectations or legal standards, if any, regarding sustainability performance. As our business context continues to change, we will continue to evaluate pathways and feasibility of our carbon reduction journey. Moreover, we may determine that it is in the best interest of our Company and our stockholders to prioritize other business, social, governance or sustainable investments over the achievement of our current commitments based on economic, technological developments, regulatory and social factors, business strategy or pressure from investors, activist groups or other stakeholders. If we are unable to meet these commitments, then we could incur adverse publicity and reaction from investors, activist groups or other stakeholders, which could adversely impact the perception of us and our products and services by current and potential customers, as well as investors, which could in turn adversely impact our results of operations. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware law contain provisions that could discourage a third-party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +24 +Table of Contents +Increasing scrutiny from investors, regulators, and other key stakeholders with respect to our environmental, social, and governance practices may impose additional costs on us or expose us to new or additional risks. +Investor advocacy groups, certain institutional investors, investment funds, proxy advisory firms, stockholders, customers, non-governmental organizations, consumers and regulators, such as the SEC, are increasingly focused on corporate responsibility, specifically on the CRS practices of companies. These parties have placed increased importance on the implications of the social cost of their investments. From time to time, we communicate certain CRS initiatives and goals to market participants and our customers and business partners. Any corporate responsibility disclosure we make may include our policies, practices, initiatives, and goals on a variety of social and ethical matters, corporate governance, environmental compliance, sustainability, employee health and safety practices, human capital management, product quality, supply chain management, and workforce inclusion and diversity. Although we have undertaken significant efforts to improve and implement our CRS initiatives, it is possible that the aforementioned parties may not be satisfied with such disclosures, our CRS practices, or the speed with which we adopt and/or implement our plans. The establishment of CRS criteria, as well as the collection of relevant CRS data, can be costly, challenging, and time consuming and is subject to evolving CRS reporting standards and regulations. +Furthermore, some stakeholders may disagree with our goals. There is also a risk that stakeholders may change their views on these topics over time. These parties and regulators may also hold divergent opinions on these issues as well as conflicting expectations regarding our culture, values, goals and business, which may affect how we are regulated or perceived. Moreover, we may determine that it is in the best interest of our Company and our stockholders to prioritize other business investments over the achievement of our current goals based on economic, technological developments, regulatory and social factors, business strategy or pressure from investors, activists, or other stakeholders. +If our CRS practices do not meet investor or other stakeholder expectations and standards, which continue to evolve, or if we are perceived or deemed to have not appropriately responded to the growing concern for CRS issues, regardless of whether there is a legal requirement to do so, we may suffer from reputational damage from stakeholders and consumers and our business and financial condition could be materially and adversely affected. We may also incur additional costs or require additional resources to monitor such stakeholder expectations and standards and to meet our targets and commitments. Further, we could fail, or be perceived to fail, to achieve our CRS initiatives or goals, or we could fail to fully and accurately report our progress on such initiatives and goals, which could negatively impact our business. +Indebtedness Risks +The Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Indentures (each as defined below) each impose significant operating and financial restrictions on us and certain of our subsidiaries, which may prevent us from capitalizing on business opportunities. A breach of any of those restrictive covenants may cause us to be in default under the Revolving Credit Agreement, the Term Loan B Credit Agreement and/or the Indentures, and our lenders could foreclose on our assets. +Our Revolving Credit Agreement requires us to maintain certain financial covenants. A decline in our operating performance could negatively impact our ability to meet these financial covenants. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the Revolving Credit Agreement. We may not have sufficient funds to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lenders. If we are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the Revolving Credit Agreement. The foregoing risks also apply to the Term Loan B Credit Agreement. +The Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Indentures also contain certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things: incur additional debt or issue preferred stock; sell, lease or transfer our assets; pay dividends on, and make other distributions on, or redeem or repurchase, our common stock; make certain capital expenditures and investments; guarantee debt or obligations; create certain liens; repurchase our common stock; enter into transactions with our affiliates; and enter into certain merger, consolidation, or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, incur or guarantee additional debt, incur certain liens, enter into transactions with affiliates, transfer or sell certain assets, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business, or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors. +The terms of any future indebtedness we may incur could include more restrictive covenants. We cannot assure you that we will be able to maintain compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers +25 +Table of Contents +from the lenders and/or amend the covenants. In addition, our ability to comply with these negative covenants can be affected by events beyond our control. Our failure to comply with the restrictive covenants described above as well as other terms of our indebtedness could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms or cannot refinance these borrowings, our results of operations and financial condition could be adversely affected. +Our indebtedness, including the incurrence by us of substantial indebtedness in connection with the financing of the Acquisition, could adversely affect our business, financial condition, and results of operations, as well as the ability to meet payment obligations under our Revolving Credit Agreement, the Term Loan B Credit Agreement, and the Notes (as defined below). +To finance the Acquisition in part, we entered into an agreement (as amended to date, the “Term Loan B Credit Agreement”) with respect to a senior secured term loan B facility (as amended to date, the “Term Loan B Facility”) and borrowed under the Revolving Facility. The use of indebtedness to finance the Acquisition reduced our liquidity and has caused, and could continue to cause, us to place more reliance on cash generated from operations to pay principal and interest on our debt, thereby reducing the availability of our cash flow for working capital and capital expenditure needs or to pursue other potential strategic plans. As of December 31, 2024, we had $1,349.3 million in total indebtedness outstanding (net of $40.7 million of unamortized issuance costs related to the Term Loan B Facility and issuance of the Notes). +Subject to the limits contained in the Revolving Credit Agreement, the Indentures, the Term Loan B Credit Agreement and the applicable agreements governing our other existing indebtedness, we may be able to incur substantial additional debt from time to time. If we do so, the risks related to our level of debt could increase. Specifically, our level of debt could have important consequences, including the following: +• making it more difficult for us to meet our obligations with respect to our debt; +• limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate purposes; +• requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions or other general corporate purposes; +• increasing our vulnerability to general adverse economic and industry conditions; +• exposing us to the risk of increased interest rates as certain of our borrowings are at variable rates of interest; +• placing us at a disadvantage compared to other, less leveraged competitors; +• increasing our cost of borrowing; and +• limiting our flexibility in planning for changes in our business and reacting to changes in the industry in which we compete. +Furthermore, if we are unable to meet our debt service obligations or should we fail to comply with our financial and other negative covenants contained in the agreements governing our indebtedness, we may be required to refinance all or part of our debt, sell important strategic assets at unfavorable prices, incur additional indebtedness or issue common stock or other equity securities. We may not be able to, at any given time, refinance our debt, sell assets, incur additional indebtedness or issue equity securities on terms acceptable to us, in amounts sufficient to meet our needs. If we are able to raise additional funds through the issuance of equity securities, such issuance would also result in dilution to our stockholders. Our inability to service our obligations or refinance our debt could have a material and adverse effect on our business, financial condition or operating results. In addition, our debt obligations may limit our ability to make required investments in capacity, technology, or other areas of our business, which could have a material adverse effect on our business, financial condition, or operating results. +Any of these factors could have an adverse effect on our business, financial condition, and results of operations and our ability to meet our debt payment obligations. +Despite our current level of indebtedness, we may be able to incur substantially more debt, which could increase the risks to our financial condition described above. +We may be able to incur substantial additional indebtedness in the future. Although certain of the agreements governing our existing indebtedness contain restrictions on the incurrence of additional indebtedness and entering into certain types of other +26 +Table of Contents +transactions, these restrictions are subject to a number of qualifications and exceptions, including compliance with various financial conditions. Additional indebtedness incurred in compliance with our existing debt instruments could be substantial. To the extent new debt is added to our current debt levels, the substantial leverage risks described in the immediately preceding risk factor would increase. +As of December 31, 2024, we had approximately $1,349.3 million in total indebtedness outstanding (net of $40.7 million of unamortized issuance costs related to the Term Loan B Facility and issuance of the Notes), including $500.0 million outstanding on the Term Loan B Facility. We had borrowings outstanding of $190.0 million under the Revolving Facility, with total borrowing capacity of approximately $809.4 million thereunder (including $0.6 million of letters of credit outstanding as of such date). +Financial and Accounting Risks +We may be required to record impairments of long-lived assets or incur other charges relating to our company-operated retail operations. +Impairment testing of our retail stores’ long-lived assets requires us to make estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the fixed-cost structure associated with our retail operations, negative cash flows, or the closure of a store could result in impairment of leasehold improvements, impairment of right-of-use assets, impairment of other long-lived assets, write-downs of inventory, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our business and financial results. Impairment charges may increase as we continue to evaluate our retail operations. The recording of additional impairments in the future may have a material adverse impact on our business and financial results. +We may incur impairments of the carrying value of our goodwill and other intangible assets, which could have a material adverse effect on our business and financial results. +In connection with the Acquisition, we allocated approximately $710.0 million and $1,780.0 million to goodwill and definite- and indefinite-lived intangible assets, respectively. These assets are tested for impairment at least annually, using estimates and assumptions affected by factors such as economic and industry conditions and changes in operating performance. Additionally, in conjunction with the impairment tests, we also reassess the indefinite-life classification. Potential resulting charges from an impairment of goodwill or our indefinite-lived intangible, as well as reclassification of an indefinite-lived to a definite-lived intangible, could have a material adverse effect on our business and results of operations. +The testing of our goodwill for impairment is predicated upon our determination of our reporting units. Any change to the conclusion of our reporting units or the aggregation of components within our reporting units could result in a different outcome to our annual impairment test. Although the fair values of our HEYDUDE Brand reporting unit goodwill and indefinite-lived intangible assets are either equal to or in excess of their carrying values, the fair values are sensitive to the aforementioned potential unfavorable changes that could have an adverse impact on future analyses. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 5 — Goodwill and Intangible Assets, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, which could increase the volatility of the price of our common stock. +Quarterly results may also fluctuate as a result of several factors, including new style introductions, general economic conditions, or changes in consumer preferences. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any other year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +The risks of maintaining significant cash abroad could adversely affect our cash flows in the U.S., our business, and financial results. +We have substantial cash requirements in the U.S., but a significant portion of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside the U.S. to be indefinitely reinvested, and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business +27 +Table of Contents +in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., and under the U.S. Tax Cuts and Jobs Act, could be repatriated without incurring additional U.S. federal income taxes, although some states will continue to subject cash repatriations to income tax. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +Changes in tax laws and unanticipated tax liabilities and adverse outcomes from tax audits or tax litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the outcome of income tax audits or tax litigation in various jurisdictions around the world. We are regularly subject to, and are currently undergoing, audits by tax authorities in the U.S. and foreign jurisdictions for prior tax years. Please refer to Note 14 — Income Taxes and Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for additional details regarding current tax audits. The final outcome of tax audits and related litigation is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or future audits, which could have an adverse effect on our financial position and results of operations. +Future changes in domestic or international tax laws and regulations could also adversely affect our effective tax rate or result in higher income tax liabilities. In August 2022, the U.S. government enacted the Inflation Reduction Act of 2022, which included among other provisions, a 15% minimum tax on “adjusted financial statement income” and became effective for us beginning January 1, 2023. Recently, intergovernmental organizations such as the Organization for Economic Co-operation and Development (“OECD”) and European Union (“EU”) have proposed changes to the existing tax laws of member countries. For example, the OECD has introduced model rules for a new 15% global minimum tax framework, as well as a proposal on the allocation of profit among tax jurisdictions in which companies operate. In December 2022, the EU member states agreed to incorporate the 15% global minimum tax into their respective domestic laws effective for fiscal years beginning on or after December 31, 2023. Additionally, several non-EU countries, including the United Kingdom, have recently proposed and/or adopted legislation consistent with the OECD global minimum tax framework. These tax laws and regulations could adversely impact our financial position and results of operations beyond 2025. Continued economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult, and prior decisions by tax authorities regarding treatments and positions of corporate income taxes could be subject to enforcement activities, as well as legislative investigation and inquiry, which could also result in changes in tax policies or prior tax rulings. The final resolution of such tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse effect on our financial performance. These and any other additional changes could adversely affect our effective tax rate or result in higher cash tax liabilities. +We may fail to meet analyst and investor expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly, and various securities analysts follow our financial results and frequently issue reports on us which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and expectations of our investors, our stock price could decline. +ITEM 1B. Unresolved Staff Comments +None. +28 +Table of Contents +ITEM 1C. Cybersecurity +We maintain a Cybersecurity Incident Response Plan that is an important component of our Cybersecurity Risk Management Program, which then integrates into our Enterprise Risk Management (“ERM”) Program. Our Cybersecurity Incident Response Plan is designed to facilitate a timely, consistent, and compliant response to actual or attempted cybersecurity incidents impacting the Company. The Cybersecurity Incident Response Plan is built on a framework that is aligned with publication 800-61 of the National Institute of Standards and Technology and is tailored to our people, processes, and technology. Cybersecurity Incident Response Plan phases include (1) preparation, (2) detection and analysis, which includes processes to assess the materiality of cybersecurity incidents and make timely reports, (3) containment, eradication, and recovery, and (4) post-incident activity. The Cybersecurity Incident Response Plan also defines the objectives, roles and responsibilities, and scope of our incident response program. +We maintain a formal information security training program for all employees that includes training on matters such as security awareness, phishing, and email security best practices. Employees are also required to complete compulsory training on compliance and data privacy. +We engage with third-party assessors, consultants, and auditors to test our cybersecurity maturity and to drive continuous monitoring and improvements. The engagement includes having independent third parties perform compliance, technical, and maturity assessments, such as (1) attack surface assessment, (2) penetration testing assessment, and (3) cybersecurity maturity assessments. We also annually engage third parties and/or our internal audit department to assess our information security programs, whose findings are reported to the Audit Committee of the Board. +We rely on our information technology (“IT”) systems and networks in connection with our business activities. Some of these networks and systems are managed by third-party service providers and are not under our direct control. We have implemented processes to manage the cybersecurity risks associated with our use of third-party service providers through our vendor risk management program and an application governance policy. +Despite the security measures we have implemented, certain cyber incidents could materially disrupt operational systems. If our IT resources are compromised by an intentional attack and results in loss of trade secrets or other proprietary or competitively sensitive information; compromise personally identifiable information regarding customers or employees; delay our ability to deliver products to customers; jeopardize the security of our facilities; or cause other damage. Although the risks from cybersecurity threats, including as a result of any previous cybersecurity incidents, have not materially affected or are reasonably likely to materially affect the Company, including its business strategy, results of operations, or financial condition, such incidents could have a material adverse effect in the future as cyberattacks continue to increase in frequency and sophistication. We continuously seek to maintain a robust program of information security and controls, but the impact of a material cybersecurity incident could have an adverse effect on our competitive position, reputation, results of operations, financial condition, and cash flows. Additionally, while we have a cybersecurity program designed to protect and preserve the confidentiality, integrity, and availability of our information systems, we also maintain cybersecurity insurance to manage potential liabilities resulting from specific cyber-attacks. Although we maintain cybersecurity insurance, there can be no guarantee that our insurer(s) will cover specific claims, pay the full costs of an incident, or provide payment in a timely manner. +For more information, please see “Item 1A – Risk Factors – Risks Specific to Our Company and Strategy-Our business relies significantly on the use of information technology. A significant disruption to our operational technology or those of our business partners, a privacy law violation, or a data security breach could harm our reputation and/or our ability to effectively operate our business, and our financial results.” +The Audit Committee of the Board is responsible for monitoring and overseeing risk management from cybersecurity threats. In accordance with the Audit Committee’s charter, the Audit Committee is responsible for oversight of our ERM program, which includes cyber risk management. It is the Audit Committee’s responsibility to review and discuss with management the adequacy and effectiveness of our cybersecurity policies and the internal controls regarding cybersecurity and privacy related areas. To satisfy this responsibility, the Audit Committee receives periodic updates from management regarding our cybersecurity program. The updates may include information on, among other things, actual events or incidents, results of vulnerability assessments and penetration testing, results of security incident and event management monitoring, updates to the cybersecurity strategy and program, new or modified security policy recommendations, and cybersecurity risk in general. On at least an annual basis, management presents to the Audit Committee on cybersecurity strategy and framework, roadmaps for continued program maturity, key risk areas and related actions, and any significant incidents that have occurred or are reasonably likely to occur. The entire Board is invited to attend this annual cybersecurity meeting of the Audit Committee. +29 +Table of Contents +Our Executive Leadership Team is responsible for managing enterprise risk, which is inclusive of cybersecurity. The Chief Information Officer (“CIO”), a member of the Executive Leadership Team, and the Chief Information Security Officer (“CISO”), who reports to the CIO, are responsible for assessing and managing cybersecurity risk, including the prevention, detection, mitigation, and remediation of cybersecurity incidents. The CIO has over 30 years of experience in Information Technology and Operations including executive-level experience within the consumer goods industry. The CISO possesses relevant expertise in cybersecurity, including 25 years in both IT and cybersecurity . +The cybersecurity team reports to the CISO and has responsibility to prevent, mitigate, detect, and remediate cybersecurity incidents through various processes. These processes include regular vulnerability assessments and penetration testing, security incident and event management, continuous monitoring, and threat intelligence gathering. Additionally, we employ several third parties with expertise in specific cybersecurity risk areas. These third parties report to the CISO, who actively engages with these third parties to monitor their activities and compliance with service level agreements. Through these activities and monitoring, both internally and externally, any events or incidents identified will be escalated to the Board in accordance with our formal Cybersecurity Incident Response Plan. +ITEM 2. Properties +Our principal executive and administrative offices are located at 500 Eldorado Blvd., Building 5, Broomfield, CO 80021. We lease all of our domestic and international facilities. We currently enter into short-term and long-term leases for office, warehouse, and retail, including kiosk and store-in-store, space. The terms of our leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations and expire at various dates through the year 2034. The general location, use, and approximate size of our principal properties, as well as the reportable operating segment that utilizes each property, are given below. +Location Reportable Operating Segment(s) Use Approximate Square Feet +Dayton, Ohio Crocs Brand Distribution center 1,322,000 +Las Vegas, Nevada +HEYDUDE Brand Distribution center 1,044,000 +Dordrecht, the Netherlands Crocs Brand, HEYDUDE Brand Distribution center 517,000 +Broomfield, Colorado Crocs Brand, HEYDUDE Brand Regional office and Crocs Brand headquarters 190,000 +Westwood, Massachusetts Crocs Brand, HEYDUDE Brand Regional office and HEYDUDE Brand headquarters 70,000 +Hoofddorp, the Netherlands Crocs Brand, HEYDUDE Brand Regional office 47,000 +Singapore Crocs Brand Regional office 24,000 +We believe these properties, particularly our distribution centers and warehouses, along with various third-party distribution centers not included above, are adequate for our operations. Aside from the principal properties listed above, we lease various other offices and distribution centers worldwide to meet our sales and operational needs. We also lease 442 retail locations worldwide as of December 31, 2024. See Item 1. Business of this Annual Report on Form 10-K for further discussion regarding global company-operated stores. +ITEM 3. Legal Proceedings +A discussion of legal matters is found in Note 18 — Legal Proceedings in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +ITEM 4. Mine Safety Disclosures +Not applicable. +30 +Table of Contents +PART II +ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock is listed on the Nasdaq Global Select Market under the stock symbol “CROX.” +Performance Graph +The following performance graph illustrates a five-year comparison from December 31, 2019 through December 31, 2024 of cumulative total return of our common stock, the Nasdaq Composite Total Return Index, and the Dow Jones U.S. Footwear Total Return Index. The graph assumes an investment of $100.00 on December 31, 2019 and assumes the reinvestment of all dividends and other distributions. +The Dow Jones U.S. Footwear Total Return Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. The Nasdaq Composite Total Return Index is a market capitalization-weighted index that includes reinvestment of all cash distributions of index members and consists of more than 3,000 common equities, including Crocs, Inc. The stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 37 as of February 6, 2025. +31 +Table of Contents +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our financing arrangements include restrictions on cash dividends paid on our common stock. Any future determination to declare cash dividends on our common stock will be made at the discretion of our Board, subject to, among other things, our results of operations, financial condition, level of indebtedness, capital requirements, and compliance with covenants under any then-existing financing agreements. +Purchases of Equity Securities by the Issuer +Period Total Number of Shares Purchased Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) +Maximum Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs (1) +October 1-31, 2024 +346,038 $ 132.29 346,038 $ 503,104,749 +November 1-30, 2024 +790,674 102.59 790,674 422,007,927 +December 1-31, 2024 +881,549 111.36 881,549 323,859,355 +Total 2,018,261 $ 111.51 2,018,261 $ 323,859,355 +(1) On April 23, 2021, the Board approved and authorized a program to repurchase up to $1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. As of December 31, 2024, approximately $323.9 million remained available for repurchase under our share repurchase authorization. On February 10, 2025, the Board approved a $1.0 billion increase to our share repurchase authorization, after which approximately $1.3 billion remained available for future common stock repurchases. The number, price, structure, and timing of the repurchases, if any, will be at our sole discretion and future repurchases will be evaluated by us depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify, or terminate the repurchase program at any time without prior notice. +ITEM 6. [Reserved] +32 +Table of Contents +ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +Crocs, Inc. and its consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for all. We strive to be the world leader in innovative casual footwear for all, combining comfort and style with a value that consumers want. The vast majority of shoes within the Crocs Brand’s collection contain Croslite™ material, a proprietary, molded footwear technology, delivering extraordinary comfort with each step. The HEYDUDE Brand provides an innovative loafer concept that is differentiated through easy on and off, quality, and comfort. The broad appeal of our footwear has allowed us to market our products through a wide range of distribution channels. We currently sell our products in more than 80 countries, through two distribution channels: wholesale and direct-to-consumer. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors; our direct-to-consumer channel includes company-operated retail stores, company-operated e-commerce sites, and third-party marketplaces. +Known or Anticipated Trends +Based on our recent operating results and our assessment of the current operating environment, we anticipate certain trends will continue to impact our future operating results: +• We continue to operate in an environment where consumers are feeling the effects of elevated interest rates and inflation, and as a result, they are spending more cautiously. In addition, geopolitical tensions have increased across the globe. In February 2025, the U.S. presidential administration has also imposed tariffs on foreign imports into the United States, including, most relevant to us, an additional 10% tariff on all imports from China and an additional 25% tariff on all imports from Mexico, which tariffs on imports from Mexico were subsequently suspended in order to facilitate negotiations. As of the date of this Annual Report, the proposed tariffs on all imports from Mexico remain suspended. We remain focused on making the right decisions for the health of our brands, maintaining tight inventory control, and investing in strategic initiatives to support durable long-term growth. +• In 2025, we plan to continue to invest in talent, marketing, digital, and retail to drive our strategic pillars, including awareness and relevance for our brands and iconic product, increased market share in our core markets, and product diversification into sandals, sneakers, and other key silhouettes. We will also remain focused on launching and scaling digital marketplaces and selectively adding retail stores for both brands. +• Our liquidity position remains strong with approximately $180.5 million in cash and cash equivalents and $824 million in available borrowing capacity as of December 31, 2024. Our total borrowings were $1.3 billion as of December 31, 2024. We repurchased $551.2 million of our common stock during the year. +Use of Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), we present certain information related to our current period results of operations through “constant currency,” which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been retranslated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rates on reported amounts. +Management uses constant currency to assist in comparing business trends from period to period on a consistent basis in communications with the Board, stockholders, analysts, and investors concerning our financial performance. We believe constant currency is useful to investors and other users of our consolidated financial statements as an additional tool to evaluate operating performance and trends. Investors should not consider constant currency in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +Key Performance Indicators +Management utilizes the key performance metrics of gross margin, operating margin, footwear unit sales, and average footwear selling price to gauge the Company’s operational efficiency and market competitiveness, identify trends, formulate financial projections, and make strategic decisions. Management continuously monitors and analyzes these metrics in an effort to ensure we remain agile, competitive, and aligned with our long-term growth objectives. The titles and/or definitions of certain of these +33 +Table of Contents +metrics may vary from company to company. As a result, our calculation of certain of these metrics may not be comparable to similarly titled metrics used by other companies. +Gross Margin +Gross margin is defined as gross profit divided by revenues. Management uses this metric and believes it is useful for investors because it provides insights into profitability, cost management, and pricing strategy. +Operating Margin +Operating margin is defined as income from operations divided by revenues. Management uses this metric and believes it is useful for investors because it provides a comprehensive view of profitability from its core business operations, excluding the effects of financing and tax considerations. +Footwear Unit Sales +Footwear unit sales is defined as wholesale and DTC footwear only sales. Management uses this metric and believes it is useful for investors because it provides a direct measure of our sales volume and can offer valuable insights into its market performance and growth potential. +Average Footwear Selling Price +Average footwear selling price is defined as footwear and footwear accessories revenues divided by footwear units. Management uses this metric and believes it is useful for investors because it provides insights into our pricing strategy, market positioning, and revenue generation capabilities. +Direct-to-consumer (“DTC”) Comparable Sales +DTC comparable sales include revenues from stores and e-commerce sites that have been in operation for more than twelve months, as defined further below. Management uses this metric to evaluate the performance of our stores and e-commerce platforms on a consistent basis. +2024 Financial and Operational Highlights +Revenues were $4,102.1 million for the year ended December 31, 2024, a 3.5% increase compared to the year ended December 31, 2023. The increase was due to the net effects of: (i) higher average selling price on a constant currency basis (“ASP”) in both brands, which increased revenues by $156.2 million, or 3.9%; (ii) higher unit sales volume, which resulted in an increase in revenues of $13.7 million, or 0.3%; and (iii) net unfavorable changes in exchange rates, which decreased revenues by $30.1 million, or 0.8%. +The following were significant developments affecting our businesses during the year ended December 31, 2024: +• We grew Crocs Brand revenues 8.8% compared to the same period in 2023. HEYDUDE Brand revenues decreased 13.2%. +• Gross margin was 58.8% compared to 55.8% in 2023, an increase of 300 basis points. This was primarily due to prior year distribution costs associated with the move to our new HEYDUDE distribution center in Las Vegas, Nevada that did not recur in the current year, higher ASP, favorable customer mix, and favorable brand mix. +• Selling, general & administrative expenses (“SG&A”) were $1,388.3 million compared to $1,173.2 million 2023, primarily as a result of higher variable expenses related to higher revenues in the DTC channel and continued investment in talent and marketing. As a percent of revenues, SG&A increased to 33.8% of revenues compared to 29.6% in 2023. +• Income from operations was $1,021.9 million for the year ended December 31, 2024 compared to income from operations of $1,036.8 million for the year ended December 31, 2023. Net income was $950.1 million, or $15.88 per diluted share, compared to $792.6 million, or $12.79 per diluted share, in 2023. +34 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2024 and 2023 +A discussion of our comparison between 2024 and 2023 is presented below. A discussion of the changes in our results of operations between the years ended December 31, 2023 and December 31, 2022 has been omitted from this Annual Report on Form 10-K but may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2023, filed with the SEC on February 15, 2024, which is available free of charge on the SEC’s website at www.sec.gov and our corporate website (www.crocs.com). +Year Ended December 31, $ Change % Change +Favorable (Unfavorable) +2024 2023 2024-2023 2024-2023 +(in thousands, except per share data, margin, and average selling price data) +Revenues $ 4,102,108 $ 3,962,347 $ 139,761 3.5 % +Cost of sales 1,691,850 1,752,337 60,487 3.5 % +Gross profit 2,410,258 2,210,010 200,248 9.1 % +Selling, general and administrative expenses +1,388,347 1,173,227 (215,120) (18.3) % +Income from operations +1,021,911 1,036,783 (14,872) (1.4) % +Foreign currency losses, net +(6,777) (1,240) (5,537) (446.5) % +Interest income 3,484 2,406 1,078 44.8 % +Interest expense (109,264) (161,351) 52,087 32.3 % +Other income (expense), net +1,231 (326) 1,557 477.6 % +Income before income taxes +910,585 876,272 34,313 3.9 % +Income tax expense (benefit) +(39,486) 83,706 123,192 147.2 % +Net income +$ 950,071 $ 792,566 $ 157,505 19.9 % +Net income per common share: +Basic $ 16.00 $ 12.91 $ 3.09 23.9 % +Diluted $ 15.88 $ 12.79 $ 3.09 24.2 % +Gross margin (1) +58.8 % 55.8 % 300 bp 5.4 % +Operating margin (1) +24.9 % 26.2 % (130) bp (5.0) % +Selling, general and administrative expenses as a percentage of revenues (1) +33.8 % 29.6 % (420) bp (14.2) % +Footwear unit sales: +Crocs Brand 127,000 119,577 7,423 6.2 % +HEYDUDE Brand +26,950 32,969 (6,019) (18.3) % +Average footwear selling price - nominal basis (2) : +Crocs Brand $ 25.52 $ 24.92 $ 0.60 2.4 % +HEYDUDE Brand +$ 30.54 $ 28.80 $ 1.74 6.0 % +(1) Changes for gross margin, operating margin, and SG&A as a percentage of revenues are shown in basis points (“bp”). +(2) Average footwear selling price is calculated as footwear and footwear accessories revenues divided by footwear units. +35 +Table of Contents +Revenues by Channel +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2024 2023 2024-2023 2024-2023 +(in thousands) +Crocs Brand: +Wholesale $ 1,607,546 $ 1,493,537 7.6 % 8.8 % +Direct-to-consumer 1,670,421 1,519,417 9.9 % 10.7 % +Total Crocs Brand 3,277,967 3,012,954 8.8 % 9.8 % +HEYDUDE Brand: +Wholesale 456,472 566,937 (19.5) % (19.5) % +Direct-to-consumer 367,669 382,456 (3.9) % (3.9) % +Total HEYDUDE Brand 824,141 949,393 (13.2) % (13.2) % +Total consolidated revenues +$ 4,102,108 $ 3,962,347 3.5 % 4.3 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +Revenues. In the year ended December 31, 2024, revenues increased $139.8 million, or 3.5%, compared to 2023. Higher average selling price on a constant currency basis (“ASP”) increased revenues by $156.2 million, or 3.9%, primarily due to higher ASP in both brands, driven mostly by net price increases, favorable channel mix, and favorable product mix. Higher volume of $13.7 million, or 0.3%, primarily due to higher volume in the Crocs Brand, partially offset by lower volume in the HEYDUDE Brand, also increased revenues. Net unfavorable foreign currency fluctuations, primarily in the South Korean Won, Brazilian Real, Japanese Yen, and Chinese Yuan decreased revenues by $30.1 million, or 0.8%. +Gross margin. Gross margin was 58.8% compared to 55.8% in 2023. This was primarily driven by the absence of prior year distribution costs of approximately 70 basis points, primarily associated with the move to our new HEYDUDE distribution center in Las Vegas, Nevada that did not recur in the current year, higher ASP, as described above, of 50 basis points, favorable customer mix of 50 basis points, and favorable brand mix of 50 basis points. +In the years ended December 31, 2024 and 2023, cost of sales included $487.1 million and $515.3 million, respectively, of distribution expenses primarily related to receiving, inspecting, warehousing, and packaging product in owned and third-party warehouses, combined with transportation costs associated with delivering products from distribution centers to wholesale partners, retail stores, and end customers. +Selling, general and administrative expenses. SG&A as a percent of revenue increased to 33.8% during the year ended December 31, 2024 compared to 2023, as SG&A expenses increased $215.1 million, or 18.3%, largely driven by higher variable expenses related to higher revenues in the DTC channel of $84.7 million. There were also higher compensation costs of $62.0 million, primarily associated with an investment in talent, and higher marketing costs of $37.1 million. Additionally, there was an increase in impairment charges of $14.8 million due to current year impairments of information technology systems related to the HEYDUDE integration, our former HEYDUDE warehouse in Las Vegas, Nevada, and our former Crocs Brand warehouse in Oudenbosch, the Netherlands, partially offset by a prior year impairment related to the right-of-use asset and leasehold improvement assets for our former headquarters which did not recur in the current year. An increase in information technology costs of $6.9 million and net increases in other costs, including an increase in professional services and facilities costs, of $9.6 million, also contributed to the overall increase in selling, general and administrative expenses. +Foreign currency gains (losses), net. Foreign currency gains (losses), net, consists of unrealized and realized foreign currency gains and losses from the remeasurement and settlement of monetary assets and liabilities denominated in non-functional currencies as well as realized and unrealized gains and losses on certain foreign currency derivative instruments. During the year ended December 31, 2024, we recognized realized and unrealized net foreign currency losses of $6.8 million compared to losses of $1.2 million during the year ended December 31, 2023. +Interest expense. Interest expense during the year ended December 31, 2024 decreased $52.1 million, or 32.3%, primarily due to lower outstanding borrowings and lower weighted average interest rates on the Term Loan B Facility (as defined herein) in the current year. +36 +Table of Contents +Income tax expense (benefit). During the year ended December 31, 2024, we recognized an income tax benefit of $39.5 million on pre-tax book income of $910.6 million, representing an effective tax rate of (4.3)%, compared to an income tax expense of $83.7 million on pre-tax book income of $876.3 million in 2023, which represented an effective tax rate of 9.6%. The current year effective tax rate is lower primarily due to the current year foreign net income tax benefit as a result of an intra-entity transaction related to certain intellectual property rights, offset by the increase of valuation allowances. Our effective tax rate has varied dramatically in recent years due to intra-entity intellectual property rights transactions, differences in our profitability levels and relative operating earnings across multiple jurisdictions, and by changes in the valuation allowance. +During the three months ended December 31, 2024, we completed an intra-entity transaction related to certain intellectual property rights primarily to align with current and future international operations. The transaction resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the intellectual property rights. Foreign deferred tax assets increased by $268.8 million and this benefit was offset by an increase in uncertain tax positions of $145.6 million. As such, a net change in deferred tax asset of $123.2 million was recognized along with a corresponding foreign income tax benefit. In 2024, we received new information and remeasured the reserve for uncertain tax positions related to the 2020 and 2021 intellectual property rights transactions which resulted in the release of uncertain tax positions of $141.2 million along with a corresponding foreign income tax benefit. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not that the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance as of December 31, 2024, we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. Valuation allowances recorded against deferred tax assets increased by a net $58.0 million. +The 2024 impact of changes in valuation allowances to the effective tax rate was an unfavorable impact of $58.9 million , equating to a 6.5% unfavorable impact. There is also a $0.9 million favorable change in the valuation allowance related to cumulative translation adjustments. We maintain valuation allowances of approximately $241.6 million as of December 31, 2024, which may be reduced in the future depending upon the achieved profitability of certain jurisdictions as well as the magnitude of the profitability. +37 +Table of Contents +Reportable Operating Segments +The following table sets forth information related to our reportable operating segments for the years ended December 31, 2024 and 2023. +Year Ended December 31, % Change +Constant +Currency % Change (1) +Favorable (Unfavorable) +2024 2023 2024-2023 2024-2023 +(in thousands) +Revenues: +Crocs Brand revenues +$ 3,277,967 $ 3,012,954 8.8 % 9.8 % +HEYDUDE Brand revenues +824,141 949,393 (13.2) % (13.2) % +Total consolidated revenues $ 4,102,108 $ 3,962,347 3.5 % 4.3 % +Income from operations: +Crocs Brand income from operations (2) +$ 1,182,012 $ 1,079,330 9.5 % 12.2 % +HEYDUDE Brand income from operations (2) +137,401 212,386 (35.3) % (35.2) % +Enterprise corporate (2) +(297,502) (254,933) (16.7) % (16.7) % +Total consolidated income from operations +1,021,911 1,036,783 (1.4) % 1.4 % +Foreign currency gains (losses), net (6,777) (1,240) (446.5) % +Interest income 3,484 2,406 44.8 % +Interest expense (109,264) (161,351) 32.3 % +Other income (expense), net 1,231 (326) 477.6 % +Income before income taxes +$ 910,585 $ 876,272 3.9 % +(1) Reflects year over year change as if the current period results were in constant currency, which is a non-GAAP financial measure. See “Use of Non-GAAP Financial Measures” for more information. +(2) In the first quarter of 2024, to reflect a change in the way management evaluates segment performance, makes operating decisions, and allocates resources, we made changes to segment profitability related to certain foreign currency amounts impacting cost of sales. These amounts have shifted costs or benefits that were previously presented in each of our reportable segments to ‘Enterprise corporate.’ We believe that the impact of these changes on prior periods is insignificant to each segment and thus have not recast prior periods. +Crocs Brand +Revenues. The Crocs Brand segment grew revenues for the year ended December 31, 2024 compared to 2023 due to higher volume, primarily in the DTC channel, and higher ASP, mostly due to favorable channel mix, price increases in certain international markets, and favorable product mix. The overall increase in revenues was partially offset by net unfavorable currency fluctuations driven by the South Korean Won, Brazilian Real, Japanese Yen, and Chinese Yuan. +Income from Operations. During the year ended December 31, 2024, income from operations for our Crocs Brand segment was $1,182.0 million, an increase of $102.7 million, or 9.5% from 2023. Gross margin was 61.6% for the year ended December 31, 2024, an increase of 160 basis points compared to 2023. The increase in gross margin was primarily due to lower freight and fulfillment costs and favorable product mix. +During the year ended December 31, 2024, SG&A for our Crocs Brand segment increased by $109.3 million, or 15.0%, compared to 2023, primarily due to increases in marketing costs, variable expenses related to higher revenues in the DTC channel, and depreciation and amortization expense. +HEYDUDE Brand +Revenues. During the year ended December 31, 2024, HEYDUDE revenues decreased compared to 2023, due to lower volume. Higher ASP was driven by less discounting in the current year and favorable channel mix, partially offset by unfavorable product mix. +Income from Operations. For the HEYDUDE Brand, income from operations during the year ended December 31, 2024 was $137.4 million, a decrease of $75.0 million, or 35.3%, compared to 2023. Gross margin was 47.7% for the year ended +38 +Table of Contents +December 31, 2024, an increase of 370 basis points. The increase in gross margin is largely due to higher ASP, as described above, favorable channel mix, and lower freight costs. Additionally, there were prior year distribution costs associated with the move to our new HEYDUDE distribution center in Las Vegas, Nevada that did not recur in the current year, offset in part by transition costs and infrastructure investments incurred in the current year associated with the move. +During the year ended December 31, 2024, SG&A for the HEYDUDE Brand segment increased by $50.3 million, or 24.4%, primarily due to increases in marketing costs, compensation costs, and facilities costs, all of which partially relate to investments in our DTC channel. Impairment costs of the right-of-use assets for our former HEYDUDE Brand warehouses in Las Vegas, Nevada in the current year also contributed to the increase in SG&A. +Enterprise Corporate +During the year ended December 31, 2024, total net costs within ‘Enterprise corporate’ increased $42.6 million, or 16.7%, compared to the same period in 2023, primarily due to an increase in compensation costs. An increase in impairment charges due to a current year information technology systems impairment of $18.2 million, partially offset by a prior year impairment of $9.3 million related to the right-of-use asset and leasehold improvement assets for our former corporate headquarters which did not recur in the current year, also increased costs. Additionally, depreciation and amortization expense and information technology costs increased. +Store Locations and Digital Sales Percentage +As of December 31, 2024, we had 390 company-operated retail locations for the Crocs Brand, inclusive of 184 retail locations in North America and 206 retail locations internationally. As of December 31, 2024, we had 52 company-operated retail locations for the HEYDUDE Brand. As of December 31, 2023, we had 349 company-operated retail locations for the Crocs Brand, inclusive of 174 retail locations in North America and 175 retail locations internationally. As of December 31, 2023, we had 14 company-operated retail locations for the HEYDUDE Brand. +Digital sales, which includes sales through our company-owned website, third-party marketplaces, and e-tailers (which are reported in our wholesale channel), as a percent of total revenues, by reportable operating segment were: +Year Ended December 31, +2024 2023 +Digital sales as a percent of total revenues: +Crocs Brand 36.4 % 36.6 % +HEYDUDE Brand +40.3 % 41.8 % +Total 37.2 % 37.9 % +Direct-to-consumer (“DTC”) comparable sales are as follows: +Constant Currency (1) +Year Ended December 31, +2024 2023 +Direct-to-consumer comparable sales: (2) +Crocs Brand 7.2 % 15.5 % +HEYDUDE Brand +(15.8) % 3.6 % +(1) Reflects period over period change on a constant currency basis, which is a non-GAAP financial measure. See the “Use of Non-GAAP Financial Measures” section for additional information. +(2) Comparable store status, as included in the DTC comparable sales figures above, is determined on a monthly basis. Comparable store sales include the revenues of stores that have been in operation for more than twelve months. Stores in which selling square footage has changed more than 15% as a result of a remodel, expansion, or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily closed stores are excluded from the comparable store sales calculation during the month of closure and in the same month in the following year. Location closures in excess of three months are excluded until the thirteenth month post re-opening. E-commerce comparable revenues are based on same site sales period over period. E-commerce sites that are temporarily offline or unable to transact or fulfill orders (“site disruption”) are excluded from the comparable sales calculation during the month of site disruption and in the same month in the following year. E-commerce site disruptions in excess of three months are excluded until the thirteenth month after the site has re-opened. Additionally, comparable sales do not include leap days in leap years. +39 +Table of Contents +Liquidity and Capital Resources +Our liquidity position as of December 31, 2024 was: +December 31, 2024 +(in thousands) +Cash and cash equivalents $ 180,485 +Available borrowings 824,416 +As of December 31, 2024, we had $180.5 million in cash and cash equivalents and up to $824.4 million of available borrowings, including $809.4 million remaining borrowing availability under the Revolving Facility (as defined below) and $15.0 million of remaining borrowing availability under the Citibank Facility (as defined below). As of December 31, 2024, the Term Loan B Facility (as defined below) was fully drawn, and there was no available borrowing capacity. We believe that our cash flows from operations, our cash and cash equivalents on hand, and available borrowings under our Revolving Facility and Citibank Facility will be sufficient to meet our ongoing liquidity needs and capital expenditure requirements for at least the next twelve months. +Additional future financing may be necessary to fund our operations and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. Although we believe we have adequate sources of liquidity over the long term, the success of our operations, the global economic outlook, and the pace of sustainable growth in our markets could each impact our business and liquidity. +Repatriation of Cash +As a global business, we have cash balances in various countries and amounts are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries may have additional restrictions and covenants associated with them which could adversely impact our liquidity and our ability to timely access and transfer cash balances between entities. +All of the cash held outside of the U.S. could be repatriated to the U.S. as of December 31, 2024 without incurring additional U.S. federal income taxes. In some countries, repatriation of certain foreign balances is restricted by local laws. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2024, we held $108.0 million of our total $180.5 million in cash in internationa l locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $108.0 million, an insignificant amount could potentially be restricted by local laws. +Senior Revolving Credit Facility +In July 2019, the Company and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. Since that time, we have amended the Credit Agreement, which, as amended to date, provides for a revolving credit facility of $1.0 billion, which can be increased by an additional $400.0 million, subject to certain conditions (the “Revolving Facility”). Borrowings under the Credit Agreement bear interest at a variable interest rate based on (A) a Base Rate (defined as the highest of (i) the Overnight Bank Funding Rate (as defined in the Credit Agreement), plus 0.25%, (ii) the Prime Rate (as defined in the Credit Agreement), and (iii) the Daily Simple SOFR (as defined in the Credit Agreement), plus 1.00%), plus an applicable margin ranging from 0.25% to 0.875% based on our leverage ratio or 1.35% to 1.975% for the Daily Simple SOFR based on the leverage ratio, inclusive of a 0.10% SOFR adjustment, or (B) the Term SOFR Rate (as defined in the Credit Agreement), plus an applicable margin ranging from 1.35% to 1.975% based on our leverage ratio for one-month interest periods and three-month interest periods, inclusive of a 0.10% SOFR adjustment. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement required or requires, as applicable, us to maintain a minimum interest coverage ratio of 3.00 to 1.00, and a maximum leverage ratio of (i) 4.00 to 1.00 from the quarter ended March 31, 2022 through, and including, the quarter ended December 31, 2023, (ii) 3.75 to 1.00 for the quarter ended March 31, 2024, (iii) 3.50 to 1.00 for the quarter ended June 30, 2024, and (iv) 3.25 to 1.00 for the quarter ended September 30, 2024 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits, among other things, (i) stock repurchases subject to certain restrictions, +40 +Table of Contents +including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $40.0 million. As of December 31, 2024, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2024, the total commitments available from the lenders under the Revolving Facility were $1.0 billion. At December 31, 2024, we had $190.0 million in outstanding borrowings and $0.6 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2024 and 2023, we had $809.4 million and $558.7 million, respectively, of available borrowing capacity under the Revolving Facility, which matures in November 2027. +Term Loan B Facility +On February 17, 2022, the Company entered into a credit agreement (the “Original Term Loan B Credit Agreement”) with Citibank, N.A., as administrative agent and lender, to among other things, finance a portion of the cash consideration for the Acquisition, which was amended on August 8, 2023 (the “August 2023 Amendment”) and on February 13, 2024 (the “February 2024 Amendment”). The Original Term Loan B Credit Agreement, as amended by the August 2023 Amendment and the February 2024 Amendment is referred to herein as the “Term Loan B Credit Agreement”. +The Original Term Loan B Credit Agreement provided for an aggregate term loan B facility in the principal amount of $2.0 billion. Prior to the February 2024 Amendment, the outstanding balance was $820.0 million. Among other things, the February 2024 Amendment provided for a new $820.0 million tranche of term loans (the “2024 Refinancing Term Loans” and, such facility, the “Term Loan B Facility”), to refinance the then-outstanding principal balance. The 2024 Refinancing Term Loans are secured by substantially all of the Company’s and each subsidiary guarantor’s assets on a pari passu basis with their obligations arising from the Term Loan B Credit Agreement and is scheduled to mature on February 17, 2029, subject to certain exceptions set forth in the Term Loan B Credit Agreement. Additionally, subject to certain conditions, including, without limitation, satisfying certain leverage ratios, the Company may, at any time, on one or more occasions, add one or more new classes of term facilities and/or increase the principal amount of the loans of any existing class by requesting one or more incremental term facilities +Pursuant to the reduced interest rate margins applicable to the 2024 Refinancing Term Loans, each term loan borrowing which is an alternate base rate borrowing bears interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 1.25%. Each term loan borrowing which is a term SOFR borrowing bears interest at a rate per annum equal to the Adjusted Term SOFR Rate (as defined in the Term Loan B Credit Agreement) plus 2.25%. +As of December 31, 2024, the Term Loan B Facility was fully drawn with no remaining borrowing capacity, and we had $500.0 million in outstanding principal on the Term Loan B Facility, which matures on February 17, 2029. +The Term Loan B Credit Agreement also contains customary affirmative and negative covenants, incurrence financial covenants, representations and warranties, events of default and other provisions. As of December 31, 2024, we were in compliance with all financial covenants under the Term Loan B Credit Agreement. +Asia Revolving Credit Facility +During the year ended December 31, 2024, we had one revolving credit facility in Asia with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”), which, as amended, provides up to an equivalent of $15.0 million. +As of December 31, 2024, we had no borrowings outstanding on the Citibank Facility. As of December 31, 2023, we had borrowings outstanding of $3.3 million on the Citibank Facility. +Senior Notes Issuances +In March 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.250% Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, the “2029 Notes Indenture”). Additionally, in August 2021, the Company completed the issuance and sale of $350.0 million aggregate principal amount of 4.125% Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, “the 2031 Notes Indenture” and, together with the 2029 Notes Indenture, the “Indentures” and, each, an “Indenture”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +41 +Table of Contents +The Company had or will have, as applicable, the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company also had the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company could have redeemed up to 40% of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100% of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company could have redeemed up to 40% of the aggregate principal amount of the 2031 Notes at a redemption price of 104.125% of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; pay dividends or repurchase or redeem capital stock or make other restricted payments; declare or pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2024, we were in compliance with all financial covenants under the Notes. +Consolidated Statements of Cash Flows +Our consolidated statements of cash flows are summarized as follows: +Year Ended December 31, $ Change % Change +2024 2023 Favorable (Unfavorable) +(in thousands) +Cash provided by operating activities +$ 992,486 $ 930,444 $ 62,042 6.7 % +Cash used in investing activities +(69,347) (115,671) 46,324 40.0 % +Cash used in financing activities +(886,048) (859,639) (26,409) (3.1) % +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +(6,510) 3,078 (9,588) (311.5) % +Net change in cash, cash equivalents, and restricted cash $ 30,581 $ (41,788) $ 72,369 173.2 % +Operating Activities. Our primary source of liquidity is cash provided by operating activities, consisting of net income adjusted for non-cash items and changes in working capital. Cash provided by operating activities increased $62.0 million for the year ended December 31, 2024 compared to the year ended December 31, 2023, driven by higher net income, adjusted for non-cash items, of $360.1 million, partially offset by decreases in operating assets and liabilities of $298.1 million, primarily due to the change in income taxes and inventories. +Investing Activities. There was a $46.3 million decrease in cash used in investing activities for the year ended December 31, 2024 compared to the year ended December 31, 2023. This was due to a decrease in purchases of property, equipment, and software, primarily as a result of prior year purchases related to the expansion of our distribution centers and headquarters in North America in the year ended December 31, 2023, that did not recur in the current year. +Financing Activities. Cash used in financing activities increased by $26.4 million in the year ended December 31, 2024 compared to the year ended December 31, 2023. The increase in cash used in financing activities was due to a decrease in +42 +Table of Contents +proceeds from borrowings of $155.7 million, an increase of $377.4 million in repurchases of common stock, including excise tax, and an increase of $0.5 million in deferred debt issuance costs. The overall increase in cash used in financing activities was offset by a decrease in repayments of borrowings of $498.3 million, a decrease of $8.8 million in repurchases of common stock for tax withholding, and other decreases in cash used of $0.1 million. +Stock Repurchases +On April 23, 2021, the Board approved and authorized a program to repurchase up to $1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $1.0 billion to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +During the year ended December 31, 2024, we repurchased 4.3 million shares of our common stock at a cost of $551.2 million, including commissions. During the year ended December 31, 2023, we repurchased 1.7 million shares of our common stock at a cost of $175.0 million, including commissions. +As of December 31, 2024, we had remaining authorization to repurchase approximately $323.9 million of our common stock, subject to restrictions under our Indentures, Credit Agreement, and Term Loan B Credit Agreement. On February 10, 2025, the Board approved a $1.0 billion increase to our share repurchase authorization, after which approximately $1.3 billion remained available for future common stock repurchases. +See Note 11 — Equity in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information on our repurchases and repurchase authorizations. +Contractual Obligations +We believe we have sufficient liquidity to fund our operations and meet our short-term and long-term obligations. Our material future cash obligations as of December 31, 2024 include the following: +Less than 1 Year Thereafter Total +(approximately, in thousands) +Debt-related: +Debt obligations (1) +$ — $ 1,349,300 $ 1,349,300 +Interest on debt obligations (2) +73,900 293,400 367,300 +Purchase commitments (3) +301,900 — 301,900 +Lease-related (4) : +Lease obligations +80,900 349,600 430,500 +Total $ 456,700 $ 1,992,300 $ 2,449,000 +(1) Net of $40.7 million of unamortized issuance costs. +(2) Represents future interest payment obligations, which are estimated by assuming the amounts outstanding under our Term Loan B Facility, Notes, Revolving Facility, and Citibank Facility and the interest rates in effect as of December 31, 2024, will remain constant into the future. This is only an estimate, as actual amounts borrowed and rates may vary over time for certain borrowing instruments, as described in Note 10 — Borrowings. +(3) Represents purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products. We expect to fulfill our commitments under these agreements in the next twelve months in the normal course of business and are only liable for the portion of the purchase obligations that have been purchased by the third-party manufacturer or manufactured by the vendor, with the remainder cancellable without penalty. Refer to Note 16 — Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +(4) Our operating lease obligations consist of leases for real estate, which includes retail, warehouse, distribution center, and office spaces and represent the minimum cash commitment under contract to various third parties for operating lease obligations. For more information on our lease obligations and obligations for leases not yet commenced, refer to Note 7 — Leases in the accompanying notes to the +43 +Table of Contents +consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information. +We had no material off-balance sheet arrangements as of December 31, 2024, other than certain purchase commitments, as described in the footnote (3) above. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency, is based on the consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. +An accounting policy is considered to be critical if it is important to our results of operations, financial condition, and cash flows, and requires significant judgment and estimates on the part of management in its application. Our estimates are often based on historical experience, complex judgments, assessments of probability, and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. We believe that the following discussion represents those accounting policies that are the most critical to the reporting of our financial condition and results of operations. For a discussion of our significant accounting policies, see Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. +Impairment of Goodwill and Indefinite-Lived Intangible Assets +Our goodwill and indefinite-lived intangible assets, which primarily consist of the HEYDUDE trademark, are not amortized. We evaluate the carrying value of our goodwill and indefinite-lived intangible assets at least annually or when an interim triggering event has occurred indicating potential impairment. Our annual test is performed as of the first day of the fourth quarter. Our impairment evaluations represent a critical accounting policy as they require significant judgments and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. +We perform our goodwill impairment testing for each reporting unit that has goodwill. During the years ended December 31, 2024, 2023, and 2022 we had two reporting units, comprised of a reporting unit within the HEYDUDE Brand segment and a reporting unit within the Crocs Brand segment. We perform our indefinite-lived intangible impairment testing at the asset level. +When performing our annual test for impairment, we may assess goodwill and indefinite-lived intangible assets for potential impairment using either a qualitative or quantitative assessment. The qualitative assessment may evaluate factors such as macroeconomic conditions, industry and market considerations, and overall financial performance, among other factors. If we determine that it is more likely than not that the fair value of a reporting unit or an indefinite-lived intangible asset is less than its carrying value, a quantitative assessment is performed. For the quantitative assessment, we compare the estimated fair value of a reporting unit with its carrying value, including the goodwill assigned to the reporting unit. If carrying value of the reporting unit exceeds its estimated fair value, an impairment charge is recorded. +For the year ended December 31, 2024, we performed a quantitative assessment for the HEYDUDE Brand reporting unit goodwill and the HEYDUDE Brand indefinite-lived intangible assets. Both quantitative assessments were performed with the assistance of third-party valuation specialists. We performed the quantitative assessment for the HEYDUDE Brand reporting unit goodwill using the discounted cash flow method. For the impairment testing of the indefinite-lived trademark, we used the Multi-Period Excess Earnings approach. The primary assumptions developed by management and used in the quantitative assessments of the HEYDUDE Brand reporting unit and indefinite-lived trademark included future revenue growth rates, earnings before interest, taxes, depreciation, and amortization (“EBITDA”), and market-based discount rates. The estimated fair values of the HEYDUDE Brand reporting unit goodwill and indefinite-lived trademark exceeded their carrying values. +For the year ended December 31, 2023, we performed a qualitative and quantitative assessment for the HEYDUDE Brand reporting unit goodwill, and we performed a quantitative assessment for the HEYDUDE Brand indefinite-lived intangible assets, each of which indicated the estimated fair values exceeded their carrying values. +44 +Table of Contents +For the year ended December 31, 2022, we performed a quantitative assessment for the HEYDUDE Brand reporting unit goodwill and the HEYDUDE Brand indefinite-lived intangible assets, each of which indicated the estimated fair values exceeded their carrying values. +Additionally, for the years ended December 31, 2024, 2023, and 2022, we performed a qualitative assessment for the goodwill in our Crocs Brand segment, which indicated that it was more likely than not that the estimated fair value exceeded its carrying value. +Changes in the assumptions used to estimate the fair value of our goodwill and indefinite-lived intangible assets could result in impairment charges in future periods as the key assumptions are inherently uncertain, require significant judgment and are subject to change based on, among others, industry and geopolitical conditions, our ability to navigate changing macroeconomic conditions and trends as well as the timing and success of strategic initiatives. Certain factors, such as failure to achieve forecasted revenue growth rates, EBITDA, or increases in the discount rates, have the potential to create variances in the estimated fair values of our goodwill and indefinite-lived intangible assets that could result in impairment charges. See also the risk factor under “Financial and Accounting Risks — We may incur impairments of the carrying value of our goodwill and other intangible assets, which could have a material adverse effect on our business and financial results.” +We did not record any impairment charges in the years ended December 31, 2024, 2023, or 2022 based on the results of our goodwill and indefinite-lived intangible assets impairment testing. Refer to Note 1 — Basis of Presentation and Summary of Significant Accounting Policies and Note 5 — Goodwill and Intangible Assets, Net, Net in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to our goodwill and indefinite-lived intangible assets. +Impairment of Long-Lived Assets +Property and equipment, right-of-use assets, and definite-lived intangible assets, such as customer relationships and capitalized software, are evaluated for impairment whenever events or changes in circumstances indicate that their carrying values may not be fully recoverable. This represents a critical accounting policy as our impairment evaluations include significant judgments and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. Testing of long-lived assets for impairment is at the level of an asset group, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In our retail business, the asset group for impairment testing is each individual retail store. For customer relationships, impairment testing is performed at the customer group level. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition, where applicable. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan of disposal are reported at the lower of carrying value or fair value, less costs to sell. +In determining future cash flows, we take various factors into account, including the remaining useful life of each asset group, forecasted growth rates, pricing, working capital, capital expenditures, and other cash needs specific to the asset group. Additional considerations when assessing impairment include changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product, and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Since the determination of future cash flows is an estimate of future performance, future impairments may arise in the event that future cash flows do not meet expectations. +In 2024, we recorded non-cash impairments of $18.2 million for information technology systems related to the HEYDUDE integration and $5.9 million related to our former HEYDUDE Brand warehouse in Las Vegas, Nevada and our former Crocs Brand warehouse in Oudenbosch, the Netherlands. In 2023, we recorded non-cash impairments of $9.3 million related to our former corporate headquarters. In 2022, we did not record impairments to reduce the net carrying value of certain long-lived assets. See Note 8 — Fair Value Measurements in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to long-lived asset impairments. +45 +Table of Contents +Revenues and Reserves for Sales Returns and Allowances +While our revenue recognition does not involve significant judgment, it does represent a key accounting policy as it is important to our results of operations. Revenues are recognized in the amount expected to be received when control of the product transfers to customers. Revenues are reported net of various promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. An area of judgment affecting our reported revenues and net income involves estimating reserves for sales returns and allowances, which represent a portion of revenues not expected to be realized. Revenues in our direct-to-consumer channels are reduced by an estimate of returns. We may also accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Wholesale revenues are reduced by estimates of returns and allowances. +Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Changes to our estimates for customer returns and allowances may be caused by many factors, including, but not limited to, whether customers accept our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products, and macroeconomic factors affecting our customers. Historically, actual amounts of customer returns, allowances, discounts, and rebates have not differed significantly from our estimates. A hypothetical 1% increase in our reserves for returns and allowances as of December 31, 2024 would have had an insignificant impact on our 2024 revenues. +See Schedule II in Part IV - Item 15. Exhibits, Financial Statement Schedule to the accompanying consolidated financial statements of this Annual Report on Form 10-K for an analysis of the activity in our reserves for uncollectible accounts receivable, sales returns, allowances, and discounts. +46 +Table of Contents +Income Taxes +Intellectual Property Income Tax Implications +During 2024, we completed an intra-entity transaction related to certain intellectual property (“IP”) rights primarily to align with current and future international operations. The transaction was executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth, which is inherently uncertain and, therefore, may ultimately differ materially from our actual results. Foreign deferred tax assets increased by $268.8 million and this benefit was offset by an increase in uncertain tax positions of $145.6 million. As such, a net change in deferred tax asset of $123.2 million was recognized along with a corresponding foreign income tax benefit. In 2024, we received new information and remeasured the reserve for uncertain tax positions related to the 2020 and 2021 intellectual property rights transactions which resulted in the release of uncertain tax positions of $141.2 million along with a corresponding foreign income tax benefit. +In 2023, we completed transactions that created an amortizable step-up in tax basis of the intangible asset and a corresponding increase in foreign deferred tax assets based on the fair value of that IP. These transactions were also executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of these transactions. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from our actual results. As of December 31, 2023, the related net deferred tax asset was $310.7 million, net of a reserve for uncertain tax positions of $318.6 million and a valuation allowance of $164.0 million for amounts not more-likely-than-not to be realized based on available objective evidence. As of December 31, 2024, the related net deferred tax asset was $271.7 million, net of a reserve for uncertain tax positions of $314.8 million and a valuation allowance of $184.7 million for amounts not more-likely-than-not to be realized based on available objective evidence. +In 2020 and in 2021, we completed transactions that created an amortizable step-up in tax basis of the intangible asset and a corresponding increase in foreign deferred tax assets based on the fair value of that IP. These transactions were also executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of these transactions. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from our actual results. As of December 31, 2021, the related net deferred tax asset was $490.2 million, net of a reserve for uncertain tax positions of $206.0 million. As of December 31, 2022, the related net deferred tax asset was $438.5 million, net of a reserve for uncertain tax positions of $194.4 million. As of December 31, 2023, the related net deferred tax asset was $427.1 million, net of a reserve for uncertain tax positions of $200.5 million. As of December 31, 2024, the related net deferred tax asset was $377.1 million, net of a reserve for uncertain tax positions of $46.8 million. In 2024, we received new information and remeasured the reserve for uncertain tax positions related to the 2020 and 2021 intellectual property rights transactions which resulted in the release of uncertain tax positions of $141.2 million along with a corresponding foreign income tax benefit. +In order to support and sustain the amortizable tax basis for these transactions (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands and Singapore. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands and Singapore subsidiaries serve as the primary corporate headquarters outside of the U.S. and already perform significant functions in support of the economic ownership of the IP. In 2024, we undertook many additional activities to align business operations that support the economic substance of the IP. +We have also recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +47 +Table of Contents +Income Tax Accounting +We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low tax income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. We recognize interest and penalties related to unrecognized tax benefits within the ‘Income tax expense (benefit)’ line in the accompanying consolidated statements of income. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Foreign withholding taxes have not been provided on cumulative undistributed foreign earnings of the non-U.S. subsidiaries as of December 31, 2024, which are considered to be indefinitely reinvested outside of the U.S. +See Note 14 — Income Taxes in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information related to income taxes. +Recent Accounting Pronouncements +See Note 2 — Recent Accounting Pronouncements in the accompanying notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a description of recently adopted accounting pronouncements and issued accounting pronouncements that we believe may have an impact on our consolidated financial statements when adopted. +48 +Table of Contents +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our Revolving Facility and certain financial instruments. +As of December 31, 2024, we had borrowings with a face value of $1,390.0 million, comprised of the Notes, which carry a fixed interest rate, the Term Loan B Facility, and the Revolving Facility. We also had $0.6 million in outstanding letters of credit under our Revolving Facility as of December 31, 2024. As of December 31, 2023, we had long-term borrowings with a face value of $1,713.3 million and $1.3 million in outstanding letters of credit under our Revolving Facility. +A hypothetical increase of 1% in the interest rate on the variable rate borrowings under our Term Loan B Facility and Revolving Facility would increase our interest expense over the next twelve months by $6.9 million based on the balances outstanding for these borrowings as of December 31, 2024. +Foreign Currency Exchange Risk +Changes in exchange rates have a direct effect on our reported USD consolidated financial statements because we translate the operating results and financial position of our international subsidiaries to USD using current period exchange rates. Specifically, we translate the statements of income of our foreign subsidiaries into the USD reporting currency using exchange rates in effect during each reporting period. As a result, comparisons of reported results between reporting periods may be impacted significantly due to differences in the exchange rates in effect at the time such exchange rates are used to translate the operating results of our international subsidiaries. +An increase of 1% of the value of the USD relative to foreign currencies would have decreased our revenues and income before taxes during the year ended December 31, 2024 by approximately $16.1 million and $2.8 million, respectively. The volatility of the exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. +In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we enter into forward contracts to buy and sell foreign currency. Changes in the fair value of these forward contracts are recognized in earnings in the period that the changes occur or in the period in which the hedged transaction affects earnings for derivatives classified as non-hedged or hedged, respectively, as defined in Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on this Form 10-K. As of December 31, 2024, the USD notional value of our outstanding foreign currency forward exchange contracts was approximately $239.6 million. The fair value of these contracts at December 31, 2024 was an insignificant liability. See Part I - Item 1A. Risk Factors of this Annual Report on Form 10-K for a discussion of risks to our business and financial results associated with foreign currencies. +We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our foreign currency forward exchange contracts. To perform the sensitivity analysis, we assess the risk of changes in fair values from the effect of hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the USD. As of December 31, 2024, a 10% appreciation in the value of the USD would result in a net decrease in the fair value of our derivative portfolio of approximately $3.0 million. +See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for a discussion of the impact of the change in foreign exchange rates on our USD consolidated statements of income for the years ended December 31, 2024 and 2023. +49 +Table of Contents +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of December 31, 2024. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2024, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2024, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2024. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2024, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the three months ended December 31, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +50 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2024, of the Company and our report dated February 13, 2025, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 13, 2025 +51 +Table of Contents +ITEM 9B. Other Information +The following table shows all directors or officers who adopted or terminated a “Rule 10b5-1 trading arrangement” or a “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K, during the three months ended December 31, 2024. Except as shown below, during the three months ended December 31, 2024, no other directors or officers adopted or terminated a “Rule 10b5-1 trading arrangement” or a “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K. +Trading Arrangement +Name and Position Action Date Rule 10b5-1* Non-Rule 10b5-1** Total Number of Shares to be Sold Expiration Date +Anne Mehlman , +Executive Vice President and Brand President for Crocs +Adopt 12/17/2024 X 12,145 9/18/2025 +* Intended to satisfy the affirmative defense of Rule 10b5-1(c). +** Not intended to satisfy the affirmative defense of Rule 10b5-1(c). +ITEM 9C. Disclosures Regarding Foreign Jurisdictions that Prevent Inspection +None. +52 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2025 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2024. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer and principal financial officer. A copy of our code of ethics is available on our website: www.crocs.com. We are required to disclose certain changes to, or waivers from, that code for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our code of ethics as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2025 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2024. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2025 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2024, with the exception of those items listed below. +Equity Compensation Plan Information +As shown in the table below, we reserved 0.9 million shares of common stock for future issuance pursuant to exercise of outstanding awards under equity compensation plans as of December 31, 2024. +Plan Category +Number of Securities to be Issued on Exercise of Outstanding +Options, Warrants, and Rights (1) +Weighted Average Exercise Price of Outstanding +Options, Warrants, and Rights (2) +Number of Securities Remaining Available for Future Issuance Under Plans, Excluding Securities Available in First Column +Equity compensation plans approved by stockholders (3) +871,800 $ 6.98 3,097,338 +Equity compensation plans not approved by stockholders +— — — +Total 871,800 $ 6.98 3,097,338 +(1) The number of shares outstanding includes restricted stock awards and restricted stock units that were outstanding on December 31, 2024 and assumes target performance for performance-based equity awards. +(2) The weighted average exercise price of outstanding options pertains to 0.2 million shares issuable on the exercise of outstanding options. +(3) On June 10, 2020, our stockholders approved the Crocs, Inc. 2020 Equity Incentive Plan (the “Plan”). The number of shares of our common stock available for issuance under the Plan consisted of (i) 3.8 million newly available shares, (ii) 1.4 million shares of our common stock available for issuance under the 2015 Equity Incentive Plan (the “2015 Plan”) as of June 10, 2020, and (iii) 2015 Plan shares associated with outstanding options or awards that are canceled or forfeited after June 10, 2020. The number of shares authorized for issuance under the Plan is subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. The Plan became effective immediately upon stockholder approval. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2025 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2024. +53 +Table of Contents +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2025 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2024. +54 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedule +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedule +The following consolidated financial statement schedule of Crocs, Inc. and its subsidiaries is filed as a part of this report: +• Schedule II - Valuation and Qualifying Accounts. +Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. +55 +Table of Contents +(3) Exhibit list +Exhibit +Number Description +2.1 # +Securities Purchase Agreement, dated as of December 22, 2021, by and among: (i) Crocs, Inc.; (ii) Full Fortune Wealth Limited; (iii) Mr. Daniele Guidi; (iv) Full Fortune Intellectual Limited; (v) Full Fortune Worldwide Limited; (vi) Full Fortune Online Limited; (vii) Happy One LLC; (viii) Lucky Top Inc.; (ix) Mr. Alessandro Rosano; and (x) Full Fortune Wealth Limited, in its capacity as representative and agent for Sellers (incorporated herein by reference to Exhibit 2.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on December 23, 2021). +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.2 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, 2007). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +3.4 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +4.2 +Description of Registrant's Securities (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Annual Report on Form 10-K filed on February 27, 2020). +4.3 +Indenture (including Form of Global 4.250% Senior Notes due 2029), dated March 12, 2021, by and among Crocs, Inc., the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 12, 2021). +4.4 +Indenture (including Form of Global 4.125% Senior Notes due 2031), dated August 10, 2021, by and among Crocs, Inc. the Guarantors party thereto from time to time and U.S. Bank National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on August 10, 2021). +4.5 +First Supplemental Indenture, dated February 17, 2022, by and among Crocs, Inc., Hey Dude LLC, Happy One LLC and Lucky Top Inc. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +4.6 +First Supplemental Indenture, dated February 17, 2022, by and among Crocs, Inc., Hey Dude LLC, Happy One LLC and Lucky Top Inc. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +4.7 +Second Supplemental Indenture, dated January 19, 2023, by and among Crocs, Inc., Crocs UK Holdings Limited, Crocs UK Fin Co Limited, Crocs Finance UK Limited, Crocs SG Fin Co. Pte. Ltd. and Crocs Malta Global Ltd. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.7 to Crocs, Inc.’s Annual Report on Form 10-K filed on February 16, 2023). +4.8 +Second Supplemental Indenture, dated January 19, 2023, by and among Crocs, Inc., Crocs UK Holdings Limited, Crocs UK Fin Co Limited, Crocs Finance UK Limited, Crocs SG Fin Co. Pte. Ltd. and Crocs Malta Global Ltd. and U.S. Bank Trust Company, National Association, as trustee (incorporated herein by reference to Exhibit 4.8 to Crocs, Inc.’s Annual Report on Form 10-K filed on February 16, 2023). +4.9 † +Third Supplemental Indenture, dated January 2 9, 202 5 , by and among Crocs, Inc., C olorado F ootwear F inancial H oldings LLC and U.S. Bank Trust Company, National Association, as trustee . +56 +Table of Contents +Exhibit +Number Description +4.10 +† +Third Supplemental Indenture, dated January 29, 2025, by and among Crocs, Inc., Colorado Footwear Financial Holdings LLC and U.S. Bank Trust Company, National Association, as trustee. +10.1 ## +Second Amended and Restated Credit Agreement, dated July 26, 2019, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed August 1, 2019). +10.2 ## +First Amendment to Second Amended and Restated Credit Agreement, dated March 26, 2020, among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, the lenders named therein, KeyBank National Association, as syndication agent, and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed March 30, 2020). +10.3 +Second Amendment to Second Amended and Restated Credit Agreement, dated November 13, 2020, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the lenders named therein, PNC Capital Markets LLC, as sole bookrunner, cosyndication agent and joint lead arranger, Citibank, N.A., Bank of America, N.A. and KeyBank National Association, each as joint lead arranger and co-syndication agent, and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.12 to Crocs, Inc.’s Annual Report on Form 10-K, filed February 23, 2021). +10.4 +Third Amendment to Second Amended and Restated Credit Agreement, dated July 23, 2021, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, LLC, Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PNC Bank, National Association, as administrative agent (incorporated herein by reference herein to Exhibit 10.7 to Crocs, Inc.’s Annual Report on Form 10-K, filed February 16, 2022). +10.5 ## +Fourth Amendment to Second Amended and Restated Credit Agreement, dated February 17, 2022, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, Inc., Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PNC Bank, National Association, as administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +10.6 ## +Fifth Amendment to Second Amended and Restated Credit Agreement, dated November 30, 2022, by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, Inc., Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, Bank of America, N.A., London Branch, as alternative currency swing loan lender and PNC Bank, National Association, as administrative agent, U.S. dollar swing loan lender and issuing lender (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 1, 2022. +10.7 ## +Sixth Amendment to Second Amended and Restated Credit Agreement, date d December 4 , 202 4 , by and among Crocs, Inc., Crocs Retail, LLC, Jibbitz, Inc., Colorado Footwear C.V., Crocs Europe B.V., the guarantors named therein, the lenders named therein, and PN C Bank , National Association, as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 5 , 202 4 . +10.8 +## +Term Loan Credit Agreement, dated February 17, 2022, by and among Crocs, Inc., the lenders from time to time party thereto and Citibank, N.A., as administrative agent (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on February 18, 2022). +10.9 +## +Refinancing Amendment, dated as of August 8, 2023, by and among Crocs, Inc., a Delaware corporation, the subsidiary guarantors party thereto, Citibank, N.A., as administrative agent, and each of the lenders party thereto (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on August 8, 2023). +57 +Table of Contents +Exhibit +Number Description +10.10 +## +2024 Refinancing Amendment, dated as of February 13, 2024, by and among Crocs, Inc., a Delaware corporation, the subsidiary guarantors party thereto, Citibank, N.A., as administrative agent, and each of the lenders party thereto (incorporated herein by reference to Exhibit 10.12 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 15, 2024). +10.11 * +Crocs, Inc. 2015 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 9, 2015). +10.12 * +Crocs, Inc. 2020 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 11, 2020). +10.13 +* +Crocs, Inc. Change of Control Plan (as Amended and Restated) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on October 4, 2018). +10.14 * +Employment Offer Letter, dated May 13, 2014, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 14, 2014) . +10.15 * +Supplement to Offer Letter, dated February 23, 2017, between Crocs, Inc. and Andrew Rees (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed on March 1, 2017). +10.16 * +Employment Offer Letter, dated April 30, 2024, between Crocs, Inc. and Susan Healy (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on May 7, 2024). +10.17 * +Andrew Rees Performance-Vested Restricted Stock Unit Agreement (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on June 13, 2018). +10.18 * +Form of Performance-Vested Restricted Stock Award (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on January 13, 2021). +10.19 * +Employment Offer Letter, dated January 28, 2024, between Crocs, Inc. and Anne Mehlman (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on May 7, 2024). +10.20 * +Employment Offer Letter dated September 10, 2020 between Crocs, Inc. and Michelle Poole (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on September 14, 2020). +10.21 * +Transition Agreement dated January 28, 2024 between Crocs, Inc. and Michelle Poole (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on May 7, 2024). +10.22 * +Employment Offer Letter dated December 22, 2021 between Crocs, Inc. and Rick Blackshaw (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 1, 2024). +10.23 * +Settlement Agreement and General Release dated May 23, 2024, between Rick Blackshaw and Hey Dude Inc. (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on Form 10-Q, filed on August 1, 2024). +19 † +Securities Trading & Information Disclosure Policy +21 † +Subsidiaries of the registrant. +23.1 † +Consent of Deloitte & Touche LLP. +31.1 † +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +58 +Table of Contents +Exhibit +Number Description +31.2 † +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley Act. +32 + +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +97 +* +Incentive Compensation Recovery Policy (incorporated herein by reference to Exhibit 97 to Crocs, Inc.’s Annual Report on Form 10-K, filed on February 15, 2024). +101.INS † XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. +101.SCH † XBRL Taxonomy Extension Schema Document +101.CAL † XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF † XBRL Taxonomy Extension Definition Linkbase Document +101.LAB † XBRL Taxonomy Extension Label Linkbase Document +101.PRE † XBRL Taxonomy Extension Presentation Linkbase Document +104 Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101). +* Compensatory plan or arrangement. +# Certain exhibits and schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted exhibits or schedules upon request; provided that the Company may request confidential treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. +## Schedules and exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K. The Company hereby undertakes to supplementally furnish copies of any omitted schedules and exhibits to the Securities and Exchange Commission upon request. +† Filed herewith. ++ Furnished herewith. +59 +Table of Contents +Item 16. Form 10–K Summary. +None. +60 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 13, 2025. +CROCS, INC. +a Delaware Corporation +By: /s/ ANDREW REES +Name: Andrew Rees +Title: Chief Executive Officer +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signature Title Date +/s/ ANDREW REES Chief Executive Officer and Director (Principal Executive Officer) February 13, 2025 +Andrew Rees +/s/ SUSAN HEALY +Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 13, 2025 +Susan Healy +/s/ THOMAS J. SMACH Chairman of the Board February 13, 2025 +Thomas J. Smach +/s/ IAN M. BICKLEY Director February 13, 2025 +Ian M. Bickley +/s/ RONALD L. FRASCH Director February 13, 2025 +Ronald L. Frasch +/s/ CHARISSE FORD HUGHES Director February 13, 2025 +Charisse Ford Hughes +/s/ BETH J. KAPLAN Director February 13, 2025 +Beth J. Kaplan +/s/ JOHN REPLOGLE Director February 13, 2025 +John Replogle +/s/ NEERAJ TOLMARE Director February 13, 2025 +Neeraj Tolmare +/s/ DOUGLAS J. TREFF Director February 13, 2025 +Douglas J. Treff +61 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) +F- 2 +Consolidated Statements of Income for the Years Ended December 31, 2024, 2023, and 2022 +F- 4 +Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2024, 2023, and 2022 +F- 5 +Consolidated Balance Sheets as of December 31, 2024 and 2023 +F- 6 +Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2024, 2023, and 2022 +F- 7 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2024, 2023, and 2022 +F- 8 +Notes to Consolidated Financial Statements +F- 9 +Schedule II: Valuation and Qualifying Accounts +F- 40 +F- 1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on the Financial Statements +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2024 and 2023, the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows, for each of the three years in the period ended December 31, 2024, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2024 and 2023, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2024, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 13, 2025, expressed an unqualified opinion on the Company's internal control over financial reporting. +Basis for Opinion +These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. +Critical Audit Matter +The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. +Income Taxes – Evaluation of the Deferred Tax Asset resulting from Intra-entity Intellectual Property Transaction — Refer to Note 14 to the consolidated financial statements +Critical Audit Matter Description +The Company recognizes deferred income taxes for tax attributes and for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the deferred tax liability or asset is expected to be settled or realized. The Company takes a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a return and disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not to be sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. +During 2024, the Company completed an intra-entity transaction related to certain intellectual property rights primarily to align with current and future international operations and a corresponding increase in foreign deferred tax assets based on the fair value of certain intellectual property (“IP”) rights. The transaction was executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of the transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth, which by their nature are inherently uncertain and, therefore, may ultimately differ materially from actual results. Foreign deferred tax assets increased by $268.8 million, which was offset by an increase in uncertain tax positions of $145.6 million for amounts not more-likely-than-not to be realized based on available objective evidence. As such, a net change in deferred tax asset of $123.2 million was recognized along with a corresponding foreign income tax benefit. +F- 2 +Table of Contents +We identified management’s valuation of the deferred tax asset and related uncertain tax positions resulting from the Company’s transaction of certain intellectual property as a critical audit matter because of the significant judgments and estimates that were required to be made by management to properly value the deferred tax asset and uncertain tax positions. The judgments and estimates were related to the Company’s interpretation of related tax laws and regulations, as well as the use of estimates and assumptions regarding future events. +As a result, we utilized a high degree of auditor judgment and an increased extent of effort when performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions for the measurement of the deferred tax asset related to the forecasts of future revenue growth. We also utilized a high degree of auditor judgment and an increased extent of effort, including the need to involve our income tax and transfer pricing specialists, when performing audit procedures to evaluate whether management’s judgments in interpreting and applying tax laws and estimates and assumptions regarding future settlements were appropriate in determining the value of the uncertain tax positions. +How the Critical Audit Matter Was Addressed in the Audit +Our audit procedures, performed with the assistance of our tax and transfer pricing specialists, related to the Company’s evaluation of the deferred tax asset resulting from the intra-entity IP transaction included the following, among others: +• We tested the effectiveness of management’s controls over the determination of the measurement of deferred tax asset, such as controls related to management’s forecasts of future revenues, and management’s controls over the measurement of the uncertain tax position, such as controls related to the evaluation of subjective estimates in the amounts to be realized. +• We evaluated the reasonableness of management’s revenue forecasts by comparing to: +– Historical revenue growth rates +– Historical revenue growth of peer companies +– Internal communications to management and the Board of Directors +– Forecasted information included in analyst and industry reports +– Expected macroeconomic trends. +• With the assistance of our tax and transfer pricing specialists, we evaluated the measurement of uncertain tax positions. Our procedures included the following, among others: +– Reviewed the Company’s analysis of the uncertain tax positions and evaluated the reasonableness of the assumptions and calculations the Company used to develop the amount of the related uncertain tax positions. +– Obtained the Company’s supporting documentation to assess the technical tax merits applicable to local country, international tax, and transfer pricing standards, the more-likely-than-not recognition and measurement thresholds and evaluated the application of these relevant tax laws in the Company’s recognition determination. +– Evaluated the Company’s measurement of the liability using our knowledge of international, domestic, and local income tax laws, as well as settlement activity from the relevant income tax authorities. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 13, 2025 +We have served as the Company's auditor since 2005. +F- 3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF INCOME +(in thousands, except per share data) +Year Ended December 31, +2024 2023 2022 +Revenues +$ 4,102,108 $ 3,962,347 $ 3,554,985 +Cost of sales +1,691,850 1,752,337 1,694,703 +Gross profit +2,410,258 2,210,010 1,860,282 +Selling, general and administrative expenses (1) +1,388,347 1,173,227 1,009,526 +Income from operations +1,021,911 1,036,783 850,756 +Foreign currency gains (losses), net +( 6,777 ) ( 1,240 ) 3,228 +Interest income +3,484 2,406 1,020 +Interest expense +( 109,264 ) ( 161,351 ) ( 136,158 ) +Other income (expense), net +1,231 ( 326 ) ( 338 ) +Income before income taxes +910,585 876,272 718,508 +Income tax expense (benefit) +( 39,486 ) 83,706 178,349 +Net income +$ 950,071 $ 792,566 $ 540,159 +Net income per common share: +Basic +$ 16.00 $ 12.91 $ 8.82 +Diluted +$ 15.88 $ 12.79 $ 8.71 +Weighted average common shares outstanding: +Basic +59,381 61,386 61,220 +Diluted +59,832 61,952 62,006 +(1) Amounts for the year ended December 31, 2023 have been reclassified to conform to current period presentation. +The accompanying notes are an integral part of these consolidated financial statements. +F- 4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(in thousands) +Year Ended December 31, +2024 2023 2022 +Net income +$ 950,071 $ 792,566 $ 540,159 +Other comprehensive income (loss), net of tax: +Derivatives designated as hedging instruments: +Unrealized gains (losses) on derivative instruments +936 ( 281 ) ( 576 ) +Reclassification adjustment for realized (gains) losses on derivative instruments +( 564 ) 563 — +Net increase (decrease) from derivatives designated as hedging instruments +372 282 ( 576 ) +Foreign currency gains (losses), net +( 37,249 ) 7,441 ( 17,929 ) +Reclassification of foreign currency translation gain (loss) to income (1) +— — ( 8,148 ) +Total comprehensive income, net of tax +$ 913,194 $ 800,289 $ 513,506 +(1) Represents the reclassification of a cumulative foreign currency translation adjustment upon substantial liquidation of foreign subsidiaries which is presented within ‘Selling, general and administrative expenses’ in the consolidated statements of income. +The accompanying notes are an integral part of these consolidated financial statements. +F- 5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(in thousands, except share and par value amounts) +December 31, +2024 2023 +ASSETS +Current assets: +Cash and cash equivalents +$ 180,485 $ 149,288 +Restricted cash — current +— 2 +Accounts receivable, net of allowances of $ 31,579 and $ 27,591 , respectively +257,657 305,747 +Inventories +356,254 385,054 +Income taxes receivable +4,046 4,413 +Other receivables +22,204 21,071 +Prepaid expenses and other assets +51,623 45,129 +Total current assets +872,269 910,704 +Property and equipment, net +244,335 238,315 +Intangible assets, net +1,777,080 1,792,562 +Goodwill +711,491 711,588 +Deferred tax assets, net +872,350 667,972 +Restricted cash +3,193 3,807 +Right-of-use assets +307,228 287,440 +Other assets +24,207 31,446 +Total assets +$ 4,812,153 $ 4,643,834 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ 264,901 $ 260,978 +Accrued expenses and other liabilities +298,068 285,771 +Income taxes payable +108,688 65,952 +Current borrowings +— 23,328 +Current operating lease liabilities +68,551 62,267 +Total current liabilities +740,208 698,296 +Deferred tax liabilities, net +4,086 12,912 +Long-term income taxes payable +595,434 565,171 +Long-term borrowings +1,349,339 1,640,996 +Long-term operating lease liabilities +283,406 269,769 +Other liabilities +3,948 2,767 +Total liabilities +2,976,421 3,189,911 +Commitments and contingencies +Stockholders’ equity: +Common stock, par value $ 0.001 per share, 110.4 million and 110.1 million issued, 56.5 million and 60.5 million shares outstanding, respectively +110 110 +Treasury stock, at cost, 53.9 million and 49.6 million shares, respectively +( 2,453,473 ) ( 1,888,869 ) +Additional paid-in capital +859,904 826,685 +Retained earnings +3,561,836 2,611,765 +Accumulated other comprehensive loss +( 132,645 ) ( 95,768 ) +Total stockholders’ equity +1,835,732 1,453,923 +Total liabilities and stockholders’ equity +$ 4,812,153 $ 4,643,834 +The accompanying notes are an integral part of these consolidated financial statements. +F- 6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +(in thousands) +Common Stock Treasury Stock Additional +Paid-in +Capital Retained +Earnings +Accumulated +Other +Comprehensive +Income (Loss) +Total +Stock-holders' +Equity +Shares Amount Shares Amount +Balance at December 31, 2021 +58,330 $ 106 47,583 $ ( 1,684,262 ) $ 496,036 $ 1,279,040 $ ( 76,838 ) $ 14,082 +Share-based compensation — — — — 31,303 — — 31,303 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes 567 1 147 ( 11,239 ) ( 118 ) — — ( 11,356 ) +Share issuance at Acquisition 2,852 3 — — 270,393 — — 270,396 +Net income +— — — — — 540,159 — 540,159 +Other comprehensive loss +— — — — — — ( 26,653 ) ( 26,653 ) +Balance at December 31, 2022 +61,749 $ 110 47,730 $ ( 1,695,501 ) $ 797,614 $ 1,819,199 $ ( 103,491 ) $ 817,931 +Share-based compensation — — — — 29,072 — — 29,072 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes +427 — 147 ( 17,086 ) ( 1 ) — — ( 17,087 ) +Repurchases of common stock, including excise tax ( 1,681 ) — 1,681 ( 176,282 ) — — — ( 176,282 ) +Net income +— — — — — 792,566 — 792,566 +Other comprehensive income +— — — — — — 7,723 7,723 +Balance at December 31, 2023 +60,495 $ 110 49,558 $ ( 1,888,869 ) $ 826,685 $ 2,611,765 $ ( 95,768 ) $ 1,453,923 +Share-based compensation — — — — 33,053 — — 33,053 +Exercises of stock options and issuance of restricted stock units, net of shares withheld for taxes +289 — 63 ( 8,239 ) 166 — — ( 8,073 ) +Repurchases of common stock, including excise tax ( 4,309 ) — 4,309 ( 556,365 ) — — — ( 556,365 ) +Net income +— — — — — 950,071 — 950,071 +Other comprehensive loss +— — — — — — ( 36,877 ) ( 36,877 ) +Balance at December 31, 2024 +56,475 $ 110 53,930 $ ( 2,453,473 ) $ 859,904 $ 3,561,836 $ ( 132,645 ) $ 1,835,732 +The accompanying notes are an integral part of these consolidated financial statements. +F- 7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(in thousands) +Year Ended December 31, +2024 2023 2022 +Cash flows from operating activities: +Net income +$ 950,071 $ 792,566 540,159 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +69,840 54,304 39,229 +Loss on disposal of assets +958 419 9,063 +Operating lease cost +85,130 79,543 66,012 +Inventory donations 812 2,078 2,770 +Provision for doubtful accounts, net +1,352 3,568 1,101 +Share-based compensation +33,053 29,072 31,303 +Asset impairments +24,081 9,287 — +Deferred taxes +( 254,454 ) ( 410,319 ) ( 4,760 ) +Other non-cash items +13,213 3,401 9,947 +Changes in operating assets and liabilities, net of acquired assets and assumed liabilities: +Accounts receivable, net of allowances +42,587 ( 13,317 ) ( 56,766 ) +Inventories +22,055 86,350 ( 91,614 ) +Prepaid expenses and other assets +( 13,892 ) ( 31,839 ) ( 14,435 ) +Accounts payable +3,951 37,197 41,701 +Accrued expenses and other liabilities +9,971 46,695 38,629 +Right-of-use assets and operating lease liabilities +( 88,772 ) ( 75,107 ) ( 63,355 ) +Income taxes +92,530 316,546 54,158 +Cash provided by operating activities +992,486 930,444 603,142 +Cash flows from investing activities: +Purchases of property, equipment, and software +( 69,347 ) ( 115,625 ) ( 104,190 ) +Acquisition of HEYDUDE, net of cash acquired +— — ( 2,046,881 ) +Other +— ( 46 ) ( 20 ) +Cash used in investing activities +( 69,347 ) ( 115,671 ) ( 2,151,091 ) +Cash flows from financing activities: +Proceeds from bank borrowings +102,156 257,905 2,169,898 +Repayments of bank borrowings +( 425,405 ) ( 923,703 ) ( 575,285 ) +Deferred debt issuance costs +( 2,277 ) ( 1,736 ) ( 53,596 ) +Repurchases of common stock, including excise taxes paid +( 552,451 ) ( 175,019 ) — +Repurchases of common stock for tax withholding +( 8,239 ) ( 17,086 ) ( 11,477 ) +Other +168 — 119 +Cash provided by (used in) financing activities +( 886,048 ) ( 859,639 ) 1,529,659 +Effect of exchange rate changes on cash, cash equivalents, and restricted cash +( 6,510 ) 3,078 ( 3,750 ) +Net change in cash, cash equivalents, and restricted cash +30,581 ( 41,788 ) ( 22,040 ) +Cash, cash equivalents, and restricted cash — beginning of year 153,097 194,885 216,925 +Cash, cash equivalents, and restricted cash — end of year $ 183,678 $ 153,097 $ 194,885 +Cash paid for interest $ 99,463 $ 151,621 $ 127,809 +Cash paid for income taxes 124,959 179,721 130,084 +Cash paid for operating leases 90,943 74,729 62,852 +Right-of-use assets obtained in exchange for operating lease liabilities, net of terminations 92,101 120,865 137,554 +Accrued purchases of property, equipment, and software 9,517 7,668 18,245 +Share issuance at Acquisition — — 270,396 +The accompanying notes are an integral part of these consolidated financial statements. +F- 8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Unless otherwise noted in this report, any description of the “Company,” “we,” “us,” or “our” includes Crocs, Inc. and its consolidated subsidiaries within our reportable operating segments and corporate operations. We are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for all. We strive to be the global leader in the sale of casual footwear characterized by functionality, comfort, color, and lightweight design. +On February 17, 2022, we acquired (the “Acquisition”) 100 % of the equity of a privately-owned casual footwear brand business (“HEYDUDE”). HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand. See Note 17 — Operating Segments and Geographic Information for additional information. +Basis of Presentation and Consolidation +Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries, and they reflect all adjustments which are necessary for a fair statement of results of operations, financial position, and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions used to determine certain amounts that affect the financial statements are reasonable, based on information available at the time they are made. Management believes that the estimates, judgments, and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, customer rebates, sales returns and allowances, impairment assessments and charges, recoverability of long-lived assets, deferred tax assets, valuation allowances, uncertain tax positions, income tax expense, share-based compensation expense, the assessment of lower of cost or net realizable value on inventory, useful lives assigned to long-lived assets, goodwill, and indefinite-lived intangible assets, and purchase price allocation for the Acquisition, as described in Note 3 — Acquisition of HEYDUDE, are reasonable based on information available at the time they are made. +Additionally, we are periodically exposed to various contingencies in the ordinary course of conducting our business, including certain litigation, contractual disputes, employee relations matters, various tax or other governmental audits, and trademark and intellectual property matters and disputes. We record a liability for such contingencies to the extent that we conclude their occurrence is probable and the related losses are estimable. If it is reasonably possible that an unfavorable settlement of a contingency could exceed the established liability, we disclose the estimated impact on our liquidity, financial condition, and results of operations, if practicable. As the ultimate resolution of contingencies is inherently unpredictable, these assessments can involve a series of complex judgments about future events including, but not limited to, court rulings, negotiations between affected parties, and governmental actions. As a result, the accounting for loss contingencies relies heavily on management’s judgment in developing the related estimates and assumptions. See Note 16 — Commitments and Contingencies and Note 18 — Legal Proceedings for additional information regarding our contingencies and legal proceedings. +To the extent there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. +Reclassifications +We have reclassified certain amounts on the consolidated statements of income, in Note 6 — Accrued Expenses and Other Liabilities, in Note 14 — Income Taxes, and in Note 17 — Operating Segments and Geographic Information to conform to current period presentation. +F- 9 +Table of Contents +Cash and Cash Equivalents +Cash and cash equivalents represent cash and short-term, highly-liquid investments with maturities of three months or less at the date of purchase. We report receivables from credit card companies in cash and cash equivalents. +Accounts Receivable, Net +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances. We reduce the carrying value for estimated uncollectible accounts based on a variety of factors including the length of time receivables are past due, economic trends and conditions affecting our customer base, and historical collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial obligations. We write off accounts receivable to the reserves when they are deemed uncollectible or, in certain jurisdictions, when legally able to do so. See Schedule II in Item 15. Exhibits, Financial Statement Schedule of this Annual Report on Form 10-K for more information. +Inventories +Inventories are comprised of finished goods, are stated at the lower of cost or net realizable value, and are recognized using the first-in-first-out method of inventory costing. We estimate the market value of inventory based on an analysis of historical sales trends of our individual product lines, the impact of market trends and economic conditions, and a forecast of future demand, giving consideration to the value of current orders in-house for future sales of inventory, as well as plans to sell discontinued or end-of-life inventory through our outlet stores, among other off-price channels. Estimates may differ from actual results due to the quantity, quality, and mix of products in inventory, consumer and retailer preferences, and market conditions. If the estimated market value is less than its carrying value, the carrying value is adjusted to the market value, and the difference is recorded in ‘Cost of sales’ in our consolidated statements of income. +Reserves for the risk of physical loss of inventory are estimated based on historical experience and are adjusted based upon physical inventory counts, and they are recorded within ‘Cost of sales’ in our consolidated statements of income. +Property and Equipment, Net +Property, equipment, furniture, and fixtures are stated at original cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful asset lives. The useful lives are reviewed periodically and typically range from 2 to 10 years for machinery and equipment and furniture, fixtures and others. Leasehold improvements are stated at cost and amortized on a straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Costs of enhancements or modifications that substantially extend the capacity or useful life of an asset are capitalized and depreciated accordingly. Ordinary repairs and maintenance are expensed as incurred. Depreciation of warehouse- and distribution-related assets is included in ‘Cost of sales’ in our consolidated statements of income. Depreciation related to retail store, corporate, and non-product assets is included in ‘Selling, general and administrative expenses’ in our consolidated statements of income. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from our consolidated balance sheets, and the resulting gain or loss, if any, is reflected in ‘Income from operations’ in the consolidated statements of income. +Goodwill and Other Intangible Assets, Net +We evaluate the carrying value of our goodwill and indefinite-lived intangible assets for impairment at the reporting unit level at least annually or when an interim triggering event has occurred indicating potential impairment. +The excess of the purchase price over the fair value of acquired net assets represents goodwill. Our goodwill balance as of December 31, 2024 was $ 711.5 million and primarily related to the Acquisition. As of December 31, 2024, a goodwill amount of $ 710.0 million was assigned to the HEYDUDE Brand segment and consisted of the acquired workforce and economies of scale resulting from the Acquisition. +F- 10 +Table of Contents +When performing our annual test for impairment, we may assess goodwill and indefinite-lived intangible assets for potential impairment using either a qualitative or quantitative assessment. Significant judgments and assumptions are required in such impairment evaluations. For the quantitative assessment, we compare the estimated fair value of a reporting unit with its carrying value, including the goodwill assigned to the reporting unit. If the carrying value of the reporting unit exceeds its estimated fair value, an impairment charge is recorded. For the year ended December 31, 2024 , we performed a quantitative assessment for the HE YDUDE Brand reporting unit goodwill and the HEYDUDE Brand indefinite-lived intangible assets. The estimated fair values of the HEYDUDE Brand reporting unit goodwill and indefinite-lived trademark exceeded their carrying values. For the year ended December 31, 2023, we performed a qualitative and quantitative assessment for the HEYDUDE Brand reporting unit goodwill, and we performed a quantitative assessment for the HEYDUDE Brand indefinite-lived intangible assets, each of which indicated the estimated fair values exceeded their carrying values. For the year ended December 31, 2022, we performed a quantitative assessment for the HEYDUDE Brand reporting unit goodwill and the HEYDUDE Brand indefinite-lived intangible assets, each of which indicated the estimated fair values exceeded their carrying values. Additionally for the years ended December 31, 2024, 2023, and 2022, we performed a qualitative assessment for the goodwill in our Crocs Brand segment, which indicated that it was more likely than not that the estimated fair value exceeded its carrying value. We did not record any impairment charges in the years ended December 31, 2024, 2023, or 2022 based on the results of our goodwill and indefinite-lived intangible assets impairment testing. +We continuously monitor the performance of our definite-lived intangible assets, which includes software, customer relationships, patents, copyrights, and certain trademarks, and evaluate for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations. Definite-lived intangible assets are stated at cost, less accumulated amortization. Amortization is recorded using the straight-line method over the estimated lives of the assets. +We amortize our customer relationships on a straight-line basis over a useful life of 15 years. Amortization for patents, copyrights, and trademarks is provided using the straight-line method over the estimated useful asset lives, which are reviewed periodically and typically range from 7 to 25 years. +Internal-Use Software and Cloud Computing Arrangements +We capitalize direct costs of materials and services used in the development and purchase of internal-use software. Amounts capitalized are amortized on a straight-line basis over a period of 2 to 8 years and are reported as a component of ‘Intangible assets, net’ in the consolidated balance sheets. +We also capitalize certain costs incurred during the application development stage of implementation of internal-use software in cloud computing arrangements. Amounts capitalized are amortized on a straight-line basis over the expected length of the related contract and are reported as a component of ‘Other assets’ in the consolidated balance sheets. +Amortization of capitalized software used in warehouse- and distribution-related activities is included in ‘Cost of sales’ in the consolidated statements of income. Amortization related to corporate and non-product, assets, such as our global information systems, is included in ‘Selling, general, and administrative expenses’ in the consolidated statements of income. +Restricted Cash +Restricted cash primarily consists of funds to secure certain retail store leases, certain customs requirements, and other contractual arrangements. +Leases +Our lease portfolio consists primarily of real estate assets, which includes retail, warehouse, distribution center, and office spaces, under operating leases expiring at various dates through 2034. Leases with an original term of twelve months or less are not reported in the consolidated balance sheets; expense for these short-term leases is recognized on a straight-line basis over the lease term. +Many leases include one or more options to renew, with renewal terms that, if exercised by us, may extend the lease term. The exercise of these renewal options is at our discretion. When assessing the likelihood of a renewal or termination, we consider the significance of leasehold improvements, availability of alternative locations, and the cost of relocation or replacement, among other considerations. The depreciable lives of leasehold improvements are the shorter of the useful lives of the improvements or the expected lease term. We determine the lease term for each lease based on the terms of each contract and factor in renewal and early termination options if such options are reasonably certain to be exercised. We do not generally +F- 11 +Table of Contents +believe such options are reasonably certain, and therefore, we have excluded them from the recorded right-of-use assets and operating lease liabilities. +Due to our centralized treasury function, we utilize a portfolio approach to discount our lease obligations. We assess the expected lease term at lease inception and discount the lease using a fully-secured annual incremental borrowing rate, adjusted for time value corresponding with the expected lease term. +Certain of our retail store leases include rental payments based upon a percentage of retail sales in excess of a minimum fixed rental. In some cases, there is no fixed minimum rental, and the entire rental payment is based upon a percentage of sales. In addition, certain leases include rental payments adjusted periodically for changes in price level indices. We recognize expense for these types of payments as incurred and report them as variable lease expense. See Note 7 — Leases for additional information. +Derivative Financial Instruments +We transact business in various foreign entities and are therefore exposed to foreign currency exchange rate risk that impacts the reported U.S. Dollar (“USD”) amounts of revenues, expenses, and certain foreign currency monetary assets and liabilities. In order to manage exposure to fluctuations in foreign currency and to reduce the volatility in earnings caused by fluctuations in foreign exchange rates, we may enter into forward contracts to buy and sell foreign currency. By policy, we do not enter into these contracts for trading purposes or speculation. +Counterparty default risk is considered low because the forward contracts we enter into are over-the-counter instruments transacted with highly-rated financial institutions. We were not required to and did not post collateral as of December 31, 2024 or 2023. +Our derivative instruments are recorded at fair value as a derivative asset or liability in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2024 and 2023. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain components of its risk, even though hedge accounting does not apply, or we elect not to apply hedge accounting. +We report derivative instruments with the same counterparty on a net basis when a master netting arrangement is in place. For the consolidated statements of cash flows, we classify cash flows from derivative instruments at settlement in the same category as the cash flows from the related hedged items within ‘Cash provided by operating activities.’ +As of December 31, 2024, we have derivatives not designated as hedging instruments (“non-hedged derivatives”), which consist of foreign currency forward contracts primarily used to hedge monetary assets and liabilities denominated in non-functional currencies. For our non-hedged derivatives, changes in fair value are recognized within ‘Foreign currency gains (losses), net’ in the consolidated statements of income. +We also have cash flow hedges (“hedged derivatives”) as of December 31, 2024. We are exposed to fluctuations in various foreign currencies against our functional currency, the USD. Specifically, we have subsidiaries that transact in currencies other than their functional currency. We use cash flow hedges to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. Currency forward agreements involve fixing the exchange rates for delivery of a specified amount of foreign currency on a specified date. The currency forward agreements are typically cash settled in USD for their fair value at or close to their settlement date. We may also use currency option contracts under which we will pay a premium for the right to sell a specified amount of a foreign currency prior to the maturity date of the option. +For derivatives designated and that qualify as cash flow hedges of foreign exchange risk, the gain or loss on the derivative is recorded in ‘Accumulated other comprehensive loss’ in the consolidated balance sheets. In the period during which the hedged transaction affects earnings, the related gain or loss is subsequently reclassified to ‘Revenues’ or ‘Cost of sales’ in the consolidated statement of operations, which is consistent with the nature of the hedged transaction. +F- 12 +Table of Contents +See Note 9 — Derivative Financial Instruments for further information on derivative financial instruments. +Other Comprehensive Income (Loss) +Our foreign subsidiaries generally use their foreign currency as their functional currency. Functional currency assets and liabilities are translated into USD using exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates during the period. Resulting translation gains and losses are reported in other comprehensive income (loss), until the substantial liquidation of a subsidiary, at which time accumulated translation gains or losses are reclassified into net income. During the year ended December 31, 2022, we recognized a net loss of $ 8.1 million of cumulative foreign currency translation adjustments related to the substantial liquidation of a foreign subsidiary. +Revenues +Revenues are recognized in the amount expected to be received in exchange for when control of the products transfers to customers and excludes various forms of promotions, which range from contractually-fixed percentage price reductions to sales returns, discounts, rebates, and other incentives that may vary in amount, must be estimated, and are reported as a reduction in revenues. Variable amounts are estimated based on an analysis of historical experience and adjusted as better estimates become available. During the years ended December 31, 2024, 2023, and 2022, we recognized no changes to estimates for wholesale or direct-to-consumer revenues. +We have also elected to expense incremental costs to obtain customer contracts, consisting primarily of commission incentives, when incurred because the related amortization period is less than one year. These costs are reported within ‘Selling, general and administrative expenses’ in our consolidated statements of income. +The following is a description of our principal revenue-generating activities by distribution channel. We have two reportable operating segments and sell our products using two primary distribution channels. For more detailed information about reportable operating segments, see Note 17 — Operating Segments and Geographic Information. +Wholesale Channel +For the majority of wholesale customers, control transfers and revenues are recognized when the product is shipped or delivered from a manufacturing facility or distribution center to the wholesale customer. In certain cases, control of the product transfers and revenues are recognized when the customer receives the product at the designated delivery point. For certain customers, primarily in international markets, cash payment is required in advance of delivery and revenues continue to be recognized upon the transfer of control to the customer. We may accept returns from our wholesale customers, on an exception basis, to ensure that our products are merchandised in the proper assortments and may provide markdown allowances at our sole discretion to key wholesalers and distributors to facilitate sales of slower moving products. Wholesale revenues are reduced by estimates of returns and allowances based on historical experience, and adjustments to our estimates are made when the expected value changes. +We have arrangements that grant certain wholesale customers exclusive licenses, concurrent with the terms of the related distribution agreements, to use our intellectual property in exchange for a sales-based royalty. Sales-based royalty revenues are recognized over the terms of the related license agreements as sales are made by the wholesalers. +Direct-to-Consumer Channel +Direct-to-consumer revenues consist of sales generated through our company-operated retail stores and company-operated e-commerce websites and third-party e-commerce marketplaces. We transfer control of products and recognize revenues at company-operated retail stores at the point of sale, in exchange for cash or other payment. For sales made through company-operated e-commerce websites and third-party e-commerce marketplaces, we transfer control and recognize revenues when the product is shipped from the distribution centers, the point at which payment, primarily through debit and credit card and other e-payment methods, is made. A portion of the transaction price charged to our customers is variable, primarily due to promotional discounts or allowances. When recognizing revenues, the amount of revenues associated with expected sales returns is estimated based on historical experience, and adjustments to our estimates are made when the most likely amount of consideration we expect to receive changes. +For additional information about revenues, see Note 12 — Revenues. +F- 13 +Table of Contents +Shipping and Handling Costs and Fees +Shipping and handling costs are expensed as incurred and are included in ‘Cost of sales’ in the consolidated statements of income. Shipping and handling fees billed to customers are included in revenues. +Taxes Assessed by Governmental Authorities +Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from revenues. +Cost of Sales +Our cost of sales includes costs incurred to design, produce, procure, and ship our footwear. These costs include our raw materials, both direct and indirect labor, shipping and handling including freight costs, utilities, maintenance costs, licensing fees, depreciation, amortization, packaging, and other warehouse and distribution overhead and costs. +Selling, General and Administrative Expenses +Selling, general and administrative expenses consist primarily of labor and outside services, rent expense, bad debt expense, legal costs, amortization of intangible assets, as well as certain depreciation costs related to corporate and non-product assets and share-based compensation. Selling, general and administrative expenses also include costs for our marketing and sales organizations, and other functions including finance, legal, human resources, and information technology. +Our selling, general and administrative expenses include media advertising (television, radio, print, social, digital), tactical advertising (signs, banners, point-of-sale materials) and promotional costs. Advertising production costs are expensed when the advertising is first run. Advertising communication costs are expensed in the periods that the communications occur. Certain of our promotional expenses result from payments under endorsement contracts. Endorsement-related expenses are recognized as performance is received over the term of each endorsement agreement. +Total marketing expenses, inclusive of advertising, production, promotion, and agency expenses, including variable marketing expenses, were $ 377.5 million, $ 317.4 million, and $ 260.8 million for the years ended December 31, 2024, 2023, and 2022, respectively. +Research, Design and Development Expenses +We continue to dedicate resources to product design and development based on opportunities we identify in the marketplace. We incurred expenses of $ 25.6 million, $ 21.4 million, and $ 18.7 million in research, design, and development activities for the years ended December 31, 2024, 2023, and 2022, respectively, which are expensed as incurred and are reported in ‘Selling, general and administrative expenses’ in the consolidated statements of income. +Share-Based Compensation +Restricted Stock Awards (“RSAs”) and Restricted Stock Units (“RSUs”) +We grant RSAs, service-condition RSUs, performance-condition RSUs, and market-condition RSUs. The grant date fair values of RSAs, service-condition RSUs, and performance-condition RSUs are based on the closing market price of our common stock on the grant date; the grant date fair value and derived service period of market-condition RSUs are estimated using a Monte Carlo simulation valuation model. Our service-condition RSUs vest based on continued service; our performance-condition RSUs vest based on achievement of multiple weighted performance goals, certification of performance achievement by the Compensation Committee of the Board of Directors, and continued service; and our market-condition RSUs vest based on the market price of our stock and continued service. Compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service period. For performance-condition RSUs, compensation expense is updated for our expected performance level against performance goals at the end of each reporting period, which involves judgment as to the achievement of certain performance metrics. +See Note 13 — Share-Based Compensation for additional information related to share-based compensation. +F- 14 +Table of Contents +Impairment of Long-Lived Assets +Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset or asset group is less than the undiscounted cash flows from its use and eventual disposition over its remaining economic life. We assess recoverability by comparing the sum of projected undiscounted cash flows from the use and eventual disposition over the remaining economic life of a long-lived asset or asset group to its carrying value, and record a loss from impairment if the carrying value is more than its undiscounted cash flows. For customer relationships, impairment testing is performed at the customer group level. For assets involved in our retail businesses, the asset group is at the retail store level. As retail store performance will vary in new and existing markets due to many factors, including maturity of the market and brand recognition, we periodically evaluate the fixed assets, leasehold improvements, and right-of-use assets related to our retail locations for impairment. For all other long-lived assets, we perform impairment testing at the asset group level for which separately identifiable cash flows are available. Assets or asset groups to be abandoned are written down to zero in the period it is determined they will no longer be used and are removed entirely from service. See Note 4 — Property and Equipment, Net, Note 5 — Goodwill and Intangible Assets, Net, and Note 7 — Leases for a discussion of impairment losses recorded during the periods presented. +Foreign Currency Gains (Losses), Net +Foreign currency gains (losses), net includes realized and unrealized foreign exchange gains and losses resulting from remeasurement and settlement of foreign-currency transactions denominated in a currency other than the functional currency of an entity and realized and unrealized gains and losses on forward foreign currency exchange derivative contracts that do not qualify for hedge accounting. +Other Income (Expense), Net +Other income (expense), net primarily includes gains and losses associated with activities not directly related to making and selling footwear. +Income Taxes +Income taxes are accounted for using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We account for the tax effects of global intangible low-taxed income (“GILTI”) as a component of income tax expense in the period the tax arises, to the extent applicable. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statements of income. See Note 14 — Income Taxes for further discussion. +Earnings per Share +Basic and diluted earnings per common share (“EPS”) is presented using the treasury stock method. Diluted EPS reflects the potential dilution to common shareholders from securities that could share in our earnings and is calculated by adjusting weighted average outstanding shares, assuming conversion of all potentially dilutive stock options and awards. Anti-dilutive securities are excluded from diluted EPS. See Note 15 — Earnings per Share for additional information. +F- 15 +Table of Contents +Fair Value +U.S. GAAP for fair value establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach, and cost approach). We utilize a combination of market and income approaches to value derivative instruments. Our financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels of the hierarchy and the related inputs are as follows: +Level Inputs +1 Unadjusted quoted prices in active markets for identical assets and liabilities. +2 Unadjusted quoted prices in active markets for similar assets and liabilities; +Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active; or +Inputs other than quoted prices that are observable for the asset or liability. +3 Unobservable inputs for the asset or liability. +We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine fair value. +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable (and at least annually for goodwill and indefinite-lived intangible assets), non-financial instruments are assessed for impairment and, if applicable, written down to and recorded at fair value. See Note 8 — Fair Value Measurements for further discussion related to estimated fair value measurements. +2. RECENT ACCOUNTING PRONOUNCEMENTS +New Accounting Pronouncement Adopted +Segment Reporting: Improvements to Reportable Segment Disclosures +In November 2023, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance related to the segment disclosures. This guidance became effective for annual periods beginning after December 15, 2023 and interim periods beginning after December 15, 2024, with early adoption permitted and should be applied on a retrospective basis. This standard did not have a material impact on our consolidated financial statements, but it did require increased disclosures within the notes to our consolidated financial statements for the year ended December 31, 2024. See Note 17 — Operating Segments and Geographic Information for additional information regarding our segment reporting. +Pillar Two Global Minimum Tax +The Organization for Economic Co-operation and Development (“OECD”) has released Pillar Two model rules introducing a 15% global minimum tax rate applied on a country-by-country basis for large multinational corporations. Various jurisdictions we operate in have enacted the legislation with a subset of the rules effective January 1, 2024, and the remaining rules becoming effective January 1, 2025. These new laws did not have a material impact on our consolidated financial statements for the year ended December 31, 2024. There remains uncertainty as to the final Pillar Two rules as the OECD continues to release guidance and modifications to the rules. We are monitoring continuing development of these laws and the potential impact they will have on our Company. We do not anticipate the Pillar Two rules will have a significant impact on our 2025 consolidated financial statements. +New Accounting Pronouncements Not Yet Adopted +Income Taxes: Improvements to Income Tax Disclosure +In December 2023, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance related to the disclosure of rate reconciliation and income taxes paid. This guidance becomes effective for annual periods beginning after December 15, 2024 with early adoption permitted and should be applied on a prospective basis. We do not expect this standard to have a material impact on our consolidated financial statements, but it will require increased disclosures within the notes to our consolidated financial statements. +F- 16 +Table of Contents +Disaggregation of Income Statement Expenses +In November 2024, the FASB issued authoritative guidance related to the disclosure of disaggregation of income statement expenses. This guidance becomes effective for annual periods beginning after December 15, 2026 with early adoption permitted and should be applied on a retrospective basis. We do not expect this standard to have a material impact on our consolidated financial statements, but it will require increased disclosures within the notes to our consolidated financial statements. +Other new pronouncements issued but not effective until after December 31, 2024 are not expected to have a material impact on our consolidated financial statements. +3. ACQUISITION OF HEYDUDE +On February 17, 2022, (the “Acquisition Date”), we acquired 100 % of the equity of HEYDUDE, pursuant to the SPA. HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The Acquisition allows us to diversify and expand our business by adding a second brand to the Crocs, Inc. portfolio. +The aggregate preliminary purchase price at the closing of the Acquisition was $ 2.3 billion. We paid aggregate consideration of $ 2.05 billion in cash (the “Cash Consideration”), subject to adjustment based on, among other things, the cash, indebtedness, transaction expenses, and working capital of the companies comprising HEYDUDE and their respective subsidiaries as of the Acquisition Date, and issued 2,852,280 shares of the Company’s common stock to one of the sellers (the “Equity Consideration Shares”). The Equity Consideration Shares were subject to a lock-up period beginning on the Acquisition Date, which has since expired so all of the Equity Consideration Shares have been released from the lock-up. The purchase price paid to the sellers is final. +The Cash Consideration was financed via the Company’s entry into the $ 2.0 billion Term Loan B Facility (as defined below) and $ 50.0 million of borrowings under the Revolving Facility (as defined below). As a result of the Acquisition, HEYDUDE has become wholly owned by us. +Purchase Price Allocation +The Acquisition was accounted for in accordance with the ASC Topic 805 Business Combinations . As a result, we have applied acquisition accounting, which requires, among other things, that the assets acquired and liabilities assumed be recognized at their estimated fair values as of the Acquisition Date. For certain assets and liabilities, those fair values were consistent with historical carrying values. The fair value of inventory was determined using both a market approach and a cost approach. With respect to intangible assets, the estimated fair value was based on the Multi-Period Excess Earnings approach for the trademark and the distributor method for the customer relationships. These models used primarily Level 2 and Level 3 inputs, including an estimate of future revenues, future cash flows, and discount rates. +F- 17 +Table of Contents +The following table summarizes the final allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed on the Acquisition Date: +February 17, 2022 +(in thousands) +Cash and cash equivalents $ 6,232 +Accounts receivable, net 68,698 +Inventories 155,773 +Prepaid expenses and other assets (1) +7,880 +Intangible assets 1,780,000 +Goodwill (1) (2) +710,034 +Right-of-use assets 2,844 +Accounts payable (2) +( 30,017 ) +Accrued expenses and other liabilities ( 18,860 ) +Income taxes payable ( 30,572 ) +Long-term deferred tax liability +( 312,656 ) +Long-term income taxes payable ( 13,004 ) +Operating lease liabilities ( 2,843 ) +Net assets acquired $ 2,323,509 +(1) Includes a valuation adjustment that increased prepaid expenses and other assets by $ 3.5 million and decreased goodwill by $ 3.5 million during the three months ended March 31, 2023. +(2) Includes a valuation adjustment that increased goodwill by $ 0.2 million and increased accounts payable by $ 0.2 million during the three months ended March 31, 2023. +Intangible Assets +The components of intangible assets acquired in connection with the Acquisition were as follows: +Weighted-Average Useful Life Amortization Method Estimated Fair Value +(in thousands) +Customer relationships 15 Straight-line $ 210,000 +Trademark Indefinite — 1,570,000 +Total intangible assets $ 1,780,000 +Goodwill +The excess of the purchase price over the fair value of the acquired business’ net assets represents goodwill. The goodwill amount of $ 710.0 million at December 31, 2023 includes an aggregate adjustment of $ 3.3 million recorded in the three months March 31, 2023 as a result of changes to preliminary valuation estimates. The total goodwill amount acquired was assigned to the HEYDUDE reporting segment. None of the goodwill will be deductible for income tax purposes. The purchase price allocation was finalized during the three months ended March 31, 2023. +Escrow and Holdback Amounts +Additionally, $ 125.0 million of the Cash Consideration (the “Escrow Amount”) was placed in an escrow account to partially secure the indemnification obligations of the sellers. As of December 31, 2024, a substantial portion of the Escrow Amount remained in the escrow account in connection with claims that were noticed prior to the date that was 18 months after the Acquisition Date but was not yet resolved by that date, as provided in the SPA. Further, $ 8.5 million of the Cash Consideration (the “Adjustment Holdback Amount”) was held back and retained as security (but not as the sole source of recovery) for any downward adjustments to the purchase price made in accordance with the SPA. During the year ended December 31, 2022, the Adjustment Holdback Amount was paid to the sellers. +F- 18 +Table of Contents +Acquisition-related Costs +Costs incurred to complete the Acquisition are expensed as incurred and included in ‘Selling, general, and administrative expenses’ in our consolidated statements of income. During the years ended December 31, 2024 and 2023, no Acquisition-related costs were recognized. During the year ended December 31, 2022, there were approximately $ 25.7 million of Acquisition-related costs recognized. These costs represent legal, professional, and transaction fees. +Unaudited Pro Forma Information +The following unaudited pro forma financial information for the year ended December 31, 2022 and 2021 combines the historical results of the Crocs and HEYDUDE Brands, assuming that the companies were combined as of January 1, 2021 and include business combination accounting effects from the Acquisition, including amortization charges from acquired intangible assets, adjustments to the fair value of inventory, interest expense on the financing transactions used to fund the Acquisition, and Acquisition-related transaction costs and tax-related effects. The pro forma information as presented below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the Acquisition had taken place on January 1, 2021. +Year Ended December 31, +2022 2021 +(in thousands) +Revenues $ 3,645,291 $ 2,894,094 +Net income 614,463 706,853 +4. PROPERTY AND EQUIPMENT, NET +‘Property and equipment, net’ consists of the following: +December 31, +2024 2023 +(in thousands) +Machinery and equipment $ 190,134 $ 163,919 +Leasehold improvements 156,091 149,132 +Furniture, fixtures, and other 40,702 32,356 +Construction-in-progress 10,863 13,418 +Property and equipment 397,790 358,825 +Less: Accumulated depreciation and amortization ( 153,455 ) ( 120,510 ) +Property and equipment, net $ 244,335 $ 238,315 +Asset Retirement Obligations +We are contractually obligated, under certain of our lease agreements, to restore certain retail and office facilities back to their original condition. At lease inception, the estimated fair value of these liabilities is recorded along with a related asset. Asset retirement obligations were not significant to the consolidated balance sheets in the years ended December 31, 2024 or 2023. +Depreciation and Amortization Expense +Depreciation and amortization expense related to property and equipment, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Cost of sales $ 20,673 $ 18,809 $ 10,043 +Selling, general and administrative expenses 26,233 12,876 9,599 +Total depreciation and amortization expense $ 46,906 $ 31,685 $ 19,642 +F- 19 +Table of Contents +Disposals of Property and Equipment and Intangible Assets +During the years ended December 31, 2024, 2023, and 2022, we recognized net losses on disposals of property and equipment and intangible assets of $ 1.0 million, $ 0.4 million, and $ 1.0 million, respectively. Gains and losses on disposals of property and equipment and intangible assets are included in ‘Selling, general and administrative expenses’ in the consolidated statements of income. +Additionally, we impaired our leasehold improvement assets for our former corporate headquarters in the year ended December 31, 2023, as described in Note 8 — Fair Value Measurements. +5. GOODWILL AND INTANGIBLE ASSETS, NET +Goodwill +The changes in goodwill for the years ended December 31, 2024 and 2023 were: +Goodwill +(in thousands) +Balance at December 31, 2022 +$ 714,814 +HEYDUDE valuation adjustment (1) +( 3,274 ) +Foreign currency translation (2) +48 +Balance at December 31, 2023 +711,588 +Foreign currency translation (2) +( 97 ) +Balance at December 31, 2024 +$ 711,491 +(1) We acquired HEYDUDE on February 17, 2022, and the purchase price allocation was finalized during the year ended December 31, 2023, resulting in a change to the goodwill balance. During the year ended December 31, 2023, there were valuation adjustments that resulted in a net decrease to goodwill of $ 3.3 million. Refer to Note 3 — Acquisition of HEYDUDE for additional details. +(2) Foreign currency translation only relates to the goodwill in our Crocs Brand operating segment. +At December 31, 2024, accumulated goodwill impairment was $ 0.8 million. +Intangible Assets, Net +‘Intangible assets, net’ reported in the consolidated balance sheets consist of the following: +December 31, 2024 December 31, 2023 +Gross Accum. Amortiz. Net Gross Accum. Amortiz. Net +(in thousands) +Intangible assets subject to amortization: +Capitalized software $ 139,569 $ ( 117,001 ) $ 22,568 $ 136,343 $ ( 108,675 ) $ 27,668 +Customer relationships 210,000 ( 40,250 ) 169,750 210,000 ( 26,250 ) 183,750 +Patents, copyrights, and trademarks 4,916 ( 3,791 ) 1,125 5,055 ( 3,686 ) 1,369 +Intangible assets not subject to amortization: +HEYDUDE trademark 1,570,000 — 1,570,000 1,570,000 — 1,570,000 +In progress 12,644 — 12,644 8,562 — 8,562 +Other 993 — 993 1,213 — 1,213 +Total $ 1,938,122 $ ( 161,042 ) $ 1,777,080 $ 1,931,173 $ ( 138,611 ) $ 1,792,562 +At December 31, 2024, the weighted average remaining useful life of intangibles subject to amortization was approximately 13.8 years. +F- 20 +Table of Contents +Amortization Expense +Amortization expense related to definite-lived intangible assets, reported in ‘Cost of sales’ and ‘Selling, general and administrative expenses’ was: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Cost of sales $ 2,395 $ 3,080 $ 2,366 +Selling, general and administrative expenses 20,539 19,539 17,221 +Total amortization expense $ 22,934 $ 22,619 $ 19,587 +Estimated future annual amortization expense of intangible assets is: +As of +December 31, 2024 +(in thousands) +2025 $ 22,428 +2026 20,923 +2027 18,882 +2028 16,918 +2029 14,853 +Thereafter 99,439 +Total $ 193,443 +6. ACCRUED EXPENSES AND OTHER LIABILITIES +Amounts reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets were: +December 31, +2024 2023 +(in thousands) +Accrued compensation and benefits $ 81,265 $ 70,245 +Professional services 64,683 80,986 +Fulfillment, freight, and duties 38,752 22,269 +Return liabilities 34,255 38,644 +Sales/use and value added taxes payable 17,330 23,768 +Other (1) +61,783 49,859 +Total accrued expenses and other liabilities $ 298,068 $ 285,771 +(1) Amounts as of December 31, 2023 have been reclassified to conform to current period presentation. +F- 21 +Table of Contents +7. LEASES +Right-of-Use Assets and Operating Lease Liabilities +Amounts reported in the consolidated balance sheets were: +December 31, +2024 2023 +(in thousands) +Assets: +Right-of-use assets $ 307,228 $ 287,440 +Liabilities: +Current operating lease liabilities $ 68,551 $ 62,267 +Long-term operating lease liabilities 283,406 269,769 +Total operating lease liabilities $ 351,957 $ 332,036 +Lease Costs and Other Information +Lease-related costs reported within ‘Cost of sales’ and ‘Selling, general and administrative expenses’ were: +Year Ended December 31, +2024 2023 +(in thousands) +Operating lease cost $ 85,130 $ 79,543 +Short-term lease cost 12,051 13,258 +Variable lease cost 48,402 44,706 +Total lease costs $ 145,583 $ 137,507 +The weighted average remaining lease term and discount rate related to our lease liabilities as of December 31, 2024 were 6.2 years and 6.5 %, respectively. As of December 31, 2023, the weighted average remaining lease term and discount rate related to our lease liabilities were 7.1 years and 5.5 %, respectively. +We also impaired certain right-of-use assets as described in Note 8 — Fair Value Measurements. +Maturities +The maturities of our operating lease liabilities were: +As of +December 31, 2024 +(in thousands) +2025 $ 80,878 +2026 77,305 +2027 65,330 +2028 53,942 +2029 44,084 +Thereafter 108,992 +Total future minimum lease payments 430,531 +Less: imputed interest ( 78,574 ) +Total operating lease liabilities $ 351,957 +F- 22 +Table of Contents +8. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The financial assets and liabilities that are measured and recorded at fair value on a recurring basis consist of our derivative instruments. Our derivative instruments are forward foreign currency exchange contracts. We manage credit risk of our derivative instruments on the basis of our net exposure with our counterparty. All of our derivative instruments are classified as Level 2 of the fair value hierarchy and are reported in the consolidated balance sheets within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ at December 31, 2024 and 2023, netted by counterparty. The fair values of our derivative instruments were an insignificant asset and an insignificant liability at December 31, 2024 and an insignificant asset and an insignificant liability at December 31, 2023. See Note 9 — Derivative Financial Instruments for more information. +The carrying amounts of our cash, cash equivalents, and restricted cash approximate their fair value and are classified as Level 1 of the fair value hierarchy. The carrying amounts of our accounts receivable, accounts payable, and current accrued expenses and other liabilities approximate their fair value as recorded due to the short-term maturity of these instruments and are classified as Level 2 of the fair value hierarchy. +Our borrowing instruments are recorded at their carrying values in the consolidated balance sheets, which may differ from their respective fair values. The Term Loan B Facility, as described in more detail in Note 10 — Borrowings, is classified as Level 1 of the fair value hierarchy. The Notes (as defined below) are also classified as Level 1 of the fair value hierarchy and are reported in our consolidated balance sheet at face value, less unamortized issuance costs. The fair value of our Revolving Facility (as defined below) approximates its carrying value at December 31, 2024 and 2023 based on interest rates currently available to us for similar borrowings. The carrying values and fair values of our borrowing instruments as of December 31, 2024 and 2023 were: +December 31, 2024 December 31, 2023 +Carrying Value Fair +Value Carrying Value Fair +Value +(in thousands) +Term Loan B Facility $ 500,000 $ 503,125 $ 820,000 $ 824,100 +2029 Notes 350,000 323,780 350,000 313,987 +2031 Notes 350,000 305,610 350,000 296,742 +Revolving Facility 190,000 190,000 190,000 190,000 +Non-Financial Assets and Liabilities +Our non-financial assets, which primarily consist of property and equipment, right-of-use assets, goodwill, trademarks, customer relationships, and other intangible assets, are not required to be carried at fair value on a recurring basis and are reported at carrying value. +The fair values of these assets were determined based on Level 3 measurements, including estimates of the amount and timing of future cash flows based upon historical experience, expected market conditions, and management’s plans. We recorded impairments within ‘Selling, general and administrative expenses’ in our consolidated statements of income as follows: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Information technology systems impairment (1) +$ 18,172 $ — $ — +Leasehold improvement assets impairment (2) +— 1,007 — +Right-of-use assets impairment (2) (3) +5,909 8,280 — +Total asset impairments $ 24,081 $ 9,287 $ — +(1) During the year ended December 31, 2024, we recognized an impairment charge for information technology systems related to the HEYDUDE integration of $ 17.4 million to prepaid assets and $ 0.8 million to intangible assets. +(2) During the year ended December 31, 2023, we recognized an impairment of $ 9.3 million for our former corporate headquarters in Broomfield, Colorado. +(3) During the year ended December 31, 2024, we recognized an impairment of $ 5.5 million for our former HEYDUDE Brand warehouses in Las Vegas, Nevada and $ 0.4 million for our former Crocs Brand warehouse in Oudenbosch, the Netherlands. +F- 23 +Table of Contents +9. DERIVATIVE FINANCIAL INSTRUMENTS +As of December 31, 2024, we have derivatives not designated as hedging instruments (“non-hedged derivatives”), which consist of foreign currency forward contracts primarily used to hedge monetary assets and liabilities denominated in non-functional currencies, and cash flow hedges (“hedged derivatives”), which are used to minimize the variability in cash flows caused by fluctuations in foreign currency exchange rates related to our external sales and external purchases of inventory. During the years ended December 31, 2024 and December 31, 2023, there was a gain of $ 0.8 million and a loss of $ 0.8 million, respectively, recognized due to reclassification from ‘Accumulated other comprehensive loss’ to ‘Revenues’ or ‘Cost of sales’ related to our hedged derivatives. During the next twelve months, we estimate that a gain of $ 0.4 million will be reclassified to the consolidated statement of operations. +The fair values of derivative assets and liabilities, net, all of which are classified as Level 2, are reported within either ‘Prepaid expenses and other assets’ or ‘Accrued expenses and other liabilities’ in the consolidated balance sheets and were: +December 31, 2024 December 31, 2023 +Derivative Assets Derivative Liabilities Derivative Assets Derivative Liabilities +(in thousands) +Non-hedged derivatives: +Forward foreign currency exchange contracts $ 2,691 $ ( 3,433 ) $ 2,850 $ ( 1,333 ) +Hedged derivatives: +Cash flow foreign currency contracts 1,242 ( 856 ) 142 ( 229 ) +Total derivatives 3,933 ( 4,289 ) 2,992 ( 1,562 ) +Netting of counterparty contracts ( 2,762 ) 2,762 ( 1,547 ) 1,547 +Total derivatives, net of counterparty contracts $ 1,171 $ ( 1,527 ) $ 1,445 $ ( 15 ) +The notional amounts of outstanding forward foreign currency exchange contracts shown below report the total U.S. Dollar equivalent position and the net contract fair values for each foreign currency position. +December 31, 2024 December 31, 2023 +Notional Fair Value Notional Fair Value +(in thousands) +Non-hedged derivatives: +Euro $ 49,833 $ ( 1,303 ) $ 30,757 $ 1,343 +Singapore Dollar 31,524 ( 1,251 ) 41,441 1,507 +British Pound Sterling 28,223 536 17,662 ( 835 ) +South Korean Won 9,274 655 9,759 ( 428 ) +Japanese Yen 5,510 289 969 ( 47 ) +Indian Rupee 494 8 5,291 ( 23 ) +Other currencies 24,613 324 — — +Total non-hedged derivatives 149,471 ( 742 ) 105,879 1,517 +Hedged derivatives: +Chinese Yuan 40,458 ( 553 ) — — +British Pound Sterling 23,678 ( 303 ) 22,320 135 +Euro 17,246 628 40,014 ( 186 ) +South Korean Won 8,790 614 11,093 ( 42 ) +Indian Rupee — — 5,703 6 +Total hedged derivatives 90,172 386 79,130 ( 87 ) +Total derivatives $ 239,643 $ ( 356 ) $ 185,009 $ 1,430 +Latest maturity date, non-hedged derivatives January 2025 January 2024 +Latest maturity date, hedged derivatives October 2025 December 2024 +F- 24 +Table of Contents +Amounts reported in ‘Foreign currency gains (losses), net’ in the consolidated statements of income include both realized and unrealized gains (losses) from foreign currency transactions and derivative contracts and were as follows: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Foreign currency transaction gains (losses) +$ ( 4,693 ) $ ( 1,992 ) $ ( 2,858 ) +Foreign currency forward exchange contracts gains (losses) +( 2,084 ) 752 6,086 +Foreign currency gains (losses), net +$ ( 6,777 ) $ ( 1,240 ) $ 3,228 +10. BORROWINGS +Our long-term borrowings were as follows: +Stated Interest Rate Effective Interest Rate December 31, +Maturity 2024 2023 +(in thousands) +Notes issuance of $ 350.0 million +2029 4.250 % 4.64 % $ 350,000 $ 350,000 +Notes issuance of $ 350.0 million +2031 4.125 % 4.35 % 350,000 350,000 +Term Loan B Facility 2029 500,000 820,000 +Revolving Facility 2027 190,000 190,000 +Total face value of long-term borrowings 1,390,000 1,710,000 +Less: +Unamortized issuance costs 40,661 49,004 +Current portion of long-term borrowings (1) +— 20,000 +Total long-term borrowings $ 1,349,339 $ 1,640,996 +(1) Represents the current portion of the borrowings on the Term Loan B facility. +At December 31, 2024 and 2023, $ 10.2 million and $ 10.7 million, respectively, of accrued interest related to our borrowings was reported in ‘Accounts payable’ in the consolidated balance sheets. +Senior Revolving Credit Facility +In July 2019, the Company and certain of its subsidiaries (the “Borrowers”) entered into a Second Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), with the lenders named therein and PNC Bank, National Association, as a lender and administrative agent for the lenders. Since that time, we have amended the Credit Agreement, which, as amended to date, provides for a revolving credit facility of $ 1.0 billion, which can be increased by an additional $ 400.0 million, subject to certain conditions (the “Revolving Facility”). Borrowings under the Credit Agreement bear interest at a variable interest rate based on (A) a Base Rate (defined as the highest of (i) the Overnight Bank Funding Rate (as defined in the Credit Agreement), plus 0.25 %, (ii) the Prime Rate (as defined in the Credit Agreement), and (iii) the Daily Simple SOFR (as defined in the Credit Agreement), plus 1.00 %), plus an applicable margin ranging from 0.25 % to 0.875 % based on our leverage ratio or 1.35 % to 1.975 % for the Daily Simple SOFR based on the leverage ratio, inclusive of a 0.10 % SOFR adjustment, or (B) the Term SOFR Rate (as defined in the Credit Agreement), plus an applicable margin ranging from 1.35 % to 1.975 % based on our leverage ratio for one-month interest periods and three-month interest periods, inclusive of a 0.10 % SOFR adjustment. Borrowings under the Credit Agreement are secured by all of the assets of the Borrowers and guaranteed by certain other subsidiaries of the Borrowers. +The Credit Agreement required or requires, as applicable, us to maintain a minimum interest coverage ratio of 3.00 to 1.00, and a maximum leverage ratio of (i) 4.00 to 1.00 from the quarter ended March 31, 2022 through, and including, the quarter ended December 31, 2023, (ii) 3.75 to 1.00 for the quarter ended March 31, 2024, (iii) 3.50 to 1.00 for the quarter ended June 30, 2024, and (iv) 3.25 to 1.00 for the quarter ended September 30, 2024 and thereafter (subject to adjustment in certain circumstances). The Credit Agreement permits, among other things, (i) stock repurchases subject to certain restrictions, including after giving effect to such stock repurchases, the maximum leverage ratio does not exceed certain levels; and (ii) +F- 25 +Table of Contents +certain acquisitions so long as there is borrowing availability under the Credit Agreement of at least $ 40.0 million. As of December 31, 2024, we were in compliance with all financial covenants under the Credit Agreement. +As of December 31, 2024, the total commitments available from the lenders under the Revolving Facility were $ 1.0 billion. At December 31, 2024, we had $ 190.0 million in outstanding borrowings and $ 0.6 million in outstanding letters of credit under the Revolving Facility, which reduces amounts available for borrowing under the Revolving Facility. As of December 31, 2024 and 2023, we had $ 809.4 million and $ 558.7 million, respectively, of available borrowing capacity under the Revolving Facility, which matures in November 2027. +Term Loan B Facility +On February 17, 2022, the Company entered into a credit agreement (the “Original Term Loan B Credit Agreement”) with Citibank, N.A., as administrative agent and lender, to among other things, finance a portion of the cash consideration for the Acquisition, which was amended on August 8, 2023 (the “August 2023 Amendment”) and on February 13, 2024 (the “February 2024 Amendment”). The Original Term Loan B Credit Agreement, as amended by the August 2023 Amendment and the February 2024 Amendment is referred to herein as the “Term Loan B Credit Agreement”. +The Original Term Loan B Credit Agreement provided for an aggregate term loan B facility in the principal amount of $ 2.0 billion. Prior to the February 2024 Amendment, the outstanding balance was $ 820.0 million. Among other things, the February 2024 Amendment provided for a new $ 820.0 million tranche of term loans (the “2024 Refinancing Term Loans” and, such facility, the “Term Loan B Facility”), to refinance the then-outstanding principal balance. The 2024 Refinancing Term Loans are secured by substantially all of the Company’s and each subsidiary guarantor’s assets on a pari passu basis with their obligations arising from the Term Loan B Credit Agreement and is scheduled to mature on February 17, 2029, subject to certain exceptions set forth in the Term Loan B Credit Agreement. Additionally, subject to certain conditions, including, without limitation, satisfying certain leverage ratios, the Company may, at any time, on one or more occasions, add one or more new classes of term facilities and/or increase the principal amount of the loans of any existing class by requesting one or more incremental term facilities. +Pursuant to the reduced interest rate margins applicable to the 2024 Refinancing Term Loans, each term loan borrowing which is an alternate base rate borrowing bears interest at a rate per annum equal to the Alternate Base Rate (as defined in the Term Loan B Credit Agreement), plus 1.25 %. Each term loan borrowing which is a term SOFR borrowing bears interest at a rate per annum equal to the Adjusted Term SOFR Rate (as defined in the Term Loan B Credit Agreement) plus 2.25 %. +As of December 31, 2024, the Term Loan B Facility was fully drawn with no remaining borrowing capacity, and we had $ 500.0 million in outstanding principal on the Term Loan B Facility, which matures on February 17, 2029. +The Term Loan B Credit Agreement also contains customary affirmative and negative covenants, incurrence financial covenants, representations and warranties, events of default and other provisions. As of December 31, 2024, we were in compliance with all financial covenants under the Term Loan B Credit Agreement. +Asia Revolving Credit Facility +During the year ended December 31, 2024, we had one revolving credit facility in Asia with Citibank (China) Company Limited, Shanghai Branch (the “Citibank Facility”), which, as amended, provides up to an equivalent of $ 15.0 million. +As of December 31, 2024, we had no borrowings outstanding on the Citibank Facility. As of December 31, 2023, we had borrowings outstanding of $ 3.3 million on the Citibank Facility. +Senior Notes Issuances +In March 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.250 % Senior Notes due March 15, 2029 (the “2029 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, the “2029 Notes Indenture”). Additionally, in August 2021, the Company completed the issuance and sale of $ 350.0 million aggregate principal amount of 4.125 % Senior Notes due August 15, 2031 (the “2031 Notes”), pursuant to the indenture related thereto (as amended and/or supplemented to date, “the 2031 Notes Indenture” and, together with the 2029 Notes Indenture, the “Indentures” and, each, an “Indenture”). Interest on each of the 2029 Notes and the 2031 Notes (collectively, the “Notes”) is payable semi-annually. +F- 26 +Table of Contents +The Company had or will have, as applicable, the option to redeem all or any portion of the 2029 Notes, at once or over time, at any time on or after March 15, 2024, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company also had the option to redeem some or all of the 2029 Notes at any time before March 15, 2024 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before March 15, 2024, the Company could have redeemed up to 40 % of the aggregate principal amount of the 2029 Notes at a redemption price of 104.250 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Company will have the option to redeem all or any portion of the 2031 Notes, at once or over time, at any time on or after August 15, 2026, at a redemption price equal to 100 % of the principal amount thereof, plus a premium declining ratably on an annual basis to par and accrued and unpaid interest, if any, to, but excluding, the date of redemption. The Company will also have the option to redeem some or all of the 2031 Notes at any time before August 15, 2026 at a redemption price of 100 % of the principal amount to be redeemed, plus a “make-whole” premium and accrued and unpaid interest, if any, to, but excluding, the date of redemption. In addition, at any time before August 15, 2024, the Company could have redeemed up to 40 % of the aggregate principal amount of the 2031 Notes at a redemption price of 104.125 % of the principal amount with the proceeds from certain equity issuances, plus accrued and unpaid interest, if any, to, but excluding, the date of redemption. +The Notes rank pari passu in right of payment with all of the Company’s existing and future senior debt, including the Credit Agreement, and are senior in right of payment to any of the Company’s future debt that is, by its term, expressly subordinated in right of payment to the Notes. The Notes are unconditionally guaranteed by each of the Company’s restricted subsidiaries that is a borrower or guarantor under the Credit Agreement and by each of the Company’s wholly-owned restricted subsidiaries that guarantees any debt of the Company or any guarantor under any syndicated credit facility or capital markets debt in an aggregate principal amount in excess of $ 25.0 million. +The Indentures contain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to incur additional debt or issue certain preferred stock; pay dividends or repurchase or redeem capital stock or make other restricted payments; declare or pay dividends or other payments; incur liens; enter into certain types of transactions with the Company’s affiliates; and consolidate or merge with or into other companies. As of December 31, 2024, we were in compliance with all financial covenants under the Notes. +11. EQUITY +Common Stock +We have one class of common stock with a par value of $ 0.001 per share. There are 250.0 million shares of common stock authorized for issuance. Holders of common stock are entitled to one vote per share on all matters presented to common stockholders. +Common Stock Repurchase Program +On April 23, 2021, the Board approved and authorized a program to repurchase up to $ 1.0 billion of our common stock. Additionally, on September 23, 2021, the Board approved an increase of $ 1.0 billion to our share repurchase authorization. The number, price, structure, and timing of the repurchases are at our sole discretion and may be made depending on market conditions, liquidity needs, restrictions under the agreements governing our indebtedness, and other factors. The Board of Directors may suspend, modify, or terminate the program at any time without prior notice. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any amount of our common stock. Under Delaware state law, these shares are not retired, and we have the right to resell any of the shares repurchased. +During the year ended December 31, 2024 we repurchased 4.3 million shares of our common stock at a cost of $ 551.2 million, including commissions. During the year ended December 31, 2023 we repurchased 1.7 million shares of our common stock at a cost of $ 175.0 million, including commissions. +As of December 31, 2024 and 2023, we have recorded an accrual for the stock repurchase excise tax of $ 5.1 million and $ 1.3 million, respectively, which is reported in ‘Accrued expenses and other liabilities’ and ‘Treasury stock’ in our consolidated balance sheet. +F- 27 +Table of Contents +As of December 31, 2024, we had remaining authorization to repurchase approximately $ 323.9 million of our common stock, subject to restrictions under our Indentures, Credit Agreement, and Term Loan B Credit Agreement. On February 10, 2025, the Board approved a $ 1.0 billion increase to our share repurchase authorization, after which approximately $ 1.3 billion remained available for future common stock repurchases. +Preferred Stock +We have authorized and available for issuance 5.0 million shares of preferred stock. Of these preferred shares, 1.0 million were authorized as Series A Convertible Preferred Stock with a par value of $ 0.001 per share and none were issued and outstanding as of December 31, 2024. +12. REVENUES +Revenues by reportable operating segment and by channel were: +Year Ended December 31, +2024 2023 2022 +Crocs Brand: +North America: +Wholesale $ 644,511 $ 652,943 $ 644,215 +Direct-to-consumer 1,188,911 1,124,942 1,000,441 +Total North America (1) +1,833,422 1,777,885 1,644,656 +International: +Wholesale 963,035 840,594 733,087 +Direct-to-consumer 481,510 394,475 281,382 +Total International 1,444,545 1,235,069 1,014,469 +Total Crocs Brand $ 3,277,967 $ 3,012,954 $ 2,659,125 +Crocs Brand: +Total Wholesale $ 1,607,546 $ 1,493,537 $ 1,377,302 +Total Direct-to-consumer 1,670,421 1,519,417 1,281,823 +Total Crocs Brand 3,277,967 3,012,954 2,659,125 +HEYDUDE Brand: +Wholesale 456,472 566,937 574,140 +Direct-to-consumer 367,669 382,456 321,720 +Total HEYDUDE Brand (2) +824,141 949,393 895,860 +Total consolidated revenues $ 4,102,108 $ 3,962,347 $ 3,554,985 +(1) North America includes the United States and Canada. +(2) We acquired HEYDUDE on February 17, 2022 and, as a result, added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the Partial Period. The vast majority of HEYDUDE Brand revenues are derived from North America. +Contract Liabilities +Contract liabilities consist of advance cash deposits received from wholesale customers to secure product orders in connection with selling seasons and payments received in advance of delivery. As products are shipped and control transfers, we recognize the deferred revenue in ‘Revenues’ in the consolidated statements of income. At December 31, 2024 and 2023, we recorded an insignificant amount of deferred revenues associated with advance customer deposits in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +F- 28 +Table of Contents +Refund Liabilities +Refund liabilities, primarily associated with product sales returns, retrospective volume rebates, and early payment discounts are estimated based on an analysis of historical experience, and adjustments to our estimates are made when the expected value changes. At December 31, 2024 and 2023, $ 34.3 million and $ 38.6 million, respectively, of refund liabilities, primarily associated with product returns, were reported in ‘Accrued expenses and other liabilities’ in the consolidated balance sheets. +13. SHARE-BASED COMPENSATION +Our share-based compensation awards are issued under the 2020 Equity Incentive Plan (“2020 Plan”) and predecessor plan, the 2015 Equity Incentive Plan (“2015 Plan”). Any awards that expire or are forfeited under the 2015 Plan become available for issuance under the 2020 Plan. We account for forfeitures as they occur when calculating share-based compensation expense. The aforementioned plans provide for the issuance of previously unissued common stock in connection with the exercise of stock options and conversion of other share-based awards. As of December 31, 2024, 3.1 million shares of common stock remained available for future issuance under all plans, subject to adjustment for future stock splits, stock dividends, and similar changes in capitalization. +The majority of share-based compensation expense is reported in our consolidated statements of income as ‘Selling, general and administrative expenses’ with an insignificant amount recorded within ‘Cost of sales.’ +Stock Option Activity +Stock option activity during the year ended December 31, 2024 was: +Number of Options Weighted Average Exercise Price Weighted Average Contractual Life (Years) Aggregate Intrinsic Value +(in thousands, except exercise price and years) +Outstanding as of December 31, 2023 +210 $ 7.44 3.28 $ 18,053 +Granted — — +Exercised 10 16.68 +Forfeited or expired — — +Outstanding as of December 31, 2024 +200 $ 6.98 2.42 $ 20,510 +Exercisable at December 31, 2024 +200 $ 6.98 2.42 $ 20,510 +Vested at December 31, 2024 +200 $ 6.98 2.42 $ 20,510 +No stock options were granted during 2024, 2023, or 2022. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2024 and 2022 was $ 1.0 million and $ 0.4 million, respectively. No stock options were exercised during 2023. During the years ended December 31, 2024 and 2022, we received $ 0.2 million and $ 0.1 million cash, respectively, in connection with the exercise of stock options. As of December 31, 2024, we did not have any unrecognized share-based compensation expense related to unvested options. +Stock options under our equity incentive plans generally expire ten years after the date of grant. +Restricted Stock Awards and Restricted Stock Units Activity +Generally on an annual basis, we grant RSAs and RSUs. RSAs and RSUs generally vest over three years , depending on the terms of the grant. Holders of unvested RSAs have the same rights as those of common stockholders including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until vested. Holders of unvested RSUs have a contractual right to receive shares of common stock upon vesting. RSUs have dividend equivalent rights, which accrue over the term of the award and are paid if and when the RSUs vest, but RSU holders have no voting rights. We grant service-condition RSUs, performance-condition RSUs, and market-condition RSUs. +Service-condition RSUs are typically granted on an annual basis and vest over time in three equal annual installments, beginning one year after the grant date. During the years ended December 31, 2024, 2023, and 2022, we granted 0.3 million, 0.2 million, and 0.2 million service-condition RSUs, respectively. +F- 29 +Table of Contents +Performance-condition RSUs are typically granted on an annual basis and consist of a performance-based and service-based component. The performance targets and vesting conditions for performance-condition RSUs are based on achievement of multiple weighted performance goals. The number of performance-condition RSUs ultimately awarded may be between 0 % and 200 %, based on performance. These RSUs vest in three equal annual installments beginning one year after the grant date, pending certification of performance achievement by the Compensation Committee of our Board of Directors and continued service. The fair value of performance-condition awards is based on the closing market price of our common stock on the grant date. Compensation expense, net of forfeitures, is updated for our probable expected performance level against performance goals at the end of each reporting period. During the years ended December 31, 2024, 2023, and 2022, we granted 0.3 million, 0.2 million, and 0.3 million performance-condition RSUs, respectively. We also periodically grant market-condition RSUs to certain executives. During the years ended December 31, 2024, 2023, and 2022, we did not grant market-conditions RSUs. The grant date fair value and derived service period for market-condition RSUs are estimated using a Monte Carlo simulation model. +RSA and RSU activity during the year ended December 31, 2024 was: +Restricted Stock Awards Restricted Stock Units +Shares Weighted Average Grant Date Fair Value Shares Weighted Average Grant Date Fair Value +(in thousands, except fair value data) +Unvested at December 31, 2023 +2 $ 105.95 847 $ 94.05 +Granted 6 130.75 627 124.04 +Vested ( 6 ) 115.82 ( 328 ) 89.90 +Forfeited — — ( 146 ) 119.07 +Unvested at December 31, 2024 +2 $ 148.72 1,000 $ 110.82 +The weighted average grant date fair value of RSAs granted during the years ended December 31, 2024, 2023, and 2022 was $ 130.75 , $ 105.95 , and $ 51.13 per share, respectively. RSAs vested during the years ended December 31, 2024, 2023, and 2022 consisted entirely of service-condition awards. The total grant date fair value of RSAs vested in the years ended December 31, 2024, 2023, and 2022 was $ 0.7 million, $ 0.5 million and $ 0.3 million, respectively. +As of December 31, 2024, unrecognized share-based compensation expense for RSAs was $ 0.2 million, which is expected to amortize over a remaining weighted average period of 0.4 years. +The weighted average grant date fair value of RSUs granted during the years ended December 31, 2024, 2023, and 2022 was $ 124.04 , $ 122.97 , and $ 76.06 per share, respectively. RSUs vested during the year ended December 31, 2024 consisted of 0.2 million service-condition awards and 0.2 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2023 consisted of 0.3 million service-condition awards and 0.3 million performance- and market-condition awards. RSUs vested during the year ended December 31, 2022 consisted of 0.3 million service-condition awards and 0.4 million performance- and market-condition awards. The total grant date fair value of RSUs vested during the years ended December 31, 2024, 2023, and 2022 was $ 29.5 million, $ 31.1 million and $ 29.7 million, respectively. +As of December 31, 2024, unrecognized share-based compensation expenses for service-condition RSUs were $ 33.2 million and for performance- and market-condition RSUs were $ 13.2 million, and are expected to amortize over remaining weighted average periods of 1.7 years and 1.8 years, respectively. +F- 30 +Table of Contents +14. INCOME TAXES +During the three months ended December 31, 2024, we completed an intra-entity transaction related to certain intellectual property rights primarily to align with current and future international operations. The transaction resulted in a step-up in tax basis of intellectual property rights and a correlated increase in foreign deferred tax assets based on the fair value of the intellectual property righ ts. Foreign deferred tax assets increased by $ 268.8 million and this benefit was offset by an increase in uncertain tax positions of $ 145.6 million. As such, a net change in deferred tax asset of $ 123.2 million was recognized along with a corresponding foreign income tax benefit. In 2024, we received new information and remeasured the reserve for uncertain tax positions related to the 2020 and 2021 intellectual property rights transactions which resulted in the release of uncertain tax positions of $ 141.2 million along with a corresponding foreign income tax benefit. +During 2020, 2021, and 2023, w e completed intra-entity transfers of certain intellectual property rights primarily to align with current and future international operations. The transactions were executed using transfer pricing guidelines issued by the relevant taxing authorities. Significant estimates and assumptions were required to compute the valuation of this transaction. These estimates and assumptions include, but are not limited to, estimated future revenue growth and discount rates, which by their nature are inherently uncertain, and, therefore, may ultimately differ materially from our actual results. +We have recorded certain tax reserves to address potential differences involving our income tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. While our tax position is not uncertain, because of the significant estimates used in the value of certain intellectual property rights, our tax reserves contain assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the costs of the ultimate tax liability or benefit from these matters may be materially more or less than the amount that we estimated. +In order to support and sustain the amortizable tax basis for these transactions (and associated deferred tax asset, net of uncertain tax position), we must demonstrate economic ownership, including the appropriate authority and expertise to manage the IP owned and serviced in the Netherlands and Singapore. The determination of economic substance is a judgment that has to be evaluated by management on a continual basis requiring understanding and expertise of local laws of each associated tax jurisdiction. The Netherlands and Singapore subsidiaries serve as the primary corporate headquarters outside of the U.S. and already perform significant functions in support of the economic ownership of the IP. In 2024, we undertook many additional activities to align business operations that support the economic substance of the IP. +The following table sets forth income before taxes and the expense for income taxes: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Income before taxes: +U.S. $ 217,429 $ 309,098 $ 312,501 +Foreign 693,156 567,174 406,007 +Total income before taxes $ 910,585 $ 876,272 $ 718,508 +Income tax expense (benefit): +Current income taxes: +U.S. federal $ 98,137 $ 85,075 $ 76,092 +U.S. state 18,005 21,884 19,257 +Foreign 98,826 387,066 87,760 +Total current income taxes 214,968 494,025 183,109 +Deferred income taxes: +U.S. federal ( 8,393 ) ( 12,873 ) ( 12,032 ) +U.S. state ( 797 ) ( 1,662 ) 861 +Foreign ( 245,264 ) ( 395,784 ) 6,411 +Total deferred income taxes ( 254,454 ) ( 410,319 ) ( 4,760 ) +Total income tax expense (benefit) +$ ( 39,486 ) $ 83,706 $ 178,349 +F- 31 +Table of Contents +The following table sets forth income reconciliations of the statutory federal income tax rate to actual rates based on income or loss before income taxes: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Income tax expense and rate attributable to: +Federal income tax rate $ 191,223 21.0 % $ 184,017 21.0 % $ 150,887 21.0 % +State income tax rate, net of federal benefit +13,301 1.5 % 16,854 1.9 % 15,981 2.2 % +Foreign income tax rate differential ( 34,166 ) ( 3.8 ) % 31,495 3.6 % 12,405 1.7 % +GILTI, net 61,440 6.6 % 44,003 5.0 % 4,834 0.7 % +Non-deductible / non-taxable items ( 12,028 ) ( 1.3 ) % ( 1,129 ) ( 0.1 ) % 3,743 0.5 % +Change in valuation allowance 58,861 6.5 % 156,312 17.8 % 4,414 0.6 % +U.S. tax on foreign earnings 12,684 1.4 % 1,752 0.2 % 16,822 2.3 % +Foreign tax credits ( 98,551 ) ( 10.8 ) % ( 55,648 ) ( 6.4 ) % ( 28,087 ) ( 3.9 ) % +Research and development credits ( 9,903 ) ( 1.1 ) % ( 6,754 ) ( 0.8 ) % ( 5,488 ) ( 0.8 ) % +Uncertain tax positions 50,193 5.5 % 330,819 37.8 % 3,952 0.6 % +Share-based compensation ( 1,157 ) ( 0.1 ) % ( 2,097 ) ( 0.2 ) % ( 1,231 ) ( 0.2 ) % +Intra-entity IP transactions +( 271,700 ) ( 29.8 ) % ( 611,403 ) ( 69.8 ) % — — % +Other 317 0.1 % ( 4,515 ) ( 0.4 ) % 117 0.1 % +Effective income tax expense and rate $ ( 39,486 ) ( 4.3 ) % $ 83,706 9.6 % $ 178,349 24.8 % +Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table sets forth deferred income tax assets and liabilities as of the date shown: +December 31, +2024 2023 +(in thousands) +Non-current deferred tax assets: +Share-based compensation expense $ 4,081 $ 3,248 +Accruals, reserves, and other expenses 22,974 27,914 +Net operating loss 65,776 47,951 +Intangible assets 918,000 737,976 +Foreign tax credit 49,027 28,053 +Operating lease liabilities 75,396 71,012 +Unrealized loss on foreign currency (1) +59,111 208 +Other (1) +48,866 43,453 +Valuation allowance ( 241,568 ) ( 183,545 ) +Total non-current deferred tax assets $ 1,001,663 $ 776,270 +Non-current deferred tax liabilities: +Property and equipment ( 25,896 ) ( 13,948 ) +Right-of-use assets ( 63,782 ) ( 59,806 ) +Intangible assets ( 42,409 ) ( 46,177 ) +Other ( 1,313 ) ( 1,280 ) +Total non-current deferred tax liabilities $ ( 133,400 ) $ ( 121,211 ) +(1) Amounts for the year ended December 31, 2023 have been reclassified to conform to current period presentation. +F- 32 +Table of Contents +The intra-entity transaction related to intellectual property rights resulted in an increase in the intangible assets deferred tax asset of $ 268.8 million and this benefit was offset by an increase in uncertain tax positions of $ 145.6 million. I n 2024, we received new information and remeasured the reserve for uncertain tax positions related to the 2020 and 2021 intellectual property rights transactions which resulted in the release of uncertain tax positions of $ 141.2 million along with a corresponding foreign income tax benefit. +During 2024, valuation allowances recorded against deferred tax assets increased by $ 58.0 million. The change in the valuation allowance includes an increase of $ 58.9 million related to income tax expense and a decrease of $ 0.9 million that does not impact the tax provision because this amount reflects the cumulative impact of unrecorded tax attributes related to changes in cumulative translation adjustments. During 2023, valuation allowances increased by $ 155.4 million. The change in the valuation allowance includes an increase of $ 156.3 million related to income tax expense and a decrease of $ 0.9 million that does not impact the tax provision because this amount reflects the impact of unrecorded tax attributes related to changes in cumulative translation adjustments. +Our valuation allowances are primarily the result of uncertainties regarding the future realization of tax attributes recorded in various jurisdictions. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available evidence, it is more likely than not the deferred tax assets will not be realized. We have evaluated the realizability of our deferred tax assets in each jurisdiction by assessing the adequacy of expected taxable income, including the reversal of existing temporary differences, historical and projected operating results and the availability of prudent and feasible tax planning strategies. In assessing our valuation allowance we considered all available evidence, including the magnitude of recent and current operating results, the duration of statutory carryforward periods, our historical experience utilizing tax attributes prior to their expiration dates, the historical volatility of operating results of these jurisdictions and our assessment regarding the sustainability of their profitability. The weight we give to any particular item is, in part, dependent upon the degree to which it can be objectively verified. Separate from the intra-entity transfers of intellectual property rights, we released immaterial valuation allowances in various jurisdictions. +In certain other jurisdictions, we recorded additional attributes, primarily driven by operational losses recognized based on local tax accounting requirements. These carryforwards were generated in jurisdictions where results indicate it is not more likely than not the deferred tax assets would be realized. We maintain a valuation allowance against the majority of these balances. +We have included in the table above deferred tax assets related to U.S. federal tax carryforwards of foreign tax credits and various state tax credits which expire starting in 2030 of $ 17.9 million and $ 3.8 million at December 31, 2024 and 2023, respectively. We have included in the table above deferred tax assets related to U.S. state tax net operating loss carryforwards, some of which expire at various dates beginning in 2029 and others of which do not expire, of $ 0.3 million and $ 0.3 million at December 31, 2024 and 2023, respectively. We have recorded deferred tax assets related to foreign tax carryforwards, including foreign tax credits and net operating losses, which expire starting in 2025 and those which do not expire of $ 98.3 million and $ 73.3 million as of December 31, 2024 and 2023, respectively. +The transition tax in the U.S. Tax Cuts and Jobs Act (“Tax Act”) imposed a tax on undistributed and previously untaxed foreign earnings at various tax rates. This tax largely eliminated the differences between the financial reporting and income tax basis of foreign undistributed earnings. Furthermore, as of December 31, 2024, foreign withholding taxes have not been provided on unremitted earnings of subsidiaries operating outside of the U.S. as these amounts are considered to be indefinitely reinvested. +F- 33 +Table of Contents +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Unrecognized tax benefit as of January 1 $ 556,482 $ 219,363 $ 218,399 +Additions in tax positions taken in prior period 9,855 3,690 1,697 +Reductions in tax positions taken in prior period ( 147,561 ) ( 7 ) ( 904 ) +Additions in tax positions taken in current period 184,184 325,058 2,948 +Settlements — — ( 375 ) +Lapse of statute of limitations ( 366 ) ( 148 ) ( 510 ) +Current year acquisitions — — 10,426 +Cumulative foreign currency translation adjustment ( 20,366 ) 8,526 ( 12,318 ) +Unrecognized tax benefit as of December 31 $ 582,228 $ 556,482 $ 219,363 +We recorded a net expense of $ 50.2 million related to increases in 2024 unrecognized tax benefits. The impact of uncertain tax benefits on the rate reconciliation includes net increases and decreases in position changes and accrued interest expense. +Any settlements or statute of limitations expirations could result in a significant decrease in our uncertain tax positions. Our assessments are based on estimates and assumptions using the best available information to management. However, our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and any variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible change related to our uncertain tax positions, and such changes could be significant. +Interest and penalties related to income tax liabilities are included in ‘Income tax expense (benefit)’ in the consolidated statements of income. For the years ended December 31, 2024, 2023, and 2022, we recorded approximately $ 4.5 million, $ 3.2 million, and $ 3.8 million, respectively, of penalties and interest. During the year ended December 31, 2024, we released $ 0.2 million of interest from settlements, lapse of statutes, and change in certainty. The cumulative accrued balance of penalties and interest was $ 13.3 million, $ 8.8 million, and $ 5.6 million, as of December 31, 2024, 2023, and 2022, respectively. +Unrecognized tax benefits of $ 591.7 million, $ 562.0 million, and $ 222.5 million as of December 31, 2024, 2023, and 2022, respectively, if recognized, would reduce the annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +The following table sets forth the tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2024: +The Netherlands +2012 to 2024 +Canada +2016 to 2024 +Hong Kong +2020 to 2024 +Japan +2016 to 2024 +China +2018 to 2024 +Singapore +2019 to 2024 +United States +2007 to 2024 +U.S. state tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. As such, U.S. state income tax returns for us are generally subject to examination for the years 2019 to 2024. Although the timing of income tax audit resolutions and negotiations with taxing authorities is highly uncertain, we do not anticipate a significant change in the total amount of unrecognized tax benefits within the next twelve months. +F- 34 +Table of Contents +15. EARNINGS PER SHARE +Basic and diluted EPS for the years ended December 31, 2024, 2023, and 2022 were as follows: +Year Ended December 31, +2024 2023 2022 +(in thousands, except per share data) +Numerator: +Net income attributable to common stockholders +$ 950,071 $ 792,566 $ 540,159 +Denominator: +Weighted average common shares outstanding - basic 59,381 61,386 61,220 +Plus: Dilutive effect of stock options and unvested restricted stock units +451 566 786 +Weighted average common shares outstanding - diluted +59,832 61,952 62,006 +Net income per common share: +Basic $ 16.00 $ 12.91 $ 8.82 +Diluted $ 15.88 $ 12.79 $ 8.71 +For the years ended December 31, 2024, 2023, and 2022, an insignificant number of outstanding shares issued under share-based compensation awards were anti-dilutive and, therefore, excluded from the calculation of diluted EPS. +16. COMMITMENTS AND CONTINGENCIES +Purchase Commitments +As of December 31, 2024, we had purchase commitments to our third-party manufacturers, primarily for materials and supplies used in the manufacture of our products, for an aggregate of $ 301.9 million. We expect to fulfill our commitments under these agreements in the normal course of business, and as such, no liability has been recorded. +Other +We are regularly subject to, and are currently undergoing, audits by various tax authorities in the U.S. and several foreign jurisdictions, including customs duties, import and other taxes for prior tax years. +During our normal course of business, we may make certain indemnities, commitments, and guarantees under which we may be required to make payments in relation to certain matters. We cannot determine a range of estimated future payments and have not recorded any liability for such payments in the accompanying consolidated balance sheets. +See Note 18 — Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +F- 35 +Table of Contents +17. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand. Each of the reportable operating segments derives its revenues from the sale of footwear and accessories to external customers. +Additionally, ‘Enterprise corporate’ costs include global corporate costs associated with both brands, including legal, information technology, human resources, and finance. +Each segment’s performance is evaluated based on segment results without allocating Enterprise corporate expenses. Segment profits or losses include adjustments to eliminate inter-segment sales. Reconciling items between segment income from operations and income from operations consist of unallocated enterprise corporate expenses. Our chief operating decision maker is Andrew Rees, Chief Executive Officer. Mr. Rees uses income from operations as a measure of profit or loss. Mr. Rees considers the performance of these measures against management expectations when making decisions about the allocation of operating and capital resources to each segment. +We do not report asset information by segment because that information is not used to evaluate performance or allocate resources between segments. +F- 36 +Table of Contents +The following tables set forth information related to reportable operating segments: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Crocs Brand: (1) +Revenues $ 3,277,967 $ 3,012,954 $ 2,659,125 +Cost of sales (2) +1,258,727 1,205,670 1,161,374 +Selling, general and administrative expenses (2) +837,228 727,954 645,726 +Income from operations (3) +1,182,012 1,079,330 852,025 +HEYDUDE Brand: (4) +Revenues +824,141 949,393 895,860 +Cost of sales (2) +430,893 531,414 530,059 +Selling, general and administrative expenses (2) +255,847 205,593 154,440 +Income from operations (3) +137,401 212,386 211,361 +Total segment income from operations +$ 1,319,413 $ 1,291,716 $ 1,063,386 +Reconciliation of segment income from operations to income before income taxes: +Enterprise corporate costs (3) +( 297,502 ) ( 254,933 ) ( 212,630 ) +Foreign currency gains (losses), net ( 6,777 ) ( 1,240 ) 3,228 +Interest income 3,484 2,406 1,020 +Interest expense ( 109,264 ) ( 161,351 ) ( 136,158 ) +Other income (expense), net 1,231 ( 326 ) ( 338 ) +Income before income taxes $ 910,585 $ 876,272 $ 718,508 +Revenues: +Total segment revenues +$ 4,102,108 $ 3,962,347 $ 3,554,985 +Total consolidated revenues +$ 4,102,108 $ 3,962,347 $ 3,554,985 +Depreciation and amortization: (5) +Crocs Brand (1) +$ 35,165 $ 31,950 $ 18,877 +HEYDUDE Brand (4) +19,353 14,200 12,248 +Enterprise corporate 15,322 8,154 8,104 +Total consolidated depreciation and amortization $ 69,840 $ 54,304 $ 39,229 +(1) In the fourth quarter of 2023, to reflect changes in the way management evaluates performance, makes operating decisions, and allocates resources, we updated our reportable operating segments to be (i) Crocs Brand and (ii) HEYDUDE Brand. Our ‘North America,’ ‘Asia Pacific,’ and ‘EMEALA’ segments as well as revenues and expenses related to Crocs ‘Brand corporate’ have been consolidated to the ‘Crocs Brand.’ As a result of these changes, the previously reported amounts for revenues, income from operations, and depreciation and amortization for the year ended December 31, 2022 have been recast to conform to current period presentation. +(2) In November 2023, the FASB issued authoritative guidance related to the segment disclosures. This guidance became effective beginning for the year ended December 31, 2024 and should be applied on a retrospective basis. The guidance requires disclosure of significant segment expenses that are regularly provided to the chief operating decision maker and included within each reported measure of segment profit or loss. As a result of this guidance, we disclosed cost of sales and selling, general and administrative expenses as measures of significant expenses included within income from operations shown in the table above. +(3) In the first quarter of 2024, to reflect a change in the way management evaluates segment performance, makes operating decisions, and allocates resources, we made changes to segment profitability related to certain foreign currency amounts impacting cost of sales. These amounts have shifted costs or benefits that were previously presented in each of our reportable segments to ‘Enterprise corporate.’ We believe that the impact of these changes on prior periods is insignificant to each segment and thus have not recast prior periods. +(4) We acquired HEYDUDE on February 17, 2022 and in connection therewith added the HEYDUDE Brand as a new reportable operating segment. Therefore, the amounts shown above for the year ended December 31, 2022 represent results during the partial period beginning on the Acquisition Date through December 31, 2022. +(5) The amounts of depreciation and amortization disclosed by reportable segment and ‘Enterprise corporate’ are included within ‘Cost of sales’ and ‘Selling, general and administrative expenses.’ +F- 37 +Table of Contents +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2024, 2023 and 2022. The following table sets forth certain geographical information regarding our consolidated revenues for the periods as shown: +Year Ended December 31, +2024 2023 2022 +(in thousands) +Location: +United States $ 2,482,218 $ 2,573,663 $ 2,438,923 +International (1) +1,619,890 1,388,684 1,116,062 +Total revenues $ 4,102,108 $ 3,962,347 $ 3,554,985 +(1) No individual international country represented 10% or more of consolidated revenues in any of the years presented. +The following table sets forth geographical information regarding property and equipment assets as of the dates shown: +December 31, +2024 2023 +(in thousands) +Location: +United States $ 205,166 $ 200,869 +International (1) +39,169 37,446 +Total property and equipment, net $ 244,335 $ 238,315 +(1) As of December 31, 2024 and 2023, property and equipment, net in the Netherlands represented approximately 10 % and 12 % respectively, of consolidated property and equipment, net, comprised primarily of property and equipment related to the distribution center in Dordrecht. No other individual international country represented 10% or more of consolidated property and equipment, net in any of the years presented. +18. LEGAL PROCEEDINGS +On January 22, 2025, a putative class action lawsuit titled Carretta v. Crocs, Inc., et al., Case No. 1:25-cv-00096, was filed in the District Court for the District of Delaware against the Company and certain of its current officers. The complaint was filed on behalf of a purported class consisting of all purchasers of the Company’s common stock between November 3, 2022 and October 28, 2024, inclusive. The complaint asserts violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 based on allegedly false and misleading statements related to the Company’s wholesaler inventory and its alleged impact on the Company’s revenue. The complaint seeks unspecified damages, an award of costs and expenses, and other unspecified relief. The Company and its officers intend to vigorously defend this action in all respects. The case is in its early stages and a lead plaintiff has yet to be appointed. The Company is not in a position to assess the likelihood of any potential loss or adverse effect on its financial condition or to estimate the amount or range of potential loss, if any, from this action at this time. +For all other legal claims and disputes, we have accrued estimated losses of $ 2.7 million within ‘Accrued expenses and other liabilities’ in our consolidated balance sheet as of December 31, 2024. As we are able, we estimate reasonably possible losses or a range of reasonably possible losses. As of December 31, 2024, we estimated that reasonably possible losses associated with these legal claims and other disputes could potentially exceed amounts accrued by an insignificant amount. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property, and product liability claims, other than as set forth above, we are not party to any other pending legal proceedings that we believe would reasonably have a material adverse impact on our business, financial results, and cash flows. +F- 38 +Table of Contents +19. EMPLOYEE BENEFIT PLAN +Defined Contribution Plan +We sponsor a qualified defined contribution benefit plan (the “Plan”), covering substantially all of our U.S. employees. The Plan includes a savings plan feature under Section 401(k) of the Internal Revenue Code. We make matching contributions to the plans equal to 100 % of the first 3 %, and up to 50 % of the next 2 % of salary contributed by an eligible employee. Participants are vested 100 % in our matching contributions when made. Contributions made by us under the Plan were $ 14.8 million, $ 12.6 million, and $ 9.0 million for the years ended December 31, 2024 , 2023 , and 2022, respectively. +F- 39 +Table of Contents +APPENDIX A +SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS +CROCS, INC. AND SUBSIDIARIES +Balance at Beginning of Period Charged to Costs and Expenses +Deductions (1) +Balance at End of Period +(in thousands) +Year Ended December 31, 2024 +Allowance for doubtful accounts $ 13,627 $ 1,352 $ ( 2,330 ) $ 12,649 +Reserve for sales returns and allowances 8,128 306,273 ( 304,594 ) 9,807 +Reserve for unapplied rebates 5,836 12,038 ( 8,751 ) 9,123 +Total $ 27,591 $ 319,663 $ ( 315,675 ) $ 31,579 +Year Ended December 31, 2023 +Allowance for doubtful accounts $ 10,513 $ 3,567 $ ( 453 ) $ 13,627 +Reserve for sales returns and allowances 8,877 271,990 ( 272,739 ) 8,128 +Reserve for unapplied rebates +5,103 8,181 ( 7,448 ) 5,836 +Total $ 24,493 $ 283,738 $ ( 280,640 ) $ 27,591 +Year Ended December 31, 2022 +Allowance for doubtful accounts $ 7,828 $ 1,101 $ 1,584 $ 10,513 +Reserve for sales returns and allowances 9,606 192,543 ( 193,272 ) 8,877 +Reserve for unapplied rebates +3,281 6,107 ( 4,285 ) 5,103 +Total $ 20,715 $ 199,751 $ ( 195,973 ) $ 24,493 +(1) Deductions include accounts written off, net of recoveries, and the effects of foreign currency translation. +F- 40 \ No newline at end of file diff --git a/raw/filings/0001334036/2024/0001334036-25-000009/filing_metadata.csv b/raw/filings/0001334036/2024/0001334036-25-000009/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..47ff9034a8a8e1c7191a36b674af8a9702083e9f --- /dev/null +++ b/raw/filings/0001334036/2024/0001334036-25-000009/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2025-02-13,2024-12-31,2025-02-13T20:29:00.000Z,0001334036-25-000009,crox-20241231.htm,10-K,12662148,1,1,https://www.sec.gov/Archives/edgar/data/1334036/000133403625000009/crox-20241231.htm,https://www.sec.gov/Archives/edgar/data/1334036/000133403625000009/,2024,2024,1 diff --git a/raw/filings/0001334036/2024/0001334036-25-000009/item1.txt b/raw/filings/0001334036/2024/0001334036-25-000009/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..612bf3bf0a05c3794f59e8c835df12a498a0ea9b --- /dev/null +++ b/raw/filings/0001334036/2024/0001334036-25-000009/item1.txt @@ -0,0 +1,118 @@ +ITEM 1. Business +The Company +Crocs, Inc. and our consolidated subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) are engaged in the design, development, worldwide marketing, distribution, and sale of casual lifestyle footwear and accessories for all. We strive to be the world leader in innovative casual footwear, combining comfort and style with a value that consumers want. +On February 17, 2022 (the “Acquisition Date”), we acquired (the “Acquisition”) 100% of the equity of a privately-owned casual footwear brand business (“HEYDUDE”). HEYDUDE is engaged in the business of distributing and selling casual footwear under the brand name “HEYDUDE.” The majority of HEYDUDE sales are currently in the United States. +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand, which are discussed in more detail in “Business Segments and Geographic Information” below. +Our Vision +At the heart of our brands are our consumers. We have brands with a broad democratic appeal and accessible price points, which are aligned with global megatrends such as casualization, comfort, and personalization. The philosophy and vision for our brands have been important drivers of our results and, we believe, will continue to be important as we strive to realize the full global potential of our brands. To that end, in 2024, we continued our message of “Come As You Are” for the Crocs Brand and the slogan “Good To Go-To” for the HEYDUDE Brand. +Our enterprise growth priorities are centered around three strategic areas of focus: +• Ignite our icons to drive awareness and relevance for our brands — Central to our Crocs Brand’s DNA are our clogs, sandals, and Jibbitz™ charms, which are key product pillars that we believe will drive long-term growth. Our Classic Clog is our icon, and we continue to grow our broader clog silhouette with new designs, colors, graphics, licensed properties and collaborations. The addition of the HEYDUDE Brand to our portfolio provides opportunity to play in a broader casual footwear market. The brand is known for its versatility, easy on and off characteristics, and comfort. The Wendy and Wally are distinct and innovative loafer silhouettes and represent our icons. +• Drive market share gains across our Tier 1 markets through strategic investment in talent, marketing, digital, and retail — For the Crocs Brand, we are focused on six Tier 1 markets: (i) China, (ii) India, (iii) Japan, (iv) South Korea, (v), the U.S., and (vi) Western Europe. Our international sales in 2024 were 44.1% of Crocs Brand revenues compared to 41.0% and 38.2% in 2023 and 2022, respectively. For the HEYDUDE Brand, which predominantly operates in the United States, we have embarked, and plan to continue to embark, on various marketing activities to drive higher awareness. This includes developing a pipeline of collaborations and brand activations. We have rightsized HEYDUDE’s wholesale distribution footprint and are evolving our channel diversification strategy through the thoughtful development of premium outlet retail stores. At the end of 2024 and 2023, we had a fleet of 52 and 14 HEYDUDE Brand outlet stores, respectively. +Across our portfolio, leading with digital remains a priority. Digital sales include sales directly to consumers through our company-owned websites and third-party marketplaces as well as wholesale sales to our global e-tailers. Our digital sales in 2024 were 37.2% of consolidated revenues, compared to 37.9% and 37.8% of consolidated revenues in 2023 and 2022, respectively. +• Attract new consumers by diversifying our product range and wearing occasions — For the Crocs Brand, we see opportunity to attract new consumers by driving diversification in wearing occasions. We believe sandals are a natural extension of the Crocs Brand and allow us to access new consumers by leveraging our signature molding technology to provide casual, comfortable footwear for a variety of wearing occasions. In addition to the development of our sandals product pillar, we see further opportunity to expand into broader footwear silhouettes and lifestyle occasions. For the HEYDUDE Brand, our primary focus is diversification within our core Wendy and Wally silhouettes, while pursuing natural extensions into sneakers, dress casual, boots and sandals. +2 +Table of Contents +Products +Since we first introduced a single-style clog in six colors in 2002, we have grown to be a world leader of innovative, casual footwear for all. We offer a broad portfolio of all-season products, while remaining true to our core casual footwear heritage. +Crocs Brand +Recognized globally for our unmistakable iconic molded clog silhouette, we have taken the successful formula of a simple design aesthetic, paired it with modern comfort, and expanded into a wide variety of casual footwear products including sandals—wedges, flips, and slides—that meet the needs of the whole family. Our mission of “everyone comfortable in their own shoes” continued in 2024 as we repeatedly brought our consumers new silhouettes, compelling collaborations, trend-right colors and graphics, and increased personalization through our Jibbitz™ charms accessories. +The vast majority of Crocs™ shoes feature Croslite™ material, a proprietary, revolutionary technology that gives each pair of shoes the soft, comfortable, and lightweight qualities that our fans know and love. We also use Croslite™ material formulations in connection with material technologies used in our visible comfort collections, such as our LiteRide™ and Free Feel Technology™ products. Our products containing LiteRide™ and Free Feel Technology™ feature comfort-focused, proprietary foam insoles which are soft, lightweight, and resilient. +HEYDUDE Brand +The HEYDUDE Brand offers shoes with an iconic and versatile loafer silhouette with many wearing occasions that focus on casualization, comfort-led functionality, and personalization. The HEYDUDE Brand utilizes leading technologies including a flex-and-fold outsole and ergonomic insole. The shoes are known for being lightweight, flexible, and soft, with design and functional flexibility for convenience. +Marketing +Each season, we focus on presenting compelling brand stories and experiences for our new product introductions as well as our ongoing core products. We employ social and digital marketing centered on showcasing our clog, sandal silhouettes, and Jibbitz™ charms for the Crocs Brand and our versatile loafer silhouette for the HEYDUDE Brand. We continue to invest in partnerships including McDonald’s, Toy Story, Simone Rocha, Sydney Sweeney, and Jelly Roll. Innovation is not only core to our brands’ values; it is at the forefront of how we drive consumer acquisition and engagement. We strive to listen and respond quickly to our customers to give them new and innovative reasons to continue to choose the Crocs and HEYDUDE brands. See Note 1 — Basis of Presentation and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information on total marketing costs for the year. +Corporate Responsibility and Sustainability Initiatives +As one of the world’s largest footwear companies, we aim to make a positive impact on the global footwear industry, for people, and for our planet. Our 2024 Comfort Report, which is expected to be published in the first half of 2025, is our fourth annual publication that provides an explanation of our progress towards our purpose of creating a more comfortable world for all. Our Comfort Report will be made available on the Investor Relations section of our website located at www.investors.crocs.com. Except where specified otherwise, all information in the forthcoming Comfort Report and below corporate responsibility and sustainability (“CRS”) discussion pertains to Crocs, Inc. as of December 31, 2024. The content provided in our Comfort Report or accessible through our website is not incorporated by reference as part of this Annual Report on Form 10-K. +We are continuously evaluating our business practices towards our goal of consistently delivering products that exceed customer and consumer expectations while meeting all regulatory and compliance requirements. We believe the progress of our sustainability efforts is best understood through transparent and comparable disclosures and, to this end, we continue to align our reporting with the Sustainability Accounting Standards Board (“SASB”) and the Taskforce on Climate-related Financial Disclosures (“TCFD”) frameworks. +3 +Table of Contents +Environmental +We are committed to taking steps to reduce our impact on the environment and are particularly focused on carbon reduction, sustainable operations, and product circularity. +In 2024, we completed a greenhouse gas inventory for the Crocs, Inc. enterprise, including both the Crocs and HEYDUDE brands, based on 2023 data. We also updated our 2022 and 2021 emissions based on updates in calculation methodology due to more accurate emission factors and advancements in data quality. In 2024, we increased the amount of bio-circular materials in our Croslite™ compound, reaching 25% bio-circular content on a mass balance basis as verified by the International Sustainability and Carbon Certification (“ISCC PLUS”), supporting our journey to Net Zero by 2040. We also maintained our membership with Cascale (formerly the Sustainable Apparel Coalition), continued to progress the work of the Footwear Collective as a founding member and enhanced the tracking of our energy use, water use, and waste generation. +In 2024, we also expanded “Old Crocs New Life,” a circularity program in the United States and Canada that allows our Crocs consumers to return their gently worn or well-loved Crocs shoes to over 160 retail stores or via a mail-back initiative to be donated to communities in need or repurposed into something new. We also launched our first “Keep it Going” classic clog, made of 25% post-consumer recycled content created from Crocs shoes we’ve taken back. +More detail on these initiatives, as well as our ambitions, will be provided in our upcoming Comfort Report. +Social +As of December 31, 2024, we employed more than 7,910 employees globally, including approximately 4,560 employees in our retail stores, 2,300 employees at our corporate/regional offices, and 1,050 employees at our distribution centers. +We believe we have one of the most talented workforces in the footwear industry and continue to improve and implement new initiatives to remain an employer of choice across all of our businesses and geographies. These initiatives include pay transparency in hiring, offering employee training and developing leadership capabilities, enabling meaningful professional experiences, offering a compelling employee value proposition, and creating a collaborative culture. We strive to create a culture of inclusion through people-practices that support and empower all employees. We are proud of the workplace culture we have created. To that end, our regular employee engagement scores continue to reflect a highly engaged global workforce. +Our efforts around inclusion, collaboration, and human rights extend through our supply chain. We work to ensure our products are sourced, produced, and delivered to our customers in a manner that upholds international labor and human rights standards, inclusive of occupational safety and chemical safety. In addition, we maintain numerous measures to ensure our supply chain complies with our Social Compliance Code of Conduct, Restricted Substances Policy, and Human Rights Policy, as well as with local laws and customs regarding hiring practices, wages, and working conditions. +We also seek to extend the reach of our impact through our global community giving program. In 2024, we launched our “Step Up to Greatness” program focused on supporting non-profit partners that help young people build new skills, grow confidence, and open doors to new opportunities. We also partnered with Big Brothers Big Sisters, the largest youth mentoring organization in the United States, to support them in empowering young people. We continued to show up for our communities in times of need, donating shoes and funds in the wake of crises, such as the impacts following the hurricanes in the southeastern United States in 2024. +Governance +Strong corporate governance mechanisms, along with robust internal controls over our financial reporting framework, are the foundation for our progress toward our environmental and social ambitions. The basis of this is our Board of Directors (the “Board”), which was comprised of 22% female and 22% historically underrepresented racial/ethnic members as of December 31, 2024. +In 2024, our Corporate Responsibility and Sustainability Steering Committee (the “CRS Committee”) of our Board, comprised of three independent directors, continued its oversight of our CRS efforts and received quarterly updates on the development of our CRS program. Specifically, the CRS Committee assisted the Board in (i) carrying out the responsibilities delegated by the Board regarding the review and oversight of our goals, policies, procedures and disclosures related to sustainability and CRS matters and (ii) its oversight of the sustainability and CRS matters material to us, our employees, our communities, and the planet. Additionally, we regularly review our Enterprise Risk Management and Ethics & Compliance program frameworks to account for our social and environmental risks and opportunities, specifically including those related to climate change. All +4 +Table of Contents +material findings and updates are elevated to and discussed with our Board quarterly by our Chief Sustainability Officer, who reports directly to our Chief Executive Officer. +We believe our employees are critical to the maintenance of strong corporate governance and, to that end, we continue to conduct annual in-person and online compliance trainings for all corporate employees, as well as retail and distribution center management. We also maintain a global ethics hotline, which is monitored by our Legal department, should any of our stakeholders identify concerns or have grievances. +Distribution Channels +The broad appeal of our footwear has allowed us to market our products in more than 80 countries through two distribution channels: wholesale and direct-to-consumer (“DTC”). +Wholesale Channel +During the years ended December 31, 2024, 2023, and 2022, 50.3%, 52.0%, and 54.9% of our consolidated revenues, respectively, were derived through our wholesale channel. Our wholesale channel includes domestic and international multi-brand retailers, mono-branded partner stores, e-tailers, and distributors. Brick-and-mortar customers typically include family footwear retailers, international, national, and regional retail chains, sporting goods stores, and independent footwear retailers. +Outside the U.S., we use distributors when we believe such arrangements are economically preferable to direct sales. Distributors purchase products pursuant to a price list and are granted the right to resell those products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to five years and can be terminated or renegotiated if minimum requirements or other terms are not met. +Direct-to-Consumer Channel +Our DTC channel includes company-operated e-commerce sites, third-party marketplaces, company-operated full-price retail stores, outlet stores, and kiosks/store-in-store locations. During the years ended December 31, 2024, 2023, and 2022, 49.7%, 48.0%, and 45.1%, respectively, of our consolidated revenues were derived through our DTC channel. +E-commerce +As of December 31, 2024, we offered our products through 23 company-operated e-commerce sites worldwide and also on third-party marketplaces. Our e-commerce presence facilitates a greater connection with our consumers and provides us with an opportunity to educate them about our products and brands. We continue to leverage increasingly sophisticated digital marketing activities to enhance the consumer experience and drive sales, thereby benefiting from the continued migration of consumers to online shopping. +Retail +With the continued worldwide consumer shift toward e-commerce, we carefully manage our retail fleet, especially full-priced retail stores. As of December 31, 2024, we had 390 and 52 company-operated stores for the Crocs Brand and HEYDUDE Brand, respectively. +Our company-operated full-price retail stores allow us to effectively showcase the full extent of our product range to consumers and provide us with the opportunity to interact with those consumers directly. As of December 31, 2024, we had 87 full-price Crocs Brand retail stores. +Our company-operated outlet stores allow us to sell discontinued and overstocked merchandise directly to consumers at discounted prices. We also sell full-priced products in our outlet stores as well as built-for-outlet products. As of December 31, 2024, we had 232 Crocs Brand outlet stores and 52 HEYDUDE Brand outlet stores, of which 9 were clearance locations. +Our company-operated kiosks and store-in-store locations allow us to market specific product lines, with flexibility to tailor products to consumer preferences in shopping malls and other high foot-traffic areas. With efficient use of retail space and limited fixed cost and capital investment, we believe kiosks and store-in-store locations can be effective vehicles for selling our products in certain geographic areas. As of December 31, 2024, we had 71 Crocs Brand kiosks and store-in-store locations. +5 +Table of Contents +The following table illustrates the net change during 2024 in the number of our company-operated retail stores (inclusive of full-price retail stores, outlet stores, kiosks, store-in-store locations, and temporary stores) by reportable operating segment and country: +December 31, 2023 Opened Closed December 31, 2024 +Crocs Brand +United States 163 13 4 172 +South Korea +91 4 — 95 +China 36 18 3 51 +Japan 14 7 — 21 +Singapore 17 — — 17 +Germany 11 1 2 10 +Canada 8 2 1 9 +Great Britain — 4 — 4 +Austria 3 — — 3 +Puerto Rico 3 — — 3 +France 2 — — 2 +The Netherlands 1 1 — 2 +Australia +— 1 — 1 +Total Crocs Brand 349 51 10 390 +HEYDUDE Brand +United States 14 39 1 52 +Total HEYDUDE Brand 14 39 1 52 +Total 363 90 11 442 +Business Segments and Geographic Information +We have two reportable operating segments: the Crocs Brand and the HEYDUDE Brand. See Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 17 — Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements included in Part II - Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for financial information related to our reportable operating segments. +Raw Materials +Crocs Brand +Croslite™, our proprietary closed-cell resin material, incorporates the primary material formulations used in the vast majority of our Crocs Brand footwear and some of our accessories. Our Croslite™ materials are formulated to create soft, comfortable, and lightweight footwear. We continue to invest in research and development to refine our materials to enhance these properties, develop new properties for specific applications, as well as reduce our environmental impact through various sustainability initiatives described in the previous section. +Croslite™ is produced by compounding elastomer resins, purchased from major chemical manufacturers, with certain other production inputs such as color dyes. Multiple suppliers produce the elastomer resins used in the Croslite™ material. In the future, we may identify and utilize materials produced by other suppliers as an alternative to, or in addition to, those elastomer resins. All other raw materials that we use to produce the Croslite™ formulations are readily available for purchase from multiple suppliers. +Some of the products we offer are constructed using textile fabrics or other material formulations, such as those we brand LiteRide™ and Free Feel Technology™. These materials are obtained from a number of third-party sources, and we believe these materials are also broadly available. +6 +Table of Contents +HEYDUDE Brand +The primary raw materials for the HEYDUDE Brand are fabrics, including polyester and cotton, Ethylene-vinyl acetate (“EVA”) insoles and outsoles, and other materials such as leather and polyurethane. We purchase this material from a select group of third-party sources, and we believe these materials are broadly available. +Sourcing +Our sourcing strategy is to maintain a flexible, globally-diversified, cost-efficient third-party manufacturing base. We source our inventory production from multiple third-party manufacturers, primarily in: +• Vietnam for the Crocs Brand. We have additional third-party manufacturers in China, Indonesia, India, and Mexico, among other countries. During the years ended December 31, 2024, 2023, and 2022, approximately 51%, 56%, and 53%, respectively, of our Crocs Brand production was in Vietnam. Our largest third-party manufacturer for the Crocs Brand, with the majority of operations in Vietnam, produced approximately 50%, 47%, and 42% of our production during the years ended December 31, 2024, 2023, and 2022, respectively, and our second largest third-party manufacturer for the Crocs Brand, primarily operating in both Vietnam and China, produced approximately 25%, 26%, and 27% of our production during the years ended December 31, 2024, 2023, and 2022, respectively. +• China for the HEYDUDE Brand. We have additional third-party manufacturers in Vietnam, Cambodia, Indonesia, and India. During the years ended December 31, 2024 and 2023, approximately 58% and 83%, respectively, of our HEYDUDE Brand production was in China. During the partial period beginning on the Acquisition Date through December 31, 2022 (the “Partial Period”), the vast majority of production was in China for the HEYDUDE Brand. +We believe any potential concentration risk is mitigated by the fact that the manufacturing capabilities required to produce our footwear are broadly available for both brands. Nonetheless, see the risk factors under “Risks Related to our Supply Chain — We depend solely on third-party manufacturers located outside of the U.S.” and “Risks Related to International Operations —Government actions and regulations, such as export restrictions, tariffs, and other trade protection measures could adversely affect our business” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information on risks associated with sourcing. +Distribution and Logistics +We strive to enhance our distribution and logistics network to further streamline our supply chain, increase our speed to market, and lower operating costs. As of December 31, 2024, we principally stored our finished goods inventory in company-operated warehouses and distribution and logistics facilities located in the U.S. and the Netherlands. During 2024, we further expanded our U.S. distribution centers in Nevada for the HEYDUDE Brand to increase distribution capacity. We also utilized third-party operated distribution centers located in the United States, Japan, China, Australia, South Korea, Singapore, India, Brazil, Canada, the Netherlands, and the United Kingdom. As of December 31, 2024, our company-operated warehouse and distribution facilities provided us with 2.9 million square feet, and our third-party operated distribution facilities provided us with 0.9 million square feet, with additional area available based on inventory levels. We also ship directly to certain wholesale customers from our third-party manufacturers and certain distributors pick up orders directly from our third-party manufacturers or from the port of entry. +See the risk factors under “Risks Related to our Supply Chain — Our operations are dependent on the global supply chain and impacts of supply chain constraints and inflationary pressure could adversely impact our operating results” and “Risks Related to Our Supply Chain — Supply chain disruptions could interrupt product manufacturing and global logistics and product costs” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for information on risks associated with distribution and logistics. +7 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademarks, copyrights, trade secrets, trade dress, and patent protections to establish, protect, and enforce our intellectual property rights in our product designs, brands, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution, and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks for the Crocs Brand include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China, and Canada, among other countries. Our major trademarks for the HEYDUDE Brand include the HEYDUDE logo and word mark. The HEYDUDE word mark is registered in the U.S., the European Union, China, and Singapore, among others. Protection for the HEYDUDE logo has been filed in the U.S. and other countries and has moved to registration in some, including Singapore, the United Kingdom, and Australia among others. We also have registrations or pending trademark applications for other marks and logos in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of filing the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to have become generic. We believe our trademarks and patents are crucial to the successful marketing and sale of our products. We strategically register, both domestically and internationally, the trademarks and patents covering certain product designs and branding that we utilize today. We aggressively police our patents, trademarks, and copyrights and pursue those who infringe upon them, both domestically and internationally, through litigation and otherwise as we deem necessary. +We consider the formulations of the materials used to produce our Crocs Brand footwear covered by our trademarks Croslite™, LiteRide™, and Free Feel Technology™, among others, valuable trade secrets. The material formulations are manufactured through a process that combines a number of components in various proportions to achieve the properties for which our Crocs Brand products are known. We use multiple suppliers to source these components but protect the formulations by using an exclusive supply agreement for key components and confidentiality agreements with our third-party processors, and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our third-party processors, we are unaware of any third-party using our formulations in the production of footwear. We believe the comfort and utility of our Crocs Brand products depend on the properties achieved from the compounding of the Croslite™, LiteRide™, and Free Feel Technology™ materials, which constitutes a key competitive advantage for us, and we intend to continue to vigorously protect these trade secrets. +We also actively combat counterfeiting and other infringements of our brand by monitoring the global marketplace. We use our employees, sales representatives, distributors, and retailers, as well as outside investigators, attorneys, and customs agents, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and distributors are also educated on our patents, pending patents, trademarks, and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain foreign jurisdictions. See the risk factor under “Risks Related to our Products — Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brands’ image, and adversely affect our business” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Competition +The global casual, athletic, and fashion footwear markets are highly competitive. Although we do not believe that we compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale, retail, and e-commerce businesses compete with companies including, but not limited to: NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Birkenstock Holding plc., Steven Madden, Ltd., Wolverine World Wide, Inc., and V.F. Corporation. Our company-operated retail locations and e-commerce sites also compete with some of our wholesale partners. +The principal elements of competition in these markets include brand awareness, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. We believe that our unique footwear designs, material formulations, prices, product line, and distribution networks position us well in the marketplace. However, a number of companies in the casual footwear industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition, +8 +Table of Contents +and greater marketing resources than we have. See the risk factor under “Risks Related to our Products — We face significant competition” included in Item 1A. Risk Factors of this Annual Report on Form 10-K for more information. +Available Information +We file with, or furnish to, the SEC reports including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are available free of charge on our corporate website (www.crocs.com) as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Copies of any materials we file with the SEC can be obtained free of charge at www.sec.gov. The foregoing website addresses are provided as inactive textual references only. The information provided on our website (or any other website referred to in this Annual Report on Form 10-K) is not part of this report and is not incorporated by reference as part of this Annual Report on Form 10-K. \ No newline at end of file diff --git a/raw/filings/0001334036/2024/0001334036-25-000009/item13.txt b/raw/filings/0001334036/2024/0001334036-25-000009/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..55771c6366cea6e9763a7c245e5ba6dcca65c106 --- /dev/null +++ b/raw/filings/0001334036/2024/0001334036-25-000009/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2025 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2024. +53 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2024/0001334036-25-000009/item9a.txt b/raw/filings/0001334036/2024/0001334036-25-000009/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..24cfc354050f24f14fe18d7a7b3ec10d49c86d6a --- /dev/null +++ b/raw/filings/0001334036/2024/0001334036-25-000009/item9a.txt @@ -0,0 +1,28 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act) of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of December 31, 2024. +Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2024, to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can only provide reasonable assurance regarding management’s control objectives. +Management’s Annual Report on Internal Control over Financial Reporting +Our management is responsible for establishing and maintaining effective internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our Chief Executive Officer and Chief Financial Officer, with assistance from other members of management, assessed the effectiveness of our internal control over financial reporting as of December 31, 2024, based on the framework and criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2024. +Our independent registered public accounting firm has audited the effectiveness of our internal control over financial reporting as of December 31, 2024, as stated in their report, which appears herein. +Changes in Internal Control Over Financial Reporting +There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the three months ended December 31, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +50 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the stockholders and the Board of Directors of Crocs, Inc. +Opinion on Internal Control over Financial Reporting +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2024, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2024, of the Company and our report dated February 13, 2025, expressed an unqualified opinion on those financial statements. +Basis for Opinion +The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. +We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +Definition and Limitations of Internal Control over Financial Reporting +A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 13, 2025 +51 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2024/0001334036-25-000009/rp_note.txt b/raw/filings/0001334036/2024/0001334036-25-000009/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2024/0001334036-25-000009/rpt_disclosure.txt b/raw/filings/0001334036/2024/0001334036-25-000009/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..80f6cc68a582313829ff82a4a261e6651c575e3f --- /dev/null +++ b/raw/filings/0001334036/2024/0001334036-25-000009/rpt_disclosure.txt @@ -0,0 +1,8 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Since January 1, 2024, there have been no related person transactions in which we were or are to be a participant and the amount involved exceeds $120,000 and in which any current related person had or will have a direct or indirect material interest. +Policy on Transactions with Related Persons +Our Worldwide Code of Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board’s annual director independence review, and our Worldwide Code of Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +Director and Officer Indemnification +We have entered into agreements to indemnify our directors in addition to the indemnification provided for both directors and executive officers in our certificate of incorporation and bylaws. These documents, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +30 \ No newline at end of file